RF Stock | Regions Financial Corporation Q1 2022 Earnings Call

Good morning and welcome to Regions Financial Corporation's quarterly earnings call. My name is Jamaria and I will be your operator for today's call. I would like to remind everyone that all participant phone lines have been placed on listen-only. At the end of the call there will be a question and answer session. If you wish to ask a question, please press star one on your telephone keypad. I will now turn the call over to Dana Nolan to begin.

Thank you, Jamaria. Welcome to Regions First Quarter 2022 Earnings Call. John and David will provide high-level commentary regarding the quarter. Earnings documents which include our forward-looking statement disclaimer and non-GAAP information are available in the Investor Relations section of our website. These disclosures cover our presentation materials, prepared comments, and Q&A. I will now turn the call over to John.

Thank you, John. Let's start with balance sheet. Average loans grew 1.5% while ending loans grew 2% during the quarter. Average business loans increased 3% reflecting broad-based growth in corporate, middle market, and real estate lending across our diversified and specialized portfolios. While still below pre-pandemic levels, commercial loan line utilization levels ended the quarter at approximately 43.9%, increasing 160 basis points over the prior quarter. Loan production also remains strong, late quarter commitments up approximately $1.6 billion. Average consumer loans declined 1% as increases in mortgage and other consumer were offset by declines in other categories. Within other consumer, Interbank loans grew approximately 2% compared to the fourth quarter. Looking forward, we expect full year 2022 average loan balances to grow 4% to 5% compared to 2021. And excluding PPP loans and consumer exit portfolios, we expect full year average loan balances to grow 9% to 10%.

So let's turn to deposits. Although the pace of deposit growth has slowed, balances continued to increase seasonally this quarter to new record levels. Average consumer and wealth management deposits increased compared to the fourth quarter while corporate deposits remain relatively stable. We are continuing to analyze our deposit base and pandemic related deposit increases. Approximately 35% of the increase, or $15 billion, is expected to be more stable with behavior similar to our core consumer deposit book. This segment is historically quite granular and generally rate insensitive, and therefore can be relied upon to support longer term asset growth through the rate cycle. The remaining 65% of the deposit increases is a mixture of commercial and other customer types that are expected to be more rate sensitive or that we are less certain about their long-term behavior. We assume this segment may have all-in beta of roughly 70%. This elevated beta assumption includes relationship repricing and some balances shifting from non-interest to interest-bearing categories. It also reflects a range of $5 to $10 billion of balance reduction attributable to tightening monetary policy. The combination of these segments and our legacy deposit base represents significant upside for us as rates increase.

So let's shift to net interest income and margin. Net interest income was stable quarter over quarter. Excluding reduced contributions from PPP, net interest income grew 2%, benefiting from solid loan growth and rising interest rates. Net interest income from PPP loans decreased $27 million from the prior quarter and will be less of a contributor going forward. Approximately 93% of estimated PPP fees have been recognized. Cash averaged $27 billion during the quarter and when combined with PPP reduced first quarter's reported margin by 58 basis points. Our adjusted margin was 3.43%, higher by nine basis points versus the fourth quarter. The path for net interest income enters the second quarter with strong momentum for both balance sheet growth and higher interest rates. Excluding PPP, average loan balances grew 2% in the first quarter and a similar amount of growth is expected next quarter. Roughly $1.5 billion of securities were also added late in the quarter, further benefiting future periods. The recent run-up in rates has certainly validated our decision to wait to deploy into securities, and while not included in our current outlook, additional securities would provide incremental benefit. Higher short and long-term interest rates provided additional lift to net interest income in the first quarter, and these benefits are expected to expand in the coming quarters. Total net interest income is projected to increase 5% to 7% in the second quarter and is expected to accelerate throughout the year such that the fourth quarter net interest income is expected to be approximately 15% higher than our first quarter. Regions' balance sheet is positioned to benefit meaningfully from higher interest rates over the first 100 basis points of rate tightening. Each 25 basis point increase in the federal funds rate is projected to add between $60 and $80 million over a full 12 month period. This benefit is supported by a large proportion of stable deposit funding and a significant amount of earning assets held in cash, which compares favorably to the industry overall. Over a longer horizon, a more normal interest rate environment, or roughly a 2.5% fed funds rate, will support our net interest margin goal of approximately 3.75%. While we have purposefully retained leverage to higher interest rates during a period of low rates, we will attempt to manage a more normal interest rate risk profile as the interest rate environment normalizes. The Fed's aggressive path for interest rates gives us the opportunity to protect NII at attractive levels. We have begun this process by adding $4.7 billion year-to-date of forward starting receive fixed swaps and $1.5 billion of spot starting securities. This represents approximately 30% of the total hedging amount needed this cycle.

Now let's take a look at fee revenue and expense. Adjusted non-interest income decreased 5% from the prior quarter primarily due to reduced HR asset valuations as well as lower capital markets and card and ATM fees. Within capital markets, M&A advisory activity was muted by seasonality as well as the timing of transactions. Pipelines remain robust but some deals have been pushed to later in the year. Additionally, debt and real estate capital markets were impacted by uncertainty surrounding rates, geopolitical tensions, and volatility in credit spreads. However, we are seeing some stabilization in the loan and fixed income markets and anticipate conditions will improve in coming quarters. Further, the reduction in real estate capital markets activity was offset by the addition of Sabal Capital Partners for the full quarter. Similar to the corporate fixed income market, refinance demand has been softer than expected in our agency multifamily finance business as investors assess a significant move in interest rates. We continue to expect capital markets to generate quarterly revenue of $90 to $110 million excluding the impact of CVA and DVA. While we expect to be near the lower end of the range next quarter, we expect activity to pick up in the second half of the year. Card and ATM fees reflect seasonally lower interchange on both debit and credit cards. In addition, debit card fees were further impacted by fewer days in the quarter. Mortgage income remained relatively stable and included approximately $12 million in gains associated with previously repurchased Ginnie Mae loans sold during the quarter. While mortgage is anticipated to decline relative to 2021, it is still expected to remain a key contributor to fee revenue. Wealth management income also remains stable this quarter despite elevated market volatility. Service charges were also stable during the quarter despite seasonal declines in NSF and overdraft related fees. The first phase of previously announced NSF and overdraft policy changes were effective at the end of the first quarter, and the remaining changes will be implemented over the second and third quarters. These changes, when combined with previously implemented changes, are expected to result in full year 2022 service charges of approximately $600 million, and full year 2023 service charges of approximately $575 million. We expect 2022 adjusted total revenue to be up 4.5% to 5.5% compared to the prior year, driven primarily by growth in net interest income. This growth includes the impact of lower PPP related revenue and the anticipated impact of NSF and overdraft changes.

So let's move on to non-interest expense. Adjusted non-interest expenses decreased 4% in the quarter driven by lower salaries and benefits expense and professional and legal fees. Salaries and benefits decreased 5% primarily due to lower incentive compensation, despite higher payroll taxes and 401(k) expense. Salaries and benefits also include the favorable impact of lower HR asset valuations. Professional legal fees decreased significantly as elevated fees associated with our bolt-on M&A activity in the fourth quarter did not repeat. We will continue to prudently manage expenses while investing in technology, products, and people to grow our business. As a result, our core expense base will grow. We expect 2022 adjusted non-interest expenses to be up 3% to 4% compared to 2021. Importantly, this includes the full year impact of recent acquisitions as well as anticipated inflationary impacts. We remain committed to generating positive operating leverage in 2022.

Overall credit performance remains strong. Annualized net charge-offs increased one basis point to 21 basis points. Non-performing loans continued to improve during the quarter and remain below pre-pandemic levels at just 37 basis points of total loans. Our allowance for credit losses decreased 12 basis points to 1.67% of total loans, while the allowance as a percentage of non-performing loans increased 97 percentage points to 446%. The decline in the allowance reflects ongoing improvement in asset quality and continued resolution of pandemic issues, partially offset by loan growth and general economic volatility associated primarily with inflation and geopolitical unrest. The allowance reduction resulted in a net $36 million benefit to the provision. We expect credit losses to slowly begin to normalize in the back half of 2022 and currently expect full year net charge-offs to be in the 20 to 30 basis point range. With respect to capital, we ended the quarter with our common equity tier 1 ratio modestly lower at an estimated 9.4%, and we expect to maintain it near the midpoint of our 9.25% to 9.75% operating range. So wrapping up on the next slide of our updated 2022 expectations which we've already addressed, I do want to point out that these expectations do not include any additional security purchases, so that certainly provides the opportunity for incremental benefit. In closing, as John mentioned, we began 2022 with great momentum and despite geopolitical tensions and market uncertainty, we remain well positioned for growth as the economic recovery continues. Pre-tax, pre-provision income remains strong. Expenses are well controlled. Credit risk is relatively benign. Capital and liquidity are solid. And we are optimistic about the pace of the economic recovery in our markets. With that, we're happy to take your questions.

Thank you. The floor is now open for questions. If you have a question, please press the star key followed by the number one on your touchtone phone. If at any point your question is answered, you may remove yourself from the queue by pressing the pound key. We'll pause for just a moment to compile the Q&A roster.

Your first question comes from the line of Ryan Nash with Goldman Sachs. Please proceed with your question.

Hey, good morning John, good morning David. Good morning. I'm hoping maybe you could talk about expectations for deposit growth which came in better than expected, and particularly as it pertains to the surge deposit. So maybe just how you're thinking about the trade-off between keeping some of these deposits and the potential for a higher beta. And I think David you highlighted a potential for a $5 to $10 billion reduction. Can you maybe just clarify how much you expect for these to stick around and what it means for deposit growth?

Sure. So we were, we had expected that $5 to $10 billion of deposits to start flowing out in the first quarter. We maintained some pretty conservative deposit assumptions but, if you look at the growth and where it came from, it was in our consumer book. We continue to grow accounts and continue to have a high level of privacy with our retail customers. And so our deposit base is our competitive advantage and it's been that way for a long time, and we're looking to leverage that as we get into this higher rate environment. As you think about the surge deposits, we have a third of those that we think are going to be fairly similar to our legacy deposits in terms of rate, price insensitive. Then we have the other third on the other end — we think are much higher beta, 80% to 100% beta. Those are corporate deposits that are non-operational deposits that are probably going to look for a better home or a higher rate as time goes by. We'll see what happens after the next rate increase, but we've expected that to either reprice or really flow out of the bank. And then you have in the middle which is another third, deposits that are stimulus receiving deposits, small business type deposits. That one's a little harder to predict. We do have a higher beta on it, not as high as the second group but any event. If we're wrong on the $5 to $10, it's likely that we've maintained our deposits at a higher level. And over time if we see that, then that gives us a little more comfort to be able to take some of our excess cash that we have, some $26 billion sitting on the balance sheet, to deploy that into the securities book. But our guidance that we're giving you does not have that deployed intentionally.

Got it. And, you know, if we could dig a little bit into the new hedging program. So they haven't had enough Darrin's in the room I guess, you guys were the masters of adding swaps at a timely manner last cycle and now you've begun this new program. So I think the market is having a little bit of trouble understanding why banks are adding swaps at this part of the cycle, and I think all of us understand, so can you maybe just talk about thoughts regarding locking in here, particularly using forward starters, and I think you talked about another 10 to 12 of additions. Can you maybe just talk about pacing and why this is the right decision at this point in the cycle for Regions? Thanks.

I'll go ahead and start and Darren is here and he can add to it. But you hit on a key word, and that is forward starting. And so what we're trying to do is get our margin to the optimum level and then layer in protection for that margin over time. So if you look at where we put the first, call it $4.7 billion in, that's at a received fixed rate of 232. Those are largely going to be effective for 2024. So we intentionally had them forward starting because we believe there's risk at that point in the cycle that actually rates could go the other way and we want to be able to protect that if we're wrong and it happens to not reverse and go lower, then we haven't lost anything, we haven't given up any of our net interest income or margin at that point. These are all five year duration just like they were last cycle, and so when you do it forward starting you can take advantage of pricing, they're not all that expensive to get into, and we're not giving up our asset sensitivity today. That's important. We are becoming and maintain our sensitivity and if you saw the comments just a minute ago, the way we're structured in the balance sheet is to benefit in particular at the back end such that our NII in the fourth quarter should be up 15% from the first quarter, and it's just the nature of how our sensitivity is structured at this point in time. Darren, anything you want to add to that?

The only thing I would add is David said it well. Page 8 of the deck just really shows the path of the net interest margin, which really underscores what David is saying. We're going to enjoy nice margin expansion as the Fed is tightening policy, but we have a very disciplined approach to manage that exposure as rates push higher. As David said, the probability of a downturn at some point if the Fed has to push higher increases over time, and so we want to be cognizant of that, and as we get delivered those higher rates, put in that protection and really manage the downside risk in those out years.

Thank you both for all the color.

Thank you. Your next question will come from the line of Christopher Spahr with Wells Fargo. Please proceed with your question.

Good morning. Other banks seem to be spending their rate driven incremental net interest income or at least some of it, whereas you've kept your 2022 cost guidance unchanged. So why do you think that is? And with this higher NII outlook, how confident are you that you can expand on your positive operating leverage this year and next year?

Well, kind of leveraging the comments just before, you know the way we structured the balance sheet, our NII will be growing nicely throughout the year but, really strong in the fourth quarter, which sets up a really strong 2023. We're still asset sensitive through that time period, and so we should have a nice tailwind in terms of revenue growth. And we pride ourselves on being able to control our cost. We did a good job this quarter. There is that HR evaluation asset that benefited us by $14 million, so you need to add that back to get us level set. But in any event, we continue to leverage our continuous improvement program to stay focused on how we get better every day and how we can leverage technology and process improvement so that we can keep our costs down, because we are taking our savings and reinvesting those savings in things like digital, talent, and continuing to hire people so that we can grow. We had mentioned that the vast majority of our growth in expenses this year are related to the three acquisitions that we closed in the fourth quarter of '21. So we've had a little bit of inflation we've had to deal with. And so, you know, we're continuing to work at all levels to try and keep our costs under control and generate positive operating leverage which we believe we will have in 2022. We didn't have it this quarter but we will when you look at the whole year, and expect to have that going forward in '23.

Thank you.

Your next question will come from the line of Gerard Cassidy with RBC. Please proceed with your question.

Good morning, good morning David.

Hey, good morning Gerard.

Uh, David, uh in the slide deck slide six you give us the difference in the net interest margins based upon what's weighing down your margin today with the PPP loans and the excess cash. Can you share with us on the excess cash portion, where does the Fed funds rate need to go where you're not going to need to have that bullet point anymore because it will match your reported margin?

Well, it really gets back to the deposit expectations. So we've maintained this excess cash to be prepared to the extent the surge deposits do seek other alternatives and we have to pay that out. Obviously we're getting 100 beta on the cash while we wait, but being patient has benefited us. Putting that into the securities book earlier would have really cost us. And we did put a little bit of that to work this quarter, $1.5 billion of that at about a 2.80% carry. If we were to do it today, it'd be even higher, in the 3.5% range. So I think it's important for us to understand what the surge deposit flows are going to do relative to what the Fed rate movements are going to be. And I think over a fairly short period of time, our cash will get down to our normalized level which is $1 billion to $2 billion, and then we won't have to have this disclosure. And of course PPP will run off for the most part after this year, we won't have to talk about that one either.

Very good. And then as a follow-up, especially talking to you with your background as an accountant, can you share with us your thoughts about AOCI and we all understand it's an accounting issue and it's only for the securities portfolio obviously. You, similar to your peers, had a big negative number this quarter which took down tangible book value per share and book value per share, again similar to your peers, so you're not standing out. But at what point does it become an issue for banks? And again I know it doesn't go through your CET1 ratio like it does for the advanced approach banks, but do we have to ever get concerned about it if it keeps on getting larger on the negative side?

So I'll try to answer this without getting upset. I think the, I think that counts, I didn't know he did we did it, I didn't ask you about Cecil. So you've hit on two of them, there are four accounting standards relative to what we're doing but in any event we have to file GAAP. So OCI does not, the change in OCI relative to securities gains doesn't affect our thinking whatsoever. You know, we manage the company based on regulatory capital, our capital based on the regulatory rules, and for category four banks like Regions and most of our peers, that's excluded from the regulatory calculation. Importantly, it's also excluded from the rating agencies, so they carve out the change in OCI relative to securities (not pension or other things) but securities they carve out. And what's frustrating about it is that nobody talks about measuring the fair value of our deposit base which is where the cash came from to go buy the securities, and so we're marking one element of a balance sheet through capital, and that's just not how we manage the company. And so it's really irrelevant. It's done because it's easy to do, we can go get a quote, but the fair value of the deposits, in particular for Regions because of the primacy, because of the granularity, the fair value of our deposits are shooting through the roof. You just don't see that manifest itself on the balance sheet, you will see it manifest itself in growing NII and the interest margin. This is the time period we've been waiting for for rates to rise, so the fact that OCI is working against tangible book value, we could care less.

Very good, appreciate the insights.

Your next question will come from the line of Erica Najarian with UBS. Please proceed with your question.

Hi, good morning, good morning. Erica, my first question is the follow-up to Ryan's questioning. The way you wrote out slide 14, it seems like your NII guide includes both a $5 to $10 billion potential runoff of deposits and 70% beta. I guess I'm asking if that's if I'm reading that correctly. Isn't it, shouldn't be one or the other? In other words, if they stick around it might have a 70% beta. Does that make sense?

Yeah, yeah, don't duplicate that. The $5 to $10 is baked into the 70. So, you know if we're wrong, you know our beta will be lower. You know, thus far as I mentioned on Ryan's question, we thought these particular $5 to $10 billion worth of deposits would start flowing out in the first quarter. They did not. We still think that's going to happen, perhaps it's just delayed a little bit, waiting for the next move which we believe is going to be

By the way, in May, and we think those which are largely corporate non-operational deposits are going to seek a higher return than we're willing to pay, and they're probably going to move off the balance sheet in that case. So this really doesn't — this is not going to be a big deal to us. We've been planning for it all along.

Got it. And, um, you know, as we think about your NII guide, David, what type of earning asset should we assume? Again, it goes back to the deposit question, right? Because your outlook has felt very conservative since you first put it out, but, um, you know, what interest asset gross range should we assume lies underneath this NII guide?

Yeah, so you have to take the pieces and look at it. So there's not an appreciable change there. We've got two things working: one, we ought to have pretty good loan growth, as we mentioned, you know, ex-PPP and runoff portfolios, that's nine to ten percent growth in the loan balances. But then we've got the five to ten billion of deposits going the other way, and so the cash will come down. So, you know, it's not as much of an earning asset change as it is mix and what the carry, what the yield is on the net assets that we do have — earning assets that we do have. And so we should see our margin continuing to increase. We're trying to give you the guide by telling you that, you know, by the time we get to the fourth quarter, our NII is 15% higher than where we are today. Kind of cutting to the chase because there's a lot of moving parts there.

No, understood. Thanks, David.

Your next question will come from the line of Peter Winter with Wedbush Securities. Please proceed with your question.

Good morning. I wanted to ask about InterBank. You know, the economic environment has changed quite a bit since you guys acquired them, and I was wondering, have your views changed at all with regards to the loan outlook from InterBank or any consideration maybe further tightening the underwriting standards given a much higher rate environment?

No, we're very bullish on InterBank. We're excited about the fact that we closed that in the fourth quarter. You know, if you look at our growth of InterBank this quarter, it was 2%. Obviously, if you analyze that, it's 8% which is below the guide that we gave you, and the big driver there is seasonality. So it's the first quarter is the low water mark for them. You'll see that pick up. This is a prime book. We're really excited about the carry that we can get there and the margin. We are ahead of schedule on where we thought we would be. And so, Peter, absolutely not. We're looking to that to be a good component of our growth. And again, we feel good about the credit quality, in particular being paid for the risk that we're taking and a nice return for our shareholders on the capital deployed in that book.

Got it. And then, if I could just ask about the capital management strategies going forward, just between both on acquisitions, which have really increased profitability, versus buybacks. I saw yesterday you've got the $2.5 billion buyback. The question is, how aggressive will you be, or is it just being opportunistic and just want to have that authorization in place?

Sure. So let's go back through how we think about capital deployment. First and foremost, our capital is there for organic growth. It's to support our business. As mentioned, ex-PPP and runoff, we've got loans growing 9% to 10%. That's where we want our capital to go first and foremost. The second is we want to make sure we pay an appropriate dividend to our shareholders. Our guide is 35% to 45% of earnings in the form of a dividend. So as earnings grow, so will the dividend. We then think about non-bank acquisitions, and the three we closed in the fourth quarter are great examples. We have a whole team continuing to look and work with our three business segment leaders on how we can provide products and services that we don't have to our customers, so we'll continue to do that. And then we use share repurchases as the mechanism to maintain capital at the optimum level. And that optimum level is informed by things like CCAR and how we think about risk in our book. Of course, we just filed our CCAR submission in April; we'll hear back at the end of June on that. And yes, we did ask the board and received approval for a $2.5 billion share repurchase program over the next couple of years. The control factor there, Peter, is CET1 that needs to be in the range of 9.25% to 9.75%. That's what our risk profile tells us we need to have CET1 in that range. We're targeting the middle of it at 9.5%. And so we won't buy shares back if it takes us outside of our operating range, even if the price were right, which is where you're going opportunistically. I think that's just to help us manage our capital at the optimum level because that informs the denominator of our return on capital calculation, which we think is critically important to our shareholders.

Great, that's really helpful. And just one housekeeping: just how much was the credit interest recovery this quarter and that interest income?

I didn't commit that to memory. Hold on just a minute, I'll tell you.

It's at the bottom of the page. No, that's not the number he's asking. Peter, we'll get that to you, okay?

Yes, interest recovery in NII, yeah that.

Yeah, well look, somebody looked that up. We'll get it in a minute.

Thanks, David. Thanks for taking the questions.

Your next question will come from the line of Matt O'Connor with Deutsche Bank. Please proceed with your question.

Good morning. You did mention earlier about some consideration in your reserves for inflation, and I do want to ask you always talk about your average account size being a bit smaller than some of your peers, and I guess logic would have it that that customer base might be a little more impacted by inflation, by rising energy gas prices, and just wondering what you're seeing on some of those, you know, call it leading indicators, would be helpful.

OK, that's helpful. And then I guess on the other side of the loan book and the commercial side, you had a big drop in non-performing loans, big drop in the criticized assets. Was that anything specific, like a couple of borrowers or sectors, or it has been improving for some time but it's gotten quite low?

Thank you.

Your next question will come from the line of Ken Austin with Jefferies. Please proceed with your questions.

Good morning, Ken. Hey, hey, good morning, hi everybody. So, Joe, just a follow-up on the fee side. Now that you're getting close to the implementation of your changes to the deposit products and you're continuing to reiterate your service charges expectations for '22 and '23. It serves your service charges are actually probably better than people expected in the first quarter. So just wanted to kind of get your updated views on, you know, your confidence that you've got the right outlook and as you start to put the products in place, like, you know, what are your early takeaways from the continuation of that view?

Yeah, so, um, our service charges were a little better than anticipated. I will say that we put in some changes at the end of the first quarter. You'll see more change coming in the second and third. So it's too early to change our guidance that we gave you. We reiterated it this quarter, which was $600 million for service charges in '22 and $575 million in the next year. As we go through and see what the impact is for these changes, we'll update that, you know, whichever way it might go, and we'll probably have a better feel for the year 2022 next earnings call. But right now it's probably too early to change.

Yeah, understood. OK. And then one just follow-up on credit. You know, following up on Matt's question about your provisioning thoughts, but can you just talk about as you talked about normalization of losses starting to happen towards the back half of the year, what parts of the portfolio are you expecting to see charge-offs increase in first, and what areas are you just noticing that potential change in terms of, you know, delinquencies and loss rates? Thanks, David.

Well, I think that, you know, we lowered our range 20 to 30 basis points as we think about risk going forward. You know, certainly the consumer on the consumer side of the house, there's been a lot of stimulus money. I think we feel pretty good about the consumer, but that's an area we need to watch closely to see what that starts to move first. The second piece of that would be small business, I think. Small business is an area that probably has on a relative basis incremental risk. The issue is we're just not seeing any of that right now. John had mentioned all of our asset quality indicators are getting better. You know, we believe our normalized loss rate is likely to be lower than our history because of our derisking that we just mentioned in our whole credit book. So we feel pretty good about that. I think the leveraged book we would want to watch closely as well as we see rates increasing and what kind of pressure might that put on the leveraged portfolios. So those would be two or three that we watch.

All right, thank you.

I do, I do want to get back, Peter. You asked about the recovery that was in NII. It's $4 million this quarter. I want to close that out.

Your next question will come from the line of John Penkari with Evercore ISI. Please proceed with your question.

Morning, John.

On the expense side, I want to see if I can kind of ask the opposite of Chris Farr's question earlier. You know, wondering what type of expense flexibility you may have if revenue, the revenue backdrop comes in weaker than expected this year, and do you still think that you're implying about 150 basis points of positive operating leverage in your guidance? Is that sustainable if the revenue backdrop gets tougher?

Well, so you saw a pretty good quarter this quarter. Again, make sure you add back the $14 million on the HR to get level set there. The reason we were down is because our revenue was down in certain areas like capital markets. That has a tendency to be more variable in terms of the cost relative to the revenue. Things like M&A, if you don't have M&A transactions and you don't have the compensation that goes with the deal, so it depends where the revenue challenges come from, John. If we're seeing it in places like that, then we should have lower compensation. Mortgage, if we don't have the mortgage production that we think, then you're going to see lower compensation for that as well. So we do have some mechanism to take care of revenue if it's lower than we thought. Now, a big driver of our change, and we've changed I guess two times now, our revenue outlook has been because of the rate environment and just more carry there. So, you know, if we don't get the rate increases that the forwards imply implied at March 31st, which is what's baked into our guidance, then we're probably going to have lower incentive compensation. So there are puts and takes there. We still feel confident with the operating leverage number that you just mentioned. That's exactly what's baked into our guidance, and we are committed to having operating leverage over time.

OK, thanks, David, that's helpful. And then on the loan side, as you look at the remainder of the year, in terms of overall growth drivers, where do you see the strongest loan generation coming out of, both on the commercial side and the consumer side? What are the biggest drivers of growth over the remainder of this year as you look at the economic backdrop?

Got it. All right, John, thank you.

Your next question will come from the line of Betsy Gracik with Morgan Stanley. Please proceed with your question.

Hi, good morning. I had a couple of questions. One is, I just want to make sure I understand how you are positioning yourself for this surge deposit activity that you outline on Slide 5. I know you put the expected beta of 40% to 60% for the mid stable mid beta and 80% to 100% for the least stable higher beta. Is that your indication to us of what you think it would take to retain these deposits, and would you go after them, or are you saying look, we think it would retain this and we're not going to go after them, or it depends on how it progresses? Could you just give some color on that?

I think if you looked at the if you're on that page five, let's start with the right-hand side. Those are the higher beta 80% to 100%, characterize those as non-operational corporate deposits. These are deposits that are parked here that probably are going to seek a better avenue, a better yield than we're willing to pay for. So you could expect those to most likely move off the balance sheet first. When you get to the middle, which is that 40% to 60% beta, those are accounts that had stimulus or small business accounts with a disproportionate amount of cash in their accounts that we think will normalize over time. I think you'll see a little bit of both. You'll see some of that move off the balance sheet, you'll see some of that where we'll pay a higher price. But at the end of the day, we're going to have to monitor that. We have a deposit rate committee, this is what they do every month, they meet to try to figure out what we should pay. As you know, our deposit beta was among the lowest of the peer group. We expect that to be true going forward because of our granular, high primacy deposit base. So that one has that middle $13 billion is something we're going to have to watch closely to see whether it stays on and if it does, what will it cost us. There is going to be an avenue for both of these that is in the middle column and the right for all balance sheet opportunities where we'll move those out of the bank, but we'll be able to have a fee associated with that that'll help compensate us a little bit. Won't cover what we're earning today or likely earning as rates move up, but nonetheless it'll be a bit of a carry for us going forward.

OK. And then, since we're looking for 100 bps up in 2Q, right, in May and June 50 each, we should start to see some of this search deposit exit in 2Q, shouldn't we? Or do I have that wrong?

Yeah, no, I think you're exactly right. I think that, again, when it's 25 basis points, that may have been different. 50, if you're a large corporation that has non-operational deposits, you're going to be moving pretty quickly. So again, we expected the $5 to $10 billion that we talked about to move off in the first quarter. It did not. Now our corporate deposits were about flat on an average basis. We do expect that after this 50 basis points for that to start happening. So, yes, you would expect deposits to be down in the second quarter as a result of that.

OK. And then just two other things. One is, what factors will drive you to shift your excess cash to securities? Are you going to be waiting to get through like 80% of the Fed funds rate hikes to assess and then redeploy, or are you going to be redeploying along the way?

Well, I think we've redeployed some. So we put a million and a half to work this last quarter. You know, as spreads continue to actually gap out a bit, things like CMBS, agency CMBS, it was a good place for us. You know, I guess we put at 280, was the billion and a half. If we do that today, it'd be closer to three and a half. So it's kind of a little bit of a game we need to just watch and see what the rate environment will give us. We do have some cash we can put to work if our beta assumptions are better, then we'll have that much more cash to deploy over time. Now, our guidance we're giving you doesn't have that baked into the guidance, but using the spot securities and the forward starting swaps, all that's baked into our hedging strategy that we're trying to put in place so that we can protect a really nice margin that we think we can get to over time, and we've given you that guidance on one of our slides, Slide 8. And I think in our prerecorded message, we think we can push up to 3.75% with a 250 fed fund, so that'd be quite nice for us.

OK. And last question is just on, you know, you had the AOCI hit. I know Gerard spoke about that with you earlier on the call. The long end of the curve obviously is up since March 31st. So, should we expect, you know, for the DV01 hit in this quarter would be similar to last quarter for a like DV01 move, or are some of these hedging strategies that you indicated earlier changing that? And I'm really asking what we need to take into consideration as we think through to 2Q with this rate backup what the AOCI hit could be.

Yeah, so my first point would be to ignore it and you don't have to do the math and go on something else. But if you want to track it for whatever reason that you have, I would expect it to probably negatively impact us but not to the tune of what it did this past quarter, partially because of what we're legging into right now and frankly the change in the long end isn't going to be as we don't think be as severe as it was this quarter. So, good luck with your math.

But those hedging strategies you talked about earlier help you on that front? Is that accurate statement or not?

That's right.

All right, thanks.

Your final question will come from the line of Bill Carcacci with Wolf Research. Please proceed with your question.

Thank you. Welcome. Hey, good morning. Thank you for taking my question. Following up on your response to both Gerard and Betsy, I appreciate your comments around how it doesn't make any fundamental economic sense to mark securities to fair value on the left-hand side of your balance sheet without also marking the deposits to fair value on the right side. And so fundamentally, available for sale OCI hits are nothing more than accounting noise. But how would you respond to the idea that in a recession, bank stocks are going to trade down to tangible book value, and so while it may not matter fundamentally, from a practical perspective, it's something that investors tend to care about?

Yeah, so, you know, this whole concept of tangible book value came about in the recession. To the extent we have a recession, the rate environment's actually going to go the other way, and securities are going to be worth that much more. And so, again, I think you if you want to mark the entire balance sheet to fair value, that would be reasonable, especially in trying times where you're trying to figure out what the true fair value of net assets are for a given company. But the total concept of tangible book value, my opinion, is really not a going concern issue, it's a failure notion. It's a 'I'm going out of business, what might I get as a shareholder if we liquidate everything?' And the biggest issue I have with OCI is you're marking one element of the entire balance sheet, you know, securities, you're not marking loans, you're not marketing deposits or anything else. So you're not getting a very good understanding of what true tangible book value is in any rate scenario. But I realize I'm in the minority, and people just do are going to do what they want. But in a recession, it actually goes the other way because the rates will be down.

Understood. And that makes sense. I mean, you guys have exhibited such prowess in protecting your margins through the hedging program. Is there anything that could lead you to ever consider wanting to protect that tangible book or maybe since it is a focus of investors, maybe introducing the cost of tangible book value ex the available for sale? It might be something that people focus on because I guess with the passage of time, those marks would not be realized if you held the securities of maturity.

Yeah, I don't again. We don't use this to manage our bank at all. We don't use it for capital, we don't use for rating agency. So to put it in held-to-maturity, where we don't have to have a mark, all that does is restrict our ability to manage the portfolio the way we want. And so we don't see any need for that. We do realize there are some people for whatever reason that this is important, and all I'm saying is go calculate the fair value of our deposits which will be in our 10-Q coming up, and just add that in as you're thinking about tangible book value, then we at least have a better idea what it is.

Understood. Thank you for taking my questions.

Thank you very much.

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