Regions Financial Corporation’s ( RF - Analyst Report ) third quarter 2012 earnings from continuing operations came in at 22 cents per share, marginally beating the Zacks Consensus Estimate by 2 cents. Moreover, results compare favorably with 20 cents per share reported in the prior quarter.

Quarterly results benefited from a rise in non-interest income backed by improved funding mix and reduced non-performing assets. Yet, increased non-interest expenses and higher provision for loan losses were dampeners. Moreover, contraction in net interest margin depicts persistent low interest rate environment.

Net income available to common shareholders was $301 million, up from $284 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. However, revenue increased slightly on a sequential basis.

Regions reported pre-tax pre-provision net revenue of $481 million, down 4.4% sequentially, mainly attributed to increased non-interest expenses and reduced net interest income. These negatives were partially offset by improved non-interest revenue.

Net interest income was $817 million, down 2.5% sequentially. Moreover, net interest margin contracted 8 basis points (bps) sequentially to 3.08% in the quarter, attributed to lower yields in the investment portfolio, partly offset by reduced deposit costs. Funding mix showed an improvement as average low-cost deposits inched up as a percentage of total deposits from 82% in the prior quarter to 84%.

Regions’ non-interest income was $533 million, up 5% sequentially. Non-interest income included $12 million in securities gains. Excluding securities gains, non-interest income surged 5.3% sequentially, as mortgage revenue improved. Year-to-date HARP II loan production was $1.2 billion, surpassing the full year target of $1 billion.

However, non-interest expense increased 3% sequentially to $869 million. The rise was attributable to higher credit related expenses and elevated marketing expenses.

Credit Quality

Credit quality was a mixed bag during the quarter at Regions. Net charge-offs decreased 1% sequentially to $262 million. Additionally, net charge-offs as percentage of average net loans stood at 1.38%, down 1 bp sequentially.

Further, non-performing assets reduced 11 bps sequentially to 2.93% of loans, foreclosed properties and non-performing loans held for sale. Yet, provision for loan losses was up by 26.9% sequentially to $33 million.

Inflows of non-performing loans increased 47% sequentially to $463 million. Non-performing loans, excluding loans held for sale, declined 2% sequentially to $1.9 billion.

Capital Ratios

As of September 30, 2012, Regions’ Tier 1 capital ratio came in at 11.5% compared with 11.0% in the prior quarter. Tier 1 common risk-based ratio was 10.5%, up from 10.0% in the prior quarter. The company’s loan-to-deposit ratio was 79.0% as of the same date.

Developments in the Quarter

In September, Regions announced the managerial reorganization of its Wealth Management Group, created in June 2011. The appointment of new leaders came on the heels of Regions’ plan of expanding its Wealth Management solutions for individual and institutional clients.

Regions have pooled its trust, insurance, asset management and private banking units into one group for some time now, so that it could cater to affluent clients. It aims at providing clients with simple, expedient and more beneficial financial management solutions across the 16 states in which it operates.

The organization of the new group will aid in diversifying revenue streams and will help in gaining profitable customers, which in turn, will raise fee income.

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, significant improvement in credit quality would act as a positive catalyst. Yet, regulatory issues and elevated non-interest expenses remain major areas of concern.

Currently, shares of Regions retain a Zacks #2 Rank, which translates into a short-term Buy rating. Considering the fundamentals, we also maintain our long-term ‘Outperform’ recommendation on the stock.

Among Regions’ peers - Midsouth Bancorp Inc. ( MSL - Snapshot Report ) is expected to report its third-quarter 2012 earnings on October 30, 2012.