DBRS Comments on SunTrust Banks, Inc.’s 3Q12 Results – Senior at A (low); Trend Stable

DBRS, Inc. (DBRS) has today commented on the 3Q12 earnings of SunTrust Banks, Inc. (SunTrust or the Company). DBRS rates the Company’s Issuer & Senior Debt rating at A (low) with a Stable trend. The Company reported net income available to common shareholders of $1.1 billion, up from $270 million in 2Q12 and from $215 million a year ago.

Following the realization of $1.9 billion of pre-tax securities gains related to its Coca-Cola (Coke) holdings, SunTrust took numerous actions to strengthen its balance sheet. These actions included taking a $371 million mortgage repurchase provision to increase the reserve to an amount that the Company believes will cover all future losses related to pre-2009 vintage loans sold to Government Sponsored Enterprises, the movement of $2.4 billion of loans to held for sale (included $1.4 billion of student loans, $500 million of nonperforming mortgage and commercial real estate loans, and $500 million of delinquent Ginnie Mae loans) with an additional $600 million of student loans being transferred to held for sale in 4Q12, valuation losses on affordable housing investments, and a charitable donation, which in aggregate (including Coke gains) added $753 million to net income available to common shareholders.

While SunTrust no longer has the financial flexibility the large Coke gains afforded it, DBRS views these various balance sheet moves positively. Indeed, the Company was able to lower risk on its balance sheet by selling nonperforming loans (NPLs), while improving capital metrics. Other highlights of the quarter include strong mortgage production income and modest core loan growth. Moreover, SunTrust has already achieved the $300 million in targeted savings as outlined in its Playbook for Profitable Growth (PPG) program during 3Q12, more than a full year ahead of schedule. DBRS notes that the Company will remain focused on managing expenses given the difficult revenue environment.

Positively, NPLs declined $727 million, or 30%, during the quarter to $1.731 billion, or 1.42% of total loans, driven primarily by the transfer of $544 million of NPLs to loans held for sale. During the quarter, the Company also transferred $81 million of junior lien loans that were current, but subordinate to first liens that were seriously delinquent, following regulatory guidance to nonperforming status. DBRS notes that the Company has not made any changes to how it treats consumer loans following post Chapter 7 bankruptcy that some other banks disclosed changes to, which will likely negatively impact results in future, if adopted. Meanwhile, net charge-offs increased to $511 million, or $161 million, during the quarter driven by loan sales and a change in credit policy that speeds the timing of charge-offs related to junior lien loans. Excluding these two items, NCOs would have declined $76 million to $274 million, or a much improved 0.88% of average loans (annualized). Importantly, higher risk loan balances have declined $14.6 billion, or 62%, since 4Q08 to a manageable $8.8 billion. Overall, the allowance for credit losses was a sufficient 1.84% of total loans, or approximately 2% excluding government guaranteed loans.

Net interest income declined a modest $5 million to $1.301 billion reflecting the foregone $15 million of Coke dividend income. Overall, the margin was relatively stable, declining only one basis point to 3.38%. The foregone dividend income and lower asset yields were almost completely offset by lower funding costs which included the redemption of $1.2 billion in higher cost trust preferred securities early in 3Q12, as well as lower deposit costs. Given the low rate environment, the margin should remain under pressure over the intermediate term.

Adjusted core noninterest income declined a material $192 million, or 21%, to $729 million. DBRS notes that $92 million of the decline was related to moving the aforementioned student and mortgage loans to held for sale. However, excluding the mortgage repurchase provision (increased an incremental $216 million), noninterest income would have increased $24 million to $1.1 billion reflecting higher mortgage production income and investment banking income. Specifically, (excluding the mortgage repurchase provision), mortgage production income increased by $49 million sequentially, driven by improved margins, as still strong origination volume declined by 1.4% to $8.1 billion. As noted earlier, the Company expects the $371 million mortgage repurchase provision taken in 3Q12, to cover all estimated losses related to pre-2009 vintage GSE loan sales. Meanwhile, investment banking income increased $8 million to $83 million reflecting higher syndicated finance fees.

Core expenses, excluding severance, losses on the extinguishment of debt, goodwill impairment, intangible amortization, and the previously mentioned special 3Q12 items, were relatively stable at $1.527 billion. Full-time employees decreased by 324 employees during the quarter and by 1,483 employees compared to 3Q11. Overall, the Company has targeted an efficiency ratio below 60%, which will necessitate additional expense savings, as well as revenue growth.

Overall, capital metrics remain solid and improved during the quarter. Specifically, the Company’s tangible common equity to tangible assets ratio increased 17 basis points to 8.48%. Moreover, all regulatory capital metrics were bolstered during the quarter as well. SunTrust noted that its Basel III tier 1 common ratio remained relatively stable at 7.9% under its interpretation of the proposed rules.

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 DBRS Criteria – Intrinsic and Support Assessments, Rating Bank Subordinated Debt and Hybrid Instruments with Discretionary Payments, and Rating Bank Preferred Shares and Equivalent Hybrids. All can be found on the DBRS website under Methodologies.

The sources of information used for this rating include 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.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Michael Driscoll
Approver: Roger Lister
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.