Regions Financial Corporation (RF) Earnings Call Transcript & Summary

Good morning, everyone. This is Gerard Cassidy from RBC Capital Markets. Once again, thank you for joining us for our 25th Annual Financial Institutions Conference. And in this fireside chat, we have Regions Financial Corporation. As many of you know, that's the 15th largest bank in the United States, does banking across 15 states with over 19,000 employees. It currently trades at about 1.2x book value, and it has a common equity Tier 1 ratio of 9.8%. Joining us is David Turner, who many of you know, is their CFO of Regions. Also with us is Dana Nolan, who is Head of Investor Relations; Ronnie Smith, the Head of the Corporate Bank; and Deron Smithy, the Treasurer of Regions. Gentlemen and Dana, thank you for joining us.

A pleasure.

Thank you, Gerard. We appreciate you putting us on again and looking forward to questions and thoughts from the crowd.

Great. David, maybe you can share with us, obviously, 2020 was a very crazy year. Big surprise, of course, was pandemic. But if you put the pandemic aside for a moment. What were some of the big surprises that Regions experienced and you experienced? And how did you manage through those surprises? And what were some of the takeaways that you saw from what you went through in the past 12 months?

Yes. Well, thank you, great question. I'm getting a little bit of feedback, so I may -- if you would go on mute. Gerard, I think that, last year, clearly kind of came out of the blue. We had not anticipated, obviously, a pandemic. We were in the middle of doing our own small business transaction that we closed in April, about the same time that the pandemic hit. And so we had anticipated using some capital on the transaction. And then of course, we used a lot of capital to build reserves in the second and third quarters. But what surprised us was how resilient the workforce was to be able to work remotely without missing a beat. We were one of the first who -- to open our branches up to -- for reservations. And the transition that we made in serving our customers, we thought we did a really good job. We're also surprised by the amount of deposits that came into the system. Clearly, the stimulus and unprecedented actions by the Fed, created this massive amount of liquidity. I mean we grew deposits $25 billion between the beginning and the end of the year. And we continue to have some $15 billion, $16 billion of cash sitting at the Fed, earning 10 basis points. So that was a surprise to us, and we continue to battle that. And I'm sure we'll have some further questions on it later. A very volatile -- the credit kind of deteriorated rapidly there. I can remember back in March of the beginning of the pandemic, we were trying to figure out what allowance for loan losses should be and looking at different models and the volatility for those 2, 3 weeks in March were just unprecedented. But I think the banking system was very resilient from a capital and liquidity standpoint. And we kind of got over that after the first couple of quarters. And I think because of the unprecedented amount of accommodation, it was kicked in by the government, settle things down a bit. And we finished very strong for the year. And I think our industry finished pretty strong for the year. So we're all set up and ready. And I hate to say the word cold spring, but you really -- we have a lot of capital and liquidity we want to put to work. We continue to be the financial intermediaries that we are or asked to be. And we're looking forward to helping that economy continue to recover. There's still a little bit of uncertainty, but I think the vaccines are working and case counts are coming down. And so we see a path to a much better back half of the year. How good that can be? I don't know yet, but incrementally better. And I think you're going to continue to see a low rate environment for the rest of this year. You may get some steepening, further steepening with the 10 year close to 2 and then backing -- back down a bit. But short rates probably aren't going anywhere for a while. So I think we still have 10 million people that are unemployed. That was also a shocker for the year. There's an uneven rebound, economic recovery going on. And I think we need to kind of help each other along, help a broader part of the economy continue to recover would be in order. And if we can get that done, there's a lot of pent-up frustration in terms of people wanting to get out and about, in particular, spending money in the services sector, restaurants, hospitality, travel and so forth, that, I think, could be a good driver to GDP growth in the back half of the year.

David, speaking of the back half of the year. You're fortunate, your franchise is located in some of the faster-growing parts of the United States. Can you -- and we know banks are products of their economy. Can you give us any added color on what you guys are seeing in some of your important markets and the growth prospects? And what that may mean for improved profitability for Regions in the upcoming year?

Yes. Let me start, and then I'll ask Ronnie Smith to talk a little bit about what we're hearing from customers because certain industries are rebounding quicker than others. So you're right, we're in very good markets. And I think that, especially with the continued stimulus that's being put into the markets, there's a lot of ability to create growth in GDP. I think loan growth is going to lag though. And if I talk about the consumer side, I just don't see a lot of demand for credit. With the exception of mortgage, we should have a very strong mortgage year, maybe not the $12 billion of production we had last year, but should be very strong, and we sell half of that, retain half of it. So I think that's going to be beneficial. Because of all the stimulus money, though, the pay downs on things like home equity lines of credit, we'll continue to plague our ability to grow consumer loans there. I think that we exited the auto business. So you're going to see that continue to decline. And then kind of point-of-sale lending and other consumer, we have some portfolios that are running off and some that are growing. So I think net-net, the consumer probably is not going to have a ton of growth from a loan standpoint, which is what we really need, ultimately, to be able to grow net interest income over time. We continue to benefit from our hedging, but we really want to see some balance sheet growth. If we get it, Gerard, it's going to really come through the Corporate Banking group, and we're seeing certain sectors that we think are poised for great rebounds there. But Ronnie, why don't you take that and run with it a little bit.

Yes, sure, David and Gerard. Happy to answer the question from what we see from our clients today. And they have responded like you would think they would respond in a pandemic and some of that hangover continues by building cash that Deron and I talk about a good bit on how to deploy and how sticky is that cash. We ended the year with line utilization at about 40% of the committed amount. And normally, we would be in the 44%, 45% range. So that shows you how far we are down on line commitments, but our overall commitments continue to be strong. And as David talked about us being poised to take advantage, we see a lot of our companies poised to take advantage of a rebounding economy as well. So there are -- and David referenced some industries that we see, and we've seen stream throughout 2020 really on the construction side and all the supply chain that actually occurs in the construction business, we've seen terrific resilience and continued strength in that space. And there's more activity going on in that particular area. But we've seen some traction with health care, not early in 2020, but as we finished up in the latter half of 2020 and have kicked off '21. We've seen some strength in that particular area as well. So we do see energy coming back. Prices have certainly rebounded over the past several weeks as well. It's a volatile industry. We continue to do business in that industry, but cautious. And cautiously optimistic about what we're seeing in that particular area of our franchise as well, which is important to us in the Gulf South Region. So I would say, overall, it's by industry, it's not as much by geography. It's really, if you go from Florida to our Texas market, to our Indiana markets, what you're seeing are industries that are providing good resources to consumer, consumer products and services, transportation that are involved in the last-mile delivery, warehousing, those kind of things that we've seen coming and developing out of the pandemic continue into '21 and continue to get stronger. But most of our clients are optimistic about the second half of '21. They talk about what they've built in cash and some of the deferred things that they need to do as the economy continues to reopen. So we're cautiously optimistic with them as well.

Very good. And David, you touched on, in your opening comments, to the first question about interest rates and the steepening yield curve. One of the themes investors have been focused on for buying bank stocks in 2021 has been the possibility or probability that the yield curve will continue to steepen. And even maybe the federal reserve will come up and have to raise short-term interest rates sooner than the current policy statement of end of 2023. So maybe you can -- if you would, can you share with us -- again, I know you touched on it, the steepening of the curve, what it means to Regions and also maybe some added updates and color on your derivatives book that has been very helpful to maintaining that net interest income, just where that stands. And then third would be, if the Fed was to raise short-term interest rates, what would that effect be on your organization as well?

Okay. Deron, why don't you start with that, and then I'll add some color.

Yes, sure. So the short answer is, clearly, the deepening yield curve is a benefit to us. I think it's -- we'll just start with what our natural exposure, if you will, that we have to manage from a net interest income volatility is low rates or longer and a flat curve. And so one of the things that we certainly attempted to do, and I think we've been fairly successful so far is to eliminate that short rate exposure through our hedging program and those hedges have done their job, and I think they will continue to do their job in helping to reduce that variability in NII. The shape of the curve really impacts us more from an ongoing reinvestment standpoint, both in securities as well as new originations for fixed rate lending. And so to the extent that we see the curve hold these levels and continue to steepen from here, that's a benefit to us. It has been a headwind. We've been largely able to overcome that headwind, again, through hedging, but also from balance sheet management strategies. And so the movement in the curve we've seen today just helps to get us closer to that being a tailwind going forward. But it's certainly helpful to us to put us in a position. To the extent we start seeing firming of loan demand and the balance sheet grow, we're going to see net interest income grow as well. Your question about the Fed, it's -- again, our hedges were designed to protect us in that continued low rate environment. And I would say we're largely neutral to rates staying low. But interestingly, through the structure of our hedging as well as now in a potentially rising rate environment, how we think about deposit costs changing through time. We're actually in a position where if rates were to start moving sooner rather than later, we will see widening margins, and we will see improvement in net interest income as well. So the hedge is, again, designed to protect low rate, but we do have a lot more levers in a rising rate environment to ensure that we can grow net interest income and see the margin expand.

So I mean, Gerard, one of the things that we do is we look out and try to anticipate what -- based on our expectations of inflation and what the Fed might do. And clearly, they've been clear on letting inflation run a little high -- a little bit over the 2% mandate before they start moving, which tells us that '21 is probably not going to see any movement, most likely not much in '22. And if it moves, that would be the back end of '22. So we're kind of thinking '23, '24 is where rates start to move. And as you know, our hedges go out an additional 4 years from where we are right now. We didn't enter into those with the expectation they would run the term that we'd be convicted that, that protection was no longer needed for low rates, and therefore, we would terminate those. We take whatever gains we have. They would amortize into NII over the remaining hedge term. And that we would get back a little bit of our sensitivity, which is natural for us. We have more natural asset sensitivity because of the deposit base and how it moves, as Deron just mentioned. So right now, the forwards, I guess, have a couple of tightenings in '23 and a couple in '24. And so we're starting to think out a little bit. Just like we did when we put the hedges on, we were thinking out 2 or 3 years, what does this mean we had our swaps that started in -- I mean, our hedges started in 2020 because that's when we thought the Fed would become more accommodative. They actually started, as you now know, in '19. So we missed it by a year, but nonetheless, we had the concept down, and we'll do the same thing on rates going up. So it's a little bit of a look at the data, see what the data says and then position ourselves as best we can.

One of the interesting developments in this period has been this growth in deposits. You guys touched on it. The liquidity on your balance sheet as well as your peers is certainly elevated. How do you think that's going to impact. I can't believe, I'm asking this question, but how do you think it's going to impact deposit betas when that becomes one of the talking points, possibly in '22 or '23? They were very slow in rising, as I recall, in the last tightening cycle in 2017 into '18. What's your view on just being able to really capture maybe more of that revenue growth with higher rates because you just don't have to be as quick to raise deposit rates?

Yes. Gerard, I think that's a great question. It's something we haven't had to manage through to the degree that we will this time around. But I think it's a bit of a bifurcated story. I think there's an underlying core deposit base that is driven by our efforts to be part of the operating account for our customers on the commercial side and then checking accounts and more traditional deposit accounts on the consumer side that, I think, will perform similarly to what we've seen in the past. But there is now a surge in what I would call excess liquidity that companies may continue to hold as we see the environment continue to improve. And certainly, perhaps so on the consumer side, I think there is a core underlying position that will perform similarly to what we've seen in the past. But this layer on top that we're all questioning how long will it be with us from a liquidity standpoint, we also have to consider the fact that it's likely going to command a higher return as well. And so that's the way we're thinking about it is we're -- we are, in general, thinking about the surge in deposits as perhaps creating a layer of greater sensitivity through the normalization. Certainly, I don't think that with the Fed being as accommodative as it is and appears to be for some time till the Fed begins to normalize its balance sheet, I don't think we'll see material normalization in the deposit balances. But once they do signal that they're going to begin tapering and adjusting their bond buying activities as a precursor to raising rates, I think you could see some of that cash begin to normalize, but the liquidity that remains with us more persistently, I think, will likely be more rate sensitive. And so we have to think about that in our overall positioning.

I would add to all that, that's where our competitive advantage has been historically. So we've had a lower loan deposit ratio. We've had sticky core deposits. We've been -- our beta has been lower. And I think that, net-net, we start to shine a whole lot more and with higher rates. Today, our competitive advantage of low sticky core deposits really aren't benefiting as much because deposits are free for everybody. But in time, if we get rising rates, we really start to shine in that environment. And we're looking forward to that day. We just don't think it happens really for a couple of years. And that's our best guess today.

Yes. No. Understandable. Coming back to the extra layer that you guys just described. I think you may have answered this question in those comments. But maybe going back to it, it will be helpful for people listening in. What metrics are you looking at to see how sticky that extra lay of deposits that has come into your bank than the banking industry? Is it the Fed halting it's purchases of government securities every month? Is it higher interest rates? Can you give us a little more color about how you're watching? How sticky that layer is? And what could make it move differently than it's behaving so far?

Sure. So I do think the Fed's activities and their continued support of QE or tapering will have a big influence. In particular, to the dollars themselves, I mean, we're analyzing and studying the source of those dollars. What are the industries that we're seeing those dollars come from and looking at that on a client-by-client basis within the context of industry and looking for trends that might tell us some of this has this excess liquidity could be used to pay down debt, some of it could be used to put to work in expansionary activities, some could be used just carrying excess liquidity into the future. So it's a bit of a mixed bag, and it's a little early to tell how that's going to play out. But it's a combination of what the Fed -- the decisions that Fed makes with regard to its balance sheet. And then it's individual client-by-client decisions on how much future liquidity they may choose to hold. But again, I think it's reasonable to assume that there is a core underlying operating position that is going to perform similar to what it has in the past. But to the extent there's excess liquidity, we have to think about that as potentially having more sensitivity.

Very good. Very -- really helpful. To pivot a bit on -- and new folks, shifting over to another big theme that investors are focused on why to buy Region stock as well as your peers is the credit quality picture for your bank and your peers. Clearly, last year was an incredible year for what happened to credit quality. Maybe, David, can you share with us your thoughts on the reserve -- loan loss reserve releasing possibly in 2021? Were you surprised with how well your credit held up in such a volatile year? And what does that really mean possibly for credit quality over the next 12 to 24 months?

Yes, Gerard. So my opening comments. Clearly, the change in degradation and the economy, early on, caused us to have pretty massive provisioning, both in the second and the third quarter. And as I mentioned, I was a little surprised. Things kind of snapped back. A big driver of that is government intervention. And so the question we've been asking ourselves is all these programs creating a bridge to a better day or are we kicking the can down the road, and therefore, those losses are there, they've just been deferred. And I think the jury is still out on that, but it is feeling incrementally better that this bridge -- this is more of a bridge because of the vaccine and the effectiveness that we're starting to see in the case count. So if we can bridge to where we can open up our economy a lot better than some of the companies that were struggling early on without stimulus, make it through, and therefore, we don't have losses that we originally thought that we had, that will be a big driver of ultimately whether or not we need the reserves that we've built. We've given you our charge-off guidance. So we said 55 to 65 basis points of charge-offs. That's gotten better than we thought at the end of last year. We ended up for the year at 58 basis points. And so we still believe in the 55 to 65. And so now your question is, what do you do with the rest of the reserves? Every quarter, we have to look at a lot of data points. We look at our models. We've -- I think virtually everybody's models weren't built for a pandemic. So we end up making -- as saying is degraded, we are making overlays of the models to reserve faster. And I think the models don't predict the recovery as fast either. So you have tendency to have underlays from time to time go in the opposite direction. Your question really gets to, "Okay, how much?" How much is, therefore, that you have reserved today that you might not need at the end of March, June, September and December. And I wish I could tell you that precise number, but we have to look at the data that exists at the end of the quarter. I think the way CECL works, which you know I'm not a fan of, I think it's horribly volatile for our industry, and it's not helpful to investors to try to figure out what earnings are through that. But it is what it is. We have to deal with it. So I think that you could see adjustments to reserves quicker under CECL than you would have under the incurred method that we used to have. So that's going to create volatility going the other way than we saw in 2020. How much of that -- those reserves come back in the income, we'll just have to wait and see. We still have some uncertainty. So I don't think we need to get ahead of ourselves a bit. If we didn't have uncertainty, I don't think we would need a $1.9 trillion stimulus program coming from the government. So the federal government clearly sees that there are still issues, and I think we need to be careful about letting reserves go that we've built, unless we just don't need them based on the data. And as the data tells us what to do, and our evaluation of many, many data points, then we'll adjust accordingly.

Very good. We're winding down here. And maybe 1 final question. Over the years or over the quarters, David, you've been very clear on your targeted capital ratios, your CET1 ratio. Can you remind us of that target? And you've been building up capital as was your peers. How do you look to bring the capital ratios down to the level where you're comfortable with? Is it through higher dividends, stock buybacks, et cetera?

Yes. So our common equity Tier 1 was 9.8%. At the end of the year, we're I don't call it, 20 basis points lower than the peer median, which was right at 10%. We've espoused an operating target range of 9.5% to 10% and said that we would operate at the higher end of that for the time being. And that was really predicated on the fact that there's still uncertainty in the economy. We are also in the middle of -- we got to receive the scenarios from the Federal Reserve for the CCAR submission. We are going to participate in that, even though it's our off year, we'll be running that. And that's also an indicator to us in terms of capital. Not just the CCAR test, but our own internal runs of an adverse scenario. And so we're seeing things incrementally improve, and therefore, we would expect that range to come down a bit. When it does, we'll reset that with the investors. We need to finish our work this quarter, running those -- running CCAR and our internal run, the Fed scenario. And likely come back and make an adjustment there. How you get that down is a little more difficult today because we still are subject to the full quarter income test in terms of capital distributions, whether it be in the form of dividends or share buyback. And so I think that from a dividend standpoint, our first goal is to pay a fair dividend that's sustainable, that's based on a reasonable percentage of income. We like to use our capital to grow our business. The nonbank transactions, in particular, like we did at Ascentium Capital. So we're always looking to invest our capital there. And when we can't use our capital because of we don't have the loan growth, we don't have those other things I just mentioned, dividends and nonbank transactions, and we'll buy it back. And we don't want our capital to be too high, and we don't want to be too low. We need the sweet spot. So today, it's at 10%. If things continue to progress, that number will come down. And eventually, we'll buy stock back if we can't put it to work otherwise.

Well, David and Ronnie and Deron and Dana, I really thank you for joining us, once again, at our Financial Institutions Conference. As always, very insightful comments, really helpful to investors in understanding your story better, but also banking as well. So thank you, everybody.

Thank you, Gerard. Appreciate it. Have a good day

Thank you.

You too. Thank you.