Kevin Kabat - Chairman, Chief Executive Officer, President, Chairman of Finance Committee, Member of Trust Committee and Chief Executive Officer of Cincinnati at Fifth Third Bank
Jeff Richardson - Director of Investor Relations and Corporate Analysis
Mary Tuuk - Chief Risk Officer and Executive Vice President
Daniel Poston - Chief Financial Officer and Executive Vice President
Brian Foran - Goldman Sachs
Robert Patten - Morgan Keegan & Company, Inc.
Matthew O'Connor - Deutsche Bank AG
Fifth Third Bancorp (FITB) Q4 2010 Earnings Call January 19, 2011 5:30 PM ET
Good evening. My name is Daniella, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fifth Third Bancorp Fourth Quarter 2010 Earnings Conference Call. [Operator Instructions] At this time, I would now like to turn the call over to Mr. Jeff Richardson, director of Investor Relations. Sir, you may begin your conference.
Thanks. Hello, and thanks for joining us this evening. Today, we'll be talking with you about our full year and fourth quarter 2010 results.
This call may contain certain forward-looking statements about Fifth Third pertaining to our financial condition, results of operations, plans and objectives. These statements involve certain risks and uncertainties. There are a number of factors that could cause results to differ materially from historical performance in these statements. We've identified a number of these factors in our forward-looking cautionary statement, at the end of our earnings release and on other materials, and we encourage you to review those factors. Fifth Third undertakes no obligation and would not expect to update any such forward-looking statements after the date of this call.
I'm joined on the call by several people: Kevin Kabat, our President and CEO; Chief Financial Officer, Dan Poston; Chief Risk Officer, Mary Tuuk; Treasurer, Mahesh Sankaran; and Jim Eglseder of Investor Relations. During the question-and-answer period, please provide your name and that of your firm to the operator.
With that I'll turn the call over to Kevin Kabat. Kevin?
Thanks, Jeff. Good evening and thanks for joining us. We appreciate your time and expect you seeing both that we announced earnings after the market closed today and also that we have announced an offering to issue $1.7 billion in common stock, with the intention of using the proceeds of that offering, a planned senior debt offering and other available funds to fully repay our TARP Preferred Stock of $3.4 billion, subject to notification and approval of the U.S. Treasury. This action would eliminate the annual $170 million reduction to net income to shareholders from the preferred dividend, plus another approximately $11 million in discount accretion that runs through the preferred dividend line every quarter. I'd note that the warrant associated with the TARP investment will remain outstanding after TARP is repaid, but we plan to engage the U.S. Treasury in discussions about their repurchase. If we can't reach agreement on their value, we'd evaluate participating in the auction.
I'll make a few remarks about our plans, but before we continue our discussion of earnings and our outlook, although those remarks will be limited because we've launched a Securities offering. We have discussed with you for the past year or so our thoughts about TARP repayment. We believed it was important that we generate the kind of results that we have been generating and have just reported, that we allow time for the demonstration that economic trends were well-established and that we await more clarity related to capital standards and industry capital levels, clarity that was important for ourselves and also for regulators. We have had ongoing dialogue with regulators on this topic, including these plans. We believe that the conditions we were waiting for now exist and that now is the right time for us to repay TARP. We have carefully considered the size of the capital raise in light of an assessment of our capital needs, industry capital levels, regulatory expectation, the Basel III proposals and the desire for future flexibility in capital management policy and for the opportunities that we expect to be available to us as we emerge from the cycle. These actions are expected to produce the capital position that is in excess of our internal targets and the Basel III fully phased in minimums. Our Tier 1 common equity ratio, pro forma for the offering and TARP repayment would be 9% versus our internal target in the 8% range. We believe this will position us for maximum flexibility in managing capital and pursuing growth opportunities.
We have provided more information about our plans and their pro forma effects in the appendix of this earnings presentation that we'll walk through today. There are many questions you may want to ask us on this call that we won't be able to answer, either because we've launched a Securities offering or we can't answer it for other reasons related to regulatory confidentiality. We try to be pretty open and transparent about our own company, but legal and regulatory considerations limit what I can say about these topics at this time.
Now with that behind us, I'll make some opening comments about fourth quarter and 2010 earnings, and then hand the call over to Dan and Mary for a more detailed discussion of our financial and credit performance and outlook. As I noted, we've posted a presentation on our website to facilitate our discussion. Let's get started on Page 3.
Today we reported full year net income to common shareholders of $503 million or $0.63 per common share, compared with full year 2009 earnings of $511 million, which included a $1.1 billion after-tax gain from the sale of our interest in our processing business. For the fourth quarter, we continued our strong momentum and posted a $0.33 per share profit and ROA approaching 1.2%. Net income was $333 million, up 40% and ROE was 10%. Those were very strong results and show the core earnings power of our company.
A significant highlight of the year was our return to profitability, maintaining high levels of pretax, pre-provision earnings. We also continued our positive momentum on the credit front. Net charge-offs fell below 2% as expected on an annualized basis for the first time since the second quarter of 2008. Nonperforming assets, including loans held for sale declined 11% and NPA inflows were much lower than levels experienced earlier in 2010.
We also posted significantly lower delinquencies, which were down 7% on a sequential quarter basis and we're at the lowest level since the first quarter of 2007. The results of our efforts on this front are encouraging, and we look forward to continued improvement.
In terms of our outlook for 2011, the overall environment for business has improved somewhat, and we're seeing some growth as corporate earnings continue to be strong. There's positive momentum in ISM manufacturing surveys, which have been trending up for nearly a year and a half, as well as GDP growth. Those improvements are beginning to show up in companies' bottom lines and are reflected in our C&I loans growth in this quarter. We're seeing good momentum in middle market commercial lending, as well as our auto originations.
In the second half of 2010, we saw record levels of originations and broad-based growth within C&I loans, which is a good sign, and we believe that growth will continue into 2011. Commercial real estate loans continue to decline, with the runoff is slowing and we're seeing some selective, but attractive opportunities here and there. Of course, unemployment remained high and consumers generally continue to deleverage. But consumer spending has been reasonably good the past several months and I think people are generally feeling more optimistic about their own circumstances in the environment than they have in a long time. The Midwest, where we're strongest, is doing okay. It's not robust, but there's a noticeable change in tone, and that's supportive of continued moderate growth, as we turn the quarter into 2011.
The industry faces some headwinds from the Dodd-Frank Act, including debit card interchange caps, but we know our business and will adapt accordingly. Dan will talk more about that in his comments. We are in touch with the needs of our customers and we know our markets. Our traditional banking focus is very much in line with the direction of financial reform. We continue to support consumer protection. We are proactively evaluating and addressing areas, where we will be most significantly impacted, such as debit interchange fees, to ensure we'll able to mitigate a substantial amount of these impacts and costs.
Let me give you some additional highlights of the quarter. We had very strong loan and deposit growth during the quarter. C&I loans grew $889 million on an end-of-period basis, despite the $842 million negative impact of the FTPS loan refinancing. Our growth within C&I is broad-based across many industries, where we've invested resources.
Average auto loans grew about $300 million and this continues to be a strong performing asset class with net charge-offs below 70 basis points. Average transaction deposits grew $3 billion on a sequential basis or 5%, which was driven by across-the-board growth in all products, including 9% sequential growth in DDA balances. NII increased $3 million sequentially, while NIM was up five basis points to 3.75%. We saw balance sheet growth and that allowed us to deploy some of our excess liquidity, helping drive those results.
Corporate banking revenue grew 21% on a sequential basis, as closely tied to loan activity. Investment advisory revenue grew 4% and card and processing revenues was up 5%. And lastly, net charge-offs of $356 million were down 63% sequentially, and down 20% excluding charges related to the quarter credit actions that we took, and we've moved the majority of the commercial loan balances transferred to held-for-sale last quarter.
Before I turn it over to Dan, I just want to say that I'm excited to begin a new year here in 2011, which I think is going to have a much different feel for Fifth Third. We've continued to invest in high opportunity and growth businesses, and I expect that the results of all the things we've done in our company that have been overshadowed by credit will start showing up more clearly.
With that, I'll ask Dan to discuss operating results and give some comments about our outlook. Dan?
Thanks, Kevin. As Kevin mentioned, we had a very strong quarter and we've got many positive operating trends to discuss. If you turn to Slide 4 of the presentation, in the fourth quarter, we reported net income of $333 million, and paid preferred dividends of $63 million. This resulted in $270 million of net income available to common shareholders or $0.33 per diluted share. Compared with the third quarter, this is a 40% increase in net income and a 50% increase in diluted earnings per share.
You'll notice that our average diluted share count was up this quarter by almost 40 million shares. That simply represents the effect of the if converted method of computing diluted EPS as the share is underlying our Series G convertible preferred stock and our warrants were now included on our fully diluted share count. This resulted from increased profitability, but reduced the EPS by about $0.05 for the quarter. These strong results were driven by $583 million of PPNR, which reflected solid fee and net interest income result and by significantly reduced net charge-offs and provision expense as our credit profile continue to approve.
Before I turn to detailed results, let me stop here for just a moment. In my comments, I will provide information relating to our outlook for the first quarter results and for trends going forward. The offering we've announced and the TARP repayment may affect some of those expectations. In the interest of clarity, our providing outlook, excluding effects of those actions rather than incorporating them into our guidance. We've provided several slides that outline our plans and provide pro forma effects of those plans. Those slides are in the appendix to the presentation, that part of our earnings materials and those effects are pretty simple to calculate.
So turning now to Slide 5 in NII. Net interest income on a fully taxable equivalent basis increased $3 million sequentially to $919 million, while net interest margin increased five basis points to 3.75%. There were a number of puts and takes in the quarter that led to this sequential improvement. NII and NIM both benefited from ongoing CD repricing and deposit mix shift away from CDs, as well as continued deposit pricing discipline. Also, we experienced higher average total loan balances, despite the refinancing of a portion of our loan to FTPS, which we outlined in the release, that I'll talk a little bit more about in a minute. The net result of that muted one on what would otherwise have been a more substantial contribution to the growth in loans and the trends there.
On the other hand, we experienced higher premium amortization expense due to higher securities prepayments during the quarter. And finally, and this is more of a NIM factor, we have had strong C&I loan originations to highly rated credits, and the yield on those loans reflected that high quality.
With that context and turning to Slide 6, let's go through the balance sheet in a bit more detail. Average earning assets were down about $1 billion sequentially or 1%, which was primarily driven by lower investment securities balances, partially offset by growth in average total loan balances. Average short-term investments declined $1 billion, driven by lower cash balances held with the fed. We reduced excess liquidity through the runoff of CDs, which kept overall deposits flat, and we prepaid $1 billion in Federal Home Loan Bank funding.
Average taxable investment securities balances declined about $210 million, which was primarily the result of the sale of agency securities during the quarter, which generated gains of about $18 million. Additionally, we continued to invest a portion of portfolio cash flows in high-quality mortgage originations, generally with maturities of 20 years or less in order to maintain the duration of our earning assets portfolio. We continue to be very careful about managing the interest rate risk profile of our balance sheet, and we continue to target a neutral to modestly asset-sensitive position.
Average wholesale funding declined about $2 billion compared with the third quarter. As I noted during the quarter, we terminated $1 billion in Federal Home Loan Bank funding based on our excess liquidity position and our reduced funding needs. So we saw a partial impact of that during this quarter. We incurred about $17 million in charges on the early extinguishment of these borrowings and the associating cash flow hedge, which was also terminated. That charge is recorded in other noninterest expense. The remaining decline in wholesale funding was attributable to the decline in jumbo CDs.
Average total loan balances were up about $300 million compared to the prior quarter even after the impact of refinancing our loan to FTPS during the quarter. In connection with their acquisition of National Processing Company, FTPS increased the size of its loan facilities, which were then syndicated through a group of banks. We are part of that syndicate, but our share of that loan is now about a-third of the original $1.25 billion. Excluding the impact of that refinancing, average total loan balances would have been up about $845 million over the prior quarter.
Period and total loans increased $965 million and would have increased $1.8 billion after the FTPS refinancing. We are very pleased with our core loan production. We're seeing some growth within several areas. We saw positive loan balance trends within C&I, Residential Mortgage and Auto Loans.
Looking at each portfolio. Average commercial loans in the portfolio were down 2% from last quarter, which was driven by the $961 million of loans that we transferred to held-for-sale, in connection with the credit actions taken at the very end of the third quarter, as well as the impact of the FTPS loan refinancing. On an end-of-period basis, commercial loans were up $522 million, driven by growth in C&I loans and partially offset by the runoff in the Commercial Real Estate portfolio.
Period-end C&I loans increased 3% sequentially. And excluding the impact of the FTPS loan refinancing, period-end C&I loans increased 7% sequentially. We see broad-based growth across many industries and sectors, with continued particularly strong production within manufacturing and healthcare industries.
Commercial line utilization was stable again this quarter, although it remains at low levels still at 32.7% compared with 32.4% last quarter and 32.7% a year ago. And as you know, that's down from normal levels that are in the low- to mid-40s. We saw continued runoff in the Commercial Mortgage and Commercial Construction portfolios, but the rate of decline has slowed. In aggregate, on a period-end basis, those portfolios were down 3% sequentially. We'd expect these balances to continue to trend down over the near term, but as I noted, that headwind is diminishing.
Average Consumer Loans in the portfolio increased 2% sequentially and increased 3% on a period-end basis. Average Residential Mortgage balances were up 7% sequentially, including the $228 million of nonperforming loans that were sold at the end of the third quarter.
Mortgage originations were $7.4 billion in the fourth quarter, a 33% decrease over last year. The increased origination volume was due to increased refinance activity and record low mortgage rates. As we mentioned last quarter, we began retaining simplified refi mortgages originated through our retail branch system, which is a product that has lower LTVs, shorter durations and higher average rates than most of the conforming loans that we sell to agencies. Mortgage retention added about $710 million to our average balances during this quarter.
Average auto loan balances increased 3% sequentially and 21% from last year due to strong originations throughout the year. The loans we brought back on the balance sheet in the first quarter contributed pretty significantly to the year-over-year increase. Our Auto portfolio has continued to perform very well at spreads that remained attractive, although we've begun to see some pressure on spreads recently due to increased competition. Average credit card balances were flat sequentially and down 7% from a year ago, and average home equity loan balances were down 2% from the third quarter and 5% on a year-over-year basis.
Looking ahead in the first quarter of 2011, we expect to see continued loan growth in the first quarter, with solid C&I growth despite the full quarter effect of the FTPS loan refinancing on that quarter. For reference, while our period-end balances already fully reflects that, our average balances will be impacted by about another $300 million or so in the first quarter.
Moving onto deposits. Average core deposits increased 2% on a sequential basis and 6% year-over-year. Consumer CDs, which are included in core deposits, declined 17% sequentially and 35% year-over-year. That reflects the continuation of the repricing of the CD portfolio, including higher rate CDs that were originated in the second half of 2008. We still have about $2.5 billion of those CDs, which have rates in excess of 4% and we expect about $1.5 billion to mature primarily during the second half of 2011.
Excluding consumer CDs, average transaction deposits were up 5% sequentially and 16% from a year ago. The main driver of this sequential increase was seasonally high DDAs, which were up 9% sequentially and 16% from a year ago. Average retail transaction deposits increased 4% sequentially and 14% year-over-year, with growth across all categories. We've had great success with our relationship savings product, which has now attracted over $9 billion of balances since its inception. These balances have more than tripled from a year ago. And more importantly, they've deepened relationships with our core transaction customers.
Average commercial transaction deposits increased 5% from last quarter and 18% from a year ago. Average public fund balances were down 1% sequentially and 18% year-over-year, as we've adjusted our pricing due to our excess liquidity position. If you exclude public funds balances, average commercial transaction deposits increased 6% sequentially and 33% from a year ago. That reflects continued strong liquidity among our commercial customers, as well as seasonally high DDA balances. They were up 10% sequentially and 19% from a year ago.
We'd expect a modest decline in core deposits in the first quarter, as consumer CDs continue to run off, although we have continued to be pleasantly surprised each quarter by the strength of trends in the core transaction deposit area.
With that background, let me circle back to our overall outlook for NII and NIM. Due to the short month in February, we experienced significant seasonality in the first quarter due to day count. That affects NII and NIM comparisons between the fourth quarter and the first quarter and also between the first quarter and the second quarter. Day count alone will reduce NII by about $12 million and increase the NIM by about three basis points in the first quarter. As a result, we expect NII to be down about $5 million to $10 million in the first quarter and for NIM to be up about 5 to 10 basis points. Both NII and NIM should also benefit from CD run off and from expected loan growth, both of which will help absorb some of our excess liquidity. This seasonality will reverse itself in the second quarter, and we currently expect NII and NIM to return to levels similar to the fourth quarter or perhaps a little better.
Moving onto fees, as outlined on Slide 7. Third quarter noninterest income was $656 million, a decrease of $171 million from last quarter. But you'll remember that fee income in the third quarter included $152 million gain from the settlement of BOLI litigation. If you exclude this gain, fee income declined 3%, largely due to exceptionally strong third quarter mortgage results.
Deposit service charges decreased 3% sequentially, with commercial deposit fees up 3% and consumer deposit fees down 10%. As you know, Reg E went into effect for all accounts in July and August. We sold about $17 million in the full run rate impact of this in the fourth quarter, which is right in line with our expectations of $15 million to $20 million impact per quarter. We'd expect first quarter deposit fees to be down about $5 million from seasonally strong fourth quarter levels.
Investment Advisory revenue increased 4% from last quarter and 8% on a year-over-year basis. Both the sequential and year-over-year increases were driven by an overall lift in equity and bond markets, as well as improved production, particularly in the private client services, institutional and Brokerage areas. Securities and brokerage fee revenue increased 2% sequentially and 13% from a year ago, reflecting the benefit of investments in our sales force and sales management. We expect Investment Advisory revenue to grow another $5 million in the first quarter.
Corporate Banking revenue of $103 million increased 21% from the third quarter to the fourth and 16% from last year. The sequential improvement was partially the result of higher loans syndication fees given the favorable market conditions.
Additionally, sequential results benefited from higher business lending fees, lease remarketing results and seasonally high foreign exchange revenue. The year-over-year increase was also largely driven by those same factors. We expect first quarter corporate banking revenue to be down about $10 million from the very strong fourth quarter levels.
Mortgage banking revenue of about $149 million decreased $83 million from very strong third quarter results, primarily driven by the swing of MSR impairment, net of hedging results that was a $20 million loss this quarter compared with a gain of $46 million in the third quarter. Third quarter results were up $17 million from a year ago.
If you look at gains on deliveries, they were $158 million this quarter compared with $173 million last quarter, as we continue to have strong originations volume from refinancing activity. But margins declined due to rising mortgage rates.
Servicing fees of $59 million were up modestly and MSR amortization was $47 million in the fourth quarter compared with $43 million last quarter. Additionally, net securities gains on nonqualifying hedges on MSRs in the fourth quarter totaled $14 million, which we currently wouldn't expect to repeat in the first quarter.
On an overall basis, we expect total mortgage banking-related revenue to decrease in the first quarter by about $40 million, primarily driven by lower gains on deliveries due to the impact of the high-rate environment and lower refinancing activity.
Payment processing revenue was $81 million, which was a 5% increase from last quarter and a 7% increase from a year ago, driven by seasonally strong consumer spending in the fourth quarter. We expect first quarter processing revenue to be up a similar amount.
Before I move on, Kevin touched on the Durbin amendment, and it's pretty mature to estimate the actual impact of this legislation, as the proposals that are out there right now are currently out for comment, but it's certainly much less than just calculating the proposed interchange caps based on volume because that would not incorporate any mitigation, which we believe will be substantial, both for us and for the industry.
We had about $204 million in debit interchange revenue for the year of 2010, driven by volume of 433 million transactions. The proposed caps are $0.12 or $0.07 per transaction. And until we have final rules, we're not really prepared to directly comment on the gross financial impact of this legislation. But you can kind of do the math in terms of the range of potential results that, that produces. However, I just want to mention again that we expect to substantially mitigate the effect of the new rules, so we would not expect to ever experience anything like that kind of drop in revenue, even if these kinds of proposals are ultimately adopted.
This is a valuable service to our customers and to merchants, and it costs us a lot more than $0.12 per transaction to make this service available. We have no intention of offering a loss linear product that is core to the fundamental nature of deposit and payments offerings. We've been studying this for many months, and we've got a number of alternatives that's available to us. Which of those we ultimately pursue, will depend a lot on a number of factors, including the final proposal, the competitor's actions and our own internal work and planning over the next five or six months until it is scheduled to take effect. Because we haven't decided what to do for all the reasons that I just mentioned, including that the final rules aren't in place, I can't tell you what the mitigating effect will be. We're going to be very careful on what we do and how we implement. And we will ultimately expect to recapture most, if not all, of the value that we deliver through this channel.
Net gains on investment securities were $21 million in the fourth quarter compared with net gains of $4 million in the previous quarter. And then turning to other income within the fee income area. Other income declined $140 million sequentially, due primarily to the $152 million BOLI gain that we had last quarter, but as well as lower credit-related costs realized in revenue this quarter.
Credit card recorded in fee income was $34 million in the fourth quarter compared with $42 million last quarter. Net gains on held-for-sale loans that were sold or settled during the quarter, were $21 million, which were offset by $35 million in fair value charges on commercial loans held for sale for a net of $14 million. Last quarter, losses of that nature were about $10 million. Additionally, losses on the OREO properties were $19 million this quarter versus $29 million last quarter. We expect credit-related cost within fee income on an overall basis to drop about $15 million in the first quarter. Overall, we currently expect first quarter fee income of about $600 million, plus or minus, with the decline primarily driven by lower mortgage banking revenue, as I discussed, and lower securities gains, as well as seasonality. That seasonality and continued organic growth should produce favorable sequential comparisons in the second quarter in virtually every fee category.
Turning to expenses on Slide 8. Noninterest expense of $987 million was up $8 million or 1% sequentially, which was driven by higher revenue-based incentives resulting from increased production and full year revenue results, as well as continued investment in our sales force expansion. As I previously mentioned, during the quarter, we also incurred a $17 million charge in other noninterest expense, in conjunction with the early extinguishment of $1 billion in FHLP funding, along with an associated interest rate cash flow hedge.
As you would expect in this environment, we continue to see elevated credit-related costs. Third quarter credit-related costs included within the operating expense were $53 million versus $67 million last quarter. The declines in the prior quarter was driven by decreased expenses related to mortgage repurchases, $20 million this quarter compared with $45 million last quarter. You'll remember that we increased the repurchase reserves by about $15 million last quarter, and we believe that we are adequately reserved given our current exposure and our expectations. File requests and repurchase demands have been volatile and difficult to predict, although repurchase demands did come down this quarter. We currently expect demands for repurchases and loss severities to remain elevated, and our current expectation for first quarter of 2011 is for repurchase expense to be about $20 million, similar to this quarter.
Reserve related to unfunded commitments declined $4 million in the fourth quarter compared with a $23 million reduction in the third quarter. We currently expect that total credit-related cost included in the expense in the first quarter to be consistent with these fourth quarter levels. In total, we expect first quarter expenses to be down $35 million to the $950 million range. That decline would be driven primarily by lower mortgage-related compensation and lower loan closing costs, as well as the effect of the $17 million charge on debt extinguishment that we incurred in the fourth quarter. Those reductions will be partially offset by the traditional seasonal spike in FICA and unemployment costs within the employee benefits expense line of about $21 million. The great majority of those incremental costs will not recur in the second quarter, as you may recall from prior years.
Moving on to Slide 9 taking a look at PPNR. Preprovision net revenue was $583 million in the quarter, in line with our expectations. If you exclude the gain we had from BOLI settlement in the third quarter, PPNR declined about $50 million, as we expected, due to lower mortgage banking results. We currently expect first quarter PPNR in the $550 million to $560 million range. Coupled with mortgage banking, the drivers there are largely seasonal, $33 million due to day count and employee benefits alone. We'll recapture about $30 million of that seasonality in the second quarter, and we currently expect second quarter PPNR to be more similar to the fourth quarter level of $580 million or perhaps a little better.
You'll see in the release that the effective tax rate for the fourth quarter was about 20%, which was consistent with last quarter and in line with our expectations. We expect that in 2011, our effective tax rate will return to more normalized levels of closer to 30%, as the tax rate resets for the year and a higher level of expected earnings for 2011. The first quarter effective tax rate should be in that range or perhaps a little bit higher.
Turning to capital on Slide 10. Capital levels remained very strong. Tangible common equity was 7%, a 34 basis point improvement from the end of the third quarter. That ratio, as we calculate it, excludes unrealized securities gains, which totaled $314 million. All in, TCE was 7.3%. Tier 1 common increased 16 basis points to 7.5% and the Tier 1 ratio was up nine basis points to 13.9%, and the total capitalization was down 14 basis points to 18.1%. That's a strong capital position. In our proposed capital plan that we announced today, we'll make it even stronger. We also have solid trends in earnings and capital generation, and thus we would expect to exceed our target levels in the near term, but that will also provide us with a significant amount of flexibility over time to support attractive opportunities for balance sheet growth, appropriate distributions to shareholders and opportunistic but disciplined evaluation of M&A opportunities.
Fifth Third has a strong earnings position. We reported a 118 basis points of ROA this quarter. While we'll have some seasonality in the first quarter and we'll be back to a more normalized tax rate, we think we'll produce something close to that 118 basis points in the second quarter. Longer-term, we continue to believe that a more normalized ROA for us is in the 130- to 150-basis point range. I think the 130 basis points is imminently doable without any long delay to get there. Our provision expense is still over 80 basis points, and that is well above what we would expect on a normalized basis.
We also had $87 million in credit cost reported in both fees and expenses and that's still probably $50 million above where those amounts were before the crisis. There are headwinds like Durbin, but I believe we'll adapt to that as I discussed earlier.
Finally and significantly, our business is significantly underleveraged relative to what it's capable of. We've made every effort to protect the revenue-generating resources of the company during the crisis because we wanted to maintain our capacity to act on opportunities when they returned, which we believe they are now doing. But our asset base and our fee revenue currently reflects an economic environment that's not yet firing on all cylinders.
To put it another way, as we begin to grow, we don't expect that we'll have to grow expenses and headcount at the same rate. We all know that Fifth Third's philosophy is to be pretty lean. But we're currently at an efficiency ratio a little North of 60% and that's a function of the underleveraging of our franchising capabilities. I'd expect that to move back into the 50s on a normalized basis and we'll work to ensure that we're as efficient as possible, while we continue to invest for the revenue growth we're confident that we can generate. You've seen that the revenue generation capability is there even during the crisis in our operating results. So we feel very good about our competitive position, our strategic position, and we'll look forward to 2011, as the year where we have the opportunity to demonstrate those strengths clearly.
That wraps up my remarks. I'll now turn it over to Mary to discuss credit results and trends. Mary?
Thanks, Dan. We continued to see progress in most of our loan portfolios during the quarter. Nonperforming inflows continue to remain more moderate. Charge-offs were down significantly on both the reported and core basis. And as expected, dropped below 2% in the fourth quarter. We sold the majority of the loans we moved to held-for-sale last quarter at prices consistent with our mark. And delinquencies continue to improve, and our outlook for all key credit metrics continues to be for improving trends going forward.
Let's get into the details, starting with charge-offs on Slide 11. Total net charge-offs of $356 million dropped $600 million from the third quarter, which included $510 million in charge-offs related to our credit actions. Those included the sale of residential mortgage loans on non-accrual status and the transfer of commercial NPAs to held-for-sale. On a core basis, net charge-offs were $446 million last quarter and thus, the sequential core improvement was $90 million or a 20% reduction. That was better than we were expecting coming into the quarter.
I'm going to exclude the impact of these third quarter credit actions in my remaining discussion of net charge-offs trends by portfolio in order to provide a better feel for trends in the ongoing portfolio. Total commercial net charge-offs were $173 million compared with portfolio commercial net charge-offs of $240 million in the third quarter, a 28% decline. C&I portfolio net charge-offs were $85 million, down 34% from the third quarter. Commercial mortgage portfolio charge-offs were $80 million for the quarter compared with $66 million in the third quarter. Approximately 58% of the losses came from Michigan and Florida.
Commercial Construction portfolio charge-offs were $11 million, down 75% on a sequential quarter basis. I'd note that Commercial Construction balances are down to $2 billion on an end-of-period basis compared with $3.8 billion a year ago. Homebuilder losses continued to decline in the quarter, totaling just $19 million compared with $32 million of portfolio losses last quarter. You'll recall that we suspended homebuilder originations three years ago, have already recorded significant charge-offs against that portfolio and have made nice progress in reducing our exposure. Portfolio balances are down to $699 million, significantly below the peak of $3.3 billion back in mid-2008. We currently anticipate that first quarter commercial net charge-offs will be relatively stable, although the longer-term trend is still favorable.
Total Consumer net charge-offs were $183 million compared with the core result of $206 million last quarter. Residential Mortgage net charge-offs were $62 million, down 23% from the third quarter, largely due to the benefit of the third quarter credit actions, although they were still better than we expected. Home Equity losses decreased slightly to $65 million. About 38% of the fourth quarter losses were from the brokered Home Equity portfolio, which at $1.7 billion is down from a peak of about $2.7 billion in 2007.
Auto net charge-offs remained low at $19 million or 68 basis points. Credit card net charge-offs declined to $33 million or a relatively low 712 basis points. We currently expect first quarter consumer net charge-offs to be fairly stable, but like Commercial, with continued improving trends.
Now moving to NPAs on Slide 12. NPAs, including held-for-sale, totaled $2.5 billion at quarter end, down $313 million or 11% from the third quarter. NPAs, excluding held-for-sale, were $2.2 billion or 2.79% of loans, up modestly from 2.72% of loans in the third quarter. That growth reflects the effect of our third quarter credit actions.
Inflows were relatively stable, but outflows in the form of charge-offs obviously declined. My remaining comments on NPAs will focus on the held-for-investment portfolio, unless otherwise noted. Overall, Florida and Michigan remain our most challenged geographies from an NPA standpoint and accounted for 42% of NPAs in the Commercial and Consumer portfolios. However, NPAs in those two states were down $13 million sequentially, a continuation of trends we've seen for some time now. Commercial portfolio NPAs were $1.7 billion or 3.79% of loans, compared with 3.71% of loans in the third quarter. Commercial Construction NPAs declined $32 million while Commercial Mortgage NPAs were consistent with the prior quarter.
C&I NPAs increased $102 million, primarily driven by a $78 million credit placed on nonaccrual this quarter. This was sort of an unusual situation, and we do expect C&I NPAs to decline again in the first quarter. Across the Commercial portfolios, residential, builder and developer NPAs of $259 million were down $29 million or 7% sequentially and represented about 16% of total Commercial NPAs. Within NPAs, Commercial TDRs on nonaccrual status increased to $141 million this quarter from $31 million last quarter. We expect to continue to selectively restructure commercial loans where it makes economic sense for the bank.
Looking ahead to the first quarter, we expect Commercial portfolio NPAs to be down versus current levels. On the Consumer side, portfolio NPAs totaled $513 million at the end of the quarter or 1.5% of loans, an increase from the 1.44% recorded in the third quarter and in line with our expectations.
Residential mortgage NPAs increased $40 million during the quarter to $368 million. Home equity NPAs totaled $72 million at the end of the third quarter, a $1 million drop from third quarter levels. Auto NPAs were down $1 million and credit card NPAs were down $2 million. We expect first quarter Consumer portfolio NPAs to be up modestly compared with the fourth quarter with stable inflows.
To give an update on the pool of Commercial NPAs that are in held-for-sale. Of the $574 million of balances transferred in the third quarter, $223 million remains, of which about $44 million is under contract. Our mark still feels appropriate, and we had a realized net gain on loans sold from this pool, which was offset by a similar amount of valuation adjustments on the remaining loans.
We've been proactive in addressing problem loans and writing them down to realistic and realizable values. Total portfolio NPAs, Commercial and Consumer, are being carried at about approximately 63% of their original face value through the process of taking charge-offs, marks and specific reserves recorded through the fourth quarter. That overall hair cut is lower than earlier in the year and it reflects our having cleared out or dealt with much of our most stressed credits. This metric may well continue to trend upward due to a lower level of loss content on our NPAs, which we're seeing in our charge-off trends.
The next slide, Slide 13, includes a roll forward of nonperforming loans. As I mentioned earlier, our commercial nonperforming loan inflows were up slightly at $308 million, resulting in a relatively stable commercial nonperforming loan total for the quarter. Consumer inflows were essentially flat at $159 million.
As you can see on Slide 14, our level of inflows remains relatively low versus peers on a proportional basis. A couple of years ago, we had higher proportional inflows, and I think that's a reflection of our geographies, which were impacted earlier than others, and the fact that we aggressively identified and dealt with issues as they occurred.
Turning to Slide 15. We provide some data on our Consumer Troubled Debt Restructuring. We have $1.8 billion of Consumer TDRs on the books, as of December 31, of which $1.6 billion were accruing loans and $206 million were nonaccrual. Out of that $1.6 billion of accruing TDRs, approximately $1.3 billion were current. And of current loans, about $1.1 billion were current and were restructured six months ago or more. Based on that experience in our redefault rates overall, we expect the vast majority of that $1 billion pool to stay current.
Overtime, we've learned more about what works and doesn't work in modifying loans. As a result, more recent modification vintages have shown lower redefault rates than loans we restructured earlier in the cycle. Those recent vintages also constitute a larger proportion of the aggregate TDR pool. As you can see from the slide, while 2008 vintages experienced higher redefault levels, more recent vintages have trended toward a 12-month default frequency in the 25% range. Overall, we continue to be pleased with the results of our loss-mitigation efforts, and I think the vintage trends indicates that they're working.
Moving to Slide 16, which outlines delinquency trends. Loans 30 days to 89 days past due totaled $636 million, down $31 million from last quarter, with Consumer up $14 million due to seasonal factors and Commercial down $45 million. Loans 90 days past due were $274 million, down $43 million from the third quarter, with Consumer down $9 million and Commercial down $34 million to just $30 million. The Commercial delinquency levels are the lowest that we've seen since year-end 2004.
Total delinquencies of $910 million this quarter were down 7% from last quarter, the lowest level since the first quarter of 2007. We believe we're seeing signs of stabilization, and don't currently expect a lot of movement next quarter, although delinquencies can move around a bit, given seasonality and timing issues.
Now for a couple of comments on provision in the allowance, which is outlined on Slide 17. Provision expense for the quarter was $166 million, and reflected a reduction to the loan loss allowance of $190 million. Our allowance coverage ratios remain very strong, with coverage of non-performing loans of 179%, nonperforming assets of 138% and coverage of annualized net charge-offs of over 2x.
Slide 18 contains the credit loss results of our most recent stress tests, as well as performance against the SCAP scenario. Starting with actual results, as you can see, 2010 losses were $2.3 billion, below 2009 losses of $2.6 billion and significantly below SCAP assumptions, including our baseline submission. This is despite our recognition of $510 million of charge-offs from the third quarter through marks on loans transferred to held-for-sale, the vast majority of which would otherwise not likely have been incurred until 2011, absent our disposition plan.
Turning to 2011. We provide the results of our internal stress scenarios. These scenarios are based on Moody's economy.com, macroeconomic scenarios, and are outlined on Page 34 in the appendix. We disclosed these same scenarios last month, so I won't discuss in detail. The Moody's scenarios are their base case scenarios. They are recession case scenarios, to which they assign a 25% probability and the Depression case or complete collapse scenario, which is assigned a 4% probability.
I think our expectations for 2011 under the conditions included in any of the scenarios speaks for themselves. Under base and recession conditions in 2011, we'd expect charge-offs to be below 2010. Under Depression case conditions, we'd expect charge-offs consistent with 2010. I think the inset box explains why we would expect charge-offs not to go up under Depression scenario. The influence of the $500 million in marks we took in 2010, on both 2010 losses and those we would have otherwise expected in 2011.
As we noted last month, these scenarios do not include that based on the said specified supervisory stress macroeconomic scenario. That scenario was provided under the CCPR and we can't share it. However, we believe our internal scenarios cover an appropriate range of either likely or unlikely, but possible, macro environments and the results that we would expect from them. We obviously share these scenarios with our regulators.
Kevin, I'll turn it back to you for any closing comments before we get to the Q&A.
Thanks, Mary. Just wanted to finish by saying 2010 was a year of great progress for Fifth Third, including a return to solid profitability, significant improvement, credit results and trends, market share gains and higher customer sat scores. In fact, in the most recent survey of Fifth Third customers by the University of Michigan, our overall customer satisfaction score broke our previous record. Our score exceeded that of any large bank in the industry published under Michigan's broad industry survey. We're focused on deepening customer relations, growing our customer base through the strength of the Fifth Third brand. We can either focus on the strategic initiatives that are helping us drive revenue growth. I want to thank all of the hard work of our employees. And at this point, I want to open it up then for any questions.
[Operator Instructions] Your first question comes from the line of Bob Patten with Morgan Keegan.
Robert Patten - Morgan Keegan & Company, Inc.
FDIC insurance wasn't broken out. Is it the same as the third quarter?
This is Jeff. I think FDIC expense is big enough to be a reportable category.
Matthew O'Connor - Deutsche Bank AG
Kevin, can you just review hypothetically, assuming your plans get done and executed as you want, what your prioritization of capital uses is going to be over the next six to 12 months?
Let me turn that over to Dan to address for you, Bob.
Bob, and some of this is included in the earnings power point deck, specifically on Page 25. We have outlined some elements of how we would seek to manage capital on a going forward basis. First and foremost, I think we have some pretty significant organic growth opportunities. We are starting to see some growth in the low portfolios, I think particularly in the C&I area. We were very encouraged in the most recent quarter of the demand of there. So we think there's organic growth opportunity. We also think there are strategic opportunities that are on the horizon. Whether that be via acquisition or whether that be through de novo expansions, we believe that the opportunities for growth, particularly in the recovering economy, are pretty significant. Relative to capital management policy going forward. We believe that our current earnings position as well as our capital position both now and even more so in the future based on the plans that we have would support a return to a more normalized dividend policy. And as we look forward, that's certainly something that would be included in our plans. Share repurchases, in our minds, I think, will probably be at the bottom of the list to the extent that the other deployments of capital I just mentioned, if those left us still with excess capital as we go down the road, share repurchases would be something we would evaluate but we would expect that, that would be something that would be on the longer-term nature.
Matthew O'Connor - Deutsche Bank AG
You guys have done two dividend reductions. Under the way that the rules work, you guys have repaid TARP, can you increase it back to $0.15 a quarter without permission?
I think there's kind of two levels of restrictions right now. One restriction that's embedded into the actual TARP document itself, I believe that restriction says that we can't increase it to any level above the level at which it was when we entered into TARP. And then beyond that, based on the Fed's recent announcement relative to capital management policies and the CCPR process, those types of changes would be subject to approval through that process as well. So I think the CCPR process effectively trumps whatever the restrictions in the TARP document themselves are and all dividend increases would need to go through that process --
Our next question comes from the line of Brian Foran with Nomura.
Brian Foran - Goldman Sachs
I know you spent a lot of time upfront addressing the why now question on TARP, but maybe I've gotten the same question from several people so maybe I'll just ask the way they ask it which is, you needed $1.7 billion, you made $270 million this quarter, why not wait a few quarters and raise half as much?
Brian, as you said, I think we did address that somewhat. We've talked in the past about being patient. I think we have been patient. But that wasn't just to be patient because there were certain things we thought were important in order for us to have the right environment for TARP repayment to make sense. And those were improvements in our earnings, improvement in our credit, a more solid economy, a more well-established recovery, and perhaps, most significantly, increased clarity on future revelatory. I think all of those things, particularly in the fourth quarter, started to come into fruition and come into existence with a fair amount of clarity. So in the fourth quarter, I think we're really started to believe that the time for us to repay TARP was right. The time for us to consider that issue more significantly with our regulators was right, so we've been involved in discussions with our regulators since that time. And we think we have those things created the right time for us to make the decision. And with our discussions with the regulators, with our observation of what regulators have apparently asked others to do, we thought that the amount of capital the we've decided to raise and the resulting capital levels of 9.0% were the right levels for us at bigger point in time. All that, I think, was also impacted by the new the CCPR process. The fact that the reinstatement of dividends was something that is becoming more important for the industry, as well as the sense that opportunities were becoming closer and closer on the horizon, whether those were opportunities related to continuing economic recovery or opportunities related to strategic opportunities that might become available as M&A activity took place. So those were all things, I think, that contributed to our evaluation of this being an appropriate time for us to make this move.
Brian Foran - Goldman Sachs
As we think about normalized earnings power, I had always had 60 bps provision rate in for you guys based on 50 bps for everything but cards, and then 500 bps for cards. I guess where you are now and still heading lower suggest maybe that's a little high. But I don't know, can you give us any thoughts on what you think of as a normal provisioning run rate for the company overall has been?
Brian, this is Jeff. I think in the situation we're in right now with the announcement that we've made, we haven't commented on in any direct way about what we think our normalized provision would be. We talked about ranges of reasonable assumptions for dividends just for purposes of explaining where we thought we could get to, but I don't feel like we ought to -- I feel like we can't answer that question right now. I apologize. I understand your thinking behind the way you came up with your result. I'm sorry.
We have reached the allotted time for questions. This concludes today's teleconference. You may now disconnect at this time.
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