Regions Financial: Earnings Growth Through Provisions Reversal Appears Priced-In
Summary
- Further reversals of provisioning for loan losses cannot be ruled out because allowances are quite high relative to loan losses.
- Excess liquidity will likely continue to build in the year ahead. This will likely pressurize the net interest margin.
- Deposit growth will likely drive earning assets growth, which will cancel out the impact of margin compression on net interest income.
- The December 2021 target price is quite close to the current market price. Further, Regions Financial is offering a modest dividend yield.
Earnings of Regions Financial Corporation (NYSE: NYSE:RF) will likely receive a boost this year from the reversals of provisioning for loan losses. Meanwhile, net interest income will likely remain stable as the negative impact of excess liquidity on net interest margin will likely cancel out the effect of earning asset growth. Overall, I'm expecting Regions Financial to report earnings of $1.42 per share in the last three quarters of 2021, taking full-year earnings to $2.06 per share. The year-end target price is quite close to the current market price. Therefore, I'm adopting a neutral rating on Regions Financial.
Provision Reversals to Chiefly Drive Earnings
After substantial provisioning in the first half of 2020, Regions Financial released some of its provisions in the previous two quarters. Further provisioning reversal in the second quarter cannot be ruled out because the allowance level appears excessive relative to anticipated loan losses. Allowances made up 2.3% of total loans at the end of March. In comparison, the management expects full-year net charge-offs to range from 0.4% to 0.5% of average loans, as mentioned in the first quarter's investor presentation.
Moreover, Regions Financial’s credit risk appears manageable. One of the riskiest industries, hotels, made up just 1.3% of total loans at the end of March, as mentioned in the presentation.
Overall, I'm expecting further reversals in the second quarter, and below normal provisioning in the second half of 2021. For the full year, I'm expecting the company to report a net provision reversal of $67 million in 2021, as compared to a provision expense of $1,330 million in 2020.
Deposit Growth to Drive Earning Asset Growth
The management appeared positive about deposit growth in the presentation. The disbursement of federal stimulus will likely boost deposits in the year ahead. Additionally, the management expects corporate consumers to maintain high cash levels in the remainder of the year. As a result, I'm expecting deposits to grow by 7% by the end of 2021 from the end of 2020.
On the other hand, loan growth will likely remain subdued in the year ahead. Regions Financial's loans declined for the last three quarters, which shows that the company is struggling to balance originations with payoffs. Further, as mentioned above, the management expects corporate clients to have high cash balances, which will keep credit line utilization low. Moreover, the forgiveness of Paycheck Protection Program (“PPP”) loans will likely constrain the loan growth. As can be determined by details given in the first quarter’s conference call, the remaining round one PPP loans made up 3.3% of total loans at the end of March. I'm expecting most of these loans to get forgiven before the mid of 2021.
The management mentioned in the presentation that it expects average loans in 2021 to be down by a low-single-digit rate in 2020, and year-end loans to grow by a low-single-digit rate. Considering these factors, I'm expecting loans to grow by 0.9% by the end of December from the end of March 2021. For the full year, I'm expecting loans to grow by 0.5%.
Due to the mismatch between deposit growth and loan growth, I'm expecting the company to invest in other earning assets. This will likely boost net interest income. However, this earning asset growth will come at the cost of a plunge in net interest margin, as discussed in the next section. The following table shows my estimates for loans, other earning assets, and deposits.
Impact of Excess Liquidity on Margin to Cancel Out Earning Asset Growth Effect
Excess liquidity has recently become somewhat problematic for Regions Financial. Interest-bearing deposits with other banks more than doubled in the last two quarters, as shown below.
As mentioned in the investor presentation, excess cash accounted for a 42 basis point impact on net interest margin in the first quarter. The anticipated outpacing of loan growth by deposit growth will likely exacerbate the excess liquidity situation for the company in the year ahead. As a result, I'm expecting the average earning asset yield to decline further in the remainder of the year.
Additionally, the reinvestment of maturing assets at lower rates will likely pressurize the average earning asset yield. As mentioned in the investor presentation, the management estimates fixed-rate securities totaling $5 billion to mature and get reinvested this year.
Considering these factors, I'm expecting the net interest margin to decline by nine basis points in the last three quarters of 2021. This will lead to the average net interest margin in 2021 being 33 basis points below the average margin for 2020.
Expecting Full-Year Earnings of $2.06 per Share
The anticipated reversal in provisioning will likely drive earnings this year. Meanwhile, the net interest income will likely remain stable as growth in earning assets will cancel out margin compression. Mortgage banking income will likely decline from the 2020 level because of stable to rising interest rates that will disincentivize refinancing activity. However, mortgage income doesn't make a big part of Regions Financial's non-interest income. According to details given in the first quarter's earnings release, mortgage income made up just 14% of non-interest income in the first quarter.
Overall, I'm expecting the company to report earnings of $1.42 per share in the last three quarters of 2021, taking full-year earnings to $2.06 per share. The following table shows my income statement estimates.
Actual earnings may differ materially from estimates because of the risks and uncertainties related to the COVID-19 pandemic and new variants.
Earnings Outlook Appears Priced-In
Regions Financial is offering a dividend yield of 2.8%, assuming the company maintains its quarterly dividend at the current level of $0.155 per share. The earnings and dividend estimates suggest a payout ratio of 30% for 2021, which is in line with the average ratio of 32.5% from 2016 to 2019. Hence, I’m not expecting an increase in the dividend this year.
I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Regions Financial. The stock has traded at an average P/TB ratio of 1.53 in the past, as shown below.
Multiplying the average P/TB multiple with the forecast tangible book value per share of $12.2 gives a target price of $18.7 for the end of 2021. This price target implies a 16.4% downside from the May 4 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.
The stock has traded at an average P/E ratio of around 12.0x in the past, as shown below.
Multiplying the average P/E multiple with the forecast earnings per share of $2.06 gives a target price of $24.8 for the end of 2021. This price target implies an 11.0% upside from the May 4 closing price. The following table shows the sensitivity of the target price to the P/E ratio.
Equally weighting the target prices from the two valuation methods gives a combined target price of $21.7, which implies a 2.7% downside from the current market price. Adding the forward dividend yield gives a total expected return of 0.1%. Hence, I’m adopting a neutral rating on Regions Financial Corporation.
The company’s earnings are likely to surge this year mostly because of a reversal of provisioning. The positive earnings outlook appears to be priced in as Regions Financial is currently trading at a level that is quite close to the year-end target price.
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