Regions Financial: Looking Quite Solid

Summary

• Regions Financial has seen a solid 2022, not been hurt by huge deposit outflows.
• The bank looks quite alright from a deposit base point of view amidst reasonably modest unrealized capital losses on investments, at least compared to other banks.
• While the bank looks to be doing quite alright, shares have held up quite well, as idiosyncratic risks in the banking sector are huge and hard to price.
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Shares of Regions Financial (NYSE:RF) have come down amidst the turmoil in the (regional) banking sector, but the reality is that shares have held up quite well in relation to many peers. This comes amidst reasonable deposit outflows as well as modest unrealized losses on securities, as this is likely the reason why shares have held up comparatively well. Amidst all this, and the increased deposit "guarantees" and Fed assistance, the situation could be interesting, but I fear lower banking profitability here going forward.

The Issue With Banks

Following turmoil in the banking sector, it is evident that banks are faced with two linked challenges. It started with a situation in which banks ended the pandemic with a lot of deposit inflows, which made them deposit-rich. As the Fed started a very aggressive rate hiking campaign last year, the banking sector was slow to hike deposit rates, making them not competitive enough versus risk-free alternatives in order to prevent deposit outflows.

These outflows were worrying, but banks typically have the liquidity to meet these deposit requests. The issue is that once the liquid asset base of the bank gets depleted, banks are forced to sell less liquid assets such as treasuries and agency securities. Default risks are not the concern here, but banks that have taken on some duration risks have seen lower prices for these assets, and those facing huge deposit outflows could be forced to sell these assets. That, however, was before the Fed offered various kinds of assistance programs to banks, to avoid just this.

About Regions

Like so many banks all look fine if we look at 2022 profitability, as net interest income has risen sharply. Net interest income, pre-provisions for credit losses rose from $3.9 billion to $4.8 billion, although that only tells part of the story. This comes as interest expenses rose sharply as fourth quarter deposit interest expenses of $114 million were up from just $13 million in the final quarter of 2021. These expenses trend at $450 million a year here, but the company still had a very profitable year, with pre-tax profits reported at $2.9 billion in 2022.

The bank actually shrunk a bit over the past year as total assets fell from $163 billion to $155 billion. Amidst a declining balance sheet, I am not too worried about the deposit base being down from $139 billion to nearly $132 billion over the same period of time, although fourth quarter outflows totaled $3.6 billion. The $450 million annualized interest expenses only averages 34 basis points of the total deposit base. The pre-tax profits of $2.9 billion actually leave quite some room to hike deposit rates, in fact, the bank could hike the deposit rates across the board by 220 basis points across the board to 2.5% while continuing to post break-even results.

Amidst a declining asset base the company actually increased its loan base over the year as net loans rose from $86 billion to $95 billion. This came amidst declines in interest-bearing deposits at other banks as the company held a stable portfolio of securities available for sale at around $28 billion.

The company has reported a $3.6 billion unrealized loss on debt securities for sale, and while this is a substantial number in relation to these assets, it is not going to create a huge hole in the $15.4 billion equity base of the company by year end, in part because the company hedged some of its exposure.

Bank Uncertainty

The reality is that the bank is very profitable, and the capital base is quite strong in relation to the unrealized losses. While it is a quality that the average deposit rates only come in at just 30 odd basis points, it is a risk as well, although the deposit base is pretty stable, certainly if we factor in the declining balance sheet.

Shares have fallen from the mid-twenties to $18 in recent weeks, with shares actually trading at par with the lows seen last summer, which is a bit at odds with the share price performance of other (regional) banks.

Fortunately, the bank has not provided an update yet on the deposit flows of the business since the banking sector saw turmoil from early March onwards. This will be key as Regions is a regional bank, but it should benefit from the FDIC insurance limit of $250k, the (implicit) guarantees for amounts higher than that, as well as the facilities offered by the Fed to help banks out which face distress.

So with capital losses no longer being the primary concern, investors are focusing on subdued earnings power of the banking sector. After all, the bank can only increase the average deposit rate to 250 basis points without turning into loss making territory, which is about half the Fed funds rate. While this sounds low, it is at par or even better compared to some other banks.

The reality is that the situation at Regions looks quite decent, but turmoil is hard to predict in the banking industry and while shares have come down quite a bit, I am not sure if I feel comfortable to add a lot of banking exposure here.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.