DBRS Comments on Regions’ 3Q11 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 third quarter 2011 results. Regions reported its fourth consecutive quarterly profit, featuring earnings of $155 million in the quarter, representing a $46 million increase from 2Q11 but a more substantial improvement over the $155 million loss in 3Q10. DBRS sees the Company’s results as reflecting the continual progress the Company has made in dealing with its credit quality issues. It also highlights, however, the overall lagging pace of credit quality improvement and the longer-term challenge facing the Company in restoring profitability to pre-crisis levels. 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’ revenues (excluding security gains) were $1.6 billion, down 1.0% from 2Q11 and 0.7% from 3Q10 as net interest income remained stable under pressure. Regions took a $1 million security loss in 3Q11 after selling $4 billion in agency MBS in 2Q11 for a gain of $24 million, 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 8% sequentially at $540 million in 3Q11, and up almost 19% from 3Q10 primarily from ongoing expense control and the release of reserves. Net interest income was down a modest 0.7% over the quarter as the 0.7% decline in average earning assets and 9 basis point (bps) decline in yield (primarily from prepayments and security premium amortization) were only partially offset by the 6 bps decline in interest-bearing liabilities and growth in non-interest bearing deposits which resulted in a 3 bps decline in the net interest margin to 3.02%.

Adjusted non-interest income was down $9 million (1.2%) as volatile markets led to a 12.5% drop in brokerage, investment banking and capital market income that was only partially offset by stronger mortgage, deposit service, and interchange revenues. 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 an 11% ($132 million) decline in non-interest expense and a 10.8% ($43 million) quarterly decline in the provision for loan losses. The expense decline, when adjusted for the $77 million branch consolidation charge taken in 2Q11, would still be a 4.9% or $55 million decline. The loan loss provision declined to $355 million while credit-related expenses rose $8 million in the quarter to comprise a more significant 9% of adjusted expenses, up from 8% in the prior quarter, the highest level in three quarters, and highlighting the remaining credit overhang.

The Company, like most of the industry, is focusing on controlling expenses in a difficult operating environment where higher credit and regulatory expenses have been constraining profitability. Expenses remain elevated at $1.1 billion but were about 11% lower than 2Q11 (5% on an adjusted basis) and 8% below 3Q10. Compared to 2Q11, lower deferred employee compensation and FDIC premiums were only partially offset by higher credit-related costs (mentioned above) and professional/legal fees. Importantly for DBRS, provisioning is down considerably from peak levels and continues to improve, yet also continues to consume most of IBPT and underscores the need for additional progress. In 3Q11, the $355 million provision represented 66% of the quarterly adjusted IBPT of $540 million, but reflected progress relative to the 80% result in the second quarter, and is noteworthy as the second quarter below 100% since 1Q09.

Average loans declined 0.7% over the quarter with period end loans declining a steeper 2.1%. In June, the Company acquired a $1 billion credit card portfolio of existing Regions deposit customers and generated growth in Commercial and Industrial (C&I) lending (particularly specialty lending) which was more than offset by declines in commercial real estate, first mortgages and home equity as consumers continue to delever. The Company continues to work down its investor commercial real estate exposure (CRE) which declined 11.5%, or $1.5 billion in 3Q11 to $11.9 billion. Positively, C&I commitments have increased 3% in 3Q11 and have grown for 6 consecutive quarters. Average C&I loans increased for the fifth consecutive quarter, up 1.9% ($447 million) from 2Q11 and line utilization was up to 43% in 3Q11, up from about 42% in 2Q11, but still well below the normal range in the high 40’s.

DBRS notes that most asset quality metrics improved in the quarter including NPAs, 90+ day past dues and business classified and special mention loans. The allowance for credit losses declined in the past two quarters after being roughly flat for six quarters as credit losses have contracted. At 3Q11, the $3.0 billion allowance fell $154 million from the prior quarter with the $355 million provision set at $156 million less than the $511 million in quarterly net charge-offs (NCOs). In 3Q11, Regions sold and/or transferred $198 million of loans to held-for-sale (HFS) to accelerate loan dispositions, however net charge-offs (NCOs) still declined 6.8% or $37 million to $511 million in the quarter. The Company sold $299 million of non-accruals and $146 million of OREO at or near their marks.

Of concern, however, NPA inflows rose nearly 33% or $203 million in the quarter while the overall rate of credit quality improvement seemed to be slowing as evidenced by the flat quarterly rate of 30 to 89 past due loans at 1.05%. DBRS notes that the Company advised caution in its comments around asset quality given the struggling economy, but it did guide to lower future provisions, but perhaps at a slowing pace. The $1.2 billion increase in accruing restructured loans (TDRs) reflected implementation of new accounting guidance and had no material impact to the allowance. Current and accruing TDRs were 72% of total TDRs down 1 bps from 2Q11 and 3Q10.

With the declining 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 $3.05 billion at quarter-end, representing 3.84% of loans and 90% of nonperforming assets.

Funding and liquidity remain sound, in DBRS’s view, with deposits funding the entire loan portfolio 1.2 times and an abundance of liquidity including $6 billion on deposit at the Federal Reserve and $2 billion in Cash or due from banks. Deposits continued to grow in the quarter with the mix of low cost deposits improving and overall deposit costs down 7 bps over the quarter and 24 bps over the year. The Company’s current estimated Tier 1 common equity ratio of 8.16% was up 21 bps over the quarter, the estimated Tier 1 ratio of 12.8% improved 27 bps, and the tangible common equity to tangible assets ratio rose 30 bps to 6.48%. DBRS notes that Regions’ capital ratios lag both the average of its rated and large regional peer groups but are moving in the right direction. The Company reported a pro-forma Basel III Tier 1 Common Capital ratio of 7.7% and is well-positioned with respect to the LCR liquidity requirement. The regulatory capital ratios included $846 million in qualifying trust preferred securities (91 bps to Tier 1) that are scheduled to be phased out beginning in 2013, and excluded $506 million in deferred tax assets. DBRS is also mindful that Regions’ $3.5 billion of TARP preferred shares remained outstanding in 3Q11. In 2Q11, the Company announced the strategic review of its Morgan Keegan investment securities and brokerage division and DBRS expects a sale announcement to be forthcoming in the near future. The proceeds of a potential sale could be used to toward the repayment of its TARP or other high-yielding debt.

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

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organizations. Other methodologies used include the 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, all of 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: 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 under Related Research.