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Regions Shares Punished After Margin Squeeze (Update 2)

Updated with market close and return information, and comment from Guggenheim analyst Marty Mosby.

NEW YORK ( TheStreet) -- Regions Financial (RF - Get Report) was pummeled by investors Tuesday, with shares dropping 8% to close at $6.54.

The Birmingham, Ala., lender reported third-quarter net earnings from continuing operations available to common shareholders of $312 million, or 22 cents a share, increasing from $280 million, or 20 cents a share, the previous quarter, and $87 million, or seven cents a share, during the third quarter of 2011.

The third-quarter results beat the consensus estimate among analysts polled by Thomson Reuters by a penny, as mortgage banking income grew to $106 million, from $90 million the previous quarter, and $68 million a year earlier.

Investors were likely spooked by a sequential decline in the net interest margin -- the difference between the average yield on loans and investments and the average cost for deposits and borrowings -- which narrowed by eight basis points to 3.08% in the third quarter, because heading into earnings, Regions was considered one of the best-positioned among large regional banks in the current rate environment, as the company was less asset-sensitive, and had realized the brunt of its margin squeeze earlier in the cycle.

The Federal Reserve has kept its short-term federal funds rate in a target range of between zero and 0.25% since late 2008, and the central bank last month announced it was increasing its purchases of long-term mortgage-backed securities by $40 billion a month, in an effort to keep long-term rates at historically low levels. Most banks have already seen most of the benefit they will realize from a decline in funding costs, and most of the large regional players reported a significant decline in third-quarter net interest margins.

Jefferies analyst Ken Usdin said after the earnings release that Regions Financial's net interest margin decline "will be seen as disappointing given that the company had guided to stable NIM and flattish net interest income for the back half of the year." The company's net interest declined significantly, to $817 million in the third quarter, from $838 million in the second quarter, and $850 million, in last year's third quarter.

Regions said that the margin narrowed "due to lower loan yields and higher prepayments resulting in lower yields in the investment portfolio partially offset by lower deposit costs."

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