This summary is based on the fourth quarter fiscal 2007 earnings call conducted by SunTrust Banks Inc. (STI) on January 23, 2008.
President, Chief Executive Officer, Director: James M. Wells III
Chief Financial Officer, Corporate Executive Vice President: Mark A. Chancy
Chief Risk Officer: Thomas E. Freeman
Corporate Executive Vice President: William H. Rogers Jr.
Director, Investor Relations: Steve Shriner
Key Investors Issues
- Earnings per share fell to one cent as against $1.39 in the previous year.
- The total non-interest income in Q4 was $576 million, down 35% from last year.
- In fiscal 2007, earnings were $1.6 billion or $4.55 a share versus $2.11 billion or $5.82 a share in 2006.
Fourth Quarter Fiscal 2007 Financial Highlights
The company reported earnings of one cent per share in t he fourth quarter.
SunTrust was impacted by the rapid deterioration of the residential real estate market, the change in the credit cycle, and specifically consumer credit quality, and the resulting impact on liquidity in the financial markets.
The firm had previously indicated that its tier one ratio target is 7.5%.
At year-end, the estimated tier one ratio is about 50 basis points below that stated target. However, the tangible equity-to-assets ratio is about 6.3%. Although 7% is below the firm’s target, the expected outcome of transactions relating to its common stock holdings of the Coca-Cola Company, potential issuance of capital securities and expected earnings will move the firm above its current target during 2008. In May 2007, the company announced a comprehensive evaluation of its ownership position, which currently totals 43.6 million shares. The company has completed that evaluation and the Board of Directors has authorized it to pursue certain transactions that accomplish the stated goals of both improving the tier one capital contribution from the holdings, as well as increasing shareholder value. Under any of the expected scenarios, tier one capital would increase by approximately $1 billion. The firm is currently sharing the approved strategy with the appropriate regulatory and other relevant parties and will announce the final decision and related actions following the completion of that review.
After three consecutive quarters of margin expansion totaling 24 basis points, margins slipped five basis points during the quarter.
Margin improvement this past year was a direct result of the balance sheet management strategies that the firm implemented in connection with its shareholder value initiatives in 2007. Unfortunately, the decline in margin in the fourth quarter was primarily the result of competitive deposit pressures that did not allow the company to pass along the impact of declining short-term interest rates in the form of lower deposit rates consistent with the decline in loan yields. The management’s expectation is that the margin is also likely to compress slightly in the first quarter due to the securities that the firm purchased during the fourth quarter. For the remainder of 2008, the firm expects margins to stabilize and possibly expand, depending on deposit pricing and volumes, the LIBOR to prime relationship, and the level of non-performing assets.
The rapid deterioration of the consumer and residential real estate portfolios in the fourth quarter drove charge-offs to 55 basis points, up from 34 basis points in the third quarter.
In October, the firm saw an increase in delinquency and severity of losses that was within its previous expectations of 35 to 45 basis points annualized for the quarter. However, a significant acceleration in roll rates through the delinquency queues and severity of losses occurred in November. In mid-December, once the firm was able to fully analyze the November trends, it became apparent that it would exceed its previous estimate. In addition to these factors, the accelerating decline in residential real estate values created a need to significantly increase the allowance for loan and lease losses to 1.05% of loans. The current allowance recognizes that some further erosion in real estate values is likely and assumes similar roll rate and delinquency trends during the first half of 2008.
There is a great deal of uncertainty regarding the economy and the health of the residential real estate market. The firm expects that the first half of 2008 will be very sluggish, while it expects some improvement in the second half of 2008, and the economy and credit environment will return to a more normal state in 2009. As such, the firm expects charge-offs to increase in the first quarter and the second quarter in the consumer and residential real estate based portfolios. Further, the firm is projecting charge-offs to moderate in the second half in these portfolios to have relatively good CNI performance and an increasing risk in charge-offs in residential construction, as current weakness turns into charge-offs later this year. Key risks to these expectations are a broad recession and significant additional declines in real estate value.
The management’s views on the Three Pillars funding and purchase of over $700 million in asset-backed securities from this multi-seller asset-backed commercial paper conduit.
For background, Three Pillars was formed in 1999 to provide the service of financing receivables for the firm’s corporate clients. Client transactions are typically structured to an implied A rating and the company has not incurred any losses on this client related transaction since inception. In addition to customer receivables, Three Pillars also held approximately $720 million of highly rated asset-backed securities in the fourth quarter. This position represented less than 10% of Three Pillars total commitment at that time. These securities were all highly rated and specifically on the date of acquisition, 83% were Triple A rated and the remaining 17% were Double A rated.
In the third and fourth quarter, deterioration in the performance of the underlying collateral began to materially decrease the market value of these securities and a review of the remittance reports received on the 26th of December showed continued deterioration in collateral performance. In order to reduce the risk profile of Three Pillars, the firm ultimately decided to purchase all of the asset-backed securities and recorded a market valuation write-down of $145 million. As the decision to purchase the securities was based in part on this remittance information that was not made until the end of the year, this loss was not included in our December 20th disclosure.
Now, in order to mitigate the risk going forward on these assets, during the week of January 7th, the firm sold three of the highest risk positions with a par value of slightly over $100 million at prices roughly equal to the year-end carrying values. Markets remain volatile and the valuations on these trading assets are subject to further fluctuations. The conduit has performed well from a financing standpoint ever since the market turmoil began back in August of 2007, and the firm expects that it will remain off balance sheet going forward.
At the end of the quarter, the firm also purchased $1.4 billion in securities from its affiliated mutual fund complex, specifically from the STI Classic Prime Quality Money Market Fund and the STI Classic Institutional Cash Management Money Market Fund.
When these securities were originally purchased by Trust Co. on behalf of the funds, all were first tier securities as defined by Rule 2A7. The securities are primarily SIVs recorded as trading assets now on SunTrust''s books and a market valuation write-down of $250 million was recorded during the quarter. SunTrust took this preemptive action to protect its approximately 142,000 account holders from possible future losses associated with these securities. The management believes that this action will enhance its relationship with these clients and protect the revenue value of the other products and services purchased by the fund’s shareholders throughout the bank.
