UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
x | Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended March 31, 2010
or
¨ | Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the transition period from to
Commission File Number: 000-50831
Regions Financial Corporation
(Exact name of registrant as specified in its charter)
Delaware | 63-0589368 | |
(State or other jurisdiction of incorporation or organization) |
(IRS Employer Identification Number) | |
1900 Fifth Avenue North Birmingham, Alabama |
35203 | |
(Address of principal executive offices) | (Zip code) |
(205) 326-5807
(Registrants telephone number, including area code)
NOT APPLICABLE
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes ¨ No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨ (Do not check if a smaller reporting company) Smaller reporting company ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes x No
The number of shares outstanding of each of the issuers classes of common stock was 1,192,471,000 shares of common stock, par value $.01, outstanding as of April 30, 2010.
FORM 10-Q
INDEX
Page | ||||||
Part I. Financial Information |
||||||
Item 1. |
||||||
Consolidated Balance SheetsMarch 31, 2010, December 31, 2009 and March 31, 2009 |
5 | |||||
Consolidated Statements of OperationsThree months ended March 31, 2010 and 2009 |
6 | |||||
7 | ||||||
Consolidated Statements of Cash FlowsThree months ended March 31, 2010 and 2009 |
8 | |||||
9 | ||||||
Item 2. |
Managements Discussion and Analysis of Financial Condition and Results of Operations |
41 | ||||
Item 3. |
73 | |||||
Item 4. |
73 | |||||
Part II. Other Information |
||||||
Item 1. |
74 | |||||
Item 1A. |
75 | |||||
Item 2. |
76 | |||||
Item 6. |
77 | |||||
78 |
2
Forward-Looking Statements
This Quarterly Report on Form 10-Q, other periodic reports filed by Regions Financial Corporation (Regions) under the Securities Exchange Act of 1934, as amended, and any other written or oral statements made by or on behalf of Regions may include forward-looking statements. The Private Securities Litigation Reform Act of 1995 (the Act) provides a safe harbor for forward-looking statements which are identified as such and are accompanied by the identification of important factors that could cause actual results to differ materially from the forward-looking statements. For these statements, we, together with our subsidiaries, claim the protection afforded by the safe harbor in the Act. Forward-looking statements are not based on historical information, but rather are related to future operations, strategies, financial results or other developments. Forward-looking statements are based on managements expectations as well as certain assumptions and estimates made by, and information available to, management at the time the statements are made. Those statements are based on general assumptions and are subject to various risks, uncertainties and other factors that may cause actual results to differ materially from the views, beliefs and projections expressed in such statements. These risks, uncertainties and other factors include, but are not limited to, those described below:
| In 2008, the Emergency Economic Stabilization Act of 2008 became law, and in February 2009 the American Recovery and Reinvestment Act of 2009 was signed into law. Additionally, the U.S. Treasury and federal banking regulators are implementing a number of programs to address capital and liquidity issues in the banking system, and there are a number of pending legislative, regulatory and tax proposals, all of which may have significant effects on Regions and the financial services industry, the exact nature and extent of which cannot be determined at this time. |
| The impact of compensation and other restrictions imposed under the Troubled Asset Relief Program (TARP) until Regions is able to repay the outstanding preferred stock and warrant issued under the TARP. |
| Possible additional loan losses, impairment of goodwill and other intangibles, and adjustment of valuation allowances on deferred tax assets and the impact on earnings and capital. |
| Possible changes in interest rates may affect funding costs and reduce earning asset yields, thus reducing margins. |
| Possible changes in general economic and business conditions in the United States in general and in the communities Regions serves in particular. |
| Possible changes in the creditworthiness of customers and the possible impairment of the collectability of loans. |
| Possible changes in trade, monetary and fiscal policies, and other activities of governments, agencies, and similar organizations, including changes in accounting standards, may have an adverse effect on business. |
| The current stresses in the financial and real estate markets, including possible continued deterioration in property values. |
| Regions ability to manage fluctuations in the value of assets and liabilities and off-balance sheet exposure so as to maintain sufficient capital and liquidity to support Regions business. |
| Regions ability to achieve the earnings expectations related to businesses that have been acquired or that may be acquired in the future. |
| Regions ability to expand into new markets and to maintain profit margins in the face of competitive pressures. |
| Regions ability to develop competitive new products and services in a timely manner and the acceptance of such products and services by Regions customers and potential customers. |
| Regions ability to keep pace with technological changes. |
3
| Regions ability to effectively manage credit risk, interest rate risk, market risk, operational risk, legal risk, liquidity risk, and regulatory and compliance risk. |
| Regions ability to ensure adequate capitalization is impacted by inherent uncertainties in forecasting credit losses. |
| The cost and other effects of material contingencies, including litigation contingencies. |
| The effects of increased competition from both banks and non-banks. |
| The effects of geopolitical instability and risks such as terrorist attacks. |
| Possible changes in consumer and business spending and saving habits could affect Regions ability to increase assets and to attract deposits. |
| The effects of weather and natural disasters such as droughts and hurricanes, and the effects of the Gulf of Mexico oil spill. |
The words believe, expect, anticipate, project, and similar expressions often signify forward-looking statements. You should not place undue reliance on any forward-looking statements, which speak only as of the date made. We assume no obligation to update or revise any forward-looking statements that are made from time to time.
See also Item 1A. Risk Factors of Regions Annual Report on Form 10-K for the year ended December 31, 2009 and of this Form 10-Q.
4
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
REGIONS FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31 2010 |
December 31 2009 |
March 31 2009 |
||||||||||
(In millions, except share data) | ||||||||||||
Assets | ||||||||||||
Cash and due from banks |
$ | 2,252 | $ | 2,052 | $ | 2,429 | ||||||
Interest-bearing deposits in other banks |
4,295 | 5,580 | 2,288 | |||||||||
Federal funds sold and securities purchased under agreements to resell |
324 | 379 | 418 | |||||||||
Trading account assets |
1,238 | 3,039 | 1,348 | |||||||||
Securities available for sale |
24,219 | 24,069 | 20,970 | |||||||||
Securities held to maturity |
30 | 31 | 45 | |||||||||
Loans held for sale (includes $549, $780 and $1,365 measured at fair value at March 31, 2010, December 31, 2009 and March 31, 2009, respectively) |
1,048 | 1,511 | 1,956 | |||||||||
Loans, net of unearned income |
88,174 | 90,674 | 95,686 | |||||||||
Allowance for loan losses |
(3,184 | ) | (3,114 | ) | (1,861 | ) | ||||||
Net loans |
84,990 | 87,560 | 93,825 | |||||||||
Other interest-earning assets |
819 | 734 | 849 | |||||||||
Premises and equipment, net |
2,637 | 2,668 | 2,808 | |||||||||
Interest receivable |
503 | 468 | 426 | |||||||||
Goodwill |
5,559 | 5,557 | 5,551 | |||||||||
Mortgage servicing rights |
270 | 247 | 161 | |||||||||
Other identifiable intangible assets |
472 | 503 | 603 | |||||||||
Other assets |
8,574 | 7,920 | 8,303 | |||||||||
Total assets |
$ | 137,230 | $ | 142,318 | $ | 141,980 | ||||||
Liabilities and Stockholders Equity | ||||||||||||
Deposits: |
||||||||||||
Non-interest-bearing |
$ | 23,391 | $ | 23,204 | $ | 19,988 | ||||||
Interest-bearing |
74,941 | 75,476 | 73,548 | |||||||||
Total deposits |
98,332 | 98,680 | 93,536 | |||||||||
Borrowed funds: |
||||||||||||
Short-term borrowings: |
||||||||||||
Federal funds purchased and securities sold under agreements to repurchase |
1,687 | 1,893 | 2,828 | |||||||||
Other short-term borrowings |
997 | 1,775 | 6,525 | |||||||||
Total short-term borrowings |
2,684 | 3,668 | 9,353 | |||||||||
Long-term borrowings |
15,683 | 18,464 | 18,762 | |||||||||
Total borrowed funds |
18,367 | 22,132 | 28,115 | |||||||||
Other liabilities |
2,893 | 3,625 | 3,512 | |||||||||
Total liabilities |
119,592 | 124,437 | 125,163 | |||||||||
Stockholders equity: |
||||||||||||
Preferred stock, authorized 10 million shares |
||||||||||||
Series A, cumulative perpetual participating, par value $1.00 (liquidation preference $1,000.00) per share, net of
discount; |
3,351 | 3,343 | 3,316 | |||||||||
Series B, mandatorily convertible, cumulative perpetual participating, par value $1,000.00 (liquidation preference $1,000.00) per
share; |
259 | 259 | | |||||||||
Common stock, par value $.01 per share: |
||||||||||||
Authorized 1.5 billion shares |
||||||||||||
Issued including treasury stock1,235,340,936, 1,235,850,589 and 738,570,609 shares, respectively |
12 | 12 | 7 | |||||||||
Additional paid-in capital |
18,781 | 18,781 | 16,828 | |||||||||
Retained earnings (deficit) |
(3,502 | ) | (3,235 | ) | (1,913 | ) | ||||||
Treasury stock, at cost43,166,437, 43,241,020 and 43,676,701 shares, respectively |
(1,407 | ) | (1,409 | ) | (1,415 | ) | ||||||
Accumulated other comprehensive income (loss), net |
144 | 130 | (6 | ) | ||||||||
Total stockholders equity |
17,638 | 17,881 | 16,817 | |||||||||
Total liabilities and stockholders' equity |
$ | 137,230 | $ | 142,318 | $ | 141,980 | ||||||
See notes to consolidated financial statements.
5
REGIONS FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended March 31 | |||||||
2010 | 2009 | ||||||
(In millions, except per share data) | |||||||
Interest income on: |
|||||||
Loans, including fees |
$ | 945 | $ | 1,099 | |||
Securities: |
|||||||
Taxable |
242 | 239 | |||||
Tax-exempt |
1 | 7 | |||||
Total securities |
243 | 246 | |||||
Loans held for sale |
8 | 15 | |||||
Federal funds sold and securities purchased under agreements to resell |
| 1 | |||||
Trading account assets |
12 | 12 | |||||
Other interest-earning assets |
7 | 6 | |||||
Total interest income |
1,215 | 1,379 | |||||
Interest expense on: |
|||||||
Deposits |
242 | 366 | |||||
Short-term borrowings |
3 | 20 | |||||
Long-term borrowings |
139 | 184 | |||||
Total interest expense |
384 | 570 | |||||
Net interest income |
831 | 809 | |||||
Provision for loan losses |
770 | 425 | |||||
Net interest income after provision for loan losses |
61 | 384 | |||||
Non-interest income: |
|||||||
Service charges on deposit accounts |
288 | 269 | |||||
Brokerage, investment banking and capital markets |
236 | 217 | |||||
Mortgage income |
67 | 73 | |||||
Trust department income |
48 | 46 | |||||
Securities gains, net |
59 | 53 | |||||
Leveraged lease termination gains |
19 | 323 | |||||
Other |
95 | 85 | |||||
Total non-interest income |
812 | 1,066 | |||||
Non-interest expense: |
|||||||
Salaries and employee benefits |
575 | 539 | |||||
Net occupancy expense |
120 | 107 | |||||
Furniture and equipment expense |
74 | 76 | |||||
Other |
461 | 336 | |||||
Total non-interest expense |
1,230 | 1,058 | |||||
Income (loss) before income taxes |
(357 | ) | 392 | ||||
Income taxes |
(161 | ) | 315 | ||||
Net income (loss) |
$ | (196 | ) | $ | 77 | ||
Net income (loss) available to common shareholders |
$ | (255 | ) | $ | 26 | ||
Weighted-average number of shares outstanding: |
|||||||
Basic |
1,194 | 693 | |||||
Diluted |
1,194 | 694 | |||||
Earnings (loss) per common share: |
|||||||
Basic |
$ | (0.21 | ) | $ | 0.04 | ||
Diluted |
(0.21 | ) | 0.04 | ||||
Cash dividends declared per common share |
0.01 | 0.10 |
See notes to consolidated financial statements.
6
REGIONS FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
Preferred Stock | Common Stock | Additional Paid-In Capital |
Retained Earnings (Deficit) |
Treasury Stock, At Cost |
Accumulated Other Comprehensive Income (Loss) |
Total | |||||||||||||||||||||||||
Shares | Amount | Shares | Amount | ||||||||||||||||||||||||||||
(In millions, except share and per share data) | |||||||||||||||||||||||||||||||
BALANCE AT JANUARY 1, 2009 |
4 | $ | 3,307 | 691 | $ | 7 | $ | 16,815 | $ | (1,869 | ) | $ | (1,425 | ) | $ | (22 | ) | $ | 16,813 | ||||||||||||
Comprehensive income: |
|||||||||||||||||||||||||||||||
Net income |
| | | | | 77 | | | 77 | ||||||||||||||||||||||
Net change in unrealized gains and losses on securities available for sale, net of tax and reclassification adjustment* |
| | | | | | | 52 | 52 | ||||||||||||||||||||||
Net change in unrealized gains and losses on derivative instruments, net of tax and reclassification adjustment* |
| | | | | | | (35 | ) | (35 | ) | ||||||||||||||||||||
Net change from defined benefit pension plans, net of tax* |
| | | | | | | (1 | ) | (1 | ) | ||||||||||||||||||||
Comprehensive income |
93 | ||||||||||||||||||||||||||||||
Cash dividends declared - $0.10 per share |
| | | | | (70 | ) | | | (70 | ) | ||||||||||||||||||||
Preferred dividends |
| | | | | (42 | ) | | | (42 | ) | ||||||||||||||||||||
Preferred stock transactions: |
|||||||||||||||||||||||||||||||
Discount accretion |
| 9 | | | | (9 | ) | | | | |||||||||||||||||||||
Common stock transactions: |
|||||||||||||||||||||||||||||||
Stock transactions under compensation plans, net |
| | 4 | | 5 | | 10 | | 15 | ||||||||||||||||||||||
Amortization of unearned restricted stock and related adjustments |
| | | | 8 | | | | 8 | ||||||||||||||||||||||
BALANCE AT MARCH 31, 2009 |
4 | $ | 3,316 | 695 | $ | 7 | $ | 16,828 | $ | (1,913 | ) | $ | (1,415 | ) | $ | (6 | ) | $ | 16,817 | ||||||||||||
BALANCE AT JANUARY 1, 2010 |
4 | $ | 3,602 | 1,193 | $ | 12 | $ | 18,781 | $ | (3,235 | ) | $ | (1,409 | ) | $ | 130 | $ | 17,881 | |||||||||||||
Comprehensive income (loss): |
|||||||||||||||||||||||||||||||
Net income (loss) |
| | | | | (196 | ) | | | (196 | ) | ||||||||||||||||||||
Net change in unrealized gains and losses on securities available for sale, net of tax and reclassification adjustment* |
| | | | | | | 29 | 29 | ||||||||||||||||||||||
Net change in unrealized gains and losses on derivative instruments, net of tax and reclassification adjustment* |
| | | | | | | (18 | ) | (18 | ) | ||||||||||||||||||||
Net change from defined benefit pension plans, net of tax* |
| | | | | | | 3 | 3 | ||||||||||||||||||||||
Comprehensive income (loss) |
(182 | ) | |||||||||||||||||||||||||||||
Cash dividends declared - $0.01 per share |
| | | | | (12 | ) | | | (12 | ) | ||||||||||||||||||||
Preferred dividends |
| | | | | (51 | ) | | | (51 | ) | ||||||||||||||||||||
Preferred stock transactions: |
|||||||||||||||||||||||||||||||
Discount accretion |
| 8 | | | | (8 | ) | | | | |||||||||||||||||||||
Common stock transactions: |
|||||||||||||||||||||||||||||||
Stock transactions under compensation plans, net |
| | | | 2 | | 2 | | 4 | ||||||||||||||||||||||
Amortization of unearned restricted stock and related adjustments |
| | (1 | ) | | (2 | ) | | | | (2 | ) | |||||||||||||||||||
BALANCE AT MARCH 31, 2010 |
4 | $ | 3,610 | 1,192 | $ | 12 | $ | 18,781 | $ | (3,502 | ) | $ | (1,407 | ) | $ | 144 | $ | 17,638 | |||||||||||||
See notes to consolidated financial statements.
* | See disclosure of reclassification adjustment amount and tax effect, as applicable, in Note 3 to the consolidated financial statements. |
7
REGIONS FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended March 31 | ||||||||
2010 | 2009 | |||||||
(In millions) | ||||||||
Operating activities: |
||||||||
Net income (loss) |
$ | (196 | ) | $ | 77 | |||
Adjustments to reconcile net cash provided by operating activities: |
||||||||
Provision for loan losses |
770 | 425 | ||||||
Depreciation and amortization of premises and equipment |
73 | 68 | ||||||
Provision for losses on other real estate, net |
32 | 19 | ||||||
Net amortization (accretion) of securities |
40 | (5 | ) | |||||
Net amortization of loans and other assets |
51 | 64 | ||||||
Net accretion of deposits and borrowings |
| (4 | ) | |||||
Net securities gains |
(59 | ) | (53 | ) | ||||
Loss on early extinguishment of debt |
53 | | ||||||
Other-than-temporary impairments, net |
1 | 3 | ||||||
Deferred income tax benefit |
(113 | ) | (139 | ) | ||||
Excess tax benefits from share-based payments |
(1 | ) | | |||||
Originations and purchases of loans held for sale |
(1,101 | ) | (2,477 | ) | ||||
Proceeds from sales of loans held for sale |
1,656 | 1,900 | ||||||
Gain on sale of loans, net |
(24 | ) | (37 | ) | ||||
Decrease (increase) in trading account assets |
1,801 | (298 | ) | |||||
(Increase) decrease in other interest-earning assets |
(85 | ) | 48 | |||||
(Increase) decrease in interest receivable |
(35 | ) | 32 | |||||
Increase in other assets |
(445 | ) | (285 | ) | ||||
(Decrease) increase in other liabilities |
(726 | ) | 32 | |||||
Other |
33 | 9 | ||||||
Net cash from operating activities |
1,725 | (621 | ) | |||||
Investing activities: |
||||||||
Proceeds from sales of securities available for sale |
1,443 | 795 | ||||||
Proceeds from maturites of: |
||||||||
Securities available for sale |
1,853 | 1,089 | ||||||
Securities held to maturity |
1 | 2 | ||||||
Purchases of: |
||||||||
Securities available for sale |
(3,381 | ) | (3,865 | ) | ||||
Proceeds from sales of loans |
299 | 88 | ||||||
Net decrease in loans |
1,225 | 1,167 | ||||||
Net purchases of premises and equipment |
(43 | ) | (90 | ) | ||||
Net cash received from deposits assumed |
| 279 | ||||||
Net cash from investing activities |
1,397 | (535 | ) | |||||
Financing activities: |
||||||||
Net (decrease) increase in deposits |
(348 | ) | 2,354 | |||||
Net decrease in short-term borrowings |
(984 | ) | (6,469 | ) | ||||
Proceeds from long-term borrowings |
| 100 | ||||||
Payments on long-term borrowings |
(2,870 | ) | (560 | ) | ||||
Cash dividends on common stock |
(12 | ) | (70 | ) | ||||
Cash dividends on preferred stock |
(51 | ) | (42 | ) | ||||
Proceeds from stock transactions under compensation plans |
2 | 5 | ||||||
Excess tax benefits from share-based payments |
1 | | ||||||
Net cash from financing activities |
(4,262 | ) | (4,682 | ) | ||||
Decrease in cash and cash equivalents |
(1,140 | ) | (5,838 | ) | ||||
Cash and cash equivalents at beginning of year |
8,011 | 10,973 | ||||||
Cash and cash equivalents at end of period |
$ | 6,871 | $ | 5,135 | ||||
See notes to consolidated financial statements.
8
REGIONS FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Three Months Ended March 31, 2010 and 2009
NOTE 1Basis of Presentation
Regions Financial Corporation (Regions or the Company) provides a full range of banking and bank-related services to individual and corporate customers through its subsidiaries and branch offices located primarily in Alabama, Arkansas, Florida, Georgia, Illinois, Indiana, Iowa, Kentucky, Louisiana, Mississippi, Missouri, North Carolina, South Carolina, Tennessee, Texas and Virginia. The Company is subject to competition from other financial institutions, is subject to the regulations of certain government agencies and undergoes periodic examinations by those regulatory authorities.
The accounting and reporting policies of Regions and the methods of applying those policies that materially affect the consolidated financial statements conform with accounting principles generally accepted in the United States (GAAP) and with general financial services industry practices. The accompanying interim financial statements have been prepared in accordance with the instructions for Form 10-Q and, therefore, do not include all information and notes to the consolidated financial statements necessary for a complete presentation of financial position, results of operations and cash flows in conformity with GAAP. In the opinion of management, all adjustments, consisting of only normal and recurring items, necessary for the fair presentation of the consolidated financial statements have been included. These interim financial statements should be read in conjunction with the consolidated financial statements and notes thereto in Regions Form 10-K for the year ended December 31, 2009.
Regions has evaluated all subsequent events for potential recognition and disclosure through the filing date of this Form 10-Q.
Certain amounts in prior period financial statements have been reclassified to conform to the current period presentation. These reclassifications are immaterial and have no effect on net income, total assets or stockholders equity.
NOTE 2Earnings (Loss) per Common Share
The following table sets forth the computation of basic earnings (loss) per common share and diluted earnings (loss) per common share:
Three Months Ended March 31 |
||||||||
2010 | 2009 | |||||||
(In millions, except per share amounts) |
||||||||
Numerator: |
||||||||
Net income (loss) |
$ | (196 | ) | $ | 77 | |||
Preferred stock dividends and accretion |
(59 | ) | (51 | ) | ||||
Net income (loss) available to common shareholders |
$ | (255 | ) | $ | 26 | |||
Denominator: |
||||||||
Weighted-average common shares outstanding - basic |
1,194 | 693 | ||||||
Common stock equivalents |
| 1 | ||||||
Weighted-average common shares outstanding - diluted |
1,194 | 694 | ||||||
Earnings (loss) per common share: |
||||||||
Basic |
$ | (0.21 | ) | $ | 0.04 | |||
Diluted |
(0.21 | ) | 0.04 |
9
The effect from the assumed issuance of 61 million common shares upon conversion of mandatorily convertible preferred stock issued in May 2009 for the three months ended March 31, 2010 was not included in the above computations of diluted earnings (loss) per common share because such amounts would have had an antidilutive effect on earnings (loss) per common share (see Note 3 for further discussion). The effect from the assumed exercise of 50 million and 53 million stock options for the three months ended March 31, 2010 and 2009, respectively, was not included in the above computations of diluted earnings (loss) per common share because such amounts would have had an antidilutive effect on earnings (loss) per common share.
NOTE 3Stockholders Equity and Comprehensive Income (Loss)
On November 14, 2008, Regions completed the sale of 3.5 million shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A, par value $1.00 and liquidation preference $1,000.00 per share (and $3.5 billion liquidation preference in the aggregate) to the U.S. Treasury as part of the Capital Purchase Program (CPP). Regions will pay the U.S. Treasury on a quarterly basis a 5% dividend, or $175 million annually, for each of the first five years of the investment, and 9% thereafter unless Regions redeems the shares. Regions performed a discounted cash flow analysis to value the preferred stock at the date of issuance. For purposes of this analysis, Regions assumed that the preferred stock would most likely be redeemed five years from the valuation date based on optimal financial budgeting considerations. Regions used the Bloomberg USD US Bank BBB index to derive the market yield curve as of the valuation date to discount future expected cash flows to the valuation date. The discount rate used to value the preferred stock was 7.46%, based on this yield curve at a 5-year maturity. Dividends were assumed to be accrued until redemption. While the discounting was required based on a 5-year redemption, Regions did not have a 5-year security or similarly termed security available. As a result, it was necessary to use a benchmark yield curve to calculate the 5-year value. To determine the appropriate yield curve that was applicable to Regions, the yield to maturity on the outstanding debt instrument with the longest dated maturity (8.875% junior subordinated notes due June 2048) was compared to the longest point on the USD US Bank BBB index as of November 14, 2008. Regions concluded that the yield to maturity as of the valuation date of the debt, which was 11.03%, was consistent with the indicative yield of the curve noted above. The longest available point on this curve was 10.55% at 30 years.
As part of its purchase of the preferred securities, the U.S. Treasury also received a warrant to purchase 48.3 million shares of Regions common stock at an exercise price of $10.88 per share, subject to anti-dilution and other adjustments. The warrant expires ten years from the issuance date. Regions used the Cox-Ross-Rubinstein Binomial Option Pricing Model (CRR Model) to value the warrant at the date of issuance. The CRR Model is a standard option pricing model which incorporates optimal early exercise in order to receive the benefit of future dividend payments. Based on the transferability of the warrant, the CRR Model approach that was applied assumes that the warrant holder will not sub-optimally exercise its warrant. The following assumptions were used in the CRR Model:
Stock price (a) |
$ | 9.67 | ||
Exercise price (b) |
$ | 10.88 | ||
Expected volatility (c) |
45.22 | % | ||
Risk-free rate (d) |
4.25 | % | ||
Dividend yield (e) |
3.88 | % | ||
Warrant term (in years) (b) |
10 |
(a) | Closing stock price of Regions as of the valuation date (November 14, 2008). |
(b) | As outlined in the Warrant to Purchase Agreement, dated November 14, 2008. |
(c) | Expected volatility based on Regions historical volatility, as of November 14, 2008, over a look-back period of 10 years, commensurate with the terms of the warrant. |
(d) | The risk-free rate represents the yield on 10-year U.S. Treasury Strips as of November 14, 2008. |
(e) | The dividend yield assumption was calculated based on a weighting of 30% on managements dividend yield expectations for the next 3 years and a weighting of 70% on Regions average dividend yield over the 10 years prior to the valuation date. |
10
The fair value allocation of the $3.5 billion between the preferred shares and the warrant resulted in $3.304 billion allocated to the preferred shares and $196 million allocated to the warrant. Accrued dividends on the preferred shares reduced retained earnings by $44 million and $42 million during the first three months of 2010 and 2009, respectively. The unamortized discount on the preferred shares at March 31, 2010 was $149 million and $157 million at December 31, 2009. Discount accretion on the preferred shares reduced retained earnings by $8 million and $9 million during the first quarter of 2010 and 2009, respectively. Both the preferred securities and the warrant are accounted for as components of Regions regulatory Tier 1 Capital.
On May 20, 2009 the Company issued 287,500 shares of mandatory convertible preferred stock, Series B (Series B shares), generating net proceeds of approximately $278 million. Regions will pay annual dividends at a rate of 10% per share on the initial liquidation preference of $1,000.00 per share. Series B shares may be converted into common shares: 1) at December 15, 2010 (the mandatory conversion date); 2) prior to December 15, 2010 at the option of the holder; 3) upon occurrence of certain changes in ownership as defined in the offering documents; or 4) prior to December 15, 2010 at the option of the Company. At the mandatory conversion date, the Series B shares are subject to conversion into shares of Regions common stock with a per share conversion rate of not more than approximately 250 shares of common stock and not less than approximately 227 shares of common stock dependent upon the applicable market price, subject to anti-dilution adjustments. The Series B shares are not redeemable and rank senior to common stock and to each other class of capital stock established in the future, and on parity with the Series A preferred stock previously issued to the U.S. Treasury. If converted at March 31, 2010, approximately 61 million shares of Regions common stock would have been issued. In November 2009, a single investor converted approximately 20,000 Series B shares to common shares as allowed under the original transaction documents. Accrued dividends on the Series B shares reduced retained earnings by $7 million for the first three months of 2010. See Note 13 Subsequent Events to the consolidated financial statements for discussion of early conversion of the Series B shares subsequent to the balance sheet date.
On May 20, 2009, the Company announced a public equity offering and issued 460 million shares of common stock at $4 per share, generating proceeds of $1.8 billion, net of issuance costs.
In addition to the offerings mentioned above, the Company also exchanged approximately 33 million common shares for $202 million of outstanding 6.625% trust preferred securities issued by Regions Financing Trust II (the Trust) in the second quarter of 2009. The trust preferred securities were exchanged for junior subordinated notes issued by the Company to the Trust. The Company recognized a pre-tax gain of approximately $61 million on the extinguishment of the junior subordinated notes. The increase in stockholders equity related to the debt for common share exchange was approximately $135 million, net of issuance costs.
At March 31, 2010, Regions had 23.1 million common shares available for repurchase through open market transactions under an existing share repurchase authorization. There were no treasury stock purchases through open market transactions during the first three months of 2010. The Companys ability to repurchase its common stock is limited by the terms of the CPP mentioned above.
The Board of Directors declared a $0.01 cash dividend for the first quarter of 2010, compared to $0.10 for the first quarter of 2009. Regions does not expect to increase its quarterly dividend above $0.01 for the foreseeable future.
Comprehensive income (loss) is the total of net income (loss) and all other non-owner changes in equity. Items are recognized as components of comprehensive income (loss) and are displayed in the consolidated statements of changes in stockholders equity. In the calculation of comprehensive income (loss), certain reclassification adjustments are made to avoid double-counting items that are displayed as part of net income (loss) for a period that also had been displayed as part of other comprehensive income (loss) in that period or earlier periods.
11
The following disclosure reflects the components of comprehensive income (loss) and any associated reclassification amounts:
Three Months Ended March 31, 2010 | ||||||||||||
Before Tax | Tax Effect | Net of Tax | ||||||||||
(In millions) | ||||||||||||
Net income (loss) |
$ | (357 | ) | $ | 161 | $ | (196 | ) | ||||
Net unrealized holding gains and losses on securities available for sale arising during the period |
106 | (39 | ) | 67 | ||||||||
Less: reclassification adjustments for net securities gains realized in net income (loss) |
59 | (21 | ) | 38 | ||||||||
Net change in unrealized gains and losses on securities available for sale |
47 | (18 | ) | 29 | ||||||||
Net unrealized holding gains and losses on derivatives arising during the period |
34 | (13 | ) | 21 | ||||||||
Less: reclassification adjustments for net gains realized in net income (loss) |
63 | (24 | ) | 39 | ||||||||
Net change in unrealized gains and losses on derivative instruments |
(29 | ) | 11 | (18 | ) | |||||||
Net actuarial gains and losses arising during the period |
17 | (7 | ) | 10 | ||||||||
Less: amortization of actuarial loss and prior service credit realized in net income (loss) |
11 | (4 | ) | 7 | ||||||||
Net change from defined benefit plans |
6 | (3 | ) | 3 | ||||||||
Comprehensive income (loss) |
$ | (333 | ) | $ | 151 | $ | (182 | ) | ||||
Three Months Ended March 31, 2009 | ||||||||||||
Before Tax | Tax Effect | Net of Tax | ||||||||||
(In millions) | ||||||||||||
Net income |
$ | 392 | $ | (315 | ) | $ | 77 | |||||
Net unrealized holding gains and losses on securities available for sale arising during the period |
134 | (48 | ) | 86 | ||||||||
Less: reclassification adjustments for net securities gains realized in net income |
53 | (19 | ) | 34 | ||||||||
Net change in unrealized gains and losses on securities available for sale |
81 | (29 | ) | 52 | ||||||||
Net unrealized holding gains and losses on derivatives arising during the period |
39 | (15 | ) | 24 | ||||||||
Less: reclassification adjustments for net gains realized in net income |
95 | (36 | ) | 59 | ||||||||
Net change in unrealized gains and losses on derivative instruments |
(56 | ) | 21 | (35 | ) | |||||||
Net actuarial gains and losses arising during the period |
9 | (3 | ) | 6 | ||||||||
Less: amortization of actuarial loss and prior service credit realized in net income |
11 | (4 | ) | 7 | ||||||||
Net change from defined benefit plans |
(2 | ) | 1 | (1 | ) | |||||||
Comprehensive income |
$ | 415 | $ | (322 | ) | $ | 93 | |||||
12
NOTE 4Pension and Other Postretirement Benefits
Net periodic pension and other postretirement benefits cost included the following components:
For The Three Months Ended March 31 | ||||||||||||||
Pension | Other Postretirement Benefits | |||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||
(In millions) | ||||||||||||||
Service cost |
$ | 9 | $ | 1 | $ | | $ | | ||||||
Interest cost |
23 | 22 | 1 | | ||||||||||
Expected return on plan assets |
(25 | ) | (22 | ) | | | ||||||||
Amortization of actuarial loss |
11 | 11 | | | ||||||||||
$ | 18 | $ | 12 | $ | 1 | $ | | |||||||
During 2009, participant accruals of service in the Regions Financial Corporation Retirement Plan and the Companys current active non-qualified supplemental retirement plan (the SERP) were temporarily suspended resulting in a reduction in service cost. Effective January 1, 2010, the benefit accruals were reinstated for pension plan and SERP participants.
Matching contributions in the 401(K) plan were temporarily suspended beginning in the second quarter of 2009. Effective January 1, 2010, Regions restored matching contributions to the 401(K) plan to pre-existing levels.
NOTE 5Securities
The amortized cost, gross unrealized gains and losses, and estimated fair value of securities available for sale and securities held to maturity are as follows:
March 31, 2010 |
Cost | Gross Unrealized Gains |
Gross Unrealized Losses |
Estimated Fair Value | |||||||||
(In millions) | |||||||||||||
Securities available for sale: |
|||||||||||||
U.S. Treasury securities |
$ | 55 | $ | 4 | $ | | $ | 59 | |||||
Federal agency securities |
44 | 1 | | 45 | |||||||||
Obligations of states and political subdivisions |
46 | | | 46 | |||||||||
Mortgage-backed securities: |
|||||||||||||
Residential agency |
22,396 | 486 | (24 | ) | 22,858 | ||||||||
Residential non-agency |
23 | 3 | | 26 | |||||||||
Commercial agency |
19 | 2 | | 21 | |||||||||
Other debt securities |
26 | | (3 | ) | 23 | ||||||||
Equity securities |
1,128 | 13 | | 1,141 | |||||||||
$ | 23,737 | $ | 509 | $ | (27 | ) | $ | 24,219 | |||||
Securities held to maturity: |
|||||||||||||
U.S. Treasury securities |
$ | 7 | $ | | $ | | $ | 7 | |||||
Federal agency securities |
6 | 1 | | 7 | |||||||||
Mortgage-backed securities: |
|||||||||||||
Residential agency |
15 | | | 15 | |||||||||
Other debt securities |
2 | | | 2 | |||||||||
$ | 30 | $ | 1 | $ | | $ | 31 | ||||||
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December 31, 2009 |
Cost | Gross Unrealized Gains |
Gross Unrealized Losses |
Estimated Fair Value | |||||||||
(In millions) | |||||||||||||
Securities available for sale: |
|||||||||||||
U.S. Treasury securities |
$ | 46 | $ | 4 | $ | | $ | 50 | |||||
Federal agency securities |
44 | 1 | | 45 | |||||||||
Obligations of states and political subdivisions |
70 | | | 70 | |||||||||
Mortgage-backed securities: |
|||||||||||||
Residential agency |
22,271 | 474 | (61 | ) | 22,684 | ||||||||
Residential non-agency |
33 | 3 | | 36 | |||||||||
Commercial agency |
20 | 1 | | 21 | |||||||||
Other debt securities |
22 | | (3 | ) | 19 | ||||||||
Equity securities |
1,132 | 12 | | 1,144 | |||||||||
$ | 23,638 | $ | 495 | $ | (64 | ) | $ | 24,069 | |||||
Securities held to maturity: |
|||||||||||||
U.S. Treasury securities |
$ | 7 | $ | | $ | | $ | 7 | |||||
Federal agency securities |
6 | | | 6 | |||||||||
Mortgage-backed securities: |
|||||||||||||
Residential agency |
16 | | | 16 | |||||||||
Other debt securities |
2 | | | 2 | |||||||||
$ | 31 | $ | | $ | | $ | 31 | ||||||
Regions evaluates securities in a loss position for other-than-temporary impairment, considering such factors as the length of time and the extent to which the market value has been below cost, the credit standing of the issuer, Regions intent to hold the security and the likelihood that the Company will hold the security until its market value recovers. Activity related to the credit loss component of other-than-temporary impairment is recognized in earnings. For debt securities, the portion of other-than-temporary impairment related to all other factors is recognized in other comprehensive income. For the three months ended March 31, 2010, Regions recorded a credit related impairment charge of approximately $1 million. There were no non-credit related impairment charges recorded during the three months ended March 31, 2010.
14
The following tables present unrealized loss and estimated fair value of securities available for sale at March 31, 2010 and December 31, 2009. These securities are segregated between investments that have been in a continuous unrealized loss position for less than twelve months and twelve months or more.
Less Than Twelve Months |
Twelve Months or More | Total | |||||||||||||||||||
March 31, 2010 |
Estimated Fair Value |
Gross Unrealized Losses |
Estimated Fair Value |
Gross Unrealized Losses |
Estimated Fair Value |
Gross Unrealized Losses |
|||||||||||||||
(In millions) | |||||||||||||||||||||
Mortgage-backed securities: |
|||||||||||||||||||||
Residential agency |
$ | 4,475 | $ | (22 | ) | $ | 143 | $ | (2 | ) | $ | 4,618 | $ | (24 | ) | ||||||
Other debt securities |
| | 7 | (3 | ) | 7 | (3 | ) | |||||||||||||
$ | 4,475 | $ | (22 | ) | $ | 150 | $ | (5 | ) | $ | 4,625 | $ | (27 | ) | |||||||
Less Than Twelve Months |
Twelve Months or More | Total | |||||||||||||||||||
December 31, 2009 |
Estimated Fair Value |
Gross Unrealized Losses |
Estimated Fair Value |
Gross Unrealized Losses |
Estimated Fair Value |
Gross Unrealized Losses |
|||||||||||||||
(In millions) | |||||||||||||||||||||
Mortgage-backed securities: |
|||||||||||||||||||||
Residential agency |
$ | 6,686 | $ | (61 | ) | $ | | $ | | $ | 6,686 | $ | (61 | ) | |||||||
Other debt securities |
| | 8 | (3 | ) | 8 | (3 | ) | |||||||||||||
$ | 6,686 | $ | (61 | ) | $ | 8 | $ | (3 | ) | $ | 6,694 | $ | (64 | ) | |||||||
The gross unrealized loss on debt securities held to maturity was less than $1 million at March 31, 2010 and December 31, 2009.
For securities included in the tables above, management does not believe that any of the 127 securities and 151 securities at March 31, 2010 and December 31, 2009, respectively, in an individual loss position represented an other-than-temporary impairment as of those dates.
15
The cost and estimated fair value of securities available for sale and securities held to maturity at March 31, 2010, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Cost | Estimated Fair Value | |||||
(In millions) | ||||||
Securities available for sale: |
||||||
Due in one year or less |
$ | 35 | $ | 35 | ||
Due after one year through five years |
69 | 74 | ||||
Due after five years through ten years |
9 | 10 | ||||
Due after ten years |
58 | 54 | ||||
Mortgage-backed securities: |
||||||
Residential agency |
22,396 | 22,858 | ||||
Residential non-agency |
23 | 26 | ||||
Commercial agency |
19 | 21 | ||||
Equity securities |
1,128 | 1,141 | ||||
$ | 23,737 | $ | 24,219 | |||
Securities held to maturity: |
||||||
Due in one year or less |
$ | 5 | $ | 5 | ||
Due after one year through five years |
7 | 8 | ||||
Due after five years through ten years |
3 | 3 | ||||
Mortgage-backed securities: |
||||||
Residential agency |
15 | 15 | ||||
$ | 30 | $ | 31 | |||
Proceeds from sales of securities available for sale in the first three months of 2010 were $1.4 billion, with gross realized gains and losses of $82 million and $23 million, respectively. Proceeds from sales of securities available for sale in the first three months of 2009 were $0.8 billion, with gross realized gains and losses of $53 million and $0 million, respectively. The cost of securities sold is based on the specific identification method.
Equity securities included $492 million and $473 million of amortized cost related to Federal Reserve Bank stock and Federal Home Loan Bank (FHLB) stock as of March 31, 2010 and $492 million and $533 million of amortized cost related to Federal Reserve Bank stock and FHLB stock as of December 31, 2009. The estimated fair value of both the Federal Reserve Bank and FHLB stock approximates their carrying amounts.
Securities with carrying values of $15.3 billion and $12.4 billion at March 31, 2010 and December 31, 2009, respectively, were pledged to secure public funds, trust deposits and certain borrowing arrangements.
Trading account net gains totaled $14 million for the three months ended March 31, 2010 and trading account net losses totaled $5 million for the three months ended March 31, 2009 (including $16 million of net unrealized gains and $18 million of net unrealized losses for the three months ended March 31, 2010 and 2009, respectively).
NOTE 6Business Segment Information
Regions segment information is presented based on Regions key segments of business. Each segment is a strategic business unit that serves specific needs of Regions customers. The Companys primary segment is Banking/Treasury, which represents the Companys branch network, including consumer and commercial banking functions, and has separate management that is responsible for the operation of that business unit. This segment also includes the Companys Treasury function, including the Companys securities portfolio and other wholesale funding activities.
16
In addition to Banking/Treasury, Regions has designated as distinct reportable segments the activity of its Investment Banking/Brokerage/Trust and Insurance divisions. Investment Banking/Brokerage/Trust includes trust activities and all brokerage and investment activities associated with Morgan Keegan. Insurance includes all business associated with commercial insurance and credit life products sold to consumer customers.
The following tables present financial information for each reportable segment for the period indicated.
Banking/ Treasury |
Investment Banking/ Brokerage/ Trust |
Insurance | Total Company |
|||||||||||
Three months ended March 31, 2010 | (In millions) | |||||||||||||
Net interest income |
$ | 816 | $ | 14 | $ | 1 | $ | 831 | ||||||
Provision for loan losses |
770 | | | 770 | ||||||||||
Non-interest income |
488 | 297 | 27 | 812 | ||||||||||
Non-interest expense |
936 | 272 | 22 | 1,230 | ||||||||||
Income taxes |
(177 | ) | 14 | 2 | (161 | ) | ||||||||
Net income (loss) |
$ | (225 | ) | $ | 25 | $ | 4 | $ | (196 | ) | ||||
Average assets |
$ | 134,003 | $ | 5,055 | $ | 507 | $ | 139,565 | ||||||
Banking/ Treasury |
Investment Banking/ Brokerage/ Trust |
Insurance | Total Company |
|||||||||||
Three months ended March 31, 2009 | (In millions) | |||||||||||||
Net interest income |
$ | 792 | $ | 16 | $ | 1 | $ | 809 | ||||||
Provision for loan losses |
425 | | | 425 | ||||||||||
Non-interest income |
784 | 253 | 29 | 1,066 | ||||||||||
Non-interest expense |
787 | 248 | 23 | 1,058 | ||||||||||
Income taxes |
305 | 8 | 2 | 315 | ||||||||||
Net income |
$ | 59 | $ | 13 | $ | 5 | $ | 77 | ||||||
Average assets |
$ | 139,534 | $ | 3,549 | $ | 480 | $ | 143,563 |
NOTE 7Goodwill
Goodwill allocated to each reportable segment as of March 31, 2010, December, 31, 2009, and March 31, 2009 is presented as follows:
March 31 2010 |
December 31 2009 |
March 31 2009 | |||||||
(In millions) | |||||||||
Banking/Treasury |
$ | 4,691 | $ | 4,691 | $ | 4,691 | |||
Investment Banking/Brokerage/Trust |
745 | 745 | 740 | ||||||
Insurance |
123 | 121 | 120 | ||||||
Total goodwill |
$ | 5,559 | $ | 5,557 | $ | 5,551 | |||
The Companys goodwill is tested for impairment on an annual basis, or more often if events or circumstances indicate that there may be impairment. Adverse changes in the economic environment, declining operations, or other factors could result in a decline in the implied fair value of goodwill. A goodwill impairment test includes two steps. Step One, used to identify potential impairment, compares the estimated fair value of a reporting unit with its carrying amount, including goodwill. If the estimated fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not to be impaired. If the carrying amount of a reporting unit exceeds its estimated fair value, the second step of the goodwill impairment test is performed to
17
measure the amount of impairment loss, if any. Step Two of the goodwill impairment test compares the implied estimated fair value of reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount of goodwill for that reporting unit exceeds the implied fair value of that units goodwill, an impairment loss is recognized in an amount equal to that excess.
During the first quarter of 2010, Regions assessed the indicators of goodwill impairment as of February 28, 2010, and through the date of the filing of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2010. The indicators assessed included:
| Recent operating performance, |
| Changes in market capitalization, |
| Regulatory actions and assessments, |
| Changes in the business climate (including legal factors and competition), |
| Company-specific factors (including changes in key personnel, asset impairments, and business dispositions), and |
| Trends in the banking industry. |
Based on the assessment of the indicators above, quantitative testing of goodwill was required for the Banking/Treasury, Investment Banking/ Brokerage/Trust, and Insurance reporting units for the March 31, 2010 interim period.
For purposes of performing Step One of the goodwill impairment test, Regions uses both the income and market approaches to value its reporting units. The income approach, which is the primary valuation approach, consists of discounting projected long-term future cash flows, which are derived from internal forecasts and economic expectations for the respective reporting units. The projected future cash flows are discounted using cost of capital metrics for Regions peer group or a build-up approach (such as the capital asset pricing model) applicable to each reporting unit. The significant inputs to the income approach include expected future cash flows, the long-term target tangible equity to tangible assets ratio, and the discount rate, which is determined in the build-up approach using the risk-free rate of return, adjusted equity beta, equity risk premium, and a company-specific risk factor. The company-specific risk factor is used to address the uncertainty of growth estimates and earnings projections of management.
Regions uses the public company method and the transaction method as the two market approaches. The public company method applies a value multiplier derived from each reporting units peer group to a financial metric of the reporting unit (e.g. tangible common equity or last twelve months net income) and an implied control premium to the respective reporting unit. The control premium is evaluated and compared to similar financial services transactions. The transaction method applies a value multiplier to a financial metric of the reporting unit based on comparable observed purchase transactions in the financial services industry for the reporting unit (where available).
18
Regions uses the output from these approaches to determine the estimated fair value of each reporting unit. Below is a table of assumptions used in estimating the fair value of each reporting unit for the March 31, 2010 interim period. The table includes the discount rate used in the income approach, the market multiplier used in the market approaches, and the public company method control premium applied to all reporting units.
As of March 31, 2010 |
Banking/ Treasury |
Investment Banking/ Brokerage/ Trust |
Insurance | |||
Discount rate used in income approach |
16% | 13% | 13% | |||
Public company method market multiplier(a) |
0.8x | 1.8x | 21.0x | |||
Public company method control premium |
30% | 30% | 30% | |||
Transaction method market multiplier(b) |
0.9x | 2.2x | n/a |
(a) | For the Banking/Treasury and Investment Banking/Brokerage/Trust reporting units, these multipliers are applied to tangible common book value. For the Insurance reporting unit, this multiplier is applied to the last twelve months of net income. |
(b) | For the Banking/Treasury and Investment Banking/Brokerage/Trust reporting units, these multipliers are applied to tangible common book value. |
The Step One analyses performed for the Investment Banking/Brokerage/Trust and Insurance reporting units during the first quarter of 2010 indicated that the estimated fair values of the reporting units exceeded their carrying values (including goodwill). Therefore, a Step Two analysis was not required for these reporting units.
The Step One analysis performed for the Banking/Treasury reporting unit during the first quarter of 2010 indicated that the carrying value (including goodwill) of the reporting unit exceeded its estimated fair value. Therefore, Step Two was performed for the Banking/Treasury reporting unit as discussed below.
For purposes of performing Step Two of the goodwill impairment test, Regions compared the implied estimated fair value of the Banking/Treasury reporting unit goodwill with the carrying amount of that goodwill. In order to determine the implied estimated fair value, a full purchase price allocation was performed in the same manner as if a business combination had occurred. As part of the Step Two analysis, Regions estimated the fair value of all of the assets and liabilities of the reporting unit, including unrecognized assets and liabilities. The fair values of certain material financial assets and liabilities and the valuation methodologies are discussed in Note 10, Fair Value Measurements. Based on the results of the Step Two analysis performed, Regions concluded the Banking/Treasury reporting units goodwill was not impaired for the March 31, 2010 interim period.
NOTE 8Loan Servicing
The fair value of mortgage servicing rights is calculated using various assumptions including future cash flows, market discount rates, expected prepayment rates, servicing costs and other factors. A significant change in prepayments of mortgages in the servicing portfolio could result in significant changes in the valuation adjustments, thus creating potential volatility in the carrying amount of mortgage servicing rights. Regions uses various derivative instruments and trading securities to mitigate the effect of changes in the fair value of its mortgage servicing rights in the statement of operations. During the three months ended March 31, 2010, Regions recognized a $23 million net gain associated with changes in mortgage servicing rights and related derivatives which is included in several line items in the statement of operations: $3 million is included in interest income, $4 million is included in brokerage, investment banking and capital markets income, and $16 million is included in mortgage income. During the three months ended March 31, 2009, Regions recognized a net $1 million loss associated with changes in mortgage servicing rights and related derivatives, which is included in mortgage income. Beginning in the third quarter of 2009, Regions began using an option-adjusted spread (OAS) valuation approach. The OAS represents the additional spread over the swap rate that is required in order for the assets discounted cash flows to equal its market price. An analysis of the OAS and its sensitivity to rate fluctuations is presented below.
19
The table below presents an analysis of mortgage servicing rights for the three months ended March 31, 2010 and 2009, under the fair value measurement method:
Three Months Ended March 31 | ||||||||
2010 | 2009 | |||||||
(In millions) | ||||||||
Carrying value, beginning of period |
$ | 247 | $ | 161 | ||||
Additions |
17 | 19 | ||||||
Increase (decrease) in fair value: |
||||||||
Due to change in valuation inputs or assumptions |
11 | (9 | ) | |||||
Other changes(1) |
(5 | ) | (10 | ) | ||||
Carrying value, end of period |
$ | 270 | $ | 161 | ||||
(1) | Represents economic amortization associated with borrower repayments. |
Data and assumptions used in the fair value calculation related to residential mortgage servicing rights (excluding related derivative instruments) as of March 31, 2010 and 2009 are as follows (dollars in millions):
March 31 | ||||||||
2010 | 2009 | |||||||
Unpaid principal balance |
$ | 23,469 | $ | 22,341 | ||||
Weighted-average prepayment speed (CPR; percentage) |
12.2 | % | 37.3 | % | ||||
Estimated impact on fair value of a 10% increase |
$ | (12 | ) | $ | (9 | ) | ||
Estimated impact on fair value of a 20% increase |
$ | (23 | ) | $ | (18 | ) | ||
Option-adjusted spread (basis points) |
576 | (NA | ) | |||||
Estimated impact on fair value of a 10% increase |
$ | (6 | ) | (NA | ) | |||
Estimated impact on fair value of a 20% increase |
$ | (11 | ) | (NA | ) | |||
Weighted-average coupon interest rate |
5.74 | % | 6.06 | % | ||||
Weighted-average remaining maturity (months) |
288 | 278 | ||||||
Weighted-average servicing fee (basis points) |
28.9 | 28.8 |
(NA) | Regions adopted the option-adjusted spread valuation approach during the third quarter of 2009. |
The decrease in the weighted-average prepayment speed assumption from March 31, 2009 to March 31, 2010 was driven by the impact of historically low interest rates on prepayments. At March 31, 2009, low market interest rates led to a higher level of refinancing activity and higher prepayment speeds. Refinancing activity at March 31, 2010 was lower, impacting the prepayment speed assumption.
The sensitivity calculations above are hypothetical and should not be considered to be predictive of future performance. Changes in fair value based on adverse changes in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, the effect of an adverse variation in a particular assumption on the fair value of the mortgage servicing rights is calculated without changing any other assumption, while in reality changes in one factor may result in changes in another which may either magnify or counteract the effect of the change. The derivative instruments utilized by Regions would serve to reduce the estimated impacts to fair value included in the table above.
20
NOTE 9Derivative Financial Instruments and Hedging Activities
Regions enters into derivative financial instruments to manage interest rate risk, facilitate asset/liability management strategies and manage other exposures. These derivative instruments primarily include interest rate swaps, options on interest rate swaps, interest rate caps and floors, Eurodollar futures, forward rate contracts and forward sale commitments. All derivative financial instruments are recognized on the consolidated balance sheets as other assets or other liabilities at fair value. Regions enters into master netting agreements with counterparties and/or requires collateral based on counterparty credit ratings to cover exposures.
Interest rate swaps are agreements to exchange interest payments based upon notional amounts. Interest rate swaps subject Regions to market risk associated with changes in interest rates, as well as the credit risk that the counterparty will fail to perform. Option contracts involve rights to buy or sell financial instruments on a specified date or over a period at a specified price. These rights do not have to be exercised. Some option contracts, such as interest rate floors, involve the exchange of cash based on changes in specified indices. Interest rate floors are contracts to hedge interest rate declines based on a notional amount. Interest rate floors subject Regions to market risk associated with changes in interest rates, as well as the credit risk that the counterparty will fail to perform. Forward rate contracts are commitments to buy or sell financial instruments at a future date at a specified price or yield. Regions primarily enters into forward rate contracts on market instruments, which expose Regions to market risk associated with changes in the value of the underlying financial instrument, as well as the credit risk that the counterparty will fail to perform. Eurodollar futures are futures contracts on Eurodollar deposits. Eurodollar futures subject Regions to market risk associated with changes in interest rates. Because futures contracts are cash settled daily, there is minimal credit risk associated with Eurodollar futures.
The following tables present the fair value of derivative instruments on a gross basis as of March 31, 2010 and December 31, 2009, respectively:
March 31, 2010 | ||||||||||
Asset Derivatives |
Liability Derivatives | |||||||||
Balance Sheet Location |
Fair Value |
Balance Sheet Location |
Fair Value | |||||||
(In millions) | ||||||||||
Derivatives designated as hedging instruments |
||||||||||
Interest rate swaps |
Other assets | $ | 367 | Other liabilities | $ | 2 | ||||
Interest rate options |
Other assets | 43 | Other liabilities | | ||||||
Eurodollar futures (1) |
Other assets | | Other liabilities | | ||||||
Total derivatives designated as hedging instruments |
$ | 410 | $ | 2 | ||||||
Derivatives not designated as hedging instruments |
||||||||||
Interest rate swaps |
Other assets | $ | 1,488 | Other liabilities | $ | 1,497 | ||||
Interest rate options |
Other assets | 45 | Other liabilities | 24 | ||||||
Interest rate futures and forward commitments |
Other assets | 3 | Other liabilities | 7 | ||||||
Other contracts |
Other assets | 24 | Other liabilities | 23 | ||||||
Total derivatives not designated as hedging instruments |
$ | 1,560 | $ | 1,551 | ||||||
Total derivatives |
$ | 1,970 | $ | 1,553 | ||||||
(1) | Changes in fair value are cash-settled daily; therefore there is no ending balance at any given reporting period. |
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December 31, 2009 | ||||||||||
Asset Derivatives |
Liability Derivatives | |||||||||
Balance Sheet Location |
Fair Value |
Balance Sheet Location |
Fair Value | |||||||
(In millions) | ||||||||||
Derivatives designated as hedging instruments |
||||||||||
Interest rate swaps |
Other assets | $ | 390 | Other liabilities | $ | 22 | ||||
Interest rate options |
Other assets | 52 | Other liabilities | | ||||||
Eurodollar futures (1) |
Other assets | | Other liabilities | | ||||||
Total derivatives designated as hedging instruments |
$ | 442 | $ | 22 | ||||||
Derivatives not designated as hedging instruments |
||||||||||
Interest rate swaps |
Other assets | $ | 1,518 | Other liabilities | $ | 1,505 | ||||
Interest rate options |
Other assets | 26 | Other liabilities | 33 | ||||||
Interest rate futures and forward commitments |
Other assets | 13 | Other liabilities | | ||||||
Other contracts |
Other assets | 20 | Other liabilities | 19 | ||||||
Total derivatives not designated as hedging instruments |
$ | 1,577 | $ | 1,557 | ||||||
Total derivatives |
$ | 2,019 | $ | 1,579 | ||||||
(1) | Changes in fair value are cash-settled daily; therefore there is no ending balance at any given reporting period. |
HEDGING DERIVATIVES
Derivatives entered into to manage interest rate risk and facilitate asset/liability management strategies are designated as hedging derivatives. Derivative financial instruments that qualify in a hedging relationship are classified, based on the exposure being hedged, as either fair value or cash flow hedges. The Company formally documents all hedging relationships between hedging instruments and the hedged items, as well as its risk management objective and strategy for entering into various hedge transactions. The Company performs periodic assessments to determine whether the hedging relationship has been highly effective in offsetting changes in fair values or cash flows of hedged items and whether the relationship is expected to continue to be highly effective in the future.
When a hedge is terminated or hedge accounting is discontinued because the hedged item no longer meets the definition of a firm commitment, or because it is probable that the forecasted transaction will not occur by the end of the specified time period, the derivative will continue to be recorded in the consolidated balance sheets at its fair value, with changes in fair value recognized currently in other non-interest income. Any asset or liability that was recorded pursuant to recognition of the firm commitment is removed from the consolidated balance sheets and recognized currently in other non-interest expense. Gains and losses that were accumulated in other comprehensive income pursuant to the hedge of a forecasted transaction are recognized immediately in other non-interest expense.
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The following tables present the effect of derivative instruments on the statement of operations for the three months ended March 31, 2010 and 2009, respectively:
March 31, 2010 | ||||||||||
Derivatives in Fair Value |
Location of |
Amount of Gain(Loss) |
Hedged Items in Fair |
Location of Gain(Loss) |
Amount of Gain(Loss) | |||||
(In millions) | ||||||||||
Interest rate swaps |
Other non-interest expense | $ 52 | Debt/CDs | Other non-interest expense | $ (67) | |||||
Interest rate swaps |
Interest expense | 60 | Debt | Interest expense | 1 | |||||
Total |
$ 112 | $ (66) | ||||||||
Derivatives in Cash Flow |
Amount of Gain(Loss) |
Location of Gain(Loss) |
Amount of Gain(Loss) |
Location of Gain(Loss) |
Amount of Gain(Loss) | |||||
(In millions) | ||||||||||
Interest rate swaps |
$ (14) | Interest income on loans | $ 48 | Other non-interest expense | $ 1 | |||||
Forward starting swaps |
(10) | Interest expense on debt | | Other non-interest expense | | |||||
Interest rate options |
(3) | Interest income on loans | 11 | Interest income on loans | | |||||
Eurodollar futures |
15 | Interest income on loans | 3 | Other non-interest expense | (4) | |||||
Total |
$ (12) | $ 62 | $ (3) | |||||||
(1) | After-tax |
(2) | Pre-tax |
23
March 31, 2009 |
|||||||||||||||
Derivatives in Fair Value |
Location
of Gain(Loss) Recognized in Income on Derivatives |
Amount of Gain(Loss) Recognized in Income on Derivatives |
Hedged Items in Fair Value Hedge Relationships |
Location of Gain(Loss) Recognized in Income on Related Hedged Item |
Amount of Gain(Loss) Recognized in Income on Related Hedged Item |
||||||||||
(In millions) | |||||||||||||||
Interest rate swaps |
Other non-interest expense | $ | (5) | Debt | Other non-interest expense | $ | 5 | ||||||||
Interest rate swaps |
Interest expense | 34 | Debt | Interest expense | 1 | ||||||||||
Total |
$ | 29 | $ | 6 | |||||||||||
Derivatives in Cash Flow |
Amount of Gain(Loss) Recognized in OCI on Derivatives (Effective Portion) (1) |
Location of Gain(Loss) Reclassified from Accumulated OCI into Income (Effective Portion) |
Amount of Gain(Loss) Reclassified from Accumulated OCI into Income (Effective Portion) (2) |
Location of Gain(Loss) Recognized in Income |
Amount of
Gain(Loss) Recognized in Income on Derivatives (Ineffective Portion and Amount Excluded from Effectiveness Testing) (2) |
||||||||||
(In millions) | |||||||||||||||
Interest rate swaps |
$ | (17) | Interest income on loans | $ | 64 | Other non-interest expense | $ | | |||||||
Interest rate options |
(9) | Interest income on loans | 33 | Interest income on loans | (4 | ) | |||||||||
Eurodollar futures |
(3) | Interest income on loans | 2 | Other non-interest expense | | ||||||||||
Total |
$ | (29) | $ | 99 | $ | (4 | ) | ||||||||
(1) | After-tax |
(2) | Pre-tax |
FAIR VALUE HEDGES
Fair value hedge relationships mitigate exposure to the change in fair value of an asset, liability or firm commitment. Under the fair value hedging model, gains or losses attributable to the change in fair value of the derivative instrument, as well as the gains and losses attributable to the change in fair value of the hedged item, are recognized in earnings in the period in which the change in fair value occurs. The corresponding adjustment to the hedged asset or liability is included in the basis of the hedged item, while the corresponding change in the fair value of the derivative instrument is recorded as an adjustment to other assets or other liabilities, as applicable. Hedge ineffectiveness exists to the extent the changes in fair value of the derivative do not offset the changes in fair value of the hedged item and is recorded as other non-interest expense.
Regions enters into interest rate swap agreements to manage interest rate exposure on the Companys fixed-rate borrowings, which includes long-term debt and certificates of deposit. These agreements involve the receipt of fixed-rate amounts in exchange for floating-rate interest payments over the life of the agreements. As of March 31, 2010 and December 31, 2009, the total notional amount of the Companys interest rate swaps designated in fair value hedges was $10.2 billion and $10.3 billion, respectively.
CASH FLOW HEDGES
Cash flow hedge relationships mitigate exposure to the variability of future cash flows or other forecasted transactions. For cash flow hedge relationships, the effective portion of the gain or loss related to the derivative instrument is recognized as a component of other comprehensive income. Ineffectiveness is measured by comparing the change in fair value of the respective derivative instrument and the change in fair value of a perfectly effective hypothetical derivative instrument. Ineffectiveness will be recognized in earnings only if it results from an over hedge. The ineffective portion of the gain or loss related to the derivative instrument, if any, is recognized in earnings as other non-interest expense during the period of change. Amounts recorded in other comprehensive income are recognized in earnings in the period or periods during which the hedged item impacts earnings.
24
Regions enters into interest rate swap agreements to manage overall cash flow changes related to interest rate risk exposure on LIBOR-based loans. The agreements effectively modify the Companys exposure to interest rate risk by utilizing receive fixed/pay LIBOR interest rate swaps. As of both March 31, 2010 and December 31, 2009, the total notional amount of the Companys interest rate swaps hedging cash flows on LIBOR loans was $4.3 billion.
Regions issues long-term fixed-rate debt for various funding needs. Regions enters into receive LIBOR/pay-fixed forward starting swaps to hedge risks of changes in the projected quarterly interest payments attributable to changes in the benchmark interest rate (LIBOR) during the time leading up to the probable issuance date of the new long term fixed-rate debt. As of both March 31, 2010 and December 31, 2009, the total notional amount of the Companys forward-starting swaps was $1.0 billion.
Regions enters into interest rate option contracts to protect cash flows through the maturity date of the hedging instrument on designated one-month LIBOR floating-rate loans from adverse extreme market interest rate changes. As of both March 31, 2010 and December 31, 2009, the total notional amount of the Companys interest rate options was $2.0 billion.
Regions purchases Eurodollar futures to hedge the variability in future cash flows based on forecasted resets of one-month LIBOR-based floating rate loans due to changes in the benchmark interest rate. As of both March 31, 2010 and December 31, 2009, the total notional amount of the Companys Eurodollar futures was $30.2 billion.
Regions realized an after-tax benefit of $8 million and $20 million in accumulated other comprehensive income at March 31, 2010 and 2009, respectively, related to terminated cash flow hedges of loan and debt instruments which will be amortized into earnings in conjunction with the recognition of interest payments through 2012. Regions recognized pre-tax income of $9 million during the first three months of both 2010 and 2009 related to the amortization of terminated cash flow hedges of loan and debt instruments.
Regions expects to reclassify out of other comprehensive income and into earnings approximately $183 million in pre-tax income due to the receipt of interest payments on all cash flow hedges within the next twelve months. Of this amount, $10 million relates to the amortization of discontinued cash flow hedges. The maximum length of time over which Regions is hedging its exposure to the variability in future cash flows for forecasted transactions is approximately two years as of March 31, 2010.
TRADING DERIVATIVES
Derivative contracts that do not qualify for hedge accounting are classified as trading with gains and losses related to the change in fair value recognized in earnings during the period.
The Company maintains a derivatives trading portfolio of interest rate swaps, option contracts, and futures and forward commitments used to meet the needs of its customers. The portfolio is used to generate trading profit and to help clients manage market risk. The Company is subject to the credit risk that a counterparty will fail to perform. The Company is also subject to market risk, which is monitored by the asset/liability management function and evaluated by the Company. Separate derivative contracts are entered into to reduce overall market exposure to pre-defined limits. The contracts in this portfolio do not qualify for hedge accounting and are marked-to-market through earnings and included in other assets and other liabilities. As of March 31, 2010 and 2009, the total absolute notional amount of the Companys derivatives trading portfolio was $64.9 billion and $67.3 billion, respectively.
In the normal course of business, Morgan Keegan enters into underwriting and forward and future commitments on U.S. Government and municipal securities. As of March 31, 2010 and 2009, the contractual
25
amounts of forward and future commitments was approximately $56 million and $8 million, respectively. The brokerage subsidiary typically settles its position by entering into equal but opposite contracts and, as such, the contract amounts do not necessarily represent future cash requirements. Settlement of the transactions relating to such commitments is not expected to have a material effect on the subsidiarys financial position. Transactions involving future settlement give rise to market risk, which represents the potential loss that can be caused by a change in the market value of a particular financial instrument. The exposure to market risk is determined by a number of factors, including size, composition and diversification of positions held, the absolute and relative levels of interest rates, and market volatility.
Regions enters into interest rate lock commitments, which are commitments to originate mortgage loans whereby the interest rate on the loan is determined prior to funding and the customers have locked into that interest rate. Fair value is based on fees currently charged to enter into similar agreements and, for fixed-rate commitments, considers the difference between current levels of interest rates and the committed rates. As of March 31, 2010 and 2009, Regions had $534 million and $1.4 billion, respectively, in notional amounts of rate lock commitments. Regions manages market risk on interest rate lock commitments and mortgage loans held for sale with corresponding forward sale commitments, which are recorded at fair value with changes in fair value recorded in mortgage income. As of March 31, 2010 and 2009, Regions had $979 million and $2.5 billion, respectively, in absolute notional amounts related to these forward rate commitments.
On January 1, 2009, Regions made an election to account for mortgage servicing rights at fair market value with any changes to fair value being recorded within mortgage income. Concurrent with the election to use the fair value measurement method, Regions began using various derivative instruments to mitigate the income statement effect of changes in the fair value of its mortgage servicing rights. Regions continues to use derivatives such as forward rate commitments, swaptions, and futures contracts to mitigate these fair value changes. Regions has and may prospectively use trading securities to mitigate these changes. As of March 31, 2010 and 2009, the total notional amount related to these swaptions, forward rate commitments and futures contracts was $3.6 billion and $2.1 billion, respectively.
26
The following tables present information for derivatives not designated as hedging instruments in the statement of operations for the three months ended March 31, 2010 and 2009, respectively:
March 31, 2010 |
||||||
Derivatives Not Designated as Hedging Instruments |
Location of Gain(Loss) Recognized in Income on Derivatives |
Amount of Gain(Loss) Recognized in Income on Derivatives |
||||
(In millions) | ||||||
Interest rate swaps |
Brokerage income | $ | (7 | ) | ||
Interest rate options |
Brokerage income | 1 | ||||
Interest rate options |
Mortgage income | (18 | ) | |||
Interest rate futures and forward commitments |
Brokerage income | (2 | ) | |||
Interest rate futures and forward commitments |
Mortgage income | 24 | ||||
Other contracts |
Brokerage income | | ||||
$ | (2 | ) | ||||
March 31, 2009 |
||||||
Derivatives Not Designated as Hedging Instruments |
Location of Gain(Loss) Recognized in Income on Derivatives |
Amount of Gain(Loss) Recognized in Income on Derivatives |
||||
(In millions) | ||||||
Interest rate swaps |
Brokerage income | $ | 43 | |||
Interest rate options |
Brokerage income | (37 | ) | |||
Interest rate options |
Mortgage income | 17 | ||||
Interest rate futures and forward commitments |
Brokerage income | (1 | ) | |||
Interest rate futures and forward commitments |
Mortgage income | (6 | ) | |||
Other contracts |
Brokerage income | 1 | ||||
$ | 17 | |||||
Credit risk, defined as all positive exposures not collateralized with cash or other liquid assets, at March 31, 2010 and 2009, totaled approximately $1.0 billion and $1.5 billion, respectively. This amount represents the net credit risk on all trading and other derivative positions held by Regions.
CREDIT DERIVATIVES
Regions has both bought and sold credit protection in the form of participations on interest rate swaps (swap participations). These swap participations, which meet the definition of credit derivatives, were entered into in the ordinary course of business to serve the credit needs of customers. Credit derivatives, whereby Regions has purchased credit protection, entitle Regions to receive a payment from the counterparty when the customer fails to make payment on any amounts due to Regions upon early termination of the swap transaction and have maturities between 2012 and 2026. Credit derivatives whereby Regions has sold credit protection have maturities between 2010 and 2015. For contracts where Regions sold credit protection, Regions would be required to make payment to the counterparty when the customer fails to make payment on any amounts due to the counterparty upon early termination of the swap transaction. Regions bases the current status of the prepayment/performance risk on bought and sold credit derivatives on recently issued internal risk ratings consistent with the risk management practices of unfunded commitments.
Regions maximum potential amount of future payments under these contracts is approximately $44 million. This scenario would only occur if variable interest rates were at zero percent and all counterparties defaulted with zero recovery. The fair value of sold protection at March 31, 2010 and 2009 was immaterial. In transactions where Regions has sold credit protection, recourse to collateral associated with the original swap transaction is available to offset some or all of Regions obligation.
27
CONTINGENT FEATURES
Certain Regions derivative instruments contain provisions that require Regions debt to maintain an investment grade credit rating from each of the major credit rating agencies. If Regions debt were to fall below investment grade, it would be in violation of these provisions, and the counterparties to the derivative instruments could request immediate payment or demand immediate and ongoing full overnight collateralization on derivative instruments in net liability positions. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that are in a liability position on March 31, 2010 and December 31, 2009, was $402 million and $347 million, respectively, for which Regions had posted collateral of $391 million and $336 million, respectively, in the normal course of business. If the credit-risk-related contingent features underlying these agreements were triggered on March 31, 2010, and December 31, 2009, Regions would be required to post an additional $10 million and $11 million of collateral to its counterparties.
NOTE 10Fair Value Measurements
Fair value guidance establishes a framework for using fair value to measure assets and liabilities and defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) as opposed to the price that would be paid to acquire the asset or received to assume the liability (an entry price). A fair value measure should reflect the assumptions that market participants would use in pricing the asset or liability, including the assumptions about the risk inherent in a particular valuation technique, the effect of a restriction on the sale or use of an asset and the risk of nonperformance. Required disclosures include stratification of balance sheet amounts measured at fair value based on inputs the Company uses to derive fair value measurements. These strata include:
| Level 1 valuations, where the valuation is based on quoted market prices for identical assets or liabilities traded in active markets (which include exchanges and over-the-counter markets with sufficient volume), |
| Level 2 valuations, where the valuation is based on quoted market prices for similar instruments traded in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market, and |
| Level 3 valuations, where the valuation is generated from model-based techniques that use significant assumptions not observable in the market, but observable based on Company-specific data. These unobservable assumptions reflect the Companys own estimates for assumptions that market participants would use in pricing the asset or liability. Valuation techniques typically include option pricing models, discounted cash flow models and similar techniques, but may also include the use of market prices of assets or liabilities that are not directly comparable to the subject asset or liability. |
ITEMS MEASURED AT FAIR VALUE ON A RECURRING BASIS
Trading account assets (net of certain short-term borrowings), securities available for sale, mortgage loans held for sale, mortgage servicing rights and derivatives were recorded at fair value on a recurring basis during 2010 and 2009. Below is a description of valuation methodologies for these assets and liabilities:
Trading account assets, net and securities available for sale primarily consist of U.S. Treasuries, obligations of states and political subdivisions, mortgage-backed securities (including agency securities), and equity securities. Trading account assets are presented net of short-sale liabilities which are valued based on the fair value of the underlying securities.
| U.S. Treasuries and mortgage-backed securities are valued primarily using data from third-party pricing services for similar securities as applicable. Pricing from these third party services is generally based on quoted market prices of similar instruments (including matrix pricing); these valuations are Level 2 measurements. |
28
| Obligations of states and political subdivisions are generally based on data from third party pricing services for similar securities (Level 2 measurements as described above). Where such comparable data is not available, the Company develops valuations based on assumptions that are not readily observable in the market place; these valuations are Level 3 measurements. For example, auction-rate securities fall into this category; for these instruments, internal pricing models assume converting the securities into fixed-rate debt securities with similar credit ratings and maturity dates based on managements estimates of the term of the securities. Assumed terms generally fall within a range of one to four years. |
| Equity securities are valued based on quoted market prices of identical assets on active exchanges; these valuations are Level 1 measurements. |
Mortgage loans held for sale consist of residential first mortgage loans held for sale that are valued based on traded market prices of similar assets where available and/or discounted cash flows at market interest rates, adjusted for securitization activities that include servicing value and market conditions, a Level 2 measurement. Regions has elected to measure mortgage loans held for sale at fair value by applying the fair value option (see additional discussion under the Fair Value Option section below).
Mortgage servicing rights consist of residential mortgage servicing rights and were valued using an option-adjusted spread valuation approach, a Level 3 measurement. See Note 8, Loan Servicing for additional details regarding assumptions relevant to this valuation.
Derivatives, net which primarily consist of interest rate contracts that include futures, options and swaps, are included in other assets and other liabilities (as applicable) on the consolidated balance sheets, and are presented in the tables below as a net amount. Interest rate swaps are predominantly traded in over-the-counter markets and, as such, values are determined using widely accepted discounted cash flow models, or Level 2 measurements. These discounted cash flow models use projections of future cash payments/receipts that are discounted at mid-market rates. The assumed cash flows are sourced from an assumed yield curve, which is consistent with industry standards and conventions. These valuations are adjusted for the unsecured credit risk at the reporting date, which considers collateral posted and the impact of master netting agreements. For exchange-traded options and futures contracts, values are based on quoted market prices, or Level 1 measurements. For all other options and futures contracts traded in over-the-counter markets, values are determined using discounted cash flow analyses and option pricing models based on market rates and volatilities, or Level 2 measurements. Interest rate lock commitments on loans intended for sale, treasury locks and credit derivatives are valued using option pricing models that incorporate significant unobservable inputs, and therefore are Level 3 measurements.
Regions rarely transfers assets and liabilities measured at fair value between Level 1 and Level 2 measurements. There were no such transfers during the three months ended March 31, 2010 or 2009. Trading account assets are periodically transferred to or from Level 3 valuation based on managements conclusion regarding the best method for pricing for an individual security. Such transfers are accounted for as if they occur at the beginning of a reporting period.
29
New accounting literature effective for 2010 financial reporting requires more granular levels of disclosure for fair value measurements. The new guidance does not require any changes to presentation of prior periods. The following tables present assets and liabilities measured at fair value on a recurring basis as of March 31, 2010 and 2009, respectively:
March 31, 2010 |
Level 1 | Level 2 | Level 3 | Fair Value |
||||||||||
(In millions) | ||||||||||||||
Trading account assets, net(1) |
||||||||||||||
U.S. Treasury securities |
$ | | $ | (139 | ) | $ | | $ | (139 | ) | ||||
Obligations of states and political subdivisions |
| 186 | 170 | 356 | ||||||||||
Mortgage-backed securities: |
| |||||||||||||
Residential agency |
| 195 | | 195 | ||||||||||
Residential non-agency |
| 1 | | 1 | ||||||||||
Commercial agency |
| | 66 | 66 | ||||||||||
Other securities |
161 | 97 | 2 | 260 | ||||||||||
Equity securities |
185 | | | 185 | ||||||||||
Total trading account assets, net(1) |
$ | 346 | $ | 340 | $ | 238 | $ | 924 | ||||||
Securities available for sale |
||||||||||||||
U.S. Treasury securities |
59 | | | 59 | ||||||||||
Federal agency securities |
26 | 19 | | 45 | ||||||||||
Obligations of states and political subdivisions |
| 29 | 17 | 46 | ||||||||||
Mortgage-backed securities: |
||||||||||||||
Residential agency |
| 22,858 | | 22,858 | ||||||||||
Residential non-agency |
| | 26 | 26 | ||||||||||
Commercial agency |
| 21 | | 21 | ||||||||||
Other debt securities |
| 23 | | 23 | ||||||||||
Equity securities |
1,141 | | | 1,141 | ||||||||||
Total securities available for sale |
$ | 1,226 | $ | 22,950 | $ | 43 | $ | 24,219 | ||||||
Mortgage loans held for sale |
$ | | $ | 549 | $ | | $ | 549 | ||||||
Mortgage servicing rights |
$ | | $ | | $ | 270 | $ | 270 | ||||||
Derivatives, net(2) |
||||||||||||||
Interest rate swaps |
$ | | $ | 357 | $ | | $ | 357 | ||||||
Interest rate options |
| 55 | | 55 | ||||||||||
Interest rate futures and forward commitments |
| (4 | ) | 8 | 4 | |||||||||
Other contracts |
| 1 | | 1 | ||||||||||
Total derivatives, net(2) |
$ | | $ | 409 | $ | 8 | $ | 417 | ||||||
(1) | Trading account assets are presented in the table above net of short-sale liabilities; accordingly, the total of the balances above are not in agreement with trading account assets as shown on the balance sheet. |
(2) | Derivatives include approximately $910 million related to legally enforceable master netting agreements that allow the Company to settle positive and negative positions. Derivatives, net are also presented excluding cash collateral received of $120 million and cash collateral posted of $391 million with counterparties. |
30
March 31, 2009 |
Level 1 | Level 2 | Level 3 | Fair Value | ||||||||
(In millions) | ||||||||||||
Trading account assets, net |
$ | 113 | $ | 444 | $ | 191 | $ | 748 | ||||
Securities available for sale |
1,791 | 19,090 | 89 | 20,970 | ||||||||
Mortgage loans held for sale |
| 1,365 | | 1,365 | ||||||||
Mortgage servicing rights |
| | 161 | 161 | ||||||||
Derivatives, net(1) |
| 921 | 30 | 951 |
(1) | Derivative assets and liabilities include approximately $1.4 billion related to legally enforceable master netting agreements that allow the Company to settle positive and negative positions. Derivative assets and liabilities are also presented excluding cash collateral received of $100 million and cash collateral posted of $427 million with counterparties. |
Assets and liabilities in all levels could result in volatile and material price fluctuations. Realized and unrealized gains and losses on Level 3 assets represent only a portion of the risk to market fluctuations in Regions consolidated balance sheets. Further, net trading account assets and net derivatives included in Levels 1, 2 and 3 are used by the Asset and Liability Management Committee of the Company in a holistic approach to managing price fluctuation risks.
The following tables illustrate a roll forward for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2010 and 2009, respectively. The tables do not reflect the change in fair value attributable to any related economic hedges the Company used to mitigate the interest rate risk associated with these assets.
Fair Value Measurements Using Significant Unobservable Inputs
Three Months Ended March 31, 2010
(Level 3 measurements only)
Trading account assets, net (1) | Securities available for sale | Derivatives, net | ||||||||||||||||||||||||
Obligations of states and political subdivisions |
Commercial agency MBS |
Other securities | Obligations of states and political subdivisions |
Residential non-agency MBS |
Mortgage servicing rights |
Interest rate futures and forward commitments |
||||||||||||||||||||
(In millions) | ||||||||||||||||||||||||||
Beginning balance, January 1, 2010 |
$ | 171 | $ | 39 | $ | 4 | $ | 17 | $ | 36 | $ | 247 | $ | 3 | ||||||||||||
Total gains (losses) realized and unrealized: |
||||||||||||||||||||||||||
Included in earnings (1) |
| | 6 | | | 6 | 21 | |||||||||||||||||||
Included in other comprehensive income |
| | | | | | | |||||||||||||||||||
Purchases and issuances |
15 | 379 | 3,573 | | | 17 | | |||||||||||||||||||
Settlements |
(16 | ) | (362 | ) | (3,587 | ) | | (10 | ) | | (16 | ) | ||||||||||||||
Transfers into Level 3 |
| 10 | 6 | | | | | |||||||||||||||||||
Ending balance, March 31, 2010 |
$ | 170 | $ | 66 | $ | 2 | $ | 17 | $ | 26 | $ | 270 | $ | 8 | ||||||||||||
(1) | Brokerage income from trading account assets, net, primarily represents gains/(losses) on disposition, which inherently includes commissions on security transactions during the period. |
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Fair Value Measurements Using Significant Unobservable Inputs
Three Months Ended March 31, 2009
(Level 3 measurements only)
Trading account assets, net |
Securities available for sale |
Mortgage servicing rights |
Derivatives, net |
|||||||||||||
(In millions) | ||||||||||||||||
Beginning balance, January 1, 2009 |
$ | 275 | $ | 95 | $ | 161 | $ | 55 | ||||||||
Total gains (losses) realized and unrealized: |
||||||||||||||||
Included in earnings (1) |
1 | | (19 | ) | 3 | |||||||||||
Included in other comprehensive income |
| | | | ||||||||||||
Purchases and issuances |
180 | | 19 | | ||||||||||||
Settlements |
(202 | ) | (6 | ) | | (28 | ) | |||||||||
Transfers in and/or out of Level 3, net |
(63 | ) | | | | |||||||||||
Ending balance, March 31, 2009 |
$ | 191 | $ | 89 | $ | 161 | $ | 30 | ||||||||
(1) | Brokerage income from trading account assets, net, primarily represents gains/(losses) on disposition, which inherently includes commission on security transactions during the period. |
The following tables detail the presentation of both realized and unrealized gains and losses recorded in earnings for Level 3 assets for the three months ended March 31, 2010 and 2009, respectively:
Total Gains and Losses (Level 3 measurements only) Three Months Ended March 31, 2010 | |||||||||
Trading account assets, net (1) |
Derivatives, net | ||||||||
Other securities |
Mortgage servicing rights |
Interest rate futures and forward commitments | |||||||
(In millions) | |||||||||
Classifications of gains (losses) both realized and unrealized included in earnings for the period: |
|||||||||
Brokerage, investment banking and capital markets |
$ | 6 | $ | | $ | | |||
Mortgage income |
| 6 | 21 | ||||||
Total realized and unrealized gains and (losses) |
$ | 6 | $ | 6 | $ | 21 | |||
(1) | Brokerage income from trading account assets, net, primarily represents gains/(losses) on disposition, which inherently includes commissions on security transactions during the period. |
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Total Gains and Losses (Level 3 measurements only) Three Months Ended March 31, 2009 |
|||||||||||
Trading account assets, net (1) |
Mortgage servicing rights |
Derivatives, net |
|||||||||
(In millions) | |||||||||||
Classifications of gains (losses) both realized and unrealized included in earnings for the period: |
|||||||||||
Brokerage, investment banking and capital markets |
$ | 1 | $ | | $ | (37 | ) | ||||
Mortgage income |
| (19 | ) | 40 | |||||||
Total realized and unrealized gains and (losses) |
$ | 1 | $ | (19 | ) | $ | 3 | ||||
(1) | Brokerage income from trading account assets, net, primarily represents gains/(losses) on disposition, which inherently includes commission on security transactions during the period. |
The following tables detail the presentation of only unrealized gains and losses recorded in earnings for Level 3 assets for the three months ended March 31, 2010 and 2009, respectively:
Three Months Ended March 31, 2010 | ||||||
Mortgage servicing rights |
Interest rate futures and forward commitments | |||||
(In millions) | ||||||
The amount of total gains and losses for the period, included in earnings, attributable to the change in unrealized gains (losses) relating to assets and liabilities still held at March 31, 2010: |
||||||
Mortgage income |
$ | 11 | $ | 21 | ||
Total unrealized gains and (losses) |
$ | 11 | $ | 21 | ||
Three Months
Ended March 31, 2009 | |||||||||
Trading account assets, net |
Mortgage servicing rights |
Derivatives, net | |||||||
(In millions) | |||||||||
The amount of total gains and losses for the period included in earnings, attributable to the change in unrealized gains (losses) relating to assets and liabilities still held at March 31, 2009: |
|||||||||
Brokerage, investment banking and capital markets |
$ | | $ | | $ | 4 | |||
Mortgage income |
| | 40 | ||||||
Total unrealized gains and (losses) |
$ | | $ | | $ | 44 | |||
ITEMS MEASURED AT FAIR VALUE ON A NON-RECURRING BASIS
From time to time, certain assets may be recorded at fair value on a non-recurring basis. These non-recurring fair value adjustments typically are a result of the application of lower of cost or fair value accounting or a write-down occurring during the period. For example, if the fair value of an asset in these categories falls below its cost basis, it is considered to be at fair value at the end of the period of the adjustment.
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In periods where there is no adjustment, the asset is generally not considered to be at fair value. The following is a description of the valuation methodologies used for certain assets that are recorded at fair value.
Foreclosed property and other real estate is carried in other assets at the lower of the recorded investment in the loan or fair value less estimated costs to sell the property. The fair value for foreclosed property that is based on either observable transactions of similar instruments or formally committed sale prices is classified as a Level 2 measurement. If no formally committed sale price is available, a professional valuation is obtained. Updated valuations are obtained on at least an annual basis. Foreclosed property exceeding established dollar thresholds are valued based on appraisals. Appraisals are performed by third-parties with appropriate professional certifications and conform to generally accepted appraisal standards as evidenced by the Uniform Standards of Professional Appraisal Practice (USPAP). Regions policies related to appraisals conform with regulations established by the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) and other regulatory guidance. Professional valuations are considered Level 2 measurements because they are based largely on observable inputs.
Loans held for sale for which the fair value option has not been elected are recorded at the lower of cost or fair value and therefore are reported at fair value on a non-recurring basis. The fair values for loans held for sale that are based on formally committed loan sale prices or valuations performed using observable inputs are classified as a Level 2 measurement. If no formally committed sales price is available, a professional valuation is obtained, consistent with the process described above for foreclosed property and other real estate.
The following tables present the carrying value of those assets measured at fair value on a non-recurring basis as of March 31, 2010 and 2009, as well as the corresponding fair value adjustments.
Carrying Value as of March 31, 2010 | Fair
value adjustments for the three months ended March 31, 2010 |
|||||||||||||||
Level 1 | Level 2 | Level 3 | Total | |||||||||||||
(In millions) | ||||||||||||||||
Loans held for sale |
$ | | $ | 88 | $ | | $ | 88 | $ | (21 | ) | |||||
Foreclosed property and other real estate |
| 258 | | 258 | (45 | ) |
Carrying Value as of March 31, 2009 | Fair value adjustments for the three months ended March 31, 2009 |
|||||||||||||||
Level 1 | Level 2 | Level 3 | Total | |||||||||||||
(In millions) | ||||||||||||||||
Loans held for sale |
$ | | $ | 60 | $ | | $ | 60 | $ | (31 | ) | |||||
Foreclosed property and other real estate |
| 164 | | 164 | (27 | ) |
FAIR VALUE OPTION
Regions elected the fair value option for residential mortgage loans held for sale originated after January 1, 2008. This election allows for a more effective offset of the changes in fair values of the loans and the derivative instruments used to economically hedge them without the burden of complying with the requirements for hedge accounting. Regions has not elected the fair value option for other loans held for sale primarily because they are not economically hedged using derivative instruments. Fair values of mortgage loans held for sale are based on traded market prices of similar assets where available and/or discounted cash flows at market interest rates, adjusted for securitization activities that include servicing values and market conditions. At March 31, 2010 and 2009, loans held for sale for which the fair value option was elected had an aggregate fair value of $549 million and $1.4 billion, respectively, and an aggregate outstanding principal balance of $539 million and $1.3 billion, respectively, and were recorded in loans held for sale in the consolidated balance sheets. Interest income on mortgage loans held for sale is recognized based on contractual rates and is reflected in interest income on loans
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held for sale in the consolidated statements of operations. Net gains (losses) resulting from changes in fair value of these loans of ($2) million and $20 million was recorded in mortgage income in the consolidated statements of operations during the first quarter of 2010 and 2009, respectively. These changes in fair value are mostly offset by economic hedging activities. An immaterial portion of these amounts was attributable to changes in instrument-specific credit risk.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The methods and assumptions used by the Company in estimating fair values of financial instruments are disclosed in Regions Form 10-K for the year ended December 31, 2009. The carrying amounts and estimated fair values of the Companys financial instruments as of March 31, 2010 and December 31, 2009 are as follows:
March 31, 2010 | December 31, 2009 | ||||||||||
Carrying Amount |
Estimated Fair Value (1) |
Carrying Amount |
Estimated Fair Value (1) | ||||||||
(In millions) | |||||||||||
Financial assets: |
|||||||||||
Cash and cash equivalents |
$ | 6,871 | 6,871 | $ | 8,011 | $ | 8,011 | ||||
Trading account assets |
1,238 | 1,238 | 3,039 | 3,039 | |||||||
Securities available for sale |
24,219 | 24,219 | 24,069 | 24,069 | |||||||
Securities held to maturity |
30 | 31 | 31 | 31 | |||||||
Loans held for sale |
1,048 | 1,048 | 1,511 | 1,511 | |||||||
Loans (excluding leases), net of unearned income and |
82,976 | 70,187 | 85,452 | 72,119 | |||||||
Other interest-earning assets |
819 | 819 | 734 | 734 | |||||||
Derivatives, net |
417 | 417 | 520 | 520 | |||||||
Financial liabilities: |
|||||||||||
Deposits |
98,332 | 98,763 | 98,680 | 99,168 | |||||||
Short-term borrowings |
2,684 | 2,684 | 3,668 | 3,668 | |||||||
Long-term borrowings |
15,683 | 15,297 | 18,464 | 17,710 | |||||||
Loan commitments and letters of credit |
176 | 1,014 | 194 | 1,014 |
(1) | Estimated fair values are consistent with an exit price concept. The assumptions used to estimate the fair values are intended to approximate those that a market participant would use in a hypothetical orderly transaction. In estimating fair value, the Company makes adjustments for interest rates, market liquidity and credit spreads as appropriate. |
(2) | The estimated fair value of portfolio loans assumes sale of the notes to a third-party financial investor. Accordingly, the value to the Company if the notes were held to maturity is not reflected in the fair value estimate. In the current whole loan market, financial investors are generally requiring a much higher rate of return than the return inherent in loans if held to maturity. The fair value discount at March 31, 2010 was $12.8 billion or 15.4%. The majority of the discount represents the higher rate of return required by financial investors. |
(3) | Excluded from this table is the lease carrying amount of $2.0 billion at March 31, 2010 and $2.1 billion at December 31, 2009, which approximates fair value. |
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NOTE 11Commitments and Contingencies
COMMERCIAL COMMITMENTS
Regions issues off-balance sheet financial instruments in connection with lending activities. The credit risk associated with these instruments is essentially the same as that involved in extending loans to customers and is subject to Regions normal credit approval policies and procedures. Regions measures inherent risk associated with these instruments by recording a reserve for unfunded commitments based on an assessment of the likelihood that the guarantee will be funded and the creditworthiness of the customer or counterparty. Collateral is obtained based on managements assessment of the creditworthiness of the customer.
Credit risk associated with these instruments is represented by the contractual amounts indicated in the following table:
March 31 2010 |
December 31 2009 |
March 31 2009 | |||||||
(In millions) | |||||||||
Unused commitments to extend credit |
$ | 31,960 | $ | 31,008 | $ | 35,697 | |||
Standby letters of credit |
4,901 | 4,610 | 7,518 | ||||||
Commercial letter of credit |
35 | 30 | 15 |
Unused commitments to extend creditTo accommodate the financial needs of its customers, Regions makes commitments under various terms to lend funds to consumers, businesses and other entities. These commitments include (among others) revolving credit agreements, term loan commitments and short-term borrowing agreements. Many of these loan commitments have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of these commitments are expected to expire without being funded, the total commitment amounts do not necessarily represent future liquidity requirements.
Standby letters of creditStandby letters of credit are also issued to customers, which commit Regions to make payments on behalf of customers if certain specified future events occur. Regions has recourse against the customer for any amount required to be paid to a third party under a standby letter of credit. Historically, a large percentage of standby letters of credit expired without being funded. The contractual amount of standby letters of credit represents the maximum potential amount of future payments Regions could be required to make and represents Regions maximum credit risk. At March 31, 2010, December 31, 2009 and March 31, 2009, Regions had $109 million, $119 million and $116 million, respectively, of liabilities associated with standby letter of credit agreements, with related assets of $106 million, $114 million and $107 million, respectively.
Commercial letters of creditCommercial letters of credit are issued to facilitate foreign or domestic trade transactions for customers. As a general rule, drafts will be drawn when the goods underlying the transaction are in transit.
The reserve for all of these off-balance sheet financial instruments was $66 million, $74 million and $74 million at March 31, 2010, December 31, 2009 and March 31, 2009, respectively.
LEGAL
Regions and its affiliates are subject to litigation and claims arising in the ordinary course of business. Punitive damages are routinely claimed in these cases. Regions continues to be concerned about the general trend in litigation involving large damage awards against financial service company defendants. Regions evaluates these contingencies based on information currently available, including advice of counsel and assessment of available insurance coverage. Although it is not possible to predict the ultimate resolution or financial liability with respect to these litigation contingencies, management is currently of the opinion that the outcome of pending and threatened litigation would not have a material effect on Regions business, consolidated financial position or results of operations, except to the extent indicated in the discussion below.
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Regions and certain of its affiliates have been named in class-action lawsuits filed in federal and state courts on behalf of investors who purchased shares of certain Regions Morgan Keegan Select Funds (the Funds) and shareholders of Regions. The Funds were formerly managed by Morgan Asset Management, Inc. (Morgan Asset Management). Morgan Asset Management no longer manages these Funds, which were transferred to Hyperion Brookfield Asset Management in 2008. Certain of the funds have since been terminated by Hyperion. The complaints contain various allegations, including claims that the Funds and the defendants misrepresented or failed to disclose material facts relating to the activities of the Funds. No class has been certified and at this stage of the lawsuits Regions cannot determine the probability of a material adverse result or reasonably estimate a range of potential exposures, if any. However, it is possible that an adverse resolution of these matters may be material to Regions business, consolidated financial position or results of operations.
Certain of the shareholders in these Funds and other interested parties have entered into arbitration proceedings and individual civil claims, in lieu of participating in the class actions. Although it is not possible to predict the ultimate resolution or financial liability with respect to these contingencies, management is currently of the opinion that the outcome of these proceedings would not have a material effect on Regions business, consolidated financial position or results of operations.
On April 7, 2010, the Securities and Exchange Commission (SEC), the Financial Industry Regulatory Authority (FINRA) and a joint state task force of securities regulators from Alabama, Kentucky, Mississippi, and South Carolina (Task Force) announced that they were commencing administrative proceedings against Morgan Keegan, Morgan Asset Management and certain of their employees for violations of federal and state securities laws and NASD rules relating to the Funds. The proceedings contain various allegations, including that the defendants failed to disclose certain risks associated with the Funds and misrepresented the value of the Funds. The administrative proceedings seek civil penalties, injunctive relief, disgorgement, rescission and other relief. The SEC, FINRA and the Task Force had previously informed Morgan Keegan that they were considering commencing these actions. Although it is not possible to predict the ultimate resolution or financial liability with respect to these matters, it is possible that an adverse resolution of these matters may be material to Regions business, consolidated financial position or results of operations.
In March 2009, Morgan Keegan received a Wells notice from the SECs Atlanta Regional Office related to auction rate securities (ARS) indicating that the SEC staff intended to recommend that the Commission take civil action against Morgan Keegan. On July 21, 2009, the SEC filed a complaint in United States District Court for the Northern District of Georgia against Morgan Keegan alleging violations of the federal securities laws in connection with ARS that Morgan Keegan underwrote, marketed and sold. The SEC is seeking an injunction against Morgan Keegan for violations of the antifraud provisions of the federal securities laws, as well as disgorgement, financial penalties and other equitable relief for customers, including repurchase by Morgan Keegan of all ARS that it sold prior to March 20, 2008. Beginning in February 2009, Morgan Keegan commenced a voluntary program to repurchase ARS that it underwrote and sold to the firms customers, and extended that repurchase program on October 1, 2009 to include ARS that were sold by Morgan Keegan to its customers but were underwritten by other firms. As of March 31, 2010, customers of Morgan Keegan owned approximately $210 million of ARS and Morgan Keegan held approximately $165 million of ARS on its balance sheet. On July 21, 2009, the Alabama Securities Commission issued a Show Cause order to Morgan Keegan arising out of the ARS matter that is the subject of the SEC complaint described above. The order requires Morgan Keegan to show cause why its registration as a broker-dealer should not be suspended or revoked in the State of Alabama and also why it should not be subject to disgorgement, repurchasing all ARS sold to Alabama residents and payment of costs and penalties. Although it is not possible to predict the ultimate resolution or financial liability with respect to the ARS matter, management is currently of the opinion that the outcome of this matter will not have a material effect on Regions business, consolidated financial position or results of operations.
In April 2009, Regions, Regions Financing Trust III (the Trust) and certain of Regions current and former directors, were named in a purported class-action lawsuit filed in the U.S. District Court for the Southern District of New York on behalf of the purchasers of trust preferred securities offered by the Trust. The complaint alleges that defendants made statements in Regions registration statement, prospectus and year-end filings which
37
were materially false and misleading. No class has been certified and at this stage of the lawsuit Regions cannot determine the probability of a material adverse result or reasonably estimate a range of potential exposures, if any. However, it is possible that an adverse resolution of these matters may be material to Regions business, consolidated financial position or results of operations.
In December 2009, Regions and certain current and former directors and officers were named in a consolidated shareholder derivative action filed in Jefferson County, Alabama. The complaint alleges mismanagement, waste of corporate assets, breach of fiduciary duty and unjust enrichment relating to bonuses and other benefits received by executive management. Although it is not possible to predict the ultimate resolution or financial liability with respect to this matter, management is currently of the opinion that the outcome of this matter will not have a material effect on Regions business, consolidated financial position or results of operations.
NOTE 12Recent Accounting Pronouncements
In April 2009, the FASB issued FASB Staff Position No. 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly, codified in the Fair Value Topic, to provide additional guidance for estimating fair value when the volume and level of activity for the asset or liability have significantly decreased. Additionally, it includes guidance on identifying circumstances that indicate a transaction is not orderly. The guidance emphasizes that even if there has been a significant decrease in the volume and level of activity for the asset or liability and regardless of the valuation technique(s) used, the objective of a fair value measurement remains the same. This guidance is effective for interim and annual reporting periods ending after June 15, 2009, and is applied prospectively. Regions adopted these provisions during the second quarter of 2009, and the effect of the adoption on the consolidated financial statements was not material.
In April 2009, the FASB issued FASB Staff Position No. 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments, codified in the Financial Instruments Topic of the ASC, to require disclosures about fair value of financial instruments for interim reporting periods as well as in annual financial statements. This guidance is effective for interim and annual reporting periods ending after June 15, 2009, and is applied prospectively. Regions adopted these provisions during the second quarter of 2009. Refer to Note 10, Fair Value Measurements for additional information.
In April 2009, the FASB issued FSP 115-2 and 124-2, Recognition and Presentation of Other-Than-Temporary Impairments, codified in the Investments Topic of the ASC, which modifies and expands other- than-temporary impairment guidance for debt securities. This guidance addresses the unique features of debt securities and clarifies the interaction of the factors that should be considered when determining whether a debt security is other-than-temporarily impaired. Additionally, it requires an entity to recognize the credit component of an other-than-temporary impairment of a debt security in earnings and the noncredit component in other comprehensive income when the entity does not intend to sell the security and it is more likely than not that the entity will not be required to sell the security prior to recovery. The guidance also expands and increases the frequency of existing disclosures about other-than-temporary impairments for debt and equity securities. This guidance is effective for interim and annual reporting periods ending after June 15, 2009, and is applied prospectively. Regions adopted these provisions during the second quarter of 2009. Refer to Note 5, Securities for additional information.
In May 2009, the FASB issued Statement of Financial Accounting Standards No. 165, Subsequent Events, codified in the Subsequent Events Topic of the ASC, which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. This guidance also requires entities to disclose the date through which subsequent events were evaluated as well as whether that date is the date that the financial statements were issued or were available to be issued. Regions adopted the Subsequent Events Topic during the second quarter of 2009. Additionally, in
38
January 2010, the FASB issued Accounting Standard Update (ASU) 2010-09 Subsequent Events: Amendments to Certain Recognition and Disclosure Requirements. ASU 2010-09 clarified the subsequent events disclosure provisions for SEC filers. Regions adopted these provisions on January 1, 2010, and their adoption did not have a material impact on the consolidated financial statements.
In August 2009, the FASB issued ASU 2009-05 Measuring Liabilities at Fair Value. ASU 2009-05 provides further guidance on how to measure the fair value of a liability. ASU 2009-05 is effective for the first reporting period beginning after August 26, 2009. The adoption of ASU 2009-05 did not have a material impact to the consolidated financial statements.
In September 2009, the FASB issued ASU 2009-12 Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent). ASU 2009-12 permits the use of net asset value per share to estimate the fair value of these investments as a practical expedient. The ASU also requires disclosure, by major category of investment, of the attributes of the investments, such as the nature of any restrictions on the investors ability to redeem its investments at the measurement date, any unfunded commitments, and the investment strategies of the investees. ASU 2009-12 is effective for interim and annual reporting periods ending after December 15, 2009. The adoption of ASU 2009-12 did not have a material impact to the consolidated financial statements.
In June 2009, the FASB issued Statement of Financial Accounting Standards No. 166, Accounting for Transfers of Financial Assetsan amendment of FASB Statement No. 140, codified in the Consolidation Topic of the ASC as ASU 2009-16, which eliminates the concept of a Qualified Special Purpose Entity from FAS 140, changes the requirements for derecognizing financial assets, and requires additional disclosures. ASU 2009-16 is effective for fiscal years beginning after November 15, 2009. The adoption of ASU 2009-16 did not have a material impact to the consolidated financial statements.
In June 2009, the FASB issued Statement of Financial Accounting Standards No. 167, Amendments to FASB Interpretation No. 46(R), codified in the Consolidation Topic of the ASC as ASU 2009-17, which modifies how a company determines when a VIE should be consolidated. It also requires a qualitative assessment of an entitys determination of the primary beneficiary of a VIE based on whether the entity (1) has the power to direct the activities of a VIE that most significantly impact the entitys economic performance, and (2) has the obligation to absorb losses of the entity that could potentially be significant to the VIE or the right to receive benefits from the entity that could potentially be significant to the VIE. An ongoing reassessment is also required to determine whether a company is the primary beneficiary of a VIE as well as additional disclosures about a companys involvement in VIEs. ASU 2009-17 is effective for fiscal years beginning after November 15, 2009. The adoption of ASU 2009-17 did not have a material impact to the consolidated financial statements.
In January 2010, the FASB issued ASU 2010-06, Improving Disclosures about Fair Value Measurements, which requires additional disclosures related to the transfers in and out of fair value hierarchy and the activity of Level 3 financial instruments. This ASU also provides clarification for the classification of financial instruments and the discussion of inputs and valuation techniques. The new disclosures and clarification are effective for interim and annual reporting periods after December 15, 2009, except for the disclosures related to the activity of Level 3 financial instruments. Those disclosures are effective for periods after December 15, 2010 and for interim periods within those years. Regions adopted all of the provisions of ASU 2010-06 during the first quarter of 2010. See Note 10, Fair Value Measurements for additional information.
In February 2010 the FASB issued ASU 2010-10, Consolidation: Amendments for Certain Investment Funds, which defers, for certain investment funds, the consolidation requirements resulting from the issuance of ASU 2009-17. Specifically, the deferral is applicable for a reporting entitys interest in an entity (1) that has all the attributes of an investment company or (2) for which it is industry practice to apply measurement principles for financial reporting purposes that are consistent with those followed by investment companies. ASU 2010-10 is effective for periods beginning after November 15, 2009. Regions adopted the provisions of ASU 2010-10
39
during the first quarter of 2010. The adoption of ASU 2010-10 did not have a material impact to the consolidated financial statements.
In March 2010 the FASB issued ASU 2010-11, Derivatives and Hedging: Scope Exception Related to Embedded Credit Derivatives, which amends and clarifies the accounting for credit derivatives embedded in interests in securitized financial assets. ASU 2010-11 is effective for interim periods beginning after June 15, 2010. The adoption of ASU 2010-11 is not expected to have a material impact to the consolidated financial statements.
NOTE 13Subsequent Events
In April 2010, Regions issued an aggregate principal amount of $750 million of senior unsecured notes. The issuance included $250 million of 4.875% senior notes which mature in 2013. The issuance also included $500 million of 5.75% senior notes which mature in 2015. The notes are obligations of the parent company.
In April 2010, Regions announced that it was exercising its option to convert all 267,665 outstanding shares of its 10% Mandatorily Convertible Preferred Stock, Series B (Series B Preferred Stock), into shares of Regions common stock, par value $0.01 per share, in accordance with the terms of the Certificate of Designations with respect to the Series B Preferred Stock (the Certificate of Designations). The conversion rate for each of the outstanding shares of Series B Preferred Stock will be determined as set forth in the Certificate of Designations based on the average volume weighted average price per share of Regions common stock during the five trading days immediately preceding the effective date of the conversion. The conversion will be effective on or about June 18, 2010 and Regions will issue the shares of common stock soon after that date. Regions expects an increase in its Tier 1 common ratio of approximately 25 basis points upon the increase in common shares outstanding.
In connection with the conversion, as provided in the Certificate of Designations, Regions board of directors declared a dividend on all outstanding shares of Series B Preferred Stock in the amount of all dividends which would accrue between May 15, 2010 and June 18, 2010. The board declared that this dividend will be payable in shares of common stock at a price per share of 97% of the average volume weighted average price per share of Regions common stock during the five trading days immediately preceding the effective date of the conversion. The dividend will be paid on June 18, 2010 or shortly thereafter to holders of record at the close of business on the effective date of the conversion.
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Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations |
INTRODUCTION
The following discussion and analysis is part of Regions Financial Corporations (Regions or the Company) Quarterly Report on Form 10-Q to the Securities and Exchange Commission (SEC) and updates Regions Form 10-K for the year ended December 31, 2009, which was previously filed with the SEC. This financial information is presented to aid in understanding Regions financial position and results of operations and should be read together with the financial information contained in the Form 10-K. Certain prior period amounts presented in this discussion and analysis have been reclassified to conform to current period classifications, except as otherwise noted. The emphasis of this discussion will be on the three months ended March 31, 2010 compared to the three months ended March 31, 2009 for the statement of operations. For the balance sheet, the emphasis of this discussion will be the balances as of March 31, 2010 compared to December 31, 2009.
This discussion and analysis contains statements that may be considered forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. See pages 3 and 4 for additional information regarding forward-looking statements.
CORPORATE PROFILE
Regions is a financial holding company headquartered in Birmingham, Alabama, which operates in the South, Midwest and Texas. Regions provides traditional commercial, retail and mortgage banking services, as well as other financial services in the fields of investment banking, asset management, trust, securities brokerage, insurance and other specialty financing.
Regions conducts its banking operations through Regions Bank, an Alabama chartered commercial bank that is a member of the Federal Reserve System. At March 31, 2010, Regions operated approximately 1,774 full-service banking offices in Alabama, Arkansas, Florida, Georgia, Illinois, Indiana, Iowa, Kentucky, Louisiana, Mississippi, Missouri, North Carolina, South Carolina, Tennessee, Texas and Virginia. Regions provides brokerage services and investment banking from approximately 321 offices of Morgan Keegan & Company, Inc. (Morgan Keegan), a full-service regional brokerage and investment banking firm. Regions provides full-line insurance brokerage services primarily through Regions Insurance, Inc.
Regions profitability, like that of many other financial institutions, is dependent on its ability to generate revenue from net interest income and non-interest income sources. Net interest income is the difference between the interest income Regions receives on interest-earning assets, such as loans and securities, and the interest expense Regions pays on interest-bearing liabilities, principally deposits and borrowings. Regions net interest income is impacted by the size and mix of its balance sheet components and the interest rate spread between interest earned on its assets and interest paid on its liabilities. Non-interest income includes fees from service charges on deposit accounts, securities brokerage, investment banking and trust activities, mortgage servicing and secondary marketing, insurance activities, and other customer services which Regions provides. Results of operations are also affected by the provision for loan losses and non-interest expenses, such as salaries and employee benefits, occupancy and other operating expenses, as well as income taxes.
Economic conditions, competition, and the monetary and fiscal policies of the Federal government significantly affect most financial institutions, including Regions. Lending and deposit activities and fee income generation are influenced by levels of business spending and investment, consumer income, consumer spending and savings, capital market activities, and competition among financial institutions, as well as customer preferences, interest rate conditions and prevailing market rates on competing products in Regions market areas.
Regions business strategy has been and continues to be focused on providing a competitive mix of products and services, delivering quality customer service and maintaining a branch distribution network with offices in convenient locations. Regions delivers this business strategy with the personal attention and feel of a community bank and with the service and product offerings of a large regional bank.
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FIRST QUARTER HIGHLIGHTS
Regions reported a net loss available to common shareholders of $255 million, or $0.21 loss per diluted share in the first quarter of 2010, compared to first quarter 2009 earnings per diluted share of $0.04. Higher credit costs was the primary driver of the period over period decrease in earnings. During the first quarter of 2010, Regions recorded a $770 million provision for loan losses, $345 million higher than the first quarter of 2009. However, as compared to more recent quarters, credit costs are stabilizing. Loans, net of unearned income, decreased $2.5 billion from December 31, 2009 to March 31, 2010, reflecting weak customer demand as well as strategic reductions of investor real estate exposure. Average low cost deposits at March 31, 2010 increased $4.2 billion, or 6.5% from December 31, 2009, continuing an increasing trend. Average low cost deposits increased $9.6 billion or 16.4% from the first quarter of 2009 to the first quarter of 2010.
Net interest income on a fully taxable-equivalent basis for the first quarter of 2010 was $839 million compared to $817 million in the first quarter of 2009. The net interest margin (taxable-equivalent basis) was 2.77% in the first quarter of 2010, compared to 2.64% during the first quarter of 2009. Improved deposit pricing, as well as a favorable mix shift to lower cost products drove the improvement.
Net charge-offs totaled $700 million, or an annualized 3.16% of average loans, in the first quarter of 2010, compared to 1.64% for the first quarter of 2009. Charge-offs were higher across most major categories when comparing the 2010 period to prior year, with investor real estate representing the most significant driver of the increase. The provision for loan losses totaled $770 million in the first quarter of 2010 compared to $425 million during the first quarter of 2009. The allowance for loan losses at March 31, 2010 was 3.61% of total loans, net of unearned income, compared to 3.43% at December 31, 2009 and 1.94% at March 31, 2009. Total non-performing assets, excluding loans held for sale, at March 31, 2010 were $4.3 billion, compared to $4.1 billion at December 31, 2009 and $1.9 billion at March 31, 2009. During 2009, the growth in non-performing loans was driven by the land, single family, condominium and the income producing components of investor real estate. For the quarter ended March 31, 2010, there was a slight decline of land, single family and condominium non-performing loans, while income-producing increased at a more moderate rate. Additionally, commercial and industrial loans contributed to the quarterly increase. In spite of the increase in non-performing assets, credit costs and related metrics have begun to stabilize. Net inflows of non-performing assets for the first quarter of 2010 were lower than recent quarters. Some categories of internally risk rated problem assets, an indicator of future non-performing assets, showed improvement during the first quarter of 2010. The Company expects non-performing assets and net charge-offs to peak by the end of the second quarter of 2010 and decline thereafter.
Non-interest income for the first quarter of 2010 decreased by $254 million compared to the first quarter of 2009. Non-interest income included $19 million in leveraged lease termination gains for the first quarter of 2010 versus $323 million for the 2009 period. The decrease in termination gains was partially offset by increases in income from service charges on deposit accounts and brokerage, investment banking and capital markets. Service charges will be negatively impacted going forward due to new policies implemented during the second quarter of 2010 as well as regulatory changes. Mortgage income, while relatively stable period over period, benefitted from mortgage servicing rights and related derivative valuation adjustments during the 2010 period. This increase was offset by the normalization of income related to mortgage origination activity, which was unusually high during the first quarter of 2009.
Total non-interest expense was $1.2 billion and $1.1 billion in the first quarter of 2010 and 2009, respectively. The 2010 period included a $53 million loss on the prepayment of approximately $1.5 billion in FHLB advances. Higher FDIC premiums and higher salaries and employee benefits expenses also contributed to the period over period increase in non-interest expense.
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TOTAL ASSETS
Regions total assets at March 31, 2010 were $137.2 billion, compared to $142.3 billion at December 31, 2009. The decrease in total assets from year-end 2009 resulted primarily from decreases in the loan portfolio, a product of weak demand as well as strategic decisions to reduce the concentration in investor real estate loans. Lower interest-bearing deposits in other banks also contributed to the decrease.
LOANS
At March 31, 2010, loans represented 73% of Regions interest-earning assets compared to 72% at December 31, 2009. The following table presents the distribution by loan type of Regions loan portfolio, net of unearned income:
Table 1Loan Portfolio
March 31 2010 |
December 31 2009 |
March 31 2009 | |||||||
(In millions, net of unearned income) | |||||||||
Commercial and industrial |
$ | 21,220 | $ | 21,547 | $ | 22,585 | |||
Commercial real estate mortgageowner occupied |
12,028 | 12,054 | 11,926 | ||||||
Commercial real estate constructionowner occupied |
598 | 751 | 1,328 | ||||||
Total commercial |
33,846 | 34,352 | 35,839 | ||||||
Commercial investor real estate mortgage |
15,702 | 16,109 | 15,969 | ||||||
Commercial investor real estate construction |
4,703 | 5,591 | 7,611 | ||||||
Total investor real estate |
20,405 | 21,700 | 23,580 | ||||||
Residential first mortgage |
15,592 | 15,632 | 15,678 | ||||||
Home equity |
15,066 | 15,381 | 16,023 | ||||||
Indirect |
2,162 | 2,452 | 3,464 | ||||||
Other consumer |
1,103 | 1,157 | 1,102 | ||||||
Total consumer |
33,923 | 34,622 | 36,267 | ||||||
$ | 88,174 | $ | 90,674 | $ | 95,686 | ||||
Loans, net of unearned income, totaled $88.2 billion at March 31, 2010, a decrease of $2.5 billion from year-end 2009 levels. Strategic decisions to reduce the concentration in investor real estate were the primary contributor to the decrease. All other categories decreased reflecting continued weak loan demand.
In spite of the impact of weak economic conditions on loan growth, commitment levels remain strong and commercial line utilization has begun to stabilize.
CREDIT QUALITY
Recent weak economic conditions, including declining property values and high levels of unemployment, impacted the credit quality of Regions loan portfolio. Investor real estate loans and home equity products (particularly, Florida second lien) may carry a higher risk of non-collection than other loans.
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The following chart presents detail of Regions $20.4 billion investor real estate portfolio as of March 31, 2010 (dollars in billions):
LAND, SINGLE-FAMILY, AND CONDOMINIUM
Beginning in late 2007, the land, single-family, and condominium components of the investor real estate portfolio came under significant pressure. Credit quality of the investor real estate portfolio is sensitive to risks associated with construction loans such as cost overruns, project completion risk, general contractor credit risk, environmental and other hazard risks, and market risks associated with the sale or rental of completed properties. While losses within these loan types were influenced by conditions described above, the most significant drivers of losses were the continued decline in demand for residential real estate and in the value of property. Beginning in 2008, Regions strategically reduced exposures in these product types through pro-active workouts, appropriate charge-offs, and asset dispositions. Land totaled $2.6 billion at March 31, 2010, a decrease of approximately $1.2 billion from March 31, 2009 levels. Single-family totaled $1.9 billion at March 31, 2010, a decrease of approximately $0.8 billion from March 31, 2009 levels. Regions exposure to condominium loans is $487 million at March 31, 2010, a decrease of approximately $0.4 billion since March 31, 2009.
The following table presents credit metrics for land, single-family and condominium loans:
Table 2Land, Single-Family and Condominium
March 31 2010 |
December 31 2009 |
March 31 2009 | |||||||
(In millions, net of unearned income) | |||||||||
Land |
|||||||||
Loan balance |
$ | 2,613 | $ | 2,979 | $ | 3,861 | |||
90 days past due |
12 | 16 | 27 | ||||||
Non-accruing loans |
713 | 724 | 394 |
March 31 2010 |
December 31 2009 |
March 31 2009 | |||||||
(In millions, net of unearned income) | |||||||||
Single-Family |
|||||||||
Loan balance |
$ | 1,885 | $ | 2,083 | $ | 2,710 | |||
90 days past due |
3 | 7 | 26 | ||||||
Non-accruing loans |
496 | 545 | 293 |
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March 31 2010 |
December 31 2009 |
March 31 2009 | |||||||
(In millions, net of unearned income) | |||||||||
Condominium |
|||||||||
Loan balance |
$ | 487 | $ | 586 | $ | 889 | |||
90 days past due |
| | 4 | ||||||
Non-accruing loans |
157 | 184 | 155 |
MULTI-FAMILY AND RETAIL
Beginning in 2009, multi-family and retail loans experienced increased pressure and contributed to increases in non-accrual loans. Continued weak economic conditions impacted demand for products and services in these sectors. Lower demand impacted cash flows generated by these properties, leading to a higher rate of non-collection for these types of loans. Offsetting the risk of non-collection is the geographic diversity of Regions exposure. Additionally, because of the cash flow associated with income-producing categories, the Company can more easily restructure these loans than other types of investor real estate loans. Accordingly, the loss content is expected to be generally lower than other types of investor real estate.
The following table presents credit metrics and geographic distribution for multi-family and retail loans:
Table 3Multi-family and Retail
March 31 2010(1) |
December 31 2009 |
March 31 2009 | |||||||
(In millions, net of unearned income) | |||||||||
Multi-family |
|||||||||
Loan balance |
$ | 4,999 | $ | 5,049 | $ | 4,769 | |||
90 days past due |
| 1 | | ||||||
Non-accruing loans |
122 | 113 | 17 |
(1) | The majority of the balance related to multi-family loans is geographically distributed throughout the following areas: Texas 21%, Florida 14%, Georgia 10%, Tennessee 7%, Louisiana 6% and Alabama 6%. All other states, none of which comprise more than 5%, make up the remainder of the balance. |
March 31 2010(1) |
December 31 2009 |
March 31 2009 | |||||||
(In millions, net of unearned income) | |||||||||
Retail |
|||||||||
Loan balance |
$ | 3,895 | $ | 4,120 | $ | 4,462 | |||
90 days past due |
28 | 4 | 37 | ||||||
Non-accruing loans |
347 | 288 | 44 |
(1) | The majority of the balance related to retail loans is geographically distributed throughout the following areas: Florida 22%, Texas 13%, Georgia 10%, Alabama 9%, Tennessee 8% and North Carolina 7%. All other states, none of which comprise more than 5%, make up the remainder of the balance. |
HOME EQUITY PORTFOLIO
The home equity portfolio totaled $15.1 billion at March 31, 2010 as compared to $16.0 billion at March 31, 2009. Losses in this portfolio generally track overall economic conditions. The main source of economic stress has been in Florida, where residential property values have declined significantly while unemployment rates have risen to historically high levels. Losses on relationships in Florida where Regions is in a second lien position are higher than first lien losses.
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The Company calculated an estimate of the current value of property secured as collateral for home equity lending products (current LTV). The estimate is based on home price indices compiled by the Federal Housing Finance Agency (FHFA). The FHFA data indicates trends for Metropolitan Statistical Areas (MSA). Regions uses the FHFA valuation trends from the MSAs in the Companys footprint in its estimate. The trend data is applied to the loan portfolios taking into account the age of the most recent valuation and geographic area. At March 31, 2010, the Company estimates that the number of home equity loans where the current LTV exceeded 100 was approximately 8.2 percent, while approximately 15.9 percent of the outstanding balances of home equity loans had a current LTV greater than 100.
The following tables provide details related to the home equity portfolio as follows:
Table 4Selected Home Equity Portfolio Information
Three Months Ended March 31, 2010 | ||||||||||||||||||||||||||||||||||||
Florida | All Other States | Total | ||||||||||||||||||||||||||||||||||
(In millions) | 1st Lien | 2nd Lien | Total | 1st Lien | 2nd Lien | Total | 1st Lien | 2nd Lien | Total | |||||||||||||||||||||||||||
Balance |
$ | 2,127 | $ | 3,425 | $ | 5,552 | $ | 4,306 | $ | 5,208 | $ | 9,514 | $ | 6,433 | $ | 8,633 | $ | 15,066 | ||||||||||||||||||
Net Charge-offs |
15 | 68 | 83 | 8 | 24 | 32 | 23 | 92 | 115 | |||||||||||||||||||||||||||
Net Charge-off %(1) |
2.92 | % | 7.96 | % | 6.04 | % | 0.74 | % | 1.85 | % | 1.35 | % | 1.46 | % | 4.27 | % | 3.07 | % |
Three Months Ended March 31, 2009 | ||||||||||||||||||||||||||||||||||||
Florida | All Other States | Total | ||||||||||||||||||||||||||||||||||
(In millions) | 1st Lien | 2nd Lien | Total | 1st Lien | 2nd Lien | Total | 1st Lien | 2nd Lien | Total | |||||||||||||||||||||||||||
Balance |
$ | 2,170 | $ | 3,677 | $ | 5,847 | $ | 4,569 | $ | 5,607 | $ | 10,176 | $ | 6,739 | $ | 9,284 | $ | 16,023 | ||||||||||||||||||
Net Charge-offs |
16 | 55 | 71 | 6 | 18 | 24 | 22 | 73 | 95 | |||||||||||||||||||||||||||
Net Charge-off %(1) |
3.07 | % | 5.99 | % | 4.91 | % | 0.52 | % | 1.27 | % | 0.93 | % | 1.34 | % | 3.14 | % | 2.38 | % |
(1) | Net charge-off percentages are calculated on an annualized basis as a percent of average balances. |
OTHER CREDIT QUALITY MATTERS
Regions does not have any option adjustable rate mortgage (ARM) products, loans with initial teaser rates or other higher-risk residential loans. Regions has approximately $58 million in book value of sub-prime loans retained from the disposition of EquiFirst, down from the year-end 2009 balance of $61 million. The credit loss exposure related to these loans is addressed in managements periodic determination of the allowance for credit losses.
Using the same methodology described in the above discussion of home equity loans, at March 31, 2010, the Company estimates that the number of residential first mortgage loans where the current LTV exceeded 100 was approximately 4.3 percent, while approximately 9.7 percent of the outstanding balances of residential first mortgage loans had a current LTV greater than 100.
ALLOWANCE FOR CREDIT LOSSES
The allowance for credit losses represents managements estimate of credit losses inherent in the portfolio as of year-end. The allowance for credit losses consists of two components: the allowance for loan losses and the reserve for unfunded credit commitments. Managements assessment of the adequacy of the allowance for credit losses is based on a combination of both of these components. Regions determines its allowance for credit losses in accordance with applicable accounting literature as well as regulatory guidance related to receivables and contingencies. Binding unfunded credit commitments include items such as letters of credit, financial guarantees and binding unfunded loan commitments.
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Factors considered by management in determining the adequacy of the allowance include, but are not limited to: (1) detailed reviews of individual loans; (2) historical and current trends in gross and net loan charge-offs for the various portfolio segments evaluated; (3) the Companys policies relating to delinquent loans and charge-offs; (4) the level of the allowance in relation to total loans and to historical loss levels; (5) levels and trends in non-performing and past due loans; (6) collateral values of properties securing loans; (7) the composition of the loan portfolio, including unfunded credit commitments; (8) managements analysis of current economic conditions; and (9) migration of loans between risk rating categories. In support of collateral values, Regions obtains updated valuations for non-performing loans on at least an annual basis.
Credit Review, Commercial and Consumer Credit Risk Management, and Special Assets are all involved in the credit risk management process to assess the accuracy of risk ratings, the quality of the portfolio and the estimation of inherent credit losses in the loan portfolio. This comprehensive process also assists in the prompt identification of problem credits. The Company has taken a number of measures to manage the portfolios and mitigate losses, particularly in the more problematic portfolios. In addition, a strong Customer Assistance Program is in place which educates customers about options and initiates early contact with customers to discuss solutions when a loan first becomes delinquent.
For the majority of the loan portfolio, management uses information from its ongoing review processes to stratify the loan portfolio into pools sharing common risk characteristics. Loans that share common risk characteristics are assigned a portion of the allowance for credit losses based on the assessment process described above. Credit exposures are categorized by type and assigned estimated amounts of inherent loss based on several factors, including current and historical loss experience for each pool and managements judgment of current economic conditions and their expected impact on credit performance.
The allowance for loan losses totaled $3.2 billion at March 31, 2010 and $3.1 billion at December 31, 2009. The allowance for loan losses as a percentage of net loans was 3.61 percent at March 31, 2010 compared to 3.43 percent at December 31, 2009 and 1.94 percent at March 31, 2009. The reserve for unfunded credit commitments was $66 million at March 31, 2010 and $74 million at December 31, 2009. The quarterly increase in the allowance for loan losses was attributable to investor real estate (primarily land), commercial, residential first mortgage, and home equity. Despite the continued losses, there are indications that credit costs have begun to stabilize, as compared to recent quarters. Non-performing assets, excluding loans held for sale, increased $221 million from December 31, 2009, continuing a trend of lower levels of inflows as compared to prior quarters. The Company expects non-performing assets and net charge-offs to peak by the end of the second quarter of 2010 and decline thereafter.
Net charge-offs as a percentage of average loans (annualized) were 3.16 percent and 1.64 percent in the first three months of 2010 and 2009, respectively. Charge-off ratios were higher across all major categories, period over period. Commercial investor real estate losses were the highest contributor.
Net charge-offs were an annualized 3.07 percent of home equity loans for the first three months of 2010 compared to an annualized 2.38 percent through the first three months of 2009. Losses in Florida-based credits remained at elevated levels, as unemployment levels remain high and property valuations in certain markets have continued to experience ongoing deterioration. As illustrated in Table 4, these loans and lines represent approximately $5.6 billion of Regions total home equity portfolio at March 31, 2010. Of that balance, approximately $2.1 billion represent first liens, while second liens, which total $3.5 billion, are the main source of losses. Florida second lien losses were 7.96 percent annualized through the first three months of 2010 as compared to 5.99 percent for the same period of 2009. Through the first three months of 2010, home equity losses in Florida amounted to an annualized 6.04 percent of loans and lines versus 1.35 percent across the remainder of Regions footprint. This compares to the first three months of 2009 losses of 4.91 percent and 0.93 percent respectively.
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Management considers the current level of allowance for credit losses adequate to absorb losses inherent in the loan portfolio and unfunded commitments. Managements determination of the adequacy of the allowance for credit losses, which is based on the factors and risk identification procedures previously discussed, requires the use of judgments and estimations that may change in the future. Changes in the factors used by management to determine the adequacy of the allowance or the availability of new information could cause the allowance for credit losses to be increased or decreased in future periods. In addition, bank regulatory agencies, as part of their examination process, may require changes in the level of the allowance based on their judgments and estimates.
As a result of the unfavorable trends in credit quality previously described, including low consumer confidence, depressed property valuations, uncertainty around unemployment, and weak demand for goods and services, management expects that net loan charge-offs for all portfolios will continue at an elevated level during 2010. However, as compared to most recent periods, credit costs and many related metrics are showing signs of stabilization. Management expects net charge-offs to peak by the end of the second quarter of 2010 and decline thereafter. Details regarding the allowance and net charge-offs, including an analysis of activity from the previous years totals, are included in Table 5 Allowance for Credit Losses.
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Activity in the allowance for credit losses is summarized as follows:
Table 5Allowance for Credit Losses
Three Months Ended March 31 |
||||||||
2010 | 2009 | |||||||
(Dollars in millions) | ||||||||
Allowance for loan losses at beginning of year |
$ | 3,114 | $ | 1,826 | ||||
Loans charged-off: |
||||||||
Commercial and industrial |
98 | 63 | ||||||
Commercial real estate mortgageowner occupied |
34 | 14 | ||||||
Commercial real estate constructionowner occupied |
14 | 4 | ||||||
Commercial investor real estate mortgage |
212 | 87 | ||||||
Commercial investor real estate construction |
151 | 67 | ||||||
Residential first mortgage |
63 | 40 | ||||||
Home equity |
120 | 98 | ||||||
Indirect |
13 | 20 | ||||||
Other consumer |
25 | 19 | ||||||
730 | 412 | |||||||
Recoveries of loans previously charged-off: |
||||||||
Commercial and industrial |
6 | 5 | ||||||
Commercial real estate mortgageowner occupied |
2 | 2 | ||||||
Commercial real estate constructionowner occupied |
| | ||||||
Commercial investor real estate mortgage |
5 | | ||||||
Commercial investor real estate construction |
1 | 1 | ||||||
Residential first mortgage |
1 | 1 | ||||||
Home equity |
4 | 3 | ||||||
Indirect |
5 | 4 | ||||||
Other consumer |
6 | 6 | ||||||
30 | 22 | |||||||
Net charge-offs: |
||||||||
Commercial and industrial |
92 | 58 | ||||||
Commercial real estate mortgageowner occupied |
32 | 12 | ||||||
Commercial real estate constructionowner occupied |
14 | 4 | ||||||
Commercial investor real estate mortgage |
207 | 87 | ||||||
Commercial investor real estate construction |
150 | 66 | ||||||
Residential first mortgage |
62 | 39 | ||||||
Home equity |
116 | 95 | ||||||
Indirect |
8 | 16 | ||||||
Other consumer |
19 | 13 | ||||||
700 | 390 | |||||||
Provision for loan losses |
770 | 425 | ||||||
Allowance for loan losses at March 31 |
$ | 3,184 | $ | 1,861 | ||||
Reserve for unfunded credit commitments at January 1 |
$ | 74 | $ | 74 | ||||
Provision for unfunded credit commitments |
(8 | ) | | |||||
Reserve for unfunded credit commitments at March 31 |
$ | 66 | $ | 74 | ||||
Allowance for credit losses at end of period |
$ | 3,250 | $ | 1,935 | ||||
Loans, net of unearned income, outstanding at end of period |
$ | 88,174 | $ | 95,686 | ||||
Average loans, net of unearned income, outstanding for the period |
$ | 89,723 | $ | 96,648 | ||||
Ratios: |
||||||||
Allowance for loan losses at end of period to loans, net of unearned income |
3.61 | % | 1.94 | % | ||||
Net charge-offs as percentage of: |
||||||||
Average loans, net of unearned income |
3.16 | 1.64 | ||||||
Provision for loan losses |
90.87 | 91.78 |
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Loans deemed to be impaired include troubled debt restructurings (TDRs), plus commercial non-accrual loans. Commercial and investor real estate impaired loans with outstanding balances equal to or greater than $2.5 million are evaluated individually for impairment. For these loans, Regions measures the level of impairment based on the present value of the estimated projected cash flows, the estimated value of the collateral or, if available, observable market prices. For consumer TDRs, Regions measures the level of impairment based on pools of loans stratified by common risk characteristics. If current valuations are lower than the current book balance of the credit, the negative differences are reviewed for possible charge-off. In instances where management determines that a charge-off is not appropriate, a specific reserve is established for the individual loan in question. This specific reserve is incorporated as a part of the overall allowance for credit losses. The recorded investment in impaired loans was approximately $4.9 billion at March 31, 2010, compared to $5.0 billion at December 31, 2009. The allowance allocated to impaired loans, excluding TDRs, totaled $395 million and $403 million at March 31, 2010 and December 31, 2009, respectively. Loans that were characterized as TDRs totaled $1.7 billion and $1.9 billion at March 31, 2010 and December 31, 2009, respectively. The allowance allocated to TDRs, excluding specifically-impaired loans referred to above, totaled $38 million at both March 31, 2010 and December 31, 2009.
The following table summarizes TDRs for the periods ending March 31, 2010 and December 31, 2009:
Table 6Troubled Debt Restructurings
March 31 2010 |
December 31 2009 | |||||
(In millions) | ||||||
Accruing: |
||||||
Commercial and industrial |
$ | 48 | $ | 25 | ||
Residential first mortgage |
927 | 1,291 | ||||
Home equity |
274 | 241 | ||||
Other consumer |
57 | 51 | ||||
1,306 | 1,608 | |||||
Non-accrual status or 90 days past due: |
||||||
Commercial and industrial |
139 | 92 | ||||
Residential first mortgage |
216 | 178 | ||||
Home equity |
24 | 17 | ||||
379 | 287 | |||||
$ | 1,685 | $ | 1,895 | |||
If loans characterized as TDRs perform according to the restructured terms for a satisfactory period of time, the TDR designation may be removed in a new calendar year if the loan yields a market rate. The high rate of performance of residential first mortgage loans, which were characterized as TDRs in 2009, drove the decrease in TDR balances during the first quarter of 2010.
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NON-PERFORMING ASSETS
Non-performing assets are summarized as follows:
Table 7Non-Performing Assets
March 31 2010 |
December 31 2009 |
March 31 2009 |
||||||||||
(Dollars in millions) | ||||||||||||
Non-performing loans: |
||||||||||||
Commercial and industrial |
$ | 517 | $ | 427 | $ | 260 | ||||||
Commercial real estate mortgageowner occupied |
623 | 560 | 234 | |||||||||
Commercial real estate constructionowner occupied |
38 | 50 | 31 | |||||||||
Total commercial |
1,178 | 1,037 | 525 | |||||||||
Commercial investor real estate mortgage |
1,343 | 1,203 | 475 | |||||||||
Commercial investor real estate construction |
986 | 1,067 | 497 | |||||||||
Total investor real estate |
2,329 | 2,270 | 972 | |||||||||
Residential first mortgage |
199 | 180 | 140 | |||||||||
Home equity |
| 1 | 4 | |||||||||
Total non-performing loans |
3,706 | 3,488 | 1,641 | |||||||||
Foreclosed properties |
610 | 607 | 294 | |||||||||
Total non-performing assets* excluding loans held for sale |
4,316 | 4,095 | 1,935 | |||||||||
Non-performing loans held for sale |
256 | 317 | 393 | |||||||||
Total non-performing assets* including loans held for sale |
$ | 4,572 | $ | 4,412 | $ | 2,328 | ||||||
Non-performing loans*, excluding loans held for sale, to loans, net of unearned income |
4.20 | % | 3.85 | % | 1.71 | % | ||||||
Non-performing assets* excluding loans held for sale, to loans, net of unearned income, and foreclosed properties |
4.86 | % | 4.49 | % | 2.02 | % | ||||||
Non-performing assets* to loans, net of unearned income, and foreclosed properties |
5.15 | % | 4.83 | % | 2.43 | % | ||||||
Allowance for loan losses to non-performing loans* |
0.86 | x | 0.89 | x | 1.13 | x | ||||||
Accruing loans 90 days past due: |
||||||||||||
Commercial and industrial |
$ | 24 | $ | 24 | $ | 42 | ||||||
Commercial real estate mortgageowner occupied |
6 | 16 | 20 | |||||||||
Commercial real estate constructionowner occupied |
| 2 | 4 | |||||||||
Total commercial |
30 | 42 | 66 | |||||||||