DBRS Comments on SunTrust Banks, Inc.’s 2Q10 Results – Senior at A (low) Unchanged

DBRS has today commented on the 2Q10 results of SunTrust Banks, Inc. (SunTrust or the Company). SunTrust’s ratings remain unaffected by the Company’s improving 2Q10 financial performance as the Company recovers from this unusually severe credit cycle, particularly for the Southeast region. On March 26, 2010, DBRS downgraded SunTrust’s ratings, including its Issuer & Senior Debt ratings to A (low) and changed the trend for all Long- and Short-Term ratings to Stable.

While still struggling with elevated credit costs and expenses, the Company posted improved results with a few notable milestones in the quarter as it continues to recover. SunTrust reported net income of $12 million before $68 million of preferred dividends resulting in a $56 million loss to common shareholders. This represents a 66% improvement compared to the loss of $164 million reported a year ago same quarter and an increase of 76% on a linked-quarter basis. It also marks the first quarter of positive net income since 3Q08. Core results, excluding nonrecurrent items, improved on both linked-quarter and year-over-year (YOY) basis and reflected a 23% sequential and 31% YOY decline in provision for loan losses to $662 million. Net charge-offs (NCOs) exceeded loan loss provisions by $60 million in the quarter further underscoring SunTrust’s confidence in the improving credit picture. STI’s adjusted income before provision and taxes (adjusted IBPT) of $626 million increased 13.5% over the prior quarter and 25.2% above 2Q09. It is also notable that adjusted IBPT is now nearly in parity with provisions, which could signal a return to full operating profitability in the near term if current trends are sustained. Furthermore, the Company generated positive operating leverage, on an adjusted basis, for the second consecutive quarter. These trends, among others, further validate the March 2010 change to Stable Trend. Significant nonrecurrent items in the quarter included a $57 million gain on the sales of securities related to repositioning the investment portfolio, a $63 million gain in the mark on the Company’s publicly traded debt and a $63 million charge for debt extinguishment.

SunTrust’s financial results improved substantially in the quarter with a 23% ($200 million) decline in loan loss provisions over the quarter and a 36% ($254 million) increase in noninterest income driving the improvement. Net interest income rose a modest 1% in the quarter as lower deposit funding costs more than offset slightly lower asset yields and earning assets were flat. The Company’s 4% increase in consumer loans, particularly auto and student loans, offset a 2% decline in commercial lending. For similar reasons, NIM was stable, increasing 1 basis point (bp) over the quarter to 3.33% and the company expects it to remain in the 3.25% to 3.35% range for the balance of the year.

Noninterest income increased 36% sequentially and was down 11% from the prior year. Compared to the prior year, mortgage production declined approximately 60%, mortgage repurchases were higher in 2Q10 and 2Q09 results included a large MSR recovery. After adjusting for security gains and fair value marks, the sequential increase was still a healthy 12% increase and reflected higher mortgage income from hedges and growth in customer fee categories. DBRS notes that noninterest income was also impacted by a $20 million increase in mortgage repurchase reserves to $148 million for the quarter as new request volumes increased in June as this line item becomes an increasing drag on fee income. With regard to financial regulatory reform, the Company believes Reg E will result in a 10% reduction in service fees and an unknown impact (until the Federal Reserve provides clarification) on approximately $250 million in interchange fees from the Durbin amendment. Changes in derivative regulation are not expected to have a material impact.

SunTrust’s noninterest expense was $1.5 billion, or $1.4 billion adjusted for debt extinguishment costs, rising 6% on an adjusted basis compared to 1Q10 and 3% compared to 2Q09. The increases were driven by higher credit-related, marketing and processing costs. Credit-related costs increased to $177 million in the quarter as the Company’s real estate owned climbed to a high $700 million underscoring the credit overhang that still needs to be resolved.

STI’s asset quality metrics improved in the quarter and appear to be further stabilizing. After remaining essentially flat for the entire year, nonperforming assets (NPAs), declined nearly 10% to $5.5 billion in 2Q10. NPAs as a percentage of loans plus OREO decreased 45 bps to 4.8% sequentially, primarily driven by improvement in residential mortgage and construction loans. Of note, however, is the 19% growth in accruing TDRs to $2.3 billion as SunTrust continues to modify large numbers of mortgages. Positively, 87% of accruing TDRs are current on principal and interest payments. Nonaccruing TDRs increased 6.4% over the quarter to $986 million. Early stage delinquencies (30 to 89 day) also reflected further improvement of 6 bp (adjusted for guaranteed loans and repurchases) to 0.98% of loans. Improved credit metrics may signal stabilization in asset quality erosion, however, DBRS comments that the Company’s loan loss reserve covers only 68% of nonperforming loans, which could lead to further losses if residential mortgage conditions worsen rather than improve. Credit surveillance will continue to focus on the performance of STI’s residential mortgage and residential construction portfolios (comprising 54% of NPLs at 2Q10) in addition to TDR performance this year and into 2011. SunTrust also disclosed that their loan exposure to the Florida Panhandle is relatively modest at 1% of loans or $1.3 billion including $345 million of commercial loans. While DBRS sees this as a positive statistic, the potentially far-reaching and long-term effects of the oil spill are unknown and only time will reveal the actual exposure.

The Company has improved its funding, liquidity and capital levels compared to 2009. Average consumer and commercial deposits were roughly flat in the quarter; however, the mix shift toward lower cost deposits, a 4% rise in average noninterest-bearing deposits and the termination of higher yield debt improved funding costs. Moreover, SunTrust’s foreign deposits declined 75% or $191 million. Capital levels further increased over the quarter with estimated Tier 1 common and Tier 1 risked-based capital ratios of 7.85% and 13.40% respectively. DBRS notes, however, that regulatory capital ratios include $4.85 billion in TARP preferred shares that contributed an estimated 3.6% to the Tier 1 capital ratio at June 30, 2010. Tangible common equity improved 30 bps to 7.18% of tangible assets for 2Q10.

Note:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodologies are the Global Methodology for Rating Banks and Banking Organizations, and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.