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SunTrust Banks, Inc. (STI - Analyst Report) has announced a set of restructuring initiatives in order to fortify its balance sheet, improvise on the risk profile and maintain the regulatory capital ratios. All these initiatives will have significant financial impact on the third quarter results.

Initiatives

SunTrust hastened up the termination of the two Variable Forward Purchase Agreements (VFPAs), inked in 2008, involving the shares of The Coca-Cola Company (KO - Analyst Report) with an unaffiliated third party. According to the terms of the agreement, SunTrust needed to sell the Coca-Cola shares to the third party in the 2014-15 settlement dates. For this, the third party was supposed to pay a sum not lower than $19 per KO share and not exceeding $33 per KO share.

However, after assessing the deal under the new regulatory requirements of the Basel III guidelines, SunTrust discovered that the deal was augmenting its risk-weighted assets and bought possible volatility to regulatory capital ratios through variations in other comprehensive income. Consequently, SunTrust hastened the termination of the VPFAs and vended off all the Coca-Cola shares, keeping aside 1 million shares to be transferred to the SunTrust foundation.

This contribution to the SunTrust foundation will result in an estimated $37 million rise in non-interest expenses in the third quarter, partially offset by a pre-tax gain of approximately $1.9 billion, arising from the termination. The termination will also boost SunTrust's Tier 1 common equity by around $490 million, but reduce the annual net interest income (NII) by approximately $40 million due to the relinquished dividend income from the Coca-Cola stock.

Further, SunTrust is looking forward to register nearly $375 million worth of mortgage repurchase losses provision during the current quarter, stemming from the continued discussions with Fannie Mae (FNMA) and Freddie Mac (FMCC) and keeping in mind the company’s general trends regarding mortgage repurchases.

Therefore, the company would be able to boost the mortgage repurchase reserve to a level that will be adequate to cover the remaining demands on loans sold to these two Government Sponsored Enterprises (GSEs) before 2009.

Moreover, SunTrust anticipates transferring nearly $3 billion of loans to loans held for sale. These loans comprise of nonperforming mortgage loans, nonperforming commercial real estate loans, delinquent Ginnie Mae loans along with delinquent and current student loans. This is expected to lead to nearly $250 million in pre-tax charges, mainly driven by market valuation modifications.

In addition, sales of the student and delinquent Ginnie Mae loans would lower NII, while the sales of delinquent and nonperforming loans will result in a fall in credit-related non-interest expenses. The sale would also help in re-aligning the loan portfolio according to the long-term balance sheet goals. The disposal of loans will be carried out in the remaining half of 2012.

Furthermore, SunTrust also intends to sell properties worth $200 million in its housing subsidiary Transom Development, Inc. The company expects $100 million of pre-tax loss stemming from this sale.  

Financials Implications

SunTrust expects the cumulative effect of all these initiatives to increase the net income by $750 million or $1.40 per share in the third quarter. Moreover, the initiative would be marginally accretive to the Tier 1 common equity ratio as it was already benefited by the Federal Reserve’s capital grant pertaining to the Coca-Cola shares. Further, SunTrust expects its regulatory capital ratios to have minimal impact from these initiatives.

Conclusion

The stringent regulatory landscape prompted SunTrust to restructure its balance sheet and enhance capital ratios. By selling off loans, the company would be able to reduce interest expense burden, fueling NII growth. The restructuring initiatives will also assist in limiting the margin pressure, thereby providing more financial flexibility. We believe all these initiatives to favor overall growth going forward.

SunTrust currently retains a Zacks #3 Rank, which translates into a short-term Hold rating. Considering the fundamentals, we also maintain a long-term Neutral recommendation on the stock.

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