3 Ways SunTrust Banks, Inc. Is Beating PNC and KeyCorp

Banks earnings quality continue to suffer.

May 10, 2014 at 7:29AM


If you thought things were only looking up when PNC (NYSE:PNC), KeyCorp (NYSE:KEY), and Suntrust Banks (NYSE:STI) all reported quarterly profits above estimates, think again.

Yet when focusing on how, rather than by how much, these institutions beat their respective estimates, it is clear the industry continues to face major headwinds.

After all, PNC. Key, and SunTrust each reported quarter over quarter revenue drops in the first quarter of 2014, thanks largely to tight interest rate spreads and lower mortgage refinancing activity.

While many factors collectively offset the revenue declines, including the slashing of payrolls and the shedding of peripheral businesses, banks like PNC, Key, and SunTrust continue to rely on the release of loan loss reserves accrued during the height of the financial crisis to bolster their bottom lines.

What are reserves?
A bank's reserves are money set aside to account for loans that ultimately are not repaid. The release of reserves therefore, indicates that a bank is optimistic that fewer loans will go bad in the future.

This can be a positive signal to the market because reserve releases typically coincide with economic expansion and lower unemployment, they also have the added benefit of bolstering a bank's earnings. In fact, the amount released flows straight to a bank's bottom line.

Unfortunately, the release of reserves is not a substitute for genuine growth. Sooner or later, a bank runs out of reserves to release, and further cuts cannot be made without reducing outstanding loans. In fact, the slashing of loan loss reserves may be near its end.

Since the end of 2008, PNC, Key, and SunTrust have reduced their loan loss reserves by 20%, 36%, and 15%, respectively.

While these reductions are undeniably attributable, in part, to the implementation of more conservative lending guidelines since the financial crisis, all three of these institutions have cut their respective reserves by at least 10% in the last 12 months alone. In consequence, they will need to find new avenues, namely top line growth, to boost future EPS figures.

SunTrust's outshines its peers
With that in mind, it's rather startling to note that the release of loan loss reserves accounted for 6.5% and 4.2% of PNC and Key's respective first quarter pre-tax incomes, compared to only 1.5% for SunTrust. More troubling for PNC and Key is the fact that SunTrust's 3% quarter over quarter decline in non-interest revenue, driven by lower mortgage servicing fees, compares favorably to the 12% and 4% declines reported by PNC and Key, respectively.  

Given their reliance on the release of loan loss reserves to bolster EPS, perhaps it's no surprise that PNC and Key were only able to grow their outstanding loan portfolios by 1.3% and 1.8% in the first three months of 2014, compared to the 2.1% loan growth reported by SunTrust.

Furthermore, SunTrust managed this loan growth without relaxing its underwriting standards, as non-performing loans totaled only 0.72% of its outstanding loan portfolio at the end of the first quarter. PNC's non-performing loans account for 1.49% of its outstanding loan portfolio, compared to 0.81% for Key.

These considerations raise legitimate concerns for investors who have been, and will likely remain, reluctant to channel money into banks that are unable to demonstrate meaningful growth through their core lending operations.

This is especially true given the recent release of sluggish economic growth data, which suggests that the Federal Reserve will continue to keep short-term interest rates low through at least 2014.

As banks and the financial industry as a whole continue to shift their focus from a defensive to offensive strategy, investors will similarly concern themselves with the quality of an institution's earnings, rather than simply the extent of those earnings.

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Erik Knight has no position in any stocks mentioned. The Motley Fool owns shares of KeyCorp and PNC Financial Services. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Jun 12, 2015 at 5:01PM

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