Regions Financial Corp. is in a vise of its own making.

Investors voted with their wallets again this week in subscribing only lightly to Regions' plan to swap common stock for preferred shares, just weeks after it deeply discounted a common stock offering, meaning the bank may be hard-pressed to tap those channels again, observers said.

Unfortunately for Regions, with lingering questions about credit exposures and management, it may need to do just that — or sell its prized brokerage and investment bank unit, Morgan Keegan & Co. Inc., instead.

Christopher Marinac, an analyst at FIG Partners LLC, said a decision on Morgan Keegan "still lurks out there" if Regions were to need more capital. "They survived the stress test," he said, but the crucial question is whether the company can earn enough from its core business to offset any increases in loan losses. If not, then more capital would have to be sought.

Selling Morgan Keegan for a ripe price isn't a slam dunk, either, as it faces challenges of its own, including litigation tied to sales of auction-rate securities. But selling the unit could at least raise capital if conditions continue to deteriorate and would shed the litigation liability, some observers said.

Regions spokesman Tim Deighton said the $142 billion-asset company's ability to satisfy the government's capital mandate "in such a short period of time indicates that investors recognize the value and strength of our franchise." The exchange and the offering raised $2.33 billion of the $2.5 billion required after the stress tests. Regarding Morgan Keegan, the unit is "a core asset that remains an integral part of our business," he said.

Regions managed to meet the government's capital requirement but did so by significantly diluting existing shareholders. It sold $1.8 billion of common stock last month at a 24% discount — a much steeper cut than in other banks' offerings. Regions also said this week that it had gotten 29% acceptance of an offer to swap common stock for trust-preferred securities.

"Investors were particularly skittish on this one," said Jeff Davis, director of research at Howe Barnes Hoefer & Arnett Inc. He said discounting the common stock "was the right call in terms of staying in the game" but that Regions "was hoping for more than the 29% acceptance on the exchange."

Analysts said Regions now has fewer options to raise funds. Last month it raised $177 million by selling a Visa Inc. stake and $200 million in deferred-tax assets. Regions also cut its quarterly dividend to a penny and has said it may sell noncore assets if more capital is needed.

Analysts said Regions, which last year got $3.5 billion in government capital, could feel pressure to sell Morgan Keegan if it suffers further credit losses. The company has said its exposure has been mostly in residential development, home equity and condominium loans, but analysts say it's inevitable there will be spillover into loans in lines that have yet to bear the full brunt of the recession.

"If losses a year from now create the need for more capital, they would need to come back to selling assets," Davis said, including Morgan Keegan.

C. Dowd Ritter, Regions' chairman and CEO, has steadfastly defended Morgan Keegan, touting brokerage revenue as a complement to returns from traditional banking.

Last year, the unit earned $128.3 million. As of March 31, it had about 1,300 financial advisers and 330 offices, and it operated in fixed-income and equity capital markets, including a sizable municipal bond business. Morgan Keegan also has a private-client business, a trust operation and asset management.

"There's no doubt that the brokerage business is feeling pressure, but Morgan Keegan is weathering the conditions well," said Irene Esteves, Regions' chief financial officer, in April.

Morgan Keegan, however, has legal issues linked to losses and disclosures at its RMK Fund. So far, the unit has won more than half the cases that have gone to arbitration before the Financial Industry Regulatory Authority, but the authority has ordered the unit to pay about $3.3 million to investors. (This excludes any settlements made outside Finra.) Regions also disclosed in its last quarterly report that Morgan Keegan got a Wells notice in March from the Securities and Exchange Commission related to an investigation of auction-rate securities sold and underwritten by the unit. The SEC has been examining "the adequacy of the disclosures of the liquidity risks" and whether the unit sold securities "after its ability to support auctions was diminished," according to the filing.

Davis said the most likely buyer for Morgan Keegan would be an employee-led consortium that could include founder Allen Morgan. Morgan, who retired in December 2007, declined to comment.

Several sources close to key managers at the investment banking unit said an employee-led buyout is unlikely right now, however, because Regions supplies Morgan Keegan with difficult-to-replace revenue sources.

One source said Regions has repeatedly turned down opportunities to sell Morgan Keegan and that the capital it could yield — estimated at $800 million to $1 billion — would be insufficient to persuade Ritter to divest the unit.

Another investment banker familiar with the unit said the liabilities associated with the litigation could make a sale more difficult and less lucrative.

Marinac agreed that Morgan Keegan's employees are split about whether to go independent or remain part of Regions. "There is a mixed amount of interest within the employee base about doing this type of deal," he said.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.