Regions Financial Corporation (RF) Earnings Call Transcript & Summary

Next, we are excited to kick-off day 2 for the Regional banks with Regions Financial. Over the past years Regions has navigated the current environment better than most by layering on timely hedges and building significant reserves across its high risk exposers. In addition, it continues to show a solid expense discipline as we it gets deeper into its Simplify and Grow initiatives. Here to tell us more about the strategy is President and CEO, John Turner; also joining him is Chief Financial Officer, David Turner. In addition, there are a handful of others in the room, including Anil Chada, Head of Risk Analytics, Ronnie Smith, Head of the Corporate Bank; Matt Lusco, Chief Risk Officer, and we also have Deron Smithy, Treasurer; and Martha Raber, who's Head of Credit Financial Risk; and of course, Dana Nolan. So thanks. Good morning, and thanks for joining me today.

God Morning. Thanks for having us.

So John, maybe to kick it off, while I'm sure none of us expected 2020 to play out the way it did. The bank has fared better than I think many have expected, and shares are close to flat on the year. So with that as a backdrop, can you talk about how you feel the bank is positioned to succeed as we move into 2021?

Yes. Thank you, again, for having us. I think we're very proud of what we've accomplished. We spent the last 10 years working hard our goal has been to build a bank that was consistently performing that was sustainable during periods of stress. We certainly couldn't have imagined a stress like this, but we think that the work that we've done in the past to derisk our business, to hedge our interest rate risk to effectively manage expenses while making investments, has positioned us really well. We operate in markets that have -- seem to have done a little better on average than states across the country. And so we've seen a little lower unemployment rates in our markets. We've seen a little less closure of small businesses. Generally, our customers are cautiously optimistic. I'd underscore the word cautious as are we about the continued improvement in the economy, we think, Ryan, the work that we've done to this point has really positioned us well to get through what likely will be a bumpy first half of 2021, maybe all of 2021, maybe bumpy for all we know. But our expectation is, at least the first half will be bumpy. But then we think the economy will continue to grow and expand, and we're in a position to take advantage of that we think.

So maybe to dig into some of the initiatives that the bank has going on. So Simplify and Grow has been your continuous improvement program that you've had in place for a number of years. I think you've completed, if my memory serves correct, 42 of the 92 target initiatives. A lot more have been on the expense side. As we look forward, they look a little bit more balanced between revenue and expenses. And if I look, I think 80% of the remaining savings comes from your 5 largest initiatives. So can you maybe just talk about what are some of the largest main remaining initiatives? And as you deliver on these, should it allow you to deliver positive operating leverage over time?

Yes. Well, our largest expense categories are people. Obviously, our facilities and the costs associated with facilities, our vendor spend, that's where a good bit of our savings will continue to come over time as we work on how we improve processes, how we think about the way we do business. As we adjust to the new work environment that likely we'll experience over time, we'll need less space. That gives us opportunity to reduce costs. And our sense of that is still certainly still evolving. We are and have been and will continue to be committed to generating positive operating leverage. 2021 is a transitional year it'll be very challenging, we think, to generate positive operating leverage. Our view of that commitment is longer term. So while we may not achieve it in 2021, we're committed to 2022, 2023, as we begin to normalize to generating positive operating lever. And our continuous improvement program is an important part of that.

Got it. So when you kicked off, you talked about a potential bumpy road for the first half or maybe even most of 2021. Clearly, loan balances, particularly on the corporate side, had been under pressure. I think they were down 3% in the most recent quarter, driven by commercial pay downs. And as we look into 2021, clearly, we going to have the headwind of PPP rolling off. So as you look across the footprint, can you talk about the prospects for loan growth into 2021? Maybe, John, even broader, what is the sentiment like amongst your clients? And what do they need to see in order to begin [indiscernible] again? And maybe compare and contrast what your expectations are on the corporate side versus what we could see on the consumer side?

Yes. Well, as I said earlier, I think our customers are cautiously optimistic and we think that bodes well for expansion to the economy and ultimately, some loan growth as the economy begins to stabilize, normalize, people get back to doing the things that they've historically done. I think commercial or corporate loan growth will be difficult to achieve in 2021. Inventory levels are down, borrowings, under lines of credit are down, liquidity is way up. So we expect customers to put that liquidity to work first as they begin to expand inventories and use their working capital to grow their businesses. On the consumer side, similarly, the consumer is well situated. We've got a couple of runoff portfolios still in our book in direct auto. We're exiting the indirect unsecured business. And so those will be headwinds as we grow our mortgage book as we grow our equity lending portfolio to offset those things. So we're not anticipating much, if any, loan growth in 2021, but believe as the economy begins to expand again that the latter part of the year and into 2022, we should see some long term.

Now, john, you mentioned a handful of businesses that you've exited indirect auto, unsecured -- parts of unsecured consumer and under the GreenSky partnership. As you look across the bank, where do you think we are in terms of optimization of whether it's the lending portfolio or different or various fee businesses? And what criteria are you using to determine whether or not a business or lending vertical stays or goes?

Yes. Well, I would say optimization is an ongoing effort. And we can always get better at how we think about allocation of capital. It's 1 of the, I think, real opportunities that we continue to have is a more disciplined, continued disciplined focus on allocation of capital and returns on capital. When we think about returns on a couple of different dimensions, returns on tangible common equity, returns on regulatory capital and how do we think about what we're getting paid, how broad is our relationship, both on the commercial and the consumer side. I don't know that we -- that there is a specific businesses or portfolios that we think we may need or want to exit. But our ongoing allocation of capital to relationships is an important part, I think, of both our strategy and our ability to generate positive results over time as we think about how we use that capital.

Maybe sticking with the revenue side. So we saw a hit to fees early in the onset of COVID. They've bounced back nicely in recent quarters driven by mortgage and capital markets and -- but some consumer fee categories are still down, and David has indicated that probably stay depressed for a period of time. So as you look into 2021, what do you see as the biggest driver of these across the bank at this point?

We've been investing in mortgage, we've actually began making those investments 2.5 or so years ago, and we think that as a result of that, we're actually taking market share. We've had a tremendous year in mortgage, don't anticipate it will be quite as good in 2021. We believe that mortgage will continue to be an important driver of fee revenue. We made investments in wealth management, capital markets, and we're continuing to grow our consumer checking business. And as we do that, it brings with us card activation, and additional fee income associated with just the expansion of consumer checking. So while it is true that certain categories of fee income have declined during the pandemic and may not recover, we see other sources of revenue that will make up for that loss of NIR in the future.

Yes, Ryan, I'll add to that, that -- and one of the things that we're looking for is if we can get some get the vaccine, get the virus under control. And if we start traveling a bit more, commercial interchange is really heavily predicated on travel. And so that's been depressed since March. So we don't anticipate that coming back just yet, but there's a chance, there's an opportunity, I should say, if we can get to open up again, so that could be a positive.

Got it. So I think you, over the past few months, extended your vendor support on your core systems, I think til 2028, which I guess, hopefully, lowers the investment burden for you. So can you maybe just talk about how this is allowing you to reallocate funds into some revenue-enhancing initiatives? What are those initiatives? And what are the priorities for CapEx spending over the next few years?

Yes. So priorities would be digital, digital and digital. We...

The list the big one.

We did extend our agreements with our vendors that gives us more time, which we're -- we think is really helpful. As it -- as we can make that transition of our core systems in a more orderly and less, I guess with less pressure on us to get it done. It also allows us, to your point, to distribute the cost over a longer period of time while making investments, and importantly, in things like digital. So coming out of the crisis, one of the things we wanted to do was capture some of the behaviors that we thought were things that we wanted to do in the future. We made decisions more quickly, we implemented technology more quickly. And so we've got a couple of initiatives that we're investing in that we think will have near-term impact. One is upgrades to our mobile banking platform, which continues to improve and is rated as -- now in the top quartile, we think, of the industry and improving every day, and that's key to our continuing to grow consumer checking accounts. We're investing in e-signature, which has enterprise-wide application and helps us reduce cost. And then online origination capabilities across all our platforms. And we think we get a kind of a 2:1, at least, return on revenue versus expense associated with those investments.

So maybe sticking with the theme of expenses. You spoke earlier about your efficiency initiatives regarding Simplify and Grow. And when I think about some of the things you highlighted, personnel, real estate, third party spend, digital, the main areas where you're investing across the bank. And as I was preparing for the conference, I was struck by the fact that core expenses have been the $3.4 billion to $3.5 billion range literally since 2011. So where are we going to see incremental savings come from? And is this enough to allow you to make the necessary investments in talent and technology? And can you continue to hold the line on expenses as you've done for the last 10 years?

Yes, Ryan, so we think we've done a pretty good job as you mentioned. Our compound annual growth rate is less than 1% and expenses over the last 4 years, and we seek to keep expenses flat year in and year out. Now we have a couple of things that we have to pay for. One, our Ascentium transaction that we acquired in April only had 3 months of expense -- 3 quarters of expense this year, we'll have an extra quarter next year. We have inflation that's baked into our run rate, roughly 2%, 2.5%. Most of that's driven by merit, but also vendor increases. And then we're making investments, as John mentioned, in terms of digital and the other areas. We have to pay for that. And if we're going to keep expenses flat, then we have savings elsewhere. So to date, our #1 driver of expenses, our salaries and benefits. It's 55% of the expense base. We've been able to reduce branch count. That's an area we still have more branches than others on a relative basis. Part of that's our geography and where we operate. But given the transformation, the quick transformation to digital will cause us to continue to evaluate the branch count. So I think you'll see consolidations be pretty strong for us, and we're seeking to to move on that, which is a cost savings for us. We're continuing -- continuous improvement is all about everybody, all 20,000 people in the company looking at how to improve whatever they're responsible for and leveraging technology and going through a process improvement. And over time, attrition will help take care of people and get that down. So that's an area of focus. Our square footage should be down, part of that's branches, other part of that is our office. And what we haven't determined yet is what does the return on new normal look like and how does that tie into our real estate, our square footage program. And I think that that we -- it's too early to call on that. We certainly want people ultimately to come back together to build the team and keep the culture going. But can we leverage the return of new normal and save there is in something we're looking at. Clearly, vendors, we have -- our Head of Procurement is really -- you've got to have to go through his team on vendor spend. We really are watching that very closely, both on demand management. But when we have to have a third-party really challenging how much we're going to pay for that. So there's no area of expense that we're not just hitting on extremely hard because the goal and we're going to update this in January. So we're not giving you guidance for next year, but our goal all along has been trying to keep expenses relatively stable year-on-year.

Just maybe 1 follow-up on branches. So I think you're scheduled to reduce the cap by 54 this year. And I think you've discussed another 60 next year. But I think about all the things you said about digital. And if I look at some of your stats, mobile deposits up 50%; account openings, up 24%. Can we see an acceleration of branch closures just given the move to digital and how things are moving? And second, maybe a question for John. As you think about the de novo strategies, you've outlined in markets like Houston, Atlanta, St. Louis and some of the others you're ramping. Does this at all change the approach to expansion in markets the way you approach the markets?

I don't think so. I mean, we -- first of all, I think we've been consistent in the process we use to evaluate branches. And as a result, have been closing, on average, 40 to 50 branches a year. As I recall, we've closed over 400 branches since 2014. And so that process will continue. I don't expect us necessarily to accelerate closing branches, but we'll be very deliberate and methodical in our approach. We believe that customers continue to want to come into branches despite the fact that mobile logins are up 22%, branch transactions are down 23%. Branch traffic is still very important. Customers come into our branches for advice and guidance, for education and to take care of things that are particularly important to them. When we made a transition over 2 years ago now to a single job family in our branches, so that everybody in the branch can do every function of the branch and that really positioned us, we think, very well when the pandemic hit, and we had to begin operating our branches in a different environment. And going forward, we think those branches will still be important and what customers actually want is to bank with us multiple ways when they want to, how they want to. And so I think we're going to continue to make investments in branches while making investment in digital. And the key will be, can we create the same great experience in the branch that we do through our digital channels, online, call center, et cetera, to create that good omnichannel experience customers are looking for.

So the team has probably done a better job than any other bank out there in terms of preserving the net interest margin due to the hedging program that was put in, in the latter part of 2018 to really preserve NII. And if I think about it, the core margin is hovering around à, and I think the expectation it's going to remain in the 330s over the coming quarters. Can you maybe just remind us of some of the drivers to keep it relatively stable? How long could that last if the rate backdrop doesn't change into 2021? And then maybe for both David and Deron, maybe just talk about the sensitivities to long-term rates. I think your fixed rate production is somewhere around 100 basis points dilutive. But how does it evolve as we get curve steepening in the coming quarters?

Deron, do you want to take that?

Yes, sure. So Ryan, you've got all the relevant statistics right. So obviously, we've -- I think we've done a good job of neutralizing the impact to short rates. The long-term rates do continue to present a challenge from a reinvestment standpoint. So you're right that we're roughly 100 basis points. It's improved a little bit of late, it's probably 90 basis points across securities and loans of a headwind from a repricing standpoint. And so obviously, any incremental steepening in the curve helps to offset that. And that will play out over the next year or so. But ultimately, that runs its course as well. But I think your question more is, well, how do we overcome that? And it's really 2 ways. One, we continue to have some deposit leverage -- deposit cost leverage. And so we'll see deposit costs come down in this quarter. We'll see them come down, albeit at a slower pace into early next year. So that helps to offset that. We -- but primarily the way we'll offset it over time is through stability in the balance sheet and a return of loan demand and growth in the balance sheet. And so again, we've reduced the variability. You can't completely escape the impact of low rates. We've reduced that variability. And over time, we'll overcome it with -- through the business and through growth in the balance sheet. The last point is despite what we're seeing from a reinvestment standpoint, we are seeing some positives from a loan spread standpoint. We're starting to see spreads widen in the commercial space over the last few months, couple of quarters, expect that to be a bit sustained. And some of that is just general market. And some of it is what is -- what we're doing internally from a client selection standpoint, focus on improving returns and focusing on growing profitable relationships. And so we do think that continues into the future and helps us to overcome the rate dynamics.

Let me add to that, Ryan, because this is important for everybody to understand what we're -- how we think about loan growth. You heard earlier, we think our loan growth will be challenged in 2021. But we're here, we're open for business to make loans to all creditworthy borrowers when we can develop a fulsome relationship. What we don't want to do is because of the pressure with loan growth is to go chase that loan growth and get ourselves in to credit problem. As much as we want to grow the balance sheet, we are being very selective when we can have a good relationship, we are all over it. We think there are going to be some opportunities in our market. There's like a lot of disruption that are going on through different acquisitions. And so we think there could be some opportunities there, but we're going to be very careful on how we cross -- move through and proceed with that type of growth.

Maybe just 1 follow-up on the discussion. So there's obviously a wide gap between the core and the reported margin because of highly elevated liquidity. Just maybe talking about -- talk a little bit about the strategy of deploying liquidity, Deron. Do you think most of the 6 rounds? And if so, what is the action plan for deploying the liquidity and how are you approaching that?

Yes. So we've been pretty active there on both sides of the balance sheet. We obviously have seen tremendous deposit flows, and that's enabled us over the last several quarters. To reduce all of our wholesale funding. Our home loan bank advances are down to 0. We've been able to tender for debt. We've called more expensive debt. And so we continue to look for opportunities to reduce funding costs from a wholesale standpoint, but those are clearly becoming less available as we've exhausted most of the opportunities there. We have recently grown the securities portfolio in the third quarter. We grew it $3 billion, and that's really reflecting the fact that we do think a fair amount of these deposits stay with us longer term. But as we've alluded to, there is a tremendous amount of excess liquidity that has been built up by companies and individuals. And as the economy continues to improve, they'll look to put that to work first. And so we do expect that deposits will normalize over time, but certainly, a meaningful amount will stay with us, and we see opportunities to put that to work. I will say, Ryan, there are marginal opportunities. The recent steepening in the curve makes it a bit more incrementally attractive. But absolutely, it's still -- it's not a great entry point for adding securities in a meaningful way. We may do some marginal investments here. But if you look at, in general, where mortgage spreads are -- and just spreads in general for investment products, there's a lot of demand as well as the Fed being very active in those markets. And so we don't think there's a lot of value that's being created by growing the securities portfolio in a big way, but there could be some marginal increases there.

And I guess, on the long end forecast, we still don't see that moving dramatically. We think there are a couple of things at work here that work to offset each other. We do see steepening coming through maybe deficit spending and more stimulus and things of that nature. But then you've got the FOMC and as the Fed continuing to pump in stimulus and increase the balance sheet, which serves to offset that a bit. So we don't see the long end moving dramatically. It had -- it's up a bit more and that's an opportunity should it -- should we get more steepening than we think.

David, you mentioned stimulus, maybe a question for John and Martha. Just how -- one, how important is further stimulus to the health of your client base? Maybe talk about it in the context of some of the high-risk exposures that you have. And which parts of the portfolio are you still the most concerned about? And how does that influence your view on the ultimate range of outcomes of losses in 2021?

Yes. I think we'd like to see some Congress appropriate, some additional stimulus targeted to the services industries, so restaurants, hotels, hospitality related industries and those companies that serve them and then target it to consumers who work in those industries. Those seem to be, without question, the hardest hit. The portfolios that we are actively managing and have some concerns about are energy, restaurant, hotel and to some extent, office, although our office portfolio is really solid we believe and then anything hospitality related. And so additional stimulus, particularly for small business, targeted at those industry sectors, I think, could be very helpful to get us through the period of time when the vaccine really begins to put people in a position where they begin to travel again and move around.

Maybe I was...

This is just..

Sorry, go ahead Martha.

I'm sorry, I was just going to add, since you mentioned my name that the way John framed it up is spot on. All of those sectors are stressed due to the pandemic. And -- but we're we've been cautiously optimistic, and we've also been a little surprised about how well the clients in those sectors are reacting and responding to the headwinds that are facing them. There is a lot of stress there, and we do think that additional stimulus that would be targeted to those sectors would be very welcomed and would go a long way to continue to repair those sectors in the coming months.

So maybe as a follow-up to that, if we do get additional stimulus, is that enough in and of itself to begin releasing reserves? And then we had a handful of banks talk about where they think losses are headed. I think someone on the team talked last quarter that you still thought, last Monday, you still felt confident about some of the ranges that you gave a couple of years ago about Investor Day. Can you maybe just help us understand how do you think about the ultimate loss content that we could experience in 2021 is? Do you feel confident that, that range that we've heard from others is where the ultimate outcome could be for regions?

Yes. So Ryan, I'll start and let Anil Chadha talk a little bit about the fact, we really don't have stimulus baked into our reserve methodology right now. So that could be a positive if that comes. But we really aren't going to give guidance in terms of charge-offs for next year. What we've said is we'd be in that 55% to 65% ranges next quarter. Things that can -- and we do think -- still think that charge-offs will peak in '21. But what we're seeing is, as Martha just mentioned, we're seeing some of our most troubled industries and customers actually react pretty positively. It's encouraging, credit metrics are encouraging, but we need to wait to get to the end of each quarter. As you know, it's incredibly volatile. We have to wait to get to the end of the quarter, and we'll make adjustments to the reserve that we need to have. We'll come out and we'll give you guidance in January as to what we think next year will be. But we are feeling incrementally better where we are right now, but it's -- there's still some uncertainty out there that we need to be careful of. Anil, why don't you add to that?

Yes, you summarized it very well. And each of those factors that David, you mentioned as well as Martha, that comes into play as we think about the allowance and the timing of any future changes in the allowance. So each quarter, we look at what's evolving in a positive way, but also very mindful of the risk, the way John described the specific pockets of risk within certain sectors in the small businesses. The companies that feed the restaurant retail, hospitality sector, these are all risks that we have to continue to monitor. And clearly, as we approach the end of the fourth quarter, we're very mindful of the potential for further stimulus, but we're also very mindful of the risks that exist with the surge in cases of the virus, what does that mean in terms of localized shutdowns. So these are all things we have to take into consideration in each quarter in the past of the allowance will follow our ability to monitor that, assess the risk and feel comfortable with the coverage at each point.

So David, you mentioned we are getting towards the end of the quarter. And any thoughts on how 4Q is progressing from a high level? And any changes to expectations that you wanted to highlight at this point?

Well, I think you really need to go back to what we had at our last conference's deck that we sent out. And we gave you pretty decent guidance in terms of what we thought charge-offs. I just mentioned that. We talked about NII at that time being flat to maybe slightly down. All that's predicated on a bit on PPP forgiveness too. We talked about at line utilization is still low. At that 41% is where we were last time we talked. So all those are kind of the guidance that we had given you then. And we're encouraged with the fourth quarter, but we've got a few weeks to go.

Got it. And maybe shifting gears to talk a little bit about capital. I mean, you're back in the low to mid 9s and you're expecting it to continue to increase. Can you maybe just talk about the near to intermediate-term priorities for capital heading into 2021? And if the Fed were to give us the green light, how aggressive can you be in terms of deploying capital?

Well, certainly, so going back through, as we think about capital, we want to use it for organic growth first and then pay our shareholders a reasonable dividend. And we look for opportunities to have bolt-on acquisitions like the Ascentium Capitals of the world or portfolios that might come up from time to time. And we use then our share repurchase as the title to keep us at our targeted capital levels. So for common equity Tier 1, that target is 10%. We've talked about accreting up to that. We had pretty good accretion in the third quarter. We'll see what it looks like for the fourth quarter. But hopefully, we can continue to accrete to that. Even if we're at 10% today, as you know, we are precluded from repurchasing our shares. We as well as others are in the process of going through the supplemental CCAR submission. We'll hear about that just before Christmas, we understand. And so there's more to come on that front. We don't know. We've obviously run our own stress test, but we'll have to wait and see what the -- what our regulatory supervisors results are relative to that. And whether there's any type of concern or regime change with regards to allowing people to repurchase shares. And I think there's still uncertainty, everybody feels that. Especially with this, as Anil mentioned, with the case counts going up, I think we're all trying to be a bit cautious here as much as we'd like to optimize capital, I think, being a bit conservative at this point is prudent. And that's where we've changed our capital target, as you know, from 9% to 10% because of the environment. That can change going other way if things open up a bit and we get control of the virus. But that's where we are today. Deron, anything to add to that? I don't know if I left anything open.

No, I think that's well said.

We've got about a minute to go here. And John, David talked about disruptions in your market. I know the bank hasn't done a whole bank deal in over 10 years. I think those were FDIC deals. The currency has strengthened, you're in a better position post the outperformance. Has the pandemic at all changed your approach to M&A? And if you -- and if it has, what would your approach be and your criteria for doing a deal?

Yes. Yes, it hasn't changed our approach. We -- our focus -- primary focus is still on nonbank acquisitions, adding capabilities in capital markets, wealth management, acquiring more servicing rights, doing the things that we've done over the past few years to grow and diversify revenue and add to our capabilities. As we think about depository acquisitions, bank acquisitions, and we've said that we had to build a stronger currency. And that we believe that if we just executed our plan then we could deliver outstanding results for our shareholders, that bank M&A is disruptive, and we didn't want to do anything to getting in the way of executing on that plan. Recognizing there's a lot going on in the marketplace, we'll continue to watch the market, to continue to understand what the implications of all that is and are. But our focus is still on executing our plan and strengthening our currency so that we can earn the right to potentially be an acquirer 1 day.

Great. I think we're out of time. So on behalf of me and all the investors. I want to say thank you very much for participating and look forward to engaging again in -- on the fourth quarter earnings call, and hopefully, look forward to seeing you in person next year.

Yes. Thank you.

Thank you, Ryan.

Thank you.

Thanks, everyone.