Regional Banks Trapped In The Florida Quagmire

Several years ago, most banks were rushing to get into some of the high-growth markets in the United States. Florida was one of the most coveted areas, with banks looking either for acquisitions or expansions. Fifth Third Bancorp (Nasdaq:FITB) was among these banks, paying 25-times earnings for its purchase of First National Bankshares of Florida in early 2005.

Investors and analysts led this pressure for expansion, as banks with significant market share in Florida and other higher growth areas were frequently rewarded with higher multiples in the market. In the current environment, it's probably a safe bet to say that bank managements wish they had never heard of Florida, as losses and bad loans mount in this and other erstwhile growth areas.

Regions Financial (NYSE:RF)
Recently Regions Financial reported results for the second quarter of 2008. The bank reported net income of $206.4 million, or 30 cents per diluted share. Excluding merger-related expenses, earnings per diluted share from continuing operations was 39 cents. While still profitable in the quarter, Regions Financial's results show how a strategy of expanding out of a bank's core stable markets can backfire when the economy and the credit cycle turns down. Regions Financial also announced:

• Net loan charge-offs are now at an annualized rate of 0.86 % of average loans, due mostly to credit deterioration in the bank's portfolio of home equity and residential homebuilder loans.
• An increase in the allowance for credit losses to 1.56 % of loans.
• Non-performing assets increased to 1.65 % of total loans and other real estate.
• A reduction in Regions Financial's quarterly cash dividend to 10 cents from 38 cents per common share.

During the conference call, management put the blame squarely on Florida, with particular problems in the Bradenton, Sarasota, Fort Myers, Cape Coral, Naples, Marco Island, and Fort Walton markets. The bank noted that it has $5.4 billion in home equity loans in Florida, of which $3.5 billion are second lien. These second lien loans are experiencing more problems due to the presence of speculators and less collateral protection if the borrower defaults. The annualized loss rate in the second lien portfolio is now at 4.74%. (To learn how to break down these complex documents, read Analyzing A Bank's Financial Statements.)

The situation doesn't seem likely to change soon, as Dowd Ritter, the bank's chairman and CEO said, "Given the continuing deterioration in residential property values, especially in Florida and the generally uncertain economic backdrop, we expect credit costs to remain elevated. While we are not predicting the duration of this economic downturn, we think it is prudent to plan for no real improvements until 2010."

SunTrust Banks (NYSE:STI)
SunTrust also reported earnings for the second quarter, and while the bank didn't specifically blame Florida for its problems, it didn't fare much better than Regions Financial. SunTrust reported net income of $535.3 million, or $1.53 per diluted share, but that number included several one-time items. After removing these items the bank earned 78 cents per share.

Once again, a profitable quarter hid a myriad of problems:

• There was an increase in the allowance for loan losses to $1.83 billion, or 1.46% of total loans outstanding. This was up 42 basis points from the end of 2007.
• Net charge-offs to average loans was 1.04% on an annualized basis.
• Non-performing loans were 2.22% of total loans, up from only 0.64% in the second quarter of 2007, underscoring the rapid deterioration in asset quality.

SunTrust Bank also sold 10 million shares of Coca-Cola (NYSE:KO) during the quarter, and an additional 30 million shares in July, in order to boost capital ratios. The net effect was to boost Tier 1 capital by 64 basis points, or 0.64%. Management did note that although credit has continued to deteriorate, it was at a slower pace than before. The bulk of the problem loans came from residential mortgage and the home equity loan portfolios. (To learn more, check out How Do Banks Determine Risk?)

Bottom Line
As problems mount in Florida and other high-growth areas of the United States, bank managements may regret this headlong rush into these cyclical banking markets.