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Regions Financial Corporation’s (RF - Analyst Report) second quarter 2012 earnings from continuing operations came in at 20 cents per share, outshining the Zacks Consensus Estimate by 6 cents. Moreover, results compare favorably with 14 cents per share reported in the prior quarter.

Quarterly results benefited from improved net interest margin and better credit quality backed by lower loan loss provisions and reduced non-performing assets. Moreover, improved funding mix and decline in non-interest expenses were the positives for the quarter. Yet, lower top-line, aided by reduced non-interest income was a dampener.

Net income available to common shareholders, including income of $4 million from discontinued operations due to the gain from the sale of Morgan Keegan was $284 million. Moreover, related to the repayment of the company’s Series A preferred stock, Regions increased the accretion of the discount along with the final preferred stock dividends, which decreased net income by $71 million or by a nickel. Yet, results compare favorably with net income of $145.0 million reported in the prior quarter.

Performance in Detail

Total revenue (net of interest expense) came in at $1.3 billion, below the Zacks Consensus Estimate of $1.4 billion. Moreover, revenue fell 7.1% sequentially.
 
Regions reported pre-tax pre-provision net revenue of $503 million, up 15% sequentially, mainly attributed to reduced non-interest expenses and improved net interest income. These positives were offset by decreased non-interest revenue.

Net interest income was $838 million, up 1.3% sequentially. Moreover, net interest margin improved by 7 basis points (bps) sequentially to 3.16% in the quarter. Margins were benefited by lower deposit costs, reduced non-accrual levels and increased deployment of excess cash. Funding mix showed an improvement as average low-cost deposits inched up as a percentage of total deposits from 80% in the prior quarter to 82%.

Regions’ non-interest income was $507 million, down 3% sequentially. Non-interest income included $12 million in securities gains. Excluding securities gains, non-interest income declined 3.3% sequentially, as account service fees and charges declined $21 million.

Non-interest expense fell 8% sequentially to $842 million. The decline was attributable to lower credit related expenses.

Credit Quality

Credit quality improved during the quarter at Regions. Inflows of non-performing loans decreased 17% sequentially to $315 million. Non-performing loans, excluding loans held for sale, declined 11% sequentially to $1.9 billion.

Net charge-offs decreased 20% sequentially to $265 million. Additionally, net charge-offs as percentage of average net loans stood at 1.39%, down 34 bps sequentially.

Further, non-performing assets reduced 38 bps sequentially to 3.04% of loans, foreclosed properties and non-performing loans held for sale. Also, provision for loan losses was down significantly by 78% sequentially to $26 million.

Capital Ratios

As of June 30, 2012, Regions’ Tier 1 capital ratio came in at 11.0% compared with 14.3% in the prior quarter. Tier 1 common risk-based ratio was 10.0%, up from 9.6% in the prior quarter. The company’s loan-to-deposit ratio was 80.0% as of the same date.

Developments in the Quarter

In April 2012, Regions completed the sale of Morgan Keegan to Raymond James Financial Inc. (RJF - Analyst Report) resulting in proceeds of $1.2 billion. Along with the divestiture, it repaid $3.5 billion to the U.S. Treasury department.

Additionally, in May 2012, Regions also completed the buyback of warrants by paying $45 million to the U.S. Treasury Department.  These warrants were issued to the U.S. Department of the Treasury as part of the company’s participation in the Troubled Asset Relief Program’s (TARP).

Our Viewpoint

We believe the company’s favorable funding mix, improved core business performance, its expansion mode and strategies will continue to yield profitable earnings in the upcoming quarters. Additionally, improved credit quality and TARP repayment would act as positive catalysts. Yet, regulatory issues remain a major area of concern.

Shares of Regions retain a Zacks #2 Rank, which translates into a short-term Buy rating. However, considering the fundamentals, we maintain a long-term ‘Neutral’ recommendation on the stock.

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