I would like to welcome everyone to the Comerica's third quarter 2008 earnings conference call. (Operator Instructions) I would now like to turn the conference over to Miss Darlene Persons, Director of Investor Relations.
Good morning and welcome to Comerica's third quarter 2008 earnings conference call. This is Darlene Persons, Director of Investor Relations. I'm here with Ralph Babb, Chairman and Chief Executive Officer, Beth Acton, Chief Financial Officer and Dale Green, Chief Credit Officer.
A copy of our earnings release, financial statement and supplemental information is available on the SEC's web site as well as on our website. Before we get started, I would like to remind you that this conference call contains forward-looking statements and in that regard you should be mindful of the risks and uncertainties that can cause future results to vary from expectations. Our filings from the Safe Harbor statement contained in the earnings release issued today are incorporated into this call as well as our filings with the SEC.
Now I'll turn the call over to Ralph.
We are pleased by the announcement from the Treasury Department, the Federal Reserve and the FDIC which are aimed at restoring liquidity to the market place and boosting consumer confidence. Subject to review of the final details, we intend to remain in the FDIC temporary liquidity guarantee program beyond the 30 day initial period. We are also reviewing and evaluation the Treasury Departments capital purchase program.
In an economic environment that is as challenging and volatile as any we have ever seen, Comerica's core operating earnings remain stable compared to the two prior quarters. As expected, net credit related charge offs and the provision for loan losses were unchanged. Maintaining a solid capital position in this uncertain environment is prudent. It provides us the flexibility to navigate the swift economic currents and continue to invest in our growth markets.
We are therefore, taking actions to improve our capital ratios and enhance our balance sheet strength including a previously announced intention to reduce our dividend and the execution of a loan optimization program.
As part of the loan optimization program, we are focused on the appropriate loan pricing and return hurdles with the aim to optimize the revenue per relationship. The program is working and producing the desired results and our process ensures we take care of our relationship customers.
Our third quarter earnings per share of $0.18 were impacted by a $0.40 after tax charge related to a previously announced offer to repurchase at par, auction rate securities from our retail and institutional clients. We know our clients holding auction rate securities have been facing unprecedented market conditions, so we sought relief for them in a prompt and appropriate manner.
Our net interest margin of 3.11% or 3.17% excluding the charge to interest income on certain structured lease trends reflects improved loan spreads and lower deposit rates. As expected, net credit related charge offs were similar to the first and second quarters at $116 million or 90 basis points of average total loans.
Net charge offs related to western market residential real estate development were lower, reflecting our aggressive management of this portfolio. As expected, we are seeing softness in small business and middle market which is consistent with our outlook. We continue to provide for loan losses in excess of charge offs.
Our core expenses remain well controlled. We have reduced our personnel by about 3% from a year ago and by almost 2% from the second quarter, even as we continued our banking center expansion program. In response to our loan optimization program, average loans decreased 7% on an annualized basis compared to the second quarter.
On an annualized basis non interest bearing deposits excluding the financial services division increased 13% compared to the second quarter. We gained momentum in our deposit gathering toward the end of the quarter as evidenced by the increase in period end core balances.
We are encouraged by this trend as the last four weeks have been the best of the year with respect to net new retail customers. We opened eight new banking centers in the third quarter and plan to open 15 more by year end. All of the 28 banking centers we expect to open in 2008 will be in our higher growth markets. We plan to open about 17 new banking centers in 2009.
Looking ahead, we will remain vigilant in managing our problem loans and our capital while working our way through this particular cycle of the economy. Our core operating performance has been stable this year. Our strong focus on customer service will continue to serve us well in this environment as it has over many years and through various cycles of the economy.
And now I'll turn the call over to Beth and Dale who will discuss our third quarter results in more detail.
As I review our third quarter results, I will be referring to slide we have prepared that provide additional details on our earnings. Turning to Slide 3, we outline the major components of our third quarter results compared to prior periods. Today, we reported third quarter 2008 earnings per share from continuing operations of $0.18. This included a $0.40 per share charge related to our previously announced offer to repurchase at par auction rate securities from our customers.
Core operating results were consistent with the last two quarters. Net charge offs and provision, the net interest margin and our capital ratios excluding the impact of the auction rate securities repurchase all were in line with our expectations.
Slide 4 provides the after tax impact of certain items on income and operations. The third quarter was impacted by the private sale of our remaining Visa shares, $0.11, and the second quarter was impacted by the sale of Master Card shares, $0.06. Third quarter earnings were also impacted by a $61 million after tax charge, $0.40 related to the repurchase of auction rate securities which I'll provide further detail in a moment.
Third quarter and second quarter earnings were impacted by tax related leasing charges, $0.04 and $0.21 respectively. Excluding the net interest income component of the leasing charges, net interest margin would have been 3.17% for the third quarter and 3.10% for the second quarter.
Slide 5 provides an overview of the financial results from the quarter. In line with our loan optimization strategy average loans outstanding are 7% on an annualized basis. We are making headway in our efforts to increase loan spreads and relationship returns as well as remain selective in terms of new business as this is prudent in an increasingly challenging economic environment.
Non interest bearing deposit generation excluding the financial services division was excellent and gained momentum toward the end of the quarter. Interest margin in the third quarter was 3.17% excluding the effect of the six basis point tax related leasing charge. The higher margin reflected better loan spreads as well as lower deposit rates.
Net credit related charge offs and provisions were stable with continued weakness evidenced in residential real estate development. Provision for loan losses for the third quarter was $165 million compared to $170 million in the second quarter. The allowance to total loans increased in the third quarter to 1.38% compared to 1.28% last quarter as we continue to provide for loan losses in excess of charge offs.
We continue to carefully control expenses and excluding the effect of the auction rate securities repurchase, expenses declined. Salary expenses remain flat as head count decreased by almost 2% in the quarter. Our tier one capital ratio of 7.35% was within our targeted range.
Turning to Slide 6 and the details behind our recently announced repurchase of auction rate securities held by our customers, we estimate that the par value of auction rate securities held by customers at September 30 totaled $1.5 billion. Based on the current market conditions and an assessment by third party valuation experts, we incurred a $61 million after tax charge in the third quarter, primarily reflecting the difference between par and fair value.
The final estimate of the charge was reduced to $0.40 per share from $0.50 per share at the time of the announcement as a result of completed a detailed review of the securities. The repurchase of these securities will occur between October 1 and December 19. We will hold these assets in the available for sale account on our balance sheet.
The current yield is in excess of our funding costs therefore we expect they will accreted to net income going forward. The underlying assets consist of preferred stock closed end mutual funds, municipal bonds and a small portion of student loans. All are generally of good credit quality but lack a liquid market to sell them.
Turning to Slide 7, net interest income in the second and third quarters were impacted by a non-cash charge to lease income. In the third quarter we accepted a global settlement offered by the IRS on certain structured leasing transactions. Excluding the impact from the lease income charge, the net interest margin was 3.17% the third quarter, up seven basis points from the second quarter reflecting higher loan spreads and lower deposit rates.
As part of our interest rate risk management strategy, we added $900 million of two-year interest rate swaps in the third quarter plus an additional $200 since the beginning of October. This is in addition to the $8 billion securities portfolio which assists us in mitigating our asset sensitivity.
Moving to the balance sheet and Slide 8, compared to the prior year, average loans increased $1.6 billion or 3% paced by a 12% increase in our Texas market. We continue to make steady progress toward our goal of achieving more geographic balance with markets outside of the mid west now comprising 63% of average loans. In addition, our loan portfolio is well diversified among many business lines.
As I mentioned a moment ago, average loan outstanding declined $859 million or 7% on an annualized basis in the third quarter compared to the second quarter as we work to optimize our loan portfolio. On a linked quarter basis the largest decreased were noted in national dealer services, $568 million, middle market, $404 million and energy, $134 million.
Loan commitments declined $2.6 billion in the quarter. This exceeded the decline in draws under the commitments with a net effect of an increase in line utilization by over 51% at the end of the third quarter. Increased line utilization was focused in the areas where we maintain large corporate relationships and we believe the increased utilization can be partly attributed to the dysfunctional credit market.
Now Dale Green, our Chief Credit Officer will discuss recent quality trends, credit quality trends, starting on Slide 9.
Net credit related charge offs and provisions in the third quarter remain stable. Our biggest challenge continues to be the ongoing issues in the residential real estate development portfolio which is part of our commercial real estate line of business. In addition, as expected given the challenges in the economy, we have started to see some softness in middle market and small business but the issues remain within our expected ranges.
Net credit related charge offs were $116 million in the third quarter. Net charge offs included $57 million in the commercial real estate line of business primarily related to the California residential real estate development sector. This is a decrease from the $73 million in net charge offs for this line of business in the second quarter. Provision for credit losses of $174 million exceeded credit related charge offs of $116 million.
Turning to Slide 10, non-performing assets were 171 basis points of total loans and property or 76 basis points excluding the commercial real estate line of business. Our watch loans were $5.5 billion or 10.6% of total loans up from 9.3% in the second quarter. Loans past due 90 days were more and still accruing of $97 million at September 30, decreased from $112 million at June 30.
These loans are in the process of being restructured, continue to pay interest and are expected to continue to pay interest on a restructured basis.
The allowance for loan losses was 1.38% of total loans an increase of 10 basis points from the second quarter. The allowance for loan losses was 82% of non-performing loans. Comerica's portfolio is more heavily composed of commercial loans which in the event of default, are typically carried on the books as non-performing assets for a longer period of time than our consumer loans which are typically charged off when they become non-performing.
Therefore, banks with a heavier commercial loan mix in their portfolios tend to have MPA coverage ratios than do retail focused banks. In addition, we have written down our non-accrual loans by almost one-third.
Excluding western residential real estate, MPA coverage for the remainder of the portfolio is in excess of 100%. With regard to western residential real estate, we have obtained independent appraisals and taken the appropriate charge offs and provided additional reserves. As we apply stress scenarios to this portfolio, we are comfortable with our reserve coverage.
On Slide 11, we provide information on the make up of the non-accrual loans. Commercial real estates which consists primarily of residential real estate development loans comprise the largest portion of the non-accrual loans. By geography, almost half of the non-accruals are in the western market.
As far as granularity in non-accrual loans, there are 22 relationships totaling $295 million that aggregates between $10 million and $25 million each, and there are only two relationships over $25 million. The average write downs of non-accrual loans was 32%.
Transfers to non-accruals slowed in the third quarter, $280 million in loans, greater than $2 million transferred to non-accrual status. This is a reduction from the $304 million transferred into non-accruals in the second quarter. Commercial real estate line of business accounted for $145 million or 52% of the transfers to non-accrual, down $43 million from the second quarter.
On Slide 12, we provide a break down of net charge offs by geography. Net charge offs in the western market which comprise 44% of net charge offs in the quarter can be largely attributed to the residential real estate development portfolio. Net charge offs for the mid west, which made up 38% of the total was primarily comprised of $20 million in middle market and $11 million in commercial real estate line of business.
Mid west charge offs were relatively stable as we have been dealing with the challenges of the mid west economy for the past several years.
On Slide 13, we provide a detailed break down by geography and project type of our commercial real estate line of business which was relatively unchanged from the prior quarter. There is further detail provided in the appendix to these slides.
At September 30, 45% of this portfolio consisted of loans made to residential real estate developers secured by the underlying real estate. Geographically, the western market, California primarily, comprised 44% of the total portfolio.
On Slide 14, we provided the geographic break down of the commercial real estate loan line of business net loan charge offs over the last two quarters. Residential real estate development loans accounted for 97% of these charge offs in the third quarter. Deterioration in the California residential development portfolio has slowed as is apparent in the reduced level of net charge offs in the quarter as well as fewer inflows of non-accrual loans.
As far as the mid west, the net charge offs declined slightly in this quarter as we have been working through the issues of falling home prices and slower absorption rates in this portfolio for several years.
In the commercial real estate line of business, we transferred $145 million in relationships over to $2 million to non-accrual loans in the third quarter, down from $188 million in the second quarter and $233 million in the first quarter. 100% of these inflows to non-accrual in the third quarter were related to residential development. We have not seen any significant deterioration in non-residential real estate development.
The issues in California are centered in one area, the western local residential real estate developer portfolio which is outlined on Slide 15. This portfolio was focused on local, smaller residential developers which built starter and first time move up homes. We continue to make progress in reducing the portfolio which has about $625 million outstanding as of September 30, down from $932 million at December 31, 2007.
This portfolio accounted for 34% of the bank's non-accrual loans and 94% of the western markets commercial real estate line of business net charge offs of $39 million in the third quarter. We continue to obtain updated, independent appraisals and take the appropriate charge offs and reserves to reflect current market values.
Average charge offs plus reserves for the loans that would be generally defined as sub-standard and doubtful loans is approximately 42% of the contractual value which is an increase from about 40% at the end of the second quarter. Loan sales and foreclosures involving real estate involve a lengthy process; however, we expect to complete the sale of some of these assets in the fourth quarter.
Slide 16 provides an overview of our consumer loan portfolio which includes the consumer and residential loan categories on the balance sheet. This portfolio is relatively small, representing just 9% of our total loans. These loans are self originated and are part of a full service relationship. The performance of our consumer portfolio has been stable.
Slide 17 provides detail on the recent performance of the automotive portfolio. Our dealer business is well diversified with nearly two-thirds of the portfolio located in the western market and over two-thirds of the portfolio with dealerships selling foreign name plates. These are long term relationships.
Many of our customers have diversified and operate multiple dealerships. We have not experienced a significant loss in the dealer portfolio in many years and the majority of the portfolio is of a well secured, floor plan nature. We expect it will continue to perform well.
Looking at our non-dealer automotive exposure, we have reduced our loan outstandings $188 million in the first eight months of 2008 and over one-third or $1.1 billion since the end of 2005. This portfolio now represents about 3% of our total loans and we plan to continue to reduce our exposure to the automotive sector.
Net accrual loans were only $9 million, down $4 million from the previous quarter and we had a small recovery in this portfolio in the third quarter. The performance of this portfolio continues to be excellent. However, given the challenges the sector faces, we added to our stress portfolio reserves in the third quarter.
To conclude, our outlook is for continued stability in net charge offs in the fourth quarter. We are clearly focused on the credit issues on the residential real estate development portfolio. We expect that the stress on the residential real estate sector will continue. However, the issues will start to fade as we continue to work through that portfolio. Based on recent appraisals and market conditions, we believe that we have taken the necessary charge offs and reserves.
Outside of residential real estate development, we are seeing some modest softening in middle market and small business. However, the issues remain manageable. Early recognition of issues is key. Therefore, we have stepped up frequency of our credit reviews in certain segments and we are moving credits to our work out group at the first sign of significant stress.
Now, I'll turn the call back to Beth.
Turning to Slide 18, average core account interest bearing deposits including the financial services division grew $279 million or 13% on an annualized basis. Core deposits exclude institutional CD's and foreign office time deposits. Non interest bearing deposits account for about 27% of our average total deposits.
Deposit competition became more intense in the third quarter. Mid to late in the quarter we increased rates moderately to remain in line with competition. As a result we saw excellent deposit growth toward the end of the quarter as evidenced by the increase in period end core balances.
Specifically on a period end basis, we saw an $836 million increase in core non-interest bearing deposits and a $401 million increase in customer CD's. We are encouraged by this trend as the last four weeks have been the best of the year with respect to net new retail customers.
On Slide 19, we've highlighted our diverse funding base. Liquidity and access to funds has become a hot topic as financial market conditions have changed significantly over the past few months and weeks. Overall, our access to funding has been good, particularly for shorter term funds as evidence by the fact that we funded $3.5 billion in senior debt and institutional CD maturities in the third quarter.
We have been regular participants in the Federal Reserves term auction facility and have tapped into the repo market through Comerica securities, as well as raised over $3.5 billion in retail brokered CD's since the beginning of October. Also, we joined the Federal Home Loan Bank in Dallas in February, and as of the end of the third quarter, we had $7.5 billion outstanding with a further $500 million drawn since the beginning of October.
These advances are at very attractive rates with maturities of one year to six years and we have significant undrawn capacity available.
On Slide 20, we provided an update on our capital optimization plan which we introduced last quarter. We are making headway in our efforts to optimize our loan portfolio. Loan commitments and outstandings declined in the third quarter while charge offs and the provision remain stable in a very challenging economic environment. The increased governance on loan pricing is also working, and we are starting to see the effects in spread improvement.
As far as expense control, we have consistently reduced personnel over the past several years and expect this to continue in conjunction with the loan portfolio optimization. In addition, we are slowing our banking center expansion and expect to open 17 new banking centers in 2009.
Turning to Slide 21, we believe we have a solid capital position as evidenced by the fact that we remain within our targeted ranges and well in excess of the regulatory minimum guidelines. We previously announced that it is the intention of our Board of Directors to reduce the quarterly dividend by [inaudible] commencing with the fourth quarter payment. The resulting capital retention will help us further enhance our balance sheet strength in this uncertain economic environment.
Also, through our loan optimization plan, we expect to further strengthen our capital ratios through the balance of 2008 and into 2009. Finally, the quality of our capital is strong, with the preferred stock accounting for only a relatively small percentage of our capital.
As Ralph mentioned, we are in the process of reviewing and evaluating the Treasury Department's capital purchase program.
Slide 22 updates our expectations for the full year 2008 compared to full year 2007. In conjunction with our loan optimization plan, we expect loan outstandings will decline over the remainder of 2008.
Our net interest margin outlook for the full year is about 3.10% excluding the second and third quarter tax related leased income charges. This decrease from our previous outlook of 3.15% largely reflects the 50 basis point reduction in the Fed funds rate announced last week. Our full year outlook for credit quality is for net credit related charge offs of $450 million.
We expect the stress in the residential real estate development market to fade as we continue to work through the issues. Our outlook incorporates softening in the middle market and small business portfolios. Also, our outlook is to maintain our tier one capital ratio within our targeted range.
Now, we'd be happy to answer any questions you may have.
(Operator Instructions) Your first question comes from David Rochester – FBR.
David Rochester – FBR
On your NIM guidance, what does another 50 basis point rate cut get you to on top of the one that we just had? Do you have a sense for that?
There would be further pressure on the margin, but it's hard to estimate that in a vacuum in the sense that there are so many moving parts related to it, including the reaction by financial institutions related to deposit pricing. We have a pretty conservative assumption in the outlook we gave you in terms of the ability to significantly impact deposit rates.
I think that's the key element that would be in play if there were a further decline. But obviously, given the nature of our balance sheet there would be a modest negative affect.
David Rochester – FBR
You had mentioned loan sales potentially in the fourth quarter. What kind of an attitude are you expecting or shooting for at this point.
We have said exactly what that will be, but it be primarily in the residential real estate portfolio where that portfolio is now about $625 million, and we've broken that portfolio into different segments for potential sale. So we would hope that a piece of that, and we're working on the details and amounts. They would be concluded in the fourth quarter.
Because there's a lot of things in play, I can't exactly quantify for you. It would probably be in the terms of number of loans, it would probably be 10 to 15 loans in that portfolio.
David Rochester – FBR
On the strong deposit growth you mentioned, what's your sense of where these deposits are coming from? Are they coming from larger banks, smaller banks, failed banks?
At times it's hard to tell. It comes from a variety of places and our goal here regardless of the competition is to make sure we're attracting customers to develop long term relationship with them, and that's our focus.
David Rochester – FBR
You mentioned stepping up credit reviews. Can you tell us exactly what that means and which areas you're doing this? Is this in certain industries or within the shared national credit portfolio, anything specific you can point to?
I would say that given the stress in Michigan, we're looking obviously all the time at real estate, but we're doing a little more frequent reviews in small business and middle market in terms of the types of things we're looking at. We're obviously trying to stay ahead of the issues and moving deals to special assets, our work out area, earlier. The whole intent is to make sure we're doing the right thing as soon as we see the deterioration.
David Rochester – FBR
The increase in the provision in the mid west, you're cited CRA in the global corporate, could you provide some color there as to the industries in which you're seeing that weakness on the global corporate side?
We don't really get into a lot of that. I think it's fair to say that given the distress in the market that whether it's small business or middle market, we're going to continue to see some softness. We're not really seeing any big significant issues in global corporate, but obviously those companies have been stressed a bit by what's been going on. Most of what you're seeing tends to be small business and middle market.
David Rochester – FBR
Texas, you talked about a provision build, loans have declined there, but you cited energy lending. Are you seeing any impact from the drop off in oil? Is that what that's linked to, or are there other things going on there?
That's not linked to the drop in oil prices given the way we manage our price stats for oil and natural gas. It's just that there's some softness in middle market in Texas. Texas is not unaffected by what's going on in the economy. But again, we're not seeing anything of significance. We are certainly seeing some of that softness occurring and therefore, we're providing some additional reserves.
David Rochester – FBR
Do you have any updated credit metrics from the shared national credit portfolio?
Everything that would have come out of that review would have been reflected primarily in the second quarter. As I've indicated in the past, clearly we're of the age of when we get those results. If we're not, we call to get the results, and most of the time, we do get them from the agent bank. So everything that has occurred in the shared national credit for us has been reflected certainly fully through the third quarter.
Your next question comes from Ken Zerbe – Morgan Stanley
Ken Zerbe – Morgan Stanley
Can you comment on the outlook for CNI given what's happening in the overall economy? There's two slides that actually stuck out for me. One was on the non-accrual loans, if you just look at middle markets, small business it looks like non-accruals were up over 30% and that bucket on a sequential basis. You also made another comment about CRE, CNO's being down sequentially, but given your overall sales were actually up, is it fair to assume that that exaggerated increase was driven by CNI charge offs rather than construction.
If you look at the overall level of charge offs, it's $116 million, clearly similar to first and second quarter, you can see that real estate line of business charge offs were down. Therefore you could see the charge offs in some of the other business lines were up. Again, you're seeing some softness in small business particularly in the mid west and the same would be true of middle market in the mid west.
We are obviously aggressively managing real estate, but also aggressively managing the middle market and small business portfolio which is why we've gone to more frequent reviews that I talked about earlier. But you have seen in fact, a bit of shift in where the charge offs are occurring.
Ken Zerbe – Morgan Stanley
The other question I had was on home builder portfolio. I think you said that you expect to sell some of those loans in fourth quarter, whereas your current statements were more than you expect to sell all of the loans in the quarter. I was hoping you could tell me what's changed on the margin to get you a little less confident that those can be sold quickly.
I don't believe that I've ever said that we were going to sell them all in the fourth quarter simply because that would be a lot to get accomplished in the market. I don't think it would absorb it in the way we want. We always talked about tiering the portfolio, really three different tiers in terms of how we would group these and we've been in the last year working to sell the bulk of those loans which we have in fact worked on in the last couple of quarters.
We would hope that piece, as I said earlier, 10 to 15 loans approximately would be able to be concluded in the fourth quarter.
Your next question comes from Steven Alexopoulos – J.P. Morgan.
Steven Alexopoulos – J.P. Morgan
When you stress the Michigan portfolio, in a recession scenario is there any merit that loans there will actually hold up better since that market's been weak for several years? Do you expect losses there to be just as much as the rest of the portfolio or possibly even more?
In commercial real estate in the mid west?
Steven Alexopoulos – J.P. Morgan
Specifically to your Michigan credit.
Not really. I think what we're seeing, it's not as though the issues there have suddenly emerged in the last year or two. As we've indicated, the recession there has been ongoing for six or seven years. We've been working those portfolios down. We had a larger auto book. As you can see, we've worked that down substantially and the credit metrics there are outstanding.
We have a dealer book there that those credit metrics are outstanding. So the real issue there tends to be more in the real estate space and we've worked down those portfolios. We get appraisals there like we do in other markets for real estate. We write them down to the appraised value to provide reserves and so forth, and then we stress it based on certain scenarios that we employ.
I think what you're seeing is fundamentally what we have been seeing there. It's softer in small business and middle market real estate tends to be the way it has been.
Steven Alexopoulos – J.P. Morgan
But no reason to think that that would hold up better than the rest of the portfolio given that it's been stressed?
I think it's going to be. We are seeing some improvements. We're seeing data that suggests that lower prices, residential real estate sales are actually increasing in Michigan. I wouldn't expect it to be significantly worse. It would be roughly the same as we're seeing elsewhere.
Steven Alexopoulos – J.P. Morgan
Are you becoming more extra sensitive with the loan optimization plan? Just curious why the move to reduce asset sensitivity just given where we are at the Feds fund rate.
As you know, earlier this year we significantly increased our investment portfolio to ensure as we go through cycles that we have less impact from lower rates. And in addition, I might mention that we had added $1.1 billion in swaps since the end of June, and that includes $200 million we did in the month of October.
So we're continuing to make sure we can continue to contain within our policy limits the asset sensitivity. We have seen growth in the last couple of months in our CD portfolio, particularly in the one year area, so those are fixed terms. That's good for liquidity but we have to manage around the interest rates related to fixed term CD's.
So we're seeing good growth there, and that's one reason we're continuing to make sure we're doing additional hedging as we go forward.
Your next question comes from Mathew O'Connor – UBS.
Mathew O'Connor - UBS
You mentioned that you raised about $3.5 million of brokered CD's in October. I was wondering what funding was replaced?
It goes into the general pool, and that's how we manage it. I think we feel very good about the variety of sources we have, be it Fed funds, be it repo, be it the new retail brokerage CD's, the home loan bank advances. We've actually done a good job of using the home loan advances to really help our one to six year, put maturities out and spread them out nicely over the next few years.
If you look in the third quarter, obviously we have seen institutional CD's lower on average in the third versus the second. All of those sources of funds that I just described would have certainly replaced those as well as we will be bringing on to the balance sheet the auction rate securities in the fourth quarter which is $1.4 billion.
Mathew O'Connor – UBS
It sounds like the core deposit was improved both in September and so far this quarter. If we look at the last couple of quarters they were down about 7%, 8% on an average basis. As you look to fourth quarter on an average basis, do you expect those levels to be up?
Prognosticating on the positive is always safe. We are encouraged at the traction that we've seen in the last six weeks or so.
We have maintained our rational pricing throughout that period as well, and as you may have seen and I'm sure everybody's aware, there's been in various markets pricing that has gone from the top to the bottom of the spectrum.
Mathew O'Connor – UBS
It seems like with the branch expansion that there might be more upward trajectory to the deposit ex all the noise.
I think longer term that is certainly the strategy and will be the case as the markets begin to come back to more traditional relationships with institutional and wholesale funding.
You have to remember that when you look at our deposit numbers in total which includes financial services division, the DDA for financial services division is down $1.1 billion year over year, so we've done a good job on the rest of the business in improving, particularly DDA. In the slides, we highlight a nice growth over the last number of quarters in DDA excluding FSD.
As we get to the bottom of this real estate cycle, we'll see FSD bottoming out at some point, and then have stability there and then moving forward. So that kind of blurs some of the detail in some of our financial statements on deposit is what's going on with FSD.
Your next question comes from Scott Siefers – Sandler, O'Neill.
Scott Siefers – Sandler, O'Neill
Can you talk a little bit about the sale of the Visa shares and how you were able to do that? Was that a transfer to another former member bank? I thought they were locked up but I know there are various ways you can jettison them.
The shares that we sold, and it's our remaining interest so we have no further shares after this sale, were class B shares which are not able to be sold into the public market until they convert to class A shares which probably isn't until 2011.
We chose to go a private sale route to another member bank. That's the only way you can do it. We affected that in the third quarter and completed the sale. It's something that we have a position in, a significant position that taking market risk for the next three or four years was not something that is not typical. Our pattern is that when things are able to be sold on these kinds of things that we do affect the sale. So we went ahead and did that.
Your next question comes from Michael Mayo – Deutsche Bank.
Michael Mayo – Deutsche Bank
Can you comment on the new Treasury plan in three parts? Number one in the preferred, you said you're evaluating that but a 5% coupon seems pretty good. Second would be the insurance on new unsecured bank lending, how you might use that. And the third part would be the unlimited deposit insurance for non interest bearing deposits; I guess mostly small business accounts. I imagine you have more of that than the average bank.
Let me start with you last point. That is true because we are heavily commercial so we do have a larger deposit base in the DDA side, and certainly the FDIC temporary liquidity guarantee program as it's called which as the terms are today, starts at out 30 days and then you must opt out or remain in.
As I said earlier it is our feeling that we will remain in both for the deposit side as well as for the debt side. While we're still getting some of the details and understanding all of the requirements of the program, that is our initial feeling, that we will participate in that program.
You mentioned that the 5% yield on the preferred stock in the Treasury Department's capital purchase program appears to be an attractive yield and I don't disagree with that. But we are, as I said earlier looking and evaluating all of the facts as they come out. When they come out, we'll come to an appropriate decision there.
Michael Mayo – Deutsche Bank
As far as the guarantee on new bank debt, how much debt do you have maturing over the next several months and as that matures is that a real possibility to use the new government program?
There isn't total clarity from the FDIC yet on what is and isn't covered. We believe it's unsecured debt. We believe that Fed funds is included in that as well as the maturity of senior notes, not subordinated notes. But we also think that institutional CD maturities, and we have used that distribution channel for raising that also, is not covered, but it isn't totally clear.
Assuming that it's just senior notes maturing as well as Fed funds, we would have under the rules about $5 billion of capacity under the guarantee program.
Michael Mayo – Deutsche Bank
Might that change your strategy away from institutional CD's to other forms of wholesale borrowing?
The institutional CD market has not been really very attractive in recent quarters so absolutely.
Michael Mayo – Deutsche Bank
You're not alone in not having a lot of the details and I just wonder what's the information dissemination process to the extent that the Fed, the Treasury, the government put so much fire power into resolving the crisis, but there seems to be a disconnect between you and others getting that information. When do you think you'll get all the information you need to help decide?
I don't know when that will be. I would underline that the communications between the regulators and certainly in our case, are very good. As soon as they come out I would fully expect that we will have all the detail that we need. But I have not heard anything as to when everything will be fully disseminated.
There are further conference calls that the FDIC is having to help answer questions so that dialogue is going on practically daily. There's progress being made.
Your next question comes from Brian Foran – Goldman Sachs.
Brian Foran – Goldman Sachs
Following up on the government preferred, if you do take it, would it change your lending appetite at all or would you just use it to strengthen capital ratios and also as part of that, are you interested in doing sale bank deals, and if so, what geographies would be you be most likely to target?
Starting with the first part of your question, what we've been doing in our optimization program is focusing on our customers and taking care of those customers and a customer who wants to be a full relationship. When there's excess capital, financial institutions tend to take advantage of more product versus relationship as well. We're refocused that to make sure that we're there for our customers and certainly in the future we will be looking for further new relationships as well.
Certainly preferred stock adds to the capital base. As Beth said earlier, we're comfortable and within our ranges on the capital but we certainly will look at this program to see if it will work favorably for us.
As far as failed institutions, we're always interested in opportunities if they're in our markets, and provide us the locations and the type of business that is key to our strategies moving forward.
Brian Foran – Goldman Sachs
Part of the reason I'm asking, a lot of the program seems designed to get banks lending again and the consistent message from a lot of banks is that this program doesn't really change their appetite for extending credit. It sounds like you're kind of saying the same thing.
I'm saying from our standpoint, we have refocused and made sure that we are using our resources for our relationship customers and that can mean growth as well because new relationships, and I underline meaning a total type of relationship, is very important to our strategy going forward.
Your next question comes from [Jedd Core – Diamondback Capital].
[Jedd Core – Diamondback Capital]
I'm looking at on an average basis your loans were down as your managing optimization process, but on a period end basis, loans are more flat. I assume the difference is line utilization picking up towards the end of the quarter? I was wondering if that's accurate. Do you have an outlook on line utilization?
That is the case. We did have line utilization pick up a bit toward the end of the quarter as Beth mentioned earlier. I attribute that in all likelihood to our larger customer base that has seen the disruption in the capital markets that you're familiar with. We were a little over 51% and had been running in the 49.5% range. So it wasn't an overly significant increase but I attribute it to be basically the dislocation in the capital market and I would expect we'll see that begin to decline as those markets free up in the future.
Your next question comes from Brian Klock – KBW.
Brian Klock – KBW
The guidance for charge offs for the full year would imply about $110 million to $111 million of charge offs for the fourth quarter?
Brian Klock – KBW
Can you give us any guidance or character to the third quarter; you said you've seen the geographic contribution decline from the western. It seems like the Texas charge offs were up a little bit in the third quarter, mid west up a little bit. Is there any expectation in that charge off guidance? Is it coming more out of mid west commercial, Texas, or other markets, and western would continue to decline? Maybe some color on where we might see that charge offs coming from in the fourth quarter.
I would say that it will be much like what we have seen particularly in the third quarter. I don't know that I would at this point say that the contribution, the charge offs would be significantly different. I would certainly hope and expect that real estate would continue to be performing as it has. I would hope that we could complete some of the real estate sales as we've discussed. Clearly the mid west will continue to be soft and struggle and we know that. But I think it's going to be consistent with what we've seen, particularly in the third quarter.
Brian Klock – KBW
Can you give us the watch list or classified loan balances for the third quarter?
It's $5.5 billion, about 10.3% of loans.
Brian Klock – KBW
You've talked before about the state portfolio. Is there any material move in that watch list category out of your niche portfolio and/or the mid west commercial book?
I think all of the results of share national credit exam were fully reflected to the third quarter in our numbers and beyond that wouldn't make any additional comments. I think it is fair to say that with softness in the middle market and small business in the mid west, you would see more of those loans showing up on the watch list this quarter. Those are loans that are already in our special assets group, our work out group that are being actively worked and collected.
Brian Klock – KBW
Would we expect to see the same relationship of provision in the charge offs in the fourth quarter?
We'll continue to see provisions for charge offs as we have. You can look back through the first three quarters and see what it's been, and it's probably likely to be something like that.
Your next question comes from Heather Wolf – Merrill Lynch.
Heather Wolf – Merrill Lynch
On the CNI non-performers, can you talk about any partial charge offs you've taken for the new non-performers and also just give us a feel for historically what your loss severity experience has been on CNI?
We've written our accruals down by 32% and that's fairly consistent. We are pretty aggressive in the way we look at things. When we move something to non-accrual we look at the collateral position, the cash flow, and a whole range of things and make the assessment based on that. We've written that down 32%.
The substandard non-accrual piece of real estate down to 42% based on appraisals, very current independent appraisals and so forth, so I think we've been doing what we need to do in terms of recognizing losses in those portfolios.
The non-accruals are changed down 32%, that's not atypical looking at long series of years. We update our loss given defaults on a quarterly basis and these are very consistent with long term and recent trends.
Heather Wolf – Merrill Lynch
Just a point of clarification, revenue construction has been written down to 42%. The 32% is that the total book, or is that just CNI?
Heather Wolf – Merrill Lynch
Do have those numbers for just the CNI portfolio?
I don't. You know that it's the 42% of residential real estate, so back into [inaudible] that number separately.
The 42% includes substandard and doubtful which the 32% that we mentioned on non-accrual is just non-accrual. So the res is higher not only non-accruals but substandard and doubtful.
Your last question comes from Christopher Mutascio – Stifel Nicolaus.
Christopher Mutascio – Stifel Nicolaus
I wanted to get your view on the macro. Looking at the numbers it looks like we're seeing some stability or the signs of stability on the real estate construction portfolio. Could we see a lull here in the economic activity or the credit quality deterioration where the construction portfolios do see some sign of stabilization? But could it be a false positive to some degree as we see the CNI portfolios run off, whether it's you specifically or just in general, the banking sector as the economy starts taking a broader toll?
It's hard to predict. The message we have is that we've seen a fair amount of stability. You can see in terms of the inflows and non-accruals, they're down. You can see the real estate component of that in charge offs down from the last quarter as well. In terms of that segment, is it a lull, is it a - all we can say is what we've seen through the third quarter and that's the stability that we have mentioned.
We also talked about some softness in middle market and small business. That's what you would expect in this kind of economy. I've certainly seen enough of those in my tenure here. There's so much uncertainty right now, that we're just blocking and tackling every day, and whether it's a lull or not, I don't know, but it is at least stable for now.
There are no further questions. Mr. Babb, do you have any closing remarks?
I want to thank everyone for joining us today and your continued interest in Comerica. Thank you very much.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: firstname.lastname@example.org. Thank you!