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Regions Financial Corporation's (NYSE:RF) bottom line exceeded expectations, while its top line slightly missed consensus estimates, when the bank reported earnings on July 24, 2012.

The bank earned $0.20 per share on revenues of $1.345 billion during Q2 2012. Its revenues slightly missed consensus analyst estimates. However, the EPS displayed a surprise of 46%. The strength in the performance was largely attributed to an improved net interest margin, growth in the commercial and industrial portfolios, growth in mortgage loans production, and reduced operating expenses. These factors led to a significant improvement of 53% in the reported net income of $284 million, compared to the first quarter of the current year.

Click to enlarge images.

Source: Company presentation.

As illustrated in the table above, the bank was able to earn net interest income of $856 million, up by 1% and down by 2% when compared to Q1 2012 and Q2 2011, respectively. Net interest margin increased from 3.09% in Q1 2012 to 3.16% in Q2 2012. The increase was largely due to an improvement in deposit costs and lower excess cash. Low-cost deposits on average improved by 2%, while higher cost deposits plunged by 10%. Long-term interest rates have decreased as a result of the Fed's efforts. This will make it difficult for the bank to continue to grow its net interest income, unless it continues to grow its low-cost deposits.

Non-interest income of $543 million was down by 3% and 7% when compared to Q1 2012 and Q2 2011, respectively. The decrease in non-interest revenues was partially offset by revenues accruing from mortgage-related activities, which advanced by 17% compared to the prior quarter. The improvement was largely due to increased new-home purchases and refinancing, as home owners took advantage of the continuous low interest rates and HARP II. Besides, non-interest expense declined by 8% compared to the prior quarter due to lower credit-related expenses.

Commercial and Industrial loans, as illustrated in the figure, grew by 4% compared to the prior quarter. However, despite the near-zero interest rate environment, the overall loan yield remained flat. Consumer loans originations amounted to $2.8 billion, up by 24% over the same quarter from last year. The growth was largely attributed to a 6% surge in indirect auto loans. Overall loans portfolio declined by 100 bps, reflecting a decline in residential mortgage and home equity portfolios.

Other key points of the results included the fact that the bank was able to reduce inflows in non-performing loans by 11%, compared to the first quarter, and it repaid $3.5 billion worth of preferred stock investment to the U.S. Treasury Department. Although this had depressed the second-quarter earnings, it will result in lower cost of funds in the coming quarter. The Tier 1 common ratio for the bank improved from 9.6% in the first quarter of the current year to 10% in the second quarter. This is comparable to a 9.3% Tier 1 common ratio for PNC Financial Services Group (NYSE:PNC). The bank's Tier 1 capital ratio decreased from 14.3% to 11% over the same time period. However, excluding the TARP impact, the ratio improved by 50 bps over the same time period to reach 11% by the end of June.

Valuations

The stock, with regard to its book value multiple of 0.67 times, is trading at a discount of 44% and 29% when compared to both BB&T Corp. (NYSE:BBT) and PNC Financial Services Group, respectively.

The key to Regions Financial's outperformance was its ability to grow its low cost deposits base, which has led it to earn a higher net interest spread during the second quarter of the current year. The stock is up 5% since the announcement of results and has appreciated 62% in value since the beginning of the year.

Although the bank will face difficulty in enhancing its interest rate margin due to the continuous low interest rate environment, its superior capital position and ability to grow low-cost deposits, combined with attractive valuations, makes it a long candidate.

Source: Buy Regions Financial - A Story Of Expanding Net Interest Income Margins