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SunTrust Banks, Inc. (NYSE:STI)

Q3 2007 Earnings Call

October 18, 2007 8:00 am ET

Executives

Steve Shriner - Director of IR

Jim Wells - President and CEO

Mark Chancy - CFO & EVP

Analysts

Gary Townsend - Friedman, Billings

Matthew O'Connor - UBS

Christopher Marinac - Fig Partners

Kevin St. Pierre - Sanford Bernstein

Mike Holton - Merrill Lynch Strategic Investment Group

John McDonald - Banc of America Securities

Operator

Welcome to the SunTrust Third Quarter Earnings Conference Call. All participants have been placed on a listen-only mode until the Question-and-Answer Session. (Operator Instructions) Today's conference is being recorded. If you have any objections, please disconnect at this time.

I would now like to turn the call over to Mr. Steve Shriner, Director of Investor Relations. Sir, you may begin.

Steve Shriner

Good morning, and welcome to SunTrust third quarter 2007 earnings conference call. Thanks for joining us. In addition to the press release, we have also provided a presentation that covers the focus of our call today. You will hear an overview of the financial results, including market impacts, an update on our shareholder value initiatives, including our efficiency and productivity program, and a detailed view of our credit picture.

The press release, presentation, and detailed financial schedules, are available on our website www.suntrust.com. Information can be accessed directly today by using the quick link on the suntrust.com homepage entitled Third Quarter Earnings Release or by going to the Investor Relations section of the website.

With me today, among members of our executive Management team, are Jim Wells, our Chief Executive Officer and Mark Chancy, our Chief Financial Officer. Jim will start the call with an overview of the quarter and discussion regarding our progress on the shareholder value initiatives. Mark will be covering financial topics and will provide an in-depth overview of credit, and then we will open the session for questions.

First, I will remind you that our comments today may include forward-looking statements. These statements are subject to risks and uncertainties 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 our website.

Further, we do not intend to update any forward-looking statements to reflect circumstances or events that occur after the date forward-looking statements are made, and we disclaim any responsibility to do so.

We’ve detailed the forward-looking statements made in conjunction with today’s earnings release in the Appendix of our 3Q earnings presentation.

During the call we will discuss some non-GAAP financial measures in talking about the Company's performance. You can find the reconciliation of these measures to your GAAP financial measures in our press release and on our website.

Finally, SunTrust is not responsible for, and does not edit, or 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 let me turn it over to Jim.

Jim Wells

Thanks. Good morning, everyone. Glad you are with us. As you saw on our press release this morning we reported earnings per share for the third quarter of a $1.18. Our results included a $0.28 per share negative impact on net valuation losses attributable to the recent disruptions of credit and capital markets, and a $45 million or $0.08 per share negative impact of severance expenses related to our ongoing E-Square Efficiency and Productivity Program.

Clearly we were not immune to the deterioration in the housing market and the related turmoil in the capital markets, as well as the change on the credit side. However, based on what we have seen so far, we were impacted to a lesser extent than many other institutions. It is disappointing, however, that the positive impact of the continuing progress we have made on our initiatives driving net shareholder value was overshadowed by the difficult market conditions. In a few moments Mark will detail the impacts of this environment and what it has done to our results this quarter.

On a positive note regarding our financials, the net interest income was up 4% over the same quarter last year, but was flat over the prior quarter. The net interest margin increased 8 basis points from the second quarter making this the third consecutive quarter an 8 basis point margin expansion.

This continued improvement is a direct result of the shareholder value initiatives, in particular, the balance sheet management strategies we have recently implemented. Notwithstanding our strong credit culture, we did experience higher net charge-offs of 34 basis points, principally as a result of the change in the credit cycle, and particularly in the consumer portfolio, and we have increased our provision and reserves. We will expand on this discussion later on the call this morning.

Non-interest income was down 5% from the same quarter last year. As I mentioned, we had a negative impact of a $161 million from the net valuation losses this quarter. Despite a difficult operating environment, we grew revenue across a number of areas. Once you peel back the net mark-to-market adjustment there was underlying growth in trading account profits and commissions, which were due to stronger customer related trading activities, principally in derivatives and structured leasing. Also, trust and investment management revenues were up slightly as a result of impacts of enhanced revenue initiatives.

However, the comparative growth rate of trust income was negatively impacted by the merger of Lighthouse in the first quarter of 2007, as well as the Bond Trustee sale in the third quarter of 2006.

Additionally there was good growth in service charge income, up 10% and strong annuity sales that drove retail investment services income growth up 28%. Mortgage servicing income increased 56% primarily from growth in the servicing portfolio.

Non-interest expense increased 7% from the third quarter of last year due to a number of significant non-recurring items. Excluding the one-time items, expenses actually grew in the 2.6% range in the quarter and these results would have been even better that warrant for the increasing expenses associated with the current credit environment, including increased operating losses driven by mortgage related fraud. The low growth rate of expenses is a continued reflection of the significant progress we've made on the fundamental initiatives in place to grab shareholder value.

We have continued with a high degree of success in our E2 program. As you can see on page three of the presentation text, cost savings in the first three quarters totaled $140.1 million with $59.5 million was that achieved in the third quarter. So, note that we are slightly ahead of our 2007 projections.

At this point, we anticipate that we will exceed our upwardly revised target of $181 million and estimated cost savings for the year, but while we are confident that we will achieve our 2008 goal of $350 million, it is premature to comment on what an upward revision is appropriate, as there are number of initiatives whose precise timing and benefits are still being developed.

Needless to say, we are quiet pleased with the results of all of these efforts and what they are producing. So, I'll take a moment to outline some of the recent highlights associated with the program. Do recall that we launched a rigorous internal study of various organizational structures and processes that included evaluating certain back office functions, consolidating various support functions and reviewing management spans and layers. We announced in August that we would eliminate approximately 2,400, primarily non-customer contact employee positions by year-end 2008. And as previously disclosed, these actions necessitated a third quarter pre-tax one-time charge of $45 million or $0.08 per share.

Discharge of these positions have been eliminated including over a 1,000 individuals being notified of position elimination in August. We will begin to realize the associated cost savings in the fourth quarter with the full impact on these position eliminations coming in the first quarter of 2008.

A great deal of the savings associated with our organizational review effort stem from streamlining internal processes with more efficient activities, thereby making it easier to do business with us both internally and externally.

We do this value elimination of non-client related activity often. It is important to point out that these changes did not eliminate direct revenue for losing positions. In actuality, the percentage of SunTrust employees and revenue and client facing job has been steadily increasing.

Moving to corporate real estate, the implementation of our corporate real estate space utilization strategy, including sale leaseback, is progressing according to plan. Completed transactions today represent nearly one quarter of the 2009 run rate improvement bill of a $100 million.

We've been actively marketing 469 properties over the past several months. Majority of these properties are currently under contract and we expect to have the remaining properties that are for sale under contract by the end of the year. Based on current data, it actually looks like all of them will be under contract within the next several weeks with closings on the remaining sales expected to occur during the fourth quarter of '07 and the first quarter of 2008.

As I previously articulated, it is a crucial part of our ongoing effort to grab shareholder value and we strategically invest to ensure that we are able to capture market opportunities and to grow the business overtime.

So, on page 4 of the presentation deck we've outlined some recent examples of where we are investing for growth. Our mobile banking application, which we will launch next month is designed to target Gen X and Gen Y segments of the population. It will allow users to access account balance and transaction history via mobile devices and it'll also enable users to connect to the increasingly popular Bill Pay platform.

We are also implementing an online payroll application for our highly valued small business clients. It will be integrated with the online cash manager product and provide end-to-end payroll functionalities. This will also launch in November.

In the mortgage line of business, we continue to capitalize on the current environments to obtain highly seasoned, top-producing mortgage originative to augment our efforts to grow that business and to increase their market share. We added 178 net new real estate mortgage loan officers in 2007, and the net overall sales team increased by over 300.

Also during 2007, we'll open 47 new branches, improve, renovate or refresh over 50% of our existing branches. Last investments I mentioned today are those related to our GenSpring family offices formerly known as AMA. In addition to the recent rebranding, we've also opened a New York office, hired several more client advisors and completed a small acquisition. These examples are only a subset of the various investments we are making for the future growth of the institution.

Moving to the capital management side of our shareholder value efforts, we've repurchased 10.2 million shares to date in 2007 through the combination of an accelerated share repurchase program and open-market transactions.

We remain committed to our goal of maintaining a 7.5% Tier 1 capital ratio and have an estimated Tier 1 ratio of 7.45% in the third quarter.

We are also continuing our evaluation of how to optimize our capital structure in light of our holdings of Coca-Cola of common stock. I will point out the obvious in saying that this evaluation is not about the Coca-Cola Company. We believe their management team and board are leading the company in the right direction for the benefit of all shareholders. This is only about the SunTrust Capital structure and uncovering ways to optimize are inherent efficiencies for SunTrust in holding a significant portion of our equity base in a publicly traded stock. As a result, as we've noted, we are going for a methodical approach of evaluating our alternatives, and we expect evaluation to be complete and to communicate our plans by the end of this year.

In summary, despite the difficult operating environment this quarter, we are pleased with the results of our efforts to drive shareholder value, and the tangible benefit they are producing. Our focus remains on key components of our plan, while revenues reduce the growth rate of expenses, increase the efficiency of the balance sheet and optimize our capital structure, while returning a high rate of our earnings to shareholders.

I'll look forward to continuing our share -- to share our success on these fronts, as we finish at the current year and move into 2008.

Now, I'd like to turn it over to Mark Chancy. Mark?

Mark Chancy

Thanks Jim, and good morning. Given the difficult environment that we are operating in, I am going to be providing near-term guidance regarding certain key metrics in my comments, and for your reference, we've included in the appendix a summary of the forward-looking statements that I plan to make.

I'll begin the discussion outlining the key drivers of our third quarter results, before spending time discussing the credit environment in some level of detail.

As Jim noted and as outlined on page 5 of our earnings presentation, we reported net interest margin of 3.18, our third consecutive 8 basis point margin increase. Margin improvement was a direct result of the balance sheet management strategies that we've implemented in connection with our shareholder value initiatives in 2007.

We would also expect this positive trend in margin to continue in the fourth quarter. I'll remind you that we were slightly liability sensitive, and as such lower short-term rates and a more steeply sloped yield curve creating an environment conducive to maintaining or growing our net interest margin.

As we remain focused on maximizing the value of our balance sheet, we will continue to be selective in the businesses and the assets that we are likely to grow.

Average loans for the third quarter of 2007 were approximately $120 billion, down 1% from the third quarter of last year. The decline was due to the balance sheet management strategies implemented since the second quarter of 2006, and which accelerated in the first half of 2007.

Strategies resulted in the sale of nearly $10 billion in loans over the past year primarily comprise of mortgage, student and corporate loans. Taking into account these loan sales the company actually had underlying loan growth across most categories, and compared to the second quarter of 2007, average loans were up $1.4 billion or 5% on a sequential annualized basis, primarily driven by commercial loan growth. And with regard to loan growth, one thing that you should not expect to see is any meaningful increase in large corporate loans related to "hung" leveraged buyout transactions, as SunTrust does not have any significant exposure in this area.

Now shifting to deposits. We continue our focus on generating low-cost deposit growth despite our client’s increasing preference for higher rate products and the highly competitive market for deposits at this time. Despite a 1% decline in average customer deposits year-over-year, we were successful in reducing total brokered and foreign deposits by over 20% relative to the third quarter of 2006, thereby reducing our reliance on these higher cost earning sources and improving margin.

We have also recently experienced significant lift in new checking account acquisitions as a result of our successful My Cause campaign. This promotion will continue in the fourth quarter and we are focused on expanding our relationships with these new customers through cost sale of additional products and services.

Now moving to the $42 million increase in provision this quarter relative to last quarter. As you saw this morning, third quarter net charge-offs were 34 basis points. The year-to-date charge-off ratio is 28 basis points, which is within the 25 to 30 basis point guidance range that we provided in July.

However, we expect net charge-offs to increase somewhat in the fourth quarter, though at a slower rate of increase than we have experienced in recent quarters. To be more specific, looking out over the next three quarters, we anticipate charge-offs to fall in the 35 to 45 basis point range, assuming there is no material further deterioration in the economy.

I will be providing an in-depth look at our credit picture momentarily, though I want to point out here that given the fact that we are in a period of increased uncertainty regarding the direction of the economy, interest rates and residential real estate, we are limiting our guidance on charge-offs out until mid-2008.

Ultimately, the level will be highly dependent on the direction of the currently isolated and industry-wide consumer credit quality issues, the health of the residential construction market, as well as home prices. However, I am going to spend a good deal of time dissecting our portfolios in providing statistics on various components to demonstrate their overall health. I will also get very specific on a few areas where we are having some problems, and what we are doing to mitigate the associated potential losses.

And one final note before I move on to non-interest income. You will note that our allowance total loans increased this quarter by $43 million to 91 basis points. Debt allowance to non-performing loans decreased. I want to reiterate that we believe the reserve coverage is adequate given our current view of losses embedded in our existing loan portfolio, I will provide a little more color on this when I discuss the components of the portfolio and our current non-performing loans in a minute.

Now with regard to non-interest income, as Jim mentioned earlier, we were not immune to the financial impacts of the difficult capital market conditions this quarter.

The net mark-to-market impacts to our EPS came in at $0.28 per share, or a little over $160 million pre-tax during the quarter. This number is up from our prior disclosure in early September, which as you recall, was based on our actual results through August. And it was up due to additional declines primarily in mortgage related fixed income valuations in September.

We provided a breakout of the impacts on page six of the earnings presentation for your review. As you can see, the most significant valuations declines, as noted in the capital markets section of this slide, were related to collateralized debt obligations and residential mortgage-backed securities.

And although these losses are currently largely unrealized, we don't expect material recovery in the short run. The mortgage impact was related to credit-spread widening during July and August where spreads widened at an unprecedented speed and magnitude. For SunTrust, the spread widening impacted mortgages originated for sales through non-agency investors, as agency product is forward sold as part of our normal practice.

Beginning back in the fourth quarter of 2006, and accelerating in the third quarter of 2007, we dramatically reduced our exposure to non-agency products. Currently, less than 5% of our originated for sale volume is non-agency, and it is primarily high-quality jumbo product for that small component. While we are disappointed with the mark-to-market loss in this area, had we not taken actions to reduce non-agency production beginning last year, our mortgage related losses would have been significantly higher.

The impact that is noted in treasury is primarily related to a net positive mark on the $3.3 billion of publicly issued debt that was moved to fair value earlier in the year. As credit spreads widened for the industry and for SunTrust specifically, this debt position gained value. And as with the majority of the negative marks that were incurred in the quarter, this gain is largely unrealized at this point.

Capital markets disruption that we and the industry experienced was unprecedented in terms of speed and size. However, observing the comparative impact on other firm's capital markets and mortgage businesses, it provides us some comfort in our business mix and risk management business.

Now moving to expenses, and I am going to focus on the year-to-date numbers that you can see on the chart. Year-to-date expenses increased 3.6% over the same period last year. However, there are numerous non-recurring items that affected the expense base and current year expenses as summarized on page six. Largest of these items is the net non-recurring E2 items of $58 million in 2007, of which severance represents $45 million.

Additionally, the $44.5 million impact noted in '07 is related to our election to record certain newly originated mortgage loans held for sale at fair value. Under this election, costs associated with the origination of mortgage loans held for sale are recognized as a component of compensation expense when the loan is originated. Prior to the fair value election and specifically in the year-to-date period for 2006, these costs were deferred and recognized as part of the gain or loss on sale of the loan.

The approximately $11 million reversal of the LILO reserve primarily relates to truing up some of the reserves that we held against our leasing program in 2006.

The next item relates to an accrual reversal associated with a private placement of legacy trust preferred securities. As a result of the early termination of these securities we recorded a life-to-date adjustment to our accrued liability resulting in a one-time expense reduction of $33.6 million in the quarter.

In connection with our capital optimization initiative, we intend to replace this Tier 1 capital in the fourth quarter with hybrid capital securities that have higher equity content. And lastly, in the same vein the $9.8 million increase in expense is due to the loss on early retirement of certain legacy trust preferred securities, which we also intend to re-finance in connection with our capital strategy, with higher equity content securities in the fourth quarter.

So the reason we go through this reconciliation process, and after considering all these various one-time expenses, the bottom line is to give you a view of year-over-year expense growth, which was approximately 1.5%.

And the growth on a year-over-year basis after making these adjustments is really focused in one primary area, which relates to the mortgage fraud related operating losses and other costs associated with the changing credit environment. And if you take into account those expenses that grew year-over-year, our overall company expense growth was basically flat.

So needless to say, we are extremely encouraged by the progress we've been making in our ongoing efforts to enhance productivity and efficiency across the Company and the results of those efforts are producing.

Let me also note that our effective tax-rate for the quarter was 27%, which is below our year-to-date rate of 30%. Reduction in rate was primarily attributable to the lower level of earnings that we generated in the quarter, due to the mark-to-market losses in the severance related expenses, as well as, the true-up of expense associated with the early termination of the referred security, and it was not related to any specific tax event that occurred during the quarter. The expected tax rate in the fourth quarter would approximate 30%, resulting in about that level for the full year of 2007.

I am going to shift gears and talk about SunTrust credit posture. I will begin this discussion with some general comments about our loan portfolio, and then spend time delving into some of the specific products and loan categories within the portfolio.

As you can see on the page seven of the presentation, our loan portfolio is a $120.7 billion. It’s well diversified from both a product and a client perspective. From a geographic viewpoint, the loans are distributed throughout the SunTrust footprint, and we have no material exposure to credit card and/or other consumer unsecured lending.

The commercial and commercial real estate portfolios, which comprise about 40% of the overall portfolio are performing well overall. However, there is an increasing trend of charge-offs in residential mortgage and home equity lines, which collectively represent 38% of the portfolio. So, I will spend a few minutes reviewing these in more detail.

Page eight of the earnings presentation depicts the residential mortgage product breakout. The largest portion is our core mortgage portfolio, which represents 63% of the overall portfolio. It’s roughly half prime jumbo and half ARMs originated for the portfolio. And we have said this before, but I want to reiterate, that we do not have a portfolio option ARMs, sub-prime loans or negative amortizing loans. We do have interest-only ARMs, but the interest only period is 10 years unlike many sub-prime loans. As you can see in the bullets, this is a highly-quality portfolio with a weighted average loan-to-value at origination of 73% and current average FICO scores of 729.

As you can see Lot loans, which are made for individuals for developed plots, represent only 5% of the portfolio. FICO score is also very strong at 735. Our Prime 2nd Mortgages, which represent 11% of the residential portfolio are comprised of insured purchase money second liens. These are often called combos or piggybacks because they are closed at the same time as the first mortgage, and the proceeds are used to purchase the home.

Now, we also have Alt-A loans of $1.7 billion on a combined basis, which comprise 5% of the overall portfolio. $1.1 billion of these are first liens and are well secured with a weighted average LTV of 76%. The remaining $600 million are second lien loans and this portion of the portfolio has insurance, and we've established a reserve for potential claim denials based on our experience to date.

It is important to note that this is basically a declining portfolio as we began making a series of changes in the underwriting standards in the fourth quarter of 2006 that ultimately resulted in rationing down our production of Alt-A loans to virtually zero by the end of the third quarter of 2007.

Our next loan category Home Equity loans, comprises 12% of the residential portfolio, and it too has healthy statistics with a weighted average FICO score of 725, loan-to-value at origination of 71%, and 40% of these loans are actually in a first lien position.

And finally, the 4% of portfolio labeled Wealth and Investment Management are loans made to high net worth clients in this line of business. That gives you a detailed overview of our residential mortgage portfolio. And now, I am going to move on to page 9, which depicts the end of quarter home equity line portfolio approximately $14.6 billion, and you can see that the weighted average FICO on this portfolio is 734 and 24% of the portfolio is also in a first lien position.

87% of these loans are originated through what would be considered low-risk channels. The most common of which is VAR branches, and to a lesser degree, through our wealth and investment management relationships and for cross sales to our mortgage customers. The remaining 13% has originated through somewhat higher risk wholesale channel.

Weighted average seasoning of this portfolio is 27 months. Further, 72% of the portfolio has FICO scores of above 700 and 72% of the portfolio has LTVs of 90% or less. Now the bottom line is that we are experiencing the most pronounced deterioration in a portion of this portfolio that has LTVs greater than 90% and current FICO scores that are less than 660.

You have the data in front of you now, so you can draw your own conclusions, but ours is that the percentage of this portfolio that poses the greatest risk of loss to SunTrust is in the single digits.

Now moving to the construction portfolio on page 10. Construction and acquisition and development for commercial business purposes accounts for 27% of our total construction portfolio. On the residential side, the quarter represents 38% of total residential related development loans, and this percentage is inclusive of residential acquisition and development, residential construction, construction perm and raw land. 95% of our construction nonaccruals are from residential related construction, and they are geographically dispersed throughout the SunTrust footprint. We are well diversified by client in residential construction, which we believe is a real positive.

And as you can see, the loan size, on average, is a relatively small $560,000. So to summarize the point at this slide, a large piece of the portfolio is currently well performing commercial purpose financing. On residential, we are well diversified by geography and the number of borrowers, and finally, we have minimal exposure to raw land.

I will finish today by talking about our nonaccrual loans on page 11, which as I am sure, you have noted increased $238 million since June 30th. First, let me be clear about this slide. We are focusing on a subset of NPAs, the non-performing loans in this discussion, because by and large when a loan moves from nonaccrual to OREO, it has been written down to the expected realizable value. The second point is that nonaccrual balances represent the loan amount and the expected loss can be far less, which we intend to point out.

Two of the most important points on page 11 of the presentation are that the Alt-A portfolio is 50% of nonaccrual loans and that 65% of these loans are in the first lien position with a weighted average LTV of 76%. Second, we have insurance and reserves established to the Alt-A seconds. So while a 76% loan-to-value insurance and reserves don't eliminate potential additional losses, these facts should help you reach a conclusion that there will be relatively low-loss severity on the Alt-A portion of nonaccrual loans.

Most of the remaining portion of the residential nonaccruals are from our core portfolio, which we noted previously has a weighted average LTV of 73%. So, once again, while there is likely some loss content in this non-performance, the lower LTVs will help significantly mitigate the loss severity.

95% of construction nonaccruals are from residential related construction and development, and this is an area that we are watching very closely. We have not realized any material losses in the construction portfolio yet, but the weakening in the housing market warrants our attention.

Now I'll leave the credit discussion by repeating the point we believe the severity of losses in residential mortgage NPLs is mitigated by the loan-to-values and insurance, and noting that our allowance for loan and lease losses covers annualized third quarter 2007 charge-offs by over 260%.

Our intent with this detailed discussion today was to help provide a better understanding of the overall health of our loan portfolio, and where we see the isolated issues. We have been, and will continue to aggressively monitor and adjust underwriting guidelines, product mix and pricing as warranted. With that, I’ll turn the call back over to the operator to begin the Q-&-A session of the call. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question today is from Gary Townsend. You may ask your question and please state your company name.

Gary Townsend - Friedman, Billings

Hi, this is Gary Townsend with Friedman, Billings. Good morning Mark and Jim. Mark could you discuss in the home equity portfolio the issues of severity versus frequency? And, if you could also focus it on, has there been, as we have seen in other companies, a concentration, as I would presume, in correspondent delivered or wholesale purchase loans?

Mark Chancy

We have Tom Freeman, our Chief Credit Risk Officer with us this morning, so I am going to ask him to address that question.

Tom Freeman

I think severity versus frequency was the first part of the question, if you look at the charts that were provided, and we are really trying to go over a thought process in terms of the home equity loans, is that we are actually seeing most of our charge-offs and problems in that portfolio coming through a relatively small portion of the portfolio, which is the high loan-to-value and the low FICO score portfolio. Now the portfolios were generated with our general profile of strong FICO scores, but we did, in fact, have some that we generated loan-to-values in excess of 90%. It is a relatively small number of the portfolio, and it is generating a significant amount of where the losses are coming from.

In terms of channels, most of our channel, if you take a look at this, comes out of primarily bank originated loan activity, but I think we would be disingenuous if we didn't say that those loans generated out of our wholesale channels where we are buying loans from the marketplace, perform in an inferior manner to our core originated portfolios.

Gary Townsend - Friedman, Billings

I am sorry, did I understand you, probably to say that the wholesale originated is performing equally to what you --?

Tom Freeman

No. It's performing poor than our core originated portfolios out of our branches itself.

Gary Townsend - Friedman, Billings

Okay. Thank you for comment.

Eugene Kirby

This is Eugene Kirby, and we have made a number of changes in our origination. It's around the wholesale segment, significantly increasing our pricing and tightening up on our credit standards. And have basically moved to a pass that, by the end of this quarter heading into the fourth quarter we will have no loans over 90% LTV coming through the wholesale channel and have a significant reduction in the overall production in that channel, because it has performed at a level that we are not happy with compared to the core bank.

Gary Townsend - Friedman, Billings

Thank you for your comment.

Steve Shriner

Thank you, Gary.

Operator

Thank you. Our next question comes from Matthew O'Connor. You may ask your question, and please state your company name.

Matthew O'Connor - UBS

Yes, UBS. Jim, earlier this year, you had said there were no sacred cows, as you look to evaluate the businesses and the balance sheet mix that you have. Given the macro environments, it’s probably going to be lot more difficult than we would have thought both for capital markets and credit. Are you going to take a kind of a double look at some of the businesses and consider downsizing or exiting some of them?

Jim Wells

Yeah, Matt, as you know, I remain in my no-sacred cows position, and we are re-looking at the sub-lines of business actively to see what is going on there, what the future potential is, and if we see things out of that work that leads us to conclude the risk is not worth the reward we'll certainly deal with.

Matthew O'Connor - UBS

Okay. And can you give us a sense of what areas you might be looking at and the timing of when a decision might be made?

Jim Wells

I would actually care not to until the work is done, Matt, if you don't mind. You could imagine what they would be based on what's going on in the market, I think.

Matthew O'Connor - UBS

Okay. How about on the timing side?

Jim Wells

We are looking at it, we constantly look at the sub-lines of business and I would expect that some of that are getting a re-look, you will see some activity in over the next month or two or three.

Matthew O'Connor - UBS

Okay. And then, just a question for Mark, obviously, a lot of moving pieces here, care to take an estimate of what run rate earnings might be, as we go into 4Q and beyond?

Mark Chancy

You know, Matt, I am going to leave that to you and your colleagues. We have tried to be very clear about the items that have, you know, affected our earnings. We’ve talked about severance specifically, we’ve talked about the mark-to-market adjustments, the early extinguishment of our legacy trust preferred securities as part of our capital optimization strategy of a couple of cents. We also were very explicit about the benefits that we received in connection with the termination of the REIT related transaction. So, I'll leave that to you’ll discretion in terms of determining the run rate.

Matthew O'Connor - UBS

Okay. And then, just lastly, I am sorry, I missed it, but in terms of provisions versus charge-offs going forward, would you expect, can you build to the extent that we saw this quarter?

Mark Chancy

No. Like we, in terms of the valuation of the allowance, we feel comfortable based on the data that we have, and our current loan portfolio that the allowance adequately stated. It will depend on a variety of factors; it will depend on loan growth, the type of growth that we get in the loan book, whether or not we have improvement or deterioration in the existing portfolios, what the level of charge-offs are. So, there are a lot of factors that go into the determination of what the provision will be in a given period, as you know, and I won't speculate on how all those different variables are going to reflect in the next quarter's results.

Matthew O'Connor - UBS

Okay. But just in general assuming your charge-offs falling in that 35 to 45 basis point range for the next few quarters?

Mark Chancy

You know Matt, if you assume all of being equal that loans continue to grow, then by default, you will expect some level of increase in the provision relative to charge-offs. How about that?

Matthew O'Connor - UBS

Okay.

Mark Chancy

Thank you for your questions.

Matthew O'Connor - UBS

Okay, thanks.

Operator

Thank you. Our next question comes from Christopher Marinac. You may ask your question, and please state your company name.

Christopher Marinac - Fig Partners

Hi, Fig Partners in Atlanta. This question is for, if I guess, for Mark, but also for Jim as well. You are all aware that there is some practice in the industry of building interest reserves for construction loans and also making loan modification as things change. To what extent is SunTrust doing that or what is your policy as customers go through changes?

Tom Freeman

Perhaps, it’s Tom Freeman again, and maybe I will wait in here and I have Walt Mercer with me who runs our commercial real estate business here at the bank. Our policy is, of course, as you know that interest reserves are in fact an inherent part of what we are doing, doing construction activity, because one can't be in construction activity without making sure there are adequate interest reserves. We re-evaluate our construction loans on a rolling ongoing basis. We evaluate monthly, whether or not the interest reserves are appropriate, and are more than willing to press for incremental reserves, if in fact we think that they are required.

We have a very rigorous review process, and we also have the support of, I think, some very good systems in knowing the construction progress, the progress of sales activity under the individual loans, and therefore, kind of, what do we need, and in terms of interest reserves to the sell-out periods. I will also speak to the fundamental underwriting, which is pretty down rigorous in terms of with whom we do business, making sure that they have substantial liquidity, and are they sorts of borrowers, who during difficult periods can afford to extend and ride through difficult periods within the markets. So, yes, we do have interest reserves, yes they are rigorously applied, and yes we look at them constantly.

Christopher Marinac - Fig Partners

Okay. Great. That’s helpful, Tom, and just a follow-up. Are there any markets on the construction side where you are not taking new construction customers on the commercial construction?

Tom Freeman

Maybe Walt will answer that for us.

Walt Mercer

Hi. Well, we look across the whole footprint sort of customers, there are a number of areas especially in residential real estate. We were looking carefully at the portfolios, especially in South Florida right now, and given the housing market there, we are not picking on a lot of new construction.

Christopher Marinac - Fig Partners

Okay. But will South Florida be the only example or are there others?

Walt Mercer

I think that's a primary example right now, we are looking at the whole portfolio very rigorously, monthly, given the current economic environment.

Christopher Marinac - Fig Partners

Okay. Great. Thank you very much.

Operator

Thank you. Our next question comes from Kevin St. Pierre. You may ask your question and please state your company name.

Kevin St. Pierre - Sanford Bernstein

Sanford Bernstein. Good morning. The loan-to-value ratios, average loan-to-value ratios which you have given us on a few of the portfolios are at origination. I presume, you have done some analysis to estimate what current loan-to-values might be, I was wondering if you could perhaps share some of that with us?

Tom Freeman

We have an ongoing evaluation process upon renewal or in any of the lending activity, where we believe that there is any sort of restriction in value, and as anyone who can read the literature knows that we have had shrinkage in value. We have seen shrinkage in value most aggressive in South Florida. We have seen minor shrinkage in value in terms of single-family housing prices, pretty much across the portfolio. But you got to remember that in some of these instances we get amortization on the portfolios. We have extensions and repayments on the commercial side and we do keep a very clear set of rebalancing initiatives during the renewal periods or re-negotiation periods in any of the lot.

Kevin St. Pierre - Sanford Bernstein

Yeah, but can you share with us any stats on what loan-to-value might be on the core mortgage portfolio based on what you expect their current values?

Tom Freeman

The answer is no. I mean, we are keeping at it. We have seen some increase in the loan-to-value since the origination, which you got to remember that parts of the portfolio are in the average life of the portfolio approaches 3 years, which means that large parts of the portfolio are 5 years or 6 years old and older and wherefrom the initial origination actively to where it is now. We still see shrinking loan-to-values in terms of some of that stuff given the progress of loans through the loan lifecycle.

Kevin St. Pierre - Sanford Bernstein

Okay. Thank you very much.

Tom Freeman

We’ve offsetting characteristics here.

Kevin St. Pierre - Sanford Bernstein

Thank you.

Operator

Thank you. Mike Holton, you may ask your question and please state your company name.

Mike Holton - Merrill Lynch Strategic Investment Group

Merrill Lynch Strategic Investment Group. I appreciate the additional disclosure on the construction portfolio, and my question there is, given the NPAs, I guess, about doubled from June to September, Mark, you eluded to them probably going higher in the future, can you guys kind of provide a range on how much of an increase we might see there, maybe over the next two to three quarters?

Mark Chancy

We are really not going to get into forecasting the ranges related to NPAs and NPLs, I guess, our point in the detailed discussion was to know where the NPLs are coming from, what the characteristics of those portfolios are, so that you can get a better understanding of potential loss severity, and, of course, find out both to the charge-off levels, as well as, the adequacy of the reserve. Now that's probably as far as we want to go in terms of providing you with forward-looking information. We have said before that we would expect some keeping of the NPAs, particularly related to our Alt-A portfolio is probably going to be a little bit later than we had hoped, which was in the third and fourth quarter, it will probably be in early 2008. Now that's our current expectation, but that's probably the only incremental data point that I am going to provide you.

Mike Holton - Merrill Lynch Strategic Investment Group

Okay. Let me ask one, I guess, backward looking question, and of the $158 million in construction NPAs, how much of that is raw land?

Mark Chancy

I am sorry, could you repeat your question?

Mike Holton - Merrill Lynch Strategic Investment Group

Right. You had a $158 million in construction NPAs in the quarter and within the construction portfolio you pointed out that there is about $1 billion of raw land?

Mark Chancy

Correct.

Mike Holton - Merrill Lynch Strategic Investment Group

How much is on NPA status?

Mark Chancy

It's a de minimus amount.

Mike Holton - Merrill Lynch Strategic Investment Group

Okay, thanks.

Mark Chancy

Thanks. Time for one more question?

Operator

Thank you. Our final question is from John McDonald. You may ask your question and please state your company name.

John McDonald - Banc of America Securities

Hi, it's Banc of America Securities. You gave some helpful stab at what the charge-offs might do in the first half of '08. You mentioned margins in the fourth quarter and early '08 today? Sorry, if I missed it, did you give any quantification mark of how much the margin could benefit in the fourth quarter and into the first half of '08?

Steve Shriner

Yes John, this is Steve. We expect the margin trend that you see on page 5 of the presentation to continue into the fourth quarter, and have not provided any additional guidance beyond that for a quarter period.

John McDonald - Banc of America Securities

Okay, meaning that you are kind of up 8 basis point, and quarter-to-quarter you could have a similar jump in the fourth quarter?

Mark Chancy

Yeah, we're just commenting that the trend that you have seen, you can see here over the last three quarters…

John McDonald - Banc of America Securities

Okay.

Mark Chancy

It is likely to continue on a positive note.

John McDonald - Banc of America Securities

Okay.

Mark Chancy

But we are not going to get into the specifics of what that target should be for the quarter.

John McDonald - Banc of America Securities

Okay. And is this some continued pull through of the balance sheet positioning, and as a function of the fact that -- has the curve rate and yield curves done a little better?

Mark Chancy

Yeah, that's exactly right.

John McDonald - Banc of America Securities

Okay. And in '08, you are saying, we should get some benefit there, you are saying also in '08 this trend should continue?

Mark Chancy

Well, that would depend on interest rates and the slow book to curve and a variety of other factors. In the short run, we see continued improvement. Beyond that, it’s kind of hard to tell, and also it would be dependent upon loan growth, deposit growth and other factors.

John McDonald - Banc of America Securities

Sure. Okay, that's fair. And then just a quick question if you could, could you just kind of give us a little flavor for the considerations that are applied as you think through the Coke decision? Obviously, you get something through it, but what are the factors there that, you know, will drive your decision, and if you do end up selling some of the Coke stock, would you likely have to replace it with some other form of capital. Well, early in the year when you sold your Coke stock, you could buyback SunTrust shares, does the equation become a little different going forward?

Jim Wells

Sure, John, that evaluation does continue. We obviously have a capital that is in our tangible equity-to-assets. It's in our total capital, but it’s not in our Tier 1 capital, based on the regulatory framework. So, considerations include our long-term Tier 1 target, our relationships and the capital level relative to the rest of our businesses as it's evaluated by the rating agencies. Opening up a decision process around structure of our holdings will be predicated on an evaluation of how that Coke in its current form or alternative form, fits into our long-term capital strategy and it’s evaluated between regulatory, our safety and soundness review, as well as, the rating agencies.

And, we plan to be completed with that review by the end of the year. We obviously have a significant embedded gain in the Coke Holdings, that’s a consideration. So, it’s around the optimization of our capital structure as we have set our target. One of the things we are clearly doing is evaluating the Tier 1 target in the context of how we might manage the Coke stock going forward. So, it’s a variety of factors that are at play here, and it's obviously a complicated set of issues, and we are going to come back and explain to you where we are at some point later in the quarter.

John McDonald - Banc of America Securities

Okay. One quick follow-up there, Mark did you mention anything outside of that about if you are in a position, you kind of be doing buybacks in the fourth quarter?

Mark Chancy

Yeah, John we are right at our Tier 1 capital target at 745 versus the 750, obviously the decision process around the Coke holdings, as well as, the growth in Tier 1 capital during the quarter will dictate whether or not we have incremental flexibility. And so we will be evaluating that throughout the quarter. I wouldn’t expect a significant share repurchase in the fourth quarter, again aside from any Coke related decisions, although there maybe some modest repurchases based on the growth of the balance sheet and our earnings.

John McDonald - Banc of America Securities

Okay.

Mark Chancy

Given the level of repurchase that we’ve had, through the year-to-date period, we anticipate that we’ll meet the guidance that we provided earlier in the year in terms of return of capital to shareholders, both through a combination of dividends and share repurchase.

John McDonald - Banc of America Securities

Okay. Thanks.

Mark Chancy

Thank you. And that concludes the third quarter earnings call. Thank you very much.

Operator

Thank you. This concludes today's conference. Thank you for your participating. You may disconnect at this time.

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Source: SunTrust Banks Q3 2007 Earnings Call Transcript
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