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We are maintaining our Neutral recommendation on SunTrust Banks, Inc. (STI - Analyst Report) based on its successful expense reduction strategy and recently launched restructuring initiatives. However, elevated mortgage repurchase demand and deposit pricing pressure along with stringent regulatory landscape remain the causes of concern.

Back in 2011, SunTrust launched an expense reduction strategy – PPG Expense Initiative.  This strategy turned out to be highly successful as it achieved its targeted cost savings of $300 million in the third quarter of 2012, almost a year ahead of the scheduled date. Further, with this program, management reiterated its aim to reduce the efficiency ratio below 60% over the long term.

Moreover, in September 2012, SunTrust had announced a set of restructuring initiatives in order to fortify its balance sheet, improvise the risk profile and meet the regulatory capital ratio requirements. Going forward, these are expected to be marginally accretive to the company’s Tier 1 common equity ratio. Moreover, such initiatives will enable SunTrust to limit the margin pressure and witness a better top-line growth.

Further, SunTrust continues to expect increased loan demand from creditworthy commercial borrowers; however, the timing of such a pickup in demand is uncertain. For the nine months ended September 30, 2012, the company extended approximately $66 billion in new loan originations, commitments, and renewals of commercial, residential and consumer loans to its clients. With the gradual revival of the economy, we expect loan demand to improve in the medium term, providing SunTrust the buoyancy to maintain its profitability.

On the flip side, the company anticipates mortgage repurchase demand to remain elevated and volatile from quarter to quarter. If the repurchase requests continue to escalate, SunTrust would need to increase its repurchase reserve further, which will adversely hit its profitability.

SunTrust continues to face competition for deposits in the recent quarters. Consequently, there remains deposit pricing pressure, which will make the company lose its market share for deposits to some extent.

Moreover, rising consolidation activities, driven by increasing bank failures, as well as advantages of limited regulatory restriction to non-banking financial institutions have significantly elevated the competitive environment for the company, which could result in an unfavorable blow to its profitability in the long run.

Also, like many other peers – PNC Financial Services Group Inc. (PNC - Analyst Report) and BB&T Corporation (BBT - Analyst Report) – SunTrust’s profitability will be affected by the financial reform law due to the rising costs and fee restrictions. Further, the new capital proposals unveiled by the Federal Reserve suggest that banks would be required to maintain a total tier 1 ratio of 7% to risk-weighted assets. In the mid term, stricter capital requirement is expected to reduce the company’s flexibility with respect to its business investments and lending volume to some extent.

Currently, SunTrust retains a Zacks #3 Rank, which translates into a short-term Hold rating.

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