SunTrust Banks Inc. (NYSE:STI)
Q4 2009 Earnings Call
January 22, 2010 8:00 am ET
Jim Wells - Chief Executive Officer
Mark Chancy - Chief Financial Officer
Tom Freeman - Chief Risk Officer
Bill Rogers - President
Steve Shriner - Director of Investor Relations
Scott Valentin - FBR
Brian Foran - Goldman Sachs
Ken Usdin - Bank of America Securities
Nancy Bush - NAB Research
Jason Goldberg - Barclays
Craig Siegenthaler - Credit Suisse
Kevin Fitzsimmons - Sandler O’Neill
Welcome to the SunTrust fourth quarter earnings conference call. Parties will be on a listen-only mode until the question-and-answer session of today’s conference. (Operator instruction)
I’d like to introduce your speaker, Mr. Steve Shriner, the Director of Investor Relations.
Good morning, welcome to SunTrust’s fourth quarter earnings conference call. Thank you for joining us. In addition to the press release, we’ve also provided a presentation that covers the topics we planned to address during the call today. Slide two outlines the content, which includes an overview of the quarter, financial results discussion and an in-depth credit review. Press release presentation and detailed financial schedules are available on our website, which is www.suntrust.com. This information can be accessed by going to the Investor Relations section of the website.
With me today, among other members of our Executive Management team are Jim Wells, our Chief Executive Officer; Mark Chancy, our Chief Financial Officer; and Tom Freeman, our Chief Risk Officer. Jim will start the call with an overview of the quarter, Mark will then discuss financial performance, and Tom will conclude with the review of asset quality. At the conclusion of formal remarks, we’ll open the session for questions.
Before I get started, I need to remind that our comments today may include forward-looking statements. These statements are subject to risks and uncertainty, and actual result to differ materially. We list the factors that may cause actual results to differ materially in our press release and SEC filing, which are also available on our website.
Further, we do not intend to update any forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made and we disclaim any responsibility to do so. During the call, we’ll discuss non-GAAP financial measures in talking about the company’s performance. You can find the reconciliation of these measures to GAAP financial measures in our press release and on the website.
Finally, SunTrust does not responsible for and does not edit nor guarantee the accuracy of our earnings teleconference transcripts provided by third parties. The only authorized live and archived webcast are located on our website.
With that, I’ll turn it over to Jim.
Good morning, again. I’d like to join with Steve and thanking for being with us this morning. As has been the case for several quarters now, our results were affected by the challenging economic environment. We reported $0.64 per share loss for the fourth quarter and $3.98 loss for the full year. As you would expect in this type of operating environment revenue was soft, loan demand was down and asset quality was weak.
So like last quarter, they were certain positive operating trends. The most notable positive in the fourth quarter was improved credit trends from the prior quarter. Both credit losses and early stage to delinquencies declined, and non-performing loans were stable. Further deposit growth and the positive mix shift continued. The Net interest margin significantly expanded and certain businesses delivered very solid revenue growth.
Now before we provided detail on the results, I want to point out that our optimism is certainly tempered during those positive trends, especially those related to credit. The economy remains far from strong and there’s more uncertainty and then clarity in the outlook.
As I’ve said before, the beginning of recovery is just added to beginning, history tells us that it will take sometime before economics stabilization meaningfully translate in the bottom line results. Asset quality revenues and ultimately earnings improvement will need time to gain transaction and that timing is largely dependent from the strength and sustainability of the economic recovery.
Now taking a closer look at the overall results, revenue remains soft with stable net interest income and a small increase in non-interest income over the same quarter last year. Unchanged net interest income was the result of a significantly improved net interest margin, which was offset by the reduction in average earning assets.
An increase in client deposits, improved mix, and lower rates paid enabled the reduction in higher cost sources of funding and pushed the margin higher, while loans and earning assets declined more rapidly, offsetting that benefit. What we’re seeing is that sustained economic weakness has reduced demand for loans as clients have focused on capital preservation and debt reduction and many have also accessed the debt markets in lieu of bank loans.
Additionally, overall fee revenue remains cyclically soft, reduced consumer spending was evident in the declined in many fee related sources of income throughout there the year. Those I mentioned, there were selective positive trends that emerged. For instance, investment banking income improved significantly over 2008 to a record level. Capital markets activity was higher in 2009, and as the year progressed, and numbers reflected the improved operating environment for our corporate and investment banking businesses.
In commercial banking, we’ve been able to improve loan spreads, despite the fact that the appetite for loans has been weak during the recession. Further while deposit growth was cyclical, there are strong indications that a part of the employees was SunTrust specific. We are improving client satisfaction and getting to the drivers that build loyalty by understanding individual preferences and learning our business models to respond.
As a result, we’ve increased client satisfaction and it showed up in our deposit numbers in 2009. This reflects favorably on the tremendous effort being put forth by our team to improve client retention and acquisition capabilities. The result of disciplined expense management was evident again across controllable operating expenses this quarter.
As you’ve haired me emphasize before, we continue to capitalize upon the strength we have built in this area, and we remain focused on continuously uncovering efficiency and improving opportunities. Cyclical costs including other real estate, FDIC, pension and credit, and collection costs remain high.
On the asset-quality front, we are quite pleased with the lower charge-offs and improved metrics generally. I was alluded to earlier, we’re not ready to declare a victory, in fact we believe charge-offs will increase modestly in the next quarter. Tom Freeman will provide more commentary on credit expectation later on.
It all comes down to this that all of those sum things, notably the economic and regulatory environment are ultimately out of our control. I believe we are doing a very good job of controlling the things that we can control. We are laser focused on improved credit and risk related results.
At the same time, we are focused on the client on improving service quality and front line execution, while controlling expenses and managing risk. The positive results of our efforts are reflected in various aspects of our core performance over the last few quarters. Our continued success in these areas will permit us to deliver steadily improving results as the credit operating environment improves.
Turning to slide four, I’d like to talk about our capital position, before turning the call over to Mark. Slide four illustrates our significant capital position and our book value per share. We maintain a solid capital position with an estimated Tier 1 common ratio, 7.65% and a Tier 1 ratio of 12.90%.
Capital ratios increased as the decline in risk related asset more than offset the reduction of capital due to the earnings loss in the fourth quarter. We continue to have substantial liquidities, the aforementioned inflow of deposits have been largely retained in cash and invested in high quality government-backed securities. Book value was $35.29 and tangible common was $22.59 at the close of the year.
A final note on capital, given a 9.5% Tier 1 ratio, excluding TARP, and our current capital and liquidity, we are well positioned to repay TARP when regulatory approval is received. I’ll conclude by underscoring a point of this is true today it has been in throughout 2009.
SunTrust continues to operate from a position of strength, and we are focused on growing revenue, improving expense efficiency, increasable the profitability of the balance sheet, investing for the future, and prudently managing credit. Our strong foundation coupled with our client focused execution, broad risk mitigation capabilities, and the long term economic prospects of our markets all position us to deliver improving financial performance as we move beyond this cycle.
Now, I’ll turn it over to Mark. Mark.
Thanks, Jim and good morning, everybody. I’ll begin my comments today on slide five of the earnings presentation with a summary income statement. For the quarter, we posted a loss to common shareholders of $316 million or $0.64 per share.
As has been the case in recent quarters, our financial results continued to be dominated by credit losses, cyclically sensitive expenses and to a lesser extend soft revenue generation in certain units. In particular for the quarter, loan demand remained weak, and mortgage production income was negatively impacted by the cost associated with the potential repurchase of mortgage loans originated and sold the government agencies in prior periods
On the other hand, there are some positive operating trends that I will also point out. Most notably is the decline in provision, primarily driven by lower charge-offs. Additionally, margin and net interest income increased as the deposit mix continued to improve, while core client deposits grew. I’ll cover this reported result in more detail in just a minute.
For the full year 2009, the loss to common shareholders was $3.98 per share, and $2.34 per share, if you exclude the impacted of $750 million in goodwill impairment reported in the first quarter. In addition to the impact of goodwill impairment on expenses, there were several areas driving a net loss in 2009, compared to a profit in 2008. The biggest impact of course was credit quality. Provision for credit losses increased by $1.6 billion, as charge-offs rough doubled to $3.2 billion, and we increased the allowance for loan losses by one-third to $3.1 billion.
Non-interest income decline by $760 million, compared to 2008’s level, and while overall fee generation was somewhat impacted by recessionary pressures. The decline was largely due to the absence of gains associated with the Coke stock transactions that were completed during 2008. The final item of note is the full year cost of dividends on the TARP preferred securities, which increased to $266 million. So with that brief summary of 2009, I’ll now provide more detail on the fourth quarter result, starting on slide six with the balance sheet summary.
Overall, average loan balances excluding non-accruals declined 4% and 12% as compared to last quarter, and last year respectively. Decline in balances in our higher risk categories continued, but we also experienced the decline in certain of our higher quality categories. On the higher risk side, construction balances continued their rapid decline, down another 12% in the current quarter, and down 47% compared to last year. The residential mortgage and home equity line portfolios also continued their downward trend.
On the higher quality side, commercial and industrial loans declined 8% sequentially, and are down 19% compared to the fourth quarter of 2008. This reduction resulted primarily from a continued trend of declining line of credit utilization among our mid sized and larger corporate clients due to lower working capital needs, and enhanced access to the capital markets during the quarter, which resulted in loan pay downs.
However, the pace of decline did slow during the quarter, and in the financial tables we published today, you can see evidence of this, in the roughly equal year end and fourth quarter average balance figures, and in the lower period and sequential quarter decline of 3%, versus the 8% on average. While we are pleased at the pace of decline slowed, it is too early to tell, whether or not this trend will be sustained as we move into the first quarter of 2010.
Relative to loan volumes, please note that we expect an increase of approximately $2 billion in loans and loans held for sale, as a result of implementing FAS 167 in the first quarter. This consolidation is expected to have minimal impact on capital ratios, and net interest margin, and there is a slide in the appendix that will provide some additional information on this topic for your review.
Now, moving onto deposits at the bottom of the slide, where you can see that lower cost deposits continued to grow, while higher cost deposits continued to shrink. We noted last quarter, that the pace of growth in deposits had moderated. While growth picked back up this quarter, it is primarily a seasonal increase. Nonetheless, overall average consumer and commercial deposits, increased 2% sequentially this quarter, and remained up 14% on a year-over-year basis.
While maintaining competitive pricing in our markets, CD balances declined in the quarter, as we have continued to carefully manage the tradeoff between price and volume, given our increased liquidity position. Finally, while there wasn’t much change on a sequential quarter basis, please note that brokered and foreign deposits have been reduced by over $7 billion or nearly 60% compared to the same quarter last year.
Our current liquidity position has enabled us to take actions I just mentioned to refine and lower the cost of our funding profile. In addition to these actions, we have also increased our securities portfolio, so please turn to slide seven for a brief review of the available for sale portfolio securities.
The portfolio continues to be concentrated in higher quality and very liquid securities. Government and agency securities in the first four rows of the table comprise over 85 % of the portfolio, and as a reminder, the other equity holdings are largely Coke stock, Federal Reserve, and federal home loan bank stock.
During the quarter, we increased our holdings of U.S. Treasury securities to over $5 billion. These securities are held at the holder company level specifically in anticipation of ultimate TARP repayment upon regulatory approval. The agency mortgage-backed securities portfolio increased by over $3 billion. This increase along with a net gain of roughly $70 million realized during the quarter represents a continuation of the portfolio repositioning begun at the end of the third quarter, and continued in the fourth quarter.
Given the growth in the securities portfolio during 2009, and where we are in the rate cycle, let me take a minute to describe how we are thinking about managing this portfolio in 2010. The significant 2009 portfolio growth was driven by two key factors: strong inflow of deposits and declining loan demand. We expect both of these trends to moderate and potentially reverse course in 2010, and as a result, we do not anticipate continued portfolio growth.
That being said, we will continue our strategy of maintaining the vast majority of our portfolio in highly liquid, U.S. government, and agency debt, and mortgage-backed securities. We believe that this approach allows us to generate returns on our excess liquidity, while retaining maximum flexibility to respond the changes in the environment.
I’ll now take a minute to cover the margin on slide eight. Margin expanded again this quarter, increasing by a better than expected 17 basis points to 327. We’re very pleased with this result, as we were able to reduce deposit pricing more than expected, while at the same time growing core deposits faster than anticipated. Additionally, increased liquidity from deposit growth, coupled with declining loans facilitated a reduction in higher cost debt and federal home loan bank advances.
Our current expectations for the margin in the first quarter, is for modest compression the full quarter impact of holding $5 billion in treasury securities, and the first quarter consolidation of three pillars, which is our off-balance sheet conduit, are both expected to have a small negative impact on margin.
Additionally, we expect to experience a seasonal decline in deposits. However, even as these items place some downward pressure on margin, we expect continued progress on loan and deposit pricing to partially mitigate the extent of compression.
Moving to slide nine and provision expense; Tom will cover credit in detail in just a minute, so I’m going to be brief here. Total provision for credit losses for the quarter was $974 million, down $160 million from the third quarter. Now beginning in the fourth quarter, we have combined the traditional provision for loan losses with the provision for unfunded commitments into a total provision for credit losses. The provision for unfunded commitments was included in other non-interest expense in prior periods.
Provision for loan losses actually declined over $200 million versus the third quarter, excluding the provision for unfunded commitment reserves. This reduction was driven by $185 million, or 18% decrease in charge-offs, and a slower pace of reserve building. The allowance for loan and lease losses was increased $96 million to $3.1 billion, or 276 as a percentage of loans, while the unfunded commitment reserve increased $57 million to $115 million.
Now moving on to non-interest income on slide 10; reported non-interest income growth in the quarter was down 4%, and up 3% as compared to last quarter and last year respectively. After adjustments for a number of items in each quarter, non-interest income declined by 16%, and 11% respectively. The adjustments primarily relate to fair value marks, securities gains, and impairment and recovery of mortgage servicing rights carried at the lower of cost or market. As in prior quarters, we provided the underlying detail in the appendix of today’s presentation.
In the current quarter, the largest adjustments are for securities gains that $73 million related to the repositioning of the securities portfolio I discussed a minute ago, and a $38 million valuation loss on a fair value debt and related hedges. During the third quarter, the loss associated with the fair value debt was $131 million, at SunTrust credit spreads continued to improve during both periods.
The primary reason for the decline in adjusted non-interest income is increased mortgage repurchase cost. I’m going to talk about more in detail on the next slide. Excluding this driver produces adjusted growth of 8% on a year-over-year basis, and a 5% decline on a sequential quarter basis.
The sequential quarter decline was due to lower investment banking, and core trading revenue, and lower mortgage production and servicing income. The sequential decline in investment banking revenue was due to lower equity origination in Syndicated Finance volumes coming off of a very strong second and third quarter performances.
Core trading declined sequentially primarily due to lower revenues from fixed income and equity derivatives. Mortgage production revenue declined sequentially due to a 27% decrease in a closed volume, and an 11% decrease in application volume. Mortgage servicing revenue declined given a reduction in the out performance our fair value MSR hedge.
Now, please turn to slide 11, I’m going to provide more detail on the mortgage repurchase trends. This slide depicts the 2009 trends experienced with mortgage repurchases. Before I get into the details, let me remind you that these loans and reserves are for representation and warranty claims associated with mortgages originated by SunTrust and then sold to government-sponsored agencies with servicing rights retained by us.
Reserves for this repurchase liability are originally established by vintage when the loans are sold, and are accounted for as a reduction in mortgage production income. As credit loss is associated with these loans have exceeded the original estimates at the time of sale, we are now recording higher losses and increasing reserves for loans sold in prior periods.
Another thing to note is that while these are called repurchase request, more often than not we settle the claim with a make whole payment to the investor in lieu of actually repurchasing the mortgage. To the extend we do repurchase the loan are reflected in our non-performing loan categories.
On the top left portion of this slide, shows the increasing impact on earnings and growth in the reserve during 2009. To the right, is a graph that illustrates the underlying reasons for the increased impact, indexing new repurchase request, and the period-end inventory of pending request to fourth quarter 2008 level.
As you can see, after dipping in the first quarter, new repurchase claims from the agencies have steadily increased. On the other line, you can see that in spite of increasing requests, SunTrust has made significant progress in the second half of 2009 in reducing the backlog of pending requests.
Given the rising level of requests, we had more information available to us to use in our analysis and we’ve significantly augmented the granularity of our analytics during the second half of 2009, by analyzing the population of sold loans by vintage and product in relation to our recent repurchase experience. We believe that we have increased the precision of the current reserve estimate.
In addition, some underlying trends give us reason to be cautiously optimistic about future losses and reserves. Specifically, on the bottom left of this slide, you can see the vintage of repurchase request has shifted from older to newer-vintage loans. On the right hand side, you can see that the risk profile of the newer vintages is significantly lower. For example, the original loan-to-value declines with newer production even as home prices were continuing to decline.
This suggests significantly lower loss severity as the repurchase request shifted to newer vintages. Also, in addition to the statistics presented, be tightened credit, and underwriting guidelines, added enhanced fraud detection tools and implemented a whole host of process improvements that cause us to believe that the rate of successful requests will decline overtime.
In conclusion, the increased demand activity has allowed us to recalibrate and refine the precision of our estimate of incurred losses, and as a result, we have more confidence that the reserve should not increase significantly from here. As for charge-offs, fourth quarter request volumes and vintage composition suggest that losses are likely to remain elevated forth over at least the next quarter or two.
Declining charge-offs and reserves during 2010 are dependant primarily upon a shift in request volume to newer loan vintages and no significant deterioration in the overall asset quality of all loans within agency securities.
Now turning to slide 12 for review of expenses, non-interest expense declined 8% when compared to the fourth quarter of 2008, and increased 2% compared to last quarter. On this slide, we have adjusted for some items that are relatively modest in amount they are detailed in the appendix of today’s presentation.
A largest adjustment in the quarter is a net $24 million in debt extinguishment costs primarily related to the early termination fees associated with home loan bank advances that were repaid during the quarter. These advance termination were a component of the steps we took during the quarter, to repay wholesale funding and improve margin due to the strong liquidity position we currently enjoy.
Excluding adjustments, expenses are down 10%, compared to the same quarter last year, and up only 1% compared to last quarter. Now even though these numbers are positive at face value, there are a few items impacting the comparison that warrant additional explanation and are listed in the lower section of the slide.
Now let me explain the schedule. The total year-over-year decrease in adjusted expenses is $157 million. As you can see, the sum of the expense items under the expense analysis is a decrease of $181 million, and therefore, the expense change net of these items is an increase of $24 million noted at the very bottom.
What this means is that the large decline in expenses is driven by the decrease in credit-related costs associated with fraud and mortgage re-insurance losses, and partially offset by higher FDIC premium and pension expenses. The net of all the remaining expense increases of $24 million is only 1.5% of our adjusted fourth quarter 2008 base.
The conclusion of the sequential quarter analysis is similar, with declines in other real estate expense and unfunded commitment reserves, partially offset by increased FDIC premiums. The remaining sequential quarter increase in expenses is largely due to personnel and marketing expenses.
Personnel expenses increased for incentive compensation primarily related to improved performance in certain businesses as headcount remained relatively constant. Advertising and marketing expense was also stepped up in support of our client acquisition, and retention efforts.
Let me sum up the company’s financial results during the fourth quarter. SunTrust Capital ratios and liquidity position improved. Our deposit levels increased, and the mix was further enhanced and net interest margin expanded. Provision expense declined on lower charge-offs and a smaller addition to the reserve. However, the operating environment continues to be challenging for revenue and cyclical expenses. Loan demand remains weak, and certain fee income categories continue to be soft, while expenses associated with asset quality continued to weigh on performance.
It goes without saying that 2009 was a difficult year. However, while the pace and strength of the economic recovery remains uncertain, we are encouraged by emerging asset quality trends and by elements within our operating performance and as such, we are looking forward to improving financial results in 2010.
With that, I’ll turn the call over to Tom Freeman to discuss asset quality.
Thank you, Mark. This morning, I’m going to review our asset quality, beginning on slide 13. As Jim mentioned earlier in the call, we noted some asset quality stabilization this quarter. Short term delinquencies, 90 day-plus delinquencies and charge-offs all continued to decline, along with entrance in to the foreclosure queues.
Non-performing assets remained flat for the quarter. This is notable as the fourth quarter particularly, for consumers is seasonally expected to show increases in default and delinquencies. In fact, charge-offs declined in every category with the sole exception of construction, where we continued to make progress in the workout of our residential construction book.
Please turn to slide 14 for a review of the loan portfolio. This portfolio view of asset quality illustrates our fourth quarter improvement in both charge-offs and early-stage delinquencies. While trends showed improvement, absolute asset quality issues remained centered in the residential real estate related portfolios, including residential mortgages, home equity products, and residential construction.
The commercial portfolio continues to perform reasonably well overall. Commercial loan charge-offs, early-stage delinquency and non-performing loans all declined in the quarter. We continued to see stress in more cyclically sensitive industries, and our small business portfolio with improvements in large corporate. We expect that we could continue to see variability in asset quality in the C&I portfolio from quarter-to-quarter due to the nature of the investment grade portfolio.
The commercial real estate portfolio, including owner-occupied and income producing properties is performing satisfactorily overall. The charge-off ratio in the quarter declined to single digit basis points, where it was during the first half of the year. While early-stage delinquency improved slightly.
As a reminder, the majority of charge-offs last quarter related to one loan secured by an owner-occupied property to a manufacturer supplying the auto industry. Non-performing commercial real estate loans increased in the quarter to just over $400 million, or 2.6% of the portfolio. The increase incurred in a variety of property types, including office and hotel.
Additionally, all of the increase was in smaller loans with the largest being $7 million. Given conditions in the commercial real estate market, we expect stress and credit losses in this portfolio. However, we also expect it to perform relatively well given its composition. We continue to monitor this portfolio closely, and are proactively working with clients to strengthen loan structures and to address future maturities as appropriate.
Asset quality in the consumer portfolio has held up well in the quarter, especially given that the fourth quarter is a typically seasonally weak time of the year. Charge-offs and early-stage delinquencies were stable to declining in almost all of our non-residential secured consumer portfolios.
The only exception was in the consumer-direct portfolio, which is largely comprised of federally guaranteed or privately insured loans that caused the increase. Excluding student loans, the early-stage delinquency ratio for the consumer direct portfolio was 107 basis points.
I’m going to talk about each of the higher risk residential real estate secured and construction portfolios in detail in a moment. So for now I will summarize. Home equity performance improved slightly as charge-offs declined while early-stage delinquency rolled back to the second quarter level.
Charge-offs in the residential mortgage portfolio dropped 14% on declining frequency and stable severity, while early-stage delinquencies continued to decline. Construction charge-offs trended up again after nearly doubling in the third quarter as we continue to aggressively work through the problem credits in our residential construction portfolio.
Next I’m going to discuss our real estate secured portfolios in more detail, beginning with the residential mortgage portfolio on slide 15. The residential mortgage portfolio continued to show signs of stabilization during the fourth quarter. Although on an absolute basis, this portfolio continues to perform poorly.
Annualized charge-offs in the fourth quarter, were 4.4%, and non-accrual loans continued to increase. However, charge-offs declined in the quarter, non-accruals increased at a slower pace, and 60 day-plus delinquencies remained stable.
The trends we’ve noted in past quarters continued this quarter. Specifically, Florida-based loans comprise roughly a third of the portfolio, and contribute to well over half of the asset-quality issues. Also, balances in most of the higher-risk portfolios continue to runoff.
Overall, deterioration continued to slow. With fourth quarter results augmenting last quarter’s perspective that asset quality may be stabilizing, at least from a frequency perspective. However, we continue to expect sustained softness in jobs across our markets, and weakness in home values, particularly in Florida.
These expectations suggest that loss severities may increase while frequency of loss declines. Our outlook for charge-offs in this portfolio is an expectation that the level of charge-offs will remain elevated for at least the next two quarters, and may increase depending upon home price stability and unemployment levels.
Moving to home equity lines on slide 16; over two-thirds of the home equity line core portfolio is performing relatively well. Elevated credit metrics are largely driven by the highest risk, 30% of the portfolio. Third-party originated, Florida, and higher loan to value in general.
These higher-risk segments continued to decline, as they’re in runoff with little line availability and no new production. Overall, this portfolio was displayed stable or better asset quality metrics for all segments. However, this continues to be a portfolio under stress, and we believe losses will remain elevated at least in the short run.
Now if you will turn to slide 17, I will talk about our construction portfolio. As expected, and continuing a multi-quarters trend, balances declined by 10% again this quarter to $6.6 billion, or 6% of our total loan portfolio. Construction to perm portfolio balances and non-performers continued to wind down, as new production remains minimal and workouts continue on the non-performers.
Residential builder charge-offs increased again this quarter, as we continue to manage the portfolio through foreclosures and workouts. As a result, non-performing loans declined somewhat again this quarter. Perhaps more importantly, 30 days plus delinquency declined significantly again this quarter.
This means that the inflow of new problem loans declined and as further evidence of progress in resolving the risk in the residential builder portfolio. At this point, we believe that the residential builder portfolio non-performing loans are at or near their peak. The vast majority of the problem loans in the portfolio has been identified and is in the workout process.
We expect related charge-offs will remain elevated, but declining over the next two to three quarters. Credit performance in the commercial construction portfolio remains acceptable overall. Balances decline, charge-offs and non-performers increased modestly, and delinquency declined significantly in the quarter.
Please turn to slide 18 for an update on allowance in non-performing loans. While non-performing loan levels are not an input into our allowance process, the ratio of allowance to non-performers is a commonly used metric in assessing the adequacy of the loan loss reserve.
We provide this disclosure again this quarter as our coverage ratio was below some other banks. This is due to our asset quality issues being skewed towards consumer loans secured by residential real estate in the judicial foreclosure state of Florida. Given the extended time lengths to foreclose in Florida, on average 18 to 24 months, we expect our NPL levels will remain elevated throughout 2010.
As a reminder, this slide incorporates the analysis of residential mortgage and details that is included in the appendix of today’s presentation into a framework that includes our FAS 114 reserves. The result of this analysis is that our allowance coverage of non-performing loans increases from 59% to 113%, when you factor in the impact of mortgages that have been through the write-down process, and launch with specific reserves.
The base coverage ratio has improved each of the last two quarters. A table of the FAS 114 reserves for commercial loans by business segment is also included on this slide. We’ve included this detail to provide you some perspective on the level of specific reserves and implied severities in our larger impaired loans, while overall implied severity varies by business segment, the average is 34%.
Please turn to slide 19 for a review of our mortgage modification efforts and resulting trouble debt restructures, or TDRs. First I’d like to note that 97% of these TDRs are first and second lien residential mortgages, and home equity lines of credit, not commercial or commercial real estate loans.
Also, as a reminder from last quarter, we are aggressively pursuing modifications when there is a reasonable chance that the modification will allow the client to continue to remain in their home. When there has been a loss of income, such that the client cannot reasonably support even a modified loan, we are strongly encouraging short sales and deed and lieu arrangements and relocation to more affordable housing.
Dollar growth in total TDRs in the fourth quarter was roughly equivalent to the growth in the third quarter. At the end of the fourth quarter, accruing TDRs totaled $1.6 billion, up $330 million, or 22% from the third quarter. Non-accruing TDRs were $913 million, up $236 million or 35% from the third quarter. While three-fourths of the growth in TDRs last quarter was accruing TDRs, this quarter 45% of the increase was in the accruing category.
We’ve chosen to provide more detail on our modification efforts and results this quarter, so please turn to slide 20 for more on this topic, the table on these slide shows that 70% of our TDRs are current and an additional 14% are in early stage delinquency. Note that accruing TDRs consist of TDRs where the account was accruing at the time of the modification or where the account was non-accruing at the time of the modification and the account has completed its peer period.
New mortgage and consumer TDRs during the fourth quarter totaled roughly $545 million, of which 55% were for seriously delinquent loans in non-accrual status. These TDRs will continue to be reported as non-accruing until they go through the six-month cure period.
22% of modifications in the quarter were for clients who were current on principal and interest payments while the remaining accounts were in early-stage delinquency. In the fourth quarter, the vast majority of our new mortgage TDRs included both reduced rates and term spending.
The final discussion point on this topic relates to the requirement to establish specific FAS 114 reserves for TDRs. Our FAS 114 reserve at 12/31 for TDRs was $343 million. In addition, we have already reported $140 million in charge-offs on the non-accruing TDRs, and also have $86 million mark-to-market adjustment on TDRs carried at fair value.
The sum of these amounts has already run through the income statement and equates to 20% of the original balance of all TDRs and nearly 75% of the non-current TDR balances. With this level of reserves and write-downs on a largely current portfolio, that is predominantly first lien residential real estate, we believe the potential for future incremental loss is low.
I’ll summarize the key points from today’s credit update before turning this call back over to Steve. Please turn to slide 21. Overall, asset quality is beginning to stabilize, albeit at relatively high levels of non-performing loans and charge-offs. During the quarter, net charge-offs, non-performing loans, and early stage delinquencies all declined.
Improvements in charge-offs and delinquencies were broad based among the portfolios. The allowance for loan losses increased to $3.1 billion or 2.76% of loans. We continue to work through the risk inherent in residential mortgage, home equity and builder portfolios. We’re making progress on these higher-risk portfolios as balances decline and asset quality metrics stabilize.
Our view of allowance coverage of non-performing loans continues to improve as the level of non-performing loans was stable, while the allowance increased. Pace of mortgage modifications continued in the fourth quarter and at the end of the quarter, over two-thirds of the modified loans were current in principal and interest.
Although fourth quarter charge-offs came in at the low end of our loss forecast, our overall outlook for credit losses remains consistent with the view expressed last quarter. At the current time we expect charge-offs to increase in the first quarter from fourth quarter levels, but we do not expect it to reach third quarter 2009 levels.
Further, we believe charge-offs will vary around this level in the second quarter with a possibility that improvement will begin at some point in the second half of 2010, depending upon the strength and pace of economic recovery.
With that, I’ll turn it over to Steve.
Thanks, Tom. We’re ready to take some questions now and in order to accommodate as many as possible, please limit yourself to one question and one follow-up. With that, operator, we’re ready to take our first question.
(Operator Instructions) Your first question comes from Scott Valentin - FBR.
Scott Valentin - FBR
With regard to TARP payment, you mentioned you have sufficient cash and capital to repay TARP. Can you give us some guidance or an indication on the timing of that and maybe also what other alternatives would there be to repaying TARP would you consider keeping TARP if there’s an assisted transaction or something like that?
The facts are that we are balancing regulatory matters and shareholder matters as best we can and intend to continue to do that. The world changes radically and so we’re trying to be certain that we are thinking about it in a complete way while being very sensitive to what the shareholder risk might or might not be. At the same time, financially observed in others who have repaid it financially given the coupon, whatnot it is the desirable thing to do, but we’re not certain when we’ll do it. We need to have the stars and moon aligns and then we’ll proceed from there.
Your next question comes from Brian Foran - Goldman Sachs.
Brian Foran - Goldman Sachs
I appreciate all of the detail about credit quality, but I guess if I think about what you had said on the 3Q call and then at the Boston conference about charge-offs likely being stable for the next couple of quarters versus this quarter’s decline. Was there any one thing, lower severities or a particular geography just being better or workouts being more successful, is this one thing or theme that drove the charge-offs this quarter?
I wish it was that easy. It was actually across all of the portfolios in our expectation and realization of the charge-offs. It came in at the lower end of the forecast, that was in our large commercial portfolios and then with the fall in delinquencies in previous quarters, and tier rates in the consumer side of the portfolio, we picked up momentum.
I think that was pretty good against all of the portfolios, which were a little surprising, I think that everything got better all at the same time. That doesn’t mean that going forward, we don’t have some fairly large charge-offs to take specifically as we work through our Florida residential real estate portfolio.
Brian Foran - Goldman Sachs
If I could ask one follow-up on the mortgage repurchase trends. Again, thank you for the slide. It’s actually more data than I think anyone has put out so far. I guess, the question would be, when you look at the ending balance at $200 million, what is the right denominator to compare that to? Do you think about that relative to your current loss experience, relative to the pending requests, relative to the total loans sold in the 2007 vintage? I mean, what should we compare that to?
This is Mark Chancy, let me start, maybe Bill Rogers will add some. I think you’re going down the right path, the kind of analysis we’re doing is on a vintage-by-vintage basis. In terms of the reserve, we’re looking at the delinquent loans and then running a roll rate model to try to identify, what we think will roll into not only delinquency, but ultimate loss position, what the level of repurchase requests might be by vintage, the level of success rate if you will, in terms of our repurchases and then the loss severity on those individual loans by vintage.
We have provided the data that shows a pretty significant difference between the underlying credit, and underwriting statistics associated with each of those years of vintage, the repurchase request now coming increasingly from newer vintages with better underwriting guidelines.
So as you extrapolate that forward, we are making an estimate with much better data and a more granular analysis around what the current losses are within that portfolio to determine that reserve and we’ve given you a little bit of information around our expectation for charge-offs, which is that they will remain at this kind of elevated level for the next couple of quarters, although we’re not expecting a significant increase in the reserve at this point, given the information that we have and the trend line that we’re on.
Your next question comes from Ken Usdin - Bank of America Securities.
Ken Usdin - Bank of America Securities
I just wanted to ask in terms of reserve build, expectations, looking ahead. The reserve build was a little bigger than it had been in the third quarter, but fairly consistent with what you’ve been doing. Given your comments about charge-offs needing to step up a little bit, and then maybe from this quarter’s level to the next few quarters, and your presumption that things could start to improve in the second half. Where are you in your view of where you stand on your reserve and incremental additions from here?
This is Mark Chancy and then Tom Freeman may add. The reserve build actually for the allowance itself was lower than in prior quarters. If you go back to the third quarter, I think the number was about $128 million. The reserve build in the fourth quarter was $96 million.
We did include in the provision expense the incremental reserve build associated with the unfunded commitments reserve and when you aggregate that increase of $57 million with the ALLL increase of $96 million, you get to a number of $153 million, and that may be what you’re comparing to last quarter’s $128 million.
So I think the correct comparison is $128 million to $96 million, so it’s actually on a downward trend. We did increase the unfunded commitments reserve, and that was related, in part, to a large corporate credit that did not charge off during the course of the fourth quarter, but we added to the reserves both on balance sheet as well as off balance sheet.
Ken Usdin - Bank of America Securities
My second question is just, maybe Jim, if you could touch on Florida, just generally speaking. Underlying trends you’re seeing there economically and from a real estate and business activity perspective?
It’s actually it remains spotty depending on where you are in Florida. The reality is that the home sales are doing better than they have been, the continuation of the third quarter trend and the fourth quarter, I think was there. The tourist dollars are less than anyone would like, but in terms of volume of visitors to the parks and whatnot, the volumes are up, the dollars are down, as is true in that industry across the country and maybe the world for that matter.
Home values, I think we maybe at some inflection point here, because depending on which home valuation service it is you pay attention to you get different answers about the decline rates, 2010 versus 2009 and I think at this point it’s now devolving into, it depends on what the property is, it is under $0.5 million home, is it near the beach, is it in the middle of what used to be an Orange Grove in the center of the state, and those kinds of specific and detailed things. So from a general matter, it’s better, it’s not great yet, but it’s better.
Your next question comes from Nancy Bush - NAB Research.
Nancy Bush - NAB Research
Some regulatory questions, Jim, I realize this is probably going to be tough to answer, and I kind of think I know the answer in advance, but I need to ask the question anyway. Given the credit outlook that you’ve put forth here, it looks like there are still loss quarters to come at least for the next several quarters. Have you gotten any indications from the regulators about whether you will be able to payback TARP while you are still in a loss position?
All we are talking about publicly, as I’m sure you do know, which is why you asked the question the way you did, Nancy, is that the guidance that came out in June about one who wants to pay TARP back, there are obviously shareholder dilution issues in some aspects of that. The guideline is just that, and I think if you analyze those who repaid it recently, what you see is a high variation and how it actually worked and what it meant, and what the math was.
So what we are trying to do, as I said earlier is to balance regulatory issues, future capital ratios, obviously and the shareholder aspect of this as best we can. You can be sure that there are constant viewers of the way the world is working and at this point, I think we’re sort of thinking about it in the right way. We’ll just to have seen how it plays out.
Nancy Bush - NAB Research
Secondly, given yesterday’s new rules, whatever they maybe, do you see anything that would impact your company in there, particularly with regard to the coming period of consolidation in the industry?
Obviously, I’m not sure I understand it exactly, I don’t think anyone does. So if we projected what it might mean ultimately, which is a long time from now, I think in terms of actually knowing anything about it. You would have to believe that those who are more heavily weighted to proprietary trading and those sorts of things than we are would be more affected by it.
We have a very nice client focused business as you know Nancy, as that’s what we have been trying to do for a period of time, and my guess is it wouldn’t have much impact on that. SO we do a very little, certainly on a relative basis deep proprietary trading.
Your next question comes from Jason Goldberg - Barclays.
Jason Goldberg - Barclays
We’ve seen, I guess improvement in early stage delinquencies the last several quarters, I guess NPAs and restructures have continued to increase. Can you talk about the dynamics of those two, what is I guess is their lag effect? How long that lag typically is or maybe that’s not the best way to look at it?
Maybe I could offer an alternative sort of view of this. As we’ve been talking about the TDRs and the compositions of TDRs over the past couple of quarters, while the delinquencies are declining, our restructuring efforts are getting, we’ve gone through the inventory of severely delinquent loans to a large extent. Our methodology and analytics have gotten increasingly proactive to try to identify people early in their issues. So that don’t get in so much financial trouble that we can’t get them through their issues.
As you look at the composition of the workout streams, we’re actually reaching deeper and deeper in to our current queues for folks that need some help in identifying that they’ve got problems or restructuring requirements. That’s kind of what we’re trying to indicate in those slides that we’ve begun to put in there.
Jason Goldberg - Barclays
Secondly, sorry if I missed this, in terms of the tax rate for the quarter, I guess adjusting for some of the noise. It still looked like it was relatively low. I guess anything else in there and just maybe give some guidance to go forward?
As far as guidance going forward, obviously in this environment, we have been in a loss position, and you have certain permanent tax differences. You have items that are in our income stream that are municipal interest, for example. You have tax planning strategies, both at the state and Federal level that have been implemented and get reserved periodically.
We have several of those planning sessions come to fruition during the course of 2009 as the years were reserved with the taxing authorities, all of those various variables affect the tax rate in a given period. So at this point, we’re not providing any specific guidance as we move in to 2010. There wasn’t any large transaction resolved in the fourth quarter that drove a specific tax rate. There were some smaller favorable adjustments that occurred during the course of the fourth quarter, but nothing significant.
Your next question comes from Craig Siegenthaler - Credit Suisse.
Craig Siegenthaler - Credit Suisse
Just on the trust and investment management and the asset management business. Just wondering were there any performance fees or prop gains in the fourth quarter number? You picked up a lot, and I’m wondering is there anything offsetting that comp?
This is Bill Rogers. There were some perform related fees in the fourth quarter that accounted for that.
Craig Siegenthaler - Credit Suisse
Can you quantify that at all? Was that mostly the delta?
No, it was really about probably, a little less than half of the total increase.
Craig Siegenthaler - Credit Suisse
Was any of that offsetting comp, because normally about half of that will close to the comp?
Yes, and there’s a corresponding, if you go down a lot bit, corresponding increase in comp related to that performance base.
This is Mark Chancy, I mentioned the quarter-over-quarter expense in increase in personnel with items like that that drove the increase.
Craig Siegenthaler - Credit Suisse
Then just a quick question, do you disclose your six months redefault rate? I love the disclosure you have on slide 20, but I’m wondering what that redefault rate was on the TDRs?
Don’t disclose it, but of the reasons for that was the lack of industry standardization around the method of calculation makes it very difficult to put a number out that could be compared correctly on a company-over-company basis, and that’s one of the reasons why we don’t make that public.
We’re closing in on the top of the hour. So we’ll take one more question.
Your final question comes from Kevin Fitzsimmons - Sandler O’Neill.
Kevin Fitzsimmons - Sandler O’Neill
Just wondering if you should we be looking at the trading account profits that declined nicely link quarter and I guess largely because of lower market valuation losses. Should we expect that to continue or given the environment are we kind of probably going to stay at a certain level.
Just wondering if you could just address quickly the deferred tax asset issue, which you mention in the release that you went from a DTL position to a small DTA position? Does that put you guys anymore at risk of having to write that down at some point in the future? Thanks.
Kevin, this is Steve. Kind of the core trading as you know has been a little volatile. It’s been on a down trend. That was basically driven by core client activity such as equity and fixed income derivatives volume in our client business. In terms of where that’s going to go in the future, clearly interest rate volatility and stock market volatility tends to increase transaction volume. So if you have a view of that, you would tend to think that trading is going to be flat from where it is to up, but probably not down again. I’m going to let Mark address specifically the DTA question.
This is Mark Chancy. The DTA number for Federal was $25 million, and I think was the net. So it was a very modest change if you will, and increased in the DTA. The increase was driven, actually by a change in our OCI that was correlated. We have some received fixed swaps that have been deeply in the money, and with marginal change and increase in rates, the AOCI was reduced and that affected the calculation.
There is no valuation reserve that is warranted in connection with our Federal, and we have a modest valuation reserve that has already been established in connection with our state DTAs. So the bottom line answer to your question is, no. We do not anticipate at this point, the need for a valuation reserve on our Federal and there’s a little bit of noise in terms of the relevant change because of things like variations in OCI.
Thank you, everybody; we appreciate you all joining us this morning.
That concludes today’s conference. You may disconnect at this time.
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