We maintain our Neutral recommendation on Regions Financial Corp. (RF). The decision is based on the company’s move toward profitability in the fourth quarter of 2010.

In January, Regions’ announced fourth-quarter 2010 operating earnings per share of 3 cents, significantly surpassing the Zacks Consensus Estimate loss of 13 cents per share. Results compared favorably with a loss of 17 cents per share in the prior quarter and 51 cents per share in the year-ago quarter.

Results significantly benefited from improved core business performance.  Further, the company’s improved non-interest income, high pre-tax pre-provision net revenue and net margin expansion attributed to favorable funding mix and deposit pricing, which led to impressive results. However, these increases were partly offset by the escalation in non-interest expenses. Moreover, the company took aggressive credit quality improving measures by disposing off non-performing assets in the quarter.

In the fourth quarter of 2010, Regions conducted a bulk sale of non-performing assets for $405 million and plans for the same in the forthcoming quarters. The company has taken a strong stance in realizing the risk of its portfolio and is trying to successfully resolve the remaining problem assets in the near term.

After declining since the second quarter of 2006, net interest margin (NIM) at Regions is showing signs of improvement, with 3.00%, 2.96%, 2.87% and 2.77%, respectively, in the last four quarters. Management’s actions taken on loan and low cost deposit produced an improving NIM throughout 2010, with the target achievement of 3% by the end of 2010.

At current level, Regions must remain meticulous in its efforts to manage expenses. Consequently, the company has constantly reviewed all areas of staffing and has eliminated approximately 700 positions in 2010.  The company is also trying to reduce occupancy and discretionary expenditures in an effort to improve productivity and efficiency.  Therefore, we expect core non-interest expenses in 2011 to be slightly down from 2010 level.

Regions stands well capitalized, with Tier 1 common and Tier 1 capital ratios of 7.9% and 12.4%, respectively, as of December 31, 2010. On a Basel III pro-forma basis, the ratios were 7.6% and 11.4%. These ratios remain above the minimum requirements of 7.0% and 8.5% under Basel III, respectively. Further, Regions is evaluating the probable impact of Basel III on the capital ratios. The company also expects to meet the Basel III liquidity requirements in its current form. However, there is still need for some visibility of the Basel III rules and implementation of the same by the U.S. banking regulators to estimate the impact on Regions.

On the flip side, with Fed’s second round of stress testing underway; Troubled Assets Relief program (TARP) repayment of $3.5 billion seems to be postponed. Though Regions is encouraged by signs of economic recovery, improving credit quality metrics, and continued success in customer base expansion in most of the markets, its southeastern economy is recovering at a slower space, particularly in Florida, where housing remains a serious concern and unemployment continues to persistently soar at 12%.

Though Regions has undertaken cost-control measures, an unusually high recession and credit related costs such as higher other real estate owned, professional fees and FDIC premiums more than offset its expense reduction efforts and continued at least through 2010. The Dodd-Frank Act requires changes to a number of components of the FDIC insurance assessment, with an expected implementation date of April 1, 2011 by the FDIC.

While the de-risking measures at Regions are encouraging, the upfront costs of such initiatives cannot be avoided.  Nevertheless, the favorable funding mix, improved core business performance and an expected improvement in the economy in the forthcoming quarters would, however, support the company’s earnings.

Regions currently retain its Zacks #3 Rank, which translates into a short-term ‘Hold’ rating. Moreover, we also maintain a ‘Neutral’ recommendation on Regions’ closest competitor – First Horizon National Corp. (FHN).

 
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