SunTrust CEO Discusses Q3 2010 Results - Earnings Call Transcript

Oct.21.10 | About: SunTrust Banks, (STI)

SunTrust Banks, Inc. (NYSE:STI)

Q3 2010 Earnings Call

October 21, 2010 8:00 AM ET

Executives

Steve Shriner – Director, Investor Relations

Jim Wells – Chief Executive Officer

Mark Chancy – Chief Financial Officer]

Tom Freeman – Chief Risk Officer

Analysts

Matthew O’Connor – Deutsche Bank

Nancy Bush – NAB Research

Tom Sherlock – CLSA

David Hilder – Susquehanna

Bob Patten – Morgan Keegan

Operator

Welcome to the SunTrust Third Quarter Earnings Conference Call. Parties will be on a listen-only mode until the question-and-answer session of today’s conference. (Operator Instructions)

This call is being recorded. If you have any objections you may disconnect. I’d like to introduce your speaker, Mr. Steve Shriner and he is the Director of Investor Relations.

Steve Shriner

Good morning. Welcome to SunTrust’s third 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 during our call today. Slide two outlines the content, which includes an overview of the quarter, financial results and a review of credit quality. The press release presentation and detailed financial schedules are available on our website, www.suntrust.com. This information can be accessed by going to the Investor Relations section of the website.

With me today are members of our management team Jim Wells, 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 review of asset quality. At the conclusion of the formal remarks, we’ll open the session for questions.

Before we get started, I need to remind you 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 available on the website. Further, we do not intend to update any further forward-looking statements to reflect circumstances or events that occur after the date the 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 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 -- websites are located on our website.

With that, I’ll turn the call over to Jim.

Jim Wells

Thank you, Steve. Good morning, everybody. Glad you’re with us this morning. Financial results improved significantly this quarter as we earned $84 million or $0.17 per share. Strong revenue coupled with lower credit costs grew significantly increased profitability.

As you’re all aware throughout this economic cycle we have been positioning our businesses for growth. Those efforts are gaining traction and resulting in improved performance. Until macroeconomic indicators are mixed and there remains uncertainty in regard to regulation we are increasingly encouraged by the improvement in our operating results.

Revenue growth in the quarter was particularly strong in mortgage related revenues as we benefited from the lower interest rate. SunTrust Robinson Humphrey also had a terrific quarter posting report investment banking revenues. Partially offsetting the performance of these core businesses, excuse me, was a decrease in service charges, largely related to Reg E and $81 million of mark-to-market losses on debt and indexed linked CDs.

Net interest income and net interest margin increased compared to last quarter, up 5% and 8 basis points, respectively. Net interest margin increased largely due to the improved funding mix and lower rate paid on deposits.

Additionally, the securities and loan portfolios increased, while earning asset yields remained stable. Total expenses were flat compared to last quarter while core expenses increased mostly driven by revenue related compensation and legal related expenses. Mark will provide more detail on this momentarily, however, I will reiterate that we continue to manage expenses tightly across the organization while making what we believe are appropriate investments in our business to facilitate growth.

Asset quality trends continue to improve with non-performing asset, non-accrual loans, net charge-offs and provision for loan losses all declining this quarter. As anticipated, early stage delinquencies were stable overall.

We made a significant stride toward our goal to improve the client experience and thereby increase client satisfaction and loyalty. These efforts are beginning to manifest themselves in revenue growth. There’s still a challenging operating environment, we are moving the needle in several key areas of the business.

At the same time, we’re aware of lingering operating environmental uncertainties such as regulatory and legislative matters. We’ll move to slide four where we’ve provided some information to add some clarity on that topic.

It is clear that the financial regulation will impact our financial results, but we believe that for us it will be manageable. The information on slide four highlights selected items of interest though it is not intended to be all inclusive. Certain changes are expected to have little impact on SunTrust such as the Card Act while others such as the impact of the Consumer Financial Protection Bureau are simply not predictable at this time.

First, I’ll focus on deposit service charges. Last quarter we indicated that the impact of Reg E on service charges was expected to be at the low end of the previously provided 10% to 20% range. That expectation remains. However, additional clarity is probably necessary.

Clients continue to opt in and we expect them to do so over the next two to three quarters. Therefore, we expect to see a more substantial negative impact on service charges now but as clients continue to opt in the impact will trend down. We expect the impact from Reg E to stabilize to a low double-digit figure as we approach mid 2011. In the meantime it will probably be a little more elevated.

We also chose to make changes outside of Reg E that were designed to improve client satisfaction. We decided to stop charging overdraft fees on individual transactions with a value of less than $5 and to reduce the number of maximum daily overdraft fees.

These changes were effective July 1st and are expected to reduce service charges by an additional 5% to 6% annually. I’ll also point out that these estimates do not include any mitigating effects of household retention, household growth or any changes to products or pricing.

Derivatives contributed about $100 million in revenue in 2009, most of which was generated from clients. This is an area where we do not currently believe that the legislative and regulatory changes will have a material impact on the revenue for SunTrust.

Consumer and small business debit card interchange contributed about $250 million in fee income during 2009. We expect some impact to this revenue stream, obviously. However, the ultimate amount will remain unknown until final regulations are written. This is a higher growth opportunity area and is driven by household growth, higher product penetration and increasing consumer usage pattern, which will help to offset the potential impact of lower interchange rates.

We had anticipated an increase in FDIC deposit insurance costs as a result of the change in assessment base from deposits to assets. However, based on the FDIC’s recent announcement, it appears that the impact will be less than originally anticipated though the amount is still not known at this time.

The final item of note is the Collins Amendment and the effect it will have on Tier 1 capital. With $2.3 billion in outstanding instruments we expect a cumulative reduction in the Tier 1 ratio approximately 175 basis points. This is on an incremental basis and obviously will not include all the other factors that affect capital overtime. This reduction will occur over three years beginning in 2013 and with our solid capital position this is another completely manageable outcome.

The time being, we view these instruments as reasonably attractive capital though we’ll continue to valuate whether to call these securities by weighing their costs against the capital benefits.

Now, turning to slide five an review of our capital position, virtually all of our key capital ratios increased again this quarter as they have each quarter depicted on the slide. During the third quarter Tier 1 capital increased to an estimated 13.6%, while estimated Tier 1 common increased to 8%. The total capital ratio declined in the current quarter as a result of the tender for subordinated debt that we completed in the third quarter.

I’d like to take a moment before I turn the call over to Mark to give some context to our estimated 8% Tier 1 common ratio in light of the recently announced Basel III requirements, so if you turn to slide six, the Tier 1 common capital ratio of 8%, which I mentioned, represents $10.7 billion of capital. That ratio is well above the announced Basel III regulatory standard.

SunTrust estimated Tier 1 ratio of 8% is a full 1% of $1.3 billion above the threshold of 4.5% plus the 2.5% conservation buffer, which is not scheduled to become effective fully until 2019.

SunTrust’s capital position today is particularly strong, especially when you consider our proven credit risk profile. We reduced our higher risk portfolios by 10% to 15% since the end of 2008 and further more we have relatively low market and operating risk and high liquidity.

And with strong capital, more clarity on capital standards, lower risk, high liquidity and improved earnings, we believe that we are well positioned to repay TARP. As I said, we will repay at the appropriate time and in a fashion that makes the most sense from both our shareholder and regulatory perspectives.

The efforts being made to position SunTrust for growth beyond the cycle are translating into improved core performance. We are investing to grow the business. We are managing expenses prudently and we returned the company to profitability. And though modestly improving economic conditions are helping performance, we remain encouraged by our emerging operating results, there are certainly still quite a lot of work to be done, but we’re making strides in the right direction.

And with that, I’ll turn it over to Mark to provide more detail.

Mark Chancy

Thanks, Jim and good morning everybody. I’ll begin my comments today on slide seven of the earnings presentation with a review of the summary income statement. For the quarter, we posted net income to common shareholders of $84 million or $0.17 per share. This is $140 million improvement from the loss to common shareholders of $56 million that we posted in the second quarter. The improvement was largely attributable to strong core revenue performance, which increased $153 million sequentially.

Net interest income increased 5%, non-interest income increased 10%, with a combined result of 7% increase in revenues. Now the key revenue drivers included increased earning assets, expanded net interest margin, significant increases in mortgage production and servicing revenue and a very strong quarter for investment banking.

Further, a $47 million decline in provision for credit losses and flat non-interest expenses supported the sequential improvement in earnings. Provision for taxes increased $63 million to a small tax liability of $14 million with no material discrete items impacting tax provision in the quarter.

The net effect of securities gains, debt extinguishment costs and mark-to-market gains and losses contributed $47 million to pre-tax income and we’ve adjusted for these items when presenting SunTrust’s core non-interest income for the quarter.

In addition, third quarter results included $59 million in mark-to-market losses and an increase in legal related cost that we’ve not adjusted for. I’ll talk more about these puts and takes in just a minute. However, the overall takeaway was that this was a solid quarter of earnings for SunTrust.

Now, with that said, I’ll also acknowledge that the sustainable earnings of the company are still not where we want them to be. While we are very pleased with the revenue performance of our investment in mortgage banking businesses, we recognize that these revenue sources are subject to seasonal and cyclical variability.

However, there are areas that we believe will drive sustained improvement in our financial results, while the economy remains weak, we expect that gradual continued improvement in economic conditions will result in lower charge-offs and reserves, reduced credit related expenses and increased client demand for loans and financial services in general.

In terms of things that we have greater control over, we are encouraged by our continued success in improving client satisfaction and loyalty. Deposit growth, mix and rates paid and our investment banking performance are tangible examples where we believe this success is driving revenue. Additionally, we remain vigilant in managing expense growth to a proper balance between current income and investments for future profits.

Now, with that brief summary of our third quarter results, I’ll now shift to slide eight a review of loans and deposits. Average loan balances again excluding non-accruals were flat and down 6% as compared to last quarter and last year, respectively. The story here hasn’t changed much since last quarter.

Consumer loan categories continued to increase with commercial loan categories flat to down. However, there are some things I’d like to call to your attention starting with the commercial loan category. Average commercial loan balances stabilized, breaking a declining trend that started in early 2009, excluding the impact that we had from the FAS 167 consolidation in the first quarter of 2010.

Revolving line of credit utilization rates were stable during the quarter overall. Large corporate utilization was basically stable, while middle market and smaller client utilization declined marginally.

Average balances stabilized and period end balances increased due to higher term loan balances and growth in the balances of three pillars, which you’ll remember is our asset back commercial paper conduit.

Average construction loan balances increased roughly one-half of 1%, which is an anomaly relative to recent trends. However, if you refer to the period end balance sheet in the press release tables, you’ll see that construction loans actually declined $565 million or 11%, as compared to June 30th.

Residential one to four family mortgages increased in the quarter, driven exclusively by increased holdings of federally guaranteed loans. With weak overall loan demand and high liquidity, we have chosen to retain some agency eligible mortgage loan production on balance sheet.

Specifically, we increased our holdings of guaranteed mortgage loans by roughly $1.2 billion during the quarter and these loans are guaranteed by Fannie Mae under its long-term standby commitment program. While we have been growing consumer loans fairly consistently over the past year, growth in the current quarter was robust.

In the current quarter organic growth remained and was augmented significantly by two actions. While it did not impact the average balance significantly, period end consumer direct growth concludes the consolidation of a previously off-balance sheet student loan securitization of just under $500 million.

Growth in the consumer indirect category also includes the purchase of approximately $740 million in high quality consumer auto loans. We continue to expect that broad-based commercial loan growth will return with an improving economy. However, the evidence to date suggests that improvement will occur gradually. As this occurs, we will continue to look for opportunities to grow commercial loans and client segments and products that offer opportunity and to originate and acquire high-quality consumer loans.

Now, moving on to deposits at the bottom of the slide, you can see that core deposits increased and the positive shift in mix to lower cost deposits continued. Balance increases were driven by DDA and money market accounts which sequentially increased four and 6% respectively. These categories combined provided over $3 billion in deposit growth.

Now, partially offsetting this growth were now and CD balances which declined roughly $2.4 billion in the quarter. Overall, we continue to be very pleased with the enhanced liquidity and lower cost funding that deposit growth has provided during this past year. 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 and improvement in our net interest margin.

Actions in the quarter taken to reduce higher cost funding sources include the repayment of bank sub-debt via a tender offer and additional home loan bank repayments, the combination of which was approximately $1 billion. We also continued during the quarter to reposition the securities portfolio. So let’s turn to slide nine.

Our total available for sale portfolio stood at $30.3 billion at the end of the quarter, up $2.7 billion from the end of the second quarter. At the beginning of the quarter, we developed a view that rates would decline due to the weakening economic indicators, that coupled with high liquidity caused us to take the opportunity to increase our holdings of high quality, liquid treasury and agency securities early in the third quarter.

More specifically, we rebalanced the agency portion of our portfolio slightly lengthening the duration and netting securities gains of $69 million. With the decline in rates during the quarter, the unrealized gain on the portfolio increased to approximately $830 million from $680 million at the end of the second quarter.

We continue to regularly review this portfolio and so far in October, we’ve sold $1.5 billion in securities, primarily to reduce our exposure to certain tranches of mortgage-backed securities that had increased in value during the quarter. As we look forward, over a longer time frame, we continue to expect that a growing economy will result in loan balances trending up and deposits trending down. With a basically stable cash position, we expect to decrease the securities portfolio in response to increasing loans and/or decreasing deposits.

Now, I’ll take a moment to cover the margin on slide 10. As I mentioned, lower cost funding drove an eight-basis point improvement in the margin to 3.41%, as earning asset yields were basically stable. Margin exceeded our prior expectations and guidance due primarily to better than expected deposit pricing and mix and the effects of the previously mentioned securities portfolio transactions.

Relative to the prior year, margin is up 31 basis points and this improvement is driven primarily by the lower funding cost discussed earlier. We currently expect margin to be relatively stable in the fourth quarter as compared to the third quarter and the risk and opportunities to this view are listed on the slide.

So let’s move on to provision on slide 11. Total provision for credit losses for the quarter was $615 million, down $47 million from the second quarter as credit trends continued to improve. Provision expense was $75 million less than charge-offs with $5 million of this differential coming from a reduction in the unfunded commitments reserve that we hold due to the improved credit quality related to certain commercial and large corporate clients.

Charge-offs were $690 million, a decrease of $32 million or 4%, compared to last quarter. The decline occurred in most product categories and was partially offset by an anticipated increase in commercial real estate and a very small increase in residential mortgage.

The allowance ratio declined from 2.81% to 2.69%, as a result of both the decrease in the allowance as well as the increase in period-end loan balances. As I mentioned earlier, the increase in loans is the result of increases in high-quality consumer, commercial and government guaranteed mortgage loans, partially offset by declines in the higher risk categories including construction and home equity. Tom will cover asset quality in more detail in a few minutes, so let’s move on to noninterest income on slide 12.

On a reported basis, noninterest income was up 10% sequentially and 35% from the prior year. We’ve adjusted for a number of items in each quarter and after the adjustments, noninterest income increased by 19 and 17% 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 for $69 million in securities gains and a net of $10 million in mark-to-market losses on securities and our fair value debt and related hedges. As mentioned previously, the main drivers of the sequential quarter increase in noninterest income relates to our investment banking and mortgage businesses and key items of note in this quarter’s noninterest income results include investment banking income increasing by 66% or $38 million to a record level of $96 million in the quarter.

This result was driven by strong syndication, bond origination and merger and acquisition revenues. Mortgage production income increased $150 million, driven by an increase in application volume of over 25%, increased production margins and a $53 million decrease in the cost of mortgage repurchases which I’ll cover in more detail in just a minute.

Mortgage servicing income increased $44 million or 51% as compared to the prior quarter, due almost entirely to hedge performance. Trading income actually declined $130 million in the quarter, which needs a little more explanation. The majority of the decline was caused by mark-to-market losses on our publicly traded debt and related hedges of $22 million in the current quarter as compared to gains of $63 million in the second quarter.

Not included in the adjustments on this page is an additional mark-to-market loss of $59 million on index-linked certificates of deposit. In prior quarters, the marks on these deposits which total about $1.2 billion, have been relatively insignificant and mostly positive.

Tightening of SunTrust credit spreads and the declining interest rates in the current quarter resulted in a $59 million loss this period. A view excluding the impact of the mark on index-linked CDs and the items included in the appendix reflected increase in trading income driven largely by fixed income and derivatives trading.

Now, the final item, I will note is the decline in service charges on deposit accounts of $24 million or 11%. This reduction is related to the implementation of the required Reg E changes and the voluntary changes that we have made to our fee schedules that Jim talked about earlier.

Our voluntary changes were in place for the entire quarter and the Reg E changes were effective August 15th. As a result, we expect a full quarter of Reg E to have a negative sequential quarter impact going into the fourth quarter, with some mitigating impact from increased client opt-in and a typical seasonal increase.

Let’s now turn to slide 13 for a discussion of mortgage repurchase trends. The noninterest income impact of mortgage repurchases decreased $53 million this quarter. The reduction was primarily due to lower charge-offs, coupled with a smaller increase in reserves.

Repurchase losses declined in part due to the implementation in the quarter of an enhanced review process and in part due to a decline of the average loan size of the volume process. In addition, new request volumes declined back to the levels more consistent with the first quarter and resulted in a basically stable population of pending requests. However, new request volume remains volatile from month-to-month and as such, future results are difficult to estimate with precision.

If third quarter trends continue and they have so far in October, our current expectation is that fourth quarter charge-offs will increase back closer to the second quarter levels. However, if -- and I want to emphasize if, new request volumes remain stable, our current view is that reserve additions in the fourth quarter will be roughly stable with the third quarter, despite the expected increase in charge-offs.

Now, said another way, we expect the income statement impact in the fourth quarter to remain relatively stable with that realized in the third quarter at this time. Now, of course, all of this is related to the assumptions that I’ve just walked you through.

The key points from the bottom part of this slide are slightly altered from prior quarters. Most of our current request volume is coming from the higher loss vintages of 2007 and prior years and this has continued longer than we originally expected. We continue to expect, however, that normal seasoning patterns for origination vintages overtime will shift new request volume to newer vintages.

As that occurs, we expect lower request volumes and lower loss frequencies and severities as the newer vintages exhibit more favorable characteristics as depicted on the bottom right of slide 13. The last point I’ll make on this topic does not have a reference point on the slide.

The topic is the recent speculation regarding repurchase liability for non-agency loan sales. So first, let me put the numbers into perspective. The timeframe we should focus on is 2005 through 2007 as we had very few of such sales in 2008. The total sales volume of non-agency product during this timeframe is approximately $30 billion and the remaining unpaid balance today is roughly $17 billion.

In addition, the composition of our non-agency sales is dramatically different than from the industry produced over this time frame. For example, our percentage of prime non-agency productions sold was approximately 56%, with the balance being generally high quality, low doc production.

By contrast, external data sources show the total industry with a much lower composition of prime product loan sales. Finally, we have not had a material volume of repurchase requests on non-agency sales to date, nor have we sustained losses of a substantial nature.

So with that, let me turn to slide 14 for a review of expenses. Noninterest expense was flat when compared to last quarter and increased 5% compared to the third quarter of 2009. Adjusting for a few items that are detailed in the appendix of today’s presentation, expenses increased 4% sequentially and 7% compared to the third quarter of last year.

At the bottom of the slide, we’ve included the three primary drivers of the sequential quarter increase which combined drove the majority of the change. Personnel-related expenses are the biggest contributor and the majority of the growth is associated with improved revenue generation.

Incentive compensation associated with mortgage, investment banking performance increased as you would expect. Further, of the increase in headcount of approximately 350, the majority is related to mortgage production. The remaining increase is largely related to investment in personnel in our technology area and revenue producers in other lines of business.

As I mentioned earlier, we are seeking to balance current expenses against investment in future revenue and this is an example. The other area of growth is embedded within other noninterest expense and on the slide we’ve removed credit-related expenses and adjustments from the appendix of the presentation to highlight this embedded increase.

The reconciliation for this line is in the appendix as well. The increase of $17 million you see on the slide is more than 100% associated with legal-related costs. And while future litigation-related expenses are never certain, our current expectation is that these costs will not recur next quarter.

So with that overview of our third quarter results, I will turn the call over to Tom Freeman to discuss asset quality in more detail. Tom?

Tom Freeman

Thanks Mark. This morning, I’m going to review our asset quality beginning on slide 15. 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.

Loan balances increased and overall delinquencies were basically stable. Net charge-offs during the second quarter were $690 million, down $32 million from last quarter. Charge-offs continued to be heavily concentrated in the residential real estate related portfolios, including residential mortgages, construction and home equity.

The net charge-off ratio declined from 2.57% to 2.42% with most portfolios showing improvement. Stable mortgage and higher commercial real estate charge-offs were the exceptions to this declining trend and I’ll talk about these more in a moment.

Provision expense declined as a result of lower charge-offs. In addition, with improved asset quality metrics in the current quarter and an outlook for continued gradual improvement, the allowance for loan losses was reduced by a modest $70 million. The allowance to loan ratio declined to 2.69% of loans or 12 basis points.

With roughly half the decline related to lower reserves, the other half of the decline is related to higher loan balances. As Mark mentioned earlier, the portfolio mix continued to improve, with higher risk portfolio balances like construction continuing to decline and growth occurring in both higher quality and federally guaranteed portfolios.

Nonperforming loans declined during the quarter by over $325 million or 7%. This is a fifth consecutive quarter of declining nonperforming loans. Owned real estate also declined resulting in nonperforming assets declining by nearly $400 million.

Aggressive problem asset resolution coupled with continuing trending of lower inflows into nonperforming drove the decline in the current quarter. Early stage delinquencies remained basically stable during the quarter. Delinquencies are currently below 1% after excluding government guaranteed loans.

The early stage delinquencies have declined significantly since the beginning of 2009. While the economic and employment environments have remained sluggish. As a result, we do not expect significant further improvement in overall early stage delinquencies until general economic conditions improve.

Please turn to slide 16 for review of loan portfolios. This slide provides a net charge-off and early stage delinquency metric by loan type. It illustrates on a more granular level that overall asset quality has improved and that asset quality issues remain concentrated in the residential real estate portfolios.

Charge-offs declined broadly among the portfolios. Early stage delinquencies were stable to down and balances in some of the higher risk portfolios continue to decline. Commercial portfolio continues to perform well with early stage delinquencies, non-performing loans and charge-offs stable to down in the quarter.

Charge-offs in the commercial real estate portfolio increased to just over 1% of loans on an annualized basis. While a significant increase in the annualized charge-off rate, the actual dollars involved were relatively low, with charge-offs in the segment totaling $40 million.

We expect some additional stress and charge-offs in this portfolio as the economic cycle plays out. However, the timing of problem resolution in commercial real estate can be varied. Overall, we continue to believe that this portfolio will perform comparatively well given its composition, the quality of underwriting and our ongoing management disciplines. Evidence of this can be seen in the relatively low and stable levels of non-performing loans and delinquencies.

As a reminder, this portfolio is largely owner occupied and has an average loan size of about $700,000 overall. The average loan size of investor real estate loans is about $1.1 million. Asset quality is generally improved in the consumer portfolios with stable-to-lower early stage delinquencies and charge-offs.

We provided additional detail this quarter on the consumer direct portfolio, to highlight the relatively high delinquency and relatively low losses contained in the student loan portfolio. Student loans comprise two-thirds of the consumer direct portfolio and roughly 90% of the student loans are government guaranteed.

I’m going to talk about each of the higher risk residential real estate secured and construction portfolios in the next few slides. In general, balances in these portfolios continue to decline and they are disciplined generally stable to improving performance with construction continuing to show some variability.

Mortgage charge-offs increased slightly this quarter but our outlook for charge-offs in the residential mortgage portfolio continues to be stable to improve. Next I’m going to briefly review a more detailed presentation of our residential mortgage portfolio on slide 17.

Asset quality in the residential mortgage portfolio continued to show overall improvement in terms of nonperforming loans and delinquencies driven in large part by performance in the core portfolio. Growth in the core mortgage portfolio was due to the origination and retention of mortgages that have Federal Government guarantees from Fannie Mae and the FHA.

This government guaranteed subset of the core portfolio increased by over $1.2 billion during the quarter and now stands at over $3 billion. A non-core portion of the portfolio continued its declining trend during the quarter, dropping by over $300 million.

Non-performing balances declined in every segment of this portfolio during the quarter. Total delinquencies declined seven basis points overall, driven down by small decrease in the core portfolio and larger declines in the home equity loan and lot loan portfolio segments.

Despite stable sequential charge-offs, delinquency trends in this portfolio continued to point to reduced frequency of over the next quarter or two. We expect home prices to remain soft overall, trending down in some markets and stable to modestly up in others.

We believe that lower expected default frequency and moderating loss severity will produce stable to declining non-performing loan and charge-off levels over the next quarter or two. There are some risks to this generally improving outlook.

The first is the pace of economic recovery and more specifically unemployment rates and housing prices. The second risk relates to the foreclosure process. SunTrust is reviewing pending foreclosures to ensure compliance with applicable regulations and practices. We take this issue very seriously and we’re pursuing it aggressively.

While technical issues may arise in the preparation of any legal document, we are taking this opportunity to resolve any issues which are uncovered. We have completed this review process for the states of Florida, Georgia and North Carolina. These states account for approximately 85 or 80% of the unit volume in our portfolio.

To provide some context regarding the impact to SunTrust, in Florida which represents about 70% of our foreclosure activity, we have less than 300 loans scheduled for hearings in the next 60 to 90 days. As a result, we do not expect any required rescheduling to have a material impact on the resolution of our mortgage non-accruals.

We’ll now move to slide 18 to discuss home equity lines. Home equity portfolio balances and charge-offs continued to decline, while nonaccruals were relatively stable. Over two-thirds of the portfolio is labeled as core and is performing reasonably well. The rest of the portfolio is running off with no new production and little to no line availability.

As you would expect, elevated credit metrics are largely driven by these higher risk segments. These include lines originated by third parties, lines in Florida and other states with high loan to value ratios.

Now, if you turn to slide 19, I’ll talk about our construction portfolio. We continue to aggressively reduce our exposure to higher risk construction loans with balances dropping another 11% during the third quarter. Balances are down 40% on a year-over-year basis while overall charge-offs were down sequentially, they remain elevated and uneven.

The amount and timing of construction charge-offs are variable due to the nature of the workout process. In addition, commercial construction loans are typically larger and more complex than consumer construction loans and introduce another element of variability.

As you can see on this slide, residential construction has been the most problematic construction portfolio. We expect that charge-offs related to these loans will remain elevated and somewhat variable over the next few quarters as we continue to work through this rapidly declining portfolio.

Commercial construction balances continue to decline and this portfolio has generally performed better than its residential counterpart but it too has demonstrated, elevated and somewhat variable charge-offs. Overall, nonperforming construction loans decreased for the second straight quarter but are expected to remain elevated. We believe that residential construction nonperforming levels will be stable to down with modest increases in nonperforming commercial construction loans.

The overall construction delinquency ratio increased quarter-over-quarter. However, this was driven by lower portfolio balances rather than by an increase in the dollars delinquent which remains stable.

Next, I’m going to review loan modification results on slide 20 of today’s presentation. Accruing TDRs totaled just over $2.5 billion at the end of the quarter and performance continued to be at an acceptable level with 86% of accruing restructured loans remaining current on principal and interest payments.

Balances of accruing TDRs increased by roughly $250 million during the current quarter as compared to approximately $360 million last quarter. The vast majority, 97%, of accruing TDRs are consumer, residential-related loans. The slowing growth trends in residential TDRs continued and the pace of newly delinquent loans eligible for restructure decreased.

Overall, the performance of the accruing TDRs continued to exceed our expectations during the third quarter. Accruing TDRs have a weighted average age of 12 months, evidencing a level of sustained performance. With 94% of accruing TDRs being current or one payment past due, the performance of this portfolio remained much closer to traditional mortgage portfolios than our restructured portfolio.

Before turning the call back over to Steve, I’m going to provide a brief summary of today’s asset quality review on slide 21. Overall, asset quality continued to improve in the quarter. Nonperforming loans and nonperforming assets declined. Delinquencies were stable to down in most of the portfolios. However, we do not expect significant additional improvements in overall early stage delinquencies until economic conditions strengthen.

Charge-offs declined modestly overall, with most portfolios stable to down. Commercial real estate charge-offs increased as specific problem loans were resolved. Given continuing stress in this segment, the timing and amount of future commercial real estate charge-offs will remain variable and elevated.

Mortgage asset quality metrics were stable or improved. We continue to aggressively and successfully reduce the risk in the construction portfolio as evidenced by additional balance reductions, lower non-performing loans and elevated charge-off levels. Accruing TDRs remain predominantly centered around consumer mortgages. Balances increased modestly in the quarter and solid payment performance continued.

At the current time, we expect overall credit quality to improve again in the fourth quarter, with total net charge-offs stable to slightly down and nonperformers declining modestly. Finally, at this point in the cycle, we expect the allowance for loan losses to continue to trend downward at a pace consistent with the improvement in credit quality.

With that, I’ll turn it back over to Steve.

Steve Shriner

Operator, I think we’re ready to take our first question.

Question-and-Answer Session

Operator

(Operator Instruction) The first question is from Matthew O’Connor from Deutsche Bank.

Matthew O’Connor – Deutsche Bank

Hi, guys.

Jim Wells

Good morning.

Mark Chancy

Good morning.

Matthew O’Connor – Deutsche Bank

Regarding the private label mortgages that you sold or securitized, do you have any more color on the LTVs or the FICO scores or how the loans are actually performing?

Mark Chancy

Matt, it’s Mark Chancy. How are you?

Matthew O’Connor – Deutsche Bank

Good.

Mark Chancy

You know, the data that we are providing, let me just run back through it. So we’ve got the information that we’re putting out publicly today. We have about $30 billion of non-agency related product that was sold during the ‘05 to ‘07 period with $17 billion that’s currently unpaid principal balance. What we noted in the call was that 56% of that $30 billion is prime-related product including prime jumbo loans with the remaining 44% high quality, low doc loans.

The non-agency product is included in our reserve process but we’ve had few requests to date and few losses and the bulk of the reserves that we’ve been talking about and that we show in our presentation materials relate to the agency products. You’ll recall that total reserve is around $270 million, which was up $14 million. But as far as the individual statistics of the various loans by vintage, we just have not put that out in the public domain at this point.

Matthew O’Connor – Deutsche Bank

Okay. And then just separately, I know as companies start to become profitable, the tax rate can get all funky. If you could just remind us of what the recurring tax credits are and how long we should assume they stick around?

Steve Shriner

Hey, Matt. This is Steve. You know, you’ll notice that with a pretax, I think it was around $170 million or so this quarter, we posted a small tax provision. If you compare that to our historical kind of at run rate earnings of call it 30 to 32%, what you’ll see is excluding discrete items, you should get a fairly linear function for tax rate going forward between that near breakeven level we’re at today and that long-term rate of 30 to 32% as we return to a run rate of earnings in the future. Does that help?

Matthew O’Connor – Deutsche Bank

I guess it’s just going to be -- it will probably take a couple years to get back to that normal tax rate, right? So as we’re modeling it out, is there a kind of tax credit that we should assume each quarter plus a rate on top of that?

Steve Shriner

Well, with $170 million in pretax and tax liability of 14, you can assume that we have a permanent GAAP tax differences that shelter somewhere around $150 million of taxable income every quarter.

Matthew O’Connor – Deutsche Bank

Okay. And then just lastly, if I may, the page on capital where you show 8% Tier 1 common, just to be clear, is that under the Basel III calculation?

Steve Shriner

Yeah.

Matthew O’Connor – Deutsche Bank

Okay. And so I guess there’s not any meaningful change in RWAs or anything like that?

Mark Chancy

We have not made, let me clarify. We do not have any current significant adjustment to the capital calculation associated with things like DTA and SSR. So as we sit here today, that’s an immaterial effect on our overall calculation, so we basically just provided to you a straight calculation of our Tier 1 common but you should assume that those two things as of today are basically equivalent at 8%.

Matthew O’Connor – Deutsche Bank

I guess if they adopt the OCI or if the U.S. adopts the OCI rule, there’s some Coke stock that is not included in regulatory capital that we would add back.

Mark Chancy

I’ll get back to you on that, Matt. Just to be clear.

Matthew O’Connor – Deutsche Bank

Okay. Thank you.

Operator

The next question is from Nancy Bush from NAB Research.

Nancy Bush – NAB Research

Good morning, gentlemen.

Mark Chancy

Good morning.

Nancy Bush – NAB Research

Jim, could you just speak to the whole foreclosure moratorium issue and where SunTrust kind of sits in the spectrum of what’s going on right now? That’s my first question.

Jim Wells

Well, as you heard from Tom, Nancy, we have, 70% of our activity is in Florida and the number there of loans in the next period of time for hearing is less than $300 million. At the same time -- excuse me, 300 loans. Sorry.

Nancy Bush – NAB Research

Big difference.

Jim Wells

I will correct it. 300 loans. And I guess what I would say to you is that I think the results of all this furor will be variable based on institutions and how many loans they’ve been working on and how they’ve done it. We’re just trying to be very clear and very cautious, making sure we comply with everything we need to comply with, but the effects so far have been limited. Now, what happens to others, honestly I don’t know and I find reading the press not particularly helpful about that.

Nancy Bush – NAB Research

Okay. Secondly, the big increase you had in nonperform -- pardon me, in non-interest bearing deposits from sequentially, could you just speak to the sort of new account acquisition trends that may be embedded in that and how that big number came about?

Jim Wells

I’m going to let Bill Rogers answer that one, Nancy.

Bill Rogers

Hey, Nancy.

Nancy Bush – NAB Research

Hi.

Bill Rogers

We have been -- the whole transition in the deposit mix from learning CDs, single service CDs, okay, and really high focus on money market and demand. You can see the impact of that, but really underlying all that is the focus on household growth.

I mean, that’s really what we’re trying to accomplish and on an annualized basis we’re somewhere in the 3% to 4% in total household growth which is where the focus is. And checking accounts box asking sort of have a lot of variability around them but that’s the focus.

Nancy Bush – NAB Research

Are you seeing any impact, Bill, as – I mean, Wells Fargo, I guess has now changed the name on the building and they are sort of beginning to make its presence better known there and I think JPM is being pretty aggressive in the market, although they may be more aggressive on the loan side. Are you seeing any kind of shift as the competitive situation changes there?

Bill Rogers

I think the answer would be -- it’s always been really competitive in our markets and we’ve never been better positioned from a competitive standpoint.

Nancy Bush – NAB Research

Are you guys beginning to sort of tout hometown bank advantage that sort of thing a bit more?

Bill Rogers

Well, we’ve been pretty aggressive on the marketing side in Atlanta. This is -- particularly here, this is our home turf here and we’ve been -- we have been and will be highly protective of our franchise.

Jim Wells

Thank you, Nancy.

Nancy Bush – NAB Research

Thank you.

Operator

The next question is from Mike Mayo from CLSA.

Tom Sherlock – CLSA

Yeah. Hi. Good morning. This is [Tom Sherlock] filling in for Mike. I just had a follow-up on your loan utilization. You mentioned that it is flat to slightly down in some categories. I just want to see if you can give more color on what the actual percentages are in the different areas and where you expect that to go?

Bill Rogers

Yeah. I’ll handle that. It’s Bill again. On the large corporate side it’s sort of generally in the 17% kind of range and that’s pretty much all-time lows. Generally that could be somewhere in the mid to high 20s, sort of on an average kind of basis and on the commercial -- sort of commercial, middle market basis it’s in the low 30s and has historically averaged somewhere in the low to mid-40s. And it has for the last three quarters sort of -- the rate of decline has abated. But we’re sort of bobbling around those kind of numbers.

Tom Sherlock – CLSA

Okay. So you would expect that to maybe go a little bit farther down?

Bill Rogers

No, no, I’m not saying that. I’m just saying it sort of has hovered consistently in the last three quarters.

Tom Sherlock – CLSA

Okay. That’s would be consistent. Okay.

Bill Rogers

I would hope that we would start to see some kind of increase, depending on some type of economic recovery and then certain parts of our business, middle market would be the example, I mean, the commitments are going up. So we’re increasing our at bats and increasing our relationships, but the utilization rate’s still low.

Tom Sherlock – CLSA

Got it. Great. Thank you.

Jim Wells

Okay. We’ve got time for one more, I think.

Operator

The next question is from David Hilder from Susquehanna.

David Hilder – Susquehanna

Good morning. Actually, two quick questions. First, Tom I think mentioned that you have been putting some agency mortgages on the balance sheet and I wondered what your appetite for that is going forward and what your interest rate management strategy would be, assuming they’re 30 year fixed paper.

Jim Wells

If you don’t mind, let’s get Mark to answer that.

Mark Chancy

Yeah. This is Mark Chancy. We have added as we mentioned a little over $1 billion worth of that product during the quarter. We have other aspects of the mortgage portfolio that have been driving and as a result, this is somewhat of an offset, if you will, to that attrition. We’re not looking to grow the overall on balance sheet mortgage portfolio significantly. We’re trying to continue to de-risk our overall loan portfolio and add back quality assets, particularly in this case with a government guarantee.

One of the things that you’ll note in our earnings release is that during the -- we have over the course of the past couple of quarters both added mortgage loans with the guarantee as well as certain student loans as well as other product that is government guaranteed, such that the total is now about 7% of our total loan book or about $8 billion.

So it’s certainly something to take into consideration as you’re looking on a forward basis at both our improving credit trends as well as the de-risking that’s taken place in the higher risk portfolio and where the growth has come is on the margin in some of these government guaranteed areas as well as the consumer book that we outlined during the presentation. So you shouldn’t expect to see that mortgage portfolio grow significantly over the course of the next couple quarters.

David Hilder – Susquehanna

Okay. Thanks. That’s helpful, very helpful. And then back to page six on the Basel III calculation, you said that you wouldn’t have much of an impact because of MSR or DTA on the numerator, but I think what Matt may have been asking about was the impact of the Basel III rules on the denominator, the RWA amount.

Mark Chancy

At this point based on the calculation that’s we have made, we don’t expect any significant effect on the calculation under the new rules.

David Hilder – Susquehanna

Okay. Thanks. Thanks very much.

Mark Chancy

Thank you.

Jim Wells

It’s 5, although, it looks like we have time for one more.

Operator

The next question is from Bob Patten from Morgan Keegan.

Bob Patten – Morgan Keegan

Hey, good morning, everybody.

Jim Wells

Good morning.

Bob Patten Morgan Keegan

What’s your thoughts about the mortgage production, if you talked about this I apologize but just in terms of the look forward, do you continue to see several more quarters of strong, this type of mortgage production.

Bill Rogers

This is Bill. I can’t say for several quarters. Our application’s been up in the 27 or so percent in the last quarter. Rates certainly have continued at an attractive pace and we’re on that pace again through where we are in October. How long that will continue, given the fact that the bulk of this activity is refinance, I mean, eventually we’re going to have to have some purchase volume for that to continue at this kind of pace.

Bob Patten Morgan Keegan

Okay. Thanks, Bill, appreciate it.

Jim Wells

There are no more questions. We will end the call. Thanks, Bob.

Operator

That concludes today’s conference. You may disconnect at this time.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!