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) 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."

Along with the strong mortgage revenue, Regions Financial's third-quarter earnings were boosted by a $229 million decline in the company's loan loss reserves.

Stifel Nicolaus analyst Christopher Mutascio wrote after the earnings release that "we were only expecting a release of $185 million. The substantial reserve release came despite the fact that nonaccrual loans (excluding held for sale) decreased only 1.6% ($31 million) during the quarter versus a more substantial 11.0% ($236 million) decrease in 2Q12."

Mutascio added that "total gross nonperforming loan inflows actually increased to $463 million in 3Q12 from $315 million in 2Q12. Finally, net charge-offs of 1.38% of average loans ($262 million) were essentially flat with the 2Q12 level of 1.38% ($265 million)."

CEO Grayson Hall said that "assuming market conditions are favorable, we do expect to consider issuing preferred stock in the near future." Under the Federal Reserve's proposed rules to implement the Basel III capital requirements, most trust preferred equity will be excluded from regulatory Tier 1 capital.

Regions had $846 million in trust preferred securities as of Sept. 30, and while the company's executives could not comment on their specific plans to redeem the trust preferred securities, analysts expect the company eventually to issue sufficient noncumulative perpetual preferred shares, to make up the maximum of 150 basis points of the company's Basel III Tier 1 common equity ratio.

Usdin said that "RF's announcement that it is looking to issue preferreds could also have a negative drag on EPS.

When discussing the net interest margin, Regions CFO David Turner said during the conference call that the company "had guided to 3.13% being kind of the normal recurring margin for the third quarter," and that "from that, we had indicated we would be relatively stable." But "obviously QE3 the Fed's increase in MBS purchases came in the latter part of the quarter."

Looking ahead, Turner said that "when you look at some of the things that we are doing in the investment portfolio and changing that risk profile, moving new investments into new issued CMBS and corporate bonds, we think that that will serve to offset some of the downward pressure we see in the reinvestment rates," and that "we believe we can guide to a stable margin from where we are today."

Guggenheim analyst Marty Mosby emphasizes that Regions did see its net interest margin increase from 3.04% in the third quarter of 2011, and also says that "their margin compressed because last quarter was higher than it should have been," because of recoveries on problem loans.

Mosby adds that "earnings from operations increased by 10% from last quarter, which reflects over 80 cents in annualized earnings power." The analyst sees a buying opportunity for investors right now, because "tangible book value that grew 5% and now exceeds seven dollars," and the company's "earnings power can easily justify an $8 stock price."

Shares of Regions Financial have now returned 53% year-to-date, following a 38% decline during 2011.

The shares for 0.9 times their reported Sept. 30 tangible book value of $7.02, and for eight times the consensus 2013 EPS estimate of 80 cents.

RF Chart RF data by YCharts

Interested in more on Regions Financial? See TheStreet Ratings' report card for this stock.

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-- Written by Philip van Doorn in Jupiter, Fla.

>Contact by Email.

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., 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.

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