Regions Financial Corporation — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018; unaudited consolidated results. Regions is a bank holding company operating across the South, Midwest and Texas. Unless otherwise noted, amounts are in U.S. dollars.
Financial results and position
| Metric | Q2 2018 / June 30, 2018 | Comparison |
|---|---|---|
| Net income | $375 million; $359 million available to common shareholders; diluted EPS $0.32 | Q2 2017: $316 million; $300 million available to common shareholders; diluted EPS $0.25 |
| Continuing operations | Net income $378 million; diluted EPS $0.32 | Q2 2017: $316 million; diluted EPS $0.25 |
| Net interest income and other financing income | $926 million GAAP; $938 million taxable-equivalent | Q2 2017: $882 million GAAP; $904 million taxable-equivalent |
| Net interest margin | 3.49% taxable-equivalent | Q2 2017: 3.32% |
| Non-interest income / expense | $512 million / $911 million | Q2 2017: $490 million / $875 million |
| Loans / deposits | $80.5 billion / $95.3 billion | Loans rose $0.5 billion and deposits declined $1.6 billion from December 31, 2017 |
| Borrowings | $11.3 billion total; $9.9 billion long-term | Total borrowings were $8.6 billion at year-end 2017 |
| Stockholders’ equity / tangible common equity | $15.8 billion / $10.0 billion | Equity declined $415 million from year-end, including a $506 million reduction in AOCI |
For the first six months, net income was $789 million and diluted EPS was $0.67, compared with $617 million and $0.48 in 2017. Net cash from operating activities was $660 million, versus $1.152 billion; ending cash and cash equivalents were $4.286 billion. The cash-flow statement reflects $1.606 billion of net deposit outflows and $470 million of share repurchases.
Adjusted efficiency ratio, a non-GAAP measure, was 60.41% for Q2 and 60.47% for the first half, versus 62.29% and 62.10%, respectively, in 2017. Tangible common equity to tangible assets was 8.36%, compared with 8.71% at year-end. Estimated Basel III CET1 was 11.00% on a transitional basis and 10.93% fully phased-in pro forma; the filing cautions that the latter is an estimate.
Material changes and credit quality
- Q2 continuing-operations income improved mainly from higher net interest income and lower income tax expense. Tax expense fell to $89 million from $133 million; the effective tax rate was 19.2% versus 29.5%, reflecting the lower federal tax rate under Tax Reform.
- Q2 net interest margin benefited from higher market rates and deposit-cost management. Interest expense increased, including deposit expense of $57 million versus $37 million a year earlier.
- Capital markets income rose 50% to $57 million in Q2, contributing to higher non-interest income. Non-interest expense increased 4.1%; salaries and benefits rose $41 million, including higher severance costs.
- Allowance for loan losses was $838 million, or 1.04% of loans, down from $934 million and 1.17% at year-end. Q2 provision was $60 million versus $48 million; net charge-offs were $62 million, or an annualized 0.32% of average loans, versus $68 million and 0.34%.
- Non-performing assets declined to $666 million, or 0.83% of relevant loans and assets, from $740 million and 0.92% at year-end. Total non-performing loans were $605 million. Management cited broad-based improvement, but identified $75–$150 million of potential problem commercial and investor real estate loans that could migrate to non-accrual status in the following quarter.
- Commercial and industrial loans grew $964 million from year-end; indirect-other consumer loans increased $422 million. Home equity loans declined $485 million, and indirect-vehicle loans declined $107 million.
Outlook, capital actions and notable items
- For 2018, management expects adjusted average loan growth and average deposit growth in the low single digits; adjusted net interest income growth of 4%–6%, currently toward the upper end; adjusted non-interest income growth of 3%–6%; relatively stable adjusted non-interest expense; adjusted efficiency ratio below 60%; and positive adjusted operating leverage of approximately 3%–5%.
- Management expects a 20%–22% full-year effective tax rate and net charge-offs of 35–50 basis points, currently toward the lower end, subject to economic conditions and credit developments.
- Regions received no objection to its 2018 capital plan. A new $2.031 billion repurchase authorization covers Q3 2018 through Q2 2019. The Board approved a quarterly common dividend increase to $0.14 per share beginning in Q3, subject to quarterly approval. By August 7, the company had repurchased 16.4 million shares for approximately $308.8 million under the new plan.
- The sale of Regions Insurance Group to BB&T closed July 2, after quarter-end. The company expects an approximately $200 million after-tax gain and approximately $300 million of CET1 capital generation, to be recorded in Q3 discontinued operations.
- Regions was compliant with the Liquidity Coverage Ratio requirement. At June 30, it reported $17.4 billion of Federal Reserve borrowing availability and $17.1 billion of FHLB capacity, subject to eligible collateral. The holding company had $1.0 billion in cash.
- Adoption of CECL is planned for Q1 2020. Regions expects a potentially material increase in credit-loss allowance at adoption, particularly for longer-dated residential mortgage, home-equity and indirect-other consumer loans; the amount will depend on portfolio quality and economic conditions at that time.
Risks, contingencies and unusual items
- Management identifies interest-rate and deposit-pricing assumptions as important to earnings sensitivity. Its model estimates that a sustained 100-basis-point increase in intermediate and longer-term rates would add approximately $83 million to 12-month net interest income versus its base case; a 100-basis-point decline would reduce it by approximately $116 million. Parallel-rate scenarios also show downside under falling rates. These are estimates, not forecasts.
- Other disclosed risks include credit deterioration, changes in property values, funding costs and deposit behavior, regulatory changes, litigation, cybersecurity and third-party operational risks, and market or economic weakness.
- Regions estimated that reasonably possible legal losses above accruals could be up to approximately $20 million, though no excess loss was also reasonably possible. The estimate may not cover every disclosed matter. The company is cooperating with a U.S. Attorney’s Office investigation concerning a former customer and related AML/BSA compliance matters.
- Regions’ Fannie Mae DUS loss-share guarantee had a maximum quantifiable contingent exposure of approximately $967 million; its recorded fair value liability was approximately $4 million. The maximum assumes severe defaults and no collateral value and is not management’s expected loss.
- Q2 salaries and benefits included $34 million of severance; first-half severance totaled $49 million. First-half earnings also included $7 million of net gains on certain low-income housing investments, a $6 million equity-method investment valuation increase, and $4 million of leveraged-lease termination gains.
- First-half AOCI declined $506 million, primarily reflecting unrealized losses on available-for-sale securities and derivatives, contributing to lower reported stockholders’ equity.
Important facts for investors to verify
- Whether loan and deposit growth, deposit pricing, and net interest margin support management’s full-year guidance as rates and competition change.
- Whether credit quality continues to improve, including movement in potential problem loans, non-performing loans, charge-offs, and the adequacy of the allowance.
- Actual Q3 recognition of the insurance-sale gain and capital generation, and execution of the authorized repurchases and increased dividend.
- How AOCI and market-rate changes affect equity, securities values, and modeled interest-rate sensitivity.
- Developments in the AML/BSA investigation and litigation exposures, and the eventual regulatory and financial effects of CECL implementation.