REGIONS FINANCIAL CORP quarterly report, Q1 FY2014

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Regions Financial Corporation — Q1 2014 Form 10-Q

Business context and period. Regions is a Birmingham-based bank holding company serving markets across the South, Midwest and Texas. It provides commercial, consumer and mortgage banking, wealth management and related services. This unaudited report covers the three months ended March 31, 2014; income-statement comparisons are to Q1 2013, while balance-sheet comparisons are to December 31, 2013. Figures below are in U.S. dollars; financial-statement amounts are generally in millions unless stated otherwise.

Financial performance and condition

  • Earnings and revenue: Net income was $319 million versus $335 million; net income available to common shareholders was $311 million versus $327 million. Diluted EPS was $0.22 versus $0.23, including $0.01 per share from discontinued operations in 2014. Continuing-operations income was $307 million versus $333 million. Taxable-equivalent net interest income rose to $831 million from $811 million, while continuing-operations non-interest income fell to $438 million from $501 million. Adjusted total revenue, a non-GAAP measure, was $1.266 billion versus $1.297 billion.
  • Margins and expenses: Taxable-equivalent net interest margin improved to 3.26% from 3.13%, as funding costs declined; total funding cost was 0.33% versus 0.45%. Continuing-operations non-interest expense decreased to $817 million from $842 million. The adjusted efficiency ratio (non-GAAP) worsened to 66.85% from 64.92%. The effective tax rate rose to 29.4% from 25.5%.
  • Cash flow: Operating activities provided $421 million, compared with $1.130 billion in Q1 2013; investing activities used $580 million versus $579 million provided; financing activities provided $82 million versus $1.107 billion used. Cash and cash equivalents were $5.196 billion at quarter-end, down from $5.273 billion at year-end.
  • Balance sheet and funding: Total assets were $117.9 billion, up from $117.4 billion. Loans, net of unearned income, increased to $75.7 billion from $74.6 billion. Deposits rose to $93.4 billion from $92.5 billion, led by non-interest-bearing demand and savings accounts; time deposits declined. Total borrowed funds fell to $6.2 billion from $7.0 billion, including long-term borrowings of $4.2 billion versus $4.8 billion. Stockholders’ equity was $16.1 billion versus $15.8 billion.
  • Credit quality: Provision for loan losses was $2 million versus $10 million. Net charge-offs fell to $82 million, or an annualized 0.44% of average loans, from $180 million, or 0.99%. The allowance for loan losses was $1.261 billion, 1.67% of loans, compared with $1.341 billion, or 1.80%, at year-end. Non-performing assets declined to $1.239 billion from $1.300 billion; non-performing loans including loans held for sale were $1.110 billion versus $1.164 billion.
  • Capital and liquidity: Reported Tier 1 capital ratios were 11.83% for Regions Financial and 12.42% for Regions Bank; total capital ratios were 14.86% and 14.88%, respectively. Estimated Basel III CET1 was 10.77% (non-GAAP). Tangible common equity to tangible assets was 9.53% (non-GAAP). Regions reported $22.4 billion of Federal Reserve borrowing availability and $9.6 billion of FHLB availability, subject to collateral. It held approximately $3.1 billion of excess cash on deposit with the Federal Reserve.

Material changes and notable items

  • Revenue and common earnings declined year over year despite higher net interest income, lower expenses and reduced credit costs. The main revenue pressure was mortgage income, down $32 million; mortgage production fell 47% as demand slowed with rising rates. Lower securities gains and service charges also contributed to lower non-interest income.
  • Regions sold substantially all of the approximately $535 million of residential mortgage TDRs transferred to loans held for sale in Q4 2013, recording a $35 million net gain. Loans held for sale declined to $395 million from $1.055 billion.
  • Commercial and industrial loans grew by $1.1 billion from year-end, while total investor real estate loans rose $242 million—the first quarterly net growth in that portfolio in over four years. Home equity balances continued to decline.
  • Regions recorded $12 million of after-tax income from discontinued operations, primarily from a reduction in the Morgan Keegan indemnification liability. The liability stood at approximately $233 million at March 31.
  • Other comprehensive income was $90 million, principally reflecting gains on available-for-sale securities; total stockholders’ equity increased during the quarter.

Outlook, risks and contingencies

  • Management expected net charge-offs and non-performing assets to continue improving in 2014 compared with 2013, while cautioning that real estate values, interest rates, unemployment and individual large credits could cause volatility. Management estimated $150–$250 million of potential problem commercial and investor real estate loans that could migrate to non-accrual in the following quarter.
  • Regions was moderately asset-sensitive in its interest-rate models. A sustained 100-basis-point increase in long-term rates was estimated to raise 12-month net interest income by about $112 million; a 50-basis-point decline was estimated to reduce it by about $66 million. These are model estimates, not guidance or assured outcomes.
  • Regions said it anticipated meeting the proposed liquidity coverage requirements when finalized and implemented. Basel III rules were scheduled to begin taking effect in 2015, with phased implementation; the estimated capital measures may change as rules and interpretations develop.
  • Legal matters include legacy Morgan Keegan-related litigation and indemnification obligations, securities-related investigations and claims, and a HUD Inspector General investigation into loan origination and servicing practices. Regions estimated that reasonably possible losses above amounts accrued could be up to approximately $100 million in aggregate, while noting it could incur no additional losses and that some matters could not be estimated. Management stated it did not then expect pending matters to materially affect the Company as a whole, but acknowledged an adverse outcome could be material in a particular period.
  • Risks identified include credit deterioration, changing rates and mortgage prepayments, deposit competition, regulatory and capital requirements, litigation, cyber and operational disruptions, and possible credit-rating downgrades. Regions reported denial-of-service attacks in 2013 that disrupted website performance but no client-data breach; it reported none in Q1 2014.
  • After quarter-end: The Federal Reserve did not object to Regions’ 2014 capital plan. On April 24, the Board approved a quarterly common dividend increase to $0.05 per share, effective with the July payment, and a new $350 million repurchase plan. On April 29, Regions issued $500 million of Series B preferred depositary shares, with a 6.375% initial annual dividend rate, changing to three-month LIBOR plus 3.536% from September 15, 2024.

Important facts for investors to verify

  1. Whether improvement in credit metrics continues, particularly given the estimated $150–$250 million of potential problem commercial and investor real estate loans.
  2. Whether lower mortgage production, service charges and other fee income persist, and how recurring earnings compare after excluding the $35 million TDR-sale gain.
  3. How loan growth and deposit mix evolve, including the sustainability of commercial and indirect-auto growth and the decline in time deposits.
  4. Regions’ capital and liquidity position under finalized Basel III and liquidity rules, including the effect of the new preferred issuance, dividend increase and repurchase authorization.
  5. Developments in legal and regulatory matters, especially potential losses beyond accrued amounts and the Morgan Keegan indemnification obligation.