SunTrust's Earnings Show Squeeze

Meanwhile, Commerce Bank posts sharply higher profits.
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Updated from 9:33 a.m. EDT

The bank earnings season kicked off Thursday with

SunTrust

(STI) - Get Report

, the nation's 10th largest bank, reporting a 7.5% gain in first-quarter profits, amid signs that low interest rates are beginning to eat into lending margins.

The Atlanta-based regional earned $327.8 million in the quarter, or $1.17 a share, compared with $304.9 million, or $1.06 a share, a year ago. The bank's earnings beat the Thomson Financial First Call consensus estimate by 2 cents.

But the bank's performance wasn't as strong as it might first seem. On an operating basis, the bank earned $344.7 million in last year's quarter, 5% higher than this year. And last year's numbers were weighed down by $39.8 million charge stemming from a bank acquisition in Florida.

"Once again, like everybody else in our industry, we're reporting bottom line results that reflect the effects of a still slow economy,'' said SunTrust Chairman and Chief Executive Office Phillip Humann, in a prepared statement.

Wall Street, however, focused on SunTrust beating the consensus estimate, and the stock rose $1.90, or 3.7%, to $53.47.

Many banking analysts are expecting the first quarter to be a rocky one for the nation's lenders -- especially regional banks that rely heavily on their lending operations. The problem for banks is that low interest rates are beginning to put a crimp in net interest income -- the difference between the amount of money banks earn on loans and their own borrowing costs.

Indeed, some of that squeeze on net income margins showed up in SunTrust's first quarter numbers. It's net interest margin -- a ratio that reflects the difference between what a bank pays on deposits and earns on loans -- declined by 8.5% in the year-over-year period to 3.21%

In terms of actual dollars-and-cents, the bank took in $833 million in net interest income, a 3.1% gain over a year ago, but essentially flat with the fourth quarter of 2002.

SunTrust executives, in a conference call with analysts, said the bank could face even greater margin pressure later this year, if the Federal Reserve decides to cut interest rate to spark the economy.

In another important measure of a bank's fiscal strength, SunTrust's tier 1 capital ratio declined by 5% to 7.35 from the first quarter of 2002. Tier 1 capital ratio is one way of measuring a bank's ability to absorb losses.

But it wasn't all bad news for SunTrust. The bank made substantial improvement in reducing the dollar value of bad loans in its portfolio. Compared to a year ago, SunTrust listed $548 million in loans as nonperforming, which is to say, in danger of default. That's down 5% from a year ago.

Last year many banks took significant charges against earnings to write down billions of dollars in bad loans to businesses and consumers.

In light of the decline in nonperforming loans, the amount of money SunTrust set aside for credit losses in the quarter declined to $80 million, a 50% reduction from a year ago. That went along way in helping SunTrust generate the 7.5% gain in net income in the quarter.

SunTrust wasn't the only important regional lender to report earnings on Thursday.

New Jersey-based

Commerce Bank

(CBH) - Get Report

, one of the nation's fastest-growing banks, reported a 35% gain in first-quarter profits. The bank earned $43 million, or 60 cents a share, compared to $31.7 million, or 45 cents a share last year.

The First Call consensus estimate called for Commerce to earn 58 cents a share.

The bank, in an earnings release, said it expects to grow earnings by an average of 25% this year -- something it has said before.

But Commerce also is feeling some margin compression in its lending operation. The bank's net interest margin in the quarter was 4.6%, compared to 4.85% a year ago. The bank reported generating $167 million in net interest income, a 35% gain from a year ago. But much of that gain can be attributed to the bank's rapid expansion in the New York City area.