SunTrust's Putbacks Starting to Look Like a Trend

If the government is bent on winding down Fannie Mae and Freddie Mac sooner rather than later, then it helps that some major lenders are committing to buy back soured loans from the government-sponsored enterprises all at once, rather than quarter by quarter.

What's unclear is whether banks with significant mortgage exposure will follow the lead of SunTrust Banks (STI), First Horizon (FHN) and PNC Financial Services Group (PNC), or continue to repurchase problem loans in a more piecemeal fashion. Many analysts believe that Fannie and Freddie are showing an increased willingness to work with banks to determine their level of exposure, but note that banks risk angering investors if they take a massive charge in one quarter only to see more problems crop up in future ones.

"SunTrust and First Horizon say they've now capped their costs and that the next quarter [they will] really just have residual charges," says Chris Marinac, managing principal and director of research at FIG Partners in Atlanta. "But there is an audience that doesn't believe them."

For now, though, the banks appear to be getting the benefit of the doubt. SunTrust's shares rose sharply early Friday following the company's announcement Thursday that it would repurchase $375 million from the GSEs this quarter as part of a broad balance-sheet restructuring that included the sale of 59 million of its shares in Coca-Cola. Several analysts responded to the news by raising earnings estimates for this year and next.

First Horizon and PNC made similar moves in the second quarter, and like those companies SunTrust said its action would improve its risk profile while providing investors with clearer earnings guidance going forward.

"With [SunTrust] now front-loading the pain, this meaningfully eases the drag on future quarters," Kevin Fitzsimmons, an analyst at Sandler O'Neill, wrote in a research note to investors Friday.

SunTrust said it opted to increase its repurchase reserve in the third quarter following discussions with Fannie and Freddie. The majority of the provision relates to loans sold to the GSEs before 2009.

Fannie and Freddie could be under some political pressure from their regulator to be more "cooperative" in helping banks assess their level of exposure as the government looks to wind down Fannie and Freddie, Fitzsimmons says. The Treasury Department said last month it will now hold on to all the GSEs' profits, rather than pay them a dividend, a move that will reduce capital levels and accelerate the shrinkage of their balance sheets.

The GSEs may also be more willing to sit down with the banks simply because they've now got more information to work with, others say.

"They should be able to know or dive in and have a good feeling for what loans they can push back at these banks," says Marty Mosby, an analyst with Guggenheim Partners. "So they can start working with the banks to know what the potential future exposure looks like."

For a bank like SunTrust, with a strong capital position, the decision to take the brunt of mortgage repurchase losses in a single quarter makes strategic sense, Mosby says.

"Taking a onetime charge depresses the capital ratio, but it generates future earnings potential when you recapture that going forward," he says. "If you have capital to spend, it makes a lot of sense."

Gerard Cassidy, managing director for bank equity research at RBC Capital Markets, says that SunTrust was able to set aside $375 million because it had a significant asset to sell — the Coke stock — that more than offset the hit. Other banks might not have that luxury, he says.

Larger companies might have a harder time getting their arms around the scope of their exposure and might be better off addressing it quarter by quarter rather than in one fell swoop, Cassidy says.

Still, he says, the market reaction to SunTrust's announcement might change some banks' thinking. The stock rose nearly 5% early Friday before retreating somewhat in the late afternoon. It was trading at $27.46 late Friday, up nearly 3%.

"Based upon the reaction of the stock today, it might encourage others to think about this," he says.

Paul Miller, an analyst at FBR Capital Markets, says he is not sure other banks will mimic SunTrust and First Horizon because most believe that they have a handle on their exposure to GSE repurchases and are not under any particular pressure from investors to take action. But he remains skeptical.

"There is a surprise lurking out there, and we don't know where it is," he says.