Regions Financial Corporation (RF) Earnings Call Transcript & Summary

So we're going to get started with our next speaker here. Next up for me in the large-cap bank group, I'm joined by Regions Financial. Welcome back. You are my last speaker of the conference. So let me take one more opportunity to say thank you to everybody who's joined us in person or online over the last 2 days. From Regions, I feel very lucky to be joined today by David Turner, Regions CFO; Deron Smithy, Regions' Treasurer; and Ronnie Smith, the Head of Corporate. The -- turning to David and Deron for 1 minute here, I have to tell you, your titles are very well earned with a brilliant somewhat contrarian, move of putting hedges on the balance sheet well in front of this most recent drop in interest rates. I don't think you had a crystal ball as much as a determination to embrace the reality of cycles and momentum. So that being the case, we look forward to digging a little bit deeper into that strategy and the balance sheet and the wherewithal that you have to manage through the current environment, whatever it might bring.

So why don't we start with some discussion around this macro environment. In January, you obviously sounded reasonably confident about the outlook. And while it's very early in what's going on and where the yield curve has moved, why don't we talk about what it is that you are or aren't seeing at this point in time, and then we'll get into the balance sheet and hedging strategy a little bit.

Okay. Well, I'll let Ronnie also talk about this. So obviously, there's been a lot of changes here over the past few days even. Now we've anticipated that the economy was going to slow in 2020. And we knew -- we anticipated that 3 years ago, which is why we have the hedges in place. We'll talk about that in a minute as we get into questions. But right now, we -- there is uncertainty out there. Personal income is up, as I noted this morning. So we still feel okay there. We're talking -- Ronnie's team is talking to all of our customers on the business side to try to figure out what it means to their business, what that might mean for loan demand, fees and that -- of that nature. It's too early to call. We have in our model a 1.8% GDP environment. We came out at earnings and said our loan growth expectation, we're going to be low single digits on an adjusted basis. So we didn't have a lot of growth baked in already. Maybe we were a little conservative, and this gets us to about what will happen. We'll see. But I think that it's too early to call any real difference from what we had at earnings, but Ronnie, do you want to add to this?

Yes, David. I would say that the majority of our conversations are centering around supply chain. And that's early on. Most of our clients do feel like that they have adequate inventories for about the next 30 to 45 days that are dependent on those international shipments. But the longer that this persists is the more pressure that most of them are predicting that they will feel along the way. That conversation quickly turns to alternative sources. And so some companies, some operating companies do have alternative sources. We see more pressure in the technology space than any other space at this point. But daily contact, looking for feedback, trying to keep open lines of communication is the best thing that we can do at this point until all of us know more about what's next.

And so in terms of -- let's talk about kind of where financing demand was. You said you're a little bit less than 2% loan growth baked in -- or I'm sorry, 2% GDP growth for the year but modest loan growth expectations. And across both the consumer and the corporate loan books, what were you seeing up until now in terms of financing demand? Because if you look at the H8 data, it wasn't exactly robust on the commercial side, and some of that could have been really just a disintermediation to the debt capital markets. What are you hearing from customers on the commercial side? And then we'll talk consumers.

Yes. David, I'll take that first and then maybe you follow back up on the consumer side. But 2 things that really have had impact there. One is, you mentioned the debt markets that certainly opened up in the fourth quarter, and we saw great activity and really strong fees that were produced. You could see that in the capital markets revenue that we posted in the fourth quarter. Fixed income was very hot. Derivative type products were also very hot in the fourth quarter. So that did have some impact off of the balance sheet. The other thing that we have tried to be disciplined about and that we feel like has developed into an expertise is really being selective on relationships that provide us more of a broad relationship return instead of just a transaction. We've moved out a little more than $2 billion this year through a process that we refer to as capital allocation. We -- I chaired that particular group within our company. We reviewed more than $30 billion last year of both new and renewed opportunities. And if we don't feel like we can gain traction developing core banking business with those entities, we've redeployed that capital. And so that created a $2 billion headwind for us. And then on top of that, what you referenced just a moment ago, the strength in capital markets, just because of where rates are, both created a little more muted growth on the balance sheet. We could have maintained growth, but it would've been more transactional than what we feel like we want to do on a go-forward basis.

So our low single-digit expectations that we had going into the last couple of weeks was really driven by the growth we got to see in Ronnie's Corporate Banking group. On the consumer side, we have puts and takes. So we see good decent growth in mortgage. We see growth in card. We see growth in direct other consumer. But our indirect auto book, we ceased that business, so that's running off. And then the HELOC book, the production is getting overwhelmed by the paydowns and payoffs. So the consumer growth net-net would be fairly flat with -- than growth in the company driven by the Corporate Banking group.

Okay. So let's talk about balance sheet positioning for a moment. And why don't we actually start because I'm not sure that it's necessarily being appreciated in the marketplace today. Let's just kind of revisit the lay of the land in terms of the hedging strategy that you put in place.

So let me start and then we'll get Deron to cover. So 3 years ago -- so we do a 3-year strategic plan and we roll that every year. And we started about 3 years ago and we anticipate what GDP is going to be. So we had GDP going down to just under 2% this year and 1% next year. And with that, we believe the Fed was going to become more accommodated beginning in 2020. We're coming off of December '18 rate increase. We had 2 rate increases factored into '19, and we didn't get those. We got 3 cuts. So we anticipated the reaction of the Fed. We just got our timing off a year. We had put in a lot of swaps. They were forward starting swaps and floors, and Deron will talk about the nuances of that, at that time. So they're out of the money, and it was insurance. It was insurance for exactly what we have today with the expectation if we were wrong and rates go the other way, but then we're winning. We're just not winning as much. And so we thought that was a good trade for us. It's turning out to be better. It's -- you never want to call on your insurance, but that's essentially what's happening. But do you want to talk about the details?

Yes, sure. So David mentioned we have a rolling 3-year plan that we -- that we're always considering what are the range of possible outcomes. I think the key to the strategy was -- our overarching goal was just to reduce variability in net interest income. We came from an environment when rates were very low, where the deposit base, which is our competitive advantage, we couldn't extract the full value out of -- at low rates. As rates began to normalize and rise, starting a couple of years ago, we were able to see the value of our deposit base emerge. And we knew that if rates -- if the economy slowed and rates turned and went the other way, we were going to give all that back. And so the goal was to just simply reduce the variability in that. And that was the precursor of how we thought about constructing the strategy. And as David mentioned, we felt like the economy was going to continually slow '19 into '20, that the risk of a recession was building. Not -- we weren't forecasting that but again, we wanted to be prepared for that potential downturn. And so a year ago, I think it was a year ago yesterday, it was Investor Day, we wanted to be able to -- which feels like 10 years in treasury years, but we wanted to be able to send a message to the market that we still have the opportunity to see our margin expand in a rising rate environment or a robust economy. But wanted to be able to put a floor on where we thought the margin could go in a declining rate environment. And I think we've largely done that with respect to short rates. We still have some exposure as any bank does who engages in fixed-rate term lending as the long end of the curve declines. And certainly, it's -- we've seen big moves recently. The new business that you're putting on is coming on at rates that are lower than what is maturing or amortizing. And so most of our hedging was designed to reduce the exposure to changes in short rates. But last fall, we did see that as exposure to perhaps a flattening of the yield curve where just a decline in long-term rates that we wanted to address as well. So we started -- we've described them as rate locks. And it's pretty simple. It's we just put forward starting hedges on that were a proxy for locking in the market of where new loans would come on in the future. And those were first -- in the first part of the quarter, those were roughly at a push. They were put on, call it, a receive rate of around 1.80%, and that's roughly on the 10-year -- and that's roughly where the 10-year was. But obviously, we've seen a big move today. We still have about $3 billion of those hedges that originally we had intended to tear up as the loans came on and just take whatever the gain/loss is, and that would effectively influence the yield one way or the other. Our decisions have changed a bit or our strategy has changed a bit. We think those are likely more valuable to us left in play. And so you think about the hedging that we have in the aggregate, just $23.5-ish billion, I think. That is 5 years in duration. And so if you just think about the value that, that is creating for us today, it's over $1 billion worth of value that we will accrete into income over the next 5 years. And so it does give us nice protection. Clearly, this low rate environment is not conducive to anything we're hoping to do in terms of trying to grow revenue, but it is -- certainly, these hedges help us to stabilize revenue and give us a more firm foundation from which to grow.

Okay. So that's a perfect segue into allowing you to comment, if you'd like to, on first quarter guidance. I assume that your margin is hanging in there a little bit better than the average of your peer group. But if you would update your guidance for the first quarter and just confirm what you're seeing, if you would, on the net interest margin and net interest revenue, that would be helpful.

Yes. So we've messaged that we expected the margin to expand as our hedges became active in the first quarter, expand into the low 3.40s. And we think -- we certainly think that is intact. The impact of rate changes that we're seeing today on the long end, those will take some time to play out through a repricing of your book. But we expect the margin to expand into the low 3.40s, low to mid-3.40s and be relatively stable for the first half of the year. But if we stay in this lower rate environment for an extended period, you could see then the impacts of a repricing balance sheet have some modest pressure in the second half of the year. But as we think about where we are from a long-term rate standpoint and the fact that if we were to stay here for an extended period, the Fed would likely need to take action. We think the changes in short rates, that's a fairly muted impact to us. The long end, we'll have some impact over time. But we still think that for the full year, our net interest margin can be in that 3.40-ish range. Certainly, if we move lower on long-term rates, there's some additional pressure. But that -- we may see. But again, high 3.30s or around 3.40 for a full year, even in this environment, we think, is achievable.

Okay. Well done. So let's switch with -- switch topics a little bit. And let's go to the next hot topic of the day, which is always M&A. So you actually -- I was going to start with bank M&A. But let's talk about what you did. Yesterday morning, you announced the acquisition of Ascentium Capital, which is an equipment -- leasing equipment finance company. So let's talk about that in terms of what the acquisition brings to you as well as kind of when we think about bolt-on deals, what else you might like to do, how this fits in broadly?

You want to kick it off?

Yes, let me kick it off. So Ascentium, it's going to be a great bolt-on for us. We've told everybody we were looking for things like that. They're very well-known and very experienced. Most of these are loans, not leases. They got both.

Okay.

But most of them are loans and there are essential equipment loans for small businesses. Ronnie will talk a little bit more about why that's important. But it gives us some more diversification, it gives us a great platform to really leverage into our 400,000 small business customers that we have, where we may have a deposit relationship, calling that a customer and gives us an opportunity to really provide a product that they may need in terms of the essential equipment financing. They have 100,000 customers too that would give us an opportunity to cross-sell it into them. And then the 4,000 vendors that we could have -- that they have relationships with. So it will take some time to get all that working through the system. And you ignore the CECL. And in our deck, we said CECL day 2. That's really CECL the acquisition piece of CECL, okay? The word day 2 really came from the fact we already had day 1, which was January 1. So our mind was saying day 2, but I think that confused everybody a little bit. But that's kind of a one-and-done charge that you get on an acquisition. And we could debate the merits of CECL all day. But anyway, that's the accounting. But, Ronnie, why don't you talk a little bit about what we see in the deal?

Yes. It's an acquisition that I'm really excited about because it's a space that we do not have expertise in on the lower end. We have a very solid Regions equipment finance group, but most of that is focused on upstream or at least the way that we define upstream for us. And not to repeat the press release, but it's a $2 billion asset company. They produce about $1.5 billion a year, and they've been somewhat capital and liquidity restrained. And so we've seen them actively selling off, which, given our liquidity position, along with the capital position that we hold, we're going to be able to allow that to grow naturally. And we feel like over the next 5-year period, we could double the amount of assets that are outstanding. It provides us with double digit return from a yield standpoint. The risk is a bit higher but still at about 2.5% charge-off rate. It creates really nice margins for us. As we took a look at this transaction, though, we made it -- we made the decision based on it as a stand-alone entity, tagging on a little bit to what David said. We really have not factored in the 400,000 small businesses that exist within our company today that now will have access to financing of essential business equipment. And that's really key because that's at the core of what Ascentium does. They look for opportunities to be a secured lender with equipment that's essential for the business to operate each day. And some of the quality that we see coming out of that space is simply the cost of that. So when I think about the gap that it fills for us, the yield that it gives to us and the upside opportunity to cross-sell into their client base, but also our client base, it's a pretty compelling story for us.

Okay. And so what else might you look to acquire in that bolt-on, whether it's additional, I hate to call it gaps, but where you could benefit from an incremental loan portfolio, loan expertise or Regions on the corporate side or more broadly for Regions?

So we've looked at continuing to -- so we've been carrying about 50 basis points of excess capital for opportunities like this. We gave you a slide in the release. It said our capital is likely to be in the middle of the 9%, 9.5%, so call it 9.25% in terms of capital. So we still have a little bit of excess there to put forth for opportunities. Opportunities are when we see products or services that we don't have or we don't -- are better than what we have. In this case, their technology was better than what we have, and we weren't serving that market. That's the kind of bolt-ons we look for. So we don't have anything specific. We look at a lot of nonbank transactions. Obviously, there's fintech that are coming up with good ideas and serve customers from time to time. We partnered with fintechs. You could call this a little bit of a fintech, if you want. And so nothing specific, but we are still in the game of looking for more nonbank transactions in bank M&A.

Just one other brief comment, listening to your clients really directs you where the demand is. And so as we started thinking about the small business equipment finance world, it really came back from our clients on taking a look at balance sheets, what they were doing, who was financing. And then also on the capital markets side, we do feel like as we continue to build out that particular group, there are other products that we do -- don't offer today to our clients they're taking advantage of. And that may not be a bolt-on acquisition as much as it is developing talent and space in the capital markets group. So we continue to try to do the basics of banking as is, listen back to our clients, what are you utilizing, what do you need, and how can we help provide that solution.

Okay. So let's go one step further into bigger bank deals with you or without you. I have to say I've been fascinated by the level of activity in the southeast, in particular, and we know the demographics in the market are very good. And many of the metro markets in the southeast remain extremely fragmented. So when you think about that, I'm curious what your view is on the pace of consolidation in the southeast. And how if you look at either under -- feeling the need to create scale as opposed to continuing to do business the way you're doing business today and taking advantage of disruptions that exists in the marketplace alongside integration and et cetera. How do you think about the alternatives today?

Yes. So there's been a lot of activity with regionals and those that are smaller. I think you're going to continue to see most of the activity be around those smaller institutions. And we used the word scale a lot in the industry. We like to think about it in terms of share. So when you have share in the market that you're in, most of our markets don't have a money center presence. We are the money center bank. When you have that kind of density in the market, that's where your profitability really comes from. So we look at opportunities to continue to densify the markets that we are already in first. And so while we're not focused on bank M&A, we have our strategic plan we want to execute with, and bolt-ons are a piece of that. We continue to look at opportunities in our markets to densify and -- but one thing that we all ought to remember is doing these transactions are really difficult. They take a lot of time. They're distracting. You got cultural integration that you're going to go through, and all of us get through that. It just takes time to do it. So you need to be very careful with what you pick. So we continue to monitor opportunities in the -- what the market is telling us is that doing a right way transaction with the normal premium that you would see is not acceptable. People do start -- investors aren't willing to let you do that. So you've seen these no low premium deals, and low being defined 10% and under, as being where investors want this market to go. So clearly, there are opportunities to capitalize on cost saves and things of that nature in putting 2 banks together that the seller has to be willing to ride a little longer than they otherwise would. And so they want a good quality organization as to come partner with. For us, we believe we have to earn our right to be independent every day, and we're executing our strategic plan to get our return up. We've done a good job of that. There's more work to do. We have to become more efficient. And if we stay focused on that, then we can control our destiny and maybe there's an opportunity that comes our way one day. But we're not going to force anything, and especially in this environment where there's a lot -- even more uncertainty that gets created. But we think we've been very patient, and we think we're well positioned to take advantage of something should that arise.

Okay. And so it's interesting. Let's talk about Simplify and Grow for a minute because that's almost your own internal merger integration in certain respects, creating opportunities both on the expense side and the revenue side. And so it's really -- it's still pretty early innings in that Simplify and Grow program and realizing the benefits. You want to update us a little bit on where you stand, given that I think in January, you spoke to being about 1/3 complete.