SunTrust Banks Q4 2007 Earnings Call Transcript

| About: SunTrust Banks, (STI)

SunTrust Banks, Inc. (NYSE:STI)

Q4 2007 Earnings Call

January 23, 2008 8:00 am ET


Steve Shriner - Director, Investor Relations

James M. Wells III - President, Chief Executive Officer, Director

Mark A. Chancy - Chief Financial Officer, Corporate Executive Vice President

Thomas E. Freeman - Chief Risk Officer

William H. Rogers Jr. - Corporate Executive Vice President


Jennifer Thompson - Oppenheimer

Mike Mayo - Deutsche Bank

Edward Najarian - Merrill Lynch

John Mcdonald - Banc of America Securities

Jefferson Harralson - Keefe, Bruyette & Woods


-- the SunTrust fourth quarter earnings conference call. (Operator Instructions) I would now like to turn the call over to Mr. Steve Shriner, the Director of Investor Relations. Sir, you may begin.

Steve Shriner

Good morning. Welcome to SunTrust's fourth quarter 2007 earnings conference call. Thanks for joining us. In addition to the press release, we’ve also provided a presentation that covers the focus of our call today, an overview of financial results, including a detailed overview of market impacts, an update on our efficiency and productivity program, and a broad view of our credit picture. Press release, presentation, and detailed financial schedules are available on our website, Information can be accessed directly today by using the quick link on the homepage entitled fourth 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, including an update on progress in our efficiency and productivity initiatives. Mark will cover financial topics, including capital, impacts to earnings this quarter, and more detail on credit. We will then open the session for questions.

First, I’ll 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 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 fourth quarter earnings presentation.

During the call, we will discuss non-GAAP financial measures in talking about the company’s performance. You can find a reconciliation of these measures to GAAP financial measures in our press release and on our website.

Finally, SunTrust is not responsible for and does not edit 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.

James M. Wells III

Good morning, everyone. I am glad you’re with us this morning. As I embarked upon my tenure as SunTrust's Chief Executive Officer just over one year ago, I certainly could not have imagined the challenges the banking industry would face in the second half of the year, nor would I have considered that we’d be reporting barely positive earnings in the fourth quarter. Clearly not the news I had hoped to be delivering this morning, especially in light of the progress we’ve made over the year on the execution of our shareholder value initiatives.

Be all that as it may, SunTrust was impacted by the rapid deterioration of the residential real estate market, the change in the credit cycle, and specifically consumer credit quality, and the resulting impact on liquidity in the financial markets. Convergence of these factors resulted in earnings of $0.01 per share in the fourth quarter. For the year, earnings per share was $4.55, down $1.27 or 22% under last year.

There were numerous items affected by the broader market conditions and Mark Chancy will detail these impacts to you shortly. In the meantime, I’ll provide a high level overview of our results.

Deliberate balance sheet restructuring we conducted in early 2007 slowed the growth in earning assets and the shift to deposit mix to higher cost products resulted in net interest income growing by only 1% over the same quarter of last year, despite an improvement in the margin over that timeframe of 19 basis points.

The provision for loan losses in 2007 was significantly higher than the historically low 2006 provision, with the lion’s share of the increase coming in the fourth quarter. The sharp increase was driven primarily by consumer and residential real estate deterioration.

Non-interest income was down versus the fourth quarter of 2006 due to market valuation write-downs. For the year, non-interest income was essentially flat as market valuation issues and lower mortgage production income largely offset the gain on sale of certain Coke shares in the second quarter, E-squared real estate transaction gains in the fourth quarter, and fundamentally solid performance in most of the income categories.

On the surface, the fact that non-interest expense was up 7% for the year and 18% for the quarter over the same quarter last year would indicate that our performance here was quite poor. However, as Mark will explain, a lot of noise in the numbers, combined with the cost associated with the turn in the credit cycle, are masking a strong performance in reducing our core operating expenses.

As you can see on slide three, we’ve achieved E-squared run-rate savings of $215 million, which represents 119% of our 2007 goal, which in turn was increased from $135 million in the second quarter. Further, the fourth quarter gross cost savings of $75 million is $16 million or 27% higher than the third quarter rate. The increase is primarily attributable to the partial impact of our organizational review efforts, which resulted in the elimination of 2,400 positions. We will achieve additional cost savings from these efforts in the first quarter of ’08.

We are very pleased with the overall success we are achieving in our E-squared program. I’ll remind you that our efforts here are not a reaction to the current environment. They are comprised of a carefully planned and executed series of initiatives contemplated beginning in 2006 to drive out inefficiencies, to streamline processes in order to be easier to do business with, both internally and externally, and ultimately to become the catalyst for fundamental change in our culture relative to efficiency and expense management.

We initially set a goal of reducing operating expenses by $400 million, which we expected to achieve on a run-rate basis by the end of 2009. However, in the second quarter of this year we expanded and expedited the goal. This new, more aggressive E-squared goal is to achieve savings of $530 million, or 10% of our 2006 expense base during the 2009 fiscal year. And with a fourth quarter run-rate of $75 million, we are well on our way to meeting our 2008 goal of $350 million.

The full impact of our organizational review efforts, the lower cost of more efficient space utilization, results of the supplier management initiatives and additional initiatives planned for 2008 will create success in meeting our 2008 goal and provide a foundation for meeting our ultimate 2009 goal.

I’ll take a moment now to update you as I have been previously on the corporate real estate transactions executed specifically in the fourth quarter. We closed six transactions totaling over $750 million and resulting in a one-time gain of $119 million. Additionally, we have contracts that are scheduled to close in the first quarter for another approximately $250 million in proceeds.

Not only will these sale lease-back transactions remove non-earning assets from the balance sheet but we will lower occupancy costs by compressing space utilization by 25% to 35% in our moderate to large office buildings. This will obviously drive ongoing occupancy expense benefits.

Given the difficult operating environment, I can assure you that we will remain vigilant on costs and continue to explore additional ways to improve efficiency. Having said that, we also believe it is important not to lose sight of the opportunities that exist in our footprint and to make the necessary investments to harvest those opportunities. We will therefore continue to invest in branches in advertising, revenue producing personnel and higher growth businesses, technology for revenue growth and improved client service, and credit and selection staff. I am also hopeful that revenue growth and earnings will improve and when they do, obviously incentive compensation will grow as well.

I would like to take a moment now before I pass the call over to Mark to provide the framework of our economic outlook for 2008. This will serve as a backdrop for the capital, financial, and credit performance discussions.

At SunTrust, we generally start with the consensus forecast as the baseline for assessing the impact of economic factors on our future business. The most recently published blue chip consensus indicates a very sluggish first half of 2008, with lessening impact from the decline in residential investment in the second half and a more normal economy returning in 2009. While I am not in a position to predict the path of the economy, the downside risk to this view appears to significantly outweigh the upside.

In particular, restraints on consumer spending from a weakening labor market, higher prices for food and energy, and flat to declining home values are all troublesome. The Federal Reserve’s action yesterday is a positive but also serves to underscore our caution. In addition, in this environment we would expect our commercial clients to be relatively conservative in investing for growth.

Likely, this means for SunTrust that our 2008 year will be a tough one for loan and revenue growth. It also means that without more clarity on the health of the consumer and the path of real estate values and investment, the impact of charge-offs and provision on our 2008 earnings is difficult to gauge with any certainty.

Finally, while the credit environment and the liquidity situation in the markets has taken its toll on our earnings and capital position, markets were anything but stable in the second half of 2007 and the operating environment was certainly not accommodating.

I am disappointed that the resulting effects understandably overshadowed the real and substantial progress we are making in implementing our shareholder value-oriented strategies. Nonetheless, we are laser focused on continuing to drive those initiatives while effectively navigating through this unprecedented operating environment and though I don’t know how long this environment will persist, I do know that the banking industry will weather the storm and that SunTrust will retain its legacy in safety and soundness.

With that, I’ll turn it over to Mark to provide some details on our financial results and a credit perspective.

Mark A. Chancy

Thanks, Jim and good morning, everyone. I’ll begin today with a discussion of our capital position. First, I want to be clear that we do not anticipate any issues in maintaining our dividend. As has been the standard practice over the years, our board of directors will consider our dividend policy when it meets in February.

We have previously indicated that our tier one ratio target is 7.5%. At year-end, our estimated tier one ratio is about 50 basis points below that stated target. However, our tangible equity-to-assets ratio is about 6.3%.

To help provide a clear picture of the drivers of the decline in the tier one capital, we’ve outlined the puts and takes from the third quarter level of about 7.44% on slide five of the presentation. Although 7% is below our target, the expected outcome of transactions relating to our common stock holdings of the Coca-Cola Company, potential issuance of capital securities and expected earnings will move us above our current target during 2008.

More specifically regarding the Coke stock, as you know in May 2007 we announced a comprehensive evaluation of our ownership position which currently totals 43.6 million shares. We have completed that evaluation and the Board of Directors has authorized us to pursue certain transactions that accomplish the stated goals of both improving the tier one capital contribution from the holdings, as well as increasing shareholder value.

Under any of the expected scenarios, tier one capital would increase by approximately $1 billion. We are currently sharing the approved strategy with the appropriate regulatory and other relevant parties and will announce the final decision and related actions following the completion of that review.

Additionally, we are assessing the capital markets and may issue securities during the first quarter.

Now, moving on to slide six and margin; after three consecutive quarters of margin expansion totaling 24 basis points, margins slipped five basis points during the quarter. Margin improvement this past year was a direct result of the balance sheet management strategies that we implemented in connection with our shareholder value initiatives in 2007.

Unfortunately, the decline in margin in the fourth quarter was primarily the result of competitive deposit pressures that did not allow us to pass along the impact of declining short-term interest rates in the form of lower deposit rates consistent with the decline in loan yields. Our expectation is that the margin is also likely to compress slightly in the first quarter due to the securities that we purchased during the fourth quarter and that I’ll review here in just a few minutes.

For the remainder of 2008, we expect margins to stabilize and possibly expand, depending on deposit pricing and volumes, the LIBOR to prime relationship, and the level of non-performing assets.

Next on slide seven, I’m going to spend a few minutes explaining the increase in provision and then we’ll cover credit in significantly more detail later in the discussion.

The rapid deterioration of the consumer and residential real estate portfolios in the fourth quarter drove charge-offs to 55 basis points, up from 34 basis points in the third quarter. In October, we saw an increase in delinquency and severity of losses that was within our previous expectations of 35 to 45 basis points annualized for the quarter. However, a significant acceleration in roll rates through the delinquency queues and severity of losses occurred in November. In mid-December, once we were able to fully analyze the November trends, it became apparent that we would exceed our previous estimate.

In addition to these factors, the accelerating decline in residential real estate values created a need to significantly increase the allowance for loan and lease losses to 1.05% of loans. Our current allowance recognizes that some further erosion in real estate values is likely and assumes similar roll rate and delinquency trends during the first half of 2008.

As Jim pointed out, there is a great deal of uncertainty regarding the economy and the health of the residential real estate market. Our credit related expectations are similar to those conveyed by Jim regarding the economic outlook. Specifically, that the first half of 2008 will be very sluggish, we’ll see some improvement in the second half of ’08, and the economy and credit environment will return to a more normal state in 2009.

As such, we expect charge-offs to increase in the first quarter and perhaps the second quarter in the consumer and residential real estate based portfolios. Further, we are projecting charge-offs to moderate in the second half in these portfolios to have relatively good CNI performance and an increasing risk in charge-offs in residential construction as current weakness turns into charge-offs later this year.

Key risks to these expectations are a broad recession and significant additional declines in real estate value.

The next several slides provide an overview of the market valuation adjustments that we realized in the fourth quarter and we’ve provided you some incremental detail so that you can follow what occurred during the course of the quarter.

On slide eight, I’ll start with the discussion of Three Pillars funding and our purchase of over $700 million in asset-backed securities from this off-balance sheet, multi-seller asset-backed commercial paper conduit.

For background, Three Pillars was formed in 1999 to provide the service of financing receivables for our corporate clients. Client transactions are typically structured to an implied A rating and we have not incurred any losses on this client related transaction since inception.

In addition to customer receivables, Three Pillars also held approximately $720 million of highly rated asset-backed securities in the fourth quarter. This position represented less than 10% of Three Pillars total commitment at that time. These securities were all highly rated and specifically on the date of acquisition, 83% were Triple A rated and the remaining 17% were Double A rated.

In the third and fourth quarter, deterioration in the performance of the underlying collateral began to materially decrease the market value of these securities and a review of the remittance reports received on the 26th of December showed continued deterioration in collateral performance. In order to reduce the risk profile of Three Pillars, we ultimately decided to purchase all of the asset-backed securities and recorded a market valuation write-down of $145 million.

As the decision to purchase the securities was based in part on this remittance information that was not made until the end of the year, this loss was not included in our December 20th disclosure.

Now, in order to mitigate our risk going forward on these assets, during the week of January 7th, we sold three of the highest risk positions with a par value of slightly over $100 million at prices roughly equal to the year-end carrying values. Markets remain volatile and the valuations on these trading assets are subject to further fluctuations.

And I’ll end my comments on Three Pillars by conveying that the conduit is performing well, has performed well from a financing standpoint ever since the market turmoil began back in August of 2007, and we expect that it will remain off balance sheet going forward.

Moving to slide nine, as we previously announced, at the end of the quarter we also purchased $1.4 billion in securities from our affiliated mutual fund complex, specifically from the STI Classic Prime Quality Money Market Fund and the STI Classic Institutional Cash Management Money Market Fund. When these securities were originally purchased by Trust Co. on behalf of the funds, all were first tier securities as defined by Rule 2A7.

The securities are primarily SIVs recorded as trading assets now on SunTrust's books and a market valuation write-down of $250 million was recorded during the quarter. SunTrust took this preemptive action to protect its approximately 142,000 account holders from possible future losses associated with these securities. We believe this action will enhance our relationship with these clients and protect the revenue value of the other products and services purchased by the fund’s shareholders throughout the bank.

Excluding the non-performing SIVs, 94% of the securities mature by June 30th of 2008. $185 million in payments have already been received in January and another $155 million is expected by month-end. In addition, we are actively managing this portfolio to mitigate future losses; however, it’s important to note that given the volatility of the underlying assets and market valuations, future losses are possible.

Moving to slide ten -- in the fourth quarter, we also recorded a market valuation write-down of $116 million on $967 million of securities we consolidated in the third quarter of 2007 as a result of our intent to close a privately placed money market fund. These securities had original Triple A ratings and consist of roughly 80% residential mortgage-backed securities.

Market valuation write-down of approximately $16 million was recorded in the third quarter; however, the market value for these securities declined significantly during the fourth quarter due to some trading activity in certain of the securities and we determined that an additional write-down of $116 million was appropriate.

After a fundamental review of the likely intrinsic value of the securities if held to maturity, we have decided to hold these securities for now in trading assets. As such, further market valuation adjustments are possible.

But when you look at this in aggregate and moving to slide 11 and the impact on non-interest income, total non-interest income for the quarter was $576 million, down 35% from the fourth quarter of 2006. Total non-interest income for the year was essentially flat as a result of market valuation write-downs, a 58% decrease in mortgage production income largely driven by spread widening, and the third quarter 2006 bond trustee gain which was partially offset with the gain on the Coke stock in the second quarter of 2007.

As I mentioned earlier, we -- or Jim mentioned, we also recognized $119 million gain on the sale and leaseback of real estate in the fourth quarter.

I’ve just covered the biggest contributors to the $555 million in write-downs. Other market valuation impacts include: capital markets related write-downs, which actually declined in the fourth quarter to $50 million from $121 million in the third quarter, as we have continued to mitigate our exposure, and I’ll get into that in greater detail in a minute; mortgage related write-downs decreased from $88 million in the third quarter to $78 million in the fourth quarter. The drivers shifted from primarily spread widening to a mix of spread related, liquidity, and credit valuation write-downs in the fourth quarter; we also had corporate debt security spreads widen during the quarter, creating an $84 million write-up in the value of SunTrust debt.

So in summary, in the last few months, we’ve purchased over $3 billion in securities and marked them to reasonable market values. We are seeking to mitigate risk via sales, expecting near-term cash flows in some situations and choosing to hold other securities. Markets remain volatile and we expect to receive December performance data later this month that could affect the value of these securities.

So with the write-downs fully outlined, I’d like to move to and talk about some of the positive elements of the core business, as we did have and experienced solid fundamental fee income performance in most categories.

Fee income growth over the fourth quarter last year occurred in service charges as a result of growth in both consumer and commercial sides of the business. Consumer growth was derived from an increase in NSF fees and growth in the number of accounts. In our commercial line of business, lower DDA balances and higher treasury management revenue contributed to the growth.

Retail investment services was a bright spot for growth, driven by success with sales of investment products, particularly annuities and managed accounts and higher managed account fees. Card fee growth was also driven mainly by debit card activity and mortgage servicing growth was primarily the result of a larger servicing portfolio and a $19 million gain on MSR sales versus [nine] in the fourth quarter of 2006.

Now let’s move to slide 12, and on this slide we note that trading assets are up approximately $950 million over last quarter, which is mainly the result of the purchase of securities that I’ve just mentioned from SunTrust mutual funds and Three Pillars.

Growth in corporate and other includes the carrying value of the SIV and Three Pillars securities purchased in December. I’ll address the decline in the securitization warehouse as we move to the next slide, slide 13.

During the quarter, we made good progress in mitigating our securitization related exposures. Key actions include securitizing commercial loans and retaining only the Triple A securities, selling off half of the SBA loans, and selling off other selected positions. Our remaining exposure is over 90% government guaranteed SBA and CLO assets and $46 million of that residual is residual interest on our own commercial loans that were securitized in the first quarter of 2007 as part of our balance sheet management strategies.

In summary, as you can see from this slide, our exposure to further losses has been reduced by over $850 million since the third quarter.

Now I am going to shift gears and talk about expenses. On slide 14, on a reported basis expenses grew 7% over last year and 18% over the fourth quarter of 2006. Now, both of these numbers are somewhat misleading due to large charges, particularly in the fourth quarter related to a Visa litigation accrual and a write-down related to our affordable housing portfolio of multi-family housing properties.

Adjusting for these items shows core operating expenses of $124 million, up 2.6% for the full year 2007 over 2006. But I want to be clear -- the increase in operating expenses as highlighted at the bottom of this slide was entirely driven by higher credit costs, including mortgage fraud losses, credit and collections expenses, and expenses associated with repossessed real estate. You’re already familiar with several of those so I’ll limit my comments to a couple of these items.

We recorded a Visa litigation accrual in total of $77 million for the quarter. Based on estimates provided by Visa regarding its planned IPO, we currently believe that our ownership position in Visa has a value significantly in excess of this $77 million reserve.

The affordable housing charges are related to the ongoing review of our business units and our decision to de-emphasize ownership and management of affordable multi-family housing properties in connection with our community reinvestment strategies. 2006 charges relate primarily to a portfolio of 15 properties marketed during 2007 and currently under contract for sale. 2007 charges are for another portfolio of 18 properties which we are writing down in anticipation of placing them for sale later this year.

To be clear, we are continuing our longstanding commitment to assist in providing affordable housing in our communities and we will continue to play a strong role in equity investments and lending relationships. We just will not take large ownership positions in the future.

One final note on expenses; I’m sure that you will notice that expenses grew from the third quarter to the fourth quarter even after adjusting for the large charges and credit costs that I just mentioned. The contributors to this growth were increased advertising in support of the My Cause deposit campaign, investments in branch refreshes completed during the quarter, investments in technology and information infrastructure, and a year-to-date adjustment in the third quarter to reduce the annual incentive compensation accrual based on our year-to-date results.

Now moving to slide 15, I am going to provide a review of our credit profile and give a brief review of the balance sheet trends from the third quarter to the fourth quarter.

Overall, sequential loan growth for the fourth quarter was 1.3% and we had growth in commercial and industrial, as well as mortgage, while the construction and consumer portfolios actually declined.

C&I growth was primarily in large corporate, with some concentration of growth in the energy sector and, to a lesser extent, growth in auto dealership floor plan outstandings. Business banking outstandings also increased during the quarter.

Construction outstandings declined again in the fourth quarter after peaking in the second quarter, due in part to aggressive management and fewer new projects being funded. Additionally, total exposure to residential construction has declined by over 15%, or approximately $1.4 billion since the fourth quarter of last year, due to proactive risk management.

Residential mortgage outstandings increased slightly over $1 billion. Now this increase was driven primarily by the transfer of over $800 million of illiquid but performing loans from the warehouse to the portfolio. We moved these loans as a result of the fact that we don’t expect liquidity to return in the whole loan market anytime soon and the transfer of performing loans decreases our hedging costs and our mark-to-market volatility.

Consumer loans declined due to an intentional de-emphasis of lower yielding student and indirect auto loans. Growth in the credit card balance, while small in dollars, is also the result of an increase in consumer card accounts issued in related outstandings, which resulted from a new marketing relationship established to originate consumer credit card accounts to SunTrust banking clients.

Next I’m going to discuss credit quality in the three portfolios that are directly exposed to residential real estate.

Slide 16 includes a number of statistics on the residential mortgage portfolio. The first three rows in the slide represent 90% of the portfolio and all have very good FICO scores well above 700. Additionally, this group has original LTVs below 80% or are insured to 80%.

In particular, the core and home equity loan portfolios, which comprise over three quarters of the balances, have lower LTVs, good current FICO scores, and are performing well considering the environment.

Prime seconds are loans originated in conjunction with a home purchase and are also referred to in the industry as piggy-backs or combo seconds. Performance of this portfolio has been good to date with 60-day plus delinquency and NPLs similar to the core portfolio of first lien loans. The LTV is a little on the high side but even if performance deteriorates in this portfolio, we have insurance as a loss mitigate.

Five percent of the portfolio that is secured by residential lots is showing stress, with 60-plus day delinquencies in excess of 3%. While the borrowers’ FICO scores are holding up well, the delinquency rates, original LTV, and outlook for residential values and construction activity point to more loss this year.

The issue in this portfolio overall continues to be the Alt-A loans. The first lien loans in this run-off portfolio are performing poorly with a high level of 60-plus day delinquency and NPLs, and we expect NPLs to increase further. However, ultimately we expect the loss content to be manageable, given the 24% valuation cushion at origination.

The Alt-A seconds are also performing poorly and this portfolio is no longer insured. It became apparent in the fourth quarter that we would reach the insurance cap at some point in 2008. As such, we reached a settlement agreement with our insurer to save us the cost of both the claim and the review processes. Our reserves were increased appropriately in the fourth quarter to cover expected loss on this segment of the portfolio.

Now, turning to the home equity line of credit portfolio on slide 17 -- slide 17 of the presentation shows a different cut of the HELOC portfolio than we provided in the third quarter. This time, we provided metrics on the key contributors to risk in cascading order. The data illustrates in detail that the troublesome parts of the portfolio are third-party and higher LTVs, which comprise 30% of our $15 billion in outstandings.

There are some other points worth noting: third-party is 12% of balances but over 40% of charge-offs; over 90% LTV lines have maintained a high average current FICO score of 736; the core portfolio from Florida is performing adequately due to the low LTV and high FICO scores; finally, almost half the portfolio, or 47%, is very well secured, has maintained an average FICO score greater than 720, and is performing well given the environment.

We have implemented a number of policy and pricing changes throughout 2007 including the elimination of greater than 90% LTV production from all channels and restrictions on LTV in declining markets and for higher risk property types. These and other changes have resulted in a 70% reduction in new volume in the fourth quarter as compared to the second quarter of 2007.

Now moving to the construction portfolio on slide 18, there are three key messages related to our $13.8 billion construction lending portfolio. The first is that we have not experienced meaningful charge-offs to date; however, we are expecting net charge-offs to increase in 2008 from the approximately $7 million level recorded in the fourth quarter.

Second is that almost 40% of the portfolio is comprised of commercial purpose construction, which is performing very well. The risk is currently concentrated in the residential related portfolio.

The third key message is that while the portfolio is geographically well diversified with under a third in Florida, the risk is skewed with approximately half the residential NPLs coming from Florida.

We have been aggressively managing our residential construction exposure beginning in early 2007 and we will continue to do so. I noted earlier that the results of our efforts include declining balances and exposure. Less evident to you are the results of our efforts during 2007 to improve the quality of the portfolio by reviewing all of our builder relationships and projects.

Over the course of last year, we identified less well-positioned builders and engaged in a variety of risk mitigation activities. Additionally, during 2007 we placed restrictions on new residential builder relationships and the financing of new projects with existing clients.

In Construction Perm lending, we made numerous changes, adding significantly more controls, tightening underwriting standards, and implementing specialized guidelines for declining markets.

Now I’ll turn to our final slide which shows our current NPAs. Slide 19 illustrates the fact that NPAs have increased in the fourth quarter by $486 million and that 90% of the increase was in residential mortgage and construction loans. However, we continue to expect that the lost content in current NPAs will be manageable.

For example, approximately two-thirds of the non-performing loans are from residential mortgages, of which 60% are first lien core portfolio and Alt-A first, with original LTVs typically below 80%. We do however expect these portfolios to be under pressure from declining residential property values.

Let me summarize the credit discussion before we conclude the presentation and take some questions.

Consumer and residential real estate are clearly under stress throughout the industry and the same is true at SunTrust, though our commercial portfolio is generally performing well. Credit deterioration is not broad-based; it comes from specific sub-segments of our portfolio, including Alt-A loans, high LTV second liens, broker originated loans, and residential construction and construction to perm. These portfolios total approximately $16 billion in outstandings, or roughly 13% of our total portfolio at December 31st and much of this is reasonably well-secured.

We implemented numerous actions throughout 2007 to curtail or eliminate the inflow of new higher risk loans and will focus in 2008 on mitigating the risk that we do have.

Finally, as noted earlier, we expect charge-offs to trend up in the near term; however, giver our under-writing standards, collateral position, and risk mitigation activities, we expect 2008 losses to be manageable.

And with that, let me turn it back over to Steve.

Steve Shriner

We’re ready to open it up for questions.

Question-and-Answer Session


(Operator Instructions) Our first question is from Jennifer Thompson. You may ask your question and please state your company name.

Jennifer Thompson - Oppenheimer

A couple of questions; first, in the past you have given us net charge-off range guidance. Would you be willing to update that guidance for your best guess for 2008?

James M. Wells III

Jen, we provided some specific information in the forward-looking statements about our expectations of certain elements of the portfolio but we are not providing a specific range for 2008, given all the comments that we’ve made this morning.

Jennifer Thompson - Oppenheimer

Okay. In that case, you spoke about the increased frequency and severity of losses. Could you give us more color in terms of either the magnitude of the increases you saw through 4Q? Has that increase in frequency and severity continued into the first quarter of this year?

Thomas E. Freeman

What has gone is we saw in the -- really in the fourth quarter an increase in roll rates and some fairly substantial movement, specifically on the residential side of the house. What we are beginning to see and what we’ve seen over the past couple of months is a leveling out of the entry into the roll [queues]. We believe we are starting to see some flattening, specifically in the Alt-A portfolio in terms of the rate of incidents of things entering the [queues].

I can’t say that it is coming down but it is no longer increasing and nowhere near -- the rate of increase is nowhere near what it was during last quarter.

Jennifer Thompson - Oppenheimer

Okay, but still increasing but not increasing as fast, is that the message?

Thomas E. Freeman

That’s exactly correct.

Jennifer Thompson - Oppenheimer

Okay. Will you share with us what the average severity you are seeing on for the portfolio in general?

Thomas E. Freeman

Can you ask the question a different way for me?

Jennifer Thompson - Oppenheimer

The average severity of losses say for the residential portfolio for the company?

Thomas E. Freeman

It’s a really difficult question to answer because the severity is product specific and also geographic specific in terms of what’s going on. We’re seeing more severity in the declining markets than we are in the more stable markets and the level of severity in terms of the types of product has a lot to do with the loan-to-values and the quality of the underlying assets, and so that would be a range across the whole product set.

Jennifer Thompson - Oppenheimer

Okay, but the worst severities, would that be fair to say would be in Florida, as you discussed?

Thomas E. Freeman

Actually, what we tried to do in the slides was walk you through where the severity is actually coming from. The severity is really coming out of the Alt-A portfolio and the high loan-to-value home equity portfolio and that is where you are seeing the severity, as well as in the brokered lines. If you take those out, actually Florida is performing just about what the rest of the portfolio is performing.

It’s not geographic specific. It’s more product specific and channel specific.

Jennifer Thompson - Oppenheimer

Okay. Great, thanks very much.


Thank you. Our next question is from Mike Mayo. You may ask your question and please state your company name.

Mike Mayo - Deutsche Bank

Good morning. First, the E-squared efficiency initiative, you are at a $300 million annualized rate in the fourth quarter and your target is 350 for ’08, so a deceleration in the savings or might you increase that goal?

James M. Wells III

Mike, there are additional savings to be had. We are not prepared to increase our number as yet. We’ll see what goes on in the first one or two quarters of the year, but the preponderance of the savings from certain of the activities have shown up and so we are dealing with not the whole portfolio of savings opportunities but rather a reduce portion, so hard to say at this point. I think we’ll stick with our 350 for now.

Mark A. Chancy

What it does, Mike, is it gives us a lot of confidence as we move into 2008 that the 350 is a very realistic goal and to the extent that it makes sense in the early part of the year to modify it, we’ll certainly share that with you.

Mike Mayo - Deutsche Bank

And then a separate question on charge-offs; I know you don’t want to give guidance but what do you think of normalized charge-offs? Are they above where they are? Do you have a number?

James M. Wells III

Try and ask the question again, just a little differently, Mike. I’m trying to figure out what you are trying to get at.

Mike Mayo - Deutsche Bank

Through a cycle, where do you think loan losses will be for SunTrust?

James M. Wells III

Over the whole cycle?

Mike Mayo - Deutsche Bank

Yeah, if we were to think about normalized loan losses, clearly we were way below normal for a number of years and at some point we might be above, but if you were to take an average through cycles --

James M. Wells III

Mike, in the past what we’ve said is that our historical average over cycles has been in the 30 to 40 basis point range. We’ve clearly been at levels that are higher than what we recorded in the fourth quarter of 55 basis points, if you look back at various times of stress in the economy and in certain, particularly real estate, markets and we’ve also been as low as eight to 10 basis points. So I think it’s hard to generalize your question but in the past we have experienced in that 30 to 40 basis points on average through historical cycles.

Mike Mayo - Deutsche Bank

And one other separate question; what is the impact of interest rates on SunTrust? The Fed cut by 75 basis points. Maybe they’ll cut again, so that certainly is a positive. On the other hand, funding costs for longer term debt for SunTrust and other banks has gone up. How does it all play out?

Mark A. Chancy

The short-term rate reduction helps as we are economically liability sensitive, although not significantly so. However, the shape of the interest rate curve has a significant impact, as you know, on whether or not it’s a benefit to us. A lower and flatter curve is not beneficial. A lower -- a steeper curve, particularly with a more normalized LIBOR to prime relationship, is a real positive to us. So if you’ve got a lower and steeper curve, we certainly should feel a benefit.

I will caution, and we were very specific in the fourth quarter, that due to the liquidity issues generally in the financial services industry, and you can pick your example, the fact is that deposit rates did not move down on a competitive widespread basis in lock-step with the short-end of the curve and with LIBOR, as they have historically. And as a result, that was the primary issue as it relates to the margin decline that we realized five basis points during the fourth quarter.

So I’ve given you a couple of data points that are all relevant as to whether or not the lower rates are beneficial to net interest income and specifically with deposit growth as well as a more normalized relationship between deposit pricing and short-term rates will be key components, as well as the shape of the curve, on whether or not it’s beneficial to net interest income in the short run.

Mike Mayo - Deutsche Bank

And as it relates to SunTrust, are you going more to the deposit market away from the wholesale markets, given --

Mark A. Chancy

You can see a dramatic reduction in our wholesale funding during the course of 2007. Specifically, in the first half of the year with a reduction in our deleveraging balance sheet strategies that were implemented. We had a significant reduction in wholesale funding and certainly in our strategy and our My Cause campaign and other deposit related initiatives, not only in retail but in wealth and investment management and our corporate lending businesses are all very focused on driving a core -- checking account relationships, core deposits. We noted some incremental advertising to support some successful campaigns that we’ve been running -- all of those are initiatives designed to drive core deposit relationships and reduce the company’s reliance on wholesale funding and we anticipate continuing to evaluate further steps that we could take to reduce our reliance on that wholesale funding.

Mike Mayo - Deutsche Bank

All right. Thank you.


Thank you. Our next question is from Ed Najarian. You may ask your question and please state your company name.

Edward Najarian - Merrill Lynch

A quick question with respect to reserves; obviously a reserve build this quarter but it still looks like your reserve ratios are meaningfully below peer levels. I think I heard you say that you expect -- and correct me if I’m wrong about this -- a $250 million gain from more sale leaseback transactions in the first quarter. Without linking to --

Mark A. Chancy

Let me stop you there. What we said is that we --

Edward Najarian - Merrill Lynch

We also see a potential for additional reserve build in the first quarter to sort of use up that gain, if you will, and come more in line with your peers on the reserving side.

Mark A. Chancy

Ed, let me clarify one piece; what Jim said was that we sold $750 million worth of real estate and booked $119 million gain in the fourth quarter. We are also under contract to sell $250 million of additional real estate assets in the first quarter. That will have a marginal gain associated with it but it is not a $250 million gain. That’s the notional amount of the real estate.

Edward Najarian - Merrill Lynch

Okay. Thank you. That was my mistake. Sorry about that.

Mark A. Chancy

So as it relates to the adequacy of the allowance, as you know in the industry on a quarterly basis, you go through and you evaluate the credit statistics and you create an allowance that is consistent with both the current information and what it indicates to you as you look out into future periods as it relates to the losses that you have embedded in your portfolio. And so we will do that as normal course at the end of each quarter and I won’t speculate at this point as to whether or not 105 will increase or decrease from its current level as we move through the course of the year.

I will tell you that we are going through a rigorous review process trying, as we mentioned earlier, to evaluate the new information as it becomes available. We did that in detail in November and December and we made the adjustment that you see in the fourth quarter. We will continue that rigorous review as the landscape continues to evolve.

Edward Najarian - Merrill Lynch

Any initial estimate or range as to what that gain on the sale leaseback will be in the first quarter? If you are under contract, I would expect that you would have a pretty good idea.

Mark A. Chancy

We do. We haven’t released that information publicly. It’s not a significant number as it relates to SunTrust quarterly results, so I would put it in the very nice but not significant category.

Edward Najarian - Merrill Lynch

Okay, and then last question; what are your thoughts on repurchasing any stocks this year, selling Coke stock to repurchase stock?

Mark A. Chancy

As I mentioned, notwithstanding the fact that our tier one capital is at 7%, we feel good about our capital position. We feel very good about our liquidity position as an institution. As it relates to capital, we have a number of initiatives underway that would put us well above our 7.5% target. The $1 billion reference in tier one related to the Coke transaction is a good example. We obviously have the opportunity to access the public markets if we deem it appropriate, as well as earnings in the first half of the year.

So we are confident that we will be at or above our target as we move through the course of 2008 and I would say in the short run, you should not expect any significant repurchases of shares but as we implement these strategies and get ourselves back above target, we will come back and communicate to you as to those expectations looking forward. But I would say in the next couple of quarters, you should not expect significant repurchases.

Edward Najarian - Merrill Lynch

Okay. Thank you very much.


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

John Mcdonald - Banc of America Securities

Mark, just following up on that last comment on the capital, can you comment on your capacity to issue hybrids? Are there any restrictions on that? And is that part of the factors that you’ll go through in thinking about capital?

Mark A. Chancy

Yes, we still have hybrid capacity and we are evaluating that marketplace. There’s been a lot of both public and private capital issuance that you are aware of and so given the fact that we feel that we are well-capitalized and we are in the process of finalizing our Coke transaction, we felt no compulsion to access the markets during the very difficult and volatile environment here over the past several months.

We do have hybrid capacity though and that is part of the evaluation as we move forward into 2008.

John Mcdonald - Banc of America Securities

Okay, thanks. And could you comment on any exposure you might have to the bond insurers?

Thomas E. Freeman

We have no direct credit exposure whatsoever to the bond insurers. We do have some municipal securities where we do have some wraps from that. Our practice has always been to directly underwrite the municipalities. It’s primarily a single A to double A wrap portfolio. We think we are in very good shape with the portfolio and don’t anticipate any problems coming out of this.

John Mcdonald - Banc of America Securities

Okay. Thanks, Tom.

Mark A. Chancy

I would note that certain of the securities that were acquired in connection with our Trust Co. purchase, Three Pillars purchase, et cetera, do have the insurance wrap so we are subject to some market volatility associated with that insurance but as Tom mentioned, we do not have direct exposure to any of the insurance companies and we are, as you would expect us to, managing that risk actively as we move forward.

John Mcdonald - Banc of America Securities

Okay. My last thing was any strategically changes to your capital markets business? And also, could you comment on your mortgage strategy going forward, how you are approaching the mortgage business as we go into ’08 here?

Mark A. Chancy

Let me start with mortgage and we have representatives from that area here with us if they’d like to pile on. Mortgage is an important product for us. We think the mortgage is a core aspect of the consumer relationship and we work closely with our retail line of business, our wealth investment line of business, to leverage that household to the benefit of SunTrust shareholders.

We think that this is an opportunity for SunTrust to improve our long-term position in the mortgage industry. As we’ve talked at length, we have pulled back in certain product areas. We have tightened underwriting standards and we have modified our approach to certain elements of the marketplace.

But with that said, we have been adding originators through this period, adding to our long-term market share goal, as well as the profitability that we can generate out of that mortgage production despite a narrowing of spreads on that production income in the short run.

So I would tell you that our approach to the business is not waning in any way. We are focused on a long-term basis with the caveats that I mentioned, where we are cutting back on certain product areas as appropriate in this environment.

Bill Rogers, if you have anything to add to that.

William H. Rogers Jr.

I’ll take the CIB part of that question. We late third quarter decided to exit the principal part of the CDO and RMBS business and you can see the evidence of that in what Mark has talked about in the warehousing, so you know we essentially have sort of zero warehouses in those businesses and we won’t be in the principal part of that business.

Mark A. Chancy

John, one of the things that was overshadowed, rightfully so, is that many of the areas of our capital markets business had a very strong year in 2007. As Bill mentioned, we are paring back and/or eliminating certain activities but the debt capital markets, equity capital markets business and how we leverage our corporate and commercial customer base, wealth and investment management customer base, continues to be an important business for us as we move forward.

John Mcdonald - Banc of America Securities

Okay, thanks.

Steve Shriner

Operator, we’re out of time. Let’s take one more question, please.


Thank you. Jefferson Harralson, you may ask your question and please state your company name.

Jefferson Harralson - Keefe, Bruyette & Woods

Can you guys talk about the Florida and Atlanta markets and help give us some context to forecast loss rates for the residential construction portfolio?

Thomas E. Freeman

Why don’t we talk about Atlanta to start with? The Atlanta marketplace is -- while it’s seen a fall-off in housing starts and sale of housings remains very strong within the perimeter. In some of the surrounding communities, you are seeing some weakness and fall-off in sales activity. Inventories, however, in Atlanta, have been showing signs of reduction and people reacting to some softness in the underlying marketplace.

The high-end activity, the custom built home business still seems to be holding up very well. The lower end of the market is showing real softness and that would be Atlanta. We’re not heavily positioned, I would say, in the low-end of the market. We do substantially more mid- to higher-end custom build activity here.

The regional builders here are beginning to adjust inventory in a moderate to aggressive manner. There’s still positive job formation here and still positive sales activity going on within the Atlanta marketplace.

In Florida, it’s a tale of three or four markets. The West Coast, specifically the southern West Coast, we’re seeing falling housing prices. In some instances in some of the communities, some rollbacks in prices which would look to be 5% to 10% rollbacks in those pricing activities. Very narrow volume, not a lot of buyers within the southwest Florida marketplace.

The northern market around Orlando is holding up moderately well. Still positive job formation there, although rollback in some of the housing prices, nothing like the significant rollback you see in southwestern Florida.

The pan-handle is showing signs of weakness. We have very little concentration throughout the pan-handle area in Florida.

Jefferson Harralson - Keefe, Bruyette & Woods

Do you think that Florida deteriorates all year or do you think Florida is in a recession now?

Thomas E. Freeman

I couldn’t define what “in a recession now” means. We’re watching housing prices. They are trying to get some stability around that and I can’t -- I just can’t forecast what’s going to happen in the residential markets in Florida.

Jefferson Harralson - Keefe, Bruyette & Woods

All right. Thanks a lot.


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

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