S&P Junks Regions Financial

Tyler Durden's picture

From S&P

Overview

  • U.S. regional bank Regions Financial Corp.'s financial performance in recent quarters has lagged our expectations. Furthermore, we think the company's financial flexibility has been somewhat reduced.
  • We lowered our counterparty credit ratings on Regions and its primary bank subsidiary, Regions Bank. The outlooks on their long-term ratings remain negative.
  • We expect net losses to persist at Regions in the near term, largely due to unfavorable loan and geographic concentrations. We think net losses could continue to modestly pressure capital ratios in the near term.

Rating Action

On Nov. 23, 2010, Standard & Poor's Ratings Services lowered its ratings on Regions Financial Corp., including the counterparty credit rating to 'BB+/B' from 'BBB-/A-3'. The outlook is negative. At the same time, we also lowered our rating on the company's primary bank subsidiary, Regions Bank, to 'BBB-/A-3' from 'BBB/A-2'.

Rationale

We primarily based the rating action, which follows our full annual review of the company's financial performance, on our view that net losses are likely to persist longer than we had previously anticipated. As a result, we see continued pressure in the near term on the company's capital ratios, which we currently view as somewhat aggressive after taking into consideration its high commercial real estate (CRE) exposures and unfavorable geographic concentrations. Furthermore, we think the company's financial flexibility has decreased somewhat in recent weeks, which could hurt its ability to access the debt and equity markets on favorable terms.

We think net losses at Regions will remain significant over the next several quarters given our expectations of ongoing elevated loan-loss provisions. While the company's financial performance improved somewhat in the first half of this year, the most recent quarter largely undid this progress, particularly as it relates to asset quality, and remains weak in our opinion. In third-quarter 2010, operating losses remained high, hurt by a sequential rebound in loan-loss provisions resulting from elevated problem asset dispositions. These dispositions resulted in $233 million of incremental net charge-offs. Also, the company is still seeing declines in commercial property valuations within its geographic footprint based on updated real estate appraisals. Moreover, the company fared poorly in our credit stress testing, which was updated with slightly higher loss assumptions for a number of loan portfolios at Regions.

In our opinion, credit quality has also not improved substantially, unlike at certain regional bank peers. Specifically, overall loan performance appeared to deteriorate meaningfully in the third quarter after some improvement in the second quarter. We believe that loan performance at Regions will continue to lag many other large regional banks given its significant CRE loan exposures and large exposures in the Southeast, particularly in Florida and Georgia. Combined, these two economically depressed states represent about one-fourth of the company's total loans and about one-third of its investor real estate loans, by our estimate. As such, we think any improvement in loan performance will be at best gradual over the next several quarters. As of Sept. 30, 2010, the allowance for loan losses was just over 50% of gross nonperforming assets (NPAs; including delinquent and restructured loans), by our calculation--which is somewhat below several other large regional bank peers.

We currently view the company's capital ratios as to some extent aggressive, and see continued modest pressure on them in the near term. In the third quarter of 2010, the tangible common equity ratio declined slightly sequentially to 6.13%, despite a contraction in the balance sheet, and it remains lower than those of most large regional bank peers. This trend is in contrast with most other large regional banks, which are generally increasing their capital ratios. Finally, the company's ratios under our risk-adjusted capital framework have been trending lower in recent quarters and are also below most other U.S. regional banks that we rate.

Positively, we think liquidity is strong, as reflected by the improvement in the ratio of loans to deposits in recent quarters and large cash balances at the parent holding company, which totaled just more than $4.5 billion as of Sept. 30, 2010. However, we think liquidity at the parent could be reduced should regulators require the company to downstream additional equity capital to its primary bank subsidiary. Furthermore, we think that Regions' financial flexibility has been modestly reduced in recent weeks given wider spreads on the company's outstanding debt and declines in its common stock price (see related research section).

We think the company maintains a good competitive position in the markets in which it operates and is well diversified by business line, which also support the ratings. However, senior management turnover, particularly in the risk-management department, has been high in recent quarters, which we view somewhat negatively in our overall rating assessment.

Outlook

The negative outlook reflects our belief that the rating could remain under pressure, primarily given Regions' large CRE loan exposures and unfavorable geographic concentrations. If loan performance or capital ratios deteriorate meaningfully from current levels or if operating losses do not moderate, we could lower the rating. More specifically, the rating may come under further pressure if NPAs, including past-due and restructured loans, exceeds 7.5% of total loans or if the tangible common equity ratio declines significantly below 6%. Alternatively, if financial performance improves materially, we could revise the outlook to stable.