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SunTrust Banks (NYSE:STI)

Q2 2011 Earnings Call

July 22, 2011 8:00 am ET

Executives

Thomas Freeman - Chief Risk Officer and Corporate Executive Vice President

Aleem Gillani - Chief Financial Officer and Treasurer

Kristopher Dickson -

Mark Chancy - Corporate Executive Vice President and Wholesale Banking Executive

William Rogers - Chief Executive Officer, President and Director

Analysts

Todd Hagerman - Sterne Agee & Leach Inc.

Matthew Burnell - Wells Fargo Securities, LLC

Kevin Fitzsimmons - Sandler O'Neill + Partners, L.P.

Brian Foran - Nomura Securities Co. Ltd.

Betsy Graseck - Morgan Stanley

Jefferson Harralson - Keefe, Bruyette, & Woods, Inc.

Kenneth Usdin - Jefferies & Company, Inc.

Robert Patten - Morgan Keegan & Company, Inc.

Christopher Marinac - FIG Partners, LLC

Scott Valentin - FBR Capital Markets & Co.

Marty Mosby - Guggenheim Securities, LLC

Matthew O'Connor - Deutsche Bank AG

Operator

Welcome to the SunTrust Second Quarter Earnings Conference Call. [Operator Instructions] Today's conference is being recorded. If you have any objections, please disconnect at this time. I'd now like to turn the conference over to Kris Dickson, the Director of Investor Relations. You may begin.

Kristopher Dickson

Thanks, Wendy, and good morning, everyone. Welcome to SunTrust's Second Quarter Earnings Conference Call. Thanks for joining us today.

In addition to the press release, we've also provided a presentation that covers the topics we plan to address during our call today. The press release, presentation and detailed financial schedules are available on our website, www.suntrust.com. This information can be accessed by going to the Investor Relations section of the website.

Discussing our results today will be Bill Rogers, our President and Chief Executive Officer; and Aleem Gillani, our Chief Financial Officer. Also joining me are Tom Freeman, our Chief Risk officer; C. T. Hill, our Head of Consumer Banking, and Mark Chancy, our Head of Wholesale Banking.

Before we get started, I need to remind you our comments today may include forward-looking statements. These statements are subject to risk and uncertainty, and actual results could differ materially. We list the factors that might cause actual results to differ materially in our press release and SEC filings, which are available on our website. During the call, we will discuss non-GAAP financial measures in talking about the company's performance. You can find the reconciliation of [indiscernible] to GAAP financial [indiscernible] press release and on our website.

Finally, SunTrust is not responsible for and does not edit nor guarantee the accuracy of our earnings teleconference transcripts provided by third parties. The only authorized live and archived webcasts are located on our website. And with that out of the way, I'll turn the call over to Bill.

William Rogers

Okay. Kris, thanks. Good morning, everybody, and glad to have you with us today. As you saw this morning, we reported net income available to common shareholders of $174 million or $0.33 per share. While the operating environment still has many uncertainties, we continue to show meaningful improvement in all aspects of our asset quality and improved performance in our business results. I'll spend a few moments providing a high-level overview of this quarter's results and a little more [ph] color, excuse me, later in the call.

Since the peak of nonperforming loans and charge-offs in 2009, our asset quality has demonstrated continued improvement. This quarter [indiscernible] as nonperforming loans and assets, early-stage delinquencies, net charge-offs and [indiscernible] declined again during the quarter. Deposit growth has also continued its multi [indiscernible]. Client deposits reached a new record high, and the favorable mix shift continued as lower cost deposit increases more than offset the decline in higher cost deposits. Aleem, let me turn it over to you.

Aleem Gillani

Thanks, Bill, and good morning. I'll begin my comments today with a high-level review of the income statement on Slide 4.

Net income available to common shareholders for the quarter was $174 million or $0.33 per share. This compares favorably to the first quarter reported EPS of $0.08 or $0.22 when adjusted for the noncash charge associated with TARP redemption. The primary drivers of the sequential EPS growth were a lower provision due to continued improvements in credit quality, higher fee income across multiple categories and lower preferred dividends due to TARP redemption, partially offset by higher noninterest expenses.

These results also compare very favorably to the prior year, driven by higher net interest income, a lower provision and lower preferred dividends. I'll share additional color on our performance in a moment, so let's turn to Page 5 for a review of the loan portfolio.

Average performing loans were flat compared to first quarter levels of $111 billion. However, we continued to make progress in diversifying the loan portfolio as we drove growth in targeted commercial and consumer areas while further reducing our residential real estate exposure. We also continued to de-risk the portfolio, and I'll share more detail with you about that later. Growth this quarter within the commercial segment was driven by C&I loans, which increased by $1 billion or more than 2%. This growth came generally from larger corporate borrowers and was most pronounced within areas that we've been targeting for growth, such as asset-based lending, middle market and certain industry verticals within our Corporate and Investment Banking business.

The consumer segment expanded modestly, driven by guaranteed student loans. Conversely, residential loans declined by about $650 million, a similar amount to last quarter, mostly due to lower non-guaranteed mortgage and home equity balances.

Relative to the prior year, performing loans increased by about $3 billion or almost 3%. This growth was driven by consumer loans, which were up about $4 billion, specifically in student loans and indirect. Residential balances were down marginally as non-guaranteed mortgages and home equity balances both declined by about $1 billion, which more than offset the growth in the guaranteed mortgage portfolio. The commercial segment also declined, primarily due to intentional reductions in commercial construction, as well as lower commercial real estate balances, which more than offset the C&I growth that we've experienced for the last several quarters.

Overall, loan growth and loan demand remained weaker than we would like, but we are pleased with our progress in growing selected areas of the portfolio, while concurrently reducing risk. Further detail on this risk reduction is on Slide 6.

This page provides a visual of the trends in loans that, for this purpose, we categorize as higher risk. These portfolios now total $11.4 billion and have been declining consistently and meaningfully, down over 50% since the end of 2008. Concurrent with these declining higher risk balances, we've also grown our government-guaranteed loan portfolio, which now totals over $9 billion or about 8% of our total portfolio. Taken together, the reduction in higher-risk balances, combined with growth in government-guaranteed loans, constitute a substantial improvement in our risk profile.

During the second quarter, higher-risk balances declined by about $700 million or 6%, with roughly half of that coming from commercial construction. Relative to the prior year, balances are down about $3.8 billion or 25%, with significant declines in each of the categories you see on this slide. We expect declines in the higher-risk portfolios to continue in the future, although, given their smaller aggregate balance, the absolute dollar decline could moderate somewhat. As such, the runoff in these portfolios could be less of a headwind for total loan growth than it has been in prior periods.

Turning to Slide 7 for a discussion on deposits. Average client deposits were up $1.2 billion from the first quarter, reaching a record level of $121.9 billion. The favorable shift in the deposit mix toward lower-cost accounts continued, most notably by a DDA growth of $1.6 billion or 5.5%. Higher-cost time deposits declined $300 million. And NOW accounts also decreased in part due to public fund migrations into DDA. Relative to the second quarter of 2010, average deposits were up $5.4 billion or 4.7%. This growth was entirely from lower-cost accounts, primarily DDA and Money Market, which increased by a combined $9.5 billion. This growth in lower cost accounts has enabled us to manage down our higher-cost time deposits, which decreased by $4.3 billion or 18% from the prior year.

Slide 8 covers net interest income, which declined modestly from the first quarter of 2011, primarily due -- which has increased modestly, I'm sorry, from the first quarter of 2011, primarily due to day count. The net interest margin, after expanding for 8 consecutive quarters, stabilized at 3.53%. Interest-earning asset yields declined 5 basis points due to lower loan yields. This was offset by a 7-basis-point contraction in interest-bearing liability costs due to the favorable deposit mix shift, lower rates paid and a reduction in our long-term debt costs.

Relative to last year, net interest income increased by $78 million or 6%. The net interest margin expanded by 20 basis points. Favorable deposit trends were the primary drivers as rates paid declined and lower-cost deposit accounts increased. The enhanced liquidity position also enabled an almost $3 billion or 17% reduction in our average long-term debt balances. As we look to the third quarter, while we see both headwinds and tailwinds to the margin, our current expectation is for a modest decline, due primarily to further decreases in interest-earning asset yields resulting from the low-rate environment.

Let's turn to noninterest income. As in previous quarters, we have made certain adjustments to our noninterest income for items like securities gains and mark-to-market accounts. And we've included these details in the appendix. After adjustments, noninterest income increased $37 million or 5% sequentially. Most prominent was the $28 million increase in investment banking due to strong syndicated financial revenue and another really good quarter for SunTrust Robinson Humphrey, our investment banking business. While the investment banking line item has and continued to experience volatility due to market factors, it's clear that the investments we've been making in our Corporate and Investment Banking businesses are paying off.

Other notable sequential quarter increases in fee income included deposit service charges and card fees. Relative to the prior year, adjusted noninterest income was up $53 million or 7% despite the $38 million decline in deposit service charges due primarily to Reg E.

We saw increases across a broad range of consumer and commercial categories, including growth of $11 million or 12% from higher debit interchange revenue and retail investment services growth of $11 million or 23%.

Let's now turn to Slide 10 for a discussion of mortgage repurchase trends. This is the same information that we've shown you for the last few quarters, reordered just a little bit. The top left shows new repurchase demands, which were $348 million in the second quarter. That's up by $35 million from the prior quarter, $26 million of which was from the 2007 vintage. As you see at the bottom of that table, a very limited amount of the demands, only 5% this quarter, are non-agency related. As a result of the new demands, the pending population, which is shown at the top right part of the page, grew to $472 million. In light of this larger pending population, we've increased the mortgage repurchase reserves to $299 million, which is shown on the bottom left portion of the slide. You'll also see that the income statement impact this quarter grew to $90 million despite actual charge-offs declining to $61 million. While demands will likely continue to be volatile on a quarter-over-quarter basis, we continue to believe that demands from the higher-loss 2006 and 2007 vintages will decline as normal seasoning patterns occur.

Let's now turn to Slide 11 for a review of expenses. Expenses were up $77 million on a sequential quarter basis. Credit-related expenses accounted for $37 million or about half of this increase due to legal and compliance-related accruals. We also saw a $10 million increase in the FDIC premium due to the new asset-based assessment methodology. So overall, I'd characterize the growth in expenses as primarily due to the credit and regulatory environment, but I'd also say that at roughly $1.5 billion a quarter, which is where we've been plus or minus, our expense base is too high for this environment. Bill will speak momentarily to our efficiency improvement focus.

Compared to the prior year, adjusted noninterest expense was up by about $100 million and you see the factors listed on this slide. Compensation was the highest driver due to improved revenue in certain businesses, as well as for additional teammates that we've hired, primarily in client-facing and loss-mitigation positions. Let's switch to Slide 12 for a review of credit quality.

Our asset quality story is a good one again this quarter. We continued and, in some cases, accelerated the multi-quarter trend of improvement that we've seen in all of our primary metrics. Early-stage delinquencies, excluding government-guaranteed loans, improved to 73 basis points, down 7 basis points from the prior quarter. Delinquency declines were evident across most loan categories, notably an 18 basis point improvement in non-guaranteed mortgages following the 27 basis point improvement last quarter. Commercial and consumer loan delinquency rates of 22 and 66 basis points, respectively, are at relatively low levels. As such, we believe that any future improvements in delinquencies will be driven by the residential segment and be influenced by the overall health of the economy.

Nonperforming loans and nonperforming assets were down 9% and 10%, respectively, and we also saw a reduction in NPL inflows. Net charge-offs also showed notable improvements, declining from the first quarter by 12%, while the net charge-off ratio fell 25 basis points.

In light of the improvement in credit quality and the continued reduction in our risk profile, the allowance for loan losses declined by 4% for the first quarter to $2.7 billion.

Let's turn to Slide 13 for some additional detail on nonperforming loans and net charge-offs by loan segment. Like last quarter, we've also provided some supplemental information by loan class in the appendix. The $361 million sequential decline in nonperforming loans marked the eighth consecutive quarterly decline and was primarily due to our commercial segment, including a 25% reduction in commercial construction. Reductions in almost all other loan classes occurred as well. The $1.1 billion or 23% decline in nonperforming loans from 2010 was largely driven by commercial construction, non-guaranteed mortgages and C&I.

Net charge-offs are shown at the bottom of the page, and the $66 million sequential decline was driven by our residential segment, specifically by the non-guaranteed mortgage and home equity portfolios. The $217 million or 30% improvement in charge-offs from the prior year was widespread across loan categories, with the largest dollar declines coming from non-guaranteed mortgages, commercial construction and residential construction.

Overall, we're pleased with the direction in which all of our credit metrics are moving. The early-stage delinquency data indicate we may expect these trends to continue. Therefore, as we look to the rest of this year, we expect NPLs to continue to decline. We also expect net charge-offs to continue to trend favorably over time, although given the significant second quarter decline, third quarter net charge-offs are likely to approximate those of the second quarter, plus or minus.

I'll continue my comments by focusing on capital. Capital ratios continued their expansion this quarter and remained well above regulatory minimums and the proposed Basel III ratios. Tier 1 common grew by an estimated 15 basis points to 9.2%, while Tier 1 was up by an estimated 10 basis points to 11.1%. Tangible common equity ratio expanded to 7.96% and tangible book value per share increased to $24.57.

I'll conclude by noting that in light of the improved earnings per share we have generated this year, as well as the momentum that we're demonstrating in several of our businesses, we intend to request a modest dividend increase from our Board of Directors during the second half of this year. With that, I'll turn the call back over to Bill.

William Rogers

Thanks, Aleem. Now I'll turn you to Slide 15, and as you'll remember, we're organized around a consumer and wholesale businesses and this outlines several of the accomplishments in both. I'm not going to detail all of them this morning, but I'll point to the fact that we continue to make progress as we pursue a strategy that's grounded in providing the best service to our clients, thereby fostering loyalty, which helps us in attracting, retaining and expanding relationships.

A few highlights from the quarter on these areas where we've succeeded include: Retail client loyalty, which continues to improve and is exceeding our internal benchmarks. The loan production in the consumer businesses, while still low, is up 14% over the same quarter in 2010. Corporate and Investment Banking experienced its second-highest quarter of revenue generation and its third highest quarter of net income. Diversified Commercial Banking net income is up over 40% year-to-date, with favorable trends in both client acquisition and attrition as compared to last year. So overall, we continue to be pleased with the progress we've made, and I think more importantly, with the momentum we've established. Now as you're all aware, and in light of regulatory changes, banks are evaluating how they charge for their services. We have invested significantly in the science of understanding consumers' behaviors and needs and clearly, that has shown us that attitudes about money and banking are evolving. So in response, we have reviewed our consumer product offerings to ensure they remain relevant, competitive and profitable.

This quarter we announced some key changes to our checking account portfolio. And as part of these changes, we've simplified our products suite. We've discontinued free checking and introduced products that respond to how clients use their bank, including our new core product, Everyday Checking. This is one of the means by which we're both responding to clients' needs and mitigating the impact from regulations that are impacting our revenue stream. I'll outline a few more monetarily. But now that we've had clarity on the Durbin amendment, let me first provide some transparency around our estimates to the run rate impact of that particular piece of legislation and its impact on fee income.

Now based on our business mix, we estimate that Durbin will have a 50% annualized impact before any mitigating actions. So to give you some additional context, our year-to-date annual debit interchange revenue is approximately $370 million. And as you're aware, the final rules will not be implemented until the beginning of the fourth quarter, so we'll only experience a small percentage of this in calendar 2011.

And we've been evaluating a variety of methods to mitigate both the impacts of Durbin and Reg E. And you will recall that we made no immediate changes to our products or fees in response to Reg E as we wanted to monitor both the competitive and regulatory dynamics. Now with some additional clarity on both fronts and with a lot of client insights, we've moved into implementation mode on certain mitigation efforts.

Now for example, we recently eliminated our debit rewards program, and I told you about the current rollout of our new checking product set. We also have other value-added checking features that we plan to introduce later, which we believe will be beneficial to our clients, as well as enhance our deposit fee income. So collectively and over time, we currently estimate that the benefits from all these changes will enable us to recapture around 50% of the revenue lost from both Durbin and Reg E.

Now I want to emphasize that we've been very deliberate in this process, and we've spent a lot of time garnering feedback from our clients. During the implementation of Reg E, we received accolades from our clients and within the industry in terms of client satisfaction and with our communication efforts. We needed to understand the final impacts of both Reg E and Durbin before we rolled out our new product set. In the last few months, I've been in virtually all 4 corners of our retail franchise, and I'm really pleased with our teammates' responsiveness. The early results are exceeding our expectations and producing more primary accounts and accounts with higher balances.

Now let me turn to the last slide for closing remarks. Now overall, we had some encouraging signs during the quarter, growth in targeted loan categories, a continued favorable shift in the deposit mix, good growth in certain fee areas and continued encouraging asset quality trends. Now while our results aren't yet where we'd like them to be, progress is being made, momentum is building, and we have specific initiatives aimed at accelerating our performance in the future. Some of these efforts are designed to further improve our revenue generation, and we feel good about our prospects, particularly as the economy improves and provides a little bit of tailwind.

Now we also recognize that expenses or the run rate is just simply too high for this new environment. As a result, we also have initiatives underway to lower our expense base with a targeted run rate reduction of $300 million by the end of 2013. Now similar to our successful E squared expense reduction initiatives a few years ago, there are multiple tactics involved that are structural and will accrue benefits over a period of time. And I'll just take a moment or 2 to give you a flavor of how we plan to do this.

First, a key focus will be on implementing an aggressive approach to what's commonly referred to as shared services wherein we will centralize and eliminate redundancy of similar functions currently housed in multiple parts of the organization. This will allow us to more effectively balance costs, quality and service, so we can more efficiently meet the needs of our lines of business, geographies and support projects. We've identified enterprise-wide solutions in such disciplines as technology and operations, finance, procurement, marketing and human resources to maximize their impact and improve their efficiency. Further, our supplier management efforts will be intensified to yield greater cost savings, and plans to reduce paper usage both within the organization and our interaction with clients will be accelerated.

And while we're not approaching this as a headcount reduction exercise per se, we will be providing these services with fewer people in the future. Our clients continue to demonstrate an increasing preference for more technology-driven, self-service channels such as a more robust ATM network and enhanced mobile banking platforms. This increase in convenience for clients also results in lower delivery costs and improved efficiency in the branch network. As all of these reductions are intended to produce permanent alterations to our expense base versus a quick fix, only a small portion will be realized in 2011, while we expect that we'll have approximately 80% of the expense savings in our run rate by the end of 2012, with the remainder occurring in 2013.

So to be clear, these expense reductions are above and beyond those that we expect to normalize as the environment improves. Credit-related noninterest expenses, for example, have been running about $700 million in annual clip or roughly 12% of our expense base. That's several multiples above where they were pre-cycle and a big drag on our efficiency ratio. Even if these expenses normalized to a level somewhat higher than they were pre-cycle, there are still several hundred million dollars in credit-related expenses that, over time, we expect to come out of our current expense run rate as the environment improves.

Our individual efforts and an improving economy are ingredients to our overall effort to permanently reduce our normalized efficiency ratio to under 60%. Getting to that level will take some time, and the realization of it is in part dependent upon an improving economy, but I've outlined elements that we can impact regardless. And I can assure you they we will receive the requisite intensity. It's important to note our efforts will be focused on driving expense savings without compromising the high service levels that our clients have come to expect and we believe strategically differentiate us from our competitors.

So put another way, we are approaching this as we approach all aspects of our business: with a focus on the guiding principles of our operating philosophy, putting the client first by viewing the relationship through the eyes of those who choose our services, building a [indiscernible] team and focusing on profitable growth by operating efficiently and investing prudently. This planned development has been a team effort, and I have great confidence and a strong belief in our franchise potential and ability to deliver. So Kris, let me turn it over to you, and we can start the Q&A.

Kristopher Dickson

Thanks, Bill. Wendy, we're ready to open up for Q&A. [Operator Instructions]

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today is from Brian Foran with Nomura.

Brian Foran - Nomura Securities Co. Ltd.

I lost you a little bit in the expense targets. You threw out $300 million as well as $700 million of credit-related expenses. So is it $1 billion of annual expenses that come out between the cost-save program and credit normalizing, or is it some number in between?

William Rogers

Yes. Really, what I wanted to point out is a couple of things. So the $300 million is a specific initiative with the things that I identified. The credit-related expenses, we don't know -- don't know the timing. Normalized credit expenses were somewhere in the past around $200 million. Will it get that low again? I don't know, but I don't think they'll operate at the current $700 million.

Brian Foran - Nomura Securities Co. Ltd.

Okay. So maybe we have $400 million to $500 million of credit-related expense reduction that will drop to the bottom line. And then on the $300 million, can you just clarify, is that a targeted $300 million reduction relative to the current level, or is that $300 million of expense saves, some of which will be offset by natural growth and reinvestment and things like that?

William Rogers

Think of this specific $300 million as a net run rate reduction by the end of 2013. I mean, I think that's sort of the easiest way to think about it. The other investments that we'll make in our business, which we'll continue to do, will be self-funded. So this is intended as sort of a permanent reduction of a run rate by end of 2013.

Brian Foran

And so a run [indiscernible] $0.5 [ph] billion we see today?

William Rogers

Yes. Think about a normal quarterly expense [indiscernible] billion [ph] and a half. Does that make sense?

Brian Foran - Nomura Securities Co. Ltd.

That does make sense.

William Rogers

Thanks, Brian.

Operator

Our next question is from Matt O'Connor with Deutsche Bank.

Matthew O'Connor - Deutsche Bank AG

I think you just answered this, but just putting all the numbers together, so you're at $6 billion run rate right now on the expense side. And as you think about the end of 2013, you take away the $300 million and then take away the estimate, that $400 million or $500 million of environmental costs, and your all-in expenses would be in the $5.5 billion range, plus or minus would be how to think about it?

William Rogers

Yes, I think if you assume that as sort of a run rate kind of basis, and that doesn't assume other investments that we might make relative to growth. But I think your math is right in terms of how you're thinking about it, and you need to make your own assumptions on the credit-related costs. So I think you got to put that in your model because I think we're all sort of -- speculating as to what the new normal might be as to credit run rate.

Matthew O'Connor - Deutsche Bank AG

And then of that $5.5 billion or so of expenses, that would be the base that you'd hope to get an efficiency ratio I think you said of 60% or the low 60s?

William Rogers

Yes, I think if you sort of do the math, think about our current non- and net-interest income, think about the expense base minus the $300 million, minus whatever you would assume for credit-related costs and then minus repurchase costs, mortgage repurchase costs, which we assume will get back to some sort of normalized level, and then you sort of crank that [indiscernible] you can sort of see a way to a below 60% efficiency ratio and an above 1x ROA.

Matthew O'Connor - Deutsche Bank AG

Okay, yes. Makes sense. And then separately, if you look at your tax rate this quarter, it was high versus last quarter, even though the pretax earnings was similar. You pointed to several specific discrete items that drove a higher tax rate. I don't know if you have any comment on what those things might be and what's the tax rate going forward?

Aleem Gillani

Matt, it's Aleem. There were several individual tax items that affected us this particular quarter. There are actually several of those every quarter. That's sort of a normal thing. There are always going to be some adjustments. Typically, some go positive, some go negative, and they may average out overall. This quarter, we had several which ended up actually just being net unfavorable, and that raised our effective tax rate. But if you think about what our normalized tax rate is and how that looks over time, as a general rule, think about us as having sort of $100 million to $120 million of tax-free income. So if you take a look at our overall income, subtract $100 million to $120 million per quarter of tax-free income and then apply our marginal rate to the remainder, you sort of get a generally effective tax rate number. What that tells you is that over time, as our income rises, our effective tax rate should be rising also as our marginal rate then gets applied to a higher proportion of our total income.

Operator

Our next question is from Marty Mosby with Guggenheim Securities.

Marty Mosby - Guggenheim Securities, LLC

I wanted to ask you about the credit-related expenses. If you look at the metrics and what we've seen in net charge-offs and nonperformers, they're all moving in a favorable direction. But when you look at the credit-related expenses this quarter, we actually saw about a $40 million increase to a number that was higher than what we've seen in the last 3 or 4 quarters. So was there any kind of proactive cleanup or some things that we did on the balance sheet that pushed that number up this quarter?

William Rogers

This is Bill. The largest part of that was really operating losses and the increase in operating losses. And that line item was impacted by sort of legal and compliance-related accruals, the preponderance of those being mortgage related, which I don't think would be a surprise to anybody.

Marty Mosby - Guggenheim Securities, LLC

Right. And [indiscernible] something we hadn't added [ph] that came out this quarter that allowed us to make those and then who knows what going forward, but at this point, we wouldn't see that reoccurring as much or at that level?

William Rogers

Well, I can't promise that. I mean, new information comes out and we have to react to it and things that are, as my accounting friends will say, estimable and probable. So when we know them in that category, we'll address them, and they were in that category for this quarter.

Marty Mosby - Guggenheim Securities, LLC

Okay. And then last question was, as we look at our normalized kind of earnings going forward, one of the things that in the past, you all had just a pristine kind of asset quality experience, so we always assume that your [indiscernible] was going to kind of cycle through run rates are going to be relatively low, especially compared to your peers. Now that we've gone through a little more stressful period and the Southeast was hit a little bit harder, I think it was kind of [indiscernible] higher. Is that part of why we go through this efficiency initiative to get back to normalized kind of profitability levels above 1% ROA [indiscernible] assuming higher in this cycle kind of losses?

William Rogers

Yes. I think when you sort of crank through that math, you could assume we've operated in the high 30s to low 40s in our past. And will we ever get back to that kind of level as a country and as a region and as a company? I don't know. But I think even assuming some sort of higher numbers, 50 basis points, for example, and that kind of run rate, you can still operate sort of at a north of 1% ROA. I can't tell you whether it will be at the same level as before. I can tell you we'll continue to have a focus on pristine credit quality. And I think if you look at particularly the areas where we had significant management focus and what we're known for the past, in the C&I and CRE, and our numbers really look good.

Marty Mosby - Guggenheim Securities, LLC

Right. And I was just wondering what the efficiency initiative -- is that part of the motivation [indiscernible] really feeling the need to keep pushing that forward or is it just as we're going forward in the environment, revenue growth is going to be [indiscernible] because of the economy, so efficiencies become more a greater of a focus?

William Rogers

Yes, I think it's a combination of all those things, and the keyword of that being uncertainty. And as we sit here, the certainty of a revenue increase, while we expect it and expect the economy to rebound, probably has a longer tail attached to it than we all thought. And what we want to ensure is that we go into that with the most efficient organization that we can have.

Operator

Our next question is from Ken Usdin with Jefferies.

Kenneth Usdin - Jefferies & Company, Inc.

It's a question about the earning asset growth and progression, the earning assets were down, but period ends, it looks like it was above the averages. And I'm just wondering with loans flattening out and now the securities reinvested post the TARP, are we at the point where we should start to see earning assets begin growing again?

William Rogers

Well, if you sort of look at our earning assets and dissect them, say, on the loan side, C&I growth was a little over 2%. So I mean, we're starting to see some real C&I growth. For us, it's the flattening out is offset by the fact that we had significant, continued decrease in our -- what we labeled higher-risk loan categories. Those will start to level off. They won't go to 0. Those will start to level off. And as we continue to see improvement, particularly on the C&I side, which appears to be significantly leading the consumer side, I'm more optimistic that we'll have core asset growth.

Kenneth Usdin - Jefferies & Company, Inc.

Okay, great. And just my second clarification. I hate to come back to the expensing again, but I just wanted to make sure that the point you're making is that whatever we take out of expenses is separate from what you'll also be investing in the business over time. So I just want to make sure, are we supposed to think about it as a purposeful net reduction to whatever around that $5.5 billion number it is? Or is it that $5.5 billion number before we consider ongoing investments that you'll always be continuing to make in the business?

William Rogers

I think you need to think of it as a net reduction, sort of a permanent $300 million reduction and -- off that base, and then we will continue to make investments in the business. And those investments will be funded, call it self-funded, by the growth in our respective businesses.

Kenneth Usdin - Jefferies & Company, Inc.

Right. So in line with revenue growth, you'll be investing within the businesses?

William Rogers

Absolutely.

Operator

Our next question is from Matt Burnell with Wells Fargo Securities.

Matthew Burnell - Wells Fargo Securities, LLC

I just wanted to follow up on the mortgage repurchase trends. You certainly noted the increase in the repurchase demands in 2007, and I know it's relatively small numbers. But I was just curious about the increase in the repurchase demand from 2009 to 2011 vintage mortgages. That strikes me as a little interesting given that most of the focus has been on the pre-2008 vintages. So if you can just provide some color on that, that would be helpful.

Aleem Gillani

Sure thing, Matt. It's Aleem. The agencies are often just changing their internal processes for sampling and for file review. So it's hard for us to pinpoint what leads to a change like this. The increase this quarter that you saw actually related more specifically to the 2010 vintage. And overall, it doesn't overly concern us for several reasons. These were demands and our success rate in refuting this vintage of demand is actually very high. The loss content in this vintage is expected to be very small, given the tightening of overall credit guidelines and the focus on quality in 2010. And to date, we've actually repurchased a very small amount of loans from the 2010 vintage. In fact, our total losses to date on the 2010 vintage have been less than $1 million.

William Rogers

Aleem, let me provide a little bit of point of clarification, just to make sure that we answer the question. So you asked about the 2009 and 2010 increase in demands and our experience, which Aleem answered. But you might have gotten an implication that increase in demands for this quarter actually was sort of from the vintage -- pre-vintage that you are thinking about. So you asked sort of 2 different questions. Is that fair?

Matthew Burnell - Wells Fargo Securities, LLC

I think so, yes. And Jim, if I could follow up with a question really on your branch system? Clearly, you've done a lot of work trying to assess what your customers need, how your customers want the products delivered, particularly in the new regulatory environment. Within the focus that you're providing in terms of cost reduction, how are you thinking about your branch network and how aggressively you want to grow or perhaps shrink that part of the business over the next 3 years or so to provide the service level that your customers want but also right size the expense base?

William Rogers

Yes, I mean, we'll be looking at that. We come into this within our markets as one of the most convenient branch operating networks in our region. And that's a combination of our traditional branches and a good reliance on our in-store. So we go into it with an entity that's fairly efficient. I think it'll be more in the thought of how we staff and run that network versus big increases or big decreases in branches. I think that's probably a better way to think about it as we start shifting more consumer activity to online channels, ATM channels, which we've been very successful of introduction of technology. So I think it'll be -- think more of the efficiency within the boxes versus a large number of increases versus decreases.

Operator

Our next question is from Scott Valentin with FBR Capital Markets.

Scott Valentin - FBR Capital Markets & Co.

Just a little bit of a philosophical question. As capital frees up and you seek to grow the balance sheet, what's the thought process regarding margin versus the net interest income? In other words, if loan growth remains tepid, do you then start growing the securities book and we can expect a decline in margin? Or would you then decide some way that maybe not growing the company as fast and allocate capital elsewhere?

Aleem Gillani

Well, I think the -- from a margin perspective, we are very focused on what our clients are doing, and we're trying to make sure that we're there for them. And so to the extent that we can grow the loan book and focus on our client business, that's what we will be trying to do first. To the extent that loan growth does remain tepid and deposit growth continues to -- cash continues to flow in, about the only place we can put excess cash for now is, in fact, in the securities book. So we will be growing securities if that happens. Having said that, we're also focused on the potential rate risk within the securities book, so we'll be managing that very closely to make sure we don't overemphasize that book over time.

Scott Valentin - FBR Capital Markets & Co.

Okay. And just as a follow-up, in terms of the Durbin impact and some of the offsets, your deposit -- I'm sorry, on Reg E, your deposit service charges were up link quarter. Should we expect additional growth in deposit service charges as we go forward?

Mark Chancy

Scott, that's where the interchange income gets booked, so I think starting in the fourth quarter, as you see Durbin come into effect, so it's actually in card fees, that's where you'll see the card fees to come down. As you look at deposit fees, some of the things that Bill talked about earlier in the context of the new checking product suite and some value-added features would be where the majority of that would flow through.

William Rogers

Yes. And one of the reasons they're up is just new accounts. I mean so we've been successful at expanding and growing our business, so the core -- not related to any fee or particular issue, but just growing more accounts and due to the investments we've made on the service quality side, we're losing fewer.

Operator

Our next question is from Betsy Graseck with Morgan Stanley.

Betsy Graseck - Morgan Stanley

A couple of questions. One is on just cost of funds. Could you just give us a sense as to what levers you see in managing cost of funds to be as low as possible over the next couple of quarters?

Aleem Gillani

Well, Betsy, I think, 2 major levers we see there. Number one, on the deposit side. As you know, rates are very low. We've managed to extract a lot of value by driving deposit costs lower over the last several quarters. I think some of that is -- or most of that has played out. However, perhaps not all, so we're hoping to be able to grind out an extra basis point or 2 in our deposit costs and bring our overall cost of funds down there somewhat. Secondly, as you know, we've been very active on our liability management side, done a tender for a bit. We've repurchased it. We've had some high-cost debt maturities, and we're going to continue to stay focused on that to bring down whatever we can on the -- on our high-cost debt side. So I think those are the 2 major levers we'll be focusing on when it comes to cost of funds.

Betsy Graseck - Morgan Stanley

And degree of impact on NIM you think those have?

Aleem Gillani

It will be positive, but I think it will be slightly outweighed by the maturing loans that we have on the asset side. And as those loans mature, we'll be reinvesting that cash into new loans. And new loans are coming on at slightly lower rates in the current low-yield environment. So overall, I do think that our NIM will decline a little bit as we look to Q3 and Q4.

Betsy Graseck - Morgan Stanley

Okay. And then just separately on the dividends, you mentioned that you were going to be requesting a dividend hike from the Board of Directors. I would expect that, that would need to be passed by the Fed as well [indiscernible] and sort of how you're thinking about payout ratios and the like as you put the request in?

Aleem Gillani

Well, over time, over the long run, we do expect our payout ratio to climb. You're aware that the Fed, through the SICAR process, appears to have limited or capped the total amount of payout ratios for all of the 19 banks in the SICAR process. But over time, we do expect that our payout ratio would climb toward that kind of a number, and we're looking for ways in which we can return capital to shareholders.

William Rogers

And to set expectations, I mean, Aleem did say modest increase we'd be asking for [indiscernible] second half of the year, which is consistent where we've been all year.

Operator

Our next question is from Kevin Fitzsimmons with Sandler O'Neill.

Kevin Fitzsimmons - Sandler O'Neill + Partners, L.P.

Just 1 clarification. I know you quantified the revenue base that's being affected by Durbin and then you're going to be putting these mitigating steps in, you're going to look to recapture 50% of the revenues lost from that, but also Reg E. I'm assuming Reg E is already in the run rate. Can you quantify how much has been lost from Reg E so if we have to think about you recapturing 50% of that, what that is?

William Rogers

How about if I just do it in sort of total run rates of which we've talked about before? So we talked about a range on Reg E of $80 million to $120 million sort of normalized run rate. Let's just use the high end of that for just purpose of the discussion. And then Durbin, has about a 307 [indiscernible] rate as to where we are right now, so you've got $180-ish-plus million [indiscernible] as it relates to that. So that's the total run rate number that we're talking about offsetting 50% of. And I think -- and I hope and I think that that's a conservative estimate because I think the high end of both ranges and the low end of the range are offsetting. So I think we'll be somewhat north of 50% in terms of recovery of that total run rate number. [indiscernible] clarify.

Kevin Fitzsimmons - Sandler O'Neill + Partners, L.P.

That's great. And one quick [indiscernible] net charge-offs in the third quarter maybe approximate to where they were in the second quarter. How about the pace of reserving? Should we expect -- as long as credit metrics continue to improve, do we expect you to continue to release, but maybe not at the pace we've seen for the past couple of quarters?

Thomas Freeman

It's Tom Freeman. As we've looked at the pace of release about what's going on, I think the release of the reserve will stay in line with the improvement in credit metrics. We expect the credit metrics to continue to improve over the next several quarters. We think the release actually lags by a couple of quarters, the improvement in credit quality. Because you want to make sure that what you're not getting is a false signal in an individual quarter. So we've been pretty cautious about the amount of money we've released out of the reserves [ph].

Operator

Our next question is from Christopher Marinac with FIG Partners.

Christopher Marinac - FIG Partners, LLC

[indiscernible] acquisition. And I guess the question really relates more to as folks bring opportunities to you -- and I'm thinking more smaller than anything large or strategic, do you want the organization to be at a particular point before you consider them? Or do you feel you can consider acquisitions or the things that are related to the franchise now?

William Rogers

Yes. I mean, Chris, we've got a core competency, so I mean, it's not that we can't handle it. I mean, we've got people and systems and process and competency in doing this. But all that being said, I mean, I'm spending 99% of my time on our franchise because I think we've got such an upside and opportunity within our own franchise. That's where I'm devoting most of my time. But we have competencies, so we would look at things. But we kept out of the FDIC buyout of small bank just because we thought it would be a diversion, quite frankly, to our overall objective of what we're trying to accomplish. And I want to just make sure that the company is, again, focused on the opportunity within our franchise.

Operator

Our next question is from Bob Patten with Morgan Keegan.

Robert Patten - Morgan Keegan & Company, Inc.

Just a quick question. Could you -- 1% ROA seems kind of like a low bar for what SunTrust -- the history of SunTrust. Can you give us sort of a reminder of what the long-term return profile of the company is going to look like, ROE, ROA, earnings growth efficiency, and sort of when you think you're going to get there?

Aleem Gillani

We don't normally guide toward long-term ROE and ROA targets. And with the current uncertainty, of course, it's very hard for any bank to do that over time. We have set ourselves an ROA target. We have set ourselves an efficiency target. And what we are focused on is really excellent execution within our franchise and delivering the bank to all of our clients. So over time, I do think that you will see from us an ROA that will be north of 1%. I think you will see from us an efficiency ratio that will be below 60%. But we frankly don't guide to long-term ROE targets.

Robert Patten - Morgan Keegan & Company, Inc.

Okay. Did you guys give a timeframe of when you hope to attain the 1% ROA?

William Rogers

We didn't. And really, what I was trying to sort of going through the math was an ability to just sort of get to a calculation where you can see to north of 1%. A lot of this is obviously just is economic driven. Sort of when are we going to see in improvement in general economy such that those normalized charge-off ratios we talked about earlier and normalized credit expenses will start to materialize? Those are less in our control. The things that we can control is the expense base and the chassis from which we attack the business, and that's what we're going to be -- have a laser focus on.

Robert Patten - Morgan Keegan & Company, Inc.

And then just last question for Bill. How much of your time are you spending with the regulators on your daily job today versus, say, a year ago?

William Rogers

Well, a year ago, I wasn't in this slot, so. Let me sort of start that from that framework. It's hard to put a percentage of the time. We've got a great team. We have a lot of focus. We spend time with our regulators. Can I put a specific percentage on it? No. Am I focused every day to make sure that I'm balancing how much time we're spending with the regulators, ensuring that we're doing all the right things, complying with the consent order, all of the things that we need to be doing to making sure that we're on the right track, but also ensuring the fact that I'm spending enough time on running the business and making sure that we're achieving our objectives. So I haven't done the calendar calculation on that. So I don't know if I've dodged your answer or answered it, but...

Robert Patten - Morgan Keegan & Company, Inc.

No, I understand what you're saying. It's just a point of I was just trying to see how much time is being taken up by non-revenue producing issues with the regulators and so forth versus...

William Rogers

I think one of things -- and this was Jim's leadership -- is if you go down one layer in our company, they're spending the appropriate amount of time on running the business. Now there are a few of us that are spending a higher percentage on regulatory things than we'd like to, and than we will going forward. But the core team in the field, the guys running our businesses, they're certainly doing the things they need to do to respond to the regulatory issues. But they're running the business, and we're very focused on ensuring that we've got that right balance.

Operator

Our next question is from Todd Hagerman with Sterne Agee.

Todd Hagerman - Sterne Agee & Leach Inc.

Just a couple of follow-ups. Bill, you mentioned before, just on the expenses, some of the structural changes. And I'm just curious, with some of the changes that are coming through within the mortgage business and the mortgage industry, just wondering kind of as you guys are addressing some of the recent Fed orders and so forth, how are you thinking about the mortgage business today and kind of going forward? And does that potentially kind of fall into your outlook in terms of some of the structural changes that you're thinking about on the expense side?

William Rogers

Yes, in fairness, related to the expense thing, I've really sort of tried to exclude mortgage from that discussion because it'll have ups and downs and offsets as originations goes down and the regulatory expenses go up. So I've tried to [indiscernible] that from the overall expense discussion. Now that being said, if you're asking the question are we going to be in the mortgage business going forward, I mean, mortgage has been an important part of what we do. 1 in 5 of our clients who have a mortgage have it with SunTrust. We've got a lot of our new client origination comes from the mortgage channel. Will we evaluate the efficiency and productivity in that business going forward? Absolutely. Will we look at sort of what volumes of servicing we have versus what volumes of origination? Are we going to be in retail? Are we going to be in the [indiscernible] we are and will be evaluating all of that. But mortgage is a core business for SunTrust. It's been a big part of the relationship strategy that we have as a company.

Todd Hagerman - Sterne Agee & Leach Inc.

Okay, that's helpful. And then just as follow-up. Operating leverage was negative this quarter, and certainly, the -- addressing expenses is obviously important. But how should we think about just kind of generating positive operating leverage going forward? You mentioned that a small amount of the cost saves were likely to come out in the back half of 2011. But as I look at the business mix and some of the seasonality and some of the headwinds in the back half of the year, how should we think about kind of positive operating leverage going forward and kind of the timing of that?

William Rogers

Well, we did talk about the expense run rate, the expenses being a little less impacted this year. And that's really because we're trying to put in structural permanent changes in the business such that we've got a permanent run rate and smaller chassis as we approach the business. So this isn't a quick fix, go lop off a lot of expenses just to accomplish a short-term objective. By the same token, we have the same amount of intensity on a bunch of revenue opportunities. And you've seen the growth on our deposit business. You've started to see some of that C&I growth starting to come back. That's supported by really good production numbers, increases in commitments, which bode well for the future. And you've seen things like, in our fee businesses, our Investment Banking business, which is sort of significantly run rate, last 4 quarters, above where it was 4 quarters before that. So the answer is, I can't give you specific timing other than to say I can assure you the focus is on both ends of that equation.

Operator

Our final question today is from Jefferson Harralson with KBW.

Jefferson Harralson - Keefe, Bruyette, & Woods, Inc.

Aleem, you didn't talk -- I don't think you talked too much about the margin and what the drivers are of it in the future. Can you talk about your outlook for the margin?

Aleem Gillani

Sure thing, Jefferson. So over the next couple of quarters, obviously, there are some headwinds and tailwinds in the margin overall. The -- I think, overall, we are guiding and I do expect that we'll have a modestly declined margin from the 3.53% that you saw this quarter and in the first quarter. And the primary reason for that really are maturing loans. So there is good [indiscernible] bad news there. The good news is that there are clients in America who do believe in repaying their debts. And so we are having some loans mature. And the bad news, of course, is that we're putting on new loans at slightly lower yields than the old ones came off at.

Jefferson Harralson - Keefe, Bruyette, & Woods, Inc.

All right. And a follow-up, when I look at that rate bucket sheet, I see a 4.36% rate beside that brokerage CD number. Are those just old CDs or they -- or some hedging stuff going through there? Or what's that large rate cost doing there?

Aleem Gillani

Those are silks. Those are the $2.3 billion of silks that we'd put on some time ago. They are old, and the overall duration of that portfolio is coming down. I think we're down to under 3 years now on that particular book. You can see the overall balance of brokered CDs has been falling very considerably year-over-year. This is not an area of focus for us.

Kristopher Dickson

Thanks, everybody, for joining us. We appreciate it. If anybody has any follow-up questions, as always, please feel free to contact the IR department.

Operator

Thank you. This does conclude today's conference. Thank you for participating. You may disconnect at this time.

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