When Smart Bankers Do Dumb Things

Aug.30.11 | About: SunTrust Banks, (STI)

Theoretically speaking, people who run large regional or national banks ought to be smart people. After all, not just anyone can become the CEO of a billion-dollar corporation, right? But after some of the largest banks in the United States needed the assistance of the federal government to bail them out during the financial crisis of 2008-2009, this thesis was clearly in need of modification. It seemed that the only thing that the book-smart executives of major banks were good at doing was, well, destroying book value. Some investors hope that such foolishness does not extend over to the smaller, regional banks. But, as we all know, human folly comes in different stripes and colors, and we are going to look at how Suntrust Bank (NYSE:STI) managed to whittle away one of its most unique strengths, destroying almost a century of tradition in the process.

Let me ask you this: Would you rather own shares of a regional bank with decent operations and growing profitability OR would you rather own shares of a regional bank with decent operations and growing profitability that also owned $2 billion worth of Coca-Cola (NYSE:KO) stock that paid out about $60 million each year in dividends for you to deploy as you wish?

Unfortunately for investors, the latter no longer exists. Back in 1919, an earlier version of Suntrust Banks was the primary underwriter for the initial public offering of Coca-Cola common stock. The bank had the option to either accept $100,000 in shares of the newly-public Georgia beverage company, or they could accept $100,000 in cash. In one of the best financial decisions of the century, the underwriting agents opted to receive the Coca-Cola common stock.

And the rest is history. For almost 90 years, Suntrust acted like a perfectly diligent and persevering buy-and-hold investor. No matter what event was threatening to unhinge the American economy—WWII, The Korean War, The Cold War, Vietnam, 9/11—Suntrust held on to their KO shares, letting the miracle of compounding work its magic. Come 2006, the Georgia-based bank owned over 48 million shares of Coke (about 3.5% of the company), which had come to be worth over $2 billion. In 2006, the company received a $15 million check from Coca-Cola every three months in the form of dividends that the bank could deploy as it wished. They could use their Coke dividends to renovate their brick-and-mortar stores, expand into new areas, upgrade services, hire more employees, or gobble up small start-up banks. Having $60 million flow into your company’s coffers every year courtesy of Coke gives your bank an accelerated growth platform that most other banks could barely dream of.

Looking at the success stories of American capitalism in the 20th century, there are some great blue-chips that exist today that we can only dream of having bought decades and decades ago. Johnson & Johnson (NYSE:JNJ). IBM (NYSE:IBM). Standard Oil (XOM, CVX). Proctor & Gamble (NYSE:PG). PepsiCo (NYSE:PEP). And certainly, Coca-Cola would fit right in on that short list. So in 2007, what did the executives at Suntrust decide to do with a near-century old stock holding that had treated them phenomenally well? Why, sell it, of course!

The folks at Suntrust thought it would be a good way to raise capital. So in July 2008, they announced to investors that, over the course of the next few years, they would liquidate their entire Coke holding of 43 million shares. Had they had held on, they would have been receiving $80 million a year in Coke dividends now. But that didn’t matter—the bank said they were no longer comfortable having their future prospects tied so closely to that of another corporation. Why fix your star to the same company that Warren Buffett owns more common stock of than any other in his investment portfolio? They’ve only increased dividends every year for over a half-century. Who needs Coke when you can bolster Tier 1 capital!

Of course, as an investor, you should ask yourself one question going forward from this. Do you think Suntrust Bank will be in a better position years from now by selling that $2 billion stake and investing the capital themselves, or do you think they not only destroyed a century of tradition, but have largely destroyed the one thing that separated them from the other regional banks? All things being equal, I would much rather own a small bank stock that has $2 billion of Coca-Cola on the books. If Suntrust deploys the $2 billion (or whatever is left, after taxes) over the long term to generate better returns than had they held the Coke stock, then I’ll eat my words. But I suspect that ten years from now, Suntrust will wish that they hadn’t given up a growing, large, reliable stream of income that flowed in every three months like clockwork.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.