Regions Financial Corporation — Q2 2012 Form 10-Q
Reporting period: Three and six months ended June 30, 2012; balance-sheet comparisons are to December 31, 2011. Amounts are in millions unless noted.
Business context and reporting period
Regions is a Birmingham-based bank holding company serving retail and commercial customers across the South, Midwest and Texas. It sold Morgan Keegan and related affiliates to Raymond James on April 2, 2012; Regions Investment Management and Regions Trust were retained. Morgan Keegan results are presented as discontinued operations.
Financial performance and position
- Q2 earnings: Net income was $355 million, versus $109 million a year earlier; net income available to common shareholders was $284 million, or $0.20 per diluted share, versus $55 million, or $0.04. Continuing-operations income available to common shareholders was $280 million, or $0.20 per diluted share.
- First-half earnings: Net income was $554 million versus $178 million; common-shareholder income was $429 million, or $0.32 per diluted share. Continuing-operations common income was $465 million.
- Net interest and margin: Q2 continuing-operations net interest income on a taxable-equivalent basis was $850 million versus $864 million; net interest margin was 3.16% versus 3.07%. First-half net interest income was $1.689 billion versus $1.728 billion, with margin of 3.13% versus 3.08%. Lower deposit costs supported margin improvement.
- Non-interest income and expense: Q2 continuing non-interest income was $507 million, down from $543 million; expense was $842 million, down from $956 million. First-half amounts were $1.031 billion and $1.755 billion, respectively. The adjusted Q2 efficiency ratio was 62.78%, versus 63.56%.
- Credit costs: Q2 provision for loan losses was $26 million versus $398 million; first-half provision was $143 million versus $880 million. Q2 net charge-offs were $265 million, or an annualized 1.39% of average loans, versus $548 million and 2.71% a year earlier. First-half net charge-offs were $597 million, or 1.56% of average loans.
- Assets and loans: Total assets were $122.3 billion, down from $127.1 billion at year-end. Loans were $76.2 billion, down $1.4 billion; commercial and industrial loans grew, while investor real estate, residential mortgage and home equity balances declined. Securities were $27.2 billion, up $2.8 billion.
- Credit quality: Allowance for loan losses was $2.291 billion, 3.01% of loans, versus $2.745 billion and 3.54% at year-end. Non-performing assets declined to $2.331 billion from $2.996 billion. Non-accrual loans excluding loans held for sale were $1.915 billion, versus $2.372 billion. Management identified approximately $300–$400 million of potential problem commercial and investor real estate loans.
- Deposits, debt and liquidity: Deposits were $95.1 billion, down $529 million; low-cost deposits increased while time deposits fell. Total borrowed funds declined to $9.536 billion from $11.177 billion, including long-term borrowings of $6.230 billion. Cash and cash equivalents were $3.766 billion, down from $7.245 billion. Regions reported $12.3 billion of unencumbered liquid securities, $18.6 billion of Federal Reserve borrowing availability and $5.6 billion of FHLB availability.
- Cash flow: First-half operating cash flow was $1.037 billion, investing cash outflow was $562 million and financing cash outflow was $3.954 billion. Cash and cash equivalents decreased $3.479 billion.
- Capital: At June 30, parent Tier 1 capital ratio was 11.02%, total capital 14.50% and leverage 8.67%; Regions Bank ratios were 12.91%, 15.78% and 10.14%, respectively. The estimated Basel III Tier 1 common ratio was 8.0%, based on proposed rules. Tangible common equity to tangible assets was 8.04%, versus 6.57% at year-end.
Material changes and unusual items
- Regions repurchased the U.S. Treasury’s $3.5 billion Series A preferred stock on April 4 and its warrant for $45 million in early May. The preferred repurchase caused $71 million of accelerated discount accretion, reducing Q2 income available to common shareholders. A March common-stock offering of 153 million shares generated $875 million net proceeds.
- The Morgan Keegan sale generated an estimated $15 million pre-tax gain, but Regions recorded a $385 million fair-value indemnification obligation for pre-closing litigation; its June 30 carrying value was $383 million. The maximum potential future payments are indeterminable. Management estimated reasonably possible litigation losses above accruals of up to approximately $200 million, while noting outcomes could be zero or higher.
- Q2 deposit service charges included a $24 million reserve for customer refunds following a change in the non-sufficient-funds policy. Deposit service charges also faced regulatory and interchange-related pressure; management estimated the Durbin rule could reduce annual debit interchange revenue by about $180 million before mitigation.
- Mortgage income rose to $90 million from $50 million, partly reflecting HARP II refinancing. Q2 expense benefited from the absence of $77 million of prior-year branch-consolidation charges and from lower OREO expense and FDIC premiums.
- Management said credit indicators continued to improve and expected 2012 net charge-offs to be below 2011 levels, though still elevated; non-performing assets were expected to decline during the rest of 2012 but remain elevated. The filing gives no numerical earnings or revenue guidance.
- Goodwill of $4.816 billion was not impaired in the interim test, but the Banking/Treasury reporting unit’s implied goodwill fair value exceeded carrying value by about 39%, down from 48% in the prior-quarter test. Regions said post-sale reporting-unit reorganization and testing could result in a goodwill write-down.
- Moody’s ratings for Regions Financial and Regions Bank were below investment grade. Certain derivative counterparties had termination or collateral rights; Regions reported $186 million of additional collateral posted under amended arrangements. Regions also said it was below the proposed 100% Basel III liquidity coverage ratio target after the preferred and warrant repurchases, while anticipating compliance after rules are finalized and implemented.
- Risks highlighted include credit deterioration, real estate values and unemployment, interest-rate and prepayment exposure, regulatory changes and capital requirements, litigation and indemnification, and funding or collateral needs. The company reported effective disclosure controls and no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether credit improvement persists, especially in home equity and investor real estate, and how the $300–$400 million potential-problem estimate develops.
- The adequacy of loan-loss reserves and the effect of charge-offs, loan runoff and future economic conditions.
- The ultimate Morgan Keegan indemnification and litigation costs, including the status of significant proceedings and the estimated additional exposure.
- How Regions replaces lost Morgan Keegan earnings and addresses continued pressure on deposit fees and debit interchange income.
- Final Basel III capital and liquidity rules, Regions’ resulting ratios and any implications for dividends or funding.
- Any change in goodwill impairment assumptions or reporting-unit results after the planned reorganization.