While the recent performance of Regions Financial's (NYSE:RF) stock might make you believe that the negativism surrounding banks with oil exposure is over, but it is far from over. With allowance for loan losses covering only 1.16X of nonperforming loans, the need for substantial amount of provisioning in the coming quarters is unavoidable. As the real pain of having 4% energy exposure (both direct and indirect Oil & gas loans) out of the total loan portfolio is about to create more problems to Regions Financial in the coming quarters due to continued low oil prices and mainly due to RF's very low allowance balance compared to nonperforming loans.
Most banks are getting support from healthy economy in the form of low nonperforming loans, allowing them to mitigate the continued low interest rates and the negative pressure from crude oil prices to some extent. Increase in nonperforming loans in parts of loan portfolio other than energy will have a cumulative negative impact on earnings. Banks that have huge excess reserves can overcome this kind of situations with very less stress on earnings; unfortunately, Regions Financial is not in that kind of situation.
It would have been much better if Regions Financial had more excess reserves to put less pressure on earnings in the coming quarters. At the same time, Regions Financial expects to cut its existing noninterest expenses by $300 million between 2016 and 2018. In addition, 35% to 45% of that reduction is expected to achieve in 2016, 45% of $300 million is $135 million that is about 15.5% of the existing total noninterest expense, this is a significant reduction and will help RF ease some pressure on earnings from critical energy loans. RF already achieved strong improvements in efficiency ratio in Q1, 2016. Adjusted efficiency ratio improved by 430 basis points to 60.6% in Q1, 2016 from 64.9% in the year ago quarter.
The cost reduction initiative from the management only came in at a situation when its energy loans are about to create more problems to RF's earnings. From the year 2011, Regions Financial is running with an adjusted efficiency ratio in between 63% - 65% (annual), in the past three years it mostly stayed above 64% but the management has not made any strong effort[s] that has resulted in significant improvement.
However, now when its earnings are about to face more pressure due to RF's energy exposure, management wants to exploit its fat cost structure to decrease negative impact from the energy exposure. While the 15.5% reduction in noninterest expense is a big positive in the short term and long term, if it was able to sustain that benefit, but the real problem in my view is RF's not dynamic management. Dynamic managements try to position their organizations' in a strong position to deliver optimal performance at all times in most cases and they constantly change the way things happen at the organization to put it in a better position to let their organizations deliver strong performance in changing situation(s). Regions Financial's cost structure is fat in the first place for many years and it does not have sufficient reserves to face the negative pressure from its energy loans, indicating that the management is not dynamic. In my view, this kind of management is most likely to leave weaknesses unturned that are most likely to put drastic negative impact on the earnings in a weak economic environment than most banks.
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