SunTrust Bank Inc.’s (STI) first quarter operating loss of 46 cents per share beat the Zacks Consensus Estimate of a loss of 58 cents. The company had reported an identical operating loss in the year-ago quarter. The operating loss for the year-ago quarter excluded a non-cash goodwill impairment charge of $2.03 per share.

Results for the quarter were primarily benefited by a lower non-interest expense on a sequential as well as year-over-year basis, chiefly reflecting a decline in credit-related expenses. A continuation of declining provision for credit losses over the last year, and a strong capital position were also impressive during the reported quarter. However, results continued to be affected by recessionary pressures as evidenced by soft revenue and weak loan demand.

Behind the Headlines

Revenues on a fully taxable-equivalent basis decreased 14.2% year-over-year to $1.9 billion. The year-over-year decrease was due to a decline in non-interest income, partially offset by an increase in net interest income.

Net interest income increased 10.0% year-over to $1.2 billion. The increase in net interest income was primarily aided by improved net interest margin (NIM). NIM improved 45 basis points (bps) year-over-year to 3.32%. NIM primarily improved as a result of a decline in funding costs and improved deposit mix. However, average earning assets decreased 4.9% year-over-year due to a decline in average loans and trading assets, partially offset by an increase in average securities available for sale.

Non-interest income for the reported quarter decreased 37.7% year-over-year to $698 million. The decline in non-interest income was driven primarily by mortgage production income and trading account profits and commissions.

Non-interest expense for the reported quarter came in at $1.4 billion, down 36.8% from the prior-year quarter. The decline in non-interest expense was primarily a result of lower credit-related expenses. Personnel expenses decreased 6.0% year-over-year due to lower pension expenses from higher discount rates and improved performance in the underlying retirement plan assets.

During the reported quarter, SunTrust reported a 13.3% year-over-year decline in provision for credit losses to $862 million.

Evaluation of Credit Quality

Credit quality metrics were mixed during the quarter. Early stage delinquencies declined to 1.19% from 1.76% in the prior-year quarter. Nonaccrual loans declined 20 bps sequentially to 4.55% of total loans. However, net charge-offs increased 8 bps sequentially to 2.91% of average loans. As the company is taking steps to resolve residential real estate-related risk, we expect net charge-off and Nonaccrual loan ratios to stabilize and come down to our comfort zone in the near term.

Capital Ratios

SunTrust’s capital ratios remained strong during the reported quarter, with Tier 1 capital ratio of 13.05% (up 9 bps) and tangible equity to tangible asset ratio of 9.86% (up 20 bps).

Despite operating in attractive demographic markets, top-line growth remained somewhat lackluster at SunTrust during the last several quarters. We do not expect any significant improvement with respect to revenue trends in the near term as the global economy will take some time to rebound to its historical highs.

With the concerns of continued weakness in mortgages and commercial loan losses, in Mar 2010, rating agency Fitch Ratings had lowered SunTrust’s ratings.

The rating agency downgraded the long-term issuer default ratings (IDR) for SunTrust and its banking subsidiary to “BBB+” from “A-.” Also, the short-term IDR was lowered to “F2” from “F1.” There were several other rating downgrades. However, the rating outlooks remain stable.

We are concerned about SunTrust’s exposure to Alt-A mortgage and construction loans, which have been facing headwinds. Besides, higher mortgage rates and slow home sales will restrict the growth in mortgage income. However, cost containment measures have been allowing SunTrust to increase investments and it is experiencing signs of stabilization in its credit metrics. We expect the continuation of NIM expansion with the help of the low cost of funding to support the top line as well as bottom line in the upcoming quarters.
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