DBRS Comments on SunTrust Banks, Inc.’s 4Q10 Results – Senior at A (low); Unchanged

DBRS Inc. (DBRS) has today commented on the 4Q10 results of SunTrust Banks, Inc. (SunTrust or the Company). SunTrust’s earnings continued to improve in the fourth quarter driven by further declines in credit costs as income before provisions and taxes (IBPT) remained solid, but was down about 4% from 3Q10. For the quarter, SunTrust reported net income available to common shareholders of $114 million, its second consecutive profitable quarter after earning $84 million in 3Q10. The Company continued to improve its risk profile, evidenced by ongoing reductions in some of its most problematic loan portfolios, while it also continued to strengthen capital. DBRS sees SunTrust’s improving performance as in line with expectations and consistent with its current ratings and Stable trend. The Company is currently rated A (low) and R-1 (low) for senior and short-term obligations, respectively.

Fourth quarter revenues (on an FTE-basis) of $2.3 billion were essentially flat from the third quarter, as growth in net interest income, was offset by a decline in fee revenues. Net interest income of $1.3 billion benefited from a further 3 bps expansion in NIM to 3.44%, driven by lower funding costs, though average loans did grow 2% from 3Q10. Noninterest income declined $15 million from last quarter to $1.0 billion in 4Q10. In the quarter, SunTrust benefited from a $76 million swing in adjusted trading income, which tends to be volatile. This was offset by a weaker mortgage banking quarter. Of note, investment banking income posted another strong quarter, generating a record $103 million of revenues. DBRS sees the resilient fee revenue performance in 4Q10, despite Reg E related pressures and a tougher mortgage banking quarter, as highlighting the revenue generating ability of the Company’s diverse business lines. Nevertheless, regulatory reform will continue to pressure noninterest income. In addition to Reg E related fee reductions which are already reflected in 4Q10 run rates, SunTrust estimates that, in its current form, the Durbin amendment could reduce debit interchange revenues by 75% beginning in 2H11. DBRS notes that this estimate does not consider any mitigating actions the Company could take to recoup lost revenues. In 2010 debit interchange revenues were $332 million.

As noted, IBPT declined 4% from 3Q10 to $778 million as noninterest expenses grew 3% to $1.55 billion, primarily due to higher compensation expense and the cost of investments to enhance the Company’s client acquisition and risk management technology. The $103 million decline in quarterly provisions to $512 million in 4Q10, drove the linked-quarter improvement in earnings. Importantly, provisions constituted about 62% of adjusted 4Q10 IBPT, down from 71% in 3Q10, as SunTrust results again reflected a healthier, but not healed, relationship between net revenue and credit costs.

Continuing the trend seen in recent quarters, SunTrust’s asset quality metrics improved further in the fourth quarter. Nonperforming assets (NPAs) declined 6% from 3Q10 to $4.8 billion at year-end. Year-end NPA’s represented 4.08% of loans plus OREO, down 30 bps from September 30, 2010. Construction and residential mortgage continue to comprise the majority of NPAs, and contribute the majority of quarterly charge-offs, but these portfolios are also showing some improvement. Core residential mortgage and home equity portfolios continue to perform reasonably well, while higher-risk portfolios are also showing stable or somewhat improving credit metrics as balances continue to decline. The problematic construction portfolio also continues to decline. Year-end balances in this portfolio were $3.8 billion, down 13% from the end of 3Q10. DBRS notes that accruing TDRs were $2.6 billion at year end, a modest increase from the third quarter. Positively, 86% of accruing TDRs are current on principal and interest payments. Nonaccruing TDRs increased $17 million over the quarter to $1.0 billion.

Early stage delinquencies (30 to 89 days past due) also fell, improving 6 bps (adjusted for guaranteed loans and repurchases) to 0.90% of loans, supporting the outlook for additional (moderate) improvement in credit costs in coming quarters. Taking that into consideration, the 4Q10 provision of $512 million was $109 million less than quarterly net-charge offs and SunTrust’s allowance for credit losses declined to $3.0 billion. At December 31, the allowance for credit losses represented 2.58% of total loans (3Q10: 2.69%).

The Company’s capital levels further increased in the fourth quarter with estimated Tier 1 common and Tier 1 risked-based capital ratios at year end of 8.08% and 13.65% respectively. Under Basel III calculations, SunTrust expects that its Tier 1 Common ratio, which already exceeds the 7% requirement for 2019, would increase modestly. DBRS notes that the Company’s $4.85 billion in TARP preferred shares contributed an estimated 3.65% to the Tier 1 capital ratio at year end. Currently, SunTrust is one of the 19 banks subject to a second round of Federal Reserve stress tests to ensure capital adequacy. The stress tests will test a bank’s ability to absorb losses over the next two years under at least two scenarios (baseline and adverse) and will take the proposed Basel III capital requirements into account as well as TARP repayment. Test results will also determine whether an institution may resume capital distributions (stock dividends and/or repurchases). The stress test results are expected to be communicated to BHCs (not publicly) no later than March 21, 2011.

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

The applicable methodologies are Global Methodology for Rating Banks and Banking Organizations, Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments, Rating Bank Subordinated Debt and Hybrid Instruments with Discretionary Payments, and Rating Bank Preferred Shares and Equivalent Hybrids which can be found on the DBRS website under Methodologies.

The sources of information used for this rating include the company documents, the Federal Deposit Insurance Corporation and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Lead Analyst: William Schwartz
Initial Rating Date: 28 November 2005
Most Recent Rating Update: 26 March 2010

For additional information on this rating, please see the linking document below.