Regions Financial Corp (RF) — Q3 2023 Earnings Call Transcript

Thank you, Christine. Welcome to Regions’ third 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.

Thank you, Dana, and good morning everyone. We appreciate you joining our call today. Earlier this morning, we reported earnings of $465 million, resulting in earnings per share of $0.49. While we have some unusual items in our results this quarter, our core performance remains strong. We continue to have one of the best return on average tangible common equity ratios in our peer group at 21%. During the quarter, we experienced elevated levels of check-related fraud. Our third quarter results reflect an incremental $53 million in losses stemming from a second fraud scheme. This scheme manifested itself in delayed returns, resulting in a longer tail. After adjusting countermeasures to identify potential fraud instances more quickly, the volume of new fraud claims has slowed. Based on what we know today, we expect quarterly fraud losses to decrease significantly to approximately $25 million in the fourth quarter. Future losses are expected to normalize in the $25 million per quarter range in 2024. Although the industry faces headwinds from lingering economic and regulatory uncertainty, we continue to benefit from our strong and diverse balance sheet with solid capital, robust liquidity, and prudent credit risk management. Our proactive hedging strategies have positioned us for success across any interest rate environment, and our granular deposit base continues to serve us well. We have spent over a decade de-risking our balance sheet and are well positioned to manage proposed regulatory changes without significant impact to our business model. We remain committed to under appropriate risk-adjusted returns, as now is not the time to stretch for growth. We focus on supporting existing customers where we have a relationship and a proven history. I am confident in our team’s ability to adapt to the changing landscape while continuing to generate top quartile returns throughout the cycle. Now, David will provide some highlights regarding the quarter.

Thank you, John. Let's start with the balance sheet. Average and ending loans remain relatively stable quarter-over-quarter. Within the business portfolio, average loans were stable, while ending loans decreased 1%. As John mentioned, we are being judicious in reserving our capital for business where we can have a full relationship. Client sentiment varies across industries, with some continuing to expect growth, while others have a more muted outlook. Commercial commitments are down 1% compared to the second quarter. Average and ending consumer loans increased 1% with growth in mortgage and EnerBank partially offset by declines in home equity. Subsequent to quarter-end, we executed a sale of our remaining GreenSky portfolio of approximately $300 million. The economics of this transaction are relatively neutral, resulting in approximately 14 basis points of incremental charge-offs in Q4, offset by the related reserve release. Looking forward, we expect 2023 ending loan growth to be in the low single digits. From a deposit standpoint, modest deposit declines were in line with expectations, largely driven by late-cycle rate-seeking behavior. We ended the quarter with non-interest bearing deposits representing 35% of total deposits, and we expect this percentage to level off in a low 30% range. Despite some customers seeking alternatives in other investment channels, many are moving to our CDs and money market accounts. We also continue to provide off-balance sheet opportunities through our wealth management platform and corporate banking segment. In the case of corporate clients, overall liquidity under management has remained stable quarter-over-quarter. Acquisition and retention of high-priority operating relationships remain strong. Looking forward, the higher rate environment and heightened competition will likely continue to constrain deposit growth and pressure costs for the industry into early 2024. Accordingly, we expect deposits to remain stable or modestly lower in Q4. Net interest income declined by 6.5% in Q3, reflecting the anticipated normalization from elevated net interest income and margin levels towards a sustainable longer-term range. This decline is driven by deposit cost normalization and the start of the active period on $6 billion of incremental hedging. As the Federal Reserve approaches the end of its tightening cycle, we expect net interest income to be supported by elevated floating rate loan yields at higher market interest rates. Deposit costs continue to increase through a combination of re-pricing and remixing. The cycle-to-date interest-bearing deposit beta is at 34%. We believe this behavior will continue for a few quarters after the Fed stops moving interest rates. We project the beta to increase to near 40% by year-end. Regardless, we remain confident that our deposit composition will provide a competitive advantage compared to the broader industry. If the Fed remains on hold, we expect Q4 net interest income to decline approximately 5%, driven by normalization and the beginning of new hedging on an additional $3 billion of forward-starting swaps. Net interest income is projected to grow approximately 11% in 2023 compared to 2022. Looking ahead to 2024, we anticipate higher rates for longer will extend the period of deposit cost and mix normalization. We expect trends to stabilize in the first half of the year and grow in the back half. The balance sheet hedging program is an important source of earning stability in today's uncertain environment. Hedges added to date create a net interest income profile that protects against changes in interest rates through 2025. We continue to look for opportunities to add protection at attractive rates through derivatives or securities. When it comes to fee revenue, adjusted non-interest income decreased by 2% from the prior quarter. Modest increases in mortgage and wealth management income were offset by declines primarily in service charges. The increase in mortgage income was driven by higher servicing income associated with a bulk purchase of $6.2 billion of residential mortgage loans. Service charges declined 7%, reflecting the run-rate impact of the company's overdraft grace feature implemented late in Q2. We now expect full-year service charges of approximately $590 million. Total capital markets income decreased $4 million. Excluding the impact of CVA and DVA, capital markets income decreased 13% sequentially. We now expect full-year 2023 adjusted total revenue to be up 5% to 6% compared to 2022. On the expense front, adjusted non-interest expense decreased 2% compared to the prior quarter, despite elevated operational losses. Excluding the fraud experienced in Q2 and Q3, adjusted non-interest expenses increased 1% sequentially. Salaries and benefits decreased 2%, driven primarily by lower incentives, while other non-interest expense increased 12%, primarily due to a $7 million pension settlement charge. We will continue to manage expenses to fund investments in our business, focusing on our largest categories. We expect full-year 2023 adjusted non-interest expenses to be up 9.5%. Excluding the $135 million in operational losses, we expect adjusted non-interest expenses to be up approximately 6% in 2023 compared to 2022. From an asset quality standpoint, overall credit performance continues to normalize. Net charge-offs increased 7 basis points to 40 basis points, influenced by a solar program we've since discontinued at EnerBank. Non-performing loans, criticized loans, and total delinquencies also increased. The allowance for credit loss ratio increased 5 basis points to 1.70%, while the allowance as a percentage of non-performing loans declined to 261%. The increase to our allowance is due to adverse risk migration and continued credit quality normalization across certain portfolios. We do not expect any meaningful loss in our office portfolio, as the majority of our office exposure is in Class A properties. We expect net charge-offs to continue to normalize. Excluding the GreenSky loan sale impact, we expect the full-year 2023 adjusted net charge-off ratio to be slightly above 35 basis points. With respect to recent regulatory changes, we are well positioned to absorb impacts without major shifts to our business. Our estimates for the Basel III end-game suggest a low to mid-single digit increase in risk-weighted assets. Importantly, we anticipate share repurchases to resume in the near term. We acknowledge the economic and geopolitical uncertainty but maintain confidence in our business and operational performance. We expect service charges to stabilize moving forward, reflecting our treasury management team's efforts to penetrate our commercial base. Our 2023 service charges should be consistent with expectations.

Good morning, everyone. Thank you for taking the question. I wanted to start out just on the NII trajectory, suggesting it could continue to compress a bit after the fourth quarter's dip. Can you help us size any potential pressure beyond year-end ‘23, and thoughts on what would allow it to resume growing in the second half of next year?

You're right. You will see some pressure in Q4 particularly as we see continued remixing of non-interest bearing deposits going into interest-bearing, given higher rates. The remixing will likely start slowing after the fourth quarter. We're expecting our margin to stabilize after that.

Good morning, guys. Could you clarify the implied charge-off estimate for the year? Does it imply around 45 for the fourth quarter? Also, could you expand on what you're seeing in office, multifamily, and EnerBank?

We expect core charge-offs to be slightly higher than 35 basis points, which implies a fourth quarter in the 40 basis point charge-off range. For office, we continue to monitor and engage with our clients closely. We have seen some uptick in non-accruals but still remain confident in our portfolio's performance. Regarding EnerBank, we discontinued a buy-now-pay-later program, and we're now beginning to see some elevated losses accordingly. However, the overall performance remains consistent with our expectations. With respect to expenses, we will need to double down on expense management for 2024. We're committed to managing expenses in order to keep them flat amidst challenging revenue outlook. Our focus is on essential cost control to maintain strong performance.

On the fraud costs, were they running higher than expected? And what are your thoughts on the regulatory pressures regarding new controls?

The fraud costs have increased dramatically across the industry. We're adjusting our expectations, and the $25 million per quarter forecast is slightly higher than our historical run rate. We are actively putting new controls in place, but we are disappointed with the ongoing challenges. We are confident in our capital position and are prepared to resume buybacks as soon as we exit the current blackout period.

Can you discuss the multifamily exposure, particularly in the Sunbelt states, especially related to oversupply issues?

Our total exposure in multifamily exceeds $3 billion. We are closely monitoring our diverse portfolio across multiple submarkets. We're not seeing any adverse movements, and over 50% of our portfolio is still under construction.

On service charges, are we getting close to the leveling-out period here?

We expect service charges to stabilize. The impact of the overdraft grace feature has been fully accounted for, and we have a strong treasury management team.

Can you provide insights on the Shared National Credit exam and what you're seeing in the economy across your markets?

We are still seeing a strong economy across the Southeast. Unemployment rates are low and consumer sentiment remains positive but cautious. The focus is on inflation control and stability in interest rates. Thank you for your support as we navigate this quarter. We believe our business is strong and we are well-positioned for future performance despite uncertainties.