And then we will kick it off.
Okay.
F or important disclosures, please see Morgan Stanley Research Disclosure website at morganstanley.com/researchdisclosures. The taking of photographs and the use of recording devices is not allowed. If you have any questions, please reach out to your Morgan Stanley sales representative. All right. T hank you very much for joining us this morning, which is the kickoff session for day three of our 15th annual Morgan Stanley financials conference.
We are so delighted to have with us today the management team from Regions Financial: John Turner, CEO; David Turner, CFO; and Deron Smithy, Treasurer. Thank you so much for joining us this morning.
Thanks for having us.
Thanks for having us.
Our pleasure.
Well, I did want to kick off with a bit of a more technical couple of questions here and then get into the strategy, if you don't mind.
Great.
L et's talk a little bit about that net interest income guidance that you've got, which is really impressive. You've got an NII guidance range with only $100 million between the high end and the low end. T here is some detail in the slides that you have on your website, the investor presentation that's outstanding. And so folks can find that on the Regions Financial website if they'd like to take a look. But on slide 14, it gives you a lot of detail around that guidance. I f I recall correctly, the biggest driver of that differential is going to be how deposit pricing plays out. Is that a fair statement?
Yes.
Okay. Now that we're halfway through the year, could you update us on how things are trending on that deposit pricing side?
Sure.
Thank you.
Yeah. Happy to do that. Good morning, everyone. Yeah. As you pointed out, the range is fairly narrow. And coming into the year, we weren't quite sure what we would experience from a continued improvement in inflation and Fed policy. So we tried to really anchor both ends of the range with a set of circumstances that would lead you to one end or the other. The upper end of the range was a soft landing, Fed beginning to return to more normal policy. Low end of the range is one in which inflation is stubborn and rates are on hold for most of the year.
I think the conditions that we're experiencing today probably would tend you to be in that framework toward the lower end of the range. The biggest driver, as you point out, deposit costs or deposit pricing and really the continuation of normalization of non-interest-bearing moving into interest-bearing as well as just the tail on repricing. So one of the data points that we pointed out in the first quarter release was that February and March, we had flat deposit costs, that they were the same deposit costs for February and March. What I would say today is that trend has continued into the second quarter.
Very stable deposit costs. I would say the outlook there is performing in line to modestly better than our expectations. We had built into that guidance some, even if the Fed was on hold with rates for some continuation of deposit cost increases and our betas getting up into the mid-40s. But I would say so far we're seeing stabilization again in line, if not modestly better than what we were expecting for the year under those circumstances.
T hat coupled with some of the things we've done, you've seen us use our capital to reposition a part of the investment portfolio, which helps improve the forward run rate for net interest income. I would say, again, the conditions coming into the year would probably tend you toward the lower end of the range. I think there's an opportunity for us to outperform that even in this environment, just given the performance of deposits so far as well as some of the actions we've taken from a securities standpoint.
We are continuing to look at potentially doing another securities repositioning, which was not contemplated when we came up with that range. That's incrementally helpful if we actually pull that off. But we're still sticking with the range that we gave you. No guidance change on that at all.
Right. To be clear, not change the range, but improve where we actually perform within the range.
The other thing to say is the securities repositioning, if we did it, would be fairly modest, just as the last one we did was fairly modest. So nothing dramatic.
Right.
Excellent. Well, thank you so much for all that color. So one of the conclusions here is no matter what the Fed dot plot says today, you're in good shape.
We are.
Okay. Maybe you could also talk a little bit about the deposit strategy. I ask the question because your deposit betas have been low. We know that there's baked into your guidance and expectation for a little bit of an increase there, b ut deposit betas have been below. O ne of the most frequently asked questions I get is, oh, doesn't Regions have to raise that deposit beta in a higher-for-longer environment? So let's ask the expert.
I'll start and John, Deron can weigh in. But so our competitive advantage is our deposit base. It's a very granular deposit base with 4.5 million customers centered on consumer, which is two-thirds of our deposits. A lot of those are checking accounts that are average balance of $5,000-$6,000 in them. The other non-interest bearing piece are corporate deposits. So our non-interest bearing component is 33% at the end of the quarter.
We said it would finish in the low 30s. We're tracking towards that. And so I think that confidence in terms of where our deposit behavior is consistent with our expectations. We haven't seen a lot of loan growth in the system. You can look at the H.8 and see that. So the demand, the competition for deposits has simmered dramatically from March 2023.
There's no loan deposit ratio of 75%. We don't need to go out and go raise deposits by using price. Our whole strategy is around relationship banking and growing checking accounts of a consumer, operating accounts of a business. We're going to stick to that. As a result of that strategy, we're able to control that critical input cost of deposits.
Super. My answer has been accurate. All right. Very good. On that loan-to-deposit ratio, 75%, how high are you comfortable with that going?
We don't solve for the loan-to-deposit ratio. It's just a result. I would tell you that's lower than history. In this world where liquidity became even more important as a result of last year, we're comfortable where we are. We don't solve for it, though. What we don't want to do is have loan growth that outstrips our ability to grow low-cost deposits because then you have margin pressure and profitability pressure.
A gain, that's why we focus on relationships starting with the deposits. We don't start with loans as a relationship. The foundation of our customer engagement is on the deposit side, a nd we'll let the loan-to-deposit ratio end where it ends.
Okay. Very good. Ju st lastly here on deposits, what about non-interest bearing deposits? How's that trending? Is there a mixed shift going on still, or is it stabilizing?
Yeah. A gain, we've been experiencing some normalization there for well over a year, sort of post-pandemic and then in the tightening cycle. W hat we had messaged that we thought that settled out in the low 30s%. We've come through a more volatile period from a seasonal standpoint, first to second quarter with tax payments and such. But as you transition past Tax Day and observing where non-interest bearing is performing, again, it's performing in line with expectations. S o we do think that it levels out in the low 30s% as a percentage of deposits.
Okay. Great. Then just lastly on this topic, maybe we could get an update on the hedging strategy. Are you doing anything differently in this environment to lock in that NII expectation for the full year? If you could share with us your base case for rate outlook and then what happens if there's more cuts or less cuts?
Sure. W e've positioned the balance sheet relatively neutral to short rates for the next one to two. W e're really happy with our position in here in the short run. W e're not doing much at the margin to change that position. Obviously, if the mix of the business changes, we'll react to it. R ight now, we feel very good about the way we're positioned. We have turned our attention a little farther out. And so thinking 2026, 2027, 2028.
A gain, just continuing to execute with the philosophy and the strategy that our goal is over time, through time, to reduce the variability in net interest income and really ensure that in the environment that is a tougher environment for us, which is low rates, that we've reduced that downside volatility. And so obviously, hedging is how we do that. There have been some good opportunities with the recent backup in rates to continue to chip away at adding protection out in those out years at some pretty attractive levels. So if the Fed's returning to neutral, those are not going to work against you.
If we're in a more challenging environment, they're going to do their job and help you protect the downside. But in an environment where rates stay higher for longer, again, they're not working against you either. So it's really continuing with that strategy to stay more neutral. Now, our expectations, obviously, coming into the year was that we would start to see the Fed begin to cut second half of the year. Obviously, inflation has been a little more stubborn than any of us would like. And so I think that has been pushed out.
I think if we get any cuts this year, they'll be very late in the year and maybe one or two. And so likely, we're starting to see relief in next year. But again, well positioned with the way the balance sheet is positioned today, we think net interest income, given the current outlook, the current outlook for rates is bottoming here in the second quarter.
W e're going to see opportunities for growth in the second half of the year, modest growth in net interest income. And so if we're continuing to see a decent economy and we do get some rate relief and loan demand begins to grow a bit in the second half of the year, I think all of that gives us a nice tailwind into 2025 for growth in net interest income.
Super. Well, I do have to say you've done a fantastic job at managing the interest rate risk. The NII durability is quite impressive.
Thank you.
O n that topic of loan growth, let's switch to that. C&I clearly is critical with C&I roughly, I think, half the loan book. Is that right? Roughly half your loan book is commercial industrial loans.
Yes.
I realize that it's a bit of a tough environment from an industry perspective right now, -2 to +1 depending on the week and the H.8 data year-over-year. Maybe you could help us understand how your portfolio is positioned right now today in commercial and industrial loans and how you're seeing the growth opportunities there. Should we expect you're running in line with H.8, or is there any differentiation that you want to call out for us?
Make a couple of comments. First of all, customers are generally, I would say, cautiously optimistic. Coming off of really good years in 2020, 2021, 2022, 2023, customers have a lot of liquidity. A s a result, line utilization has been fairly low. They're building some inventory levels, but still inventory levels have been somewhat depressed with the excess liquidity. Modest line utilization off from historical levels, not seeing a real catalyst there. The cautious optimism has led customers to defer some investment.
And so we're not seeing a lot of activity, although I would say pipelines are beginning to build a little bit, which is a positive sign. On the other side, we had $870 million in direct paydowns in the first quarter resulting from customers' ability to access the capital markets. So you have excess liquidity, capital markets beginning to open, allowing customers to raise more debt to reduce short-term obligations. That's working against us. And then real estate, while it's not been necessarily a growth engine, has certainly supported our balances. And we're seeing a real estate portfolio, as you might imagine.
I n this environment, there are very few originations, and so some runoff in that portfolio. All that to say, we are experiencing some paydowns that are a headwind to growth. W e do believe that in the second half of the year and certainly in 2025, we'll see more investment and more opportunity for loan growth in C&I. Overall, the customer is healthy. There are some segments we've been calling out for a number of quarters now. We see some softness. But in general, I think the market is good and the opportunities will come.
It's been four years since you acquired Ascentium, which, if I recall correctly, asset-based finance was part of the, right?
Yeah. Small business lender focused on what they refer to as business-essential equipment.
Right. I just wanted to get an update here on how integrated it is to your entire footprint. I s there an opportunity to lean into that sleeve?
Yeah, for sure. We bought the company because we liked their business model. We liked their approach. We liked their technology. And we thought we had the ability to leverage that technology. We liked the way they executed. And what we've observed over time is they do a really nice job lending to small businesses focused on what they would describe as business-essential equipment, equipment companies have to have in order to operate their businesses, which implies that you're going to get paid over time because they need the equipment to operate, and w e found that to be generally true.
Credit metrics are good. We've been able to integrate the platform into our branches. T oday, virtually every one of our 1,300 branches has made a referral over the last year to year and a half to Ascentium. We're using it as a platform to leverage into our small business customer base. I think that has great potential to continue to grow. So we've been very pleased with that acquisition and our ability to leverage it.
One of the other questions we've been getting is how are you dealing with the competitive-I don't know if I want to call it pressures-but the competition coming from the private credit market, which might be willing to do more levered vehicles than maybe you are, but also term. T he question we've been getting is, would you consider doing more term loans to-and really the first question is, do you see private credit as a competitor?
Well, we're seeing them more as a competitor, to be sure. In fact, I was reading an email this morning about a couple of instances where private credit has been involved in an opportunity. And in fact, we lost a potential opportunity to private credit recently. So far, anyway, I would characterize what private credit is doing as primarily lending to private equity-owned companies. Generally, there's an acquisition involved, not always, but an acquisition, dividend recap, some sort of expansion.
T ypically, they're providing a couple of turns more leverage than we would be willing to provide. They're providing longer terms. They're providing more loan proceeds. So larger loans, more leverage implied there, longer terms, getting a little higher rate, but they're taking more risk than we expect.
Less covenants.
Right. L ess covenants. T oday, they're not infringing yet, knock on wood, on the part of the business that we're really active in. They're more active in the area we probably are not going to participate in, b ut it's coming, I suspect.
Okay. I guess the conclusion here is doing a term loan to a customer that you know is not necessarily attractive. Is that?
Well, no. I mean, we make term loans on equipment. We make term loans on plant expansion and other things. But making longer-term credit available to customers for acquisition, for dividend recap, other things where there's a lot of leverage involved, that's not the profile of a credit that we're interested in.
Yeah. Totally understand that. I realize there's regulatory constructs around max leverage that banks can offer.
Just outside our risk profile.
Yeah. Yeah. Okay. But interesting on the Ascentium part because that's another sleeve that private credit is interested in, which is equipment asset-based lending. And you're very well positioned there.
We think we are. Again, we're lending primarily to small businesses. We've got a really good distribution network, really good technology to execution. We can approve a loan in 72 minutes and get it closed. And for small businesses, that's a really nice opportunity. And to be able to drive it through our branch network in our footprint is, we think, really important to our longer-term strategy to grow small business.
I was excited when you bought it, so I'm thrilled.
It's been four years. Actually, we bought it just as COVID started, which was sort of a hold-your-breath moment. But it worked out.
Yeah. Excellent. Excellent. Well, congratulations on that. I wanted to turn to residential mortgage as that's the next biggest loan category for you running at about 20% of your loan book. And there, we've actually seen some nice growth outpacing the industry. I would love to hear what's driving that.
A couple of thoughts about mortgage. First of all, we've always had more purchase volume than most of our peers. T hat's, I think, the result of a couple of factors. One is about 30% of our mortgage originations come from referrals from our branches. But we've built our consumer lending strategy around lending to homeowners, a nd we're explicit. We bought EnerBank and said, "We want to be great at first mortgage lending. We want to have a really good HELOC product. And we want to loan on an unsecured basis to homeowners for home improvement," which is why we bought EnerBank.
We think lending to the homeowner is a really important part of our relationship banking strategy. So you have this referral momentum coming from the branches, which is helpful. You have an in-migration of people into the markets that we operate in. In a higher-rate environment, customers are opting for the on-balance sheet product, which is an adjustable-rate mortgage.
W e're seeing growth in the on-balance sheet product because, as compared to an agency origination, it's just a better interest rate today. And I think we'll see that continue until mortgage rates begin to return to more, let's say, recent levels. There may be a shift back to agency origination.
Okay. That's fantastic. And then we can't finish up a conversation on loans without talking about the commercial real estate segment, which is 12% of your loans, right?
Right.
Over the last two years, it's had somewhere between a 1.5% and a 2% growth rate. Then commercial real estate construction, which is 7% of your loans, has been growing at a healthy clip in 2023, right? Like double digits, some quarters 20% year-on-year. I wanted to understand your risk appetite for this, how you're managing the book, and just generally thoughts on those questions.
Yeah. The three biggest components of our commercial real estate book would be industrial, office, and multifamily. Industrial is performing well. It's a $1+ billion, $1.2 billion, $1.3 billion dollar portfolio. We are originating some credit in industrial, but the volume there has slowed down as well. Within office, I think we've talked a lot about that portfolio. It's about $1.5 billion. Roughly 40% is single-tenant credit exposure. So the balance of about $900 million would be the multi-tenant exposure that we have.
It's originated across 40+ sub-markets. It is 90+% Class A. It's 62%-63% in the Sun Belt. W hile we have a couple of credits in that portfolio that we're having to work through, generally, it's in pretty good shape. About half the portfolio is maturing this year. And so we've already had experience with extensions, with renewals, and with workouts.
I would tell you we've experienced about a 5% payoff. Roughly, if I do my math right, roughly 65% of the book has been extended or renewed on terms acceptable, obviously, to us and the borrower. Roughly 30% is now in some workout status where we're having to do a little more work to agree on how we're going to renew the credit. But that's consistent with our expectations. It's consistent with our experience in 2024 or 2023 with maturities. We feel good about the office book. We have fewer than 100 loans.
We have really good insight into what we have. If you take out the single-tenant portfolio, which is 80+% to investment-grade credit, we're carrying about 8+% reserves against the remaining $900 million multi-tenant portfolio. I feel like that's well reserved. Multifamily is continuing to perform well. There's some softness in markets that we have credit exposure in. But we don't believe that that results in any real problems. We're in 143 different sub-markets across a $4+ billion portfolio. Roughly 60% of that is in construction.
We expect most of that to come out of construction and to convert to an agency origination. So remember, we have the real estate capital markets capabilities. Much of what we're doing in our construction book is originating construction loans to seasoned multifamily developers who like the Fannie, Freddie, and HUD product. And that's where most of that goes. And we believe that trend will continue. So all in all, feel good about the real estate exposure. Have good distribution across products and markets. No concentrations of exposure.
I'll add, just make it clear, based on that last piece that John was talking about, as a result of going out to capital markets or the agencies, in this case, you're going to see real estate balances probably decline throughout the year instead of increase.
That decline should start in the next several quarters?
Yeah. I mean, it's starting.
It's already starting to decline. Okay. Very good.
It won't be drastic. It's not a growth area for us.
Right. So commercial real estate construction likely starts to decline as you are.
Just don't have a lot of origination opportunities. The cost of construction is very high. Difficult to make the economics work associated with the projects. There's a fair amount of inventory available or coming on the market. So we're cautious, and our developer customers are cautious today.
That decline is a function of the property being.
Planned. Planned execution.
Right. Agency origination taking over.
Right. Right.
Got it. Okay. That's fantastic. Let's just spend a couple of minutes on other parts of the book as it relates to credit. The first question here is on your outlook for net charge-offs. I think it's in the 40-50 basis point range. Which loan categories do you feel we're running at normalized loss levels given the economy we have? Are there any where we're still needing where you anticipate there's still normalization to come?
Yeah. I think we said we thought our credit metrics would peak in the second quarter, a nd we believe that's true. W e actually may see some modest improvement. So we said non-accruals, levels of charge-offs, criticized classified loans would peak in this quarter. AAnd again, I think that is going to be true. And we may actually see some improvement over the first quarter. So that's a good thing. I'd say C&I charge-offs have returned to historical levels across the board. And we've expressed for now 4, 5, 6 quarters that we have been following a couple of industry sectors that have more stress than others.
Transportation would be one. Healthcare, some aspects of healthcare technology, senior housing, and then, of course, office. W e believe that charge-offs will be between 40 and 50 basis points generally. Sometimes on the high end of that, sometimes on the lower end. We have some larger credit exposures that we've talked about as part of our strategy to grow capital markets. But it does create some lumpiness from time to time. Consumers performing well, again, consistent with expectations. Don't expect a lot of change.
Okay. Very good. Let's move on to fees. You have some very nice fee businesses. I think your guidance implies a 3%-4% growth rate year-over-year, full year, full year. Y ou had a very strong capital markets quarter in 1Q, if I recall correctly. Would you characterize as such?
Yeah. It was good. We had some momentum coming into the year as a result of some business we pulled forward or pushed into 2024. That was helpful.
Okay. So as we're thinking through the rest of this year, is that 1Q capital markets revenue level something that is seasonally high in 1Q and we should expect a just like I cover other capital markets folks where 1Q tends to be the strongest? There's some seasonality there. Does that apply to you as well, or?
Yes. In this particular case, we've said we think, I guess it'd go back to 2022. We generated about $320 million in capital markets revenue. That has been on a nice increase until 2023 when the impact of interest rates really had a negative impact on that business. But we believe it's a $70-$80 million kind of round number of business every quarter. It should grow over time to be $100 million a quarter on average. But it's got a nice trajectory up from $65 million for the year in 2014 to $320 million in 2022. And we should continue that trajectory over time.
Okay. Great. M aybe just remind people what the key elements of that strategy is in capital markets.
Yeah. Well, we built a debt capital markets platform around financial risk management, so swaps, foreign exchange, around capital raising, particularly loan syndications. And we participate in some fixed income debt raises. We have a significant real estate capital markets business, which represents about 25% of the revenue on an ongoing basis.
I mentioned earlier Fannie Mae, Freddie Mac and DUS, I mean, HUD capabilities, a nd that's been good. T he fourth component is M&A advisory. And we've acquired two firms, both of which contribute on an ongoing basis, kind of 20%-25% of revenue as well. So those are the four components of the business.
Super. How would you think about the next biggest driver for your fees on a year-on-year basis? Wealth, mortgage banking, treasury management?
All three really good. Treasury grew. Treasury management grew for the second year in a row at 7%+. We're seeing nice growth there as our bankers are focused on helping customers manage cash in their businesses. We've added new products in treasury management, which have contributed to about 25% of the growth in treasury management over the last 10 years has come from new product capabilities.
The wealth management business grew at a 6%+ clip. It's a really nice opportunity. I think we'll see it continue to grow and expand and make a bigger contribution. Then mortgages, as I mentioned earlier, is fundamentally a key component of our relationship banking strategy.
Are there any offsets we should be considering here? I know there's some proposals out there on.
Yeah. We've seen a steady decline in consumer-related fee income. If you go back to 2011 and come forward to today, we have lost or given up over $500 million in fee income associated with the Durbin Amendment, Reg II, and changes in our overdraft NSF policies. And yet, we've grown fee income by $150 million over that period of time. So it's actually about a $700 million delta over that 10+ year period. I think we'll continue to see a decline, likely from Reg II and continued changes in overdraft in consumer-related fees.
A t the same time, we're going to be growing consumer accounts, which helps offset that, mitigate some of the loss. T he other businesses we refer to, capital markets, wealth management, treasury management, mortgage, all are going to continue to contribute. And so we feel like it's very manageable, the impact. We've demonstrated that again over a 10-year period, offsetting the loss of significant fee income.
Is there any target level of fees as a percentage of revenues that you've got your eye on?
Yeah. We've always said we want it to be a little bit higher than where we are just for diversification of the revenue stream. So if we could take that up another 5 points from where we are, 10 points, something like that would be great. We've been working on that for literally 12 years. And it hadn't moved a whole lot. But to John's point, we've had $700 million worth of challenges. W e've offset more than that just because of all the things we've been able to do in growing our customer base. So to put a finer point, Reg II is about $25 million a quarter when it's implemented, if it's implemented as proposed.
W e offset that by growing clients in AUM and wealth, treasury management. We've rolled out CashFlowIQ, we call it, for small business literally yesterday. We have some things that we're continuing to look for ways to offer products and services to our customer base that they value. If we can do that, we can offset the pressure.
Super. So last question here is just on expenses. R eally, I'd love to understand how you're thinking about managing the expense base to be able to deliver positive operating leverage, in particular as you're in the process of a systems upgrade, I believe, this year. And NII is trending, as we discussed earlier.
Yeah. Well, so we continue to look at expenses. We won't have positive operating leverage in 2024. But our goal is to seek that out for 2025. We're not committing to that yet. We'll tell you that in January, b ut the way we do that, we have to make investments in putting in our new deposit system, which has been running. It's in our run rate. You won't see us put in the system for another three years. We're also putting in a new commercial loan system. That work has already begun as well. We got to invest in cyber, consumer compliance. We have to make all these investments.
We have to figure out how to pay for that so that we can keep our expense growth under control. W e do that by managing our headcount, leveraging technology better. We still have a lot of manual processes. If we can put technology in, that'll help cut costs. Working on vendors. Any cost pool, we are all over. We've done actually a pretty good job doing that.
Okay. And then just, well, actually, we're out of time. Okay. Thank you so much for joining us this morning, John, David, and Deron. Appreciate your insights.
Thank you.
Thank you.