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Regions Financial's Acquisition of EnerBank USA Has Merits, But Also Gives Me Concerns

By Bram Berkowitz – Jun 13, 2021 at 6:31AM

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The bank is buying a specialized home improvement lender with high-quality loans, but it's also spending a lot in the process.

Regions Financial's (RF -2.02%) recent acquisition of EnerBank USA certainly looks a little different from other bank acquisitions this year, as the $153-billion-asset bank based in Alabama is acquiring a subsidiary bank from an energy company.

EnerBank is one of the country's largest specialty home improvement lenders, mainly financing projects such as pools, solar, roofing and siding, windows and doors, and HVAC (heating, ventilation, and air conditioning). For the past 20 years, the company has been owned by CMS Energy, and it's insured by the Federal Deposit Insurance Corp.

Let's take a look at some of the pros and cons of the deal, as well as some of the merits behind it and concerns I have.

A group of businesspeople shake hands on a deal.

Image source: Getty Images.

Con: The financials don't look great

Regions is paying $960 million in cash for roughly $2.8 billion in loans and $2.7 billion in deposits. EnerBank has a tangible book value (equity minus goodwill and intangible assets) of $318 million, so Regions is paying an amount equivalent to 300% tangible book value. That's a hefty price even in this current climate, where banks are trading at high valuations.

The price of EnerBank is expected to dilute Regions' tangible book value by 1% to 2%, which certainly seems like a lot for such a small deal. The deal is also not very accretive to earnings per share (EPS), meaning that when the transaction closes, Regions will only see EPS in 2022 improve in the low-single-digit percentage range, with the potential to see the deal be 5% accretive to EPS. Bank investors hardly like acquisitions that are dilutive, let alone those that don't bring a lot of EPS accretion, although this is a smaller deal and revenue synergies are not baked in. Roughly 55% of the loans made by EnerBank in the last year have been made in Regions' retail footprint, so there may be opportunities for Regions to create more holistic banking relationships with these new customers.

However, the deposit base Regions is acquiring is not great either, being composed of all time deposits, which have a set maturity date once the customer puts the money into the account (examples include certificates of deposit). These deposits tend to pay out a higher rate, which is not ideal for banks. The cost of the deposits at EnerBank is roughly 1.5% interest, which is really bad in this kind of low-rate environment, although Regions plans to eventually replace that funding with its own deposits over time. Although consistent with Regions' previously stated strategy of prioritizing strategic investments, the capital being used to make this acquisition is capital that can no longer be used for share repurchases, so it's certainly a big trade-off if the deal doesn't pan out.

Pro: Putting liquidity into good assets

I can certainly see why Regions is making this deal. Like most of the industry, Regions has been very successful at bringing in deposits since the pandemic began. Non-interest-bearing deposits at Regions, which don't cost any interest, have jumped from roughly $37 billion at the end of the first quarter of 2020 to nearly $56 billion at the end of the first quarter of this year. Non-interest-bearing deposits now make up nearly 43% of total deposits at the bank, which is a very strong number.

But while deposits have been a success story, loan growth has been mighty hard to come by. At the end of the first quarter, total loan balances had declined roughly $4 billion year over year.The bank's loan-to-deposit ratio had declined to 65% at the end of the first quarter, meaning the bank  had only deployed 65% of deposits into loans. Furthermore, management is guiding for adjusted period end loan balances to only grow in the low single digit percentage range for the full year in 2021.

The acquisition will allow Regions to soak up some of its liquidity with nearly $3 billion of high-quality loans. The loans from EnerBank have a gross yield of 9% and once Regions replaces EnerBank's current high-cost deposits with its cheaper deposits, the margins are going to look very good. Additionally, the loans from EnerBank are to prime and super-prime lenders who's credit quality has held up well during the Great Recession and the pandemic. The loans are also fixed-rate, which obviously has ups and downs depending on the rate environment, but does diversify Regions' balance sheet and would have been particularly beneficial in the ultra-low-rate environment last year.

Final takeaway

In some regards, I do like this deal, because it does generate some high-quality and high-yielding loan growth at a time when both loan growth and yield are hard to come by. Regions also has a ton of extra liquidity, so it should be able to replace the higher-costing deposits with cheaper ones and expand the current margins on the loans. But ultimately, for this deal to really pay off, Regions needs to successfully cross-sell other banking products to EnerBank's loan customers and grow the home improvement business to its customer bases, as well.

The deal also concerns me, however, because it suggests Regions is concerned about muted loan growth on a somewhat longer timeline, which is why it's willing to pay such a high acquisition cost. In theory, if the loan growth were readily available, it could take the $960 million of capital it's spending on the less than $3 billion of loans at EnerBank and originate $9.6 billion of loans (banks tend to hold 10% of reserves for each loan they originate). Additionally, Regions has bought some more specialized finance lenders before and is in some fast-growing and attractive markets like Florida, Georgia, and Texas, so you would think organic loan growth might be a little easier to come by. Ultimately, the deal makes me wonder how well-positioned Regions' lending franchise really is.

Bram Berkowitz has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Regions Financial Corporation Stock Quote
Regions Financial Corporation
$20.88 (-2.02%) $0.43
CMS Energy Corporation Stock Quote
CMS Energy Corporation
$65.26 (-0.79%) $0.52

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