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We have upgraded our recommendation on Regions Financial Corp. (RF - Analyst Report) to Outperform from Neutral based on its improving credit quality and the repayment of the bailout money. Moreover, we believe that the company is well positioned to benefit from de-risking of the balance-sheet and cost-control measures it undertook. However, regulatory issues remain a major area of concern.

Regions is expected to announce its third-quarter results on October 23. The Zacks Consensus Estimate earnings per share for the quarter is 20 cents on revenue expectation of $1.36 billion. Regions has surpassed the Zacks Consensus Estimate in the last four quarters.

Regions qualified the stress test in March, 2012. Following the Federal Reserve’s approval, it also cleared-off its Troubled Asset Relief Program (TARP) dues in April this year. Further, in May, the company completed the buyback of warrants issued to the Treasury as part of the company’s participation in TARP. TARP repayment removed the restrictions on the company’s financial flexibility. Moreover, the company’s well-capitalized financial position is a positive.

Further, with the improvements in its loan loss performance and profitability, the major rating agencies upgraded their outlook to reflect that Regions had decreased its risk concentrations and is showing signs of stability in its asset quality. The aforementioned actions boost investors’ confidence in the company to a great extent.

Moreover, Regions continued to de-risk its portfolio through the liquidation of problem assets and foreclosed properties. With such initiatives, overall credit trends are anticipated to improve and nonperforming assets are expected to decrease as the year progresses.

Further, the company is focused on strengthening its core franchise through productivity and efficiency initiatives. Looking ahead, management anticipates overall 2012 expenses from continuing operations, excluding goodwill impairment, to decline from the 2011 level due to continued and disciplined focus on cost control.

On the flip side, the regulatory environment has become more stringent for the U.S. banks. Further, the current market volatility and limited credit availability could continue to adversely affect the U.S. banking industry and the global economies in the foreseeable future.

Moreover, the Fed’s newly announced rules suggest that banks would need to maintain minimum tier 1 capital ratio of 7.0% of risk-weighted assets, which is well above the current requirement of around 2%. These rules might limit the flexibility of the banks with respect to their investments and lending volumes.

Regions currently retain a Zacks #2 Rank, which translates into a short-term Buy rating. However, one of its peers, First Horizon National Corporation (FHN - Analyst Report) retains a Zacks #3 Rank (short-term Hold rating).

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