On Monday, Fitch Ratings lowered the rating outlook on SunTrust Banks Inc. (STI) and its subsidiaries, while affirming the long-term Issuer Default Ratings (IDRs). The agency downgraded the company’s rating outlook to “Stable” from “Positive” and retained the IDRs at “BBB+”.

This ratings downgrade by Fitch is based on SunTrust’s still weak earnings compared with its other regional peers. Further, the ratings agency expects the company’s elevated mortgage repurchase provisions to hamper its earnings growth in the foreseeable future.

Though SunTrust has come up with an expense reduction initiative in mid-2011, Fitch expects the full impact (costing savings of $300 million) to be seen by the end of 2013. Till then, the company will continue to face lower operating margins.

Another factor considered by Fitch while revising the rating outlook was SunTrust’s asset quality. Though almost all the credit quality metrics of the company have been falling for the last several quarters, it still has a long way to go as nonperforming assets remain elevated compared to historical averages.

Additionally, SunTrust’s financials remain vulnerable to further weakness to the residential housing market and high unemployment rate as it has significant exposure to residential and home equity lending. However, the company is expected to tide over the losses with a stable capital cushion and adequate reserves.

SunTrust’s capital ratios are well above the current regulatory requirements as well as Basel III. As of December 31, 2011, the company’s tier 1 capital ratio was 10.95%. Moreover, a healthy liquidity position and a stable deposit base will enable the company to deploy capital meaningfully through dividend hike and share repurchases.

Additionally, as of December 31, 2011, Standard & Poor’s had a “Stable” outlook for SunTrust. Similarly, Moody’s, the ratings arm of Moody’s Corporation (MCO) had also assigned “Stable” rating outlook to the company.

Though we remain concerned about SunTrust’s significant exposure to risky assets, a slow economic recovery and new regulatory headwinds, improved client deposits, stable capital position and favorable deposit mix continue to raise our hopes for improved results.

Currently, SunTrust retains a Zacks #3 Rank, which translates into a short-term Hold rating. Considering the fundamentals, we are also maintaining our long-term Neutral” recommendation on the shares.

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