Regions Financial Corporation (RF) Earnings Call Transcript & Summary

Thank you, everyone, for joining us this morning. I'm pleased to have with me Regions Financial. We have with us this morning John Turner, President and CEO; David Turner, CFO; Barb Godin, Chief Credit Officer; Ronnie Smith, Head of Corporate Banking; Martha Raber, Head of Financial Risk; Tom Speir, Assistant Treasurer; and Anil Chadha, Head of Risk Shared Services. Now for the disclosure statement, I just want to highlight, please see Morgan Stanley Research Disclosure website at morganstanley.com, Research Disclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. So with that housekeeping out of the way, John, I would be delighted if you could kick us off with a few opening remarks, and then we're going to head into Q&A. And as always, audience on the webcast, you can feel free to shoot a question to me, and we can ask your questions towards the end of the Q&A. John?

Thank you, Betsy, and thanks for having us. We appreciate the opportunity to present this morning. These are clearly challenging times, but despite that, we think our core business is performing well. Our teams have adapted to the uncertainty, and we think it really positioned the bank to operate remotely. Our bankers are focused on helping their customers, and to that end, we've had a lot of really good conversations over the last 3 months or so with our customers. Our bankers are lending money. We've been very active in the Paycheck Protection Program, and as a result, we're seeing growth in loans and deposits. Fee income has been under a little pressure because we've seen a decline in consumer activity particularly, but that's beginning to recover. And mortgage has clearly been a bright spot as we've seen a tremendous amount of activity in the mortgage business. Expense management has been solid. We're benefiting from the derisking of our -- we hope we're benefiting from the derisking of our loan portfolios and the work we've done over the last couple of years to better position our balance sheet with more balance and diversity. Our interest rate, derisking strategy and the hedges that we have in place are clearly benefiting us today. The real unknown is the length and severity of the crisis and the open impact on credit. We are experiencing some stress in our energy portfolio, in hotel, in restaurant and in retail, and we'll certainly talk about that. Interestingly, over 90% or almost 90% of our deposits are in 7 Southeastern states, and we do believe the Southeast, at least to this point, has fared a little better than other parts of the economy as evidenced by the fact that the unemployment rate and the majority of our Southeastern states is a little better than national average. The number of small businesses that closed as a result of the crisis is a little better than the national average. And we estimate 70% to 80% of small businesses in the Southeast are now open. 7 out of 10 states that we operate in have been amongst the fastest to reopen. So beginning to see some positive things in the economy, but still we remain very, very cautious about the depth and speed of the recovery. As we begin to think about returning to the office and providing greater access to our branches, very focused on the health and safety of our associates and customers. And I'll close with just saying that we talk about in this period of uncertainty what we need to focus on, and that's the things that we can control: client selectivity, sound underwriting, active credit servicing, providing effective advice and guidance to our customers and customer service. Those are things that we think we can control and really impact our business. So with that, Betsy, we'll answer questions.

Super, John. That's a great overview. I appreciate that. And we're going to dig into some of those themes, like you mentioned. Just kind of an overarching question I have in this environment. I know you removed your guidance like many folks did. How are you managing the team? What kind of top line management tools or goals do you have? And then how are you dealing with the expense side of the equation in this environment?

Yes. Well, I think we've -- first of all, I think we've done historically a very good job of managing expenses. And we recognize in this environment, where revenue growth is hard to achieve and where we may be over the next few years operating in a fairly low interest rate environment, we've got to continue to manage expenses well. And so we're leaning into our Simplify and Grow continuous improvement effort. We still have 60-plus percent of the opportunities we identified in that process to complete, and we think that will provide some significant benefit. And just overall, we are very committed to effectively managing expenses. In terms of how we're managing the team, it is different. It's more challenging in this uncertain environment. There are lots of variables that we have to consider. I think what we want to do is take care of our customers. And we believe if we do that and stay focused on making sure that we are talking to our customers on a regular basis, that we're positioned to meet their needs, that we can still, we believe, maintain revenue and potentially grow revenue over time. And hopefully, that will have a positive impact on our business.

And just on the expense side, how are you thinking about commercial real estate either in the headquarters or your branch footprint? We've seen an increase in digital adoption, I think, even your customers. Is that right?

Yes. We have, Betsy. This is David.

Yes. I think we're -- what we've discovered is that we can do a lot of things remotely that we couldn't do before, and we clearly have transitioned roughly all of our workforce, virtually 100% of our workforce that's not in our branches. So roughly 10,000 people are working remotely. And that's -- I think that's been -- has really benefited us. I don't know that, though, that is a long-term solution for Regions. I think we will see some subset of our workforce continue to work remotely. But over time, our expectation is that we'll bring more of our nonbranch-related associates back into the business. We like working together. Having said that, we occupy over 12 million square feet of space, and about half of that is in office space. We have a number of large buildings that we own and occupy. And we do believe there's opportunity to continue to reduce expenses by bringing that level of space down. And we can do that. We believe whether we work more people remotely or not, we still have lots of opportunity to reduce office space.

And Betsy, we spend so a little over $300 million on occupancy expense, as John mentioned, half of our square footage being in branches and half in operations in office. And so from the branch standpoint, given the reduction in branch transactions, obviously, part of that's due to closing the branches except for appointments and drive-throughs. Those transactions would be down. But you've seen the digital side pick up quite a bit, mobile and online, and we're pretty good at that. So the challenge for us is to evaluate our retail network strategy, which we continue to look at. We have consolidated a number of branches over the years, and we will continue to challenge ourselves there as we seek to optimize our retail network in each of our markets. So there's likely to be some opportunity there, the exact amount of which is hard to tell at this time.

Okay. Flipping to some of the opportunities in this kind of environment. Sometimes this kind of rate pressures or credit challenges comes with opportunities to expand footprint or products. Is this something you think you would be taking advantage of?

No, I think in terms of opportunities, we still believe we have a solid plan, and that's built around making investments in people and markets and technology and continuing to grow and diversify our revenue base. We've made some nonbank acquisitions over the last few years that have been helpful to us. And we believe that currently, that we enjoy a very good 15-state footprint, a lot of growth opportunities within the markets that we currently serve. We want to continue to work on developing our capabilities to meet our customer needs. And I would say, just executing the plan that we've developed continues to be our primary focus. And we believe that if we do that and do it well, that will generate nice returns for our shareholders.

What about -- maybe we could spend a little bit of time on one of those nonbank acquisitions you did recently, Ascentium. Could you give us some sense as to how it fits into Regions' strategy? And how you anticipate working with small businesses in those -- in that portfolio? And will it be a lever for some incremental growth going forward?

Yes. Sure. We really liked Ascentium for a couple of reasons. One, they had a technology platform that we thought allowed them to very efficiently originate credit to small business. Importantly, they had carved out a niche around what we call business-essential equipment finance through strategic vendor relationships that we thought would be very helpful to us. Small business is a customer segment that we have historically banked, banked well and want to continue to bank. And as we've seen sort of disintermediation of credit origination to small business, it was an opportunity for us to acquire a platform that we thought gave us reach into that market with a different approach and one that we liked a lot. We believe we can leverage it significantly across our footprint. Today, there, Ascentium is originating credit on a national basis from Texas, which is obviously in our market. Our approach will primarily be focused on, obviously, continue to operate the business that they've been running, but primarily focused on small businesses in our footprint and the opportunities that those present to build broader and deeper relationships. So we think we can leverage their technology platform, some of the efficiencies that we've observed in the way they do business as effectively a fintech into our operations, and at the same time, leverage that platform into a small business across our 15-state footprint.

So one of the questions we get a lot from investors is around small business, small business health, trying to keep up with that in this recession here. How is Ascentium and also Regions' overall small business portfolio holding up? I'm wondering how you're assessing the credit of this new acquisition that you just got.

The last numbers I had on Ascentium were about a 25%. 25% of the customer base have been granted deferrals, which is higher than the overall business portfolio within Regions. But I think to be expected, given that a lot of the customer base that they bank would be small businesses and professionals in particular. Historically, loss rates have been in the 2.5% range. But remember, their yields on that portfolio are significantly higher than we experienced. Overall, credit quality has been good, and we would expect it to continue to perform well. Within Regions, we've granted about 15,000 deferrals to small business customers. We've seen the rate of request slow down over the last few weeks. We granted over -- or participated in the origination of over 40,000 Paycheck Protection Program loans with an average size of about $114,000. I think 98% of the loans that we originated were to customers who employ 100 people or less. And today, about 70% of that money still sits in the bank. So what we've seen is those customers who took advantage of the PPP program are carefully using the funding. And as I mentioned earlier, 70% to 80%, we think of small businesses in the Southeast have reopened. So it's a mixed bag. You're going to hear -- if you talk to 5 small business owners, 1 or 2 are doing okay, doing fine; 1 or 2 have been moderately impacted negatively; and 1 or 2 have been severely negatively impacted. And I think it's going to take some time, given all the relief money that the government has put in the marketplace, takes some time to determine what the impact of all that's going to be.

So on the PPP side, since you brought that up, there were some rule changes over the weekend that were adopted or passed by -- fund by the White House. Could you give us a sense as to how you're anticipating that PPP fees that come through NII to traject here over the next several quarters? Is it likely to be really lumpy in 3Q that you recognized that are due to the rule change over the weekend, could it be more extended into next year?

Yes. So Betsy, our expectation is this probably gets pushed out a bit. It is ultimately dependent on the customer. So originally, they borrowed 2.5 months of payroll. They can spend it now longer. They can spend it on other things, but you would expect a good portion of that to ultimately be forgiven. And if they spend it like they originally were willing to do, you would expect that to be expended in a couple of months' time, in which case, they'd turn around and ask for forgiveness, which triggers the fee recognition. So we don't know what they're going to do because it's in their court. We suspect that's going to get pushed out. We'll have a little bit of fees we recognized in the second quarter, a little more in the third, but it's probably a fourth quarter to 2021-type event for anything meaningful at this time. And we'll see how this transitions over the next month or so through our discussions with them. We'll provide an update at earnings based on what we hear.

Okay. And we're going to get into the credit side of this in a minute, but one of the other questions around small business we've been getting is pricing. Obviously, LIBOR spreads have come down quite significantly over the past month. How are you working with your small businesses on that front? Are you putting in floors? I know you had some last cycle. Just wondering what your approach is this cycle.

Hey Betsy, it's Ronnie Smith. We are putting floors in place, and that's on a deal-by-deal basis as we have the opportunity to have an event with the client, whether that's a new request or a deferral or whether they have a covenant issue. It gives us the chance to sit back down, talk with them about the interest rate environment, and we are putting LIBOR floors in place consistently.

Okay. I think last cycle, I can't remember exactly what the percentage was, but do you think you'll get as high? Was it like 40%, is that right, last cycle?

No. Betsy, I don't remember that percentage. We'll -- let us get back with you on that.

Okay. All right. Got it.

Betsy, just a -- I'm sorry, Betsy, just a point there that you're focused a bit on the small business side, but as you look upstream, virtually all of our larger corporate credits have floors in place already. And so your question is right, focus back on the small business and what we consider to be the commercial side of our house. So that's where a lot of the work is being focused today. But if you look at dollars versus the number of deals, that's the percentage that we'll come back to you with.

Got it. Okay. Great. So I think you gave a lot of color on how your small businesses are feeling right now today. Any difference from what you're seeing on the consumer side or the large corporate side, commercial real estate, your at-risk industries with regard to how they're evolving right now?

Our large corporate customers and our real estate customers were seeking to build as much liquidity as they could. Those that qualify for deferral or need a deferral would generally ask for them. I think customers are focused on doing the things they need to do to protect themselves and to position themselves to continue to be viable postcrisis, whatever that is. And so we've had some requests from each of those groups for deferrals. But by and large, I think while we've necessarily seen some movement in credit classification just because of the ongoing weakness in the industry, business is working hard to do all the right things they need to do during the crisis. The consumer seems to be and did enter this period of time in pretty good shape. Again, we're seeing consumers gather up liquidity. Balances in consumer accounts are up. Consumer spending picked up in the last few weeks, but primarily only on debit card. We haven't seen it on credit. So that really demonstrates to us a carefulness, if you will, on the part of the consumer. They're going to spend what they know they have, which is money in their checking account via use of their debit card without building significant credit card balances. In fact, credit card balances are about flat and continue to be. So all in all, consumer is doing pretty well. We've seen roughly 9% of our mortgage customers request a deferral, and somewhere between 20% and 25% of those customers are still making payments on their loan. Similarly, I think, last number I saw was 45% of our credit card customers who had requested a deferral were still making payments. So I think we're seeing customers get the protection they think they could need, but still demonstrate, I think, good discipline in terms of, if they can, paying their loans to the bank.

Okay. Maybe we can turn to credit and the credit outlook here. And I guess there's been a couple of questions that have been coming in. One is just on how you're thinking about the reserve build as we go into 2Q '20 since the unemployment rate obviously came up since the end of March?

This is Anil Chadha. So I lead the allowance process at Regions. So you're right. So when we closed the books at the end of March, clearly, the economic backdrop was evolving rather rapidly. And when we set the reserve at the end of the quarter, I'd say probably the most severe outlook that we saw as of 3/31 was probably an unemployment rate around 9% and then rebounding from there. GDP contraction was meaningfully less than what we're seeing now. So now that we're a good part of the way through the second quarter, clearly we've seen the unemployment rate spike to a higher level. We're optimistic in terms of what we saw last Friday in terms of the jobs report. So we are hoping that, that suggests a quick recovery. With respect to the allowance, we clearly have observed that as we've gone into the second quarter, the economic outlook has declined since the first quarter. So that sets the stage for kind of how we think about provisioning. To the points we've already discussed, there's a lot of other factors that we need to consider that our models really don't know how to take into consideration. We've talked about the stimulus programs that have been enacted. The $6 trillion that have come out very rapidly dwarfs anything we saw on the financial crisis. So it's clearly something that we need to take into consideration as we think about life of loan, expected losses. The other things that we've talked about already, the deferral activity and how our customers are using that to build liquidity, we think is positive. I'd echo John's comments with respect to the consumer and how strong they are entering this crisis. And the data that we're seeing as of now suggests that they're doing all the right things from a prudent standpoint. So ultimately, where we really need to spend our time as we think about the allowance are those industries that have been most affected given the pandemic, retail, hotels, restaurant, energy. This is where we're squarely focused. And you've seen us disclose some high-risk industry segments of about $12.5 billion in total across many different areas. Our focus is to really fine-tune the risk we're seeing in those. And ultimately, we'll use our allowance process, both modeled, but then also other analytics, to ultimately get to what we feel will be an appropriate reserve at the end of the quarter. In many cases, as we think about provisioning over charge-offs, that really is a capital discussion, moving capital from one bucket to the other. So clearly, we feel good about where we are there. But we'll execute the rest of our process over the balance of the quarter. We'd expect that we will be providing over charge-offs given what we've seen this quarter, but more work yet to be done there.

I'll add to that, Betsy, is we will be receiving CCAR results. It could be as early as any day now. And so we'll see how our regulatory supervisors evaluate the COVID-19 overlay to what they otherwise would have done, and we'll obviously be getting back to the market with expectations there as we get to the end of the quarter.

Got it. Yes. Maybe you could give us a little color on how we should think about the at-risk, the C&I book, the impacted industry is like around 12%, and then your CRE book. People see these numbers in the $12.5 billion, but we don't know as much as how much collateral is backing that. Could you give us a sense of that?

Yes. If we want to start with energy -- it's Barb. If we want to start with energy as an example, we're senior-secured. We have no second lien positions as an example. So we look at the energy book. We know there's stress. We know there's going to continue to be stress. Glad that the price of a barrel of oil has come back up, but notwithstanding, it is going to shake some players out. So all eyes on that portfolio. As you look at some of the other portfolios that we talk about, which is freight transport, which is rail, trucking and water, et cetera, there's some pressure there. And again, it's because we're just not moving a lot of things across the country. Health care, and health care would be providers, especially elective surgery, assisted living and nursing homes would fall into that as well, and that portfolio is $1.56 billion. And that is on the C&I side. We have some additional senior housing that sits in our CRE-related exposure. Then we have restaurants, and it's the full service in the drinking places and catering segment, which is about $780 million, which I would say has already seen a lot of stress. It was under stress coming into the cycle, and it continues to be in stress. Especially given that even in our footprint, most of the places that have opened are limited to 50% capacity. And so it's hard for the restaurants, a lot of the restaurants to survive at least at the level that they were at previously. So we'll see some fallout there. And then you've got, of course, retail and a lot of the anchored tenants. Some of the big names that you see have already declared bankruptcy. Others are struggling. So we anticipate some continued pressure on that portfolio. And of course, travel and leisure that we've listed as being another area of concern. With the travel segment, a lot of people are starting to think about travel. There isn't a lot of travel yet. It's picked up. But it certainly hasn't picked up to the level that it needs to be. So a careful eye on that one. And the last that I would point out on the CRE is hotels. The hotels were running at about 10% occupancy at one point. There are about, what, 32% now or so, Ronnie?

Yes.

Occupancy. So they are moving up, but again, slowly. So with all of these segments, it is staying close to your customer, making sure we're listening to what their issues are, seeing if we can help them. But at the same time, and I just want to make sure I comment on this, we are risk-rating these loans as they move through. And they've got issues, and we see the issues, and we've seen that it's going to impact their cash flows. We are actually risk-rating them based on that, not based on the fact that they can or can't get a deferral. So that will clearly impact some of the credit metrics that you see this quarter. But it's because, again, we are being conservative on that front and making sure that we are calling it the way we see it.

Just to add one more point to that, Barb. We're taking the current events versus the trailing-12, which would not be indicative of what that organization or hotel company would look like at this point. So we are trying to sit down with them, look at projections, forecast where we think that they will be given the trends that are developing today.

Thanks, Ronnie.

Okay. So we might just go over a few minutes here, if you don't mind. I have a couple other questions that we want to get through. One is around how your hedges are helping you in this rate environment. And maybe you could give us a sense of how long they are on for, how long of a low-rate environment they can protect you for? Why don't we start there, and then I have a follow-up.

I'll start and then let Tom kind of weigh in. But as we mentioned in the first quarter, the benefit to NII was about $10 million. We said that as a result of the timing of when the hedges became effective that, that number would increase to somewhere in the $75 million range per quarter. Those are 5-year hedges, and it's not quite straight line like that for all 5 years. Benefit follows the curve. But it's a --that's a reasonable proxy. So we're going to start seeing that benefit. That's part of the increase we were able to give you in terms of expectations of NII growth in the second quarter along with PPP and other deposit growth, but that kind of frames it up top. Tom, you want to add some -- any details to that?

David, I think you framed that up well. I think that's correct. Will the hedges come on? Majority of them came on in the first quarter and will continue to come on throughout the remainder of the year. They are 5 years in nature, and we've got roughly $6.75 billion of floors and the rest in interest rate swaps for a total of $22.75 billion. And those, at the time of our disclosure we've put out, was -- the P&L was around $1.9 billion. It's modestly lower today just given the move back in rates. But suffice it to say that, to David's point, we will realize that income over the next 5-year period. So we've got -- we think we have a well-constructed hedge portfolio that positions us for a lower for longer rate period here.

And let me add one other thing, Betsy. Let me add one other thing to that, that it's important that the fair value of those swaps which, depending on where rates are, can range somewhere in the $1.7 billion to $1.9 billion pretax, that's sitting in OCI along with about $1 billion in security gains, too. So that's not in our capital numbers, like they are for the money center folks because we exclude OCI from capital calculations, but nonetheless is loss-absorbing to the extent we're starting to think about capital and the ability to absorb losses.

So 2 quick follow-ups. One is on whether or not you would take those realized gain at any time. What would be the trigger for that decision?

Well, we constantly look at the benefit of having that protection. And while the Federal Reserve has stated a couple of different times that they aren't interested in having rates negative, they have also caveated that with they'll do whatever it takes to keep the economy going. There just hasn't been very solid proof that rates can go negative, but they can't be low for an extraordinarily long period of time. And we think that there is more downside risk than there is the fact that rates are going up anytime soon. And so there was never an intent for these swaps and for these derivatives to be on the books 4, 5 years. We wanted that protection because when we bought them, we bought them out of the money and they were cheap. And that what we would do is wait until we had conviction and the market had conviction in terms of what rates we're going to do, increasing, obviously. At which time we would terminate the swaps, we would take whatever gain was there at the time. And that gain is amortized over the remaining life of the swap. So that's a nuance that a lot of people think that you can just trigger the gain and it goes straight into capital. It does not work like a security where we could sell all the securities and take those gains. Today, we would obviously harm NII going forward. So we're not anticipating doing that either. But I just want to make sure everybody was aware that's how mechanically it would work.

And then just lastly, David, you mentioned CCAR could come any day now. And I guess investors have been asking if that -- if you've received a kind of 2-week warning from the Fed. There's this opinion that regulators are required to give banks a 2-week notice before giving CCAR results. Is that something that you've received already? Or is that a misunderstanding on investors' part?

I think the 2-week warning is, they give us the information before they release it to the public for 2 weeks. So that it gives us an opportunity to understand what they're saying. And we've had meetings with them, and so it's internal to us. We have not received the results yet. As I mentioned, they could come today, and they can come any time this week or next week. But I don't expect the market to get that information for a couple of weeks after we receive it.

Got it. All right. Great. Well, appreciate all your time, John, David, Barb, Ronnie, Martha, Tom and Anil. Really appreciate your time this morning.

Okay. Thank you, Betsy.

Thanks for having us.