SunTrust Could Reach $36 by 2014

By Maxwell Fisher - September 13, 2012 | Tickers: BAC, KO, PNC, STI | 0 Comments

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Originally, this article erroneously stated that PNC purchased Hudson City Bancorp. In fact, Hudson City was purchased by M&T Bank Corporation

One reason I became interested in following SunTrust Bank (NYSE: STI) back in the 1980's was that its balance sheet held at that time over about a billion dollars’ worth of Coca-Cola (NYSE: KO) stock, and for each share of Suntrust investors bought, they were getting about one fifth of a share of Coca-Cola. The companies had officers on each others' Board of Directors, which for each was something of a “who's who” of Southern business aristocrats.

Then, of course, SunTrust got socked by real estate loans in Florida and Georgia, and the pressure from regulators to have the bank pick up its capital by selling the Coca-Cola stake was significant. Finally, in 2009, a deal was cut for SunTrust to sell the stake, in either 2014 or 2015. I held out some hope that if the sale were not done, it might never get done. But a group of factors forced SunTrust's hand, and the stake, now worth about $2 billion, and with a cost basis of $110,000, is being sold at least two years ahead of schedule.

The biggest issue is that under Basel III rules, most common stock holdings will count negatively on a risk based capital model. Since SunTrust was one of the four of the 19 large banks to have failed the Fed's “stress test” earlier this year, a boost to capital would come in handy. We should note though, that even prior to the announced Coca-Cola stock sale, SunTrust had resubmitted a new Capital Plan for consideration that was approved. Not a surprise, as the amended plan contained no capital action, and SunTrust announced it would not seek a dividend hike until 2013.

But SunTrust is also taking advantage of the one time, $1.9 billion gain to clean up some outstanding issues. As with most larger mortgage writing banks, SunTrust has had a deluge of claims to repurchase soured real estate loans. SunTrust is planning to take a $375 million charge to fully reserve for all loans prior to 2009 that are likely to be called for repurchase by Fannie Mae (FNMA) or Freddie Mac (FMCC). SunTrust also plans to transfer to “loans held for sale” a $3 billion portfolio of its most troubled holdings, including non performing real estate and mortgage loans. The bank will take a pretax $250 million charge to write down the value of the portfolio to market before transferring it. SunTrust will also transfer its portfolio of affordable housing loans, and take a $100 million charge in that transaction. These steps, combined with SunTrust contributing one million Coca-Cola shares to the SunTrust Charitable Foundation, will result in a roughly $750 million net gain, after tax, or about $1.40 per share benefit in the third quarter.

The market and analysts have been uniformly positive about these moves, as they essentially “free” SunTrust from last decade and allows it to focus instead on its future. Tier one capital also will be increased somewhat, further clearing the way for a dividend hike next year. Earnings are going to be a confused mess this year, but I see earnings up to about $3 per share next year, and don't see any reason why this stock cannot reach $36 per share by the end of next year. Shareholders of SunTrust have had a rough few years, but there really are better days ahead.

The issue of repurchases of loans sold to Fannie Mae and Freddie Mac has bedeviled most big banks in recent years. I wish some banks were a bit firmer in holding their ground. If a homeowner makes payments for a few years, and then stops because the homeowner lost his or her job, how is that the bank's fault? That has been Bank of America's (NYSE: BAC) position, and the resulting dispute has forced Bank of America to cede its dominant role in the mortgage market and stop accepting loans from third party brokers.

Bank of America has yet to post back to back “clean” quarters of profit since 2009. It and many other banks have presented at Barclays Financial Services Conference in New York September 10 and 11^th.  I will be reviewing many of those presentations with interest.

The result of the agencies' over $80 billion of forced buybacks has over the last three years has put a great deal of distortion and inconsistency into the mortgage market. The Federal Housing Finance Agency, which has responsibility over Fannie Mae and Freddie Mac, has a current minimum credit score of 500 for qualification. Fannie and Freddie require a credit score of 660. Yet, banks, being leery of the aggressive stances of the agency organizations, have had average loans supported by FICO scores of about 760. There are still many who most would be considered credit worthy, being denied mortgage loans, the blame for which can be placed at the lobbies of Fannie Mae and Freddie Mac along with the law firms they employ.

Another top tier bank stammering under the weight of demands of the government agencies is PNC Financial (NYSE: PNC). After greatly expanding its balance sheets through purchases of National City and Royal Bank of Canada, it also was forced to set aside $350 million in the second quarter for mortgage repurchase claims, and I expect another boost to reserves in this third quarter. In each of the large bank purchases PNC has made, it has picked up mortgage portfolios that its own underwriters had no involvement in creating. Well, that is one of the costs of buying banks to grow, as opposed to growing “organically.”

Because of those increased reserves, it will be very hard for PNC to increase its earnings this year. But, assuming reserves for these sorts of legal claims will fall in 2013, I look for PNC to have a banner 2013 with earnings up to nearly $7 per share. Due to that, along with its 2.6% yield, I see PNC as a long-term winner.

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