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Regions Financial Corp. (NYSE:RF)

Q3 2010 Earnings Call

October 26, 2010 11:00 am ET

Executives

Grayson Hall - President & CEO

David Turner - CFO

Bill Wells - Chief Risk Officer

Barb Godin - Head, Consumer Credit

Analysts

Marty Mosby - Guggenheim Securities

Craig Siegenthaler - Credit Suisse

Betsy Graseck - Morgan Stanley

Matt O'Connor - Deutsche Bank

Casey Ambrecht - Millennium

Heather Wolf - UBS

Jefferson Harralson - KBW

Scott Valentin - FBR Capital Markets

Operator

Appreciate your participation this morning. Our presenters today are our President, Chief Executive Officer, Grayson Hall; our Chief Financial Officer, David Turner; and also here and available to answer questions is Bill Wells, our Chief Risk Officer.

Let me quickly touch on our presentation format. We've prepared a short slide presentation to accompany David's comments. It's available under the Investor Relations section of regions.com. For those of you in the investment community that dialed in by phone, once you are on the Investor Relations section of our website, just click on Live Phone Player, and the slides will automatically advance in sync with the audio of the presentation. A copy of the slides is available on our website.

With that said, I will direct your attention to the forward-looking statements slide that should be on the screen right now. And now I will turn it over to Grayson.

Grayson Hall

Good morning, and thank you for your time and participation in our conference call. Although we saw continued improvements in our core business performance this quarter, we have announced the third quarter loss of $0.17 per share due to still elevated credit expense with an economy that is demonstrating a slow paced recovery and actions that we have taken to accelerate the disposal of problem assets, and reduce our balance sheet risk going forward.

In addition to absorbing higher costs related to problem asset sales and loans transferred to held for sale, we also reported a loan loss provision essentially equal to the elevated level of loan charge-offs. Loan loss provision, OREO and held for sale cost in total were an estimated $0.41 per share after tax this quarter.

We executed disposition of $1 billion in problem loans, including 709 in distressed asset sales. We remain confident our business plans and our determination to execute these plans and returning Regions to sustainable profitability as powerfully and prudently as possible. Our actions are moving Region to Regions closer to the improvement needed to achieve a breakeven point. We are encouraged by this course of business progress that result in steps towards achieving that goal. Our credit teams are diligently working to resolve credit related issues. Majority of our associates have demonstrated a focus on profitably grow our revenue and constraining operating expenses in our core businesses.

In the third quarter net interest income rose 1% from second quarter driven as expected by continued reduction in overall cost of deposits and a favorable shift and mix. And while our fee based revenues declined 1% versus last quarter, the drop was primarily driven by the impact from regulation E on service charges. Notably, while the implication of Reg E did negatively impact the quarter that impact was less than we forecasted, and we continue to be encouraged by the efforts of our associates and our branches and our call centers to further mitigate the impact in this regulatory requirement as we assist customers in making the best decisions to accommodate their needs.

At the same time, operating expenses on being closely managed did unfortunately increase due to the impact of higher credit related expenses. We remain confident in the current progress we're making in spite of the slow paced economic recovery. Our strategies are working with discipline and are focused on customers, and we have developed strong accountability for execution and results.

The operating environment does continue to be a challenge. The economy is gradually recovering. But growth is forecasted to be unfavorably slow for the next few quarters with stubbornly high unemployment, a weak housing market and unusually low interest rates.

Today economic recovery within our markets has been uneven. Residential home values have now stabilized in many of our markets, especially the markets within the state of Florida where we could potentially experience another 10% or so decline relative to mid 2010 prices depending on the ability of the banks and the courts to process foreclosures effectively, and the amount of shadow inventory remaining in the system.

With that in mind, we are careful when making general statements. It may prove to be inaccurate due to the inconsistent valuation from market to market. But we are starting to see what appears to be stabilization in some of our market.

Fortunately, the Gulf oil spills impact on individuals and business customers has been far less economically negative than initially forecasted. It's still a difficult situation for these markets, but far less impacted than earlier feared.

Regions maximum loss potential is projected now to be $20 million or less, sharply less than our initial $100 million estimate. That being said, the long term economic environmental impacts remain a concern as the markets and businesses along the Gulf Coast recover very slowly.

Across all of our markets, I am convinced the economic conditions are improving. But the slow pace of recovery is weighing on borrowers capacity, and borrowers willingness to continue to fill credit obligations. And thus has decreased the implied potential benefit of guarantor support on many of our credits. As such we have become incrementally more cautious on our economic outlook, which was a driving factor in the increased gross migration loans moving to a non-performing status.

I think it's important, however to consider the composition of that migration. Of the $1.4 billion of third quarter gross non-performing additions approximately $390 million were disposed off during the quarter. Of the commercial loans remaining $933 million 62% or $575 million were current home payments.

Overall the percentage of non-performing commercial loans their internal payments has risen from 24% at the end of second quarter to 36% at the end of third quarter giving us more confidence in the ability to manage the potential loss content and the potential to restructure in some cases. It's also important to point out that our internally risk-rated problem loans declined on a linked quarter basis. Our early stage and late stage delinquencies have stabilized and our moderating.

The lingering effects of the slow pace of the economic recovery has not helped many of our borrowers, and we have acted cautiously and prudently reassessing and modifying risks ratings as appropriate. We are focused on being very careful and accurate in assessing the financial condition of our borrowers in taking prompt action as required and as appropriate.

Protracted economic challenges have also reaffirmed our stance for your card to disposing a problem asset, as well as our strategy to reduce exposure at a higher risk loan portfolios, especially investor real estate. Investor real estate declined $1.5 billion point to point ending balance in this quarter achieving $17.5 billion in investor commercial real state.

In terms of strategic growth, our customer focus remains a top priority as we strive to deepen existing relationships and acquire new customers. Our efforts continue to payoff in the third quarter as evidenced by further strengthening in new checking account sales. We remain on track open more than $1 million new business consumer checking accounts this year exceeding 2009's record level.

The addition of new relationships is fuelling revenue across multiple lines of business for Regions. For example, in third quarter we processed a $182 million debit card transactions, representing a 14% increase over the third quarter of last year.

With respect to deposit balances, in line with our overall balance sheet strategy overall deposit levels have declined. As many of you are aware we had a sizable amount higher-interest rate CDs mature in the third quarter, and forecasted some run-off as rates were reduced to market levels.

Given the reduction in higher cost deposits, Regions funding mix and costs continue to improve, declining another 9 basis points driving third quarters net interest income and net interest margin higher. We made it on track to reach our targeted 3% year end margin. Our liquidity remains solid, with a loan deposit ratio of 89%. While maintaining clear focus on reducing the overall cost deposits, we are successful in improving our market position.

According to the recently released data by the FDIC summary deposit analysis Regions deposit growth ranked first in our peer group and seventh among 25 largest US banks. Furthermore, we grew market share in 6 to 16 states in which we operate, and in 15 of our top 25 MSA's. Unfortunately, total average loans did decline in the third quarter, but importantly at a slower pace than previous quarters. And despite the continuing de-risking efforts in investor real estate portfolio generating good quality profitable loans remains a challenge, but we are starting to see some encouraging signs, including a 2% linked quarter in the period commercial industrial outstandings.

Within CNI the growth story really is about our middle market segment, which represents about half the outstandings. These balances grew 5% in the quarter, despite loan with stable land utilization. Most of this production was related to capital expenditures and re-financing of existing debt.

Small business lending is starting to get tractions well, but this is yet to materialize and to grow to net outstanding given the generally locked demand. Nevertheless small business lending is a significant opportunity for Regions as we are the number three small business lender in the country of the small business administration. On the whole we remain cautious but optimistic. Net production volumes will further strengthen in the first quarter due to increasingly solid new business pipelines.

On the consumer side, we continue to emphasize residential first mortgage lending, production was $2.3 billion for the quarter, a 31% increase over the last quarter. We continue to incrementally adjust our business model to mitigate the unfavorable revenue impact of new regulation. In fact we've already begun mitigation efforts and even eliminated free accounts for all customers except students and seniors and have arranged balance and transaction hurdles for a waiver of monthly service charges.

We are closely monitoring performance on a new structure and we will make further adjustments as necessary taking into account both customer value provided and related cost of delivery. In all instances we continue to focus on superior customer service which we believe sets us apart and which customer probably value. We continue to provide many free account services for customers but will incrementally adjust our pricing models over time to better rationalize the value proposition.

Please keep in mind that the actual impact of Regulation E changes are proving less negative than anticipated. Originally we'd expected implementation to reduce service charge revenues of $72 million here in the second half of this year. Based on third quarter results the second half impact is now expected to be in the range of $50 million to $60 million. This performance and the continued adoption of overdraft services indicate customers find value in these services.

In terms of interchange revenue, like the rest of the industry we're awaiting OREO rules for our regulators. So it's difficult to project final financial impact. We do have annual interchange fees of approximately $330 million. So any change in fee structure could be significant. But we are seeing a 14% increase in transaction activity year-over-year.

Although our offerings are still being finalized, we are not estimating it to have a significant impact on all regions. Our Tier 1 common ratio is currently at a solid 7.6% and based on our understanding of OREO rules it's above (inaudible) minimum 7% guidelines. Regions is also expected to meet [Bozell] 3 liquidity requirements in this current form. In any case we will ensure that Regions capital levels remain strong and OREO compliant as the formal implementation of Bozell 3 requirements are better known.

In summary, we are successful executing our plan to return Regions to sustainable profitability. We are aggressively reducing credit risk, growing our customer base, implementing productivity and efficiency initiatives and taking appropriate steps to ensure that we are positioned to fully capitalize on the profitable revenue growth opportunities. At the same time we've recognized that environmental economic and regulatory challenges persists creating head wins and caution on our part but I am convinced, that Regions has the right strategy and the right people and place to deliver on our commitment.

David will now discuss third quarter financial results.

David Turner

Thank you Grayson and good morning everyone. Let's begin with a summary of our third quarter results on Slide 1.

As Grayson mentioned, our third quarter loss amounted to $0.17 per diluted share. Pretax, pre-provision net revenue or PPNR amounted to $454 million down about 7% linked quarter due primarily to the impact of higher credit related cost and Regulation E. Compared to the same period a year ago, adjusted PPNR was up 11%.

Within PPNR, net interest income continued to grow increasing $12 million which grew which drove a 9 basis points improvement in the net interest margin. Non interest revenues dipped 1% linked quarter primarily driven by the impact of service charges from Regulation E which I will cover in just a minute. After this impact, non-interest revenues were higher primarily due to strong mortgage and fixed income brokerage revenues. Non-interest expenses increased $37 million or 3% second to third excluding second quarter's $200 million regulatory charge.

Total non-interest expenses were negatively impacted by the rise in credit related cost primarily due to the higher OREO and HealthSouth expenses related to the bulk sale of distressed assets. Regarding credit quality the level of non-performing assets excluding loan sale for sale was down $186 million this quarter to $3.8 billion. The provision for loan losses rose to $760 million from $651 million in the previous quarter and essentially equaled net charge offs. The increase in charge offs reflects about $233 million of charges associated with distressed asset sales and the transfer of loans held for sale.

Let's now take a deeper look at the quarterly results beginning with credit. Shown in slide 2 non-performing assets excluding loans held for sale were down 5% this quarter, but remain elevated. I will now reiterate what was said earlier, an increasing and substantial portion of the migration into non-performing loans was attributable to loans that are paying as agreed. The sluggish and persistent nature of the economy necessities that we remain cautious which internally risk rating our portfolio. Despite that cautious stands internally risk related problem loans did decline this quarter.

However factors like Florida Unemployment which has been greater than 10% since May 2009 and its now over 12% and pressured housing prices in parts of the state require that we not get ahead of ourselves and that we maintain a clear and objective view of the economic environment. To that end, we remain focused on de-risking our portfolio.

Our proactive disposition efforts remain a key element of our risk management strategy. This quarter we sold or transferred the held for sale, a total of $1 billion of troubled assets. This total reflects a broadened effort as it included approximately $350 million of distressed asset sales on a bulk basis. These assets which will predominantly land included both non-performing loans and OREO and resulted in $108 million of associated charge offs and $30 million in losses that are recorded in non-interest expense.

While the markdowns are greater than we have previously experienced, we believe that long term economics justify getting these assets off our books and behind us. Land is one of the most difficult assets to sell and we were pleased to be able to dispose off these assets as opportunities arose during the quarter. We don't want to be in the property management business and we'll make every reasonable effort to remove properties and risk from our books when it makes long-term economic since.

As you can see on Slide 4, net charge offs increased to $759 million or an annualized 3.52% of average loans and reflect our efforts this quarter to de-risk our balance sheet and dispose off problem assets which contributed $233 million in charge offs. Drilling down the main source of charge-offs continues to be our investor real estate portfolio. Our loan-loss provision essentially matched net charge-offs this quarter and was up $109 million linked quarter.

Our loan loss allowance to loans ratio increased six basis points, linked quarter to 3.77%. As we said at our Investor Day, we were mainly cautious about the economy when evaluating the loan portfolio and our allowance methodology reflects this stance.

Turning to the balance sheet, slide 5 breaks down this quarter's change in loans. Although investor real estates still accounts for a relatively high percentage of our loan portfolio we have reduced this exposure substantially through the credit crisis. In fact, total investor real estate loans have declined by $6.5 billion over the last two years and we continue to make solid progress in reducing this segment of our portfolio as shown by the current quarter reduction of $1.5 billion.

At the same time targeted efforts to grow segments of our portfolio are getting traction. Most notably commercial and industrial loan balances were 2% in the quarter, primarily through our energy and health care lending groups. Energy lending in Texas has been particularly strong. New client acquisition is driving this growth as line utilization have remained about 40% over the last several months.

Furthermore, we continue to invest in specialized lending groups including business capital, health care, transportation and franchise restaurant. Lastly, we are excited about the opportunity to leverage our small business expertise through our extensive branch network. Our plan to grow consumer loans is most multifaceted and includes increased emphasis on direct lending for leveraging the strength of our branch network. Also on the consumer side we are evaluating products targeted at the underserved customer segment, a large group with short term funding needs.

This next slide shows changes in our deposit basis quarter, ending time deposits declined $2.1 billion, reflecting expected run-off of balances as we reduced the maturing high cost CD rate to market levels. Low cost deposit growth was somewhat offsetting with ending balances increasing $854 million or 1% in the quarter.

Total deposit levels were also affected by our more disciplined approach to deposit pricing with some customers choosing to pay down the debt rather than hold deposits at current rates. Although customers are deleveraging and paying down their loans our new checking account growth has helped offset this down refresher on deposit balances.

Net interest income on a fully taxable equivalent basis rose $13 million linked quarter, while the margin strengthened 9 basis points increasing to 2.96%. Improvements stemmed primarily from continued optimization of deposit cost and mix. For the quarter, deposit cost declined another 9 basis points to 0.7% in the third quarter, and loan yields remained stable at 4.29%.

We expect to see continued improvement in deposit cost and expect to reach a 3% margin in the fourth quarter, as originally projected. In fact, we expected to reach our target of 3% this quarter. But the recent decline in long term interest rates accelerated mortgage refinance activity, and premium amortization within the investment portfolio which had an adverse impact on net interest margin of around 4 basis points.

Driving further margin improvement, we have approximately $11.4 billion subsidies maturing over the next nine months which will be repriced to market rates as they mature. These CDs currently carry an average 2.1% interest rate, and should enable us to reduce our overall deposit costs. In addition, the drag to net interest margin associated with interest reversals in carrying excess cash deferred will fade with time. These items were margin headwinds of 16 and 8 basis points, respectively on an annualized basis in the third quarter.

As an update, we have recently adjusted the hedges in places to support the margin in a prolonged low rate environment. These now reduce our interest rate sensitivity through December 2012. Our emphasis on improving deposit mix and cost combined with the projected impact of these hedges is expected to result in modest margin improvement going forward in our most likely rate forecast scenario.

Let's now shift gears and look at non-interest revenue and expenses this quarter. Non-interest revenues were down by about 1% linked-quarter, driven by approximate $16 million impact of Regulation E. Except this impact, non-interest revenues were higher reflecting strong mortgage revenue driven by heavy refinancing activity. In fact, we originated $2.4 billion of loans this quarter versus $1.8 billion last quarter, and refinance activity was much higher representing 67% of current quarter originations up from second quarter's 41%. Also contributing to non-interest revenues, Morgan Keegan's brokerage revenues were up 6% versus the prior quarter, reflecting continued private client and fixed income strength. Fixed income revenue was especially strong, increasing 13% linked quarter driven by higher by customer purchasing short term securities.

In terms of non-interest expense, while credit related costs continue to remain high, we continue to focus on containing other overall cost. Excluding prior quarter's regulatory charge, total non-interest expense was up $37 million or 3% linked quarter, due to a $31 million linked quarter rise in OREO and held for sale cost. As I mentioned earlier, the rise in these costs reflects approximately $30 million resulting from a bulk sale of OREO during the quarter.

In all of PPNR continues to be impact by credit related cost, which on a normalized basis are impacting us by $75 million to $100 million per quarter. We recognize in this economy to be successful we have to be diligent in our efforts to manage expenses. It's going to be a low growth, low rate environment for an extended period of time, and we have to continue to target all areas of staffing, occupancy, discretionary expending and credit related expenses. Rest assured that any changes we implement, will at the same time maintain focus on the service quality and making sure that we are serving the needs of our customers.

Let me now discuss our capital and liquidity. We continue to execute our disciplined capital planning process that we developed over the past year so, which encompasses various scenario analysis, including stress testing under a range of adverse conditions. It begins with the development of macro economic forecast scenarios, which serve as a basis for our credit modeling. Our capital ratios remain strong with a Tier 1 capital ratio that now stands at 12.1%, and a Tier 1 common ratio at a very solid 7.6%. As we stated last quarter, cards amendment will have little impact to our risk based ratios, since trust preferred securities at about $846 million are a fairly small part of our overall capital base.

Let me briefly touch on Basel III, which will be phased in over the next several years beginning in 2013. We continue to assess the impact and are awaiting the details, but we feel very good about our capital base as our Tier 1 common and Tier 1 risk based capital ratios are above the respective 7% and 8.5% minimums required under Basel III. The proposed adjustments are expected to have a minimal impact on us. Similarly, Regions is well positioned with respect to the liquidity coverage ratio described under Basel III. In fact, we have been internally managing to similar measure for some time.

Moving to the broader impact of recent regulatory reform, there is no doubt that recent sweeping legislative actions will ripple through bank's operations and financial statements from this quarter forward. But we are well positioned to effectively manage any potential impact in terms of Regulation E with the August 12 full implementation date behind us, we now have good visibility and foreseeable financial ramifications.

As Grayson noted earlier, the negative impact is proving less than our original forecast. To-date, roughly half of all of our customers who have overdrawn their account in the past year have chosen to opt in or link their account for overdraft protection. And 97% of customers who have made an election after experiencing a declined transaction are choosing to opt in or participate in overdraft protection. Clearly, customers are seeing value and services that ensure their ability to make purchases.

The Durbin amendment which effects debit card interchange fees will likely result in a revenue reduction as well. But keep in mind, that final rules have not been established. They will be determined by the federal reserve as we head into next year, and we will make adjustments to our products and services as appropriate.

Lastly, unlike many of the larger money center banks or brokerage houses, regulatory reform will only minimally impact our brokerage revenues since Morgan Keegan is not engaged in proprietary trading as little to no private equity exposure and faces very minor impact to its derivatives business. Bottom-line, while regulatory changes are certainly challenging from a revenue perspective, I'm confident that we will be able to make adjustments to minimize any long term financial effect on Regions.

In summary, although we are not pleased with the loss this quarter, our associates remain focused on executing both our short term and long term goals. We continue to remain focused on returning the company to sustainable profitability as promptly as possible and with this quarter's further de-risking efforts we are building a stronger company with an emphasis on improving our risk profile we will have ultimately tested our shareholders. With that I'll turn it back over to Grayson for closing comments.

Grayson Hall

Thank you David and before we move to question, I'd like to give you Regions' position and topic. It has received a tremendous amount of publicity of late, residential foreclosures. Regions have a solid and tested foreclosure process in place to ensure the fairness for customers and compliance with state and federal regulations.

In cases where all options to avoid foreclosures had been exhausted the committee of key managers approves the decision to perceive before closure after a thorough dealing of loan documentation. Once the decision has been made to proceed the process is the same where the loan is owned by Regions or by an investor that we service the mortgage for.

In each case, department managers review and verify the accuracies of loan documents and states where mortgage foreclosure affidavit or some other legal documentation is required. The document is completed and signed by the department manager in the presence of a notary employed by Regions. Due to our foreclosure prevention efforts and a relatively small sized Regions' servicing portfolio, our foreclosure volumes have remained relatively low.

Regions foreclosures on approximately 100 loans that we own each month and 160 investor loans each month. Staffing levels are sufficient to internally verify loan information and appropriately execute required documentation. Regions has a residential mortgage servicing portfolio of $41.2 billion. Of that $16.3 billion are loans that we own while $24.9 billion are loans owned by government agencies or investors such as Fannie Mae and Freddie Mac. Our foreclosure rate for the entire portfolio both owned and investor is less than half the national average.

Our ability to maintain lower foreclosure rates is the result of proactive efforts to provide solutions to distressed customers. In late 2007 Regions began reaching out to customers at the risk of falling behind in payments through our customer systems program. This program is available to customers whose loans we own and service. To date, we have helped more then 30,000 customer stay in their home. We have received all available options to help homeowners avoid the foreclosure including loan modifications, rate reductions, short sales and Deed-in-Lieu of Foreclosure.

Foreclosure is the option of the last resort when forward foreclosure does take place, evictions are rare as many homes are second homes investment properties are no longer occupied. Our focus on the customer has resulted in the Regions second consecutive year ranking in the top five of J.D. Power and Associates customer satisfaction survey from a (inaudible) of mortgage services. That being said we have directed our leadership and the business in internal audit and in risks management to review and validate each process step to ensure full compliance with all laws and regulations and customer needs.

Operator that concludes our remarks and now we will open it up for questions.

Question-and-Answer Session

Operator

Certainly. (Operator Instructions). Your first question comes from the line of Marty Mosby with Guggenheim Securities.

Marty Mosby - Guggenheim Securities

I had a question on inflows. We had to schedule in there in the past that we are kind of showing as what that migration was. I estimate that it's still above a $1 billion per quarter so I wanted to kind of get a feel for maybe what that number might have been this quarter and then also you are talking about the inflows being more related to paying as agreed. So what triggered moving more of those into non-performers this quarter.

Grayson Hall

Marty, good morning, just a couple of comments, then I will ask Bill Wells, Chief Risk Officer to make some additional comments. Number one is that we do see some of our credit trends clearly moderating. Our early stage and late stage delinquencies appear to have stabilized and declining slightly. We do see internal risk created loans improving as you saw in our numbers.

However the migration to non-performing status clearly stands out this quarter. It was significantly up from last quarter and as we mentioned last quarter we were very cautious. One quarter does not make a trend and as we look to loan portfolio the cause and economic recovery, it really focused around commercial real estate and in particular the guarantor.

If you look at it, as the economy continues to have a slow recovery, the capacity and willingness of these guarantors comes into question. And as we look at what's migrated into the non-performing status this quarter as you saw the amount we disposed off a significant amount of that migration but we also retained quite a bit and of what we retained 64% is still paying as agreed. But there are good question even though they are paying they are questions raised regarding the capacity or the willingness of those guarantors to continue. With that I will ask Bill to make a few comments.

With that I'll ask Bill to make a few comments.

Bill Wells

Yes, Marty. The first thing we talked about last quarter about being very cautious about where we were with the economy the slow growth economy and all we saw on our migration really is a reflection of what we've seen in the economy. Also, as we looked at our valuations, that has caused us to be very conservative in how we've looked at our non-accrual calls and that's what with the up tick in looking at our growth inflows.

As Grayson mentioned, the one thing to talk about while we are disappointed in the inflow, increase in inflow and migration, what we did note is that a high percentage of ours, over 60% of the non-performing loans that we had remaining at the end of the quarter were currently paying. But what the difference is as Grayson mentioned there were some questions about the guarantors' willingness or capacity to pay. So we thought it was very (inaudible) on a non-accrual.

Having said that, we do think the loan severity is less than what we have seen before in earlier migrations and also gives us the ability to do more restructures which in the past we have not done a lot of restructuring. The other thing that Grayson mentioned is that as we see the gross migration coming in, we are continuing our efforts to aggressively de-risk the balance sheet. We've seen that not only in the reduction and investor real estate of 1.5 billion over the quarter but also our ability to dispose off problem assets in our sales program which continues to work very well for us.

Marty Mosby - Guggenheim Securities

And I guess a follow-up to that would be if you are looking at the pricing and you said that deteriorated this quarter, was that related to what you were selling. In essence was it more distressed or more land oriented or was that really just contraction and you think in the market in the sense over the willingness of investors.

Bill Wells

The one thing Marty what we did is a couple of quarters ago we were approached by two or three companies to look at some efforts of disposing of our problem asset and we did a bulk land sale at this time. It was well up to almost 4000 properties. These were small loans located primarily land located throughout our footprint and so in our pricing that we saw, we saw a little bit more discount than what we have been seeing in the past. That bulk sale discount was about 40% of the book balance that we had. The other thing that I would say is that on our additional sales we were probably averaging in the low 20s. So an average for us when you face the bulk sale and what we did on the node sale was the discount rate on our dispositions of about 31% as opposed to what we did last quarter of 24%.

Grayson Hall

And Marty we've remained cautious in regards to bulk sale. It's really the first material bulk sale we've participated in. Clearly, when we moved as Bill said close to 4000 properties, out of our portfolio, the economics of bulk sales are very challenging and we were pleased to be able to execute this transaction internally. We still are not particularly encouraged by the economics of bulk sales but we still believe the best way to do these, our strategic sales but as we looked at these particular properties and how long we estimated that we'd have to carry them to sell them the strategic bars, we believe this was the right decision to accelerate the de-risking of our portfolio.

Marty Mosby - Guggenheim Securities

Well, I guess what we were talking about is the composition of the bulk sale drove some of the pricing being lower, and then also did you have any other process where you looked at the guarantors or was there something in the sense of review process that triggered you to say I need to go look at those and then expedite moving some of those more in the non-performer. And I will let the questions move on. Thank you so much.

Grayson Hall

Marty as we were entering into the third quarter, clearly there was a pause in the economic recovery in the country and we have taken a much more disciplined, much more conservative approach to looking at guarantor support. And we have challenged ourselves on guarantor support to determine as Bill said, the capacity of our guarantor is, has it held up through this economic cycle, where did they stand purely from a capacity prospective? But also as you continue to see valuations of these properties decline, how much decline and willingness of these guarantors did we see?

And so we have taken a very rigorous and disciplined approach to look at guarantor support, and that's why you are seeing many of these, they are paying as agreed moving to a non-performing status.

Operator

Your next question comes from the line of Craig Siegenthaler with Credit Suisse.

Craig Siegenthaler - Credit Suisse

Relative to the billion dollars of loans sold or transferred the held for sale this quarter, how is disposition trending in October? And do you think how should this trend in November, December here?

David Turner

Well right now we have about $40 million to $50 million under contract, it's trending again very, very good. But the marks are holding back to what we saw pretty much in the second quarter, when you take out the bulk sales.

So again there is a lot of interest in properties. We continue to move it. We try to strike our best deal possible. And as Grayson said, we have seen our best result, is when we find a strategic buyer for these properties.

Grayson Hall

Was your question specific to loan sales?

Craig Siegenthaler - Credit Suisse

It was actually on both, there was transfer to held for sale, plus the loan disposition. The aggregate activity level we saw in the third quarter, should we expect that level to remain flat, move higher move down in the fourth quarter?

Grayson Hall

Craig I think that we have sort of stayed the course with our strategy of acceleration of disposition of stressed assets, and we would anticipate continuing that strategy till we see a clear turn in the credit metrics.

David Turner

And also to Craig what I'd say is you would see us continue to use the held for sale. And then as you look at our marks that once it moves and the held for sale have been pretty consistent overtime, and hold to when we actually move it into held for sale and marks have held true.

Craig Siegenthaler - Credit Suisse

And then just a follow-up on the net interest margin, what is the dollar value of CDs maturing in the fourth quarter? And do you know roughly what the average cost is?

David Turner

We have about $4 billion that our CDs that are maturing in the fourth quarter. The cost of that was just over 2%.

Craig Siegenthaler - Credit Suisse

About 21?

Grayson Hall

Yes, the more meaningful maturities come in the first quarter of next year where we do have some CDs maturing in the first quarter that are over in access of 4% cost of funds.

Craig Siegenthaler - Credit Suisse

And is that a big number, it's a couple of billion dollars?

Grayson Hall

It's roughly $4 billion.

Operator

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

Betsy Graseck - Morgan Stanley

I had a follow-up on MPA question, and then a separate line of questions on just loan growth. When we look at the additions of 1.4 in the quarter, should I read that as a little bit of a one timer for this reassessment of how you are treating guarantor credit loans?

Grayson Hall

Betsy, I think the way to look at it, last quarter we saw the migration in last quarter, we expressed that we saw moderation in our credit trends, but we were cautious because we are seeing a little bit of volatility, if you will in migration quarter-to-quarter. And as we progressed into the third quarter we're disappointed with the amount of migration that occurred, but nevertheless that's where the economics of our customer base took us in that review.

As I've said earlier, we see encouragement in some of the trends in terms of early stage and late stage delinquencies. We didn't see any surprises on the consumer side. Consumer side while still elevated continues to modestly improve a little, but really tracks very closely to our forecast. The disappointment this quarter was all around investor commercial real estate that continues to be the problem segment in our portfolio. We do believe that the aggressive stands that we took on guarantor support is reflected in these numbers, but in terms of trying to give guidance on where this goes in the fourth quarter I'm reluctant to do that.

Betsy Graseck - Morgan Stanley

I can understand, I guess I am just wondering of the 1.4 that was addition in 3Q can you give us a dollar amount that was associated with the guarantor credit portfolio?

Bill Wells

I would say that probably the majority when we say that 60% of what was non-performing loans that were current I think you would say that a good percentage of what we saw is dealing with that guarantor support. The other thing I had also mentioned too, Grayson mentioned early stage delinquencies were at about 2.09% that's relatively flat quarter-over-quarter.

You look at our 90 plus stage they are actually down in business services. And the one thing that David had also mentioned earlier, while we don't disclose the actual number, we have seen a second quarter decline of our internally risk-rated of credits which shows a another positive trend when we talk about what we think will happen for the future.

Betsy Graseck - Morgan Stanley

And then you mentioned that you retriggered the hedges a little bit, were still expecting to get to near about 3% at year end, and then is it modest improvement from there? Could you maybe describe what you did to retrigger the hedges and what you mean by modest improvement?

David Turner

Yes, we do feel good Betsy about getting to our net interest margin goal of 3%. Like I said earlier we were hopeful to get to it in this past quarter, didn't get there for the prepayments I had mentioned on the mortgage-backed security portfolio. The ultimate net interest margin is going to be driven by the rate environment, which is driven by the economy.

We have positioned the balance sheet in the hedging strategy to protect us on the low side from a protracted low rate environment for 2012. If on the other hand rates continue to go up the economy rebounds, then we will still participate in that rebound just not as much as we otherwise without the hedges. And we think that, that means everything is getting that much better.

So we are willing to take that risk to protect ourselves on the low side. And I would expect that you would see like I said modest improvement in the net interest margin. But it's all driven by what rates there.

Betsy Graseck - Morgan Stanley

And the modest improvement is not from 3Q, but it is from your 3% expected?

David Turner

That is correct.

Betsy Graseck - Morgan Stanley

And then on loan growth, I went to a couple of areas of loan growth, could you just give us some color to on the CNI side while you're getting that growth you mentioned new customers is it, and how are you extracting them from competitors? And then maybe if you could just talk a little bit about the resi-mortgage and that was up 1%, is that a change in demand or is that a change in migration you shifting investments from securities into loans?

David Turner

In terms of loan demand we have been encouraged by areas within our CNI portfolio or middle market. We are able to fully leverage our strength there. And specific industries I have mentioned energy in Texas has really been a spot for us to generate loan growth. We think that will continue. We have continued to invest in specially teamed in energy specifically out of Houston, and we expect that to continue for us for some time.

We do have other specialized industries that we will be investing in, and Regions business capital. We also have investments in healthcare. We think it's particularly strong for us. So areas of those industries where we see capital expenditures and continued expansion in those businesses really was driving our loan growth and our investment in the areas of the country that are driving that.

As it relates to the Resi mortgage growth obviously a lot of refinance activity going on across the country for the rate environment that we have, we have continued to, we put the product on our books. We continually evaluate what we want to put on our books from a rate standpoint, duration standpoint. So I think we have opportunities to grow that but we will be evaluating and have evaluated is whether or not we want to put a given rate or duration on that's available to us.

Grayson Hall

An interesting fact Ed to that when you look at the growth in our commercial and industrial segment it really is the middle market segment and those customers have really won and lost one at a time. And our efforts around making sure our bankers are calling frequently and calling prospects because if you look at our commercial line utilization it's approximately 40% this time, roughly 39% last quarter. It hasn't moved much and it sort of bounced around that 39% to 40% for several quarters in a row.

If you look at our pipelines, as we mentioned in last quarter's conference call, we started to see some strength in July. That strength, we were a little cautious, it might not hold up in terms of new business. It's continued to hold up through the quarter and the sales pipelines that we're looking at today are strong but it really, there's nothing really special that we're doing from a growth standpoint. It's just executing our plans of calling on customers. It's a very competitive market, obviously, the industry is struggling with loan credit and so it's very competitive and we're trying to win these customers, one at a time each and every day.

David Turner

Let me give you a little more color on you asked the margin questions, so did Craig earlier. As we continue to reflect on where we think we can go for 3%, it's more specifics on our maturing CD's. In the fourth quarter we do have the $4 billion maturing, the average rate there is 1.37% and then in the first quarter its $4.6 billion of CD's maturing with a rate of 2.36%. So you could think about that in terms of where we might go with our continued improvement in large and net interest income and margin expansion.

Grayson Hall

So I mean, because I do think that we will continue to see some improvement on our deposit cost. We believe that's going to occur but the patient improvement coming from deposit cost will obviously slow and the material improvement on our margin going forward has to be in loan pricing discipline.

Betsy Graseck - Morgan Stanley

Okay. And the pace of (improvement) CD's slows post 1Q.

David Turner

It carries a little bit into the second quarter but the strongest is in the first quarter where we have some CD's at 4.55%.

Betsy Graseck - Morgan Stanley

Sure. But the average is 2 to 3 short.

David Turner

That's right.

Operator

Thank you. Your next question comes from a line of Matt O'Connor with Deutsche Bank.

Matt O'Connor - Deutsche Bank

Maybe I'm just missing something here but I'm trying to understand the Reg E impact that you had this quarter which hit was $60 million drag and how you get from that to the 50 to 60 for the back half of the year. I guess I thought I would just take double that 60 million.

David Turner

I think if you just did a straight line, you have 16 for the quarter, we just had, which was essentially a month and a half. So if you double that in your 32, straight lines, so 32 and the 16 is 48. That's your 50 million. And there's a little question in caution's caution. Caution in there with respect to what might happen, that's where the number comes from.

Matt O'Connor - Deutsche Bank

Okay. And then just something on your deferred tax assets, it looks like the amount that was excluded from Reg capital came down a little bit this quarter. And I was just wondering if you could give us one, the overall deferred tax asset amount and then just how we should think about how much is included versus excluded going forward in the inventory capital.

David Turner

Today our deferred tax assets is a little over $1 billion. We exclude just over $400 million from our capital calculation and that's based on regulatory rules. We look at and forecast our income as defined by the regulators and that 400 didn't change dramatically from quarter to quarter, do we continue at it every quarter and it's dependent on our return to sustainable profitability. So I guess the way I would look at it is as we see the economy turn, the credit turns and our return to sustainable profitability will be the triggering point where we can count that little over $400 million with just 40 some odd basis points in Tier 1 common and so we continue to look at that every quarter.

Matt O'Connor - Deutsche Bank

Lastly if we look at the securities portfolio, I think you have one of the higher quality books out there and that might be driving some of the increase in prepayments which is obviously happening industry wide but if you could give us a sense of what the prepayments have been doing there and I guess what the strategy is on the securities book going forward, do you plan to reinvest or let something run off like you this quarter and use us (inaudible).

David Turner

Yeah, we had mentioned in the conference about pre-payment really coming through the government short revive program versus this which is kind of market driven with a low rate environment. Given, we do have substantial gains in our investment portfolio, a little over $600 million at the end of the quarter, that's up even today, we measured today, which poses risk to us to the extent pre-payments occur. We are going to evaluate what that risk is and whether it makes sense to continue along with our strategy which has been a fairly clean investment portfolio virtually all of it in agency guaranteed and we did that as we de-risked our balance sheet at CMBS, taking credit risk and our investment portfolio.

We had on the loan side and we did think that was prudent for us to do. We are looking at ways to re-invest proceeds coming off the investment portfolio as well as whether it makes sense to take any gains and reposition into other asset classes, whether it would be back into some of newer (inaudible) CMBS or corporate or whatever the case maybe and we will reevaluate that during the quarter. What we have been seeing from a cash flow perspective of the investment portfolio, it's been about $500 million per month to re-invest. As a result of prepayments that number's been up about $300 million on top of that. So we have about $800 million right now to deal with from a reinvestment standpoint and we will consider that in our overall balance sheet strategy going forward through this fourth quarter.

Operator

Thank you. Your next question comes from line of Casey Ambrecht with Millennium.

Casey Ambrecht - Millennium

One thing we are looking at, we are trying to figure out if Regions has enough capital? Right now if your tangible common equity of 6.13% or 7.8 billion seemed light considering you have criticized assets around 6.2 billion, can you comment on that?

David Turner

Your percentages that you came up with Tier 1 comment or we have about.

Casey Ambrecht - Millennium

No, I'm just looking at your tangible equity. The tangible equity of 7.8 billion and you have about 6.2 billion of criticized assets.

David Turner

We've continued to honestly look at our capital levels. We feel like we are in good position from that standpoint. We do have, as I mentioned earlier, over $600 million for the gains sitting in our portfolio. We have in order to really get our capital generation goal, we've realized we have to return the sustainable profitability there, which is dependent on our turn, in our credit metrics.

Casey Ambrecht - Millennium

But it sounds like from the call that the provision should be elevated for a lot more quarters to come.

David Turner

We've continued to evaluate the level of our reserves that we need to have. Our charge offs will remain elevated as we discussed. Our provisioning will be dependent on what we see credit metrics doing from a migration to non-performing status. And as we see that while our charge offs may remain high, the question is when are you able, when is it prudent to do, to provide less than your charge offs and that's what we have to watch each and every day for that turn.

Casey Ambrecht - Millennium

Maybe I can ask you one other way then. What happens if housing were to rollover 10% from here or 15%? How much cushion do you have to protect yourselves for housing double debts?

David Turner

We have a robust capital planning process that we go through, including multiple scenarios, adverse scenarios. We have about, actually five scenarios that we run from an adverse standpoint, which includes GET and housing prices and unemployment. And we have gone through those scenarios and believe we will be adequately capitalized through those scenarios.

We continue to update that each and every month as the group meets, and we think from that prospective that we have enough capital. If you go through another double debt I will see if it strains on capital, no question about that. But we think based on our forecasting that we should be in okay shape from that standpoint.

Casey Ambrecht - Millennium

And then one last question, if you had to look forward a year, I know a lot of things are dependent on housing and the markets, but if you had to look forward a year and considering you had $6.2 billion in criticized assets, a lot of which already related. How much do you think your book size is going to be down in a year? Last year at this time it's $7.40 now it's $6.22. So you are down 16% a year, where do you think you will be in a year from now?

David Turner

We haven't given guidance with respect to what we think our book value will be or our earnings for the next year. I think there is no question that the determinant of where we will be with regards to tour book value is going to based on the economy and the turn in our credit metrics. And that is the key driver. And if you can tell me when the economy is going to settle down and improve, I can give you better perspective on that. But that is really what it is going to be driven off of.

Operator

Thank you your next question comes from line of Heather Wolf with UBS.

Heather Wolf - UBS

A couple of quick questions, on the billion dollars of troubled assets sold or transferred and the $4 billion of inflows, can you give us a sense for how much of that is related to resi-real estate, and how much of it is related to commercial real estate?

David Turner

Yes, Heather I would say that the majority of what you saw in our dispositions was really dealt with on the commercial side. We did do that bulk transaction that has to do on our sales of, I believe it was $350 million that had part of it coming out of the loan sale and OREO, but the majority of what you saw coming through was from the commercial side.

Heather Wolf - UBS

I think I had this problem last quarter, let me clarify again. I understand it is all coming from the commercial side of it, but is it land and property for you in resi, or four years on commercial real estate, such as retail, lodging, hotel et cetera?

David Turner

It is predominantly coming through on the land side. If you look resi land. If you look at page 24, of our earnings supplement that gives a little bit of a break down. And I would say when you look at land condo and single family, the majority of the green part is coming out of the resi side.

Heather Wolf - UBS

Can you give us a sense for all of your NPA, OREO and NPL, where do you have that resi land marked currently?

David Turner

I am trying to go through and think of our numbers of how I will have to get lift and get back to you on that and make sure we have the right number. Because we're gone through and marked down over a period of time and then did a recent markdown we move the held for sale.

Grayson Hall

And every time we revaluate evaluations, and so we will have to calculate that. It's a good question.

David Turner

Let me give you some broad strokes, and this may not be what you are looking for, but obviously if we have that in OREO or held for sale, that's been marked to market. So we have that covered to whatever the current market price is. Now if you are asking what's the percentage of book we'll have to get back to you on that.

Also we do have those mortgages and non-performing loans too, and I don't have the reserve coverage on those. Is that what you want to know about?

Heather Wolf - UBS

Yes, I am trying to figure out, how much more in the way of marks we can expect on the existing NPL book?

Grayson Hall

I mean it's a good question. We can certainly spend some time.

David Turner

We will get back to the list, and then contact you.

Heather Wolf - UBS

And then, one last question on your consumer leverage structured but not included in NPAs. Can you give us a sense for the types of redefaults you are seeing currently versus what they may have looked like previously?

Grayson Hall

Heather I've got Barb Godin here with us, and I'll ask Barb to sort of answer that question, please.

Barb Godin

Yes, we are continuing to see (inaudible) rate give or take around 20% on that book. And that's sold a pretty confident for us over the last six or seven quarters.

Operator

Your next question comes from the line of Jefferson Harralson with KBW.

Jefferson Harralson - KBW

Thought you guys could help with put back risk and the amount of loans that you have originated, I was thinking specifically about EcoFirst, I know it's been a long time ago you sold it, but do you hold like a warranty risk on EcoFirst?

Barb Godin

No, we don't have any.

Grayson Hall

We do not.

Jefferson Harralson - KBW

And can you talk by the put back that you've received so far, and what you expect over the next two quarters?

David Turner

In terms of our put back they've been fairly consistent and not all that large, we're probably in the $3 million to $5 million range per quarter. We think we have our reserve covered about almost two years of our exposure based on our experience with our reserve of around little over $30 million. So our put backs repurchased reserve issue that you've seen in other places just have not been an issue for us.

Grayson Hall

And Jefferson we have predominantly sold to the agencies, and so almost all our put backs coming from the agencies. They come in two forms. They come in and make hold transactions which is where the agency has disposed of that property at a loss, and they're expecting to make them whole on that loss.

They also come back in mortgages that they're asking us to put back on our balance sheet. As David said, we're incurring a loss on the combined of those two in the $3 million to $5 million a quarter. That's a little bit up from last year, but not materially.

And we look at a $40 billion loan portfolio that we're servicing it's just not material to our numbers, and that we don't anticipate it in the coming material. I would tell you on the loans that they are putting back to us. We are challenging or appealing some numbers of those. We are probably the ones we feel. We probably win half of those but I would tell you successfully they are putting back about 80% of what they desire to put back and so but overall I mean if you look at our numbers, the size of our portfolio, just not a material issue for Regions.

Jefferson Harralson - KBW

And lastly on the GAAP DTA, what type of scenario would it take for the GAAP DTA to have to be written down. Do you need to be profitable you think by second or third quarter next year or do you, I guess if you are not profitable by I don't know third quarter next year would you expect GAAP DTA write-downs.

David Turner

The threshold is more likely than not. If you would realize the benefits of that deferred tax asset and so we evaluate that. The vast majority of our DTA is due to our allowance for loan losses and the timing differences related to that, for booking tax. We don't have a lot of net operating loss carry forwards that are about to expire which would put more risk that you would have to have evaluation allowance for GAAP purposes.

So we've obviously trended out cash flows and profitability over an extended period of time in support of the DTA and from a GAAP standpoint we don't foresee at least at this juncture any valuation allowance, anything in addition to what we already have. I think we had some valuation allowance for some state net operating loss carry forwards that are fairly minor but we do not anticipate having that valuation allowance for GAAP purposes.

Operator

Thank you. Your final question comes from the line of Scott Valentin with FBR Capital Markets.

Scott Valentin - FBR Capital Markets

You mentioned Florida is still being an area of concern, just wondering with the foreclosure issues starting to creep up, what that would do to foreclosure timelines and potentially OREO expense going forward.

Grayson Hall

Scott, we continue to see from market to market. There are markets in Florida stabilizing but there are many who still are showing the clients and we are predicting further clients in the next year. Right now on average in Florida our foreclosure process, we are taking about 23 months. We are trying to work hard with those customers but obviously our foreclosure rate in the State of Florida is high. Its about at the national average for all the US but Florida as you know is probably three or four times the national average of Florida and so we are disappointed that we got foreclosures period but encouraged it for forward closure rate compared so favorably but we would anticipate that there's going to be a lot of attention on this issue, its too early to call.

There is a certain amount of media attention and there will be a certain amount of regulatory intensity around this foreclosure issue. I think in today's call its way too early for us to predict what some of the implications to foreclosures will be going forward. I can tell you we feel good about our process but we are going back and revalidating and retesting to make sure that everything is working as it should be but I think it's going to take a few weeks for this issue to fold out across the industry and as it does, we will react appropriately but I think we are in a good position today.

Scott Valentin - FBR Capital Markets

And just in terms of kind of duration of the foreclosure process, do you test for impairments initially, you booked the asset I guess and do a fair market, mark-to-market on the asset and do you test later maybe 12 months or some period later for impairment?

Barb Godin

Yes we do.

Grayson Hall

Yeah, Barb, can you speak there just a second.

Barb Godin

Yes, we absolutely do and I guess its way back to increase (inaudible) the gross profit. I should just give you some metrics on our quarter foreclosure rate. We are at 434 compared to an industry of 14% and even during this entire timeframe with the foreclosure issue, factoring in the media, we have not stopped our foreclosure process again. We work very diligently with our customers, up to the point of foreclosure and even up to the point of being sold on the courthouse steps so that we get every opportunity to avoid foreclosure where possible. But again the second part of your question is yes we could touch on impairment.

David Turner

Let me add to that. We go through a process and get updated with appraisals periodically but we have, you know, its incumbent upon us to make sure we are taking markdowns on our OREO at least quarterly for the accounting rules. So even if we don't have an appraisal, doesn't mean we don't at least consider what we are seeing with sales activities, what's going on in the marketplace. We would leverage that information to think whatever much we think we need to on a quarterly basis.

Scott Valentin - FBR Capital Markets

On a different note, on the guarantor issue, it sounded like you reviewed loans for guarantor financial ability to carry loan, was that an entire loan portfolio, or you are just doing a segment of the portfolio and is there much more to review there.

Bill Wells

What we do Scott is, as we go through our risk rating scale, we go through and look at guarantor support on an ongoing basis. These are some of our credits that we had identified and we went through those specifically to identify where the guarantor issues were. Usually these are in some of your troubled assets when the question came up about valuation and that in part came about the question about looking at guarantors. But we look at our whole portfolio on an ongoing basis to look about where we are as far as the guarantor's willingness and capacity to repay.

Grayson Hall

But Scott let me be clear, the valuation is a big part of this issue. It's not just revaluating guarantor support, its revaluating guarantor support and a lot of valuation change.

Scott Valentin - FBR Capital Markets

Okay and because you mentioned before its ongoing I guess it's direct all time.

Grayson Hall

That's correct.

Operator

Thank you. I will now turn the call back over to Mr. Hall for closing remarks.

Grayson Hall

Well, thank you everyone for your questions. We appreciate your time this morning and we will stand adjourned. Thank you.

Operator

Thank you ladies and gentlemen. This concludes today's conference call. You may now disconnect.

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