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Regions Financial

(RF) - Get Regions Financial Corporation Report

faces an increase in credit losses for the next year and a half. That's the bad news.

The good news is the Birmingham, Ala.-based bank now has sufficient capital and deposit growth to ride out the rest of the credit crisis, making it an attractive investment over the next five years.

Because of a surge in the company's nonperforming loans during the first half of this year, its shares have lagged behind most of the other 17 publicly traded holding companies that underwent the government's stress tests. (Deutsche Bank has cut Regions'


to "hold" from "buy.")

The S&P 500 Financials Index jumped 48% from a low on March 6 through last Friday. Shares of

FifthThird Bancorp

(FITB) - Get Fifth Third Bancorp Report

returned a whopping 721% over that period.

The group of 18 enjoyed triple-digit gains for the period, save

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Bank of New York Mellon

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, up 24%; and Regions, which nearly doubled.

Regions shares also lagged because of chatter making hay of the company's fair-value estimate for its loan portfolio as of June 30. With a carrying amount of $90.9 billion, the estimate of the loan portfolio's fair value was only $68.1 billion.

While bank holding companies report outstanding loan balances as the carrying value of loans held for investment on their balance sheets, they're required to disclose a fair-value estimate according to accounting rules. While the result can be scary, the fact is that Regions isn't trying to sell the vast majority of the loans, so an estimate of their market value is meaningless.

When the stress tests were completed, Regions was told by federal regulators to raise $2.5 billion in new capital. The company met the requirement during the second quarter, which left it with a tier 1 leverage ratio of 12.26% and a total risk-based capital ratio of 16.67%. Those levels would usually be considered high for a holding company with $143 billion in total assets. Most banks and thrifts are required to maintain a tier 1 leverage ratio of 5% and total risk-based capital ratio of 10% to be considered



Large holding companies tend to avoid holding lots of excess capital to maximize returns on equity. For Regions, the extra capital is needed to offset loan losses expected to mount through next year.

Nonperforming loans (including those past due 90-plus days or in nonaccrual status) totaled $3.6 billion as of June 30, up from $2.8 billion in the previous quarter. Net charge-offs (actual loan losses) came to $491 million during the second quarter, up from $390 million in the first quarter.

Regions has kept ahead of the annualized pace of loan charge-offs. The company added $912 million to loan-loss reserves in the second quarter, and its ratio of reserves to total loans was 2.33%, compared with an annualized net charge-off ratio of 2.02%.

The company's net interest spread -- the average rate on earning assets, minus the average cost of deposits and borrowings -- was 2.62% for the second quarter. That's a weak spread, and while an industry aggregate for the second quarter isn't yet available, the aggregate net interest spread for all U.S. commercial banks for the first quarter was 3.25%, according to SNL Financial.

Regions Financial Chief Executive Officer Dowd Ritter said during the company's second-quarter conference call that spreads would improve "due to better pricing discipline." In a report from Aug. 14, which included a "buy" recommendation for Regions shares, Merrill Lynch analyst Kenneth Usdin said that improvement in the company's net-interest margins would be "gradual," since only a third of the company's loan portfolio has interest rates reset each year.

Still, a third of Regions' loan portfolio is significant, and the company increased its non-interest-bearing checking accounts 15% year-over-year to $21 billion as of June 30.

Regions' stock rose 8% a week ago, with word that hedge fund

Paulson & Co.

purchased $35 million shares, representing about 3% of outstanding common shares. Paulson founder John Paulson earned billions of dollars betting on the decline in credit and bank shares.

Other large financials held by Paulson & Co. as of June 30, according to an SEC filing, included

Bank of America

(BAC) - Get Bank of America Corp Report


Capital One

(COF) - Get Capital One Financial Corporation Report


Goldman Sachs

(GS) - Get Goldman Sachs Group, Inc. Report


JPMorgan Chase

(JPM) - Get JPMorgan Chase & Co. Report


With Paulson on board, Regions Financial investors seem to be in good company.


Reported by Philip van Doorn in Jupiter, Fla.

Philip W. van Doorn joined Ratings., Inc., in February 2007. He is the senior analyst responsible for assigning financial strength ratings to banks and savings and loan institutions. He also comments on industry and regulatory trends. Mr. van Doorn has fifteen years experience, having served as a loan operations officer at Riverside National Bank in Fort Pierce, Florida, and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a Bachelor of Science in business administration from Long Island University.