The Federal Reserve has currently capped bank dividends to an amount equal to a bank's average net income over the previous four quarters. While this cap is temporary, it could certainly continue into the fourth quarter, especially if economic conditions continue to be volatile. What this means is that a bank's ability to continue paying its current dividend can really be limited by its ability to generate earnings.
In its second quarter, Regions Financial (NYSE: RF), a $144 billion asset bank headquartered in Birmingham, Alabama, reported a net loss of $214 million. If the Fed's current cap continues into the fourth quarter, Regions would have to generate a certain amount of income in the third quarter to maintain its current dividend.
Executives on Region's recent earning call said the bank plans to maintain its normal common dividend of $0.155 per share for a total quarterly payout of $149 million to common shareholders. UBS Analyst Saul Martinez pointed out that to do this, Regions would have to generate about $260 million in net income in the third quarter to have a four-quarter average net income to cover that $149 million common dividend.
This doesn't even include the $23 million in preferred dividends the bank is liable for before it can pay dividends to common shareholders. Including those, Regions would have to have an average four-quarter net income of $172 million ($149 million plus $23 million), meaning it would have to generate about $350 million in net income in the third quarter.
|Quarter||Net Income (millions)|
|Fourth Quarter, 2019||$389|
|First Quarter, 2020||$162|
|Second Quarter, 2020||($214)|
|Third Quarter, 2020||$350 (projection)|
|Average Net Income||$171.75|
Although a $350 million profit in this economy seems like a high number considering Regions hasn't gotten anywhere close to that in the first two quarters of the year, management said it was confident in the company's ability to generate that level of earnings.
Management's confidence makes a certain amount of sense: Under the new current expected credit losses (CECL) accounting method, banks are supposed to project losses on the life of all loans currently on their balance sheet even if there is no reason to believe a loan has been impaired yet. That means, at least in theory, that Regions should have already set aside all the money it needs for losses that may result from its current balance sheet. The bank set aside $373 million to cover potential loan losses in the first quarter and then $882 million in the second quarter. Its total allowance for credit losses now amounts to 2.68% of total loans, which is certainly a healthy amount.
"Based upon the work we've done in our assumptions around the economic outlook, we do not anticipate substantial reserve builds during the remainder of 2020," Regions President and CEO John Turner Jr. said on theearnings call The high provisioning in the last few quarters has really been the driver behind reduced earnings, as the bank's total revenue in the second quarter was the highest its been in the past year. Before the pandemic, the bank was regularly generating over $360 million in net income, meaning if it can get a handle on the credit provision, there is no reason why it can't deliver on its profit goal in the third quarter.
Although there is logic behind management's thinking, there is still lots of uncertainty there. For one, even if Regions pays its normal dividend in the fourth quarter, if the Fed extends its restriction into the first quarter of 2021, maintaining that dividend would be even harder because the $389 million net income from the fourth quarter of 2019 would be removed from the average net income equation. That could mean Regions would have to generate even higher profits in the fourth quarter than in the third quarter. Additionally, the economy is still very fluid right now. Regions has lent to some vulnerable industries including energy, retail, transportation, and hotels, so while the bank has set aside a healthy reserve amount, things could still get worse. There is also the possibility of a second round of shelter-in-place orders to prevent the spread of the coronavirus, which would hurt all businesses.
Finally, in a healthy economy Regions typically generated between $390 million and $410 million in profits per quarter, and the bank needs to do about $350 million in the third quarter, so there isn't a huge margin of error.
10 stocks we like better than Regions Financial
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*
David and Tom just revealed what they believe are the ten best stocks for investors to buy right now... and Regions Financial wasn't one of them! That's right -- they think these 10 stocks are even better buys.
*Stock Advisor returns as of June 2, 2020
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.