Forget EPS Miss: Regions Shows Strong C&I Loan Growth, Expanded Margin (Update 1)

Third-quarter net income of $285 million, or 20 cents a share
EPS a penny shy of consensus estimate
Adjusted noninterest expenses up 6% sequentially to $879 million.
Average commercial and industrial loans grow 4% from Q2, 13% from year-earlier
Mortgage revenue down 14% sequentially, down 51% from year earlier

Updated from 8:38 a.m. ET with increase in adjusted noninterest expenses, market reaction and comment from Jefferies analyst Ken Usdin.

NEW YORK ( TheStreet) -- Investors will see headlines saying Regions Financial ( RF) missed the consensus third-quarter earnings estimate, but there was plenty of good news in the company's earnings announcement on Tuesday.

Regions of Birmingham, Ala., reported third-quarter net income available to common shareholders of $285 million, or 20 cents a share, increasing from $259 million, or 18 cents a share, in the second quarter, but declining from $301 million, or 22 cents a share, during the third quarter of 2013.

The third-quarter results came in a penny shy of the consensus estimate of 21 cents a share, among analysts polled by Thomson Reuters.

The main factor in the year-over-year earnings decline was a 51% decline in mortgage income to $52 million in the third quarter, following the industry trend as a rise in long-term interest rates has slowed the wave of mortgage refinancing in the U.S. Mortgage income was also down from $69 million in the second quarter.

Third-quarter highlights for Regions included an expansion of the net interest margin to 3.24% from 3.16% the previous quarter and 3.08% a year earlier. Net interest income increased to $824 million in the third quarter from $808 million in the second quarter and $817 million in the third quarter of 2012. Those are significant achievements in the current environment, with some regional lenders seeing net interest margins continuing to contract.

Feeding the expanded margin was an improved funding mix, with interest-bearing deposits down 4% year-over-year, while non-interest-bearing deposits declined only slightly. The company said in its earnings release that "average low-cost deposits increased from the previous year by $2.6 billion, while higher cost time deposits declined $5.1 billion. As a result, low-cost deposits as a percent of total deposits improved to 89 percent, compared to 84 percent last year."

Meanwhile, average loans were down slightly year-over-year, as the bank's commercial real estate (CRE) and home equity loans continued to run off. But coveted commercial and industrial (C&I) loans were up considerably, with average balances rising 4% sequentially and 13% year-over-year, to $29.3 billion in the third quarter.

Regions said new production of C&I loans during the third quarter was up by $824 million or 24% year-over-year, and also said "commitments for future loans increased 17 percent to $38 billion." Those commitments include renewals, but that is still a solid number for pipeline growth.

Partially offsetting the mortgage revenue decline was an increase in services charges on deposit accounts to $251 million in the third quarter, from $237 million the previous quarter and $244 million a year earlier, and a decline in the provision for loan losses to $18 million in the third quarter, from $31 million in the second quarter and $33 million in the third quarter of 2012.

Total noninterest expenses were $884 million in the third quarter, which was "steady" from the second quarter and up from $869 million in the third quarter of 2012. However, on an adjusted basis, netting out losses from debt prepayments, Regions saw core noninterest expense rise to $879 million in the third quarter from $828 million the previous quarter and $869 million a year earlier.

" The company continues to increase staffing in customer-facing, revenue-generating and compliance positions as headcount increased 376 positions," Regions said, adding "As a reminder, the previous quarter's expenses benefited from a lower level of professional and legal expenses and unfunded commitment expenses, and also included higher costs associated with the early termination of certain debt and preferred securities."

In its guidance, Regions also said it continued to expect its 2013 noninterest expense to come in below its total for 2012.

Regions said its nonperforming loans had "consistently declined for more than three years." Nonperforming loans totaled $1.354 billion as of Sept. 30 and made up 1.78% of total loans, improving from 2.01% the previous quarter and 2.50% a year earlier. The third-quarter annualized ratio of net charge-offs to average loans was 0.60%, declining from 0.77% in the second quarter and 1.38% in the third quarter of 2012.

Loan loss reserves covered 2.03%, which implied plenty of reserve coverage when considering the decline in nonperformers and the improved net charge-off ratio, implying that Regions has further "credit leverage" and that subsequent provisions for loan losses will remain low.

Regions CEO Grayson Hall in the earnings release said "This marks the second consecutive quarter that we achieved loan growth and expanded net interest income. At the same time, our asset quality continues to improve and our strong capital levels position us well for the future."

The company reported an estimated Sept. 30 Tier 1 common equity ratio of 11.6% as of Sept. 30, unchanged from the previous quarter but up from 11.5% a year earlier.

The third-quarter return on average assets was 0.97% in the third quarter, compared to 0.88% in the second quarter and 1.02% in the third quarter of 2012. Regions reported a third-quarter return on average tangible common equity of 11.41%, up from 10.15% the previous quarter, but down from 12.39% a year earlier.

Shares of Regions Financial closed at $10.04 Friday, returning 42% this year. The shares trade for 11.4 times the consensus 2013 EPS estimate of 88 cents.

The shares were down over 2% in morning trading, to $9.83.

Jefferies analyst Ken Usdin in a note to clients following the earnings release wrote that "Salaries and benefits expense (up $3mm) was well controlled,but professional and legal (up $13mm) and "other" (up $9mm) came in higherthan our model."

"We continue to believe RF is well-positioned for this year's stress test, and we expect the bank will return more capital (both dividends and buybacks) to shareholders in '14," Usdin wrote.

The analyst rates Regions a "buy," with an $11 price target.