Bank of America Q3 2007 Earnings Call Transcript

Oct.18.07 | About: Bank of (BAC)

Bank of America Corporation (NYSE: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 WorldMarkets

Operator

[Call Starts Abruptly]

…that this presentation doescontain some forward-looking statements regarding both our financial conditionand financial results. And these statements involve certain risks that maycause actual results in the future to be different from our currentexpectations. These factors include among other things, changes in economicconditions, changes in interest rates, competitive pressures within thefinancial services industry, and legislative or regulatory requirements thatmay affect our businesses. For additional factors please see our press releaseand SEC documents.

And with that, let me turn itover to Ken Lewis.

Ken Lewis

Thanks, Kevin. Good morning.

I know you know the Bank ofAmerica Corporation reported quarterly earnings up $3.7 billion or $0.82 perdiluted share down approximately 31% from the year ago and down 36% in thesecond quarter of this year. You also know by now that lower earnings werelargely due to market dislocation in the third quarter that took total in ourcapital markets business.

Unfortunately this will be one ofthose quarters we will spend our time discussing areas of underperformedexpense both, business that consistently contribute both of our earnings andfurther more have been the main drivers helping this growth.

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

Our business model by design actsas a defense for exactly what occurred in the third quarter and although we arevery disappointed of the magnitude of the hit we took. The strength in ourother businesses allows us to maintain our strategic direction and allows us tobe opportunistic wherever such opportunities arise.

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

Before I move to the businesslevel discussion, let me mention a few things about LaSalle. We closed ourLaSalle acquisition on October the 1st with an effort to expanding the Bank ofAmerica brand in Chicago and introducing thebrand in Michigan.Customers and markets LaSalle operate in will now have access the largestdistribution networking financial services and expensive array of products tomeet their needs.

We have not changed our financialassumptions on LaSalle that we discussed in April. In the fourth quarter, weexpect LaSalle to be accredited by penny or so before restructuring charges. Wewill talk more about the impact of LaSalle in 2008 when we meet with youdiscuss fourth quarter result.

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

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

Global Wealth and InvestmentManagement had a good quarter and reflected the addition of U.S. Trust on July1st 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 ourremaining closed in funds in the second quarter.

The integration of the U.S. Trustis going as planned. U.S. Trust added about $230 million in revenue and $200million 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 remindyou to expect a reduction of approximately $65 billion in assets undermanagement with the fourth quarter sale of (inaudible).

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

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

Before I turn over to Joe let mesummarize by saying the obvious, that overall earnings in the quarter were notexpectable to us, but still reflected the momentum in several of our corebusinesses. In July, at the prior earnings discussion, we certainly looking forGDP growth of 3% in the second half of the year, but we were concerned aboutdomestic consumptions spending given the prolonged housing slump sub-primeissues and our fuel prices. We now expect growth in the fourth quarter to bearound 2% with low loft side due to our export strength.

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

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

The after tax impact of theappreciation will not flow through earnings, but instead flows through OCIincreasing our equity and book value.

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

Joe Price

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

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

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

Debt purchase volume increased to11% over last year and revenue grew by 10% or $51 million. Net new retailaccounts drove service charge growth up a $108 million or 8% over the lastyear. Card Services revenue grew 6% from last year, as ending managed loanswere up 11%. Comparing earnings in this business to last year is tough, as weare coming off the credit loss low is resulting from the bankruptcy reforms.

And new account growth withinCard Services was $3.7 million for the quarter reflecting strong sales effortsand direct mail and e-commerce. Our more profitable franchised sales stillrepresent over a quarter of our sales and e-commerce represents 19%. Ourbalance transfer programs highlighted in our Investor Day in February arebeginning to rollout and should benefit growth as we move into 2008.

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

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

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

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

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

Finally let me turn to GCIB andaddress capital markets and advisory services and you can follow this on slide11. Last quarter we were point out record earnings in this business. Thisquarter unfortunately, we are point to record losses. Consequently, I will gointo more detail than usual in order to provide the level of transparency themost of you are looking for.

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

As Ken said, CMAS had a loss thisquarter 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 $184million, partially offset by lower expenses of $702 million as a result ofperformance related incentives.

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

On the liquid product side, whichincludes interest rate products, foreign exchange commodities and municipalfinance, we produced $585 million revenue for the quarter, which strong resultsand interest rate products and foreign exchange and tempering what would haveotherwise been a record quarter was the negative impact of correlationsbreaking down between the cash and hedge positions in municipal finance.

Now, before going into othercapital markets businesses, let me address credits underwriting and the relatedmarks, we took this quarter. We took a negative mark of $247 million pretax netof $528 million in lump fees on the loans that we have underwritten, and wherewe are above our intended hold levels on completed deals and on deals on ourforward pipeline.

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

After considering lump fees, wetook marks on all deals down to a level, where we believe the paper would clearthe 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 thequarter, 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 theway.

Our exposures concentrated insenior bank debt, and we actively syndicate bridge exposure. Now contrast tosome others, we have only modest exposure in the covenant light B loans, secondlien or subordinated positions, where the market disruption has had the mostsevere impact.

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

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

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

Trading revenue had a negativeswing of $1.2 billion. We were not well positioned from a directionalstandpoint for what happened in the quarter and this was aggregated by adecoupling of historical hedge correlations.

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

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

The third business within CMAS isstructure products, which includes residential mortgage and asset-backedsecurities, commercial mortgages, structured credit trading and structuredsecurities including our CDO business. Results in the quarter reflected anegative swing in revenue of $1.2 billion and also includes the relevantportion of the loan commitment marks I discussed earlier.

In our MBS, we had a negativeswing in revenue of $150 million due mainly the trading losses on ournon-agency inventory as many of our hedges were in agency base product andspread relationships decoupled. Our inventory peaked to just over $10 billionin 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 apositive number. We had a negative swing compared to the second quarter, as[instruments] activity was limited and we incurred only modest losses on thesub-prime warehouse. We have reduced our inventory significantly in this spaceover the last year in an effort to limit our exposure to the asset class, wherethe inventory of just under $2 billion at the end of September.

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

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

We are not satisfied with ourperformance this quarter in Capital Markets and Advisory Services. And while wefeel comparatively well in the core client driven leveraged finance in sub-primebusinesses, we got caught in the breakdown of hedge correlations principally inour sales and trading operation facilitating several client rates and on acouple of directional calls.

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

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

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

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

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

Non-performing assets increased11 basis points to 43, in third quarter provision of $2 billion exceeded netcharge-offs resulting the addition of $457 million to the reverse. This reservebill was driven by seasoning and higher loss expectations in several portfolioswe targeted for growth, including small business, which was about 50% of theincrease in home equity, were about 30%.

We also build commercial reservesprincipally related to our home builder exposures. Now as expected, managedconsumer credit card losses as a percent of portfolio dropped to 4.67% from5.02% in the second quarter, which is inline what we have been telling you forthe last several quarters.

We accept the net loss ratio,after peaking in the second quarter and a declining in the third we begin tomove 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 to5.24%.

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

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

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

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

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

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

Now given the turbulence in thethird quarter, we are due diligent in moving exposure to both non-performingand criticized categories. We believe our home builder portfolio reflects bothgranularity and geographic diversity and further erosion are expected to bemanageable.

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

The net interest margin on amanaged basis was up 3 basis points, although the core net interest margin was down11 basis points. The benefits of good loan growth and one additional day ofinterest were offset by the negative impact of rates particularly the move inLIBOR as well as market based funding of asset growth.

As you can see on the bubblecharts on slide 17, our interest rate positioning is less liability sensitivecompared to the end of June. But remember, these are estimates of NII changeare based of the [930] forward curve, so the base is also higher. We addedabout $100 billion in pay fixed losses, we felt that forward rate curves wereslightly overdone; and this position help protect us if the forward rate cutdon’t materialize, and also contribute to the lower liability sensitivityposition.

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

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

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

Although, our overall fundinglevels for the acquisition are on target with our projections, we have notraised as much tier 1 capital as we originally projected. As a result, our estimatefor year and maybe slightly lower than the original forecast depending upon thetiming of the tier 1 capital raises, but we remain committed to getting back toour 8% target. The upcoming [Maursica] gain was embedded in our capitalforecast, when we announce the transaction.

The positive impact from expensedsynergies with LaSalle won’t really be evident until first quarter of 2008. Wewill discuss that benefit in January, when we talk about our ’08 outlook. Andone final comment before closing, the lower effective tax rate reflects thereassessment and ketchup of our annual rate given the lower third quarterearnings.

So, in closing, let me reinforceKen’s comments and say that while the earnings in the third quarter were notwhere we wanted, we did have businesses that performed in line with ourexpectations showing the strength of our diversified model.

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

Question-and-Answer session

Operator

(Operator Instructions). And ourfirst 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 sortof, an over urgent question here in Ken probably more and you. I mean, you’renot that big in investment bank relative to some of your Wall Streetcompetition you have been building out the bank over the last few years. Hasthe third quarter experience sort of changed your plans for the build out andhow do you assess this. How much of this was due to the market and how much ofthis was due to perhaps not having the trading talent that you need?

Ken Lewis

Well, we obviously are in themiddle of assessing all of that Nancy and what I can’t say is that, we stay thecourse and go forward as we have in the past. I mean, I think it is incumbentupon me and my responsibility to look at every single business and see, wherewe 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 pointthat you’ve made skill set assessment, judgment assessment and kind ofindividual accountability.

Then secondly, I explain what wewould be looking at what we think the markets will be like now in 2008. And wedon’t think there would be as robust, for instance as the first half of thisyear. And so we have to look at the infrastructure as the result of that. Andthen finally, again to your point, we are going to work it every singlebusiness 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 oneyear.

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

Nancy Bush - NAB Research

I would just ask Joe, I guess, Imean it seems like the number of the hedges didn’t work. And I know that therewas part of that certainly was due to the unusual moves in many credit productsthat 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 toaccess this yet?

Joe Price

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

We clearly felt comfortablecoming into this given some of the more historical norm two of those pricingrelationships, but they decoupled and that did. So, I guess, what’s yourfollowing question would be, we are proud to be accused of being a little moreclient accommodative on balance sheet and otherwise, then we wouldn’t have hadas much to hedge.

Ken Lewis

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

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

Nancy Bush - NAB Research

If I could just ask thefollow-up, I don’t know. I don't know if Liam is in the room or somebody isavailable to comment on this, maybe you Joe. There was report on the BostonGlobe this morning saying you guys were losing deposit market share in thatmarket 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 aboutthat market. I’ll tell you overall, we had quite strong retail deposit growththis quarter now had included the addition of U.S. Trust, when you take thatout we were reasonably inline with market growth. So I don’t know of anyparticular 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 MikeMayo with Deutsche Bank.

Mike Mayo - Deutsche Bank

Good morning.

Ken Lewis

Good morning.

Mike Mayo - Deutsche Bank

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

Ken Lewis

I don’t think so, Mike. I alwayssay, I never say never, but, I had fun. I can stand in investment banking atthe 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 ofthese businesses and see put our strengths whether not and act accordingly.

Mike Mayo - Deutsche Bank

And as it relates to assetquality generally, you mentioned not only home equity homebuilders, but allsmall business. So, I guess the question is what percent of your loan portfolioare you worried about? You said there is an additional softness that you aren’texactly anticipating?

Joe Price

Mike, I think, obviously ourbiggest look into the kind of the U.S. consumer larges in our cardbook 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’regrowing that portfolio it’s about $16 billion portfolio, when you aggregate allthe pieces. I mean, see we have got quite a bit of seasoning in there as wellas some deterioration on the hedges, but as much growth as anything.

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

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

On the commercial side, wementioned about home builders, we clearly our philosophy is to get aggressivewhen there is weakness up there and move these things into criticized asset, sothat 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 thisperiod.

Ken Lewis

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

Mike Mayo - Deutsche Bank

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

Joe Price

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

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

Mike Mayo - Deutsche Bank

Alright, thank you.

Operator

And our next question comes fromEd 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 bitpremature, but of course it comes back to GCIB, $100 million this quarter,obviously much lower than anticipated compared to levels in the prior quarterwas so much higher, I think obviously all of our exception is the futurequarter will be somewhere in the middle of this very low quarter, but lowerthan the kind of quarters you were putting up, prior to the third quarter.

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

Ken Lewis

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

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

Ed Najarian - Merrill Lynch

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

Ken Lewis

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

Ed Najarian - Merrill Lynch

And you expect to be prettyaggressive in that regard?

Ken Lewis

Very.

Ed Najarian - Merrill Lynch

Okay. Thank you.

Operator

(Operator Instructions). And ournext 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 morecolor on the rationale that continue growing the home equity and auto portfolioso much, and I think the growth rates somewhere in the 20%, 30% range. And itseems 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 eitherthose are first mortgages over they are where we hope first mortgage.

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

Joe Price

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

Matthew O’Connor - UBS

Well, I think the concern wasthat if home prices continues to decline from here a lot of home equity for theindustry overall is based on FICO’s, which is proven to be that great if anindicator in the LTVs as well. So start creeping up as prices decline, so itjust does a lot of other banks go back. I think you guys have been underpenetrated 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 natureof most people and so the assets are a function. What you think employment’sgoing 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, areyou guys thinking differently about using FICO scores as you evaluate it justall your consumer lending especially relate to real estate?

Ken Lewis

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

Matthew O’Connor - UBS

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

Joe Price

I think, as we continue to growthe business, we would obviously have to deal with that. And I guess the way, Iphrase 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, youwould hope so, if you are asked, if it’s for growth.

Matthew O’Connor - UBS

Okay. All right. Thank you verymuch.

Operator

And our next question comes fromRon Mandle with GIC

Ron Mandle - GIC

I thought, I was wondering, ifyou 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 whateverelaboration you could give on that?

Ken Lewis

Yeah Ron, the increase incriticize, the principle driver, as I mentioned before was home builders, wherewe specifically reviewed the home builder portfolio across the nation, andtrying to be pretty aggressive on identifying, where we felt there could beweakness.

So that we could get extra focuson what happened, when you put something in the credit side, so that was theprimary driver other things that would have had some impact would be mortgagecompanies has obviously, but the overwhelming driver was on the home builderside.

Ron Mandle - GIC

And how big is your homebuilderportfolio?

Joe Price

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

Ron Mandle - GIC

I’m sorry.

Ken Lewis

That includes public and privatehomebuilders.

Ron Mandle - GIC

And how much of the funded partis now criticized?

Ken Lewis

The funded criticized is approachin a third.

Ron Mandle - GIC

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

Ken Lewis

You got it.

Ron Mandle - GIC

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

Joe Price

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

Ron Mandle - GIC

Okay. And just one of this andadd in the rest of more traditional commercial the implication is that thecredit 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 fromthe Jefferson Harralson with KBW.

Jefferson Harralson - KBW

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

Ken Lewis

We haven’t been going aroundthis. 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 tothe transcript and get it out.

Ken Lewis

Okay. Okay.

Operator

And our next question comes fromMike Mayo with Deutsche Bank.

Mike Mayo - Deutsche Bank

Hi, a couple of follow-ups. Thelevel of write downs on the leveraged loans, I guess $247 million losses and Itook the midpoint of the average leveraged loans and I guess is 3.4%. Is thatkind of ballpark correct?

Joe Price

Mike, it’s a, as you are probablyaware, it's difficult to do an average simply because of, if something, let’ssay if there is a, it’s subordinated position it going to have a heavierdiscount and if that was a first lien senior bank debt which had completecovenant etcetera.

So, I am little cautious ontrying to what you use an average from that standpoint. What I would say is goback to kind of the comments, we’ve said earlier that the vast majority of ourexposure is in senior bank debt and we’re not overly concentrated and beingought to subordinate et cetera from that standpoint and think about it thatway. But there we do have some of that and therefore, we would through you offtrying to do it on an average.

Mike Mayo - Deutsche Bank

That means the percentage wouldbe 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 ratepositioning, I thought you might benefit some days, what was in the queue andkind 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 tobenefit or get hurt if the fed continues to lower interest rates?

Joe Price

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

And obviously, rates have movedsome in there. We didn’t benefit quite as much from that is, I would haveexpected intra-quarter, in the quarter. Because of this short end LIBOR fedfund spread. But over an extended period of time I think that, they would dowhat would you excepted to.

Mike Mayo - Deutsche Bank

And when you talk that short endLIBOR 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 kindof market disruption that rode that, but that would be the principal reason. Ifyou look at the futures, you would see that converging, and quite frankly, ithas in the quarter and then some.

Mike Mayo - Deutsche Bank

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

Joe Price

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

Mike Mayo - Deutsche Bank

All right. Thank you.

Operator

(Operator Instructions). We’lltake 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 andoff the call, but I’m just wondering if you could comment a little bit on thesuper structure that’s being discussed in the marketplace and how you’rethinking about the potential to participate and what the positives would befrom participation?

Ken Lewis

Joe, you might answer.

Joe Price

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

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

Betsy Graseck - Morgan Stanley

How do you think about thecapital allocation to debt structure I mean, how do you think through what sizeis appropriate for you?

Joe Price

You mean, size of any particularfacility.

Betsy Graseck - Morgan Stanley

That’s fine, yeah. Correct.

Joe Price

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

Betsy Graseck - Morgan Stanley

Okay. And I seem you pretty deepin the discussions on it. What's your sense as to the probability that it goesthrough?

Ken Lewis

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

Betsy Graseck - Morgan Stanley

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

Joe Price

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

Betsy Graseck - Morgan Stanley

Okay. Thanks.

Operator

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

Jeff Harte - Sandler O’Neill & Partners

Good morning. A couple ofquestions, 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, notso much pipelines I was interested is to whether you finding, kind of quitestill 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 thisperiod you still have had active dialogues with your strategic with your corporateclients about strategic matters and potential transactions and things, and, asyou saw just on the underwriting side, in markets, the hybrid market, functionpretty orderly during this.

So, I think in general, where weare seeing the most slow down, obviously it’s been in the financial sponsorsmarket and in the associated leverage finance market, and then in the structurecredit mainly in the collateral debt obligation type of markets, and that’skind of what you should except. So, the general client activity dialog,discussions and ongoing flow businesses, as remained there and remained, thosedialogs have remained pretty healthy.

Ken Lewis

I would say that this period hasaffected the cycle of the financial services industry a lot more than it hasoutside the financial services engine.

Jeff Harte - Sandler O’Neill & Partners

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

Joe Price

It’s consistent with kind of whatwe told you before. Our intend is to rebuild the capital levels associated withthe diminishing that comes from the transaction and that’s our first goal, andso 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 netrepurchases. I mean, I guess, I am getting, do you think, you will able tobuyback stocked offset kind of compensation dilution or kind of a cessation?

Ken Lewis

Yeah. We’ve kind of been goingthrough, 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 talkingabout net.

Joe Price

And that will happen sometime in2008, 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 ishousing continues to be tough, and there are markdowns across kind of thoseportfolio. And if you move behind housing things seem to be holding up allright on the credit quality basis, and I was interesting if you’re seeing thatbecause you cover the country so well. The differentiation between housing andthe 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 fromMeredith Whitney with CIBC World Markets.

Meredith Whitney - CIBC World Markets

Good morning. I have justrudimentary question. I appreciate your comments on directionally revenues fromGCIB and the cause for action and within that unit. Can you speak in broadstrokes in terms of what you would like and what you see the GCIB looking likeover the next year or so just in terms of product expertise skill set niche totie 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 expecthave that to be more clear in the next week or so.

Meredith Whitney - CIBC World Markets

Okay. And then when would it behow articulated to us?

Ken Lewis

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

Meredith Whitney - CIBC World Markets

Okay. All right, thank you.

Operator

Mr. Price it appears that we haveno further questions.

Joe Price

Thank you very much. Have a goodday.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!