Suntrust Banks Inc. (NYSE:STI)
Citigroup US Financial Services Conference
March 05, 2013 8:50 am ET
William Henry Rogers - Chairman, Chief Executive Officer, President and Chairman of Executive Committee
Good morning, everyone. My name is Arjun Sharma. I work with Josh Levin. In his absence, I will be introducing our companies. So next up, we have SunTrust, and we're very pleased to have SunTrust here with us today. As the housing market has begun a path to recovery, over last year, SunTrust has enjoyed a significant reduction in environmental costs. And as we move through '13 and the housing marketing continues to improve, SunTrust expected to continue to enjoy improvements in the reduction in these environmental costs. So from SunTrust, we're happy here to have Chairman and CEO, William Rogers, and also Director of IR, Kris Dickson. With that, I'll turn it over to William Rogers. Thanks.
William Henry Rogers
Thanks. Well, good morning, everyone, and thanks for joining Kris and me here today. So before I get started, as you know, I've got some housekeeping things to get out of the way. Our comments today may include forward-looking statements. These statements are subject to risks and uncertainties, and actual results could differ materially. We list some of the factors that might cause actual results to differ materially on Slide 2. We'll also discuss non-GAAP financial measures today. You can find the reconciliation of GAAP in the Appendix and on our website, www.suntrust.com.
So we'll start today's presentation by briefly discussing our franchise and the momentum that we've built. Then I'm going to spend the bulk of my time focused on what we're doing to foster revenue growth and further drive down our expense base to build on our earnings momentum.
We operate approximately 1,600 branches and 2,900 ATMs in the Southeast and mid-Atlantic portions of the United States. Within these markets, we're skewed to the major metropolitan areas. This is made clear on the map on this slide. The darker shades indicate more densely populated counties. Our branch network is then overlaid. And you can see the significant concentration in those areas that are more darkly shaded. As you would expect, this concentration helps drive very attractive, longer-term demographic and growth characteristics. 75% of the MSAs in which we operate have better household income projections than the national average. Furthermore, projected population growth in our footprint also exceeds the national average. We're also well positioned within those markets, and as I've said before, scale to me is about being relevant in the markets you serve. And our deposit share is first, second or third in 19 of the 25 largest MSAs, and within those markets, our average market share is about 14%. So we're clearly relevant in our footprint, and importantly, this provides us great opportunity to grow coincident with our markets and to gain share. While we have the absolute scale to compete, we're structured in a way that enables and encourages personal relationship-building in our markets. We believe this provides a distinctive competitive advantage and is a key component to our high service level model, a model that helped drive our industry-leading loyalty. SunTrust has a diverse revenue mix, which is 56% comprised of net interest income and 44% noninterest income. You can also see the diversity within our fee income streams. All businesses have some level of cyclicality, and banks are certainly no exception. You're aware of the headwinds that are facing our industry today in certain revenue categories. The key, we believe, for sustainable long-term growth is to have diversity of income sources, which SunTrust clearly does. Revenue diversity is also evident within the business mix.
This slide shows each of our 3 major business segments' contribution to overall revenue. We also show the primary business units within each of those segments. Consumer Banking and Private Wealth Management is our largest segment, with nearly $4 billion in 2012 revenue, which equated to about 45% of the company's total. By line of business, retail banking is the largest contributor at 61% of the segment's total revenue; private wealth management makes up 24%; and national consumer lending, 15%. Our Wholesale Banking segment represented 40% of SunTrust 2012 revenue and over 40% of our loan portfolio. This segment provides a complete line of banking and capital market solutions to our corporate investment banking, commercial, business, as well as those commercial- class with commercial real estate needs. There's good revenue diversity within this segment. You'll note that our smaller commercial clients generate nearly the same amount of revenues as our larger commercial clients. Our mortgage business comprised 12% of total 2012 revenue. A little over 3/4 of the revenue was derived from production income. We also have $145 billion servicing portfolio and servicing-related income generated about 20% of the segment's business.
Now I'm going to spend a few moments outlining our improved momentum over the past year from both a financial perspective and as it relates to the markets in which we operate. Let's take a look at some of the positive balance sheet trends. Average deposits for 2012 were up $3.5 billion from the prior year. Now the bigger story here is the continued favorable shift and the mix towards lower-cost deposits, which were up $6.5 billion, driven by a 20% increase in DDA. Average loans were up $6.6 billion or 6% over last year. This growth was driven primarily by targeted loan categories included in C&I and certain consumer loans. And it was accomplished against a headwind of intentional reductions in our higher-risk loan categories. While our loan balances declined in the fourth quarter of 2012 due to the previously announced loan sales, we do expect the portfolio to resume its growth as 2013 continues to unfold. As you've seen in the H8 data, loans have been sluggish in the first quarter, which is due to seasonality, I believe, as well as some acceleration of demand that occurred late in the fourth quarter of last year. From both a credit and capital perspective, we continue to see favorable trends. Tier 1 common reached a record 10% in the fourth quarter, and NPAs were down 45% from the prior year, continuing our multiyear trend of improving credit quality.
Now taking a look at the income statement. The actions we preannounced in September generated some unusually large revenue items, particularly the Coca-Cola gain. However, on a core basis, earnings increased meaningfully over last year, driven by improved operating leverage. One of the largest drivers of revenue growth was higher mortgage-related income, driven by refinance activity related to the low interest rate environment, the HARP 2.0 program and an increase in purchase activity. Another meaningful driver was corporate investment banking, which produced record revenue. I'll discuss both of these in more detail in relation to our strategic priorities, along with our ongoing efforts to drive down expenses and improve efficiency.
Let's spend a moment looking at the momentum that's occurred in several of the major markets in which we operate. There is no question that the Southeastern markets were hit harder than most during the economic downturn. However, they now appear to be recovering at a faster pace than the rest of the country. You can see in the graph on the left that home price growth in most of our large -- largest metropolitan areas exceeded the growth in the Case-Shiller U.S. composite index. The employment situation is also improving. The absolute unemployment rates in most Southeastern states are now nearing the U.S. average, and the rate of improvement is more rapid within some of the larger states in our footprint. For example, Florida, which is about 1/3 of our deposit base, saw unemployment peak at above 11%. But we've seen a 3.3 percentage point decline over the past 3 years, and the pace of that improvement has been most pronounced within the last year. Our markets are clearly recovering, and we're better positioned to leverage that improvement.
Let's turn now to the discussion of our strategic priorities, how they translate operationally through the organization and the impact they're having on results. This slide provides a high-level view of what we've set out to do and how we're accomplishing that. I'll go into more detail on our progress on each of these priorities over the next several slides. Our first major strategic priority is to optimize our balance sheet and business mix. Our efforts here have been centered on improving the diversification of our loan portfolio, increasing C&I and consumer loans while decreasing the concentration of residential real estate. At the same time, we're also focused on achieving better diversification from a business mix standpoint and in particular, expanding our wholesale business.
The next strategic priority is to deepen share of wallet and drive market share. There's a real opportunity to monetize the loyalty we've built over the last several years by expanding our relationships with existing consumer clients. We also have opportunities in mortgage banking to increase our share. You're all aware that a primary priority for us is to improve the efficiency of the organization, with a stated objective of reducing our efficiency ratio to under 60%. Ongoing actions to eliminate operating expenses and the natural abatement of cyclically high costs are key components of achieving that goal. Underpinning all of this is our drive for excellence and execution and building a performance-winning culture. We have been transforming our corporate culture around these objectives as they are key to maximizing our opportunity. Excellence in execution speaks to our need to have a more standard, measurable and repeatable process to reduce performance variability, ensure a more consistent experience for clients, improve productivity and reduce risk. Part of this is ensuring accountability through enhanced role clarity, rigorous performance management, which is our other foundational element building a performance-winning culture. In a relationship-driven industry, teammates are among our most valuable assets. As such, we're dedicated to attracting and retaining top talent across the organization. We're also increasing the rigor of our pay-for-performance culture, ensuring that we pay for outcomes, not just effort, and focusing even more on the long-term development of our teammates.
I'll now delve deeper into the corporate priorities, starting with our efforts to optimize the balance sheet and business mix. We've made notable progress in better diversifying the loan portfolio via reducing our concentration of real estate loans and increasing our C&I guaranteed and consumer portfolios. In 2009, non-guaranteed mortgages, home equities, CRE and construction loans totaled half of our portfolio. Today, they're down to 36%. Over this same time, we've more than offset this decline with growth in the remaining targeted loan categories. As we look to the future, we expect the largest growth driver to continue to be C&I. We also believe now is an opportune time to grow commercial real estate. On the flip side, we expect to continue to reduce our residential real estate exposure as a percentage, and the guaranteed book is also expected to decline in both dollars and percentage.
Turning to the next side, let's take a closer look at our recent C&I and consumer loan growth. You can see that growth in both of these targeted categories has been strong over the last 2 years. C&I balances are up 20%, with most of the growth coming from our larger corporate clients and across a diverse array of industry verticals. At the same time, we've been focusing on growing our consumer book, and you can see that we've gained traction here as well, with all of the underlying categories up by at least 25%.
Now let's take a closer look at our Wholesale business, including where we've generated momentum and where we see opportunity. SunTrust Robinson Humphrey has established a strong track record with revenue and net income expanding to new record levels in recent years. The revenue was generated from a diverse mix of clients, which you can see in the middle of the page. We've significantly improved our revenue generation capacity in this line of business by attracting top talent into our comprehensive model and building key capacities in such areas as syndications, investment-grade and high-yield bond origination and distribution, sales and trading and M&A. This has contributed to 12% compound annual growth and revenue per FTE since 2008. Filling some industry expertise and expanding certain capabilities represents a noteworthy opportunity to leverage the momentum and expand our reach. Furthermore, there's ample opportunity to better penetrate and expand our corporate banking client base. Our commercial and business banking lines of business have been steadily growing over the last several years. Collectively, the profitability of this business is very solid, and we have meaningful opportunity to better penetrate our client base and meet more client needs. We are investing in the client planning process and demanding more from our internal partner engagement model.
For the commercial banking component of this business, we have a goal of 16% growth in client penetration, representing a revenue opportunity well into the tens of millions of dollars.
Now moving to commercial real estate. Over the last several years, this segment was operating in a loss mitigation mode, focusing almost exclusively on maximizing the recovery of distressed assets. With the bulk of those problems behind us, we're now turning to growth. We are employing a very targeted approach of valuating each asset class by individual geographic market. We're targeting clients and prospects that have track records of success and sustainable capital and liquidity structures, where we can realize sizable, profitable relationships. Our resulting portfolio will be more diversified by product and geography. We have plenty of balance sheet capacity for growth, as current CRE loan balances, excluding special asset division loans, are less than 4% of our total balance sheet.
The next major strategic initiative is to deepen our share of clients' wallets or as we direct our teams internally, meet more client needs to drive market share. This opportunity is particularly notable within consumer banking and private wealth management. In late 2009, in conjunction with the Gallup organization, we began tracking client loyalty. We focus on this measure as our research indicated that loyalty drives profitability. In fact, clients who become loyal are 20% more profitable. At the time of our first measurement, SunTrust ranks sixth in our footprint, but we set an ambitious goal of becoming #1 in our market for client loyalty by 2012. Through a series of actions we took to improve service, reduce client pain points, we achieved that goal. Our next phase is to monetize this loyalty as we're not yet the leader in terms of how many of our clients' needs we're meeting. We've identified and have multiple plans in place to help us capture this opportunity, and you'll see some examples on this slide. I won't go through them all, but they include enhanced client segmentation, improving sales management, ensuring teammates have the tools they need to increase productivity, augmenting our team with top talent and refining our product suite. All told, we estimate that a 7% improvement in penetration of our client base would represent a $200 million-plus opportunity in the consumer segment. In addition to this significant revenue opportunity, the efficiency angle here is also compelling as generating more revenue from existing clients is obviously a cost-effective method for growth.
The other notable area where we have meaningful opportunity to drive market share and increase our share of wallet is mortgage. Before I speak to that, though, let me address the current mortgage trends, especially gain on sale. Margins were historically high throughout 2012 and for SunTrust, peaked during the third quarter. We saw some contraction during the fourth quarter, and consistent with the recent primary versus secondary spread compression, the decline has continued in the first quarter. This is expected to drive first quarter mortgage production income lower sequentially. However, the fact that we're seeing some compression off of historic highs is not a surprise, and a directionally lower margin is certainly something that we've planned for in 2013.
While the bias for margin continues to be down, we remain much more constructive about the trends in volume. As a top 10 mortgage producer, our volume will naturally be driven in part by the overall market. However, SunTrust has some unique opportunities which should enable us to increase our share. In the near term, we continue to have meaningful HARP opportunity. We estimate that the remaining HARP 2.0 eligible population within our servicing book is 3x that of which we originated in 2012. Now, of course, not all of the remaining class will ultimately refinance, but we'll be proactively seeking to help as many of them over the course of the year as we can. To this end, we've recently increased our outbound calling efforts, and we really have some good success. This has been aided by the capacity additions we've made to our origination platform, particularly in our consumer direct channel. This channel, which is telephone and online based, represented only 3% of our volume in 2009 but grew to 8% in 2012. Despite this growth, I still think we're under-penetrated here, and we expect our capacity additions to drive notably higher volume in this channel in 2013. Not only is consumer direct the preferred alternative for many clients due to its convenience, but it's also our most profitable channel. So its buildup provides an attractive opportunity to grow market share, combined with higher profitability.
As I mentioned earlier, the Southeastern home prices have been improving at an above-average pace following several years of underperformance. This helps for higher purchase and refinance activity in 2012, lower inventory levels, lower loss severities and overall improving housing sentiment. As one of the largest originators in our footprint, these trends are obviously beneficial. We're also well positioned to capitalize on the eventual shift in industry volume away from refinance activity into purchase volume as we've maintained a meaningful purchase presence throughout the cycle.
The last point I'll make on this slide is the longer-term opportunity we have in meeting more of our consumer clients' mortgage needs. Third-party research tells us that our referrals of mortgage clients to our consumer segment is amongst the best in the industry. However, as you can see from the visual on this page, we have some opportunity going the other direction. Today, of our consumer households who have a mortgage, only 12% of them have their mortgage with SunTrust, whereas we estimate that best-in-class is closer to a 20% penetration. Using round numbers, each percentage point increase in consumer household penetration could generate about $100 million in production revenue on an agency product, which provides us with a potential for a lot of upside as we endeavor to meet more of our consumer clients' mortgage needs. And as you can imagine, we have specific initiatives against this opportunity.
The final strategic priority I'll discuss is efficiency improvement. Our efficiency ratio trended favorably over last year, and we expect to continue making progress in 2013. We've previously established a 2013 tangible efficiency ratio expectation in the 65% range as we progress towards our longer-term target of sub-60%. And I'm confident today that we're well on that path. The improvement in 2012, the improvements were driven by higher core revenue, coupled with stable expenses. For 2013, we expect efficiency ratio improvements will be driven more by the expense side of the equation.
And let's talk about some of the drivers, beginning with the next slide. Over the past several years, we've been investing in technology, including the build-out of our digital and ATM channels. Examples include enhanced mobile and online platforms, remote deposit capture and 1,700 new ATMs with deposit imaging capabilities. Clients clearly value the conveniences of these channels, and the adoption rates have been very, very high. As a couple of examples, mobile banking sign-ons are up over 250% from 2 years ago, and ATM deposits have almost tripled. And with that, it'll come as no surprise to anyone as that client shift -- as they shift to self-service channels, they utilize the branch network less. In light of these changing client preferences, we've reevaluated our branch infrastructure. Declining branch traffic has freed up capacity for us to have more conversations with clients about meeting their needs. It's also enabled us to reduce cost.
Branch staffing is down by 14% since 2010, and we've also begun trimming our branch network. We're down 43 branches during 2012, and we expect about a 40 branch reduction in the first quarter. There'll be some additional closures throughout 2013, with more than half of them expected to come from our in-store network. We'll be reducing the overall number of our grocer partners but maintain our long-standing key partnerships, such as Publix, Safeway, Kroger and Walmart.
Following our anticipated in-store closures, we still have 90% of our in-store branches within a 5-mile radius of a traditional branch, plus maintain a dominant 50% in-store deposit market share within our footprint. This is a good example of how our concentrated branch network, as well as our mix of traditional and in-store branches, affords us flexibility and the opportunity to consolidate without a lot of lost relationships. In fact, historically, we've been able to retain 90% to 95% of the deposits from branches we've closed, and the early indications are that we're on that pace. I'd also point out that because our branch closings will be skewed towards in-stores, overall, our whole effort will only be impacting about 2% of our overall deposit base. So while the number of branches will be declining, I'll note that branches, though, remain a very important part of a banking relationship. They're still where most new products are sold and where clients typically go to resolve a problem. So while the role of the branch may be changing, they remain a key sales and service distribution channel.
Overall, SunTrust is transitioning from episodic initiatives to a continuous improvement mindset with a clear objective of reducing our efficiency ratio. This includes an ongoing focus on core operating cost. You'll see several examples listed on this slide, and I'll take a moment to highlight a couple.
First, we're operating the company today with about 9% fewer FTEs than we did in the third quarter of 2011, which was when we began some of our efficiency focus in earnest. And I'd point out over the same time, we've increased revenue and maintained client loyalty. We've become leaner, more intentional and more effective. Going forward, staffing levels, talent management and performance standards will continue to be areas of focus. We'll also be looking at staffing levels in our default management area. We peaked at over 1,700 FTEs in this group in 2012, which compares to about 400 pre-cycle. In light of the fewer problem assets, default management FTEs are down today by about 10% from their peaks, and we expect the declining trend to continue, which will enable us to redeploy certain teammates into more productive roles.
Lean processes are another area of focus, and we've had some notable wins in terms of improving cycle times, reducing error rates and just plain saving money. We're also evaluating our real estate needs and reducing our overall occupancy requirements. Concurrent with our focus on operating costs, we expect to have some tailwinds via declining credit-related costs and operating losses. Such costs totaled over $900 million in 2011 but fell to $656 million in 2012, and we continue to expect a meaningful year-over-year decline in these costs in 2013, as well as for them to ultimately normalize somewhere around the $325 million range, plus or minus.
In summary, while we have room to grow, I like the higher level of intensity we're developing on expenses and the cyclical cost abatement is additive to that. You saw the benefits of this with our fourth quarter noninterest expense declining, and we're forecasting an expense decline again in the first quarter.
Now I'll conclude my prepared remarks today on Slide 21, with a recap of the main themes I presented, which, in aggregate, I think makes SunTrust a compelling investment opportunity. We have an attractive franchise with the right size to compete effectively. We have a strong market share in the majority of the markets that we serve, and the Southeast has very attractive long-term growth prospects.
Furthermore, we have a diverse revenue and business mix. Core earning trends were increasingly favorable in 2012, and our credit quality has improved substantially. Concurrent with that, we have some tailwinds as we anticipate ongoing credit improvement and meaningful declines in our cyclically high cost. We also have the benefit of improving housing prices and employment in our footprint. And lastly, we have strategic priorities that are designed to help us grow from here.
I hope you've gotten a good feel for these plans today. So in summary, I think we have a lot of opportunities ahead of us. The intensity is very high across SunTrust, and we have a keen focus on capitalizing on our franchise's potential.
With that said, I'll be happy to answer any questions.
Thanks a lot for your comments today. Just kind of getting back to the efficiency ratio, I appreciate the detail around it, but if you think about where you were in the fourth quarter, roughly 66%, and your long-term goal of 60% and kind of the 3 levers that are really working for you, as I define them, the decrease in environmental costs, the kind of operating efficiency improvements and then obviously, a revenue uptick, if you were to kind of segment how much benefit you'd get from each one of those 3, I understand it's a combination, but kind of where you see the most opportunity and where you think maybe there may not be as much opportunity.
William Henry Rogers
Yes, in 2013, as I mentioned, I mean, I think in 2012, we had a good combination of, really, revenue improvement. I think sort of we went from $2.2 billion a quarter. We added about $100 million to that, and expenses were essentially flat. So that's really how we achieved the efficiency ratio. 2013 is going to be more about expenses. That's going to be more of the focus. So if you put those in the 3 buckets, certainly, the cyclical cost and the core operating cost are going to be the primary drivers of that initiative. Cyclically high costs are sort of -- they're harder to predict. I think they'll be bumpier and more episodic as we go down. And on the controllable costs, you've seen the efforts we've put in terms of reduced FTEs. We're operating, really, the company with a completely different chassis size, chassis than we did in 2012. So the focus will be on the latter 2.
On the gain on sale, spread compression, you mentioned, could you maybe quantify what you expect to see there? And then also, do you see that accelerating, decelerating from here?
William Henry Rogers
Yes, if you look at sort of where we are today from our peak in the third quarter, and I guess everybody might have peaked at a different time, gain on sale is down about 1/3 from where it was at its peak, although it is some percentage, let's call it north of 50%, above where it has been, sort of at low points in the past. It's hard to predict exactly sort of where the new normal is going to be. I do think there are fundamental things that have changed in the industry. There are fewer players. The barriers to entry are much higher. The cost of delivery, with the exception of things that we're doing, but the cost of delivery for the industry as a whole are higher. So I think there are fundamental changes in the business that would be barriers as to us going all the way back to where we were before. So I think there is probably some more downward pressure than there is upward pressure, but I don't think it's going to fall at the same sort of pace it's fallen over the last 2 quarters. That answered your question?
Given the significant improvements that you mentioned on house prices and employment, why is it taking so long for your credit cost to normalize?
William Henry Rogers
Yes, we've got a couple of things that take longer. So if you think about credit cost in terms of maintenance of a real estate portfolio, remember that the bulk of our portfolio is in a judicial foreclosure state. And Florida, as a particular, has a just under 2 years, in some cases, full cycle to go through in terms of getting control of the asset. So during that whole time, we on the asset -- and we're experiencing the cost of that, and the cost of assets in a state like Florida are higher than the rest of the country. It's a nonpersonal income state, so they're higher property taxes, insurance taxes, some of the coast wind, you have to insure against, and those costs are typically higher. So part of what you saw us do in the third quarter, for example, with the sale of some assets, 75% of those were in judicial foreclosure states because we just felt like we needed to do something to start generating momentum on that basis. But there is just a natural lag effect that's somewhat unique to us.
And just getting to -- changing direction a little bit, looking at the C&I loan growth and how that's trended, can you think about a competitive environment, even in 1Q versus 4Q? Could you just give us a little bit of color on pricing and maybe competition around other things, like structure and term?
William Henry Rogers
Yes, I think it has clearly become a very competitive market. I don't know geographically -- within our markets, it doesn't appear to be particularly different within any particular geography. Some of the industry verticals might be a little more competitive from a structure standpoint than some of the others. But clearly, in the first quarter, the competition has increased. That wouldn't be surprising if you look again at the H8 data and you sort of see where loans are as a total. You sort of have natural forces of supply and demand. But competitive on pricing, competitive on structure. Most of the structural things we've seen have been more term-oriented than leverage-oriented. So something that might have been a 3- to 5-year loan now is a 5- to 7-year loan and stretching out on the term side. I haven't seen as much in sort of the middle market core commercial sort of pure leverage. We do see that on some of the industry verticals, and where we see that, we're throttling back. If it gets to a point where it doesn't meet our criteria, we're throttling back and putting emphasis in other places.
Can you give us a walk-through on your target to 60% efficiency, how that might unfold over the next several years?
William Henry Rogers
Yes, you want to take a crack at that one?
Sure. So for 2013, you saw we put out an objective of 65% longer term, the 60% goal, as you noted. As Bill mentioned earlier, I think the key levers in 2013 will likely be on the expense side, meaningful declines in the cyclical cost, as well as on the operating side, continuing to find ways to reduce that. As we transition into '14 and beyond, we'd see revenue will kick in, in a more meaningful fashion, and we got clear initiatives against that opportunity as well. So nearer term, I'd expect to see the improvements from the 70s, what were reported for the full year 2012, down to 65% range for 2013, really driven by the expense side, and on a go-forward basis, revenue will help get us to the finish line, if you will.
William Henry Rogers
And we try to put a stake on the ground today on what would be normalized cyclical expenses. I mean, in fairness, I think it's got a lot of plus and minus to it. But we felt it's important to sort of put that in, so you can get a clearer picture of how we get to 60%.
Well, thanks a lot to both of you guys from SunTrust, and thank you to everyone here [indiscernible].
William Henry Rogers
Great. Thank you. Thank you for coming.
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