The large Southeastern bank Regions Financial (RF 1.05%) has done a great job of transforming its business since the Great Recession.
The bank now has a very strong balance sheet supported by healthy credit quality and a lot of excess capital. The bank also has a great deposit base and an increasingly strong lending franchise, which has led to strong earnings recently.
For its great work, the market has rewarded the stock with a premium valuation and Regions now trades at close to 300% of its tangible book value, or net worth. But banks are always looking to get better. This will be Regions' next challenge.
Reliance on net interest income
Very broadly speaking, you can clump a bank's revenue sources into two overarching line items: net interest income (NII) and noninterest income, or fee income.
NII is the money banks make on loans and securities after funding those assets. Fee income is from any fee-based business such as investment banking, wealth management, treasury management, trading, insurance, and much more. While there's no one size fits all, investors tend to like banks with healthy streams of fee income because it makes them less beholden to interest rates.
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Regions, however, has an above-average reliance on NII, which made up roughly 70% of total revenue in the fourth quarter of 2022. Now, this is mostly a good thing because Regions management seemed to have correctly projected just how aggressive the Federal Reserve would be with interest rates and was able to position the balance sheet so it could really benefit from rising rates. The bank generated great results in 2022.
But just like a bank has to worry about rates rising, it also has to worry about rates falling and if a bank benefits a lot from rising interest rates it will also suffer from lower interest rates. Regions' management team knows this and as such has a big hedging program in place. The bank purchases derivative contracts such as interest rate swaps that can be used to make the balance sheet less sensitive to interest rates. A hedging program can lower your downside risk but it also limits a bank's upside. Regions could probably do less hedging if it had more sources of fee income.
Bolstering fee income
Regions is also a little more challenged than some of its competitors because its two largest fee income sources are from service charges on deposit accounts and card and ATM fees.
Service charges on deposit accounts include fees from treasury management services the bank provides. But this line item has also been on the decline recently because it includes fees associated with overdrafts and non-sufficient funds. As these practices have become more scrutinized by lawmakers, Regions has made changes to its overdraft policies in an effort to better accommodate its customers. This is the right move for Regions and will likely create better client satisfaction and loyalty, but it hurts the bank's largest fee revenue line item. Card and ATM fees are also not exactly a very differentiated source of fee income.
NYSE: RF
Key Data Points
Regions' third-largest fee income revenue source is wealth management, then capital markets, and then mortgage income. But all of these could use more scale to become more material to revenue and earnings.
The good news is that the bank does have excess capital and management has expressed interest in making bolt-on acquisitions to bolster fee income, which it has done before, although more so on the lending side. Earlier this year, Regions bolstered its capital markets division with the acquisition of Clearsight Advisors, a mergers and acquisitions advisory company focused on the tech sector.
Where to next?
Regions has clearly done a great job of transitioning the bank into a strong deposit-and-lending franchise. This is a bank's bread and butter, so it makes sense it put a lot of its energy into NII. It has paid off.
Now, the next challenge is for Regions to work on fee income. I expect the bank to continue to look to bulk up wealth management and capital markets, businesses it already operates. These are less capital-intensive businesses and could likely create synergies with Regions' already strong commercial franchise.
