Regions Financial Corporation (RF) Earnings Call Transcript & Summary

Good morning. This is Gerard Cassidy from RBC Capital Markets. Welcome, everybody, to our annual financial services conference. As you all know, this is now a virtual conference. We changed it over last week from an in-person conference, obviously, due to the coronavirus. I feel very lucky and privileged to introduce our first panel that -- or first fireside chat with Regions Financial Corporation. Joining us from Regions is John Turner, President and CEO; also, David Turner, Senior Executive Vice President and Chief Financial Officer; and Deron Smithy, the Treasurer. As many of you know, Regions is headquartered in Birmingham, Alabama. It has a market cap of about $10 billion, total assets of $126 billion, deposits of almost $100 billion and about 1,400 branches. So gentlemen, thank you again for joining us.

Thank you for having us.

What I'd like to do is maybe start off, obviously, with what's going on in the markets today. There's been quite a bit of volatility. And when you take a look at the 10-year Treasury rates and the unprecedented decline, can you share with us how it's impacting your business, your balance sheet and your income statement? And possibly, David, you talked about on your fourth quarter the hedging strategies you guys have implemented, which probably were some of the best hedging strategies we saw from the regional banks at that time. So with that, I'll pass it over to you, gentlemen.

Okay. Well, good morning. Thank you, Gerard. I appreciate you putting this together and giving us an opportunity to speak with our investors and analysts. But yes, so the environment -- we had anticipated the environment slowing down a bit. We had, in our current model, a GDP for the year of 1.8%. We anticipated this slowing some years ago. And as a result of that expectation of a slowing economy and that the Fed would begin easing, we put a series of forward-starting hedges on, most of them swaps, some of them floors. You can see in our material, if you go back to earnings, you'll see what we're talking about in terms of the derivatives. But we got over $20 billion of derivatives working for us to protect us in this low-rate environment. We're glad we did that. The fair value of that at the end of the year was just over $1 billion, and you could imagine what the fair value as we get -- we haven't updated that yet, but with the cuts that we've had, we've continued to increase pretty dramatically the fair value of those swaps. What that means is that, that value will be nearer to our benefit over the swap term, and the swaps have average 5-year lives attached to them. So we feel relatively protected, in particular, on the short end, where we're virtually neutral for rates. We do have a little bit of exposure in terms of reinvestment risk. We've hedged some of that, but -- and Deron can talk a little bit about that in just a minute. But from an output standpoint, we still feel okay. Obviously, there's some uncertainties in the economy with the coronavirus and what that might mean to ultimate GDP for the year. So we're likely to see some slowdown. But as we talk to customers, we feel pretty good about -- they feel pretty good about their businesses right now, which I think will bode well for us. So do you want us to go into more in the hedging, Gerard?

Sure, David. That would be great if you could because, again, you guys, I think, stand out. And as you and I have chatted, you've done a very good job explaining to people what you've actually done so they can understand it. So yes, a few more minutes would be great.

Well, Deron, why don't you talk about the margin protection and then the reinvestment hedging that we've done?

Sure. So as you know, Gerard, the hedges began this quarter in 2020. So as we've messaged, the $23-or-so billion of hedges begin to come online in 2020, the bulk of which comes on in the first quarter. And so we'll see some margin improvement relative to the fourth quarter, even despite this volatility that we've seen more recently. And so we should see some nice expansion in the margin in the first quarter and then relatively stable -- we've messaged in the low- to mid-3.40s expected in the first quarter. And then relatively stable second quarter, maybe some modest deterioration. And what that represents is that we're largely unimpacted by changes in short-term rates. The hedging that we've done is taken -- that, coupled with our deposit management, has taken most of the impact of changing short rates out of the equation. But as David -- as you mentioned, the 10-year Treasury obviously have seen unprecedented declines. And so that will affect us in 3 ways over time. First is new business originations. We'll see $8 billion to $9 billion of new loans coming on the books over the next 12 months. And obviously, they're coming on at lower levels, given the change in the tenure. Second, with the securities reinvestment. We have somewhere in the $3.5 billion of securities reinvestment over the course of the year. So obviously, those are coming on at lower levels. And then finally, we will see -- if rates stay at these levels, we will see increases in prepayments in mortgage securities as well as loans. And so, obviously, those come on at lower levels as well as the premium amortization. I'll just touch on premium amortization for a minute. What we've been experiencing for the last several quarters is in the high 20s per quarter premium amortization. We've messaged we would expect, given the change in rates, that we would see that tick up a bit in the first quarter. But certainly, given what has happened to mortgage rates, roughly the entire universe of mortgage assets is prepayable at this point. And so we do expect an uptick in prepayments, and we'll see premium amortization increase accordingly. But we think that moves from in the low 30s per quarter to perhaps the high 30s and as high as maybe $40 million per quarter, if these rates persist. But I think the message is we've certainly stabilized the net interest income stream from a short rate perspective. And the longer the long-term rates stay down, we'll feel some pressure from that reinvestment over time. But we do feel good about the protection that's in place that we will see some impact, but not a dramatic shift.

Let me clarify one thing. Deron talked about $8 billion worth of new loans. That's new and renewed loans this year. We still are anticipating loan growth in that low single digits. So I just want to clarify that.

Correct.

Very good. Maybe, David or even Deron, can you talk a little bit about what's happening on the deposit side of the balance sheet in this rate environment? Have you been able to lower deposit rates in view of what the Fed did last week and possibly will do next week?

Yes. So in short, we have. One of the things that we've been focused on over the last several months as we've shifted to this declining rate environment is moving a greater portion of our managed largely commercial accounts, which have seen the highest data, to more of an indexed position. And so I think we're up to today, 60-plus percent of that portfolio being driven by changes in short-term rates. And so what that means is they're more reactive sooner as we see changes in Fed funds. And so the combination of our activities to bring rates down as well as those that are indexed means that we'll start to see deposit rates decline accordingly. We have planned around a 30% beta here in the near term. I think we'll achieve something in that range. And then, over time, if rates go back to where the forward suggests, closer to 0, we'll just retrace the deposit rate increases that we've seen over the last 2 years. But we think that, that, coupled with our hedging, gives us a pretty good opportunity to manage the impact to the margin.

Very good. And similar to our conferences in the past when we had them in-person and we take questions from the audience, for folks that are listening through the webcasting, in the lower left-hand corner, there's a box. If you want to submit a question, we have an access to those questions. So please feel free to submit questions. John, coming back -- or coming to you, can you share with us your conversations with your larger customers about what's going on with the economy and the coronavirus? I know David touched on it already, but maybe you can give us some more information or color around what you're hearing from your customers.

Yes. Happy to. I've actually been in a couple of markets in the last 2 weeks visiting with customers, been on the phone with customers. And I would say that business is still pretty good. There is some concern about supply chain disruption, a few anecdotes here and there, where some customers are experiencing some delay in acquiring certain inventories that they may need. But by and large, customers anticipated some disruption, and as a result of that, we're accumulating some inventories and excess parts, things of that nature, that they need. There clearly are some examples of disruption. But to this point, we haven't seen it affecting our customers or the economy in a significant negative way.

It seems like we have, obviously, the current events of what's going on, not just with the coronavirus but in the markets, we also -- what happened to the price of oil in the last 24 hours. John, can you share with us your focus on just building long-term value for Regions as you build out new branches in markets that you're looking to expand into, consolidating other branches? And then if you could also touch on your technology spending and the digital efforts that you have made in the past and the success that you've had with that.

Yes. Let me first start by, when you think about building a long-term franchise value, talk about our focus on credit risk management. We talked about interest rate risk management earlier. Over the last several years, we've been derisking our portfolio. We've been remixing our business. We've been building a balance sheet that will be more consistently performing, more resilient, more sustainable. We don't have any significant concentrations in asset classes. And in fact, while there's a lot of concern about energy yesterday, our portfolio today stands at just over $2 billion in outstandings, down over $1 billion from 2014. And importantly, the exposure falls into different categories than it did back in 2014 when we had a relatively high exposure to the oilfield services sector, which is where most of the losses typically occur. So we've been disciplined, originating investor real estate credit. We have one of the lowest exposures amongst our peer group. We think that's good business. We continue to grow it, but we're managing it carefully, as we are other parts of our business in preparation for a time like this when there would be some volatility in the market. So we feel good about how we're positioned and the long-term value proposition associated with the strength of our balance sheet. With respect to growth, we're making investments in markets like Atlanta, Orlando and Houston, building branches in those markets. And what we're seeing is that growth in consumer checking accounts, which is the core of our business, is increasing at a rate more than 2x faster than we're opening accounts in markets where we have a more traditional or core presence, where we're not making near the investment we are in those markets. So we feel very good about that. We'll spend $625 million, roughly, on technology this year. 10% of that investment will go to cybersecurity, protecting our customers' safety and security and their personal information; 48% to maintaining our core systems; and 42% to new products, new services, new innovation. We'll be updating our mobile banking platform in the second quarter. We're excited about that. We've announced the replacement of our core systems, which is a 5-plus year project, that we think will really transform both the way we serve customers and the way we operate the bank. And we think that, that ultimately can be a real differentiator for us over time.

Shifting back to the balance sheet management that you guys have been doing. Can you share with us, in your commercial loan book, the percentage of loans that may have floors in those -- in your documents with your customers?

I don't have that number on hand. We'll...

We'll look it up and get it to you by the time the call is over.

Okay. Yes. Very good. You touched on the energy portfolio and you touched on credit, John. Can you share with us -- and you have been very clear and demonstrated derisking the balance sheet over the last 3 to 5 years. Can you share with us your outlook for credit in view of these changing times we're living in?

Yes. I mean, clearly, with all the volatility and with respect to energy, we'll see some pressure -- additional pressure in that portfolio, given where prices are today. If they stay in this range, there will be some additional stress. Within the services sector, we have about $400 million in outstandings today, again, down from almost $1.4 billion in 2014. Roughly 40% of that portfolio is either criticized or classified that represent long-term relationships, customers that we continue to work with. We think we've identified most of the exposure there. The balance of our portfolio is in midstream, which are borrowing arrangements supported by longer-term contracts, typically with very strong counterparties. And then E&P, where we've had great success, I think, since 2014, we recorded $5 million in losses associated with that portfolio. It's a business we've been in for 50-plus years. We focus on client selectivity, right relationships and a very conservative borrowing base structure and credit risk management. And so while we, again, we expect some stress, additional stress in energy at these prices, I think that portfolio will perform at least as well as it did in the 2014 crisis, probably better, given how we position the portfolio. Other sectors that are under some stress, we talked about restaurant for a couple of quarters now. We still have a portfolio of assets that we're working -- problem assets we're working through there. So I talked to customers who are in travel and leisure. Some of them are beginning to see an impact on their business. We still haven't seen a lot of that, but that's clearly a sector that we'll have some concern for and be watching, working closely with our customers there.

Very good.

Gerard, let me interject. The loans with the floor, 6% of our portfolio have floors.

That's great. Thank you, David. I know this is a fluid situation in view of what's going on in the U.S. We've seen in other disasters, particularly, hurricanes that have hit Puerto Rico a couple of years ago, where the banks in conjunction with the regulators helped give customers some relief in suspending payments until they got back up on their feet. Are you guys hearing from the regulators or other folks that if the economy was to really take a dive temporarily because of what's going on with the coronavirus, that there may be some regulatory relief or fiscal relief that could help us through the next, let's say, 2 or 3 months, should we need it?

Well, I was with a number of CEOs last -- peer CEOs last week. It was a topic of a lot of conversation. We had an opportunity to meet with the heads of all regulatory agencies. We talked about it. And we have a lot of history and experience with natural disasters given our footprint on the Gulf Coast and the Atlantic Coast. We're routinely exercising disaster recovery programs, both internally and externally, as we think about how we reach out to customers, how we help customers during challenging times. And we're prepared and, in fact, have already activated some of our external programs reaching out to customers. We haven't had much need to this point. But as an example, we had a tornado in Nashville last week, did over $1 billion worth of damage ball accounts. Did not have a lot of impact to our customers based upon the survey work that we've done so far, but we are -- have reached out to that market. We provided aid. We've offered temporary relief with respect to credit repayment, et cetera, to those customers that might be impacted. And we'll exercise those same programs to the extent we need to in this environment.

Very good. Maybe if we could shift for a moment and talk about -- obviously, you guys have managed capital very effectively. We have the CCAR coming up. Maybe can you give us any color how that might change in view of the rate environment that we're living in?

Well, as you know, we've had a pretty extensive capital planning process. We are subject to submitting our capital plans to our regulatory supervisors. And this year, our CCAR will be reviewed. You did see the change in the SCB that gave some relief in terms of how we think about dividends and how we think about share repurchases outside of a 4-quarter period that will be beneficial to the process to at least a submission. Our gating factor has been our internal policies in terms of how we manage capital, including -- all the way through Board review. We have had a stated objective of having our Common Equity Tier 1 in the range of 9% to 9.5%. We suspect we'd be in the middle of that. And so we actually -- we'll continue to evaluate where along that range we think we need to be given the circumstances that exist and uncertainties that exist at this point in time. We'll be putting that capital plan together and filing it by April 5. And just to remind everybody on how we think about capital allocation, first and foremost, we use our capital to grow our business prudently and ensuring that we get paid for the risk that we take from a loan portfolio standpoint. We then want to make sure we have a sustainable dividend, and we do a lot of stress testing on our dividend. And we've set our policy to be in that 30% to 40% of our earnings paid out in the form of a dividend. And we set that at the rates so that when we do have stress events, we can continue to pay that kind of dividend. We'll make some nonbank investments. You saw our Ascentium transaction. That used up a little bit of capital as well and things like that. And then we use share repurchases to balance the equation. So that has not changed for us, and we'll continue to work in that -- with that as a guidepost.

Following up, maybe, John, with the Ascentium acquisition, it was relatively small compared to your footings of, what, $126 billion. They had about $2 billion in loans, if I recall, and originated about $1.5 billion in 2019. What was your thoughts behind doing that transaction?

Well, we continue to look for investments that will allow us to grow and diversify our revenue, to develop new capabilities. Ascentium has a particular expertise in making equipment loans to small businesses. Small businesses are a core of our business. They're really important to us. Increasingly, that segment is being disintermediated by financial technology companies, point-of-sale lending and other transactions-type transactions that are -- have been -- have reduced the opportunity that we have had to make loans to small businesses. So we saw an opportunity to acquire a company that has some proprietary technology, has a particular business model that we like a lot, we think, particularly focused on professionals and business essential equipment lending, which is core to small business. And we see this as an opportunity to grow that market segment and to expand relationships. We have some 400,000 small business customers. They have about 100,000 small business customers. We see an opportunity, really, to grow that business. It's located just outside of Houston in our footprint. So a real opportunity, we think, to grow and diversify that segment.

And a follow-up on the mergers and acquisitions, John. Can you share with us any interest in depository acquisitions or shifting entirely to possibly a merger of equals? We've seen some of those, of course, last year. So maybe if you -- we get some of your thoughts on -- from that standpoint.

Well, our point of view really hasn't changed. I mean, we're obligated to consider all of our options all the time, and we're certainly paying attention to what's going on in the market. But we have a strong belief, despite the volatility, and maybe as a result of the volatility, that we have an opportunity to stay focused on our plan, focused on the things that we can control, take care of our customers, make sure that we're picking the right customers to bank with, continue to invest in talent and technology. And if we execute our plan, we believe we can deliver significant results to our shareholders. And as a result, that's what we're focused on and not depository acquisitions.

Very good. David, coming back to you. Obviously, you and your peers gave us the so-called day 1 numbers for the CECL loan loss reserving methodology with the fourth quarter results and your 10-Ks. Any update or any color on how the quarter is going for the so-called day 2 provisions under CECL?

Well, Gerard, as you know, so we have our day 1 number. But for day 2, we have to evaluate the environment that we're under when we report at the end of the third quarter. Clearly, there's been more uncertainty with regards to economic outlook today versus when we had day 1. So it's too early for us to tell exactly what that's going to mean. But I do believe there would be some adjustment to our economic outlook, that would probably be negative. How much all that would be is just too early to tell. But I think this is what the CECL standard was trying to get at, is that, when you anticipate a decline in the economy, that you take that into account each and every reporting period. So we're all learning this, and so we'll figure it out. But it's likely to mean some adjustment to CECL provisioning in the quarter.

I see. We've got about 3 minutes here remaining. Maybe coming back to John or even Deron. Have you guys -- with this volatility we're seeing in the financial markets, are there any signs of stress that you guys have noticed in terms of payments or corporates not being able to function properly? Any color behind that?

Not for me, Gerard. I don't know if Deron has anything to offer?

No. Actually, Gerard, despite the volatility in the market, the balance sheet flows, both on the deposit side and loan side, have been relatively as expected. And so nothing -- we're not seeing anything unusual. So the good news is there that, from the customer perspective, things -- things seem pretty stable. Nothing unusual.

No. That's good to hear because, obviously, the financial markets have been quite volatile these last couple of weeks. And I guess, wrapping up, John, and just the final question here. Any final thoughts or words that you have for investors on what you're just experiencing and seeing to reinforce your message?

Yes. Thanks, Gerard. No, I would just say, we have been managing our business and building our business for a time like this. We've been preparing for a potential downturn in the economy. We're certainly prepared for volatility in the marketplace as we've sought to build a balance sheet that was resilient, was sustainable, would perform consistently over time. We think we've effectively managed our interest rate risk to the extent possible, managed the credit risk we have in our portfolio, creating greater balance and diversity. And we feel that's -- given the market that we're in today, we feel like we're well positioned to adjust to the conditions and to perform well for our shareholders.

And with that, we've run out of time. And I want to thank John, David and Deron for joining us. We're very privileged to have you guys with us, and I'm very pleased that you joined us. And thank you very much. And thank you, everybody, for participating.

Thank you.

Thank you.

Our pleasure.