SunTrust Shines Up Balance Sheet Ahead of Wachovia Battle

SunTrust (STI) spent Friday serving up solid second-quarter earnings and saying nasty things about First Union (FTU).

By most accounts, SunTrust delivered a strong quarter, posting a profit of $1.19 a share, 3 cents better than the Thomson Financial/First Call consensus, and 13% higher than the year-ago $1.05. Businesses including mortgage production bolstered the bottom line. SunTrust also moved to shore up its balance sheet against credit quality and interest-rate worries as a proxy fight shapes up with First Union, its rival in the fight for Wachovia (WB).

Nonperforming assets, those that are past due but haven't been written off, jumped 17% from the prior quarter, to $431.4 million. On a conference call with investors and analysts, a SunTrust spokesman said the bulk of the increase was due to two large credits, both of which are in bankruptcy proceedings. The bank identified the companies as Warnaco (WAC) and USG (USG).

Primping for an Aug. 3 vote by Wachovia shareholders on the First Union deal, SunTrust spent much of the last quarter prettifying its balance sheet. It sold off about $73 million in loans in the latest quarter, compared with $57 million in nonperforming loans sold in the first quarter. In addition, SunTrust sold the assets and liabilities of its SunTrust Credit unit at an $11.3 million after-tax loss. The unit made higher-yielding loans to small businesses with limited credit access. Last, the company "repositioned its balance sheet" in order to minimize its interest-rate sensitivity, by repaying some long-term debt and shortening the average life of its investment portfolio.

What Now?

On the earnings call, some questions focused on whether SunTrust will eventually sweeten its bid, now that the premium on its unsolicited bid has shrunk to almost nothing. SunTrust stood by its position, which is that it will not raise its offer.

When SunTrust bid for Wachovia in April, its offer represented a 17% premium to First Union's negotiated deal. But SunTrust's stock promptly plunged as investors feared the acquisition would dilute shares; as a result, the premium shrank to 6% by the end of the day of the bid. Subsequent SunTrust weakness and First Union strength have made the value of the bids virtually indistinguishable.

Based on recent prices, SunTrust's offer is worth a mere 1.3% more than First Union's. On the call Friday, analysts bandied about a 7% figure as the spread SunTrust would need to start enticing Wachovia shareholders to its offer. The SunTrust bid is currently worth about $14.5 billion, while the First Union offer is worth about $14.3 billion.

But SunTrust stood firm. One participant on the call asked SunTrust if it would stand by its stated intent not to raise its bid even if the spread hasn't improved a week or two before the Wachovia shareholder vote. "Absolutely," said SunTrust CEO Phil Humann.

Mud Bath

Near the end of its earnings presentation, SunTrust addressed a First Union ad that appeared Friday in some papers. SunTrust quipped it would accommodate its "newfound analyst community at First Union" and went on to address six issues that the First Union ad asserted SunTrust wouldn't discuss, regarding dividends, capital position and earnings growth.

After a week in which SunTrust accused First Union of using an illegal tax shelter, Ryan Beck banks analyst Nancy Bush wondered when the back-and-forth might turn into "mutually assured destruction."

Not quite yet, apparently. Friday afternoon, on a sharp down day for stocks, SunTrust fell $1.55 to $63.58, First Union dropped 52 cents to $33.91 and Wachovia slid $1.53 to $69.07.

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