Regions Financial Corporation (NYSE:RF) Q4 2022 Earnings Call Transcript

Regions Financial Corporation (NYSE:RF) Q4 2022 Earnings Call Transcript January 20, 2023

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. I will now turn the call over to Dana Nolan to begin.

Dana Nolan: Thank you, Christine. Welcome to Regions fourth quarter 2022 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. With that, I’ll now turn the call over to John.

John Turner: Thank you, Dana, and good morning, everyone. We appreciate you joining our call today. Let me begin by saying that we’re very pleased with our fourth quarter and full year results. Earlier this morning, we reported full year earnings of $2.1 billion, reflecting record pretax pre-provision income of $3.1 billion, adjusted positive operating leverage of 7% and industry-leading returns on both average tangible common equity and total shareholder return. Our results speak to and underscore the comprehensive work that’s taken place over the past decade to position the Company to generate consistent, sustainable long-term performance. We have enhanced our credit, interest rate and operational risk management processes and platforms while sharpening our focus on risk-adjusted returns and capital allocation.

We made investments in markets, technology, talent and capabilities to diversify our revenue base and enhance our offerings to customers. For example, investments in our treasury management products and services led to record revenue this year. Similarly, our Wealth Management segment also generated record revenue despite volatile market conditions. And now we’re seeing positive results of our comprehensive strategy. Over the course of the year, we grew revenue and average loans while prudently managing expenses, further illustrating the successful execution of our strategic plan. So, as we enter 2023, it is from a position of strength. Our business customers have strong balance sheets. They have benefited from population migration and many continue to carry more liquidity than in the past.

Our consumer customer base remains healthy. Deposit balances remain strong and credit card payments remain elevated. The job market continues to be solid with approximately two open jobs available for each unemployed person across the Regions’ footprint. We have a robust credit risk management framework, and a disciplined and dynamic approach to managing concentration risk. Our portfolios are more balanced and diverse than at any point in the past. We have a strong balance sheet that’s well positioned to perform an array of economic conditions. We have solid capital and liquidity position to support balance sheet growth and strategic investments. And most importantly, we have a solid strategic plan, an outstanding team and a proven track record of successful execution.

So as we look ahead, although there is uncertainty, we feel good about how we’re positioned. Now, Dave will provide some highlights regarding the quarter.

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David Turner: Thank you, John. Let’s start with the balance sheet. Average loans increased 1% sequentially or 9% year-over-year. Average business loans increased 2% compared to the prior quarter, reflecting high-quality broad-based growth. Average consumer loans declined 1% as growth in mortgage, Interbank and credit card was offset by the strategic sale of consumer loans late in the third quarter and continued runoff of exit portfolios. Looking forward, we expect 2023 ending loan growth of approximately 4%. From a deposit standpoint, as expected, deposits continued to normalize during the quarter, consistent with a rapidly rising rate environment. Average total consumer balances were modestly lower, primarily driven by higher balance customers seeking marginal investment alternatives.

Meanwhile, the median consumer balance remains relatively stable, still about 50% above pre-pandemic levels. Normalization was more pronounced in average corporate and commercial deposits, which were down 2% during the quarter. As anticipated, our business clients continue to optimize the level and structure of their liquidity position. We experienced remixing away from noninterest-bearing deposits to other options, both on and off balance sheet, including those offered through our treasury management platform. Ending deposit balances have declined approximately $7 billion year-over-year, in line with our previously provided 2022 expectations. Looking forward, we do anticipate further deposit declines of approximately $3 billion to $5 billion in the first half of 2023, reflecting continued Federal Reserve balance sheet normalization, seasonal trends and late-cycle rate-seeking behavior.

We expect to experience stabilization of deposit balances midyear with the potential for modest growth in the second half of the year. Our deliberate approach to managing liquidity allows for deposit normalization and growth in the balance sheet without the need for material wholesale borrowings in the near term. So, let’s shift to net interest income and margin. Reflecting our asset-sensitive profile, net interest income grew to a record $1.4 billion this quarter, representing an 11% increase while reported net interest margin increased 46 basis points to 3.99%, its highest level in the last 15 years. While deposit repricing continues to accelerate, the cycle-to-date beta remains low at 14%. Importantly, our guidance for 2023 assumes a 35% full-cycle beta by year-end.

There is uncertainty regarding full cycle deposit betas for the industry. However, we remain confident that our deposit composition will provide a meaningful competitive advantage. Growth in net interest income is expected to continue until the Federal Reserve reaches the end of its tightening cycle. Once the Fed pauses, we would expect deposit costs to continue increasing for a couple of more quarters. This equates to 1% to 3% net interest income growth in the first quarter and 13% to 15% growth in 2023, assuming the December 31st forward rate curve. Earlier in 2022, we added a meaningful amount of hedges focused on protecting 2024 and 2025. The swaps become effective in the latter half of 2023 and 2024 and generally have a term of three years.

Activity in the fourth quarter focused on extending that protection beyond 2025. We will look for attractive opportunities to continue to expand this protection. We have constructed the balance sheet 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 reported net interest margin is projected to surpass the high end of the range until deposits fully reprice. So, let’s take a look at fee revenue and expense. Reported noninterest income includes $50 million of insurance proceeds related to a third quarter regulatory settlement. Excluding that, adjusted noninterest income declined 9% from the prior quarter as stability in wealth management income and a modest increase in card and ATM fees were offset by declines in other categories, mainly mortgage and capital markets.

Service charges declined 3% due primarily to three fewer days in the fourth quarter versus the third. We expect to offer a grace period feature to cover overdrafts around midyear 2023 and when combined with our previously implemented enhancements, will result in full year service charges of approximately $550 million. Within capital markets, increases in M&A fees were offset by declines in all other categories, including a negative $11 million CVA and DVA adjustment. Despite an increase in servicing income, elevated interest rates and seasonally lower production drove total mortgage income lower during the quarter. With respect to outlook, we expect full year 2023 adjusted total revenue to be up 8% to 10% compared to 2022. Let’s move on to noninterest expense.

Reported professional and legal expenses declined significantly driven by charges related to the settlement of a regulatory matter in the third quarter. Excluding this and other adjusted items, adjusted noninterest expenses increased 2% compared to the prior quarter. Salaries and benefits increased 2%, primarily due to an increase in associate headcount during the fourth quarter and higher benefits expense. Equipment and software expenses increased 4%, reflecting increased technology investments. The fourth quarter level does provide a reasonable quarterly run rate for 2023. We expect full year 2023 adjusted noninterest expenses to be up 4.5% to 5.5%, and we expect to generate positive adjusted operating leverage of approximately 4%. From an asset quality standpoint, overall credit performance remains broadly stable while experiencing expected normalization.

Net charge-offs were 29 basis points in the quarter. Excluding the impact of the third quarter consumer loan sale, adjusted full year net charge-offs were 22 basis points. Nonperforming loans remained relatively stable quarter-over-quarter and were below pre-pandemic levels. Provision expense was $112 million this quarter. While the allowance for credit loss ratio remained unchanged at 1.63%, the increase to the allowance was due primarily to economic conditions, normalizing credit from historically low levels and loan growth. These increases were partially offset by the elimination of the hurricane-related reserves established last quarter. Just to remind you, we believe our normalized charge-offs based on our current book of business should range from 35 to 45 basis points on an annual basis.

However, due to the strength of the consumer and to businesses, we expect our full year 2023 net charge-off ratio to be in the range of 25 to 35 basis points. From a capital standpoint, we ended the quarter with a common equity Tier 1 ratio at an estimated 9.6%, reflecting solid capital generation through earnings, partially offset by continued loan growth. Given the uncertain economic outlook, we plan to manage capital levels near the upper end of our 9.25% to 9.75% operating range over the near term. So, in closing, we delivered strong results in 2022, despite volatile 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 remains strong, expenses are well controlled, credit remains broadly stable, and capital and liquidity are solid. And with that, we’ll move to the Q&A portion of the call.

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Q&A Session

Operator: Our first question comes from the line of John Pancari with Evercore ISI.

John Pancari: In terms of your deposit beta, regarding that 35% beta assumption by year-end €˜23, what is your — maybe help us think about what your assumption is around noninterest-bearing mix as a percentage of total deposits. How do you see that trending through the year? What’s underlying that assumption?

David Turner: Yes. John, this is David. So what we did, we’re at 39% noninterest-bearing right now. We’ve always had more noninterest-bearing than most everybody. It’s just the nature of our deposit base. We said we would continue to see deposit runoff this year somewhere in the $3 billion to $5 billion range. And for our guidance, we’ve taken all of that out of NIB. So you should expect that percentage of NIB to decline somewhat during the year. Now, that’s just what we put in the guide. We could see some mix changes from that NIB and maybe not — that’s the most harsh it could be. So that’s why we put it in the guide. So, I don’t know if there’s a follow-up there.

John Pancari: Okay. No, that’s helpful. And I think the other color on the beta provides some of the additional detail. But just separately, if I could just hop over to credit for my follow-up. Can you give us a little bit of color around what drove the increase in charge-offs in the quarter. It looks like that may have been in C&I, but I want to get a little bit of color around what you’re seeing there? Are you seeing any stresses in certain pockets of your loan categories that you’re watching that are starting to generate some losses? And then also what drove the 14% increase in the criticized loans? Thanks.

John Turner: Yes. John, this is John. So, we did see a little uptick in business services charge-offs in the quarter related to a handful of credits. We’ve identified couple areas or a couple of segments of the portfolio where we see elevated stress at the office, healthcare, consumer discretionary, senior housing and transportation on the small end of trucking in particular. We’re seeing elevated levels of — or elevating levels, I should say, of classified loans, in particular. So, to the second part of your question, we are seeing some normalization in the portfolio. Classified loans are increasing toward levels that we would expect to be more “normalized” and the categories in which that — we’re seeing that change are the 5 identified, but there are some odds and ends in the portfolio as well as inflationary impacts and rising rates affect isolated customers.

In general, we still feel very good about credit quality. And as David said, we’re guiding to 25 to 35 basis points of charge-offs in 2023.

David Turner: And John, I’ll add. If you look at page 19, we tried to help you with the areas that John just mentioned in terms of the higher risk segments. And you can see on that page, the strength of the allowance to cover those increases in the criticized level that we have listed in the supplement. And we don’t necessarily have a loss in every one of those that migrated into criticized. But what we do see, we have already embedded in the reserve and it’s factored in, as John mentioned, in our guidance of 25 to 35 in charge-offs for 2023.

John Pancari: Yes. Thanks David. I appreciate that. If I could just ask one more on that, on the reserve, you pretty much kept it stable this quarter. Could you maybe discuss the likelihood of incremental builds here, or do you think it fairly represents the scenarios of outlook that you’re looking at here?