Monday, 02 June 2008 01:00

Doo-Doo Bank 32 Drill Down - part 3, Sun Trust Bank

This is the 16th installment of Reggie Middleton on the Asset Securitization Crisis series. It was supposed to end at 15 parts, but by popular demand and partially due to the fact that I can't count, we will be extending it considerably past 20 parts. This is part is a drill down on Doo-Doo 32 member, Sun Trust Bank.

The Asset Securitization Crisis Analysis road-map to date:

•5. Municipal bond market and the securitization crisis - part I

And here we go...

SunTrust Bank observations

Loan Portfolio:

image015.png

Large exposure to real estate loans: SunTrust Bank (STI) has a significant exposure to real estate loans which together stood at around 60% of its total loans of around $124 bn as on March 31, 2008. Within the real estate category, residential mortgages accounted for the largest share at 27% of the total loans while home equity lines and real estate construction loans accounted for 12% and 10% of the total loans, respectively. Such a high proportion of real estate loans in the loan portfolio makes STI highly susceptible to rising troubles in the real estate market which have not shown any signs of waning over the past few quarters. Further, in spite of the bank's balance sheet asset/liability and risk management strategies, there has not been any significant change in its loan composition over the last year. This causes me to significantly question the capability of management to whether, or even to recognize, the coming storm. The real estate loans have only marginally declined to 60% as on March 31, 2008 from 61% a year earlier, which makes no sense unless the company believes that the real estate market will turn positive some time soon (see graph below for the likelihood of that happening).

Increasing NPAs and charge-offs are on a very strong uptrend in just the one past year, one that cannot and should not be ignored:

STI's nonperforming assets (NPAs) as a percent of loans have been increasing consistently over the last few quarters, having gone up to 1.88% in 1Q08 from 0.64% in 1Q07 - considerable 294% increase.

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Non-performing loans in real estate construction category have recorded the most significant upward movement from 0.39% of total real estate construction loans in 1Q07 to 4.01% in 1Q08 - a NIGH UNBELIEVEABLE 1,028% increase!

The increase in residential mortgages NPLs has also been noteworthy, with NPLs as a percent of residential mortgages rising to 3.95% from 1.30% over the period - an alarming 304%.

image009.png

Gross charge-offs in the real estate loans have also witnessed a stupendous rise over the last year commensurate with rising delinquency levels in the US economy. Gross charge-offs in real estate loans as a percent of real estate loans increased to 0.31% in 1Q08 from 0.04% in 1Q07 (775% - nearly an 8 fold increase) with most significant increases recorded in home equity lines, real estate construction and residential mortgages.

STI's loans 90 days or more past due and still accruing have also witnessed significant increase over the last year, doubling from 0.32% of the total loans in 1Q07 to 0.60% of the total loans in 1Q08. Be aware that this figure is susceptible to manipulation by management - ala Wells Fargo. I haven't encountered any firm evidence of such, but I haven't looked for it with a fine tooth comb either.

Higher provisions have diminished the bank's net earnings: As a result of rising NPAs and charge-offs, STI has been forced to increase its provisions to cover its expected loan losses which seem to be on a consistent rise. STI's provision for loan losses has increased nearly 10 times to $560 mn in 1Q08 from $56 mn in 1Q07. STI's rising provision levels are eroding its income levels as is apparent from the fact that while the bank's net interest income before provision for losses in 1Q08 has fallen a nominal 2.1% over the last year, its net interest income after provision has dipped a drastic 47.7% over the period. Consequently, STI's diluted EPS has declined 43.8% to $0.81 from $1.44 in 1Q07.

STI's provision for losses as a percent of NPAs has more than tripled to 24.14% from 7.57% over the period indicating the bank's rising expectation of its NPAs converting to losses. However, STI's reserve for loan losses still seems inadequate considering its large exposure to real estate loans. The bank's end-of-the-period allowance for loan losses has dipped to 66.61% as at the end of 1Q08 from 138.61% a year earlier which indicates that rising charge-offs are fast eating up the bank's reserve cushion which is not being sufficiently compensated by the provision charge to the income statement.

Rising Texas ratio a cause for concern: As a proportion of shareholders' equity, STI's NPAs have risen from 4.2% in 1Q07 to 12.6% in 1Q08. Owing to corroding cushion of shareholders' equity and loan loss allowance to cover rising NPAs, STI's Texas ratio (NPAs including 90 days past accruing loans to the sum of tangible shareholders' equity and reserve for loan losses - a measure that proved to be quite predictive of failures in Texas during the S&L crisis) has risen steeply over the past few quarters as depicted below. Keep in mind that I have not performed a full blown forensic accounting of STI, thus I am sure there is a lot of trash in the published, spam out-o-the-can tangible equity figures that would not be in my home brewed calculations. Thus, this Texas ratio is quite possibly understated (100%) means effectively insolvent). I will update these figures for the full Doo-Doo 32 and add my own twist to it in order to make it more realistic in today's environment.

image011.png

Declining trend in real estate construction and consumer loans off set by growth in other loans: Over the last four quarters, STI has witnessed continual decline in its real estate construction loans which have gone down 5.8% in 1Q08 over 4Q07 following a 4.1% decline in 4Q07 over the preceding quarter. However, the other classes of real estate loans have each witnessed a nominal growth with a result that the total real estate loans have increased 4.5% in 1Q08 over the level one year before. This has resulted in the bank's total real estate exposure to total loans remaining nearly same over the year. The continual deterioration in the housing sector has now spread to the other categories of loans as well, including commercial loans, home equity and consumer loans, besides bringing the entire US economy in its ambit. Under such worsening conditions, STI faces a serious threat to its future earnings in the form of rising loan losses. Why this company has not reduced its balance sheet exposure and unadjusted leverage ratio of 6.9x (most likely greater when economically adjusted) is beyond my reckoning! I may not be a successful bank exec, but I can sure see a train wreck coming when that beaming bright light starts to bounce off of my forehead!

SUNTRUST 1Q-2008 4Q-2007 3Q-2007 2Q-2007
US$ mn
Loan Composition
Commercial

37,306.9

35,929.4

34,969.7

34,362.8

Real Estate:

Home equity lines

15,134.3

14,911.6

14,598.8

14,303.7

Real estate construction

12,980.9

13,776.7

14,359.0

14,417.9

Residential mortgages

33,092.4

32,779.7

31,603.9

30,759.2

Commercial real estate

12,893.7

12,609.5

12,487.3

12,416.3

Total Real Estate

74,101.4

74,077.5

73,049.0

71,897.2

Total commercial and real estate

111,408.2

110,006.9

108,018.7

106,260.0

Consumer:

Consumer direct

4,192.2

3,963.9

4,419.3

4,391.7

Consumer indirect

7,305.2

7,494.1

7,642.1

7,739.4

Credit card

807.6

854.1

668.4

396.6

Total consumer

12,305.0

12,312.1

12,729.7

12,527.7

Total Loans

123,713.2

122,319.0

120,748.4

118,787.7

% Change over preceding quarter

1Q-2008

4Q-2007

3Q-2007

2Q-2007

Commercial

3.8%

2.7%

1.8%

2.6%

Real Estate:

Home equity lines

1.5%

2.1%

2.1%

1.9%

Real estate construction

-5.8%

-4.1%

-0.4%

1.7%

Residential mortgages

1.0%

3.7%

2.7%

1.7%

Commercial real estate

2.3%

1.0%

0.6%

-0.3%

Total Real Estate

0.0%

1.4%

1.6%

1.4%

Total commercial and commercial real estate

1.3%

1.8%

1.7%

1.8%

Consumer:

Consumer direct

5.8%

-10.3%

0.6%

2.3%

Consumer indirect

-2.5%

-1.9%

-1.3%

-1.3%

Credit card

-5.4%

27.8%

68.5%

5.5%

Total consumer

-0.1%

-3.3%

1.6%

0.1%

Total Loans

1.1%

1.3%

1.7%

1.6%

On an overall scale, STI's total loans are 5.8% up from 1Q07 levels primarily off growth in commercial loans, home equity loans, and residential mortgages. We believe that the strategy of offsetting exposure to real estate construction and consumer loans through higher commercial and residential mortgage loans would not help the bank in mitigating the overall risk to its balance sheet in the form of risky loans prone to higher delinquencies. My analysts wrote that last bit. You know I'm much more of a smart ass than that. They put it nicely. My take is, "Their out of their damn minds!"

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See the following for my take and research on the prospects of growing your balance sheet in those "other" loan categories:

  1. Capital, Leverage and Loss in the Banking System
  2. The Commercial Real Estate Crash Cometh, and I know who is leading the way!
Last modified on Monday, 02 June 2008 01:00

11 comments

  • Comment Link Avl Dao Wednesday, 18 June 2008 13:09 posted by Avl Dao

    Wonko, don't let Reggie's online modesty about his 'formal qualifications' fool you...he's clearly got some experience & exposure to what he writes about. It shows as well as his good combination of gutsy-ness, smarts, balls, critical-thinking skills, balls, and a comfort with numbers. Yeah, I stressed 'balls' because they are so lacking in so many parts of American society that I wonder if evolution isn't playing a trick on us humans.

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  • Comment Link Big Wave Wednesday, 18 June 2008 01:14 posted by Big Wave

    Reggie,

    Have you read it?

    http://www.sec.gov/Archives/edgar/data/750556/000119312508112421/dex991.htm

    What are your thoughts?

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  • Comment Link a b Thursday, 12 June 2008 23:09 posted by a b

    Commerce bank customer service here in nyc told me that if I had a checking, savings, and money market account they would each be insured for 100,000. Fortunately I was skeptical enough to check with the fdic: 100,000 per individual per bank, regardless of number of accounts. (Different for joint accounts and IRA's). Maybe the question hadn't come up before. In looking at other cash accounts I saw that ETrade gave good rates, and you could link to a SIPC insured brokerage account. So in doing my own investment research I came across this blog. Something about the presentation of the analysis, though of course not polished in appearance, gave me the confidence to jump in and buy puts on major brand name financial institutions. I had never bought options before and my buddy whose hedge fund trades mainly options said, "you'll never beat the pros, just buy some BRIC's...or an apartment in Manhattan" I am convinced now that apartments will come down, at least in real terms. Sorry for the cornball testimonial but thanks to Reggie M. I will be able to afford more apartment when I bite the bullet. Much, much appreciated but stay a little under the radar for a little longer. ;D

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  • Comment Link W0nk0 Thursday, 12 June 2008 21:50 posted by W0nk0

    Reggie,

    I just love your work. You have given me a lot of confidence in doing similar things like those you do, also without possessing any _formal_ qualification for it. Your blog helped me a lot in adding some longer-term strategies to my very short-term oriented portfolio of "quant-y" strategies.

    I totally agree with your reckoning on banks being vastly overleveraged given the current risks and conditions. I have a couple of stories to tell from times when I was an IT consultant for risk management departments of 2 banks over here. These chaps have totally redefined risk, and in a bad way.

    It also helps to reassure me of my assessment of the situation when I see so much denial everywhere and even find replies to YOUR blog doubting YOUR credibility and formal qualification. This is so ridicuolus when seen in front of the background of your clear-thinking research, it tells a lot about the person questioning you :).

    With best regards from across the big pond,
    W0nk0

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  • Comment Link Don Peters Wednesday, 11 June 2008 18:45 posted by Don Peters

    Always remember that bankers are the least savy investors in the world-I spent 23 years with one --take that for what it's worth

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  • Comment Link Reggie Middleton Wednesday, 11 June 2008 16:15 posted by Reggie Middleton

    I have no certifications. I'm just a guy that pays attention to facts and figures. I invite all to take it or leave it solely on its merits and not on the little stickers with lots of letters pasted behind someone's name.

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  • Comment Link PeteParker007 Wednesday, 11 June 2008 16:10 posted by PeteParker007

    Interesting analysis but what kind of certifications do you posses to make this stand? Are you CFA?

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  • Comment Link Reed Harvey Tuesday, 10 June 2008 01:54 posted by Reed Harvey

    In this market, I wouldn't go above the FDIC limits in any one bank even Wells Fargo. My suggestion, is that if you believe that banks are in for a bad time, is to buy December puts of the XLF (I have done this). I do not offer investment advice but am merely an amateur investor :o

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  • Comment Link Reggie Middleton Wednesday, 04 June 2008 20:07 posted by Reggie Middleton

    What makes you think SunTrust is conservative? Looking at their numbers tells me otherwise. They have the 4th highest weighted average LTV on this list (Behind Countrywide, 5th3rd, and Huntington – all of which are in horrible condition). They have about 17% of their 2nd liens over 90LTV in rapidly depreciating areas. If they sell coke shares to raise capital (doing so in a weak market) to replace capital destroyed by their lending practices, then that value will have to be removed from valuation. There are no free rides.
    They have one of the highest rates of progression towards insolvency in the list and are one of the top 10 most likely to end up insolvent of the list. If this is conservative, I hate to see what risky looks like!

    @Mials S:
    I really am not comfortable giving an opinion regarding financial planning or taking your money out of XYZ bank. It is not my place. I am just a blogger. I will post a list of blanks who I feel are the weakest or most at risk out of the Doo Doo 32, and you can draw your own conclusions from that.

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  • Comment Link pa leppert Wednesday, 04 June 2008 19:20 posted by pa leppert

    True STI is exposed some in Florida but they are basically a direct lender and do so on a conservative basis. They also can sell some shares of Coke to raise capital.

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  • Comment Link Mials S Tuesday, 03 June 2008 10:46 posted by Mials S

    Hey Reggie thanks for the awesome info!!

    I had a quick question. I live in Florida and have several accounts at suntrust over the FDIC limit... Do you think my money is safe there or should i consider cashing it all in for gold bullion and putting it in my closet. haha jp but really do you think suntrust has a chance to go under taking my precious greenbacks with it?

    Thanks,
    Mials

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