Is SunTrust Bank a Buy?

Before you go, we thought you'd like these...
Before you go close icon

My grandfather used to say, though never to me directly, "Banking is like sex. When it's good, it's great. And when it's bad, it's still pretty good."

While the financial crisis may have led the average investor to question this -- 454 banks have been seized by regulators since the beginning of 2008 -- the industry is back on its feet and growing again -- albeit at a less frenetic pace than before. In its most recent quarterly banking profile, for instance, the FDIC noted that the industry's first-quarter aggregate net income of $35.3 billion is the highest it's been since the second quarter of 2007.

Yet many banks are still trading for fractions of book value. While the average savings and loan institution is selling for an 11% discount, mega-money center banks like Bank of America and Citigroup are trading for less than half of their book value. In this environment, it's become exceedingly important for investors in financial stocks to be able to weed out the winners from the losers. And to do this appropriately, one must look under the proverbial hood.


In this series, I examine seven of the most important metrics to assess the quality of a bank's operations. The current bank under the microscope is SunTrust Banks (NYS: STI) , the Atlanta-based regional lender with assets of $178 billion.

Metric

SunTrust Bank

Target Figure

Tier 1 capital ratio10.2% approx. 8%
Net interest rate margin3.4% >= 3.5%
Provision for loan losses (as a % of net interest income)23.6%<= 5%
Net noninterest expense (as a % of net interest income)47.6%<= 33%
Nonperforming loans (as a % of total loans)2%<= 1%
Return on equity (TTM)4.1% >= 15%
Price-to-book ratio0.67approx. 1.0

Sources: SunTrust's Q2 2012 10-Q and Yahoo! Finance.

While many regional banks are seen as relatively healthy and stable investments, SunTrust is one of the exceptions. The most glaring problem with the Atlanta-based lender is that its 4% return on equity, the cumulative and most important statistic in banking, is less than half the industry average and well below the target rate of 15%.

The good news is that this isn't the result of an extreme misallocation of assets and liabilities. On the asset side, approximately 70% of its assets are made up of loans, yielding a respectable 4.3%. On the liability side, a full 81% of its liabilities consist of deposits, over a quarter of which are noninterest-bearing demand deposits. Taken together, SunTrust's net interest margin is 3.44%, only slightly below the industry average for the first three months of the year. Thus, while the bank could and should increase the relative proportions of both, they're not egregiously out of whack.

From the perspective of leverage, moreover, which is the easiest way to juice return on equity, SunTrust's capital is close to maxed out, with a tier 1 risk-based capital ratio of 10.2%. Although this exceeds the 6% level necessary to be considered "well-capitalized" by the FDIC, the inherent quality of the capital is lacking, as earlier in the year it was one of four out of the nation's largest lenders that failed the regulatory stress test administered by the Federal Reserve and Office of the Comptroller of the Currency.

The problem, in turn, lies farther down on SunTrust's balance sheet. In the first case, SunTrust's provisions for loan losses remain unacceptably high relative to net interest income, consuming a full quarter of the bank's top line in the second quarter. On the bright side, as you can see in the figure below, the trend in this regard is proceeding in the right direction and tracking the overall industry trend. But this isn't susceptible to a quick fix, as the provisions will only gradually diminish as the lender cleans up its loan book.

Source: FDIC's Statistics on Depository Institutions.

In the second case, the bank's noninterest expense is simply way too high without an accompanying increase in noninterest income. Even after netting it against the latter, the figure still consumes nearly half of SunTrust's net interest income. To make matters worse, moreover, the bank recorded significantly higher noninterest income for the quarter due to an increase in "mortgage production related income" from $4 million in the second quarter of 2011 to $103 million in the second quarter of this year.

When all is said and done, the easiest way to address this problem is by attacking the lender's compensation expense. To put the extremity of this metric in perspective, the $762 million in employee compensation exceeded the bank's net income by a factor of three. This is particularly disturbing when you consider that the cumulative compensation of SunTrust's top four executives increased from $9 million in 2007 to well over $23 million in 2011. Over this same time period, meanwhile, shareholders in the bank lost almost 70% of their investments.

Foolish bottom line
It's tempting to conclude that SunTrust is a temporarily struggling bank similar to, say, Huntington Bancshares that merely needs to work through its soured loan portfolio before it can start returning copious amounts of capital to shareholders. But beyond its operational challenges lies its flagrantly misaligned executive compensation. Quite simply, it's difficult to trust any group of executives and directors that would approve of such a scheme.

To learn the identity of the only big bank that's built to last, click here to download our newest free report instantly.

The article Is SunTrust Bank a Buy? originally appeared on Fool.com.

Fool contributor John Maxfield owns shares of Bank of America. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Read Full Story

Want more news like this?

Sign up for Finance Report by AOL and get everything from business news to personal finance tips delivered directly to your inbox daily!

Subscribe to our other newsletters

Emails may offer personalized content or ads. Learn more. You may unsubscribe any time.

From Our Partners