Observers Say Regions Financial's Disappointing Earnings Reveal Operational Difficulties

Third-quarter numbers suggest Regions may be having problems digesting some of its many acquisitions.
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Fast-growing Regions Financial (RGBK) hit its speed limit Monday, posting disappointing third-quarter results that analysts and investors say reveal operational difficulties that likely won't be righted for several quarters.

For the third quarter, Regions, the fourth-largest bank in the Southeast, with $41 billion in assets, reported operating income of $131 million, or 59 cents per fully diluted share, up slightly from $128 million, or 57 cents a share, in the year-earlier period. The third-quarter earnings fell 3 cents short of the estimate quoted by

First Call/Thomson Financial


In an unusually heavy volume, Regions shares retreated 1 1/16, or 3.8%, Tuesday afternoon to close at 27 1/16, even as the

KBW Bank Index

rallied a solid 3.6%.

The Birmingham, Ala.-based institution also said in an earnings release Monday that it had overstated this year's first-half profits by nearly 5% in earlier financial statements. The release attributed the erroneous profit figures to "an overaccrual of interest income on a certain portion of the company's mortgage loan portfolio following a processing system conversion."

Regions representatives didn't immediately return calls seeking comment.

With the restated profit numbers, the bank actually earned $266 million in the year's first six months, 4.6% lower than the originally reported $278 million.

Watching the Margins

Pressures on the bank can chiefly be seen in its net interest margin, the percentage difference between lending revenue and the cost of the money used to fund those loans.

This margin shrank to 3.86% in the third quarter from 4.08% in the restated second quarter. Facing slow growth in deposits, Regions had to borrow at higher rates from other institutions, pushing up costs.

Some investors don't think this pressure on the interest margin will ease anytime soon.

"We'll have to watch the

net interest margin well into next year," says Lisa Welch, analyst for the

John Hancock

(FRBAX) - Get Report

Regional Bank fund, which holds Regions shares.

The shrinking margin wouldn't be such a problem if Regions weren't lending so robustly. But loan growth in the 12 months through the end of September hit a torrid 15%.

The stretch this puts on the bank's funding can be seen in the ratio of its loans to deposits. In this year's third quarter, loans totaled 92.3% of deposits, vs. 87.7% in the year-ago period.

The average ratio for all publicly traded banks was 82.7% in the year's second quarter, according to

SNL Securities

, the Charlottesville, Va.-based banking research firm.

Mark Davis, head of research for the


Banc Stock Group fund, says this ratio should ideally be around 80%. "Regions has to ask itself how they're going to fund its growth," Davis says. (Davis' fund doesn't own Regions stock.)

Acquiring other banks was one way that Regions had increased deposits. But investors may question that strategy after the restatement.

This revision "had absolutely everything to do with the integration" of recent acquisitions, says Marni Pont O'Doherty, an analyst with

Keefe Bruyette & Woods

, which hasn't done recent underwriting for Regions. Regions shares are rated hold by the New York brokerage.

Regions has had to combine some 39 banking units bought in the last 18 months, Pont O'Doherty says. (She's adding 13 separate banks to the 26 institutions with separate charters that were part of Little Rock, Ark.-based

First Commercial

, acquired last year.)

Bargain Basement?

Nonetheless, investors aren't about to forsake the bank entirely. Part of the reason is that Regions' stock, down a third from its 1999 high set in January, has fallen to a level that gives the bank a comparatively cheap valuation.

Along with several other analysts, Christopher Marinac, who covers banks for Atlanta-based

Robinson Humphrey

, has cut his 2000 earnings forecast for Regions. Instead of $2.75 per share, Marinac now thinks the bank will earn $2.57. But even at his new estimate, the bank trades on a 2000 price-to-earnings ratio of 10.5, lower than the 13 times for the KBW Banks Index. (Robinson Humphrey hasn't done recent investment banking work for Regions, and Marinac rates the bank a long-term buy.)

Marinac believes that Regions has managed relations well with borrowers -- as shown by the strong loan growth -- but has not done so well with depositors. He thinks management is capable of building deposits, but adds, "It's going to take a couple of quarters."