SunTrust Deserves a Better Reaction
It's been one heck of a sour day for SunTrust (NYS: STI) shareholders, but the stock's decline may not be telling the whole story.
During this edition of earnings season, investors and analysts are reading between the lines and have been unimpressed by the usual top- or bottom-line beats. Financial stocks have largely witnessed tremendous year-over-year growth, but most have ticked down in price since releasing their reports and talking with analysts. The latest victim is SunTrust -- a bank that was able to post eye-opening triple-digit gains, yet failed to meet expectations.
Are investors right about the bank's outlook, or are they being too harsh?
Without reading too much like an earnings release, let's do a quick recap of SunTrust's latest quarterly results. On the top line, things looked great. For the third quarter, EPS was up an astounding 408%. Unfortunately, this wasn't due to a miraculous rebound in banking activity, but instead because of the company's continued divestiture of its Coca-Cola (NYS: KO) shares. Way back in the day, a prehistoric form of SunTrust was the IPO underwriter of Coca-Cola in 1919. Instead of typical i-banking fees, the company wisely (very wisely) accepted shares instead. As of the end of 2011, the company still owned around 30 million, or $2.1 billion worth of the soda giant.
Last quarter must have been the company's garage sale of Coke shares, as the company recognized a $1.9 billion gain pre-tax from its soda holdings, contributing to a total third-quarter revenue of $3.8 billion. This easily surpassed analyst expectations of $3.04 billion. Earnings per share, again driven by the Coke sale, was up 408% to $1.98 per share.
Between the sale of Coke shares and other one-time items, the company noted in its management call that $1.40 per share is due to one-offs. But even with a less astounding $0.58 in EPS, the company exhibited healthy growth from last year's $0.39 as well as from the second quarter's $0.50. Despite these seemingly encouraging numbers, though, investors still leaned toward sell rather than buy. So, what's the problem?
For one thing, the company added another $371 million in reserves to cover pre-2009 delinquent loans. Perhaps this was enough to upset investors and analysts, who obviously don't want to see write-offs in any substantial amount. Management seemed encouraged, though, during the conference call after mentioning that they are now fully covered on their pre-2009 bad loans -- the culprit for the bulk of losses.
One important metric for commercial banks is the net interest income -- the difference between the company's loans out and interest in. It's a good sign for evaluating the bank's ability to underwrite loans. The margin narrowed slightly year over year from 3.49% to 3.38%. It's a small enough change that I can't see this as a serious negative going forward.
The company's interest income from earning assets was down a total of $50 million sequentially. This is because of the loan yield compression mentioned, the elimination of dividend income from the Coke holdings, and a reduction in bond investments. This may have troubled some investors, but again, I'm not so bothered.
To me, SunTrust is being responsible. During the conference call, I was impressed by the 30% reduction in non-performing loans -- something that has proved difficult for most of the financials since the crisis. Also, the company's Tier 1 common ratio ticked up 40 basis points from the prior quarter, even during mortgage repurchases (the aforementioned $371 million), a charitable donation of 1 million Coke shares (worth $38 million), and other proactive initiatives taken to strengthen the company's balance sheet -- which is now looking, to me, quite healthy.
One term I love to use for describing financial stocks is "lumpy." For cyclical businesses, quarter-to-quarter results can be lumpy for many reasons. Investors tend to ignore this, and it could lend reason to today's stock dive.
Perhaps what upset Mr. Market most were the forward-looking statements. The company expects its net interest margin to continue downward, losing somewhere in the mid-single digits basis points in the upcoming quarter. However, management expects that this will likely be offset to some extent by lower liability costs. I'm OK with reduced margins when the greater trends look positive. Management expects its loan portfolio to benefit from the housing rebound and continued low interest rates.
As I mentioned before, the bank is beefing up its defenses, and maybe it's not impressing investors who want to see chunkier profits. But with non-performing loans down 70% since 2009, and high-risk balance-sheet positions down nearly $15 billion since the same time, I see a bank that is committed to risk-aversion and capital improvements. Once the related expenses tick down and the derisking is complete, wait for the company's stronger asset base to start shining through and demonstrating its value to shareholders.
In the meantime, investors looking for a quick discount may want to buy the current dip and then hold on for the next quarter or two as the situation should only improve.
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The article SunTrust Deserves a Better Reaction originally appeared on Fool.com.Fool contributor Michael B. Lewis has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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