Is Regions Financial Due for a Bounce?

Regions Financial (RF) has plummeted to $11.40 from its July 2007 levels of $32. For most of 2008, RF traded in the $18-22 range, but since May, RF has been on a pronounced downtrend. It’s also important to note, that the regional banking group as a whole, has been extremely weak for the past several weeks.

Regions fell 7.4% on Tuesday, June 17th, and then fell 10.4% on Wednesday. In the last 30 days, RF has plummeted 45%. Also under pressure are Suntrust (STI), Key Corp (KEY), Fifth Third (FITB), BB&T (BBT), and Wachovia (WB). Looking at the table, most of the 3 & 6 month cumulative losses occurred just in the last month.



The obvious question- is the selling overdone? Regions may be due for a bounce. The two key possibilities that must be examined are 1) Has indiscriminate selling of the regional bank industry unfairly punished RF shares? 2) Does the market know that disappointing news from RF is imminent- or consensus EPS estimate revisions?

Regarding the first possibility- if shares have been unfairly crushed, then the answer is simple: RF should be bought. In order to ascertain if RF’s situation differs from the rest of its peers, the second possibility needs to be examined.

It’s tough to predict negative news announcements and earnings misses. However, it’s rather apparent that investors have been pricing in these events. Thus, the balance of risks appears favorable. If earnings come in below the consensus, or if the dividend is cut etc., it’s likely that much, if not all, are already reflected in the share price. Therefore, disappointing news wouldn’t adversely affect RF’s stock price. If news turns out to be better than expected, then RF should rally. Hence, the potential upside exceeds the risk to the downside; this creates a favorable risk-return tradeoff.

Asset Quality:
Regions Financial doesn’t have any sub-prime exposure. It did have a sub-prime origination business- EquiFirst, but those mortgages were sold servicing-released and not retained on the books. Regions sold EquiFirst to Barclays (BCS) back in 2007. In addition, Regions isn’t exposed to non-traditional mortgages such as option ARMs or loans with teaser rates.

Regions' primary concern is its $11.5 billion construction loan portfolio with $447 million in non-performing loans. Regions hasn’t had to take any major write-downs, and earnings have held up in the past several quarters relative to peers.



Earnings Expectations:
Analysts are forecasting EPS of 48 cents for the June quarter, which is down from 54 cents 90 days ago. For FY08, the consensus estimate is $1.95, down from $2.14 three months ago, but has been steady for the past month. Regions is trading 5.8x this year’s EPS estimate. This is quite low given RF’s 12.8x 5-year average and industry average of 13.5x. This might suggest that investors expect Regions to earn half of the current consensus, or 97 cents for FY08.

The trailing 12m dividend is $1.50, a yield of 13.2%. The stock price definitely reflects a cut or elimination. A 5% dividend yield at the current share price would be 57 cents. Assuming a 60% payout ratio, EPS would need to total at least 95 cents over the next 4 quarters.






It appears that analysts haven’t revised RF estimates down to reflect current market expectations. Why do investors think estimates are too high? It’s likely concerns center on Regions' construction lending portfolio as it has been deteriorating. 3.5B of the 6.2B residential homebuilder segment consists of vacant lot and land, which could experience high losses. Regions' management states that they are moving aggressively to manage losses in this portfolio.

Regions recorded a loan loss provision of 181 million for 1Q08, down from 358 million in 4Q07. It’s likely that Q2’s provision will have to return to at least 400 million. Even so, RF has been reducing costs through last year’s merger with AmSouth. In the March quarter, merger cost saves totaled 127 million, and management expects total cost saves of 700 million by year-end 2008. In addition, Regions Financial also owns Morgan Keegan, a strong brokerage firm, which will help diversify revenue streams during this downturn.

Short Interest:
RF’s short interest surged 13.1 million shares (27%) during the last period reported (May 15-30). This represents about 9% of the outstanding share float with cover ratio of 6.3 days. Since the last report, short interest has likely increased further given the declining share price. Short interest represents future share demand as shorts must buy shares to cover their positions.

Option investors are betting on further share declines in RF shares. On Wednesday, trading in Regions Financial's options surged to eight times the normal daily volume, as investors bought 48,000 puts and 8,000 calls. Activity was heavy in the July $10 puts, trading at 95 cents and will be in the money if RF slides below $9.05 before July 18.

It’s quite evident that investors are negative on RF. This positive aspect is that weak sellers are folding their hands and negative expectations are being priced-in. With so many investors negative, the supply of sellers begins to dry up, as the supply of future buyers increases. If future developments are not as dire as expected, then RF should see a nice bounce as short-sellers scramble to cover positions.





Conclusion:
Capital ratios are decent- Tier 1 capital ratio is 7.3% and Total capital ratio is 11.1%. These are well above the minimum requirements of 4% and 8%. Regions book value / share is $28.82 resulting in a P/BV of 0.4x.

Thus, the selling of RF shares has been warranted, but has it been overdone? Or, is there more selling to come? Regions revenue streams are diversified with its banking, brokerage, and insurance businesses. Regions is also aggressively improving its cost structure through its merger cost reduction plan. The combination of these factors should help offset, to a degree, future write-downs and loan losses. RF has adequate capital ratios, thus I don’t foresee a major equity capital raising.

I believe current share prices can withstand a 50% reduction to earnings and the dividend, as these possibilities are priced-in. Thus, I think, with a considerable amount of negative news already discounted, there is significant upside potential. Hence, the balance of risks is favorable possibly making RF due for a bounce.

Disclosure: None

Comments

[mastachopchop]

Why does everyone want to be a hero? Even after bear stearns people still want to jump in and catch falling knives. Do you realize their loan portfolio has significant exposure to Florida? Just yesterday FTIB gave us an update and said Florida is a complete mess. But you want to step in and say Regions is a buy, huh? Did you notice the way the shares dropped on the day GS posted good earnings? Sentiment is horrible for a reason. And with supposed fed hikes in the near future you still think regions is a buy? Come on dude. Do your homework. This is the reason why we are in this mess in the first place. People want to make an easy buck without reading a 10K.

[T Muller]

I know they have significant exposure to Florida, and that their construction loan portfolio is a complete mess. But you miss my point. Much, if not all of this information is priced into the stock, in my opinion.

Sentiment is horrible for a reason, I agree, and I think is hard to get much worse, thus easier to improve.

Regions has 144B in assets and 96B loan portfolio, thus the loans in question are a very small portion.

[mastachopchop]

Why do you feel the shares fully discount all of the risk? Just because its lost half of its market value in the last few weeks? I saw the word value investor in your bio, but dont mistake this for value. This is crap at its finest.

Why are you only highlighting the construction loans? Their 2nd lien residential portfolio in Florida is straight boo boo as well. I also saw some condo exposure in there. They have all that good stuff. And even though the company claims LTVs < 75%, this is based on housing prices from the good old days. Today its much different and those LTVs are much higher. I dont know if all of this is fully priced in. What I do know is that this situation is evolving much quicker that the banks expected. Notice all of the revised loan loss estimates coming from mgmt teams. They have no idea what is happening from one month to another.

Sentiment can get much worse. Have we had any large regional bank bankruptcies? Nope. Look at the last credit cycle (1990) and compare how many banks went bust versus today. We have a long way to go.

[T Muller]

I agree with what you are saying. I am not mistaking this for value, just that it's possible that expectations are overdone as well as being reflected in the stock price. I am not sure that it truly is. But, what has changed at RF to warrant such recent price declines? There has been nothing RF specific, however there has been a host of negative news from its peers.

Regions is not an exception, however. But, management has seemed pretty upbeat the last several conference calls compared with more negative comments coming from peer banks.

The thing that strikes me is FHN- First Horizon, who has significant construction loans in Florida, has experienced deterioration much sooner than Regions has. I don't why there would be a 6 month or so lag, unless management has been real slow to give the true story.FHN is an example of a regional bank having severe issues.

You raise good points, and I am not all bullish on the industry, but short-term, I think it's possible that much downside risk has been priced in. Regions has Morgan Keegan and an insurance business that generates a good amount of revenue, as does the bank. I expect so big write-downs and losses, but I do think RF can sustain it's earnings enough to pay a 5% dividend at its current share price.

[Player]

I think the problems here are more qualitative than quantitative...if you catch my drift.

[huangjin]

The main question is what do the majority of investors (weighted by $$$, not individuals) think about the financial and housing mess? Even the bankers do not know. A few months (or in the case of KeyCorp, a few weeks) after saying everything is fine, they are out begging for money. What is really priced in here? Are 2 more years of housing declines, plus a recession leading to far more foreclosures, priced in? Are bank failures priced in? At some point people will be overly pessimistic, but I don't think we're there yet.

[Nimrod]

Thanks for your RF analysis and report. I have found it to be the most informative and balanced of any that I have read on Regions in recent weeks. Value and perception are both in the eye of the beholder. There is little doubt in my mind that shorts will force RF lower in coming weeks, but that only sets up the potential for a more noteworthy bounce, if and when it comes. Looking back a few years from now, we may be view this period as having been a rare opportunity for both traders and value investors. Barring any earlier reports from RF, I suppose we will move to the next chapter on Jul 22 when 2nd quarter results are reported.

[edit5410]

The market never tempers. RF decline is overdone. When equitites trade like commodities' volatility at the extremes, there is money to be made. The risk/reward now is with the longs, not shorting or buying puts. Its fun to watch bounces. RF may bounce before the earnings call.

[Aalan]

Thank you for the detailed analysis, Turley. Nice work.
I can see the point of the critics who think there aren't enough writedowns. Given this economy, flooding disaster, etc. the NPL figures are way too low. Still, at price/book ratio of 0.4, I think you are right about most of this already being priced in. The stock is oversold by any measure that I know of.
While I was checking this out, I see that it bottomed out at 10.41 today; as I write it's "up" to 11.13. So you may have just nailed the bottom for us. I'm betting (a little bit) on it.

[gaucho]

Take a close look at Regions NPL table. This show a normal reaestate market or a slite bump in the road for the company. The only problem is the real estate train has hit a brick wall. So where are the real numbers. Those are to good to be true given the markets they are in. It is not as if management would LIE. Now would they?

[Ex15:26]

Gaucho!!! Exactly!
Management may be upbeat, but that's just because they were able to sell their remaining personal shares as the stock ticked up for once!

I'm kidding, I think the theme I keep hearing from folks is that "it's overdone and there are values out there".
Yes, they are probably correct, however you must be able to trust the companies and what they are saying.
In the case of some of the larger banks, management doesn't even know what is in their portfolios and so how could they even know what guidance to give.
I bet banks like STI that gave guidance that their loan losses were in line with expectations and the dividend is safe.... will regret that.
The turnaround is contingent on a turnaround in the real estate market and overall economy. Both are not happening now.
As the consumer gets tighter and tighter we're going to see homeowners with 2nd liens and HELOCs walk, I can guarantee that these are not priced in.

[DanielJacome]

Disclosure about author's working @ the mortgage division @ RF should have been made.

[late-to-jazzmusician]

I've been buying Regions for the last nine months... Yeah, ouch. But I think it is near bottom and agree with Mr. Miller's analysis: This selling is overdone and most of the bad news is priced in. A drop in the dividend - which Regions has never had - would hurt, but the upside from there is significant. I'm buying more before July 22. If the stock bombs on that day, I'll get even more afterwards. I hate to buy a negative momentum stock, but I think the market has this one wrong. We'll see on July 23...

[T Muller]

Author left Regions Mortgage more than 18 months ago and since has no relationship/interests with RF. I guess it should have been disclosed for the sake of transparency.

[mastachopchop]

So you worked at Regions mortgage in 2006? Dude, fill us in on the details. How bad were the underwriting standards back then? Any details on the AM South acquisition which was purchased at the peak of the cycle?

[T Muller]

I can't really speak to the underwriting since I worked in secondary marketing.

The underwriting depends on who is securitizing or buying the mortgage. Majority of the mortgages were sold, and some of the short-term ARMS went to the bank's portfolio. Those mortgages, as management has said, aren't the subprime no doc, or exotic types that we see with CFC, WM, WB, etc. Looking back at the situation now, It seems the bank was pretty diligent in portfolio-ing loans.

Some of the programs from other lenders were pretty laughable A Large portion of our production we pooled into agency MBS and sold to the Street.

Overall, Regions has been conservative. If you look back, you will see in 2005, RF Mortgage sold its wholesale lending division. This was nationwide and accounted for around 50% or more of total production. The wholesale channel is one thing killing WM and WFC, Wells CEO was griping on a cc how almost the NPL were 3rd-party originations. Many on these banks did home equity through wholesale/corresponden... network.

Regions home equity & construction loans weren't originated through the mortgage company. These were done in-house through the bank's consumer lending dept. According to management, these are "relationship&quo... loans , manually underwritten, high quality borrowers.

In 2006, the Amsouth merger was announced, and essentially the combination resulted in downsizing mortgage segment and in 2007 I saw that RF disbanded the mortgage company and migrated mortgage lending to the bank's treasury area.

Even though the Amsouth merger was at peak of cycle, RF acquired at a discount to market price. That was pretty crazy. Never seen that before.

Regions has a diversified loan portfolio and revenue streams. The retail banking is quite poor, JD Power gave RF bad ratings which is no surprise, Been hearing that for a while. Don't know if it's just because all the mergers - UPC-RF in '04 then ASO in '06 and all the subsequent turnover has been holding RF back, or if it's something that will never get better. The positive is that have significant room for improvement, but that also means RF is at a competitive disadvantage right now.

One problem is the corporate governance. I believe this deters a lot of institutional investors. If this was significantly improved, the stock would rise just from removing the corp/gov discount.

I would never be inclined to invest in RF besides the current moment. A bank I would be interested in is FHN, great franchise but horrible loan portfolio and is in some trouble, so I wouldn't touch it now. Maybe down the road I'll take a closer look when some of this stuff is behind us.

[User 117900]

It appears Regions has little regard for it's shareholders. The dividend cut did not have to be this severe. This will cost me about $5,000 annually in addition to the drastic drop in the stock price.