Bank Management - The Performance of Return on Equity and Return on Assets - Assignment Example

SunTrust Bank Research Analysis Overview SunTrust Banks, Inc., incorporated in the year 1984, is a diversified financial services holding company whose subsidiaries provide a host of financial services to consumers and corporate world. The Company’s areas of operations are in four segments: retail and commercial, wholesale banking, mortgage, and wealth and investment management. Some of the recent activities of the Bank are – May 1, 2008: The Company completed the acquisition of GB&T Bancshares, Inc. (GB&T). May 30, 2008: The Company sold its interests in First Mercantile Trust Company (First Mercantile), a retirement plan services subsidiary. September 2, 2008: The Company sold its fuel card business, TransPlatinum to Fleet One Holdings LLC. Through its subsidiary SunTrust Bank, the Company provides deposit, credit, and trust and investment services. Additional subsidiaries provide mortgage banking, asset management, securities brokerage, capital market services and credit-related insurance. US Economy – The Current Scenario The current state of the $14 trillion US Economy, the largest in the world, is worst since The Great Depression of the ‘30s. The March 2009 data of Unemployment stands at 8.5% which is amongst the highest since US’s economic history. The CPI stands at -0.1 and PPI at -1.2.1 The story started with the Subprime Crisis, the real estate bubble bust engulfed almost the entire Investment Banking industry with major players like Lehman Brothers, Bear Sterns, Merril Lynch going bankrupt. The Domino effect came into play and the effects could be seen worldwide in all the industries. The industry that is mostly affected is the American Banking and Financial Industry, ironically the industry of SunTrust Bank. Economy of Georgia Georgia's 2007 total gross state product was $396 billion. If Georgia were a country on its own, it would be the 28th largest economy in the world.2 There are 15 Fortune 500 companies and 26 Fortune 1000 companies headquartered in Georgia, including corporate bigwigs like Coca Cola, UPS, Home Depot, Delta Air Lines, Southern Company, AFLAC and SunTrust Banks. Georgia has over 1700 internationally headquartered facilities representing 43 nations, which employ more than 112000 residents of Georgia. Georgia's personal income tax ranges from 1% to 6% within six tax brackets. There is a 4% state sales tax.3 The current Unemployment Rate of Georgia is 9.2%, higher than the national unemployment rate.4 Personal Opinion of SunTrust Banks’ Stock Performance Date: Apr 17, 2009 Result Lookup Share Data Market Cap 6.46 B Price 18.04 Avg Vol. 15.78M 52 Weel High/Low 64/6 Dividend 0.10 Shares 357.96M Inst. Owned 64% Valuation Ratios P/E 8.44 F P/E 13.16 Beta 0.99 EPS 2.14 SunTrust stands alone as an independent bank based in Atlanta. It has been relatively untouched by the current mayhem sweeping through the financial services industry. It remains relatively healthy, because it didn’t bet as heavily on subprime mortgages and other risky securities that have since imploded with the credit crisis sweeping the industry. However, SunTrust still remains an attractive target for would-be acquirers who want a start in the fast-growing southeastern United States. Investment banks such as Goldman Sachs and Morgan Stanley, which are being pushed by federal regulators to convert to commercial banks, could see SunTrust as an attractive target for takeover. Fitch Ratings has assigned an 'AAA/F1+' rating to debt issued by SunTrust Banks through the FDIC Temporary Liquidity Guarantee Program (TLGP).5 The low P/E of 8.44 as compared to industry P/E of 15.61 makes STI an attractive buy. My target price of STI is 30 in six month time horizon. Q1. Describe the behavior of your bank’s ROA and ROE over the last 2-3 years. You can select a time horizon of your choice within this range all the analyses you are asked to perform, but it should be identical for the first three questions. a. How does the performance of ROA and ROE relate to that of peer group over this period based on the results of your most recent. The data of ROA and ROE obtained from the UBPR of SunTrust Bank suggests some encouraging figures about the banks sustenance in the turbulence as compared to its Peer Group. As in the below mentioned graphs, SunTrust’s ROA has fallen considerably less than its peer group. In 2006, while SunTrust’s ROA was less than that of its Peer Group’s by 0.06, it was greater by 0.55 in 2008. While SunTrust had an ROA of 0.45, the peer group reported negative ROA in 2008. Year SunTrust Bank Peer Group 2006 1.17 1.24 2007 0.92 0.96 2008 0.45 -0.08 Similar trends as ROA can be observed in the ROE front. Although, SunTrust’s ROE nosedived over the three years from 12.13% to 4.26%, it was significantly less steep than its peer group. The Peer Group plunged from 12.91% to -0.43% during the same period. Year SunTrust Bank Peer Group 2006 12.13 12.91 2007 9.27 9.61 2008 4.26 -0.43 b. Given the ROE = ROA times the equity multiplier (asset/equity), has your ROE been driven more by changes in ROA or the changes in the equity multiplier? The Equity Multiplier of SunTrust for the Period is – 2006: 12.13/1.17 = 10.36 2007: 9.27/0.92 = 10.07 2008: 4.26/0.45 = 9.46 When calculated, the ROA has fallen by 61.53% over the three years and the Equity Multiplier has fallen by 8.68% in the same period. Hence the role of ROA is more significant than Equity Multiplier in the behavior of ROE in this period. c. What are the main factors that account for the behavior of your ROA over this period? The profit of SunTrust fell 44% in Q408, in spite of growth in some of its core business lines like deposits and loan activities, to $283.6 m, or 81 cents per share compared with $513.9 million or, $1.44, in the Q407. The main reasons behind the fall are6 – falling values of some asset-backed securities, such as pools of consumer mortgages and home equity lines of credit ten fold increase in the loan-loss provision to$560m, which covered $297m in bad loans Q.2 Describe the behavior of your bank’s efficiency ratio over the last 2-3 years. a. How does your performance relate to that of your peer group banks? b. What factors have affected your efficiency ration over this time period? The company has been able to keep its efficiency ratio slightly above the peer group and has also been able to increase the ratio, although by a minuscule amount, over the three years. As calculated from the UBPR of SunTrust bank, noninterest expense for Q408 was $1,588.6 m, an increase of $133.3 million, or 9.2%, over the Q407. The increase was primarily driven by a $334.3 million increase in credit-related expenses to $415.7 million in the quarter, which overshadowed the success achieved in reducing expenses through the Company's efficiency and productivity program. Q3. Describe the behavior of your bank’s Net Interest margin over the last 2-3 years and discuss how the behavior of NIM relates to that of your peer group. a. What are the primary factors that account for NIM performance over this period? For the year ended December 31, 2008, the net interest income was $4,927.6m, down $60.2 m, or 1.2%, compared to 2007. The net interest margin was 3.10% compared to 3.19% in 2007. The decline was driven by the increased level of nonperforming assets, partially offset by a reduction in higher cost funding sources. As the exposures to bad loans increased in 2008, the average earning assets suffered this downfall. The increased level of nonperforming assets was partially offset by a reduction in higher cost funding sources. b. What is the outlook for your NIM over the next 12 months and what are the primary assumptions behind this forecast? The net income has grown in the Q408 over the previous quarter. This growth over the sequential quarter was due to growth in average earning assets, an improved mix of loans and deposits, an increase in consumer and commercial deposits, and a decrease in wholesale funding during the fourth quarter. Net interest margin for the fourth quarter of 2008 was 3.14%, an increase of one basis point and seven basis points over the fourth quarter of 2007 and third quarter of 2008, respectively.7 This can be taken as a good sign of remedial steps being taken by the bank. If the company continues to improve the mix of loans and deposits and decrease the wholesale funding over the next few quarters, it can see the annual NIM in the range of 3.25 to 3.28. Q4. Describe your bank’s approach to liquidity measurement and present data that indicates whether your bank is more or less liquid than the banks in your peer group. a. What are the primary pros and cons of above average liquidity? Of below average liquidity? The bank issued $3.0 bn of debt guaranteed by the FDIC under the Temporary Liquidity Guarantee Program. It has also issued $4.85 billion of preferred stock and warrants to the U.S. Treasury under the Capital Purchase Plan. This additional debt and capital, coupled with core deposit growth has enhanced SunTrust's liquidity position, and improved its ability to meet the borrowing needs of clients and prospects throughout the economic downturn. As a result of these steps, the net non-core fund dependence ratio has consistently decreased over the period, from 39.34% in 2006 to 36.22% in 2008. The bank’s percentile position has also improved significantly from 66 to 48. The Net Loans and Leases to Assets ratio has also decreased from 74.83% in 2007 to 69.53% in 2008. If a bank keeps above average liquidity, it makes sure it has more than adequate sources to meet its obligations, but at the same time, it is not actually utilizing its assets optimally and is lagging behind in granting more loans. Similarly, if a bank keeps thin liquidity position, it must have higher assets in terms of loans but it is also risking its ability to meet its obligation which is a red flag for its investors. Q.5 How does your bank measure its interest rate risk exposure? a. What do the most recent measures show about the size of this exposure? b. How do these measures compare to the current ALCO limits on your exposure? c. If your bank wishes to reduce its interest rate risk exposure, what tactics might it use to produce such a result? The bank defines its interest rate risk (IRR) as the exposure of net interest income and Economic Value of Equity (EVE) to adverse movements in Interest Rates. IRR is the primary market risk the bank is exposed to and it mainly arises from the structure of the balance sheet. The ALCO of the bank meets regularly and is responsible for the banks open position and establishing policies to monitor and limit exposure to market risk. The major sources of the bank’s interest rate risk are timing difference in the maturity and repricing characteristics of assets and liabilities, changes in the shape of the yield curve, and the potential exercise of explicit or embedded options. The bank measures these risks and their impact by identifying and quantifying exposures through the use of sophisticated simulation and valuation models as well as repricing gap analysis. The sensitivity analysis measures the sensitivity of net interest income over two year time horizon. The analysis included below is measured as a percent change in net income due to and instaneous 100 basis points move in benchmark interest rates. The changes mentioned below are dependent upon material assumptions such as behavior in interest rates and spreads, change in product balances and the behavior of loan and deposit clients in different rate environments. Rate Change Estimate % Change in Net Interest Income over 12 Months (Basis Point) December 31, 2008 December 31, 2007 +100 3.5% (1.0%) -100 (0.1%) 0.3% The difference from 2007 to 2008 seen above is primarily due to the significant decline in interest rates year over year and the increase in fixed rate funding. The bank also performs valuation analysis to estimate the discerning levels of risk present in the balance sheet and derivative positions that might not be take into account in the simulation analysis. The sensitivity of EVE8 to changes in the level of interest rates is a measure of the long term repricing risk and option risk embedded in the balance sheet. Considering the increasing concerns over real estate mortgage loans, the bank has implemented a new vendor risk management model which analyses the residential mortgage loans and home equity loans. The new model offers a more robust prepayment model relative to the previous model. It also provides daily analysis using updated market information. Given below are the comparable EVE profiles using both models. Rate Shock Estimated % Change EVE (Basis Point) December 31, 2008 +100 (4.2%) -100 1.8% NEW MODEL Rate Change Estimate % Change in EVE (Basis Point) December 31, 2008 December 31, 2007 +100 1.4% (2.8%) -100 (0.7%) (1.2%) PREVIOUS MODEL The change in the comparable EVE profile from 2007 to 2008 can be attributed to the net impact of lower interest rates, lower pricing sensitivity on immediate maturity deposit products and lower valuations of loans and deposits. The difference between the two profiles at December 31, 2008 is the result of slower prepayments in the previous models. This caused the interest rate sensitivity in the new model to be greater than the previous one. To reduce the interest rate risk exposure, the bank would implement interest rate swaps (pay variable-receive fixed), future and forward sale agreements, swaptions all of which are used to offset changes in the value of the mortgage inventory due to changes in the market interest rates. Q6. What is your bank’s current level of non-performing loans to total loans and has the ratio been increasing or decreasing in recent quarters? a. How does this performance relate to that of your peer banks? b. Relative to peers, which category of loans have above average NPL ratios? c. What do you see as the main reason(s) accounting for this? Nonperforming assets increased significantly during the year to $4.5 billion at year end compared to $1.6 billion at the end of last year. Nonperforming loans as of December 31, 2008 were $3.9 billion, an increase of $2.5 billion, or 175.4%, from December 31, 2007. Of this total increase, nonperforming residential mortgage loans represented $1005.6 million, nonperforming real estate construction loans represented $981.5 million, nonperforming commercial loans represented $247.5 million, nonperforming home equity lines represented $136.9 million, nonperforming commercial real estate loans represented $132.1 million, and consumer loans represented $6 million. The following category of loans have above average NPL ratios as compared to peer group: SunTrust Bank had a greater exposure to Family and Commercial Construction loan category as compared to peers. The % NPLs in family construction rose to 19.76% in 2008 from 3.26% in 2007. Similarly there was a huge upsurge in Construction and Land Equipment category from 2.17% in 2007 to 11.61% in 2008. The surge in nonperforming assets is largely related to the housing correction and the related decline in the values of residential real estate. Read More