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Wells Fargo & Company (NYSE:WFC)

Q3 2010 Earnings Conference Call

October 20, 2010 9:30 AM ET

Executives

Jim Rowe – Director, IR

John Stumpf – Chairman, President and CEO

Howard Atkins – SVP and CFO

Analysts

Matt O’Connor – Deutsche Bank

John McDonald – Sanford Bernstein

Betsy Graseck – Morgan Stanley

Joe Morford – RBC Capital Markets

Mike Mayo – Calyon

Nancy Bush – NAB Research

Chris Nastasio [ph] – Stifel Nicolaus

Moshe Orenbuch – Credit Suisse

Jason Goldberg – Barclay’s Capital

Ron Mago [ph] – GIC

Fred Cannon – KBW

Carol Berger – Soleil Securities

Paul Miller – FDR Capital Market

Andrew Marcourt – Evercourt [ph] Partners

Operator

Good morning. My name is Celeste and I will be your conference operator today. At this time I would like to welcome everyone to the Wells Fargo third quarter earnings conference call. (Operator Instructions). I would now like to turn today’s call over to Mr. Jim Rowe, Director of Investor Relations. Please go ahead sir.

Jim Rowe

Thank you and good morning everyone. Thank you for joining our call today, during which our Chairman and CEO John Stumpf, and CFO Howard Atkins will review third quarter 2010 results and answer your questions.

Before we get started, I would like to remind you that our third quarter earnings release and quarterly supplement are available on our website. I’d also like to caution you that we may make forward-looking statements during today’s call and that those forward-looking statements are subject to risks and uncertainties. Factors that may cause actual results to differ materially from expectations are detailed in our SEC filings including the Form 8-K filed today and the earnings release and quarterly supplement included as exhibits. In addition, some of the discussion today about the company’s performance will include references to non-GAAP financial measures. Information about those measures including a reconciliation of those measures to GAAP measures can be found in our SEC filings and in the earnings release and quarterly supplement available on our website at wellsfargo.com.

I will now turn the call over to Chairman and CEO, John Stumpf.

John Stumpf

Thanks, Jim, and thanks to all of you for joining our call and for your interest in our company. The third quarter was the best quarter in our company’s history with record earnings of $3.3 billion, up nine percent from last quarter. The strength of our diversified business model and the power of the Wells Fargo and Wachovia merger are clearly reflected in these results.

The Wachovia merger is exceeding all of our expectations, helping us generate more than $21 billion in earnings since the merger. In the third quarter we completed the integration of Wachovia stores in our overlapping states and began the integration in our eastern states, successfully converting 170 banking stores in Alabama, Mississippi and Tennessee.

This success paves the way for the rest of the eastern market conversions which will complete next year, giving millions of customer’s access to more products and the largest banking store network in the United States.

In addition to the banking stores, we have the revenue synergies we are already realizing from the merger. But let me just say, I’m particularly pleased with the positive results we’ve had in retaining and attracting deposits which are an important contributor to our results.

Checking account growth remained strong throughout our company, up a net 7.3 percent with very strong growth across the east including nine percent growth in Florida and 11.2 percent growth in New Jersey as examples.

Now, I know we’ve all been hearing in recent months about business practices within our industry. I’m proud of Wells Fargo’s adherence to a culture of doing what’s right for customers, which not incidentally benefits our team members, our communities and our shareholders in the long run. For us, this means doing the hard work early and building processes that adhere to our standards as a company.

This is as true in our approach to merger integration as it is to our day to day business operations. Let me quickly give you my views on the latest topic related to mortgage foreclosures and repurchases. Howard will address this topic in more detail later on the call, but there are a couple of important points I want to make upfront.

First, foreclosure is always a last resort and we work hard to find other solutions for our customers. Since January 2009, we have completed over 556,000 modifications, more than twice the number of foreclosure sales completed during this period, and we have forgiven $3.5 billion of principal to help customers stay in their homes.

Second, we are confident that our practices, procedures and documentation for both foreclosures and mortgage securitizations are sound and accurate. Third, we did not and do not plan to initiate a foreclosure moratorium.

As it relates to regulatory form, we continue to work internally with our regulators to better understand how reform measures may affect our business and our customers. The services we offer our customers including financial security, convenience and advice obviously have a cost, and we need to be compensated for these benefits we provide our customers and for the capital we use to support these businesses. This is not new.

Over the years, there have been numerous environmental and regulatory issues in our industry and the breadth of our diversified model and the strength of our underlying customer relationships have enabled us to succeed in the aggregate and relative to our peers. This environment is no different.

In the same way that helping our customers avoid foreclosure is the right thing to do for them, and our shareholders, we will work to make sure than any changes we make in response to regulatory form are in the best long-term interest of our customers, our team members and of course, our shareholders.

Our customer centric approach has given us what I believe to be the best and most valuable franchise in the industry and our actions will be consistent with the principles that have driven our actions over the years.

Now let me turn it over to Howard.

Howard Atkins

Thank you, John. My remarks this morning will follow the slide presentation included in the quarterly supplement which is available on the Wells Fargo Investor Relations website. I’ve got lots of ground to cover this morning, but there are three – I’m sorry – six key themes that I’d like you to remember in my remarks.

First, as John indicated, we had record results in the quarter, best quarter ever, $3.3 billion in profit with earnings per share of $0.60 or up seven percent year over year.

Second, the way we grew earnings in the third quarter is the same as we’ve done to produce strong earnings every quarter since the merger; revenue growth in most of our businesses with expenses down.

Third, the Wachovia merger is already a big financial success for us with better than expected credit experience, expense savings on track and abundant revenue synergies.

Fourth, we had continued improvement during the quarter in credit quality. Charge offs are now some 24 percent below the peak last year, and nine percent down from the second to the third quarter.

Fifth, our balance sheet is stronger than ever. We’ve been growing tier one common at a rate about 40 to 50 basis points per quarter organically. Tier one common hit eight percent during the quarter and while the new BASEL III rules are still in process, we expect to be above seven percent tier one common on the proposed BASEL III rules as we understand them within the next few quarters.

And then finally, we are confident in our foreclosure and mortgage securitization policies, practices and controls and the adequacy of our repurchases, and I will get to that later on in this presentation.

If you look at slide four, which is our earnings trend, as indicated we earned a record profit of $3.34 billion in the third quarter. This is not a new development. Quarterly profits as you know have been consistently strong since the merger two years ago. Nor, is the strength of our earnings in the quarter due to any one factor. Our results were relatively broad based across many business segments and products.

I would like to point out a number of special items that in the aggregate reduced revenue and earnings on a link quarter basis. This would include for the first time now the impact of Reg E, which cost us $380 million during the quarter in revenue.

Second, while we continue to have commercial loans resolutions in the PCI portfolio, $202 million in the quarter, that’s down $304 million from the second quarter PCI loan resolution income. And third, we only had $17 million in bond and equity gains, down $300 million from the second quarter.

When you add those items up, it’s almost $1 billion worth of less revenue from the second to the third quarter, which means that all of our other business operations basically our core operations combined, grew revenue by some $465 million in the quarter.

We had double-digit annualized link quarter revenue growth in a number of businesses included asset-backed finance, asset management, auto dealer services, brokerage, commercial banking, commercial mortgage servicing, commercial real estate, debit card, mortgage banking, private student lending, real estate investment banking and retirement services.

When you add up all those businesses in which we had double digit revenue growth, that amounts to some, just under half of the total revenue of the company in the quarter.

The third quarter results, continuing with the special items also included $476 million in merger integration expenses. Our operating losses were down close to $400 million from the second to the third quarter, largely reflecting the higher level of legal accruals we had in the second quarter, and in the third quarter we released $650 million from the allowance, reflecting the improved loan portfolio performance at Wells Fargo, and we expect additional releases in the coming quarters absent significant deterioration in the economy.

Slide five shows you our returns and operating margins which were strong and generally up in the quarter. Return on assets was increased to 1.1 percent. Return on tangible common, 15 percent, both among the highest of the large bank peers.

Net interest margin did decline by about 13 basis points in the second quarter, but that was largely driven by lower PCI loan resolution as I mentioned earlier.

As you know, lots of factors impact the margin, some positively, some negatively. The decline that we’ve seen in the non-strategic loan portfolio that we’re running off does reduce the margin to a certain extent. On the other hand, we’ve had continued and significant growth in checking and savings deposits which helps the margin.

As I mentioned before, our earnings continue to be very broad based as has been the case for many quarters. All of our business segments continue to contribute to the company’s earnings with community banking growing earnings in the quarter by 13 percent, Wholesale banking growing earnings by two percent, and while the Wealth Brokerage and Retirement group had essential flat NIAD in the quarter, earnings in this business were almost double, a little bit more than double from a year ago.

Let me take you through each of the main business segments. On slide seven, our Wholesale banking group, you can see the trend in revenue and earnings there. Revenue in this group was down somewhat in the quarter due to the lower PCI loan resolution income and seasonal decline in insurance revenue, but many businesses in this group including customer flow trading, commercial real estate, commercial mortgage servicing and asset backed finance had double digit annualized link quarter revenue growth.

Like our retail business, in the wholesale business, revenue to a very large extent is driven by cross sell and as I mentioned, we had many businesses that contributed to the result and to the growth in our cross sell in this business.

We did see signs of lending activity with period and loans up during the quarter in commercial, commercial real estate, asset back finance and capital finance and as another example of increased activity, new commercial real estate loan commitments in this business segment, up 44 percent link quarter.

Credit quality in wholesale improved once again during the third quarter with charge offs down 29 percent and a continued drop in the number of problematic loans and transfers to work out.

In our community banking segment, community banking had a very strong sales quarter with sales up 14 percent and small business sales actually up 25 percent. We also had very solid checking account growth once again in this business.

Lending activity picked up somewhat in community banking with loan growth during the quarter in core auto’s, private student lending and SBA lending. We’ve been very active for several quarters now including the third quarter in providing credit to small businesses across the country.

On slide nine you can see our cross sell statistics which are one of the key sources of revenue growth in the company. The consumer cross sell is still increasing at legacy Wells Fargo as it has been consistently for many years, and now with Wachovia, we’ve also had success in increasing cross sell in the Wachovia footprint.

We are experiencing very broad based growth in checking accounts. This is really a very important message, very important to understand in terms of the way we’re building our franchise. The growth in checking accounts in our company has been very strong, very broad based. That’s a very important driver our company’s strong operating and financial results.

What this growth in account indicates is that more and more households and small businesses are banking with Wells Fargo, and this generally leads to more business and higher cross sell all the time.

Slide 14 talks about our mortgage banking business. Mortgage banking had a great quarter in terms of originations and applications. Originations during the third quarter were up 25 percent linked quarter. Applications were up $194 billion, roughly 80 percent driven by refi’s, and our second highest quarter ever.

The chart here shows you the relationship between the average note rate on our servicing portfolio and the current 30 years mortgage rate. We think we’re in a very unique period here, with a unique combination of historically low absolute levels of new mortgage rates, and in combination with that, the widest ever spread between new mortgage rates and rates on outstanding mortgages.

So as you can see, the average note rate on our servicing portfolio in the third quarter was 5.46 percent compared with new money rates of 4.35. What this means obviously is that the incentive to refi right now is huge and by the way, the wealth effect for homeowners who are refi’ing is also very huge.

So given this unique combination of low mortgage rates and the wide spread to the servicing portfolio, the potential is very high for every homeowner in the United States that an refi to do so, and this could take several quarters to play out if rates remain as low as they are right now.

We’ve already had our second highest mortgage application ever in the third quarter, just under $200 billion in applications, and so far in October, applications remain strong.

On slide 11, we’re now in wealth and brokerage retirement business; revenue grew two percent from the second quarter. Earnings as I said before were relatively flat although more than double from a year ago.

Client assets were up five percent. Managed accounts assets in the retail and brokerage group were up ten percent from the second quarter, and despite may retail investors being on the sidelines for the last couple of quarters, as I said, client assets were up five percent link quarter and we are growing share.

This business closed $1.7 billion in loans during the quarter, double from a year ago and for the first time since the merger. Loans in this business were flat linked quarter and were up slightly from August to September. Cross sell continues to grow in this business as it has every month and every quarter since the merger and now stands at 9.76 products relative to 9.45 products a year ago.

Deposits have been a great success in this business. Deposits in our wealth and brokerage business now stand at $127 billion. Essentially, this business has brought back all the deposits it lost during the dark days in 2008 and has incremental growth on top of that. A terrific success story. We now have 888 dedicated stand along brokerage offices across the country in basically all the markets where there is wealth that can be serviced.

In terms of our lending in the third quarter, we continue to supply credit to both U.S. consumers and businesses as we have for many quarters now. Since the merger, we have supplied over $1 trillion in credit to U.S. consumers and businesses including $176 billion in the third quarter, up 17 percent from the second quarter.

There’s not just the mortgage originations that I mentioned before. We’ve had good activity in home equity, credit card, C&I loans and commercial real estate.

In terms of loans outstanding on slide 13, here is essentially a tale of two cities if you will. We’ve been continuing to reduce our non-strategic portfolio. This is a portfolio comprised of about $119 billion in loans were we exited or no longer write new business including pick-a-pay, indirect home equity, legacy Wells Fargo Financial, and direct auto, Wells Fargo financial debt consolidation and commercial and CRE, PCI loans.

As I’ve said, we continue to work down these high risk portfolios, which have now declined over $30 billion since the second quarter of 2009.

The $616 billion in the so-called continuing portfolios are down less than one percent from the second quarter so we clearly see a flattening out in our loan portfolio and as you can see on the chart, many of our individual loan portfolios grew in the quarter.

We had growth in the auto dealer services, wealth and brokerage retirement consumer loans, wholesale commercial real estate, capital finance, asset backed finance, wholesale commercial banking and private student lending and SBA.

This reflects in our view on the commercial side at least, some inventory and CapEx financing plus in both of our consumer and commercial businesses, what we believe is market share gains.

We continue to experience exceptionally strong core deposit growth as you see on slide 14, particularly in checking and savings. Over 90 percent of our total funding right now is coming from core deposits and about 90 percent of our core deposits are in the form of checking and savings accounts.

Growth in deposits actually accelerated at Wells in the third quarter and continue to be broad based with growth in the consumer and business checking accounts and deposits up in both wholesale and wealth and growth in deposit and checking accounts in basically all parts of the country.

We, to our expenses on slide 15, non-interest expense declined $500 million roughly or four percent from the second quarter. To be fair, most of this was in the operating losses where we had higher legal accruals in the second quarter as well as in the second quarter having restructuring costs both for the Wells Fargo Financial restructuring we undertook in the second quarter.

We continue to invest in our businesses throughout our footprint, including increasing regional banking, platform banking, FTE’s in the east by some 1250 FTE’s this year so far. This investment in bankers is one of the key drivers in improvement in cross sell we are already realizing in the eastern footprint.

We have $476 million in merger expenses in the third quarter as we converted 363 stores, Wachovia stores in Texas, Kansas, Alabama, Mississippi and Tennessee. We’ve also converted many of our operating systems now improving in the third quarter our mutual fund business. The merger is on track for the $5 billion of expense savings that we have consistently articulated.

I would like to mention here, one of our highest expense items in the last year or two, and it’s obviously for problem asset management, in the third quarter we had over 24,000 people in some fashion or another working on loan modification and loss mitigation throughout Wells Fargo, and that amounts to roughly $750 million, but over time, we do expect this very high level of expenses to decline as problem assets and charge offs continue to decline.

I’d like to talk briefly about the Wachovia merger. As I mentioned earlier, this is already a big success from a financial perspective. Since the closing of the Wachovia acquisition at the end of 2008, we’ve now earned $21 billion in seven quarters.

We’ve significantly reduced higher risk assets. The credit side, we are seeing better than expected quality and credit experience. For example, the life of loan losses that we now expect in the Wachovia loan portfolio will be less than the $40.9 billion write down that we initially took. We still have remaining PCI loans on our books written down to roughly 64 percent of the remaining unpaid principal balance even after using almost $23 billion. It was a non accretable difference.

On the expense side as I mentioned, we are realizing expense saves from the merger. About 85 percent of the targeted $5 billion of consolidation savings has been realized, and then on the revenue side, we are seeing multiple revenue synergies in every one of our businesses.

To give you a couple of examples, as I mentioned earlier, Wachovia’s cross sell ratio is growing nicely. We’ve grown auto dealer market share from 4.75 percent in the first quarter of 2009 to 6.84 percent in the third quarter of this year.

The auto dealer business is an excellent business that we acquired with Wachovia that has benefited from the strength of the Wells Fargo brand and the strength of our balance sheet.

Within wholesale banking, the amount of investment banking revenue coming from our own commercial customers is up 21 percent this year, again benefiting from more legacy Wells Fargo commercial and corporate customers using Wells Fargo securities to underwrite their bond and equity financings.

In the wealth business, cross sell as I mentioned before is up to 9.76 percent, demonstrating success this business is having at growing deposits, loans and managed assets. Loan originations by financial advisors in this business were up 33 percent year to date compared with a year ago.

Let me now turn to credit quality, which continued to improve in the third quarter. To quickly summarize, charge offs continued to decline, down 9 percent link quarter. The early credit quality indicators in most of the consumer and commercial portfolios were either stable or continue to improve.

Our PCI portfolio continue to perform better than originally expected. In the third quarter, $639 million of non accretable difference was reclassified to accretable yield which will accrete the future income over the remaining life of the loans. In addition, $202 million of non accretable difference was released into the income for commercial loans that were paid off or sold.

At the end of the quarter, we had $24.4 billion in allowance for credit losses, and in addition, we had $14.5 billion in remaining non accretable difference. Because of the improved portfolio performance, we released $650 million in reserves in the third quarter and we currently expect additional releases absent significant deterioration in the economy.

Slide 18 shows you the trend in our charge offs which as I’ve indicated a couple of times are now down both link quarter and substantially lower than the peak last year. Almost all loan categories seasonal increase in auto showed a decline in charge offs during the quarter, so this is a very broad based reduction in credit costs.

Slide 19 takes you through the early indicators in the large consumer loan portfolios, which as you can see have been stable to improving for a number of quarters now, including improvements in pick-a-pay, credit card, home equity and personal credit management.

Non-accrual loans in total stabilized in the third quarter with the exception of a relatively small number of new large corporate non-accruals and a modest increase in the mortgage portfolio. Non-accrual balances in all other loan portfolios were flat to down in the third quarter including large declines in non-accrual’s and wholesale commercial real estate division, auto dealer services, pick-a-pay and Wells Fargo home mortgage.

Foreclosed assets and OREO increased from the second quarter but approximately half of the increase was a shift from PCI loans to real estate owned, and $148 million increase in fully insured Fanny Mae loans.

Keep in mind most of our loans, and therefore most of our problem assets, are in secured portfolios and so the majority of the projected loss content in these assets has already been written down or is government insured.

As I mentioned, we released $650 million in the third quarter as you can see from our allowance trends on slide 22, and absent significant deterioration in the economy as I’ve mentioned a couple of times, we expect future reductions in the allowance given the improvement we are likely to see in the portfolio.

Our appendix to this presentation includes a lot of detail on the pick-a-pay and other loan portfolios. I’d just like to mention here on slide 23, since this is a large portfolio that the pick-a-pay portfolio continues to perform better than originally expected. We’ve had great success in modifying loans in this portfolio, completing over 73,000 full term modifications and we’ve forgiven about $3.5 billion in principal since the acquisition a year and three quarters ago.

Because the modifications we’ve completed eliminate the payment option feature, at the end of the third quarter, only 62 percent of the pick-a-pay portfolio still had payment options, down from 86 percent at the time of the merger.

In the non PCI pick-a-pay portfolio, net charge offs continue to decline and non-performing loans declined for the first time now since the merger. 85 percent of the non PCI portfolio is current and 60 percent of the PCI portfolio is current, up two percent from the second quarter.

Let me now shift to our capital position on slide 24. Tier one common, reach eight percent in the third quarter through retained earnings and other internally generated sources; we have been increasing tier one common by about 40 to 50 basis points per quarter now for many quarters.

We’ve always maintained very strong capital in our company and today’s ratios including the eight percent tier one common, nine percent tier one leverage and 10.9 percent tier one capital are higher than they’ve ever been.

We’ve now purchased about $544 million in the treasury TARP warrants year to date. So far that’s at about a five basis point impact to our tier one common, but is accretive to earnings per share, and we will continue to buy the warrants opportunistically.

A couple of points about BASEL III on slide 26, as you know, BASEL III is still in proposed form and is a subject to interpretation in many cases, but under our current interpretation of BASEL III, our adjusted tier one common ration under the new guidelines would have been about 6.9 percent at September 30, about 110 basis points below our reported eight percent tier one common ratio.

When you look at the adjustments, the pro forma deductions from tier one common for mortgage servicing rights, for tax assets, investments in financial affiliates and other smaller adjustments to tier one common amount to about $5 billion less tier one common as of September 30, or about 50 basis points on our reported tier one common ratio, and in terms of the increase in risk rated assets, that would be associated with now capturing market risk, counter pointing risk, operating risk and other BASEL II and BASEL III risk elements, will also be the equivalent of about 60 basis points or adding about $85 billion of risk rated assets to the ratio calculation.

We think one of the good things about BASEL in fact, is that it does better reflect relative risks taken by the different financial institutions and we believe that given the fact that effective substantially less than our peers.

And as our asset is comparable to some of the other large mortgage banks, but we have less deferred tax assets, equity and financial affiliates, trading assets, counterparty risk. We also have less disqualified trump securities than most of the other large bank peers.

With that, let me shift to give you an overview of the foreclosure and mortgage securitization issues. These are issues obviously very important to consumers, mortgage investors and shareholders, but we believe that these issues have been somewhat overstated and to a certain extent, misrepresented in the marketplace, and I’d like to be clear here on how they impact Wells Fargo specifically.

So starting on slide 26, first as John already mentioned, foreclosure at Wells Fargo is a last resort, not a first resort. We work very early on with customers who are beginning to experience problems paying their mortgages and continue to do so for the length of time that the problems are being experienced.

80 percent of customers who are 60 days or more delinquent work with us, and when they do, we are successful in helping seven out of every ten avoid foreclosure. We attempt to contact customers on average over 75 times by phone, and nearly 50 times by letter during the roughly 16 months that it takes for foreclosures to be complete once a borrower becomes delinquent.

Second, our foreclosure and securitization policies, practices and controls, in our view are sound. To help ensure accuracy over the years, Wells Fargo has built control processes that link customer information with foreclosure procedures and documentation requirements.

Our process specifies that affidavit signers and reviewers are the same team member, not different people, and affidavits are properly notarized. Not all banks in our understanding do it this way. If we find errors, we fix them and we fix them as promptly as we can.

We assure loans and foreclosure are assigned to the appropriate party as necessary to comply with local laws and investor requirements and legal documents related to securitizations are sound and appropriate transfers of ownership are made.

Finally, we believe our purchase exposure is very manageable and our experience continue to be different from some of our peers in that our unresolved repurchase demands outstanding are actually down at the end of the third quarter compared with second quarter both in terms of number of outstanding demands and in total dollar balances.

Slide 27, the key point here really comes back to the quality of our servicing portfolio. One of the reasons we’re so confident in terms of our risk exposure is we have a very high quality servicing portfolio.

As shown on slide 27, 92 percent of our portfolio is current and only two percent is sub-prime. Roughly two-thirds of our servicing portfolio is comprised of loans sold to GSE’s. 20 percent of the portfolio are loans that we retained or acquired and hold on our own balance sheet, and of course the loss exposure to the extent that any exists on these retained loans will be reflected in our loan/loss reserves and PCI non-accretable difference.

Six percent of our servicing portfolio is non-agency acquired servicing and private whole loan sales. The majority here is acquired servicing where Wells Fargo did non underwrite and securitize and therefore we have no repurchase obligation.

And then the remaining eight percent of our servicing portfolio is private securitizations where Wells Fargo originated the loan and therefore may have some repurchase risk. But importantly, 55 percent of these loans are from the 2005 or earlier vintages and 83 percent of this eight percent are prime loans.

We had only $69 million of repurchases related to private securitizations in the third quarter.

As shown on slide 28, the quality of our servicing portfolio is clearly reflected in our relatively low delinquency and foreclosure rates. As of the end of the second quarter the most recently publicly available data, we had the lowest delinquency and foreclosure rates among large bank peers, ours being 8.15 percent, some 335 basis points better than the industry average of 11.5 percent, and at the end of the third quarter, our delinquency and foreclosure rate, actually improved the basis point to 8.14 percent.

Most of the repurchase risk we have is with agencies, and is essentially concentrated in the 2006 through 2008 vintages which when the industry contained a higher concentration of low or no doc and stated income mortgages. As shown on slide 29, our purchase demands from GSE’s for these vintages declined now for the second straight quarter. We don’t expect large losses on the pre 2006 or post 2008 vintages.

The balance of loans outstanding in the 2006 2008 vintages as I mentioned, continue to decline, and the percentage of loans 120 delinquent has also continued to decline. Delinquency as you know is an important measure of demands, and are generally correlated defaults.

However, it’s important to note that not all loans that become delinquent eventually are problematic, but are probably underwritten in applicable contract terms, eventually may not actually result in a repurchase.

At the end of the third quarter, as I mentioned before, repurchase demand both in number of loans and loan balances was down. As you can see on slide 30, another fact that I think is sometimes missed is that repurchase demand does not directly result in loss. Repurchase demand simply represents an initial request for information and loans being assessed for repurchase.

Of the repurchase demands we receive, only half roughly end up actually being repurchased with half being cured by providing additional documentation that demonstrates a contractually required repurchase event did not occur.

Of the loans that we do repurchase, roughly 20 – 25 percent of the borrowers, we are able to make current through modification. On the loans that we repurchase that we’re not able to modify, the average loss severity is about 50%.

So just to take you through the math, to recap that, as an example, for every $100 million in demands, we repurchase on average about $50 million. Of the $50 million we repurchase, $12.5 million gets modified, and on the loans we don’t modify, we would on average realize a loss of about $18.75 million.

So if you do the math on the $3.8 billion of demand if you will in the third quarter, you can see that our repurchase liability as of September 30 of $1.3 billion, we believe to be adequate to cover these potential losses.

With that, I would now like to open up the call for any questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Matt O’Connor with Deutsche Bank.

Matt O’Connor – Deutsche Bank

Hi guys.

John Stumpf

Hi, Matt.

Matt O’Connor – Deutsche Bank

I think I’ll start with the full mortgage repurchase for a change. I guess the first question is why are you excluding the 2005 vintage? Do you think that’s not going to be a material issue or hasn’t been so far? I think most people are looking at ‘05 through ‘07 vintages and you show ‘06 to ‘07, so just wondering what your thoughts on ‘05 are.

Howard Atkins

As far as we can tell, to the extent there will be problems we see it on 2006, 2007 through mid-2008 vintages, so we don’t expect any material (inaudible) prior to that.

Matt O’Connor – Deutsche Bank

OK. And then separately, the 83 percent of private securitizations that are prime, I assume those are jumbo?

Howard Atkins

Yes, mostly yes.

Matt O’Connor – Deutsche Bank

OK. Do you have any average statistics on the LTD’s and FICO there?

Howard Atkins

We’ll get back to you on that. I don’t have those on the top of my heard.

Matt O’Connor – Deutsche Bank

And just separately, like when I step back and reading all these headlines that are impacting the mortgage business in one way or another, I guess the thing that jumps out to me is the servicing business really hasn’t been priced for what we’re seeing right now, and maybe the cost to you of a purchase is a little bit less, but for some other competitors it seems like it’s going to be a pretty high cost. So how do you think about just pricing, I guess on the origination side as well as on the servicing side for your current production and going forward?

Howard Atkins

Well Matt, we’re always looking as we’re looking at this business, first it costs more money, but if you look at, I can’t remember what slide it was, I think it was 28, that tells a pretty big story there about the quality of our portfolio and that is reflective of the success we’re having in that portfolio and the profitability of that portfolio.

Matt O’Connor – Deutsche Bank

OK. I guess what I’m getting at is the servicing fees that you get as an industry I think are relatively modest, probably to what your costs are either to modify some of these loans, obviously the foreclosure process. I just feel like that’s going to be a much bigger burden for the business going forward, and it might make sense to re-pricing some of that business right now.

John Stumpf

The industry might do that and of course we look at that, but clearly for the eight percent that’s past due, and those are, that’s expensive. There’s no question about that, but you’ve got to look at a portfolio from a portfolio perspective, and if the industry reacts to it, if this is a prolonged issue, I’m sure that new servicing might be considered differently.

Matt O’Connor – Deutsche Bank

OK. Thank you very much.

Operator

Your next question comes from the line of John McDonald with Sanford Bernstein.

John McDonald – Sanford Bernstein

Hi, good morning. Question for Howard. On the interest margin, obviously lots of puts and takes go into interest income and the margin. Could you talk about some of the offsets that you might have to run off higher yielding assets to a low persists, Howard?

Howard Atkins

Well one of the costs is that our security portfolio is a pretty long duration portfolio, so keep that in mind. The main one would be, as I mentioned before, the growth in share in checking accounts. We are growing checking accounts in our company at a very high rate of growth, reflecting again, more and more customers doing business with us, and that’s zero cost money.

So the more rapidly we can grow checking accounts apart from all of the other franchise benefits of doing that is that the margin does help that interest margin.

John McDonald – Sanford Bernstein

And while you do have some high yielding securities, it also seems like you have some liquidity in very low yielding stuff in terms of dry powder for the future. Is that still true?

Howard Atkins

That’s very much true. Depending on how you define liquidity, we have as much $100 billion of potential investment power on the balance sheet. Now of course, we would hope that that gets used by loan demand picking up, and we’ve already seen activity both in the second quarter, now in the third quarter as well. So that will be our wish that that’s how the liquidity gets used up so we can serve our customers that way. But if rates pick up at some point, we have significant capacity to build the balance sheet.

John Stumpf

But John, I’d also add to that, here comes into the play the beauty of this operating model. I mean, we have a diversity of geography, a diversity of businesses, a diversity of industry and about half of our revenue comes from fee for services, the other half from the margin.

When one horse has a headwind, the other one has a tailwind, and pulls a little harder, and while these are not perfect offsets, if we continue to serve customers and customers like doing business with us, it’s a privilege to serve them and in these markets we’re outgrowing, like Howard said on the checking account side, we’re outgrowing, you know there’s now 11 percent growth in checking account in New Jersey. We’re taking share.

And no question there’s some headwinds if rates stay low, but that’s why you hear a lot of; everybody in the industry’s talking about cross sell. We’ve been talking about it for 20 years.

John McDonald – Sanford Bernstein

And is the spread on the warehouse comparable to overall margin on the company Howard, currently?

Howard Atkins

Well you know the warehouse loans to the extent that we’re writing mortgages at 4.5 percent plus, you know yield is getting higher than the margin.

John McDonald – Sanford Bernstein

OK. And just a question on the mortgage applications very high this quarter. Is that typically a pretty good pull through to next quarter’s originations that you would take?

Howard Atkins

Yes, you could assume that the pipeline was up substantially during the third quarter which does bode well for fourth quarter originations, and then in addition as I mentioned earlier, so far in the fourth quarter, we’ve continued to see very strong application volumes.

John McDonald – Sanford Bernstein

And the final thing was just two more questions on the mortgage. The origination gains were very high this quarter. It looks like they begin on (inaudible) margin. Can you talk about origination margins and also just a little detail on servicing and why the hedging column was down and if you changed the strategy there?

Howard Atkins

You know origination margins in the industry remain relatively wide, which is what you would expect given the demand for mortgages being as substantial as it is. On the servicing side, the main subtle difference in terms of the hedge between the third quarter and prior quarters as you would expect, as mortgage rates continue to come down a lot, the natural business edge if you will, the origination side of the business acts a little bit better as a natural hedge to the overall mortgage company.

So the size of the hedge, the financial hedge if you will in relationship to the overall servicing and overall business was a little bit less in the third quarter than it would have been in prior quarters, and that’s one of the reasons the hedge itself was down.

John McDonald – Sanford Bernstein

OK. Thank you.

Operator

Your next question comes from the line of Betsy Graseck with Morgan Stanley.

Betsy Graseck – Morgan Stanley

Hi. Thanks. Good morning.

John Stumpf

Good morning, Betsy.

Betsy Graseck – Morgan Stanley

So just to return the size of your hedge comes down so less earnings but you’re gaining on sales higher so it’s kind of a wash at least.

Howard Atkins

Well that’s why we’ve always said we have a balanced mortgage business so, a good example.

Betsy Graseck – Morgan Stanley

Right. Couple of other questions. One is on the BASEL III, and you laid out you know where you would be point in time in 3Q based on what you know today. I’m wondering if you’re thinking about any kind of mitigation as you move forward or should we just take that you know, effective RWA and keep that cost in the model?

Howard Atkins

There may be small things we do, but we have a much better situation here as I mentioned than the other big banks which is why we don’t really have to do a lot of mitigation. You know some of the other banks are going to on-boarding hundreds of billions worth of RWA, and as I say, we’re just not in many of those businesses or as exposed to any other business as some of the others.

And frankly, it’s a good thing that we don’t have to make adjustments here because to the extent in my view, you have to make adjustments or take mitigating action that winds up in the end with less earnings for those companies that have to take mitigating action.

So we think we’re in good shape here. As I said, we’re at roughly 6.9 as of the third quarter. I don’t want to make a prediction. I sort of gave a general statement about being over seven percent “in the next couple of quarter”.

You can see how rapidly our capital has been growing per quarter, you know 30, 40 50 basis points, so it wouldn’t take that many quarters to get over seven percent. We’re already at 6.9, but again, we don’t know how these final rules are going to shake out and what the ultimate interpretations will be on some of these things.

Betsy Graseck – Morgan Stanley

And some people have been asking about the MSR as a percentage of total above the current standard, but are you thinking of it in terms of how it factors into BASEL III over time and (inaudible) 24 with 20 percent?

Howard Atkins

You know the MSR valuation is at a cyclical low point right now and yes, that may be things down the road on the MSR that we can think about doing that would mitigate some of the volatility if you will that gets created in the capital ratios just from that asset.

But that’s something that the industry is going to be taking a look at because as you know, we all have an MSR asset. But what I can tell you is right now, that’s not a big deal for us.

Betsy Graseck – Morgan Stanley

Right. I realize that. And mitigating, you’re talking about different ways of accounting for it or...?

Howard Atkins

There’s different kind of actions you can have on accounting. You know, the institutional arrangements in the marketplace may get modified, so we’ll have to see how this shakes out.

Betsy Graseck – Morgan Stanley

OK. And then lastly on the dividend, how are you thinking about the payout ratio?

John Stumpf

Well first of all Betsy, we’re eager to return more of our capital back to our shareholders. They’ve been very patient, and you know, we historically paid in that 35 percent to 40 percent range, give or take. We’ll have to see how we – appropriate level.

Betsy Graseck – Morgan Stanley

OK, yeah because it looks like your earnings have been improving and consistently improving so I’m just wondering what the trigger point is. Is it the systemic risk buffer getting decided?

John Stumpf

Well things are becoming clearer you know, but there’s more clarity this quarter than it was last quarter, so we’re getting closer to that point, but I can’t – I don’t know if I can add anything to it other than we want to get there as soon as all parties line up.

Betsy Graseck – Morgan Stanley

Thanks very much.

Operator

Your next question comes from the line of Joe Morford with RBC Capital Markets.

Joe Morford – RBC Capital Markets

Thanks. Good morning everyone.

John Stumpf

Hi Joe.

Joe Morford – RBC Capital Markets

Just a couple of things. I guess first you talked about the commitments for commercial real estate lending in the wholesale business up 44 percent sequentially. I just wondered if you could talk a little bit more about the opportunities you’re seeing there and how the appetite for growing that portfolio and just some of the risks and returns for that business.

John Stumpf

Well, we’ve had a long history in that business. We like that business. If you look at legacy Wells, we’ve had people that have done that business for a long period of time very successfully, and frankly, quite successfully during this downturn.

Secondly, we’re putting more feet on the street not only in the commercial area but in our business banking area and so we are, and we’re making lots of investments in relationships with companies. So you know, as others, smaller players and other players are internally focused, looking at managing their balance sheet or managing problem assets, we’re finding lots of opportunity to engage with existing customers and new clients about that business, and business in general.

So that’s not new to us. This business is not new to us, and I should also tell you Joe, I think you also noticed about our business, some of our strongest cross sell is actually in the wholesale side of the business. So this is not just about capturing a loan. This is about winning a new relationship or further developing existing relationships, so the loan isn’t the end all. It’s relationship.

So when you think of profitability, you’ve got to think of it in more holistically.

Joe Morford – RBC Capital Markets

OK. Makes sense. And then, Howard I guess you touched on this a little bit, but I guess if you could update us a bit on the trends in the CNI and middle market portfolios just in terms of customer demand or line utilization levels and also what kind of competitive dynamics you see now in terms of pricing pressures and maybe terms.

Howard Atkins

The, as I mentioned, we’ve been very aggressive on the commitment side, so the lines and commitments have been growing. But to be fair, the actual line utilization remains low. It hasn’t gotten much lower, but sort of relatively flat the last quarter or two, but still is at a relatively low levels.

You know we like this business. It’s a bread and butter business for us. We did see some pickup in activity in the quarter, and I guess the other thing I’d mention, we’ve talked about this in the past. When demand generally does come back in CNI, we should be the primary beneficiary of that, because we have all the other business with many of these clients, so in terms of cash management and all the other products and services, this is very similar to the experience we had back in 2002 when (inaudible) we gained a fairly significant amount of market share during that period but we’re not at that point yet.

You know pricing is still appropriate as far as we can tell for the risks. We’re not doing anything on terms to give away the business, so we’d like to see more business there, but at our terms and pricing.

Joe Morford – RBC Capital Markets

OK. That’s very helpful. Thanks so much.

Operator

Your next question comes from the line of Mike Mayo with Calyon.

Mike Mayo – Calyon

Just a follow up, so what’s the percentage of the loan utilization? I just use that as a measure for how much loan demand there is and what’s your feeling about loan demand.

Howard Atkins

Well you know on balance Mike, and again you’re talking about composition of portfolios, roughly in the low 30’s on commercial line utilization and that’s been relatively consistent for a couple of quarters now.

And again as we say, we’re seeing somewhat increased activity, but you know, it’s not as robust as we would like to see it be, and as I said, we think we’re picking up market share because we’ve got so many relationships and all the other cross sell. So we’ll just have to see when demand comes back.

John Stumpf

Mike, I think one of the things, one of the keys is our increase in commitments is much greater than what’s happening in the portfolio, the outstandings. So we’re making investments today, spending money today to win new clients, service existing clients that we’re not seeing the benefit of yet.

So when this thing does turn around, we will get a boost. It will be like a springboard, and we’re willing to make those investments because those are good long term relationships for new customers who really value a company who’s going to stick by them.

Howard Atkins

And then of course we get the fee income on the commitments, so the loan fees have been strong as we have been as I said, very successful in growing commitments.

Mike Mayo – Calyon

And then on slide 23 you showed non-accrual loans stabilizing, but there was an uptick in both consumer and commercial non-accruals in terms of the inflows from the second to the third quarter. Not much, but it’s a little bit of an uptick. Is that just timing or is that just the economy kind of slowing down a little bit.

Howard Atkins

You know we had one, as I mentioned earlier, the first mortgages on the consumer side which could be more seasonal, just you know one quarter to the next. All of the consumer portfolios were flat to down.

And then on the commercial side it was largely a relatively small number of large corporate loans that went non-accrual and most of the other commercial portfolios actually saw declines in inflows.

Mike Mayo – Calyon

One of the questions I’m just really trying to get to, from your perspective since you’re across the country now, is the economy getting worse, a lot worse? Do we need to QE2? What’s your read from the bottom up perspective?

John Stumpf

Well you know Mike, I travel like probably a lot of others, a lot, and I’m in a lot of different geographies. And I think it depends a bit on the type of business you’re in, but in a general statement, many businesses are doing quite well.

I mean, I don’t know what the last number is, but there’s more than $1 trillion of liquidity that’s on corporate balance sheets, small business, medium sized businesses, large businesses that’s sitting in our banks and other banks, and I don’t know that I have a view on QE2 or whatever or other stimuli and so forth.

But I think that the primary factor, when you talk to businesses, when they talk about their issues, it’s not that they can’t get a loan. That’s a bit of an urban myth. In fact, we have our teams marching double time looking for lending opportunities. In more cases than not, it’s a bunch of factors.

You know, consumers are deleveraging, being more secular in what they spend. All these different reform measures and so forth cause uncertainty. So there’s just a variety of things and I don’t know that one part of the country is favored versus another.

Some States have more foreclosures issues and higher unemployment. So we deal with unemployment as low as in the high four’s, low five’s in the middle part of the country to over 12 here in California. So we see a lot of different situations. I don’t think there’s any way of categorizing one versus the other.

Mike Mayo – Calyon

All right. Thank you.

Operator

Your next question comes from the line of Nancy Bush with NAB Research.

Nancy Bush – NAB Research

A couple of things here. Howard, you’ve got more unrealized bond gains than I guess just about anybody in the industry. Would you give us your thoughts about harvesting some of these as we go down the road possibly toward higher rates someday? You know, how do you think about that and what makes that determination.

Howard Atkins

A couple of things, Nancy. Yes, we do have a substantial amount of unrealized bond gains and it actually went up in the third quarter but if we do come to the point where we believe that rates are likely to go up, one of the things we can consider doing to manage against that would be just to sell assets.

You know if you remember, back in 2003/2004, that’s exactly what we did. But the way we did it back then was to sell our lowest yielding assets, not our highest yielding assets. So again, the framework here is not take the gain for the sake of taking the gain and not looking to maximize the upfront gain but to clear the way if you will for repositioning the portfolio when rates go up, and do so by selling the lowest yielders.

And we may have other assets on the balance sheet that we’d consider doing so other than the securities portfolio. But the good news is, when we come to that point the likeliness is that we don’t have anything in the portfolio that’s at a loss right now to speak of. If we take that action, it would result in a gain.

Nancy Bush – NAB Research

Secondly, you mentioned about the, on the 13 basis point impact on NIM sequentially, I think you mentioned the shedding of some strategic run off portfolios etc. Would you just speak to whether you’re beginning to see substantial run off from Wells Fargo Financial and the discontinued lines there and how you see that impacting margin over the next year or so.

Howard Atkins

Well, that is a portfolio, the debt consolidation portfolio from Financial is included now in the so-called non-strategic grouping and again, my general comment is, as those loans continue to – you know we continue to grind down that portfolio and the other portfolios, we know we’re giving up some margin by doing so, but of course we’re also paving the way for less risk and lower potential charge offs down the road

So you know, net net, it’s a benefit to either risk or earnings or both even though it may not be a benefit to the margin.

Nancy Bush – NAB Research

John, I’ve just got one quick question for you. I know you went through your thoughts about foreclosure and the fact that you have been very careful etc., etc., but there have been a couple of instances detailed in the press of Wells Fargo robo signing, etc., and there is a great deal of speculation that you know, at some point you guys are going to cave and we’re going to find out all this bad stuff about your foreclosures. Could you just comment on that? Was this robo signing incident an isolated one or you know, could you just talk about that?

John Stumpf

Yeah, you might be talking about the one that was in the press regarding Washington State and in that case, the judge actually found in our favor and that we had done things properly. I think the key issue is what Howard covered on page 26, and I don’t know if it could say it any better than that.

I don’t know how other companies do it, but in our company our process has the affidavit signer, reviewer are the same team member, and we believe these issues, they’re properly notarized. And if we find an error, we’ll fix it.

You know, humans do make errors, but that’s what our process. One reviewer, one signer, same person.

Nancy Bush – NAB Research

OK. Thank you very much.

Operator

Your next question comes from the line of Chris Nastasio [ph] with Stifel Nicolaus.

Chris Nastasio [ph] – Stifel Nicolaus

Good morning all.

John Stumpf

Hi Chris.

Chris Nastasio [ph] – Stifel Nicolaus

Howard, I’m going to follow up on Nancy’s question. She actually stole it from me if you will. What is the actual gains in the third quarter in the unrealized gains and securities portfolio?

Howard Atkins

$9 billion pre-tax.

Chris Nastasio [ph] – Stifel Nicolaus

And a follow up, an unrelated follow up. Can you remind me when do we see the half a billion dollars of M&A expense that’s related to the merger related charges for Wachovia. When does that start to wane on a quarterly basis?

Howard Atkins

Good question. We are obviously coming up on two-thirds done with the integration process. Many of the branch related systems have now been converted. We have done the overlapping states on the branch side. We’re really now coming up to the big crunch if you will from an expense point of view and a process point of view in converting all of the non-overlapping states on the east coast up into the northeast.

So it’s going to be another couple of quarters. In fact, we may actually have higher merger integration expenses in the fourth quarter and the first couple of quarters in 2011 before this trails off during the course of 2011.

John Stumpf

Chris, we’re still looking at finishing this, substantially be finished by the end of 2011.

Chris Nastasio [ph] – Stifel Nicolaus

Great. Thank you for the color.

Operator

Your next question comes from the line of Moshe Orenbuch with Credit Suisse.

Moshe Orenbuch – Credit Suisse

Great, thanks. You talked a fair amount about the checking account growth. Could you describe the process like what you’re selling against and what you’re seeing competitors make changes in order to offset the loss of overdraft fee revenues?

John Stumpf

Well first of all, customers like to invest with us and it’s our privilege to serve them and we have taken the tack for many years now that we’re going to be, we’re going to serve customers when and how they want to be served.

We’re not going to steer somehow to an ATM because it might be cheaper to serve a customer there. We don’t think in those terms. We think in terms of the customer is at the center of what we do. We invest in stores. I think we have the best store network. Stores matter.

We think we have the best online offering. Our ATM innovation and the services that we provide there to customers are industry leading. And our phones, we have ways of serving customers there, especially the high value customers in very distinguished and differentiated way.

So when you think of those four channels, and mobile, and they behave like a distribution community, you win more business, and I’ve said this many times to many people. I get into the office about 5:30 and by quarter to six, I read the deposit report from the day before, and checking is such a big part of that.

You know that we sell about three-fourths, more than two-thirds of our checking accounts through a package, and these are well thought out packaged products to help customers succeed. So as we move forward now and as I mentioned in my comments, regulatory reform will change the way we get paid for, in some way we get paid for our business and this will be a balancing process.

We’re going to tighten our belts. We’ll get paid differently in some cases for the products and services. At the end of the day, our goal is right where our vision and values is, helping customers succeed financially and satisfying all their needs.

And that strategy is winning in the marketplace because we’re outgrowing the natural growth in those places, and we’re taking share from others.

Moshe Orenbuch – Credit Suisse

Ok. A separate question. A bunch of people asked about NSR’s. Could you talk about the outlook for the valuations of NSR’s given that you’re going to be in this low rate environment, but it’s not clear whether the pace of refi’s going to increase? How do you think the NSR valuation, already at a pretty low level tracks as we go forward?

Howard Atkins

Well, we are carrying now at really historically low levels and it remains to be seen. However the pace of refi’s picks up or not, but you know net net in terms of economics, this kind of refi market helps earnings not hurts earnings with rates being down at this level, even with accelerate refi’s in the marketplace.

And secondly, as you may remember, we tend to pick up market share during big refi waves, so this is good for us both in terms of just the economics of what happens in a refi as well as market position.

Moshe Orenbuch – Credit Suisse

Great. Thanks.

Operator

Your next question comes from the line of Jason Goldberg with Barclay’s Capital.

Jason Goldberg – Barclay’s Capital

Thank you. Just looking at the average balance it looks like residential, commercial and CNVS’s. I guess that’s non agency stuff went from an increase on (inaudible) but the balance is unchanged. I’m not sure if that’s tied to changes in accretable yield because maybe you just flushed that out.

Howard Atkins

We had in the quarter some payoffs of previously impaired CMVS’s so this is stuff that we would have written down that actually improved and that got reflected in the yield in the quarter.

Jason Goldberg – Barclay’s Capital

Without the accretable yield impact, either probably absolute or kind of link quarter change, maybe talk about your outlook on a quarter basis and then talk to maybe kind of how you see the whole accretable yield thing playing out going forward.

Howard Atkins

Well again, we’re not going to give guidance on that, and there’s so many factors as you know that impact the margin. But you the point I made before is that the bulk of the 13 basis point drop was due to the change in loan resolution income that went through the quarter, so we continue to have loan resolution income. It’s just that it was down a $200 million in the quarter, and that really was the main change.

Interestingly, if you take that away as I say, even though we had decline in earning assets and loans, our net interest income, if you again put aside the loan resolution part of it, was not really down in the quarter. And again, that comes back to the fact that we’re growing deposits.

We may not at the margin right now be earning you know, four percent on every single checking account that we get, but every single checking account that we grow in this company is earning something, and it’s showing up on the margin.

John Stumpf

You know another way of saying that Jason is the margin is the result of what we do not the reason of how we do things. I mean, we run the business the way we think is best for our constituents, and it results in a margin. We don’t wake up in the morning and say we have to have a margin of 425 or 450 or four percent or incremental business. We think it’s really the result of.

Jason Goldberg – Barclay’s Capital

Got you. And then I guess credit card fees were actually up link quarter despite a lot of banks being down due to the card act. Is anything in particular going on there?

Howard Atkins

Activity and building the business. You know, as we penetrate our customer base with more cards, especially on the Wachovia side in particular, and as activity grows in the company, you get more fees for it. So that’s a good story because that did offset – you know the growth in that business actually offset the impact of the card act – more than offset it.

Jason Goldberg – Barclay’s Capital

Great. Thank you.

Operator

Your next question comes from the line of Ron Mago [ph] with GIC.

Ron Mago [ph] – GIC

Hi. Thanks. In regard to these deposit fees were down $300 million in the quarter and I’m wondering how much of the Reg E affect has been felt at this point.

Howard Atkins

I’m sorry; I missed the end of your question, Ron.

Ron Mago [ph] – GIC

How much of the Reg E effect has been felt. So in other words, how far down, how much further down do we have to go in deposit service charges?

Howard Atkins

Well we had, as we quantify the Reg E impact, was 380 in the quarter, so you know 380 down from Reg E and only 300 down in total, so we actually did have some growth.

Ron Mago [ph] – GIC

But what percent of the Reg E effect has been felt now was really my question.

Howard Atkins

We’re assuming roughly the same kind of number, maybe a little bit higher in the fourth quarter.

Ron Mago [ph] – GIC

I’m sorry, same effect, or same level of deposit base?

John Stumpf

It could be a bit more because when some of this went into place, it was staggered in during the quarter.

Howard Atkins

Again, keep in mind Ron; this is before any actions that we may take to offset this in coming quarters in terms of pricing, product changes, so on and so forth. So that’s sort of the gross impact.

Ron Mago [ph] – GIC

So in other words, we could see, I just want to be 100 percent clear. We could see the same dollar drop in the fourth quarter from Reg E?

Howard Atkins

See the same dollar impact, right. So we already had 380 off in the third quarter. You know that might go up a tad in the fourth quarter. Again, I know exactly know yet what the number will be because it will depend a lot of customer experience. But it won’t go down by another 380 in the fourth quarter, right. We already had 380.

Ron Mago [ph] – GIC

I’m sorry; I’m really slow on this. So is it the drop that will be the same or the level, the current level that will be the same in the fourth quarter the $1.1 billion.

Howard Atkins

There may be some additional drop in service charges in the fourth quarter from the third quarter depending upon what customer experience looks like, but it won’t be another $380 million because from the second quarter to the third quarter we had, the third quarter was the first quarter we had the impact.

Ron Mago [ph] – GIC

And then in the fourth quarter, by the end of the fourth quarter you should have felt 100 percent of the impact.

Howard Atkins

Correct.

Ron Mago [ph] – GIC

OK. Thanks. And then I have a question about tier one common. You know on the slide on page 25, the reported tier one common ratio was up $0.40 but the pro forma was up $0.70 and I’m wondering if there’s anything special.

Howard Atkins

Yes. I’m glad you asked that question because given the way BASEL III works, again you have deferred tax assets and other items there, our deferred tax asset position is being realized very quickly because we’re charging off the PCI loan.

So the way PCI works is, we already reserved for it two years ago, but as we actually charge off the loans, there’s not accounting impact on earnings, but we get the tax benefit realized right away. So you should expect to see our tier one common on BASEL III basis rise more quickly than our retained earnings would be in tier one common as reported.

Ron Mago [ph] – GIC

OK. Thanks. That was my question. And then one last question. You mentioned Howard that the rising commercial non-performers reflected a few large corporate credits, and I guess I was a little surprised at that because Moody’s and so on are reporting much lower corporate defaults and everything so I was wondering if you could elaborate on that point.

Howard Atkins

You know we have a large corporate portfolio now and from one quarter to the next it goes up, it goes down, lumpy.

Ron Mago [ph] – GIC

Was there any concentrations?

Howard Atkins

No.

Ron Mago [ph] – GIC

OK. Thanks very much.

Operator

Your next question comes from the line of Fred Cannon with KBW.

Fred Cannon – KBW

Thanks. Just a quick follow up on the deposit fee issues. I believe you guys lost a Federal case on high to low regarding debit fees, and I didn’t know a, if you’d been able to get a stay on that issue, and b, if that does hold, and I think it requires you to stop high/low on debit on November 30. Would that, how much would that affect your deposit fee income?

John Stumpf

We’re appealing that and I don’t know if there’s anything more to say about that right now. It’s on appeal.

Fred Cannon – KBW

OK. Thanks, John. And then on the, I’m just curious regarding the BASEL numbers, Howard, and maybe I missed it. You’re only ten basis points away on the tier one common according to the best guess of calculations. I know it’s preliminary at this point in time. Any guidance where the total tier one with the 8.5 percent requirement would be under BASEL?

Howard Atkins

Again, you can roughly add the spread on our recorded ratios between the two, so you’ve got some 200 basis points, 200 to 250 basis point spread between tier one common and tier one regulatory in our case.

Now there’s some disallowance for trumps [ph], but in the case of our trumps, $19 billion or so of trumps that count against tier one but not tier one common, about $7 billion of the 19 converts to qualifying capital, so we’re down to 11 or 12, which right now would only amount to about 50 basis points or so on the tier one ratio.

So again, you can roughly assume 200 to 250 basis point spread between the tier one common and the tier one regulatory.

Fred Cannon – KBW

Under BASEL, so you would get credit for the perpetual preferred you have and then the $7 billion of trumps that would convert, is that correct?

Howard Atkins

Correct. Exactly.

Fred Cannon – KBW

Thank you.

Operator

Your next question comes from the line of Carol Berger with Soleil Securities.

Carol Berger – Soleil Securities

Hi there. Just a little minutia. Last quarter you took about $400 million in litigation reserves, but you didn’t talk about that this quarter. Anything?

Howard Atkins

No. We’re down from the second quarter and nothing special in this quarter.

Carol Berger – Soleil Securities

Thank you.

Operator

Your next question comes from the line of Paul Miller with FDR Capital Market.

Paul Miller – FDR Capital Market

Thank you very much. A question on mortgage banking. Right now you mention that you’re getting four to 4.5 point gross and there’s gain on sale margins, and it’s really been a big surprise for the whole industry how well it’s done, and we’re looking for another strong fourth quarter. How long do you think it can last as rates sitting down here at 2.50? And is this a new change in policy in the industry because it appears that a lot of the big guys control the space, didn’t really expand capacity, and is it just a really good sign for the whole industry in general?

Howard Atkins

The mortgage earnings are you know, what they are. I’m not quite sure where you’re going with the question. Our margins are very good right now. We’re adding capacity. We’re getting tremendous flows of business. It’s continuing into the fourth quarter, so yes, if rates remain at these kind of levels, I would expect us to continue for at least another couple of quarters.

John Stumpf

These are also very good rates for consumers. They’re also big wins. Consumers on average are picking up over 100 basis points reduction on loans, so this is one of these win/wins.

Paul Miller – FDR Capital Market

I guess where I’m going with this is, is this a change in overall industry, because at times when we’ve seen rates fall like this, I mean capacity was added so quickly and the gain on sale margins were not sustainable. I mean, I was hoping that these gain on sale margins would be much more sustainable than they were in the past and the lumpiness in the mortgage banking earning may be more smoother.

John Stumpf

Well if you think about the past, in the past there was a time when it was very little margin in the prime business because there was outside margins in the subprime business. And like I said, just a couple of seconds ago, Howard said, we’re adding capacity.

This is good for consumers. It’s good for the industry. So things change and we’re making a fair return on this, and I don’t know if there’s much more story. We continue to add capacity and adjust as we see business flows.

Paul Miller – FDR Capital Market

I guess, I mean can we expect to see these type of margins you think for the next couple quarters then or leave it at that?

John Stumpf

We don’t give guidance on that, but you can expect that we will...

Howard Atkins

If demand remains strong, margins are going to be good, right?

John Stumpf

We’re going to serve our customers.

Paul Miller – FDR Capital Market

OK. Thank you very much gentlemen.

Operator

Your last question will come from the line of Andrew Marcourt with Evercourt [ph] Partners.

Andrew Marcourt – Evercourt [ph] Partners

Morning guys.

John Stumpf

Morning Andrew.

Andrew Marcourt – Evercourt [ph] Partners

I wanted to circle back on the mortgage securitization issue and the repurchase. Can you just give us a sense of where you think we are in the kind claim cycle if you will in terms of how, are we through 50 percent of the amount of claims you expect or 75 percent? How do you think about it?

Howard Atkins

Well again, as we said earlier, we believe that most of the issues are in those 2006 to 2007 through 2008 vintages, and we’ve been working on those vintages with the agencies for five, six, seven quarters now. I can’t tell you precisely how far through we are with it, but it’s got to be the majority of the vintage that belong to those vintages are already behind us now.

And as we indicated earlier, that’s probably one of the reasons why we’re seeing repurchase demand requests actually decline in the last two quarters.

Andrew Marcourt – Evercourt [ph] Partners

Any repurchase requests from the private label side?

Howard Atkins

We had $69 million worth. Very modest. And again, the reason for that, that’s a very small part of our servicing portfolio unlike many of the other big bank peers. We didn’t do a lot of label securities.

John Stumpf

It’s a small part and most of that part is private.

Howard Atkins

And pre 2006 vintages. So we don’t see those being a big issue.

Andrew Marcourt – Evercourt [ph] Partners

OK. And then in terms of maybe I missed it. In terms of, you had mentioned at least in the release about the reserves continuing to down. I think you had mentioned any color in terms of the degree how we should think about the pace of that continuing, also maybe the context of MPA’s not going down. How do we think about reserve release going forward?

Howard Atkins

Well again, we can’t really give you guidance on that. The allowance that we had at the third quarter was adequate for the risks that we see. If you want to think about it may be overly simplistically, our charge offs per quarter are now down $1.3 billion from the peak. So you can do your own math in terms of what that means for an annualized charge off rate and draw some conclusions about where the allowance might go over a period of time if charge offs remain low and continue to go down.

Andrew Marcourt – Evercourt [ph] Partners

OK. Thanks. And then the last question is on capital. When in fact did you get the green light to have more flexibility in deploying capital? What would be the kind of top priorities from your perspective?

Howard Atkins

Well I think John said it before. The dividend is a top priority for us, and that’s important to our shareholders. Our shareholders have been very patient with us, so that will be the first place to go.

We have been and will continue to buy back the warrants when it’s economically beneficial for our shareholders for us to do so. We’ll continue to invest in the business. We hopefully will be able to do some opportunistic share repurchase.

Another use of capital, you know we talked about the trump securities before. You know we may cull some of those to the extent that we can replace with lower cost senior debt, so there’s lots of ways we can improve earnings for our shareholders by deploying capital going forward.

Andrew Marcourt – Evercourt [ph] Partners

Thank you.

John Stumpf

Well thanks everybody. We ran a little over time, but it was important and we thank you for our interest in our company and we will see you next quarter at this time. Thank you.

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