REGIONS FINANCIAL CORPORATION
 



UNITED STATES

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-K

     
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
    For the fiscal year ended December 31, 2005
OR
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
    For the transition period from               to

Commission File Number 0-6159

REGIONS FINANCIAL CORPORATION

(Exact Name of Registrant as Specified in Its Charter)
     
Delaware   63-0589368
(State or other jurisdiction of
Incorporation or Organization)
  (I.R.S. Employer
Identification No.)
417 North 20th Street, Birmingham, Alabama 35203
(Address of principal executive offices)

Registrant’s telephone number, including area code: (205) 944-1300

Securities registered pursuant to Section 12(b) of the Act:

     
Title of each class Name of each exchange on which registered


Common Stock, $.01 par value
  New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

      Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.     Yes þ          No o

      Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.   Yes o          No þ          

      Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes þ          No o

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     o

      Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ     Accelerated filer o     Non-accelerated filer o

      Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).     Yes o          No þ

      State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter.

Common Stock, $.01 par value — $15,637,625,967 as of June 30, 2005.

      Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

Common Stock, $.01 Par Value — 456,352,243 shares issued and outstanding as of February 28, 2006.

DOCUMENTS INCORPORATED BY REFERENCE

      Portions of the annual proxy statement to be dated approximately April 4, 2006 are incorporated by reference into Part III.




 

TABLE OF CONTENTS

PART I
Item 1. Business
Item 1A. Risk Factors
Item 1B. Unresolved Staff Comments
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Submission Of Matters to a Vote Of Security Holders
Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6. Selected Financial Data
Item 7. Management’s Discussion And Analysis of Financial Condition and Results of Operation
Off-Balance Sheet Arrangements and Contractual Obligations
Operating Results
Item 7A. Qualitative and Quantitative Disclosures About Market Risk
Item 8. Financial Statements and Supplementary Data
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A. Controls and Procedures
Report of Independent Registered Public Accounting Firm
Item 9B. Other Information
PART III
Item 10. Directors and Executive Officers of the Registrant
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13. Certain Relationships and Related Transactions
Item 14. Principal Accounting Fees and Services
Item 15. Exhibits, Financial Statement Schedules
SIGNATURES
EX-10.8 AMENDMENT TO SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
EX-10.9 AMENDED AND RESTATED 1996 DEFERRED COMPENSATION PLAN
EX-10.13 AMENDMENT TO DIRECTORS' DEFERRED STOCK INVESTMENT PLAN
EX-12 STATEMENTS RE: COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES
EX-21 LIST OF SUBSIDIARIES
EX-23 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
EX-31.1 SECTION 302 CERTIFICATION OF THE CEO
EX-31.2 SECTION 302 CERTIFICATION OF THE CFO
EX-32 SECTION 906 CERTIFICATION OF THE CEO AND CFO

PART I

FORWARD LOOKING STATEMENTS

      This Annual Report on Form 10-K, other periodic reports filed by Regions Financial Corporation (“Regions”) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and any other written or oral statements made by or on behalf of Regions may include forward-looking statements. The Private Securities Litigation Reform Act of 1995 (the “Act”) provides a “safe-harbor” for forward-looking statements which are identified as such and are accompanied by the identification of important factors that could cause actual results to differ materially from the forward-looking statements. For these statements, we, together with our subsidiaries, unless the context implies otherwise, claim the protection afforded by the safe harbor in the Act. Forward-looking statements are not based on historical information, but rather are related to future operations, strategies, financial results or other developments. Forward-looking statements are based on management’s expectations as well as certain assumptions and estimates made by, and information available to, management at the time the statements are made. Those statements are based on general assumptions and are subject to various risks, uncertainties, and other factors that may cause actual results to differ materially from the views, beliefs, and projections expressed in such statements. These risks, uncertainties and other factors include, but are not limited, to those described below:

  •  Regions’ ability to achieve the earnings expectations related to the businesses that were acquired, including its merger with Union Planters Corporation (“Union Planters”) in July 2004, or that may be acquired in the future, which in turn depends on a variety of factors, including:

  •  Regions’ ability to achieve the anticipated cost savings and revenue enhancements with respect to the acquired operations, or lower than expected revenues from continuing operations;
 
  •  the assimilation of the acquired operations to Regions’ corporate culture, including the ability to instill Regions’ credit practices and efficient approach to the acquired operations;
 
  •  the continued growth of the markets that the acquired entities serve, consistent with recent historical experience;
 
  •  difficulties related to the integration of the businesses, including integration of information systems and retention of key personnel.

  •  Regions’ ability to expand into new markets and to maintain profit margins in the face of pricing pressures.
 
  •  Regions’ ability to keep pace with technological changes.
 
  •  Regions’ ability to develop competitive new products and services in a timely manner and the acceptance of such products and services by Regions’ customers and potential customers.
 
  •  Regions’ ability to effectively manage interest rate risk, market risk, credit risk and operational risk.
 
  •  Regions’ ability to manage fluctuations in the value of assets and liabilities and off-balance sheet exposure so as to maintain sufficient capital and liquidity to support Regions’ business.
 
  •  The cost and other effects of material contingencies, including litigation contingencies.
 
  •  Further easing of restrictions on participants in the financial services industry, such as banks, securities brokers and dealers, investment companies and finance companies, may increase competitive pressures.
 
  •  Possible changes in interest rates may increase funding costs and reduce earning asset yields, thus reducing margins.
 
  •  Possible changes in general economic and business conditions in the United States in general and in the communities Regions serves in particular may lead to a deterioration in credit quality, thereby increasing provisioning costs, or a reduced demand for credit, thereby reducing earning assets.

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  •  The occurrence of natural disasters or the threat or occurrence of war or acts of terrorism and the existence or exacerbation of general geopolitical instability and uncertainty.
 
  •  Possible changes in trade, monetary and fiscal policies, laws, and regulations, and other activities of governments, agencies, and similar organizations, including changes in accounting standards, may have an adverse effect on business.
 
  •  Possible changes in consumer and business spending and saving habits could affect Regions’ ability to increase assets and to attract deposits.

      The words “believe,” “expect,” “anticipate,” “project,” and similar expressions signify forward looking statements. You should not place undue reliance on any forward looking statement, which speak only as of the date made. We assume no obligation to update or revise any forward looking statements that are made from time to time.

 
Item 1. Business

      Regions Financial Corporation (together with its subsidiaries on a consolidated basis, “Regions” or “Company”) is a financial holding company headquartered in Birmingham, Alabama which operates throughout the South, Midwest and Texas. Regions’ operations consist of banking, brokerage and investment services, mortgage banking, insurance brokerage, credit life insurance, leasing, commercial accounts receivable factoring and specialty financing. At December 31, 2005, Regions had total consolidated assets of approximately $84.8 billion, total consolidated deposits of approximately $60.4 billion and total consolidated stockholders’ equity of approximately $10.6 billion.

      Regions is a Delaware corporation that, on July 1, 2004, became the successor by merger to Union Planters and the former Regions Financial Corporation. Regions’ principal executive offices are located at 417 North 20th Street, Birmingham, Alabama 35203, and its telephone number at such address is (205) 944-1300.

Banking Operations

      Regions conducts its banking operations through Regions Bank, an Alabama chartered commercial bank that is a member of the Federal Reserve System. At December 31, 2005, Regions operated 1,311 full service banking offices in Alabama, Arkansas, Florida, Georgia, Illinois, Indiana, Iowa, Kentucky, Louisiana, Mississippi, Missouri, North Carolina, South Carolina, Tennessee, Texas and Virginia.

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      The following chart reflects the distribution of total assets, loans, deposits and branches in each of the states in which Regions conducts its banking operations:

                                   
Assets Loans Deposits Branches




Alabama
    18 %     19 %     21 %     175  
Arkansas
    8       8       8       103  
Florida
    14       13       12       149  
Georgia
    14       14       10       132  
Illinois
    1       3       4       71  
Indiana
    4       4       4       65  
Iowa
    1       1       1       18  
Kentucky
    2       2       1       18  
Louisiana
    6       6       9       101  
Mississippi
    4       3       6       99  
Missouri
    6       4       4       68  
North Carolina
    3       4       *       6  
South Carolina
    3       3       2       38  
Tennessee
    11       11       13       191  
Texas
    5       5       5       76  
Virginia
    *       *       *       1  
     
     
     
     
 
 
Totals
    100 %     100 %     100 %     1,311  
     
     
     
     
 


  less than 1%

Other Financial Services Operations

      In addition to its banking operations, Regions provides additional financial services through the following subsidiaries or divisions:

      Morgan Keegan & Company, Inc. (“Morgan Keegan”), a subsidiary of Regions Financial Corporation, is a full-service regional brokerage and investment banking firm. Morgan Keegan offers products and services including securities brokerage, asset management, financial planning, mutual funds, securities underwriting, sales and trading, and investment banking. Morgan Keegan, one of the largest investment firms in the South, employs approximately 1,000 financial advisors offering products and services from 281 offices located in Alabama, Arkansas, Florida, Georgia, Illinois, Kentucky, Massachusetts, Mississippi, New York, Louisiana, North Carolina, South Carolina, Tennessee, Texas and Virginia.

      Regions Mortgage, a division of Regions Bank, and EquiFirst Corporation (“EquiFirst”), a subsidiary of Regions Bank, are engaged in mortgage banking. Regions Mortgage’s primary business and source of income is the origination and servicing of mortgage loans for long-term investors. EquiFirst typically originates mortgage loans which are sold to third-party investors. Regions Mortgage’s servicing portfolio totaled approximately $37.2 billion and included approximately 398,000 real estate mortgages at December 31, 2005. Regions Mortgage and EquiFirst operate loan production offices in Alabama, Arizona, Arkansas, Florida, Georgia, Illinois, Indiana, Iowa, Kentucky, Louisiana, Mississippi, Missouri, North Carolina, South Carolina, Tennessee and Texas.

      Rebsamen Insurance, Inc., a subsidiary of Regions Financial Corporation, acts as a general insurance broker for a full-line of insurance products, primarily focusing on commercial property and casualty insurance customers.

      Regions Agency, Inc., a subsidiary of Regions Financial Corporation, acts as an insurance agent or broker with respect to credit life insurance, accident and health insurance and other types of insurance relating to extensions of credit by Regions Bank or Regions’ banking-related subsidiaries.

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      Regions Life Insurance Company, a subsidiary of Regions Financial Corporation, acts as a re-insurer of credit life insurance and accident and health insurance in connection with the activities of certain affiliates of Regions.

      Regions Interstate Billing Service, Inc., a subsidiary of Regions Financial Corporation, factors commercial accounts receivable and performs billing and collection services, focusing primarily on clients in the trucking and automotive service industry.

Acquisition Program

      In July 2004, Regions and Union Planters completed a merger of the two companies. Union Planters was a $32.2 billion bank holding company headquartered in Memphis, Tennessee. The merger was accounted for as a purchase of Union Planters by Regions for accounting and financial reporting purposes.

      A substantial portion of the growth of Regions from its inception as a bank holding company in 1971 to the merger with Union Planters has been through the acquisition of other financial institutions, including commercial banks and thrift institutions, and the assets and deposits thereof. Prior to the merger with Union Planters, Regions had completed 103 acquisitions of financial institutions and financial service providers representing in aggregate (at the time the acquisitions were completed) approximately $28.4 billion in assets. As part of its ongoing strategic plan, Regions continually evaluates business combination opportunities. Any future business combination or series of business combinations that Regions might undertake may be material, in terms of assets acquired or liabilities assumed, to Regions’ financial condition. Recent business combinations in the financial services industry have typically involved the payment of a premium over book and market values. This practice could result in dilution of book value and net income per share for the acquirer.

Segment Information

      Reference is made to Note 24 “Business Segment Information” to the consolidated financial statements included under Item 8 of this Annual Report on Form 10-K for information required by this item.

Supervision And Regulation

      General. Regions is a financial holding company, registered with the Board of Governors of the Federal Reserve System under the Bank Holding Company Act of 1956, as amended (“BHC Act”). As such, Regions and its subsidiaries are subject to the supervision, examination and reporting requirements of the BHC Act and the regulations of the Federal Reserve.

      The Gramm-Leach-Bliley Act, adopted in 1999 (“GLB Act”), significantly relaxed previously existing restrictions on the activities of banks and bank holding companies. Under such legislation, an eligible bank holding company may elect to be a “financial holding company” and thereafter may engage in a range of activities that are financial in nature and that were not previously permissible for banks and bank holding companies. A financial holding company may engage directly or through a subsidiary in the statutorily authorized activities of securities dealing, underwriting and market making, insurance underwriting and agency activities, merchant banking and insurance company portfolio investments. A financial holding company also may engage in any activity that the Federal Reserve determines by rule or order to be financial in nature, incidental to such financial activity, or complementary to a financial activity and that does not pose a substantial risk to the safety and soundness of an institution or to the financial system generally.

      In addition to these activities, a financial holding company may engage in those activities permissible for a bank holding company, including factoring accounts receivable, acquiring and servicing loans, leasing personal property, performing certain data processing services, acting as agent or broker in selling credit life insurance and certain other types of insurance in connection with credit transactions and conducting certain insurance underwriting activities. The BHC Act does not place territorial limitations on permissible nonbanking activities of bank holding companies. Despite prior approval, the Federal Reserve has the power to order any bank holding company or its subsidiaries to terminate any activity or to terminate its ownership or control of any subsidiary when the Federal Reserve has reasonable grounds to believe that continuation of

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such activity or such ownership or control constitutes a serious risk to the financial soundness, safety or stability of any bank subsidiary of the bank holding company.

      The GLB Act also permits securities brokerage firms and insurance companies to own banks and bank holding companies. The GLB Act also seeks to streamline and coordinate regulation of integrated financial holding companies, providing generally for “umbrella” regulation of financial holding companies by the Federal Reserve, and for functional regulation of banking activities by bank regulators, securities activities by securities regulators, and insurance activities by insurance regulators.

      For a bank holding company to be eligible for financial holding company status, all of its subsidiary insured depository institutions must be well-capitalized and well-managed. A bank holding company may become a financial holding company by filing a declaration with the Federal Reserve that it elects to become a financial holding company. The Federal Reserve must deny expanded authority to any bank holding company with a subsidiary insured depository institution that received less than a satisfactory rating on its most recent Community Reinvestment Act of 1977 (the “CRA”) review as of the time it submits its declaration. If, after becoming a financial holding company and undertaking activities not permissible for a bank holding company, the company fails to continue to meet any of the prerequisites for financial holding company status, the company must enter into an agreement with the Federal Reserve to comply with all applicable capital and management requirements. If the company does not return to compliance within 180 days, the Federal Reserve may order the company to divest its subsidiary banks or the company may discontinue or divest its non-permissible activities.

      The BHC Act requires every bank holding company to obtain the prior approval of the Federal Reserve before: (1) it may acquire direct or indirect ownership or control of any voting shares of any bank if, after such acquisition, the bank holding company will directly or indirectly own or control more than 5.0% of the voting shares of the bank; (2) it or any of its subsidiaries, other than a bank, may acquire all or substantially all of the assets of any bank; or (3) it may merge or consolidate with any other bank holding company.

      The BHC Act further provides that the Federal Reserve may not approve any transaction that would result in a monopoly or would be in furtherance of any combination or conspiracy to monopolize or attempt to monopolize the business of banking in any section of the United States, or the effect of which may be substantially to lessen competition or to tend to create a monopoly in any section of the country, or that in any other manner would be in restraint of trade, unless the anticompetitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served. The Federal Reserve is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned and the convenience and needs of the community to be served. Consideration of financial resources generally focuses on capital adequacy, and consideration of convenience and needs issues includes the parties’ performance under the CRA, both of which are discussed below.

      Regions Bank is a member of the Federal Deposit Insurance Corporation (“FDIC”), and as such, its deposits are insured by the FDIC to the extent provided by law. It is also subject to numerous statutes and regulations that affect its business activities and operations, and is supervised and examined by one or more state or federal bank regulatory agencies.

      Regions Bank is a state-chartered bank. Regions Bank is a member of the Federal Reserve System and is subject to supervision and examination by the Federal Reserve and the state banking authority of Alabama, the state in which it is headquartered. The Federal Reserve and the Alabama Department of Banking regularly examine the operations of Regions Bank and are given authority to approve or disapprove mergers, consolidations, the establishment of branches and similar corporate actions. The federal and state banking regulators also have the power to prevent the continuance or development of unsafe or unsound banking practices or other violations of law.

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      Community Reinvestment Act. Regions Bank is subject to the provisions of the CRA. Under the terms of the CRA, the bank has a continuing and affirmative obligation consistent with safe and sound operation to help meet the credit needs of its entire communities, including low- and moderate-income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires each appropriate federal bank regulatory agency, in connection with its examination of a subsidiary depository institution, to assess such institution’s record in assessing and meeting the credit needs of the community served by that institution, including low- and moderate-income neighborhoods. The regulatory agency’s assessment of the institution’s record is made available to the public. The assessment also is part of the Federal Reserve’s consideration of applications to acquire, merge or consolidate with another banking institution or its holding company, to establish a new branch office that will accept deposits or to relocate an office. In the case of a bank holding company applying for approval to acquire a bank or other bank holding company, the Federal Reserve will assess the records of each subsidiary depository institution of the applicant bank holding company, and such records may be the basis for denying the application. Regions Bank received a “satisfactory” CRA rating in its most recent examination.

      Patriot Act. In 2001, President Bush signed into law comprehensive anti-terrorism legislation known as the USA Patriot Act. Title III of the USA Patriot Act requires financial institutions, including Regions’ banking, broker-dealer, and insurance subsidiaries, to help prevent, detect and prosecute international money laundering and the financing of terrorism. Regions’ banking, broker-dealer and insurance subsidiaries have augmented their systems and procedures to meet the requirements of these regulations.

      Payment of Dividends. Regions Financial Corporation is a legal entity separate and distinct from its banking and other subsidiaries. The principal source of cash flow of Regions Financial Corporation, including cash flow to pay dividends to its stockholders, is dividends from Regions Bank. There are statutory and regulatory limitations on the payment of dividends by Regions Bank to Regions Financial Corporation, as well as by Regions Financial Corporation to its stockholders.

      As to the payment of dividends, Regions Bank is subject to the laws and regulations of the state of Alabama and to the regulations of the Federal Reserve.

      If, in the opinion of a federal regulatory agency, an institution under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the institution, could include the payment of dividends), such agency may require, after notice and hearing, that such institution cease and desist from such practice. The federal banking agencies have indicated that paying dividends that deplete an institution’s capital base to an inadequate level would be an unsafe and unsound banking practice. Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), an insured institution may not pay any dividend if payment would cause it to become undercapitalized or if it already is undercapitalized. See “Regulatory Remedies under FDICIA” below. Moreover, the Federal Reserve, and the FDIC have issued policy statements stating that bank holding companies and insured banks should generally pay dividends only out of current operating earnings.

      At December 31, 2005, under dividend restrictions imposed under federal and state laws, Regions Bank, without obtaining governmental approvals, could declare aggregate dividends to Regions Financial Corporation of approximately $1.1 billion.

      The payment of dividends by Regions Financial Corporation and Regions Bank may also be affected or limited by other factors, such as the requirement to maintain adequate capital above regulatory guidelines.

      Capital Adequacy. Regions Financial Corporation and its subsidiary bank are required to comply with the applicable capital adequacy standards established by the Federal Reserve. There are two basic measures of capital adequacy for bank holding companies that have been promulgated by the Federal Reserve: a risk-based measure and a leverage measure. All applicable capital standards must be satisfied for a financial holding company to be considered in compliance.

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      The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in credit and market risk profile among banks and bank holding companies, to account for off-balance-sheet exposure, and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items.

      The minimum guideline for the ratio of total capital (“Total Capital”) to risk-weighted assets (including certain off-balance-sheet items, such as standby letters of credit) is 8.0%. At least half of the Total Capital must be composed of common equity, undivided profits, minority interests in the equity accounts of consolidated subsidiaries, noncumulative perpetual preferred stock and a limited amount of cumulative perpetual preferred stock, less goodwill and certain other intangible assets (“Tier 1 Capital”). The remainder may consist of subordinated debt, other preferred stock and a limited amount of allowance for loan losses. The minimum guideline for Tier 1 Capital is 4.0%. At December 31, 2005, Regions’ consolidated Tier 1 Capital ratio was 8.60% and its Total Capital ratio was 12.76%.

      In addition, the Federal Reserve has established minimum leverage ratio guidelines for financial holding companies. These guidelines provide for a minimum ratio of Tier 1 Capital to average assets, less goodwill and certain other intangible assets (the “Leverage Ratio”), of 3.0% for bank holding companies that meet certain specified criteria, including having the highest regulatory rating. All other bank holding companies generally are required to maintain a Leverage Ratio of at least 3.0%, plus an additional cushion of 100 to 200 basis points. Regions’ Leverage Ratio at December 31, 2005, was 7.42%. The guidelines also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. Furthermore, the Federal Reserve has indicated that it will consider a “tangible Tier 1 Capital leverage ratio” (deducting all intangibles) and other indicators of capital strength in evaluating proposals for expansion or new activities.

      A subsidiary bank is subject to substantially similar risk-based and leverage capital requirements as those applicable to Regions. Regions Bank was in compliance with applicable minimum capital requirements as of December 31, 2005. Neither Regions nor Regions Bank has been advised by any federal banking agency of any specific minimum capital ratio requirement applicable to it.

      Failure to meet capital guidelines could subject a bank to a variety of enforcement remedies, including the termination of deposit insurance by the FDIC, and to certain restrictions on its business. See “Regulatory Remedies under FDICIA” below.

      Support of Subsidiary Banks. Under Federal Reserve policy, Regions Financial Corporation is expected to act as a source of financial strength to, and to commit resources to support, its subsidiary bank. This support may be required at times when, absent such Federal Reserve policy, Regions may not be inclined to provide it. In addition, any capital loans by a financial holding company to its subsidiary bank are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. In the event of a financial holding company’s bankruptcy, any commitment by the financial holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.

      Regulatory Remedies under FDICIA. FDICIA establishes a system of regulatory remedies to resolve the problems of undercapitalized institutions. Under this system, which became effective in 1992, the federal banking regulators are required to establish five capital categories (“well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized”) and to take certain mandatory supervisory actions, and are authorized to take other discretionary actions, with respect to institutions in the three undercapitalized categories, the severity of which will depend upon the capital category in which the institution is placed. Generally, subject to a narrow exception, FDICIA requires the banking regulator to appoint a receiver or conservator for an institution that is critically undercapitalized. The federal banking agencies have specified by regulation the relevant capital level for each category.

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      Under the agencies’ rules implementing FDICIA’s remedy provisions, an institution that (1) has a Total Capital ratio of 10.0% or greater, a Tier 1 Capital ratio of 6.0% or greater, and a Leverage Ratio of 5.0% or greater and (2) is not subject to any written agreement, order, capital directive, or regulatory remedy directive issued by the appropriate federal banking agency is deemed to be “well capitalized.” An institution with a Total Capital ratio of 8.0% or greater, a Tier 1 Capital ratio of 4.0% or greater, and a Leverage Ratio of 4.0% or greater is considered to be “adequately capitalized.” A depository institution that has a Total Capital ratio of less than 8.0%, a Tier 1 Capital ratio of less than 4.0%, or a Leverage Ratio of less than 4.0% is considered to be “undercapitalized.” An institution that has a Total Capital ratio of less than 6.0%, a Tier 1 Capital ratio of less than 3.0%, or a Leverage Ratio of less than 3.0% is considered to be “significantly undercapitalized,” and an institution that has a tangible equity capital to assets ratio equal to or less than 2.0% is deemed to be “critically undercapitalized.” For purposes of the regulation, the term “tangible equity” includes core capital elements counted as Tier 1 Capital for purposes of the risk-based capital standards plus the amount of outstanding cumulative perpetual preferred stock (including related surplus), minus all intangible assets with certain exceptions. A depository institution may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if it receives an unsatisfactory examination rating.

      An institution that is categorized as undercapitalized, significantly undercapitalized, or critically undercapitalized is required to submit an acceptable capital restoration plan to its appropriate federal banking agency. Under FDICIA, a bank holding company must guarantee that a subsidiary depository institution meets its capital restoration plan, subject to certain limitations. The obligation of a controlling bank holding company under FDICIA to fund a capital restoration plan is limited to the lesser of 5.0% of an undercapitalized subsidiary’s assets or the amount required to meet regulatory capital requirements. An undercapitalized institution is also generally prohibited from increasing its average total assets, making acquisitions, establishing any branches, or engaging in any new line of business, except in accordance with an accepted capital restoration plan or with the approval of the FDIC. In addition, the appropriate federal banking agency is given authority with respect to any undercapitalized depository institution to take any of the actions it is required to or may take with respect to a significantly undercapitalized institution as described below if it determines “that those actions are necessary to carry out the purpose” of FDICIA.

      For those institutions that are significantly undercapitalized or undercapitalized and either fail to submit an acceptable capital restoration plan or fail to implement an approved capital restoration plan, the appropriate federal banking agency must require the institution to take one or more of the following actions: sell enough shares, including voting shares, to become adequately capitalized; merge with (or be sold to) another institution (or holding company), but only if grounds exist for appointing a conservator or receiver; restrict certain transactions with banking affiliates as if the “sister bank” exception to the requirements of Section 23A of the Federal Reserve Act did not exist; otherwise restrict transactions with bank or nonbank affiliates; restrict interest rates that the institution pays on deposits to “prevailing rates” in the institution’s “region;” restrict asset growth or reduce total assets; alter, reduce, or terminate activities; hold a new election of directors; dismiss any director or senior executive officer who held office for more than 180 days immediately before the institution became undercapitalized, provided that in requiring dismissal of a director or senior officer, the agency must comply with certain procedural requirements, including the opportunity for an appeal in which the director or officer will have the burden of proving his or her value to the institution; employ “qualified” senior executive officers; cease accepting deposits from correspondent depository institutions; divest certain nondepository affiliates which pose a danger to the institution; or be divested by a parent holding company. In addition, without the prior approval of the appropriate federal banking agency, a significantly undercapitalized institution may not pay any bonus to any senior executive officer or increase the rate of compensation for such an officer without regulatory approval.

      At December 31, 2005, Regions Bank had the requisite capital levels to qualify as well capitalized.

      FDIC Insurance Assessments. Pursuant to FDICIA, the FDIC adopted a risk-based assessment system for insured depository institutions that takes into account the risks attributable to different categories and concentrations of assets and liabilities. The risk-based system, which went into effect in 1994, assigns an institution to one of three capital categories: (1) well capitalized; (2) adequately capitalized; and (3) undercapitalized, as determined by capital reported by the institution in the quarterly report issued before each

8


 

assessment period. Each institution also is assigned by the FDIC to one of three supervisory subgroups within each capital group. The supervisory subgroup to which an institution is assigned is based on a supervisory evaluation provided to the FDIC by the institution’s primary federal regulator and information which the FDIC determines to be relevant to the institution’s financial condition and the risk posed to the deposit insurance funds (which may include, if applicable, information provided by the institution’s state supervisor). An institution’s insurance assessment rate is then determined based on the capital category and supervisory subgroup to which it is assigned. Under the final risk-based assessment system, there are nine assessment risk classifications (i.e., combinations of capital groups and supervisory subgroups) to which different assessment rates are applied.

      Regions Bank is assessed at the well-capitalized level where the premium rate is currently zero. Like all insured banks, it also must pay a quarterly assessment of approximately $.02 per $100 of assessable deposits to pay off bonds that were issued in the late 1980’s by a mixed-ownership government corporation, the Financing Corporation, to raise funds to cover costs of the resolution of the savings and loan crisis.

      Under the Federal Deposit Insurance Act (“FDIA”), insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.

      Safety and Soundness Standards. The FDIA, as amended by FDICIA and the Riegle Community Development and Regulatory Improvement Act of 1994, requires the federal bank regulatory agencies to prescribe standards, by regulations or guidelines, relating to internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, asset quality, earnings, stock valuation and compensation, fees and benefits and such other operational and managerial standards as the agencies deem appropriate. In 1995, the federal bank regulatory agencies adopted guidelines prescribing safety and soundness standards pursuant to FDICIA, as amended. The guidelines establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risk and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director, or principal stockholder. In addition, the agencies adopted regulations that authorize, but do not require, an agency to order an institution that has been given notice by an agency that it is not satisfying any of such safety and soundness standards to submit a compliance plan. If, after being so notified, an institution fails to submit an acceptable compliance plan or fails in any material respect to implement an acceptable compliance plan, the agency must issue an order directing action to correct the deficiency and may issue an order directing other actions of the types to which an undercapitalized institution is subject under the “prompt corrective action” provisions of FDICIA. See “Regulatory Remedies under FDICIA” above. If an institution fails to comply with such an order, the agency may seek to enforce such order in judicial proceedings and to impose civil money penalties. The federal bank regulatory agencies also proposed guidelines for asset quality and earnings standards.

      Depositor Preference. The Omnibus Budget Reconciliation Act of 1993 provides that deposits and certain claims for administrative expenses and employee compensation against an insured depository institution would be afforded a priority over other general unsecured claims against such an institution in the “liquidation or other resolution” of such an institution by any receiver.

      Regulation of Morgan Keegan. As a registered investment adviser and broker-dealer, Morgan Keegan is subject to regulation and examination by the Securities and Exchange Commission (“SEC”), the National Association of Securities Dealers (“NASD”), the New York Stock Exchange (“NYSE”) and other self regulatory organizations (“SROs”), which may affect its manner of operation and profitability. Such regulations cover a broad range of subject matter. Rules and regulations for registered broker-dealers cover such issues as: capital requirements; sales and trading practices; use of client funds and securities; the conduct of directors, officers, and employees; record-keeping and recording; supervisory procedures to prevent

9


 

improper trading on material non-public information; qualification and licensing of sales personnel; and limitations on the extension of credit in securities transactions. Rules and regulations for registered investment advisers include the limitations on the ability of investment advisers to charge performance-based or non-refundable fees to clients, record-keeping and reporting requirements, disclosure requirements, limitations on principal transactions between an adviser or its affiliates and advisory clients, and anti-fraud standards.

      Morgan Keegan is subject to the net capital requirements set forth in Rule 15c3-1 of the Exchange Act. The net capital requirements measure the general financial condition and liquidity of a broker-dealer by specifying a minimum level of net capital that a broker-dealer must maintain, and by requiring that a significant portion of its assets be kept liquid. If Morgan Keegan failed to maintain its minimum required net capital, it would be required to cease executing customer transactions until it came back into compliance. This could also result in Morgan Keegan losing its NASD membership, its registration with the SEC or require a complete liquidation.

      The SEC’s risk assessment rules also apply to Morgan Keegan as a registered broker-dealer. These rules require broker-dealers to maintain and preserve records and certain information, describe risk management policies and procedures, and report on the financial condition of affiliates whose financial and securities activities are reasonably likely to have a material impact on the financial and operational condition of the broker-dealer. Certain “material associated persons” of Morgan Keegan, as defined in the risk assessment rules, may also be subject to SEC regulation.

      In addition to federal registration, state securities commissions require the registration of certain broker-dealers and investment advisers. Morgan Keegan is registered as a broker-dealer with every state, the District of Columbia, and Puerto Rico. Morgan Keegan is registered as an investment adviser in the following states: Alabama, Arkansas, California, Connecticut, Delaware, District of Columbia, Florida, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Maryland, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Hampshire, New Jersey, New Mexico, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, South Dakota, Tennessee, Texas, Utah, Vermont, Virginia, Washington, West Virginia and Wisconsin.

      Violations of federal, state, and SRO rules or regulations may result in the revocation of broker-dealer or investment adviser licenses, imposition of censures or fines, the issuance of cease and desist orders, and the suspension or expulsion of officers and employees from the securities business firm. In addition, Morgan Keegan’s business may be materially affected by new rules and regulations issued by the SEC or SROs as well as any changes in the enforcement of existing laws and rules that affect its securities business.

      Regulation of Insurors and Insurance Brokers. Regions’ operations in the areas of insurance brokerage and reinsurance of credit life insurance are subject to regulation and supervision by various state insurance regulatory authorities. Although the scope of regulation and form of supervision may vary from state to state, insurance laws generally grant broad discretion to regulatory authorities in adopting regulations and supervising regulated activities. This supervision generally includes the licensing of insurance brokers and agents and the regulation of the handling of customer funds held in a fiduciary capacity. Regions Life Insurance Company is subject to extensive regulatory supervision and to insurance laws and regulation requiring, among other things, maintenance of capital, record keeping, reporting and examinations.

      Other. The United States Congress and other state law-making bodies continue to consider a number of wide-ranging proposals for altering the structure, regulation and competitive relationships of the nation’s financial institutions. It cannot be predicted whether or in what form further legislation may be adopted or the extent to which Regions’ business may be affected thereby.

10


 

Competition

      All aspects of Regions’ business are highly competitive. Regions’ subsidiaries compete with other financial institutions located in the states in which they operate and other adjoining states, as well as large banks in major financial centers and other financial intermediaries, such as savings and loan associations, credit unions, consumer finance companies, brokerage firms, insurance companies, investment companies, mutual funds, other mortgage companies and financial service operations of major commercial and retail corporations.

      Customers for banking services and other financial services offered by Regions’ subsidiaries are generally influenced by convenience, quality of service, personal contacts, price of services and availability of products. Although Regions’ position varies in different markets, Regions believes that its affiliates effectively compete with other financial services companies in their relevant market areas.

Employees

      As of December 31, 2005, Regions and its subsidiaries had approximately 25,000 full-time-equivalent employees.

Available Information

      Regions maintains a website at www.regions.com. Regions makes available on its website free of charge its annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments to those reports which are filed with or furnished to the SEC pursuant to Section 13(a) of the Exchange Act. These documents are made available on Regions’ website as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. You may also request a copy of these filings, at no cost, by writing or telephoning Regions at the following address:

ATTENTION: Investor Relations

REGIONS FINANCIAL CORPORATION
417 North 20th Street
Birmingham, Alabama 35203
(205) 944-1300
 
Item 1A. Risk Factors

      Please refer to the section above at the beginning of Part I captioned “Forward Looking Statements” for a discussion of the risk factors applicable to Regions.

 
Item 1B. Unresolved Staff Comments

      None.

 
Item 2. Properties

      Regions’ corporate headquarters occupy several floors of the main banking facility of Regions Bank, located at 417 North 20th Street, Birmingham, Alabama 35203.

      Regions Bank, Regions’ banking subsidiary, operates through 1,311 banking offices. Regions provides investment banking and brokerage services through 281 offices of Morgan Keegan, while Regions’ mortgage divisions operate 334 offices. For offices in premises leased by Regions and its subsidiaries, annual rentals totaled approximately $84.4 million as of December 31, 2005. During 2005, Regions and its subsidiaries received approximately $11.6 million in rentals for space leased to others. At December 31, 2005, there were no significant encumbrances on the offices, equipment and other operational facilities owned by Regions and its subsidiaries.

      See Item 1. “Business” of this annual report for a description of the states in which Regions Bank branches and Morgan Keegan’s offices are located.

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Item 3. Legal Proceedings

      Reference is made to Note 13 “Commitments and Contingencies,” to the consolidated financial statements included under Item 8 of this Annual Report on Form 10-K.

      Regions is subject to litigation, including class action litigation, in the ordinary course of business. Punitive damages are routinely claimed in these cases. Regions continues to be concerned about the general trend in litigation involving large damage awards against financial service company defendants.

      Regions evaluates these contingencies based on information currently available, including advice of counsel and assessment of available insurance coverage. Although it is not possible to predict the ultimate resolution or financial liability with respect to these litigation contingencies, management is of the opinion that the outcome of pending and threatened litigation would not have a material effect on Regions’ consolidated financial position or results of operations.

 
Item 4. Submission Of Matters to a Vote Of Security Holders

      No matters were submitted to security holders for a vote during the fourth quarter of 2005.

PART II

 
Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

      Common Stock Market Prices and Dividend information for the year ended December 31, 2005, is included under Item 8 of this Annual Report filed on Form 10-K in Note 26 “Summary of Quarterly Results of Operations, Common Stock Market Prices and Dividends” to the consolidated financial statements.

      The following table presents information regarding issuer purchases of equity securities during the fourth quarter of 2005.

                                   
Total Number of Maximum Number
Shares Purchased of Shares that May
Total Number Average Price As Part of Publicly Yet Be Purchased
of Shares Paid Per Announced Plans Under the Plans or
Period Purchased Share or Programs Programs(1)(2)





October 1, 2005 - October 31, 2005
    568,900     $ 32.41       568,900       30,845,400  
November 1, 2005 - November 30, 2005
    1,806,700       33.63       1,806,700       29,038,700  
December 1, 2005 - December 31, 2005
    1,447,500       34.17       1,447,500       27,591,200  
     
             
         
 
Total
    3,823,100     $ 33.65       3,823,100          
     
             
         


(1)  On July 15, 2004, Regions’ Board of Directors assessed the pre-merger repurchase authorizations of both Regions and Union Planters and authorized the repurchase of up to 20.0 million shares of Regions’ common stock through open market transactions.
 
(2)  On October 20, 2005, Regions’ Board of Directors assessed the repurchase authorization of Regions and authorized the repurchase of an additional 25.0 million shares of Regions’ common stock through open market transactions.

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Item 6. Selected Financial Data

HISTORICAL FINANCIAL SUMMARY

REGIONS FINANCIAL CORPORATION & SUBSIDIARIES

                                                                     
Compound
Annual Growth
Change  Rate
2005 2004 2003 2002 2001 2000 2004-2005 2000-2005








(in thousands, except ratios, yields, and per share amounts)
Summary of Operating Results
                                                               
Interest income:
                                                               
 
Interest and fees on loans
  $ 3,546,767     $ 2,318,684     $ 1,702,299     $ 1,986,203     $ 2,458,503     $ 2,588,143       52.96 %     6.50 %
 
Income on federal funds sold
    19,301       7,701       5,828       8,377       17,890       5,537       150.63       28.37  
 
Taxable interest on securities
    498,666       434,009       348,765       400,705       445,919       561,974       14.90       -2.36  
 
Tax-free interest on securities
    28,800       25,319       24,355       29,967       40,434       41,726       13.75       -7.15  
 
Other interest income
    216,841       169,972       137,883       111,737       92,891       36,863       27.57       42.53  
     
     
     
     
     
     
                 
   
Total interest income
    4,310,375       2,955,685       2,219,130       2,536,989       3,055,637       3,234,243       45.83       5.91  
Interest expense:
                                                               
 
Interest on deposits
    1,004,727       496,627       430,353       652,765       1,135,695       1,372,260       102.31       -6.04  
 
Interest on short-term borrowings
    164,816       108,000       101,075       128,256       188,108       276,243       52.61       -9.81  
 
Interest on long-term borrowings
    320,213       238,024       213,104       258,380       306,341       196,943       34.53       10.21  
     
     
     
     
     
     
                 
   
Total interest expense
    1,489,756       842,651       744,532       1,039,401       1,630,144       1,845,446       76.79       -4.19  
     
     
     
     
     
     
                 
   
Net interest income
    2,820,619       2,113,034       1,474,598       1,497,588       1,425,493       1,388,797       33.49       15.22  
Provision for loan losses
    165,000       128,500       121,500       127,500       165,402       127,099       28.40       5.36  
     
     
     
     
     
     
                 
   
Net interest income after provision for loan losses
    2,655,619       1,984,534       1,353,098       1,370,088       1,260,091       1,261,698       33.82       16.05  
Non-interest income:
                                                               
 
Brokerage and investment banking income
    548,662       535,300       552,729       499,685       358,974       41,303       2.50       67.75  
 
Trust department income
    127,766       102,569       69,921       62,197       56,681       57,675       24.57       17.24  
 
Service charges on deposit accounts
    518,388       418,142       288,613       277,807       267,263       231,670       23.97       17.48  
 
Mortgage servicing and origination fees
    145,304       128,845       97,383       90,000       86,865       74,689       12.77       14.24  
 
Net securities (losses) gains
    (18,892 )     63,086       25,658       51,654       32,106       (39,928 )     -129.95       -13.90  
 
Other
    492,204       414,489       317,032       239,954       177,660       211,890       18.75       18.36  
     
     
     
     
     
     
                 
   
Total non-interest income
    1,813,432       1,662,431       1,351,336       1,221,297       979,549       577,299       9.08       25.72  
Non-interest expense:
                                                               
 
Salaries and employee benefits
    1,739,017       1,425,075       1,095,781       1,005,099       861,730       573,137       22.03       24.86  
 
Net occupancy expense
    224,073       160,060       105,847       97,924       86,901       70,675       39.99       25.96  
 
Furniture and equipment expense
    132,776       101,977       81,347       90,818       87,727       74,213       30.20       12.34  
 
Other
    951,090       784,271       509,887       528,304       485,331       379,246       21.27       20.19  
     
     
     
     
     
     
                 
   
Total non-interest expense
    3,046,956       2,471,383       1,792,862       1,722,145       1,521,689       1,097,271       23.29       22.66  
     
     
     
     
     
     
                 
   
Income before income taxes
    1,422,095       1,175,582       911,572       869,240       717,951       741,726       20.97       13.90  
Applicable income taxes
    421,551       351,817       259,731       249,338       209,017       214,203       19.82       14.50  
     
     
     
     
     
     
                 
   
Net income
  $ 1,000,544     $ 823,765     $ 651,841     $ 619,902     $ 508,934     $ 527,523       21.46 %     13.66 %
     
     
     
     
     
     
                 
   
Net income available to common shareholders
  $ 1,000,544     $ 817,745     $ 651,841     $ 614,458     $ 508,934     $ 527,523       22.35 %     13.66 %
     
     
     
     
     
     
                 
Average number of shares outstanding
    461,171       368,656       274,212       276,936       277,455       272,553       25.10 %     11.09 %
Average number of shares outstanding — diluted
    466,183       373,732       277,930       281,043       280,332       274,068       24.74 %     11.21 %
Per share:
                                                               
   
Net income
  $ 2.17     $ 2.22     $ 2.38     $ 2.22     $ 1.83     $ 1.94       -2.25 %     2.27 %
   
Net income, diluted
    2.15       2.19       2.35       2.19       1.82       1.92       -1.83       2.29  
   
Cash dividends declared
    1.36       1.33       1.00       0.94       0.91       0.87       2.26       9.35  


(1)  In 2002, Regions adopted Statement 142 which eliminated amortization of excess purchase price. Results for 2002 were also impacted by the retroactive application of EITF 03-6 “Participating Securities and the Two — Class Method under FASB Statement No. 128, Earnings per Share.”
 
(2)  Prior periods have been conformed to the current period presentation.
 
(3)  Prior period share and per share amounts have been adjusted to reflect the exchange of Regions common stock in connection with the Union Planters transaction. See Note 18 “Business Combinations” to the consolidated financial statements.

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REGIONS FINANCIAL CORPORATION & SUBSIDIARIES

HISTORICAL FINANCIAL SUMMARY — (Continued)

                                                     
2005 2004 2003 2002 2001 2000






Yields and Costs (taxable equivalent basis)
                                               
Earning assets:
                                               
 
Taxable securities
    4.29 %     4.14 %     4.06 %     5.16 %     6.17 %     6.51 %
 
Tax-free securities
    8.78       7.93       7.68       7.96       7.95       7.64  
 
Federal funds sold
    3.14       1.22       0.93       1.46       3.21       6.27  
 
Loans (net of unearned income)
    6.23       5.31       5.56       6.59       8.13       8.63  
 
Other earning assets
    6.06       5.23       4.72       5.17       5.58       8.95  
   
Total earning assets
    5.91       5.07       5.17       6.19       7.61       8.15  
Interest-bearing liabilities:
                                               
 
Interest-bearing deposits
    2.11       1.37       1.61       2.47       4.30       5.03  
 
Short-term borrowings
    2.99       1.73       1.90       2.88       4.55       6.26  
 
Long-term borrowings
    4.46       3.65       3.88       5.01       6.39       6.42  
   
Total interest-bearing liabilities
    2.47       1.72       1.98       2.89       4.61       5.31  
   
Net yield on interest earning assets
    3.91       3.66       3.49       3.73       3.66       3.55  
Ratios
                                               
Net income to:
                                               
 
Average stockholders’ equity
    9.37 %(a)     10.91 %(b)     15.06 %     15.27 %     13.49 %(c)     16.31 %(d)
 
Average total assets
    1.18 (a)     1.23 (b)     1.34       1.34       1.14 (c)     1.23 (d)
Efficiency(e)
    64.30 (a)     65.36 (b)     62.52       62.85       61.82 (c)     53.82 (d)
Dividend payout
    62.67       59.91       42.02       42.34       49.73       44.85  
Average loans to average deposits
    97.14       99.23       97.97       98.46       99.71       94.63  
Average stockholders’ equity to average total assets
    12.55       11.29       8.93       8.80       8.45       7.54  
Average interest-bearing deposits to average total deposits
    79.64       80.77       83.24       84.26       85.07       85.67  


      The ratios disclosed in the following footnotes exclude certain items which management believes aid the reader in evaluating trends.

 
(a) Ratios for 2005, excluding $115.4 million in after-tax merger and other charges, are as follows: Return on average stockholders’ equity 10.45%; Return on average total assets 1.31%; and Efficiency 61.87%.
(b) Ratios for 2004, excluding $39.1 million in after-tax merger and other charges, are as follows: Return on average stockholders’ equity 11.43%; Return on average total assets 1.29%; and Efficiency 63.90%
(c) Ratios for 2001, excluding $17.8 million in after-tax merger and other charges, are as follows: Return on average stockholders’ equity 13.96%; Return on average total assets 1.18%; and Efficiency 60.87%.
(d) Ratios for 2000, excluding $44.0 million in after-tax gain from sale of credit card portfolio and $26.2 million in after-tax loss from sale of securities, are as follows: Return on average stockholders’ equity 15.76%; Return on average total assets 1.19%; and Efficiency 55.65%.
(e) The efficiency ratio is the quotient of non-interest expense divided by the sum of net interest income (on a tax equivalent basis) and non-interest income (excluding securities gains and losses). This ratio is commonly used by financial institutions as a measure of productivity.

14


 

REGIONS FINANCIAL CORPORATION & SUBSIDIARIES

HISTORICAL FINANCIAL SUMMARY — (Continued)

                                                                     
Annual Compound
Change  Growth Rate
2005 2004 2003 2002 2001 2000 2004-2005 2000-2005








(average daily balances in thousands)
ASSETS
                                                               
Earning assets:
                                                               
 
Taxable securities
  $ 11,660,508     $ 10,530,097     $ 8,713,805     $ 7,929,950     $ 7,357,832     $ 8,651,052       10.74 %     6.15 %
 
Tax-exempt securities
    499,666       499,669       495,411       585,768       787,219       801,330       0.00       -9.01  
 
Federal funds sold
    615,222       631,844       629,896       573,050       556,843       88,361       -2.63       47.42  
 
Loans, net of unearned income
    58,002,167       44,667,472       31,455,173       30,871,093       30,946,736       30,130,808       29.85       14.00  
 
Other earning assets
    3,607,630       3,274,292       2,938,711       2,176,308       1,685,237       413,548       10.18       54.22  
     
     
     
     
     
     
                 
   
Total earning assets
    74,385,193       59,603,374       44,232,996       42,136,169       41,333,867       40,085,099       24.80       13.16  
 
Allowance for loan losses
    (765,853 )     (608,689 )     (452,296 )     (431,000 )     (384,645 )     (360,353 )     25.82       16.27  
 
Cash and due from banks
    1,961,894       1,340,116       952,971       957,893       932,787       1,094,874       46.40       12.37  
 
Other non-earning assets
    9,515,233       6,503,347       3,742,721       3,476,810       2,773,123       2,069,717       46.31       35.68  
     
     
     
     
     
     
                 
   
Total assets
  $ 85,096,467     $ 66,838,148     $ 48,476,392     $ 46,139,872     $ 44,655,132     $ 42,889,337       27.32 %     14.69 %
     
     
     
     
     
     
                 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
                                                               
Deposits:
                                                               
 
Non-interest- bearing
  $ 12,156,817     $ 8,656,768     $ 5,380,521     $ 4,933,496     $ 4,634,198     $ 4,561,900       40.43 %     21.66 %
 
Interest-bearing
    47,556,078       36,358,511       26,727,931       26,419,974       26,401,047       27,279,092       30.80       11.76  
     
     
     
     
     
     
                 
   
Total deposits
    59,712,895       45,015,279       32,108,452       31,353,470       31,035,245       31,840,992       32.65       13.40  
Borrowed funds:
                                                               
 
Short-term
    5,517,577       6,245,334       5,316,272       4,448,043       4,132,264       4,408,689       -11.65       4.59  
 
Long-term
    7,175,075       6,519,193       5,493,097       5,156,481       4,793,657       3,069,465       10.06       18.51  
     
     
     
     
     
     
                 
   
Total borrowed funds
    12,692,652       12,764,527       10,809,369       9,604,524       8,925,921       7,478,154       -0.56       11.16  
 
Other liabilities
    2,013,089       1,510,135       1,229,953       1,123,059       921,937       335,931       33.31       43.06  
     
     
     
     
     
     
                 
   
Total liabilities
    74,418,636       59,289,941       44,147,774       42,081,053       40,883,103       39,655,077       25.52       13.42  
 
Stockholders’ equity
    10,677,831       7,548,207       4,328,618       4,058,819       3,772,029       3,234,260       41.46       26.98  
     
     
     
     
     
     
                 
   
Total liabilities and stockholders’ equity
  $ 85,096,467     $ 66,838,148     $ 48,476,392     $ 46,139,872     $ 44,655,132     $ 42,889,337       27.32 %     14.69 %
     
     
     
     
     
     
                 


(-)  2005 and 2004 average balances were impacted by the mid-year 2004 merger with Union Planters.

15


 

REGIONS FINANCIAL CORPORATION & SUBSIDIARIES

HISTORICAL FINANCIAL SUMMARY — (Continued)

                                                                   
Annual Compound
Change Growth Rate
2005 2004 2003 2002 2001 2000 2004-2005 2000-2005








(in thousands, except per share amounts)
YEAR-END BALANCES
                                                               
 
Assets
  $ 84,785,600     $ 84,106,438     $ 48,597,996     $ 47,938,840     $ 45,382,712     $ 43,688,293       0.81 %     14.18 %
 
Securities
    11,979,274       12,616,589       9,087,804       8,994,600       7,847,159       8,994,171       -5.05       5.90  
 
Loans, net of unearned income
    58,404,913       57,526,954       32,184,323       30,985,774       30,885,348       31,376,463       1.53       13.23  
 
Non-interest- bearing deposits
    13,699,038       11,424,137       5,717,747       5,147,689       5,085,337       4,512,883       19.91       24.87  
 
Interest-bearing deposits
    46,679,329       47,242,886       27,014,788       27,778,512       26,462,986       27,509,608       -1.19       11.15  
     
     
     
     
     
     
                 
 
Total deposits
    60,378,367       58,667,023       32,732,535       32,926,201       31,548,323       32,022,491       2.92       13.52  
 
Long-term debt
    6,971,680       7,239,585       5,711,752       5,386,109       4,747,674       4,478,027       -3.70       9.26  
 
Stockholders’ equity
    10,614,283       10,749,457       4,452,115       4,178,422       4,035,765       3,457,944       -1.26       25.15  
 
Stockholders’ equity per share
  $ 23.26     $ 23.06     $ 16.25     $ 15.29     $ 14.21     $ 12.74       0.87 %     12.79 %
 
Market price per share of common stock
  $ 34.16     $ 35.59     $ 30.13     $ 27.02     $ 24.25     $ 22.12       -4.02 %     9.08 %


Notes to Historical Financial Summary:

(-)  Non-accruing loans, of an immaterial amount, are included in earning assets. No adjustment has been made for these loans in the calculation of yields.
 
(-)  Yields are computed on a taxable equivalent basis, net of interest disallowance, using marginal federal income tax rates of 35% for 2005-2000.
 
(-)  Prior period share and per share amounts have been adjusted to reflect the exchange of Regions common stock in connection with the Union Planters transaction. See Note 18 “Business Combinations” to the consolidated financial statements.
 
(-)  This summary should be read in conjunction with the related consolidated financial statements and notes thereto under Item 8 on pages 61 to 108 of this Annual Report on Form 10-K.

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Item 7. Management’s Discussion And Analysis of Financial Condition and Results of Operation

Introduction

General

      The following discussion and financial information is presented to aid in understanding Regions Financial Corporation’s (“Regions” or the “Company”) financial position and results of operations. The emphasis of this discussion will be on the years 2003, 2004 and 2005; in addition, financial information for prior years will also be presented when appropriate. Certain amounts in prior year financial statements have been reclassified to conform to the current year presentation.

      On July 1, 2004, Regions merged with Union Planters Corporation (“Union Planters”) headquartered in Memphis, Tennessee. The combination with Union Planters added approximately $35.7 billion of assets, $22.3 billion of loans, and $22.9 billion of deposits. This transaction was accounted for as a purchase of Union Planters by Regions and accordingly prior period financial statements have not been restated, except certain share and per share amounts related to the exchange of Regions common stock. Union Planters’ results of operations were included in Regions’ results beginning July 1, 2004. Comparisons with prior periods are significantly impacted by the merger with Union Planters (see Note 18 “Business Combinations” to the consolidated financial statements).

      Regions’ primary business is providing traditional commercial and retail banking services to customers throughout its geographic footprint. Regions’ banking subsidiary, Regions Bank, has operations in Alabama, Arkansas, Florida, Georgia, Illinois, Indiana, Iowa, Kentucky, Louisiana, Mississippi, Missouri, North Carolina, South Carolina, Tennessee, Texas and Virginia. In 2005, Regions’ banking operations, excluding trust activities, contributed approximately $789.0 million to consolidated net income.

      In addition to providing traditional commercial and retail banking services, Regions provides other financial services in the fields of investment banking, asset management, trust, mutual funds, securities brokerage, mortgage banking, insurance, commercial accounts receivable factoring and other specialty financing. Regions provides investment banking and brokerage services through 281 offices of Morgan Keegan & Company, Inc. (“Morgan Keegan”). Morgan Keegan contributed approximately $101.7 million to net income in 2005, including trust activities. Regions’ mortgage banking operations, Regions Mortgage and EquiFirst Corporation (“EquiFirst”), provide residential mortgage loan origination and servicing activities for customers and contributed approximately $76.0 million to net income in 2005. Regions Mortgage serviced approximately $37.2 billion in mortgage loans as of December 31, 2005. Regions provides full-line insurance brokerage services primarily through Rebsamen Insurance, Inc., one of the 50 largest insurance brokers in the country. Credit life insurance services for customers are provided through other Regions’ affiliates. Insurance activities contributed approximately $15.8 million to net income in 2005.

      Regions’ profitability, like that of many other financial institutions, is dependent on its ability to generate revenue from net interest income and non-interest income sources. Net interest income is the difference between the interest income Regions receives on earning assets, such as loans and securities, and the interest expense Regions pays on interest-bearing liabilities, principally deposits and borrowings. Regions’ net interest income is impacted by the size and mix of its balance sheet components and the interest rate spread between interest earned on its assets and interest paid on its liabilities. Non-interest income includes fees from service charges on deposit accounts, trust and securities brokerage activities, mortgage origination and servicing, insurance and other customer services which Regions provides. Results of operations are also affected by the provision for loan losses and non-interest expenses such as salaries and employee benefits, occupancy and other operating expenses, including income taxes.

      Economic conditions, competition and the monetary and fiscal policies of the Federal government in general, significantly affect financial institutions, including Regions. Lending and deposit activities and fee income generation are influenced by the level of business spending and investment, consumer income, spending and savings, capital market activities, competition among financial institutions, customer preferences, interest rate conditions and prevailing market rates on competing products in Regions’ primary market areas.

17


 

      Regions’ business strategy has been and continues to be focused on providing a competitive mix of products and services, delivering quality customer service and maintaining a branch distribution network with offices in convenient locations.

      The Company’s principal market areas are located in the states of Alabama, Arkansas, Florida, Georgia, Illinois, Indiana, Iowa, Kentucky, Louisiana, Mississippi, Missouri, North Carolina, South Carolina, Tennessee, Texas and Virginia. Morgan Keegan also operates offices in Massachusetts and New York.

2005 Highlights

      Regions’ most significant accomplishment in 2005 was the successful three-phase conversion of more than 700 Union Planters bank branches to Regions’ banking systems. The integration of systems was accomplished ahead of the original schedule and resulted in minimal negative impact to Regions customers. The integration is expected to result in improved returns through increased operational efficiencies and strengthened customer relationships.

      Regions reported net income available to common shareholders of $2.15 per diluted share in 2005, including a reduction of $.24 per diluted share related to $115.4 million (net of tax) in merger and storm-related expenses. Net income available to common shareholders was $2.19 per diluted share in 2004.

      Net interest income for 2005 was $2.8 billion, compared to $2.1 billion in 2004. The net interest margin for 2005 was 3.91%, up from 3.66% in 2004. The increase in the net interest margin was due primarily to favorable balance sheet positioning in a rising interest rate environment during 2005; Regions, being in a slightly asset sensitive balance sheet position, benefited from rising interest rates during 2005, as increases in asset yields outpaced increases in interest-bearing liability costs. Additionally, a shift in the mix of earning assets and interest bearing liabilities benefited the Company. Loans, typically Regions’ highest yielding asset, increased slightly as a percentage of total earning assets. Low cost core deposits comprised a larger percentage of interest-bearing liabilities, resulting from marketing campaigns targeting such products, as well as an influx of low-cost deposits during the last two quarters of 2005 in Hurricane Katrina-impacted areas. As of December 31, 2005, interest rate sensitivity analysis indicated Regions’ balance sheet remains in a slightly asset sensitive position.

      Net charge-offs totaled $136.2 million, or 0.23%, of average loans in 2005, compared to 0.29% in 2004. Non-performing assets decreased $45.4 million to $406.9 million at December 31, 2005.

      Non-interest income (excluding security gains/losses) totaled 39% of total revenue (tax-equivalent basis) in 2005, as Regions continued to benefit from a diversified revenue steam. Brokerage and investment banking revenues increased in 2005, attributable to strong private client, equity capital markets, and investment advisory income streams during the year. Service charges on deposit accounts increased significantly in 2005, due primarily to deposit accounts added from the Union Planters merger. Residential mortgage servicing and origination fees were higher in 2005, due to business activity added in connection with the Union Planters merger, as well as a relatively low interest rate environment.

      Non-interest expense totaled $3.0 billion in 2005 compared to $2.5 billion in 2004. Included in non-interest expense in 2005 are merger and storm-related charges of $176.8 million. Regions incurred merger-related expenses throughout the merger integration process incident to the Regions and Union Planters merger. Through the integration of Regions and Union Planters, Regions expects continued realization of efficiencies in the banking unit, as well as other lines of business. Regions realized $135 million in cumulative cost savings in 2005 in connection with the merger. Regions intends to continue to invest in many areas of the franchise, including personnel, technology and product delivery channels to increase revenue and improve efficiencies while continuing to provide superior customer service.

      On August 29, 2005, Hurricane Katrina struck the Gulf Coast as a powerful Category 3 hurricane, causing significant flood and wind damage and loss of life, property, power, and income along the coastal areas of Louisiana (including New Orleans), Mississippi, and Alabama. At December 31, 2005, only 11 of the 190 Regions’ branches affected by Hurricane Katrina remained closed due to the damage sustained from the hurricane and subsequent flooding. As of December 31, 2005, Regions had approximately $1.2 billion in

18


 

outstanding loans in the most significantly impacted areas. As a result of this disaster, Regions expects some continued impact to certain revenue streams due to business interruptions caused by this disaster. In addition, incremental costs are expected to be incurred related to the disaster, a significant portion of which is expected to be covered by insurance.

Critical Accounting Policies

      In preparing financial information, management is required to make significant estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses for the periods shown. The accounting principles followed by Regions and the methods of applying these principles conform with accounting principles generally accepted in the United States and general banking practices. Estimates and assumptions most significant to Regions are related primarily to allowance for loan losses, intangibles (excess purchase price, other identifiable intangible assets and mortgage serving rights) and income taxes, and are summarized in the following discussion and notes to the consolidated financial statements.

 
Allowance for Loan Losses

      Management’s determination of the adequacy of the allowance for loan losses, which is based on the factors and risk identification procedures discussed in the following pages, requires the use of judgments and estimates that may change in the future. Changes in the factors used by management to determine the adequacy of the allowance, or the availability of new information, could cause the allowance for loan losses to be increased or decreased in future periods. For example, management has used judgments and estimates in its determination of the adequacy of the allowance for loan losses related to the impact of Hurricane Katrina. The availability of additional or different information affecting customers in the Katrina-impacted areas could cause the allowance for loan losses to be increased or decreased in future periods. In addition, bank regulatory agencies, as part of their examination process, may require that additions be made to the allowance for loan losses based on their judgments and estimates.

 
Intangible Assets

      Regions’ intangible assets consist primarily of excess of cost over the fair value of net assets of acquired businesses (excess purchase price), other identifiable intangible assets (primarily core deposit intangibles) and amounts capitalized for the right to service mortgage loans.

      Regions’ excess purchase price is tested for impairment annually, or more often if events or circumstances indicate impairment may exist. Adverse changes in the economic environment, operations of acquired business units, or other factors could result in a decline in implied fair value of excess purchase price. If the implied fair value is less than the carrying amount, a loss would be recognized to reduce the carrying amount to implied fair value.

      Other identifiable intangible assets, primarily core deposit intangibles, are reviewed at least annually for events or circumstances which could impact the recoverability of the intangible asset, such as loss of core deposits, increased competition or adverse changes in the economy. To the extent an other identifiable intangible asset is deemed unrecoverable, an impairment loss would be recorded to reduce the carrying amount to the fair value.

      For purposes of evaluating mortgage servicing impairment, Regions must estimate the value of its mortgage servicing rights (“MSR”). MSR do not trade in an active market with readily observable market prices. Although sales of MSR do occur, the exact terms and conditions of sales may not be readily available. As a result, Regions stratifies its mortgage servicing portfolio on the basis of certain risk characteristics, including loan type and contractual note rate, and values its MSR using discounted cash flow modeling techniques, which require management to make estimates regarding future net servicing cash flows, taking into consideration historical and forecasted mortgage loan prepayment rates and discount rates. Changes in interest rates, prepayment speeds or other factors could result in impairment of the servicing asset and a charge against earnings to reduce the recorded carrying amount. Based on a hypothetical sensitivity analysis, Regions estimates that a reduction in the primary mortgage market rates of 25 basis points and 50 basis points

19


 

would reduce the December 31, 2005 fair value of MSR by 8% ($30 million) and 15% ($60 million), respectively.
 
Income Taxes

      Management’s determination of the realization of the deferred tax asset is based upon management’s judgment of various future events and uncertainties, including the timing and amount of future income earned by certain subsidiaries and the implementation of various tax plans to maximize realization of the deferred tax asset. Management believes that the subsidiaries will generate sufficient operating earnings to realize the deferred tax benefits. Regions’ 1998 to 2004 consolidated federal income tax returns are open for examination. From time to time Regions engages in business plans that may also have an effect on its tax liabilities. While Regions has obtained the opinion of advisors that the tax aspects of these plans should prevail, examination of Regions’ income tax returns or changes in tax law may impact these plans and resulting provisions for income taxes. For example, as a result of normal examinations of Regions’ income tax returns, Regions has received notices of proposed adjustments relating to taxes due for certain years. Regions believes that adequate provisions for income taxes have been recorded and intends to vigorously contest the proposed adjustments. To the extent, however, that final resolution of the proposed adjustments results in significantly different conclusions from Regions’ current assessment of the proposed adjustments, Regions’ effective tax rate in any given financial reporting period may be materially different from its current effective tax rate.

Acquisitions

      The acquisitions of banks and other financial service companies historically have contributed significantly to Regions’ growth. The acquisitions of other financial service companies have also allowed Regions to better diversify its revenue stream and to offer additional products and services to its customers. Regions, from time to time, evaluates potential bank and non-bank acquisition candidates; however, no transactions were pending at December 31, 2005.

      During 2005, Regions completed acquisitions of an oil and gas valuation and brokerage entity, as well as various insurance production activities. Regions paid approximately $7.2 million in cash and recorded $5.6 million in identifiable intangible assets, as well as $1.5 million of excess purchase price, related to these acquisitions.

      On July 1, 2004, Regions completed its merger with Union Planters, headquartered in Memphis, Tennessee. Union Planters provided traditional commercial and retail banking services and other financial services in the fields of mortgage banking, insurance, trust, securities brokerage and investments, professional employment services and specialty financing. The combination with Union Planters added $35.7 billion in assets, $22.3 billion in loans and $22.9 billion in deposits, and significantly expanded Regions geographic footprint as well as its customer base. Through the merger, Regions expanded its banking presence into new markets in Illinois, Indiana, Iowa, Kentucky, Mississippi and Missouri and strengthened its banking presence in existing markets in Alabama, Arkansas, Florida, Louisiana, Tennessee and Texas.

      Additionally in 2004, Regions acquired Evergreen Timber Investment Management (“ETIM”), adding approximately $20 million in assets. ETIM manages timber assets for third parties.

      In 2003, Regions consummated the purchase of three branches from Inter Savings Bank, FSB, which strengthened its community banking franchise in central Florida. These branches combined added $185 million in assets, $5 million in loans and $185 million in deposits.

Financial Condition

      Regions’ financial condition depends primarily on the quality and nature of its assets, liabilities and capital structure, market and economic conditions, and the quality of its personnel.

20


 

Loans and Allowance for Loan Losses

Loan Portfolio

      Regions’ primary investment is loans. At December 31, 2005, loans represented 79% of Regions’ earning assets.

      Lending at Regions is generally organized along three functional lines: commercial loans (including financial and agricultural), real estate loans and consumer loans. The composition of the portfolio by these major categories is presented below (with real estate loans further broken down between construction and mortgage loans):

                                           
December 31,

2005 2004 2003 2002 2001





(in thousands, net of unearned income)
Commercial
  $ 14,728,006     $ 15,028,015     $ 9,754,588     $ 10,667,855     $ 9,727,204  
Real estate — construction
    7,362,219       5,472,463       3,484,767       3,604,116       3,664,677  
Real estate — mortgage
    27,034,924       27,639,913       12,977,549       11,039,552       11,309,126  
Consumer
    9,279,764       9,386,563       5,967,419       5,674,251       6,184,341  
     
     
     
     
     
 
 
Total
  $ 58,404,913     $ 57,526,954     $ 32,184,323     $ 30,985,774     $ 30,885,348  
     
     
     
     
     
 

      As the above table demonstrates, over the last five years loans increased a total of $27.5 billion, a compound growth rate of 17%. In 2002, total loans increased $100 million, primarily due to growth in the commercial portfolio and partially offset by the reclassification of $1.1 billion of indirect auto loans to the loans held for sale category on September 30, 2002. Excluding the effect of the reclassification, total loans would have increased $1.2 billion, or 4%, in 2002. Loans increased $1.2 billion, or 4%, in 2003, due primarily to growth in the real estate portfolio partially offset by a decline in the commercial portfolio. Loans increased significantly in 2004 due to $22.3 billion of loans which were added by the Union Planters merger, $430 million of indirect auto loans reclassified to the loan portfolio from the loans held for sale category and internally generated loan growth. Excluding loans added from the merger and reclassification, loans increased 8% in 2004. Loans increased $878 million, or 2%, in 2005, due primarily to growth in the real estate construction portfolio, partially offset by declines in other loan categories.

      All major categories in the loan portfolio have increased significantly over the last five years due primarily to the merger with Union Planters during 2004. Over the last five years, commercial, financial and agricultural loans increased $5.0 billion, or 51%. Real estate construction loans increased $3.7 billion, or 101%, over the same period. Real estate mortgage loans increased $15.7 billion, or 139%, and consumer loans increased $3.1 billion, or 50%, over the last five years.

      In 2005, as economic conditions remained relatively steady, loan growth was generated in the real estate construction category, while other categories experienced slight declines. Average total loans were $31.5 billion in 2003, compared to $44.7 billion in 2004 and $58.0 billion in 2005. The modest internal loan growth trend experienced is the result of reduced loan demand attributable to slowing real estate market conditions, significant prepayments of mortgage loans, and management initiatives to focus on higher margin loans and increase diversification of the portfolio, combined with the reclassification of indirect auto loans in 2002. Regions anticipates modest overall loan growth in 2006.

      Regions’ residential real estate mortgage loans originated from the mortgage divisions totaled $8.9 billion at December 31, 2005, an increase of approximately $200 million from a year earlier. Included in these loans are approximately $5.7 billion of adjustable rate mortgages (“ARM”) and $3.2 billion of fixed rate mortgages at year end.

      The fixed rate residential mortgage portfolio’s weighted average coupon declined to 5.86% from 5.90% the previous year, while the weighted average remaining maturity increased slightly to 177 months from 170 months for 2005 and 2004, respectively. The residential ARM portfolio exhibited a yield increase with

21


 

rates averaging 5.65% in 2005, compared to 5.37% a year earlier. At December 31, 2005, the weighted average months to reprice was 33, down from 35 months at year-end 2004.

      The amounts of total gross loans (excluding residential mortgages and consumer loans) outstanding at December 31, 2005, based on remaining scheduled repayments of principal, due in (1) one year or less, (2) more than one year but less than five years and (3) more than five years, are shown in the following table. The amounts due after one year are classified according to sensitivity to changes in interest rates.

                                   
Loans Maturing

Within After One But After
One Year Within Five Years Five Years Total




(in thousands)
Commercial, financial and agricultural
  $ 7,461,448     $ 5,596,959     $ 1,829,041     $ 14,887,448  
Real estate — construction
    4,567,540       2,425,955       383,255       7,376,750  
Real estate — mortgage
    3,509,002       6,900,551       2,596,522       13,006,075  
     
     
     
     
 
 
Total
  $ 15,537,990     $ 14,923,465     $ 4,808,818     $ 35,270,273  
     
     
     
     
 
                   
Sensitivity of Loans to
Changes in Interest Rates

Predetermined Variable
Rate Rate


(in thousands)
Due after one year but within five years
  $ 4,753,581     $ 10,169,884  
Due after five years
    1,976,710       2,832,108  
     
     
 
 
Total
  $ 6,730,291     $ 13,001,992  
     
     
 

      A sound credit policy and careful, consistent credit review are vital to a successful lending program. All affiliates of Regions operate under written loan policies that attempt to maintain a consistent lending philosophy, provide sound traditional credit decisions, provide an adequate risk-adjusted return and render service to the communities in which the bank branches are located. Regions’ lending policy generally confines loans to local customers or to national firms doing business locally. Credit reviews and loan examinations help confirm that affiliates are adhering to these loan policies.

      Allowance for Loan Losses

      Every loan carries some degree of credit risk. This risk is reflected in the consolidated financial statements by the allowance for loan losses, the amount of loans charged off and the provision for loan losses charged to operating expense. It is Regions’ policy that when a loss is identified, it is charged against the allowance for loan losses in the current period. The policy regarding recognition of losses requires immediate recognition of a loss if significant doubt exists as to principal repayment.

      Regions’ provision for loan losses is a reflection of management’s judgment as to the adequacy of the allowance for loan losses. Some of the factors considered by management in determining the amount of the provision and resulting allowance include: (1) detailed reviews of individual loans; (2) gross and net loan charge-offs in the current year; (3) the current level of the allowance in relation to total loans and to historical loss levels; (4) past due and non-accruing loans; (5) collateral values of properties securing loans; (6) the composition of the loan portfolio (types of loans) and risk profiles; and (7) management’s analysis of economic conditions and the resulting impact on Regions’ loan portfolio.

      A coordinated effort is undertaken to identify credit losses in the loan portfolio for management purposes and to establish the loan loss provision and resulting allowance for accounting purposes. A regular, formal and ongoing loan review is conducted to identify loans with unusual risks or possible losses. Credit administration and internal audit are jointly responsible for this review, which tests the accuracy of loan gradings assigned at the individual banking offices, reviews significant portfolio segments for early identification of problems or potential problems, and tests for compliance with laws, regulations, and internal policies and procedures. This process provides information that helps in assessing the quality of the portfolio, assists in the prompt

22


 

identification of problems and potential problems, and aids in deciding if a loan represents a probable loss that should be recognized or a risk for which an allowance should be maintained.

      If it is determined that payment of interest on a loan is questionable, it is Regions’ policy to classify the loan as non-accrual and reverse interest previously accrued on the loan against interest income. Interest on such loans is thereafter recorded on a “cash basis” and is included in earnings only when actually received in cash and when full payment of principal is no longer doubtful.

      Although it is Regions’ policy to immediately charge off as a loss all loan amounts judged to be uncollectible, historical experience indicates that certain losses exist in the loan portfolio that have not been specifically identified. To anticipate and provide for these inherent losses, the allowance for loan losses is established by charging the provision for loan losses expense against current earnings. No portion of the resulting allowance is in any way allocated or restricted to any individual loan or group of loans. The entire allowance is available to absorb losses from any and all loans.

      Regions determines its allowance for loan losses in accordance with Statement of Financial Accounting Standards No. 114, “Accounting by Creditors for Impairment of a Loan — an Amendment of FASB Statements No. 5 and 15” and Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies.” In determining the amount of the allowance for loan losses, management uses information from its ongoing loan review process to stratify the loan portfolio into loan pools with common risk characteristics. The higher-risk-graded loans in the portfolio are assigned estimated amounts of loss based on several factors, including current and historical loss experience of each higher-risk category, regulatory guidelines for losses in each higher-risk category, and management’s judgment of economic conditions and the resulting impact on the higher-risk-graded loans. All loans deemed to be impaired, which include all non-accrual loans greater than $1 million, excluding loans to individuals, are evaluated individually. Impaired loans totaled approximately $64 million at December 31, 2005 and $95 million at December 31, 2004. The vast majority of Regions’ impaired loans are dependent upon collateral for repayment. For these loans, impairment is measured by evaluating collateral value as compared to the current investment in the loan. For all other loans, Regions compares the amount of estimated discounted cash flows to the investment in the loan. In the event a particular loan’s collateral value or discounted cash flows are not sufficient to support the collection of the investment in the loan, the loan is specifically considered in the determination of the allowance for loan losses or a charge is immediately taken against the allowance for loan losses. The amount of the allowance for loan losses related to the higher-risk loans was approximately 47% at December 31, 2005, compared to approximately 55% at December 31, 2004. Higher-risk loans, which include impaired loans, consist of loans classified as OLEM (other loans especially mentioned) and below and loans in other loan categories that are significantly past due.

      In addition to establishing allowance levels for specifically identified higher risk-graded loans, management determines allowance levels for all other loans in the portfolio for which historical experience indicates that losses exist. These loans are categorized by loan type and assigned estimated amounts of loss based on several factors, including current and historical loss experience of each loan type and management’s judgment of economic conditions and the resulting impact on each category of loans. The amount of the allowance for loan losses related to all other loans in the portfolio for which historical experience indicates that losses exist was approximately 53% of Regions’ allowance for loan losses at December 31, 2005, compared to approximately 45% at December 31, 2004. The amount of the allowance related to these loans is combined with the amount of the allowance related to the higher risk-graded loans to evaluate the overall level of the allowance for loan losses.

      In August of 2005, Hurricane Katrina struck the Gulf Coast (mainly impacting Louisiana, Mississippi and Alabama) as a Category 3 hurricane, causing significant flood and wind damage and loss of life, property, power, and income. Regions had approximately $1.2 billion in loans ($473 million in commercial real estate loans, $299 million in commercial and industrial loans, $186 million in consumer loans, and $198 million in mortgage loans) in the most significantly impacted areas at December 31, 2005. Approximately 50% of the consumer loans are home equity lines of credit. As part of its ongoing evaluation process at December 31, 2005, Regions has identified approximately $61 million in allowance for loan losses related to this portion of its

23


 

loan portfolio. As of December 31, 2005, Regions had recognized approximately $972,000 in net loan charge-offs ($641,000 for commercial loans and $331,000 for retail and consumer loans) related to Hurricane Katrina.

      Management considers the current level of allowance for loan losses adequate to absorb probable losses on loans in the portfolio. Management’s determination of the adequacy of the allowance for loan losses, which is based on the factors and risk identification procedures previously discussed, requires the use of judgments and estimations that may change in the future. Changes in the factors used by management to determine the adequacy of the allowance or the availability of new information could cause the allowance for loan losses to be increased or decreased in future periods. The amount of the allowance for loan losses related to the Hurricane Katrina impacted portfolio may change in the future as additional or different information affecting customers in the Katrina-impacted areas is obtained. Changes in (1) risk assessments of individual loans in this area, (2) collateral values of properties securing loans in this area, (3) levels of past due and non-accruing loans in this area, (4) economic conditions in the Hurricane Katrina impacted area and (5) other factors, could result in changes in Regions’ allowance for loan losses in the future. In addition, bank regulatory agencies, as part of their examination process, may require that additions be made to the allowance for loan losses based on their judgments and estimates.

      Over the last five years, the year-end allowance for loan losses as a percentage of loans ranged from a low of 1.31% at December 31, 2004 to a high of 1.41% at December 31, 2003 and 2002. As of December 31, 2005, the allowance as a percentage of loans was 1.34%.

      The following table presents information on non-performing loans and real estate acquired in settlement of loans:

                                               
December 31,

Non-Performing Assets 2005 2004 2003 2002 2001






(dollar amounts in thousands)
Non-performing loans:
                                       
 
Loans accounted for on a non-accrual basis
  $ 341,177     $ 388,379     $ 250,344     $ 226,470     $ 269,764  
 
Loans whose terms have been renegotiated to provide a reduction or deferral of interest or principal because of a deterioration in the financial position of the borrower (exclusive of non-accrual loans and loans past due 90 days or more)
    241       279       886       32,280       42,807  
     
     
     
     
     
 
   
Total non-performing loans
  $ 341,418     $ 388,658     $ 251,230     $ 258,750     $ 312,571  
Real estate acquired in settlement of loans (“other real estate”)
    65,459       63,598       52,195       59,606       40,872  
     
     
     
     
     
 
     
Total non-performing assets
  $ 406,877     $ 452,256     $ 303,425     $ 318,356     $ 353,443  
     
     
     
     
     
 
Non-performing assets as a percentage of loans and other real estate
    .70 %     .92 %     1.05 %     1.15 %     1.29 %
Loans contractually past due 90 days or more as to principal or interest payments (exclusive of non-accrual loans)
  $ 87,523     $ 74,777     $ 35,187     $ 38,499     $ 46,845  

      The analysis of loan loss experience, as reflected in the following table, shows that net loan losses over the last five years ranged from a high of $136.2 million in 2005 to a low of $104.6 million in 2003. Net loan losses were $131.0 million in 2004, $111.8 million in 2002, and $126.8 million in 2001. Over the last five years, net loan losses averaged 0.31% of average loans and were 0.23% of average loans in 2005. In 2005, Regions experienced a lower charge-off percentage for commercial and consumer credits, while real estate net charge-offs as a percentage of average loans were flat in comparison to the prior year. Regions expects charge-offs to increase slightly in 2006, although additional charge-offs could be recognized as a result of higher defaults

24


 

related to Hurricane Katrina or the hurricane season in 2006, fraud in connection with loans we originate or lower loan production as a result of rising interest rates.

      The following analysis presents a five-year history of the allowance for loan losses and loan loss data:

                                             
December 31,

2005 2004 2003 2002 2001





(dollar amounts in thousands)
Allowance for loan losses:
                                       
Balance at beginning of year
  $ 754,721     $ 454,057     $ 437,164     $ 419,167     $ 376,508  
Loans charged off:
                                       
 
Commercial
    119,737       105,855       89,250       83,562       95,584  
 
Real estate
    43,368       31,453       18,953       16,731       11,705  
 
Consumer
    48,625       51,064       36,666       56,010       61,760  
     
     
     
     
     
 
   
Total
    211,730       188,372       144,869       156,303       169,049  
Recoveries:
                                       
 
Commercial
    42,514       28,088       13,501       14,892       11,138  
 
Real estate
    8,669       6,673       5,798       5,031       5,027  
 
Consumer
    24,362       22,631       20,963       24,549       26,043  
     
     
     
     
     
 
   
Total
    75,545       57,392       40,262       44,472       42,208  
Net loans charged off:
                                       
 
Commercial
    77,223       77,767       75,749       68,670       84,446  
 
Real estate
    34,699       24,780       13,155       11,700       6,678  
 
Consumer
    24,263       28,433       15,703       31,461       35,717  
     
     
     
     
     
 
   
Total
    136,185       130,980       104,607       111,831       126,841  
Allowance of acquired banks
    -0 -     303,144       -0 -     2,328       4,098  
Provision charged to expense
    165,000       128,500       121,500       127,500       165,402  
     
     
     
     
     
 
Balance at end of year
  $ 783,536     $ 754,721     $ 454,057     $ 437,164     $ 419,167  
     
     
     
     
     
 
Average loans outstanding:
                                       
 
Commercial
  $ 14,957,525     $ 12,766,378     $ 10,647,432     $ 10,329,482     $ 9,567,538  
 
Real estate
    33,916,794       24,020,589       15,385,221       14,571,345       15,598,488  
 
Consumer
    9,127,848       7,880,505       5,422,520       5,970,266       5,780,710  
     
     
     
     
     
 
   
Total
  $ 58,002,167     $ 44,667,472     $ 31,455,173     $ 30,871,093     $ 30,946,736  
     
     
     
     
     
 
Net charge-offs as percent of average loans outstanding:
                                       
 
Commercial
    .52 %     .61 %     .71 %     .66 %     .88 %
 
Real estate
    .10       .10       .09       .08       .04  
 
Consumer
    .27       .36       .29       .53       .62  
   
Total
    .23 %     .29 %     .33 %     .36 %     .41 %
Net charge-offs as percent of:
                                       
 
Provision for loan losses
    82.5 %     101.9 %     86.1 %     87.7 %     76.7 %
 
Allowance for loan losses
    17.4       17.4       23.0       25.6       30.3  
Allowance as percentage of loans, net of unearned income
    1.34 %     1.31 %     1.41 %     1.41 %     1.36 %
Provision for loan losses (net of tax effect) as percentage of net income
    11.6 %     11.0 %     13.3 %     14.7 %     20.3 %

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Risk Characteristics of Loan Portfolio

      In order to assess the risk characteristics of the loan portfolio, it is appropriate to consider the economy of Regions’ primary banking markets as well as the three major categories of loans — commercial, real estate and consumer.

      Economy of Regions’ primary banking markets. The Alabama economy has experienced relatively stable growth over the last several years, including substantial growth in the information technology and biotechnology sectors within Birmingham and Huntsville. Industries important in the Alabama economy include vehicle and vehicle parts manufacturing and assembly, lumber and wood products, health care services and steel production. High technology and defense-related industries are important in the northern part of the state. Agriculture, particularly poultry, beef and cotton, are also important to the state’s economy.

      Tennessee’s economy is heavily influenced by automobile manufacturing, tourism, entertainment and recreation, health care and other service industries. With one out of four Tennesseans employed in service industries, the state’s economy is dependent on this sector.

      The economy of northern Georgia, where the majority of Regions’ Georgia franchise is located, is diversified with a strong presence in poultry production, carpet manufacturing, automotive manufacturing-related industries, tourism, and various service sector industries. A well-developed transportation system has contributed to the growth in north Georgia. This area has experienced rapid population growth and has favorable household income characteristics relative to many of Regions’ other markets.

      In the southern region of Georgia, while agriculture is important, other industries play a significant role in the economy as well. Georgia ranks as one of the nation’s top producers of paper and paper board products. Albany and Valdosta, Regions’ primary market areas in southern Georgia, are hubs for retail trade and health care for the entire south Georgia market. These markets are also home to numerous manufacturing and production facilities of Fortune 500 Companies.

      Florida has also experienced significant economic growth during the last several years. Tourism and space research are very important to the Florida economy, and military payrolls are significant in the panhandle area. Florida has experienced strong in-migration, contributing to strong construction activity, increasing real estate values, and a growing retirement-age population. Citrus fruit production is also important in the state.

      The Arkansas economy is supported in part by the forest products industry, due to the abundance of corporate-owned forests and public forest lands. In recent years, retail trade, transportation and steel production have become increasingly important to the state’s economy.

      Natural resources are very important to the Louisiana economy. Energy and petrochemical industries play a significant role in the economy. Shipping, shipbuilding, and other transportation equipment industries are strong in the state’s durable goods industries. Tourism, amusement and recreation, service, and health care industries are also important to the Louisiana economy. Cotton, rice and sugarcane are among Louisiana’s most important agricultural commodities, while Louisiana’s fishing industry is one of the largest in the nation. The coastal region of Louisiana was significantly impacted by Hurricane Katrina from both an infrastructure and economic perspective.

      The economy in the state of Texas has been among the strongest in the nation in recent years. In addition to oil, gas and agriculture, the Texas economy is supported by telecommunications, computer and technology research, and the health care industry.

      Manufacturing and agriculture primarily drive the Indiana economy. Steel, transportation equipment, and food products are the leading manufacturers in Indiana. Indiana’s production of corn and wheat support its livestock and meatpacking industries as well as its dairy industry.

      Missouri’s economy relies mainly on industry. Aerospace and transportation equipment production as well as printing and publishing are important to the economic growth. Missouri’s mining concerns are also vital to the economy. Missouri is a leading producer of coal, zinc and lead.

      The economy along the I-85 corridor in South Carolina is home to numerous multinational manufacturers, resulting in one of the highest per capita foreign investment areas in the nation. Auto manufacturing has become increasingly important in recent years in this area.

26


 

      The economy in Iowa is heavily influenced by agriculture. Iowa is one of the leaders in the production of corn and soybeans. In recent years, manufacturing has become increasingly important. Top products include farm machinery, tires and chemicals.

      The economy of Kentucky is primarily industrial, including manufacturing of electrical equipment, automobiles and food products. Tourism has become increasingly important in recent years. Kentucky is also a leading producer of coal.

      Timber products and agriculture continue to be important to the Mississippi economy, although tourism and entertainment have become important in recent years. Mississippi’s primary agricultural products include poultry, catfish and dairy. Mississippi’s coastal regions were significantly impacted by Hurricane Katrina, both from an infrastructure and economic perspective.

      The North Carolina economy is diversified with manufacturing, agriculture, financial services and textiles as its primary industries. North Carolina has experienced population growth well in excess of the national average in recent years. The economy is further supported by three state universities, which provide stable employment and serve as research centers in the area.

      The Illinois economy is diversified with manufacturing, mining, textiles and agriculture. Illinois’ manufactured products include food products, fabricated and primary metal products, chemicals and published materials. Illinois ranks high among the states in the production of coal as well as corn, soybeans, hay and wheat.

      Virginia’s economy is primarily industrial, including manufacturing of transportation and electrical equipment, food processing, textiles, and lumber and wood production. Agriculture remains an important industry within the state, especially production of tobacco, tomatoes, and apples. Virginia is also one of the top ten coal producers in the United States.

      The economies in the markets served by Regions continue to be among the best in the nation. General economic conditions deteriorated throughout the nation in 2001 and did not show significant recovery in 2002. In 2003, various sectors of the economy reported growth, while others continued the slow growth trends of 2002. Generally, economic conditions continued to improve during 2004. Overall economic conditions were generally steady during 2005, despite pressures from rising oil prices and the impact of Hurricanes Katrina and Rita on the Gulf Coast. These factors were offset by the continued relatively low interest rate environment, resulting in strong consumer spending, construction, and productivity growth.

      Commercial. Regions’ commercial loan portfolio is highly diversified within the markets it serves. Geographically, the largest concentration is the 18% of the commercial loan portfolio in Alabama followed by Georgia with 16%, Tennessee with 13%, Florida with 12%, and Arkansas with 9%. Commercial loans in Louisiana account for 7% of the portfolio, followed by Texas and Indiana with 5% each, Missouri with 4%, Illinois and Mississippi with 3% each, South Carolina with 2%, and Iowa, Kentucky and North Carolina with 1% each. A small portion of these loans is secured by properties outside Regions’ banking market areas.

      Included in the commercial loan classification are approximately $1.8 billion of syndicated loans. Syndicated loans are typically made to national companies and are originated through an agent bank. Regions’ syndicated loans are primarily to national companies with operations in Regions’ banking footprint.

      From 2001 to 2005, net commercial loan losses as a percent of average commercial loans outstanding ranged from a low of 0.52% in 2005 to a high of 0.88% in 2001. Commercial loan losses in 2005 totaled $77.2 million, or 0.52% of average commercial loans compared to 0.61% in 2004. The lower percentage of commercial loan losses in 2005 compared to 2004 resulted primarily from continued positive economic conditions. Future losses are a function of many variables, of which general economic conditions are the most important. Assuming moderate to slow economic growth during 2006 in Regions’ market areas and immaterial impact on Regions’ commercial loan portfolio from Hurricane Katrina, commercial loan losses in 2006 are expected to approximate 2005 levels. However, commercial loan losses may be higher than expected in 2006 as a result of slower than expected economic growth, unexpected losses from the hurricane season, and our inability to properly assess the credit of borrowers and underlying collateral value due to a number of factors, including environmental and other hazard factors.

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      Real Estate. Regions’ real estate loan portfolio consists of construction and land development loans, loans to businesses for long-term financing of land and buildings, loans on one-to four-family residential properties, loans to mortgage banking companies (which are secured primarily by loans on one- to four-family residential properties and are known as warehoused mortgage loans) and various other loans secured by real estate.

      Real estate construction loans increased $1.9 billion in 2005 to $7.4 billion, or 12.6% of Regions’ total loan portfolio. Over the last five years, real estate construction loans averaged 11.2% of Regions’ total loan portfolio. During 2002 and 2003, construction loan demand declined as the economy exhibited signs of weakness. In 2004, as the economic conditions improved, loan demand increased as new construction projects increased. During 2005, construction loan demand increased due to generally strong economic conditions. Most of the construction loans relate to shopping centers, apartment complexes, commercial buildings and residential property development. These loans are normally secured by land and buildings and are generally backed by commitments for long-term financing from other financial institutions. Real estate construction loans are closely monitored by management, since these loans are generally considered riskier than other types of loans and are particularly vulnerable in economic downturns and in periods of high interest rates. Regions generally requires higher levels of borrower equity investment in addition to other underwriting requirements for this type of lending as compared to other real estate lending. Regions has not been an active lender to real estate developers outside its market areas.

      The loans to businesses for long-term financing of land and buildings are primarily to commercial customers within Regions’ markets. Total loans secured by non-farm, non-residential properties totaled $12.8 billion at December 31, 2005. Although some risk is inherent in this type of lending, Regions attempts to minimize this risk by generally making a significant amount of loans of this type only on owner-occupied properties, and by requiring collateral values that exceed the loan amount, adequate cash flow to service the debt, and in most cases, the personal guarantees of principals of the borrowers.

      Regions also attempts to mitigate the risks of real estate lending by adhering to standard loan underwriting policies and by diversifying the portfolio both geographically within its market area and within industry groups.

      Loans on one-to four-family residential properties, which total approximately 52% of Regions’ real estate mortgage portfolio, are principally on single-family residences. These loans are geographically dispersed throughout Regions’ market areas, and some are guaranteed by government agencies or private mortgage insurers. Historically, this category of loans has not produced sizable loan losses; however, it is subject to some of the same risks as other real estate lending. Warehoused mortgage loans, since they are secured primarily by loans on one- to four-family residential properties, are similar to these loans in terms of risk.

      From 2001 to 2005, net losses on real estate loans as a percent of average real estate loans outstanding ranged from a high of 0.10% in 2004 and 2005, to a low of 0.04% in 2001. In 2005, real estate loan losses were relatively flat as compared to 2004. These losses depend, to a large degree, on the level of interest rates, economic conditions and collateral values, and thus, are very difficult to predict. Management expects 2006 net real estate loan losses to increase slightly above 2005 levels. Net losses on real estate loans in 2006 may be higher as a result of borrower defaults, risks associated with construction loans such as cost overruns, project completion risk, general contractor credit risk, environmental and other hazard risks and market risks associated with the sale of completed residential units.

      Consumer. Regions’ consumer loan portfolio consists of $3.5 billion in consumer loans and $5.8 billion in personal lines of credit (including home equity loans). Consumer loans are primarily borrowings of individuals for home improvements, automobiles and other personal and household purposes. Regions’ consumer loan portfolio included $335 million of indirect consumer auto loans at December 31, 2005, $656 million at December 31, 2004 and $10 million at December 31, 2003. Indirect consumer loans decreased significantly in 2005 due to run off of the existing portfolio and no new origination of this category of loans. Personal lines of credit increased $557.7 million in 2005 due to marketing and sales initiatives promoting home equity loans. During the past five years, the ratio of net consumer loan losses to average consumer loans ranged from a low of 0.27% in 2005 to a high of 0.62% in 2001. Consumer loan losses decreased in 2005 due to a continued relatively strong overall economic environment. Consumer loan losses are difficult to predict but historically have tended to increase during periods of economic weakness. Management expects net consumer loan losses in 2006 to increase slightly above 2005 levels.

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Non-Performing Assets

      At December 31, 2005, non-accrual loans totaled $341.2 million, or 0.59% of average loans, compared to $388.4 million, or 0.68% of average loans, at December 31, 2004. The decrease in non-accrual loans at December 31, 2005, was primarily due to the disposition of a single large commercial credit. Commercial loans amounted to $93.7 million of the 2005 total, with real estate loans accounting for $228.3 million and consumer loans $19.2 million. Regions’ non-performing loan portfolio is composed primarily of a number of small to medium-sized loans that are diversified geographically throughout its franchise. The 25 largest non-accrual loans range from $1.0 million to $7.4 million. These loans are widely dispersed among a number of industries and are generally highly collateralized. Of the $341.2 million in non-accrual loans at December 31, 2005, approximately $153.5 million (45% of total non-accrual loans) are secured by single-family residences, which historically have had very low loss ratios.

      Other real estate totaled $65.5 million at December 31, 2005, $63.6 million at December 31, 2004, and $52.2 million at December 31, 2003. The increase in other real estate in 2004 compared to the prior year resulted primarily from parcels added in connection with the Union Planters transaction. Regions’ other real estate is composed primarily of a number of small to medium-size properties that are diversified geographically throughout its franchise. The 25 largest parcels of other real estate range in recorded value from $275,000 to $5.7 million, with only four parcels over $1 million. Other real estate is recorded at the lower of (1) the recorded investment in the loan or (2) fair value less the estimated cost to sell. Although Regions does not anticipate material loss upon disposition of other real estate, sustained periods of adverse economic conditions, substantial declines in real estate values in Regions’ markets, actions by bank regulatory agencies or other factors, could result in additional loss from other real estate.

      The amount of interest income recognized in 2005 on the $341.2 million of non-accruing loans outstanding at year-end was approximately $11.7 million. If these loans had been current in accordance with their original terms, approximately $36.7 million would have been recognized on these loans in 2005.

      Loans contractually past due 90 days or more were 0.15% of total loans at December 31, 2005, compared to 0.13% of total loans at December 31, 2004. Since December 31, 2004, loan delinquencies have increased, primarily related to increases in delinquencies in the consumer loan portfolio. Loans past due 90 days or more at December 31, 2005 consisted of $44.7 million in commercial and real estate loans and $42.8 million in consumer loans. Loans with temporary payment deferrals related to Hurricane Katrina are not categorized as past due 90 days or more at December 31, 2005; however, future periods may be impacted as payment deferrals expired in December 2005.

 
Funding Commitments

      In the normal course of business, Regions makes commitments under various terms to lend funds to its customers. These commitments include (among others) revolving credit agreements, term loan agreements and short-term borrowing arrangements, which are usually for working capital needs. Many of these commitments are expected to expire without being funded; therefore, total commitment amounts do not necessarily represent future liquidity requirements. Letters of credit are also issued, which under certain conditions could result in loans. See Note 13 “Commitments and Contingencies” to the consolidated financial statements for additional information. The following table shows the amount and duration of Regions’ funding commitments.

                           
Funding Due by Period

Less than Greater than
Total 1 Year 1 Year



(in thousands)
Funding commitments:
                       
 
Home equity loan commitments
  $ 4,535,190     $ 670,186     $ 3,865,004  
 
Other loan commitments
    15,267,228       4,423,111       10,844,117  
 
Standby letters of credit
    3,092,845       1,526,231       1,566,614  
 
Commercial letters of credit
    72,834       72,834       -0 -

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      Loans by SIC Code

      The commercial, real estate and consumer loan portfolios are highly diversified in terms of industry concentrations. The following table shows the largest concentrations in terms of the customers’ Standard Industrial Classification Code at December 31, 2005 and 2004:

                                                     
2005 2004


% of % Non- % of % Non-
Standard Industrial Classification Amount Total Accrual Amount Total Accrual







(dollar amounts in millions)
Individuals
  $ 24,579.3       42.0 %     0.7 %   $ 24,452.3       42.3 %     0.7 %
Services:
                                               
 
Physicians
    525.2       0.9       0.2       579.2       1.0       0.3  
 
Business services
    410.2       0.7       0.4       404.5       0.7       0.4  
 
Religious organizations
    907.4       1.5       0.4       805.8       1.4       0.3  
 
Legal services
    231.6       0.4       0.6       255.8       0.4       0.2  
 
All other services
    6,154.7       10.5       0.5       5,348.7       9.3       0.6  
     
     
             
     
         
   
Total services
    8,229.1       14.0       0.5       7,394.0       12.8       0.5  
Manufacturing:
                                               
 
Electrical equipment
    70.7       0.1       0.3       85.2       0.2       0.3  
 
Food and kindred products
    150.5       0.2       2.9       123.2       0.2       0.0  
 
Rubber and plastic products
    56.7       0.1       0.0       86.6       0.2       3.0  
 
Lumber and wood products
    269.1       0.5       3.0       286.4       0.5       4.3  
 
Fabricated metal products
    210.4       0.4       2.0       240.4       0.4       3.4  
 
All other manufacturing
    1,353.2       2.3       0.9       1,325.9       2.3       1.5  
     
     
             
     
         
   
Total manufacturing
    2,110.6       3.6       1.4       2,147.7       3.8       2.0  
Wholesale trade
    1,507.6       2.6       0.6       1,466.9       2.5       1.1  
Finance, insurance and real estate:
                                               
 
Real estate
    9,880.9       16.9       0.3       9,756.1       16.9       0.3  
 
Banks and credit agencies
    698.8       1.2       0.2       1,534.8       2.7       0.5  
 
All other finance, insurance and real estate
    1,087.2       1.8       0.5       1,190.2       2.1       0.3  
     
     
             
     
         
   
Total finance, insurance and real estate
    11,666.9       19.9       0.3       12,481.1       21.7       0.3  
Construction:
                                               
 
Residential building construction
    3,251.6       5.5       0.3       2,557.7       4.4       0.2  
 
General contractors and builders
    328.5       0.6       0.9       294.0       0.5       0.7  
 
All other construction
    926.3       1.6       1.0       925.7       1.6       0.9  
     
     
             
     
         
   
Total construction
    4,506.4       7.7       0.5       3,777.4       6.5       0.4  
Retail trade:
                                               
 
Automobile dealers
    791.4       1.3       0.3       781.0       1.3       0.3  
 
All other retail trade
    1,809.4       3.1       0.7       1,946.1       3.4       1.1  
     
     
             
     
         
   
Total retail trade
    2,600.8       4.4       0.6       2,727.1       4.7       0.8  
Agriculture, forestry and fishing
    1,324.3       2.3       1.2       1,365.5       2.4       1.7  
Transportation, communication, electrical, gas and sanitary
    1,403.6       2.4       0.3       1,312.0       2.3       1.8  
Mining (including oil and gas extraction)
    183.9       0.3       1.7       199.8       0.3       0.6  
Public administration
    157.8       0.3       0.0       249.6       0.4       0.8  
Other
    321.5       0.5       0.1       162.2       0.3       0.2  
     
     
             
     
         
   
Total
  $ 58,591.8       100.0 %     0.6 %   $ 57,735.6       100.0 %     0.7 %
     
     
             
     
         

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Interest-Bearing Deposits In Other Banks

      Interest-bearing deposits in other banks are used primarily as temporary investments and generally have short-term maturities. This category of earning assets decreased from $115.0 million at December 31, 2004, to $92.1 million at December 31, 2005, as maturities were not reinvested in this earning asset category.

Securities

      The following table shows the carrying values of securities by category:

                             
2005 2004 2003



(in thousands)
Securities held to maturity:
                       
 
U.S. Treasury and Federal agency securities
  $ 31,464     $ 31,152     $ 30,189  
 
Obligations of states and political subdivisions
    -0 -     -0 -     754  
     
     
     
 
   
Total
  $ 31,464     $ 31,152     $ 30,943  
     
     
     
 
Securities available for sale:
                       
 
U.S. Treasury and Federal agency securities
  $ 3,384,709     $ 4,375,697     $ 2,568,163  
 
Obligations of states and political subdivisions
    447,195       569,060       451,594  
 
Mortgage-backed securities
    7,427,886       6,980,513       5,703,057  
 
Other securities
    108,163       179,374       101,825  
 
Equity securities
    579,857       480,793       232,222  
     
     
     
 
   
Total
  $ 11,947,810     $ 12,585,437     $ 9,056,861  
     
     
     
 

      In 2005, total securities decreased $637 million, or 5%, due primarily to the government and agency securities sold during 2005 for balance sheet management purposes. Partially offsetting the decrease, mortgage-backed securities increased $447.4 million, as purchases of such securities were used to manage interest rate sensitivity.

      In 2004, total securities increased $3.5 billion, or 39%, due primarily to securities added through the Union Planters transaction. U.S. Treasury and Federal agency securities increased $1.8 billion due to the Union Planters acquisition, partially offset by sales of agency securities. Agency securities were sold in 2004 for balance sheet management purposes. Mortgage-backed securities increased $1.3 billion due to balances added in connection with the merger with Union Planters, partially offset by maturities as well as sales of mortgage-backed securities to manage interest rate sensitivity.

      Regions’ investment portfolio policy stresses quality and liquidity. At December 31, 2005, the average contractual maturity of U.S. Treasury and Federal agency securities and obligations of states and political subdivisions was 5.0 years and 6.7 years, respectively. The average contractual maturity of mortgage-backed securities was 16.0 years and the average expected maturity was 3.3 years. Other securities had an average contractual maturity of 12.9 years. Overall, the average maturity of the portfolio was 12.3 years using contractual maturities and 3.7 years using expected maturities. Expected maturities differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

      The estimated fair market value of Regions’ securities held to maturity portfolio at December 31, 2005, was $4.4 million below the amount carried on Regions’ books. Regions’ securities held to maturity at December 31, 2005 included gross unrealized losses of $4.4 million and no gross unrealized gains. Regions’ securities available for sale portfolio at December 31, 2005, included net unrealized losses of $139.6 million. Regions’ securities available for sale portfolio included gross unrealized gains of $42.9 million and gross unrealized losses of $182.5 million at December 31, 2005. Market values of these portfolios vary significantly as interest rates change. Management expects normal maturities from the securities portfolios to meet liquidity needs. Of Regions’ tax-free securities rated by Moody’s Investors Service, Inc., 99% are rated “A” or

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better. The portfolio is carefully monitored to assure no unreasonable concentration of securities in the obligations of a single debtor, and current credit reviews are conducted on each security holding.

      The following table shows the contractual maturities of securities (excluding equity securities) at December 31, 2005, the weighted average yields and the taxable equivalent adjustment used in calculating the yields:

                                             
Securities Maturing

After One After Five
Within But Within But Within After
One Year Five Years Ten Years Ten Years Total





(dollar amounts in thousands)
Securities held to maturity:
                                       
 
U.S. Treasury and Federal agency securities
  $ 7,849     $ 10,345     $ 7,321     $ 5,949     $ 31,464  
     
     
     
     
     
 
   
Total
  $ 7,849     $ 10,345     $ 7,321     $ 5,949     $ 31,464  
     
     
     
     
     
 
 
Weighted average yield
    4.08 %     4.57 %     4.64 %     5.00 %     4.54 %
Securities available for sale:
                                       
 
U.S. Treasury and Federal agency securities
  $ 496,173     $ 1,277,765     $ 1,608,304     $ 2,467     $ 3,384,709  
 
Obligations of states and political subdivisions
    20,383       125,977       231,420       69,415       447,195  
 
Mortgage-backed securities
    1,021       50,444       1,124,478       6,251,943       7,427,886  
 
Other securities
    9,959       40,898       33,005       24,301       108,163  
     
     
     
     
     
 
   
Total
  $ 527,536     $ 1,495,084     $ 2,997,207     $ 6,348,126     $ 11,367,953  
     
     
     
     
     
 
 
Weighted average yield
    2.93 %     3.86 %     4.83 %     4.56 %     4.47 %
Taxable equivalent adjustment for calculation of yield
  $ 714     $ 4,411     $ 8,103     $ 2,430     $ 15,658  


Note:  The weighted average yields are calculated on the basis of the yield to maturity based on the book value of each security. Weighted average yields on tax-exempt obligations have been computed on a fully taxable equivalent basis using a tax rate of 35%. Yields on tax-exempt obligations have not been adjusted for the non-deductible portion of interest expense used to finance the purchase of tax-exempt obligations.

Trading Account Assets

      Trading account assets increased $63.4 million to $992.1 million at December 31, 2005. Trading account assets are held for the purpose of selling at a profit and are carried at market value.

      The following table shows the carrying value of trading account assets by type of security.

                     
December 31,

2005 2004


(in thousands)
Trading account assets:
               
 
U.S. Treasury and Federal agency securities
  $ 598,222     $ 708,938  
 
Obligations of states and political subdivisions
    181,467       150,049  
 
Other securities
    212,393       69,689  
     
     
 
   
Total
  $ 992,082     $ 928,676  
     
     
 

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Loans Held for Sale

      Loans held for sale consisted of residential real estate mortgage loans in 2005; in the prior year, this category also included factored accounts receivables and asset-based loans. These loans totaled $1.5 billion at December 31, 2005, a decrease of $252 million compared to December 31, 2004. This decrease was due primarily to the sale of the factored accounts receivables and asset-based loans during 2005, as well as normal sales of mortgage loans during the year.

Margin Receivables

      Margin receivables totaled $527.3 million at December 31, 2005, and $477.8 million at December 31, 2004. Margin receivables represent funds advanced to brokerage customers for the purchase of securities that are secured by certain marketable securities held in the customer’s brokerage account. The risk of loss from these receivables is minimized by requiring that customers maintain marketable securities in the brokerage account which have a fair market value substantially in excess of the funds advanced to the customer.

Premises and Equipment

      Premises and equipment at December 31, 2005 increased by $33.2 million from the prior year. This increase resulted from the normal addition of premises and equipment related to new branches added during 2005, partially offset by a $21.5 million decrease in premises related to a second quarter 2005 transaction whereby Regions sold certain properties to a third party, but agreed to lease back a portion of these properties (see Note 10 “Borrowed Funds” and Note 12 “Leases” to the consolidated financial statements). In addition, Regions wrote off approximately $1.9 million of property destroyed by Hurricane Katrina during 2005.

Excess Purchase Price

      Excess purchase price at December 31, 2005 and December 31, 2004 totaled $5.0 billion. A significant portion of this amount is related to excess purchase price added in connection with the merger with Union Planters (see Note 18 “Business Combinations” to the consolidated financial statements).

Other Identifiable Intangible Assets

      Other identifiable intangible assets totaled $314.4 million at December 31, 2005, compared to $356.9 million at December 31, 2004. The decrease from 2004 is attributable to amortization of identifiable intangible assets. This category of assets consists primarily of core deposit intangibles added in connection with the Union Planters transaction.

Other Assets

      Other assets decreased $31.7 million compared to December 31, 2004. This decrease was primarily the result of decreases in investments in low-income housing partnerships, trading receivables due from customers, and derivative assets.

Liquidity

 
General

      Liquidity is an important factor in the financial condition of Regions and affects Regions’ ability to meet the borrowing needs and deposit withdrawal requirements of its customers. Assets, consisting principally of loans and securities, are funded by customer deposits, purchased funds, borrowed funds and stockholders’ equity.

      The securities portfolio is one of Regions’ primary sources of liquidity. Maturities of securities provide a constant flow of funds available for cash needs (see previous table on Securities Maturing). Maturities in the loan portfolio also provide a steady flow of funds (see previous table on Loans Maturing). At December 31, 2005, commercial loans, real estate construction loans and commercial mortgage loans with an aggregate

33


 

balance of $15.5 billion, as well as securities of $535 million, were due to mature in one year or less. Additional funds are provided from payments on consumer loans and one- to four-family residential mortgage loans. Historically, Regions’ high levels of earnings have also contributed to cash flow. In addition, liquidity needs can be met by the purchase of funds in state and national money markets. Regions’ liquidity also continues to be enhanced by a relatively stable deposit base.

      The loan to deposit ratio was 96.73% at December 31, 2005, representing a decrease compared to 98.06% and 98.33% at December 31, 2004 and 2003, respectively. This decrease is the result of deposit growth exceeding loan growth in 2004 and 2005.

      As reflected in the consolidated statement of cash flows, operating activities provided significant levels of funds in 2005, 2004 and 2003, due primarily to high levels of net income. Investing activities were a net user of funds in 2005, primarily due to purchases of securities available for sale and loan growth, partially offset by proceeds from the sale and maturity of securities available for sale. Securities were sold in 2005 to manage interest rate sensitivity. Investing activities, primarily in loans and securities, were a net provider of funds in 2004 and a net user of funds in 2003. Loan growth in 2003 required a significant amount of funds for investing activities. Funds needed for investing activities in 2003 were provided primarily by deposits, purchased funds and borrowings.

      Financing activities were a net user of funds in 2005, as cash dividends and the purchase of treasury stock increased compared to 2004. Increased deposits provided funds in 2005 and 2004. In 2004, financing activities were a net user of funds as payments on long-term borrowings used funding, based on Regions’ decreased dependence on borrowed funds (excluding borrowings added in connection with acquisitions) as a funding source. In 2003, financing activities were a net user of funds as a result of declining deposit balances and increased payments on borrowed funds. Cash dividends and the open-market purchase of Regions’ common stock also required funds in 2004 and 2003.

      Regions’ financing arrangement with the Federal Home Loan Bank (“FHLB”) of Atlanta adds additional flexibility in managing its liquidity position. The maximum amount that could be borrowed from the FHLB under the current borrowing agreement is approximately $24.3 billion (see Note 10 “Borrowed Funds” to the consolidated financial statements). Additional investment in FHLB stock is required with each advance. The FHLB has been and is expected to continue to be a reliable and economical source of funding and can be used to fund debt maturities as well as other obligations. As of December 31, 2005, Regions’ borrowings from the FHLB totaled $1.9 billion.

      During the second quarter of 2005, Regions filed a universal shelf registration statement that allows the company to issue up to $2 billion of various debt and equity securities at market rates for future funding and liquidity needs. On August 3, 2005, Regions issued $750 million of senior debt notes ($400 million of 3-year floating rate notes and $350 million of 3-year fixed rate notes) under the above universal shelf registration statement.

      In addition, Regions’ bank subsidiary has the requisite agreements in place to issue and sell up to $5 billion of bank notes to institutional investors through placement agents. As of December 31, 2005, approximately $1 billion of bank notes were outstanding, including $400 million under a previous agreement and $600 million assumed through acquisitions. The issuance of additional bank notes could provide a significant source of liquidity and funding to meet future needs.

      Morgan Keegan maintains certain lines of credit with unaffiliated banks to manage liquidity in the ordinary course of business (see Note 10 “Borrowed Funds” to the consolidated financial statements).

      If Regions is unable to maintain or renew its financing arrangements, obtain funding in the capital markets on reasonable terms or experiences a decrease in earnings, it may be required to slow or reduce the growth of the assets on its balance sheet which may adversely impact its earnings.

34


 

          Ratings

      The table below reflects the most recent debt ratings of Regions Financial Corporation and Regions Bank by Standard & Poor’s Corporation, Moody’s Investors Service and Fitch IBCA:

                           
S&P Moody’s Fitch



Regions Financial Corporation:
                       
 
Senior notes
    A       A1       A+  
 
Subordinated notes
    A-       A2       A  
 
Trust preferred securities
    BBB+       A2       A  
Regions Bank:
                       
 
Short-term certificates of deposit
    A-1       P-1       F1+  
 
Short-term debt
    A-1       P-1       F1+  
 
Long-term certificates of deposit
    A+       Aa3       AA-  
 
Long-term debt
    A+       Aa3       A+  

      A security rating is not a recommendation to buy, sell or hold securities, and the ratings above are subject to revision or withdrawal at any time by the assigning rating agency. Each rating should be evaluated independently of any other rating.

      The trust that issued the trust preferred securities was deconsolidated on December 31, 2003, in connection with the implementation of Financial Accounting Standards Board Interpretation No. 46, “Consolidation of Variable Interest Entities” (FIN 46). Upon deconsolidation, the junior subordinated notes that are owned by the trust were included in consolidated long-term borrowings. Payments made by the Company on the junior subordinated notes fully fund the payments made by the trust on the rated trust preferred securities. See Note 19 “Variable Interest Entities” for additional discussion on the deconsolidation of the trust.

Deposits

      Deposits are Regions’ primary source of funds, providing funding for 80% of average earning assets in 2005, 76% in 2004 and 73% in 2003. During the last five years, average total deposits increased at a compound annual rate of 18%. Deposit growth was significantly impacted by the merger with Union Planters in 2004. The Union Planters transaction added $22.9 billion of total deposits (contributing $11.5 billion of average deposits in 2004 due to the mid-year closing of the transaction and $11.4 billion for the full year impact in 2005).

      Regions acquired Union Planters on July 1, 2004; thus, average balances in 2004 reflected only six months of impact from the merger. Average balances in 2005, however, reflect the full year of impact on deposits added from the merger. The impact of deposits added in connection with the Union Planters merger is a primary factor in the discussion of variances between 2005 and prior years below.

      Total deposits added in connection with the Union Planters merger in 2004 are summarized in the following table.

           
(in thousands)

Non-interest-bearing
  $ 5,373,199  
Savings
    1,484,900  
Interest-bearing transaction accounts
    3,383,281  
Money market
    5,863,360  
Time deposits
    6,798,524  
     
 
 
Total
  $ 22,903,264  
     
 

      Average deposits increased $14.7 billion, or 33%, in 2005, $12.9 billion, or 40%, in 2004 and $755 million, or 2%, in 2003. Acquisitions contributed average deposit growth of approximately $11.4 billion in 2005, $11.5 billion in 2004 and $14.0 million in 2003. The $11.5 billion of deposits added through acquisitions in

35


 

2004, consisted of $2.7 billion of non-interest-bearing deposits and $8.8 billion of interest-bearing deposits and significantly impact comparisons with prior periods discussed in the remainder of this section.

      Regions competes with other banking and financial services companies for a share of the deposit market. Regions’ ability to compete in the deposit market depends heavily on how effectively the Company meets customers’ needs. Regions employs both traditional and non-traditional means to meet customers’ needs and enhance competitiveness. The traditional means include providing well-designed products, providing a high level of customer service, providing attractive pricing and expanding the traditional branch network to provide convenient branch locations for customers throughout the South, Midwest and Texas. Regions also employs non-traditional approaches to enhance its competitiveness. These include providing centralized, high quality telephone banking services and alternative product delivery channels such as internet banking. Regions’ success at competing for deposits is discussed below.

      Average non-interest-bearing deposits have increased at a compound growth rate of 35% since 2002. This category of deposits grew 40% in 2005, 61% in 2004, and 9% in 2003. Deposit growth in 2005 in this category was primarily attributable to an increase in free-checking deposit accounts, the full-year impact of deposits added in connection with the Union Planters merger (see above) and increases in deposits in areas affected by Hurricane Katrina. Non-interest-bearing deposits continue to be a significant funding source for Regions, accounting for approximately 20% of average total deposits in 2005, 19% in 2004 and 17% in 2003.

      Savings account balances have increased at a 27% compound growth rate since 2002. Average savings account balances increased 34% in 2005 and 53% in 2004, primarily resulting from the impact of accounts added in connection with the Union Planters acquisition. Balances declined slightly in 2003 as rates paid on these accounts were less attractive than other investment alternatives. Management expects savings accounts to continue to be a stable funding source, but does not expect significant growth, as these accounts may be less attractive than other investment alternatives for many investors. In 2005 and 2004, savings accounts comprised approximately 5% of average total deposits compared to 4% of average total deposits in 2003.

      Interest-bearing transaction accounts have increased at a 44% compound growth rate since 2002. Average interest-bearing transaction account balances decreased 2% in 2005, as investors chose other investment alternatives, compared to an increase of 31% in 2004 and 134% in 2003 as investors migrated toward more liquid assets given market conditions in those periods. Interest-bearing transaction accounts accounted for 5% of average total deposits in 2005 and 7% in 2004 and 2003.

      Money market savings accounts have increased at a compound annual rate of 21% since 2002. In 2005, the average balance for money market savings accounts increased 26% compared to 2004, due to the full year impact of money market accounts added in connection with the Union Planters merger, as well as customers seeking liquid deposit accounts with a more attractive rate of return. Money market savings accounts increased 42% in 2004, primarily due to acquisitions. In 2003, as Regions less aggressively priced money market savings products, average balances declined 2%. Money market savings products are one of Regions’ most significant funding sources, accounting for 32% of average total deposits in 2005, 34% of average total deposits in 2004 and 33% of average total deposits in 2003.

      The average balance of certificates of deposit of $100,000 or more accounts increased 63% in 2005, primarily due to customer preference for higher-rate deposits, competitive pricing on these deposit instruments, and full-year impact of accounts added in connection with the Union Planters acquisition in 2004. This category of deposits increased 53% in 2004, due primarily to the deposits added in connection with the Union Planters merger. Certificates of deposit of $100,000 or more increased 2% in 2003 due to less maturities of high cost certificates of deposits than in prior years. Certificates of deposit of $100,000 or more accounted for 13% of average total deposits in 2005, 11% in 2004, and 10% in 2003.

      The average balance of other interest-bearing deposits (certificates of deposit of less than $100,000 and time open accounts) increased 31% in 2005, due primarily to attractive rates and the full year impact of accounts added in connection with the Union Planters acquisition in 2004. In 2004, this category increased 22%, primarily due to acquisitions and internal growth in retail certificates of deposits based on more attractive market interest rates. In 2003, this category of deposits declined 8% as rates on these accounts were less

36


 

attractive to investors and Regions reduced utilization of certain wholesale deposits as a funding source. This category of deposits continues to be one of Regions’ primary funding sources; it accounted for 25% of average total deposits in 2005 and 2004, and 29% of average total deposits in 2003.

      Lower-cost deposits, which include non-interest bearing demand deposits, interest-bearing transaction accounts, savings accounts and money market savings accounts, totaled 62% of average deposits in 2005, compared to 65% in 2004 and 61% in 2003. During 2005, customers migrated toward certificates of deposit due to the rising interest rate environment, resulting in a decrease in the percentage of low-cost deposits to average deposits. During 2004 and 2003, the percentage of low-cost deposits to average deposits increased, due to management initiatives to increase lower-cost deposit products as a source of funding, while reducing the company’s reliance on higher-cost deposit products such as certificates of deposit and wholesale deposit products.

      The sensitivity of Regions’ deposit rates to changes in market interest rates is reflected in Regions’ average interest rate paid on interest-bearing deposits. Market interest rates declined 25 basis points in 2003, increased 125 basis points in the latter half of 2004, and increased another 200 basis points during 2005. While Regions’ average interest rate paid on interest-bearing deposits follows these trends, a lag period exists between the change in market rates and the repricing of the deposits. The rate paid on interest-bearing deposits decreased from 1.61% in 2003 to 1.37% in 2004, but increased to 2.11% in 2005.

      A detail of interest-bearing deposit balances at December 31, 2005 and 2004, and the interest expense on these deposits for the three years ended December 31, 2005, is presented in Note 9 “Deposits” to the consolidated financial statements. The following table presents the average rates paid on deposits by category for the three years ended December 31, 2005:

                           
Average Rates Paid

2005 2004 2003



Interest-bearing transaction accounts
    1.84 %     1.05 %     0.95 %
Savings accounts
    0.27       0.22       0.27  
Money market savings accounts
    1.31       0.70       0.70  
Certificates of deposit of $100,000 or more
    3.18       2.14       2.54  
Other interest-bearing deposits
    2.99       2.23       2.71  
 
Total interest-bearing deposits
    2.11 %     1.37 %     1.61 %

      The following table presents the details of interest-bearing deposits and maturities of the larger time deposits at December 31, 2005 and 2004:

                     
December 31,

2005 2004


(in thousands)
Interest-bearing deposits of less than $100,000
  $ 38,879,777     $ 39,726,214  
Time deposits of $100,000 or more, maturing in:
               
 
3 months or less
    3,320,982       3,118,693  
 
Over 3 through 6 months
    1,177,480       1,235,081  
 
Over 6 through 12 months
    1,772,039       1,615,101  
 
Over 12 months
    1,529,051       1,547,797  
     
     
 
      7,799,552       7,516,672  
     
     
 
   
Total
  $ 46,679,329     $ 47,242,886  
     
     
 

37


 

      The following table presents the average amounts of deposits outstanding by category for the three years ended December 31, 2005:

                           
Average Amounts Outstanding

2005 2004 2003



(in thousands)
Non-interest-bearing demand deposits
  $ 12,156,817     $ 8,656,768     $ 5,380,521  
Interest-bearing transaction accounts
    2,873,955       2,931,652       2,234,794  
Savings accounts
    2,926,512       2,176,025       1,425,306  
Money market savings accounts
    19,043,326       15,105,420       10,641,217  
Certificates of deposit of $100,000 or more
    8,049,384       4,952,292       3,232,152  
Other interest-bearing deposits
    14,662,901       11,193,122       9,194,462  
     
     
     
 
 
Total interest-bearing deposits
    47,556,078       36,358,511       26,727,931  
     
     
     
 
 
Total deposits
  $ 59,712,895     $ 45,015,279     $ 32,108,452  
     
     
     
 

Borrowed Funds

      Regions’ short-term borrowings consist of federal funds purchased and security repurchase agreements, FHLB structured notes, due to brokerage customers, and other short-term borrowings.

      Federal funds purchased and security repurchase agreements are used to satisfy daily funding needs and, when advantageous, for rate arbitrage. Federal funds purchased and security repurchase agreements totaled $3.9 billion at December 31, 2005 and $4.7 billion at December 31, 2004. Balances in these accounts can fluctuate significantly on a day-to-day basis. The average daily balance of federal funds purchased and security repurchase agreements, net of federal funds sold and security reverse repurchase agreements, decreased $353 million in 2005 due to reduced reliance on purchased funds to support earning asset growth, and increased $1.3 billion in 2004 as this funding source was more widely used to support growth in earning assets.

      At December 31, 2005, no FHLB structured notes were outstanding, compared to $350 million of structured notes outstanding at both December 31, 2004 and 2003, due to the maturities of the notes during 2005 (see Note 10 “Borrowed Funds” to the consolidated financial statements). During 2003, Regions prepaid $350 million of these advances in addition to maturities of $150 million. Regions incurred a $11.5 million charge related to the prepayment in 2003 that is recorded in other non-interest expense (see Note 16 “Other Income and Expense” to the consolidated financial statements).

      Morgan Keegan maintains certain lines of credit with unaffiliated banks. As of December 31, 2005, $129.7 million was outstanding under these agreements with an average interest rate of 4.5%, compared to $56.4 million outstanding at December 31, 2004, with an average interest rate of 2.6%.

      Regions maintains a due to brokerage customer position through Morgan Keegan. This represents liquid funds in customers’ brokerage accounts. The due to brokerage customers totaled $547.7 million at December 31, 2005, with an interest rate of 1.7%, as compared to $457.7 million at December 31, 2004, with an interest rate of 0.7%.

      Regions holds cash as collateral for certain derivative and other transactions with customers and other third parties. Upon the expiration of these agreements, cash held as collateral will be remitted to the counter-party. As of December 31, 2005, these balances totaled $22.5 million with an interest rate of 4.1%, as compared to $75.8 million at December 31, 2004 with an interest rate of 2.0%.

      Other short-term borrowings decreased by $37.5 million from December 31, 2004, due primarily to a decrease in the short sale liability, which is frequently used by Morgan Keegan to offset other market risks undertaken in the normal course of business.

38


 

      Regions’ long-term borrowings consist primarily of subordinated notes, FHLB borrowings, senior notes and other long-term notes payable.

      As of December 31, 2005, Regions had subordinated notes of $2.1 billion, compared to $2.2 billion at December 31, 2004. The merger with Union Planters added $1.0 billion in subordinated notes in 2004. Regions subordinated notes consist of five issues with interest rates ranging from 6.375% to 7.75%. A schedule of maturities is included in the table at the end of this section.

      During 2005 and 2004, Regions utilized FHLB structured notes with original call periods in excess of one year. These structured notes have various stated maturities but are callable, at the option of the FHLB, between one and two years. As of December 31, 2005 and 2004, $1.0 billion and $1.8 billion of long-term Federal Home Loan Bank advances were outstanding, respectively. In 2005, Regions prepaid $600 million of these borrowings, and as a result incurred a $10.9 million charge, which is recorded in other non-interest expense (see Note 16 “Other Income and Expense” to the consolidated financial statements). In 2004, Regions prepaid $1.1 billion of these notes and as a result, incurred a $39.6 million charge which was recorded in other non-interest expense.

      Federal Home Loan Bank long-term advances totaled $837 million at December 31, 2005, a decrease of $109 million compared to 2004, due to maturities during 2005. Regions utilized this source of funding due to favorable interest rates and terms during 2004, but utilized more advantageous alternate sources of funding during 2005. Membership in the Federal Home Loan Bank system provides access to an additional source of lower-cost funds.

      Regions issued $288 million of trust preferred securities in February 2001. These securities, which qualify as Tier 1 capital, have an interest rate of 8.00% and a 30-year term, but are callable after five years. In addition, Regions assumed $4 million of trust preferred securities in connection with a 2001 acquisition. Effective December 31, 2003, all trust preferred securities were deconsolidated in accordance with FIN 46 (see Note 19 “Variable Interest Entities” to the consolidated financial statements).

      As a result of the deconsolidation of trust preferred securities, effective December 31, 2003, Regions began reporting $301 million of junior subordinated notes. These junior subordinated notes are issued by Regions to a subsidiary business trust, which issued the trust preferred securities discussed previously (see Note 19 “Variable Interest Entities” to the consolidated financial statements). In connection with the acquisition of Union Planters, Regions assumed $224.3 million of 8.2% junior subordinated notes which were issued to subsidiary business trusts. Subsequent to December 31, 2005, the $288 million of Regions trust preferred securities were called and related junior subordinated notes were extinguished. In the first quarter of 2006, Regions recorded a pre-tax charge of approximately $7.7 million in connection with the exercise of the call option and early extinguishment of debt.

      Senior debt and bank notes totaled $2.2 billion at December 31, 2005, compared to $1.5 billion at December 31, 2004. The increase is related to $350 million of 3-year fixed rate and $400 million of 3-year floating rate senior notes issued during 2005.

      Other long-term borrowings consist of redeemable trust preferred securities, notes issued to former stockholders of acquired banks, notes for equipment financing, mark-to-market adjustments related to hedged debt items, and miscellaneous notes payable.

39


 

      The following table shows the amount and maturity of Regions’ long term borrowed funds as of December 31, 2005.

                                                             
Payments Due by Period

2011 &
Total 2006 2007 2008 2009 2010 beyond







(in thousands)
Obligations:
                                                       
 
Subordinated notes
  $ 2,070,935     $ -0 -   $ -0 -   $ -0 -   $ -0 -   $ -0 -   $ 2,070,935  
 
Junior subordinated notes
    524,143       287,500       -0 -     -0 -     -0 -     -0 -     236,643  
 
Federal Home Loan Bank borrowings
    1,872,300       350,622       251,041       66,514       1,062,627       129,805       11,691  
 
Senior debt and bank notes
    2,246,851       400,000       -0 -     750,000       -0 -     486,668       610,183  
 
Other long-term obligations
    257,451       6,655       7,149       7,819       7,600       39,237       188,991  
     
     
     
     
     
     
     
 
   
Total
  $ 6,971,680     $ 1,044,777     $ 258,190     $ 824,333     $ 1,070,227     $ 655,710     $ 3,118,443  
     
     
     
     
     
     
     
 

Stockholders’ Equity

      Over the past three years, stockholders’ equity has increased at a compound annual growth rate of 36%. Stockholders’ equity has grown from $4.2 billion at the beginning of 2003 to $10.6 billion at year-end 2005. Equity issued in connection with acquisitions, net of treasury share repurchases, added $5.2 billion, including $6.0 billion in equity issued in connection with the Union Planters merger. Internally generated retained earnings contributed $1.1 billion of this growth and $369.9 million was attributable to the exercise of stock options and to the issuance of stock for employee incentive plans. The internal capital generation rate (net income less dividends as a percentage of average stockholders’ equity) was 3.5% in 2005, compared to 4.3% in 2004 and 8.7% in 2003. This ratio declined in 2005 primarily due to a significant increase in cash dividends during the year.

      On October 20, 2005, Regions’ Board of Directors authorized the repurchase of an additional 25 million shares of Regions’ common stock from time to time through open market transactions. This authorization was in addition to the 6.4 million shares available for repurchase under a previous authorization. During 2005, Regions repurchased, under the current and previous repurchase authorizations, 16.6 million shares at a total cost of $552.5 million. At December 31, 2005, 27.6 million shares were available for repurchase under current and previous repurchase authorizations.

      Regions’ ratio of stockholders’ equity to total assets was 12.52% at December 31, 2005, compared to 12.78% at December 31, 2004, and 9.16% at December 31, 2003. This ratio decreased slightly during 2005 due to increased share repurchases. Regions’ ratio of tangible stockholders’ equity (stockholders’ equity less excess purchase price and other identifiable intangibles) to total assets was 6.64% at December 31, 2005 compared to 6.42% at December 31, 2004 and 6.92% at December 31, 2003.

      Regions attempts to balance the return to stockholders through the payment of dividends with the need to maintain strong capital levels for future growth opportunities. In 2005, Regions returned 63% of earnings to its stockholders in the form of dividends. Total dividends declared by Regions in 2005 were $628.6 million, or $1.36 per share, an increase of 2% from the $1.33 per share in 2004.

      In January of 2006, the Board of Directors declared a 2.9% increase in the quarterly cash dividend from $.34 to $.35 per share. This is the 35th consecutive year that Regions has increased quarterly cash dividends.

40


 

Bank Regulatory Capital Requirements

      Regions and Regions Bank are required to comply with capital adequacy standards established by banking regulatory agencies. Currently, there are two basic measures of capital adequacy: a risk-based measure and a leverage measure.

      The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and financial holding companies, to account for off-balance sheet exposure and interest rate risk and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories, each with specified risk-weighting factors. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items. Banking organizations that are considered to have excessive interest rate risk exposure are required to maintain additional capital.

      The minimum standard for the ratio of total capital to risk-weighted assets is 8%. At least 50% of that capital level must consist of common equity, undivided profits and non-cumulative perpetual preferred stock, less goodwill and certain other intangibles (“Tier 1 capital”). The remainder (“Tier 2 capital”) may consist of a limited amount of other preferred stock, mandatory convertible securities, subordinated debt and a limited amount of the allowance for loan losses. The sum of Tier 1 capital and Tier 2 capital is “total risk-based capital.”

      The banking regulatory agencies also have adopted regulations that supplement the risk-based guidelines to include a minimum ratio of 3% of Tier 1 capital to average assets less goodwill (the “leverage ratio”). Depending upon the risk profile of the institution and other factors, the regulatory agencies may require a leverage ratio of 1% to 2% above the minimum 3% level.

      The following chart summarizes the applicable bank regulatory capital requirements. Regions’ capital ratios at December 31, 2005, substantially exceeded all regulatory requirements.

                         
Minimum Well Capitalized Regions at
Regulatory Regulatory December 31,
Requirement Requirement 2005



Tier 1 capital to risk-adjusted assets
    4.00 %     6.00 %     8.60 %
Total risk-based capital to risk-adjusted assets
    8.00       10.00       12.76  
Tier 1 leverage ratio
    3.00       5.00       7.42  

      At December 31, 2005, Tier 1 capital totaled $5.9 billion, total risk-based capital totaled $8.8 billion and risk-adjusted assets totaled $79.8 billion.

      Total capital at Regions Bank also has an important effect on the amount of FDIC insurance premiums paid. Institutions not considered well capitalized can be subject to higher rates for FDIC insurance. As of December 31, 2005, Regions Bank had the requisite capital levels to qualify as well capitalized (see Note 22 “Regulatory Capital Requirements” to the consolidated financial statements).

41


 

Consolidated Average Balances

      The following table shows the percentage distribution of Regions’ consolidated average balances of assets, liabilities and stockholders’ equity as of the dates shown:

                                                 
As of December 31,

2005 2004 2003 2002 2001





ASSETS
Earning assets:
                                       
 
Taxable securities
    13.7 %     15.8 %     18.0 %     17.2 %     16.5 %
 
Non-taxable securities
    0.6       0.7       1.0       1.3       1.8  
 
Federal funds sold
    0.7       0.9       1.3       1.2       1.2  
 
Loans (net of unearned income):
                                       
   
Commercial
    17.6       19.1       21.9       22.4       21.5  
   
Real estate
    39.9       35.9       31.7       31.6       34.9  
   
Installment
    10.7       11.8       11.2       12.9       12.9  
     
     
     
     
     
 
       
Total loans
    68.2       66.8       64.8       66.9       69.3  
   
Allowance for loan losses
    (0.9 )     (0.9 )     (0.9 )     (0.9 )     (0.9 )
     
     
     
     
     
 
       
Net loans
    67.3       65.9       63.9       66.0       68.4  
 
Other earning assets
    4.2       4.9       6.1       4.7       3.8  
     
     
     
     
     
 
       
Total earnings assets
    86.5       88.2       90.3       90.4       91.7  
Cash and due from banks
    2.3       2.0       2.0       2.1       2.1  
Other non-earning assets
    11.2       9.8       7.7       7.5       6.2  
     
     
     
     
     
 
       
Total assets
    100.0 %     100.0 %     100.0 %     100.0 %     100.0 %
     
     
     
     
     
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits:
                                       
 
Non-interest-bearing
    14.3 %     12.9 %     11.1 %     10.7 %     10.4 %
 
Interest bearing
    55.9       54.4       55.1       57.3       59.1  
     
     
     
     
     
 
       
Total deposits
    70.2       67.3       66.2       68.0       69.5  
Borrowed funds:
                                       
 
Short-term
    6.5       9.3       11.0       9.6       9.3  
 
Long-term
    8.4       9.8       11.3       11.2       10.7  
     
     
     
     
     
 
     
Total borrowed funds
    14.9       19.1       22.3       20.8       20.0  
Other liabilities
    2.4       2.3       2.6       2.4       2.1  
     
     
     
     
     
 
     
Total liabilities
    87.5       88.7       91.1       91.2       91.6  
Stockholders’ equity
    12.5       11.3       8.9       8.8       8.4  
     
     
     
     
     
 
       
Total liabilities and stockholders’ equity
    100.0 %     100.0 %     100.0 %     100.0 %     100.0 %
     
     
     
     
     
 

      Please refer to Item 6 of this annual report on Form 10-K for a complete presentation of average balances, related interest, yields and rates paid.

42


 

Off-Balance Sheet Arrangements and Contractual Obligations

 
Off-Balance Sheet Arrangements

      In the normal course of business, Regions enters into certain relationships characterized as off-balance sheet arrangements. At December 31, 2005, these relationships included obligations under standby letters of credit and variable interests in unconsolidated variable interest entities. At December 31, 2005, the fair value of Regions’ obligation under loan standby letters of credit was $46.4 million with a maximum potential obligation of $3.1 billion (see Note 13 “Commitments and Contingencies” to the consolidated financial statements). At December 31, 2005, Regions’ investment in unconsolidated variable interest entities was $232.0 million with a maximum exposure to loss of $249.8 million (see Note 19 “Variable Interest Entities” to the consolidated financial statements).

 
Contractual Obligations

      The following table summarizes Regions’ contractual cash obligations at December 31, 2005:

                                           
Payments Due By Period

Less than More than More than
Total 1 Year 1-3 Years 3-5 Years 5 Years





(in thousands)
Long-term borrowings
  $ 6,971,680     $ 1,044,777     $ 1,082,523     $ 1,725,937     $ 3,118,443  
Lease payments
    529,382       88,834       144,433       100,637       195,478  
Purchase obligations
    544,612       196,750       252,385       94,558       919  
Other
    346,057       -0 -     -0 -     -0 -     346,057  
     
     
     
     
     
 
 
Total
  $ 8,391,731     $ 1,330,361     $ 1,479,341     $ 1,921,132     $ 3,660,897  
     
     
     
     
     
 

      A discussion regarding liquidity related to long-term borrowings is included in the “Liquidity” section presented earlier. Regions intends to fund the other contractual obligations presented in the table above primarily through cash generated from normal operations.

43


 

Operating Results

General

      Net income available to common shareholders increased 22% in 2005, 25% in 2004 and 5% in 2003. The accompanying table presents the dollar amount and percentage change in the important components of income that occurred in 2004 and 2005.

Summary Of Changes In Operating Results

                                     
Increase (Decrease)

2005 Compared 2004 Compared
to 2004 to 2003


Amount % Amount %




(dollar amounts in thousands)
Net interest income
  $ 707,585       33 %   $ 638,436       43 %
 
Provision for loan losses
    36,500       28       7,000       6  
     
             
         
Net interest income after provision for loan losses
    671,085       34       631,436       47  
Non-interest income:
                               
 
Brokerage and investment income
    13,362       2       (17,429 )     (3 )
 
Trust department income
    25,197       25       32,648       47  
 
Service charges on deposit accounts
    100,246       24       129,529       45  
 
Mortgage servicing and origination fees
    16,459       13       31,462       32  
 
Securities transactions, net
    (81,978 )     NM       37,428       NM  
 
Other
    77,715       19       97,457       31  
     
             
         
   
Total non-interest income
    151,001       9       311,095       23  
Non-interest expense:
                               
 
Salaries and employee benefits
    313,942       22       329,294       30  
 
Net occupancy expense
    64,013       40       54,213       51  
 
Furniture and equipment expense
    30,799       30       20,630       25  
 
Other
    166,819       21       274,384       54  
     
             
         
   
Total non-interest expense
    575,573       23       678,521       38  
   
Income before income taxes
    246,513       21       264,010       29  
Applicable income taxes
    69,734       20       92,086       35  
     
             
         
   
Net income
  $ 176,779       21 %   $ 171,924       26 %
     
             
         
   
Net income available to common shareholders
  $ 182,799       22 %   $ 165,904       25 %
     
             
         

Net Interest Income

      Net interest income (interest income less interest expense) is Regions’ principal source of income. Net interest income increased 33% in 2005 and 43% in 2004. On a taxable equivalent basis, net interest income increased 33% in 2005 and 42% in 2004. The following table “Analysis of Changes in Net Interest Income” provides additional information to analyze the changes in net interest income.

      Regions measures its ability to produce net interest income with a ratio called the interest margin. The interest margin is net interest income (on a taxable equivalent basis) as a percentage of average earning assets. The interest margin increased from 3.49% in 2003 to 3.66% in 2004 to 3.91% in 2005. Changes in the interest margin occur primarily due to two factors: (1) the interest rate spread (the difference between the taxable equivalent yield on earning assets and the rate on interest-bearing liabilities) and (2) the percentage of earning assets funded by interest-bearing liabilities.

44


 

      The first factor affecting Regions’ interest margin is the interest rate spread. Regions’ average interest rate spread was 3.44% in 2005, 3.35% in 2004 and 3.19% in 2003. Market interest rates, both the level of rates and the slope of the yield curve (the spread between short-term rates and longer-term rates), affect the interest rate spread by influencing the pricing on most categories of Regions’ interest-earning assets and interest-bearing liabilities.

      After reducing the Federal Funds rate significantly in 2001, the Federal Reserve Board reduced the Federal Funds rate 50 basis points in 2002 and 25 basis points in 2003. As the economy experienced growth, the Fed increased the Federal Funds rate five times totaling 125 basis points in the second half of 2004. In 2005, the Fed increased the Federal Funds rate eight times totaling 200 basis points in response to economic growth and inflation concerns. These increases resulted in a Federal Funds rate of 4.25% at December 31, 2005.

      Regions’ interest-earning asset yields and interest-bearing liability rates were both higher in 2005 as compared to 2004, reflecting increased average market interest rates in 2005. In 2005, Regions’ interest-earning asset yields increased 84 basis points while interest-bearing liability rates increased 75 basis points, resulting in an increased interest rate spread compared to 2004.

      The mix of earning assets can also affect the interest rate spread. During 2005, loans, which are typically Regions’ most significant and highest yielding earning asset, increased as a percentage of earning assets. This increase contributed to higher earning asset yields. Average loans as a percentage of earning assets was 78.0% in 2005 and 74.9% in 2004.

      During 2005 and 2004, Regions used interest rate derivatives as cash flow and fair value hedges of certain asset and liability positions. These contracts had the effect of increasing net interest income by $52.1 million in 2005 and $106.8 million in 2004.

      The second factor affecting the interest margin is the percentage of earning assets funded by interest-bearing liabilities. Funding for Regions’ earning assets comes from interest-bearing liabilities, non-interest-bearing liabilities and stockholders’ equity. The net spread on earning assets funded by non-interest-bearing liabilities and stockholders’ equity is higher than the net spread on earning assets funded by interest-bearing liabilities. The percentage of earning assets funded by interest-bearing liabilities was 81% in 2005, 82% in 2004 and 85% in 2003. This decline positively impacted the net interest margin as compared to prior years. In the future, management expects that an increasing percentage of funding will be provided from interest-bearing liabilities.

      Higher spreads, combined with significant growth in average interest-earning assets from full-year impact of the Union Planters merger in 2004, resulted in higher net interest income in 2005. The increase in net interest income for 2004 was due to higher spreads, combined with significant growth in interest-earning assets due to the Union Planters merger. In 2006, Regions anticipates moderate compression of the net interest margin as short-term rate increases begin to slow and the benefit from the re-pricing lag for deposits diminishes. In addition, if interest rates continue to rise in 2006, the demand for loans and other interest-earning assets will generally be reduced which could adversely impact Regions’ earnings by putting further pressure on the compression of the interest margin.

45


 

Analysis of Changes in Net Interest Income

                                                       
Year Ended December 31,

2005 over 2004 2004 over 2003


Volume Yield/Rate Total Volume Yield/Rate Total






(in thousands)
Increase (decrease) in:
                                               
 
Interest income on:
                                               
   
Loans
  $ 769,386     $ 458,697     $ 1,228,083     $ 688,433     $ (72,048 )   $ 616,385  
   
Federal funds sold
    (207 )     11,807       11,600       18       1,855       1,873  
   
Taxable securities
    47,888       16,769       64,657       74,590       10,654       85,244  
   
Non-taxable securities
    -0 -     3,481       3,481       211       753       964  
   
Other earning assets
    18,375       28,494       46,869       16,612       15,477       32,089  
     
     
     
     
     
     
 
     
Total
    835,442       519,248       1,354,690       779,864       (43,309 )     736,555  
 
Interest expense on:
                                               
   
Savings deposits
    1,868       1,406       3,274       1,733       (847 )     886  
   
Other interest-bearing deposits
    179,913       324,913       504,826       134,230       (68,842 )     65,388  
   
Borrowed funds
    (1,959 )     140,964       139,005       54,039       (22,194 )     31,845  
     
     
     
     
     
     
 
     
Total
    179,822       467,283       647,105       190,002       (91,883 )     98,119  
     
     
     
     
     
     
 
Increase in net interest income
  $ 655,620     $ 51,965     $ 707,585     $ 589,862     $ 48,574     $ 638,436  
     
     
     
     
     
     
 


Note:  The change in interest due to both rate and volume has been allocated to change due to volume and change due to rate in proportion to the absolute dollar amounts of the change in each.

Market Risk

      Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates, commodity prices, equity prices, or the credit quality of debt securities.

 
Interest Rate Sensitivity

      Regions’ primary market risk is interest rate risk, including uncertainty with respect to absolute interest rate levels as well as uncertainty with respect to relative interest rate levels which impact both the shape and the slope of the various yield curves affecting the financial products and services that the Company offers. To quantify this risk, Regions measures the change in its net interest income in various interest rate scenarios as compared to a base case scenario. Net interest income sensitivity (as measured over 12 months) is a useful short-term indicator of Regions’ interest rate risk.

      Sensitivity Measurement. Financial simulation models are Regions’ primary tools used to measure interest rate exposure. Using a wide range of hypothetical deterministic and stochastic simulations, these tools provide management with extensive information on the potential impact to net interest income caused by changes in interest rates.

      These models are structured to simulate cash flows and accrual characteristics of Regions’ balance sheet. Assumptions are made about the direction and volatility of interest rates, the slope of the yield curve, and the changing composition of the balance sheet that result from both strategic plans and from customer behavior. Among the assumptions are expectations of balance sheet growth and composition, the pricing and maturity characteristics of existing business and the characteristics of future business. Interest rate related risks are expressly considered, such as pricing spreads, the lag time in pricing administered rate accounts, prepayments and other option risks. Regions considers these factors, as well as the degree of certainty or uncertainty surrounding their future behavior.

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      Financial derivative instruments are used in hedging the values of selected assets and liabilities against changes in interest rates. The effect of these hedges is included in the simulations of net interest income.

      The primary objectives of Asset/Liability Management at Regions are balance sheet coordination and the management of interest rate risk in achieving reasonable and stable net interest income throughout various interest rate cycles. A standard set of alternate interest rate scenarios is compared to the results of the base case scenario to determine the extent of potential fluctuations and to establish exposure limits. The standard set of interest rate scenarios includes the traditional instantaneous parallel rate shifts of plus and minus 100 and 200 basis points. In addition, Regions includes simulations of gradual interest rate movements that may more realistically mimic potential interest rate movements. The gradual scenarios include curve steepening, flattening, and parallel movements of various magnitudes phased in over a 6 month period.

      Exposure to Interest Rate Movements. Based on the foregoing discussion, management has estimated the potential effect of shifts in interest rates on net interest income. As of December 31, 2005, Regions maintained a slight asset sensitive position to a gradual rate shift of plus or minus 100 or 200 basis points. The following table demonstrates the expected effect that a gradual (over six months beginning at December 31, 2005 and 2004, respectively) parallel interest rate shift would have on Regions’ net interest income.

                                   
2005 2004


$ Change in % Change in $ Change in % Change in
Net Interest Net Interest Net Interest Net Interest
Gradual Change in Interest Rates Income Income Income Income





(dollar amounts in thousands)
(in basis points)
                               
 
+200
  $ 140,000       4.9 %   $ 60,000       2.3 %
 
+100
    79,000       2.8       48,000       1.8  
 
-100
    (67,000 )     (2.3 )     (43,000 )     (1.6 )
 
-200
    (169,000 )     (5.9 )     (98,000 )     (3.6 )

      As of December 31, 2005, Regions maintained a slight asset sensitive position to an instantaneous rate shift of plus or minus 100 or 200 basis points. The following table demonstrates the expected effect that an instantaneous parallel interest rate shift would have on Regions’ net interest income.

                                   
2005 2004


$ Change in % Change in $ Change in % Change in
Net Interest Net Interest Net Interest Net Interest
Instantaneous Change in Interest Rates Income Income Income Income





(dollar amounts in thousands)
(in basis points)
                               
 
+200
  $ 147,000       5.2 %   $ 83,000       3.1 %
 
+100
    85,000       3.0       59,000       2.2  
 
-100
    (81,000 )     (2.9 )     (51,000 )     (1.9 )
 
-200
    (224,000 )     (7.9 )     (163,000 )     (6.1 )
 
Derivatives

      Regions uses financial derivative instruments for management of interest rate sensitivity. The Asset and Liability Committee, in its oversight role for the management of interest rate sensitivity, approves the use of derivatives in balance sheet hedging strategies. The most common derivatives the Company employs are interest rate swaps, interest rate options, forward sale commitments, interest rate and foreign exchange forward contracts and credit default swaps.

      Interest rate swaps are contractual agreements typically entered into to exchange fixed for variable streams of interest payments. The notional principal is not exchanged but is used as a reference for the size of the interest payments. Interest rate options are contracts that allow the buyer to purchase or sell a financial instrument at a pre-determined price and time. Forward sale commitments are contractual obligations to sell money market instruments at a future date for an already agreed upon price. Foreign exchange forwards are

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contractual agreements to receive or deliver a foreign currency at an agreed upon future date and price. Credit default swaps are contractual agreements between counterparties whereby one party pays the other at a fixed periodic rate for the specified life of the agreement. The other party makes no payments unless a specified credit event occurs. Credit events are typically defined to include a material default, bankruptcy or debt restructuring for a specified reference asset. If such a credit event occurs, the party makes a payment to the first party, and the swap then terminates.

      Regions has made use of interest rate swaps and interest rate options to convert a portion of its fixed-rate funding position to a variable rate position. Regions also uses derivatives to manage interest rate and pricing risk associated with its mortgage origination business. Futures contracts and forward sales commitments are used to protect the value of the loan pipeline and loans held for sale from changes in interest rates and pricing. In the period of time that elapses between the origination and sale of mortgage loans, changes in interest rates have the potential to cause a decline in the value of the loans in this held-for-sale portfolio. Futures and forward sale commitment positions are used to protect the Company from the risk of such adverse changes. Futures contracts are also used to hedge the risks associated with customer derivatives. The change in value of the hedging contracts is expected to be highly effective in offsetting the change in value of specific assets and liabilities over the life of the hedge relationship.

      Regions also uses derivatives to meet the needs of its customers. Interest rate swaps, interest rate options and foreign exchange forwards are the most common derivatives sold to customers. Positions with similar characteristics are used to offset the market risk and minimize income statement volatility associated with this portfolio. Those instruments used to service customers are entered into the trading account with changes in value recorded in the income statement. Refer to Note 14 “Derivative Financial Instruments and Hedging Activities” of the consolidated financial statements for a tabular summary of Regions’ year-end derivatives positions in the trading portfolio.

      The objective of Regions’ hedging strategies is to mitigate the impact of interest rate changes, from an economic and accounting perspective, on net interest income and the net present value of our balance sheet. The overall effectiveness of these hedging strategies is subject to market conditions, the quality of Regions’ execution, the accuracy of its asset valuation assumptions, counterparty credit risk and changes in interest rates. As a result, Regions’ hedging strategies may be ineffective in mitigating the impact of interest rate changes on its earnings.

 
Brokerage and Market Making Activity

      Morgan Keegan’s business activities expose it to market risk, including its securities inventory positions and securities held for investment.

      Morgan Keegan trades for its own account in corporate and tax-exempt securities and U.S. government, agency and guaranteed securities. Most of these transactions are entered into to facilitate the execution of customers’ orders to buy or sell these securities. In addition, it trades certain equity securities in order to “make a market” in these securities. Morgan Keegan’s trading activities require the commitment of capital. All principal transactions place the subsidiary’s capital at risk. Profits and losses are dependent upon the skills of employees and market fluctuations. In some cases, in order to economically hedge the risks of carrying inventory, Morgan Keegan enters into a low level of activity involving U.S. Treasury note futures.

      Morgan Keegan, as part of its normal brokerage activities, assumes short positions on securities. The establishment of short positions exposes Morgan Keegan to off-balance sheet risk in the event that prices increase, as it may be obligated to cover such positions at a loss. Morgan Keegan manages its exposure to these instruments by entering into offsetting or other positions in a variety of financial instruments.

      Morgan Keegan will occasionally economically hedge a portion of its long proprietary inventory position through the use of short positions in financial future contracts, which are included in securities sold, not yet purchased at market value. At December 31, 2005, Morgan Keegan had no outstanding futures contracts.

      In the normal course of business, Morgan Keegan enters into underwriting and forward and future commitments. At December 31, 2005, the contract amounts of futures contracts were $35 million to purchase

48


 

and $129 million to sell U.S. Government and municipal securities. Morgan Keegan typically settles its position by entering into equal but opposite contracts and, as such, the contract amounts do not necessarily represent future cash requirements. Settlement of the transactions relating to such commitments are not expected to have a material effect on Regions’ consolidated financial position. Transactions involving future settlement give rise to market risk, which represents the potential loss that can be caused by a change in the market value of a particular financial instrument. Regions’ exposure to market risk is determined by a number of factors, including the size, composition and diversification of positions held, the absolute and relative levels of interest rates, and market volatility.

      Additionally, in the normal course of business, Morgan Keegan enters into transactions for delayed delivery, to-be-announced securities which are recorded on the consolidated statement of financial condition at fair value. Risks arise from the possible inability of counterparties to meet the terms of their contracts and from unfavorable changes in interest rates or the market values of the securities underlying the instruments. The credit risk associated with these contracts is typically limited to the cost of replacing all contracts on which the Company has recorded an unrealized gain. For exchange-traded contracts, the clearing organization acts as the counterparty to specific transactions and, therefore, bears the risk of delivery to and from counterparties.

      Interest rate risk at Morgan Keegan arises from the exposure of holding interest-sensitive financial instruments such as government, corporate and municipal bonds and certain preferred equities. Morgan Keegan manages its exposure to interest rate risk by setting and monitoring limits and, where feasible, entering into offsetting positions in securities with similar interest rate risk characteristics. Securities inventories are marked to market, and accordingly there are no unrecorded gains or losses in value. While a significant portion of the securities inventories have contractual maturities in excess of five years, these inventories, on average, turn over in excess of twelve times per year. Accordingly, the exposure to interest rate risk inherent in Morgan Keegan’s securities inventories is less than that of similar financial instruments held by firms in other industries. Morgan Keegan’s equity securities inventories are exposed to risk of loss in the event of unfavorable price movements. The equity securities inventories are marked-to-market and there are no unrecorded gains or losses.

      Morgan Keegan is also subject to credit risk arising from non-performance by trading counterparties, customers, and issuers of debt securities owned. This risk is managed by imposing and monitoring position limits, monitoring trading counterparties, reviewing security concentrations, holding and marking to market collateral and conducting business through clearing organizations that guarantee performance. Morgan Keegan regularly participates in the trading of some derivative securities for its customers; however, this activity does not involve Morgan Keegan acquiring a position or commitment in these products and this trading is not a significant portion of Morgan Keegan’s business.

      To manage trading risks arising from interest rate and equity price risks, Regions uses a Value at Risk (“VAR”) model to measure the potential fair value the Company could lose on its trading positions given a specified statistical confidence level and time-to-liquidate time horizon. Regions assesses market risk at a 99% confidence level over a one-day holding period. Regions’ primary VAR model is based upon a variance-covariance approach with delta-gamma approximations for non-linear securities.

      The end-of-period VAR was approximately $642,000 as of December 31, 2005, and approximately $407,000 as of December 31, 2004. Maximum daily VAR utilization during 2005 was $1.2 million and average daily VAR during the same period was $466,000.

49


 

Provision For Loan Losses

      The provision for loan losses is used to establish the allowance for loan losses. Actual loan losses, net of recoveries, are charged directly to the allowance. The expense recorded each year is a reflection of management’s judgment as to the adequacy of the allowance. For an analysis and discussion of the allowance for loan losses, refer to the section entitled “Financial Condition — Loans and Allowance for Loan Losses.” During 2005, the provision for loan losses increased to $165 million (0.28% of average loans) due to higher loan losses, slightly higher past dues, and management’s evaluation of current economic factors, including the impact of Hurricane Katrina. The resulting year-end allowance for loan losses increased $28.8 million to $783.5 million. 2004 and 2003 provisions for loan losses were $128.5 million (0.29% of average loans) and $121.5 million (0.39% of average loans), respectively.

Non-Interest Income

      Non-interest income (excluding security transactions) totaled $1.8 billion in 2005, compared to $1.6 billion in 2004 and $1.3 billion in 2003. The increase in non-interest income is due primarily to fee income added by the Union Planters merger in mid-2004. Non-interest income (excluding security transactions) as a percent of total revenue equaled 39% in 2005, compared to 42% in 2004 and 46% in 2003. Non-interest income has declined as a percent of total revenue due to much faster growth in net interest income over the last three years, compared to the growth in non-interest income. Acquisition activity in recent periods has added significantly more net interest income (in comparison to non-interest income added) to the total revenue stream.

 
Brokerage and Investment Banking

      Brokerage and investment income increased 2% and totaled $548.7 million in 2005, compared to $535.3 million in 2004 and $552.7 million in 2003. Brokerage and investment income is significantly affected by economic and market conditions. The increase in brokerage and investment income in 2005 resulted from strong private client, equity capital markets, trust, and investment advisory income streams in 2005. As of December 31, 2005, Morgan Keegan employed slightly more than 1,000 financial advisors. Customer assets under management totaled approximately $56.3 billion at year-end 2005, compared to approximately $48.5 billion at year-end 2004.

      Morgan Keegan contributed $101.7 million to net income in 2005. Revenues from the private client division totaled $248.4 million, or 31% of Morgan Keegan’s total revenue in 2005, and was the top revenue producing line of business. This line of business benefited from improved equity markets in 2005. Fixed income capital markets and equity capital markets revenue totaled $160.1 million and $86.5 million, in 2005, respectively. The investment advisory services division produced $125.4 million of revenue in 2005. Revenues generated by each division are included in various line items in the following table. Regions Morgan Keegan Trust division, which produced revenue of $103.2 million in 2005, is included with Morgan Keegan. Although Regions Morgan Keegan trust division is included with Morgan Keegan, all trust income is reported as a separate item in the consolidated statements of income (see next section titled “Trust Income” for discussion of changes in trust income).

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      The following table shows the components of the contribution by Morgan Keegan for the years ended December 31, 2005, 2004 and 2003.

                           
Year Ended December 31,

2005 2004 2003



(in thousands)
Revenues:
                       
 
Commissions
  $ 201,729     $ 179,100     $ 159,482  
 
Principal transactions
    142,150       185,113       251,902  
 
Investment banking
    117,152       103,895       92,559  
 
Interest
    85,234       56,110       48,543  
 
Trust fees and services
    103,218       86,972       60,279  
 
Investment advisory
    123,294       88,036       65,010  
 
Other
    37,476       27,972       16,664  
     
     
     
 
 
Total revenues
    810,253       727,198       694,439  
Expense:
                       
 
Interest expense
    55,237       28,886       26,244  
 
Non-interest expense
    594,305       564,420       536,767  
     
     
     
 
 
Total expenses
    649,542       593,306       563,011  
     
     
     
 
Income before taxes
    160,711       133,892       131,428  
Income taxes
    59,018       50,257       49,371  
     
     
     
 
Net income
  $ 101,693     $ 83,635     $ 82,057  
     
     
     
 

      The following table shows the breakout of revenue by division contributed by Morgan Keegan for the years ended December 31, 2005, 2004 and 2003.

Morgan Keegan Breakout of Revenue by Division

                                                 
Year Ended December 31,

Fixed Income Equity
Private Capital Capital Regions Investment Interest
Client Markets Markets MK Trust Advisory And Other






(dollar amounts in thousands)
2005
                                               
Gross revenue
  $ 248,397     $ 160,062     $ 86,478     $ 103,225     $ 125,410     $ 86,681  
Percent of gross revenue
    30.7 %     19.8 %     10.7 %     12.7 %     15.5 %     10.6 %
2004
                                               
Gross revenue
  $ 228,693     $ 188,031     $ 69,971     $ 86,972     $ 92,835     $ 60,696  
Percent of gross revenue
    31.4 %     25.9 %     9.6 %     12.0 %     12.8 %     8.3 %
2003
                                               
Gross revenue
  $ 194,091     $ 254,177     $ 64,155     $ 60,279     $ 68,668     $ 53,069  
Percent of gross revenue
    27.9 %     36.6 %     9.2 %     8.7 %     9.9 %     7.7 %
 
Trust Income

      Trust income increased 25% in 2005, 47% in 2004 and 12% in 2003. The increase in 2005 was driven by higher asset values, increased fees, and a full year of activity from trust accounts added through the Union Planters merger in the third quarter of 2004. In 2005, 2004 and 2003, better performance in the financial markets and increases in trust assets contributed to higher trust fees.

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Service Charges on Deposit Accounts

      Service charge income increased 24% in 2005, 45% in 2004 and 4% in 2003. The addition of new accounts added in connection with the Union Planters transaction during the third quarter of 2004, partially offset by the expanded offering of free checking products were the primary reasons for the increases in 2005 and 2004 in comparison with prior years. Also negatively impacting service charges on deposits were deferrals or waivers of certain fees in the impacted areas of Hurricane Katrina during the third and fourth quarters of 2005. Increases in the number of deposit accounts, management initiatives and standardization in the pricing of certain deposit accounts and related services were the primary drivers of increases in 2003.

 
Mortgage Servicing and Origination Fees

      The primary source of this category of income is Regions’ mortgage banking divisions, Regions Mortgage and EquiFirst. Regions Mortgage’s primary business and source of income is the origination and servicing of mortgage loans for long-term investors. EquiFirst typically originates mortgage loans which are sold to third-party investors with servicing released. Net gains or losses related to the sale of mortgage loans are included in other non-interest income.

      In 2005, mortgage servicing and origination fees increased 13%, from $128.8 million in 2004 to $145.3 million in 2005. Origination and servicing fees increased in 2005 due to increased origination volume and servicing assets added from the Union Planters merger partially offset by a reduction in serviced loans. At December 31, 2005, Regions’ servicing portfolio totaled $37.2 billion and included approximately 398,000 loans. At December 31, 2004 and 2003, the servicing portfolio totaled $39.4 billion and $16.1 billion, respectively. The decrease in the servicing portfolio in 2005 resulted primarily from the sale of the conforming wholesale mortgage unit during the second quarter of 2005. The increase in the servicing portfolio in 2004 resulted from the addition of the Union Planters mortgage division, partially offset by certain divestitures of out-of footprint mortgage servicing rights and a relatively high level of prepayments. The decline in the servicing portfolio during 2003 resulted from high levels of prepayments due to the low interest rate environment driving record mortgage refinance activity, partially offset by higher levels of production in 2003.

      In 2004, mortgage servicing and origination fees increased 32% to $128.8 million. Origination and servicing fees increased in 2004 due to volume and servicing assets added from the Union Planters merger.

      In 2003, mortgage servicing and origination fees increased 8%, to $97.4 million. Origination fees increased in 2003 due to the significant mortgage activity resulting from the historically low interest rate environment. Servicing fees were lower in 2003, as compared to the prior year, due to a smaller servicing portfolio in 2003.

      Regions Mortgage and EquiFirst, through their retail, correspondent lending and wholesale operations, produced mortgage loans totaling $16.0 billion in 2005, $10.8 billion in 2004 and $9.4 billion in 2003. Regions Mortgage and EquiFirst produce loans from offices in Alabama, Arizona, Arkansas, Florida, Georgia, Illinois, Indiana, Iowa, Kentucky, Louisiana, Mississippi, Missouri, North Carolina, South Carolina, Tennessee and Texas.

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      A summary of mortgage servicing rights is presented as follows. The balances shown represent the original amounts capitalized, less accumulated amortization and valuation adjustments, for the right to service mortgage loans that are owned by other investors. The amortization of mortgage servicing rights is included in other non-interest expense. The carrying values of mortgage servicing rights are affected by various factors, including prepayments of the underlying mortgages. A significant change in prepayments of mortgages in the servicing portfolio could result in significant changes in the valuation adjustments.

                           
2005 2004 2003



(in thousands)
Balance at beginning of year
  $ 458,053     $ 166,346     $ 147,487  
 
Added in connection with acquisition
    -0 -     352,574       -0 -
 
Sale of servicing assets
    (4,007 )     (68,795 )     -0 -
 
Amounts capitalized
    71,968       70,745       60,918  
 
Amortization
    (84,506 )     (62,817 )     (42,059 )
     
     
     
 
    $ 441,508     $ 458,053     $ 166,346  
Valuation allowance
    (29,500 )     (61,500 )     (39,500 )
     
     
     
 
Balance at end of year
  $ 412,008     $ 396,553     $ 126,846  
     
     
     
 

      The mortgage servicing rights valuation allowance decreased by $32 million in 2005, due to a rise in mortgage rates, resulting in a decline in prepayment speeds. In contrast, the mortgage servicing rights valuation allowance increased by $22 million during 2004, due to a low mortgage rate environment, resulting in increased prepayment speeds and increased refinancing activity. See further discussion in “Other Expenses” below.

 
Securities (Losses) Gains

      Regions reported net losses of $18.9 million from the sale of available for sale securities in 2005, as compared to net gains of $63.1 million in 2004 and $25.7 million in 2003. These gains and losses were primarily related to the sale of agency and mortgage-related securities in conjunction with balance sheet management activities.

 
Other Income

      The components of other income consisted mainly of fees and commissions, insurance premiums, customer derivative fees, and net gains related to the sale of mortgage loans.

      Fees and commission income increased 30% in 2005, due primarily to a full-year of business activity related to the Union Planters merger in 2004, including ATM switch income, international income, and fees related to money orders, cashier checks, and other banking fees. Fee and commission income increased 44% in 2004 due to increased business activity related to the Union Planters merger including standby letters of credit, credit card fees, money orders, cashiers checks and other banking fees.

      Insurance premium and commission income decreased 7% in 2005, due primarily to a decrease in miscellaneous insurance commissions, but increased 13% in 2004, due primarily to increased revenues in the commercial property and casualty business.

      Regions’ customer derivative division primarily assists existing commercial customers with capital market products including interest rate swaps, caps and floors. Typically, Regions enters into offsetting derivative positions limiting its exposure related to customer derivative products. These exposures are marked-to-market on a daily basis. Capital market income totaled $27.7 million in 2005, $7.8 million in 2004 and $21.9 million in 2003. Customer derivative division revenue increased in 2005 as penetration of the legacy Union Planters customer base continued to produce sales of customer derivative products and as customers swapped floating rate loans for fixed rate loans in a flattening yield curve environment.

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      In 2005, net gains related to the sale of mortgage loans held for sale totaled $157.6 million ($129.7 million related to EquiFirst and $27.9 million related to Regions Mortgage). The increase of $20.7 million in gains during 2005 was primarily related to higher sales volume at EquiFirst during the year. For the years ended December 31, 2004 and 2003, gains totaled $136.9 million and $106.1 million, respectively.

Non-Interest Expense

      The main components of non-interest expense are salaries and employee benefits, net occupancy expense, furniture and equipment expenses and other non-interest expense. The following table presents a summary of non-interest expense for the years ended December 31, 2005, 2004 and 2003.

                           
Year Ended December 31,

2005 2004 2003



(in thousands)
Salaries and employee benefits
  $ 1,739,017     $ 1,425,075     $ 1,095,781  
Net occupancy expense
    224,073       160,060       105,847  
Furniture and equipment expense
    132,776       101,977       81,347  
Other expenses
    951,090       784,271       509,887  
     
     
     
 
 
Total
  $ 3,046,956     $ 2,471,383     $ 1,792,862  
     
     
     
 

      Total non-interest expense increased $575.6 million, or 23%, in 2005 and $678.5 million, or 38%, in 2004, due primarily to the expense base added in connection with the Union Planters merger, which occurred mid year 2004. In 2003, total non-interest expense increased 4%, due primarily to increased levels of business activity and new branch offices. Also impacting comparisons between periods are merger-related expenses, impairment charges related to mortgage servicing rights (including recapture of previously recognized impairment charges), losses related to prepayment of debt and storm-related costs. The following tables show the impact on the major non-interest expense components, excluding merger-related expenses, impairment charges/recapture for mortgage servicing assets, losses for prepayment of debt and storm-related costs. Management believes the following tables are useful in evaluating trends in non-interest expense. For further discussion of non-interest expense, refer to the following discussion of each component of non-interest expense.

2005 Non-Interest Expense

                           
Less: Merger-
Related, Debt
Retirement, MSR
Recapture, and
Storm-Related
As Reported Charges As Adjusted



(in thousands)
Salaries and employee benefits
  $ 1,739,017     $ 74,256     $ 1,664,761  
Net occupancy expense
    224,073       7,550       216,523  
Furniture and equipment expense
    132,776       826       131,950  
Other expenses
    951,090       73,113       877,977  
     
     
     
 
 
Total
  $ 3,046,956     $ 155,745     $ 2,891,211  
     
     
     
 

      In 2005, merger and storm-related charges totaled $176.8 million, impairment recapture on mortgage servicing rights totaled $32.0 million and losses on early extinguishment of debt ($600 million of Federal Home Loan Bank structured notes) totaled $10.9 million. During 2005, Regions received a $10 million advance from its insurance carrier for claims expected to be filed in connection with the damage from Hurricane Katrina. This advance was used to partially offset expenses incurred in connection with Hurricane Katrina. The advance was included in the operating activities section of the consolidated statement of cash flows. Regions recorded approximately $8.0 million in net storm-related expenses during 2005.

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      In connection with the integration of Regions and Union Planters, Regions has incurred merger-related expenses throughout the integration process. Merger-related expenses include costs incurred in connection with the merger, integration and restructuring activities, including retention and severance costs, professional fees incurred with integration activities, contract buyouts, lease termination penalties, loss on disposals of duplicate facilities and other direct and incremental costs related to the transaction. Costs incurred in connection with the merger, integration and restructuring activities were funded from cash flows from operations.

2004 Non-Interest Expense

                           
Less: Merger-
Related, Debt
Retirement and
MSR Impairment,
and Storm-related
As Reported Charges As Adjusted



(in thousands)
Salaries and employee benefits
  $ 1,425,075     $ 16,296     $ 1,408,779  
Net occupancy expense
    160,060       1,725       158,335  
Furniture and equipment expense
    101,977       169       101,808  
Other expenses
    784,271       98,569       685,702  
     
     
     
 
 
Total
  $ 2,471,383     $ 116,759     $ 2,354,624  
     
     
     
 

      In 2004, merger-related and storm-related charges totaled $55.1 million, impairment charges on mortgage servicing rights totaled $22.0 million and losses on prepayment of debt ($1.1 billion of Federal Home Loan Bank advances) totaled $39.6 million.

2003 Non-Interest Expense

                           
Less: Debt
Retirement and
MSR Recapture
As Reported Charges As Adjusted



(in thousands)
Salaries and employee benefits
  $ 1,095,781     $ -0 -   $ 1,095,781  
Net occupancy expense
    105,847       -0 -     105,847  
Furniture and equipment expense
    81,347       -0 -     81,347  
Other expenses
    509,887       19,580       490,307  
     
     
     
 
 
Total
  $ 1,792,862     $ 19,580     $ 1,773,282  
     
     
     
 

      In 2003, a net recapture of $1.0 million on mortgage servicing rights was recorded; additionally, Regions chose to prepay $650 million of Federal Home loan Bank advances, resulting in a $20.6 million charge from prepayment of this debt.

 
Salaries and Employee Benefits

      Total salaries and benefits increased 22% in 2005, 30% in 2004 and 9% in 2003. The increase in salaries and benefits during 2005 and 2004 was primarily attributable to salaries and benefits of associates added in connection with the Union Planters merger, as well as incremental incentive costs related to increased revenue production. Excluding $74.3 million of merger-related charges, salaries and benefits increased 18% in 2005 due to the above noted items. Salaries and benefits were higher in 2003, as compared to the prior year, due primarily to higher incentive costs associated with Morgan Keegan, Equifirst, and Regions Mortgage, as well as normal merit and promotional adjustments.

      At December 31, 2005, Regions had approximately 25,000 full-time equivalent employees, compared to approximately 26,000 at December 31, 2004 and approximately 16,000 at December 31, 2003. The decrease in

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full-time equivalent employees from December 31, 2004 to December 31, 2005 was related to streamlined processes, converted systems, and normal attrition; the increase in employees in 2004 resulted primarily from personnel added with the 2004 Union Planters transaction.

      Salaries, excluding benefits, totaled $985.1 million in 2005, compared to $830.8 million in 2004 and $598.5 million in 2003. Salaries increased in 2005 primarily as a result of an increase in full year headcount in connection with the Union Planters merger. Increased salaries in 2004 resulted from higher employment levels in connection with the Union Planters merger, while higher salary levels in 2003 were primarily the result of normal merit and promotional adjustments.

      Regions provides employees who meet established employment requirements with a benefits package which includes 401(k), pension, and medical, life and disability insurance plans. The total cost to Regions for fringe benefits, including payroll taxes, equaled approximately 29% of salaries in 2005.

      Regions’ 401(k) plan includes a company match of eligible employee contributions. At December 31, 2005, this match totaled 100% of the eligible employee contribution (up to 6% of compensation) after one year of service and is invested in Regions common stock. Regions’ contribution to the 401(k) plan on behalf of employees totaled $34.2 million, $25.7 million, and $16.5 million in 2005, 2004 and 2003, respectively.

      Commissions and incentives expense increased to $468.7 million in 2005, compared to $381.0 million in 2004 and $352.1 million in 2003. The increases in commissions and incentives were primarily the result of increased participants in various incentive programs, as well as higher commissions paid at Morgan Keegan and EquiFirst, linked to increased production levels and sales goals. At Morgan Keegan, commissions and incentives are a key component of compensation, which is typical in the brokerage and investment banking industry. In general, incentives continue to be used to reward employees for selling products and services, for productivity improvements and for achievement of corporate financial goals. Regions’ long-term incentive plan provides for the granting of stock options, restricted stock and performance shares (see Note 20 “Stock Option and Long-Term Incentive Plans” to the consolidated financial statements).

      Pension expense totaled $22.0 million in 2005, $22.5 million in 2004 and $19.8 million in 2003. Pension expense in 2006 is expected to approximate $19.7 million.