SunTrust Banks Q2 2010 Earnings Call Transcript

Jul.22.10 | About: SunTrust Banks, (STI)

SunTrust Banks (NYSE:STI)

Q2 2010 Earnings Call

July 22, 2010 8:00 am ET


Thomas Freeman - Chief Risk Officer and Corporate Executive Vice President

Steven Shriner - Director of Investor Relations

William Rogers - President

Mark Chancy - Chief Financial Officer and Corporate Executive Vice President

James Wells - Chairman of the Board, Chief Executive Officer and Chairman of Executive Committee


Brian Foran - Goldman Sachs Group Inc.

Nancy Bush - NAB Research

Gregory Ketron - Citigroup Inc


Welcome to the SunTrust Second Quarter Earnings Conference Call. [Operator Instructions] I would now like to turn the meeting over to Mr. Steve Shriner, Director of Investor Relations. Sir, you may begin.

Steven Shriner

Good morning, everyone. Welcome to SunTrust Second Quarter Earnings Conference Call. Thanks for joining us.

In addition to the press release, we've also provided a presentation that covers the topics we plan to address today. Slide 2 outlines the content, which includes an overview of the quarter, and then we'll have a financial results discussion and a credit review. The press release, presentation and detailed schedules are available on our website, This information can be accessed by going to the Investor Relations section of the website.

With me today, among other members of our executive 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 discuss financial performance, and Tom will conclude with a review of asset quality. At the conclusion of our formal remarks today, we'll open the session for questions.

Before we get started, I need to remind you that our comments today may include forward-looking statements. These statements are subject to risks and uncertainty, and actual results could differ materially. We list the factors that might cause actual results to differ materially in our press release and SEC filings, 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 may discuss non-GAAP financial measures in talking about our performance. You can find the reconciliation of these measures to GAAP financial measures in our press release and on our website.

Finally, SunTrust is 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 webcasts are located on our website.

With that out of the way, I'll turn it over to Jim.

James Wells

Good morning again, everyone. I'm glad you're with us this morning. Our loss significantly narrowed to $0.11 this quarter versus a $0.46 per share loss last quarter, as our operating trends gained momentum. Specifically, asset quality continued to improve. We had substantial revenue growth over last quarter, and we maintained favorable deposit volumes and mix. Furthermore, the pace of the loan balance decline has clearly slowed.

As we've been articulating for some time, we've been focused on positioning our businesses for growth as we come out of this cycle, and we're starting to see the benefits of those efforts. And though macro economic indicators are mixed, and there are uncertainty in our operating environment as it relates to financial regulation and the potential impact from the Gulf oil spill, we are increasingly encouraged by the operating trends that we're seeing.

Revenue grew compared to last quarter with growth across our core fee income category. We find this broad-based growth positive and believe that while the operating environment remains challenging, some economic traction coupled with our client-focused strategies generated these favorable results. We also had some non-core gains related to the sale of securities and fair value adjustments that Mark will detail shortly.

Net interest income and net interest margin were stable compared to last quarter but grew significantly compared to the prior year, up 8% and 39 basis points, respectively. The net interest margin increased due largely to the continued shifts in our funding mix to lower-cost deposits. Client deposit growth and improved mix enabled the reduction in higher-cost sources of funding and that, along with the lower rates pace, has had a significant impact on margin over the last year. Overall, we continue to make progress in our efforts to improve client satisfaction and our focus on the drivers that build loyalty. We're confident that this approach is having an impact.

Our core expenses remain tightly managed as we continue to capitalize upon the strength that we've built. This will remain focused on recovering efficiency improvement opportunities. This was evident in our personnel-related expenses, which were down compared to last year. Cyclical costs do remain high, and we also incurred debt extinguishment costs during the quarter, and Mark will provide more detail around those items, which drove the overall expense number higher this quarter.

Asset quality trends continue to improve. Non-performing assets, non-accrual loans, net charge-offs and provision for loan losses all declined this quarter. Though early-stage delinquencies were up slightly, more than all of that increase was due to government guaranteed loan delinquencies. Excluding such loans, early-stage delinquencies were down six basis points. While Construction charge-offs increased as we expected, there was broad-based improvement in the remainder of the portfolio.

Consistent with our efforts to align our businesses and services for the long-term satisfaction of our targeted clients, last week, we announced the completion of our strategic review of RidgeWorth, we reached definitive agreement for Federated to acquire approximately $17 billion of managed liquidity assets. We expect to record a relatively small gain in the fourth quarter that includes an upfront payment plus the estimated present value of a five-year earn-out. We believe RidgeWorth's core fixed income and equity asset management businesses offer future attractive growth opportunities for SunTrust.

In summary, we believe that modestly improving economic conditions are positively reflecting results and our efforts to position ourselves for growth beyond the cycle are evidencing themselves in our core performance. We are well positioned and with solid capital and liquidity, we operate from a position of strength. We're committed to investing in growth businesses, managing expenses prudently and returning the company to profitability.

And though lingering operating environment uncertainties certainly exist, we remain encouraged by improving results and prospects. Two particular items that we're all interested in and obviously, have been topical in recent months include the Gulf oil spill and financial regulation. I'll first address the oil spill on Slide 4.

While we realize that there is no way to predict the ultimate economic impact of the oil spill and the effect that it could have on asset quality, I wanted to provide some color on our exposure to areas currently being affected. Specifically, this slide shows our loan exposure on the Florida Panhandle region. We have a relatively small presence in this area with $1.3 billion in loans outstanding, and when you consider commercial loans to borrowers and industries that are particularly susceptible to the impact of the oil spill, the gray shaded parts of the chart, our outstanding balances are just $93 million. Though we have a small exposure, we are on top of it. We sent lenders and senior management into the affected markets to monitor the overall climate and the needs, and we continue to assess our risks and our responses. At this time, we have taken no broad actions but we are working individually with clients that have been affected.

Our entire Gulf Coast exposure, which for us, constitutes the Gulf Coast of Florida and a small amount of Alabama, is understandably larger. However, it too is well diversified with less than $1 billion in commercial loans and those industries that would be particularly vulnerable: Real estate, consumer products and services and retailing. Recent forecast suggests that there is a very high likelihood that much of this region will not be impacted by the spill.

While we believe that our relative exposure in the area currently most impacted by the oil spill is minimal, we know that in no way diminishes the impact on our clients and teammates living and working there. It's clear that the ultimate impact of this environmental tragedy has yet to be determined and we are committed to helping the region and its residents recover.

In that same vein, we're obviously closely monitoring changes to financial regulation. While some of the uncertainties surrounding regulatory reform has been resolved, it remains unclear what material effects the changes will have in terms of the economic recovery, in terms of consumer confidence and the global competitiveness of our industry. The real work of translating legislative policies into laws, regulations, rules, practices and procedures, that will directly affect our industry is just now beginning and will take time to complete. Some of our regulations once written, will have little to no impact on our results, the Volcker rule, for instance. Conversely, other items will have a quantifiable effect in the near term such as Regulation E and the new regulations regarding debit interchange fees. Mark Chancy will provide some additional commentary on these topics.

I'd like to conclude here by saying that we have a process in place for evaluating these items, we will actively engage in development of these rules and regulations, and we will react accordingly as clarity is provided.

To conclude, I will reiterate that we are encouraged by recent operating trends. The strong foundation we have created, coupled with our client-focused execution, risk mitigation capabilities and a long-term economic prospects in our markets, position SunTrust well for the future.

Now I'd like to turn the call over to Mark. Mark?

Mark Chancy

Thanks, Jim, and good morning, everybody. I'll begin my comments today on Slide 5 of the earnings presentation with a summary income statement.

For the quarter, we posted a loss to common shareholders of $56 million or $0.11 per share. The net effect of securities gains, debt extinguishment cost and mark-to-market gains on our debt contributed a positive $0.07 per share to the quarter. And even after adjusting for these items, the earnings per share loss narrowed significantly from the prior quarter and prior year levels of $0.46 and $0.41 per share, respectively. Also, the company did generate positive earnings before preferred dividends this quarter.

As in prior quarters, the net earnings losses driven by the recessionary environment with elevated net charge-offs, high cyclical expenses and tepid loan demand. Despite these impacts, there were a number of positive trends that drove continued improvement in our financials. The recovering, albeit, uneven economy contributed to a portion of our improved results. This improvement was most notable in the $200 million decline in our provision expense from the first quarter, which was driven by continued favorable credit trends.

Additionally, we also saw the positive benefits from actions that we have been taking to drive better performance. This improvement was especially evident in higher sequential fee income across a broad range of categories. We also saw continued favorable shifts in our deposit mix, which together with our proactive asset liability management actions, drove stable net interest income and margin on a sequential basis, as well as 8% net interest income growth and 39 basis points of margin expansion versus the prior year.

With that brief summary of our second quarter results, I'll now shift to Slide 6, which provides a summary balance sheet. Average loan balances, excluding non-accruals, were down 1% and 10% as compared to last quarter and last year, respectively. Overall demand remain muted but we did see a continued slowing in the pace of balance declines and slight growth in certain categories.

Overall, balance declines continue to be driven by our higher risk categories, most notably Construction, which was down 20% from the prior quarter and accounted for over 1/2 of our sequential decline in total loan balances. Increases in consumer loans essentially offset declines in the commercial loan category. Consumer direct and indirect loans grew 6% and 4%, respectively versus the prior quarter, with growth primarily driven by student and auto loans.

Commercial Loans were down 2%. The balance decline in this category was the smallest since the fourth quarter of 2008, which is the last time that we saw core growth in this portfolio. Now you will recall that we reported growth in this loan category last quarter but it was entirely driven by the impact of the implementation of FAS 167.

Line of credit utilization rates stabilized somewhat in the second quarter, down about 150 basis points for our larger corporate clients and flat for our midsized clients. We continue to remain hopeful that loan demand from credit-worthy borrowers will increase, and that loan growth will return in the second half of the year. While the slowing pace of loan decline provides some optimism that this could occur in 2010, we continue to remain uncertain of the exact magnitude and timing of a pick up in demand.

Now moving onto deposits at the bottom of the slide. You can see that core deposits increased, and that the positive shift in mix continued. Balance increases were driven by lower-cost deposits, specifically DDA [demand deposit account] and money market, which both grew 4% sequentially or about $2.4 billion combined. Other CD balances declined $1 billion in the quarter as we continue to allow run-off in this portfolio, particularly single-service CDs.

We also further reduced our brokered and foreign deposits, which were down approximately $760 million this quarter and 60% year-over-year. Overall, we have significantly enhanced our liquidity position during this past year, primarily via the growth of lower-cost deposits. This increase in deposits has enabled us to take a series of actions to reduce our higher-cost funding sources, helping to drive significant reductions in our cost of funds.

Not depicted on this slide, but one such additional action in this regard that occurred toward the end of the quarter was the early termination of $900 million in debt. This debt carried a coupon of approximately 5% and had about two years to maturity, and the cost associated with this termination of $63 million is included in the quarter's expenses. We also took actions with our securities portfolio, so let's turn to Slide 7.

Our total available for sale portfolio stood at $27.6 billion at the end of the quarter. In an effort to manage our interest rate risk profile, as well as to reposition the portfolio in areas where we saw relative value, we executed a series of transactions during the quarter.

Most notably, we extended our U.S. Treasury position and grew the MBS portfolio via purchasing $2.5 billion of mortgage-backed agency securities. The MBS purchase was funded via $1 billion sale of bullet U.S. agencies, as well as from our deposit growth. The collective actions taken during the quarter yielded $57 million in securities gains.

The portfolio continues to be concentrated in high quality and very liquid securities. Government and agency securities, which are the first four rows on the slide, constitute the vast majority of balances, and the other equity securities are largely Coca-Cola, Federal Reserve and FHLB stock.

Going forward, we continue to have the flexibility to respond to changes in the environment and to take actions that best balance our excess liquidity position against current investment returns. I'll now take a moment to cover the margin on Slide 8.

Lower funding costs more than offset slightly lower asset yields in the quarter, contributing to a one basis point sequential improvement in net interest margin to 3.33%. Margin exceeded our prior expectations and guidance due primarily to better-than-expected deposit pricing and mix, and the effects of the aforementioned securities portfolio transactions.

Relative to the prior year, margin is up 39 basis points. This improvement is driven primarily by the lower funding costs discussed earlier. In 2009 and early 2010, we also extended the duration of our Commercial Loan portfolio through a series of interest rate swaps, which have contributed a meaningful amount of net interest income in 2010, given the very low rate environment that has persisted throughout the year.

Finally, we have improved our loan pricing discipline across the company, and this effort is evident in our loan yields. You will note that we have modified our expectations somewhat regarding the margin for the remainder of the year, as we now expect it to be within a range of 3.25% to 3.35%. This modification reflects the fact that the benefits that we are currently experiencing related to deposit pricing, the favorable deposit mix, our interest rate swap position and the early debt termination are likely to continue for the next couple of quarters. As a final comment on this slide, I will note that we remained modestly asset sensitive at the end of the quarter.

Let's now move to provision on Slide 9. Total provision for credit losses for the quarter were $662 million, down $200 million from the first quarter as credit trends continued to improve. Provision was $60 million less than charge-offs with $40 million of this differential coming from a reduction in the unfunded commitments reserve due to improved equity related to certain commercial and large corporate clients.

Charge-offs were $722 million, a decrease of almost $100 million from the first quarter. Now you may recall that a move of certain non-performing loans to held for sale and a charge-off policy change increased first quarter charge-offs by a combined $182 million. When normalizing for these items, charge-offs in the second quarter were up $83 million sequentially, which was consistent with our expectations and driven as anticipated primarily by construction loans. Despite the notable improvement in asset quality in the quarter, the allowance ratio was held stable at 2.81%, due to the continued uncertainty surrounding the direction of the economy and home values at this time. Now moving to non-interest income on Slide 10.

On a reported basis, non-interest income was up 36% sequentially and down 11% from the prior year. After adjusting for a number of items in each quarter, non-interest income increased by 12% and declined by 10%, respectively. The adjustments primarily relate to fair value marks and securities gains, and as in prior quarters, we provided the underlying detail in the appendix of today's presentation.

In the current quarter, the largest adjustments are the aforementioned $57 million in securities gains, as well as a $63 million gain associated with our fair value debt and related hedges. The primary drivers of the adjusted year-over-year decline are mortgage related. Production volumes declined roughly 60% from the prior year as refinancing activity waned. Mortgage repurchase losses were higher in the current quarter and the prior year quarter included a large MSR [Mortgage Servicing Rights] recovery.

Focusing on the sequential quarter comparison, we posted increases across all major categories. Specifically, mortgage-related income was up $31 million due to the MSR hedge performance and higher production volumes, which more than offset a $20 million increase in repurchase losses.

We also saw increases in key consumer and commercial fee-based categories. The company has been placing significant focus on servicing and growing our client base, and we believe the increases in these categories, which include mid to high single-digit sequential growth in service charges, card fees, trust income and retail investment services, are all evidence of our success. And importantly, much of this growth was from underlying drivers like an increase in the number of accounts, expanded client relationships and an increase in product usage.

I'll shift gears for a minute to provide you some additional color on the potential impact to SunTrust of regulatory reform. As you all know, and Jim mentioned in his opening remarks, the situation is fluid, and we are in the process of thoroughly evaluating the possible implications and the mitigating actions. To assist you in your own estimation process, we wanted to provide a little more color on three of our fee income streams that are amongst the most obvious items that could be impacted by the reform.

First, I'll focus on deposit service charges. Last quarter, we indicated that we expected that Reg E could cause a 10% to 20% reduction in service charges. To date, the number of clients opting in, those that would be electing to continue their participation in overdraft coverage, has been well above our expectations. As such, we currently believe that the annualized impact to overdraft income will fall toward the lower end of our original range.

Second, I'll turn to interchange. Consumer and small business debit card interchange contributed about $250 million in fee income during 2009. Now for clarity, that is our full year interchange revenue, not the impact that we expect Dodd-Frank to have on this fee income category, and we continue to develop our expectations around that matter.

Third, I'll provide some color on derivatives. Derivatives contributed about $100 million in revenue in 2009, most of which was generated from end users. We do not currently believe that the legislative and regulatory changes on derivatives will have a material impact on this revenue category for SunTrust.

Finally, it's also obvious that regulatory costs will increase significantly, although the amount is difficult to quantify at this time. So let's now turn to Slide 11 for a discussion of mortgage repurchase trends.

This quarter, we increased the reserve for mortgage repurchases by $46 million. Mortgage repurchase costs, which are recorded as a reduction to mortgage production income, increased from $128 million in the first quarter to $148 million this quarter, while charge-offs declined by $16 million to $102 million. And despite this decline in charge-offs, we increased the reserve because new repurchase request volume was up during the quarter, though the request varied significantly by month. For example, April and May were relatively low months, while June was specially high. And while we have seen a significant decline in request volume month-to-date in July, it is too early in the third quarter to suggest that this reflects anything other than normal monthly volatility.

The key points from the bottom part of this slide remain the same as we have discussed last quarter. Most of our current request volume is currently coming from the higher loss of vintages of 2007 and prior. We expect that normal seasoning patterns for origination of vintages over time will shift new request volume to newer vintages. As that occurs, we expect both lower loss frequencies and severities, as the newer vintages exhibit more favorable characteristics such as higher FICOs and lower original LTVs, and they were originated during or after the periods they experienced the most significant home price depreciation.

In conclusion and consistent with what we told you last quarter, near-term losses and reserve levels will largely be driven by the volume of new repurchase requests, which are difficult to predict. If new request volume begins to taper off during the second half of the year, we expect charge-offs and reserves to likewise decline. However, if new request volumes increase or the expected shift towards newer vintages does not occur, then charge-offs and reserves could remain at current levels or higher. I'll now turn to Slide 12 for a review of expenses.

Non-interest expense declined 2% when compared to the second quarter of 2009 and increased 10% compared to last quarter. However, there were certain unusual items that warrant discussion and on this slide, we have adjusted for items that are detailed in the appendix of today's presentation.

On an adjusted basis, expenses are up 3% versus the prior year and 6% sequentially. You will note at the bottom of the slide, the three primary drivers of the increases, which include credit-related costs, marketing and outside processing. These three categories explain almost the entirety of the year-over-year expense and all the $25 million of the sequential quarter increase.

For both the year-over-year and sequential quarter comparisons, the drivers of growth in these particular categories are similar. Credit-related costs increased as a result of other real estate expenses. Marketing expenses were from planned promotional and advertising spending supporting our brand, and outside processing was largely due to investments aimed in enhancing our clients' banking experience and from higher volumes.

I'll also provide you a little color on our personnel-related expenses as they evidence our continued focus on expense management. Employee compensation and benefits declined $21 million or 3% from the prior year and $9 million or 1% from the prior quarter. The reduction from the first quarter was driven largely by the approximate $25 million seasonal decline in FICA [Federal Insurance Contributions Act] and 401(k)expenses, partially offset by modest merit increases that took effect this quarter and higher incentive compensation associated with higher revenues. Now let's turn to Slide 13 for a brief discussion of capital.

Capital ratios remain solid this quarter and increased from first quarter levels. As a few selected highlights, Tier 1 Capital increased by an estimated 27 basis points from the first quarter to 13.4%. Tier 1 Common improved by an estimated 15 basis points to 7.85%, and tangible common equity increased 30 basis points to 7.18%, driven primarily by unrealized securities gains increasing other comprehensive income, which was also the cause for the expansion in our book and tangible book values per share. Given the continued strength in our capital position, our view that we are well positioned to repay TARP at the appropriate time remains unchanged. Before concluding, I'll briefly summarize some of the key points I've discussed today.

We significantly narrowed our earnings loss this quarter and we're profitable before prepayment of preferred dividends. Provision declined due to improved asset quality without any reduction in the allowance as a percentage of loans. Favorable deposit trends continued. Net interest margin remained stable from the prior quarter and was up substantially from the prior year, primarily due to lower funding costs. Non-interest income grew sequentially across a broad range of categories, evidencing success in our client-centric initiatives. And non-interest expenses continue to be closely managed. We are encouraged by the trends in our performance, and despite continued uncertainty in the environment, we remain focused on continuing to drive improvements in our results.

With that, I'll turn the call over to Tom Freeman to discuss asset quality. Tom?

Thomas Freeman

Thanks, Mark. Today, I'm going to review our asset quality beginning on Slide 14. As Mark and Jim noted earlier in the call, asset quality continued to improve this quarter. Charge-offs, provision expense, non-performing loans and non-performing assets all decreased significantly. Delinquencies and loan balances were stable to down, particularly in certain higher risk portfolio. Despite improved asset quality metrics in the current quarter, the Allowance for Loans and Lease Losses, as a percent of loans had been maintained at the prior quarter level in light of continued uncertainty regarding the strength of the economic recovery and trends in home values.

Aggregate loan balances continued to decline in the face of lower loan demand and line usage, as well as targeted actions taken regarding higher risk portfolios such as Construction. This modest decline matched the amount of new loan originations in the portfolio, particularly in commercial lending. Through the first six months of 2010, we have originated $6.9 billion in new C&I loan commitments and leases, which is a 32% increase over the first six months of 2009.

Early-stage delinquencies represent 1.26% of the portfolio, up from 1.19% in the first quarter. This increase was driven by higher delinquencies in Federally-guaranteed student loans. After removing portfolios with Federal government guarantees for both quarters, the ratio improved to 98 basis points from 104 basis points last quarter, a six basis points improvement. We believe that the pace of improvement in delinquencies in some portfolios may slow as they approach historic numbers.

Other portfolios, such as Consumer and Commercial Real Estate are more closely aligned with the general economy and employment trends. We expect delinquencies in these portfolios to remain at elevated levels until conditions improve.

Non-performing loans declined during the quarter by over $485 million, which represented the fourth consecutive quarterly decline. Non-performing assets declined by $580 million. Inflows into non-performing are trending down, which when coupled with our aggressive problem asset resolution efforts resulted in lower balances.

Charge-offs of $722 million during the second quarter were in line with our expectations. The net charge-off ratio declined from 2.91% to 2.57%, with all portfolio showing improvement, except Commercial Real Estate and Construction. Charge-off activity continues to be centered in residential real estate-related portfolios, including residential mortgages, land and residential construction.

Please turn to Slide 15 for a review of the loan portfolio. This portfolio view of asset quality illustrates generally improving credit quality. Charge-offs declined broadly among the portfolios. Early-stage delinquencies were stable to down, and balances in some of the highest risk portfolios continued to decline. The longer-term reduction in balances in higher risk portfolio is positive. For example, over the past 12 months, construction balances, including land, have gone nearly 40%. Alt-A balances have declined nearly 18% and higher risk home equity lines have declined 12%.

Commercial portfolios continues to perform satisfactorily overall. Commercial early-stage delinquencies, non-performing loans and charge-offs were down quarter-over-quarter. Our view remains that overall C&I asset quality should improve.

While the Commercial Real Estate portfolio, consisting of owner-occupied and investor-owned properties continues to perform reasonably well. Charge-offs, early-stage delinquencies and non-performing loans increased slightly from very low basis. In fact, the increase in charge-off ratio represents only a $10 million increase in charge-offs, while the increase in NPLs was only $51 million. Given the conditions in the Commercial Real Estate market, we expect additional stress in credit losses in this portfolio. However, we also continue to believe our portfolio will perform comparatively well given its composition and the way it was underwritten.

Asset quality improved in the consumer portfolios, with lower early-stage delinquencies when Federally-guaranteed loans are excluded and charge-off ratios that were stable to down. 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.

Overall, Home Equity performance has been stable as balances and charge-offs declined, while early-stage delinquencies and non-performing loans were flat. Residential Mortgage charge-offs and delinquencies declined, while balances increased modestly. As noted last quarter, we expect the Construction charge-offs to increase, and in fact, was to level similar to what we experienced in the second half of 2009. We continue to expect the elevated charge-offs in this portfolio as problem loans move through the workout process. Next, I'm going to discuss our real estate secured portfolios in more detail, beginning with the Residential Mortgage portfolio on Slide 16.

Asset quality in the Residential Mortgage portfolio continued to show overall improvement in terms of non-performing loans and delinquencies, driven in large part by the core portfolio. Growth in the core mortgage portfolio was predominantly tied to the originations of mortgages that have Federal government guarantees. Dollar delinquencies and non-performing loans in this portfolio improved by $15 million and $303 million, respectively. Non-performing balances declined in every segment of the portfolio.

Delinquency trends in this portfolio imply a lower frequency of future loss and home price deterioration appears to be slowing in many of our markets. While our outlook for this portfolio is generally stable to improving, the pace of the economic recovery, covered with elevated unemployment rates and variability in housing prices could continue to negatively impact credit quality and the level and frequency of charge-offs.

I will now move to Slide 17 to discuss Home Equity loans. Home Equity portfolio balances and charge-offs continue to decline, while non-accruals were relatively low and stable. Elevated credit metrics are largely driven by the higher risk segments of the portfolio, such as loans, which were originated by third parties, loans in Florida and loans with higher loan-to-value ratios. Balances in these segments continue to decline but no new production and little line availability. Now if you will turn to Slide 18, I'll talk about our Construction portfolio.

We continue to aggressively reduce exposure to higher risk construction loans. Construction balances continued to decline rapidly, dropping 13% over the quarter. To put this in context, Construction balances in 2007 exceeded $14 billion and are now down by nearly $9 billion or 64%. The Construction Perm portfolio and non-accrual loan balances continue to wind down, as new production remains slow. Issues in this portfolio have been identified and work-out efforts related to older product continue. Construction non-performing loans decreased by 14% quarter-over-quarter, and we believe that residential non-performing loans will be stable to down in the future.

Construction delinquencies declined overall. The Residential Construction segment will remain problematic, with most of the portfolio being actively worked out. We expect delinquencies and losses related to Residential Construction to remain elevated, as we continue to resolve problem loans. While the timing of charge-offs is difficult to predict, we believe that this portfolio is appropriately reserved, and the problems have been aggressively addressed.

Credit performance in the Commercial Construction portfolio remains acceptable overall. Balances declined significantly, while charge-off ratios and non-performers increased only modestly. Please turn to Slide 19 for a review of our loan modification efforts and resulting troubled debt restructurings or TDRs.

TDRs increased by $360 million in the current quarter as compared to roughly $300 million last quarter and $500 million in each of the prior two quarters. Growth in consumer residential restructured loans, was about $260 million in the second quarter and was similar to the volume in the first quarter. Residential TDRs began slowing in the first quarter due to fewer newly delinquent loans and fewer modifications of more seriously delinquent loans. There's been an increase in commercial TDRs, primarily within non-accrual, income property loans.

Commercial-related TDRs account for 8% of total TDRs and only 2% of accruing TDRs. We expect moderate growth in Commercial Real Estate TDRs over the near term. Accruing TDR balances totaled $2.3 billion at June 30. Accruing TDRs comprised 70% of total TDRs and 87% are current for interest and principal payments. Approximately 73% of accruing and non-accruing TDRs are current. Non-accruing TDRs have the potential to move to accrual status, if payment performance is sustained for a defined period of time.

Overall, performance of the accruing TDRs continues to exceed our expectations during the second quarter. With 94% of accruing TDRs being current or one payment past due, the performance of this portfolio is much closer to traditional mortgage portfolios than it is to a restructured portfolio. I'll summarize the key points from today's credit update before turning the call back over to Steve. Please turn to Slide 20.

Overall, asset quality continue to improve in the quarter. Delinquencies were stable to down in most of the portfolios. Compared to the first quarter, non-performing loans and assets and charge-offs declined significantly. Significant progress has been made in reducing balances in higher risk portfolios over the past 12 to 18 months. We believe that the pace of improvement in delinquencies will slow, as delinquencies in certain portfolios approach historic norms. Other portfolios that are more closely aligned with the general economy and employment trends will remain elevated until conditions improve. Consumer and mortgage asset quality metrics generally improved. Construction charge-offs increased significantly and balances declined as we continue to aggressively work through the risk in this portfolio.

The level of Residential Mortgage modifications were stable during the second quarter. There was an increase in commercial restructures, particularly in Commercial Real Estate. We expect modest increases in Commercial Real Estate TDRs for the near term. The proportion of TDRs that are current interest in principal and interest and payments improved from last quarter to 73%. Approximately 87% of all accruing TDRs are current on interest and principal payments.

At the current time, we expect overall charge-offs to be stable to down from the third quarter. Factors which could affect general asset quality and charge-offs levels include macro or regional economic volatility and trends within specific sectors, such as Commercial Real Estate.

Finally, assuming no further material deterioration in the economy or asset quality metrics, the Allowance for Loans and Lease Losses likely peak from the first quarter. However, we maintain reserve levels for the time being, in light of continued economic and real estate value uncertainty. With that, I'll turn it over to Steve.

Steven Shriner

Thank you, Tom. Before we take questions, I'd just like to remind you to limit your questions to one with one follow-up. And with that, operator, we're ready to take our first question.

Question-and-Answer Session


[Operator Instructions] And our first question comes from Brian Foran with Goldman Sachs.

Brian Foran - Goldman Sachs Group Inc.

I appreciate the disclosure on the Panhandle, and I think one of the things people might have missed is you guys aren't that big there. As we think through the rest of Florida, as we move down the West Coast, it starts to become a much bigger exposure for you. How are you thinking about risk of some of the oil impact spreading, and maybe any color you're seeing realtime in places like Tampa and Sarasota moving down the coast or prices weakening or transactions weakening or things looking up?

James Wells

Brian, this is Jim. The most recent official forecast that I've seen was put out by the National Oceanographic and Atmospheric Administration. I'm glad I got all that out, NOAA. And it basically said that the west coast of Florida as opposed to the Panhandle, had a 1% to 20% chance of some issues with the oil spill. And that in the last -- this is two- or three-week old data, so it's before the stopping of the leakage. Declining from 20, if it were 20, it tends to be going down. They have a belief that there are some issues that the loop current in the Gulf will feed into the Gulfstream and that there maybe some issues in South Florida. But as it goes on and as the Gulfstream separates from the North American continent, they predict much less, the farther the north you go. And our experience basically so far is not bad. Of course, the devastation right on the shoreline and some parts of our footprint, are less actually than if further west on the Gulf coast. So we are obviously concerned about it. Floridians are concerned about it. We haven't seen a meaningful economic impact on the west coast of the peninsula but obviously, the tourism issue and valuations and loss of tenant rental income and all those kinds of things in the Panhandle, particularly the western part of the Florida Panhandle are worst, if that's a useful update.

Brian Foran - Goldman Sachs Group Inc.

One follow-up on the mortgage repurchase trends. Are there any leading indicators, First Horizon mentioned, mortgage insurer rescission request because there was a lag between that going to the GSEs [government-sponsored enterprises] and ultimately back to the banks. Different banks have pointed to different things, but are there any leading indicators you found useful that investors can watch to try to get a sense of what the next couple of quarters might progress like?

William Rogers

This is Bill Rogers. Let me take a shot at that. It's hard to sort of look at, as Mark pointed out, leading indicators because of so much volatility, from literally month-to-month. I think for us, primarily looking at the improvement in the portfolio that's going to be subject to a rescission is probably the best litmus test for us. As it relates to the MI [mortgage insurer] rescinds, I think probably the question you really are asking and maybe should be asking is, are those accounted for in our reserve? And what we do is exactly that. I mean, we look at MI rescinds that have not yet resulted in a repurchase request, for example, and make sure that they're incorporated into the reserve by some calculation or estimation. Is that helpful?

Brian Foran - Goldman Sachs Group Inc.

That is.


And our next question comes from Nancy Bush with NAB Research.

Nancy Bush - NAB Research

Number one, on the loan-loss reserve. Jim, do you have any indications whether the regulators are going to be putting forth some guidance? I mean, we know we're going to get capital guidance probably in November, but is there going to be any guidance on reserve and/or reserve policy going forward?

James Wells

I would hope so. But, Nancy, we're all well aware, I know you are of the issue between the SEC and the bank regulators in terms of reserve desirability levels and all that sort of thing. And while I'm sure, I don't know this, but I'm sure and confident that there are conversations going on. We received no particular indication about any of that. So I think at this point, it's a toss-up.

Nancy Bush - NAB Research

I noticed you had a step-up in marketing expenses during the quarter to kind of a new level. And I noticed the, and I'm sure you did as well, the Wall Street Journal a couple of days ago, about concentration in some of your markets. I think Orlando was the market that they had explored and it was somewhat startling, the degree to which three large banks are controlling that market now. How are you responding to this concentration issue in your markets. Is this step-up in marketing a result of that?

James Wells

The interesting thing is that the word used in the article such as dominate, why you might have a relatively large concentration on the top three in any particular market, it's by far from being dominated. The reality is all of that markets are loaded with regional and smaller institutions that compete pretty aggressively, so that's a qualitative comment. Now, basically what we're doing is we're promoting our brand and we're promoting our operating model, and we're working hard on the delivery of service quality, such as that to our clients. And this advertising uptick started actually about two and half years ago. If you go back and look at the numbers, we are much more inclined to do that. It's been very well accepted. The brand positioning has been very well accepted. And to get to Orlando specifically, we're still number one share there. And Nancy, I think in our 20 or 25 metropolitan statistical areas, the top three banks have similar, maybe less than Orlando, as a number but similar. It's always the same banks and it always has been and there's actually nothing new about that.


And our last question comes from Greg Ketron with Citigroup.

Gregory Ketron - Citigroup Inc

I have a question, kind of longer term as we move our way out through the rest of this year and into next year. You're hearing other banks talk about prices on real estate firming up, and as you look at your NPA strategy going forward, how much do you see that play out? I mean, would you be delivering properties into the marketplace that maybe on accelerated pace, and we might see things like ROE expense stay elevated for a number of quarters? Or just really any thoughts around that as we move forward?

Thomas Freeman

Greg, it's Tom. We've built a very efficient and substantial disposition machine in our OREO departments. They move through the properties we take on with some alacrity. Last quarter, you saw us go and do a disposition of some loans because we thought the market was really advantageous to a disposition activity. As the markets continue to firm and the secondary market for sale of assets or sale of loans were to be advantageous, we have the resources and capabilities to be able to do those sorts of a transaction, should we decide to. I think we will continue to work through this on a careful and thoughtful basis, very mindful of our shareholders and preserving those resources as we move it through. But if you look at the velocity of disposition over the past couple of years, we've done a pretty good job of when we get a hold of the properties, getting rid of them.

Gregory Ketron - Citigroup Inc

And would you expect ROE expense to maybe stay elevated for a number of quarters, or is it too difficult to predict?

Thomas Freeman

No, I think we have a fairly good prediction on that stuff and really know what we've got much coming in, and I think that's exactly right. You're going to have elevated ORE (sic) [ROE] expenses over the next few quarters until we're through with the disposition portion of the cycle.

James Wells

Thank you, everyone.


And that concludes today's call. Please disconnect your line at this time.

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