Regions Financial Corporation — Q2 2010 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2010. Unaudited consolidated results; amounts are in U.S. dollars. Regions is a Birmingham-based regional financial holding company offering banking and related financial services across the South, Midwest and Texas.
Financial performance and condition
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Net interest income (GAAP) | $856 million | $831 million | $1.687 billion | $1.640 billion |
| Non-interest income | $756 million | $1.199 billion | $1.568 billion | $2.265 billion |
| Provision for loan losses | $651 million | $912 million | $1.421 billion | $1.337 billion |
| Net income (loss) | $(277) million | $(188) million | $(473) million | $(111) million |
| Net loss available to common shareholders | $(335) million | $(244) million | $(590) million | $(218) million |
| Diluted loss per common share | $(0.28) | $(0.28) | $(0.49) | $(0.28) |
Revenue and margins: Net interest income plus non-interest income was approximately $1.612 billion in Q2, down from $2.030 billion a year earlier; the prior period included significant gains that did not recur. On a taxable-equivalent basis, Q2 net interest income was $863 million and net interest margin was 2.87%, versus $840 million and 2.62%. For the first half, taxable-equivalent net interest income was $1.702 billion versus $1.657 billion, and margin was 2.82% versus 2.63%. Management cited lower deposit costs and a shift toward lower-cost deposits.
Credit: Q2 provision fell $261 million year over year, but Q2 net charge-offs were $651 million, or 2.99% annualized, versus 2.06% a year earlier. The allowance for loan losses was $3.185 billion, or 3.71% of loans, at June 30, compared with 3.43% at year-end 2009 and 2.37% a year earlier. Non-performing assets, excluding loans held for sale, were $4.019 billion, down from $4.095 billion at year-end but up from $3.057 billion a year earlier. Investor real estate and Florida home-equity second liens remained notable areas of concern.
Cash flow, balance sheet and funding: Total assets were $135.340 billion at June 30, down from $142.318 billion at December 31, 2009. Loans were $85.945 billion, down $4.729 billion from year-end, reflecting weak demand and deliberate reductions in investor real estate exposure. Deposits totaled $96.250 billion, down $2.430 billion; lower time deposits were partly offset by growth in lower-cost deposits. For the six months, operating cash flow was $2.800 billion, investing cash flow was $3.018 billion, and financing cash flow was $(6.418) billion; cash and cash equivalents ended at $7.411 billion, down $600 million from year-end.
Total borrowed funds were $18.379 billion, versus $22.132 billion at year-end; long-term borrowings declined by $3.049 billion. Regions prepaid approximately $1.5 billion of Federal Home Loan Bank advances, recognizing a $53 million loss, and issued $750 million of senior notes during Q2. The filing reports Federal Reserve borrowing availability of $15.9 billion for terms under 29 days, or $12.7 billion for terms of at least 29 days, subject to collateral availability.
Capital and shareholder returns: Stockholders’ equity was $17.463 billion. Regulatory capital ratios for Regions Financial Corporation were 12.04% Tier 1, 15.90% total capital and 9.10% leverage; Tier 1 common was 7.68% (non-GAAP). The quarterly common dividend was $0.01 per share, and Regions said it did not expect to increase it above that level for the foreseeable future. The remaining Series B convertible preferred shares converted into approximately 63 million common shares in June.
Material changes versus comparable periods
- Q2 net loss available to common shareholders widened to $335 million from $244 million, although loss per share remained $0.28. Excluding the $200 million regulatory charge, management reported a non-GAAP diluted loss of $0.11 per share.
- Lower Q2 credit provision improved results, while non-performing assets declined from year-end; however, charge-offs and problem assets remained elevated compared with the prior year.
- Q2 non-interest income declined $443 million. The 2009 quarter included $108 million in securities gains, $189 million in leveraged-lease termination gains, an $80 million Visa-share sale gain and a $61 million debt-extinguishment gain.
- Q2 non-interest expense rose to $1.326 billion from $1.231 billion, principally reflecting the $200 million Morgan Keegan regulatory charge. The prior-year quarter included a $64 million FDIC special assessment and $69 million of net other-than-temporary impairment charges, which did not recur.
- Assets and loans contracted from year-end, while low-cost deposits increased approximately $2.8 billion and time deposits fell approximately $5.2 billion. Borrowings also declined, largely from lower FHLB advances.
Outlook, commentary and risks
- Management expected net interest margin to improve gradually and reach 3.00% by year-end 2010, assuming no significant interest-rate movement. This was a forecast, not a guarantee.
- Management said credit costs had begun to stabilize but expected net loan charge-offs to remain elevated during 2010. Further deterioration in economic conditions, unemployment or property values could increase losses and required provisions.
- The $200 million Morgan Keegan charge reflects management’s estimate of a probable loss in regulatory proceedings concerning certain investment funds. The filing describes other investor and customer litigation, including fund-related class actions and overdraft-fee litigation, for which material exposure could not be estimated clearly.
- The Dodd-Frank Act became law on July 21, 2010, after the quarter. Management said implementation and rule-making could affect interchange revenue, regulatory costs, capital requirements and business practices; impacts were not yet clear. Trust preferred securities, totaling approximately $846 million, were identified as about 86 basis points of Tier 1 capital and subject to phase-out under the new law.
- Regions reported that many debt ratings remained on negative outlook or watch after rating downgrades. Further downgrades could increase funding costs or limit market access. The company also highlighted Gulf oil-spill exposure, elevated FDIC premiums and risks to goodwill valuations.
- In its Q2 interim goodwill test, the Banking/Treasury unit’s carrying value exceeded estimated fair value at Step One, requiring Step Two; Regions concluded goodwill was not impaired at June 30. Management warned future adverse developments could affect valuations.
- Regions exited the FDIC Transaction Account Guarantee program effective July 1, 2010, and did not expect a significant liquidity effect. Its interim financial statements state that necessary adjustments were normal and recurring.
Important facts for investors to verify
- Whether credit quality continues to improve: charge-offs, non-performing assets, investor real estate exposure and the allowance’s coverage of losses.
- Whether the projected 3.00% year-end net interest margin is achieved, and how deposit pricing, loan demand and interest rates affect it.
- The final cost and outcome of Morgan Keegan’s fund-related regulatory proceedings and other litigation, including matters with unestimable potential exposure.
- The effects of Dodd-Frank implementation on interchange income, regulatory expenses, capital rules and trust preferred securities.
- Regions’ ability to maintain capital, liquidity and market access amid negative credit outlooks, and the recoverability of its deferred tax assets and goodwill.