SunTrust Banks ( STI) on Thursday followed the pattern for many large regional banks, reporting a steep drop in third-quarter net income vs. the prior quarter and the same period last year.

SunTrust posted a profit of $312 million, a decline of 42% on a linked-quarter basis and 26% from the third quarter of 2007. Net income available to common shareholders was $307 million, or 88 cents per average common diluted share, coming in ahead of the Thomson Reuters analyst consensus estimate of 60 cents per share.

Shares were down 7.9% in recent trading, to $36.95, with investors concerned that while the Atlanta holding company's overall capital position is strong when compared with most other large regional banks, its credit quality has continued to rapidly deteriorate in the third quarter, with major exposure in its home market of Georgia and Florida.

The decline in net income from the second quarter mainly reflected the $550 million in gains on securities, mainly from the sale of shares in the he Coca-Cola Co. ( KO). SunTrust's divestiture of its Coke holdings was completed on July 15, and securities gains in the third quarter totaled $173 million.

The increase in SunTrust's provision for loan losses to $504 million from $448 million in the second quarter also affected earnings, although the provision was lower than the peak of $560 million in the first quarter. Of course, elevated provision for reserves was the main factor in the year-over-year earnings decline, since the provision was only $147 million in the third quarter of 2008.

Capital

Because of the Coke sales, SunTrust's capital ratios have improved over the last three quarters. The company's leverage ratio was 7.95% as of Sept. 30, up from 7.54% last quarter and 7.28% in September 2008.

SunTrust has not lowered its dividend on common shares, which is 77 cents per quarter, for a yield of 7.4% on yesterday's closing price of $40.13.

CEO James Wells III said SunTrust was applying to the Treasury's troubled asset relief program, or TARP, and was continuing to consider its dividend policy. Wells said he "would clearly expect for us to deploy that capital ... if the company were actually to issue the preferred stock."

Wells said the company would look to use the capital "through organic growth, through potential purchases of different assets as well as pursuing potential acquisitions."

Asset Quality

SunTrust excludes loans past due 90 days, but still accruing interest, from its reported nonperforming loans. We have included these balances in the table below.

Click here for larger image.
Source: Company earnings releases

The company's reported nonperforming loans, mainly categorized as nonaccrual, meaning the company doesn't expect principal and interest to be repaid, totaled $3.3 billion as of Sept. 30, an increase of 26% from last quarter.

Including restructured loans and loans past due 90 days but still accruing interest, SunTrust's nonperforming assets ratio climbed to 2.77%, from 2.19% in June and 0.93% in September 2007.

Net loan charge-offs totaled $392 million for the third quarter, up from $356 million last quarter, with the bulk of the charge-offs coming from the company's residential portfolio.

SunTrust's provisions for loan losses exceeded its net loan charge-offs for the third quarter, and its ratio of loan loss reserves to total loans was 1.54% as of Sept. 30, keeping it ahead of the annualized ratio of net loan charge-offs to average loans, which was 1.08% for the third quarter.

The company's third quarter presentation listed several steps taken to reduce credit exposure, including limiting total loan-to-value to 85% for home equity borrowers and reducing third party home equity loan originations and increasing credit score requirements.

Philip W. van Doorn joined TheStreet.com Ratings., Inc., in February 2007. He is the senior analyst responsible for assigning financial strength ratings to banks and savings and loan institutions. He also comments on industry and regulatory trends. Mr. van Doorn has fifteen years experience, having served as a loan operations officer at Riverside National Bank in Fort Pierce, Florida, and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a Bachelor of Science in business administration from Long Island University.

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