DBRS Comments on Region's 4Q10 Results – Sr. Debt at BBB; Trend Negative; Ratings Unaffected

DBRS Inc. (DBRS) today commented that its rating for Regions Financial Corporation (Regions or the Company) including its Issuer & Senior Debt rating of BBB and Negative trend are unchanged following the release of the Company’s 4Q10 earnings. The Company reported its first profit to common shareholders since 1Q09 of $36 million in 4Q10, compared to a loss of $209 million in 3Q10 and a loss of $606 million in 4Q09. DBRS notes that the 4Q10 results benefitted from the sale of $8.1 billion in agency MBS that generated $333 million in investment security gains preserving capital. Positively, credit quality continued to improve as the Company sold $405 million of real estate loans, 76% of which were non-accrual asset sales. Additionally, leading credit indicators suggest ongoing improvement in credit while the provision declined 10% in the fourth quarter.

In DBRS’s view, Regions' results reflect the progress the Company has made in dealing with its significant asset quality challenges, but they also highlight the lagging pace of the credit quality improvement and the difficulty that the Company faces in restoring profitability to pre-crisis levels. Compounding the challenge of revenue growth is the upward pressure being exerted on expenses by elevated credit-related expenses and new regulatory costs. Importantly for DBRS, provisioning, while down considerably from peak levels, continues to exceed income before provisions and tax (IBPT). In 4Q10, provisions of $682 million represented 148% of the quarterly adjusted IBPT of $461 million, slightly better than the 167% in the third quarter.

DBRS downgraded Regions’ long and short-term ratings one notch on November 23, 2010. The Company’s current ratings and trend reflect the challenges facing Regions and consider the likelihood that IBPT will remain under pressure in the current environment. Positively, Regions expects provisioning and charge-offs to decline further in 2011. However, DBRS believes core fee revenues are also likely to decline further from 2010 levels while loan generation will remain constrained. As a result, the Company’s ratings, including its Issuer & Senior Debt rating of BBB, and the Negative trend on all ratings remain unchanged. Continued credit deterioration and losses beyond IBPT and/or significant revenue declines could result in negative rating actions. DBRS also sees heightened credit costs and other subjective market events as potential constraints on the Company’s access to capital markets. Further evidence of balance sheet de-risking coupled with credit quality improvement and solid financial performance would likely return the rating trend to Stable.

Regions’ adjusted quarterly revenues increased slightly (+3.5%) from 3Q10 to $1,672 billion in 4Q10. The modest revenue increase reflected higher brokerage activity and fee-based account growth coupled with a modest gain from improved funding costs and lower debt levels which more than offset a slight earning asset decline. Funding benefited from the continuing shift into lower cost deposits from time deposits with another $4.8 billion in CDs maturing in 1Q11 and $13.5 billion for 2011. NIM was 3.00% in the fourth quarter, up 4 bps from 3Q10 due to the declining deposit costs (-6 bps) and rising loan yields (+5 bps). NIM is expected to decline 5 bps to 10 bps in 1Q11 as the Company repositioned its securities portfolio and also sold $965 million in residential first mortgages in the quarter and reinvested in GNMA securities. Average loan balances (net of unearned income) declined 1.8% over the quarter as investor real estate continued to runoff and consumer loans continued to decline due to deleveraging. Positively, C&I lending grew 5% or over $1 billion in the quarter across many industries and 16 of its 20 markets with Texas, Tennessee and Georgia especially strong.

Fee revenues for the fourth quarter were $795 million (excluding securities, leveraged lease and mortgage sale gains), up 6.3% or $47 million from $748 million last quarter due to stronger interchange fees from higher debit card volume, fee-based account growth and higher Morgan Keegan private client and investment banking revenues that were only partially offset by a lower MSR valuation. Mortgage originations continued to be strong as volumes increased approximately $227 million to $2.6 billion in the fourth quarter and totaled $8.2 billion for the full year, the second best production year in Company history. Reg E related reductions to service charges were $57 million in 2H10 or right on target with the Company’s estimate of $25 million to $30 million per quarter as they also continue to migrate customers to fee eligible accounts. Debit interchange fees are estimated to be in the $346 million range annually. Given the impact of Reg E and changes to consumer behavior and with the Durbin Amendment scheduled to take effect in 2H11, fee revenues are likely to remain under pressure. DBRS therefore sees 2011 noninterest income as facing headwinds relative to 2010 levels as fee growth will likely be constrained by additional regulatory costs.

Non-interest expense, adjusted for $55 million in FHLB early payoff charges, was up 4.2% or $49 million over the quarter to $1.211 billion. The increase was centered on an increase in professional and legal fees as well as incentive compensation at Morgan Keegan. The cost of disposing real estate (including OREO expense, HFS write-downs and sales losses) rose $5 million in the quarter to $75 million and continued to weigh on costs. Regions is focused on watching all controllable expenses closely. In 2010, the Company eliminated approximately 700 positions and consolidated 122 offices. It expects core expenses to be slightly down with gradual improvement in 2011.

From DBRS’s perspective, credit continues to improve but generally lags its large regional peers while provisions remain stubbornly high. Real estate valuations in Florida and Georgia in particular, continue to experience pressure that may continue to pressure asset quality. The Company was able to reduce nonperforming balances in the quarter by selling $405 million of distressed real estate; $309 million non-accrual and $96 million OREO. This followed last quarter’s sale of $709 million in distressed assets and moving another $332 million to held-for-sale. As a result, total NPAs (including loans held for sale) declined 7.3% from the end of 3Q10 to $3.918 billion. At year end, total NPAs represented a still high 4.70% of loans plus OREO, though this was an improvement from 4.98% at the end of last quarter and 4.83% at the end of 2009.

Positively, nearly all forward-looking credit measures reflected improvement, although some were relatively modest. NPL inflows declined 29% over the quarter which together with the asset sale resulted in a $308 million decline in NPA’s, the third consecutive quarterly decline. Moreover, 48% of NPL inflows were paying as agreed. Early stage delinquencies were down and 90+ day past due loans declined for the third consecutive quarter but only modestly (1.35%). Additionally, internally risk-rated problem loans declined for the fourth consecutive quarter supporting the view that credit costs and provisions should continue to improve. Quarterly net charge-offs (NCOs) of $682 million included $111 million of charges related to the sale of non-accrual loans and were down 10% from 3Q10. Provisions in the quarter essentially matched NCOs at $682 million. At year end, Region’s allowance for loan losses represented 3.84% of year-end loans and 101% of nonaccrual balances. DBRS is mindful, however, that the Company has $1.5 billion of performing restructured loans (TDRs), $304 million of non-performing loans held-for-sale and $454 million in foreclosed properties on its balance sheet. Of the TDRs, 82% were consumer loans which currently have a 22% redefault rate. Additionally, in 4Q10, Regions sold its distressed assets at 75% of their carrying value.

Funding and liquidity remain sound, in DBRS’s view, with deposits funding the entire loan portfolio 1.14 times and an abundance of liquidity at the cost of 11 bps in 4Q10 NIM. The Company’s current estimated Tier 1 common equity ratio of 7.9% improved 24 bps over the quarter and the estimated Tier 1 ratio of 12.4% also improved. DBRS notes, however, that Regions’ capital ratios lag both the average of its rated and large regional peer groups. The Company reported a proforma Basel III Tier 1 Common Capital ratio of 7.6% and is well-positioned with respect to the LCR liquidity requirement. The regulatory capital ratios included $846 million in qualifying trust preferred securities (89 bps to Tier 1) that are scheduled to be phased out beginning in 2013 and excluded $416 million in deferred tax assets. At year end, Region’s $3.5 billion of TARP preferred shares remain outstanding.

Currently, Regions is one of the 19 banks subject to a second round of Federal Reserve stress tests to ensure capital adequacy. The stress tests will test a bank’s ability to absorb losses over the next two years under at least two scenarios (baseline and adverse) and will take the proposed Basel III capital requirements into account as well as TARP repayment. Test results will also determine whether an institution may resume capital distributions (stock dividends and/or repurchases). The stress test results are expected to be communicated to BHCs (not publicly) no later than March 21, 2011.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodologies are Global Methodology for Rating Banks and Banking Organizations, Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments, Rating Bank Subordinated Debt and Hybrid Instruments with Discretionary Payments, and Rating Bank Preferred Shares and Equivalent Hybrids which can be found on the DBRS website under Methodologies.

The sources of information used for this rating include the company documents, company presentations, company call transcripts, the Federal Deposit Insurance Corporation and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

The commentary was disclosed to the issuer and amendments were made following the disclosure.

Lead Analyst: William Schwartz
Approver: Alan G. Reid
Initial Rating Date: 5 July 2006
Most Recent Rating Update: 23 November 2010

For additional information on this rating, please refer to the linking document below.