Regions notes prospect of $300M in new legal losses

August 28, 2011

Banking & Finance, Legal Affairs

Birmingham-based Regions Financial Corp. says it could incur legal losses of up to $300 million on top of the $210 million it paid to settle fraud claims against investment brokerage subsidiary Morgan Keegan by Mississippi and other Southeastern states.

In its second quarter 10-Q filing with the U.S. Securities & Exchange Commission earlier this month, the publicly held banking company said the $300-million loss contingency is based on advice of counsel and assessment of available insurance coverage. “Regions establishes accruals for litigation and claims when a loss contingency is considered probable and the related amount is reasonably estimable,” the $130.9-billion multi-state banking company says.

While Regions said it is reasonably possible it could incur losses that reach $300 million, it also is “reasonably possible that Regions could incur no losses.”

Regions paid $200 million in June to settle regulatory claims brought by Mississippi Secretary of State Delbert Hosemann and his counterparts in Alabama, Tennessee, Kentucky and South Carolina. Together, they alleged that misleading marketing by Morgan Keegan broker caused investors to lose $1.5 billion in five Morgan Keegan funds.

Mississippi, acting on a complaint from an investor, initiated its investigation ahead of the other states. In the end, Hosemann said he found investors in the state lost between $50 million and $70 million.

For Regions, U.S. tax law takes some of the sting out of the settlement pay out. The company said in its quarterly filing with the SEC that it will get a $44-million tax benefit in the second quarter from $200 million of the settlement.

Region’s income tax benefit for the second quarter totaled $60 million, an amount that includes the $44 million deemed a deductible portion of the $200 million settlement.

Companies routinely deduct a portion of the cost of legal settlements, according to Rusty Butcher, chief of banking practices for HORNE CPAs. “It’s considered a normal business expense,” he said.

Meanwhile, Goldman Sachs continues to shop Morgan Keegan on Region’s behalf, with analysts speculating the sale could bring from $900 million to $1.3 billion.

Regions says the need to lower the $3.5 billion it still owes the U.S. Treasury’s Troubled Asset Relief program led to the decision to sell.

Morgan Keegan’s $1.3 billion in revenues last year accounted for about 20 percent of Regions Financial Corp.’s total revenues, according to a report by J.P. Morgan.

Regions bought Morgan Keegan in 2000 for $789 million. Today the full-service brokerage has more than 300 offices in 20 states.

In its analysis, J.P. Morgan said a potential buyer would likely have to come from outside Regions’ banking footprint.

This is because Regions wants to continue to coordinate with Morgan Keegan’s corporate banking business to “facilitate capital raising for corporate clients,” J.P. Morgan said in its report.

That, the report said, “would restrict buyers that are part of banks with operations in Regions’ footprint such as Wells Fargo, Bank of America, Sun Trust or BB&T.”

In his analysis, Sandler O’Neill’s Kevin Fitzsimmons said his sense is that the possible sale Goldman Sachs is studying on Regions’ behalf would include the private clients unit (which accounted for 38 percent of Morgan Keegan’s first quarter 2011 earnings); the fixed income capital markets (which accounted for 20 percent of 1Q earnings); investment banking (9 percent of 1Q earnings); equity capital markets (5 percent in 1Q) and other (11 percent in 1Q).

The trust and asset management units that Regions plans to keep accounted for 17 percent and 1 percent, respectively, of Morgan Keegan’s first quarter revenues.

Fitzsimmons said he expects an outright sale is the most likely outcome, and noted he has heard prices in the $1-billion range. Possible alternatives are a venture sale in which Regions keeps a stake or a spin-off off Morgan Keegan in the public markets, he said.

Potential buyers in an outright sale, Fitzsimmons said, range from other broker/dealers, larger regional financial institutions (either domestic or foreign) or private equity groups “perhaps with the thought of buying today and tapping the IPO market when markets improve.”

But Goldman Sachs could find it hard to get a taker for Morgan Keegan, according to Compass Point’s Chris Gamaitoni, an analyst assigned to Region. His analysis report notes the “intense regulatory scrutiny” investment brokerages are under could dampen the enthusiasm of buyers.

What’s more, Morgan Keegan’s continued legal troubles would likely force Regions to “indemnify a future acquirer… against legacy legal issues which could eliminate all economic benefits” of a sale, Gamaitoni said.

While the sale of Morgan Keegan could be a big help in repaying the TARP debt, it could put a hole of 11 percent in Region Financial Corp.’s earnings stream and a hole of 17 percent in top-line revenues, Fitzsimmons of Sandler O’Neill said.

Such holes could add to revenue challenges already created by big drops in loan demand and far lower revenues from debit card fees from merchants as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act, he said.

Then there is the possible sale of Regions Financial Corp. itself to consider, Fitzsimmons advises.

The sale of Morgan Keegan could appear to “throw water” on a sale of Regions Financial in the near term, Fitzsimmons’ report said. But offloading Morgan Keegan first “may end up making a more streamlined, plain vanilla bank more appealing to a number of potential acquirers,” the report added.

Ken Cyree, dean of the University of Mississippi College of Business Administration and chair of the Mississippi School of Banking, said he is keeping his fingers crossed that Morgan Keegan can survive in one form or another. “Morgan Keegan has been a solid regional brokerage firm. It underwrites a lot of debt for cities and municipalities.”

The sale could benefit Regions “if they can get the right price,” he said.

“My fear is that they would sell it for the wrong price just so they can move on.”

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