DBRS Comments on Q2 Earnings of SunTrust Banks, Inc. – Senior at “A”; Negative Trend Remains Unchanged

DBRS has today commented on the Q2 2009 earnings and operating performance of SunTrust Banks, Inc. (STI or the Company). STI’s Q2 2009 results, while weak, were at the low end of DBRS’s expectations; thus its ratings including Issuer and Senior Debt at “A”, and Negative trend remain unchanged.

On May 1, 2009, DBRS downgraded SunTrust’s Senior Debt to “A” and left the trend on Negative. The negative trend on the Company’s ratings reflects DBRS’s view that significant amounts of potential losses remain embedded in the Company’s loan portfolios, especially given the current macroeconomic challenges, particularly declining real estate valuations, rising unemployment and their impact on consumer-related corporate businesses. DBRS noted that SunTrust’s ratings remain under pressure, as continued credit deterioration, losses exceeding income before provisions and taxes (IBPT), and/or a sustained decline in core earnings power would likely result in negative rating actions.

SunTrust produced mixed operating trends in the second quarter resulting in a net loss due to higher credit costs and nonperforming assets, but slowing early stage consumer delinquencies. Quality of earnings were also mixed, as modest net interest income growth from net interest margin (NIM) expansion was more than offset by a 10% drop in adjusted noninterest income (coming off the unusually strong mortgage fees in Q1). However, deposits showed solid growth, some fee income lines grew, and expenses were well-controlled. A net quarterly loss of $164 million (before $66.5 million in TARP and $5.6 million in other preferred dividends) was an improvement compared to the $875 million loss in the prior quarter, but was much worse than the $530 million profit in Q2 2008. The improvement over the prior quarter primarily reflected the $715 million (after-tax) charge to goodwill impairment in the first quarter. The results continue to be ‘noisy’ reflecting many one-time adjustments, gains and charges to earnings.

Net interest income was up 3% from Q1 2009, but down 5% from Q2 2008 due to movement in the margin. STI was the beneficiary of a dramatic change in depositor behavior, with strong quarterly average deposit growth of 4.5% and noninterest bearing deposits rising a robust 7.7%. Saving and accumulating cash for contingencies has become a new priority for consumers and businesses, while low interest rates de-motivated depositors from seeking yield leaving balances in DDA accounts. On the other hand, loan demand was weak in the quarter with average loans contracting 1% while nonaccrual/restructured loans grew over 14%. Net interest margin expanded 7 basis points (bps) to 2.94% in the quarter, as the Company benefited from deposit growth, improved mix and better pricing as SunTrust rolled off some higher-yielding brokered deposits and long-term debt, a trend that is viewed positively by DBRS. Adjusted expenses were well-controlled, however credit-related expenses continue to be high ($174 million) and the quarter included a $78 million FDIC special deposit assessment. Adjusted noninterest income declined 10% sequentially and 3% from last year’s linked quarter ,as strong mortgage (but weaker than Q1) and investment banking revenues were more than offset by declines in deposit service accounts, trust, investment management and retail investment fees compared with Q2 2008. DBRS believes that achieving consistent positive operating leverage continues to be a key goal for STI to improve its profitability.

Loan quality deterioration continued as nonaccrual loans rose over 19% (not including restructured loans) in the second quarter to 4.48% of total loans. However, 90 day past due loans increased a more modest 5% and 30 to 89 days past due loans improved from 1.76% of loans to 1.54% over the quarter, both of which may be signalling some stabilization in loan quality erosion. The loan loss reserve declined, however, and now covers only 54% of nonperforming loans despite a $161 million reserve build. The allowance ratio to all loans, however, did increase to 2.37% at June 30, 2009 compared to 1.86% at year end 2008. DBRS remains concerned about adequacy of reserves given the severity of mortgage loan losses for banks in this credit cycle and signs of new stress on commercial portfolios.

Loan quality continued to deteriorate further in the quarter across all asset classes except indirect consumer. Net charge-offs in the second quarter grew briskly to 2.59% of average loans (annualized) from 1.97% in Q1 2009 due to continued losses in home equity lines, residential real estate loans, and more recently, larger commercial loans. Nonperforming loan inflows came primarily from residential mortgages (Florida especially), residential construction loans, and larger commercial loans. DBRS noted that continued high credit costs exceeding IBPT and/or a sustained decline in core net revenues would likely result in negative ratings pressure.

Provisioning expense was $962 million in Q2 2009, a 3.2% decrease over $994 million in Q1 2009, but $514 million higher than in Q2 2008. The provision was $161 million above net charge-offs in the quarter signalling the Company’s expectation of further loan deterioration.

The Company’s capital actions in the quarter (including an equity raise, the sale of Visa shares, cash tender and deferred tax assets) raised $2.29 billion exceeding its SCAP target and substantially increased its capital ratios. Tier 1 capital ratio rose to 12.25% from 11.02% in the first quarter and SunTrust estimated it to be 9.13% excluding the TARP capital. Tier 1 common was reported at 7.35% and Tangible common equity at 6.86% of Tangible assets while Total capital ratio was 15.3% clearly reflecting the higher capital cushion that the Company has built that is especially noteworthy for its asset size.

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

The applicable methodologies are Rating Banks and Bank Holding Companies Operating in the United States, 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.