Good morning, and welcome to the Regions Financial Corporation's Quarterly Earnings Call. My name is Jamaria, and I will be your operator for today's call. I would like to remind everyone that all participant phone lines have been placed on listen-only. At the end of the call, there will be a question-and-answer session. If you wish to ask a question, please press star one in your telephone keypad. I will now turn the call over to Dana Nolan to begin.
Thank you, Jamaria. Welcome to Regions Q1 2022 Earnings Call. John and David will provide high-level commentary regarding the quarter. Earnings documents, which include our forward-looking statement disclaimer and non-GAAP information, are available in the investor relations section of our website. These disclosures cover our presentation materials, prepared comments, and Q&A. I will now turn the call over to John.
Thank you, Dana, and good morning, everyone. We appreciate you joining our call today. We're very pleased with our Q1 results. Early this morning, we reported earnings of $524 million, resulting in earnings per share of $0.55. Despite the challenging geopolitical backdrop and elevated inflation, we remain optimistic about 2022. We have a strong balance sheet positioned to withstand an array of economic conditions. Business customers, for the most part, have adapted and are prospering in the new operating environment. New loan commitments and pipelines remain strong, and utilization rates continue to increase. The consumer remains healthy. Net population migration inflows in our markets remain robust, and the majority of our footprint has returned to equal or better than pre-pandemic employment levels. Asset quality remains strong, with virtually all credit-related metrics improving in the quarter, and net charge-offs remain below historical levels.
The integration of Sabal, EnerBank, and Clearsight are progressing as planned, and we're excited about their growing contributions. Additionally, we continue to make investments in talent and technology to support strategic growth initiatives. We kicked off 2022 with a strong start and expect to continue building on that momentum. We have a solid strategic plan, an outstanding team, and a proven track record of successful execution. Now David will provide you with some select highlights regarding the quarter.
Thank you, John. Let's start with the balance sheet. Average loans grew 1.5%, while ending loans grew 2% during the quarter. Average business loans increased 3%, reflecting broad-based growth in corporate, middle market, and real estate lending across our diversified and specialized portfolios. While still below pre-pandemic levels, commercial line utilization levels ended the quarter at approximately 43.9%, increasing 160 basis points over the prior quarter. Loan production also remained strong, with late quarter commitments up approximately $1.6 billion. Average consumer loans declined 1% as increases in mortgage and other consumer were offset by declines in other categories. Within other consumer, EnerBank loans grew approximately 2% compared to the Q4 .
Looking forward, we expect full year 2022 average loan balances to grow 4%-5% compared to 2021. Excluding PPP loans and consumer exit portfolios, we expect full year average loan balances to grow 9%-10%. Let's turn to deposits. Although the pace of deposit growth has slowed, balances continued to increase seasonally this quarter to new record levels. Average consumer and wealth management deposits increased compared to the Q4 , while corporate deposits remained relatively stable. We are continuing to analyze our deposit base and pandemic-related deposit increases. Approximately 35% of the increase, or $15 billion, is expected to be more stable, with behavior similar to our core consumer deposit book. This segment is historically quite granular and generally rate insensitive, and therefore can be relied upon to support longer-term asset growth through the rate cycle.
The remaining 65% of the deposit increases is a mixture of commercial and other customer types that are expected to be more rate sensitive or that we are less certain about their long-term behavior. We assume this segment may have all-in beta of roughly 70%. This elevated beta assumption includes relationship repricing and some balances shifting from non-interest to interest-bearing categories. It also reflects a range of $5 -$10 billion of balance reduction attributable to tightening monetary policy. The combination of these segments and our legacy deposit base represents significant upside for us as rates increase. Let's shift to net interest income and margin. Net interest income was stable quarter-over-quarter. Excluding reduced contributions from PPP, net interest income grew 2%, benefiting from solid loan growth and rising interest rates.
Net interest income from PPP loans decreased $27 million from the prior quarter and will be less of a contributor going forward. Approximately 93% of estimated PPP fees have been recognized. Cash averaged $27 billion during the quarter, and when combined with PPP, reduced first quarter's reported margin by 58 basis points. Our adjusted margin was 3.43%, higher by 9 basis points versus the Q4 . The path for net interest income enters the Q2 with strong momentum from both balance sheet growth and higher interest rates. Excluding PPP, average loan balances grew 2% in the Q1 and a similar amount of growth is expected next quarter. Roughly $1.5 billion of securities were also added late in the quarter, further benefiting future periods.
The recent run-up in rates has certainly validated our decision to wait to deploy into securities. While not included in our current outlook, additional securities would provide incremental benefit. Higher short and long-term interest rates provided additional lift to net interest income in the Q1 , and these benefits are expected to expand in the coming quarters. Total net interest income is projected to increase 5%-7% in the Q2 and is expected to accelerate throughout the year, such that the Q4 net interest income is expected to be approximately 15% higher than our Q1 . Regions' balance sheet is positioned to benefit meaningfully from higher interest rates. Over the first 100 basis points of rate tightening, each 25 basis point increase in the federal funds rate is projected to add between $60 million and $80 million over a full 12-month period.
This benefit is supported by a large proportion of stable deposit funding and a significant amount of earning assets held in cash, which compares favorably to the industry overall. Over a longer horizon, a more normal interest rate environment, or roughly a 2.5% Fed funds rate, will support our net interest margin goal of approximately 3.75%. While we have purposefully retained leverage to higher interest rates during a period of low rates, we will attempt to manage a more normal interest rate risk profile as interest rate environment normalizes. The Fed's aggressive path for interest rates gives us the opportunity to protect NII at attractive levels. We have begun this process by adding $4.7 billion year to date of forward starting received fixed swaps and a $1.5 billion of spot starting securities.
This represents approximately 30% of the total hedging amount needed this cycle. Now let's take a look at fee revenue and expense. Adjusted non-interest income decreased 5% from the prior quarter, primarily due to reduced HR asset valuations as well as lower capital markets and card and ATM fees. Within capital markets, M&A advisory activity was muted by seasonality as well as the timing of transactions. Pipelines remain robust, but some deals have been pushed to later in the year. Additionally, debt and real estate capital markets were impacted by uncertainty surrounding rates, geopolitical tensions, and volatility in credit spreads. However, we are seeing some stabilization in the loan and fixed income markets and anticipate conditions will improve in coming quarters. Further, the reduction in real estate capital markets activity was offset by the addition of Sabal Capital Partners for the full quarter.
Similar to the corporate fixed income market, refinance demand has been softer than expected in our agency multifamily finance business as investors assess a significant move in interest rates. We continue to expect capital markets to generate quarterly revenue of $90 -$110 million, excluding the impact of CVA and DVA. While we expect to be near the lower end of the range next quarter, we expect activity to pick up in the second half of the year. Card and ATM fees reflect seasonally lower interchange on both debit and credit cards. In addition, debit card fees were further impacted by fewer days in the quarter. Mortgage income remained relatively stable and included approximately $12 million in gains associated with previously repurchased Ginnie Mae loans sold during the quarter.
While mortgage is anticipated to decline relative to 2021, it is still expected to remain a key contributor to fee revenue. Wealth management income also remained stable this quarter despite elevated market volatility. Service charges were also stable during the quarter despite seasonal declines in NSF and overdraft-related fees. The first phase of previously announced NSF and overdraft policy changes were effective at the end of the Q1 , and the remaining changes will be implemented over the second and third quarters. These changes, when combined with the previously implemented changes, are expected to result in full year 2022 service charges of approximately $600 million and full year 2023 service charges of approximately $575 million.
We expect 2022 adjusted total revenue to be up 4.5%-5.5% compared to the prior year, driven primarily by growth in net interest income. This growth includes the impact of lower PPP-related revenue and the anticipated impact of NSF and overdraft changes. Let's move on to noninterest expense. Adjusted noninterest expenses decreased 4% in the quarter, driven by lower salaries and benefits expense and professional and legal fees. Salaries and benefits decreased 5%, primarily due to lower incentive compensation despite higher payroll taxes and 401(k) expense. Salaries and benefits also include the favorable impact of lower HR asset valuations. Professional and legal fees decreased significantly as elevated fees associated with our bolt-on M&A activity in the Q4 did not repeat. We will continue to prudently manage expenses while investing in technology, products, and people to grow our business.
As a result, our core expense base will grow. We expect 2022 adjusted non-interest expenses to be up 3%-4% compared to 2021. Importantly, this includes the full year impact of recent acquisitions as well as anticipated inflationary impacts. We remain committed to generating positive operating leverage in 2022. Overall credit performance remains strong. Annualized net charge-offs increased 1 basis point to 21 basis points. Non-performing loans continued to improve during the quarter and remain below pre-pandemic levels at just 37 basis points of total loans. Our allowance for credit losses decreased 12 basis points to 1.67% of total loans, while the allowance as a percentage of non-performing loans increased 97 percentage points to 446%.
The decline in the allowance reflects ongoing improvement in asset quality and continued resolution of pandemic issues, partially offset by loan growth and general economic volatility associated primarily with inflation and geopolitical unrest. The allowance reduction resulted in a net $36 million benefit to the provision. We expect credit losses to slowly begin to normalize in the back half of 2022, and currently expect full year net charge-offs to be in the 20-30 basis point range. With respect to capital, we ended the quarter with our common equity Tier 1 ratio modestly lower at an estimated 9.4%, and we expect to maintain it near the midpoint of our 9.25%-9.75% operating range. Wrapping up on the next slide are our updated 2022 expectations, which we've already addressed.
I do want to point out that these expectations do not include any additional security purchases, so that certainly provides the opportunity for incremental benefit. In closing, as John mentioned, we began 2022 with great momentum, and despite geopolitical tensions and market uncertainty, we remain well positioned for growth as the economic recovery continues. Pre-tax, pre-provision income remains strong. Expenses are well controlled. Credit risk is relatively benign. Capital and liquidity are solid, and we are optimistic about the pace of the economic recovery in our markets. With that, we're happy to take your questions.
Thank you. The floor is now open for questions. If you have a question, please press the star key followed by the number one on your touch tone phone. If at any point your question is answered, you may remove yourself from the key by pressing the pound key. We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Ryan Nash with Goldman Sachs. Please proceed with your question.
Hey, good morning, John. Good morning, David.
Morning, Ryan.
I was hoping maybe you could talk about expectations for deposit growth, which, you know, came in better than expected, and particularly as it pertains to the surge deposits. You know, maybe just how you're thinking about the trade-off between keeping some of these deposits and the potential for a higher beta. I think, David, you highlighted a potential for a $5 -$10 billion reduction. Can you maybe just clarify how much you expect for these to stick around and what it means for deposit growth?
Sure. We had expected the $5 -$10 billion of deposits to start flowing out in the Q1 . You know, we have maintained some pretty conservative deposit assumptions. If you look at the growth and where it came from, it was in our consumer book. We continue to grow accounts and, you know, continue to have a high level of primacy with our retail customers. Our deposit base is our competitive advantage, and it's been that way for a long time, and we're looking to leverage that as we get into this higher rate environment. As you think about the surge deposits, you know, we have a third of those that we think are gonna be fairly similar to our legacy deposits in terms of beta, price insensitive.
We have the other third on the other end, we think are much higher beta, 80%-100% beta. Those are corporate deposits that you could characterize those as non-operational deposits that are probably going to look for a better home or a higher rate, as time goes by. We'll see what happens after this next rate increase. We've expected that to either reprice or really flow out of the bank. You have in the middle, which is another third, deposits that are stimulus receiving deposits, small business type deposits. That one's a little harder to predict. We do have a higher beta on it, not as high as the second group.
In any event, if we're wrong on the 5-10, it's likely that we've maintained our deposits at a higher level. Over time, if we see that, then that gives us a little more comfort to be able to take some of our excess cash that we have, some $26 billion sitting on the balance sheet to deploy that into the securities book. Our guidance that we're giving you does not have that deployed intentionally.
Got it. You know, if we could dig a little bit into the new hedging program. David, I don't know if Darrin's in the room. I guess you guys were the masters of adding swaps in a timely manner last cycle, and now you've begun this new program. I think the market is having a little bit of trouble understanding why banks are adding swaps at this part of the cycle, and I think all of us understand. Can you maybe just talk about thoughts regarding locking in here, particularly using forward starters? I think you talked about you know, another 10-12 of additions. Can you maybe just talk about pacing and why this is the right decision at this point in the cycle for Regions? Thanks.
I'll go ahead and start, and if Darrin is here, he can add to it. You hit on a key word, and that is forward starting. What we're trying to do is get our margin to the optimum level and then layer in protection for that margin over time. If you look at where we put the first call it $4.7 billion in, that's at a received fixed rate of 2.32. Those are largely going to be effective for 2024. We intentionally had them forward starting because we believe there's risk at that point in the cycle that actually rates could go the other way, and we wanna be able to protect that.
If we're wrong and it happens to not reverse and go lower, then we haven't lost anything. We haven't given up any of our net interest income or margin at that point. These are all five-year duration, just like they were last cycle. When you do it forward starting, you can take advantage of pricing. They're not all that expensive to get into, and we're not giving up our asset sensitivity today. That's important. We are becoming and maintain our sensitivity. The way we're structured in the balance sheet is to benefit, in particular at the back end, such that our NII in the Q4 should be up 15% from the Q1 .
It's just the nature of how our sensitivity is structured at this point in time. Darrin, anything you wanna add to that?
The only thing I would add is, David said it well, page eight of the deck just really shows the path of the net interest margin, which really underscores what David is saying. We're gonna enjoy nice margin expansion as the Fed is tightening policy. We have a very disciplined approach to manage that exposure as rates push higher. As David said, the probability of a downturn at some point, if the Fed has to push higher, increases over time. We wanna be cognizant of that. As we get delivered those higher rates, put in that protection and really manage the downside risk in those out years.
Thank you both for all the color.
Thank you.
Your next question will come from the line of Christopher Spahr with Wells Fargo. Please proceed with your question.
Good morning.
Morning.
Other banks seem to be spending their rate-driven incremental net interest income, or at least some of it, whereas you've kept your 2022 cost guidance unchanged. Why do you think that is? And with this higher NII outlook, how confident are you that you can expand on your positive operating leverage this year, next year?
Well, kind of leveraging the comments just before, you know, the way we structured the balance sheet, our NII will be growing nicely throughout the year, but are really strong in the Q4 , which sets up a really strong 2023. We're still asset sensitive through that time period. We should have a nice tailwind in terms of revenue growth. You know, we prided ourselves on being able to control our cost. We did a good job this quarter. There is that HR valuation asset that benefited us by $14 million. You need to add that back to kind of get us level set.
In any event, we continue to leverage our continuous improvement program to stay focused on how we get better every day and how we can leverage technology and process improvement so that we can keep our costs down because we are taking our savings and reinvesting those savings in things like digital talent, continuing to hire people so that we can grow. We had mentioned that the vast majority of our growth and expenses this year are related to the three acquisitions that we closed in the Q4 of 2021. We've had a little bit of inflation we've had to deal with. You know, we're continuing to work at all levels to try and keep our costs under control and generate positive operating leverage, which we believe we will have in 2022.
We didn't have it this quarter, but we will when you look at the whole year, and expect to have that going forward in 2023.
Thank you.
Your next question will come from the line of Gerard Cassidy with RBC. Please proceed with your question.
Good morning, John. Good morning, David.
Hey, good morning, Gerard.
David, in the slide deck, slide six, you give us the difference in the net interest margins based upon what's weighing down your margin today with the PPP loans and the excess cash. Can you share with us on the excess cash portion, where does the Fed funds rate need to go where you're not going to need to have that bullet point anymore because it will match your reported margin?
Well, it really gets back to the deposit expectations. We've maintained, you know, this excess cash to be prepared to the extent the surge deposits do seek other alternatives, and we have to pay that out. Obviously, we're getting 100% beta on the cash while we wait, but being patient has benefited us. Putting that into the securities book earlier would have really cost us. You know, we did put a little bit of that to work this quarter, $1.5 billion of that at about a 2.80 carry. If we were to do it today, it'd be even higher. And so in the 3.5% range.
I think it's important for us to understand what the surge deposit flows are going to do relative to what the Fed rate movements are going to be. I think over, you know, a fairly short period of time, our cash will get down to our normalized level, which is $1 -$2 billion, and then we won't have to have this disclosure. Of course, PPP will run off for the most part after this year. We won't have to talk about that one either.
Very good. Then as a follow-up, especially talking to you with your background as an accountant, can you share with us your thoughts about AOCI? You know, we all understand it's an accounting issue, and it's only for the securities portfolio. Obviously, you, similar to your peers, had a big negative number this quarter, which took down tangible book value per share and book value per share, again, similar to your peers, so you're not standing out. But at what point does it become an issue for banks? And again, I know it doesn't go through your CET1 ratio like it does for the advanced approach banks, but do we ever have to get concerned about it if it keeps on, you know, the AOCI keeps on getting larger on the negative side?
I'll try to answer this without getting upset. I think that count on this
We did, I didn't ask you about CECL. I took that.
You've hit on two of them. There are four accounting standards relative to what we're doing. In any event, we have to file a GAAP.
Yeah.
OCI does not, the change in OCI relative to securities gains doesn't affect our thinking whatsoever. You know, we manage the company based on regulatory capital based on the regulatory rules. For Category IV banks like Regions and most of our peers, that's excluded from the regulatory calculation. Importantly, it's also excluded from the rating agencies. They carve out the change in OCI relative to securities, not pension or other things, but securities they carve out. What's frustrating about it is that nobody talks about measuring the fair value of our deposit base, which is where the cash came from to go buy the securities. We're marking one element of a balance sheet through capital, and that's just not how we manage the company. It's really irrelevant.
It's done because it's easy to do. We can go get a quote. The fair value of the deposits, in particular for Regions, because of the primacy, because of the granularity, the fair value of our deposits are shooting through the roof. You just don't see that manifest itself on the balance sheet. You will see it manifest itself in growing NII and net interest margin. This is the time period we've been waiting for rates to rise. The fact that OCI is working against tangible book value, we could care less.
Very good. Appreciate the insights.
Could not care less, actually.
Your next question will come from the line of Erika Najarian with UBS. Please proceed with your question.
Hi, good morning.
Good morning, Erika.
My first question is a follow-up to Ryan's questioning. The way you wrote out slide 14, it seems like your NII guide includes both a $5 -$10 billion potential accretion of deposits and 70% beta. I guess I'm asking if I'm reading that correctly, shouldn't it be one or the other? In other words, if they stick around, it might have a 70% beta.
Yeah.
Does that make sense?
Yeah, yeah. Don't duplicate that. The 5-10 is baked into the 70. You know, if we're wrong, you know, our beta will be lower. You know, thus far, as I mentioned, on Ryan's question, we thought deposits, these particular $5 -$10 billion worth of deposits would start flowing out in the Q1 . They did not. We still think that's going to happen. Perhaps it's just delayed a little bit waiting for the next move, which we believe is gonna be 50 basis points, by the way, in May. We think those, which are largely corporate non-operational deposits, are going to seek a higher return than we're willing to pay. They're probably gonna move off the balance sheet, in that case.
This is not gonna be a big deal to us. We've been planning for it all along.
Got it. You know, as we think about your NII guide, David, what type of earning asset growth should we assume? Again, it just goes back to the deposit question, right? Because your outlook has felt very conservative since you first put it out. You know, what interest asset growth range should we assume lies underneath this NII guide?
Yeah. You have to take the pieces and look at it. There's not an appreciable change there. We've got two things working. One, we ought to have pretty good loan growth. As we mentioned, you know, ex PPP and runoff portfolios, that's 9%-10% growth in the loan balances. Then we've got the $5 -$10 billion of deposits going the other way, and the cash will come down. You know, it's not as much of an earning asset change as it is mix and what the yield is on the net assets of the earning assets that we have. We should see our margin continuing to increase.
We're trying to give you the guide by telling you that, you know, by the time we get to the Q4 , our NII is 15% higher than where we are today. Kind of cutting to the chase because there's a lot of moving parts there.
No, understood. Thanks, David.
Your next question will come from the line of Peter Winter with Wedbush Securities. Please proceed with your question.
Good morning. I wanted to ask about EnerBank. You know, the economic environment has changed quite a bit since you guys acquired them. I was wondering, have your views changed at all with regards to the loan outlook from EnerBank or any consideration, maybe further tightening the underwriting standards given a much higher rate environment?
No, we're very bullish on EnerBank. We're excited about the fact that we closed that in the Q4 . You know, if you look at our growth of EnerBank, this quarter it was 2%. Obviously, if you annualize that, it's 8%, which is below the guide that we gave you. The big driver there is seasonality. This Q1 is the low water mark for them. You'll see that pick up. This is a prime book. We're really excited about the carry that we can get there and the margin. We are ahead of schedule on where we thought we would be. Peter, absolutely not. We are looking to that to be a good component of our growth.
Again, we feel good about the credit quality, in particular, being paid for the risk that we're taking and a nice return for our shareholders on the capital deployed in that book.
Got it. If I could just ask about the capital management strategies going forward, just between both on acquisitions and which have really increased profitability versus buybacks. I saw yesterday you've got the $2.5 billion buyback. The question is, how aggressive will you be, or is it just being opportunistic, and you just wanna have that authorization in place?
Sure. Let's go back through how we think about capital deployment. First and foremost, our capital is there for organic growth. It's to support our business. As I mentioned, ex PPP and runoff, we got loans growing 9%-10%. That's where we want our capital to go first and foremost. The second is we wanna make sure we pay an appropriate dividend to our shareholders. Our guide is 35%-45% of earnings in the form of a dividend. As earnings grow, so will the dividend. We then think about non-bank acquisitions, and the three we closed in the Q4 are great examples.
We have a whole team continuing to look and work with our three business segment leaders on how we can provide products and services that we don't have to our customers. We'll continue to do that. We use share repurchases as the mechanism to maintain capital at the optimum level. That optimum level is informed by things like CCAR and how we think about risk in our book. Of course, we just filed our CCAR submission in April. We'll hear back in the end of June on that. Yes, we did ask the board and received approval for a $2.5 billion share repurchase program over the next couple of years. The control factor there, Peter, is CET1. That needs to be in the range of 9.25%-9.75%.
That's what our risk profile tells us. We need to have CET1 in that range. We're targeting the middle of it at 9.5. We won't buy shares back if it takes us outside of our operating range, even if the price were right, which is where you're going opportunistically. I think that's just to help us manage our capital at the optimum level because that informs the denominator of our return on capital calculation, which we think is critically important to our shareholders.
Great. Really helpful. Just one housekeeping. Just how much was the credit interest recovery this quarter and net interest income?
I didn't commit that to memory. Hold on just a minute, I'll tell you. It's at the bottom of page.
Which is what?
No, that's not the number he's asking. Peter, we'll get that to you.
Okay.
You're talking about the impact to NII, right?
Yeah.
Interest recovery and NII.
Yeah.
Yeah.
Yeah.
Somebody will look that up. We'll get it to you in a minute.
Thanks, David. Thanks for taking the questions.
Your next question will come from the line of Matt O'Connor with Deutsche Bank. Please proceed with your question.
Good morning. You did mention earlier about some consideration in your reserves for inflation. I do want to ask, you always talk about your average account size being a bit smaller than some of your peers, and I guess logic would have it that customer base might be a little more impacted by inflation, by rising energy gas prices. Just wondering what you're seeing in some of those, you know, call it leading indicators, would be helpful. Thanks.
Yeah, Matt. Hey, this is John. I would just say, so far, not a lot of change. Generally speaking, our customer base, we look at deposit balances and the impact of COVID and relief dollars on customer deposit balances. We saw on average, even in the lowest balance segment, about a 30%-40% increase in pre-pandemic deposit balances. We are still seeing customers maintain that level of excess liquidity, as evidenced by the fact that our deposit balances actually grew quarter-over-quarter. We are aware of the impact of inflation or the likely impact of inflation on our customer base. It is a more mass market customer base, as we've talked about before. About 60% of our consumer deposit customers are in the mass market.
There will be some impact, and we're certainly watching for that, but we haven't seen it yet.
Okay, that's helpful. Then I guess on the other side of the loan book, and the commercial side, you had a big drop in non-performing loans, big drop in the criticized assets. Was that anything specific, like a couple of borrowers or sectors or? It has been improving for some time, but it's gotten quite low.
Yeah. No, I think it's broad-based, and we continue to see improvement in credit quality across the book, a reduction in criticized loans, classified loans, and non-performing assets. I think it reflects the work that our teams have continued to do, working with our customers closely to evaluate the risk in our portfolios to exit certain relationships, portfolios, and businesses where, you know, we feel like we are seeing increased amounts of risk or we're not getting an appropriate return. If I had to point to any business or businesses, portfolios where we saw improvement, it would be restaurant as we continue to work out of that portfolio and hotel as the economy recovers through the pandemic.
Thank you.
Your next question will come from the line of Ken Usdin with Jefferies. Please proceed with your question.
Morning, Ken.
Hey. Hey, good morning. Hi, everybody. John, just a follow-up on the fee side. Now that you're getting, you know, close to the implementation of your changes to the deposit products, and you're continuing to reiterate your service charges expectations for 2022 and 2023. Service charges are actually probably better than people expected in the Q1 . Just wanted to kind of get your updated views on, you know, your confidence that you've got the right outlook and as you start to put the products in place, like, you know, what are your early takeaways from the continuation of that view?
Yeah. Our service charges were a little better than anticipated. I will say that we put in some changes at the end of the Q1 . You'll see more change coming in the second and the third. It's too early to change our guidance that we gave you. Last quarter, we reiterated it this quarter, which was $600 million for service charges and in 2022 and $575 million in the next year. As we go through and see what the impact is for these changes, we'll update that, you know, whichever way it might go, and we'll probably have a better feel for the year 2022 next earnings call. Right now it's probably too early to change.
Understood. Okay. Want to just follow up on credit. You know, following up on Matt's question about your provisioning thoughts, but can you just talk about as you talked about normalization of losses starting to happen towards the back half of the year, what parts of the portfolio are you expecting to see charge-offs increase in first, and what areas are you just noticing that potential change in terms of, you know, delinquencies and loss rates? Thanks, David.
Well, I think that, you know, we lowered our range 20-30 basis points. As we think about risk going forward, you know, there's certainly the consumer. On the consumer side of the house, there's been a lot of stimulus money. I think we feel pretty good about the consumer, but that's an area we need to watch closely to see when that starts to move first. The, you know, the second piece of that would be small business. I think small business is an area that probably has, on a relative basis, incremental risk. The issue is we're just not seeing any of that right now. John had mentioned all of our asset quality indicators are getting better.
You know, we believe our normalized loss rate is likely to be lower than our history because of our de-risking that we just mentioned in our whole credit book. We feel pretty good about that. I think the leverage book we would want to watch closely as well, as we see rates increasing and what kind of pressure might that put on the leverage portfolios. Those would be two or three that we watch.
Great. Thank you.
I do want to get back. Peter, you asked about the recovery that was in NII. It's $4 million this quarter. I wanna close that out.
Your next question will come from the line of John Pancari with Evercore ISI. Please proceed with your question.
Morning, John.
Morning. On the expense side, I wanna see if I can kinda ask the opposite of Christopher Spahr's question earlier. You know, wondering what type of expense flexibility you may have if the revenue backdrop comes in weaker than expected this year. Do you still think that you know, you're implying about 150 basis points of positive operating leverage in your guidance. Is that sustainable if the revenue backdrop gets tougher?
Well, you saw a pretty good quarter- this- quarter. Again, make sure you add back the $14 million on the HR to get level set there. The reason we were down is because our revenue was down in certain areas like capital markets. That has a tendency to be more variable in terms of the cost relative to the revenue. Things like M&A, if you don't have an M&A transactions, then you don't have the compensation that goes with the deal. It depends where the revenue challenges come from, John. If we're seeing it in places like that, then we should have lower compensation. Mortgage, if we don't have the mortgage production that we think, then you're gonna see lower compensation for that as well.
We do have some mechanism to take care of revenue if it's lower than we thought. Now, a big driver of our change, and we've changed, I guess, two times now, our revenue outlook has been because of the rate environment, and just more carry there. If we don't get the rate increases that the forwards imply, implied at March 31st, which is what's baked into our guidance, then we're probably gonna have lower incentive compensation. There are puts and takes there. We still feel confident with the operating leverage number that you just mentioned. That's exactly what's baked into our guidance, and we are committed to having operating leverage over time.
Okay. Thanks, David. That's helpful. On the loan side, as you look at the remainder of the year, in terms of, you know, overall growth drivers, where do you see the strongest loan generation coming out of, both on the commercial side and the consumer side? What are the biggest drivers of growth over the remainder of this year as you look at the economic backdrop?
Yeah, John, this is John Turner. Our growth in the last quarter and frankly over the last, I guess two or three quarters, has been broad-based across all three segments. We're experiencing growth in our corporate banking business, our middle market commercial business, and our real estate business. We're seeing customers access lines of credit at increasing rates to both rebuild inventories and to adjust to increasing costs associated with inventory. Increases in line utilization are both inventory and cost-driven. We're also seeing some CapEx, which I'm excited about, across a number of different industries. Customers are investing in expansion activity. Some of it is for modernization and recognition of a much tighter labor market. In Alabama, unemployment is 2.9%. In Georgia, it's 3.1%. Florida and Tennessee, it's 3.2%.
We're at full employment across some very good markets, and as a result, customers are looking for ways to modernize and to continue to borrow. Growth in the portfolio has come in healthcare, it's come in transportation, it's come in our technology and defense sectors and asset-based lending. In the real estate business, we've seen some growth in home builder as markets are again continuing to expand as a result of consistent in-migration of people. Also seeing some growth in our real estate investment trust business, which has been an important portfolio for us and a really high, highly performing portfolio. We are optimistic about our ability to continue to grow through the balance of the year. We expect that growth to be fairly broad-based.
Got it. All right, John. Thank you.
Thank you.
Your next question will come from the line of Betsy Graseck with Morgan Stanley. Please proceed with your question.
Hi. Good morning.
Morning, Betsy. Hey.
Hey. I had a couple of questions. One is, I just wanna make sure I understand how you are positioning yourself for this surge deposit activity, you know, that you outlined on slide 5. I know you put the expected beta of 40-60 for the mid stable, mid beta and 80-100 for the least stable higher beta. Is that your indication to us of what you think it would take to retain these deposits, and would you go after them, or are you saying, "Look, we think it would retain this and we're not gonna go after them," or it depends on how it progresses? Could you just give some color on that?
I think if you're on that page five, let's start with the right-hand side. Those are the higher beta, 80%-100%. I'd characterize those as non-operational corporate deposits. These are deposits that are parked here that probably are going to seek a better avenue, a better yield than we're willing to pay for. You could expect those to most likely move off the balance sheet first. When you get to the middle, which is that 40-60 beta, those are accounts that had stimulus or small business accounts with a disproportionate amount of cash in their accounts that we think will normalize over time. I think you'll see a little bit of both. You'll see some of that move off the balance sheet.
You'll see some of that where we'll pay a higher price. At the end of the day, we're going to have to monitor that. We have a deposit rate committee. This is what they do every month. They meet to try to figure out what we should pay. As you know, our deposit beta was among the lowest of the peer group. We expect that to be true going forward because of our granular, high-primacy deposit base. That middle $13 billion is something we're gonna have to watch closely to see whether it stays on, and if it does, what will it cost us.
There is gonna be an avenue for both of these, that is in the middle column in the right for off-balance sheet opportunities, where we'll move those out of the bank, but we'll be able to have a fee associated with that. That'll help compensate us a little bit. Won't cover what we're earning today, or likely earning as rates move up. Nonetheless, it'll be a bit of a carry for us going forward.
Okay. You know, since we're looking for 100 basis points up in 2Q, right, in May and June, 50 each, we should start to see some of this, you know, core deposit exit in 2Q, shouldn't we? Or do I have that wrong?
Yeah. No, I think you're exactly right. I think, again, when it's 25 basis points, that may have been different. 50, if you're a large corporation that has non-operational deposits, you're gonna be moving pretty quickly. So, again, we expected the $5 billion-$10 billion that we talked about to move off in the Q1 . It did not. Now, our corporate deposits were about flat, on an average basis. We do expect that after this 50 basis points for that to start happening. So yes, you would expect deposits to be down in the Q2 as a result of that.
Okay. Just two other things. One is, what factors will drive you to shift your excess cash to securities? Are you going to be, you know, waiting to get through, like, 80% of the Fed funds rate hike to assess and then redeploy, or are you gonna be redeploying along the way?
Well, I think we've redeployed some. We put $1.5 billion to work this last quarter. You know, as spreads continued to actually gap out a bit, things like CMBS, agency CMBS was a good place for us. You know, I guess we put at what, 280 was the $1.5 billion. If we were to do that today, it'd be closer to 3.5. You know, it's kind of a little bit of a game we need to just watch and see what the rate environment will give us. We do have some cash we can put to work. If our beta assumptions are better, then we'll have that much more cash to deploy over time.
Now, our guidance we're giving you doesn't have that, does not have that baked into the guidance, but using the the spot securities and the forward-starting swaps, all that's baked into our hedging strategy that we're trying to put in place so that we can protect a really nice margin, that we think we can get to over time, and we've given you that guidance on one of our slides.
Yeah.
Slide eight. I think in our prerecorded message, we think we can push you up to 3.75% with a 2.50% Fed funds. That'd be quite nice for us.
Okay. The last question is just on, you know, you had the AOCI hit. I know Gerard spoke about that with you earlier on the call. The long end of the curve obviously is up since March 31st. So should we expect, like, you know, for the DV01 hit in this quarter would be similar to last quarter for a like DV01 move, or are some of these hedging strategies that you indicated earlier changing that? I'm really asking what we need to take into consideration as we think through to 2Q with this rate back up, what the AOCI hit could be.
Yeah. My first point would be to ignore it, and you don't have to do the math and go on to something else. If you want to track it for whatever reason that you have, I would expect it to probably negatively impact us, but not to the tune of what it did this past quarter, partially because of what we're lagging into right now, and frankly, the change in the long end isn't going to be as severe as it was this quarter, we don't think. Good luck with your math.
Those hedging strategies you talked about earlier help you on that front. Is that an accurate statement or not?
Yeah, that's right.
All right. Thanks.
Your final question will come from the line of Bill Carcache with Wolfe Research. Please proceed with your question.
Thank you.
Hey, good morning, and thank you for taking my questions. Following up on your response to both Gerard and Betsy, I appreciate your comments around how it doesn't make any fundamental economic sense to mark securities to fair value on the left-hand side of your balance sheet without also marking the deposits to fair value on the right side. Fundamentally, you know, available for sale OCI hits are nothing more than accounting noise. How would you respond to the idea that in a recession, bank stocks are gonna trade down to tangible book value? While it may not matter fundamentally from a practical perspective, it's something that investors tend to care about.
Yeah. You know, this whole concept of tangible book value came about in the recession. To the extent we have a recession, the rate environment's actually gonna go the other way, and securities are gonna be worth that much more. Again, I think if you wanna mark the entire balance sheet to fair value, that would be reasonable, especially in trying times, where you're trying to figure out what the true fair value of net assets are for a given company. The total concept of tangible book value, in my opinion, is really not a going concern issue, it's a failure notion.
It's, "I'm going out of business, what might I get as a shareholder if we liquidate everything?" The biggest issue I have with OCI is you're marking one element of the entire balance sheet, you know, securities. You're not marking loans, you're not marking deposits or anything else. So you're not getting a very good understanding of what true tangible book value is in any rate scenario. I realize I'm in the minority and people just are gonna do what they want. In a recession, it actually goes the other way because the rates will be down.
Understood. Yeah, that makes sense. You guys have exhibited such, you know, prowess in protecting your margins through the hedging program. I guess, is there anything that could lead you to ever consider wanting to protect that tangible book? Or maybe since it is a focus of investors, maybe introducing the concept of tangible book value ex the available for sale might be something that people focus on because, I guess, with the passage of time, those marks would not be realized if you held the security to maturity.
Yeah, I don't. Again, we don't use this to manage our bank at all. We don't use it for capital. We don't use it for rating agency. To put it in held to maturity where we don't have to have a mark, all that does is restrict our ability to manage the portfolio, the way we want. We don't see any need for that. We do realize there are some people, for whatever reason, that this is important. All I'm saying is go calculate the fair value of our deposits, which will be in our 10-Q coming up, and just add that in as you're thinking about tangible book value, and then we at least have a better idea of what it is.
Understood. Thank you for taking my questions.
Thank you very much. I think that's all the questions we had. Thank you all for your time today. Thanks for your interest in Regions. Have a great weekend.
This concludes today's conference call. You may now disconnect.