Regions Financial Corporation Q4 2007 Earnings Call Transcript

Jan.22.08 | About: Regions Financial (RF)

Regions Financial Corporation (NYSE:RF)

Q4 2007 Earnings Call

January 22, 2008, 10:00 a.m., ET

Executives

C. Dowd Ritter – President, Chief Executive Officer

William C. Wells, II – Chief Risk Officer, Senior Executive Vice President

Alton E. Yother – Chief Financial Officer, Executive Vice President

Mike Willoby (sic) – Chief Credit Officer

List Underwood – Investor Relations

Analysts

Kenneth M. Usdin – Banc of America Securities

Christopher Marinac – FIG Partners

Steven Alexopoulos – J. P. Morgan

Kevin Fitzsimmons – Sandler O’Neill and Partners

Casey Ambrich – Millennium Partners

Brag Gitawn (sic) – Citigroup

Operator

Good morning and welcome to the Regionals Financial Corporations quarterly earnings call. My name is Jennifer and I will be your operator for today’s call. I would like to remind everyone that all participants on lines have been placed on listen only. At the end of the call there will be a question and answer session. If you wish to ask a question please press *1 on your telephone keypad.

I will now turn the call over to Mr. List Underwood before Mr. Ritter begins the conference call.

List Underwood

Thank you, Operator, and good morning, everyone. We appreciate very much your participation today. Our presentation will discussion Regions’ business outlook and includes forward-looking statements. These statements may include description of management’s plans, objectives, or goals for future operations, products, or services, forecasts of financial or other performance measures, statements about the expected quality, performance, or collectability of loans, and a statement 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 10K for the year-ended December 31, 2006, subsequently filed Forms 10Q, and the information furnished in today’s Form 8K.

As a 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. Let me also mention 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?

C. Dowd Ritter

Thank you, List, and good morning, everyone. We appreciate you joining us for our fourth quarter earnings conference call. With me this morning are Al Yother, our chief financial officer, Bill Wells, our chief risk officer, Mike Willoby (sic), our chief credit officer. Al will provide a detailed discussion of our quarterly performance in a few minutes, after which we’ll certainly take any questions you may have.

Fourth quarter 2007 was without a doubt the most challenging period that our industry has dealt with in many years given the sharp downturn in the credit cycle and the slowing economic growth. As we disclosed earlier this month, Regions took aggressive steps in the fourth quarter to address the effects of the weakening housing demand on our residential home builder loan portfolio. That included increasing our reserve for credit losses to 1.45% from 1.19%.

At the same time we announced that we would book other pre-tax charges totalling approximately $134 million excluding merger related expense. Primarily due to these actions Regions fourth quarter earnings from continuing operations dropped to $0.24 per diluted share, again excluding the merger cost.

Al will provide financial details about the fourth quarter, but first I want to update you on our current operating environment outlook and how we feel we’re positioned to navigate the current challenges and fully capitalize on our many long-term growth opportunities.

A major benefit of completing our merger integration early and having it behind us is that it allows our strong and talented employee base and management team to fully focus on handling today’s industry challenges while successfully executing the newly adopted three-year strategic plan. During the fourth quarter we successfully completed all of our branch consolidations creating one common customer platform throughout our multi-state organization that should enable us to serve our customers more efficiently and more effectively.

We have a second-to-none product set, industry leading support systems, and highly trained personnel. We’re especially proud of the fact that we retained 87% of our customers going through the integration, which is higher than you would find in a typical bank not undergoing a merger. Further, despite our focus on integration in 2007 our household base has been stable since the merger and obviously, as we enter 2008, we’re shifting our focus to executing household growth strategies in each of our lines of business.

Overall we agree that 2008 is going to be an extremely difficult year for our industry, but we feel convinced that Regions has the tools and the ability to manage through these tougher times. We have been and we will continue to be proactive in recognizing credit quality issues and taking actions to mitigate earnings and balance sheet impacts. For example, last year we launched, I believe it was in March, a customer assistance program to proactively assist our customers who might be experiencing difficulty during these uncertain credit times.

Although we’ve never offer products such as payment option arms, negative amortization loans, or loans with PSA (sic) rates, the loan types that are a current source of much of the industry’s stress, we have actively sought out our customers who might need our help as their mortgage is re-priced. For instance, since early 2007 we’ve been contacting those customers with adjustable rate mortgages six months in advance of their rate reset to discuss their ability to make the increased payments. Once we’ve identified those that might have difficulties we’ve offered them credit counselling both internally as well as through agencies such as Hudd and more recently Neighbourworks.

We’ve also searched our customer base for any that might qualify for the FHA secure home loan program and helped direct them to this option. Actions like these not only help our customers, but they help the bank by reducing delinquency rates in mitigating credit losses.

As you look at specific portfolio metrics, our residential first mortgage portfolio carries a weighted average FICO score of 722 and an average loan-to-value ratio of 68%. For our home equity portfolio those same measures are a FICO score of 733 and an average loan-to-value of 74%.

Providing additional strength to our home equity portfolio those home equity loans that are the highest risk portion of the outstandings about $500 million in second lien lines with loan-to-values over 80%, we fully ensure those against credit losses. Also, all of our home equity portfolio was originated through our branch network; an important point since loans of this type are faring much better in today’s environment than the brokered variety that are causing issues at some of our peers. This is absolutely not to say that these loans are somehow immune to broad economic and market pressures, but we firmly believe we are in relatively good shape and will continue to compare very favourably to industry-wide statistics.

Shifting focus, our commercial real estate portfolio is characterized by good size, product, and geographic diversification. As an indication of its granularity, the average note size within that portfolio is $500,000, our largest five MSA concentrations are each less than 10% of the total portfolio, and although most of our overall loan portfolio – including the bulk of our commercial real estate loans – is generally performing well the one exception is our $7.2 billion residential home builder portfolio which is largely composed of loans to local or regional companies and excludes loans on land, lots, residential spec homes, and PSO residential properties. Additional details about this sector are provided in our financial supplement.

In our review of the residential home builder portfolio we’ve identified about $850 million that we would term relationships that we wish to exit. And we’ve increased the related allowances for inherent losses. We’ve also shifted experienced real estate lenders to oversee and actively manage the portfolio, as well as establishing a detailed proactive workout program. Our specifically tailored workout program calls for frequent borrower contact, continuous local market review, and comprehensive internal analysis in terms of resolution and exit options.

While I’m confident that we now have the right people and the right strategy in place to minimize our losses, we still expect both non-performing assets and loan charge offs to rise this year. In a few minutes Al will give you the amount and the estimated timing of these increases, as well as outline the key assumptions we’ve made underlying these expectations.

In addition to aggressively managing credit risk we’re also very aware of the need to maintain a strong capital base during these uncertain times. Regions is already well capitalized on a regulatory basis with a strong tangible capital ratio. At year end our tangible common equity to tangible asset ratio was 5.88% and we think it prudent to maintain the level at the upper end of our targeted range of 5.50% to 6%. That obviously means that we will probably not repurchase stock over the next several quarters.

Our emphasis on cost containment will also help us weather 2008’s challenges. We will continue to work diligently to further improve our operating cost structure. Merger-related cost saves which continue to exceed our initial targets are providing good momentum and I fully expect that we will see or significantly exceed the $500 million of pre-tax annualized merger cost saves by mid-year 2008. This should enable us to reduce full-year 2008 operating expenses below 2007’s $4.3 billion level despite higher loan workout expenses and ongoing business development investments.

We’ve also begun to focus on a number of new initiatives aimed at retaining and expanding existing customer relationships at the same time that we attract new customer relationships. These initiatives are the result of extensive and recent strategic planning process that provides our leadership a common direction for the next three years and gives us a foundation that we feel to help us successfully manage through this economically challenging period.

On an enterprise basis we particularly focus on leveraging Morgan Keegan’s capabilities with each of our lines of business, growing our emerging and massive fluent customer segment, using a fully integrated approach, increasing core customer deposits, enhancing overall company productivity, and delivering consistent superior service across all lines of business.

Additionally, we’re implementing two initiatives to identify incremental revenue streams and operating efficiencies. Six business forms each lead by line of business and geographic representatives will be responsible for driving these initiatives as well as our overall strategic plan. We plan to leverage the momentum and discipline that we’ve built as a part of our integration efforts to generate early progress and sustain focus on execution of our plans.

In summary, we feel that Regions has the ability, the commitment, and the strategies in place to successfully manage through this current difficult economic and credit cycle. With that, let me turn it over to Al for greater detail.

Alton E. Yother

Thank you, Dowd, and again good morning to everyone. EPS excluding merger charges declined $0.40 third to fourth quarter. A sharply higher loan loss provision was the major region for the fourth quarter’s weak bottom line, although $134 million in pre-tax non-merger related charges also significantly reduced EPS.

During the later part of the quarter our residential home builder loan portfolio was negatively impacted by a significant slowdown in housing demand, which lead to oversupply and declining residential real estate values. As a result, we increased our allowance for credit losses by recording a $358 million provision, which was $251 million above our net charge offs.

The credit cycle has clearly and rapidly turned downward, so credit costs are likely to be a key factor in determining 2008 banking industry profits. Accordingly, I want to spend a few extra minutes updating you on Regions credit quality and outlook, as well as our assessment of market conditions and risks.

Importantly, as Dowd pointed out, Regions loan portfolio is generally performing satisfactorily, except for the $7.2 billion residential home builder segment which represents about 8% of our total loans. Within this segment our greatest asset concentrations are located in Florida and in our east region, mainly in Atlanta.

Indicative of the granularity of the overall residential home builder portfolio, the average note size is $405,000. Non-performing loans represent 3.6% of the total home builder portfolio with the highest concentration being located in Florida and our east geography. The most pressured product types include speculative homes and lots, and they contain the highest concentration of non-performers in this portfolio.

Fourth quarter net charge offs over $1 million in size were approximately $11 million for the residential home builder portfolio as a whole. As you might expect, given the geographies just mentioned, Florida and the east are where the major forces of the write offs with again speculative homes and lots representing the most significant losses by product type.

As Dowd highlighted, we have specifically identified $850 million of residential home builder portfolio loans as exit relationships which will be managed by our special assets department. We’ve already made progress in our efforts to work through this portfolio. Since December 31st of 2006 we’ve reduced our land concentrations by $1.1 billion.

Not surprisingly, about 66% of the $276 million linked quarter jumped in Regions total non-performing assets came from loans to these residential home builders. The residential home builder credits accounted for approximately 10% of fourth quarter’s total net charge offs. We’ve included a schedule in the earnings supplement that details non-performing assets, 90 days past due, and net charge offs by loan type.

Despite the issues with our residential home builder portfolio, it’s important to reiterate that we believe that the majority of Regions’ loan portfolio is in relatively good shape. In fact, home equity – a product which has gotten a lot of industry attention lately – experienced net charge offs that were unchanged late quarter.

We currently expect Regions full year 2008 net loan charge offs to rise to a range of 55 to 65 basis points of average loan compared to fourth quarter’s 2007 annualized 45 basis points. At the same time, non-performing assets which ended 2007 at 90 basis points of loans and other real estate are anticipated to increase 20 to 30 basis points over each of the first and second quarters. They will likely continue to rise in the second half of 2008, but at a slower pace as compared to first and second quarter and could end the year at a range of 1.5% to 2% of loans.

These forecasts assume weakness in residential real estate markets along with continued secondary market weaknesses throughout 2008. The interest rate cuts such as the one this morning, the slightest economic growth, and modest deterioration in our other portfolios.

Now let me address the other financial performance aspects of the quarter. Fully taxable equivalent net interest income dropped $36 million or an annualized 13% linked quarter, reflecting a 13 basis point net interest market decline. The mortgage slippage was in line with our expectations and it was driven by a reduced level of low-cost deposits, an increased (inaudible) purchase, and the full effect of tax deposit we made in the third quarter. In addition, reversals have accrued interest on NTA inflows contributed to the decline. I should point out that both the Bowley (sic) purchase and a tax deposit are credits to net income even though the net interest margin impact was about 5 points negative on a combined basis for those two issues.

Currently we expect some continuing compression on our 2008 margin compared to fourth quarter’s 3.61%. Changes from the 2007 year end level will be influenced most significantly by the rate of growth in low-cost deposits, the composition on the earning asset mix, the level of non-performing assets, and the shape of the yield curve. Since we are slightly asset sensitive, today’s fed rate cuts will impact us somewhat negatively as well, but less than 1% of our net interest margin.

As expected, average loans grew a modest 2% annualized third to fourth quarter, although there was an uptake to an A-loans 5% at the quarter end. Notably, we have now completed all of our conversion related portfolio reclassifications, so this will improve the loan transparency going forward as all loans as of the end of the year are in the right classifications.

On a linked-quarter basis, fourth quarter’s total average deposits were a little unchanged. However, we did experience a shift from lower cost deposits into foreign deposits and large certificates of deposits.

Non-interest income excluding securities transactions grew a strong annualized 16% from third to fourth quarter. We saw particular strength in brokerage income benefitting from seasonal factors, but also indicative of the progress being made in deepening customer relationships, as well as attracting new customers. Additionally, interest rate volatility continued to boost the level of customer derivative transactions, which is a positive for commercial credit fees.

Our decision to increase bank-owned life insurance accounted for nearly $7 million of the linked quarter gain and core fee-based revenue. Full affect is the additional Bowley purchases will flow through and be reflected in 2008’s first quarter. The late quarter decrease in mortgage income reflected a $4.4 million loss on the sale of a small out-of-footprint portion of our servicing portfolio. Other income also includes $9.4 million in impairment charges related to tax preference from low-income housing investments.

Service charges also rose very nicely at an annualized 6% linked quarter, primarily due to seasonal rise in overdraft and NSF activity.

Taking a look at Morgan Keegan’s performance, revenue increased $32.5 million third to fourth quarter reflecting strength in the fixed income capital market activity as well as in higher private client revenues. However, a $38.5 billion loss on investments in two Morgan Keegan mutual funds caused earnings to decline overall versus the prior quarter.

Our investments, which are carried as of yearend at a market value of about $65 million, were made in order to provide liquidity to support the funds. These total mutual fund balances totalled $324 million as of December 31st, which is down from $2.1 billion at June 30th, 2007.

We’re satisfied with the headway we’re making with Morgan Keegan in expanding customer relationships. For example, during fourth quarter Morgan Keegan opened 21,000 new retail customer accounts compared to 17,000 a year earlier. All in all, we are very optimistic about Morgan Keegan’s 2008 growth prospects given its current momentum and healthy capital markets transaction backlog.

The linked quarter increase in fourth quarter non-interest expenses excluding our merger cost was largely driven by $120 million of the items that we had recently outlined in our January 3rd call. The balance of the pre-tax number and charges were recorded as offsets to non-interest income. The expense items include $38.5 million mutual fund investment loss at Morgan Keegan, which I just mentioned, $51.5 million related to our ownership fees (inaudible) lawsuit exposures, $23 million of mortgage servicing impairment, and $7 million in foreclosed real estate write downs. The proceeds from VISA’s planned ITO in 2008 should more than offset the $51 million VISA related charge that we took in the fourth quarter.

In addition to the audits outlined in early January, fourth quarter expenses were affected by higher commissions directly related to Morgan Keegan’s strong revenue generation and an increase of legal and other professional fees. Additionally, we invested in new marketing campaigns, as well as opened 21 new branches in the fourth quarter.

The completion of our branch conversions drove fourth quarter merger cost saves to $108 million bringing year-to-date cost saves to $345 million. As Dowd stated, this gives us confidence that we will exceed our revised goal of $500 million, versus the $400 million originally forecast at our merger announcement, by the mid-point of 2008.

For the full year of 2007 core operating expenses totalled $4.3 billion, which is in line with our year-ago January forecast of $4.1 billion to $4.3 billion. Assuming the full flow through of merger cost saves by midyear and ogling efficiency initiatives, 2008 expenses excluding the merger charges are expected to decline by 4% to 7% in 2008 versus 2007.

The fourth quarter’s effective tax rate excluding merger charges dropped to 26%, reflecting our additional Bowley purchase and an overall increase in the relative portion of tax free to total taxable income. Our 2008 tax rate is anticipated to return to more normalized levels of approximately 32%.

We repurchased 3.8 million common shares during the early part of the fourth quarter, but pulled back as the quarter progressed. As Dowd said, we’re putting our buy-back program on hold for now. In today’s uncertain environment it’s especially important to maintain a strong capital base and with this in mind we strengthened our risk-based capital during the fourth quarter by issuing $300 million of long-term debt. Our tangible equity to tangible assets ratio remains strong as well, ending the year at 5.88%.

To sum it up, it was a tumultuous fourth quarter. With the actions taken we believe that Regions is prepared to deal with industry challenges in 2008.

Operator, we would now like to open the questions.

Question-and-Answer Session

Operator

At this time I would like to remind everyone, if you would like to ask a question press *1 on your telephone keypad. Our first question comes from Steven Alexopoulos from J. P. Morgan. Your line is now open.

Steven Alexopoulos – J. P. Morgan

Hi, good morning, guys. First question related to the fed cuts we’re seeing, could you just expand a bit on the margin commentary you gave and how should we think about the basis point impact to the margin here from what’s going on with the feds year term?

Alton E. Yother

What I mentioned to you is a sold out less than 1% impact to the net interest margin. We don’t give specific guidance on the net interest margin percentage. We do see that we will get some continued compression for the year, but we don’t expect it to be anything like what you saw this past year. We do have some continuing compression but ...

C. Dowd Ritter

Steven, that less than 1% that Al is referencing, that comes directly out of our Alco (sic) and our monthly modeling and that’s where a cut of this magnitude would show. That’s why that number was thrown out. All of the things being equal.

Steven Alexopoulos – J. P. Morgan

Are you saying 1% of your net interest margin or your net interest income?

Alton E. Yother

The net interest income.

Steven Alexopoulos – J. P. Morgan

Oh, income. Okay. That clarifies that. Looking at the $850 million of the home builder loans that are now in the special assets group, how quick do you think you could run that down over the next several quarters?

C. Dowd Ritter

Well, part of the reason – and I’ll let Bill Wells, our chief risk officer, comment – one of the things in the assumptions that Al covered is this secondary market staying like it is. There’s a pretty good bit of liquidity out there if we wanted to get these off the books at $0.40 to $0.50 on the dollar and we just said we’re not willing to do that. Thus the non-performers grow a little bit. Bill, you might want to expand on that.

William C. Wells, II

Yes, Steven, what we did was we have identified problem credits we’ve put in the first part of November in ’06 a pretty robust problem loan identification program. We’ve been identifying problem credit and have identified the $850 million. We take it by individual deals and look to see how we work out of credit. Some of these are not what you’d call problem credits. These are ones that we have identified as may have some stress and we think we can turn around and work through the cycle. As Dowd mentioned, we think we may have to take them on as non-accrual right now, but we do not believe that we see the loss potential what the market is currently giving us.

Steven Alexopoulos – J. P. Morgan

And Dowd, just a final question. How are you thinking about loan growth in ’08 given you need here to preserve capital?

C. Dowd Ritter

Well, when I talked about preserved capital it’s obviously stopping the share repurchase part of it. But we saw a little loan growth in you annualize it there in the fourth quarter. I would hope that, you know, who can predict in this operating environment what’s going to happen, but executing just our basic focus in on each of our lines of business I would hope to see on the consumer side and on the commercial line some low single-digit loan growth and that’s kind of what we’re counting on is so many people that were focused throughout this organization on conversions and mergers instead of, if you think to the original plan laid out at announcement would have had us working on mergers and conversions until mid-year. We’re now complete, so we enter into 2008 with thousands of people that were working on the merger back focused on their customer and growing their business. I feel that even in these times that gives us a pretty good head start compared to last year.

Steven Alexopoulos – J. P. Morgan

Great. Thanks guys.

Operator

Your next question comes from Casey Ambrich from Millennium. Your line is now open.

Casey Ambrich – Millennium Partners

Hi. Thanks very much for taking my questions. Sorry if you’ve already answered as I was on another call. Can you just kind of go through and update us and see if you have any more information on that $7.5 billion residential builder book? Do you have kind of updated LTVs and appraisals?

C. Dowd Ritter

I’ll tell you what we might do, Casey, because we did go through that in the call, why don’t we have List Underwood give you a call and do that off line so everybody else won’t hear it again.

Casey Ambrich – Millennium Partners

Okay. What about, I’m moving on, what about reserve the loans? What’s a good target ratio we should think about right now?

C. Dowd Ritter

Okay, we covered that as well and so –

Casey Ambrich – Millennium Partners

Okay, then I’ll follow up.

C. Dowd Ritter

Okay.

Casey Ambrich – Millennium Partners

Thanks very much.

C. Dowd Ritter

He’ll give you a call.

Operator

And your next question comes from Ken Usdin. Your line is now open.

Kenneth M. Usdin – Banc of America Securities

Thanks. Good morning. I just actually do want to follow up on the reserves to loans. Could you just walk us through, you’ve given us some idea about where charge offs are and where MPAs are going, but I might of missed it then where you’re talking about how much you might need to additionally provide. Also, how do you get to a level where you anticipate being comfortable with that type of reserve level?

C. Dowd Ritter

Ken, we’ve gone through this calculation and it’s a very detailed calculation. We’ve arrived at this level based on all the factors that we look at. Unless those factors change significantly the levels that we are at at the end of the quarter should be a fairly respectable level. If factors change we’ll come back and we’ll let you know as the year progresses, but right now we will be covering charge offs and maintaining those reserves at reasonable levels compared to where they are right now.

Kenneth M. Usdin – Banc of America Securities

One follow up to that, but doesn’t the increase in non-performers that you’re expecting also invoke higher provisioning, much less what might be going on below the surface as far as incremental reserving patterns? So the banks are always saying we can’t necessarily take it all and get to a point, so why wouldn’t you have to continual to incrementally provide?

William C. Wells, II

Ken, this is Bill Wells. What we do is we take a pretty detailed analysis of our problem loan portfolio, really of our whole portfolio. We’re looking out up to 12 to 18 months ahead and based on what our best projections of looking (inaudible) non-performing assets, as well as our charge offs and exposure, what we think we’ll have is a non-performing asset. We believe that the provision that we made sets us in a very good range of where we see the portfolio in the next 12 months or so.

Given market conditions, you always have to come back and revisit that, but I don’t know seriously that our non-performance assets going up if you can relate that directly to more provisionings unless you start to see some trends that are happening within those individual credits.

Kenneth M. Usdin – Banc of America Securities

Okay. Okay, I think I understand. And one more question just on the home equity side of the book taking your comments already that you’re relatively comfortable about the fact that they were put in for an in branch and had relatively good metrics. Can you give us some discussion about the extent of deterioration that you are expecting in that book as just either normal seasoning occurs and your expectations for home prices from here?

C. Dowd Ritter

I’ll start first with the home equity. One of the things that I’ve been impressed, I’ve been with the company three years and how we actually do our underwriting, the process we go through as far as looking at individuals and making our home equity loan, and what has happened over the past year or so you’ve proven that quality has held up relatively well. You’ll probably start to see some past dues going up a little bit in the home equity book, but I think that would be normal indication of what we’ve seen in the industry and we believe why the credit people always say you have to wait and see what unemployment does and what that may affect your market or your book of business. We feel very good about how we stand up relatively to what we’re seeing elsewhere in the industry.

As far as home prices, the weaknesses that we’ve seen really have come out of the Florida area that we talked about earlier in January, as well as the Atlanta area for our residential book of business. And with them particular we’ve seen some pressure in the Fort Myers area as well as somewhat around the Miami area, and then also Atlanta.

Kenneth M. Usdin – Banc of America Securities

Okay. And if I could also just clarify Al. Your comment before that expenses should be down 4% to 7%, are you using the four-three full year as the comparison to that ex the merger charges?

Alton E. Yother

Yes.

Kenneth M. Usdin – Banc of America Securities

So we’re talking like four to four-two.

Alton E. Yother

That would be about right.

Kenneth M. Usdin – Banc of America Securities

Okay. Thanks a lot.

Operator

Your next question comes from Kevin Fitzsimmons from Sandler O’Neill. Your line is now open.

Kevin Fitzsimmons – Sandler O’Neill and Partners

Good morning, everyone. Just two quick questions to clarify. First on the $850 million that’s getting transferred into special assets. Are those already in non-performing status or what, if you can reconcile that with what’s going on non-performing with it. And then secondly if you can just touch on following up on Ken’s question on home equity, can you give us a sense for what’s branch originated, what’s broker originated, and what if any difference you’re seeing performance of those loans?

William C. Wells, II

On the $850 million, I don’t think, what I would say is it’s a combination of credits we have identified that are not all non-approvals. Those are, I forgot to percentage of those that may be, but we went back, Kevin, and looked at the whole portfolio, residential portfolio, and identified which credits that we thought might need some additional help through this cycle. So some of those had been transferred to special asset. Those that had been transferred to special asset. Some are what we consider problem credits that have well-defined weaknesses. But those some may not be non-accruals, as well as some of them are past loans right now that we feel very good about the borrowers, but we might need to take some other type of action again to help them through this credit cycle. Kevin might talk about the home equity, too.

Mike Willoby (sic)

This is Mike Willoby. I’ll just comment on this $850 million. About two-thirds of that is in special assets and would be problem loans. The other third is imminently going in but would not be considered proper loans. They’d be exists for some other reason. The non-performing piece is about 3.5%. So it’s a sub-set of that two-thirds that’s in special assets.

Kevin Fitzsimmons – Sandler O’Neill and Partners

The non-performing is 3.5% of that particular portfolio.

Mike Willoby (sic)

Of the $850 million.

Kevin Fitzsimmons – Sandler O’Neill and Partners

Okay. And then if you could just touch on the home equity.

Mike Willoby (sic)

Could you ask that question again? I didn’t hear it.

Kevin Fitzsimmons – Sandler O’Neill and Partners

I was just following up on Ken’s question. It seemed that that’s an asset class that we’ve heard about problems coming. It seems prudent to assume you’re going to see some deterioration there and particularly some companies have seen problems on the more broker originated channel than branch originated. If you could give us some colour there and just generally what’s making you sleep at night with that portfolio.

Mike Willoby (sic)

Well, we don’t have anything that we don’t originate ourselves, so there’s no broker channel in the equity book. The second thing is that we’re what I call a true-to-the-cycle underwriter. Meaning that we expect to be in that business through an entire economic cycle and part of our goal is to manage the lost volatility in that portfolio. One of the reasons as Al had mentioned for our (inaudible) second position book we ensure anything we originate where the credit score is under 740. And that’s, as you know, you’re going to find the most volatility of results at this point. Frankly, it’s why our portfolio is flat linked quarter when others are not. Now, we will, as the cycle goes through we will not be immune, but I think you’re going to see ours behave much more like it has and any increase will be gradual than as opposed to some others that you’re looking at today.

Kevin Fitzsimmons – Sandler O’Neill and Partners

Is there any reason to be concerned with, you mentioned that you insure the high LTV loans in home equity. Is there any reason to be concerned about the entities that are insuring those given what’s happening in the environment?

Mike Willoby (sic)

It’s a sub of a still very well rated company. We have one insurance provider and they have been, I would say, the star through the last 10 years of insuring home equity. No, we’re not concerned about it.

Alton E. Yother

I’d also add, too, Kevin that this high LTV, which is a small percentage of our portfolio, is usually to our private client route, which are well seasoned borrowers. So insurance is an add on factor that we decided to take because of a high LTV factor. But the underlying borrower is a very solid customer.

C. Dowd Ritter

Kevin, let me give you a couple of specifics – this is Dowd – in terms of your comment how can you sleep at night with this. A third of the accounts have first lien key locks. In other words, they’re not second mortgages. A third of those outstandings we have the first mortgage on it. The second point made earlier is the high FICO and the low loan-to-value at 75%. But I’m thinking, you know, full disclosure, that’s giving you the worst case. That’s 75% loan-to-value if those lines are fully drawn. They’re not fully drawn and I guess today on that portfolio you’d have about a 42% loan-to-value. So there is an awful lot of room and over half that portfolio was underwritten 2005 or earlier. So there’s some good seasoning to that portfolio.

Kevin Fitzsimmons – Sandler O’Neill and Partners

Just to follow up on that, Dowd, can you be, based on what you’ve seen happen in certain markets, can you go out and try to bring some of those lines in? Contract them, just to prevent risk going forward from this point?

C. Dowd Ritter

You mean, of our existing lands would we want to do something to shorten their life or cancel them or something?

Kevin Fitzsimmons – Sandler O’Neill and Partners

Right. Do you have, you know, it’s been talked a lot about just industry wide that with what’s happened with the values of the properties that it might represent an event that would allow you to go in and actually reduce the line. I know that would be something you’d have to weigh customer by customer, but –

C. Dowd Ritter

We always look customer by customer, but as we just said, we don’t have that 90% to 100% loan-to-value that are now under value. The ones that we do, as Bill Wells said, are generally our private banking clients. So we just haven’t seen any of that whatsoever. We are still through our employees and branch networks, we still are interested in home equity loans under the same terms and conditions that we’ve just described.

Kevin Fitzsimmons – Sandler O’Neill and Partners

Okay. Great. Thanks guys.

Operator

Your next question comes from Brag Gitawn (sic) from Citigroup. Your line is now open.

Brag Gitawn (sic) – Citigroup

Good morning. A couple of questions. One, I’m sorry to take you back to the reserve again, but maybe more of a hypothetical question around the reserve. You built it to 1.45% of loans and realizing trying to calculate the reserve is very difficult to do, but if your trends play out as you expect in 2008 with charge offs going to 55 to 65 basis points, is it possible that you’ve added to the reserve, brought out the 145, and then as you work your way out through 2008 everything behaves as you expect that you could actually draw down the 1.45%?

Mike Willoby (sic)

Well, I guess it’s possible, but in this environment I don’t think that’s probable. Until we get further into this year and see what’s happening with the economy and see if our expectations play out as we have, I don’t think that’s very likely.

Brag Gitawn (sic) – Citigroup

Okay, so I’ve had a situation where you’ve put aside reserves, now you can charge off against those, realizing that’s probably an oversimplification of reserving. Is that a situation where you can sit outside up front and then draw against them as 2008 progresses and everything is progressing to your expectations.

C. Dowd Ritter

That’s why Al said it that way and covered the assumptions that were made in terms of the non-performers increasing, in terms of the charge offs increasing into that 55 to 65 basis point range, and that continuing throughout 2008 those were the assumptions we made in taking that reserve and that’s what’s modeled in there. Obviously if things worsen or improve that changes, either way that changes the possibilities.

Brag Gitawn (sic) – Citigroup

Sure. I understand. Thank you. On the commercial net charge off, just looking at the CNI portion, they were up to 49 basis points in the fourth quarter. Is that a signal of maybe a trend or is that something that is more seasonally related.

Alton E. Yother

What I’d say is don’t necessarily look at the percentage because you have a shift or some reclassification of the numbers from the commercial loan portfolio. What I looked at was just the dollar increase and when I wrote that down there were probably three things that I saw. One, we had an isolated large (inaudible) that we dealt with. I didn’t see anything that would be systematic throughout our portfolio. The others, which I think was a very good risk practice, we shut down our Regions wholesale funding line, which was about a little over $3 million of that increase. The rest of it really came out of business banking, which I would tell you based on where we are in the industry and what we’re going through and the economy, that was part of the loss, too. Another thing that would alarm me one way or the other.

Brag Gitawn (sic) – Citigroup

Okay. Great. Thank you.

Operator

Your next question comes from Christopher Marinac from FIG Partners. Your line is now open.

Christopher Marinac – FIG Partners

Thanks. Good morning. Dowd, I wanted to ask you now about expected loss rates on some of these construction areas, particularly the land area. If we were to try to be conservative and wanted to expect future losses from those, what’s a fair rate?

William C. Wells, II

I’m glad you asked that now. Chris, we started back earlier in the year looking at our land portfolio. One thing that I don’t think the company has really gotten credit for is we identified from a risk perspective the land exposure with the combined company and actively have reduced that over $1 billion over the year. What we also did is tried to go to market and sell some of the land on the front end, before the market really had turned. We were probably looking at an 8% discount. As we got through the process that number had gone up to 15% to 20%. Now what you’re seeing in the market if you tried to go to market now, Chris, it could be up to, as Dowd had mentioned, 40%. Now that still depends on the individual properties, location, the current build out. So it would be very hard to look. We look at them individually and when we start to see there’s trouble then that’s what we do is move it to non-accrual.

What we’re looking at right now is looking at our non-performing go up, but not necessarily taking a full exposure liquidation value of those properties. I think that’s very hard to model in. What I would do is take what Al had given you, talked about what our charge off range would be, and that is factored in.

Christopher Marinac – FIG Partners

Okay. Very good. And then in terms of a pipeline of future issues, do you have clients that are still on interest reserves that may have those expire and therefore there’s new (inaudible) three to six months?

Alton E. Yother

There could be one or two. It’s certainly possible. We’re expecting some more divulged, but as I look at the portfolio and look at what we don’t have, I’m sitting here thinking we don’t have sub-prime, we don’t have any option arms, we don’t have any reverse end mortgages, we don’t have any exposure to sivs (sic). Yes, there will probably be a little bit of deterioration, but I think we’ve talked about the one- to four-family builder portfolio because that really is our concentration.

William C. Wells, II

And also, too, interest reserves as you’re picking up on is one of your key indicators. You’re looking at how long your interest reserves will go and that is what we’re factoring in as a projection of our non-accruals to. Also what I would tell you is our early identification of these credits, moving them into an exit strategy, is exactly doing that. It is identifying these credits that we think may have some stress on those and trying to figure out ways we can work with a customer to make sure they can, as we’re doing, manage through this tough economic cycle.

C. Dowd Ritter

Our best options, and I think somebody had asked earlier about exiting, our best options to exit will be to identify credits very early on and that’s what this whole program is about.

Christopher Marinac – FIG Partners

Great. Thanks for the colour. Appreciate it.

Operator

There are no further questions.

C. Dowd Ritter

Thank you, Operator, and thank you, everyone, for joining us and we will stand adjourned.

Operator

You may now disconnect your lines.

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