2 Core Banks to Include in Your Long-Term Portfolio, 1 to Watch

By Maxwell Fisher - October 23, 2012 | Tickers: BAC, STI, WFC | 0 Comments

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Atlanta's SunTrust Bank (NYSE: STI), this country's tenth largest commercial bank, is always among the first regional banks to release earnings. As one of the country's largest regional banks, and among the most impacted by the banking crisis last decade, it provides a glimpse of Southeastern banking conditions. 

In SunTrust's fiscal third quarter, it had a generally positive balance sheet that was boosted by it's sale of about $2 billion of its historical stake in Coca-Cola. Virtually this entire sales amount was profit, as SunTrust's basis in the stake was but $110,000. On a GAAP basis, earnings came to $1.1 billion, or $1.98 per share.

But SunTrust's core income showed signs of stress, and that caused the share price to drop nearly 4% the day earnings were released. SunTrust's net interest margin fell 3.38% in the quarter, about average for a commercial bank, but was a steep 11 basis points lower than a year earlier. Management also forecast a further, single digit compression of the margin in the fourth quarter in its conference call. Loan growth in the third quarter of the year largely offset interest margin loss, and net interest income in the quarter of $1.29 billion was less than one percent below the $1.30 billion in the third quarter of 2011. Management also indicated it was seeing lowered loan demand in the current quarter. That, when combined with the steadily declining interest margin, spells big trouble for the current fourth quarter.

If and when the interest rate environment becomes a little kinder to banks in general, the steps that SunTrust took in the quarter with its Coca-Cola profits will be well received. It spent $375 million enhancing reserves for agency mortgage clawbacks. It believes it has now fully reserved for all mortgages written in or before 2009. SunTrust also wrote down by about $250 million a $3 billion pool of loans it transferred off its main balance sheet onto its “loans held for sale or transfer” designation. The bank took another $100 million charge on a pool of affordable housing units, and made a roughly $40 million contribution to its charitable foundation.

All told, it impossible to precisely pin down what SunTrust's earnings would have been without the Coca-Cola sale and various restructuring items. Analysts were expecting a total of $1.84 per share in the quarter, but I do not know just how many of the one-time factors, particularly on the expense side, that those analysts took into account in making those predictions. My best estimate is that the sale, net of one-time items, and increased income taxes raised earnings $1.45 - $1.50 per share in the quarter. In the current quarter, while revenues will be depressed no doubt, there will be little to no agency mortgage reserves, and expenses ought to be trending down. I predict fourth quarter earnings of about $0.50 per share, below the $0.62 that analysts are projecting.

SunTrust's focus is on Florida and Georgia. About one third of its assets are in Florida, where it ranks as the state's third largest bank. The largest bank by deposit market share in Florida is Bank of America (NYSE: BAC). The larger bank recently released its third quarter earnings with its typical smorgasbord of large one-time items. GAAP earnings came to $340 million, or less than one half of one cent per share. Included in that earnings total were $1.6 billion in litigation expenses, a negative $1.9 billion debit valuation adjustment related to improved credit spreads, and an $800 million charge related to tax matters in Great Britain. The quarter was a disaster compared to the over $6 billion recorded in the third quarter of 2011, but that profit was also the result of one-time factors. Taken as a whole, the one-time factors in the third quarter of 2012 were a negative $0.28 per share.

There were some good points. For all the headaches the Merrill Lynch deal has been causing Bank of America, the global market unit's earnings in the third quarter of $789 million reversed an $856 million loss in last year's third quarter. Bank of America's capital levels continued to improve, and its non-interest expense continued to decline in accordance with its multi-billion “New BAC” cost reduction programs.

What Bank of America once again has failed to do is demonstrate that it can have a “clean” and profitable quarter. The fourth quarter has started out with a blank as well, as Bank of America has announced an over $2.4 billion settlement of a class action suit concerning its 2008 Merrill Lynch acquisition.

I see the appeal of Bank of America to certain investors. If and when it gets its act together, it has the potential to post tremendous earnings. But at long as it is paying billions in “legacy” costs seemingly each and every quarter, I do not have enough trust in the bank or its management to endorse a stock purchase.

The second largest bank in Florida by deposit market share is Wells Fargo (NYSE: WFC). Much like U.S. Bancorp, Wells Fargo has successfully navigated through the recession of last decade, is growing its loan portfolio, and is holding expenses in check. Wells Fargo's third quarter earnings of $4.9 billion, or $0.88 per share, were a 22% improvement over what was already a strong number in the third quarter of 2011. The most recent quarter included a 57.1% efficiency ratio, and a 1.45% return on assets.

Analysts see Wells Fargo's torrid earnings growth, fueled by its leading position as a mortgage lender, slowing down to a rate of under 8% annually the next five years. I am not so sure about that, as management has met every challenge that has been presented in the past five years, and I am willing to grant it an optimistic view even in this revenue challenged, low interest rate period. This is this country's premier large bank, and a core holding for many types of investors.

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