Regions Financial Delivers One Of The Better All-Around Performances So Far
Many banks have beaten expectations this quarter, but Regions' performance was one of the more comprehensive, with beats on spread income, fees, expenses, and credit.
Regions seems to be maintaining a conservative approach on credit, and delinquencies are moderating as the economy recovers.
These shares can trade toward the mid-teens as investors gain more confidence on management's ability to deliver more cost-based operating leverage and double-digit ROTCEs.
Conservatism seems to be suiting Regions Financial (RF) right now, and the bank is getting more appreciation and recognition for its meaningful fee-generating business, its hedging position, and its optionality to offset weak revenue with further cost reductions.
In my last article, I said that I thought Regions “is materially undervalued”, but I thought it would take a little longer for the Street to warm up to the name. Since then, the shares up 20%, handily beating its peer group. Although Regions has come further faster than I expected, the shares still look meaningfully undervalued, and this remains a name worth considering, though one that still doesn’t have what I’d call a top-tier pre-provision profit profile over the next few years given ongoing spread and loan demand pressures.
A Quarter That Had It All
Most banks have beaten analyst expectations this quarter, often by quite a wide margin, but the typical pattern has been soft spread performance, better than expected fee-based income, and lower provisioning. In the case of Regions, though, I see one of the best all-around quarters I’ve looked at so far (but bank earnings have started coming fast and furious, so I haven’t looked at them all). Although net interest margin was a bit light, Regions beat on spread income, fee income, expenses, and provisions, as well as charge-offs, with only loan growth coming in a little light.
Revenue rose 5% yoy and 6% qoq on an adjusted basis, beating expectations by about 6%. Net interest income rose 5% yoy and a little less than 2% qoq, beating expectations by 3%. Regions continues to suffer from the impact of excess liquidity on the balance sheet (large deposit balances earning minimal returns), but net interest margin declined a less-than-average 31bp yoy and 6bp, with Regions picking up a 29bp boost from its hedging program.
Fee-based income rose 6% yoy and more than 12% qoq on an adjusted basis, beating by about 11%. Mortgage banking saw significant growth this quarter, improving 93% yoy and 35% qoq and contributing close to 20% of non-interest income. Card and service charge lines grew by double digits on a qoq basis, though capital markets income was down 8% qoq.
Regions disappointed on expenses last quarter, but came back with a much better result this quarter, as core expenses rose 3% yoy and fell 1% qoq, leading to a two-and-a-half-point beat on efficiency ratio. Pre-provision profit rose 9% yoy and 15% qoq, beating expectations by about 11%. Tangible book improved 3% qoq and the CET 1 ratio came in at about 9%, lower than I’d like to see.
Credit Development Looks Mostly Positive, With Continued Conservatism
Regions continues to post higher charge-offs than many of its peers, but I believe the bank is taking a conservative approach to credit by quickly marking off loans.
Charge-offs declined 38% sequentially, with the charge-off ratio declining 30bp to 0.50% - 36bp lower than expected, but still above many of its peers. Non-performing loans rose 24% qoq and the non-performing asset ratio rose from 0.73% to 0.89% (also relatively high), with retail CRE and energy driving most of that, but delinquencies were down 11% qoq and management kept its reserves basically flat, with an ex-PPP ACL/loan ratio of 2.9%. The ratio of reserves to NPLs is a little lower than I might prefer (just under 300%), but the reserve ratio is robust overall and Regions has been conservative about marking down bad credits, so I’m not too concerned about it.
Deferrals declined meaningfully on a sequential basis, from 6% to 2% of total loans, with commercial deferrals declining from 6% to 1%. Mortgage deferrals would have improved more if not for a buyback of delinquent mortgages from GNMA and the large majority of loans coming off deferral have returned to performing status.
Regions’ overall exposure to COVID-19 continues to look manageable. Management has classified 7.5% of its loan book as at-risk, with a little less than a quarter of those loans in the “criticized” bucket (around 1.7% of total loans). Remember, not all criticized loans will go bad, and another round of stimulus from the government would likely help further bridge these borrowers over this period of demand shock.
The Outlook
Loan growth remains subdued, with Regions seeing a 3% decline in average loans (4% ex-PPP), including a mid-single-digit decline in C&I lending. That’s an “is what it is” issue across the banking sector, and not one that will improve anytime soon. Likewise with spread pressure, though Regions has been among the most aggressive banks in hedging its rate exposure, and that will help to boost NIM for a while (the average maturity is over four years).
Regions’ less-than-ideal capital position does create some risk if the economy spirals down in 2021 and credit losses accelerate past current expectations. I don’t think that’s a high-probability event, but it’s not a zero-probability event either. On balance, I think Regions is reasonably-reserved, and management has said they don’t anticipate needing to make further reserve additions.
My model continues to produce near-term and long-term core earnings growth rates around 2%, with a five-year growth rate a bit below 2%, and a long-term growth rate a bit above. If anything, that may well be a conservative growth rate given the above-average population and income growth across Regions’ footprint and the company’s opportunities to grow its fee-based businesses. That said, the bank has struggled to earn its cost of equity in the past, and that remains an ongoing risk.
The Bottom Line
Even with the recent surge of outperformance, Regions looks noticeably undervalued compared to many peers. Management believes they can earn a double-digit ROTCE even in a near-zero rate environment, and further cost-cutting is an alternative they’re willing to consider as a way of offsetting rate/revenue pressures. With upside to $15-$16 as the Street gets more comfortable with the idea of low-double-digit ROTCEs, this is still a name to consider.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
