Regions Financial Corporation — Q1 2010 Form 10-Q
Business context and reporting period. Regions is a bank holding company headquartered in Birmingham, Alabama, with banking, mortgage, brokerage, investment banking, trust and insurance operations across the South, Midwest and Texas. This unaudited filing covers the three months ended March 31, 2010; balance-sheet comparisons are principally to December 31, 2009 and the prior-year quarter.
Financial performance and condition
| Metric | Q1 2010 | Q1 2009 / comparison |
|---|---|---|
| Net interest income | $831 million | $809 million |
| Net interest income, taxable-equivalent | $839 million; 2.77% net interest margin | $817 million; 2.64% margin |
| Non-interest income | $812 million | $1.066 billion |
| Provision for loan losses | $770 million | $425 million |
| Non-interest expense | $1.230 billion | $1.058 billion |
| Net income (loss) | $(196) million | $77 million |
| Net income (loss) available to common shareholders | $(255) million; diluted loss per share $(0.21) | $26 million; diluted earnings per share $0.04 |
Net interest income plus non-interest income was approximately $1.643 billion, down from $1.875 billion. The loss reflected higher credit costs and expenses, as well as lower non-interest income. Net charge-offs were $700 million, or 3.16% of average loans on an annualized basis, versus $390 million, or 1.64%, in Q1 2009.
Balance sheet and liquidity. At March 31, total assets were $137.2 billion, down from $142.3 billion at year-end; loans, net of unearned income, were $88.2 billion, down $2.5 billion; and deposits were $98.3 billion, down $0.3 billion. Low-cost deposits rose about $3.2 billion during the quarter while time deposits declined about $3.6 billion. Cash and cash equivalents were $6.9 billion, compared with $8.0 billion at year-end. Q1 cash from operating activities was $1.725 billion, investing activities $1.397 billion, and financing activities negative $4.262 billion.
Total borrowed funds were $18.4 billion, down from $22.1 billion at year-end, mainly reflecting repayment of FHLB advances. Stockholders’ equity was $17.6 billion. Regulatory capital ratios at March 31 included Regions Financial Corporation Tier 1 capital of 11.66%, total capital of 15.76%, and leverage of 8.84%; the filing states that Regions and Regions Bank exceeded applicable regulatory requirements. The non-GAAP Tier 1 common ratio was 7.13%, and tangible common equity to tangible assets was 6.09%.
Material changes and unusual items
- Credit deterioration remained the principal earnings pressure. The allowance for loan losses was $3.184 billion, or 3.61% of loans, versus $1.861 billion, or 1.94%, a year earlier. Non-performing assets excluding loans held for sale rose to $4.316 billion from $4.095 billion at year-end and $1.935 billion a year earlier.
- Investor real estate was a major credit-risk area: its loans totaled $20.4 billion, and non-performing investor real estate loans were $2.329 billion. Management cited some easing in the pace of problem-asset inflows and improvement in certain problem-asset indicators.
- Non-interest income fell $254 million year over year, chiefly because leveraged-lease termination gains were $19 million versus $323 million in Q1 2009. Management said related tax expense largely offset those gains’ effect on net income in both periods.
- Non-interest expense increased $172 million. Q1 2010 included a $53 million loss from prepaying approximately $1.5 billion of FHLB advances; FDIC premiums rose to $59 million from $10 million.
- Regions sold about $1.4 billion of available-for-sale securities and recorded $59 million in securities gains. It also changed its mortgage-servicing-rights hedge approach, replacing trading positions with derivatives. Goodwill testing found the Banking/Treasury reporting unit’s carrying value exceeded estimated fair value at the first step, but the second-step test found no goodwill impairment.
Outlook, risks and contingencies
- Management expected net interest margin to improve gradually and reach 3.00% by year-end 2010, principally through lower-cost deposit mix and pricing and improved loan spreads.
- Management expected non-performing assets and net charge-offs to peak by the end of Q2 2010 and decline thereafter, while also expecting loan charge-offs to remain elevated during 2010. These are forward-looking expectations, not guarantees.
- Regions reported a $0.01 common dividend per share, down from $0.10 a year earlier, and did not expect to raise it above $0.01 for the foreseeable future. The filing notes restrictions associated with preferred stock, TARP terms and regulatory considerations.
- Credit risks include weak economic conditions, unemployment and depressed property values, particularly investor real estate and Florida home-equity second liens. Management estimated that 15.9% of home-equity outstanding balances had current loan-to-value ratios above 100%.
- Regions’ ratings were downgraded by S&P and DBRS during Q1; multiple ratings remained on negative watch or outlook. A further downgrade could increase funding costs, limit market access or trigger additional collateral requirements on derivatives. Regions reported $402 million of derivatives with rating-related contingent features in a liability position and $391 million of collateral posted.
- Legal and regulatory matters include investor suits and SEC, FINRA and state administrative proceedings concerning Morgan Keegan Select Funds, as well as SEC litigation and related state action concerning auction-rate securities. Management said certain adverse outcomes could be material; the filing does not provide a clear estimate of potential exposure for the Select Funds matters.
- Subsequent to quarter-end, Regions issued $750 million of senior unsecured notes: $250 million of 4.875% notes due 2013 and $500 million of 5.75% notes due 2015. It also announced conversion of all outstanding Series B mandatory convertible preferred stock, expected on or about June 18, 2010, with an estimated 25-basis-point increase in the Tier 1 common ratio.
Important facts for investors to verify
- Whether credit costs, non-performing assets and charge-offs actually peaked as management expected, and how investor real estate and Florida home-equity exposures evolve.
- Whether the allowance for loan losses remains adequate relative to portfolio performance and economic conditions.
- Whether deposit pricing and mix support the stated 3.00% year-end net interest margin outlook, and whether new policies or regulation reduce service-charge revenue.
- The potential financial and reputational impact of Morgan Keegan-related litigation, regulatory proceedings and auction-rate securities obligations.
- The effects of credit-rating changes, funding access, derivative collateral terms, the Series B conversion and the new debt issuance on capital, liquidity and common-share dilution.