DBRS Comments on Regions’ 2Q11 Results – Sr. Debt at BBB; Trend Negative; Ratings Unaffected

DBRS Inc. (DBRS) has today commented that its ratings for Regions Financial Corporation (Regions or the Company), including its BBB Issuer & Senior Debt rating and Negative trend, are unchanged following the release of the Company’s second quarter 2011 results. Regions reported its third consecutive quarterly profit, featuring earnings of $109 million in the quarter, representing a $40 million increase from 1Q11 but a more substantial improvement over the $277 million loss in 2Q10. DBRS sees the Company’s results as reflecting the progress the Company has made in dealing with its credit quality issues, while also highlighting the overall lagging pace of credit quality improvement and the longer-term challenge facing the Company in restoring profitability to pre-crisis levels.

Regions’ revenues (excluding security gains) were $1.6 billion, down 0.4% from 1Q11 but were up 0.6% from 2Q10. Regions took securities gains again in 2Q11 by selling $4 billion in agency MBS for a gain of $24 million in the quarter, repositioning the securities portfolio and effectively shortening its duration to just over 3 years. Excluding the securities gains and various charges, adjusted income before provisions and taxes (IBPT) was up almost 9% sequentially, at $500 million in 2Q11, and up almost 3% from 2Q10 primarily from ongoing expense control. Net interest income was flat over the quarter as the 0.5% decline in average earning assets and 8 basis point (bps) decline in yield partially offset the 6 bps decline in interest-bearing liabilities and growth in non-interest bearing deposits which resulted in a 2 bps decline in net interest margin to 3.05%. Adjusted non-interest income was also flat as stronger service charges and mortgage revenues were offset by lower Morgan Keegan fees. With its goal to increase fee revenues, the Company announced in June the integration of its trust, private banking and insurance businesses into a new business line, Wealth Management Group.

Net income primarily benefited from a 17% ($84 million) quarterly decline in the provision for credit losses and an unexpected $44 million tax benefit related to the regulatory settlement. The loan loss provision declined to $398 million while credit-related expenses fell only modestly in the quarter to comprise a significant 8% of adjusted expenses, up from 6% in the prior quarter and highlighting the remaining credit overhang.

The Company, like most of the industry, is focusing on controlling expenses in a difficult operating environment whose higher credit and regulatory expenses have been constraining profitability. Regions recorded $77 million in charges for forthcoming consolidation of approximately 40 branches in 2H11 that is expected to save $19 million (pretax) in annual expenses. Expenses remain elevated at $1.1 billion (excluding the branch consolidation charge) but were about 4% lower than 1Q11 and 0.4% below 2Q10. Compared to 1Q11, lower salary and benefit, professional fees, and real estate owned expense were only partially offset by higher FDIC premiums and marketing expenses. Importantly for DBRS, provisioning, while down considerably from peak levels, continues to consume most of IBPT and underscores the need for continued progress. In 2Q11, the $398 million provision represented 80% of the quarterly adjusted IBPT of $500 million, but reflected progress relative to the 104% result in the first quarter, and is noteworthy as the first quarter below 100% since 1Q09.

Average loans declined 1.6% over the quarter, however, period end loans declined a more modest 0.2%. The Company acquired a $1.2 billion credit card portfolio of existing Regions deposit customers and generated strong growth in indirect auto and Commercial and Industrial (C&I) lending which was more than offset by declines in investor real estate, first mortgages and home equity. The Company continues to work down its investor commercial real estate exposure which declined over 9%, or $1.4 billion, in 2Q11 to $13.4 billion. Positively, C&I commitments have increased 7% in 1H11 and have grown for 5 consecutive quarters. Average C&I loans increased for the fourth consecutive quarter, up 2.7% ($617 million) from 1Q11 and line utilization, which was 41.7% in 1Q11, was relatively stable in 2Q11, yet still well below the normal range in the high 40’s.

The allowance for credit loss has been roughly flat at $3.2 billion for six quarters as the provision has generally matched net charge-offs (NCOs). In 2Q11, Regions sold and/or transferred $207 million of loans to held-for-sale (HFS) to accelerate loan dispositions, which increased net charge-offs (NCOs) to $548 million. Adjusted for the HFS transfers, NCOs declined 9% as commercial and consumer NCO declines more than offset the increase in investor real estate NCOs. Many important asset quality metrics improved in the quarter including NPAs, NPL inflows, 90+ day past dues and business classified and special mention loans. Of concern, accruing restructured loans (TDRs) grew by over 7% in the quarter, however, non-accruing TDRs were flat. DBRS notes that Regions sold $289 million of non-performing loans in the quarter, up from $219 million in 1Q11, but indicated that prices were a breakeven and that it will primarily focus on workouts going forward and away from sales due to economics at this point in the credit cycle.

With stability in the Company-wide allowance for credit losses, the Company’s reserves remain adequate but not robust in DBRS’s view. The Company’s allowance was $3.2 billion at quarter-end, representing 3.95% of loans and 89% of nonperforming assets. DBRS is also mindful, however, that the Company has $1.7 billion of TDRs on its balance sheet of which 79% were consumer loans which currently have a 20% redefault rate, relatively flat to the first quarter.

Funding and liquidity remain sound, in DBRS’s view, with deposits funding the entire loan portfolio 1.19 times and an abundance of liquidity including $5 billion on deposit at the Federal Reserve. Deposits continued to grow in the quarter with the mix of low cost deposits improving and overall deposit costs down 6 bps over the quarter. The Company’s current estimated Tier 1 common equity ratio of 7.9% was flat over the quarter, the estimated Tier 1 ratio of 12.6% improved 10 bps, and the tangible common equity to tangible assets ratio rose 20 bps to 6.18%. DBRS notes that Regions’ capital ratios lag both the average of its rated and large regional peer groups. The Company reported a pro-forma Basel III Tier 1 Common Capital ratio of 7.2% and is well-positioned with respect to the LCR liquidity requirement. The regulatory capital ratios included $846 million in qualifying trust preferred securities (90 bps to Tier 1) that are scheduled to be phased out beginning in 2013, and excluded $499 million in deferred tax assets. DBRS is also mindful that Regions’ $3.5 billion of TARP preferred shares remained outstanding in 2Q11. In 2Q11, the Company announced the strategic review of its Morgan Keegan investment securities and brokerage division. The proceeds of a potential sale could be used to toward the repayment of its TARP or other high-yield debt.

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.

Lead Analyst: William Schwartz
Approver: Steven Picarillo
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.