Regions Financial Corporation

Good morning and welcome to Regents Financial Corporation's quarterly earnings call. My name is Natalia 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 on your telephone keypad. I will now turn the call over to Dana Nolan to begin.

Thank you, Natalia. Welcome to region's fourth quarter 2021 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'll 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 fourth quarter and full-year results. We achieved a great deal despite a challenging interest rate and operating environment. Earlier this morning, we reported full-year earnings of $2.4 billion and record pre-tax, pre-provision income of $2.7 billion. Despite continued economic uncertainty, we remain focused on what we can control and our efforts are paying off. We grew consumer checking accounts by 3% and small business accounts by 5%. Notably, our 2021 net retail account growth exceeds the previous three years combined and represents an annual growth rate that is three times higher than pre-pandemic levels. We increased new corporate banking group loan production by approximately 30% and generated record capital markets revenues. Through our enhanced risk management framework, we delivered our lowest annual net charge-off ratio since 2006. We made investments in key talent and revenue-facing associates to support strategic growth initiatives. We continue to grow and diversify revenue through our acquisitions of Interbank, Saval Capital Partners, and Clearsight Advisors. We successfully executed our LIBOR transition program. to ensure our clients were ready to move to alternative reference rates. We continue to focus on making banking easier through investments in target markets, technology, and digital capabilities. We surpassed our two-year, $12 million commitment to advance programs and initiatives that promote racial equity and economic empowerment for communities of color. Before closing, we're extremely proud of our achievements in 2021 but none of these would have been possible without the hard work and dedication of our nearly 20,000 associates. The past year posed unique challenges as we continue to transition to our new normal, both on a personal and professional level. Despite continued uncertainty, our associates remain steadfast. They continue to bring their best of work every day, providing best-in-class customer service, successfully executing our strategic plan, and maintaining strong risk management practices, all of which contributed to our success. In 2022 and beyond, we'll continue to focus on growing our business by making investments in areas that allow us to make banking easier for our customers, all while continuing to provide our associates with the tools they need to be successful. We will make incremental adjustments to our business by leaning into our strengths and investing in areas where we believe we can consistently win over time. As announced earlier this week, a key priority in 2022 will be additional comprehensive changes to our NSF and overdraft policies, which are detailed in the appendix of our presentation. These changes represent a natural extension of our commitment to making banking easier for our customers and complement the enhanced alerts, time order posting process, as well as our bank loan certified checking product we launched last year. It's important to note that the financial impact of these enhancements have been fully incorporated in our total revenue expectation for 2022. Again, we're pleased with our results and have great momentum as we head into 2022. Now, David will provide you with some select highlights regarding the quarter.

Thank you, John. Let's start with the balance sheet. including the impact of acquired loans from the interbank transaction adjusted average and ending loans grew six and seven percent respectively during the quarter although business loans continue to be impacted by excess liquidity pipelines have surpassed pre-pandemic levels and encouragingly we experienced a 240 basis point increase in line utilization rates during the fourth quarter in addition Production remained strong with line of credit commitments increasing $4.7 billion year over year. Consumer loans reflected the addition of $3 billion of acquired interbank loans, as well as another strong quarter of mortgage production, accompanied by modest growth in credit card. Looking forward, we expect full year 2022 reported average loan balances to grow 4% to 5% compared to 2021. Let's turn to deposits. Although the pace of deposit growth has slowed, balances continue to increase this quarter to new record levels. The increase includes impact of interbank deposits acquired during the fourth quarter, as well as continued growth in new accounts and account balances. We're continuing to analyze our deposit base and pandemic-related deposit inflow characteristics in order to predict future deposit behavior. Based on this analysis, we currently believe approximately 35% or $12 to $14 billion of deposit increases can be used to support longer-term asset growth through the rate cycle. Additional portions of the deposit increases could persist on the balance sheet, but are likely to be more rate-sensitive, especially later in the Fed cycle. While we expect a portion of the surge deposits to be rate-sensitive, you will recall that the granular nature and generally rate-insensitive construct of our overall deposit base represents significant upside for us when rates do begin to increase. Let's shift to net interest income and margin. Net interest income increased 6% versus the prior quarter, driven primarily from our interbank acquisition, favorable PPP income, and organic balance sheet growth. Net interest income from PPP loans increased $8 million from the prior quarter, but will be less of a contributor going forward. Approximately 89% of estimated PPP fees have been recognized. Cash averaged $26 billion during the quarter, and when combined with PPP, reduced fourth quarter's reported margin by 51 basis points. Our adjusted margin was 3.34%, modestly higher versus the third quarter. Excluding the impact of a large third quarter loan interest recovery, core net interest income was mostly stable as loan growth offset impacts from the low interest rate environment. Similar to prior quarters, net interest income was reduced by lower reinvestment yields on fixed rate loans and securities. These impacts are expected to be more neutral to positive going forward. The hedging program contributed meaningfully to net interest income in the fourth quarter. The cumulative value created from our hedging program is approximately $1.5 billion. Roughly 90% of that amount has either been recognized or is locked in to future earnings from hedge terminations. Excluding PPP, That interest income is expected to grow modestly in the first quarter, aided by strong fourth quarter ending loan growth, as well as continued loan growth in the first quarter, partially offset by day count. 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 and $80 million over a full 12-month period. This includes recent hedging changes and is supported by a large proportion of stable deposit funding and a significant amount of earning assets held in cash when compared to the industry. Importantly, we continue to shorten the maturity profile of our hedges in the fourth quarter. Hedging changes to date support increasing net interest income exposure to rising rates, positioning us well for higher rates in 2022 and beyond. In summary, net interest income is poised for growth in 2022 through balance sheet growth and a higher yield curve in an expanding economy. Now let's take a look at fee revenue and expense. Adjusted non-interest income decreased 5% from the prior quarter, primarily due to elevated other non-interest income in the third quarter that did not repeat in the fourth quarter. Organic growth and the integration of Sabal Capital Partners and Clearsight Advisors will drive growth in capital markets revenue in 2022. Going forward, we expect capital markets to generate quarterly revenue of $90 to $110 million, excluding the impact of CBA and DBA. Mortgage income remained relatively stable during the quarter, and while we don't anticipate replicating this year's performance in 2022, mortgage is expected to remain a key contributor to fee revenue, particularly as the purchase market in our footprint remains very strong. Wealth management income increased 5% driven by stronger sales and market value impacts, and is expected to grow incrementally in 2022. Seasonality drove an increase in service charges compared to the prior quarter. Looking ahead, as announced yesterday, we are making changes to our NSF and overdraft practices, which along with previously implemented changes, will further reduce these fees. NSF and overdraft fees make up approximately 50% of our service charge line item. These changes will be implemented throughout 2022, but once fully rolled out, together with our previous changes implemented last year, we expect the annual impact to result in 20 to 30% lower service charges revenue versus 2019. Based on our expectations around the implementation timeline, We estimate $50 to $70 million will be reflected in 2022 results. NSF and overdraft revenue has declined substantially over the last decade. And once fully implemented, we expect the annual contribution from these fees will be approximately 50% lower than 2011 levels. Since 2011, NSF and overdraft revenue has decreased approximately $175 million, and debit interchange legislation reduced card and ATM fees another $180 million. We have successfully offset these declines through expanded and diversified fee-based services, and as a result, total non-interest income increased approximately $400 million over this same time period. Through our ongoing investment in capabilities and services, we will continue to grow and diversify revenue to overcome the impact of these new policy changes. We expect 2022 adjusted total revenue to be up 3.5% to 4.5% 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 non-interest expense. Adjusted non-interest expenses increased 5% in the quarter. Salaries and benefits increased 4%, primarily due to higher incentive compensation. Base salaries also increased as we added approximately 660 new associates, primarily as a result of acquisitions that closed this quarter. The increased headcount also reflects key hires to support strategic initiatives within other revenue-producing businesses. We have experienced some inflationary pressures already and expect certain of those to persist in 2022. If you exclude variable-based and incentive compensation associated with better-than-expected fee income and credit performance, as well as expenses related to our fourth-quarter acquisitions, Our 2021 adjusted core expenses remained relatively stable compared to the prior year. 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% to 4% compared to 2021. Importantly, this includes the full-year impact of recent acquisitions, as well as anticipated inflationary impacts. Despite these impacts, we remain committed to generating positive adjusted operating leverage in 2022. Overall credit performance remains strong. Annualized net charge-offs increased six basis points from the third quarter's record low to 20 basis points driven in part by the addition of Interbank in the fourth quarter. Full-year net charge-offs totaled 24 basis points, the lowest level on record since 2006. Non-performing loans continued to improve during the quarter and are now below pre-pandemic levels at just 51 basis points of total loans. Our allowance for credit losses remained relatively stable at 1.79% of total loans while the allowance as a percentage of non-performing loans increased 66 percentage points to 349%. 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 25 to 35 basis point range. With respect to capital, our common equity Tier 1 ratio decreased approximately 130 basis points to an estimated 9.5% this quarter. During the fourth quarter, we closed on three acquisitions, which combined absorbed approximately $1.3 billion of capital. Additionally, we repurchased $300 million of common stock during the quarter. We expect to maintain our common equity Tier 1 ratio near the midpoint of our 9.25 to 9.75% operating range. So wrapping up on the next slide are our 2022 expectations, which we've already addressed. In closing, the momentum we experienced in the fourth quarter positions us well for growth in 2022 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're 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 telephone keypad. If at any point your question is answered, you may remove yourself from the queue by pressing the pound key. We will pause for just a moment to compile the Q&A roster. Your first question is from the line of Erica Najarian with UBS.

Good morning, Erica. Hi. Good morning. So just going to actually, I didn't expect to ask this question, but, you know, the feedback that I got from investors in terms of the performance today, you know, obviously your outlook is quite upbeat. Is that the tangible book dilution from the deals that you announced or rather closed in the fourth quarter surprised? And David, I'm wondering if you could share with us sort of the earn back period you expect for these deals on tangible book value.

Well, we look at several factors, not just tangible book value. We look at diversification of revenue. We look at return on investment. Because the alternative is buying your stock back, which also has a reduction in tangible book value. So you're trying to look at the tradeoff between how you put your capital to work. Frankly, I can't even remember what the payback was. If we were looking at a bank acquisition, that's a little different where we would expect a payback period in three years or less. But in this case, we're looking at diversification and being able to grow. And the return on that investment is higher than the return we would have had if we bought our shares back.

Your next question is from the line of Betsy Grancic with Morgan Stanley. Good morning, Betsy.

Good morning. A couple of questions. First, on the announcement that you made yesterday on the changes to the overdraft and sufficient fund fees, I know you sized it for 2022. Could you give us a sense as to You know, if that were to go in full year, full on, what that level would be? Because obviously as we think into 23, you need to understand how you're thinking about an annualized impact would be looking like.

Yeah, so the guidance we provided Betsy is if you go back to 2019, take the total service charge revenue, the impact is going to be somewhere between 20 and 30% of total service charge revenue based on 2019 revenue once all the changes are implemented and annualized.

And that includes all the things we already have done, too. So it's a cumulative number. So if you go back to that, you can calculate. And round numbers, we're going to have half to maybe slightly more than that done in 2022. And so, you know, you can double that for close proximity of what the total would be.

And when you say the service charges from 2019, you're talking about the service charges from 2019 in your income statement, not what shows up as regulatory, like overdraft?

That's correct.

Regulatory filing.

That's correct.

Okay.

And we think about it that way because, I mean, ultimately, all these fees are associated with the consumer business fee. And as we think about how we overcome that loss of revenue, it is through growth in consumer checking accounts, additional activity, debit card usage, debit card fees, other things that come with that. And as David has pointed out earlier, if you go back to 2010-11 timeframe and come forward, we've been able to significantly grow non-revenue while overcoming the loss of revenue associated with REGI and and other changes, we expect the same will be true as we look forward relative to the change we're making here.

And Betsy, just to help you out a little, if you go into our public filings in our supplement 2019, our service charge number was $729 million. It's off that number.

Right. Right. Okay. I was just going to confirm that. All right. Great. Thank you. And then follow-up question here just on how you're thinking about the Sobel acquisition and how that's going to feed into not only the income statement I heard you talk about, it's in the capital markets revenue line, but maybe help us understand, you know, is there any balance sheet impact here and the expectation that you have to grow this business from where it is today? Yeah.

So I would say the balance sheet impact will be modest. We'll have an opportunity to develop relationships that might lead to our providing credit to customers and or opening deposit relationships, we expect that to be true for sure. The primary benefit we derive from SBAL is the capabilities we have, permanent placement capabilities that we ultimately end up with. I think we're one of four or five banks in the country that will have a complete array of real estate permanent placement products, whether it be Fannie license, Freddie licenses for large and small dollar, CMBS capabilities, we can bank our real estate customers' needs across the spectrum. And, you know, as we've transitioned from the Great Recession to today, we've built, I think, a really solid real estate business. Real estate permanent placement revenue in 2021 will exceed $60 million today. That's from zero in 2014, effectively. So we've been building that business around regional and national real estate developers, really strong balance sheets, good liquidity, and access to capital. The portfolio has performed very, very well, and we think this gives us an opportunity to extend those relationships and drive additional profitability.

And there's been some pretty recently some significant uptick in that demand for that product, right?

Yes. And, again, I think if you just look at the multifamily market, it's awfully good. And, you know, those developers who like to buy and build and hold want access to both the Fannie products and the the Freddie products from time to time, and we, again, found that to be a great source of revenue and a wonderful way to build stronger, deeper relationships with that customer segment.

Thank you.

Your next question is from the line of John Pencari with Evacor ISI.

Good morning, John. Good morning. On the loan growth front, I want to see if you can Maybe give us a little more color on the 4% to 5% growth expectation you have for the year. Maybe if you can unpack it by, you know, give us a little bit of color on the growth you expect for commercial and CRE and consumer and how that could play out for the year. Thanks.

Yeah, John, it's David. So first thing we have to overcome, and it depends on if you're looking at it on the average, which is where the 4% to 5%, the first thing you have to do is overcome the PPP average, which is about $2.7 billion. So put that in your model. And if you look at areas where we can grow, clearly we're going to get benefit off Interbank, having a whole year of Interbank, along with its growth that we expect. And so that's a big driver of our averaging. Mortgage ought to have a – may not have as much production as we have in 21 for 22 – but we still believe we'll grow the balance sheet quite nicely there. We expect credit card to continue to grow. And then on commercial, even after you consider overcoming the PPP runoff on average at 2.7, we think we can still grow that on top of it. As we look at the industries that we were particularly strong in in 21 in the commercial space, financial services, healthcare, transportation, our asset-based lending, home builder, and to a lesser degree, technology. Those are areas that we did see growth in, quite nice growth, and expect to continue into 2022. And it's been geographically diverse as well.

Right. Okay. All right. Thanks. And then separate, we On the operating leverage expectation, based upon your guidance, you're looking for about 50 basis points of operating leverage. Can you just talk to us about how, if Fed hikes maybe prove to be less than expected, is that 50 basis points operating leverage still attainable? Do you still have leverage to pull to basically generate that despite any move by the Fed?

Well, you know, it certainly makes it harder, but as we've always said, you know, our goal is to generate positive operating leverage over time. And, you know, if our revenue growth isn't there, then we double down on expense management and, you know, obviously didn't get there this year, nor did anybody else that I'm aware of. But we believe there's a reasonable path to that. And, you know, that's why we gave you the guidance and showed you that roughly 50 basis points or more And, you know, we have things we can do during the year that can help us get there. But, yeah, rates not coming in at the pace we think or as many as we think will put pressure on that calculation. But we wouldn't give up on it just because of that.

Got it. All right. Thanks. Good question.

Your next question is from the line of Bill Karkachi with Wolf Research.

Thank you. Good morning. Following up on the commentary around the positive operating leverage, I was hoping you could frame a little bit more how much variability there is around that 3% to 4% increase that you have in your outlook for expenses. As those rate hikes begin to flow through, the forward curve reflects four hikes next year, but some are expecting more than that. So how does the number of hikes, I guess to the extent that we get more you know, influence the expense line? And, you know, does that three to four outlook hold? And on top of that, it would be great if, you know, if you could also discuss your confidence level and being able to control the expense base such that, you know, you continue, you still achieve that positive operating leverage even under different inflation scenarios.

Well, you asked a lot there, so let me see if I can help you out. So on the expense side of 3% to 4%, a large portion of that, substantial portion of that is related to the acquisitions that we had. So we closed on three deals in the fourth quarter, one of them right at the end of the year. So we'll have a full year run rate on all those coming through, and that's the biggest single driver there. of the three to four percent. If you go back and look at our compound annual growth rate on expense management, we've actually done a pretty good job of controlling our expenses. And we don't do that in just one area, but it's salaries and benefits and furniture fixtures and equipment and occupancy and vendor spend. All those things, we are all over. And John has us, our continuous improvement program still going where we're looking to improve processes each and every day, leveraging technology to help us control our expense load. So I think, you know, in terms of the revenue side, we have four baked into our guidance that we just gave you, four 25 basis points moves each quarter. So on average, you get two during the year. And, you know, it depends on, you know, Will we get 25? Will it be more than that? Will it be more than four or less than four? I mean, you have to – we've told you, you know, in our guidance that each 25 basis points is $60 to $80 million for. So you can put your model and kind of work with that. But back to the question earlier, I think, from John Picari in terms of operating leverage, we are committed to generating positive operating leverage over time. And, you know, when things get more challenging, we'll do what we can to manage expenses. So I'll leave it at that.

Your next question is from the line of Ibrahim Bunawala with the Bank of America.

Morning, Ibrahim.

Morning. I guess one just question follow-up on the overdraft. It's been a big overhang on the stock, and I get your guidance around the impact this year, David. But just talk to us, downside risk, the industry seems to be moving away from here. Give us a sense of the use case of why there's a subset of overdraft fees that needs to exist and why you feel okay, both competitively and from a regulatory standpoint, that component of fees will be defendable.

Well, so as we put in our guidance yesterday, we're eliminating NSF fees altogether. We still have overdraft fees for a service that we're providing, which is liquidity to our customer base, and they appreciate the ability to be able to have that liquidity in time of need. And there's a cost to that. And now we've done some things. We've given alerts. We've changed our posting order. We're going to give small-dollar loans. We're going to give your paycheck up to two days available in some cases. And so we're doing a lot of things to make it easier for our customers to bank with us and to understand where they stand at any point in time. But if they need that liquidity, we want to be there. We will be limiting our overdrafts no more than three per day to, which is one of the strongest in the industry. We're doing a lot of things that we think that's a value play for our customers. They want that ability for that short-term liquidity at the cost that we charge for it.

Noted. And I guess just a separate question around loan growth. Apologies if I missed it, but talk to us about the interbank acquisition, what that means for growth, especially some of the non-footprint. I think half of interbank is outside of the core region's footprint. Give us a perspective in terms of the opportunity that you have there, both in terms of what Interbank does today and how to scale that up.

Yeah, so we acquired about $3 billion worth of loans right at the beginning of the fourth quarter. We'll get all that in our averaging numbers, which is where our 4% to 5% growth is for next year. Their production had been about 1% of the industry growth. which equated to about $1.7 billion in terms of production, and that's what they were doing. And we think we have the ability to take that and ramp it up over time and have nice growth there. We are excited about Interbank and excited about the fact that our geographic expansion of that is outside of our core footprint. It brings us the ability to have more customers throughout the country to do other banking services with as well, including Interbank. small business contractors that offer products to consumers. So it is a big portion of our growth expectation, and we couldn't be more excited about adding Interbank and the people that work there to the region's family.

Your next question is on the line of Ken Houston with Jefferies.

Morning, Ken. Hey, good morning, guys. Another just follow-up on the expenses. David, can you help us understand of the 3% to 4% growth, what part of that is just organic growth? What part is actually coming from the acquisitions, getting into the run rate? And then what are you doing in terms of offsets, in terms of continuous improvement type of efficiencies?

Yeah. Ken, as I mentioned earlier, the overwhelming majority of our growth is related to the acquisitions that we have. We've been able and will continue to control our core expenses by managing the things I talked about, managing salaries and benefits and headcount and our square footage, whether it be branch or office square footage. You know, when you manage your your headcount, you manage the number of computers you have to have. It's vendor spend. It's our procurement group really ensuring that from a demand management standpoint that people that are asking for vendors and third-party services really need them. And when we have to have them, making sure that we get the best price for the services that we're getting. That's ongoing. That's part of our continuous improvement program. And you couple that with leveraging technology and taking out processes that we have. We're not finished there. Now, we have to create opportunities to reinvest. So embedded in the 3% to 4% are the investments that we're making in people. In our certain markets that we have that we see opportunities for growth there, we invest in technology, people, and and services to help us there. So all that's embedded in the numbers that we're giving you. But cutting to the chase of the 3% to 4%, the vast majority of that is related to the acquisitions that we announced.

Yeah, I understand. I apologize. I missed that comment earlier. Follow-up separately, David, then on that SWAPS book, you terminated a little bit more this quarter. I just want to understand what percentage of that book is now kind of locked out from either you've terminated or you understand the maturity schedule. And we see from your color NII slide what that expected trajectory is like. So I don't think there's much change, but can you let us know if there's anything different in terms of how you're viewing that portfolio going forward? Thank you.

Yeah, Ken, so we continue to kind of read the tea leaves and where the Fed's going in the market with regards to rates. So we took some of our protection off. It unwinds this summer, so we have a little bit more asset sensitivity that comes in in the second half of the year. But we have to continue to monitor that because it's important for us to make sure that we have the proper sensitivity when we expect rates to go up. We do. And now it's just timing. You know, a month ago, maybe a rate increase or two. Now today it's four. This morning there are people talking about maybe it will only be a couple. So, I mean, this is very volatile, and we're trying to do the best we can to anticipate where those rate moves are going. And you know, we've locked in a good portion of our fair value, if you will, of our hedge portfolio, over half. So I think that we're in good shape. We can terminate some of those, you know, quickly if we want to put more sensitivity in. But right now we think we're in a pretty good spot.

Do you have an upper bounds of the sensitivity and how much you'd let it float up? And thanks for answering, Steve.

You know, what we really want to do is we're not trying to top tick our margin in NII. What we're trying to do is have a repeatable, predictable income statement. What we do when rates get to a point where there's risk of it going down, we do have risk parameters in terms of how much risk we can have on NII with a 100 basis point move. But for us, it's really trying to... to anticipate where the market's going to move so we can take full advantage there. But we don't want to have an unusual pickup in any given period, whether it be a quarter or a year, that's not repeatable. That's not helpful to score our shareholders over time. So we're trying to get back. We had given you a range of getting up to our margin in the 370 range with a normal interest rate environment. We're probably going to be in the higher 330s on a core basis. this quarter coming up. So we'll have a little bit of growth there, but it's just making incremental moves on the portfolio as we see the interest rate environment change.

Thanks again, David.

Your next question is from the line of Gerard Cassidy with RBC.

Good morning, Gerard. David, can you elaborate on Further on slide eight where you give us the interest rate exposure and you talked about your deposit beta, particularly in the first 100 basis points of being 25 percent, due to the higher betas on your surge deposits, can you tell us how large are the surge deposits on the balance sheet and can you give us some color on how you define surge deposits?

Yeah, so our total surge deposits just mathematically are about $39 billion, okay? And so when you think of those surge deposits in terms of beta reaction, there's really two things that are happening with those surge deposits. Of the surge deposits, about 65% of those we think would have actually a lower beta I'm sorry, a higher beta, that's $25 billion. And we would put that beta at 75%. I think it's going to be pretty high, pretty reactive. If you look at the other 35%, we think, based on the nature of those accounts that those deposits went into, that that beta is going to be similar to our legacy to beta, which is 10%. Then if you take the rest of our core legacy deposits, we put a 10% beta on that as well. And if you go back and look at the last 100 basis point rate increase that we had the last cycle, that's what the beta was. So that's the math that we've really gotten to in our guidance that we're giving you.

And David, on the surge deposit, are those excess non-operating deposits from your corporate customers or are they the consumer's that have excess money left over from the stimulus?

Yeah, a big portion of those surge deposits are corporate deposits that came in because that's the best place they could put their money. And that's why we believe that 65% of those deposits, so call it $25 billion, that's 65% of the 39, it's going to be very reactive because they're corporate customers that are likely to want to put those to work in a more meaningful place. And we don't need to pay up for that. So we expect those to probably either move out or to be more expensive.

Very good. And then as a follow-up, you highlighted your net charge-off ratio. I think you said it's the lowest seen in about 15 years. You pointed to net charge-offs initially probably staying around the low levels you saw in the fourth quarter. gradually in the second half of the year, start to head toward maybe normalization. Is that based on just because the rates are so low that it's hard to maintain that? Or is it formulaic or some underwriting that you have done that says, no, we're going to slowly start to see higher net charge-offs later in the year, excluding, of course, the acquisitions that may influence the reporting numbers?

Yeah, it's not an underwriting change. It's a reality that obviously consumers and businesses were propped up by stimulus, consumers in particular. A lot of that stimulus is running out this quarter in terms of the child care tax credit. We've been unusually low, as has the industry. So I think that our expectation is we would start to normalize because of the runoff of the stimulus, which starts manifesting itself in the second half of the year. But that being said, we still think charge-offs will be rather low, lower than history at 25 to 35 basis points for 22. You know, if the economy continues to perform and consumers do well and manage their money well, maybe our charge-offs are at the lower end of that range. So... A bit of it is trying to anticipate when, quote, normalization will occur.

Very good. Thank you for the color.

Your next question is from the line of Matt O'Connor with Deutsche Bank. Good morning, Matt.

Good morning. It might be a little bit too early to be thinking about this. Given rate expectations have increased so much, when does that start factoring into how you're underwriting? Because obviously, you know, if rates go up to 3% or even more, it does put pressure on borrowers.

Well, I think, Matt, one thing, so we're talking about 425 basis point moves to get off of virtually 0%. If you think of a consumer, a lot of the consumer portfolios are fixed-rate portfolios, so they don't end up having much of an interest rate shock on four moves. On the corporate banking side, again, four moves on them. You know, we've been monitoring our customers. We know where they stand. A lot of them hedge. We would expect as rates start to move, we actually put on – our customers would put on more hedge protection, if you will. So, again, we don't see a lot of payment shocks there. I think it's – the risk is running out of stimulus and also is there something unique in a given business or industry that could drive losses higher versus rates – at this point.

But, you know, the only other thing I'd say is the normal course of business, when underwriting credits, we're always stressing for interest rate sensitivity and among other things that might occur. So that would not be a change in our current practice.

Okay. And then just separately, and apologies if I missed it, your capital markets revenue has been strong all year and you did increase kind of the run rates. for 22, but we've seen some of your peers have really strong cap market fees in 4Q. And I think part of it might just be a mixed issue, but maybe you could talk to that just if you did that earlier. And if you did, I'll look at the transcript. Thank you.

No, no, I think it's a good question. If you just look at the bulk of our capital markets revenue distributed across both capital raising and advisory services, so whether it's real estate, permanent placement, M&A, loan syndications or fixed income transactions, we are generating relatively similar amounts of revenue across those platforms, so we've got good diversity. Now we've added Clearsight Advisors and we've added Sebal Capital, and so when you consider the contribution that those acquisitions will make in concert with the businesses that or products capabilities that we've developed, we think the run rate of 90 to 110 per quarter is appropriate.

Okay, thank you.

Your next question is from the line of Stephen Scalton with Piper Sandler.

Morning. Yeah, good morning. Thanks. So just one clarifying question first. I wanted to make sure, David, from your earlier commentary that the loan growth the 4% to 5% does include the runoff of PPP, or is it X that PPP impact?

No, it includes that. That was one of the important points, that it includes overcoming that and having 4% to 5% growth on the average that you see for the year as it's in our supplement.

Perfect. That's what I thought I heard. Thank you. That's great. And then maybe one other question I had is can you talk a little bit about the handoff kind of from the hedging income to the greater rate sensitivity that obviously now you're pulling forward a bit. I know you have some detail there on slide 20, but I'm just kind of wondering if you can walk through that. Is there the possibility that on a quarter-to-quarter basis we could see some decline as that $114 million run rate kind of pulls down and the impact of higher rates pulls it back up?

Well, I mean, you can always have a little timing issue from a quarter to quarter, but, you know, we've got a number of things going on on that chart that you can see, in particular, our growth, our loan growth and our interbank transaction that we had. But a good portion of our hedge portfolio is locked in, and we're adding the sensitivity. I forgot to ask the question earlier, but we added a little bit of sensitivity to help us in the second half of the year. So the key thing on the early moves, too, is that we're still very asset sensitive because of our deposit base. And so when you start seeing the first couple of moves, you know, that beta is pretty close to zero. And so, you know, I think that'll aid in the handoff, but it might not be perfect. But, you know, if you're looking at making an investment in us over a period of time, we've got to We think we're well-positioned to grow. As the economy continues to grow, we get higher rates, and that's where Regions really shines because our deposit base, that low-cost core deposit base of ours, has been a differentiator for us. It's just we haven't been able to extract the value out of it because we've been in such a low-rate environment. But now we're starting to see that opportunity if, in fact, we get the rate increases that the forms have baked in.

Okay, that's very helpful. And just one other point on that chart is the impact of organic growth, obviously, is increasing in each subsequent year in 23 and 24. Is that to convey that you think organic growth can be even better from a loan growth perspective or just that it will be more meaningful given it will be at higher rates?

Well, it's a little bit of both. I think we can continue to see absolute balance growth. You know, we've acquired new portfolios, and as I mentioned, so just one example is Interbank. You know, we added $3 billion. That production there historically had been about $1.7 billion. We're in a lot of states, and we have a distribution that's far better in our bank than what they would have had, and they were a regulated company. energy company, right? So we have the ability to take that to a new level. And so that's just one example. That's why we continue to make investments because we see opportunities to take a portfolio and be able to push that through our network and all the people that we have working for us to continue to grow. You're also getting help by the rate environment, so that's baked into that 4% to 6% compound annual growth rate as well.

Perfect. That's encouraging. Thanks for the comment. Yeah.

Your next question is from the line of Christopher Spahr with Wells Fargo. Good morning.

Good morning. So my question is about 2023 expenses. Last month you said 2.5% was kind of a core run rate for at least to think about wage increases. Is that kind of a good starting point to think about expenses for next year?

Actually, Chris, we've seen some inflation. this year. That number is going to be a little bit higher as we think about merit increases, payments we need to make to retain certain folks, in particular people that are in the technology side of the house, recruiting, those type things. So that two and a half is a little bit higher than that now. That is baked into the guidance we gave you. And so I guess bottom line is we have experienced the inflation and We expect that to persist into 2022.

Now, Chris's question was around 2023, if I heard you correctly, Chris. That's correct.

And that inflation, that's not transient. That's going to be in the run rate for 22, and then you're going to continue. Now, will you be able to revert back to merit increases that are more consistent in 2023, like we had in the past, and I think that's accurate.

Yeah, I guess I'm trying to figure out the difference between deal-related costs that you're seeing this year versus what is going to be more of a run rate inflation or wage pressure.

Well, the main thing is of the 3% to 4% that we're going to experience, the vast majority of that is related to the acquisitions that we had.

Okay, and then one quick follow-up, please. So last month, you said I think 2% was a good starting point to put money to work, and given kind of your high level of dry powder, even with the surge deposits, is that still your thought process, or do you think it's going to be a higher level now, given with the 10 years already?

No, we still think, so we think the short end, as we told you, we probably have four short-term rate increases going in this year, but we still think the 10-year kind of hangs out and approaches 2% by the end of the year, so it doesn't move as much. We do think there's opportunities. There's a lot of volatility there. If we see the ability to put $1.2 billion or more to work in the securities book and we're convicted on that, we'd be happy to. We have more cash idle cash than most everybody because we just have been reluctant to want to take the duration risk because we just don't think we're appropriately compensated for it. That being said, things can change. And if we see closer to that 2% on the 10, that may persuade us to put a little bit more to work. Now, remember, we're getting paid for all the increases on the short run, short rate with the money at the Fed. So we're getting... paid a little bit more there. Thank you.

Your next question is from the line of Vivek Junaidja with JP Morgan.

Good morning, Vivek. Hi, David. Hi, John. So just a clarification on a couple of the last two questions. So you said if the tenure gets closer to 2%, you might put some to work. So do you have anything factored into your NII guidance for reinvestment of some of that liquidity or not?

No, we do not. That would be on top of what we're giving you.

Okay. And then on the expense question that was just asked, so are you assuming the incentive comp increase that you had in 21 is that stays at that level in your 22 guidance?

No, it's not forecasted to stay at that level. That was up, and the incentive count was up, I think, across the industry, and we don't forecast that it would remain at that level at this time.

Okay, and that's partly because you're assuming some of those revenues will not continue, like mortgage and capital markets?

Well, no. We've given you our revenue growth, but that's all baked into the budget, and so you don't get compensated at that level. level over par, if you hit your budget, you've got to have a much better year than that, which is what we and most of the industry players did this year. But you reset your expectations. Now you're back down to par. You've got to start all over again.

Does that make sense? Increasing targets, so that will have the impact of reducing incentives.

Right, right. Okay, makes sense. And the last one for both of you, loan growth. You know, you talked about very strong pipelines, which implies that you're expecting long growth to remain good. Are you seeing that? How are you seeing January? Has that continued to be strong? Because we obviously saw a bigger pickup later in fourth quarter, and is that continuing in these first couple, three weeks?

Yeah, pipelines are still good. Customers are optimistic. They are I think hopeful that we'll see trends continue. They're prepared to make investments. Investments are still constrained in some measure by some uncertainty and by shortage of labor in a lot of cases. But we do have, there are a lot of customers who are actively looking at investments and want to expand their balance sheets, invest in businesses. And the same is true of consumers who are spending and so we do expect to continue to see loan growth.

Great. Thank you.

Your final question is from the line of Jennifer Dimba with Truist Securities.

Good morning, Jennifer.

Good morning. Could you just talk about your interest now in more non-bank acquisitions and And where, if that's still the case, where your interest lies, where the strongest interest lies in terms of revenue diversification?

Yeah. So we do continue to have an interest in non-bank acquisitions. We'd like to, I think, continue to add to some of the consumer lending capabilities that we have acquired if those opportunities arise. Invest in capital markets. I think that Got a nice return on those investments and been able to leverage those new capabilities to expand relationships. We're interested in opportunities within wealth management. Always looking to acquire mortgage servicing rights if those are available and to potentially add to our mortgage business. So those would be a couple of areas where we would make investment.

Great. Thanks so much. Thank you. I will turn the call back over to John Turner for closing remarks.

Okay, well, thank you. We're awfully proud of 2021 and all that our associates have accomplished during some very challenging times, staying focused on our customers, on each other, investing in our communities. We think we are carrying a lot of momentum into 2022, very optimistic about the prospects of an emerging and good, strong economy, and And so I appreciate your interest and support. Thank you very much.

This concludes today's conference call. You may now disconnect.