Regions Financial Corp Q2 FY2024 Earnings Call

Good morning. And welcome to the Regions Financial Corporation's Quarterly Earnings Call. My name is Christine 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. Operator Instructions. I will now turn the call over to Dana Nolan to begin.

Thank you, Christine. Welcome to Regions' Second Quarter 2024 Earnings Call. John and David will provide high level commentary regarding our results. Earnings documents, which include our forward-looking statement disclaimer and non-GAAP information, are available in the Investor Relations section of our Web site. 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. This morning, we reported strong second quarter earnings of $477 million, resulting in earnings per share of $0.52. For the second quarter, total revenue remained relatively stable at $1.7 billion on a reported basis and $1.8 billion on an adjusted basis as net interest income remained resilient and fee revenue declined modestly compared to the first quarter. As expected, adjusted non-interest expenses declined quarter-over-quarter and are expected to remain at this approximate level for the remainder of the year. Average and ending loans remained relatively stable quarter-over-quarter, reflecting modest customer demand, continued focus on client selectivity and paydowns in the portfolio. Average deposits also remained relatively stable while ending deposits declined modestly during the quarter, consistent with seasonal tax related patterns. We experienced broad based improvement in overall asset quality this quarter. Non-performing and business services criticized loans as well as net charge-offs improved sequentially. In summary, we're proud of our second-quarter results, driven by the successful execution of our strategic plan. We have a great plan and the investments we're making in talent, technology and in products and services are positioning us to benefit as macroeconomic conditions improve. Our footprint continues to provide us with significant opportunities. And while we are experiencing more competition in our markets, our long-standing presence, commitment to communities and the favorable brand we've built over many years positions us well. As long as we remain focused on execution, I have no doubt that we can continue generating top quartile results. Now, David will provide some highlights regarding the quarter.

Thank you, John. Let's start with the balance sheet. Average and ending loans remained relatively stable on a sequential quarter basis. Within the business portfolio, while average loans remained relatively stable, ending loans increased 1%. Despite near term macroeconomic and political uncertainty, pipelines are beginning to rebuild. Average consumer loans also remained stable as modest growth in residential mortgage and consumer credit card were offset by declines in home equity and other miscellaneous consumer loans. We continue to expect 2024 average loans to be stable to down modestly compared to 2023. From a deposit standpoint, deposits remained relatively stable on an average basis while ending balances declined 2%. These declines in the second quarter reflect anticipated tax seasonality. Having largely returned to pre-pandemic patterns, we expect relative stability in deposits, which is typical for summer and early fall. As expected, deposit remixing has slowed. Competitive pricing and customer demand for promotional products has stabilized. Over the second quarter, the proportion of non-interest bearing deposits relative to total deposits has remained steady in the low 30% range. Now, let's shift to net interest income. Net interest income increased modestly during the quarter, outperforming our expectations. The increase reflects stabilizing deposit trends and asset yield expansion. Also exceeding expectations, the net interest margin declined only 4 basis points, resulting primarily from higher average cash levels. As expected, deposit remixing and cost increases slowed meaningfully in the quarter. The full cycle interest bearing deposit beta remained stable at 43%, and we continue to expect a mid-40% deposit beta will be the peak this cycle. Asset yields benefited from the maturity and replacement of fixed rate loans and securities at current higher rate levels. This includes the repositioning of approximately $1 billion of securities late in the quarter with an estimated payback period of 2.6 years relative to the $50 million pre-tax loss recorded this quarter. Following our successful $750 million debt issuance in June, we used the proceeds to purchase a like amount of securities with a similar duration in order to maintain a relatively neutral balance sheet position and bolster liquidity. We believe net interest income has reached an inflection point and is expected to grow over the second half of the year as deposit trends continue to improve and the benefits of fixed rate asset turnover persist. As we move further into 2024, a stabilizing deposit and funding environment, along with securities repositioning and favorable debt issuance levels have pushed our expectation for net interest income towards the upper end of our $4.7 billion to $4.8 billion range. This narrow range portrays a well protected profile under a wide array of possible economic outcomes. Now, let's take a look at fee revenue performance this quarter. Adjusted non-interest income declined 3%, driven primarily by lower capital markets and mortgage income. If you recall, capital markets experienced seasonally elevated activity in the first quarter as several bills were pushed from the fourth quarter of 2023. Over time and in a more favorable interest rate environment, we expect our capital markets business can consistently generate quarterly revenue of approximately $100 million. But in the near term, we expect it will run around $70 million to $80 million per quarter. The decline in mortgage income was primarily driven by a positive $6 million adjustment to the company's mortgage pipeline valuation in the first quarter that did not repeat. While modestly lower versus the seasonally high first quarter, Treasury Management continues to perform exceptionally well. Versus the second quarter of last year, Treasury Management's client base has increased 6% while total revenue is up 8%. Helping to offset this quarter's fee income declines, wealth management increased 3% to a new quarterly record, reflecting increased sales activity and stronger markets. Based on a strong first half of the year, we now expect full year 2024 adjusted non-interest income to be at the top end of our $2.3 billion to $2.4 billion range. Let's move on to non-interest expense. Adjusted non-interest expense decreased 6% compared to the prior quarter, driven primarily by lower salaries and benefits, occupancy and professional fees. The improvement in salaries and benefits was attributable primarily to lower base salaries and seasonally higher HR related expenses in the first quarter. Operational losses also decreased during the quarter and current activity continues to normalize within expected levels. We continue to expect full year 2024 operational losses to be approximately $100 million. We remain committed to prudently managing expenses to fund investments in our business. We will continue focusing on our largest expense categories, which include salaries and benefits, occupancy and vendor spend. Based on results through the first half of the year, including outperformance in revenue and our expectation to be towards the top end of our previously provided full year revenue ranges, we now expect full year 2024 adjusted non-interest expenses to be between $4.15 billion and $4.2 billion. Regarding asset quality, as John indicated, overall credit performance improved during the quarter. Provision expense was essentially equal to net charge-offs at $102 million and the resulting allowance for credit loss ratio remained relatively stable at 1.78%. We expect full year 2024 net charge-offs to be towards upper end of our 40 to 50 basis point range attributable to a few large credits within our higher risk portfolios. However, those losses are fully reserved for. Assuming stable loan balances and a relatively stable economic outlook, we expect our ACL ratio to remain flat to declining over the second half of the year. Let's turn to capital and liquidity. We ended the quarter with an estimated common equity Tier 1 ratio of 10.4%, while executing $87 million in share repurchases and $220 million in common dividends during the quarter. Earlier this week, the Board of Directors declared a quarterly common stock dividend of $0.25 per share, a 4% increase over the second quarter. This increase is in addition to the 20% increase last year, representing three consecutive years of robust dividend growth, well supported by underlying financial performance. Additionally, we received notification of our supervisory capital strength test results, including the primary stress capital buffer, which will remain at 2.5% for the fourth quarter of 2024 through the third quarter of 2025. We expect to maintain our common equity Tier 1 ratio consistent with current levels over the near-term. This level will provide sufficient flexibility to meet proposed regulatory changes along the implementation timeline while supporting strategic growth objectives and allowing us to continue to increase the dividend and repurchase shares commensurate with earnings. With that, we'll move to the Q&A portion of the call.

Operator Instructions. Our first question comes from the line of Ryan Nash with Goldman Sachs.

Maybe just walk through some of the key drivers of the updated NII guidance. You're expecting some nice growth in the second half, and given that the Fed cuts won't be a material driver. Maybe just talk a little bit about the magnitude of the growth you're expecting? And can you maintain that pace beyond the second half and what does all this mean for where you think the margin can head over the medium term?

So as we had mentioned last quarter, we're neutral to short term rates. And so the benefit that we see for this quarter, I think, going forward is, how we controlled our deposit costs. So our interest bearing costs were up 3 basis points. So the front book, back book benefit that we're getting is when you add securities and loans about, call it, 175 basis points is now overwhelming the change in deposit cost and we expect that to continue for the rest of the year. So we don't really need any cuts to help that. If we get them we get them but we're neutral to that. So we think the driver really going forward in addition to what I just mentioned will be balance sheet growth. And so we think that can help us to continue to grow NII. And when you look at all that we felt comfortable saying we'd be at the upper end of our range. We also did a repositioning trade and that'll help us march towards the upper end as well. So we think we're in pretty good shape. We get a little bit of loan growth for the back half of the year, it sets us up nicely for 2025.

Maybe as a follow-up on the expenses, the increase in expenses seems somewhat commensurate with the increase in revenue. So can you maybe just parse out how much of the increase in expenses was driven by better revenues? And is there maybe a pull forward of some expenses from next year in order to position you for improved positive operating leverage?

Really, the increase is attributable to the expected increase in revenue, both NII and NIR that you mentioned. Our expectations for that for the year being at the upper end of our ranges, that's the primary driver. Also impacting the full year, we have about $20 million in expenses associated with market value adjustments on HR assets. And so that is what it is, we'll see if that reverses or not. And to a lesser extent, we experienced some modest incremental increases in the first half of the year, and the opportunities to offset that aren't likely. So it's important when you consider all this, our revenue and expense, that we are firmly committed to generating positive operating leverage over the back half of 2024.

Our next question comes from the line of Scott Siefers with Piper Sandler.

I was hoping maybe at a top level, you could please speak to the kind of the competitive backdrop for commercial lending. I mean, it seems like it's tough everywhere but it seems like everyone appropriately wants to be in the Southeast. So maybe just the overall competitive landscape. And then maybe if you could also please highlight just sort of in your own words or thoughts what it would take to generate better commercial loan demand at this point?

So it is competitive, you're right. We're in great markets. We talk about that a lot. And as a result of that, we're seeing more and more competition. We think we're competing well. We believe our business is largely about the quality of our people, the execution of our plan, providing unique ideas and solutions to customers, those things differentiate us. And fundamentally, in our business, we think it is about talent. We continue to recruit across our markets and are having some good success doing that. As a result, we're seeing nice growth in our commercial middle market business, offset by declines in some of our specialized industries groups and in investor real estate, as you might imagine, as those portfolios pay down. But all-in-all, activity is still somewhat muted. Customers remain cautious given some concern about inflation cost, the political environment, just general uncertainty, but activity is improving. Pipelines are stronger than they were a year ago, certainly stronger than they were two quarters ago. And so while we're not projecting much loan growth for this year, we do believe that there is, and we would expect in 2025, I think, to likely see economic activity pickup, reflected by the increase in activity in our pipelines. So yes, it's competitive. We think we're competing effectively largely because of the quality of the teams that we continue to build and the long term relationships that we enjoy, and we'll continue to focus on that.

And then, David, just a quick one for you. You've done a couple of these incremental balance sheet repositionings, which has been great, especially as they've helped to sort of push up the NII expectation through the year. I think you speak in the deck to opportunities for further ones. Maybe if you could just sort of help put a frame of reference, would we look at similar ones like this, what would be the size of the opportunities, et cetera?

Yes, I think so. We continue to look for opportunities like this; that's a good use of capital. Our capital ratio is where it needs to be, so to the extent we can use capital accretion through earnings for something like this, it's good to do. This is about that size and is probably the biggest you would see from us, roughly in the 10% range of earnings. We like to take opportunities when the payback period is fairly tight, around three years. The first one had a 2.1-year payback period, this one was 2.6 years, and if we can find something in that three-year range we may take advantage of it. The curve continues to steepen, which also gives us an opportunity to act.

Our next question comes from the line of Ken Usdin with Jefferies.

A question on the deposit side, just I think the plus 3 basis points on the interest bearing cost was probably a lot better, a lot lower than people thought. Just wondering if you can kind of talk us through what you're seeing underneath there in terms of where you're continuing to see some back book catch up and where you're starting to see the ability to kind of change price and how you kind of build that into that forward expectation?

So our cumulative beta is 43%. We've said we'd be in the middle 40s, so call it 43% to 45%. We feel confident in that because we understand our customer base. There still was some remixing going on, but because the industry didn't have a lot of loan growth the demand or the aggressive competition for deposits just has not been there. We have to be competitive with our deposit rates and we think we are. We've been very short on things like CDs to take advantage of when we think rates may actually go the other way. So we have a lot of confidence, though, that the deposit cost may tick up depending on how the mix shift happens. Continuing to grow core checking accounts and operating accounts is really important to us. As a result, I don't think you're going to see a major change in our deposit cost. Therefore, our cumulative beta in that 45% range, I think, is important.

And then just a follow-up on just credit. Great to see the NPAs come down and also understanding your point that the few couple credits are fully reserved for. Can you just flush out your just general points on just how asset quality feels, what you're just seeing in underlying migration and any things that you're still just kind of watching out underneath the surface for the most?

So we've indicated, I guess, for a couple of quarters that we thought our credit metrics would likely peak in the second quarter. And I think that's proven to be true. We've highlighted a couple of industries that we've been concerned about now for, again, a couple of quarters: that's obviously asset classes, office, senior housing, transportation, manufacturing of commercial non-durables, information are areas that we are following. The particular portfolios where we think there's been some systemic impacts are specifically office, transportation, and senior housing. Senior housing seems to be improving. Transportation is still in a recession, particularly for those smaller transportation companies that are operating in the spot market, but that may be improving modestly as well. Office we're still working through really credit by credit. And we talked about office: we have 101 credits and about 40% of those are single tenant. So we're really working on about 60 to 70 relationships that are multi-tenant. We think we have a good handle on that exposure and are continuing to work through it. With respect to our guidance, our non-performing loans are centered in 20 credits that represent about 72% of our total non-performing loans. Five of those are office related. And in every case, we're working with a customer. In some instances, we're adding additional collateral to support the credit. We may be getting some additional tenant improvement money. We've got, I think, a pretty good approach to resolving the credits. We believe we are well reserved. Just as a point, we've been asked about our allowance. Allowance against our multi-tenant book is about 9.6%. Total allowance against our office book is 6.4%. So we feel like we're adequately reserved against the portfolio and we just have to continue to work through them. So our guide is charge-offs toward the upper end of a 40 to 50 basis point range; that reflects the fact that we do have some large exposures. The issue is we can't predict the timing. And so we'll expect these things will get resolved over the next two quarters; they may or may not, but we continue to work on it. Otherwise, the level of downgrades and upgrades is sort of coming into equilibrium, which indicates again that we think we've reached a point of some stabilization in our credit metrics. We should potentially see them go a little higher or a little lower; they will ebb and flow, but we think we've reached a point of stability.

Does that complete your question?

Thanks very much.

Our next question comes from the line of Erika Najarian with UBS.

Following up on Ken’s question about deposits. You’ve always had a good view and you know your consumers’ behavior very well. As we contemplate these rate cuts, how should we expect deposit balances to behave and what might the betas look like? David, could you explain how you expect betas for commercial deposits to compare with betas for consumer deposits, and comment on the speed of those adjustments?

Erika, you broke up a little there, but I think it's kind of what do we think betas will look like as rates come down. So we do have a schedule in our investor deck. It's a good one for everybody to look at. It's on Page 18. And so we really have three buckets of deposits, if you will, with different beta assumptions in all three of these buckets. So in general, we expect a mid-30% down rate beta. And so if you think about 35% of those accounts reprice with the market so they're tied to an index or their short-term CDs. So we kept our tenors fairly short, call it, five months. So that as rates came down, we would have a chance to reprice that. And then the beta for those is somewhere between 80% and 100%. If you go to the other end of the spectrum, we had about 46% of our deposit base. It was low beta, low cost, never moved up, probably not going to move down. And so that beta is going to be very low, because it never actually increased. And we have about 19% that's kind of in the middle that we think is, call it, 20% to 30% beta. And so we structured our deposit book to really take advantage of rates as they come down. And we’re only factoring in, even though on the up rates, we had 45% beta, as I mentioned earlier. We've only factored in our guidance to have 30% as down rate. It could be better than that but the 30% comes from that math that I just walked you through, which again is on Page 18 of our Investor Day.

It's been a while since we saw the level where we stopped during an easing cycle that stayed above zero. Historically, and I'm sure everyone is thinking about this as they consider 2025 net interest income, where do you price relative to the federal funds rate? If Fed funds ends up at 3.50% or 3.75%, do your deposit costs typically settle at about half of that, or is it better or worse? I'm trying to think this through. There's a lot of uncertainty about the ultimate rate path, and we could use guidance because we haven't had an easing cycle that didn't end at zero for some time.

Yes, I think a little more globally and in terms of kind of fed funds and where do you think terminal fed funds are going to be 2.5% to 3% is kind of our best guess. When we get there? Who knows. And in that, with a normal yield curve where Fed funds are 2.5% to 3%, our balance sheet structured to have a margin that's going to be in the 3.75% range to maybe 3.80%. And so that's our expectation. We think as rates start to get cut from here and we have a normalizing or less inverted yield curve then our margin can pick up. We said we'd exit at 3.50% and then we should start to climb as our managed risk partners should start to increase a bit as we go through 2025 and beyond. But kind of the steady state for us would be 3.75% to 3.80% with the fed funds that's 2.5% to 3%.

Our next question comes from the line of Ebrahim Poonawala with Bank of America.

I guess, maybe David just looking at the Slide 18 with the historical sort of net charge-offs. Is it safe to conclude that absent recession 50 basis points of charge-offs should be sort of the high end in a non-recessionary environment? I understand any given quarter can move around. But generally, is there any reason why charge-offs could be elevated even in a non-recession going forward than what we've seen, I guess, over the last 10, 11 years?

We don't believe so, Ebrahim. The composition of our loan portfolio has changed somewhat since the pre-COVID period. We've acquired Ascentium Capital and EnerBank. We believe we have a good handle on their relative charge-offs and how much they will contribute to overall charge-offs, although we are observing that as we operate those businesses. We've also grown our presence in corporate banking. As we've said before, we are taking some larger exposures intentionally to help grow our capital markets business and better serve customers. From time to time, as you noted, we could have a large charge-off that would affect the numbers. But overall, based on our observations, we believe a 40 to 50 basis point range for net charge-offs is historically appropriate and where we should operate over time. Likewise, non-performing loans in the 80 to 100 basis point range is reasonable. We may be a little higher or a little lower at times, but I wouldn't expect us to be materially higher. That's our view of what our credit metrics will look like given the current portfolio composition.

I think I heard you say in your prepared remarks that lending pipelines are beginning to pick up. Give us a sense: do we need rate cuts for those pipelines to begin to translate into loans, or do we need to get through the elections before things get going? What would be the driver to get customers off the sidelines and start borrowing? Also, from an office standpoint, where is the bank hiring? Obviously there's a lot going on across your markets competitively. Where are we investing in terms of branches or hiring bankers, etc.? That would be helpful.

So maybe I'll work backwards. We're investing in markets like Atlanta, Nashville, Houston, Dallas, Orlando, Tampa, where we either have had a significant presence over time and see an opportunity to grow or have made investment like in Houston. And so the first three or four markets, we've been there for some time. We have a strong presence. We're continuing to build on that. Markets like Houston and Dallas, we're making investments to grow and see real opportunity there. With respect to your question about pipelines, I think, I'm trying to remember the question now. I see, somebody help me…

Yes. What would be the catalyst, like when you talk to your customers, pipelines are building. Is it rate cuts, is it...

So I think, eliminating uncertainty, but cost is the bigger issue. I spent some time this week talking to one of our customers who is a large supplier of construction materials and he indicated that they're getting a lot of requests for bids, they're completing a lot of bids, but they're not seeing a lot of work awarded. And I think that's consistent with the fact that costs are still high, whether it’d be interest cost, labor cost, cost of materials. And it is costs that make things somewhat uneconomic or create more risk than customers are comfortable with. And so, I think we need to continue to see adjustments in pricing. At the same time, I expect that our customers will continue to adjust their operations to accommodate changes in pricing. I think that's the bigger factor. The election probably has some impact on just uncertainty overall as do the broader geopolitical events that are occurring. But I believe it's probably more likely interest rates and costs will be the catalyst as those things come down for more economic activity.

Our next question comes from the line of Matt O'Connor with Deutsche Bank.

Just on the expenses, the guidance kind of towards the upper end of the range. Is that just because the fees are coming in higher or anything else in terms of like increased investment spend to top that off as well?

As I mentioned earlier, the increase is largely attributable to the expected increase in revenue both from a net interest income and non-interest revenue standpoint. And we also had $20 million in expenses associated with the market value adjustments on HR related assets, that was a piece. And to a lesser extent, we've experienced some modest incremental increases in the first half of the year, and opportunities to offset that just aren't likely. However, as I mentioned earlier, we are committed to generating positive operating leverage in the second half of this year.

And then as you look out a little bit longer term, I'm not trying to pin you down '25, but just call it like the medium term the next couple of years. What do you think is a good underlying expense growth as we think about some of the positives you mentioned before like loan growth picking up, maybe the higher capital markets run rate? What would you think is a reasonable level?

Every year we go through a challenging discussion as to what we think expenses ought to be for our budget and going forward. If you look, we do have a slide in our investor deck that shows that our compound annual growth rate since about 2016 is a little over 3%. We try to keep it to 2.5% if we can. We've had some labor inflation as everybody has over the last couple of years. And obviously, technology costs continue to go up. So I would expect us to be somewhere, Matt, in that 2.5% to 3% range. And not committing to that just yet, we'll give you the guidance for '25 in January, but that should give you at least a start.

Our next question comes from the line of Chris Spahr with Wells Fargo.

So this is just a follow-up, I think, to Ebrahim's question. You’re on pace for a good mid-single-digit, around 7%, growth in core fees this year. What do you think Regions can achieve over the next two to three years with all the tactical hires you've made and when they start monetizing? And if fees are about 33% of revenues, what do you think that could be in three to five years?

Well, we continue to look for ways to generate fees by offering products and services that our customers value and need. And so you've seen us do several acquisitions to that end. We're trying to stay committed to generating positive operating leverage between growth in NII and NIR and controlling our expense base. So I think we'll continue to do that and expect to generate positive operating leverage in 25%. We'll give you a finer point on that again in January. But if we could have a little higher percentage of our fees, we've always said we would like to have revenue 50/50 between NII and NIR. We've been saying that for a long time and been able to get there. But if we could increase that, call it, 40% of our revenue and fees that'd be great. We've overcome an awful lot of consumer fee declines, whether it'd be interchange through Durbin, OD fees and the like. And we've made investments in other products and services that have helped us, including treasury management investments that we've made where we've been up, call it, 7% to 10% three years running now. So wealth management continues to grow. They had a great quarter this quarter hit a record as a matter of fact. So we're going to continue to look for ways to generate fee growth that offset some potential impacts if Durbin gets updated, we've given you that information. So I think it's incumbent upon us to continue to look for ways to continue to grow.

And then regarding capital on Slide 10. Just do you have any kind of target or aspirational target that you have for CET1 and then if it's 8.2 at quarter end?

So we have a capital operating range of 9.25% to 9.75% on CET1. We've increased that to 10.4% this quarter. The reason for that was partly uncertainty with the economy and uncertainty regarding Basel III and what that was going to mean for us. We have seen the draft of Basel III, as has everybody. We think we're within striking distance of whatever the ultimate Basel III is going to be. So we don't need to let our capital continue to accrete higher from here. As a result, if we generate income, we'll continue to pay a fair dividend. We will continue to look for ways to reposition our securities portfolio if that makes sense. If all else doesn't work, then we'll buy our stock back. We've done all three of those things this past quarter. And of course we use that to grow loans as well, and you should look for us to continue that. So a CET1 capital level of about 10.3% to 10.4% is about where you should expect it to be going forward, until we ultimately get Basel III.

So that implies there was a decline in your buybacks in the second quarter. Should we expect a meaningful increase in the third and fourth quarters?

Well, commensurate with earnings, and the reason we changed was that we used some of that capital for the $50 million pretax loss we took on the securities repositioning. So it's all predicated on how much, if any, of our capital generation we will use for that. The buyback is simply what it takes to get us to a common equity Tier 1 ratio of 10.3% to 10.4%.

Our next question comes from the line of Gerard Cassidy with RBC.

John, you and I have talked in the past about pipelines and you emphasized that they are stronger today than they have been recently. And I know it's hard to quantify this. But can you give us any kind of subjective opinion that these pipelines, the pull through could be even better than in the past or any color there?

I don't have an opinion, Gerard, that it would be any different from our historical experience. I do think we are seeing pipelines build. We've seen some softness in a few of our specialized businesses, and those pipelines, in particular, are beginning to improve, especially in areas like energy and financial services, where we also include our subscription lines and our insurance book made up of businesses where we're lending to customers who actually lend to others. We have strong relationships in consumer finance that have been good over time. But I can't tell you that I necessarily believe we're going to see any change in pull-through rates.

Our next question comes from the line of John Pancari with Evercore.

Back to credit, your ACL ratio came down slightly this quarter by about a bit. And just given what you're seeing on the credit front, given your commentary that your trends are peaking around this quarter on certain fronts. Where do you see the reserve ratio going from here? If you can kind of walk through the expectations if you could see incremental release on that front?

As we stated, our credit metrics are improving. We anticipated charge-offs at the upper end of our range, and we have reserved for those. Absent loan growth or changes in economic conditions, as those charge-offs come through you would expect the allowance for credit losses to decline. Exactly where it ultimately lands is hard to predict; we assess it each quarter using all available information. As a reference, in the fourth quarter of 2019, the pre-pandemic, pre-CECL environment, our absolute CECL reserve was 1.71%. If you take the losses by portfolio from that time and apply them to our current portfolio, that equates to about a 1.61% reserve. You can see that on the bottom of one of our charts. Over time you would expect the reserve to trend back toward a more normal level like that, but we cannot say how quickly. Generally, though, with charge-offs coming through in the short term, you should see the ACL come down.

I know you expected it flat-to-down, but helping frame it like that is definitely helpful. And then secondly, on the expense front as a follow-up to Matt's question, I know you're confident in the positive operating leverage in the back half of this year. And it sounds like you're focusing on positive operating leverage for next year as well. Your long term expense growth rate that you alluded to in your response of 2.5% to 3%, that's a bit above where it looks like consensus is running right now around 2% for next year. I guess, where are you investing in areas that could put you in that 2.5% to 3% range versus anywhere lower? And maybe if you could talk about what that would mean for a longer term efficiency ratio that you should be running at?

So we're going to give you more pointed guidance for 2025 later. We're not trying to get ahead of ourselves. Generally speaking, inflation that's baked into our book will be closer to 2.5%, and our largest category of expense is salaries and benefits, so we have to adequately pay our people. We are also investing in technology, cyber, and consumer compliance; all those areas require significant ongoing investment to improve. We have to find ways to pay for that, and that becomes harder because the low-hanging fruit is not there. We've done a really good job of controlling our expense base and have one of the lowest efficiency ratios in the peer group. We were hoping to get to the lower 50s over time and we think we can do that, but we'll have to leverage technology better over time than we do today, and I think that's true for anyone in the industry. By doing that, you rely less on labor and can let natural attrition reduce headcount as you implement technology solutions. We're spending roughly 9% to 11% of our revenue on technology. We have some big technology projects in the works—new deposit system, new commercial loan system, new general ledger—and those take money. We need to figure out how to pay for that while keeping our expense run rate as low as possible. Our goal is to continue moving our efficiency ratio down from where it is today toward the lower 50s.

And since you mentioned the deposit system, is that still running on plan?

It's a big project and it's moving according to how we have it laid out, but we've got a long way to go. So we're not there yet.

Yes, it's running on plan, John.

Our next question comes from the line of Betsy Graseck with Morgan Stanley.

I just want to make sure I heard you correctly about the normalized NIM in a normalized rate environment. So, if I'm understanding, a normalized rate environment starts with the federal funds rate roughly similar to inflation, around 2.5% to 3%, and the yield curve is steep rather than inverted. In that environment, on a full-year basis you expect your normalized NIM to be about 3.75% to 3.80%. Is that right?

That's right. You got it.

And that based on the forward curve that would be again sometime in '25 or '26?

Yes, that's right.

And that is obviously higher than your NIM this quarter. Could you walk me through it? I know you spent a lot of time on NII and NIM at the start of the call, and I just want to make sure I understand the key drivers that move your NIM from today’s level to the normalized level.

Well, I think as rates continue to come down, our funding costs and input costs will come down as well. The power of our front book and back book will continue to benefit us for a couple of years. With the curve steepening and the repricing of the balance sheet, that drives you up from the mid-3.50s to the roughly 3.75 range we discussed. It's just a question of timing. We think our rate beta is in the mid-30s, which we believe is appropriate and perhaps conservative. That's an important driver to reduce input costs. To continue to grow the balance sheet, we have some high-yielding assets that carry higher losses but deliver attractive returns and net interest margins. Growing consumer checking accounts and business operating accounts is a huge driver in lowering deposit input costs. That's why it's so important for us to keep investing in the markets John mentioned earlier, both on the consumer and business sides, to acquire those checking and operating accounts.

So should I read it as you are liability sensitive or do I read it as, you are neutral with these changes that drive the NIM higher or you're asset sensitive but decliningly so as rates fall?

We're neutral to short rates. And so to the extent, we start seeing rate cuts, then you're going to see our deposit costs continuing to come down. And we still have fixed rate assets, so we’ll continue to help benefit NII and the margin. And what will happen is the curve will steepen. Obviously, if you stay anchored on the long end and short rate comes down and we'll benefit from that as well.

Thank you. I would now like to turn the call back over to John Turner for closing comments.

Okay. Well, thank you all very much. We are again proud of our quarter, proud of our team that’s executing our plans so well. We appreciate your interest in our company. Have a great weekend.

This concludes today's teleconference. You may disconnect your lines at this time.