SunTrust Banks, Inc. (NYSE:STI)
Q1 2008 Earnings Call
April 22, 2008 8:00 am ET
Steve Shriner – Director, Investor Relations
Jim Wells - Chief Executive Officer
Mark Chancy - Chief Financial Officer
Tom Freeman - Chief Risk and Credit Officer
Brian Foran – Goldman Sachs
Matt O’Connor – UBS
Mike Mayo – Deutsche Bank
Betsy Graseck – Morgan Stanley
Jefferson Harralson - Keefe, Bruyette & Woods
Welcome to today’s SunTrust First Quarter Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Mr. Steve Shriner, Director of Investor Relations.
Good morning, welcome to SunTrust’s First Quarter 2008 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 update of capital our efficiency and productivity program, a broad risk and credit overview and a review of financial results. 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 First 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, Mark Chancy, our Chief Financial Officer and Tom Freeman, our Chief Risk and Credit Officer. Jim will start the call with an overview of the quarter, including an update on capital and our efficiency and productivity initiatives. Tom will them provide a detailed review of our risk and credit picture and Mark will conclude the call with an overview of financial topics, including impacts to earnings this quarter. 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’ll 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 first 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 nor guarantee the accuracy of our earnings teleconference transcripts provided by third parties. The only authorized live and archived webcasts are located on our website.
With that, let me turn it over to Jim.
Good morning everyone I’m glad you’re with us this morning. As anticipated, SunTrust and the industry continue to face a very challenging earnings environment in the first quarter. Growth and provision expense associated with residential real estate correction took a toll on results. However, SunTrust remains a financially strong institution with significant growth opportunities. With that point we are encouraged by underlying progress in key business lines this quarter, good deposit and even saw modest loan growth, and the positive impact of improved discipline.
Indeed non-interest income was up double digits this quarter and expenses remain flat compared to last year. However, overall earnings for the first quarter of $284 million or $0.81 per common share were largely impacted by the growth and provision expense associated with the housing correction. Provision expense was $560 million for the quarter which covered $297 million in charge offs and provided $263 million to increase the allowance for loan losses to 125 basis points.
We obviously are not pleased with our credit performance and the impact on near term earnings. However, as you will hear we are and have been working on the right things to minimize risks in new production and to mitigate losses in the existing portfolio. Tom Freeman is going to cover credit in great detail but I do want to point out that the elevated credit metrics are primarily confined to the consumer portfolio particularly the residential real estate secured categories.
Within these categories the majority of the risk that is coming from relatively small segments that are largely run off portfolios and I expect this risk will run its course. However, the commercial real estate, commercial, and commercial purpose construction categories continue to perform relatively well overall during this quarter. Home values and consumer credit have obviously deteriorated over the last two quarters particularly and while the Blue Chip forecast on the economy is zero GDP growth in the first half of 2008 there appears to be more down side risks to this view than there is up side possibility.
While I believe the Federal Reserve is being quite responsive to the difficult environment it does appear to me that the economy is going to be weak in the short term and this weakness could possibly extend into 2009. While we all certainly hope for one of the better economic scenarios to unfold we are prepared for the alternative. SunTrust remains financial strong, ample liquidity and with adequate capital in the solid balance sheet.
Turning to slide three I’ll spend a couple of minutes outlining our capital and liquidity position. Our estimated tier one ratio is 7.25% up from 6.93% last quarter. Our February trust issuance was $685 million replaced $600 million of capital securities that were redeemed during the third and fourth quarters of 2007 and moved us back in the right direction relative to a 7.5% tier one target. As we indicated at year end we expect the transactions involving our Coca-Cola equity holdings to be complete in the second quarter.
While this may be obvious to most of you, by virtue of the fact that we are sharing this strategy with external parties you can surmise that the preferred approach does not reflect a simple outright sale of this stock. I’d also like to remind you that our view and actions are 100% about SunTrust and our capital efficiency as we believe Coke is performing well and will continue to do so. Under just about any scenario we anticipate a minimum tier one capital increase of approximately $1 billion which would add roughly 65 basis points to the tier one ratio on a pro forma basis.
The additional 65 basis points would take us well above our current target and as such we anticipate reassessing the appropriateness of our long term target of 7.5% in a post transaction environment. Unless we consider a little excess capital a good thing in the short run until the future economic and credit environments become clearer.
We significantly enhanced liquidity position over the past year. For example, brokered and foreign deposits have been decreased by almost $11 billion or 42% as a result of our balance sheet restructuring initiatives. The result of these actions is that we are operating with a solid capital foundation of strong liquidity. Increasingly important positions to maintain during these uncertain times.
I’ll spend a few minutes updating you on our E² efficiency and productivity initiatives before turning it over to Tom. On slide four I’m very pleased with the results of our efficiency initiatives and the manner in which our entire team is contributing to create this success. We exceeded our expanded and expedited 2007 goals by nearly 20%. Further, with a clearer view of our 2008 and 2009 potential I’m happy to report that we expect to achieve run rate savings of $500 million in 2008 an increase of $150 million over our prior goal.
We are also increasing our overall program goal to $600 million run rate savings during 2009. This represents a $275 million or an 85% increase in 2009 savings from our original expectation communicated in early 2007. Moreover the $600 million 2009 goal represents over 11% of our 2006 non-interest expense base a significant accomplishment. I do want to emphasize that this program and the higher expected run rate in 2008 is not a short term reaction to the current environment.
Instead it relates to greater success in preexisting initiatives where the work is substantially complete. As a reminder we began our review in 2006 and are steadily progressing with initiatives that were thoughtfully conceived and carefully executed. A good example is the outsourcing agreement with Symcor that we announced just this last week. This arrangement for example will allow us to lower our costs and to increase our investment focus while providing best in class products and services to our clients.
I believe that what we are experiencing is a true transformation of the culture of the organization relative to expense discipline. Our efficiency and productivity focus is taking hold. This is important because we expect this discipline to help enable restrained expense growth and greater operating leverage on the other side of the current credit and economic cycle. As we’ve articulated previously the success now and in the future is also important in creating additional capacity to invest in the franchise particularly in high growth business opportunity.
Moving to slide five I’ll now spend a moment outlining the impact this initiative had on the first quarter results. First quarter run rate savings were $113 million an increase of $38 million or 51% from the fourth quarter of 2007. As Mark will enumerate shortly the savings we’ve been able to generate as a result of this program are contributing meaningfully to our goal of realizing lower expense growth rates. The biggest driver of the increased savings this quarter was related to our organizational design initiative in which 2,400 positions were targeted for elimination by the end of 2008, 1,900 positions were eliminated during the fourth quarter of 2007 resulting in a full fourth quarter impact.
However, it is important to note that only a third of the total increase from the fourth quarter run rate was from position elimination. We are also gaining traction in each of the other four work strengths; corporate real estate, supplier management, outsourcing, and process reengineering. We have a little more work to complete in the corporate real estate and organizational design initiative but the bulk of the growth in savings from here will be generated by supplier management, outsourcing and process reengineering.
The benefits to the process reengineering initiatives are two fold. Technology enables middle and back office efficiencies also helped to realize our vision of being easier to do business with both internally and externally. Economic uncertainty notwithstanding we remain confident in our execution of our strategies and the growth potential within our existing businesses and market. Though it’s still unclear as to how long this environment will persist as I said before I know that the banking industry will weather the storm and that SunTrust will retain its legacy of safety and soundness.
Now I’d like to turn it over to Tom Freeman to talk about risk posture at Credit Data.
This morning I’m going to provide a brief review of our securities portfolio and then spend time going over the credit data. I’ll be referring to our presentation slides beginning on slide six. As you know, the credit securities market showed high volatility around a downward trend during the first quarter. Mortgage securities continued their downward trend which started last year. As you can see on the graphs the pressure on mortgage valuation spreads to other asset classes during the quarter.
Corporate credit spread has widened significantly through mid March and then rebounded somewhat in response to the Federal Reserve’s continued efforts to add liquidity to the system. Overall for the quarter the decline in prices resulted in the net trading losses we reported this morning. You should also note that we have no un-syndicated exposure to the large syndicated leverage loan market which caused write downs across the industry during the first quarter.
Slide seven shows the progress we have made in reducing the carrying value of the securities we acquired from our asset management subsidiary and three pillars, our commercial paper conduit for client transactions. Carrying value of these acquired securities has been reduced by almost 60%. In addition to these portfolios below the subtotal we’ve included the AAA portion of the securities we retained from the securitization of almost all our purchased commercial loan securities.
Exposure on all the securities has been reduced by almost $1.9 billion, $750 million in write downs including roughly $240 million in the current quarter. In addition, we sold over $500 million of these securities at or near carrying values. Over $600 million in repayments were also received. We continue to evaluate performance of the assets underlying each security as well as market liquidity and pricing. We are actively selling when market pricing is reasonable as compared to our view of intrinsic value. We believe we are carrying these securities at appropriate values, however the markets remain volatile and further valuation adjustments up or down are possible.
Slide eight in the presentation depicts our available for sale portfolio at March 31. It does not include the unrealized gain on our Coke shares or other equity securities, primarily our Federal Reserve and Federal Home Loan bank stock. This portfolio consists of 91% AAA securities, 76% of the portfolio is government agency and US Treasury securities. The duration of the portfolio is relatively short at 4.3 years. As of March 31 the net unrealized gain is $172 million.
As Mark will point out later we did recognize a $64 million other than temporary impairment charge during the quarter. This charge arose from our normal impairment review of securities. The total charge of $64 million is related to securities with a mix of home equity and mortgage loan collateral. The remaining carrying value of these securities after the charge is approximately $200 million. Our overall AFS portfolio today is $9.6 billion smaller than it was at the end of 2006, as a result of our balance sheet restructuring.
During the second quarter of 2007 securities sales included just under $4 billion of commercial mortgage backed securities, asset backed securities, private mortgage backed securities and corporate bonds. Overall, we maintain a high quality liquid portfolio and in retrospect are pleased with the timing of the second quarter 2007 sales.
Turning to credit and slide nine of the presentation. I’m going to get right to the point. Credit metrics deteriorated in the quarter. Charge offs were 97 basis points annualized while non-performing assets increased to $2.3 billion. Residential real estate continues to be the biggest driver of charge offs and NPAs. Based on our review of the losses embedded in the portfolio we raised the allowance by $263 million to 125 basis point of loans.
On a more positive note we did experience a flattening out of early stage delinquencies as the overall 89 day delinquency rate declined by one basis point as compared to year end. Additionally, we have implemented a number of changes that have successfully minimized new risk coming into the portfolios and are working very hard to mitigate losses in the existing portfolio. We are not pleased with the risk and performance in certain portfolio segments. We expect that charge offs will remain elevated at near current levels until the second half of the year. Deterioration has slowed and we believe ultimate losses will be manageable within our current capital, liquidity and earnings framework.
Turning to slide 10 and the Loan Portfolio. Why do we think overall losses are manageable? Commercial portions of the portfolio $37 billion is performing well. Our retail and commercial real estate books are also performing satisfactorily. Our core residential mortgage portfolio is performing well with better performance than the comparable mortgage banker’s association index for prime lines. Its important to remember that we originated no sub-prime or option ARM for our residential portfolios. Our home equity loan portfolio is also performing well.
Current problems are brokerage home equity lines, Alt-A mortgages and the construction of earned portfolio, all of which have been isolated and are in a run off mode. The problem assets are concentrated in residential real estate secured loans. At 180 days past due we write these loans down to realizable current values, as a result we recognized the majority of our credit losses in the non-performing one which we will discuss in a moment.
Our loss severities where we have take charge offs are within expected ranges by product given the original loan to values. If you turn to slide 11 I’ll begin a more detailed review of the residential mortgage, home equity and construction portfolios. The residential mortgage portfolio represents 27 of our total portfolio and contributed 52% of the total non-performing loans. Core residential portfolio of $22 billion is performing well showing better than average delinquency and charge off characteristics.
Delinquencies throughout the residential book are improving with early stage delinquencies leading the way. The exception of Alt-A 2nd is driven as much by a shrinking portfolio down 10% since last quarter as it is by delinquencies. In fact, we have seen improving 30 to 59 day delinquencies for five successive months on the Alt-A book. Lot Loan portfolio is showing stress but remains relatively small portfolio. Ninety four percent of the residential mortgage portfolio shows a decrease in 60 day plus delinquencies.
We view this as a leading indicator of potentially lower future NPLs and subsequent charge offs. Over 80% of the portfolio has original loan to value ratios below 80% and as a result will show smaller loss content than higher LTV portfolio segments.
The next slide is designed to walk you through our losses within the residential portfolio. Thirty one percent of our net losses during the past 12 months have come from residential mortgages. We have already recorded a charge off using current market values on 60% of our residential mortgage non-performing loans. As a consumer residential loan moves through the delinquency tiers we stop accruing interest between 90 and 120 days past due. Charge off is typically not recognized until 180 days past due.
Prior to charge off we obtain a current property valuation and a market assessment. One hundred 180 days past due we record a charge off to reduce the balance to a level likely to be realized through the foreclosure process as prescribed the IEC. Generally a loan is written down to approximately 85% of current market value. Within any portfolio of residential mortgage NPLs it’s important to understand both the relative age of the NPLs and potential loss severity. That is what slide 12 shows you.
We have a carrying value of $648 million on 60% of our quarter end NPL balance. That has already been written down by $215 million. We have not yet taken the 180 day write down on 40% or $384 million of the NPLs. The loss severity percentage listed in the final column is the actual average write down incurred to date on the portfolio segments. We have not calculated the portfolio average for you because we believe it would be materially misleading since Alt-A 2nd drove over half the write downs at a loss severity of 81%. We also list Prime 2nd as NA because this is an insured portfolio. The other loss severities are reasonable.
For example, the Alt-A 1st portfolio showed an original LTV of 77% on the previous slide. The severity is shown at 11% on this slide. If the loans are written down by 11% had average or original loan to values of 77% like the portfolio it means that the loan is being currently valued at 31% less than the appraised value at closing. The last discussion item related to this slide may well be the most important. At quarter end we will have $384 million of NPLs which have not been written down. If you apply our prior loss severity against the remaining NPLs a write down of approximately $70 million would result.
We recognize that home and lot values are expected to decline further and severity may increase. However, the real point is that $70 million losses on over $1 billion of NPLs is manageable. Even if severity increased 50% a loss of around $105 million is still manageable on our mortgage portfolio. To summarize, the data we provided on the residential mortgage portfolio should suggest to you that losses here will be manageable. If you are optimistic that the US economy will avoid a deeper recession you might conclude that the bulk of the losses in this portfolio will be behind us after the next quarter in June.
Moving on to slide 13 and the home equity line of credit portfolio. This slide is similar to the one provided last quarter and frankly the message is much the same. Third Party Originated home equity lines continue to perform poorly. Fortunately they are only 12% of the HELOC portfolio and 1.5% of our total loan book. We identified the performance issues for this segment early 2007 and began tightening credit standards at that time.
Overall performance issues are still contained to roughly one third of the HELOC portfolio. The point of the segmentation is while current credit scores are holding up well across the board it is apparent that the origination channel and higher original LTVs are key drivers of performance. If roughly $5.7 billion in outstandings in the portfolio segments showing the most deterioration. We expect this portfolio to continue to produce significant charge offs for at least the next few quarters at 30 plus delinquency has picked up since December and as home values remain soft.
There are some mitigating factors which suggest charge offs could stabilize. Reductions in the prime rate are materially lowering payments. Approximately two thirds of the portfolio continues to perform well and while I noted that 30 plus delinquency picked up from December the rate of increase has slowed.
The last of the portfolios under stress is construction loans which is displayed on slide 14. The $13 billion construction book is declining meaningfully down roughly $800 million since December to 10% of the total loan portfolio. Construction to permanent loans are loans to individuals to build single family homes. These loans are transferred to permanent mortgage financing once construction is complete. This portfolio has not performed well but is rapidly declining. Exposure has decreased 26% to $4.1 billion versus a year ago.
Outstanding are down from a peak of $3.7 billion to $3 billion today. We expect the portfolio to rapidly decline over the next year. Charge offs in the book should peak in the next three to six months and decline after that as the portfolio runs off. Residential construction loans which are loans made to commercial home builders will continue to show increasing problems in our softer markets. Commercial construction book continues to perform well.
I’m going to move on to slide 15 then wrap up. This slide is a list of loss mitigation actions for your reference. I’m not going to cover the content, we’ll summarize by saying that we have been aggressively reducing the risk profile of new credit reduction and are laser focused on having the right people processes, systems and procedures in place to mitigate the risk we already have.
I’ll make a few comments in summary to wrap this up and then I’ll turn it over to Mark to cover financial results. We had a bad quarter for credit, currently the problem areas of our portfolio remain contained to 13% of our books. These areas, many in run off mode are degrading our credit metrics. We believe some of these problem areas will resolve more quickly than the overall cycle and further believe we are seeing early signed to that effect.
As we look at our current NPLs and delinquency queues and recognizing that our foresight is constrained by economic uncertainty we expect charge offs to increase in the second quarter by 15% to 20% from the $300 million recorded in the first quarter. We expect the economy to soften and home values to decline further. With that in mind we also expect that some additional reserve building will be required. However, after increasing the reserve ratio by a combined 34 basis points in the last two quarters including 20 basis points in the first quarter we expect the future quarterly increases will moderate.
On a longer term view it is nearly impossible at this point in the cycle to predict the future with any confidence. However, as we look at the portfolio trends and potential future scenarios we believe we should experience lower charge offs in the second half of the year if the economy and home prices don’t deteriorate too far and fast from here. With that I’ll turn it over to Mark to review our financial performance.
I’ll start with a few highlights in what was generally a good quarter for both loan and deposit growth. Overall loan growth picked up in the first quarter, the sequential annualized growth rate was 5% we are effectively back to even with last years loan balance. The reason this is significant is that as you may recall we transferred $4 billion in mortgages to held for sale in the first quarter of ’07. We subsequently sold them as part of our balance sheet restructuring initiative.
Commercial loan growth which began to pick up during the fourth quarter continued that trend this quarter. The largest contributor to the $1.5 billion or 4% sequential quarter growth was the energy sector in our wholesale segment. Leasing and the technology sector also experienced good growth this quarter. Equally notable is the $800 million decline in construction as a result of existing projects being completed coupled with dwindling demand and a low appetite on our part for new projects.
While less material to the balance sheet overall our de-emphasis of the indirect auto lending product is apparent in the annual and sequential quarter decline as well. The deterioration in the economy and pressure on the consumer this deliberate reduction is appropriate in our view. Deposits are also showing improved growth and mix strengths. The majority of the growth is occurring in interest bearing now and money market accounts.
The significant decline in high cost broker and foreign deposits as compared to last year was also the result of our balance sheet restructuring initiatives which significantly enhanced the company’s liquidity position. It’s probably not obvious from the average balance data are the very recent trends in deposit mix. You look at the period end balance for the deposit included in the press release table you will note that balances are up a similar $1.5 billion however instead of declining versus last quarter DDA is actually up $1.2 billion and money market balances are also up while consumer CDs and NOW accounts are down.
DDA balances have remained through early April and while we know that some of the DDA growth is temporary and related to anticipated tax payments it appears that we are seeing the early signs of a cyclical shift in commercial client balances out of sweep accounts and into DDA. Now I’ll spend a few minutes on margins on slide 17.
Margin increased five basis points relative to the first quarter of 2007. However, net interest income decreased 2% primarily as a result of reduction in our securities balance. Fourth to first quarter margin compression was widely expected and we experienced six basis points of margin compression bringing our net interest margin to 3.07% in the first quarter. While we are hopeful deposit mix will stabilize or perhaps even improve in 2008 we expect additional pressure on margin next quarter.
Realization of the full impact of the first quarter Fed rate reductions continuing deposit pricing competition, growing NPAs and the potential for additional Fed cuts all point to further margin compression in the second quarter. As for the second half of 2008 we currently believe margin will stabilize and possibly expand if deposit pricing pressures in volumes improve despite the continuing potential for rising NPAs.
We continue to evaluate opportunities to reduce lower margin and lower risk adjusted return assets such as student and indirect auto lending in favor of higher profit prospects as risk adjusted spread in commercial and small business are more attractive. Further, we are also continuing our aggressive efforts to attract and retain consumer and commercial deposits with investment in deposit centric advertising and promotions targeted specifically to business clients and prospects.
Now moving to provision expense on slide 18, Tom provided a detailed review of the credit so I will just point out that we have been building reserves steadily and consistently in light of current and expected charge offs. Total provision expense for the quarter of $560 million includes charge offs equal to an annualized 97 basis points from loans plus $263 million or 20 basis points added to the allowance.
Moving to non-interest income on slide 19. Non-interest income grew 20% on a reported basis versus last year and 13% adjusted for net gains in both years. This validates the solid revenue generating performance in most of our lines of business. We achieved double digit reported increases in things like service charges, retail investor sales, investment banking income and card fees. After adjustments for valuation write downs core client trading revenue and mortgage production income also increased significantly.
In order to adjust the reported growth rate for certain unusual items realized in the quarter a reconciliation of adjustments is included in the appendix for your reference. I’ll spend a few minutes outlining the major items now. During the quarter we realized a gain from the Visa IPO of $86 million, a gain of $89 million on the sale of our remaining 25% interest in our hedge fund business Lighthouse partner.
A gain on the sale and lease back of corporate owned branches and office buildings of $37 million. An $18 million increase in the time acceleration of the recognition of mortgage servicing value and the net impact of market valuation write downs was approximately $100 million and this includes $240 million in net write ups on the value of debt related hedges which partially offset the write downs. Lastly, we incurred $64 million in securities losses available for sale securities due to the classification of approximately $264 million of residential real estate collateralized securities as other than temporarily impaired.
In summary, there were a lot of unusual items in the quarter but the underlying fee income growth is in the double digits as compared to last year if you exclude all of these items. We are very pleased with that type of performance during the course of this quarter. As Jim discussed we are also very pleased with the results of our E² initiative as you can see on slide 20 results of our efforts are becoming increasingly more visible.
Our reported expenses grew 1.5% versus last year and were down 14% as compared to the fourth quarter of 2007. After adjusting for a few non-core items primarily Visa litigation accruals, PHAS 91 and asset dispositions expenses were flat compared to last year and down 2% versus last quarter. We are particularly pleased with these results for two primary reasons. First, year over year expense it would have decreased by over $36 million or 3% if not for expense increases directly attributable to the change in the credit environment.
Second, adjusted expenses are down versus last quarter in spite of the normal seasonal increase in benefits primarily employer paid social security which represented $35 million this quarter. I’ll make one last point regarding expenses. We are continuing to invest in the business in ways that create long term value for our shareholders. A visible example is the 20% plus increase in marketing and customer development dollars spent in each of the last two quarters as compared with the respective prior year quarters.
There are several investment examples to point to; I’m calling this one out because the increase spending level is directly supporting the successful acquisition of consumer and commercial client’s deposits and therefore long term revenue SunTrust. I’ll conclude the formal comment of the call with a summary of the key initiatives and performance drivers discussed in today’s presentation on slide 21.
First, we are increasing capital moreover we are currently operating with a solid capital foundation and strong liquidity. We are raising our overall E² program goal to $600 million and the run rate savings during 2009 and this represents a savings of over 11% of our 2006 non-interest expense base. We are aggressively managing our securities exposure. Furthermore we are minimizing new credit risk while mitigating our existing risk.
Finally, and perhaps most importantly we are encouraged by the underlying progress in key business lines. We are particularly pleased with our ability to grow deposits this quarter and prudently increase loans. We are executing these actions against a backdrop of a manageable level of margin pressure, solid non-interest income trends and strong expense management results. With that, let’s open the call for some questions. Operator we are now ready to begin the Q&A.
[Operator Instructions] Our first question today is from Brian Foran you may ask your question and please state your company name.
Brian Foran – Goldman Sachs
Can you talk a little bit about the dividend payout ratio that you are comfortable with in the short term and longer term just given where earnings are right now? Would you be comfortable with a near 100% payout ratio or at some point does that become a risk even with the potential capital gains from Coke?
We went through some significant evaluation as you would expect at the end of the year related to our dividend in making the decision to increase it approximately 5% year over year. We did sensitivity analysis on our earnings both in the short term as well as on longer term basis and felt comfortable with that increase. The payout ratio will ultimately be a function of the actual earnings level for the full year for the company but as I mentioned earlier and we’ve stated a couple of times we feel very good about the overall capital position of the company with a 7.25% tier one capital ratio, the prospects of completing our Coke related transaction during the second quarter that would add 65 basis points or more of capital.
The fact that our current liquidity position and our ability to grow capital on a net basis over the next several quarters so an approximate 8% or so pro forma capital at the end of the second quarter is something that we are comfortable with and feel like as we look out over the next several quarters that both dividend payout ratio and dividend yield will be at acceptable levels.
Brian Foran – Goldman Sachs
If I could follow up on a separate topic. You mentioned early delinquencies are stabilizing but a number of your competitors have noted that the problem is really roll rates and the later stage delinquency buckets as well as rising severities. Could you just put your comment about potentially being at or near the peak in loss rates in the context of roll rates and severity and what you are seeing there?
Good question, what we are seeing is that the early stage delinquencies are coming down which are really going to impact a quarter to two quarters out what we think the later stage delinquencies and roll rates are going to provide for. Current late stage delinquencies have in fact picked up somewhat and we expect them to given the previous quarters increase in early stage delinquencies. In terms of severity we saw an increase in severity particularly in the third party originated home equity lines over the last quarter.
Those severities have gotten very large and don’t think they’ve got much room upward in terms of the severity levels. We think within those individual business segments the severities have gotten about as high as they can get and then in addition we believe that the early stage roll rates will begin to mitigate flows into non performers in charge offs in the later quarters of this year.
I forgot to mention one thing. I think the tangible equity to asset ratio of 6.5% that we currently have is also a distinguishing feature as you compare us to other peers during the course of the quarter and as you look out over the next several quarters. In addition to the regulatory capital position that we are in we feel good about our overall tangible equity base.
Brian Foran – Goldman Sachs
That’s actually a pretty good point. The last thing if I could is just the debt write ups you’ve had over the past two quarters of $325 million if your spreads tightened does that come back through the P&L or how should we think about that going forward?
We have benefited and had an offset as a result of the widening of credit spread that has offset a portion of the net negative effect on the trading asset that we own. We will be working through a partial hedging related strategy to mitigate the net loss that will be ensued over the course of the next eight to nine years as those spreads come back and tighten and the debt matures. The answer to your question is yes, over the course of time those gains will normalize as the bonds mature.
Our next question is from Matt O’Connor you may ask your question and please state your company name.
Matt O’Connor – UBS
Could you quantify the decline in interest margin you expect in 2Q and then also the upside opportunity in the back half of the year assuming we are mostly done with the Fed cuts?
We anticipated some marginal decline in the margin during the first quarter which we realized six basis points quarter over quarter. We are continuing to see in the marketplace active deposit pricing as people want to maintain liquidity both on a customer and a wholesale basis. I will say that we’ve seen some normalization if you will of the rate betas on the various interest bearing deposit products in recent weeks over the past month timeframe.
While the historical relationship that mean rates paid and changes in libor have not held in the last quarter and that had put some pressure on our net interest margin. We are seeing some normalization of pricing in the marketplace to reflect the lower short term interest rate that the Federal Reserve is obviously been moving the market towards. I think that is a key element for us an also our ability to grow low cost deposits as we mentioned in the presentation our period end balances and the balance mix improved.
We have gotten growth on a year over year basis 3.5% we have a tremendous number of initiatives focused on growing our net new checking household. We have spent a significant amount as you can see in the numbers on our marketing and advertising and the growth in core customers through our My Cause campaign which has been very successful. We are focused on growing those household and those lower cost deposits and that will be a key determinant along with this rates paid scenario as to whether or not margins stabilizes in the short run and then improves.
Obviously the steeper yield curve in general is a benefit to us but we also have to get the relationship between the earning asset yield change and the liability costs to normalize somewhat before we can feel good about projecting growth in the margin.
Matt O’Connor – UBS
Its sounds like you would hope just a modest decline in Q2 if I understood correctly?
Our next question is from Mike Mayo you may ask your question and please state your company name.
Mike Mayo – Deutsche Bank
The E² initiative you have $113 million this quarter and you look for $500 million for the year. Should we expect only a little bit more incremental phase quarter to quarter?
Yes. I think that’s accurate. We are working on the longer term value aspects of our program at this point. Many of the shorter term ones have born fruit and will be what they are. We are increasing the 2009 number as well.
Mike Mayo – Deutsche Bank
Back to credit quality. You said the problems are mostly confined to residential mortgage, home equity, and construction as you mentioned but the other 87% of the portfolio, how do you feel about that? We are hearing from some other banks that increased concerns with small business and maybe even certain areas in the commercial portfolio.
In the other 87% of the portfolio the portfolio looks stable. Of the areas where we are watching it very carefully and really are intervening aggressively is we are concerned about our residential construction specifically within Southern Florida and are spending a lot of time and attention trying to get those situations stabilized. As you look at deterioration in the core portfolios they continue to perform pretty well. The CNI looks very good some softening in our lower end small business product but nothing dramatic.
I think as you really take a look at it, we don’t have what a lot of the other guys have got which is lots of unsecured consumer debt out there which is where I think a lot of the deterioration is beginning to take place. The commercial portfolios are holding up very well.
Mike Mayo – Deutsche Bank
Last question, this is a hard question. What impact does what’s going on with libor have on you guys or how you even think about some parties that you deal with?
As you can see with the relationship change that libor has had it was above Fed funds for a period of time it them moved down below Fed funds as the Federal Reserve was moving short term interest rates down and then in recent weeks its moved back up sharply. Our overall sensitivity position we are liability sensitive and so as rates decline and the curves steepens in general that benefits us and so as I mentioned they key to that relationship is not only the effect that higher libor has on earning asset yields but also the relationship of the various interest bearing deposits to whichever metric you want to reference.
If you want to think about it relative to libor, the swap curve or Fed funds. The key to our margin stability and increase over the course of the year will be affected by that libor Fed funds relationship will be more affected by the lower cost deposit growth that we realized and the manner in which deposits are priced relative to those various metrics.
Betsy Graseck you may ask your question and please state your company name.
Betsy Graseck – Morgan Stanley
On the reserve bank could you give us some indication as to how you are factoring in home price changes? I’m wondering if your reserving analysis takes into consideration home price values at present time or some future expectation for home prices.
We do a segment by segment review. The segments reviews factor in a view basically based on a Case-Shiller indexes for housing prices. We review what’s moving in housing prices and adjust our severity expectations around charge offs for the individual product segments which really captures the movement in housing prices. We make, in addition to the quantitative adjustments, which would have a tendency to lag we make qualitative adjustments in expectation of movement of the housing prices.
Betsy Graseck – Morgan Stanley
Are you factoring in the forward expectation in case Shiller forwards or are you mostly using just point in time data?
We analyze the point in time data in order to determine what we think the current loss expectations are within the portfolio and then we make qualitative adjustments based upon the future movement expectations in the Case-Shiller indexes.
Betsy Graseck – Morgan Stanley
Could you just give us a sense of what your forward look at this stage for the portfolio?
I believe that especially the Florida markets are showing some continued downward movement in the markets specifically in Southern Florida. The rest of the markets are showing slight downward trends. The Atlanta marketplace and the Georgia marketplace is stable to slightly down. Mid-Atlantic markets are stable to a little more down in the marketplace. Basically our Carolina markets are relatively stable at the moment.
Betsy Graseck – Morgan Stanley
On the Coke question, I know that you’ve been thinking about different alternatives including an outright sale and the regulators are planning on some of the proposals that you have. I’m wondering when do you decide not to wait for the regulators any more and do what you can do which is execute a sale and recognize that gain to bring that into your tier one number?
As Jim mentioned you can surmise from the evaluation that we’ve been going through now for several quarters that our targeted transactions do not include just a simple sale of the stock to generate the tier one capital out of the holdings that we have. We are not in a posture where we need to immediately convert the stock to capital. We have a strong base capital position, we have a strong liquidity position, our tangible equity asset ratio is in very good shape so we are going to finish out the process that we entered into back several quarters ago and we expect that that will be complete during the second quarter.
I just say stay tuned we’ve given you a fair amount of information as to what we expect the result to be if we are able to bring the proposed transactions to fruition to your point we always have that alternative options but we are focused on finishing up here in the second quarter and we’ll give you a full overview of the transactions at that time.
Just to add to that I think it’s important to understand that we are trying to find the best reasonable transaction for our shareholders, that’s who really matters in all of this. Given our capital position we have been searching and we hope we have found transactions that will accrete better to shareholders than a simple sale might.
As you know, Coke continues to perform very well given their earnings release last week or so their dividend increased and so we are not going to accelerate the process just to meet an arbitrary timeline. We’re going to try to complete a transaction as Jim mentioned are in the best interest of our shareholders and we anticipate doing that here in the second quarter.
Betsy Graseck – Morgan Stanley
That makes sense, I’m just thinking that since you initiated the transaction, announced it to the investing public, credit quality has been deteriorating not only at SunTrust but in the industry. The bar has been raised with regard to what tier one needs to be in this environment or asset durations or extending and credit deteriorating. I’m just wondering what degree of urgency do you feel with regard to not only the Coke holding but capital structure in general.
Fortunately we are in a position where we can be careful and caring about this to the benefit of everybody. That’s the way we are approaching it.
You next question is from Jefferson Harralson and it will be our final question you may ask your question and please state your company name.
Jefferson Harralson - Keefe, Bruyette & Woods
I have a couple questions for Tom. If you guys break out the Florida exposures that a lot of the banks we’ve seen this quarter have had or even Georgia NPAs especially on their residential construction portfolios can you talk about how Georgia is holding up maybe even versus Florida in your residential construction and maybe your HELOC portfolios?
I think the Florida portfolio is where we saw the early incurrence of our problem portfolios. We really started about a year and a half ago to take a look at our residential construction portfolios and have managed those down aggressively over the past year and a half. That exposure is down about $1.7 billion and outstandings are down $500 to $550 million over that period of time. We watch our inventory levels with all of the builders very carefully.
What we’ve seen is some softening specifically in lower home prices in the Georgia region but where we lend most of our money is in the custom home marketplace, that’s holding up relatively well. In Florida, however we’ve seen a deterioration in housing prices less and less inventory going into the marketplace and we’ve been working through that stuff fairly aggressively so we’ve seen some deterioration in the lower end of the Georgia market I guess is the best way I can answer that for you.
Jefferson Harralson - Keefe, Bruyette & Woods
In the delinquency the improving delinquencies in the home equity book in the first quarter what part does seasonality play in it? Isn’t first quarter a better seasonal quarter there and we should expect that to maybe increase since we have had home prices decline expected to continue to decline. Why do you think that improvement is going to last throughout the year if you think that?
The home equity book is one of the three problems we talked about earlier. It is the one we think is going to continue to have problems through the remainder of the year. Early state delinquencies while they flatten didn’t radically improve in the home equity book during the first quarter; they improved a lot in the other two problem portfolios. Typically the first quarter sees some seasonality adjustment but it’s not a big seasonality improvement quarter for us and in fact the second quarter would show seasonality improvement more aggressively than would the first quarter.
We are not enthusiastically optimistic about what’s going to go on in the home equity market. We think its going to be a pretty long haul over the next year to really if we move through the HELOC specifically. Our home equity loan portfolio is older and more mature and performing really well. It really is the brokered loans where we are really having the majority of our problems. That a little over $1.8 billion, as you look at that portfolio its going to continue to cause problems over the next two or three quarters.
With that, thank you very much for joining the call today.
This concludes today’s conference thank you for participating you may disconnect at this time.
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