DBRS Comments on SunTrust Banks, Inc.’s 3Q11 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 3Q11 financial results. The trend on its ratings remains at Stable.

SunTrust’s 3Q11 earnings continued to reflect subdued revenue generation that benefited from lower cost deposit growth and improved credit trends. The 3Q11 earnings included a modest sequential growth in net interest income and a 1% QoQ decline in fee revenues. DBRS notes that 3Q11 marked the fifth consecutive quarter of profits and a multi-quarter improvement in credit metrics across most categories. Asset quality improvements resulted in lower provisions for credit losses that benefited the bottom line. In 3Q11, SunTrust reported net income available to common shareholders of $211 million that reflected a 21% improvement from $174 million reported in the prior quarter, driven primarily by a loan loss reserve release and higher loan balances.

On an adjusted basis, 3Q11 revenues contracted, highlighting the impact of increased regulatory demands, pressures on net interest income from the low interest rate environment, and market volatility. SunTrust’s adjusted fee-based income declined by $21 million in 3Q11. Investment Banking revenue was down $27 million QoQ due to lower transaction volumes, while mortgage servicing revenue declined 19% to $58 million. The decrease was partially offset by increases in mortgage production-related income that grew $37 million (on an adjusted-basis) from wider margins and higher origination volume. Conversely, mortgage-related income declined due to high levels of refinance volume and strong MSR hedge performance. The Company anticipates approximately a 50% annualized or approximately $45 million to $50 million quarterly 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 new product offerings and changes.

Net interest income of $1.3 billion remained unchanged essentially from 2Q11, increasing 1% or $7 million from an additional day in the quarter and from lower cost funding. Lower yield on earning assets did, however, impact net interest margin (NIM), which declined 4 basis points (bps) to 3.49% in 3Q11 in line with Company guidance. SunTrust anticipates the persistently low rate environment to add modest downward pressure to NIM in 4Q11.

DBRS notes that SunTrust faces the challenge in improving its earnings of operating with a below peer efficiency ratio, which was approximately 70% in the third quarter, adjusted for non-recurrent items. Costs were up in 3Q11, with the 1% sequential increase in expenses to $1.6 billion, due primarily to a $19 million increase in mortgage-related costs, including higher operating losses related to mortgage servicing. Positively, management initiated a newly named PPG Expense Program earlier in 2011 that aims to reduce the Company’s efficiency ratio to under 60%, an important goal. The initiative targets a net run rate expense 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 views that management continues to focus on expense controls as a means of delivering improved shareholder value, but is struggling to cope with still elevated credit costs and increased regulatory costs in a slowly recovering economy.

SunTrust’s balance sheet expanded in 3Q11 with growth in earning assets driven by modest loan growth and a favorable shift in the deposit mix in 3Q11. Average loans increased 1% to $115.6 billion compared to the prior quarter, with growth of $1.1 billion or 2% concentrated in commercial and industrial (C&I) loans. Higher-risk loan categories, such as home equity, commercial real estate (CRE), and construction loans continued to be managed down, declining 6.1% QoQ. They are now down nearly 55% from 4Q08 levels. Also, average client deposits grew to another record level of $123 billion in the quarter, increasing by $1.1 billion or 0.9% QoQ in 3Q11. The deposit mix shift toward lower-cost accounts continued. In particular DDA balances grew $2.1 billion or 7% over the prior quarter. SunTrust continues to focus on strengthening its balance sheet that is enhanced by reduced risk, stronger liquidity, and prudent management of its lower yielding assets, particularly in the current historically low interest rate environment.

SunTrust’s asset quality metrics showed continued improvement with nonperforming assets (NPAs), nonperforming loans (NPLs), early stage delinquencies, and net charge-offs (NCOs) all declining over the quarter. NPLs declined for the ninth consecutive quarter, decreasing 10% sequentially to $3.2 billion or 2.76% of total loans. The sequential improvement was driven primarily by commercial construction NPLs that decreased approximately 39% due to continued risk mitigation activities, as well as C&I and CRE NPLs that declined nearly 11% and 15%, respectively. NCOs were down 3% over the prior quarter to $492 million or 1.69% of total average loans, driven primarily by lower losses in the residential mortgage loans. Partially offsetting the 7 bps linked-quarter improvement were commercial construction loan charge-offs that grew 66% over 2Q11.

Reflecting the overall positive credit trends, SunTrust released $144 million of reserves over the quarter, leaving its allowance for loan losses at $2.6 billion or 2.22% of total loans, 80.9% of NPLs, and 133% of annualized NCOs. SunTrust indicated that its 3Q11 reserve levels remain sufficient and in line with improved credit metrics.

Underscoring the risks surrounding the Company’s exposure to securitized mortgages and related expenses, SunTrust’s $440 million mortgage repurchase claims increased 26% over the prior quarter. Demands claims grew by $92 million QoQ, of which 67% comprised of growth from its 2007 vintage. SunTrust stated the possibility of increased demands in 4Q11 given the unpredictability of growing trends. Losses grew to $134 million in 3Q11 as a significant portion of 2Q11’s new demands came through in the last month of 2Q11 driving up the pending demand population. As such, reserve build of $117 million in the quarter resulted in an ending reserve level of $282 million. DBRS notes that improvement in the Company’s delinquency ratio signals that lower repurchase demands could eventually follow. Moreover, non-agency related claims comprised only 1% of outstanding demands at 3Q11. DBRS anticipates further volatility in mortgage repurchase trends, as the higher risk vintage demands are resolved and a normal seasoning pattern develops.

Capitalization remains solid in the quarter as Tier 1 common equity ratio was increased by 5 bps to 9.25%. The Tier 1 risk-based capital ratio stood at 11.05%, modestly lower by 5 bps QoQ due to the reduction in trust preferred securities and the impact of loan growth on risk-weighted assets. Strong retained earnings supported the 32 bps expansion in the Company’s tangible common equity ratio of 8.28%. Reflecting prudent capital management, SunTrust announced a modest dividend increase in the quarter to $0.05 per share, in line with its plans to return more capital to its shareholders. DBRS views the Company’s capital metrics as sound, leaving SunTrust well-positioned for a successful transition to Basel III.

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: Alan G. Reid
Initial Rating Date: 28 November 2005
Most Recent Rating Update: 8 August 2011

For additional information on this rating, please refer to the linking document under Related Research.