Regions, M&T Show How Low Rates Create Hollow Growth

Regions Financial and M&T Bank executives must feel like golfers who are teed up and ready to swing but have to wait impatiently on the slow group ahead.

The $120 billion-asset Regions in Birmingham, Ala., and the $97 billion-asset M&T in Buffalo, N.Y., face the same quandary as many other banks — the economy is rebounding and they're reporting healthy loan growth, but they don't have much profit growth to show for it.

The culprit is low interest rates, and the party controlling the game's tempo is the Federal Reserve, which might start raising short-term rates from nearly zero as early as midyear.

Until then, many banks' improving fundamentals will feel less than real. Regions and M&T, which reported fourth-quarter results on Tuesday, are good examples.

For the fourth quarter, Regions reported 3.6% growth in total loans to $77.3 billion. Commercial and industrial loans, Regions' largest loan category, increased 11% to $32.7 billion.

At M&T, Ken Zerbe, an analyst at Morgan Stanley, had projected growth in commercial real estate lending in the fourth quarter to be "less robust" because of "management's concern over competition and the deterioration in the market's underwriting standards." Yet, M&T posted its strongest loan growth in CRE lending, rising 5% to $27.6 billion, from a year earlier.

They seem to be well-positioned.

Regions has a strong collection of relationship-based customers, "which should bode well … especially as borrowers, both commercial and retail, lever up as economic growth returns to more normalized levels," said Julie Solar, senior director of financial institutions at Fitch Ratings.

And M&T's loan growth "should position the company well should rates rise," said Doriana Gamboa, a bond analyst at Fitch Ratings who covers M&T.

But the two East Coast banks are stuck in a waiting game. M&T and Regions are seeing their profit margins squeezed by low interest rates. M&T's net interest margin fell 46 basis points to 3.1%, and Regions' fell nine points to 3.17%.

So, until the Federal Reserve Board takes action on rates, M&T and Regions are restricted in how much they can capitalize on the new loans they are adding to the books.

"To the extent that we can get a rising rate, what we say is, we could have modest improvement to our overall net interest income and resulting [net interest margin] if that occurs," David Turner, Regions' chief financial officer, said during a Tuesday conference call. "We expect that to be an opportunity for us, in terms of revenue growth, if the loan growth will pan out like we've talked about and if the rate environment works like we've talked about."

M&T and Regions each have other obstacles, in addition to low rates, that are crimping financial performance.

M&T continues to wait on regulatory approval for its deal to acquire Hudson City Bancorp in Paramus, N.J. The companies have had to postpone the closing of the deal, as M&T upgrades its anti-money-laundering compliance policies and procedures. Regulators must approve those upgrades before they will give permission for the deal to close. M&T eagerly wants to add Hudson City, as it will give the company exposure for the first time to the giant New York City market.

René Jones, M&T's chief financial officer, did not give a specific update to the status of the deal, which currently has a deadline of April 30.

"Both parties remain committed to the merger," Jones said during a Tuesday conference call. "The financial metrics we calculated at the time the transaction was announced remain intact."

Regions, on the other hand, continues to wrestle with its expense base, as many banks have been whittling away at their costs in order to report profit growth. In the fourth quarter, Regions recorded an accrual of $100 million for "contingent legal and regulatory items," the company said in a press release.

"[The] long tail to legal expenses will likely weigh on Regions' earnings profile," Solar said.

Also, Regions recorded an additional $10 million in expenses to cover the cost of closing branches, and an additional $5 million in expenses for professional services, such as legal and consulting.

While those costs have been a burden on Regions' financial results, Turner said during Tuesday's conference call that the end of the tunnel is near.

On costs related to outside services, "that was related to third-party consultants and our capital-planning process and certain risk-management activities," Turner said. "Those are areas … we have a chance to cut those back and become more efficient."

"You should expect over time that we will work on third-party costs and get those down to a level that is appropriate for our institution," Turner said.

Then there is the potential scenario that few bankers want to see—the Fed further postponing an increase in interest rates. Regions said that if benchmark 10-year Treasury note remains in the range of 1.75% to 2% for the full year, then its net interest margin will likely narrow between 10 and 12 basis points from 3.17% in the fourth quarter.

"With deposit and funding costs expected to remain stable at historically low levels, there's limited ability to offset the continued effect of the low-rate environment on margin," Turner said.