Regions Financial Q2 2007 Earnings Call Transcript

Jul.17.07 | About: Regions Financial (RF)
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Regions Financial Corp. (NYSE:RF)

Q2 2007 Earnings Call

Jul 17, 2007, 10:00 AM ET

Executives

List Underwood - IR

C. Dowd Ritter - President and CEO

Alton E. Yother - CFO and EVP, Finance Group

Analysts

Todd Hagerman - Credit Suisse

Christopher Marinac - Fig Partners, LLC

Paul Delaney - Morgan Stanley

Gary Townsend - Friedman, Billings, Ramsey & Co.

Christopher Mutascio - Stifel Nicolaus & Company

Kevin Fitzsimmons - Sandler O'Neill

Jennifer Demba - SunTrust Robinson Humphrey

Matthew O'Connor - UBS

Jefferson Harralson - Keefe, Bruyette & Woods

Presentation

Operator

Good day, ladies and gentlemen and welcome to the Regions Financial Corporation Earnings Conference Call for the Second Quarter 2007. My name is Tania and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. [Operator Instructions]. As a reminder, this conference is being recorded for transcription purposes.

I would now like to turn the presentation over to your host for today's call, Mr. Dowd Ritter, President and CEO. Please proceed sir.

List Underwood - Investor Relations

Good morning everyone. This is List Underwood and we appreciate your participation today. Our presentation will discuss Regions' business outlook and includes forward-looking statements. Those statements include descriptions of management's plans, objectives or goals for future operations, products or services, forecast of financial and other performance measures, and statements about Regions' general outlook for economic and business conditions.

We also may make other forward-looking statements in the question-and-answer period following the discussion. These forward-looking statements are subject to a number of risks and uncertainties and actual results may differ materially. Information on the risk factors that could cause actual results to differ is available from today's earnings press release, our Form 10-K for the year ended December 31, 2006, our 10-Q for the period ended March 31, 2007 and the Form 8-K that we filed today. As reminder, forward-looking statements are effective only as of the date they are made and we assume no obligation to update information concerning our expectations.

I may mention also that our discussions may include the use of non-GAAP financial measures. A reconciliation of these to the same measures on a GAAP basis can be found in our earnings release and related supplemental financial schedules. Dowd?

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C. Dowd Ritter - President and Chief Executive Officer

Thank you, List and good morning everyone. We appreciate your joining Regions second quarter earnings conference call. With me of course this morning is Al Yother, our Chief Financial Officer, who will provide us a detail discussion of our quarterly performance later in the call.

Let me begin with a few highlights. I am pleased with Regions overall second quarter results and the progress toward developing a more efficient, more profitable business model.

Earnings from continued operations were solid $0.69 per diluted share, excluding merger charges. On the same basis, annualized return on tangible equity was a strong 25%. Notably, our EPS match first quarter's level despite lacking on an approximate $0.02 contribution from branches that we divested in the first quarter.

Significant contributions to second quarter profits include merger-related cost saves that are exceeding our expectations, along with continued low credit costs and excellent Morgan Keegan results. In addition, we repurchased approximately 20 million shares of our common stock during the quarter. Before Al covers our second quarter in greater detail, I want to spend a few minutes updating you on our merger progress.

I guess today as we sit here we are even more excited about the merger's opportunities and benefits than when the transaction was first announced, fourteen months ago. Granted the current operating environment is proving more challenging than we anticipated, but longer term prospects remain extremely bright. And meanwhile, I'm pleased to report that Regions continues to meet or exceed all of our initial merger integration goals. So far, our accomplishments include the divestiture of branches that's required by our regulators and the conversion of our brokerage and mortgage payroll and employee benefits platforms.

In our most significant milestones today, last week we successfully converted 633 Alabama and Florida branches involving just over 2.9 million deposit accounts and over 400,000 loan accounts. Importantly, this first conversion was the largest of any of our planned conversion events and bodes well for upcoming conversion success. In fact, we have decided to accelerate the timeline for our remaining conversion events by combining next year's events three and four into a single conversion. We'll give you the exact revised dates for this last event once we finalize that which would probably be some time during the next 30 days.

Given the importance of customer retention throughout the entire conversion process, we kept a close eye on customer satisfaction levels. In fact, we've hired the Gallup Organization to assist us. They help us establish benchmarks by conducting 53,000 customer service surveys at the beginning of this process. We will continue to track our customer sentiment at the branch level as we go forward, but I would tell you that the initial results show satisfaction scores slightly above industry averages and our goal is to build on those results as we progress through the integration and beyond.

Our branch consolidation plan is also well underway. Most consolidation is taking place concurrent with conversions, and therefore as a result, we closed 66 branches in Alabama and Florida last week, bringing year-to-date consolidations to 81 offices or about half of all planned consolidations during the conversion of 1, 2 and 3.

We are already reaping the rewards of our successful integration efforts by creating a more cost-efficient organization. As I noted earlier, our cost savings are actually running substantially ahead of our $150 million full year 2007 projection and are likely to be substantially above the originally estimated $400 million run rate that we expect to achieve by the second quarter of next year. Also our one-time merger-related expenditures are running below initial expectations, and shouldn't have end up less than the originally projected $700 million.

On the other hand, as all of you know, the current operating environment is making it more difficult in the short run to grow revenue particularly, spread revenue unless we were to compromise underwriting standards and increase balance sheet risk or leverage. Be assured, we don't plan to compromise either on our underwriting or our balance sheet management discipline.

Additionally, while we are committed to improving our cost structure, we are also continuing to invest on Regions future. An example is our targeted branch expansion plans. So far this year, we've opened a total of 20 new offices, 10 in the first quarter and 10 in the second and for the year, we are still on target for a total of 50 new offices. Most of those will be in Florida, where we had the land bank available as we went into the year. But a few will be located in other high growth areas that we've identified across the footprint. At the same time, we are continuing to invest in key business lines such as Morgan Keegan that have the potential to broaden and more effectively leverage our customer base through sales of higher return fee-based products and services.

In other words, even though our top priority is successfully executing the merger integration and achieving the cost saves, we indeed are not ignoring strategic planning and executions, nor are we taking our eyes off day-to-day business development, is evidenced by our solid second quarter operating results. A further key indicator is that we are continuing to grow net consumer checking households despite spending considerable time and effort on merger integration plans and execution. Specifically, our net consumer checking households have increased around 2% annualized during the first 6 months of this year. As an important measure, in that the net growth rate is the rate at which we retain customers and add additions.

So when you think about typical buying, retaining about 85% of the consumer checking relationships in the given year, we are number one, we are exceeding that rate and then you add on the addition of new counts, that two extra percentage point doesn't sound like much but when you think about over 3 million consumer checking households, the difference is actually very meaningful. And because we took a number of key actions earlier in the year ahead of conversion of this, such as replacing all customers' debit and credit cards with new re-branded ones and assigning new account numbers to any instances where it was necessary to eliminate difficult account numbers, we fully expect that these households in this growth and retention measures should remain strong throughout the entire conversion process and beyond.

In summary, we are successfully building our Regions solid foundation, improving our ability to fully capitalize our long-term growth opportunities and maximize shareholders' return. Furthermore, despite near term operating environment challenges, 2007 is still expected to be another solid year for Regions. And with that, let me turn it over to Al to give you some greater detail.

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

Thank you, Dowd and good morning again to everyone. As Dowd said, we are pleased with this quarter's earnings, especially given the fact that the results do not include the approximately $0.02 per share contribution of the 52 branches we divested in the first quarter.

Linked-quarter, the earnings per share loss from divested branches was offset by good expense control, including strong merger-related cost saves, by fee gains primarily Morgan Keegan and service charges and also aggressive share repurchases. All in all, operating results were solid. Nonetheless, it was another noisy quarter due to divestitures, merger-related items and a couple of other special items. As a result, my goal for the next few minutes is to provide you with some clarity on our first to second quarter of core operating trends.

Fully taxable equivalent net interest income dipped $64 million linked-quarter, impacted by lower net interest margin and a smaller earning asset base. Branch divestitures negatively affected both margin and earning asset levels, accounting for about $30 million of second quarter's drop in net interest income.

Our net interest margin contracted to 3.82%, over half of the linked-quarter decrease was related to the branch divestitures. The explained divestitures not only reduced low cost deposits by $2.7 billion, they also necessitated the reversal of a portion of an earlier positive purchase accounting mark-to-market on these deposits. In addition to the divestitures, narrowing spreads and our capital management efforts namely, an increased level of share repurchase activity and the issuance of long-term debt further pressured the net interest margin during this quarter.

The pace of margin compression should slow as we move into the second half of the year, leading to an estimated 3.8% average margin for the full year 2007. And this estimate assumes continued narrower spreads on new balance sheet growth, lower purchase accounting benefits as we go throughout the year and no significant change in the short end of the yield curve. Of course the deposit pricing from a competitive stand point as well as the mix of deposits between low cost and term deposits will play a critical role in the level of the net interest margin.

On an average basis, low cost deposits excluding the divestitures grew an annualized 3.8%, helped by new marketing campaigns and shifts in the money market accounts from certificates of deposit. As higher-cost certificate of deposits mature, we are either shifting the funds into lower-cost money market accounts or allowing them to not all, given the limited balance sheet growth and our own willingness to leverage our balance sheet in the current rate environment, we are using cash flows from investment securities portfolio run off to reduce the higher-cost certificate of deposits as they mature.

Average loans declined slightly during the quarter. Linked-quarter annualized commercial loans up however was 8.8%, but it was effectively offset by a drop in commercial real estate outstandings, which reflected not only a reduced demand but an increasingly competitive market and our unwillingness to compromise underwriting standard to capture volume.

In the case of home equity lendings, strong production of $2.59 billion in the quarter was offset by equally high pay downs of $2.61 billion, thus preventing any net balance sheet growth in that product.

For the year as a whole, we now expect minimal loan growth and low single-digit increase in deposits. From a growth standpoint, the banking industry is currently experiencing a challenging environment, but we are convinced that we are doing the right things to position ourselves going forward, trying to strike a good balance between what we provide current return without sacrificing long term profitability.

Turning to credit quality, net loan charge-offs remain low at $54 million, or an annualized 23 basis point of average loans, which is up 3 basis points during the quarter. Our outlook for the full year of 2007 for net loan charge-offs remains in the mid 20 basis point area. Our credit loss reserve as a percentage of loans remains strong in 1.19%, which is a 1 basis point increase from the first quarter.

Non performing assets rose to 62 basis points of loans plus other real estate, primarily driven by commercial real estate loans as a result of weaker demand or condominium in more than four construction projects. Also, in a quarter part of the integration process is been a recognition of our need to make modifications in the combined lending and credit review processes, specifically we implemented a new more prescriptive credit approval process, we placed tighter restrictions on selected types of real estate lending, we began requiring commercial real estate lending specialist to be involved in every commercial real estate loan. We established a more rules-based environment for all lending and credit functions, through increasing standardization especially in small business lending.

We strengthened the overall approval process by requiring the approval of a credit officer in most instances. We separated the sales process from the underwriting and approval functions and finally, we implemented a company-wide credit servicing review of all loans $3 million and above, which we finished this quarter.

Now these changes in the combined company's lending and credit review process coupled with the previously mentioned weaker demand for certain types of commercial real estate projects, led to the increase in non-performing assets in the quarter. We believe that we are adequately reserved for any potential losses on these credits and we are comfortable with our mid-year loan loss reserve level.

Going forward, we are confident that the underwriting-related issues affecting the increase in non-performing assets will not reoccur, given the changes in the approval process that I just described. And importantly, we still expect our net charge-offs to be in the mid 20 basis point level for the year as we previously mentioned.

Now turning to non-interest revenue, Morgan Keegan produced another excellent quarter. The company earned a record $50.1 million, which is $4.6 million above first quarter, on revenue of $328.8 million. Sales were strong across the board, but particularly in the fixed income and equity capital market period. Since closing the merger, we have 118 new offices and our sales force has increased by over 200 in Morgan Keegan in order to more effectively leverage opportunities provided by our expanded customer base.

Second quarter's performance suggest that these actions are already providing solid results. Service charges were also strong, up $13.5 million or annualized 19% linked-quarter growth despite the absence of approximately $7 million of service charges that we recorded in the first quarter related to the divested branches. These little factors along with higher NSF and interchange volume largely explained this increase.

Regions mortgage fees improved slightly first to second quarter, but remained still somewhat weak, given the ongoing market and industry challenges. Additionally, in the second quarter we realized $32.8 million loss of the sale of approximately $1 billion of securities. Without increasing duration we were able to reinvest the majority of these proceeds in higher yielding securities.

Non-interest expenses, excluding merger charges increased $62 million; I am sorry, excuse me, decreased $62 million linked-quarter. Although there were a number of other smaller moving parts, the overall decrease can be attributed primarily to a $38 million mortgage servicing rights recapture and an increase of $33 million in cost saves in the second quarter. The second quarter merger-related cost saves, most of which were personnel-related totaled $84 million, bringing the year-to-date total to $135 million in cumulative cost saves. As Dowd said, we are ahead of plan on 2008 realized cost saves and are likely to exceed the net $150 million run rate from now originally forecast to be achieved by the end of 2007 by as much as $100 million. And this would bring our total net saves to approximately $500 million as compared to the originally estimated $400 million, and we will be keeping you up-to-date each quarter as the year progresses on our cost save benefits.

In addition to the cost saves, we are also very pleased with the level of merger cost that we are experiencing. As you may recall, back at the original announcement of the merger with AmSouth, we estimated that we would spend about $700 million to put up two companies together. We are now confident that we will spend less than that amount, and although this improvement won't entirely hit the bottom line, it is a real savings that would directly benefit our capital.

Finally, efficient use of capital does remain a top priority. During the second quarter, we repurchased 19.7 million shares including a late April accelerated buyback of 14.2 million shares. And this leaves 34 million shares available for repurchase under our current authorization. Our plan is to continue to repurchase shares aggressively in the second half of 2007.

In summary, to be sure, 2007 has had its share of challenges including the effects of the implementation of FIN 48 in the first quarter, lost earnings from divestitures and industry issues like narrowing spreads and modest balance sheet growth. But given the additional cost savings that we have been able to identify and capture along with the actions we've taken to maximize the profitability of our balance sheet, the year is shaping up to be very solid and gives us great confidence as we continue to take advantage of the many opportunities afforded to us by the merger.

Operator, I think we will now be ready to take questions.

Question And Answer

Operator

[Operator Instructions]. Your first question is from Todd Hagerman from Credit Suisse.

Todd Hagerman - Credit Suisse

Good morning everybody. Al, I was just wondering if you could just spend a couple of more minutes just thinking about the margin... you took down the expectation little bit to 380 average for the year. I was just wondering if you could perhaps give a little bit more clarity in terms of the balance sheet repositioning that you did this quarter in terms of the... with the bond sales as well as some of the debt restructure and tie that into the FIN 48 in terms of how that is improving the margin and your outlook there?

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

Okay, I will be glad to. Let me take you through first quarter to second quarter, it's down 17 basis points. We mentioned that about half of that related to the branch divestitures, roughly about 10 basis points of the margin... of the net interest margin decrease. Three basis points or so was related to the balance sheet, the capital activities, the subordinated debt that we did, trust preferreds as well as the share repurchase. So that's about 3 basis points out there. Another piece is the sale of EquiFirst which took place at the end of the first quarter, also had about a 4 basis point impact on the margin in the second quarter. The margin numbers that we reported last time were on full company, they were not based on for continuing operations. But we think they were based on... had everything in there so the EquiFirst impact was in the first quarter so, quarter-over-quarter that's a 4 basis points change.

Now that pretty well explains the 17 basis points as I mentioned 3 of which had to do with the debt and share repurchase activity. Now let's not say there weren't other ins and outs, some offsetting things but that takes care of the 17 basis points. As far as the lowering of the projection from 385 to 380, that's a just a reflection thought of just changes in balance sheet mix as well as the lack of substantial growth right now, but there's change in the mix and the way we're looking at our forward progress on the net interest margin. The current is still flat, real flat and that's also continuing to have some impact on the future months of the net interest margin.

Todd Hagerman - Credit Suisse

I guess what I was getting at was just in terms of... on the balance sheet mix and the debt recast area, assuming that spreads... the balance sheet growth remains basically static and spreads remain within a fairly consistent range, I would think that may be you'd have seen a little bit more... would see some incremental pick up just from the balance sheet actions alone?

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

Well also keep in mind Todd that we... we do have a positive and we missed in this last quarter as well, we do have a positive impact from purchase accounting that diminishes over the course of the year. So that's also weighing against there.

Todd Hagerman - Credit Suisse

Okay. And was there any FIN 48 influence in the quarter again?

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

Well you know that impacted last quarter by 7 basis points, so that is already in there.

Todd Hagerman - Credit Suisse

Okay, alright. Thanks very much.

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

Okay.

Operator

Your next question is from Christopher Marinac from Fig Partners.

Christopher Marinac - Fig Partners, LLC

Thanks, good morning guys. Just want to get a little more sense on your sort of pipe line from past years or maybe even sort of watch list items. Any further deterioration there than what was in the 8-K?

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

No, I mean what we... what we have there is pretty much here. We just went through that company wide credit servicing view and take a hard look at every loan that we have above $3 million, so we've covered most other than nothing, no significant deterioration of any types since then.

Christopher Marinac - Fig Partners, LLC

Do you expect that the level of construction lending that we see that trend lower as a percentage of the portfolio hour rate still for that as we get to the cycle?

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

Well, I think is what you see is reflection of just the market self right now, the demand is slow so a lot of... the construction line we do has about an 18-month cycle. And those things turn fairly rapidly and what we are seeing is there is not as much new coming on as we have rolling off just on a natural basis. And so the market improves, and I think you would continue to see that phenomenon.

C. Dowd Ritter - President and Chief Executive Officer

And Chris and I will add in this environment that you seeing a lot of these projects that still don't have a certificate of occupancy. You are seeing them with some of these new firms being taken to permanent financing, so... but not only do we have lots of volume with new business on the real estate side, we are having the pay downs accelerate which on the commercial side basically wipes out this quarter what would have been 7% to 8% growth on the C&I side.

Christopher Marinac - Fig Partners, LLC

Right

C. Dowd Ritter - President and Chief Executive Officer

On the consumer side it is the same thing. Al gave you the figures in his details. The bad news is there is no balance sheet growth. The good news is that home equity customer has the liquidity and the credit writing to either refinance or pay off and so in spite of good production, we are seeing no growth but also no past due increase.

Christopher Marinac - Fig Partners, LLC

Great. That's helpful. Thanks very much.

Operator

Your next question is from Paul Delaney from Morgan Stanley.

Paul Delaney - Morgan Stanley

Good morning... good morning guys. Just wondering if you could just sort of give us a little more detail on the increase on non-accrual loans, the break up between just a sort of deterioration and the... thinking of its credit policies. Thanks.

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

Paul its kind of hard to delineate which is which in some of these things. Yes, it would be very difficult to do that. What we think we have seen though is that complete review of the portfolio of the large loans, and so we think we captured it as to how much of it was related to the changes in policy or tightening of policy and how much of it was just natural gravitation to NPAs, is very difficult to parch those things.

Paul Delaney - Morgan Stanley

And --

C. Dowd Ritter - President and Chief Executive Officer

Paul, this is Dowd. This part may be helpful I guess from our perspective you heard our reference to that credit review and the combination of ratings around the company. The good news is that 87% of this increase in non-performers came out of one geography with one credit underwriter and from that standpoint, we don't see this as systemic around the system and we feel very good as to the fact that all of these are well secured with real estate. And so we don't think its an alarm for any count huge loss flowing through as a result of it, that's why Al went on to make the comment in his remarks that we're still comfortable with the mid 20 basis points for the full year.

Paul Delaney - Morgan Stanley

And so which geography was that, the 87%?

C. Dowd Ritter - President and Chief Executive Officer

I don't know that... I mean, it's just one particular geography and in welding these up and the rate sinking the rating systems of the two that's just where the majority of this showed up.

Paul Delaney - Morgan Stanley

Okay. And then I am just a sort of curious, once all the merger turbulent sort of dies away, what sort of leverage do you see the bank managing to sort of longer term?

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

We've... we are going through analysis right now on the balance sheet and putting together our strategic plan and we will come to the conclusion on that. We have not reached the target level in our minds yet. Obviously, we are still above peer average, so there is room for that too to slide downward, but we have not determined exactly what that level is

Paul Delaney - Morgan Stanley

Okay. And then just one quick question for Dowd, just Dowd, you mentioned the opportunity leveraging the customer base of the Morgan Keegan platform. What do you see sort of... where do you see the major opportunities over the next couple of years to drive earnings?

C. Dowd Ritter - President and Chief Executive Officer

Wellobviously, if you think back a couple of years and look at what is been happening inside this company, Morgan Keegan has gone from 150 offices to 300 to now we are close to 450 offices and you take the number of registered reps that they are adding. I think getting that stable, its across all of our geographies because they have literally been able to go from the size they were in what I would call, the old Regions world then when the combination of Union Planners they expanded again and now with AmSouth and so we are in the process right now of finalizing a new 3-year strategic plan and I am excited particularly about Morgan Keegan's build it or leverage with so many new offices and new people. And I would also tell you, I don't think they're any where done adding new people for the new size of this company. As opportunities exist to lift out people, you will see them continuing to add experienced brokers into their network

Paul Delaney - Morgan Stanley

Thanks very much

Operator

Our next question is from Gary Townsend from Friedman Billings.

Gary Townsend - Friedman, Billings, Ramsey & Co.

Good morning gentlemen, how are you all?

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

Good morning, Gary

Gary Townsend - Friedman, Billings, Ramsey & Co.

Could you tell me when the credit review process of the new analysis began and you are well satisfied that you aren't closing the door too late then?

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

Well it was the second quarter event Gary and it all took place in the second quarter. And as part of the ongoing efforts, we plan to do two more full reviews covering a lot of same ground throughout the course of this year.

Gary Townsend - Friedman, Billings, Ramsey & Co.

Different, parts of the portfolio or --?

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

No I mean, it covered the whole portfolio. I mean we'll go to --

C. Dowd Ritter - President and Chief Executive Officer

It was every credit $3 million or above and the reason for doing two more is the best of our worlds in the way it really should work is when credit review goes out, they should be validating the ratings assigned by the line credit officers and relationship managers. And this is I would tell you, this first one, obviously in one instance that was not the case and we would hope by the other two that at the end of the processes there is no differences. It's more of an educational and getting everybody on the same methodology for rating their loans.

Gary Townsend - Friedman, Billings, Ramsey & Co.

So, it's possible then that as you do a second and then a third review that you may catch yet further problems. I guess that's an obvious question?

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

Well it is possible but it will only be generally speaking, very new things, you shouldn't expect to see --

C. Dowd Ritter - President and Chief Executive Officer

Even the... no deterioration in the portfolios since the last review.

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

Right.

Gary Townsend - Friedman, Billings, Ramsey & Co.

Okay. Alright, well, thanks. That answers my questions together with the others. Thank you.

Operator

Your next question is from Christopher Mutascio from Stifel Nicolaus.

Christopher Mutascio - Stifel Nicolaus & Company

Good morning all.

C. Dowd Ritter - President and Chief Executive Officer

Good morning.

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

Hey Chris.

Christopher Mutascio - Stifel Nicolaus & Company

Al, I've a quick question and probably it goes back to Todd's original question. I am trying to think this through. If I look at the 17 basis points of margin compression during second quarter, I think you said 10 was the branch divestitures and four may have been relative to the EquiFirst divestiture as well. So those should not I guess cause incremental margin compression going forward from second quarter to third quarter or second quarter to the second half of the year. And yet if I look at your margin outlook, it looks like it's roughly about a 370 outlook for the second half of this year to get to that 384 year estimate. Am I right in that thinking? Is the core margin actually going to come under more compression than we actually saw in second quarter, and if so, what's causing that?

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

Well we think that once again the 380 will be the average for the year. So that will lead you to conclusion that the next two quarters would pull that average down some. But we have two things; one is the continued loss of benefit from the purchase accounting adjustments, so lot of that rolls off fairly quickly.

Christopher Mutascio - Stifel Nicolaus & Company

How much is that a quarter?

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

I have to get back to you on that. It's a diminishing amount throughout the year.

Christopher Mutascio - Stifel Nicolaus & Company

Okay.

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

But we can do that. We'll come back to you on that. The other part of it is just newer business is going on in tighter spreads. So as we roll through the portfolios the spread on new business is not equal to that 380 level.

Christopher Mutascio - Stifel Nicolaus & Company

Okay. Alright, fair enough. Thank you.

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

Okay.

Operator

Your next question is from Kevin Fitzsimmons from Sandler O'Neill.

Kevin Fitzsimmons - Sandler O'Neill

Good morning everyone

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

Hi Kevin.

Kevin Fitzsimmons - Sandler O'Neill

Dowd, can I ask you to just repeat your clarifying comment on the increase in non-performers, I didn't get it. I think you said the bulk of it came from a particular geography, if you could just repeat that.

C. Dowd Ritter - President and Chief Executive Officer

Yes. If you think about it, what we've got... I think we even said it on the first quarter's earnings conference call that during the remainder of the year we were going to have three credit reviews in putting, you will remember the prior quarter we talked about giving the consumer loan policies in sync for the new company. The same thing was taking place in the second quarter with the first company-wide credit review by independent credit review personnel in terms of all commercial loans out there, $3 million and above, commercial and commercial real estate. That process, 87% of the increase in non-performing assets in the second quarter were result of that process and primarily from one geography, and again that's getting everybody on the same rating system. The good part I said about that... which the bad part is to identify them, but I look at them as a good part as well. We now know it, but these are all secured. We have been through every one of these credits and they have good collateral and I would expect the losses to be minimal compared to that amount.

Kevin Fitzsimmons - Sandler O'Neill

Okay. So 87% when you look at the two just natural deterioration and the slowdown in reduced demand for commercial real estate and then it speeds up credit underwriter or credit review process, the bulk of the increase came from the latter.

C. Dowd Ritter - President and Chief Executive Officer

Exactly.

Kevin Fitzsimmons - Sandler O'Neill

Okay. And would you say that... I mean is this just a new tighter approach or is this a... taking the credit review process more over to how Regions did it or how AmSouth did it or none of the above?

C. Dowd Ritter - President and Chief Executive Officer

I would say that, this is more of getting this to the right process for this sized company, being sure that the ratings are the same and I know before somebody called List, I'll just go ahead and tell you that where these were was not the AmSouth Florida real estate portfolio. If that helps you, because I mean I know that would be some of the questions and... but it is just a given out of one particular geography and we are very comfortable that it is a one-time item.

Kevin Fitzsimmons - Sandler O'Neill

Okay, great. Can I also just ask, you guys had in the supplement you referred to a roughly $10 million adjustment to the core deposit intangible amortization which you attributed to the divestiture. Can you just walk through not in full detail, but just the nuts and bolts to what goes into that? What I am really trying to gauge is, how much of that is just cut and drag accounting and how much is pretty discretionary and coming up with that? Thanks.

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

Okay. In that... that amount that you mentioned, also mentioned in the margin impact related to divestitures, that's a reduction in net interest income but it was also reduction in non-interest expense. So it was net-net, no impact. What happened there is we did the... we put the core deposit intangible on back into merger date with an estimate. And as we go through the months and the year we continue to fine tune that estimate and resulting from the sale of the deposits with the divestitures we had to go back and true up our core deposit intangible. And we will continue to true things up throughout the year, the timing on that as we take this information... we have a third party partner who helps us in this review. So there shouldn't be any significant adjustments like this going forward, but we will continue to true that up.

Kevin Fitzsimmons - Sandler O'Neill

So in other words the original estimate didn't have the sale the divestitures baked in so you have to alter it for that?

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

That's correct.

Kevin Fitzsimmons - Sandler O'Neill

Okay, alright, thank you.

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

That's in November 4th so you have to catch up from November 4th to that point.

Kevin Fitzsimmons - Sandler O'Neill

Okay, great, thank you.

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

Thanks.

Operator

Your next question is from Jennifer Demba from SunTrust Bank.

Jennifer Demba - SunTrust Robinson Humphrey

Good morning.

C. Dowd Ritter - President and Chief Executive Officer

Good morning.

Jennifer Demba - SunTrust Robinson Humphrey

I was just wondering if you could give us some more color on where you are seeing the upside in merger cost savings next year?

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

Well, we are seeing a lot of it... most of it is personnel-related. We've been able to take advantage very quickly; consolidating some dispersed operations, as we go through the process we are right sizing every area. We've seen people use this time to do very good analysis as they loose people just to normal attrition as to whether or not they need to replace them and in many cases, people are finding that they can do the function with fewer people. But the majority of it is it's going to be personnel-related, Jennifer.

C. Dowd Ritter - President and Chief Executive Officer

Jennifer if you'll remember at the merger announcement in May of last year, we said there'd be somewhere close to a 10% which we equated to around 3800 headcount reduction. As we finish up the second quarter this year, we're just over 34,00 headcount reductions already achieved and I would tell you we would think we'd be somewhere in the 5000 to 5500 headcounts by the time the convergence are totally complete as we get into the second quarter next year.

Jennifer Demba - SunTrust Robinson Humphrey

Is some of that related to just overall slower overall operating environment and that you don't need as many people?

C. Dowd Ritter - President and Chief Executive Officer

No. Well, some of that is going to be through attrition, but you've got one of the biggest surprises in there. The EquiFirst would have been 1200 to 1300 people of that 5500 I'm talking about.

Jennifer Demba - SunTrust Robinson Humphrey

Okay. Thank you.

Operator

Your next question is from Matthew O'Connor from UBS.

Matthew O'Connor - UBS

Good morning

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

Good morning

Matthew O'Connor - UBS

Could you guys give us a little color in terms of the pace of the buyback for the rest of the year. Obviously, as you mentioned you are sitting on higher capital than others and doesn't sound like you expect much balance sheet growth. So do you think there is some opportunity for more buybacks?

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

Well we will continue to buyback as aggressively as we possibly can. Third quarter, the buyback is impacted because the accelerated share repurchase that we did in the second quarter has to settle. So the pace in the third quarter will be slower until that settles. But over the latter half of the year, we still expect to be very aggressive, as aggressive as we can possibly be.

Matthew O'Connor - UBS

Okay just remind us when is that settling and can you buyback anything in addition to that?

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

Well there is a range of dates, it could settle late second quarter, excuse me, late third quarter and could go out into early fourth quarter. And we have a small capacity to repurchase, but it's fairly small.

Matthew O'Connor - UBS

Okay. And then separately, if you look at your cost savings this quarter; I guess its $330 million run rate or so. You just did some consolidations in closings I believe last week. Do we get the benefit of those actions last week or in the third quarter or so you will see another ramp up in cost saves this quarter or is it will take a little bit of time?

C. Dowd Ritter - President and Chief Executive Officer

That's correct.

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

You'll see some of it, yes, but at the same time we have expenditures related to branch signage and other things as we replace these branches that begin to kick in, in the third quarter as well.

Matthew O'Connor - UBS

Okay. So that was the cost saves go up potentially this quarter or does the reinvestment offset it?

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

Well the... we get cost saves benefits as we go throughout the year and we have merger events. But we do have investments that we'll be making throughout the year as well.

C. Dowd Ritter - President and Chief Executive Officer

But as Al told you, we raised that target for the year from 150 to 250. So taking your second quarter number and annualizing it, you can see there are additional cost saves to come this year.

Matthew O'Connor - UBS

Okay. Alright, thank you.

Operator

Your next question is from Jefferson Harralson from KBW.

Jefferson Harralson - Keefe, Bruyette & Woods

Thanks. Similar expense-related question, can you layout over the next six months that milepost where we should be looking at events that are going to be translating into cost savings? You tend to one... you have mentioned in the late second quarter. Where are the next ones coming up where we should anticipate cost savings coming out of it?

C. Dowd Ritter - President and Chief Executive Officer

October will be our second conversion event and you will obviously... that's when we'll have about another 600 offices consolidate and you will see some things there. All along we are working on procurement improvements, things of that nature. So from a purchasing standpoint and then of course you got the final third event, which I've described earlier would be event four been accelerated into event three which would complete all the branch conversions and at that point, the entire company is on one set of computer systems in one location and you would obviously have some cost reductions there from a technological and facility standpoint.

Jefferson Harralson - Keefe, Bruyette & Woods

Hey thanks and the follow up is on Morgan Keegan. The increase of the fixed income capital markets and the equity capital market this quarter was petty impressive. Can you talk about little bit what drove those increases and you think... you mentioned that the pipeline is pretty quality, you think those increases are sustainable into the second half of the year?

C. Dowd Ritter - President and Chief Executive Officer

Doug Edwards told me it was due to good management, but they are very pleased with their results and I think you have to say a lot of that is attributable to a larger, more diverse, more distributive franchise that they have today. They have seen more opportunities.

Jefferson Harralson - Keefe, Bruyette & Woods

Alright. And on the sustainability, I mean it's a... by nature, a volatile business but it's... you would think it would be volatile around this kind of run rate going forward?

Alton E. Yother - Chief Financial Officer and Executive Vice President, Finance Group

Well as long as the equity markets hold up and that was a good quarter for them there, as long as those hold up, they will continue to do well in that. And fixed income was strong. That has some seasonality volatility to it, but in general their outlook is good.

Jefferson Harralson - Keefe, Bruyette & Woods

Alright. Thanks a lot guys.

Operator

At this time, there are no further questions. Are there any closing remark?

C. Dowd Ritter - President and Chief Executive Officer

Operator, there are no closing remarks. We would just thank everyone on what I know is a busy day for joining us. And we will stand adjourned. Thank you.

Operator

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

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