SunTrust Cleans House (Update 1)

Updated with early price action and comment from BMO Capital Markets Analyst Lana Chan about her upgrade of SunTrust.

NEW YORK ( TheStreet) -- SunTrust ( STI) late on Thursday announced a series of major steps to move beyond the credit crisis.

The Atlanta lender is accelerating the sale of its 2.33% stake in Coca Cola ( KO), moving up two variable forward purchase agreements (VFPAs), through which SunTrust was to sell its Coke shares in two blocks in 2014 and 2015, or deliver equivalent cash, to "an unaffiliated third party." Under the original agreements, the third party was to pay between $19 and $33 dollars per Coke share.

Coke's shares closed Thursday at $38.15. Because the Federal Reserve's proposed rules to implement the Basel III capital requirements "would increase the risk-weighted assets of equity holdings and introduce potential volatility to SunTrust's regulatory capital ratios," while also increasing uncertainty in the annual regulatory stress test process, the company "and the counterparty accelerated the termination of the VFPAs, and SunTrust sold in the market or to the counterparty 59 of its 60 million shares of The Coca-Cola Company."

SunTrust said it was contributing the remaining one million Coke shares -- valued at $37 million -- to its charitable foundation.

The company also announced it would transfer roughly $3 billion in loans to held-for-sale, including performing student loans and nonperforming residential mortgage and commercial real estate loans, resulting in pre-tax charges of $250 million.

SunTrust will also sell about $200 million in affordable housing investments, resulting in a pre-tax loss of about $100 million.

Taken together, the actions will result in a pre-tax gain of $1.9 billion, or $1.2 billion after taxes. Because the Federal Reserve "granted SunTrust Tier 1 common capital credit of approximately $730 million," under the original agreements to sell the Coke shares, the company said that its Tier 1 common equity would increase by $490 million.

Investors reacted by sending SunTrust's shares up 4% in early trading, to $27.75.

SunTrust's balance sheet moves are taking place as the company continues trying to move beyond the housing crisis, also announcing on Thursday that "in light of ongoing discussions with Fannie Mae ( FNMA) and Freddie Mac ( FMCC), the Company expects to record an estimated $375 million mortgage repurchase provision" during the third quarter, which is "expected to be sufficient" to cover mortgage putback demands on loans sold to the government-sponsored mortgage giants prior to 2009.

On Aug. 22, SunTrust announced that the Federal Reserve had approved the company's revised capital plan, although the company "did not request an increase in its common stock dividend or the repurchase of shares of its common stock in 2012." The company's initial 2012 capital plan was partially rejected by the Fed back in March, with the regulator agreeing to the company's plan to redeem trust preferred shares, but objecting to any common share buybacks or an increase in the dividend on common shares.

SunTrust's shares closed at $26.68 Thursday, returning 52% year-to-date, following a 40% decline during 2011. The shares trade for 10 times the consensus 2013 earnings estimate of $2.63 a share, among analysts polled by Thomson Reuters.

FBR analyst Paul Miller on Friday reiterated his "Market Perform" rating for SunTrust, saying "we applaud management's actions as this should reduce the potential for volatility in SunTrust's securities portfolio, accelerate credit improvement, and more aggressively reserve for mortgage repurchase claims."

Miller said that the $375 million mortgage putback provision was likely to cover any loan repurchase losses over the near term and "eliminate the overhang on the company's strong mortgage banking operations," but the analyst also said "the real question is, Will this solve the company's long-term GSE and private-label repurchase liabilities problems? We believe that it is too early to tell as reps and warrants are a long-term liability that is not yet fully understood."

While maintaining his neutral rating, Miller raised his price target for SunTrust by four dollars, to $27, or roughly 1.1 times the analyst's estimated Sept. 30 tangible book value of $25.41.

Miller now estimates that SunTrust will report earnings of $2.06 a share for the third quarter, with an operating loss of 16 cents a share. For all of 2012, the analyst estimates EPS of $3.71, with operating EPS of $1.45. For 2013, Miller raised his EPS estimate to $3.10 from $2.65, because of an estimated reduction in mortgage repurchase losses "going forward, but we would note that we still forecast approximately $250 million of repurchase losses for FY13."

Jefferies analyst Ken Usdin reiterated his "Buy" rating for SunTrust, while raising his price target for the shares by a dollar to $29, viewing the "Coke sale and balance sheet derisking as a modest positive as it eliminates the mortgage repurchase overhang and creates a cleaner earnings run-rate for '13."

Usdin raised his 2013 EPS estimate for SunTrust by a dime, to $2.75.

Regarding the transfer of loans to held-for-sale, the analyst said "we assume that $500mm-$700mm of the $3B in loans are nonperforming, with the remainder being government guaranteed lending."

Usdin also said that SunTrust's announced actions would be "slightly dilutive to tangible book" value and its Basel III Tier 1 common equity ratio, with tangible book value moving "$0.75-$1.00 lower given that gains from the Coke transaction already showed up in accumulated other comprehensive income," and the estimated Basel III Tier 1 ratio declining to 7.9% from 8.0% in June.

BMO Capital Markets analyst Lana Chan upgraded SunTrust to "Outperform," from "Market Perform," while raising her price target for the shares to $35 from $26, saying that "we acknowledge that we missed the 50% move up in the stock YTD; however, STI's valuation remains one of the cheapest among the regional banks."

Chan raised her 2013 EPS estimate for SunTrust to $3.00 from $2.65, "driven mainly by lower than anticipated mortgage repurchase costs."

The analyst said her price target was "based on a target price-to-tangible-book multiple of 1.2x our year-end 2013 tangible book value estimate of roughly $29 per share," adding that "the multiple should expand to be in line with peers given an improved outlook for its return on tangible common equity of nearly 11% (in line with the regional bank group average)."

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-- Written by Philip van Doorn in Jupiter, Fla.

>Contact by Email.

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., 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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