Preferred Issues: SunTrust Profits: Good Sign, But Jury Still Out

Second-quarter earnings at SunTrust Banks Inc., which is seeking to gain momentum in its battle for Wachovia Corp., beat analysts’ expectations Friday, and the company hinted that there is more good news where that came from.

But whether that will be enough to persuade shareholders that SunTrust would be a more desirable buyer for Wachovia than First Union Corp. remains a wide open question.

L. Phillip Humann, chief executive of the Atlanta banking company, seems to think SunTrust has the upper hand. However, Wall Street is not so sure.

“Our earnings today are suggestive of a good future of earnings for SunTrust,” Mr. Humann told analysts during a conference call on Friday morning. He added that he hopes its financial strength would bolster SunTrust’s bid to win over Wachovia shareholders.

Analysts agree on the relative financial health of SunTrust.

“Not only was the quarter very good, but if you take a deep look into the quarter there’s a base there to show that the next six to eight quarters will be very good,” said Richard X. Bove, an analyst at Raymond James & Associates in St. Petersburg, Fla.

SunTrust’s net income jumped 9% from a year earlier, to $347 million, and its earnings of $1.19 per diluted share beat the First Call/Thomson Financial analyst consensus by three cents. Analysts also said that SunTrust’s second-quarter performance will make its offer somewhat more attractive to Wachovia shareholders.

“It doesn’t hurt,” said Michael Mayo, a banking analyst at Prudential Securities. But Mr. Mayo and most of his colleagues said they are not prepared to wager on what Wachovia shareholders will do until they have seen First Union Corp.’s earnings.

The Charlotte, N.C., banking company is scheduled to report next week, and the First Call consensus is for per-share earnings of 63 cents, though several analysts on Friday said that they expect the company to beat that number. “It’s like a golf tournament,” Mr. Mayo said. “SunTrust has posted its score. Now we’re waiting for First Union to post its score.”

How First Union does is important in the battle for Wachovia, which began in mid-May after SunTrust made a $14.7 billion hostile offer. First Union’s deal for the Winston-Salem, N.C., company was originally valued at $13.4 billion, but the spread between the two offers has since narrowed to almost nothing.

Kate Blecher, an equity analyst at Sandler O’Neill & Partners, said SunTrust’s earnings are “a step in the right direction,” but “a major swing factor going out right now is the results we see from First Union.”

First Union and SunTrust have traded barbs frequently since SunTrust made its hostile offer, but the gloves have really come off in recent weeks.

In a letter of protest against the First Union deal filed last Monday with the Federal Reserve Board, SunTrust accused its rival of using a questionable tax shelter on certain real estate leasing transactions. The letter suggested that First Union could have “significant exposure” to what the Internal Revenue Service has called a “tax avoidance” transaction and that First Union’s capital position could be in doubt.

First Union angrily rebutted the accusation, and Robert Kelly, its chief financial officer, described the charge “as an act of desperation.” Since then the company has reportedly asked the Fed to discipline SunTrust for its allegations.

On Friday, to coincide with SunTrust’s earnings release, First Union made its ire a little more public with full-page ads in American Banker, The Wall Street Journal, and other major newspapers.

Under the heading “Six Things SunTrust Won’t Be Talking About Today,” First Union made some accusations of its own, including the claim that a SunTrust/ Wachovia combination would create “serious regulatory capital concerns.” In the ads, First Union says the Tier 1 capital ratio —- a measure of a banking company’s financial health — of a combined SunTrust/Wachovia, which SunTrust projects at 6.5%, would put it “dead last” among the nation’s top 50 banking companies. Mr. Humann addressed First Union’s ads during the Friday conference call: “We should accommodate our new-found analyst community at First Union and Wachovia.” He then dismissed the ads as an effort to undermine SunTrust. He later reiterated that he would not increase his bid for Wachovia. “We have said so many times I can’t count them, that any change in our offer would be bidding against ourselves, and we have no intention of bidding against ourselves.”

But Mr. Bove said SunTrust could wind up as a victim of its own success. Its financial health, as evidenced by its solid performance in the mortgage sector and its improved net interest margin, could be jeopardized if it persists in its bid, he said.

“One thing that SunTrust has going against them is that they run a terrific bank, and one of the fears is that they will ruin it by buying Wachovia, which is a troubled bank,” Mr. Bove said.

But even “terrific” banks have their weak spots. SunTrust’s nonperforming assets rose 17%, to $35 million. The company cited loans to two companies — Warnaco Inc. and USG Corp. — as the primary cause for the rise. However, “their coverage ratio is 2-to-1,” Mr. Bove said, and SunTrust sold some problem loans during the quarter.

For reprint and licensing requests for this article, click here.
MORE FROM AMERICAN BANKER