Regions Financial’s takeover of EnerBank USA has advantages, but I also have concerns

Regions finance‘S (NYSE: RF) The recent EnerBank USA acquisition certainly looks a little different than other bank acquisitions this year, as the Alabama-based asset bank, with assets of $ 153 billion, acquires a subsidiary bank from an energy company.

EnerBank is one of the largest real estate lenders in the country and mainly finances projects such as pools, solar systems, roofs and cladding, windows and doors, and HVAC (heating, ventilation and air conditioning). The company has been owned by CMS energy, and it is from the Federal Deposit Insurance Corp.

Let’s take a look at some of the pros and cons of the deal, as well as some of the merits and concerns I have.

Con: The finances are not looking good

Regions paid $ 960 million in cash for approximately $ 2.8 billion in loans and $ 2.7 billion in deposits. EnerBank has a tangible book value (equity less goodwill and intangible assets) of $ 318 million, making Regions an amount equal to 300% of the tangible book value. That is a steep price to pay even in this current climate where banks are trading at high valuations.

EnerBank’s price is expected to dilute Regions’ tangible book value by 1% to 2%, which certainly seems like a lot for such a small business. The deal isn’t very conducive to earnings per share (EPS) either, meaning that once the transaction closes, the regions will only see a low single-digit percentage improvement in EPS in 2022, with the deal’s potential at 5% will. adding value to EPS. Bank investors rarely like dilutive acquisitions, let alone those that don’t bring a lot of earnings per share with them, even though this is a smaller deal and doesn’t bake in earnings synergies. Approximately 55% of the loans that EnerBank made last year were made in the retail presence of the regions, so regions may have opportunities to develop more holistic banking relationships with these new customers.

However, the deposit base that regions acquire is also not large, as it is made up of all fixed-term deposits that have a fixed due date as soon as the customer deposits the money in the account (examples are certificates of deposit). These deposits tend to pay a higher rate of interest, which is not ideal for banks. The cost of deposits with EnerBank is around 1.5% interest, which is really bad in such a low interest rate environment, although Regions plans to replace this funding with their own deposits over time. While it is in line with Regions’ previously stated strategy of prioritizing strategic investments, the capital used for this acquisition is capital that can no longer be used for share buybacks. Hence, if the deal doesn’t work, it is certainly a big tradeoff.

Pros: Investing liquidity in good assets

I can understand why Regions is doing this deal. Like most of the industry, Regions has been very successful in bringing in deposits since the pandemic began. Interest-free deposits with no-interest regions rose from approximately $ 37 billion at the end of the first quarter of 2020 to nearly $ 56 billion at the end of the first quarter of this year. The non-interest bearing deposits now make up nearly 43% of total deposits with the bank, which is a very strong number.

But while deposits have been a success story, loan growth has been very difficult to come by. At the end of the first quarter, total loan balances were down approximately $ 4 billion from a year earlier.The bank’s loan-to-deposit ratio had dropped to 65% by the end of the first quarter, meaning the bank had only 65% ​​of deposits invested in loans. In addition, management assumes that the adjusted credit balances at the end of the term for the full year 2021 will only grow in the low single-digit percentage range.

The acquisition will allow Regions to absorb some of its liquidity with high quality loans totaling nearly $ 3 billion. EnerBank’s loans have a gross return of 9% and once Regions replaces EnerBank’s current costly deposits with cheaper deposits, margins will look very good. In addition, EnerBank’s loans are aimed at prime and superprime lenders whose credit quality has held up well during the Great Recession and Pandemic. The loans are also fixed-interest, which of course has ups and downs depending on the interest rate environment, but the balance sheet of the regions diversified and would have been particularly advantageous last year in the ultra-low interest rate environment.

Last takeaway meal

In some ways, I like this deal because it generates high quality, high-yielding credit growth at a time when both credit growth and returns are hard to come by. The regions also have a lot of additional liquidity so they should be able to replace the more expensive deposits with cheaper ones and increase the current margins on the loans. But for this deal to really pay off, regions must successfully sell other banking products to EnerBank’s credit customers and expand the home improvement business to their customer bases as well.

However, the deal also worries me as it suggests that Regions may be concerned about subdued credit growth for a slightly longer period of time, which is why it is willing to pay such a high cost. In theory, if readily available, credit growth could consume the $ 960 million in capital it spends on the less than $ 3 billion in credit with EnerBank, and $ 9.6 billion in borrowing – Allocated dollars (banks usually hold 10% of the reserves for every loan they have originated). In addition, Regions has already bought some more specialized lenders and is present in some fast growing and attractive markets such as Florida, Georgia and Texas. Ultimately, the deal makes me wonder how well the lending business in the regions is really positioned.