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Morningstar | Regions Faces Tough 1Q; Reducing FVE to $15. See Updated Analyst Note from 22 Apr 2019

No-moat-rated Regions Financial had a difficult first quarter due to rising deposit costs and weak fee income. The yield on interest-bearing deposits rose 19 basis points during the quarter, which caused net interest margins to decline 2 basis points quarter over quarter. This was one of the highest deposit betas we witnessed among the banks that have reported so far, and the highest beta for Regions in the current rising rate cycle. Given that one of Regions' main strengths is its deposit base, this was a negative development. We anticipate that deposit costs will continue to rise during 2019 and in subsequent years, which will put further pressure on the bank’s interest margins and overall profitability. Management stuck to its full-year guidance, but after updating our deposit cost assumptions, we are lowering our fair value estimate to $15 per share from $16.

Although noninterest income grew 4.4% quarter over quarter, this was largely due to one-time gains, particularly a gain on sale of an affordable housing loan and a gain on a pension asset. Noninterest income has not historically been Regions' strength, and the bank has made some progress here in recent quarters, but declining capital-markets- and mortgage-related income took their toll. We could see some rebound in mortgage-related fees, given the current yield curve environment. Capital-markets-related items were also hit in the quarter for some peers, suggesting a rebound may be likely here as well. Noninterest expenses remained under control and only grew 1% year over year.

Regions’ credit remains sound, with net charge-offs coming in at an impressive 0.21%. We think this figure represents a cyclical low in credit costs and expect credit costs to increase over the medium term. We think that the next credit downturn will be a real test for Regions’ underwriting standards. The bank will have to prove it has reformed since its poor performance during the last downturn.

For a more detailed view of our expectations regarding deposit costs and their effects on banking profitability, please see our December 2018 Observer, "The Return of the Bank: Net Interest Margins Reach a Turning Point--Funding Advantages and Net Interest Income."