Regions Financial Corporation — Q3 2012 Form 10-Q
Business context and reporting period
Unaudited results cover the three and nine months ended September 30, 2012; balance-sheet comparisons are against December 31, 2011. Regions is a regional banking and financial-services company operating primarily in the South, Midwest and Texas. It reorganized reporting into Business Services, Consumer Services and Wealth Management during Q3. Morgan Keegan was sold to Raymond James on April 2, 2012; its results are presented as discontinued operations.
Financial performance and condition
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net income | $301 million | $155 million | $855 million | $333 million |
| Net income available to common shareholders | $301 million | $101 million | $730 million | $173 million |
| Diluted EPS | $0.21 | $0.08 | $0.53 | $0.14 |
| Net interest income, taxable-equivalent | $830 million | $859 million | $2.519 billion | $2.587 billion |
| Net interest margin, taxable-equivalent | 3.08% | 3.04% | 3.11% | 3.07% |
| Provision for loan losses | $33 million | $355 million | $176 million | $1.235 billion |
| Non-interest income, continuing operations | $533 million | $513 million | $1.564 billion | $1.636 billion |
| Non-interest expense, continuing operations | $869 million | $850 million | $2.624 billion | $2.738 billion |
- Q3 adjusted total revenue was $1.351 billion, down from $1.375 billion; the adjusted efficiency ratio was 64.32%, versus 61.82%. Nine-month adjusted revenue was $4.033 billion, versus $4.123 billion, and the efficiency ratio was 65.01%, versus 64.54%.
- At September 30, assets were $121.8 billion, down from $127.1 billion; loans were $75.3 billion, down from $77.6 billion. Deposits were $94.9 billion, compared with $95.6 billion. Borrowed funds fell to $8.2 billion from $11.2 billion, including long-term borrowings of $6.2 billion versus $8.1 billion.
- Stockholders’ equity was $14.9 billion, versus $16.5 billion. Tangible common equity to tangible assets increased to 8.49% from 6.57%; Tier 1 common ratio was 10.46%, versus 8.51%. Regions reported that it and Regions Bank exceeded applicable regulatory capital requirements and were categorized as well capitalized.
- For the first nine months, operating cash flow was $2.215 billion, investing cash flow was $25 million, and financing cash flow was negative $5.555 billion. Cash and cash equivalents decreased $3.315 billion to $3.930 billion. For a bank, these cash-flow totals should be considered alongside funding and liquidity disclosures.
- Q3 net charge-offs were $262 million, an annualized 1.38% of average loans, versus $511 million and 2.52% a year earlier. Nine-month net charge-offs were $859 million, or 1.50% of average loans, versus $1.540 billion, or 2.53%.
- The allowance for loan losses was $2.062 billion, or 2.74% of loans, compared with $2.745 billion, or 3.54%, at year-end 2011. Non-performing assets declined to $2.215 billion from $2.996 billion; non-accrual loans including held-for-sale loans were approximately $2.0 billion, versus $2.7 billion.
Material changes versus prior periods
- Higher earnings were principally driven by the sharp reduction in loan-loss provision, rather than stronger core net interest income. Net interest income declined as loan volumes and average earning assets fell; lower deposit costs and improved credit helped margin.
- Non-interest income increased in Q3, supported by higher mortgage and investment-fee income and securities gains, but nine-month non-interest income declined, primarily reflecting lower service charges and securities gains. Deposit service charges fell $66 million in Q3 and $174 million year to date, including effects of Regulation E, debit interchange price controls and a reserve for customer refunds.
- Mortgage income rose to $106 million in Q3 from $68 million, with management citing HARP II refinancing activity and favorable margins. Mortgage originations increased to $2.2 billion from $1.5 billion in Q3.
- Q3 non-interest expense rose $19 million year over year. Higher salaries and benefits, marketing and credit-card servicing conversion costs were partly offset by lower other-real-estate-owned expense, deposit administrative fees and legal expense.
- Investor real estate loans contracted to $8.7 billion from $10.7 billion, while commercial and industrial loans increased to $26.4 billion from $24.5 billion. Total loans declined, reflecting portfolio runoff and Regions’ strategy to reduce higher-risk investor real estate exposure.
Outlook, risks, contingencies and unusual items
- Management expected 2012 net charge-offs to be below 2011 levels but still elevated, and expected non-performing assets to decline during the remainder of 2012 while remaining elevated. Real estate values, unemployment, interest rates and economic conditions could affect credit outcomes. Management estimated $300–$400 million of potential problem commercial and investor real estate loans that could migrate to non-accrual in the next quarter.
- No specific earnings or revenue guidance was provided. Regions described itself as moderately asset-sensitive; its estimated annual net interest income change ranged from positive $207 million under a gradual +100-basis-point shift to negative $105 million under a gradual −50-basis-point shift. These are modeled sensitivities, not forecasts.
- Regions indemnified Raymond James for Morgan Keegan pre-sale litigation. The liability had a $377 million carrying value at September 30, with an estimated fair value of $360 million; the maximum potential payments are indeterminable. Regions estimated possible litigation losses above accrued amounts of up to approximately $100 million, while noting it could incur no additional losses. Management said pending litigation was not expected to materially affect the company overall, but adverse outcomes in a reporting period could be material.
- Goodwill was $4.8 billion. An interim impairment test, required in part because market capitalization was below book value and reporting units were reorganized, found no impairment. The Business Services and Consumer Services units’ estimated fair values were below carrying values in the first test step, but the second step indicated goodwill remained unimpaired.
- At September 30, Moody’s ratings for Regions Financial and Regions Bank were below investment grade. Regions disclosed derivative collateral requirements and continuing credit-related termination provisions. It estimated its Basel III Tier 1 common ratio at 8.69% under proposed rules, but noted rule interpretation and implementation remained uncertain and its liquidity coverage ratio was below the proposed 100% target at that time.
- Subsequent to quarter-end, Regions issued $500 million of 6.375% non-cumulative preferred depositary shares on November 1, 2012, and gave notice to redeem approximately $345 million of 8.875% junior subordinated notes, scheduled for December 3, 2012. In April, it repurchased $3.5 billion of Treasury Series A preferred stock; it also repurchased the Treasury warrant for $45 million and issued common stock for net proceeds of $875 million.
Most important facts for investors to verify
- Whether the substantial year-over-year earnings improvement persists when credit provisions normalize; Q3’s provision decline was the main earnings driver.
- Trends in net interest income, loan balances, deposit costs and fee income, particularly service charges and mortgage-related revenue.
- Credit quality and reserve adequacy, including migration of the estimated $300–$400 million potential problem-loan pool and losses in investor real estate and Florida home-equity second liens.
- Ultimate cost and duration of the Morgan Keegan indemnification and other litigation; compare subsequent developments with the $377 million carrying liability and estimated possible additional losses.
- Final Basel III capital and liquidity rules, Regions’ resulting capital and liquidity positions, and the impact of the post-quarter preferred issuance and planned note redemption.