Fitch Affirms Regions Financial Corporation's LT IDR at 'BBB' Following Large Regional Bank Review
The rating action follows a periodic review of the large regional banking group, which includes BB&T Corporation (BBT), Capital One Finance Corporation (COF), Comerica Incorporated (CMA), Fifth Third Bancorp (FITB), Huntington Bancshares Inc. (HBAN), Keycorp (KEY), M&T Bank Corporation (MTB), MUFG Americas Holding Corporation (MUAH), PNC Financial Services Group (PNC), Regions Financial Corporation (RF), SunTrust Banks Inc. (STI), US Bancorp (USB), Wells Fargo & Company (WFC), and Zions Bancorporation (ZION).
Company-specific rating rationales for the other banks are published separately, and for further discussion of the large regional bank sector in general, refer to the special report titled 'Large Regional Bank Periodic Review,' to be published shortly.
KEY RATING DRIVERS
IDRs, VRs, AND SENIOR DEBT
The affirmation reflects RF's good capital and liquidity profile, improving earnings, and continued improvement in asset quality. Fitch views greater upside in RF's ratings over the medium to longer term. This would be predicated on closing the gap with higher rated peers in terms of asset quality and profitability. While Fitch recognizes the notable progress RF has made thus far to improve its performance, further improvements may be more challenging until and unless rates rise. Fitch views RF's relative profitability and higher exposure to oilfield services to be rating constraints.
Although RF's earnings continue to lag the peer median, they reflect a good improvement over prior periods. RF reported an ROA of 82bps during 1H15, as compared the peer median of over 100bps. RF earnings have benefitted from growth in certain noninterest income categories, and a fairly resilient margin. RF's NIM contracted 8bps in the second quarter of 2015 (2Q15), as compared to the prior year ago quarter. This compares favorably to peers. RF maintains relatively lower deposit costs, while loan yields are in line with peer averages.
Earnings headwinds have included elevated regulatory and compliance-related costs, the low asset yield environment, and the discontinuation of the deposit advance product. To offset some of these challenges, RF is continuing to monitor its expenses, with further branch rationalizations expected over the near term. The company plans to consolidate 50 branches or 3% of the total branch count in 2015. RF is also attempting to increase its reliance on noninterest income, particularly from the insurance, mortgage servicing, and capital markets activities. RF's is currently slightly more spread income reliant than the average for large regional bank peers.
RF's capital profile remains good with an estimated fully phased-in Common Equity Tier 1 ratio under Basel III of 11% at June 30, 2015. This ratio is one of the highest of the large regional bank peer group. Fitch expects these capital levels will diminish over time but will remain above peer averages over the near term given CCAR-related capital distribution constraints.
RF's liquidity profile also remains solid with a low loan-to-deposit ratio, at 83% at quarter-end, which is up only slightly from a year ago, as loan growth has eclipsed deposit growth. RF's loan to deposit ratio is one of the lowest of the large regional peer group, and provides the company more flexibility in funding loan growth under a more robust economic environment. Loan growth over the past year for RF has been muted at roughly 5%. This is viewed favorably by Fitch given the competitive lending environment.
Fitch views RF's deposit franchise as a rating strength, especially in light of its higher growth footprint. RF has a very low cost of funds, and stands to benefit from higher than average population growth expectations given its Southeastern footprint. While depositor behavior under a higher interest rate environment is difficult to predict, RF's franchises in Alabama, Mississippi, and Arkansas in particular, where the company holds either the No. 1 or No. 2 market shares, may prove more resilient to pressures of higher deposit costs, and aid the company's earnings profile. Lastly, RF disclosed that is well positioned for the final LCR rule and expects to be fully compliant by the January 2016 deadline.
For the first time in many quarters, RF built its loan loss reserves in 2Q15. RF attributed the reserve build to loan growth but also reflective of risk rating adjustments stemming from the annual SNC exam, half of which were energy-related. Criticized and classified balances have increased 9% from year-end. RF disclosed that it has \\$3.3 billion in energy-related exposure at June 30, 2015, or 4% of the total loan book. RF also held approximately \\$265 million of energy-related investment grades bonds at quarter-end. Although this exposure is somewhat on the higher end of peer averages, it is still considered manageable in the context of loan losses and the capital base. Nonetheless, Fitch expects some weakness particularly from its oilfield services portfolio, which represents approximately 45% of energy direct outstandings, which is higher than its peers.
NCOs declined again to 23bps in 2Q15 for RF, which is in line with the peer average. Fitch expects NCOs will increase across the industry from currently unsustainable low levels, particularly in sectors such as energy.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
RF's subordinated debt is notched one level below its VR of 'bbb' for loss severity. RF's preferred stock is notched five levels below its VR, two times for loss severity and three times for non-performance. These ratings are in accordance with Fitch's criteria and assessment of the instruments non-performance and loss severity risk profiles and have thus been affirmed due to the affirmation of the VR.
LONG- AND SHORT-TERM DEPOSIT RATINGS
The uninsured deposit ratings of Regions Bank are rated one notch higher than RF's IDR and senior unsecured debt because U.S. uninsured deposits benefit from depositor preference. U.S. depositor preference gives deposit liabilities superior recovery prospects in the event of default.
HOLDING COMPANY
RF's IDR and VR are equalized with those of its bank, reflecting its role as the bank holding company, which is mandated in the U.S. to act as a source of strength for its bank subsidiaries. Ratings are also equalized reflecting the very close correlation between holding company and subsidiary failure and default probabilities.
SUPPORT RATING AND SUPPORT RATING FLOOR
RF has a Support Rating of '5' and Support Rating Floor of 'NF'. In Fitch's view, RF is not systemically important and therefore, the probability of support is unlikely. IDRs and VRs do not incorporate any support.
RATING SENSITIVITIES
VR, IDRs, AND SENIOR DEBT
Ratings could be positively affected with the improvement and maintenance of core earnings at peer levels combined with a continued reduction in problem asset levels. Fitch anticipates more ratings upside for RF than downside risk over the medium to long term.
Fitch expects some deterioration in RF's energy portfolio, as well as for its peers. If overall asset quality continues to modestly improve and deterioration in RF's energy book is not outsized relative to the performance of peers, this may be consistent with an upgrade. However, if RF's energy portfolio performs noticeably worse than peers, ratings upside may be impacted.
Conversely, a sustained reversal of moderating credit trends, combined with a large decrease in capital, would likely pressure ratings, although a downgrade is viewed as more remote given RF's recent progress in addressing many of its many legacy challenges. Fitch views more potential for ratings upside for RF than downside risk.
Similar to some of its large regional bank peers, RF is going to continue to build out its capital markets capabilities. While these businesses can result in much more volatile earnings, Fitch expects that the capital markets revenues will remain low relative to total revenues for RF. Outsized growth or contribution from capital markets-related revenues may impede upwards rating momentum, though this is considered a low likelihood over the near to medium term.
When RF sold Morgan Keegan to Raymond James in 2012, RF agreed to indemnify Raymond James for all litigation matters related to pre-closing activities. The carrying amount of the indemnification obligation at June 30, 2015 totaled \\$203 million. There is very limited visibility into the ultimate outcome of this or other pending litigation facing RF. However, Fitch's ratings of RF do not currently incorporate a charge in excess of what the indemnification obligation covers. A material charge in excess of the indemnification asset may impact ratings.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
The ratings for RF and its operating companies' subordinated debt and preferred stock are sensitive to any change to RF's VR.
LONG- AND SHORT-TERM DEPOSIT RATINGS
The long-and short-term deposit ratings are sensitive to any change to RF's long-and short-term IDR.
HOLDING COMPANY
Should RF's holding company begin to exhibit signs of weakness, demonstrate trouble accessing the capital markets, or have inadequate cash flow coverage to meet near-term obligations, there is the potential that Fitch could notch the holding company IDR and VR from the ratings of the operating companies.
SUPPORT RATING AND SUPPORT RATING FLOOR
Since RF's Support and Support Rating Floors are '5' and 'NF', respectively, there is limited likelihood that these ratings will change over the foreseeable future.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
Regions Financial Corporation
--Long-term IDR at 'BBB'; Outlook Stable
--Short-term IDR at 'F2';
--Subordinated debt at 'BBB-';
--Viability rating at 'bbb';
--Senior unsecured at 'BBB';
--Preferred stock at 'B+';
--Support at '5';
--Support floor at 'NF'.
Regions Bank
--Long-term IDR at 'BBB'; Outlook Stable;
--Long-term deposits at 'BBB+';
--Short-term deposits at 'F2';
--Short-term IDR at 'F2';
--Senior debt at 'BBB';
--Subordinated debt at 'BBB-';
--Viability rating at 'bbb';
--Support at '5';
--Support floor at 'NF'.
AmSouth Bancorporation
--Subordinated debt at 'BBB-'.
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