DBRS Comments on SunTrust Banks, Inc.’s 2Q11 Earnings – Senior at A (low) Unchanged

DBRS Inc. (DBRS) has today commented that the ratings for SunTrust Banks, Inc. (SunTrust or the Company), including its Issuer & Senior Debt rating of A (low), remain unchanged, following the release of its 2Q11 financial results. The trend on its ratings remains at Stable. DBRS views the 2Q11 earnings to be in line with expectations, marking the fourth consecutive quarter of profits. SunTrust reported net income available to common shareholders of $174 million that reflected significant improvement from $38 million reported in the prior quarter and a net loss of $56 million recorded in 2Q10.

Favorably, SunTrust’s asset quality metrics reflected continued improvements with nonperforming assets (NPAs), nonperforming loans (NPLs), NPL inflows, 90+ day delinquencies, and net charge-offs (NCOs) all declining over the quarter. Specifically, early stage delinquencies (excluding the guaranteed portfolio) improved 7 bps QoQ to 0.73%. Meanwhile, NPLs declined for the eighth consecutive quarter, decreasing 9% sequentially to $3.6 billion, or 3.14% of total loans. All loan categories showed NPL improvement, but most notably in commercial construction loans, which fell more than 25% to $627 million. NCOs declined 12% QoQ to $505 million, or 1.76% of total average loans, driven by lower losses in the non-guaranteed residential mortgage loans that were partially offset by a slight increase in commercial and industrial (C&I) loan NCOs. DBRS notes that the non-guaranteed residential mortgage problem loans represented 39% of total NPLs at 2Q11. Reflecting the asset quality improvement, SunTrust released $110 million of reserves over the quarter, resulting in an allowance for loan losses of $2.7 billion, or 2.40% of total loans, 76.6% of NPLs, and 135% of annualized NCOs. SunTrust indicated that future reserve releases will likely be consistent with the improvement in credit metrics, albeit with a lag, and NCOs are anticipated to track around 2Q11 levels for the third quarter 2011.

DBRS sees 2Q11 earnings as indicative of the broader trends for banks within the economy, with tepid loan growth and the low interest rate environment pressuring revenues and expense levels characterized by elevated credit–related costs (at about 12% of expense base) and higher operating costs. Expenses grew by $77 million, or 5%, QoQ largely due to a $37 million increase in credit-related costs. DBRS notes that SunTrust carries an inferior to peer 2Q11 efficiency ratio of approximately 70% and management has initiated a program to reduce costs with a targeted net run rate reduction of $300 million by the end of 2013, with approximately 80% of the expense savings in the run rate achieved by the end of 2012. DBRS also expects elevated servicing costs in the coming quarters from the regulatory mortgage servicing consent order to negatively impact the Company’s expense base.

Despite the increase in expenses that reduced SunTrust’s adjusted income before provision and taxes (adjusted IBPT) by 4.6% QoQ to $577 million, the Company’s earnings benefited from the lower risk profile as reserve levels continued to decline. Provisions improved to a still elevated 68% of adjusted IBPT while total revenue (adjusted for nonrecurring items) improved 2.3% over the quarter from stronger non- and net-interest income.

Fee-based income (adjusted) increased $37 million, or 5% over the quarter, attributable to strong syndicated finance revenue that drove investment banking income growth of $28 million and from a $7 million increase in deposit service charges. Based on the new regulatory guidance, the Company anticipates approximately a 50% annualized, or $185 million, impact to debit interchange revenue from the Durbin Amendment before mitigating actions. SunTrust anticipates recapturing about 50% of the revenue loss from both the Durbin Amendment and Regulation E through product changes and new product offerings.

Net interest income increased modestly QoQ by 80 basis points (bps) to $1.26 billion primarily due to additional day count in the quarter. Nonetheless, net interest margin (NIM) of 3.53% was consistent to the prior quarter despite the benefits from a favorable deposit mix shift, lower rates paid, and reduced long-term debt rates that contributed a 7 bps decline in interest bearing liabilities. The positive variance was offset by a 5 bps decline in interest earning assets yield and by a decline in average loan balances from continued runoff of its higher-risk loans. SunTrust anticipates a modest decline in NIM in 2H11 due primarily to further decreases in interest earning asset yields. Positively, the funding mix improved as customers moved to more liquid products. Total deposits grew $1.2 billion, or 1%, to a record high of $121.9 billion at 2Q11.

DBRS is mindful of SunTrust’s $348 million mortgage repurchase claims at 2Q11. Demands grew by $35 million QoQ, of which $26 million was from the 2007 vintage. Positively, losses have stabilized and declined nearly 19% QoQ to $61 million at 2Q11 and non-agency related claims comprise only 5% of outstanding demands. SunTrust increased the mortgage repurchase reserve by approximately 11% QoQ to $299 million given the 30% linked-quarter growth (to $472 million) in pending demands. DBRS anticipates further volatility in mortgage repurchase trends as the higher risk vintage demands are resolved and a normal seasoning pattern develops.

Capitalization remain solid as the Tier 1 common equity ratio grew by 15 bps to 9.20% and the Tier 1 risk-based capital ratio was 11.10%, up 10 bps from the prior quarter. The tangible common equity ratio also expanded 19 bps to 7.96%. SunTrust anticipates a successful transition to Basel III as it achieves organic capital generation and returns more capital to its shareholders. The Company announced that it plans to request for a modest dividend increase in 2H11.

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

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organizations. Other methodologies used include the 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, all of which can be found on the DBRS website under Methodologies.

The sources of information used for this rating include the company documents, the Federal Reserve, 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
Approver: Steven Picarillo
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.