Regions Financial Corporation (NYSE:RF) Q1 2023 Earnings Call Transcript April 21, 2023
Regions Financial Corporation misses on earnings expectations. Reported EPS is $0.62 EPS, expectations were $0.66.
Operator Good morning, and welcome to the Regions Financial Corporation’s Quarterly Earnings Call. My name is Christine, and I will be your operator for today’s call. [Operator Instructions]I will now turn the call over to Dana Nolan to begin.Dana Nolan Thank you, Christine. Welcome to Regions first quarter 2023 earnings call. John and David will provide high-level commentary regarding the quarter. Earnings documents, which include our forward-looking statement disclaimer and non-GAAP information are available in the Investor Relations section of our website. These disclosures cover our presentation materials, prepared comments and Q&A.I will now turn the call over to John.John Turner Thank you, Dana, and good morning, everyone. We appreciate you joining our call today.Once again, Regions delivered another solid quarter, underscoring our commitment to generating consistent, sustainable long-term performance.
We generated earnings of $588 million, resulting in earnings per share of $0.62. Despite recent events in the banking industry, we remain focused on the fundamentals and things we can control.We’ve spent over a decade enhancing our interest rate risk, credit risk, capital and liquidity management frameworks. Our relationship-based banking approach, coupled with our favorable geographic footprint uniquely positions us to weather an uncertain market backdrop.Further, balance and diversity on both sides of the balance sheet have been a key focus for years. As a result, we are well positioned to withstand an array of economic conditions. Approximately 70% of our deposits are retail deposits. These deposits tend to be granular and less rate sensitive.
In fact, approximately 90% of these deposits are insured.Our strategy focuses on primacy and customer loyalty. We want to be our customers’ primary banking relationship. This strategy is evident in the fact that over 90% of our consumer checking households include a high-quality checking account, and over 60% of consumer checking deposit balances are with customers that have been with regions for 10 years or more.Our wholesale or business services deposits are also highly diversified from an industry, size and geography perspective, with approximately 75% of deposits that are either insured, operational in nature or collateralized. In total, approximately 75% of our deposits across all business lines are insured or collateralized by securities and our deposits are with customers we know is over 97% reside within our 15-state footprint.Further supporting our high-quality deposit franchise, we had access to total primary liquidity of approximately $41 billion at the end of the quarter, sufficient to cover uninsured retail and nonoperational wholesale deposits by more than a 2:1 ratio.
If you include access to Federal Reserve discount window, available liquidity increases to $54 billion or approximately 3:1 coverage. We have a strong team of bankers and the recent disruption has given us an opportunity to connect with our customers and top prospects to answer questions and reassure them of our stability. We’ve experienced some deposit outflows as corporate treasuries look to diversify and sought higher interest rates for their excess cash. However, we’ve also experienced deposit inflows from new and existing customers.Importantly, our total deposits at March 31st were roughly unchanged from what they were prior to the onset of liquidity concerns in the industry. The majority of the $3 billion deposit decrease this quarter was as expected, due primarily to further normalization in corporate deposits, which had dramatically increased during the pandemic, as well as the continuation of rate-seeking behavior in certain wealth and higher balance consumer accounts.From a lending perspective, our focus on risk-adjusted returns continues.
Overall sentiment among our corporate customers remains positive. While most are forecasting strong performance in 2023, they are expecting modest declines from levels seen in 2022. While current market conditions warrant heightened caution, we believe our strong liquidity profile provides an advantage in terms of supporting our customers’ borrowing needs.In closing, despite all the industry turmoil, we feel very good about our balance sheet and strong liquidity position. And through our proactive hedging strategies, we are positioned for success in any interest rate environment. Our granular deposit base and relationship-based banking model continue to serve us well, and we’re proud to continue supporting our customers’ banking needs.Now, David will provide some highlights regarding the quarter.David Turner Thank you, John.
Let’s start with the balance sheet.Average loans increased 2% sequentially. Average business loans increased 2% compared to the prior quarter, reflecting high-quality, broad-based growth across the utilities, retail trade and financial services industries. Approximately 87% of this growth was again driven by existing clients accessing and expanding their credit lines to rebuild inventories and expand their businesses.Average consumer loans increased 1% as growth in mortgage and Interbank was partially offset by continued pay-downs in home equity and runoff exit portfolios. Looking forward, we continue to expect 2023 ending loan growth of approximately 4%.From a deposit standpoint, our deposit base remains a strength and competitive advantage with balances continuing to largely perform as expected.
Previously, we indicated that combination of rapidly rising interest rates and normalization of surge deposits would likely lead to $3 billion to $5 billion of deposit declines by midyear before we would begin to generate net deposit growth.While the events in March created turmoil in the banking industry, we continue to believe that range is appropriate. However, we may be at the higher end of the range as we approach midyear.The preponderance of deposit outflows this quarter occurred prior to early March and were in line with our expectations. Approximately $2 billion of the $3 billion outflow came from corporate deposits, reflecting normal seasonal activity. The other $1 billion came from a continuation of rate-seeking behavior among certain wealth and higher balance consumer clients.The same characteristics that contribute to our deposit advantage in a rising rate environment are also helpful in a time of systemic volatility.
As John noted, our focus on attracting and retaining a diverse and granular deposit base with high primacy drives loyalty and trust and instills funding stability. So, let’s shift to net interest income and margin.Net interest income continued to expand with market interest rates in the first quarter, reflecting our asset-sensitive profile and funding stability. Net interest income grew 1% linked quarter to a record $1.4 billion and net interest margin increased 23 basis points to 4.22%. As the Federal Reserve nears the end of its tightening cycle, net interest income is supported by elevated floating rate loan and cash yields at higher market interest rates and fixed rate asset turnover from the maturity of low-yielding loans and securities generated through the pandemic.At this stage in the rate cycle, we expect accelerating deposit costs through repricing and remixing Importantly, recent trends remain within our expectation.
The cycle-to-date deposit beta is 19%, and our guidance for 2023 is unchanged, a 35% full-cycle beta by year-end. We remain confident that our deposit composition will provide a meaningful competitive advantage for Regions when compared to the broader industry.Net interest income is projected to grow between 12% and 14% in 2023 when compared to 2022. The midpoint of the range is supported by the March 31st market forward yield curve, which projects nearly 75 basis points of rate cuts in 2023. A stable Fed funds level would push net interest income to the upper end of the range.The balance sheet hedging program is an important source of our earnings stability in today’s uncertain environment. Hedges added to date create a well-protected net interest margin profile through 2025.
Forward starting received fixed swaps will become effective in the latter half of 2023 and 2024 and generally have a term of three years. Activity in the first quarter focused on extending that protection beyond 2025.In addition to forward starting swaps, we added a $1.5 billion collar strategy, selling rate caps to pay for rate floors to limit exposure to extreme market rate movements. The resulting balance sheet is constructed to support a net interest margin range of 3.6% to 4% over the coming years, even if interest rates move back towards 1%. If rates remain elevated, our net interest margin is projected to remain above the high end of the range until deposits fully reprice.So, let’s take a look at fee revenue and expense. Adjusted noninterest income declined 3% from the prior quarter as modest increases in service charges and wealth management income were offset by declines in other categories, primarily capital markets and card and ATM fees.
Service charges increased slightly as seasonally higher treasury management fees offset declines in overdraft fees.Excluding the impact of CVA and DVA, capital markets increased 4% sequentially as growth in real estate capital markets, loan syndications, and debt and securities underwriting more than offset declines in M&A fees and commercial swaps. We did have a negative $33 million CVA and DVA adjustment, reflecting lower long-term interest rates, volatility in credit spreads as well as a refinement in our valuation methodology. Card and ATM fees were negatively impacted by a $5 million increase in reserves, driven by higher reward redemption rates.With respect to our outlook, and incorporating first quarter results, we expect full year 2023 adjusted total revenue to be up 6% to 8% compared to 2022.Let’s move on to noninterest expense.
Adjusted noninterest expenses increased 1% compared to the prior quarter. Salaries and benefits increased 2%, primarily due to merit and a seasonal increase in payroll taxes. FDIC insurance assessment reflects the previously announced industry-wide increase in the assessment rate schedules.In contrast to the prior two years, we expect first half 2023 adjusted expenses to be higher than the second half of the year. And we continue to expect full year 2023 adjusted noninterest expenses to be up 4.5% to 5.5%. We now expect to generate positive adjusted operating leverage of approximately 2%.From an asset quality standpoint, overall credit performance continues to normalize as expected. Net charge-offs were 35 basis points in the quarter. Nonperforming loans and business services criticized loans increased while total delinquencies decreased.
Provision expense was $135 million, while the allowance for credit loss ratio remained unchanged at 1.63%.The amount of the allowance increased due primarily to economic changes and normalizing credit from historically low levels, partially offset by a reduction associated with the elimination of the accounting for troubled debt restructured loans. It is worth noting the outcome of the most recent Shared National Credit exam is reflected in our results.I want to take a few minutes to speak to our commercial real estate portfolio. Since 2008, we have deliberately limited our exposure to this space. At quarter-end, our exposure totaled 15% of loans, excluding owner-occupied and it is highly diverse. This total includes $8.4 billion of investor real estate and $6.7 billion of unsecured exposure, of which the vast majority is within real estate investment trust.
Our REIT clients generally have low leverage and strong access to liquidity with 68% classified as investment grade.Importantly, total office represents just 1.8% of total loans at $1.8 billion. Of note, 83% consist of Class A properties with 62% located within the Sunbelt. The office portfolio was originated with an approximate weighted average loan-to-value of 58% and we have stressed the portfolio to include a 25% discount using the Green Street commercial property price index with the weighted average resulting loan-to-value of the book approximating 77%.It is also noteworthy that 37% of our secured office portfolio is single tenant. While we are carefully monitoring conditions, we believe our portfolio will be able to weather the weakness in the industry.Including first quarter results, we now expect our full year 2023 net charge-off ratio to be approximately 35 basis points.
Given the recent economic uncertainty and market volatility, we may see a pickup in the pace of normalization towards our through-the-cycle annual charge-off range of 35 to 45 basis points over time.From a capital standpoint, we ended the quarter with a common equity Tier 1 ratio at an estimated 9.8%, reflecting solid capital generation through earnings, partially offset by continued loan growth and approximately $100 million or 7 basis points related to the phase-in of CECL into regulatory capital. Given current macroeconomic conditions, and regulatory uncertainty, we anticipate managing capital levels at or modestly above 10% over the near term.So, in closing, we delivered solid results in the first quarter despite volatile conditions. We have balance and diversity on both sides of the balance sheet and are well positioned to withstand an array of economic conditions.
We are in some of the strongest markets in the country. And while we remain vigilant to indicators of potential market contraction, we will continue to be a source of stability to our customers.Pretax pre-provision income remained strong. Expenses are well controlled. Credit remains broadly stable, and capital and liquidity levels remain robust.With that, we’ll move to the Q&A portion of the call.
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Question-and-Answer Session Operator [Operator Instructions]
Our first question comes from the line of Ryan Nash with Goldman Sachs.Ryan Nash David, maybe a question on betas and deposit balances. So, you guys are one of the few that isn’t increasing your deposit beta guidance given that you’re at 19% and I think expectations are for 35%. Can you maybe just talk about where you expect the pressure to come from?
I think you noted in the remarks, repricing and remixing, how much will each of these contribute? Are you expecting more to be in retail given the push for insured deposits, or is it on the commercial side?And then second, you noted that you do expect to see stabilization of growth in balances later in the year. Can you maybe just talk about what you see driving that as we move through the year? Thanks.David Turner Sure. So, as we’ve mentioned before, we had $41 billion worth of surge deposits. We didn’t think those would stay with us as long as they actually have stayed with us. And we furthermore said as rates continue to increase that people would be seeking higher returns than we were offering at the time. And so you can see our cumulative beta, as you mentioned, at 19%, well below everybody else.
We do understand that we’re going to end up — there’s going to be a shift of deposits into CDs, more expensive deposits. And so, we do also expect some continued runoff. We had given you the guide of $3 billion to $5 billion. We’re down $3.3 billion. We expect to be at the upper end of that by the end of the second quarter. And a lot of that is putting money to work and businesses, but also some seeking higher rates.And so, the combination of where we are relative to our deposit costs relative to the peers would imply that we would be increasing some of that over time, and that’s going to drive our beta, and we still believe 35% is the right number by the end of the cycle, which we’re calling the end of this year.Ryan Nash Got it.
And maybe as a follow-up, so you guys are now expecting losses at the high end of your previous guidance. It looks like the increase this quarter was driven by C&I. And I think, David, I think you just noted you could see a pickup in the pace of normalization. Can you maybe just talk about, one, what is driving the incremental pressure? And what are you expecting to be the higher driver of charge-offs, both for the rest of this year and then the pace of normalization that we could see? Thanks.David Turner Well, so as we’ve stated many times, the charge-off level is below normal. And that we said it would be normalizing over time. We’ve furthermore set our normalized loss rate based on the risk profile we maintained as 35 to 45. As we get through the end of this year, we’re trying to give you the message that that could kind of lead you into a run rate towards that 35 to 45 by the end of the year.
We’re already at 35 this quarter, which would imply we expect a reduction in charge-offs in the second and/or third quarter. But all in, we still think we’re going to be at 35 basis points, which is below normal. So, we have a lot of confidence in that. We had certain things that happened in the first quarter, we don’t think will repeat. And so I think our 35 is a pretty good number.John Turner Yes. Ryan, I’d just add to the question about where we’re seeing the stress. We’ve identified a couple of areas on previous calls where we are experiencing some stress in the portfolio. That would be healthcare, where we’re seeing rising costs and pressure on labor. Transportation, particularly on the smaller end of the transportation sector where customers are competing in the spot market to move product.
Consumer discretionary, where consumers are changing their buying patterns and moving away from more discretionary items towards services where we’re seeing some pressure; office, obviously; and then senior housing, which is a sector that we believe is improving but still not return to occupancy levels that we experienced prior to the pandemic. And again, it’s a sector where labor is a factor in the operations of those businesses and driving cost up. So, those are all areas where we are seeing more pressure than in the rest of the portfolio.And I would finally comment, I think we’ll see some additional, quote, movement toward normalization. But, we’ve probably gotten there a little faster than I think we thought we would. So, we don’t expect a whole lot of additional deterioration as we move towards normalization.Operator Our next question comes from the line of Erika Najarian with UBS.Erika Najarian My first question is for David.
You continue to have that long — I think about a long-term NIM of 3.6% to 4%. I think investors are starting to think about rates cut in 2024. And I’m low to always ask about 2024, but I think investors are thinking about how inexpensive bank stocks are really, right, trying to evaluate them on what could be trough earnings next year. So, if the Fed cuts, can you still stay within that range? And I think nobody is expecting a cut to zero, but perhaps walk us through the scenario of that range in the scenario of like a 200 basis-point cut over one year?David Turner Yes. So, the bottom line answer is yes, we do feel comfortable under any scenario. As we mentioned that we would operate in that 3.60% to 4% range. Clearly, our guidance is based on the market.
