National City Corporation (NCC) Q4 2007 Earnings Call January 22, 2008 11:00 AM ET
Thomas A. Richlovsky - Senior Vice President and Treasurer
Jeffrey D. Kelly - Vice Chairman and Chief Financial Officer
Dale Roskom - Chief Risk Officer
Robert C. Rowe - Senior Vice President and Chief Credit Officer
Peter E. Raskind - Chairman, President and Chief Executive Officer
Dan Frate - Executive Vice President of Retail Banking
Rob Crowl - Chief Operating Officer
Jill Hennessey - Investor Relations Manager
Ladies and gentlemen, thank you for standing by and welcome to National City Corporation’s fourth quarter and full year 2007 earnings conference call. (Operator Instructions) I would now like to turn the conference over to our host, Mr. Tom Richlovsky, Treasurer of National City Corporation. Please go ahead.
Thomas A. Richlovsky
Thank you and good morning everyone. Welcome to National City Corporation’s fourth quarter earnings conference call. Before we get started, please note that the presentation and commentary that you are about to hear contain forward-looking statements. In making these statements, we base them on presently available information and current expectations. We believe the statements to be reasonable. They are subject to numerous risks and uncertainties as described in our Form 10-K and in other filings with the Securities and Exchange Commission. As a consequence, actual outcomes could differ materially from the views expressed today. We may elect to update forward-looking statements at some future point. However, we specifically disclaim any obligation to do so.
As is our usual practice, we are taking questions by email and will cover them at the end of the session. To ask a question, just send an e-mail to investor.relations@NationalCity.com. We will take as many questions as time permits.
Here with me this morning are Peter Raskind, Chairman and CEO; Jeff Kelly, Vice Chairman and CFO; Dale Roskom, Chief Risk Officer; Rob Rowe, Chief Credit Officer; and Jill Hennessey, Investor Relations Manager, along with several other members of the senior management team.
I want to call your attention to the slide deck which we’ve posted on our website, NationalCity.com, and we will be referring to this over the course of the call. The topics to be covered this morning are noted on page 3 of that slide deck and they include a review of fourth quarter results by Jeff Kelly, a discussion on credit by Rob Rowe and then some thoughts on strategic direction and issues from Peter Raskind.
With that, I’ll turn the call over to Jeff Kelly.
Jeffrey D. Kelly
Thanks, Tom and good morning, everyone. The fourth quarter results include a number of significant charges, and as a level set, I’ll start my comments by reviewing them.
First, by way of completing the shutdown of the National Home Equity business, the curtailment of non-agency eligible mortgage production, and an aggressive effort to clean up the mortgage warehouse, we incurred charges in the held-for-sale portfolio from trade fallout, scratch-and-dent losses, and mark-to-market adjustments totaling around $150 million pretax, or $0.16 per share.
As you may recall and as the slide on page 5 of the presentation deck shows, we had $11.5 billion of loans in the warehouse at September 30, including $2.5 billion of second mortgages and home equity lines of credit in unsettled trades. Of that amount, $1 billion was actually sold and the fallout from the trades was either sold at distressed prices or moved to the portfolio at market.
As a result of the settlement of trades, continued product constraints, and movement of loans into the portfolio, the warehouse balance at December 31 of $3.7 billion is dramatically smaller and effectively now contains only high quality, first mortgages.
Second, we wrote off all of the goodwill associated with the Mortgage Banking segment, some $181 million or $0.26 per share in late December. This writedown is reflective of the reduced outlook for mortgage profitability generally, and the cost associated with the liquidating portfolio of home equity loans that are carried in that business segment.
Third, in connection with the restructuring of the mortgage company, including the decision in late December to discontinue wholesale mortgage lending, we incurred severance charges of around $17 million for staff reductions in that unit.
In addition, as discussed on the October call, we implemented broad-based staff reductions across the company in non-customer facing support functions during the quarter, bringing the total of severance and related charges for the whole company in the fourth quarter to $66 million, or $0.07 per share.
Finally, we recorded charges of $132 million or $0.14 per share related to the indemnification obligations to Visa Inc. bringing the total of Visa-related charges to $289 million pretax for the full year.
As an aside, we expect that some portion of the Visa charges will be reversed in 2008 in conjunction with Visa’s proposed IPO and that the value of our 8% interest in Visa USA, currently carried at zero value on our books, will ultimately be worth more than the Visa-related liabilities recorded on the balance sheet in 2007. We do view the foregoing charges as nonrecurring.
We also recorded a loan loss provision of nearly $700 million in the fourth quarter, exceeding net charge-offs by over $400 million or $0.43 per share to build the loan loss reserve levels we believe appropriate given the current environment as Rob Rowe, our Chief Credit Officer, will cover in a few minutes.
Taken together, these charges drove the overall results of the company to a net loss for the fourth quarter and as Peter noted in the earnings release, overshadowed good fundamental performance in the core banking units outside of mortgage.
Core deposit and loan growth were strong as were most fee income categories outside of Mortgage Banking. The margin, as expected, continued to narrow. Structurally, the asset side of our balance sheet includes a fair amount of loans, mainly home equity lines, priced off the prime rate. As the Fed funds rate declines, our home equity lines tied to the prime rate were priced accordingly.
At the same time, nearly all of our purchase funding is LIBOR-based, and both LIBOR and LIBOR spreads increased relative to Fed funds and the prime rate in the fourth quarter.
To some extent, our core deposit pricing is also driven by LIBOR-based rates so overall funding costs have declined less than asset yields, compressing the margin. The margin pressure from the LIBOR Fed funds spread impact has largely abated during the month of January and as a result, downward pressure from this source should abate as well. Looking forward, our best estimates right now would be for the margin to be about flat in the first quarter and then rise slightly through the remainder of 2008.
Let me finish with some thoughts on capital and the balance sheet. Owing to the disruptions in the mortgage market, the size of the balance sheet and the risk inherent in it were both larger in the second half of 2007 and through year end versus what we had projected at the start of the year. As a consequence, year end capital levels are lower than forecast, in particular the tier 1 capital ratio, which at 6.52% is below our target range of 7% to 8%.
As we have said as early as at our analyst conference last September, our goal is to move our capital ratios to the top of or slightly above their long-term target ranges as quickly as we can. Clearly the continued market disruption in the fourth quarter delayed progress toward that goal.
As we announced earlier this month, we are evaluating a number of options for non-dilutive tier 1 capital issuance this quarter to move us closer to the target and we also cut the dividend by 49% to accelerate the growth in retained earnings.
At the same time, the overall balance sheet is getting smaller. Total assets peaked at over $154 billion early in the fourth quarter and are now down some $4 billion to $150 billion at year end. The reduction has been driven by a smaller mortgage warehouse and paydowns in liquidating loan portfolios, even as loans in the core bank have grown. We expect that these trends will carry through this year with the size of the overall balance sheet declining on a net basis throughout 2008, favorably affecting capital ratios.
A further potential boost to capital could also come from reversing some of the Visa charges and/or realization of some portion of the value of our ownership stake upon completion of Visa’s planned IPO, but obviously we don’t control either the timing or the outcome there.
With that, I’ll turn things over to Rob Rowe to discuss credit.
Robert C. Rowe
Thanks, Jeff and good morning, everyone. My remarks today will cover both the ongoing businesses of National City and the liquidating portfolios. Overall, the $99 billion core loan portfolio built on the premise of know your customer, continues to perform well and within expectations. The charge-off rate in the core loan book was 48 basis points during 2007.
We will also carve out a significant amount of the presentation to discuss our liquidating portfolios, which totaled $17 billion of loans, slightly less than 15% of the entire loan portfolio.
Please turn to page 7 where I’ll begin by giving a quick overview of the core loan portfolio. The commercial and industrial book, at $35 billion including leases, is diverse, granular and on the whole performing well and to our expectations. Much of our commercial customer base continues to perform at very high operating margins.
Charge-off of $102 million for the year, including $30 million in leveraged airplane leases inherited from a prior acquisition, were a very low 31 basis points. The overall performance of the $24 billion commercial real estate book is similarly strong with 2007 charge-offs running at 28 basis points. Like the C&I portfolio, this book is diverse and granular.
We will review this portfolio in more detail later, but our principal area of concern has been particularly focused on the $1 billion exposure to Florida and Michigan residential development.
Much of National City’s $31 billion core residential real estate portfolio also is performing well and to our expectations. In particular, results for the $16 billion of branch and direct home equity were very solid in 2007. Charge-offs of 36 basis points compares well to the 2006 rate of 32 basis points. Later in our material we provide a few characteristics to help explain the substantial difference in credit performance for this portfolio compared to our National Home Equity portfolio, which is liquidating.
We have seen deterioration in the $3 billion National City mortgage construction portfolio. I’ll cover that in more detail later in the presentation.
Lastly, our credit card and other revolving portfolio continue to perform at loss rates below industry averages. Net charge-offs in the $3 billion credit card book remain below industry averages at 342 basis points. We believe that the credit results in 2007 for the core $99 billion portfolio demonstrate a solid performance with stress points primarily rising from construction-related activities in Florida.
Please turn to page 8, which outlines the liquidating $17 billion of our total loan portfolio. These liquidating non-prime mortgage and National Home Equity portfolios have had a higher loss content than the core portfolio. I will talk in detail about both of these portfolios in later slides, but a couple of quick comments on each of these segments.
The second mortgage portion of the non-prime portfolio exhibited increased delinquency and charge-offs in the fourth quarter. Refinancing options are now limited to only the upper end of this portfolio. The lack of liquidity in the marketplace to refinance for many of our borrowers has created pressure as the rate reset activity increases.
For National City, the impact of rate resets will play out earlier than the non-prime industry overall, as much of the first reset our customers’ face already happened in 2007 or will happen within the first four months of 2008.
Results for the National Home Equity portfolio deteriorated significantly for the ‘06, ‘07 vintages. The 2005 and earlier vintages have performed reasonably close to our expectations. As a result, we substantially increased reserve levels in the fourth quarter, taking the allowance to 1.52% of loans, up from 1.18% at 12/06.
We have included for your reference on slide 9 a breakout of credit performance for the $99 billion ongoing core portfolio and the liquidating portfolio. As previously stated, the core portfolio net charge-offs were at 48 basis points for 2007, slightly above the 2006 results. Overall the charge-off rate was 64 basis points for the full year.
Slide 10 summarizes the overall National City portfolio consistent with our balance sheet presentation and supplement. In the following pages, I will take you through commercial real estate and consumer and residential real estate segments of the portfolio.
Let’s begin by turning to the $24 billion commercial real estate portfolio on slide 11 and 12. Let’s start with slide 11. The $24 billion commercial real estate portfolio was balanced and diversified. Of the $4.5 billion in residential development, about 25% is in Florida and Michigan projects. This $1.1 billion portion of the book continues to show stress.
Page 12 shows the detail of commercial real estate by geography and type of loan, which is the same format as in last quarter’s call. Nonperforming assets in the residential-related activities increased from $195 million at the end of the third quarter to $257 million at the end of the fourth quarter. Much of this increase was in the legacy Harbor and Fidelity portfolio. We have recently concluded an intensive review of the Florida portfolio and believe that the most recent stress exhibited will continue. We would expect that the delinquency trends to continue to rise in legacy Harbor and Fidelity franchises. Please note that this portfolio represents less than 1% of National City’s overall loan portfolio.
Almost $2 billion, approximately one-half of the residential portfolio, had been underwritten in our Midwestern franchise which is described on the chart as “rest of footprint”. Because of the slow growth characteristics of this region of the country, there has been far less speculative activity in the financing structures of deals. Please also note that the internal watchlist on this portfolio is still within our expectations.
Finally, nonperforming assets in the national book fell in half to 3% due to the disposition at par value of what was once our largest non-accrual credit.
Next I want to review the $56.7 billion portfolio of consumer and residential real estate loans. Please turn to page 13, which summarizes this portfolio. This $56 billion portfolio has two major segments: $39.5 billion related to our core customer business and the liquidating $17 billion of broker-originated portfolios consisting of $11 billion of National Home Equity and $6 billion of First Franklin.
The residential real estate portion of this $56.7 billion book includes our continuing branch and direct home equity portfolio, our first mortgage portfolio and two significant liquidating portfolios: the National Home Equity book and the non-prime portfolio. Risk levels vary widely across these portfolios. Let’s begin on Page 14 with a summary of our two home equity businesses.
Our home equity balances in the branch and National Home Equity portfolio total $27 billion; $5 billion of the overall home equity portfolio is in a first lien position and we believe will perform as such.
The home equity portfolio is best viewed in three segments. The first segment and the largest part of our home equity book is a $15.7 billion branch and direct home equity business. The chart on the lower left of the page depicts the annualized charge-off rates for the last five quarters. This portfolio has fourth quarter charge-offs of 36 basis points, which is only slightly above the fourth quarter of 2006. This portfolio is heavily cross sold through our branch network with strong underlying customer characteristics.
The second segment totaling $4.8 billion are older vintages, primarily the middle of 2005 and earlier, of the National Home Equity portfolio. This $5 billion was underwritten with anticipation of being held in the portfolio.
The third segment consists of the more recent National Home Equity production, primarily 2006 and 2007 vintages. They represent slightly less than 25% of our home equity overall segment, and only 5% of our entire loan portfolio. It does exhibit much higher delinquency and loss rates than the first two segments, as well as deteriorating performance through Q3 and Q4.
Let’s now look at each of those three home equity segments in more detail.
First please turn to page 15, which is a snapshot of the $15.5 billion direct home equity portfolio in our retail bank. This product is integral to our overall retail strategy of expanding household relationships. It is a growing portfolio with very strong credit performance. Approximately one-third of these loans are in a first lien position.
Delinquency trends have increased slightly from a very low base. As stated before, net charge-offs at 36 basis points remain at a very low level and are up 4 basis points from fourth quarter ‘06. To be sure, this portfolio would not be totally immune to pressures related to job losses created by a recession, but it has exhibited far more stability than the broker-based National Home Equity portfolio.
Second, we’ll turn to the portion of the National Home Equity book that was originated for the loan portfolio, shown on page 16. Page 16 illustrates production from mid-2005 and earlier, consisting entirely of loans originated and underwritten specifically to our loan portfolio. These earlier vintages included only a minimal amount of stated income products, have substantially more balances above 730 FICO, and less balances where the loan-to-value was greater than 90% than the 2006-2007 vintages. At the bottom of the chart, we have trended charge-offs in 90-plus delinquencies, which have increased slightly during the second half of 2007.
Third, on page 17, we show the more recent National Home Equity vintages. Again, this segment represents loans originated for sale and underwritten to capital markets standards but which could not be sold or were kicked out of trade and were transferred from the held for sale warehouse to the portfolio. The quality and other characteristics of these loans are visibly worse than those underwritten for our portfolio. Again, compared to the older vintages, this portion of the portfolio has fewer balances above 730 FICO and more balances above 90% loan-to-value.
As you can see by the trending provided, this segment has exhibited meaningful deteriorating conditions. We have increased the reserve significantly during the fourth quarter for this portfolio to reflect our view of much higher loss in the future.
We have provided on page 18 bullet points that contrast some of the borrower characteristics of the $15.7 billion of loans from our branch home equity lending unit and $11.2 billion of loans in the liquidating National Home Equity book. Essentially, the branch and direct home equity product is sold to long-time customers who almost always bank with us in a broad way, where we have developed a close relationship and intimately know their financial condition.
We are comfortable with the risk profile of the $16 billion branch and direct home equity portfolio. Losses in the older vintages of the National Home Equity portfolio, while higher, are not displaying the degree of volatility we see in the more recent originations.
The next part of the residential real estate portfolio to review is the National City mortgage residential construction book. Please turn to page 19, showing this $3 billion residential construction portfolio, $2.6 billion of which is to individuals to finance their primary or secondary residence and $400 million to individuals to finance the construction of real estate for investment purchases.
We talked a lot about this book last quarter, in particular the investment portfolio. Since the end of the third quarter, the 90-plus delinquency dollars and delinquency rate has risen for both the investor properties and the primary second homes segment. A fair amount of the delinquent loans have emanated from a cohort of individuals who have decided not to build due to the declining home prices. In those instances, the individuals have little equity in the deal and some have decided to default from their obligation. In those instances, our losses have and will continue to be quite high.
During the third and fourth quarter we increased our reserves to this portfolio significantly to reflect both higher frequency of default and higher loss severities. On average we are assuming a 50% loss severity in Florida on this portfolio with some developments in that state even higher. Please note that we tightened the underwriting standards for residential construction lending in late 2006 and into 2007. New lending volumes are negligible.
The last area in the residential real estate portfolio to discuss is the non-prime portfolio associated with our former First Franklin business. Please turn to page 20. Totaling $6 billion at year end, the remaining balance continues to decline steadily. Payoffs were almost $500 million during the fourth quarter even though liquidity has tightened up considerably. From a risk perspective, there are two portfolios here: $4.5 billion of first mortgages and $1.5 billion of second.
As you can see, the first liens have exhibited low loss content. Approximately one-third, almost $1.5 billion of the first liens, have mortgage insurance down to 60% loan-to-value. It is in this segment where the dollars of delinquencies have been rising. The other $3 billion of first liens have had declining delinquency during 2007 and flat delinquency over the last six months of 2007. The second liens have and will continue to drive the bulk of the losses.
As you can see from the middle of the chart, it is apparent that the trends in the 90-plus day dollar delinquency number have deteriorated since mid-summer when liquidity for this asset class dried up. We believe that many of these second liens are behind first liens, which have or will rate reset by April 2008, so we anticipate the pressure applied to this portfolio from first mortgage rate resets will abate later in 2008.
Please note that we increased our loss reserves for this portfolio in the fourth quarter meaningfully.
In summary, the $99 billion core loan portfolio is performing well except for a couple of exceptions in the portfolio and it is performing to expectations. We also believe the reserve building actions in Q3 and Q4 appropriately provide for the probable loss content in the overall loan portfolio.
However, 2008 will be difficult for several of those segments related to residential real estate with a potentially wider than usual range of outcomes. In particular, we will be closely monitoring the out-of-footprint consumer real estate exposures in the liquidating portfolios as well as the residential development component of commercial real estate and the National City mortgage company.
For the National Home Equity portfolio, primarily the most recent vintage, the higher component of stated income products, reliance on broker originations and the geographic concentrations in markets subject to home price depreciation distinguish it from our direct branch-based customer portfolio and heavily influence our outlook on losses.
For the remaining non-prime book, the effects of re-pricing our firsts that stand in front of our seconds, as well as the refinancing constraints facing these borrowers will be the most important factors driving the ultimate level of losses. It is more clear to us how our direct-to-consumer and direct-to-business portfolios should perform over the next 12 months assuming the economy stays out of a recession.
With that, as background, we would forecast 2008 net charge-offs on the order of $1 billion to $1.3 billion for the company as a whole. We recognize that range, which represents a 50% to 80% increase from 2007 and potentially a level above the Q4 trend, is wide. However, the full impact of the softening economy, future levels of capital market liquidity and declining housing prices, especially on the National Home Equity and First Franklin portfolios, drive the higher than normal level of variability in our loss estimate.
I’ll now turn the floor over to Peter Raskind for a broader look at the quarter.
Peter E. Raskind
Thanks, Rob. I think Jeff and Rob have covered well the major aspects of our financial results and credit picture. Clearly, this quarter and year has been the most difficult and disappointing in the recent history of this company. Certainly the environment since August has been the most challenging any of us have ever faced, but I have to say that our difficulties have been somewhat exacerbated by decisions we made in the past. We can’t change those decisions now, but we can learn from them and run a better company in the future. My focus this morning will be on where we stand now and where we go from here.
One of the lessons learned is that we entered this period of capital markets disruption with a thinner than ideal capital base particularly as measured by the tier 1 and total risk-based capital ratios. As we note on Slide 21 of the deck, we have adopted a capital plan designed to materially strengthen our capital position, targeting the higher end of our announced tier 1 7% to 8% range, as well as the higher end of our target tangible range of 5% to 6%.
To achieve those levels, we’ve reduced the size of our balance sheet and will be continuously evaluating the highest value usage of our balance sheet. As you know, we also intend to raise tier 1 capital during the first quarter of this year for which we have engaged Goldman Sachs as capital advisor.
Finally, we made the difficult but absolutely correct decision to reduce our dividend by 49%. While reducing the dividend as an emotional issue for all involved, the reduction will generate an additional $500 million of capital over the course of the year, helping move toward a more robust capital base which will better position us to face a persistently challenging environment.
I think yet another conclusion is that we allowed the mortgage business to become too large relative to the rest of our company. To be sure, we earned a lot from this business during the refi boom of 2003 and 2004, but the cyclicality and volatility associated with this business has not been helpful to us.
The closure of our wholesale and correspondent origination channels, together with the sale of First Franklin, fashions a mortgage business which is now 100% direct-to-consumer. The smaller origination capability will mean lower net income in that business, as well as a gradual decline in the mortgage servicing book, but the result is a more stable business model and a lower and more appropriate orientation and exposure to mortgage going forward in both origination and servicing, which we think is the right strategic direction.
As we’ve said consistently over the past couple of years, our primary focus is on direct businesses which are highly integrated with each other and the newly configured mortgage business is aligned with that model. We have still got some work to do to make sure the cost structure properly fits the smaller scope of the business, but we believe we are very close to where we want to be for the long term.
Looking ahead to 2008, our dual objectives will be to minimize losses associated with the liquidating portfolios while maintaining focus on the core businesses which will matter in the long run. We have substantially augmented the resources dedicated to the liquidating portfolios and increased the intensity of our collection and loss mitigation tactics.
As Rob described, the ultimate disposition of these portfolios will be heavily influenced by the economic environment, but we will expend every effort to manage well those factors which we can control.
Turning to the core banking business, we believe it’s well positioned heading into 2008. In the retail bank, core deposits were up 8.5% in 2007, excluding acquisitions. The increase is not the result of a singular objective of growing deposits, but rather it’s the byproduct of a sustained focus on growing and expanding households and household relationships in a targeted and thoughtful manner.
As an example, our points from National City Rewards Program, still the most complete and comprehensive among all the banks against which we compete, continues to gain traction and is really starting to drive the behaviors for which it was designed: expand relationships, increase engagement and improve retention.
Coupled with a myriad of other initiatives we have talked about in the past, along with an unrelenting focus on execution, we generated net household growth of almost 2% in 2007, excluding acquisitions; which doesn’t sound remarkable until you consider that much of our footprint has virtually flat or, in some cases, negative household growth.
Similarly, in commercial banking we are seeing good volumes and we remain focused on meeting customers’ needs. Success in commercial banking also helps the retail bank through programs such as Work Perks, our bank-at-work program, and is also a strong source of referrals to the wealth management business.
The tight integration of these three businesses -- corporate, retail and wealth management -- by way of what we call the market sales process, makes for a very effective business model that puts the customer first, with clear lines of ownership and accountability for sales, service and referrals.
Over the past several months across the company we have eliminated approximately 3,400 positions which represent about 10% of our workforce. These decisions are never easy, but it is very important that we size our expense base to reasonably fit the revenue stream of the company in the near term. Through a series of management processes, we are dedicated to maintaining that expense discipline through 2008 and beyond.
The other major focus for 2008 is the integration of our recently acquired banks. The Florida acquisitions were converted to National City systems in 2007 and now the real work is underway. Obviously, the planned-for revenue opportunities from real estate related businesses will not be achieved in the near term, given the downturn in the Florida market.
That said, the wealth management and small business opportunities are real and are happening. The branch system is extremely well situated and the demographics are dramatically more favorable than our legacy markets. So we still feel that we’ve made long-term investments here which add to the intrinsic value of the company.
The MAF acquisition in Chicago, closed last September, will convert in the first quarter. Post-conversion, we will truly be able to leverage our position as the fourth largest bank in this very large and important market.
So we think we have a solid game plan for the core banking businesses and we are prepared to execute well against it. The sharp deterioration in the mortgage and capital markets environment occurred about one week after I became CEO, a coincidence which I have not relished. That said, I believe we have taken a series of actions over the intervening six months which properly configure this company for the future. To be sure, we will face challenges in 2008; challenges which we anticipate will begin to abate toward the end of the year. But we are dedicated to confronting those challenges and thereby restoring the profitability and value which our shareholders deserve.
I am more confident than ever that our core retail, commercial and wealth management businesses can compete and win against anyone in our footprint. I can assure you that I’m working with a talented team of people who are selflessly devoted to the success of this company. I thank all of them for all of their efforts through this very challenging period.
With that, let’s move to the question-and-answer session.
Thomas A. Richlovsky
Jill, we have got some questions for the speakers, correct?
Yes, and we’ll start with you, Peter. The dividend was cut in early January and the stock continues to be under pressure. Is the balance sheet now in good shape and are the assets fairly valued? What is the future plan for National City and what will it mean for shareholders?
Peter E. Raskind
I think as we have described today, we’ve taken every action that we reasonably can in the third and fourth quarter to prepare ourselves for the future and to work through some of the issues that have been associated with the capital markets disruptions that began in earnest in early August.
That said, and as Rob described, we do have liquidating portfolios that at this point we will be needing to work through over the passage of time. If an opportunity presents itself to dispose of those portfolios more quickly we will of course take a hard look at that, but no such opportunity appears to be present today.
Our future clearly lies with success in our core businesses: retail banking, commercial banking, and the private banking and wealth management businesses. The mortgage business has presented challenges over the last several quarters and will continue to, as we’ve said, through 2008 but those challenges will begin to abate and in the long-run success of National City will turn on those core businesses.
In the near term, we think the most valuable thing we can do for our shareholders is, as I said, to pursue the dual objectives of minimizing losses in the liquidating portfolios and focusing very hard on terrific execution in our core businesses.
Do you expect to be able to raise your dividend back to its pre-cut level in the next 12 to 18 months?
Peter E. Raskind
I think it is unlikely that we would raise the dividend back to its pre-cut level in the next 12 to 18 months. We will look forward to a time when we can begin to raise the dividend again and that will depend of course entirely on our earnings levels and momentum. But I think it is highly unlikely that we would increase the dividend back to its pre-cut levels in that short a time.
Peter, another question for you. With respect to credit problems, prudent lending standards were thrown to the wind in order to generate loan volume. What actions have been taken and what assurances can you give us that this will not occur again at National City?
Peter E. Raskind
Well first off, I’m not sure I completely agree with the premise of the question. I don’t know that prudent lending standards were, as the questioner said, completely thrown to the wind. For example, in the old First Franklin business which we’ve sold, we never, for example, engaged in stated income lending in the sub-prime segment as some competitors did.
That said, and as was described earlier we did have some loans that were originated for sale, originated to capital market standards, for which we found there was no buyer and had to take into portfolio. That’s a decision we wish we could take back.
So I think going forward one of our watchwords will be that as we originate loans, whether they be for portfolio or for sale, we will be quite careful that if a series of circumstances arises that requires us to take the loans into portfolio that we will be comfortable doing so.
Another question for you. What actions are being taken to hold appropriate individuals responsible for decisions made with regard to the mortgage banking business? Are executive salaries being frozen or reduced commensurate with the bank’s recent performance?
Peter E. Raskind
Well, a couple of comments on that. As we’ve described and as I said at the beginning of my remarks, I do think that our poor performance this year has something to do certainly with a very difficult environment and certainly something to do with decisions we made in the past, probably a combination of the two.
That said, we have had very significant management changes in our mortgage business largely related to the restructuring and scaling down of that business. But it is fair to say that the management team in place in our mortgage business is, in many respects, quite different than had been the case in the past.
Secondly, to the second portion of the question, I think it is fair to say that every senior executive’s compensation this year at National City will be impacted by our poor performance over the course of this year. The higher the level in the company the greater that impact will be, and in particular for myself and for Jeff Kelly, Vice Chairman and CFO. Our bonus compensation for this year will be zero, which is perfectly appropriate given our poor performance this year.
Peter, a question with regard to Visa. Can you tell us how Visa’s IPO will benefit National City specifically as it pertains to capital levels?
Peter E. Raskind
Just to review, based on our historical card issuance activity as well as our ownership of national processing in the past, we own an unusually and actually disproportionately large share in the newly restructured Visa, somewhere between 4.5% and 5% of the new worldwide company. As Visa has announced it intends to go public -- I think it is scheduled in the first quarter of this year, although there is no guarantee or assurance of course that they will do so.
Presuming that they do, National City will benefit in a few different ways. First of all, there will be proceeds from the IPO that will accrue to us proportionately based on our significant ownership in the company. Our proceeds the day of the IPO will not be the full value of our ownership in the company, but only the portion of those shares that are sold out to the public and even then reduced by some funds that will be held back in escrow for settlement or resolution of litigation pending against Visa. We do expect those proceeds to be relatively significant.
Further, as was described earlier in Jeff’s comments, we do expect also to be able to reverse a substantial portion of the charges that we’ve taken here in 2007 for our share of Visa litigation-related matters.
I do want to point out though that our capital plan as we have described it and crafted it is not dependent on a Visa IPO, nor should it be. A capital plan should never be dependent on an event that is just simply not within our control. So we view a Visa transaction as absolutely additive to our capital base, but not required for us to achieve the capital ratios that we have said we would like to achieve.
I’ll direct this question to Dan Frate, Executive Vice President of Retail Banking. Dan, can you please comment on the growth seen in your retail banking business?
Sure, Jill, thanks. A couple of key indicators. Peter touched on one of them in his opening remarks. Our key growth indicators for the business include and continue to include household growth as well as household expansion. Both of those numbers for 2007 we were quite pleased with. As Peter had mentioned, our household growth was near 2%. That’s a significant increase over the prior-year household growth number.
But more importantly, I would say our household expansion number was extremely strong at 6.7%, and that is the number of products and services that our customers have with the bank that improved year over year, as I said, by 6.7%. It was the best performance that we have ever recorded as a retail bank so we’re quite pleased with that.
Peter also talked about the deposit balance growth. Organically that number quarter over quarter is about 8.5%. Good strong number on that front. Finally, if you looked at organic revenue growth quarter over quarter it is near double-digits at 10%. So we’re quite pleased with the retail banking growth numbers for 2007.
Thank you, Dan. I’ll direct this question to Jeff. Jeff, will the company be repurchasing its own shares? If so, how many overall?
Jeffrey D. Kelly
Thanks, Jill. At this time and I think consistent with the capital plans that we have outlined to move our capital ratios to the top of their ranges, and the challenge of doing that, we don’t currently have any plans to repurchase shares.
Jeff, another question for you. Can you provide any additional detail on the targeted size and structure of your first quarter ‘08 capital raise?
Peter E. Raskind
I think what I would do, Jill, is just reiterate what we said in early January by saying that we’re actively evaluating several options here and we are focused on capital structures that qualify for tier 1 treatment and would, at the same time, not result in the issuance of new common shares.
Do you anticipate any goodwill impairment charges for Florida acquisitions?
Jeffrey D. Kelly
No, we do not.
How will the 75 basis point interest rate cut announced today affect your net interest margin and/or net interest income?
Jeffrey D. Kelly
Well, I would say that we would expect generally that it would improve both. It’s a little hard to determine the path with which that takes but I’d point to a couple of factors that would lead us to believe that. First, we continue to have a positive duration in the company, which is not a significant mismatch, but it is as large as it’s been in some time. We’d expect that that would play through, resulting in greater net interest income and a wider margin.
The other thing I would say in addition to that, which has been probably to this point a little difficult to see particularly in net interest income in the margin, is that a portion of our positive duration -- in fact a pretty significant portion of our positive duration -- is made up by a portfolio of about $13 billion in LIBOR-based interest floors that we own that have strikes between 3% and 4%.
Those floors have an average maturity of about 3.5 years, and clearly with the LIBOR forward curve anticipating rates in the mid 2% area, we would anticipate that these would generate some significant net interest income and would enhance the margin going forward.
As I said in my comments, our view is that the margin will stabilize this quarter and then begin to rise slightly as we go throughout the year in 2008.
Rob, net charge-offs appear to be accelerating, increasing 23 basis points from November. What part of 4Q07 net charge-offs is attributable to seasonal factors, year end clean up and what part reflects accelerating deterioration?
Robert C. Rowe
Well, a fair amount of the increase on a linked-quarter basis from the third quarter to the fourth quarter is reflective of general deterioration in the loan portfolios as we described in the upfront segment. I would add that there is some seasonality in our credit card business, and in past years, consistent with this year, we have had increased losses in the fourth quarter in the commercial loan book. I would not see that persisting into the first half of 2008.
How do you think about future provisioning needs? Are they based on current deterioration rates in your loan portfolio persisting, decelerating, accelerating? Realizing that the loan book is a very difficult asset class by asset class and loan by loan, but an overall sense of how you assess the risk would be helpful.
Robert C. Rowe
In general, the base assumption we would have, particularly for the consumer portfolios including the liquidating portfolios, would be that the levels of delinquency would be persisting. I would note, however, that in a couple of the portfolios, in particular the legacy First Franklin portfolio as well as the residential construction book at the National City Mortgage Company, it is possible that later in 2008 we could see delinquencies and losses start to decline for reasons that I outlined upfront in my earlier verbiage.
You had indicated interest in an MOE in the past. Are you still willing to do an MOE today at these bank valuations?
Peter E. Raskind
I think the prospect of an MOE and whatever benefits it might offer is something that we or perhaps any bank would consider for the long term. As I said earlier, I think the most important thing we can do for our shareholders in the near term is to focus on rebuilding profitability and valuation and that’s our intention.
Another question for you, Peter, with regard to expense saves. How far along in your expense reduction plans are you? How much more expense cuts are coming and do you anticipate a higher level of cost saves from your recent acquisitions given market conditions and slowdowns?
Peter E. Raskind
I think at this point while we will always be reviewing the company, of course, for efficiency opportunities we feel that today we’ve got the business model that we think makes sense for the long term. In that context we don’t see any significant restructuring activities on the near-term horizon.
As business conditions evolve and change, I suppose that could change, but we simply don’t see that for today. We worked very hard to as much as possible crisply address our cost structure during the latter part of 2007 and we believe we’ve done so.
With respect to the second part of the question, we’ve actually I think very successfully achieved the cost objectives we had for our recent acquisitions and it’s not evident to us that market conditions would have much impact on that.
Peter, a question for you with regard to the dividend. Cutting the dividend to raise only $500 million per year is a small amount relative to National City’s overall capital needs. It seems like a bad decision given the long-term alienation of National City’s investor base that it produces. Why should a long-term owner continue to hold the stock given this type of decisionmaking? Please comment.
Peter E. Raskind
Well, as I said earlier, the decision to cut the dividend was by no means an easy one, certainly not a decision we took lightly. However, $500 million of additional capital per year is actually not a small amount. $500 million of additional capital generation will have a material impact on our capital base depending on the level of assets, as much as 40 to 50 basis points progress toward the ranges that we articulated.
Just as important for the long run, we feel strongly that our dividend needs to be consistent with our near-term earning power so that we know that it is sustainable. We have talked in the past about a payout ratio of 40% to 45%. We still think that’s the right target payout ratio for us to pay a dividend and generate new capital to support growth.
We very much thought about that as well, as we set the new dividend rate. We would like to be thought of as a management team that will confront difficult decisions and do the responsible thing. In this instance, while again very difficult, we felt that cutting the dividend to generate new capital and have the dividend rate be consist with our earning power near term and therefore sustainable, was the responsible thing to do.
Thank you, Peter. I’ll address this question to Rob Crowl, Chief Operating Officer of National City Mortgage. Rob, what checks and balances does National City Mortgage have that the valuations completed by residential appraisers are reasonable? Is there an in-house residential appraisal department that reviews the residential properties in compliance with federal regulations, or is this outsourced? Do you have any plans, if the review function is handled outside the bank, to implement an in-house review function for the mortgage company?
Thanks, Jill. That’s a great question because assessing property values right now is obviously something that is stressed and more difficult than it’s been in the past. We do use a third party basically to contract appraisers in order to maintain some separation between the loan origination process and the appraising.
However, every appraisal once received is reviewed by our underwriting staff. We have a combination of processes in-house in order to basically underwrite that appraisal to make sure that it meets all sorts of conditions, be it regulatory or for risk purposes. We use several software packages in order to do that and we have an escalation process whereby the more difficult the property or the loan may be, we escalate that to more experienced underwriters and on up the chain there to include sign-off by managers.
We feel that we’ve got good processes in place. We do not currently have any plans to in-source that function right now.
Thomas A. Richlovsky
I am told that the question box is empty. We do appreciate everyone’s participating on the call this morning. We recognize that we published a lot of information and data that’s been put onto the website this morning and we certainly welcome any follow-up calls and questions on any of the information that we’ve spoken about today.
You can give myself or Jill a call to do that. We’ll close down now and I will ask the operator to give the closing instructions, please.
Thank you, ladies and gentlemen. This conference will be made available for replay after 1:00 pm ET today until January 29 at midnight. (Operator Instructions) You may now disconnect.
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