If the Federal Reserve were handing out report cards for the Dodd-Frank stress tests, I think Regions Financial's (NYSE:RF) performance is worthy of a B-. Make no mistake about it, Regions is still far from as strong as the top banks out there. But the bank has made some great strides from last year and its stressed capital levels were well above required minimums.
Unlike the Federal Reserve's Comprehensive Capital Analysis and Review -- which comes out next week -- the Dodd-Frank stress tests do not determine whether or not the banks involved can pay higher dividends or pay out stock. But since they use essentially the same modeling and stress-case scenarios, they're a good way for investors to get a sense for how the banks will perform in the CCAR and whether they'll be able to increase capital distributions.
Perhaps the key metric that the Fed and investors are looking at in the results of the stress tests is the tier 1 common capital ratio and, in particular, how low that ratio falls under the hypothetical stressed conditions.
Here's a look at how that ratio looked for Regions -- both pre-test actual and under stressed conditions -- as compared to similar numbers during last year's CCAR tests.
As you can easily see from that chart, it appears that Regions has significantly improved its balance sheet since this time last year.
Projected net loss
How do the regulators get to the stressed capital ratios? A big piece of the puzzle is using the stress-scenario inputs to estimate how much of a profit -- or, in most cases, a loss -- the bank will register over the nine-quarter test period.
In Regions' case, the answer is a $2.2 billion loss on $3.1 billion of pre-provision net revenue -- that is, revenue before loan-loss provisions less operating expenses.
The loan losses estimated for Regions come to 7.6% of average loan balances. That's above the 6.6% median of the entire group, but far from the worst.
One step further...
Finally, if we break down those loan losses, we can see where the Fed projects that Regions would take the biggest balance-sheet hits in the hypothetical stressed scenario.
It shouldn't be too surprising that much of Regions' losses were projected to come from commercial real estate. Not only is its CRE exposure greater than its residential mortgage exposure, but it also has a good chunk of it in CRE investor/developer loans, which are riskier than average. Overall, Regions' CRE loss rate was above the 7.8% median of the group.
Going into the stress tests, I was hopeful that Regions would do well. On the other end of this first round of tests, I think we can safely say it did. Considering that Regions' stock is valued below the average bank stock, that alone is a win for investors.
As we look ahead to next week and the CCAR results, I'm not expecting anything audacious out of Regions. It does appear that the bank could have room to return capital to investors, but given that just a year ago it still had the government's TARP investment on its books, I wouldn't blame Regions' management for playing it safe for now and continuing to build its balance sheet.
Matt Koppenheffer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.