Regions Financial Corporation — Q1 2012 Form 10-Q
Business context and reporting period
Regions is a bank holding company headquartered in Birmingham, Alabama, providing consumer and commercial banking and related financial services across the South, Midwest and Texas. This unaudited filing covers the three months ended March 31, 2012; balance-sheet comparisons are to December 31, 2011. Morgan Keegan is presented as discontinued operations following its agreed sale.
Financial and operating results
| Metric | Q1 2012 | Comparable period / change |
|---|---|---|
| Net interest income, GAAP | $827 million | $855 million |
| Net interest income, taxable-equivalent, continuing operations | $839 million | $864 million |
| Net interest margin, taxable-equivalent | 3.09% | 3.09% |
| Provision for loan losses | $117 million | $482 million |
| Continuing-operations income | $239 million; $185 million available to common shareholders ($0.14/share) | $50 million; $(2) million available to common shareholders |
| Discontinued-operations result, net of tax | $(40) million | $19 million income |
| Net income / common earnings | $199 million / $145 million ($0.11 diluted EPS) | $69 million / $17 million ($0.01 diluted EPS) |
| Continuing non-interest income / expense | $524 million / $913 million | $580 million / $932 million |
| Operating cash flow | $755 million | $1.332 billion |
Reported net income improvement was driven mainly by the sharply lower loan-loss provision. Continuing net interest income declined, while the margin was unchanged. The non-GAAP efficiency ratio was 67.93%, versus 68.28% a year earlier.
At March 31, total assets were $128.3 billion, deposits $97.1 billion, loans net of unearned income $76.7 billion, net loans $74.2 billion, borrowed funds $10.1 billion and stockholders’ equity $17.5 billion. Cash and cash equivalents were $7.5 billion. Operating, investing and financing cash flows were $755 million, $(1.797) billion and $1.270 billion, respectively. Total deposits increased $1.5 billion and borrowed funds fell $1.1 billion from year-end; loans decreased $874 million.
Credit measures improved year over year: quarterly net charge-offs were $332 million, or 1.73% annualized of average loans, compared with $481 million, or 2.37%. The allowance for loan losses was $2.53 billion, 3.30% of loans, down from 3.54% at year-end. Non-performing assets declined to $2.64 billion from $3.00 billion; non-performing loans including held-for-sale loans were $2.40 billion. The allowance for credit losses, including unfunded commitments, was $2.62 billion.
Capital strengthened during the quarter, including through a March common-stock offering of 152.9 million shares that generated approximately $875 million net proceeds. At March 31, Regions reported a 9.62% Tier 1 common ratio, 14.34% Tier 1 capital ratio and 17.99% total capital ratio. Tangible common equity to tangible assets was 7.35%, versus 6.57% at year-end. These measures preceded the subsequent redemption of preferred stock.
Material changes and unusual items
- Deposit service charges fell $33 million year over year, reflecting debit interchange fee limits and Regulation E changes. Management estimated the Durbin-related annual debit interchange revenue impact at approximately $180 million before mitigation.
- Mortgage income increased $32 million to $77 million, supported by refinancing activity under HARP II. Securities gains were $12 million, versus $82 million in Q1 2011.
- Continuing non-interest expense fell $19 million. Lower professional/legal and other real estate owned costs were partly offset by higher salaries and benefits, including pension costs.
- Regions completed the Morgan Keegan sale to Raymond James on April 2, 2012 for approximately $1.2 billion. Purchase-price adjustments remained subject to closing tangible book value and employee-retention terms. Regions estimated the net balance-sheet effect of its uncapped pre-closing litigation indemnity at $200 million to $250 million; the final sale gain or loss was to be recorded in Q2 and was not expected to materially affect financial position or regulatory capital.
- On April 4, Regions repurchased the $3.5 billion Series A preferred stock held by the U.S. Treasury, using sale proceeds, stock-offering proceeds and other funds, including a $500 million bank dividend. The Q2 transaction reduced equity by $3.5 billion and included a $70 million earnings reduction for unaccreted discount. In early May, Regions repurchased the Treasury warrant for $45 million.
- The company’s first-quarter allowance methodology enhancement for home equity segmentation reduced the related allowance component by an estimated $30 million.
Outlook, commentary and risks
Management expected 2012 net charge-offs to be below 2011 levels but still elevated, and anticipated non-performing assets to decline during the remainder of 2012 while remaining elevated. Credit outcomes were identified as sensitive to property values, unemployment, interest rates and economic recovery. Management also identified approximately $350–$450 million of potential problem commercial and investor real estate loans that could migrate to non-accrual in the next quarter.
Liquidity resources included approximately $5.2 billion of excess cash at the Federal Reserve, $11.8 billion of unencumbered liquid securities, $18.4 billion of Federal Reserve borrowing availability and $6.3 billion of FHLB capacity. Management noted that below-investment-grade Moody’s ratings made unsecured short-term funding unreliable. Regions reported meeting the then-understood Basel III capital and liquidity requirements, while cautioning that rules and implementation remained subject to clarification. Major risks include credit deterioration, interest-rate and prepayment sensitivity, regulatory changes, litigation, funding access, and mortgage repurchase claims.
For litigation, the company estimated reasonably possible losses above accrued amounts of up to approximately $250 million, while noting outcomes could be zero and estimates were uncertain. Management stated that pending litigation was not expected to materially affect the company as a whole, but an adverse outcome could be material in a particular reporting period. The filing also disclosed an appealed SEC auction-rate securities case and other securities, shareholder and customer litigation.
Important facts for investors to verify
- Whether post-closing Morgan Keegan purchase-price adjustments and the litigation indemnity ultimately differ materially from management’s estimates.
- Whether credit quality continues to improve, particularly in investor real estate, Florida home-equity second liens and the identified potential-problem-loan pool.
- Whether reduced credit costs can offset pressure on net interest income and fee revenue, including the estimated debit-interchange impact.
- How the preferred-stock redemption affects subsequent-period regulatory capital, funding costs and shareholder distributions.
- Whether litigation, mortgage-loan repurchase claims, regulatory changes or credit-rating developments create material losses or liquidity constraints.