Bank of America Q3 2007 Earnings Call Transcript

Bank of America Corporation (BAC)

Q3 2007 Earnings Call

October 18, 2007 9:30 am ET

Executives

Kevin Stitt - Director of IR

Ken Lewis - President and CEO

Joe Price - CFO

Analysts

Nancy Bush - NAB Research

Mike Mayo - Deutsche Bank

Ed Najarian - Merrill Lynch

Matthew O’Connor - UBS

Ron Mandle - GIC

Jefferson Harralson - KBW

Betsy Graseck - Morgan Stanley

Jeff Harte - Sandler O'Neill & Partners

Meredith Whitney - CIBC World Markets

Presentation

Operator

[Call Starts Abruptly]

…that this presentation does contain some forward-looking statements regarding both our financial condition and financial results. And these statements involve certain risks that may cause actual results in the future to be different from our current expectations. These factors include among other things, changes in economic conditions, changes in interest rates, competitive pressures within the financial services industry, and legislative or regulatory requirements that may affect our businesses. For additional factors please see our press release and SEC documents.

And with that, let me turn it over to Ken Lewis.

Ken Lewis

Thanks, Kevin. Good morning.

I know you know the Bank of America Corporation reported quarterly earnings up $3.7 billion or $0.82 per diluted share down approximately 31% from the year ago and down 36% in the second quarter of this year. You also know by now that lower earnings were largely due to market dislocation in the third quarter that took total in our capital markets business.

Unfortunately this will be one of those quarters we will spend our time discussing areas of underperformed expense both, business that consistently contribute both of our earnings and further more have been the main drivers helping this growth.

Well some of the underperformance was difficult to avoid given the wide spread market malice. We believe we should have performed better and we are assessing all the business where that is the case. And other way, we are equally just pleased with return on equity of 11%, which is mediocre at best.

Our business model by design acts as a defense for exactly what occurred in the third quarter and although we are very disappointed of the magnitude of the hit we took. The strength in our other businesses allows us to maintain our strategic direction and allows us to be opportunistic wherever such opportunities arise.

I am not forecasting fourth quarter results, but if the economy maintains its present pace for the rest of the year, Bank of America will produce earnings for full year 2007, that’s still very strong. I am making these observations only to gain more attention to how our banking model has evolved during the past five to ten years.

Before I move to the business level discussion, let me mention a few things about LaSalle. We closed our LaSalle acquisition on October the 1st with an effort to expanding the Bank of America brand in Chicago and introducing the brand in Michigan. Customers and markets LaSalle operate in will now have access the largest distribution networking financial services and expensive array of products to meet their needs.

We have not changed our financial assumptions on LaSalle that we discussed in April. In the fourth quarter, we expect LaSalle to be accredited by penny or so before restructuring charges. We will talk more about the impact of LaSalle in 2008 when we meet with you discuss fourth quarter result.

Let me spend the next few moments touching on earnings in each of our businesses before turning over to Joe to go little deeper into the results. Staring with Global Consumers Small Business banking, earnings of $2.5 billion in the quarter were up modestly on a linked quarter basis, but down from the year ago due to higher provision.

Revenue grew 6% from the year ago reflecting strong fee growth muted by lower than interest income growth. Product sales remained strong with debt new checking accounts making a new record. Revenue growth was offset by the higher provision expense, while charge-offs in line with expectations, we book reserves due to seizing of several growth portfolios and the impact of the weak U.S. housing market.

Global Wealth and Investment Management had a good quarter and reflected the addition of U.S. Trust on July 1^st earnings were $599 million up 17% from the year ago, but down 4% from the second quarter, as we recorded a smaller gain from the sale of our remaining closed in funds in the second quarter.

The integration of the U.S. Trust is going as planned. U.S. Trust added about $230 million in revenue and $200 million in expense including about $45 million in amortization of intangibles. Assets under management rose to $710 billion with the addition of U.S. Trust, which was about $116 billion as one as legacy Bank of America grow. I remind you to expect a reduction of approximately $65 billion in assets under management with the fourth quarter sale of (inaudible).

Global Corporate Investment banking earned $100 million for the quarter, which is down from both comparative quarters. Capital Markets and Advisory Services loosed $717 million in the quarter versus earnings of $298 million a year ago and a record $641 million in the second quarter; and Joe is going to elaborate further the reasons for this performance.

Business Lending earned $379 million down from both last year and last quarter driven mainly by our provisioning compared to both periods, as well as lower leasing gains, when compared to the second quarter. Global Treasury Services earned $558 million up slightly compared to the second quarter, although down from last year, as we divested a small market services business. Our equity gains were a bit stronger than we expected and included dividends from our strategic investments.

Before I turn over to Joe let me summarize by saying the obvious, that overall earnings in the quarter were not expectable to us, but still reflected the momentum in several of our core businesses. In July, at the prior earnings discussion, we certainly looking for GDP growth of 3% in the second half of the year, but we were concerned about domestic consumptions spending given the prolonged housing slump sub-prime issues and our fuel prices. We now expect growth in the fourth quarter to be around 2% with low loft side due to our export strength.

However, we remain concerned about the risk I just mentioned. I will give you more detail in January. We are looking for GDP growth in 2008 to be around 2% as well we see much strong, but enough to keep the economy in a growth mode.

Finally, I will mention one thing has gotten a lot of attention with investors and media in the past month. In the fourth quarter, we will mark-to-market our initial $3 billion investment in China Construction Bank, excluding the value of options, which allow us to increase our ownership stake from 8.2% to 19.1%. The value of our investment was approximately $18 billion at September 30th.

The after tax impact of the appreciation will not flow through earnings, but instead flows through OCI increasing our equity and book value.

With that I will turn over to Joe to expand a bit on some of the Board of Directors.

Joe Price

Thanks, Ken. Let me spend a few minutes going into some of our business metrics, before I talk in detail about capital markets and advisory services, credit quality and some other topics.

In Global Consumer and small business banking and you see this on slide 7, as Ken mentioned, we’ve had good revenue growth that was offset by higher provisioning for total earnings of $2.5 billion in the quarter. We achieved record sales performance in the third quarter of $13 million units that’s up 12% over last year.

New customer generation continues with net new retail checking account openings of 757,000 and this is up a bit from record openings a year ago continuing the strong momentum we experienced over the past two years. As you can see on slide 9, total retail deposit balances including our wealth management balances were up $5 billion or just over 1% in the second quarter and $17 billion or 4% from last year.

Debt purchase volume increased to 11% over last year and revenue grew by 10% or $51 million. Net new retail accounts drove service charge growth up a $108 million or 8% over the last year. Card Services revenue grew 6% from last year, as ending managed loans were up 11%. Comparing earnings in this business to last year is tough, as we are coming off the credit loss low is resulting from the bankruptcy reforms.

And new account growth within Card Services was $3.7 million for the quarter reflecting strong sales efforts and direct mail and e-commerce. Our more profitable franchised sales still represent over a quarter of our sales and e-commerce represents 19%. Our balance transfer programs highlighted in our Investor Day in February are beginning to rollout and should benefit growth as we move into 2008.

Sales of small business products across the company including both loan and deposits products continue to set new heights and grow up 24% from a year ago. First mortgage originations across the company were approximately $27 billion, an increase of 27% from last year, but down 8% from the second quarter.

The increase from last year reflects our recent initiatives to grow our share in the mortgage market, and while down on a linked quarter basis due to seasonality in the terminal and the mortgage industry, we feel with our performance in the third quarter, we once again gained market share. The success of our direct to consumer focus gained more status life quarter, as we were recognized as the leader in this category.

Since the national launch in late April of our No Fee Mortgage PLUS product, the banking center application volume is up 12% versus the same period last year. Average home equity loans were up 24% from last year, and were 5% from the second quarter.

As Ken covered the highlights of our Wealth Management Business, let me now turn to other, which is essentially, equity investment results. Equity investment gains for the total corporation were $904 million, which exceeded our expectations included in the third quarter with a dividend $353 million from China Construction Bank, which included a special dividend of $184 million prior to GCIBs recent share listing.

And as we have said in the past we estimated base of about $300, $500 million in equity gains a quarter with market condition dictating anything about that.

Finally let me turn to GCIB and address capital markets and advisory services and you can follow this on slide 11. Last quarter we were point out record earnings in this business. This quarter unfortunately, we are point to record losses. Consequently, I will go into more detail than usual in order to provide the level of transparency the most of you are looking for.

I am not going to go through the market conditions we operated in during the quarter. As I am sure you have been schooled other than to say it was a tough debt market in our equity and advisory businesses were not of the size to offset the loss in revenue we experienced on the debt side.

As Ken said, CMAS had a loss this quarter of $717 million versus record results last quarter of $641 million. Revenues fell $2.9 billion from a positive $2.7 billion to a negative $184 million, partially offset by lower expenses of $702 million as a result of performance related incentives.

Within CMAS we run four business Liquid Products, Credit Products, Structured Products and Equities.

On the liquid product side, which includes interest rate products, foreign exchange commodities and municipal finance, we produced $585 million revenue for the quarter, which strong results and interest rate products and foreign exchange and tempering what would have otherwise been a record quarter was the negative impact of correlations breaking down between the cash and hedge positions in municipal finance.

Now, before going into other capital markets businesses, let me address credits underwriting and the related marks, we took this quarter. We took a negative mark of $247 million pretax net of $528 million in lump fees on the loans that we have underwritten, and where we are above our intended hold levels on completed deals and on deals on our forward pipeline.

Of these marks, a $173 million reflected in other income within the credits products group. The remaining, $74 million is recorded in trading account profits, and our structured products group, and as I said total $247 million in the quarter net of fees.

After considering lump fees, we took marks on all deals down to a level, where we believe the paper would clear the market. Our share of the leveraged loan in high yield forward calendar was $28 billion at September 30th compared to $33 billion at June 30th. During the quarter, we added $8.1 billion in new commitments, closed and syndicated $700, funded $4.3 billion that is yet to be syndicated and had $4.8 billion by the way.

Our exposures concentrated in senior bank debt, and we actively syndicate bridge exposure. Now contrast to some others, we have only modest exposure in the covenant light B loans, second lien or subordinated positions, where the market disruption has had the most severe impact.

Now, as I just noted from a funding standpoint on the leverage side at September 30th, we had $4.3 billion in excess of our designated home position, and while this is elevated from our normal inventory positions, it’s clearly manageable. In addition, we had $5.4 billion funded in excess of our designated hold levels in the commercial mortgage and investment grade portfolios. If I am not unusual due to the warehousing, the distribution nature of this business the funding level is slightly elevated, although again very manageable.

Now let me spend a few minutes on the other items impacting these businesses. Within credit products including the marks I just discussed revenue was a negative $697 million for the quarter a decline of $1.4 billion from the second quarter.

Banking fees in the high-grade markets held up well with that market continue to function orderly. However, fees on leverage side drops significantly from a record last quarter as the market disruption brought issuance to halt from much of the third quarter.

Trading revenue had a negative swing of $1.2 billion. We were not well positioned from a directional standpoint for what happened in the quarter and this was aggregated by a decoupling of historical hedge correlations.

Additionally, as you heard a say over the past few years we have been building our investor client businesses and it have been more active in the market making arena. Correlation between market making positions and associated hedge is broke down as current indices became extremely volatile in different points of single name credit curves diverged.

Within our CLO warehouse and the numbers I just referenced, we had relatively modest markdown of approximately $14 million as we reduced our exposure from approximately $3 billion at the end of June to about half that at the end of September.

The third business within CMAS is structure products, which includes residential mortgage and asset-backed securities, commercial mortgages, structured credit trading and structured securities including our CDO business. Results in the quarter reflected a negative swing in revenue of $1.2 billion and also includes the relevant portion of the loan commitment marks I discussed earlier.

In our MBS, we had a negative swing in revenue of $150 million due mainly the trading losses on our non-agency inventory as many of our hedges were in agency base product and spread relationships decoupled. Our inventory peaked to just over $10 billion in the quarter and now stands at less than $3 billion.

In our asset direct business, which is where we conduct our sub-prime securitization business, was still a positive number. We had a negative swing compared to the second quarter, as [instruments] activity was limited and we incurred only modest losses on the sub-prime warehouse. We have reduced our inventory significantly in this space over the last year in an effort to limit our exposure to the asset class, where the inventory of just under $2 billion at the end of September.

Our Commercial Real Estate business had a negative swing in revenues of $155 million due mainly to fees being well off our normal run rate given the slowdown in the market. We experienced a negative swing in trading revenues and structured credit trading of $343 million driven mainly by the breakdown and expected correlations between positions and related hedges. We also booked around $100 million loss on the CDO pipeline warehouse, and just under $200 million associated with financing of mezzanine CDO paper. Our CDO pipeline warehouse stood at just over $1 billion at the end of September.

Banking fees in this business were down around $100 million due to the market shutting down in CDOs. Now, final business within CMAS is equity, which produced revenue of $305 million compared to $535 million in the second quarter. This decline was driven by lower client activity in the equity capital markets and equity derivatives coupled with reduced trading results.

We are not satisfied with our performance this quarter in Capital Markets and Advisory Services. And while we feel comparatively well in the core client driven leveraged finance in sub-prime businesses, we got caught in the breakdown of hedge correlations principally in our sales and trading operation facilitating several client rates and on a couple of directional calls.

And while we are comfortable with our overall risk management practices, these levels of breakdowns in traditional pricing relationships in correlations, as Ken mentioned earlier, will influence future determinations of how much risk we carry.

As you heard other market participants discussed, we do much of the disruption in the quarter as more short-term in nature and it seemed the markets begin to free-up in a number of areas. That said, some areas we will take an extended period of time to normalize and some probably not returned to pre-disruption levels.

Now, let me switch to credit quality, which you can see on slide 14. During this quarter in charge-offs, we are in-line with our expectations expressed earlier this year at various times. Overall, consumer and commercial credit quality remain sound.

The given current market conditions, we began to see some softness in certain sectors causing provision to be a little higher than earlier predicted. Managed net credit losses across all businesses were 1.27% down 4 basis points from the second quarter.

Net charge-offs this quarter dropped 1 basis point to 80 basis points. 90-day past dues on a managed basis dropped from 62 to 61 basis points, while 30-days past dues showed an increase of 16% to 1.98%.

Non-performing assets increased 11 basis points to 43, in third quarter provision of $2 billion exceeded net charge-offs resulting the addition of $457 million to the reverse. This reserve bill was driven by seasoning and higher loss expectations in several portfolios we targeted for growth, including small business, which was about 50% of the increase in home equity, were about 30%.

We also build commercial reserves principally related to our home builder exposures. Now as expected, managed consumer credit card losses as a percent of portfolio dropped to 4.67% from 5.02% in the second quarter, which is inline what we have been telling you for the last several quarters.

We accept the net loss ratio, after peaking in the second quarter and a declining in the third we begin to move back toward the 5% and 5.5% range we talked to you about in February. 90-day-plus delinquencies in consumer credit card dropped from 2.55% to 2.48% in the third quarter. In 30-day-plus delinquencies increased 16 basis points to 5.24%.

In our $100 billion home equity portfolio charge-offs and delinquencies are rising due to seasoning of recent advantages as well as decline in home values. Net charge-offs in home equity are up $22 million in the quarter to $50 million or 20 basis points of average loans. 30-plus day delinquencies were up 24 basis points to 1.01%, non-performers rose from $496 million in Q2 to $764 million or 0.76% of loans this quarter.

Even though our average refreshed FICO score remained strong 721 and the cumulative of loan to value is 68% and exceed, on slide 15, we have seen a rise in the percentage of loans that have a CLTV above 90%, which is principally driving in the most recent advantages.

We believe net charge-offs in home equity will continue to rise given on-going growth seen in the portfolio and softening in the real-estate values, which are drivers of the reserve bills in these each areas. We also believe that our results will continue to benefit from our relationship based direct to consumer strategy.

Now on the residential mortgage portfolio side continues to perform very well with losses it only 2 basis points. Commercial asset quality overall was strong. Net charge-offs in small business which we reported this commercial loan losses are up $41 million from the second quarter and the net charge-offs rate has risen to 5.89% from 5.23%.

Like home equity, this too, has been a targeted area of growth, in the past several years to drive higher revenue, and as mentioned, we were taking appropriate reserves for the growth and increased loss levels in these businesses.

Excluding small business commercial net charge-offs increased $8 million from the second quarter representing a charge-off ratio of 5 basis points flat with the second quarter. Commercial criticized asset rose from second quarter levels driven by our home builders' segment exposure. The home builders' also drove the increase in NPAs with some increase in NPA is attributable to mortgage companies.

Now given the turbulence in the third quarter, we are due diligent in moving exposure to both non-performing and criticized categories. We believe our home builder portfolio reflects both granularity and geographic diversity and further erosion are expected to be manageable.

We told you in April that we are expecting an upward trajectory in net interest income from the first quarter, and we still believe that will continue through the end of the year. Compared to second quarter on a managed basis, core net interest income in the third quarter was up a $112 million or about 1%, while total net interest income including market based net interest income was up 2.5%.

The net interest margin on a managed basis was up 3 basis points, although the core net interest margin was down 11 basis points. The benefits of good loan growth and one additional day of interest were offset by the negative impact of rates particularly the move in LIBOR as well as market based funding of asset growth.

As you can see on the bubble charts on slide 17, our interest rate positioning is less liability sensitive compared to the end of June. But remember, these are estimates of NII change are based of the [930] forward curve, so the base is also higher. We added about $100 billion in pay fixed losses, we felt that forward rate curves were slightly overdone; and this position help protect us if the forward rate cut don’t materialize, and also contribute to the lower liability sensitivity position.

We will continue to benefit from curve straightening, but more so from a short end straightening versus the long end, which is what we have experienced over the last few months.

Now, let me say few things about capital on slide 20. Tier 1 capital at the end of September was 8.22% down 30 basis points from June due mainly to the acquisition of U.S. Trust, which closed on July 1st. In the fourth quarter, as Ken mentioned, we will began marking-to-market our 8.2% investment in CCB through OCI, which were the value of roughly $18 billion versus our $3 billion cost basis.

Well, Tier 1 is unaffected; it will have positive impact from intangible and total capital ratios of about 50 basis points. Now, at the time of the LaSalle announcement in April, which we thought would close at the end of the year, we told to tier 1 capital ratio on day one of LaSalle close would be approximately 7.5%.

Although, our overall funding levels for the acquisition are on target with our projections, we have not raised as much tier 1 capital as we originally projected. As a result, our estimate for year and maybe slightly lower than the original forecast depending upon the timing of the tier 1 capital raises, but we remain committed to getting back to our 8% target. The upcoming [Maursica] gain was embedded in our capital forecast, when we announce the transaction.

The positive impact from expensed synergies with LaSalle won’t really be evident until first quarter of 2008. We will discuss that benefit in January, when we talk about our ’08 outlook. And one final comment before closing, the lower effective tax rate reflects the reassessment and ketchup of our annual rate given the lower third quarter earnings.

So, in closing, let me reinforce Ken’s comments and say that while the earnings in the third quarter were not where we wanted, we did have businesses that performed in line with our expectations showing the strength of our diversified model.

With that, let me to open up for questions, and I thank you for your attention.

Question-and-Answer session

Operator

(Operator Instructions). And our first question comes from Nancy Bush with NAB Research LLC.

Nancy Bush - NAB Research

Good morning, guys.

Ken Lewis

Good morning.

Nancy Bush

I guess I’d just have to ask sort of, an over urgent question here in Ken probably more and you. I mean, you’re not that big in investment bank relative to some of your Wall Street competition you have been building out the bank over the last few years. Has the third quarter experience sort of changed your plans for the build out and how do you assess this. How much of this was due to the market and how much of this was due to perhaps not having the trading talent that you need?

Ken Lewis

Well, we obviously are in the middle of assessing all of that Nancy and what I can’t say is that, we stay the course and go forward as we have in the past. I mean, I think it is incumbent upon me and my responsibility to look at every single business and see, where we want to go forward given even what happen in the third quarter. And I see, all really on three novels and their call kind of in a twain. One is the point that you’ve made skill set assessment, judgment assessment and kind of individual accountability.

Then secondly, I explain what we would be looking at what we think the markets will be like now in 2008. And we don’t think there would be as robust, for instance as the first half of this year. And so we have to look at the infrastructure as the result of that. And then finally, again to your point, we are going to work it every single business and from a long term investor perspective you can’t have businesses, where you make money four or five years and then give it all of back in one year.

And it is kind of analogous to commercial lending in the 80’s, where we changed our model from originate and hold to originate and distribute. And so all of that is going on as we speak and I would say the probability of changes and elimination of some businesses and infrastructure, reassessment, the probability is very high.

Nancy Bush - NAB Research

I would just ask Joe, I guess, I mean it seems like the number of the hedges didn’t work. And I know that there was part of that certainly was due to the unusual moves in many credit products that we had during the third quarter. But I mean, was there just a missed hedge, we are hedging the wrong things; with the wrong things, you have been able to access this yet?

Joe Price

Yes. Nancy, I think, I would characterize the vast majority as cash versus synthetic spread decoupling number, I can’t breakdown a historical pricing relationships. And then, in the credit cards and sales, obviously, there were some changes and flattening and other things, and it was more of those type things. So, it was not a - it was less about we are just not hedging the right thing.

We clearly felt comfortable coming into this given some of the more historical norm two of those pricing relationships, but they decoupled and that did. So, I guess, what’s your following question would be, we are proud to be accused of being a little more client accommodative on balance sheet and otherwise, then we wouldn’t have had as much to hedge.

Ken Lewis

Nancy, I count in my own mind. This is way too simplistic. But first on the leverage loan side, we did a pretty good job there, and that was about one-third loss meaning that we have just bought in some deals that were big in the industries, but it was about two-thirds being smaller and turning down some deals that have got done.

On the trading side, I would kind of reverse that and say that, may be a third was market, and two-thirds were just mistakes we’ve made in judgment and so clearly, we bear a lot of the blame, much more so than just market conditions.

Nancy Bush - NAB Research

If I could just ask the follow-up, I don’t know. I don't know if Liam is in the room or somebody is available to comment on this, maybe you Joe. There was report on the Boston Globe this morning saying you guys were losing deposit market share in that market and those numbers are always fluky, we know. Can you comment on that at all? Is it a wrong assumption that you are losing market share in the Boston market?

Joe Price

We don’t have the specifics about that market. I’ll tell you overall, we had quite strong retail deposit growth this quarter now had included the addition of U.S. Trust, when you take that out we were reasonably inline with market growth. So I don’t know of any particular thing in that market. If there something I can come back to you.

Nancy Bush - NAB Research

Great, thank you.

Operator

Our next question comes from Mike Mayo with Deutsche Bank.

Mike Mayo - Deutsche Bank

Good morning.

Ken Lewis

Good morning.

Mike Mayo - Deutsche Bank

Ken just a follow-up on the investment bank. You had a lot of different heads in the investment bank over the last two years. Could one potential improvement measure be a joint venture or acquisition to gain some additional experience?

Ken Lewis

I don’t think so, Mike. I always say, I never say never, but, I had fun. I can stand in investment banking at the moment. So to get bigger and it is, is not something I really want to do. But we do have to, again as I said, we are going to back and assess all of these businesses and see put our strengths whether not and act accordingly.

Mike Mayo - Deutsche Bank

And as it relates to asset quality generally, you mentioned not only home equity homebuilders, but all small business. So, I guess the question is what percent of your loan portfolio are you worried about? You said there is an additional softness that you aren’t exactly anticipating?

Joe Price

Mike, I think, obviously our biggest look into the kind of the U.S. consumer larges in our card book and you saw the results there we are right in line with our expectations. The places that we build reserves were principally in three areas.

One was in small business; we’re growing that portfolio it’s about $16 billion portfolio, when you aggregate all the pieces. I mean, see we have got quite a bit of seasoning in there as well as some deterioration on the hedges, but as much growth as anything.

On the home equity side and this would be home equity versus our core first mortgage portfolio. We saw some deterioration there, and we would expect to see some additional elevation of charge-off level that’s about $100 billion portfolio. And our stress tends to be in the things that are above 90%, say cumulative loan to value. So, it's more of the home price.

But we had some previous growth that we talked to you about before, but this more recent stuff is more about home prices and the pressure on that piece, and I would pick that at something in the mid teens of the total portfolio even though it has strong FICO’s. When you get to that high LTV that’s where we are feeling that stress.

On the commercial side, we mentioned about home builders, we clearly our philosophy is to get aggressive when there is weakness up there and move these things into criticized asset, so that we get a special focus on. I mean, naturally what drives you’re reserving, how you risk grade those loans and that’s really what you saw us doing in this period.

Ken Lewis

But Mike, for all of the people out there that are out there a long time, as you have, these numbers are still really good. I mean, in most cases they are bumping up against the bottom end of our standards in terms of charge-offs and non-performers. So, this is a good portfolio.

Mike Mayo - Deutsche Bank

I guess to what degree are you watching things with the height in degree of caution? You know, like the recession, in the early '90s, it had been just sub-prime mortgage, then it is all A mortgage, and now we have home equity and we get a home builders. How much are you concerned that this is spreading a little bit more than you originally saw?

Joe Price

Not really. We are not surprised by anything. Obviously we are looking very close at this small business portfolio and as Joe said home builders were not obvious because of what’s happening, but home equity it’s gone to 20 basis points. I mean that is pristine 2 points in the mortgage portfolio, 5 basis points on your commercial portfolio.

These are really good quality numbers and to say that we are concerned about overall credit card quality would be going way too far. But as I said, obviously we are looking at, you can’t be predicting 2% growth and seeing some deterioration looking very carefully. But it’s not all above somehow, you can just in normal deliberation improvements.

Mike Mayo - Deutsche Bank

Alright, thank you.

Operator

And our next question comes from Ed Najarian with Merrill Lynch

Ed Najarian - Merrill Lynch

Good morning, guys.

Ken Lewis

Good morning, Ed.

Ed Najarian - Merrill Lynch

This question may be a little bit premature, but of course it comes back to GCIB, $100 million this quarter, obviously much lower than anticipated compared to levels in the prior quarter was so much higher, I think obviously all of our exception is the future quarter will be somewhere in the middle of this very low quarter, but lower than the kind of quarters you were putting up, prior to the third quarter.

How do you guys think about the pace and extends of the rebound in the profitability of GCIB over the next several quarter. And I’m sure that’s very difficult question to answer. But should we expected to get back near say ’06 kind of run rate levels relatively soon or we are going to go only say halfway back is there any kind of way to scope out the pace of rebound in GCIB profitability?

Ken Lewis

Ed Obviously, you have to start with, where do you think revenues are going to, what revenues will do, and win the throws of wrestling with that issue because it’s obviously a key issue to get to put our profit planned for 2008. And at the moment the debate is whether it’s 2005 level of revenue or 2006 level of revenue.

And I suspect, will probably come in thinking that it’s somewhere in between the two and go with that. But it is impossible to answer obviously until it happens, but that’s probably what our profit plan will look like for 2008. Again obviously had that drops, that starting point drops, how you have to write your infrastructure?

Ed Najarian - Merrill Lynch

So, if we say that ’08 revenues will be somewhere in the ’05 to ’06 level, how quickly can you reduce your expense infrastructures related to that?

Ken Lewis

Well, it varies but, you would start immediately and had as much as you could get it before the first quarter story depend on other things probably that will take you to six to nine months to kind of unwind. But you can get a lot of them pretty quickly.

Ed Najarian - Merrill Lynch

And you expect to be pretty aggressive in that regard?

Ken Lewis

Very.

Ed Najarian - Merrill Lynch

Okay. Thank you.

Operator

(Operator Instructions). And our next question comes from Matthew O’Connor with UBS.

Matthew O’Connor - UBS

Good morning.

Ken Lewis

Good morning.

Matthew O’Connor - UBS

Can you just give a little more color on the rationale that continue growing the home equity and auto portfolio so much, and I think the growth rates somewhere in the 20%, 30% range. And it seems like we're seeing increasing deterioration there at point of cycle?

Ken Lewis

If you take the home equity, first of all remember this is a direct to consumer business out of our stores. It’s a product that if you think about the suite of products to our customers, for instance in this portfolio probably over half of this portfolio either those are first mortgages over they are where we hope first mortgage.

So it our customer base that we are dealing with it. While each week the underwriting standards around the hedges based on the economic environment in what we see when we are in the economic environment, the products is a core apart, the products we as we would continue to grow amount of stores.

Joe Price

In that again we are talking about increasing rates of charge-offs look at the absolute amounts and look at the ratios. They are still pristine, and so this is good quality paper, which we will continue to want to expand in.

Matthew O’Connor - UBS

Well, I think the concern was that if home prices continues to decline from here a lot of home equity for the industry overall is based on FICO’s, which is proven to be that great if an indicator in the LTVs as well. So start creeping up as prices decline, so it just does a lot of other banks go back. I think you guys have been under penetrated for a while so it makes sense that there is some catch-up.

Ken Lewis

Well, you do have the phenomenon, people working away because house declines. But that’s not the general nature of most people and so the assets are a function. What you think employment’s going to do much more so, and what you think of housing prices are going to do, and as long as we get some reasonable job growth, I think we are okay.

Matthew O’Connor - UBS

Okay. And just in general, are you guys thinking differently about using FICO scores as you evaluate it just all your consumer lending especially relate to real estate?

Ken Lewis

I don’t know if you remember Matt, we talked about that before, when we merged with MBNA, we picked up quite a bit of expertise on the judgmental or underwriting side. And so, we actually have a blend, where with certain attributes will kind of kick out us all of our major scoring into judgmental scoring and versus team and our risk team. So, we have a pretty good robust process there. So, that is in place, and it is something that we had as part of the arsenal and clearly use.

Matthew O’Connor - UBS

Okay. And then just lastly, more reserve build this quarter seem to be supporting the strong loan growth that you had. As we look into future and into ’08, would you except continue to have provision excess of charge-offs?

Joe Price

I think, as we continue to grow the business, we would obviously have to deal with that. And I guess the way, I phrase this, there is probably, of course still be some moderate reserve bill, but where we sit today nothing that’s out of bill bounce.

Ken Lewis

Yeah, remember Matt, I mean, you would hope so, if you are asked, if it’s for growth.

Matthew O’Connor - UBS

Okay. All right. Thank you very much.

Operator

And our next question comes from Ron Mandle with GIC

Ron Mandle - GIC

I thought, I was wondering, if you could give some more color on the increase in the criticized loan, up 50% on a linked quarter basis was it all residential construction and whatever elaboration you could give on that?

Ken Lewis

Yeah Ron, the increase in criticize, the principle driver, as I mentioned before was home builders, where we specifically reviewed the home builder portfolio across the nation, and trying to be pretty aggressive on identifying, where we felt there could be weakness.

So that we could get extra focus on what happened, when you put something in the credit side, so that was the primary driver other things that would have had some impact would be mortgage companies has obviously, but the overwhelming driver was on the home builder side.

Ron Mandle - GIC

And how big is your homebuilder portfolio?

Joe Price

In the supplement you can see our commercial real-estate exposure and it’s a subset obviously of that commercial real-estate exposure, overall it’s around $17 billion in exposure and about $10 billion in funded.

Ron Mandle - GIC

I’m sorry.

Ken Lewis

That includes public and private homebuilders.

Ron Mandle - GIC

And how much of the funded part is now criticized?

Ken Lewis

The funded criticized is approach in a third.

Ron Mandle - GIC

Okay. So that was virtually all of the, or as you say the vast majority of the increase.

Ken Lewis

You got it.

Ron Mandle - GIC

And are you comfortable with the other two-thirds that you don’t think you will have future problem there in the next couple of quarters?

Joe Price

Let me backup and say we are comfortable with the whole portfolio. We think it’s very manageable. We think we were aggressive in identifying what we want the extra focus on the move it in there, as we did this review.

Ron Mandle - GIC

Okay. And just one of this and add in the rest of more traditional commercial the implication is that the credit quality hasn’t change in a measurable way?

Ken Lewis

Correct.

Ron Mandle - GIC

Okay. Thank you very much.

Operator

And our next question comes from the Jefferson Harralson with KBW.

Jefferson Harralson - KBW

Thanks. Back to the GCIB for a moment, if you take the $3 billion and revenue loss between last quarter and this quarter you’ve gone around the edges of explaining this does hoping maybe you could do it slightly more clearly. Now, why should do you think is in marks versus trading losses versus just revenue shortfalls from the weak market?

Ken Lewis

We haven’t been going around this. We’ve just, we’ve addressed everyone of those issues and the comments. You must out of been on line.

Jefferson Harralson - KBW

Right. I was on. I’ll go back to the transcript and get it out.

Ken Lewis

Okay. Okay.

Operator

And our next question comes from Mike Mayo with Deutsche Bank.

Mike Mayo - Deutsche Bank

Hi, a couple of follow-ups. The level of write downs on the leveraged loans, I guess $247 million losses and I took the midpoint of the average leveraged loans and I guess is 3.4%. Is that kind of ballpark correct?

Joe Price

Mike, it’s a, as you are probably aware, it's difficult to do an average simply because of, if something, let’s say if there is a, it’s subordinated position it going to have a heavier discount and if that was a first lien senior bank debt which had complete covenant etcetera.

So, I am little cautious on trying to what you use an average from that standpoint. What I would say is go back to kind of the comments, we’ve said earlier that the vast majority of our exposure is in senior bank debt and we’re not overly concentrated and being ought to subordinate et cetera from that standpoint and think about it that way. But there we do have some of that and therefore, we would through you off trying to do it on an average.

Mike Mayo - Deutsche Bank

That means the percentage would be a little bit higher.

Joe Price

On some, and lower on others. Simply, I mean, we’ve got some that we feel clear with entities.

Mike Mayo - Deutsche Bank

Okay. And as far as interest rate positioning, I thought you might benefit some days, what was in the queue and kind of what's the ins and outs of that analysis and what you say now?

Ken Lewis

You mean intra-quarter.

Mike Mayo - Deutsche Bank

How much do you continue to benefit or get hurt if the fed continues to lower interest rates?

Joe Price

Well, as I mentioned in the comments we were liability sensitive. We continue to be liability sensitive. We're a little less liability sensitive. All of that is based off the forward curve and if you went back to the end of last quarter looked at it and then the forward curve.

And obviously, rates have moved some in there. We didn’t benefit quite as much from that is, I would have expected intra-quarter, in the quarter. Because of this short end LIBOR fed fund spread. But over an extended period of time I think that, they would do what would you excepted to.

Mike Mayo - Deutsche Bank

And when you talk that short end LIBOR fed fund spread you are referring to LIBOR staying up?

Joe Price

Yes.

Mike Mayo - Deutsche Bank

Why do you think that the case?

Ken Lewis

I think it is the at large kind of market disruption that rode that, but that would be the principal reason. If you look at the futures, you would see that converging, and quite frankly, it has in the quarter and then some.

Mike Mayo - Deutsche Bank

And then one more just kind of big picture question, I thought to use a double negative, you might get a little bit of this intermediation that is you would be more of an intermediate as the capital markets had problems, are you seeing more of your customers go back to using bank debt as opposed to capital markets?

Joe Price

Some, but not as much as you might have expected during that period, I kind of gave you our elevated balance sheet levels in the kind of core credit underwriting. When you think about revolvers for corporate clients, and whether they were utilizing revolvers more, we’ve got some instances of that, but not overwhelming, so not quite as much as you might have intuitively thought during that period.

Mike Mayo - Deutsche Bank

All right. Thank you.

Operator

(Operator Instructions). We’ll take our next question from Betsy Graseck with Morgan Stanley.

Betsy Graseck - Morgan Stanley

Hi, good morning.

Joe Price

Good morning.

Betsy Graseck - Morgan Stanley

I’m sorry, I have to jump on and off the call, but I’m just wondering if you could comment a little bit on the super structure that’s being discussed in the marketplace and how you’re thinking about the potential to participate and what the positives would be from participation?

Ken Lewis

Joe, you might answer.

Joe Price

Yeah, that’s, when you step back from this for a minute while I mentioned that earlier in the call that the capital markets are, some portion of that are free enough are coming back. We still view the markets is pretty gradual. This is one area in the market that where liquidity is scarce and as a result we think that if in fact it created a disruption, it could had broader impacts in those market as well as economically.

And therefore, we look at this as a way to participate or our desire to participate is really associated with that kind of aspect that is coming from that standpoint. What we would do, we could have do it with market rates, and this is not the other away, we will make money at it some market based.

Betsy Graseck - Morgan Stanley

How do you think about the capital allocation to debt structure I mean, how do you think through what size is appropriate for you?

Joe Price

You mean, size of any particular facility.

Betsy Graseck - Morgan Stanley

That’s fine, yeah. Correct.

Joe Price

Well, if we look at it in the context of how you would underwrite any other piece credit. In other words, you look at the structure, you look at the asset class, you look at what’s behind that etc, and you kind of go through that process. So there was no real unique aspect of the way you look at it.

Betsy Graseck - Morgan Stanley

Okay. And I seem you pretty deep in the discussions on it. What's your sense as to the probability that it goes through?

Ken Lewis

I think, I predict something I think the most important part is the fact that it exists if needs to exist it will be there. And that is real so go back to main the reason I said, the real reason for having pursued this or us participating in this I think that is probably the most critical part. Well how much it gets utilized and what level is probably less relevant to me than the fact is available.

Betsy Graseck - Morgan Stanley

Okay. And then just on other areas within the capital markets, is there anything else that you are thinking about potentially scaling back on to make room for this or there other parts of the market, where you are anticipating a little bit less activity that you might be able to scale back on?

Joe Price

Nancy, there are really what’s going to be two separate issues. We wouldn't have to do anything to do this. But there will be some scaling back that’s the cause of the hard looking of the business is not, nothing to do with this.

Betsy Graseck - Morgan Stanley

Okay. Thanks.

Operator

And our next question comes from Jeff Harte with Sandler O'Neill & Partners

Jeff Harte - Sandler O’Neill & Partners

Good morning. A couple of questions, one certainly back is seems to be the theme to be investment bank. Can you talk a little bit about kind of the level of client conversations, not so much pipelines I was interested is to whether you finding, kind of quite still interested in making strategic acquisitions, kind of demand for capital, go into the capital markets, kind of the risk appetite of CEOs and such.

Joe Price

I think on the throughout this period you still have had active dialogues with your strategic with your corporate clients about strategic matters and potential transactions and things, and, as you saw just on the underwriting side, in markets, the hybrid market, function pretty orderly during this.

So, I think in general, where we are seeing the most slow down, obviously it’s been in the financial sponsors market and in the associated leverage finance market, and then in the structure credit mainly in the collateral debt obligation type of markets, and that’s kind of what you should except. So, the general client activity dialog, discussions and ongoing flow businesses, as remained there and remained, those dialogs have remained pretty healthy.

Ken Lewis

I would say that this period has affected the cycle of the financial services industry a lot more than it has outside the financial services engine.

Jeff Harte - Sandler O’Neill & Partners

Okay. And as we think about the potential for any buybacks going forward and they obviously declined a bit we know, capital levels they are going to be strained, will you be able to buyback stock in the near term or do you have an idea just to kind of when you might be able to step that up again?

Joe Price

It’s consistent with kind of what we told you before. Our intend is to rebuild the capital levels associated with the diminishing that comes from the transaction and that’s our first goal, and so we would be post that timing would still be in the later part of ’08.

Jeff Harte - Sandler O’Neill & Partners

Later part of ’08 for net repurchases. I mean, I guess, I am getting, do you think, you will able to buyback stocked offset kind of compensation dilution or kind of a cessation?

Ken Lewis

Yeah. We’ve kind of been going through, we are trying to, this quarter for instance, we are pretty much flat. We brought back to offset issuance under employee benefit plans. I’m talking about net.

Joe Price

And that will happen sometime in 2008, but they will be net.

Jeff Harte - Sandler O’Neill & Partners

Okay. And just quickly on the U.S. consumer kind of what we are seeing in credit. I mean, it seems, the theme is housing continues to be tough, and there are markdowns across kind of those portfolio. And if you move behind housing things seem to be holding up all right on the credit quality basis, and I was interesting if you’re seeing that because you cover the country so well. The differentiation between housing and the rest of the consumer credit?

Ken Lewis

You summed it up well.

Jeff Harte - Sandler O’Neill & Partners

Okay. Thank you.

Operator

And our next question comes from Meredith Whitney with CIBC World Markets.

Meredith Whitney - CIBC World Markets

Good morning. I have just rudimentary question. I appreciate your comments on directionally revenues from GCIB and the cause for action and within that unit. Can you speak in broad strokes in terms of what you would like and what you see the GCIB looking like over the next year or so just in terms of product expertise skill set niche to tie up of more of a fundamental view of what to expect?

Ken Lewis

I can’t give it at the moment, but that’s what we are in the process of going through Meredith. And I expect have that to be more clear in the next week or so.

Meredith Whitney - CIBC World Markets

Okay. And then when would it be how articulated to us?

Ken Lewis

I don’t know yet. It might be sometime this quarter or at the latest what we do the earnings for the fourth quarter.

Meredith Whitney - CIBC World Markets

Okay. All right, thank you.

Operator

Mr. Price it appears that we have no further questions.

Joe Price

Thank you very much. Have a good day.

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