Fifth Third Bancorp Q3 2009 Earnings Call Transcript

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Fifth Third Bancorp (NASDAQ:FITB) Q3 2009 Earnings Call October 22, 2009 8:00 AM ET


Kevin Kabat - Chairman, President and Chief Executive Officer

Dan Poston - Chief Financial Officer

Mary Tuuk - Chief Risk Officer

Mahesh Sankaran - Treasurer

Jim Eglseder - Investor Relations


Paul Miller - Friedman, Billings, Ramsey & Co.

Brian Foran - Goldman Sachs

Betsy Graseck - Morgan Stanley

Matthew Burnell - Wells Fargo Security


Good morning, my name is Hamilton and I will be your conference operator today. At this time, I would like to welcome everyone to the Fifth Third Bancorp Third Quarter 2009 Earnings Call. (Operator Instructions). I will now turn the conference over to Mr. Jeff Richardson.

Jeff Richardson

Hello, and thanks for joining us this morning. We will be talking with you today about our third quarter 2009 results. This call may contain certain forward-looking statements about Fifth Third Bancorp pertaining to our financial condition, results of operations, plans and objectives. These statements involve certain risks and uncertainties.

There are a number of factors that could cause results to differ materially from the historical performance in these statements. We’ve identified a number of those factors in our forward-looking cautionary statement at the end of our earnings release and in other materials and we encourage you to review those factors.

Fifth Third undertakes no obligation and would not expect to update any such forward-looking statements after the date of this call. I am joined on the call by several people, Kevin Kabat, our Chairman, President and CEO, Chief Financial Officer, Dan Poston, Chief Risk Officer, Mary Tuuk, Treasurer, Mahesh Sankaran and Jim Eglseder of Investor Relations.

During the question and answer period, please provide your name and that of your firm to the operator. With that I will turn the call over to Kevin Kabat. Kevin?

Kevin Kabat

Thanks Jeff. Good morning everyone and thanks for joining us. Today I will make a few opening comments before I hand the call over to Mary and Dan for a more detailed discussion of our credit and financial performance. This morning we reported a third quarter net loss of $0.20 per share, which was in line with our expectations.

That included $0.26 of benefit related to our sale of Visa shares and the release of Visa litigation reserves. High levels of credit costs continue to more than offset solid core operating results. In addition to current levels of charge-offs, results also include $0.16 of provision in excess of net charge-offs and approximately $0.12 of credit related costs.

These include provision for un-funded commitments, loan workout costs and credit write downs within operating revenue and expense. Dan will provide more color on the scope of these costs and where the show up.

Commercial credit continues to be challenging, but we've seen some positive signs on the consumer front. I think it’s too early to predict a trend from that, but it’s encouraging. Early stage consumer delinquencies were down slightly this quarter, after also being down pretty significantly in the second quarter.

Consumer 90 plus delinquencies were also down, primarily in Florida, another positive sign. Commercial 90 plus delinquencies were up, but a good number of those are administrative. Customers whose loans are still current, but the notes have matured and we haven’t extended them.

We expect many of those to be resolved in the fourth quarter and these don’t change our views with respect to NPA or charge-offs in the fourth quarter, which is reflected in our outlook that Mary will discuss.

Early stage commercial delinquencies, 30 to 89 days pass due were down $200 million, which also suggest the pipeline for 90 plus growth next quarter will be lower. As a result we expect 90 plus commercial delinquencies to be down substantially in the fourth quarter.

I know that this is the first quarter in a year and a half that early stage delinquencies in both consumer and commercial portfolios were down sequentially. Net charge-offs were $756 million, an increase of $130 million from the second quarter, but a bit lower than we were expecting last month.

Commercial net charge-offs were up $158 million, that included the effect of 95 million of charge-offs on shared national credits versus $17 million last quarter. Commercial charge-offs were up $80 million otherwise driven by continued real estate and construction loses as we discussed last month.

Consumer loses improved $28 million sequentially as we expected. NPA growth was 13% in line with our expectations with commercial NPAs up 16 and consumer NPAs up five.

The provision for loan loses exceeded net charge-offs by a $196 million this quarter increasing the reserve to loan ratio to 4.69%. We continue to have one of the highest reserved to NPL covered ratios in the industry at 125%.

We continue to work aggressively to mitigate risk in our loan portfolio and as a result we are experiencing elevated cost as we work through those credits and deal with them appropriately. Mary will talk about our outlook for the fourth quarter in her remarks.

Let me give some high level operating results. We continue to good momentum in most of our businesses in a challenging environment. We saw significant improvement in the net interest margin, up 17 basis points from the second quarter.

Improved liability pricing and wider loans spreads to over 5% sequential increase in net interest income. NII growth was otherwise subdued to extremely weak loan demand. That sequential decline in loan balance was due to lower line utilization.

Excluding the effects of the processing deal, visa and other unusual items outlined in the release, core fee income results remained solid. They were down sequentially due to the $41 million in MSR hedge gains last quarter and higher write-downs this quarter on OREO and loans held for sale. Otherwise fees were up $4 million in a seasonally weak quarter.

Transaction deposits were up 3% from last quarter and the mix continues to shift from higher cost CDs to lower cost accounts. Strong liquidity and lower assets led to further reduction in the levels of wholesale funding by about $5.3 billion in the third quarter.

Core deposits were up 2% sequentially and a strong 11% from a year ago, which is very solid organic growth without acquisitions. Our focus on customer satisfaction and building positive relationships continued to bear fruit with retail account openings up 4% and commercial openings up 2% on a sequential basis.

We have introduced new products like our secure and gold checking and safe saver accounts increasing the value proposition of checking accounts that come bundled with fee based benefits. This is consistent with our continued focus on customer loyalty and we expect to continue to roll out additional value added products over the next 12 months.

We also continue to make progress with alternative delivery methods and our mobile banking platform was recently rated as one of the four best banks out of 29 reviewed by ABI Research.

The mortgage business continues to be strong with $140 in net revenue, which was better than we were expecting. We have seen more of our volume coming from purchase activity rather than refinancing during the quarter and some of that is clearly driven by the pending expiration of the first time homebuyer tax credit program.

Further, nearly 90% of purchased mortgages from the retail channel opened a new checking account if they didn’t already have an existing account with us. So were taking share in mortgage and that is also helping us take share in deposits.

Finally, core expenses were up $37 million or about 4% from the second quarter driven by higher credit related operating expenses as I just mentioned. Those were up 54 million primarily in provision for un-funded commitments. We remain focused on carefully managing cost or devoting the appropriate resource to managing credit issues and funding key strategic initiatives.

To give you a little more color on the environment, our customers remained very cautious but more so in the commercial space, which you can see in our loan balances. Utilization is down significantly and at the lowest level we can remember seeing at Fifth Third.

While the commentary we are hearing from the companies is somewhat more optimistic, customers are still being careful and we haven’t seen much in the way of increased capital investment or working capital needs.

The credit environment remains difficult although the improvement we saw in the consumer portfolio during the third quarter was encouraging. The main challenge currently is commercial construction and real estate. This is not a new development. I think we are just in the heart of that part of the cycle.

The loss content embedded in many of these credits is significantly lower than we experience in the commercial construction book over the past year particularly in Florida and Michigan and we have tried to be aggressive from a portfolio management standpoint.

So while we would anticipate seeing continued NPA growth on this front, we wouldn’t expect that to translate into significantly higher commercial real estate charge-off levels from what we are experiencing currently.

I continue to be encouraged by the progress that our special assets group is making in dealing with troubled relationships. Our recoveries on commercial credits totaled $25 million during the quarter or nearly 5% of gross commercial charge offs versus a 1 to 3% level over the past year.

Those recoveries should improve over time as we progress through the cycle and we see some of the losses we recognized earlier fail to materialize.

Sluggish activity on the loan front means that we are not seeing balance sheet growth right now, that’s helping the margin as we run off higher cost CDs and pay down wholesale borrowings and our liquidity remains exceptionally strong.

We are continuing to take share. As an example, the FDIC just released their deposit market data for June of 2009. We grew deposits in virtually in every one of our 16 affiliate markets and gained share in most of them.

There's a lot of noise with headquarters deposits and acquisitions in that report. As you know, I think those results will look even better after we’ve scrubbed them further. Our mortgage originations are clearly demonstrating growth above what the market is seeing and while commercial loan demand is weak, we believe we are taking share there as well from weakened competitors and community banks.

Our capital levels are strong and definitely above SCAP and regulatory requirements. Pre-provision earnings are on track with the SCAP and credit losses continue to be well below those assumed in the SCAP assessment. Our current outlook for total 2009 charge-offs is about $1.5 billion lower than incorporated into the SCAP assessment.

We will give guidance for the next quarter, for 2010, but we currently see nothing on the horizon that would come close to the SCAP loss assumptions. So we feel like we are in very good shape there. I expect next quarter to be similar to this quarter from an operating standpoint and we do expect credit costs to come down.

We’ve got plenty of capital and liquidity to pick up and loan demand when that happens and we have substantial leverage to lower credit costs in the provision and also on our operating revenue and expenses when we move out of the cycle.

With that let me turn it over to Mary who will discuss credit results in more detail. Mary?

Mary Tuuk

Thanks Kevin. I will start with charge-offs. Total net charge-off of $756 million increased $130 million sequentially. On a sequential basis, consumer net charge-offs were down $28 million while commercial net charge-offs increased $158 million.

$78 million of that sequential growth in commercial was attributable to credits reviewed during the shared national credit exam.

Commercial net charge-offs in the portfolio totaled $500 million or 417 basis points, up from $342 million or 281 basis points in the second quarter. During the third quarter we realized $95 million of losses from Shared National Credit, $60 million in the C&I category and $35 million in commercial construction.

Looking at charge-offs by product. C&I losses totaled $256 million with continued pressure from construction and real estate. $43 million of the $79 million sequential quarter increase came from the SNC portfolio.

Commercial construction net charge-offs were $126 million, with Michigan and Florida generating 50% of losses. Commercial mortgage losses of $118 million increased $33 million increased $33 million from the second quarter, with Michigan and Florida contributing 55% of losses.

Across the portfolio homebuilder developer losses were $108 million of total losses. You will recall that we suspended home builder origination two years ago, have already recognized significant charge-offs in that portfolio and work to reduce our exposure. Portfolio balances are $1.8 billion, down 45% from $3.3 billion a year ago. We would expect losses there to come down going forward given the work we've done in that portfolio.

Looking ahead to the fourth quarter, we expect overall commercial net charge-offs to be lower in the fourth quarter. We generally expect commercial mortgage and construction losses to remain elevated, but C&I losses to be meaningfully lower. The high level of SNC losses in the third quarter would be a contributing factor the expected decline in C&I losses.

Turning to the consumer portfolio. Consumer net charge-offs decreased to $28 million during quarter totaling $256 million. Improvement was broad based. Net charge-offs in the residential mortgage portfolio were $92 million, a decrease of $20 million from the second quarter.

Michigan and Florida accounted for 77% of loses from 43% of the total mortgage portfolio. Home equity loses declined 8% sequentially to $80 million including $30 million of loses in the brokerage portfolio.

The net charge-off rate on brokerage home equity was 6% annualized down from 7.5% last quarter. That's about 3 times the loss rate on our branch-originated book. Debt brokerage portfolio was down to $2 billion of outstanding balances from about $3.5 billion a couple of years ago and continues to run off.

Auto loan net charge-offs were down $2 million sequentially reflecting higher values received at auction. In credit card loses, we are flat compared with the second quarter.

Right now we would expect fourth quarter consumer charge-offs to be generally consistent with third quarter levels. Perhaps slight higher given seasonality in consumer bankruptcy trend, but to remain well below second quarter levels.

Now moving to NPAs. NPAs including held for sale totaled $3.5 billion at quarter end. Excluding $288 million of NPAs in our held for sale portfolio where the loans have already been fully marked, NPAs totaled $3.2 billion or 409 basis points of total loans.

Florida and Michigan remained the most troubled geographies and account for 45% of NPAs in the portfolio. Commercial NPAs in the loan portfolio increased by $350 million or 16% from the second quarter with Florida generating $174 million of growth and Michigan contributing $72 million.

Inflows this quarter were split between C&I and commercial real estate with a significant portion of the C&I increase coming from shared national credit.

Commercial construction NPAs increased $16 million, the lowest growth rate we have seen in some time. Florida contributed $41 million or more than the total increase with most other markets down modestly. Commercial construction NPAs were down in 14 of our 16 affiliates.

Commercial mortgage NPAs were up $178 million with Florida and Michigan accounting for $104 million of the increase. C&I NPAs were up $156 million from the second quarter. Most of that growth came from SNC credits.

Across the portfolios, residential builder and developer NPAs of $601 million or 23% of total commercial NPAs were down $12 million sequentially. That’s a good sign given the level of problems we have experienced in that portfolio.

We would expect growth in commercial NPAs in the fourth quarter to be generally consistent with the mid teens growth rate we experienced in the third quarter.

Moving to consumer NPA trends. Consumer NPAs in the portfolio totaled $660 million at the end of the quarter, a $32 million or 5% sequential increase from the second quarter. Non-accrual TDRs were up $38 million with other consumer NPAs down $5 million from last quarter due in part to OREO dispositions.

Residential mortgage NPAs increased $9 million during the quarter to $484 million. Home equity NPAs totaled $72 million at the end of the third quarter down $1 million from second quarter level. Auto NPAs were up slightly and credit card NPAs were up $21 million driven by restructuring.

In terms of overall TDR activity, we've modified about $2.1 billion of loans since the third quarter of 2007 of which $225 million were carried in NPAs at September 30th. A little over a quarter of the loans we’ve restructured to-date have re-defaulted.

On a lagged basis, re-default rates are higher as you would expect coming in at just under 40% of modified loans. We believe that that experience is generally in line with the industry. As this portfolio matures we would expect TDR defaults to continue to increase due to seasoning.

Overall, we continue to be pleased with the results of our loss mitigation effort. With respect to the outlook for consumer NPAs in the fourth quarter, we'd expect growth to be generally consistent with a mid-single digit growth rate experienced in the third quarter.

One comment on carrying values, total portfolio NPAs, commercial and consumer are being carried at approximately 61% of their original face value, through the process of taking charge offs, purchase accounting mark and specific reserves recorded through the third quarter.

We think that this is a good indication of our efforts to be conservative in writing problem loans down to realizable values.

Moving to delinquency trends, as we discussed last quarter, consumer delinquency trends overall have continued to moderate. Loans made in 2005 are seasoning and home equity underwriting changes and the run off of mortgages due to 95% fallibility strategy are having a bigger impact on the performance of the portfolio

Consumer delinquencies in the 30 to 89 days past due category were down slightly on a sequential basis after last quarter’s more significant decline.

It's difficult to determine if this is a trend given seasonality by continued good news on that front. In the 90 days past due category consumer delinquencies declined $43 million with Florida accounting for almost all of the sequential decrease.

On the commercial side, commercial loans, 30 to 89 days past due declined by $200 million, while commercial 90 days past due were up $274 million compared with the second quarter.

About a third of commercial loans in this category were simply past maturity as opposed to being 90 days delinquent on their payment. A significant number of the past dues have already been in draft and will be worked through during the fourth quarter.

One of the drivers here is the movement of loans into our special asset group, which we completed in the second quarter. (Inaudible) officers are focused on resolving credits and not extending maturities can often be part of the negotiation process if they are reworked.

We've reviewed these credits thoroughly and they are incorporated into our fourth quarter outlook for charge-offs and NPA growth and the reduction in the early-stage commercial delinquencies will also benefit fourth quarter 90-plus delinquencies.

A couple of comments on provision expense and the allowance: Provision expense for the quarter was $952 million and exceeded net charge-offs by $196 million. This increased the allowance to $3.7 billion compared with $3.5 billion last quarter.

Our allowance coverage remains strong covering non-performing loans by 125% and charge-offs by 122%. Our expectation would be that the reserve will continue to build but for that build to be lower than in pervious quarters as loss levels stabilize and the growth and problem credits begins to slow.

Let me spend a moment on a couple of other topics. First an update on the non-performing loans we've moved to held for sale status. Those balances were originally $473 million in the fourth quarter and they're down to $288 million at the end of the third quarter.

During the quarter we received payments of $11 million and wrote down principal balances of retained loans by $28 million. We also sold, settled or closed $26 million of these NPAs during the quarter and realized about $5 million of gains on these sales and transferred $15 million to OREO.

Since we moved these loans, our realization of gains and write-downs have largely offset and these values overall are consistent with our original mark. We currently carry the remaining loans in this pool at $0.36 on the dollar of their original contractual balances.

A couple of comments on commercial real estate, which is a prevailing theme in industry discussions right now. The more recent focus is on income producing real estate. Given our presence in Michigan and Florida, two markets that felt these developments early, these are not new issues for us.

Commercial real estate loans are about $16 billion or about 20% of our loan portfolio. That would be on the low side of large regional. Of that $16 billion, $12 billion is in commercial mortgage and $4 billion is in commercial construction.

Obviously the construction portfolio has been under the most stress and we've provided a lot of information on trends in that portfolio over the past couple of years.

The home builder portfolio was the first set of exposures to come under pressure, because those are development activities when they fail there isn't cash flow to support a restructuring of the loan or reestablishment of value based on cash flow. As you would expect loss severities have been high there.

In response to these trends we took a number of actions over the last several years. We suspended homebuilder lending in 2007 and also suspended non-owner occupied commercial real estate lending in early 2008.

Excluding homebuilder the remaining non-owner occupied portfolios is about $8 billion and that portfolio was down over a billion dollars from a year ago as well. Non-owner occupied properties have also been under a good deal of pressure for some time.

We've established two work out areas that are set specifically to address the unique issues dealing with construction and non-owner occupied loan. We thoroughly review all of our watch in credit size loans each quarter as well as our past loans in these verticals.

As a result we review almost all of our total non-owner occupied loan portfolio each quarter. Those reviews assess impairment, credit rating, collateral and cash flow and are used to formulate specific action plans to address the risk of each borrower in the portfolio.

We are looking for problems in those reviews. We want to jump on them and resolve them. When we identify problems we aggressively take steps with our borrowers to determine the best course of action from mitigating loss to the bank.

In some cases it maybe obtaining additional collateral or working with guarantors to support the property. In other cases it's an active workout plan that may include marketing the loan or property for sale.

Given low absorption rates and reduced property values, we do expect commercial mortgaging construction losses to remain elevated in our portfolio and in the industry, but we don't believe real estate losses will trend much higher going forward than current level.

The vast majority of these loans are income producing, that income is available to either support our current loan position or support a reworked loan or to support a sale of the property at a lower price.

The income element, a critical factor in mitigating our loss exposure and reducing severities relative to what we experience in the real estate development phase of the cycle.

It will take time to work through all of the issues in the space as the economy recovers and we think certain parts of our footprint will being to recover before others. We’ve seen these trends for quite a while and the Florida market in particular remains difficult.

In contrast, the Michigan market has seen less deterioration recently and coupled with our aggressive action over the last four quarters, we don’t currently expect trends to worsen there.

You can expect us to continue to actively speak to identify problems and to mitigate or protecting its losses though improved structures where that’s appropriate or to minimize our long-term losses through an aggressive resolution where its not.

With that, I will turn it over to Dan.

Dan Poston

Let me start at the bottom of the income statement. We reported a net loss of $97 million for the quarter, which was a $159 million on an available common shareholders basis or $0.20 per share.

We paid $62 million of preferred dividends during the quarter, which should be indicative of level of dividends going forward.

One caveat would be that we would need to assume conversion of the remaining convertible preferred shares in our EPS calculations when that is more dilutive. As we've said in the past, this would apply when our quarterly earnings are about $200 million or more.

Operating results were solid but were burdened by continued elevated credit costs which were experienced through charge offs, provision above charge offs to build the reserve and credit cost realized fee income and operating expense.

Those costs are all totaled were a little over $1 billion both this quarter and last. A majority of that cost is obviously in the provision for loan losses.

But we also recorded $145 million in our revenue and expense lines this quarter versus about $55 million in both last quarter and in the year-ago quarter. Both provision for un-funding commitments and credit related operating losses were unusually high this quarter and I will talk about those in more detail where they occur.

As you would recall, we announced the sale of our Visa Class-B shares in July. And during the quarter we recognized a pre-tax benefit of $288 million from that transaction. That benefit was split between fee income and expenses.

In fee income, we recognize $244 million gain in other non-interest income. That gain reflects the value of the shares offset by the recognition of a total return swap that transferred the shares conversion ratio risk back to Fifth Third.

In expense, we’ve reversed $44 million in Visa litigation reserves as a result of this transaction. Independent of that transaction we also released an additional $29 million in litigation reserves due to Visa’s incremental funding of it's litigation Escrow account.

So to recap Visa, we recognized pre-tax benefits in the quarter of $317 million or $0.26 per share, of which $244 million were in fees and $73 million were in expenses as an offset.

With that context, lets go through the balance sheet in little more detail. Average earning assets were down about 2% compared with last quarter. The primary driver of the decline was weak loan demand, which Kevin touched on earlier.

Average loan sale for investment were down 2% sequentially and 5% on a year-over-year basis. Mortgage demand remained strong during the quarter and we originated $4.4 billion of mortgages.

That compares with $6.9 billion in the second quarter and $4.9 billion in the first quarter and was a little better than we anticipated. This favorable variance can be partially attributed to stronger new purchase activity than we saw in the first or second quarters of this year, which was assisted by the pending exploration of the first time homebuyer’s tax credit.

Now to give a little more detail by product types: Average commercial loans decreased 2% sequentially and 7% on a year-over-year basis. Line utilization was down $1.5 billion sequentially and net charge-offs reduced average balances by about $300 million.

Average commercial loans were actually up slightly otherwise. The market for variable demand notes also improved late in the quarter, which resulted in a $400 million sequential decrease in end of period commercial loans. Average consumer loans were down 1% sequentially and 3% on a year-over-year basis.

Auto loan balances increased 2% sequentially and 7% compared with the third quarter of 2008. That increase was partially attributable to the government’s cash for clunkers program, although demand and performance in this portfolio remains favorable.

Credit card balances were up 5% on a sequential basis and 14% year-over-year. This remains a relationship product for us and overall it’s a small portfolio.

Residential mortgages were down 4% sequentially and 14% from a year ago, reflecting our 95% sales target for production. Flow sales during the quarter were $5.4 billion. Home equity loans were down 1% sequentially and year-over-year. We expect little growth in this product in the near to intermediary term due to CLTV guidelines.

Moving onto deposits, we had continued strong momentum in deposits this quarter with the significant positive shift in mixed with lower cost deposits. Average core deposit growth was 2% sequentially and 11% on a year-over-year basis.

Transaction accounts showed the strongest growth with DDA balances up 2% sequentially and 20% year-over-year. Given the lower rate environment, customers continue to value liquidity and we expect that trend will continue.

Retail core deposits were flat sequentially and increased 10% on a year-over-year basis. Average retail balances per account were down about 2%. Total commercial deposits were up 8% sequentially and 12% from a year ago.

Commercial DDAs increased 7% from the second quarter and 40% year-over year while commercial interest checking increased 5% sequentially and 34% from last year. Deposit competition remains far more rational today than it was a year ago.

Our strong growth in net interest margin has been partially attributable to high rate CDs rolling off which is the trend that we see continuing in the fourth quarter. Our liquidity remains exceptionally strong.

Wholesale funding levels were down $5.3 billion sequentially or 19% and we paid down $16 billion in wholesale funding from a year ago. Just to give an update on FTPS the de-conversion process continues and we were very pleased with the progress so far on that front.

Retained card and processing fee income was a bit stronger than we initially expected coming in at $74 million for the quarter. Card and processing expense of $25 million includes $10 million of retained expense as well as $15 million charge from FTPS related to its provision of processing services to the bank.

These costs were previously embedded within non-interest expense in a variety of categories including payments processing expense. Going forward, the numbers we reported this quarter for processing fees and expenses should be reasonable starting points for run rates.

We also had $38 million of revenue from FTTS transition services agreements, the TSA, which covered costs of a similar amount incurred by Fifth Third in providing services to the processing JV.

We would expect TSA revenue to remain at about this level for the fourth quarter and then start to trend downward after that. We've reduced the gain on the transaction by $6 million in the third quarter as a result of refining estimates related to the deal, which appears in the separate line item on the income statement.

And finally we recognized equity method income of $7 million related to our 49% interest in the joint venture through the other income line item. That’s better than were expecting largely reflecting a lower rate of intangible amortization than had originally been estimated.

Moving on now to the income statement and starting with net interest income, net interest income increased $38 million sequentially to $874 million. That was driven primarily by deposit reprising partially offset by lower loan balances. NII will probably be relatively flat in the fourth quarter with continued favorable deposit reprising trends offset by lower average balances.

Net interest margin increased 17 basis points as expected, to 3.43% during the quarter based on wire deposit and loan spreads. We currently expect margin to expand about 10 basis points in the fourth quarter driven by continued liability reprising.

Moving on to fees. Third quarter non-interest income of $851 million included the $244 million gain from the Visa transaction as well as $8 million of securities gains.

Second quarter results included the $1.8 billion gain from the completion of the processing business sale and $5 million of securities gains. Second quarter results also included merchant and EFT revenue of $169 million that’s been divested. Excluding the items I just mentioned, non-interest income declined $46 million or 7% from the previous quarter.

The drivers of that decline were the $41 million in gains on MSR hedges that we realized in the second quarter as well as the net write-downs on loans held for sale and OREO which totaled $45 million this quarter, versus $9 million last quarter. These were partially offset by the $38 million of TSA revenue we realized this quarter.

The Visa gain and the FTPS income and the write-downs I just mentioned, all appear in the other income line within non-interest income.

Looking at year-over-year results, fee income was up 5% on the same basis, excluding also the unusual items experienced in the third quarter of 2008, which are outlined in the release. This increase was driven primarily by stronger mortgage results and by the TSA revenue.

Corporate banking revenue of $86 million was down $13 million or 13% sequentially and down 18% compared with third quarter of 2008. This line of item has been impacted by the weakness in new commercial loan demand and ApEx fees are also down about $5 million.

We expect seasonal growth in corporate banking revenue in the fourth quarter. Deposit service charges were up 1% from the second quarter, but down 4% from a year-ago. Commercial and consumer fees were both up modestly on a sequential basis.

We continue to position our checking account offerings for changes in the regulatory environment. As a result we expect deposit fee income to be relatively flat in the fourth quarter, which would typically show some seasonal strength.

Investment advisory revenue increased 1% sequentially and declined 18% on a year-over-year basis. While the market rally has helped, we still see a lot of assets parked in low fee money market funds as opposed to managed products, which negatively impacts year-over-year comparisons of asset management revenue.

IA revenue should increase again in the fourth quarter due to the higher market values as well as seasonality and brokerage.

As mentioned earlier mortgage origination volume remained strong during the quarter at $4.4 billion. Net mortgage revenue of $140 million was down $7 million from last quarter, while income from non-qualifying hedges of MSRs fell $41 million sequentially.

We continue to capture greater market share and purchase originations increased to 37% of volume in the third quarter, compared with 19% last quarter. Right now we’d expect mortgage-banking revenue including the MSR hedge income to be around $100 million in the fourth quarter.

Obviously that could move significantly depending on the behavior of interest rates and weather the government extends or expands the tax credits for first time homebuyers.

Fee income was $607 million this quarter excluding the Visa gain. That was in line with our expectations, although mortgage results were stronger and write-downs on OREO and loan sell for sale were higher than we had originally forecast.

We would expect total non-interest income to be about $600 million in the fourth quarter as well. That would reflect lower mortgage banking revenue, currently expected to be down about $40 million, offset by lower loan and OREO write downs and the growth in other fee categories that I just discussed.

Turning to expenses: Non-interest expense of $876 billion was down a $145 million sequentially and $91 million from the prior year. Third quarter results included a net $73 million reduction in expense related to the Visa transaction. Excluding Visa, expenses were $948 million in the third quarter.

Second quarter non-interest expenses were little over $1 billion or about $900 million excluding the $55 million FDICs special assessment and the divested payment processing expense.

Excluding all of those effects expenses were up about $50 million from the second quarter, somewhat higher than we were initially expecting. That's primarily due to a higher provision for unfunded commitments, which was $45 million this quarter compared with $8 million last quarter.

Total credit related cost within operating expenses including the provision for unfunded were $100 million, up $54 million for the quarter and up $55 million from a year ago.

Other components of credit related expenses including credit related valuation adjustments on customer derivatives of $21 million, compared to $2 million in the second quarter, OREO expenses of $6 million up from $4 million last quarter and other workout related costs of $29 million which was consistent with the second quarter.

We don't expect these expenses at the same level in the fourth quarter, but they are contributing factor to abnormally higher levels of expenses right now. For a more normalized context that $100 million of credit related expenses this quarter was about $25 million in early 2008.

Looking at the fourth quarter total non-interest expenses should come down from that quarter level of $948 million of expenses I just mentioned excluding Visa. That would be driven by lower credit related costs offset to some extent by seasonal growth in other expense categories. Now moving on to capital.

Our quarter-end capital ratios were strong. Tier-1 common equity was 7%, tier-1 capital was 13.2% and tangible common equity was about 6.8% of tangible assets. We feel very good about these levels as we move forward. And I think with that, I will open it up for questions.

Question-and-Answer Session


(Operator Instructions). And our first question will come from Paul Miller - Friedman, Billings, Ramsey & Co.

Paul Miller - Friedman, Billings, Ramsey & Co.

Can you address a little bit about the de-leveraging on your balance sheet, especially with respect to loans? Is that mainly coming out of your middle market and small business operations?

And are you seeing any loan demand at that level or you continue to see people strengthen their balance sheets in this roll-down inventory, and when do you think that will reverse itself and actually we look at going forward with the size of your balance sheet?

Dan Poston

Well, I think, as you have pointed out, loan demand remains weak and I think that’s especially true in the commercial space and I think it's pretty much across all categories of loans, certainly middle market and small business will be included in that.

We expect that weakness to continue at least in the immediate term relative to the overall positioning in the balance sheet. I think as a result of that, we will consider expanding the securities portfolio somewhat.

But clearly we would do that, with the lessons of the past clearly in mind with respect to the interest rate risk that, that might build and clearly we would take actions in connection with that to protect ourselves from any interest rate risk that we would take on there.

So relative to the future, I think the demand in commercial lending I think will be dependent on economic recovery. Clearly we've seen some signs from a GDP basis that economic growth is beginning to return and we’re optimistic that in the near future we will begin to see a slowing of the weak loan demand and begin to see growth on a going forward basis.

Paul Miller - Friedman, Billings, Ramsey & Co.

Is there any regions that has probably seen more de-leveraging loans relative to other regions like the -- the better part of the country down to Florida? Is it that Florida and Georgia where you’ve seen most of the loan contraction?

Kevin Kabat

Yeah Paul. This is Kevin. Most of the concentration, if you had to look at it, would come out of our Florida and Michigan markets. The rest would be modest in terms of its decline in demand. The other thing that I think is quite telling that we alluded to in terms of the script was line utilizations are down very, very low, the lowest that I can recall in my career.

So demand simply isn't there. People are being extremely cautious yet and I do think it will be tied as you might expect to confidence that comes back in terms of the economy. So we’re watching all those trends from that perspective and I think when that begins to turn we’ll see that first probably in some of the line utilization commitments already made in essence and then people beginning to think about investing more back into the business instead of taking it down and being more conservative.


Next question comes from the line Quan Mai of Goldman Sachs

Brian Foran - Goldman Sachs

This is Brian Foran. The on the different line item guidance you gave as well as kind of the comment on normal run rates versus some of the noise still with credit in FTPS set up, I mean can you just cut through as we put it all together.

It seems like you are saying the core pre-provision run rate of the franchise is somewhere in the $625 million range. Is that kind of the message or it's just a lot of math or?

Kevin Kabat

Clearly there was a challenge to sort through all of the impacts of FTPS on our PPNR run rates and that's why last quarter we gave a fair amount of guidance to help guide you through what we anticipated those impacts would be and largely I think that guidance was proven out in the third quarter.

In the second quarter we talked about pro-forma PPNR being about 640 for the second quarter, that wasn't our expectations necessarily going forward. That was a prof-orma number with respect to the second quarter and we gave some guidance around trends that we expected and results that we expected on an overall basis.

If you look at PPNR changes from second quarter to third, you see a couple of things, one mortgage income was down about $15 million, that was a little less than we had expected in terms of the decline in mortgage, but that did decreased PPNR quarter-to-quarter by $50 million.

And then on the credit side we saw a couple of things, credit related expenses increased about $56 million, the line share of that being in provision for unfunded commitments and from a fee income perspective, we had an increase in offsets to fee income of about $36 million related to evaluation adjustments and gains and losses, related to loans held for sale as well as OREO.

So between those two items, credit related items, we had a $92 million increase in PPNR, quarter-to-quarter. And then there were about $30 million in other improvements, throughout the other income and other expense line items to get to the 530 or so in PPNR for this quarter.

In terms our outlook going forward, certainly, there is potential for considerable improvement given the credit related items that I just talked about. Those were about $100 million higher or $90 million higher this quarter than they were last quarter or a year ago.

So as we return to a more normalized credit environment, clearly the decline in credit related items that are included in PPNR rather than in the provision would certainly get you to a more normalized PPNR number in excess of $600 million.

Brian Foran - Goldman Sachs

Can I follow up with one question on credit, if I just kind of compared the numbers this quarter, the final numbers versus what you pre-announced or guided to a month ago, it seems like NPA’s and charge-offs a little bit better, maybe the early delinquencies better than 90-plus whereas the reserves kind of maybe a little higher than people are expecting.

If you kind of mix it all together and think about how you feel about credit now, mid October versus how you felt in mid September, is the message that you feel a little bit better on credit or about the same or a little bit worse?

Dan Poston

How fine a point do you want me to put on that Brian? I think the questions and the point that you raised are the ones that we tried to highlight relative to where we were. We’re again, trying to be as transparent as possible in terms of what we see and what we’re dealing with from that perspective.

That’s why we came out when we came out with the information and still feel that way today. I guess the only thing I'd add to your perspective on the issues that you raised was that it’s still mixed messages and still mixed things that we see out there.

We know what we have to do. We know our books really well and we’re attacking them aggressively from that perspective. So that would be kind of our orientation of where we stand today.


And next we have Betsy Graseck - Morgan Stanley.

Betsy Graseck - Morgan Stanley

Two questions, one on credit and one on, just a profitability question. On credit could you just help me understand what kind of industries they were that drove the increase in the C&I? I realize that Florida and Michigan were the vast majority of the increase in C&I. What were the standout industries?

Mary Tuuk

Betsy there is really no particular standout industries that I would point out. Clearly in the third quarter there was some influence coming from the SNC review that was completed. But in terms of any particular industry trends it was really a fair amount of diversification.

You'll always have a couple of credits in there that might be larger credits that sometimes can skew any kind of a potential industry trend that you would see So from a C&I perspective there is really nothing I would point out. Clearly from a real estate perspective we have been transparent on what that trend continues to be and as we have said we continue to expect that the elevation there of credit issues will remain in place.

Betsy Graseck - Morgan Stanley

But the SNC review, did it call out more with regard to commercial real estate versus housing versus manufacturing or was it just, if I look the SNC review that was a reflection of what happened in your portfolio.

Mary Tuuk

The SNC review at least from our perspective had a larger weight towards the C&I portion of the portfolio.

Betsy Graseck - Morgan Stanley

And housing wasn't a big piece of that? Because sometimes you find housing embedded within C&I.

Mary Tuuk


Betsy Graseck - Morgan Stanley

No, okay. And just on the look forward, when we're thinking about the pre-provision as we were just discussing, obviously you should get some list as credit improves given that's embedded within the top line and in the expense base.

How should I think about what you are anticipating if you can drive your overall ROA to overtime if I factor in a little bit more efficient balance sheets plus the (inaudible) plus, where your think your credits could end up going?

Kevin Kabat

Yeah, on an overall basis obviously, difficult to predict at this particular point in time, a lot of moving pieces at this particular point in time and there is many things about the industry that will be fundamentally reset as a result of the economic environment that we are in.

But on a longer-term basis I would think that something in the range of 130 to 150 basis points is something that's achievable. We see with respect to our results in particular, on a longer-term basis, a number of things that are drivers of potential increases in profitability going forward.

Obviously the one that you mentioned is significant with respect to credit costs, both from a provision standpoint and from the standpoint of other credit costs that are embedded in the revenue and expense line items.

We also think that our balance sheet right now is under leveraged, both from a capital and liquidity perspective and therefore we believe that we have untapped NII potential in our balance sheet at this particular point in time which could fuel additional profitability going forward.

And from an expense standpoint, I think we’ve always had pretty tightly controlled expenses. But that being said, I do believe that our expense base is leverageable and that we can support increased levels of activity going forward as the economy begins to improve.

So, I think there are levers to trigger incremental profitability going forward that would get us into that 130 to 150 basis point range on an early basis.

Betsy Graseck - Morgan Stanley

Lastly on that, when you think about where the normalized credit goes versus what was pre-cycled, does that take into consideration any expectation for change in what your normalized loss rates were likely to be after having taken out quite a bit of exposure?

Kevin Kabat

Yes Betsy, as we think about it, if you -- and I know we’ve talked and we’ve tried to be transparent in terms of all of the different channels and all of the different pieces of business that we’ve really kind of exited and gotten out of, from that perspective.

I don’t see that necessarily coming back into our book or our portfolio and I think that will have a positive impact on our overall performance on a historical comparison basis. So I haven’t translated that into specifics bits, difference.

But I have to believe that again as we focus more on our core consumer and our core commercial C&I middle market, that’s where you can drive some significant improvement from a historical comparison perspective.

Mary Tuuk

And to that end I would add, we've been very transparent. All of the different improvements that we've made both in business practices, underwriting strategies, et cetera, particularly with respect to things like portfolio concentrations, more aggressive strategies in terms of portfolio management as well. So that all leads too much more anticipated improvement and performance going forward.


Our final question comes from Matthew Burnell - Wells Fargo Security.

Matthew Burnell - Wells Fargo Security

Two unrelated questions for Mary I think. First of all Mary I noticed on the period balance sheet, that it appears that other short term investments are up pretty visibly quarter-over-quarter.

The same thing with the average balance sheet, whereas we didn’t growth in the other securities portfolios. Can you give us a little more detail as to what's going on there and what your plans are?

And then second, you mentioned commercial real estate recoveries were up slightly from obviously very depressed levels. Just trying to get a little more detail on what you're seeing there, because that’s really the first time in this reporting season that we've heard anybody talk about that?

Dan Poston

Let me take that first question with respect to other short-term investments. That line item is typically driven by overnight funding activities and consists primarily of fed funds sold and in managing our overall overnight liquidity position; those overnight balances tend to fluctuate somewhat.

So that balance has been somewhat higher reflecting the liquidity that's in our balance sheet this particular point in time, but that's not an indication of any kind of longer-term commitment to the securities portfolio.

Mary Tuuk

With respect to the question that you had on recoveries we did point that out this quarter and some of it comes from the more aggressive strategies that we put in place with respect to our special asset group we talked about this fact that are percentage recoveries have increased over the levels that we saw on the past year.

Some of that is the reflection of improvement in business strategies and their practices and processes in addition that we are seeing more liquidity in the market and that certainly been a positive contribution as well.

Matthew Burnell - Wells Fargo

Okay, and just in terms of follow up on the security side. As I said you didn't appear to grow your investment securities portfolio very much this quarter and that's a little bit different from some of other banks that have reported.

What are your thoughts about using additional repayments and other deposit growth to grow the securities portfolio further?

Dan Poston

Well, that's clearly an alternative that we will be considering as we go forward. We do expect continue to be grow in demand and therefore we do expect to be giving consideration to things that we could do with respect to the investments securities portfolio.

Clearly we have room there to grow the portfolio and I would expect that as we work through those issues going forward that we will be adding somewhat to the portfolio.

Again I would just point out that we are very cognizant of the lessons that were learned by this organization from past leveraging of the investment portfolio and anything that we do will be done in conjunction with actions that make sure that any action that we take does not add significantly to interest rate risk as we go forward and that we would be very mindful of the very environment that we are in and the expected actions that were said will be taken in the next 12 to 18 months.

Kevin Kabat

I just have one comment, which our deposit to loan ratio has exceeded one for probably the first time ever. And so we’ve got a lot of liquidity and its durable core funding that gives us a different set of opportunities from looking at what we are investing then wholesale funding.

All right, that ends our call, thank you everybody for your attention. Appreciate it, talk to you next quarter.


That ends today’s call, and you may now disconnect.

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