Regions Financial Corporation — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. Amounts are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise.
Business context and reporting period
Regions is a bank holding company headquartered in Birmingham, Alabama, serving customers across the South, Midwest and Texas. Its principal segments are Business Services, Consumer Services and Wealth Management. Results from the previously sold Morgan Keegan business remain presented as discontinued operations.
Financial performance and position
- Q2 earnings: Net income was $300 million, including $292 million available to common shareholders; diluted EPS was $0.21. A year earlier, net income was $267 million, common income was $259 million and diluted EPS was $0.18.
- First-half earnings: Net income was $619 million and diluted EPS was $0.43, compared with $602 million and $0.41 in the first half of 2013. Common shareholder income was $603 million versus $586 million.
- Revenue and expenses: Q2 net interest income was $822 million ($837 million taxable-equivalent) versus $808 million ($821 million taxable-equivalent); non-interest income was $457 million versus $497 million. Non-interest expense declined to $820 million from $884 million. First-half net interest income was $1.638 billion and non-interest income was $895 million, versus $1.606 billion and $998 million, respectively, in 2013.
- Margins: Taxable-equivalent net interest margin was 3.24% for Q2, up from 3.16%; for the first half it was 3.25%, up from 3.15%. The adjusted efficiency ratio was 64.16% for Q2 versus 63.15% a year earlier.
- Credit costs: Q2 provision for loan losses was $35 million versus $31 million; first-half provision was $37 million versus $41 million. Net charge-offs were $67 million in Q2 (annualized 0.35% of average loans) versus $144 million (0.77%). First-half net charge-offs were 0.40% of average loans versus 0.88%.
- Balance sheet and liquidity: At June 30, total assets were $118.7 billion, net loans $75.3 billion, deposits $93.8 billion and stockholders’ equity $17.0 billion. At December 31, 2013, the comparable balances were $117.4 billion, $73.3 billion, $92.5 billion and $15.8 billion. Cash and cash equivalents were $4.8 billion at June 30.
- Funding and debt: Total borrowed funds declined to $5.6 billion from $7.0 billion at year-end, including long-term borrowings of $3.8 billion versus $4.8 billion. Deposits increased by $1.4 billion, mainly from non-interest-bearing, savings and transaction accounts; time deposits declined.
- Cash flows: For the first six months, operating cash flow was $743 million, investing cash flow was negative $1.552 billion and financing cash flow was positive $355 million. Cash and cash equivalents decreased $454 million to $4.819 billion; the comparable 2013 decrease was $1.209 billion.
- Capital: Estimated June 30 regulatory ratios included 12.49% Tier 1 capital and 15.29% total capital at the holding company. Estimated Basel III CET1 was 10.99%, compared with 10.58% at year-end. Tangible common equity to tangible assets was 9.84%, up from 9.24%.
Material changes versus comparable periods
- Higher net interest income and lower expenses supported earnings growth, partly offset by lower non-interest income. Mortgage income fell to $43 million in Q2 from $69 million, reflecting slower mortgage demand as rates rose; first-half mortgage income declined to $83 million from $141 million.
- Loan balances increased $1.9 billion from year-end, led by commercial and industrial and indirect auto lending. Commercial and industrial loans rose 7%; home equity balances declined $230 million.
- Non-performing assets fell to $1.047 billion from $1.300 billion at year-end; non-performing loans including held-for-sale loans declined to $919 million from $1.164 billion. The allowance for loan losses was $1.229 billion, or 1.61% of loans, versus $1.341 billion, or 1.80%, at year-end.
- Stockholders’ equity increased $1.3 billion, reflecting first-half earnings, higher accumulated other comprehensive income and issuance of $500 million of Series B preferred stock (approximately $486 million net proceeds). The quarterly common dividend was raised to $0.05 per share from $0.03. A new $350 million repurchase authorization was approved, but no shares had been repurchased under it through the report date.
Outlook, commentary, risks and unusual items
- Management expected net charge-offs and non-performing assets to continue improving in 2014 versus 2013, while noting that economic conditions, interest rates, unemployment, real-estate values and individual large credits could cause volatility. Management identified approximately $125–$200 million of potential problem commercial and investor real-estate loans that could migrate to non-accrual status in the next quarter.
- Management anticipated modest net interest margin compression in future quarters, but expected net interest income to grow alongside loan growth.
- Regions estimated that a sustained 100-basis-point rise in long-term rates would increase net interest income by approximately $111 million over a 12-month horizon; a sustained 50-basis-point decline would reduce it by approximately $72 million. These are model estimates, not earnings guidance.
- Regions paid a $51 million civil penalty under June 2014 agreements with the SEC, Federal Reserve and Alabama State Banking Department resolving inquiries into accounting for certain problem loans in 2009. The company said it had reserved for the matter in Q4 2013 and settled for $7 million less than estimated.
- Management estimated reasonably possible legal losses in excess of accrued amounts of up to approximately $180 million, while noting that no excess loss was also possible. A HUD Inspector General investigation into loan origination and servicing practices remained unresolved and could result in a monetary penalty.
- The company’s indemnification obligation to Raymond James for Morgan Keegan pre-sale legal matters was $224 million carrying value at June 30. Management stated that the ultimate outcome of pending litigation and inquiries is uncertain.
- First-half results included a $35 million net gain on the sale of residential troubled-debt-restructured loans held for sale. Q2 included a $7 million credit related to the prior regulatory charge. Mortgage-servicing-rights fair value declined $21 million in the first half, including a $25 million reduction from valuation inputs and assumptions, partly offset by additions and other movements.
- After quarter-end, Regions was approved as a Fannie Mae DUS lender and acquired a servicing portfolio of approximately $1.0 billion on July 18, 2014, recording $12 million of commercial mortgage servicing rights and $15 million of related intangible assets.
- Key risks include credit deterioration, interest-rate and prepayment exposure, competition and deposit retention, regulatory and capital requirements, litigation, and operational and cybersecurity risks. Regions reported no denial-of-service attacks in the first half of 2014; 2013 attacks had affected website performance but did not breach client data.
Important facts for investors to verify
- Whether the improvement in credit metrics persists, particularly given the $125–$200 million potential problem-loan estimate and the remaining allowance.
- Whether loan growth can offset expected margin compression and continued weakness in mortgage-related income.
- The final impact of the HUD investigation, other legal proceedings and the Raymond James indemnification obligation, including whether losses exceed accrued amounts.
- Regions’ ability to maintain capital and liquidity as Basel III and proposed liquidity requirements take effect; the filing’s Basel III figures are management estimates and non-GAAP measures.
- Execution of the new capital-return plan, subject to regulatory considerations, and the effect of preferred dividends and capital requirements on common shareholders.