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Regions Financial Corporation (NYSE:RF)

Q4 2009 Earnings Call

January 26, 2010 11:00 am ET

Executives

List Underwood – IR

Dowd Ritter – Chairman and CEO

Grayson Hall – President and COO

Irene Esteves – Senior EVP, Finance Group and CFO

Bill Wells – Senior EVP, Risk Management Group and Chief Risk Officer

Barb Godin – Head of Consumer Credit

Analysts

Matt O'Connor – Deutsche Bank

Craig Siegenthaler – Credit Suisse

Scott Valentin – FBR Capital Markets

Jason Goldberg – Barclays Capital

Jennifer Demba – SunTrust Robinson Humphrey

Jefferson Harralson – KBW

Ken Usdin – Bank of America/Merrill Lynch

Chris Mutascio – Stifel Nicolaus

Marty Mosby – FTN Equity Capital Markets

Operator

Good morning and welcome to the Regions Financial Corporation's quarterly earnings call. My name is Christine, I will be your operator for today's call. I would like to remind everyone that all participants' phone lines have been placed on listen-only. At the end of the call there will be a question-and-answer session. (Operator Instructions).

I'll now turn the call over to Mr. List Underwood before Mr. Ritter begins the conference call.

List Underwood

Thank you, operator. And good morning, everyone. We appreciate your participation this morning. Our presenters today are our Chairman and Chief Executive Officer, Dowd Ritter; our President and Chief Operating Officer, Grayson Hall; our Chief Financial Officer, Irene Esteves and Bill Wells, our Chief Risk Officer. Also here and available to answer questions are Tom Neely, our Director of Risk Analytics and Barb Godin, our Head of Consumer Credit.

Let me quickly touch on our presentation format. We have prepared a short slide presentation to accompany Irene and Bill's comments; it's available under the Investor Relations section of Regions.com.

For those of you in the investment community that dialed in by phone, once you're on the Investor Relations section of our website just click on live photo player and the slides will automatically advance in sync with the audio of Irene and Bill's presentation. A copy of the slides will be available on our website shortly after the call. I would also request in the interests of time that anyone asking a question please limit it to one per caller.

Our presentation this morning will discuss Regions's business outlook and includes forward-looking statements. These statements may include descriptions of management's plan, objectives or goals for future operations, products or services, forecasts of financial or other performance measures, statements about the expected quality, performance or collectability of loans and statements about Regions's general outlook for economic and business conditions.

We also may make other forward-looking statements in the question-and-answer period following the discussion. These forward-looking statements are subject to a number of risks and uncertainties and actual results may differ materially. Information on the risk factors that could cause actual results to differ is available from today's earnings press release, in today's Form 8-K, our 10-Qs for the quarters ended March 31, 2009, June 30, 2009 and September 30, 2009 and in our Form 10-K for the year ended December 31, 2008. As a reminder, forward-looking statements are effective only as of the date they are made and we assume no obligation to update information concerning our expectations.

Let me also mention that our discussions may include the use of non-GAAP financial measures. A reconciliation of these, the same measures on a GAAP basis, can be found in our earnings release and related supplemental financial schedules. Now, we'll turn it over to Dowd.

Dowd Ritter

Thank you, List. And good morning, everyone. We appreciate all of you joining Regions for our fourth quarter earnings conference call. In the fourth quarter, we took further aggressive actions to improve the risk profile of Region's balance sheet which resulted in a loss of $0.51 per fully diluted share.

Throughout 2009 we have taken steps to proactively recognize and reserve for credit-related problems, improve our operating efficiency, bolster our net interest margin and strengthen customer service and relationships. As a result, Regions is entering 2010 with a stronger foundation and a more effective and competitive business model.

I'm confident about Regions's future and the opportunities but acknowledge that we, along with our industry, still face some near-term credit and economic challenges. There is no better person, I believe than Grayson Hall to guide Regions through the new decade and ensure that Regions is fully prepared to realize its attractive profit potential once these current headwinds dissipate.

As you know, I'll be retiring at the end of this first quarter, at which time Grayson will become the Chief Executive Officer of Regions. During his 30 years with Regions, Grayson has played an instrumental role in growing and reshaping this company. His excellent leadership skills, along with a strong senior management team and a very talented and hard working group of associates, make me confident that Regions will prosper for years to come.

Let me now turn the call over to Grayson who'll spend a few minutes discussing Regions progress and outlook.

Grayson Hall

Thank you, Dowd. And good morning. We are obviously not pleased with either fourth quarter or full year 2009's earning loss but believe that actions we've taken to be prudent and in the best interests of Regions over the long term.

Our immediate focus is to best position our organization for a prompt return to profitability and we're taking aggressive and appropriate actions to make this happen. As part of our effort to reduce balance sheet risk, we have charged off an appropriate reserve for problem credits. For example, we increased the allowance for credit losses by a net $1.3 billion in 2009 with approximately $500 million in the net increase to reserves occurring in the fourth quarter.

To put this into perspective, loan loss provision and OREO cost totaled $1.2 billion or $0.65 a share in the fourth quarter alone and $3.7 billion or $2.33 per share full-year 2009. Credit related costs while remaining elevated should begin to decline in 2010 given our 2009 proactive stance towards credit loss recognition and prudent reserve bill.

Non-performing asset growth and gross non-performing loan inflow have slowed for the past two quarters, albeit in elevated levels. And investor interest in problem asset purchases appears to be increasing. This improvement suggests non-performing assets have the potential to peak and start to decline towards the middle of this year.

This economy and in particular its impact on employment and commercial real estate will largely determine the level and timing of the peak of non-performing assets. We are encouraged by some of the recent trends but remain cautious about the pace and substance of improvement. We clearly see improvement in our credit quality metrics but remain measured in our forecast regarding the pace of improvement. Later in today's discussion Irene and Bill will provide more details on credit quality. But in summary, let me say we're making steady progress in de-risking Regions balance sheet an in positioning the company for a prompt return to profitability.

In 2009, we also reduced interest rate risk and reversed Regions multi-year net interest margin decline. Fourth quarter marked the second consecutive period of stabilized net interest margin and the actions we have been taking on loan and deposit pricing should produce an improving margin throughout 2010.

While we don't anticipate an interest rate increase until later this year, rising short-term interest rates could meaningfully benefit Regions' margin positively affecting our future net interest income growth. We are not satisfied with net interest margin performance and continue to focus our efforts and attention on improvement opportunities. We are targeting a net interest margin at or about 3% by the end of this year.

Improving deposit mix fueled by a strong low-cost deposit growth has been and continues to be, a significant contributor to our margin stabilization. Average low cost deposits grew over 3% late quarter and a rough, nearly $8 billion or 14% year-over-year. We are taking market share in virtually all of our major markets with increased share in 15 of 16 states where we operate.

At the same time our deposit costs have steadily fallen dropping by 11 basis points linked quarter or 66 basis points since the fourth quarter of 2008. Our deposit gains reflect the success we've had in improving customer service, deepening customer loyalty and attracting new customers.

For example, in the fourth quarter alone we added over 246,000 new consumer and business checking accounts, beating our full year goal of 1 million new accounts and today we have 4.3 million active checking accounts at Regions. From a lending perspective, we are actively making prudent loans to creditworthy customers. In 2009, we made 167 new and renewed loans to businesses and individuals totaling $65 billion.

We are making $250 million in new and renewed loans every business day and we're actively seeking new relationships and strengthening existing ones as we take advantage of disruptions in this marketplace. Nevertheless, the economic backdrop remains challenging and generally speaking loan demand is reflective of the economy at large and still remains weak.

We are experiencing record loan payoffs and historically weak line usage, more than offsetting our efforts at new originations. As a result net loan outstanding climbed quarter-over-quarter. However, the good news is the majority of our loan declines have been in the commercial real estate outstandings and has had a favorable impact on our overall risk profile. We are focused on growing earning assets and in particular small business lending where we're starting to see an improvement. Earning asset growth may prove to be more challenging in 2010 and gives us every reason to focus on loan growth where opportunities exist, primarily in small business and in commercial lending.

Breaking business performance down from a line business perspective, consumer services had a solid year with customer satisfaction scores ending in the top fifth of large U.S. banks as measured by Gallup. Not only did we crest the 1 million new account thresholds, a 27% improvement year-over-year but we significantly improved our consumer checking household retention rate to above 90%. The focus on sales and customer service supported strong checking household and deposit growth. In fact, consumer households increased on a net basis by 6% this year to over 3 million consumer checking households.

Deposits generated through our retail branches grew accordingly, increasing 5% during the past year including $4 billion or 10% in low-cost deposits. In addition, we have over $8 billion of primarily high-cost certificate of deposits maturing in the first quarter and giving us an opportunity to further improve our deposit mix. This shift to a greater proportion of low-cost deposits has helped drive a 69 basis-point improvement in retail deposit costs and our average deposits per branch has improved to $52.1 million.

To maintain this momentum we continue to invest in our technology infrastructure. We have one of the largest technology projects in the company's history that will provide the latest generation of technology in our branches and positions us to take advantage of the competitive opportunities in the marketplace and provide even more efficiency and higher levels of sales and service. Our strategic focus is on growing the consumer line of business and making sure our consumer teams have the best tools in the industry.

Now, let me move to mortgage lending. In mortgage lending we had a record year with production of $9.6 billion compared to the previous year's $5.4 billion of production, our number one ranking and customer satisfaction among primary mortgage servicing companies by JD Powers and Associates to test our strength in and commitment to this important core consumer product. We continue to believe that a mortgage loan relationship leads to an opportunity to further expand into other profitable bank products.

Our business services line of business continues to focus on profitability, looking more closely than ever at structure, terms, up-front fees and interest rate spreads. To that end, commercial loan ongoing spreads continued to expand in the fourth quarter up 98 basis points versus the fourth quarter of 2008 and now stands at 254 basis points above LIBOR.

Today 76% of the business services loan portfolio is variable rate based. The majority tied to LIBOR which has been challenging in the interest rate environment we face in 2009, but positions us well for the eventual rise in rates. We have been implementing rate floors on new loans but currently only have 12% of our business loans paying at the floor and this will not prove to be a material drag on earnings when rates rise.

Specific to small-business lending we are particularly encouraged by our progress and prospects as Regions was recently recognized as number one small business lender among traditional lenders as measured by the Small Business Administration. Plus according to JD Power and Associates we moved up more than any bank in the latest small business customer satisfaction study. In fact, line utilization for small business stands at a strong 57% as compared to commercial lines that appear to have stabilized at about 41%.

Deposit growth from business relationships was tremendously strong in the fourth quarter and through 2009, up 4% this quarter and 12% annually. Deposit mix improved, as well with interest free deposits growing 7% linked quarter and 34% year-over-year. Mix improvement combined with disciplined pricing and improved market conditions has led to a drop in business services deposit costs by 54 basis points during the past year.

Now let me turn for a moment to Morgan Keegan. We continue to experience growth at Morgan Keegan in a challenging market. In 2009, we added over 80,000 new brokerage accounts and increased customer assets by $12.5 billion. Progress on new business has led to revenues of $337 million in the quarter bringing annual revenues to just under $1.3 billion for the year, very respectable given the challenging market environment.

The fixed income business segment led the way this quarter continuing its record setting pace helped by institutional customers' demand by government mortgage-backed and municipal securities. Retail brokerage revenue also improved, driven by higher improving equity markets as well as the addition of 18 new financial advisors. We continue to gain confidence and ability to grow our business at Morgan Keegan and to deliver consistent and improving profitability.

Now let me shift my comments to actions taken to improve efficiency. In 2009, we made considerable headway in lowering our core expense base and anticipate additional efforts in improvements in 2010. Unusually high recession and credit related costs such as higher OREO, professional fees and FDIC premiums are more than offsetting our expense reduction efforts and this is likely to continue into 2010. But ultimately many of these expenses will revert to more normalized level.

Meanwhile, we're continuing to diligently identify unnecessary expenses, implement more efficient operating processes, continue to rationalize staffing models across our business units and aggressively review any consolidation opportunities. In many cases, we are continuing to invest capital and commit expenses to achieve a better business model for the future but long-term we're building a more efficient business that will serve us well as the economy improves.

During 2009, we reduced head count by approximately 2,300 positions, while maintaining record high levels of service quality and record new account sales. All in all, I'm confident that we're on the right path to both properly deal with our credit problems and improve the long-term earnings potential of this franchise. As the economy recovers and credit costs begin to moderate we will see improved bottom line results and return to profitability at normalized levels.

Now let me close my comments, but before I do I want to personally recognize the contributions that Dowd Ritter has made to this organization and the tremendous leadership he has provided over his 40 plus years of service to the company. His leadership has proven invaluable, it is an honor and a humbling challenge to be assuming his leadership role and responsibility for sustaining our direction.

Regions' has an outstanding franchise in some of the best markets in the country, a dedicated and talented work force and great customers. Most of which can be attributed to Dowd's leadership and strong business vision. But most importantly his focus on customers and disciplined execution of our business plans. I believe these attributes will consistently reward shareholders over the long term with solid returns.

With that, I'll turn it over to Irene.

Irene Esteves

Thank you, Grayson. Let's begin with a summary of results for the quarter. Fourth quarter's bottom line reflects the operating environment as well as continued efforts to improve our balance sheet's risk profile. In addition and very importantly we continue to make progress in improving the fundamentals of our organization.

As shown in slide one average low-cost deposits rose $2.1 billion linked quarter, driven by an approximate 5% pickup in non-interest bearing deposits and a 3% increase in money market funds that more than offset a drop in higher cost certificates of deposit. Earning assets rose 1% with security purchases more than offsetting a decline in average loans which continued to be adversely impacted by weak demand and line utilization. The net interest margin was steady as expected with ongoing positive shift in funding mix countered by the impact of maturing interest rate swaps. As a result, net interest income was up slightly.

Fourth quarter non-interest income included a $96 million loss on sale of primarily non-agency securities equivalent to $0.05 per share after tax. A $71 million gain related to leveraged lease terminations was slightly offset in income – slightly more than offset in income taxes lowering net income by about $3 million or less than half a cent per share. Absent these items non-interest income was down about 3%.

Non-interest expenses adjusted for $41 million of branch consolidation and valuation related costs recorded in the third quarter and about $12 million in the fourth quarter was relatively unchanged, although still elevated primarily due to a rise in professional and legal fees. Our capital position remains strong with Tier 1 capital an estimated 11.6% and Tier 1 common at 7.2%. As expected, credit costs remained elevated during the quarter as we recorded a $1.2 billion loan loss provision exceeding net charge-offs by $487 million.

The net charge-off ratio was an annualized 2.99% of average loans compared to third quarter's 2.86%, with the increase driven by higher residential related consumer losses. As a result of the provisioning over charge-offs, the period end allowance for loan losses as a percentage of loans increased by 60 basis points to 3.43%.

Non-performing assets excluding loans held for sale increased $376 million or 10% linked quarter, well below third quarter's $662 million increase and the lowest quarterly dollar increase in 2009. As anticipated, CRE was the most notable contributor to non-performing loans and charge-offs. Importantly, both gross and net non-performing asset growth continued to moderate in the fourth quarter.

Loan loss allowance coverage of non-performing loans stood at 0.89 times at year-end, up from 0.82 times last quarter. Bill will cover credit in more depth in a minute but let's first talk about the other aspects of our quarterly results.

In terms of fourth quarter balance sheet changes, loan demand reflected the broader economy which was generally soft. More specifically, commercial and real estate construction demand was especially light with 2% and 15% portfolio drops, respectively. This slide illustrates that although our commitment levels remain high, commercial utilization rates were declining through year-end and are substantially lower than in a normal environment.

Nevertheless, we're beginning to see some stabilization and are continuing to search for and extend loans to creditworthy customers. There is no doubt that we are poised to grow balances once the economy improves and demand returns to more normal levels. In terms of funding, growth and low-cost deposits continue to be strong across the board including those from consumer, small business and commercial sources.

Slide three illustrates the outstanding customer deposit growth we've achieved over the last five quarters, driven largely by interest-free and money market accounts. Much of the success can be traced to new account openings.

In fact, as Grayson mentioned during 2009, we exceeded our company-wide goal of opening one million new checking accounts for consumers and small businesses. Our signature bundled product, Regions LifeGreen Checking and Savings helped fuel that growth. Robust low-cost deposit growth has significantly benefited our overall funding mix replacing higher cost certificates of deposit.

Improving new account generation and customer retention are increasing our deposit market share. The most recently released FDIC market share data showed that we had a great year in terms of market share gain. As indicated by the upward pointing arrows, we gained market share in 15 out of our 16 states, taking our state market share rankings higher in six of those 16 states.

As expected, the fourth quarter net interest margin was flat to the prior quarter. Solid low cost deposit growth, a catalyst to improving funding mix, is positively impacting our net interest margin. However, in the fourth quarter, incremental benefits were largely offset by the impact of interest rate swaps that matured in the third quarter and higher non-performing assets.

These items combined would have resulted in a 17 basis-point decline in the fourth quarter margin had it not been for the improved deposit costs and loan spread which brought us back to the forecasted stabilized margins. A steady net interest margin combined with a higher level of investment securities produced fourth quarter net interest income of $850 million.

Looking forward into 2010, we expect the margin to gradually improve throughout the year. Organic momentum in the form of CD repricing and continuous loan spread improvement will be the main drivers. Also inherent in this forecast is our expectation for a modest late-year rise in interest rates. Our goal is to reach the 3% or better NIM margin by year end.

Reported non-interest revenues were 7% lower than third quarter. However, as mentioned earlier, fourth quarter revenues were impacted by a $96 million loss on sale of primarily non-agency securities. A de-risking measure as well as a $71 million leverage lease termination gain that was more than offset in income taxes. Excluding their effect, non-interest income was 3% lower as higher brokerage revenues driven largely by Morgan Keegan, as Grayson touched on earlier were more than offset by lower hedge affected mortgage revenues.

The mortgage interest rate environment trended lower during the quarter driving up origination volumes of $2 billion compared to third quarter's $1.8 billion. Refinance activity represented 56% of origination, up from third quarter's level of 54%. During the quarter, we continued our efforts of eliminating credit risk from the balance sheet by selling $1.3 billion of investment portfolio securities including commercial and residential non-agency mortgage-backed securities and municipal bonds. We reinvested those proceeds into agency guaranteed mortgage-backed securities.

As a result of these actions, as well as securities transactions completed earlier in the year, the investment portfolio now has very minimal risk to CMBS, non-agency mortgage-backed securities or municipal bonds and has shorter duration as well. Today over 99% of our current investment securities portfolio is agency-guaranteed.

While we did record a loss this quarter for the year, securities transactions resulted in the $69 million gain. Notably, total service charges were relatively unchanged third to fourth quarter. However, in October, we announced that we will be modifying our dollar limit and daily occurrence caps relating to existing NSF and OD policies during 2010. These modifications are expected to cost us $40 million to $50 million full year 2010.

We continue to work on reigning in our baseline non-interest expenses. Excluding branch consolidation and valuation write-down costs, non-interest expenses were relatively flat linked quarter. During the quarter, improved personnel efficiency was a catalyst to the $12 million or 2% drop in salaries and benefit costs.

In 2009, we lowered head count by approximately 2,300 including a fourth quarter reduction of nearly 500. In addition, through consolidating supplier relationships, negotiating better contracts and fine-tuning staffing models, we continue to control discretionary spending.

Nevertheless, headwinds in the form of elevated FDIC and other real estate costs persist and are obscuring our progress to some extent. The good news here, as Grayson described, is that we expect many of these expenses to recede as credit-related issues return to more normalized levels. In 2010, we will continue to work diligently to improve our cost structure while continuing to make appropriate investments in developing our businesses.

As you're aware in the first quarter, we'll consolidate 121 branches into existing locations at an expected annual pre-tax net savings of $21 million. We will seek other opportunities to pare back costs. Of course, environmental costs will have a significant bearing on this year's ultimate expenses.

Let me wrap up with our strong quarter-end capital ratios. Our Tier 1 capital ratio now stands at 11.6%, while Tier 1 common ratios are a very solid 7.2%.

And now, let me turn it over to Bill Wells to go over our credit metrics.

Bill Wells

Thank you, Irene. Let me start by sharing some context for this quarter's credit results. Since the merger of Regions and AmSouth in November of 2006, a part of our business strategy has been to accelerate the disposition of problem assets and take losses as soon as possible and to confront issues early for the company's long-term benefit. Through moderation in credit metrics, we are now seeing is at least in part a result of those actions.

At the merger, we recognized the new Regions had too much real estate and too much land. We put in place new credit policies that put moratoriums on commercial real estate, centralized credit approvals and sold the so-called sub-prime mortgage company in March 2007. Shortly thereafter, real estate and the economy deteriorated significantly. We were among the first to segregate our homebuilder portfolio and discuss it publicly in January of 2008. Since then, we have aggressively disposed of problem real estate.

In the fourth quarter of 2008, we sold our mark-to-market and moved to held for sale $1 billion of non-performing loans. We described them at that time as the worst of the worst primary land and condos. We have continued to aggressively dispose of problem loans through 2009. These actions have helped produce a continuing decline in NPA migration and stabilization and charge-off.

Turning to the slide, charge-offs stabilized with a $12 million increase from the third quarter. As you can see, the components reflect our active asset disposition program and record sales of NPAs shown in orange. Business service losses were driven by higher valuation charges of $215 million in the fourth quarter versus $191 million in third quarter.

Overall, consumer losses accounted for the linked quarter rise which reflects continued high unemployment. As you will recall, the SCAP stress test was $9.2 billion in losses for 2009 and 2010 cumulatively. For 2009, that would equate to $4.6 billion against our actual performance of $2.25 billion. Said another way, 50% of the stress test period is over with actual results equal to 25% of what was expected.

Consistent with our message at the investor conference last July, we are very pleased with the continued declining trend in NPAs, especially the net number of $376 million versus $662 million in the third quarter. Our proactive sales program which included over $500 million this quarter, coupled with marks and transfers to held for sale, helped drive down the net NPA migration. During the fourth quarter, we only restructured approximately $50 million of non-performing loans and looking forward, we have the opportunity to do substantially more in the first quarter and beyond.

This is another look at non-performing asset migration. Land, condos, single-family, what we have traditionally called homebuilder and condo, continues to decline. Income-producing commercial real estate is down notably since last quarter, a very important point. Furthermore, our condominium exposure is now under $600 million.

This chart gives detail around our disposition program. During 2009's fourth quarter, we had record sales of $510 million and we moved an additional $133 million of non-performing loans to held for sale. The discounts on problem loan sales and loans that were mark to market were at 29% versus 34% last quarter.

As illustrated in the chart, over the last five quarters we have disposed of approximately $2.7 million of problem assets. Our aggressive sales marks and movement of loans to held for sale have helped us achieve the positive result in our NPA migration.

Here I wanted to explain our troubled debt restructurings because they are often misunderstood. The overwhelming majority of Regions's TDRs are residential first mortgages. In addition, over 97% of all consumer TDRs are accruing interest. TDR status is a function of our proactive customer assistance program which allows customers who are having financial difficulty to make payments as low as interest only. We have also made less than $1 million in principal balance concessions since the start of our customer assistance program.

We strongly believe that giving customers short-term relief, no matter how small, will prove beneficial for them as well as the company. While our strategy does lead to higher TDR levels under our accounting guidance, the business results have been positive. Regions recidivism rate is just over 16%, much better than government-sponsored programs and our foreclosure rate is less than half the national average.

This slide summarizes the credit costs we have discussed. During the fourth quarter, net charge-offs stabilized, NPA migration continued to decline and we had record loan sales of over $500 million at lower discounts than in previous quarters. Additionally during the quarter, we provided approximately $500 million over charge-offs to allow for credit losses.

Finally, over 90-day past-dues were up only $45 million from the third quarter. Mortgages to consumer accounted for $40 million of the growth, in line with rising unemployment. This slide shows a comparison of delinquency and foreclosures. You can easily see the impact Florida has on the portfolio. Our lower foreclosure rates reflects the quality of our portfolio coupled with our proactive customer assistance program that I mentioned before.

Given our substantial exposure to commercial real estate, we felt it only prudent to continue our reserve build in the fourth quarter to mitigate the risk. However, if our trend of declining migration of loans to a non-performing status continues on the current trajectory and the economy continues demand, the need for continued reserve build may be over.

Before I close, let me quickly touch on a topic that has gotten a lot of press recently. Potential exposure to loans originated and serviced for the GSE. Unlike many of our competitors that have large post-sale and corresponded lending channels, virtually all of our mortgage loans are originated in-house via our retail channel to strict underwriting and documentation standards.

In addition, we have comprehensive and effective controls in place to limit repurchases from the agencies. Audit procedures are performed monthly. And finally, our repurchase reserve is reviewed on a quarterly basis. Based on the nature of our portfolio, the rigor surrounding its management and based on our actual and forecast losses, we feel that we are appropriately reserved.

With that, I'll turn the call back to Dowd for closing comments.

Dowd Ritter

Thank you, Bill. As you you've just heard, a number of actions haven been taken in the fourth quarter and throughout the full-year 2009 that exacerbated the near-term pressure on Regions' bottom line but better positioned us to deal with the lingering economic and credit challenges as well as position us for longer term earning power. We've significantly reduced balance sheet risk. We appropriately increased our allowance for credit losses. We've reversed the down trend in our net interest margin. We've broadly improved market share, profitably grown our customer base, enhanced operating efficiency and raised capital. When credit and environmental costs return to more normal levels, Regions is well positioned, we believe, for a bounce-back in profitability and we'll deliver consistently solid returns.

Before opening the call for questions, I want to take the opportunity to thank you for your interest in Regions over the years. And I want to especially thank my Regions colleagues for their support and hard work. I couldn't be more confident in Regions' prospects given our talented associate base and being led by high energy and enormously talented and experienced person like Grayson. There's no doubt in my mind that great things are in store for this company as we look to the future for it and its shareholders.

With that, Operator, why don't we open it up for questions?

Question-and-Answer Session

Operator

Certainly. (Operator Instructions) Your first question comes from the line of Matt O'Connor with Deutsche Bank.

Matt O'Connor – Deutsche Bank

Hi, guys.

Irene Esteves

Hey, Matt.

Matt O'Connor – Deutsche Bank

Your net interest margin guidance calls for about a 30 basis point increase over the next four quarters, which is probably one of the more bullish outlooks for the margin among the banks. And I was just wondering if you can provide a little more color on the quarterly progression. Should we expect that a consistent step-up or more front or back-end loaded?

Matt, I would expect it to be more back-end loaded as we are repricing. As loans come up for renewal, we will be repricing, so that will build through the year as well as the building impact of our deposit costs coming down. So, we'll see some improvement in the first two quarters but I think most of it will come in the third and fourth.

Grayson Hall

And Matt, this is Grayson. When you look at the fourth quarter, we had a margin of 2.73% in the third and 2.72% in the fourth and we held that margin in spite of having about a 14 basis-point challenge on an interest swap derivative that was rolling off and approximately three basis points loans moved to non-accrual. So, we beat a 17-point headwind and held at 2.72%. We continue to see opportunities in the first quarter. We got roughly $8 billion in CDs that are maturing in the first quarter at a rate that's probably around 3.25%. And so we believe we got a lot of opportunity to improve that net interest margin going forward.

Matt O'Connor – Deutsche Bank

Okay. And then just as a follow-up on that. You increased the securities on balance sheet, but I assume some of that was to replace the swaps that rolled off. You did mentioned that you're still asset-sensitive. Can you provide us with what the interest rate positioning overall was at year end versus 9/30? Did it change much?

Irene Esteves

Yeah. Matt, our asset sensitivity is still in place. And as you'll remember last quarter, we talked about the asset sensitivity we'd be down in the short-term. So we put on a hedge for about a nine-month period that reduced our asset sensitivity to protect ourselves against a prolonged low interest rate environment. But that hedge expires in the third quarter, so you'll see our asset sensitivity increase over the next couple of quarters. You'll see that asset sensitivity show up more in our 12-month outlook.

Matt O'Connor – Deutsche Bank

Okay. And just – I am sorry, carry on.

Irene Esteves

Sorry. I was just going to add that when we reinvested, we kept the duration very short. So our average duration has dropped from 2.6 years to 1.9 years.

Matt O'Connor – Deutsche Bank

Okay. I guess, putting it altogether on the NIM, the back half of 2010, you've got the organic opportunities irrespective of rates rising and then the combination of that and some of the hedge rolling off. If rates do start to rise towards the end of this year and toward 2011 it sounds like there could be some real nice up-side to the margin even above what you said.

Irene Esteves

Yes. We do expect some good improvement in the margin.

Matt O'Connor – Deutsche Bank

Okay. Irene, very helpful. Thank you.

Irene Esteves

Sure

Operator

Your next question comes from the line of Craig Siegenthaler with Credit Suisse.

Craig Siegenthaler – Credit Suisse

Thanks and good morning.

Barb Godin

Morning.

Craig Siegenthaler – Credit Suisse

First, just on the home equity portfolio including Florida, delinquencies here continued to climb as did net charge-offs. And I'm wondering if you could share with us your expectations for home equity losses in 2010. Should we assume a step-up due to higher delinquency levels or are you seeing something in the pipeline that we should see some improvement?

Bill Wells

The question is really surrounding home equity and Barb will get to it. But one thing you have to understand that as we've watched this home equity portfolio, we have worked through the investor and second home piece in early 2009. And as we watched our past-dues and losses, it really does become a function of where you see unemployment going. And I'll let Barb drill down more on that.

Barb Godin

I want to take you back, Craig, to comments we made in the second and third quarters that we were very positively surprised in the second quarter with the amount of government stimulus that some of our customers saw as well as income tax rebates. And that really helped our 90-day past-due number and that in turn rolled into lower charge-offs for home equity in the third quarter. They have now risen back to, I would say, more normalized levels in this credit cycle. And as Bill and others have said, we have the challenge and the headwinds of rising unemployment. We're addressing that but we don't think it is going to be significant.

Craig Siegenthaler – Credit Suisse

So it seems like the government stimulus really drove the down tick in delinquencies in the second quarter but now you're seeing more of, I guess, a mix shift, within home equity from higher severity, high loss content, second home and shifting more towards lower loss content. Is that, kind of, a fair conclusion?

Barb Godin

I'm not sure that is a fair conclusion. There has been some shifting in there but I wouldn't necessarily agree with the fact that it's all moved just towards first lien production now.

Bill Wells

And what I would also say is when we looked at the home equity portfolio it is performing as we projected it would be. The second thing that I would add, when you look at our quality statistics compared to competitors, we are so much better. And I think it goes back to how we've always viewed underwriting from the beginning from our home equity products. It has been a good product for us. It has been under stress, but good quality underwriting, how we go through the process, has really proved beneficial to us, even though it may be elevated right now, compared to our peers.

Barb Godin

One last comment I would make and this is part of our customer assistance program, but nonetheless we worked through all of our collection queues. And we've actually worked through a lot of our current customers. To date we've touched 75% of our customers that we've reached out to and said do you need help and if so, we've extended that help i.e. back to TDRs increasing. But what it also says is I think we have a pretty good handle on what's happening in our home equity portfolio, again, by talking to 75% of that client base. All of this originated through our branches.

Craig Siegenthaler – Credit Suisse

Okay. And can you please just share the 30 to 89-day delinquency level for the fourth quarter versus the third quarter?

Barb Godin

Something we don't normally share but I would say that there are no surprises in it.

Craig Siegenthaler – Credit Suisse

Okay. So it is flattish?

Barb Godin

Yes. It is.

Craig Siegenthaler – Credit Suisse

Okay. Thank you very much for taking my questions.

Operator

Your next question comes from the line of Scott Valentin from FBR Capital Markets.

Scott Valentin – FBR Capital Markets

Good morning and thanks for taking my question. Just, within the loan categories, I noticed both construction buckets, owner occupied and non-owner occupied, jumped quite a bit in the fourth quarter. Was that a cleanup quarter or how should we think about that – those two buckets going forward in terms of losses?

Bill Wells

One thing you have to do when you look at owner occupied and the numbers, that they're coming off small dollar amounts. So you'll get some variation in there. And we just don't see it as a significant trend or cleanup or any of that. That is just more of what we've seen in the portfolio. Our owner occupied really attracts to what we've seen in our C&I portfolio. Do you have anything?

Grayson Hall

In the non-owner occupied portfolio, a lot of that is our homebuilder book that is a stress portfolio. It is down substantially quarter-over-quarter about $500 million and it is just going through and working out that portfolio.

Scott Valentin – FBR Capital Markets

Okay. So you would say it is more of a denominator effect, I guess, the shrinking portfolios?

Grayson Hall

Yes. That's right.

Scott Valentin – FBR Capital Markets

Okay. And just one follow-up question on credit. How should we think about normalized credit cost? I think the general guidance was hopefully peak NPA formation by mid '10 assuming the economy continues to improve. What would be the forecast, the guidance we should use when we're trying to forecast more normalized credit costs?

Bill Wells

Well, at our Investor Day, we talked about a range back in July of where we thought credit costs were going. To us, where we see that credit costs will lag a little bit of where your NPA migrates. But at that time, we had said back in July, we thought of a range of $3.4 billion to $5.9 billion. We're half-way through that. We said at that time we think we would be in the middle of the range. I think we're going to be maybe tend up a little bit from where we saw it. But still well within the range of where we gave some discussion back in July.

Scott Valentin – FBR Capital Markets

Okay. Thanks very much.

Operator

Your next question comes from the line of Jason Goldberg with Barclays Capital.

Jason Goldberg – Barclays Capital

Thank you. I guess, Grayson, with you taking the reins now as CEO, can you just elaborate in terms of, I guess, what you expect to continue to be doing and what changes we should look for ahead. And then, maybe, Dowd, in the majority of these situations we have seen the outgoing CEOs stay on as chairman through a transition period. Maybe just elaborate why you're not doing that and just the timing of your departure, particularly given the fact that you still have a couple of years to go before the management retirement age.

Dowd Ritter

Jason, I'll take the latter part second. I think after all those 41 years, no one should be surprised with my decision. Secondly, personally and I think the board agreed, I'm a big believer in proper corporate governance and I don't think there's any worse practice that a large corporation can have than to have an outgoing CEO stay on the board and for what that does to the other directors and the incoming CEO.

The transition process has been going on for years with our board and so I think the way we're doing it and me not staying on the board, is very appropriate in corporate governance in America today. And I'll turn it over to Grayson to answer the other part of that.

Grayson Hall

Yeah. Jason, I mean, first of all, it's a good question and a question that we've given thoughtful consideration to. I've had quite a few discussions with Dowd, with our corporate directors and with our senior team. And first let me say you really should not anticipate any dramatic shifts in our business strategy. We have been and will continue to be focused on the same core issues. First and foremost, we're managing and reducing the credit risk on our balance sheet. That is the first order of business.

And secondly, we are looking for any and every opportunity to improve our operating efficiency, reducing discretionary spending across the organization. We're driving the franchise to deliver higher levels of organic growth, to improve sales and service and focusing on our customers. And, lastly, is around profitability. We're trying to add discipline around loan and deposit pricing. We're trying to grow revenues in our different businesses because our focus is a prompt return to profitability. And these have been our core issues for a number of months, they continue to be. It's a balanced approach trying to put credit risk on one side and the customer and growing our organic business on the other. And you should not anticipate that you see any change in that. My only hope is that the change you see is incremental improvement over the next several quarters and our risk profile and more aggressive action to return to that level of profitability and we plan on increasing the intensity and focus on those issues.

Jason Goldberg – Barclays Capital

Helpful. And then as a follow-up, the Tier 1 common ratio came down, I think, 75th this quarter and now kind of puts you in the lower quartile or so of at least the top 25 banks. Just, maybe just comment around your capital position particularly in light of the fact that I think your outlook points that continued lack of profitability at least the early part of '10.

Irene Esteves

Jason, our capital ratios dropped because of our loss and our DTA position, of course. But they're still at very high levels, 11.6%, Tier 1 and 7.2% Tier 1 common. And as we look out through the cycle and you've heard the comments on our improving credit metrics, we feel we have sufficient capital to get to fully have a cushion throughout the cycle.

Jason Goldberg – Barclays Capital

Thank you.

Operator

Your next question comes from the line of Jennifer Demba with SunTrust Robinson Humphrey.

Jennifer Demba – SunTrust Robinson Humphrey

Thank you. Good morning. I was wondering if you could, kind of, elaborate on what you expect to do from an efficiency improvement further effort in 2010. And I was wondering if you could repeat the number. You said you outlined the amount of OREO costs and credit related non-interest expenses you had for '09.

Grayson Hall

Jennifer, this is Grayson. We continue to have our focus on managing expenses. As long as we're in the situation that we're in, from a profitability standpoint, rigorous expense management just has to be a normal course of business. We are going to close 121 branches this quarter, has annualized run rate improvement on expenses of about $21 million. We continued to reduce the amount of occupancy that we have in the company. We've sold off over the last three years roughly 3 million square feet of space in the company. We continue to reduce headcount. As we mentioned before, we're down approximately 2,300 positions for the year and we're down 500 in the fourth quarter. We would anticipate that we'll continue to rationalize headcount in this environment.

When you look at credit-related expenses that are running through NIE, we're running for 2009 a little over $800 million. You figure $200 million of that is probably pretty normal. $200 million of it is probably FDIC insurance that may or may not go away. That leaves you with about $400 million in elevated NIE or almost $100 million a quarter that we should see go away in our non-interest expense as we normalize to a more credit – more normalized credit environment.

Jennifer Demba – SunTrust Robinson Humphrey

Okay. Could you give us some thoughts on TARP repayment?

Grayson Hall

Sure. TARP repayment, we continue to take appropriate steps to position our company to repay TARP, when it becomes financially prudent and when agreed to by our regulatory authorities. Our preference continues to be to execute TARP repayment in a manner that balances really our regulatory requirements, our risk profile and our shareholder expectations. We continue to prepare ourselves for repayment, but remain disciplined in our approach.

Jennifer Demba – SunTrust Robinson Humphrey

Okay. Thank you very much.

Operator

Your next question comes from the line of Jefferson Harralson with KBW.

Jefferson Harralson – KBW

Hi. Thanks, guys. Good morning.

Irene Esteves

Morning.

Jefferson Harralson – KBW

Irene, I was going to ask you about, to followup on Jason's question, on the DTA. What is the amount of the DTA now and how much of it is counting towards the regulatory capital?

Irene Esteves

The DTA is about $1 billion and about 15% of it counts towards regulatory capital.

Jefferson Harralson – KBW

All right. How much did the DTA increase from the Q3 to Q4?

Irene Esteves

It wasn't material. It wasn't a large increase.

Jefferson Harralson – KBW

Okay. And when you guys did you – last question, when you got to the SCAP test, how much is the performance of DTA in keeping with the SCAP test? Was there also some relatively significant regulatory DTA disqualified for the SCAP test?

Irene Esteves

It is about the same in relation to our losses.

Jefferson Harralson – KBW

Okay. Thank you very much.

Operator

Your next question comes from the line of Ken Usdin with Bank of America.

Ken Usdin – Bank of America/Merrill Lynch

Hi. Good morning. Bill, I was wondering, if you could elaborate a little bit on your point about reserve building, maybe potentially being close to being complete. So in terms of you guys putting up a little bit bigger reserve build this quarter. How close do you think you are to being complete with the reserve build and how do you think that magnitude will track as we move ahead? Thanks.

Bill Wells

Yeah. One thing what we did when we looked at this quarter is we looked at the overall metrics that we're seeing. We mentioned past dues. We mentioned what we saw the trends in our non-performing and then also what we see on our charge-offs too. We're just looking out for our portfolio. So we thought it very prudently to reserve approximately $500 million over charge-offs for this time. Again, it is looking forward for the portfolio. We have always been very prudently in how we looked at our reserve and our build. We'll come to a point where you start to say where non-performings peak your internal metrics are looking better and then we'll come to that decision but right now we think we're very well provided for the losses that we see in the reserve. I was looking back at our just overall loss to loan levels and it's at a very high level compared to where we have been for a company and where you were for an industry, especially during the last cycle also too given the risk profile that we have of our company. So, again, feel good about where we are and where we're positioned for 2010.

Ken Usdin – Bank of America/Merrill Lynch

So just to ask it a different way, does that really mean we'll see a meaningful drop-off in the reserve build because if you had started to see some of those metrics turn the right way, you still built incrementally in the fourth. So if those metrics continue to improve, I would assume – are we done, do we start matching immediately as you see that turn as early as next quarter?

Bill Wells

It is hard to predict which quarter you're going to be in, but you always reach an inflection point where you start to look at what your metrics are. When we look for this quarter and for 2010, we see improving conditions. Still a stress portfolio, but we see that a lot of the programs and the actions that we took in 2009, we're bearing fruit of that, and you're going to see that again maybe higher up. It's still a stressed credit environment but we're taking the right actions and you'll get to an inflection point where you see the metrics start to continue to improve and that's where you make your decisioning about where you are on covering your charge-offs and if you do any extra provisions over that.

Ken Usdin – Bank of America/Merrill Lynch

Okay. And my second question is just can you give just a little bit of color on the CRE business and how it's acting on tear points about the inflows being a little lower this quarter on CRE. I'm just wondering if you can give us some granular color on what you're seeing in that business and what your general outlook is for commercial real estate determine income producing. Thanks.

Bill Wells

I'll first talk about on commercial real estate, in our supplement. I point everybody to – it's a pretty good breakdown of our portfolio and this time we also went through our multi-family and retail properties. One thing, I would say is it's a well diversified portfolio as we continue to work down our overall exposure. Again, I mentioned there were two slides specifically on multi-family and retail, geographically diverse. Overall a small note size from what we've seen in this portfolio, I really speak from the sales part, we are seeing more buyers come into the market looking to buy income-producing properties.

A year ago, six months ago, we probably had two, possibly three individuals looking for a piece of property to buy. Now, we can have up to nine and our marks are holding better. So what I would tell you is that I believe that the portfolio is a stressed portfolio but still seems to be working. We are managing through it as we have been. Our construction piece, investor portfolio, has come down from about $9 billion to about $6 billion. And what is most important is we're starting to see a shift in our mix of our investor real estate. Land and single-family and condo were at 33% a year ago and now it's down to 26%. And multi-family and retail which was at 67% is now at around 74%. So when you talk about that and you're seeing less loss severity, you are having some type of cash flow. So for me, looking from a risk perspective, we're able to work through some of these properties a lot better than what we had when we were talking about condos and large land deals.

Operator

Your next question comes from the line of Chris Mutascio with Stifel Nicolaus.

Chris Mutascio – Stifel Nicolaus

Good morning. Thanks for taking my question. Grayson, you had mentioned the pretty widespread or difference between the line utilization rates on small business and those of your more commercial, I guess, more traditional commercial-related customers. Can you talk a little bit about that? Is that a good or a bad thing? Are the small businesses tapping their lines of credit because of inventory rebuild and better sales or are they cash strapped relative to the more larger corporate borrowers?

Grayson Hall

It is an excellent question and one that we ask ourselves as well, you know. We've drilled down into the credit metrics on the small-business side. I would tell you that part of that utilization is we've been looking at our lines and very careful about the size of line we extend to small business. And I think part of that utilization being at that level is that we probably are more conservative on our underwriting on small business. But our small business portfolio continues to perform well relative to this market. We don't believe that that utilization level is stress-related in any large degree. We are continuing to be encouraged by the number of small business customers that we're able to attract for the company each quarter.

On commercial, I would just tell you that our customers, we have many customers anecdotally that have carried large lines with us who have no debt outstanding to us whatsoever today. And so you're seeing much more conservatism on the part of our traditional large commercial accounts.

Chris Mutascio – Stifel Nicolaus

Okay. That's helpful. If I can ask one follow-up, Bill, you had mentioned in your presentation you sold, I think $510 million of NPAs during the quarter. When I look on slide 24 – page 24 of the supplement, it looks like NPA dispositions were $312 million. How do I reconcile the difference between those two numbers?

Bill Wells

There are a couple things. What you have is coming out of held for sale is one, and then if there was a particular loan that was not necessarily in non-performing status, that would be the difference there. So that's how you reconcile between what we did and showing on that slide. The other thing I would mentioned as I talk about held for sale, it's a balance of $317 million at the end of the quarter.

Our sales have continued. We sold about $30 million since the first of the year. So our held for sale balance is under $300 million. It had been hovering around $400 million. So you've been able to see that account, that portfolio churn over a period of time. So, again, that – hopefully that answers your question the difference between the two.

Chris Mutascio – Stifel Nicolaus

It does. Thank you very much.

List Underwood

Operator, this is List Underwood. We have unfortunately just time for one more question.

Operator

Certainly. Your final question comes from Marty Mosby with FTN Equity Capital.

Marty Mosby – FTN Equity Capital Markets

Thanks for taking my question. Irene, I want to do visit the rate sensitivity and the increase in net interest margin as rates begin to climb. Last year, we reported at the end of the year that we had a 5% rate sensitivity position. Over this year, we have been de-risking the balance sheet and dropping construction loans which are all variable rate-type loans. It's about a 4% impact. So maybe we're still rate sensitive or are we going to see some less of an impact in the very near-term when rates go up because we've come out of the short pull in assets and moved into cash flow out of securities. I just wanted to know why we – have we moderated that impact somewhat as we have seen the balance sheet shift in mix?

Irene Esteves

Sure, Marty. It's the – the short answer is we are just as asset sensitive as we have always been in the longer term. We've taken the nine months that will roll off in Q3 of this year. The position that we thought interest rates would stay low, so we put on a hedge during that nine months period which will roll off and bring back the asset sensitivity. When you look at our 12-month outlook, which would be in the 10-Qs and in the 10-K, you will see that asset sensitivity reappear once that rolls off.

Marty Mosby – FTN Equity Capital Markets

Even if we have any risk to just the cash flow extending on the securities versus being in the floating rate construction loans?

Irene Esteves

It is a very short duration. We're at an average 1.9 years on the investment portfolio. We'll continue to keep that duration short.

Marty Mosby – FTN Equity Capital Markets

Okay. Thanks.

Irene Esteves

Sure.

Operator

Thank you. I'll now turn it back over for closing remarks.

Dowd Ritter

Okay. Let me just thank everyone for joining us this morning and we will stand adjourned.

Operator

Thank you. This concludes today's conference call. You may now disconnect.

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Source: Regions Financial Corporation Q4 2009 Earnings Call Transcript
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