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SunTrust Banks (NYSE:STI)

Q3 2012 Earnings Call

October 22, 2012 8:00 am ET

Executives

Kris Dickson

William Henry Rogers - Chairman, Chief Executive Officer, President and Chairman of Executive Committee

Aleem Gillani - Chief Financial Officer and Corporate Executive Vice President

Analysts

John G. Pancari - Evercore Partners Inc., Research Division

Ryan M. Nash - Goldman Sachs Group Inc., Research Division

Betsy Graseck - Morgan Stanley, Research Division

Matthew D. O'Connor - Deutsche Bank AG, Research Division

Jefferson Harralson - Keefe, Bruyette, & Woods, Inc., Research Division

Kenneth M. Usdin - Jefferies & Company, Inc., Research Division

Matthew H. Burnell - Wells Fargo Securities, LLC, Research Division

Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division

Gregory W. Ketron - UBS Investment Bank, Research Division

Operator

Welcome to the SunTrust Third Quarter Earnings Conference Call. [Operator Instructions] Today's conference is being recorded. If you have any objections, you may disconnect at this time. I would now like to introduce Kris Dickson, Director of Investor Relations. You may begin.

Kris Dickson

Thanks, Wendy, and good morning, everyone. Welcome to SunTrust Third Quarter Earnings Conference Call, and thanks for joining us. In addition to the press release, we've also provided a presentation that covers the topics we plan to address during our call today. The press release, presentation and detailed financial schedules are available on our website at www.suntrust.com. This information can be accessed by going to the Investor Relations section of the website.

With me today, among other members of our executive management team, are Bill Rogers, our Chairman and Chief Executive Officer; Aleem Gillani, our Chief Financial Officer; and Tom Freeman, our Chief Risk Officer.

Before we get started, I need to remind you that 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 the actual results to differ materially in our press release and SEC filings, which are available on our website.

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

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, I'll turn the call over to Bill.

William Henry Rogers

Okay. Thanks, Kris. In our normal fashion, I'm going to begin today's call with a brief overview of the quarter. After passing it to Aleem, I'll wrap up with an update on our expense saving program and provide some recent line of business highlights.

First, I'll begin by acknowledging there are a lot of moving parts this quarter. We have endeavored in our remarks today and throughout the presentation to provide you clarity on those items and how they impacted the results. Aleem will provide more details momentarily, and I think you'll see that we continued the trend of delivering improved core performance. Further, we're positioned to more favorably coming out of the quarter in large part due to the actions we announced in September. Our overall risk profiles improved, and our balance sheet is strengthened. This is highlighted by lower nonperforming and delinquent loans and a mortgage repurchase reserve that now fully covers estimated remaining losses on the pre-2009 vintage GSE loans. As you know, those are the loans from which the vast majority of demands and losses have been generated, and we're able to accomplish all of this while continuing to grow our capital base this quarter.

Now turning to the presentation. Slide 3 summarizes some of the key drivers of our third quarter results. Earnings per share was $1.98 with the actions we announced last month contributing $1.40 per share. The diversity of our revenue streams benefited us this quarter. Mortgage production was again strong and investment banking income also increased, while net interest income and margin were relatively stable to the prior quarter. Expenses were up on a reported basis, but excluding the non-core items, they were stable the last quarter and down from the prior year. As you're aware, this continues to be an area where we have lots of focus as we strive to achieve our ultimate goal of a sub-60 efficiency ratio. I'm going to talk more about this in context of our PPG program later in the call.

Taking a look at the balance sheet. Overall loan growth was slower, but growth in targeted categories, particularly C&I, drove a nearly $1 billion increase in average performing loan balances over last quarter and a nearly $10 billion increase over last year. This more than offset certain real estate-related loans that we have been actively managing down.

Now on the deposit side, the favorable mix continued with average DDA growth of 3% from the prior quarter and 19% from the prior year.

From a credit perspective, derisking of the balance sheet helped drive a 30% reduction in nonperforming loans over last quarter and a 47% decline from last year.

And as I mentioned earlier, our capital position continued to increase with our Tier 1 common equity ratio estimated at 9.8%, up 40 basis points from last quarter.

All in all, we're continuing to demonstrate improved core performance. And that, coupled with proactive actions we took this quarter, positions us well for the future.

I'm going to turn it over to Aleem, let him walk you through the details and I'll give you more -- and give you more clarity on the quarter's results. Aleem?

Aleem Gillani

Thanks, Bill. Good morning, everybody. Thank you for joining us today. After several noise-free quarters and consistently improving results, as Bill noted, we had a number of lumpy items that impacted the third quarter. So I'll spend a few minutes grounding you on them before we get to the -- in the operating results.

If you turn to Slide 4, I'll start with an update on the items we preannounced in September. The acceleration of the agreement regarding our Coca-Cola shares generated $1.9 billion in securities gains, and the charitable contribution of 1 million Coke shares to the SunTrust Foundation resulted in the recognition of $38 million of expense.

Our third quarter mortgage repurchase provision was $371 million. Consistent with last month's announcement, and as Bill noted earlier, we expect the resulting mortgage repurchase reserve to be sufficient to cover the estimated remaining losses from pre-2009 vintage loans sold to the GSEs.

During the third quarter, we transferred to held for sale slightly over $0.5 billion of nonperforming mortgage and commercial real estate loans. The total net charge-offs recognized in writing the loans down to disposition value was $172 million. The majority of the loan sales were completed during the third quarter with only about $40 million in net balances remaining to be sold this quarter.

We also transferred to held for sale $1.4 billion of student loans and $0.5 billion of delinquent Ginnie Mae loans. In doing so, we wrote these loans down to the expected sales price and the $92 million charge, most of which was associated with the delinquent Ginnie Mae loans, was a reduction to noninterest income. You will recall, the majority of the combined $1.9 billion in student and Ginnie Mae loans we're selling are more than 90 days delinquent. Their disposition reduces our delinquency ratio and makes the size of our government-guaranteed loan portfolio more consistent with our longer-term balance sheet targets. All of the transferred loans were included in loans held for sale at quarter end. To date, in the fourth quarter, we've already sold $1 billion of student loans and we expect to complete the remaining student and Ginnie Mae sales by year end.

We also transferred approximately $190 million of affordable housing investments to held for sale during the quarter. The $96 million write-down taken upon the transfer was recorded as a noninterest expense, and the resultant carrying value reflects our best estimate of the ultimate disposition price. We expect this sale will be completed in the second quarter of 2013.

Combined, the preannounced items contributed $753 million in net income or $1.40 per common share to the third quarter results. This was exactly on our prior guidance.

Shifting to the bottom portion of Slide 4, you see 4 other items, the first of which relates to a credit policy change. During the third quarter, we moved the timing of charge-off recognition for junior lien loans from 180 days to 120 days. Our analysis indicated that when junior lien loans go 120 days past due, they rarely cure and typically roll to 180 days. Accordingly, we altered our policy, which resulted in the accelerated recognition of $65 million in incremental net charge-offs in the quarter. For clarity, this is not related to the policy change other large banks made this quarter regarding the treatment of consumer loans that were not reaffirmed following Chapter 7 bankruptcy. We have not received such guidance from our regulator and have not taken any action in response. However, we are monitoring developments. We do estimate that we have approximately $400 million of such loans, about 35% of which are already classified as performing TDRs. We expect to receive coordinated regulatory guidance on this issue and will take any appropriate action at that time.

I'll cover the final 3 items on the page fairly quickly. I'm pleased to note that our credit spreads tightened considerably in the third quarter. Unfortunately, this also resulted in $41 million in mark-to-market losses on our fair value debt, which reduced noninterest income. Next, we accrued $29 million in severance expense associated with post-PPG efforts to streamline our organization and achieve our efficiency ratio objectives. And lastly, we incurred a $17 million expense associated with reassessments and ultimate reduction of our real estate needs.

Slide 5 provides a summary income statement and the collective impact of the items that I just reviewed are apparent. Third quarter noninterest income was up substantially from prior quarters and the gain from the Coca-Cola transaction more than offset the increased mortgage repurchase provision, the write-down on the student and Ginnie Mae loan sales and the mark-to-market loss on the fair value debt. Provision for credit losses increased this quarter due to the NPL sales and the credit policy change. Expenses were higher due to the affordable write-- affordable housing write-down, the Coke shares donation, severance and the real estate charges.

Looking at the bottom line, third quarter 2012 earnings per share of $1.98 is up markedly compared to the prior quarters. Obviously, a lot of the favorable variance is driven by the $1.40 per share impact of the September actions. After backing that out, this quarter's EPS of $0.58 continued our favorable core earnings trends, and it compares favorably to the $0.39 from a year ago and the $0.50 from last quarter.

Subsequent slides provide clearer views of our underlying trends. So let's turn to Slide 6 for a discussion of net interest income, which was $1.3 billion this quarter and the margin was 3.38%, both of which were down slightly from the prior quarter. Interest income from earning assets declined about $50 million sequentially. This was driven by 3 primary factors: first, we experienced 10 basis points of loan yield compression, mainly driven by mortgage and C&I as new loans that we're originating are coming on the books at lower yields than those that are paying off; second, we saw a 38-basis point decline in our securities yield, which was largely attributable to the elimination of the $15 million quarterly Coke dividend; and lastly, we continue to modestly reduce the size of our bond portfolio in light of the lack of attractive investment alternatives.

On the liability side, interest expense declined sequentially by $44 million, and the cost of interest-bearing liabilities was managed down by 14 basis points. This was driven by the reduced funding needs associated with the smaller balance sheet, the previously announced redemption of $1.2 billion of higher cost trust preferred securities early in the quarter and the maturity of a population of higher-cost CDs, which helped drive the overall cost of time deposits down about 20 basis points.

Relative to the prior year, net interest income was up modestly, and the margin declined 10 basis points. Key drivers were lower earning asset yields, higher loan balances and reduced interest costs associated with an improved deposit mix, lower deposit rates paid and a reduction in long-term debt.

As we look to the fourth quarter, we expect to see a reduction in the net interest margin on the order of mid-single digit basis points, driven by additional reductions in asset yields, which will partially be offset by lower liability costs. In the fourth quarter, we expect a reduction to net interest income as a result of the lower margin, coupled with our smaller balance sheet due to the closed and pending loan sales.

Let's turn to Slide 7 for a discussion of noninterest income. As we discussed earlier, reported noninterest income was up substantially this quarter due to the favorable net impact associated with the September actions. As usual, we've also provided a view of our adjusted noninterest income, and we detail the adjustments in the Appendix. The $216 million sequential quarter increase in the mortgage repurchase provision, which is booked as a contra-revenue drove the decline in adjusted noninterest income from the second quarter. Otherwise, fee income trends this quarter were solid. Most notable was core mortgage production. Excluding the impact of the repurchase provision, mortgage production income hit a record high this quarter and increased $49 million or almost 20% sequentially. Production volume was high and stable to the second quarter level of about $8 billion, which was split roughly 70-30 between refinancings and purchases.

Looking ahead, while it is reasonable to assume some volume and margin compression, we do expect overall conditions in the mortgage market to continue to remain favorable in the near term.

Investment banking was another business that was up sequentially, driven by strong syndication volume. Conversely, the other charges and fee category declined as a result of lower commitment fees, and card fees fell due to a reclassification of card rewards costs. Relative to the prior year, adjusted noninterest income declined $111 million, driven by a $254 million increase in the mortgage repurchase provision. Apart from this, adjusted noninterest income increased $143 million or 15%. Similar to the sequential quarter comparisons, strong core mortgage production was the primary driver and higher investment banking revenue also contributed, driven by syndication and bond origination fees. Conversely, card fees declined, primarily due to the impacts of regulatory reform.

Let's turn to Slide 8 to take a look at mortgage repurchases. For consistency's sake, we've continued to share with you the same layout of this page from prior quarters. But obviously, the important news on the mortgage repurchase issue for us this quarter was contained within our September announcement. Specifically, as a result of additional information we received from both Fannie Mae and Freddie Mac, coupled with our own analysis of the patterns of demands and full file requests, we were able to more precisely estimate the remaining losses on pre-2009 GSE loans, the population of loans that to date have accounted for about 95% of all repurchase losses. As such, we recorded a $371 million provision this quarter, and the resulting mortgage reserve, which you can see on the bottom left of this page, increased to $694 million. Looking forward, we expect this reserve level to decline as the losses are recognized.

The top left portion of this slide shows that demand has declined to $405 million this quarter, driven primarily by the 2006 to '08 vintages. Demand levels could continue to vary in the coming quarters; however, the trends and full file requests precursors to future demands are improving in 2 ways: first, the absolute number of full file requests is declining. This suggests that, over time, we should begin seeing a decline in the overall level of demands; second, the percentage of full file requests for loans that have never been 120 days past due is increasing, and more recently, delinquent loans tend to have better cure rates. The pending demand population, which is displayed on the top right portion of this page increased to $690 million. This is due to the new demands and a modest extension of resolution time lines. We continue to take a deliberate approach in reviewing repurchase demands, ensuring that we repurchase loans where appropriate yet cure the defects or moderate losses wherever possible. Overall, and in line with what we said in September, the mortgage repurchase trends continue to play out in a manner consistent with our expectations and information we receive from the agencies.

Let's move on to expenses. Adjusted expenses were essentially stable to the prior quarter. Other real estate costs declined $22 million due to lower losses on disposition, and outside processing fell $9 million. These were offset by increases in employee compensation and FDIC premiums. The $18 million compensation increase was largely due to the accelerated vesting of deferred compensation associated with certain organizational changes and, to a lesser degree, higher contract labor costs. $7 million increase in our FDIC premium is due to quarterly variability in the assessment rate. Relative to the prior year, adjusted expenses declined $24 million or 2%, credit-related costs declined driven by a combined $38 million reduction in other real estate and collection services expenses. FDIC premiums also fell by $13 million. Partially offsetting these reductions was an employee compensation and benefits increase of $30 million. This was in part due to the aforementioned accelerated vesting of certain deferred compensation, as well as an overall improvement in business performance.

As we look to the fourth quarter, we currently expect our adjusted expenses to be flat to down. Cyclically, high costs are expected to continue their overall declining trend and employee compensation is expected to decline. Conversely, certain volume and seasonally driven line items, for example, outside processing and advertising, may increase.

Let's turn to the balance sheet on Slide 10. Average performing loans increased by about $900 million or 1%. Growth was driven again this quarter by C&I, which was up $1.1 billion or 2%, and came predominantly from large corporate clients with not-for-profit and auto dealer also contributing. Period-end C&I growth was less robust than in recent quarters as we saw some slowing of loan demand due to borrowers' uncertainties associated with the economic environment and the fiscal cliff. This said, loan pipelines still remain fairly strong. I'll also point out that our corporate investment banking unit has benefited from the increased activity in the bond market via improving bond origination fees during the last couple of quarters. Relative to the prior year, performing loans increased by $9.5 billion or 8%. C&I was the largest driver, up $5.7 billion or 12%, with growth across a diverse array of industry verticals. Additionally, guaranteed student loans were up by $2.4 billion and guaranteed mortgages, non-guaranteed mortgages and indirect consumer all increased by around $1 billion. The overall portfolio growth was partially offset by intentional declines in home equity, commercial real estate and construction. The effects of this derisking are shown on Slide 11.

The portfolios that we've categorized as higher risk declined by another $0.5 billion this quarter. While we've continued to apply the higher-risk label to this grouping of loans, I'd point out that 95% of this book is accruing. And of that, 98% is current on principal and interest. The non-accruing high-risk loans have been appropriately reserved for and the accruing book looks a lot like the rest of our portfolio. For example, the weighted average refreshed FICO scores of the higher-risk mortgage and home equity books are well above 700. Due to the improved performance of the higher-risk book and its smaller absolute size, you can expect to hear less about this portfolio in future quarters.

You see in the bottom part of this page that the government-guaranteed portfolio declined by $2.3 billion this quarter. This is largely due to the transfers to held for sale of $1.4 billion of student loans and $0.5 billion of Ginnie Mae loans. In the fourth quarter, we also expect to transfer to held for sale another approximately $600 million of student loans. This $600 million was included in the loan sale guidance that we gave in September, but did not meet the held for sale accounting criteria at quarter end. We do not expect the gain or loss associated with the fourth quarter transfer to be material.

Let's take a look at Slide 12 for a review of credit trends. Overall, the credit story is again an improving one this quarter. Early-stage delinquency ratios were relatively stable to the prior quarter. Consumer loans saw normal seasonal increases, which were partially offset by declines in home equity delinquencies. Excluding government-guaranteed loans, consumer and commercial delinquency ratios were 58 and 18 basis points, respectively, which are at relatively low levels. As such, and as is the case with most of our credit metrics, we would expect residential loans to drive future improvements as residential delinquencies are still somewhat elevated by historical standards at just above 1%.

Nonperforming assets and nonperforming loans were down by over $700 million from the prior quarter. A 30% sequential quarter decline in nonperforming loans was largely due to the $544 million sale of the mortgage and CRE NPLs. However, excluding these sales, NPLs still declined by about $185 million or over 7%. This decline came despite our adding to NPL, for regulatory guidance, $81 million in junior lien loans that are current on their payments but subordinate to a delinquent risk mortgage. At quarter end, our ratio of nonperforming loans to total loans was 1.42%, down from 1.97% last quarter and 2.76% a year ago. This brought our allowance to NPL ratio up to 130%, a rise of 36 percentage points from the second quarter.

Net charge-offs this quarter were $511 million as compared to $350 million last quarter. Included in this quarter's figure is the $172 million in net charge-offs associated with the NPL sales and the $65 million from the junior lien credit policy change. Backing these 2 figures out, net charge-offs were $274 million, down $76 million sequentially. Core net charge-offs have trended favorably for some time and we expect that overall trend to continue in the coming quarters. We could see some increase in the fourth quarter from this $274 million level though as a function of some normal seasonality and the fact that our recoveries were about $30 million higher this quarter than what we've experienced recently.

The allowance for loan and lease losses ended the quarter at $2.2 billion, down about $60 million from the prior quarter, due to the improving core credit quality trends. Despite the modest dollar decline in the allowance this quarter, the allowance ratio remained essentially unchanged at 1.84% on a stated basis or just above 2% when excluding government-guaranteed loans from the calculation.

Taking a step back, when you take a look at what we have done to improve the risk profile of the organization over the last little while, the last 2 slides make that really evident. We've been aggressively and intentionally reducing our higher-risk book for several years. Those balances are down by $14.6 billion or more than 60% over the past few years, so our derisking is largely complete. Nonperforming loans have been on a similar trajectory, down by $3.8 billion or almost 70% since their peak in 2009. And we took actions to further accelerate this decline this quarter as well as reduce our 90-day plus delinquency ratio. Overall, we have made meaningful and substantial strides that have resulted in a much improved risk profile for SunTrust.

Let's next take a look at our deposit performance. Average deposit balances declined modestly from the prior quarter and the favorable shift in deposit mix continued. Noninterest-bearing deposits were up $1.3 billion or 3%. This was essentially offset by a $1.2 billion or 7% reduction in time deposits as we had an above average amount of CD maturities during the third quarter. We also saw a modest decline in money market balances as we're being deliberate about pricing discipline and have let certain promotional rates expire. Relative to the prior year, deposits are up $2.4 billion or about 2%. Lower-cost accounts are the driver of the growth, led by almost $6 billion or 19% DDA growth. Conversely, higher-cost time deposits are down by $3.4 billion or 17%.

Slide 14 provides information on our capital metrics. Tier 1 common capital increased by approximately $400 million. Recall that the September actions were essentially neutral to our regulatory capital level, so this quarter's increase is primarily driven by core earnings. The Tier 1 common ratio ended the quarter at an estimated 9.8%, up a healthy 40 basis points from last quarter. Our estimate for the Basel III Tier 1 common ratio, assuming that all the components of the Federal Reserve's recent notice of proposed rulemaking are implemented in their current form, held relatively stable at 7.9%.

As shown at the bottom of the page, the tangible common equity ratio increased by 16 basis points sequentially due to a reduction in the asset base, and tangible book value per share ended the quarter at $25.72, down 1% from the prior quarter as the modest tangible book value dilution associated with the September actions was largely offset by this quarter's core earnings.

With that, I'll now turn things back over to Bill to cover the last few slides.

William Henry Rogers

Okay, and I'll move to Slide 15. And during the third quarter, we achieved our PPG expense program target well ahead of schedule, realizing a little over $75 million in quarterly savings or obviously $300 million on an annualized run rate. The collective efforts that got us here so quickly should not be minimized. A lot was accomplished in a relatively short period of time, and that's a result of our teammates' intensity around delivering results. But that being said, it's not lost on me or anyone at SunTrust that we still have work to do. The PPG program served as a catalyst towards achieving our ultimate goal of significantly improving the overall efficiency of the organization. It's been successful in not only garnering meaningful savings, but also in galvanizing our team in pursuit of our sub-60 efficiency ratio goal.

So now that we've hit our PPG target, what kind of updates can you expect from here? Well, we're not going to roll out a new program with a new name nor will we publicly track our progress beyond the $300 million goal. But I will tell you that we're not finished in our efforts to improve our efficiency. As a matter of fact, we're just getting started. And going forward, I want you to measure us by the same metric that we're holding ourselves accountable, our efficiency ratio. We've incorporated this metric into our incentive compensation plans. We've built a lot of intensity throughout the bank, around improving both the revenue and expense components of the calculation. So PPG was instrumental in getting us on the track and we'll leverage that momentum as we go forward.

Now moving to the next slide, and before we move into Q&A, I want to spend a few minutes highlighting the progress we've made from a line-of-business perspective.

In Consumer Banking and Private Wealth Management, we've had another quarter of solid loan production growth with year-to-date volume 15% ahead of last year. Favorable deposit trends also continued as we generated year-over-year DDA growth of 14%. And though from a revenue perspective, this business continues to be challenged due to regulatory headwinds, we have reduced expenses here by 3% from last year. Clients are increasingly utilizing self-service channels, which, as just one example, has enabled us to make changes to our staffing model to improve our efficiency and effectiveness. Our Wholesale business continues to deliver strong results with year-to-date net income nearly double what it was a year ago. Significant growth in capital markets fees, coupled with a higher net interest income, drove Wholesale revenue gains of 14% over the third quarter of last year. Loans were up 8% and client deposits increased 5%. Furthermore, our Corporate Investment Banking business surpassed last quarter's revenue and net income levels, marking yet another quarter of record performance. While the Mortgage business reported a net loss, primarily due to the increase in the mortgage repurchase reserve and the mortgage NPL sale, core trends continued to markedly improve. Year-to-date mortgage production volume was $24 billion, up nearly $8 billion or 48% from last year and core mortgage origination income was $460 million higher, more than 130% increase from last year. The elevated levels of refinance activity have certainly been beneficial to the business while we're also continuing to devote resources to purchase activity, a core bread-and-butter business for us, and one that we think will again be the primary driver of mortgage revenue when the refi volume eventually tapers off. Additionally, we're also focused on building out channels and driving volume with better channel selection to maximize ROI and the longer-term return profile for this business.

So overall, this marked another quarter of positively trending core line of business performance. The diversity of our business mix has and will continue to benefit us as we go forward, and I'm pleased with the heightened intensity level at which our leaders and teammates are operating, focused on meeting our clients' needs and driving higher levels of return for our shareholders.

So Kris, let me turn it back over to you, and we'll take some questions.

Kris Dickson

Thanks, Bill. Wendy, we're ready to begin the Q&A portion of the call. [Operator Instructions]

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today is from John Pancari with Evercore Partners.

John G. Pancari - Evercore Partners Inc., Research Division

Wonder if you can give us more color on your -- possibly your 2013 margin outlook given your securities yields and loan yields you're seeing some downside reinvestment risk there, but relatively more resilient than we thought this quarter. So can you just give a little more color in terms of your outlook beyond the fourth quarter?

William Henry Rogers

Sure, John. Well, as you know, the big issue, obviously, is that the new loans coming on are coming on at lower going-on yields than the roll-off and securities continue to pay down. We're being very careful with the way in which we reinvest our securities book. Obviously, we're not really getting paid given the flat yield curve that take a lot of duration risk. And you saw that impact a little bit in the size of our securities book coming down a little bit this quarter. But I think what you'll see for the whole industry, as you look out, if we stay in this lower for longer environment through next year, I think you'll see the whole industry start to decrease margins probably in the, sort of, a few basis points per quarter every quarter just continuing to grind down.

John G. Pancari - Evercore Partners Inc., Research Division

Okay. So that guidance you have for the fourth quarter, is that fair to assume that, that's the pace of compression to expect going through '13, or could that accelerate at all just as your funding cost leverage gradually abates?

Aleem Gillani

It may accelerate, it may decelerate, too. I don't know that it's a consistent every-quarter decline. There is some variability quarter-to-quarter. This quarter, we did receive the benefit of a number of our higher-cost CDs rolling off and that's why our margin declined only 1 basis point overall. So I think you look for some volatility with some quarters declining less and some quarters declining more. But if you look out at the trend overall, I'd look for it to be generally on the order of a few basis points a quarter.

Operator

Our next question is from Ryan Nash with Goldman Sachs.

Ryan M. Nash - Goldman Sachs Group Inc., Research Division

So when you think about the expense base, now you have all of PPG in the run rate, I'm seeing a core efficiency ratio of somewhere in the mid-60s. So can you just talk a little bit more about how you plan on closing the gap to get below 60%? I know you highlighted that you're just getting started and clearly it's a big focus internally, but can you talk about some of the levers that you still have on the expense side, particularly if the revenue picture remains weak? And from there, if you would assess the driver of reaching the targeted levels, will we need to see more on the revenue side or the expense side from here to get there?

William Henry Rogers

Yes, so to start with, I think you've got it figured out. Obviously, this quarter's efficiency ratio is a little lower. We were very clear internally that it wasn't mission accomplished. If you think about our core expense base, say, over the last 6 quarters, it's been fairly stable, so call it sort of $1.5 billion sort of core expense base. But the revenue sort of has gone from about $2.2 billion to about $2.4 billion. So you could say one side of the coin was we'd expect to see more expense savings at this particular juncture. But we've had a couple of our businesses, mortgages and -- mortgage and CIB has been sort of 2 of the examples that we're going to invest in right now because we see good revenue opportunities. So think about it sort of from that context. So what's left, I mean what are the opportunities? I mean, the list is pretty significant. We have a lot more to do in the consumer rationalization of our business spans and layers, incentive efficiencies. You saw some of the charges we took for real estate, so we still have some other real estate opportunities. Core process, consolidation, shared services. I mean, the list is actually fairly extensive. And while I said PPG was the start, I mean I meant that. I mean, it really sort of got the ball rolling down the hill. I would call that maybe some of the more low-lying fruit. Now we're going to get a little higher in the tree. But there are significant opportunities. Is it more expense or is it more revenue? A lot of that'll depend on where the market takes us. If refinance activity continues like we think it will in Mortgage, it'll be a little slower to get down to that efficiency ratio. We continue to do what we've been able to do on the CIB side. Similarly, it'll take a little bit longer. So I think it's -- and we've been very clear about saying it's the efficiency ratio versus just expense or just revenue initiatives. And I'm confident that we're on the path. I can't commit to the exact time line, but I'm confident we're on the path. And if you look into our line of businesses, start looking at the efficiency improvements within those and I think they're pretty good leading indicators of where we're going as a total company.

Ryan M. Nash - Goldman Sachs Group Inc., Research Division

Okay, and then if I could just ask one follow-up as a follow-up to John's question. When you think about -- you obviously said the NIMs coming down a couple of basis points a quarter, but when you think about the trajectory for NII for 4Q and beyond, how should we think about, just given Aleem's comments on asset yield spreads and reinvestment yields, should we expect that NII is going to come down at a similar pace, or do you think we can actually see enough growth to offset some of the compression?

Aleem Gillani

Well, I think for next year, Ryan, I would think about NII for the full year likely to be lower than the full year 2012. Basically, we've got the changes from the foregone dividend and Coca-Cola and the loan sales. In Q2, recall we had a step-down in loan swap income. So full year I would think of as being lower next year than this year. There's some positives and negatives there. On the positive side, we are continuing to manage down our non-deposit maturity rates. Obviously, in the compressed yield environment on liabilities, there's a decreasing opportunity there, but we do have more CDs maturing. We have about $7 billion of CDs maturing during the next 5 quarters, between now and the end of next year. And as those renew, they will renew at lower yields. And against that, we're fighting against the challenging asset yield compression environment. And as a reminder, we will have another step-down as a result of swaps rolling off in Q2 next year. So year-over-year, I would think of NII coming down overall, but we know we still have some levers to pull and we're working on those.

Operator

Our next question is from Betsy Graseck with Morgan Stanley.

Betsy Graseck - Morgan Stanley, Research Division

Just wanted to talk a little bit about mortgage repurchase, reps and warranties. Could you give us a sense as to how you think your expenses are going to be running over the next several quarters? I think, in September you said $5 million to $10 million a quarter. Just wondering if that's still a good number or not.

Aleem Gillani

Yes, I think it is. I think we said $10 million a quarter in September and we think that $10 million is still a reasonable number. Small range around that, probably sort of plus or minus $5 million. But I think that's a good center for the overall number.

Betsy Graseck - Morgan Stanley, Research Division

And does that represent -- does that include the increases in repurchase requests that came through in the quarter? Obviously, they were up in the quarter.

Aleem Gillani

Well, the demands were actually down in the quarter, Q3 versus Q2. And I think they're down to the lowest level we've now seen in the last several quarters. But yes, it includes everything that we've seen so far and it includes the reserve that we need for new mortgages that we're putting on.

Betsy Graseck - Morgan Stanley, Research Division

Right. The pending repurchase requests were up, though?

Aleem Gillani

Yes, the pending repurchase requests were up, but that's partly as a result of us being very deliberate around looking at every single file and making sure that we take the time necessary to try to cure every issue rather than acceding to a demand.

William Henry Rogers

I think another way of saying it is really everything that we represented in terms of taking this reserve in September is as we thought it was or better, and particularly as it relates to full file requests, which is sort of that leading indicator, they're probably even better than we thought they'd be. In other words, lower.

Operator

Our next question is from Matt O'Connor with Deutsche Bank.

Matthew D. O'Connor - Deutsche Bank AG, Research Division

Can you just remind us what the swap impact on the NIM and the net interest income dollars will be? I guess, it's 1Q to 2Q where there's the step-down that you referenced?

Aleem Gillani

There is another step-down in Q2, Matt. I think we've got about $1 billion notional of swaps rolling off. And so that's about $10 million or $15 million per quarter in NII at that time.

Matthew D. O'Connor - Deutsche Bank AG, Research Division

Okay. And then just separately, if we look at your credit-related costs, they were down both year-over-year and linked quarter and that's actually better than what we've seen at a number of other banks that have had Q2 increases. And just maybe wondering why there's some divergence maybe between you and the industry, and it sounds like those costs will continue to come down from here.

Aleem Gillani

We do expect those costs to continue to come down a little bit, Matt. I think, maybe to be fair to the rest of the industry, they've been a little slower in coming down here. So I think this quarter, we're catching up a little bit. And you'll recall that in September, we had guided some of those costs down by about $20 million per quarter for the end of the year and we achieved $15 million of that $20 million this quarter. So perhaps a little bit faster than we had anticipated then, but we do continue to expect those costs to continue to come down.

William Henry Rogers

And as, Matt, we've said, they'll continue to trend down quarter-to-quarter. It's hard to tell exactly what's going to happen, but I think it's safe to say that the trend will continue. The slope of this quarter may have been unusually high.

Matthew D. O'Connor - Deutsche Bank AG, Research Division

So the $20 million per quarter decline that you had signaled related to the balance sheet repositioning, is most of that in the run rate in the third quarter, so we should take this run rate and take out $5 million to get to the minus $20 million then whatever else we'd assume for the rest of the pool, is that the way to think about it?

William Henry Rogers

That's generally correct. There's obviously going to be some volatility. We're not going to be able to forecast these costs within $5 million on a quarterly basis, but that's generally correct. We expected to hit $20 million by year end. We achieved a lot of that very quickly. But after we hit the $20 million, I would continue to expect those costs to move down next year.

Operator

Our next question is from Jefferson Harralson with KBW.

Jefferson Harralson - Keefe, Bruyette, & Woods, Inc., Research Division

I want to ask you about the loan demand and that how one hand is talking about the slowing loan demand. On the other, you're talking about how the pipeline is strong. Can you talk about the kind of what you're seeing there to -- for those comments to both jive together?

William Henry Rogers

Yes, Jefferson, and it is a bit of a dichotomy of different views. But what we're seeing is some slowdown and I think that's not been inconsistent with sort of HA [ph] data on pricing. But our pipelines are actually very good and they are as large or not larger than they've been in prior quarters. The pull-through rate is just slower. And we could all speculate as to why that might be. I think there clearly is some pent-up demand. When I'm out and about and talking to business owners and other CEOs, what I hear is we're going to wait. So we're encouraged by the fact that the pipeline's up. We're encouraged by the fact that we're having increased higher-level dialogue with our clients, but the pull-through rate almost has -- was slower this quarter. No doubt about it.

Jefferson Harralson - Keefe, Bruyette, & Woods, Inc., Research Division

All right. So if you think about the 2% average loan growth this quarter, you think that should generally pick up or slow down or remain the same in the future?

William Henry Rogers

It's hard to speculate because we're sort of dealing with a bit of a new phenomenon here in that, normally, we could look at pipelines. We could ascribe a pull-through rate of some consistency against those and be able to project that with a lot more consistency. Today, there's a little bit more of an unknown. So while I'm optimistic overall in the sense that we're -- the pipelines are big and the activity and the dialogue, I'm a little hesitant to predict exactly what's going to happen in the next quarter or 2.

Operator

Our next question is from Ken Usdin with Jefferies.

Kenneth M. Usdin - Jefferies & Company, Inc., Research Division

Just to follow on the environmental expense question real quick. So 2 of the most important lines within the operating losses and the credit and collection, they were slightly higher quarter-to-quarter and taking your point that it's hard to think about quarter-to-quarter, I just wanted to ask a more qualitative question. What does it take for those 2 lines to start -- I know you're expecting that those 2 subcategories are going to improve, but how long is the lag versus other credit improvement for operating losses and credit and collections, specifically, to really start moving down? Is there a trigger point where they just start to accelerate or is this a multi multiyear drag for them to meaningfully reduce?

William Henry Rogers

Well, Ken, I certainly hope it's not a multiyear drag. I don't know that there's a trigger point that I could point you to, but I think there are sort of several things that you could look at, the improvements that we've made over the last couple of years, particularly some of the actions that we took this quarter also. The sale of some of our NPL loans, the sale of the Ginnie Maes, that should help also reduce some of those credit and collection costs going forward. Those are very labor-intensive loans to attempt to collect and work on over time. So I think -- we would think of that as a little bit of a trigger point. And in operating losses, there are a lot of numbers built into there -- built into that, that includes operational losses, that includes broad losses, it includes items we've got in there to build up litigation reserves. There are a lot of different numbers in there and I would look for that line to also start to come down relatively quickly as we start to think about 2013 now. And in fairness, it's not all these numbers and it's other numbers as well. But I've been pretty clear in stating that we're going to be conservative in taking some of these costs down. I mean, this was a very expensive system to build. We're really, really good at it. And so some of these hard costs and tracking this down, we're going to probably lag a little bit. And I think that's the prudent way to do it. We don't want the trucks ahead of the gas line, so to speak. So we're going to be probably a little bit conservative in bringing these down. And think about it, a lot of the costs are related to this. They just happened in the third quarter. So we'll start seeing some of that run rate come through in the fourth quarter and moving forward.

Aleem Gillani

I think, Ken, if you look at the run rate year-over-year, I think last year our run rate was something like $800 million. This year, our run rate is considerably below that. And I would expect next year, our run rate will decline further.

Kenneth M. Usdin - Jefferies & Company, Inc., Research Division

Got it, okay. And then my second question, Aleem, just wondering if you can help us understand how the earning asset trends should look from here because period end was, what, $152.5 million versus $153.8 million average. The timing of all the moving parts in the fourth quarter is a little tricky to understand. Then you have some underlying growth. I just wondered if you can give us kind of -- maybe even just a range of how you expect the earning asset base to trend in the fourth quarter?

Aleem Gillani

Well, I think with the sales that we announced, you think about that as being about $3 billion coming out of earning assets. So start with that lower level. And I think the answer, Ken, is going to be sort of very pipeline and economy dependent in the very short term. If we can get the economy out of this malaise, you would expect to see earning assets start to climb now from that lower level that we see. But in the very short term, the next quarter or 2, while we are -- while we do have some fairly strong pipeline, it does feel like a lot of clients are being very cautious about adding new debt levels to their balance sheet and it's a bit of a challenge out there. It's a bit of a fight every day as we look to try and service our clients and grow assets that we have from here. I would look for growth. I would look for a higher balance sheet. But just to remember to start from that lower number after the sale this quarter.

Kenneth M. Usdin - Jefferies & Company, Inc., Research Division

Okay. So you're saying that the $3 billion pretty much is the right average to take out of this quarter's number?

Aleem Gillani

I think on average, that's fine. Some of those sales already came out, as I said, early this quarter, some will come out a little bit later in the quarter. But on average, that should be about right.

Operator

Our next question is from Matt Burnell with Wells Fargo Securities.

Matthew H. Burnell - Wells Fargo Securities, LLC, Research Division

I guess more of a conceptual question related to the mortgage business that's obviously doing very, very well right now, but one of the questions that I often get from investors is how confident you all are that you can take costs out of the Mortgage business once that business begins to normalize at some point next year, and how that might affect your thinking on the efficiency ratio.

Aleem Gillani

Yes, I'll take a shot. The expenses related to the Mortgage business sort of don't follow an exact quarter-to-quarter. As I said in my comments, not only sort of what we use, what I'd call the traditional methods, so as you see that decline, you see normal expenses come down and they tend to lag a quarter or 2 depending on how much of the volume is purchased and how much is refinanced. So obviously, it'll lag more for refinanced and less for purchased. But what we're doing is a fairly significant sort of redesign of the channels in the business as we're going through this. One of the real silver linings behind HARP is where it really has afforded us the opportunity to build out our consumer direct channel. And that channel, as a percent of our business a year ago, was pretty small. It's about 10% of our business now and it is a much more efficient part of the structure. So not only sort of do you have the traditional tools, we're also going through a pretty, as I said, a redesign of the channel mix. So I'm actually fairly confident when we come out of this, we'll come out of this with a higher-margin business relative to how we entered this from the changes that we're making now.

William Henry Rogers

Hey, Matt, I'd also add one more point and that is I'd also remind you that over the last little while, we've spent several tens of millions of dollars around the consent order, consulting costs around the independent workload review. And as you look out to next year, I would expect all of those costs to abate, and that'll also provide a nice lift to the overall performance of the Mortgage business.

Matthew H. Burnell - Wells Fargo Securities, LLC, Research Division

Okay. And I guess just for my follow-up, just a quick question for Aleem. Aleem, what percentage of the mortgage originations this quarter related to HARP?

Aleem Gillani

In total, if you look at our total origination, Matt, it was about sort of 70-30 refi versus purchase. And of the refi, about 30% of the total refi was HARP. So if you work that through, about 20% of our total business this quarter was HARP.

Operator

Our next question is from Gerard Cassidy with RBC.

Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division

When you guys gave us the estimates on the core expenses of about $1.5 billion for the quarter, what would your estimate be of the associated environmental cost or OREO cost in that number in this quarter? How would that compare to a more normalized number when we get out of the mess on credit?

Aleem Gillani

Well, I think, Matt -- Gerard, if you take a look at that expense slide that we got, 28, in the deck, yes, you get a sense of what the environmental costs have been within that number. And as we said earlier, that run rate is coming down pretty nicely from where it was last year and where it peaked. And I would expect that to continue to come down. If you think about a really normalized number, I mean, back in the day, that line item for us had a run rate of about $200 million annually. I don't think that we'll ever get back to that kind of a number, but it might be reasonable to assume that, that kind of a number from $200 million might double. But even when it doubles, it's 1/2 of the $800 million we ran at last year.

Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division

Great. The second question was you guys indicated that $400 million of the so-called Chapter 7 type loans that the OCC regulated banks have had to identify this quarter and put into nonperforming, how much of the $400 million -- you mentioned what's performing TDR in your release, but how much of the $400 million has already been reserved for? And if you are required to put the entire $400 million on nonperforming, what type of provision would you have to take to build up that reserve?

Aleem Gillani

I'm not sure I could give you an answer to that one yet. This guidance came out right at the end of the quarter and we were not subject to it, so we're currently doing the analysis to see what the total looks like. But at a higher level, I think given that these are performing loans, you would expect that the reserve against them would be very minimal to nonexistent. And the idea that we would take them and put them into nonperforming may or may not have an impact on provisions. We're still waiting for coordinated guidance across from all the agencies. And obviously, when we hear that, we will take action immediately.

Operator

Our final question today is from Greg Ketron with UBS.

Gregory W. Ketron - UBS Investment Bank, Research Division

Aleem, a question on mortgage repurchase. If I -- I think I heard this right. You had mentioned that you did see a uptick in requests on performing loans. And if so, how that might affect -- is that included already in the reserve that you've set up or would that change your thinking or approach on the mortgage repurchase reserve?

Aleem Gillani

Yes, Greg. Sorry, maybe I wasn't clear on that. It's not an uptick on the request in performing loans. It's a percent of change. So that, overall, the demands were down. But out of that total decreasing number, the percentage on loans that have never been 120 is going up. So they're less delinquent and they're more recent, and therefore, contain a lower loss content than the demands on previous loans that we were getting. Does that make more sense?

Gregory W. Ketron - UBS Investment Bank, Research Division

Yes, yes. I just was thinking in terms of how that might impact or if there is any impact to the reserve that you've established today.

Aleem Gillani

Any impact is positive as these have lower loss content and that was already included in the provision that we took in the quarter. So I think the reserve that we have got now should be sufficient to cover everything that we're required to cover.

Gregory W. Ketron - UBS Investment Bank, Research Division

Okay, great. And then maybe a bigger picture question for you, Bill. We've seen a number of housing data points be very positive, particularly in the Southeast in terms of home prices, housing starts, you name it, it's all been a pretty steady stream of good data. How does that impact SunTrust from a bigger picture standpoint in terms of demand, maybe seeing Florida -- you've had a tremendous backlog in Florida, maybe seeing that speed up. And does that ultimately help lower these credit costs -- if this trajectory continues, does that ultimately help lower the credit costs faster?

William Henry Rogers

I think actually the biggest tie to housing value increase and what it does for us is increasing consumer confidence. I honestly think that's sort of the biggest tie if you can think about sort of where people are coming from, this being their largest asset. When that starts to change, they look at their, sort of as a general comment, they're more deleveraged than they were before. I think this just tries to unlock some of the consumer confidence. We're still more tied to employment than housing values, but that's also seeing some positive trajectory. I mean, take -- use Florida as an example. While still above the national average, the improvement in Florida and unemployment's gone from 10.6 to 8.7. So the largest probably percent of improvement, coupled with housing values, I mean I think it's really a consumer confidence game in terms of the opportunity for us. And we feel it.

Let me just make a quick comment before we wrap up the call today. We've made significant progress in more favorably positioning the bank through -- for the future. That's through specific actions we've taken during the quarter, but really more broadly, through the benefits of some of our strategic operating decisions. We are building a more effective and efficient company, not only through expense savings, but also in the way that we're approaching revenue generation. A significant opportunity exists to leverage the loyalty that we've built, and our team has the tools and training they need to uncover more client needs and further deepen those relationships. And that's not to say that the path ahead is not without its challenges. But there is a high level of intensity across the organization around translating opportunity into results. And I believe we're focusing that energy in areas that can best impact bottom line performance. So with that said, thank you for joining us today and please reach out to our Investor Relations team with any other questions you may have.

Operator

Thank you. This does conclude today's conference. Thank you very much for joining. You may disconnect at this time.

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