Comerica Inc (CMA) 2005 Q3 法說會逐字稿

Good morning.

My name is Kevin.

I will be your conference facilitator today.

At this time, I would like to welcome everyone to the Comerica Incorporated third quarter 2005 earnings release conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question and answer period. (OPERATOR INSTRUCTIONS) Mr. Burdiss, you may begin your conference.

Thank you, Kevin.

Good morning, and welcome to Comerica's third quarter earnings conference call.

This is Paul Burdiss, Director of Investor Relations.

I'm here with Ralph Babb, Chairman;

Beth Acton, Chief Financial Officer; and Dale Greene, Chief Credit Officer.

A copy of our earnings release, financial statements, and supplemental information is available in the Edgar section of the SEC's website, as well as on our website.

Before we get started, I would like to remind you that this conference call contains forward-looking statements and, in that regard, you should be mindful of the risks and uncertainties that can cause future results to vary from expectations.

I refer you to the Safe Harbor Statement contained in the earnings release issued today, which I incorporate into this call, as well as our filings with the SEC.

Now, I'll turn the call over to Ralph.

Good morning.

Comerica's third quarter results demonstrated solid financial performance.

Revenue continued to improve, reflecting our ongoing investment in people, branches, and technology.

Excluding the impact of a change in warrant accounting, which Beth will talk about in just a moment, revenue was up 3% compared to the second quarter of 2005.

Our expenses remain controlled, excluding the impact of a change in warrant accounting and increased customer service expense in the financial services division, which was due to increased customer activity.

Average loans were up 1.4 billion in the third quarter, including a 1.2 billion increase in our Financial Services division.

Many other lines of business reported increases in average loans, partially offset by a seasonal decline in our National Dealer business.

Despite a lagging economy in our Midwest market, Comerica's credit quality continued to improve.

As a result, the allowance for loan losses was reduced, which also contributed to higher earnings per share this quarter.

We continue to return excess capital to our shareholders, as we repurchased more than 2 million shares in the third quarter.

The board authorized a purchase of up to 10 million additional shares, which will enable us to continue to actively manage capital.

We remain at the high end of our target range of 7 to 8% Tier 1 common capital ratio.

During the third quarter, we announced agreements to sell two businesses, opened seven new locations, and dealt with the hurricane in Texas.

Through Munder Capital Management, we agreed to sell our interest in the Framlington Group, because it was inconsistent with Munder's focus on domestic asset management.

We agreed to sell our bank charter in Mexico to concentrate on our dollar-based activities in that country through our representative office in Monterrey.

In our Texas market, we were very fortunate that all of our colleagues and all of our operations there came through hurricane Rita unharmed.

Earlier in the quarter, we opened two new branches in Houston.

In our Midwest market, we opened one new branch in Michigan.

In our western market, we opened three new branches: one in Northern California and two in Southern California.

And in our Florida market, we opened a new wealth and institutional management office in Stewart.

Overall, we are on target to open approximately 17 new branches this year.

As you know, we have been diversifying our earnings mix by lines of business and by geographic market in order to help achieve consistent growth through all phases of a business cycle.

Today, Comerica has a presence in seven of the largest cities in the United States, including Los Angeles, Houston, Phoenix, San Diego, Dallas, San Jose, and Detroit, according to U.S. census bureau data.

And the census bureau projects that two-thirds of all Americans will live in the south and the west United States by 2030, with 30% in just three states: California, Texas, and Florida.

Now I'll turn the call over to Beth for a more detailed review of the third quarter.

Beth?

Good morning.

As I review our third quarter results, I will be referring to slides that we have prepared that provide additional detail on our earnings.

Turning to slide 4, we highlight the major components of our current earnings as compared to prior periods.

Today, we reported third quarter 2005 net income of 238 million, or $1.41 per share, compared to 217 million, or $1.28 per share in the second quarter and 196 million, or $1.13 per share in the third quarter of last year.

On slide 5, I would like to highlight a few key profitability drivers for each business segment for the year to date 2005 results compared to the prior year period.

The Business Bank's net income increased 1 million to 524 million.

Improved net interest income due to a change in warrant accounting, which I will describe later, was largely offset by an increase in customer service expenses in our financial services division.

Small Business and Personal Financial Services reported year to date net income of 132 million, or a 4 million decline over the prior year, as net interest income improvement was offset by reduced service charge income and increased expenses, including those associated with new branches.

Wealth and Institutional Management's year to date net income was 65 million compared to 64 million in the first nine months of 2004, primarily due to higher investment advisories and personal trust revenues.

The Finance segment reported a 53 million improvement in year to date results.

In today's rising rate environment, the interest income received from the lending-related business units continues to rise more quickly than the longer-term value attributed to the business units generating deposits.

The Other category reported a 53 million improvement in year to date results and includes a reduction in the provision for loan losses not specifically assigned to business units.

The loan loss reserve in the Other category includes the unallocated allowance for loan losses and the portions of the allowance allocated based on industry-specific and geographic risks.

Slide 6 highlights contribution to net income by market segments for the year to date 2005 period compared to the same period last year.

Midwest and other markets reported 385 million of net income for the first nine months of the year, a decrease of 25 million from the prior year, as improved revenue was more than offset by an increase in provision for loan losses due to a slower pace of credit quality improvement.

The Western market reported year to date net income of 251 million, a 24 million increase over the prior year, due to the positive impact of higher deposit balances, the change in warrant accounting on net interest income, and lower provisioning for loan losses.

Partially offsetting these improvements were higher expenses related to the financial services division and branch expansion.

The Texas market reported 70 million of year to date net income, down 2 million from the previous year, partially due to higher expenses, including those associated with new branches.

Florida reported net income of 15 million of the first nine months of 2005, up 1 million from the prior period.

The market segment results exclude the unallocated allowance for loan losses and the portion of the allowance allocated based on industry-specific and geographic risks.

As outlined on slide 7, net interest income of 512 million increased 29 million from the second quarter, including 20 million from the change in warrant accounting.

Average earning assets increased 1.7 billion to 49.1 billion, primarily due to a 1.4 billion, or 3%, increase in average loans.

Average deposits of 41.3 billion increased 1.3 billion during the quarter, including an increase in non-interest bearing deposits of 739 million.

The net interest margin increased 6 basis points to 4.15%.

The warrant accounting change contributed 16 basis points to the improvement.

The Other change, which equates to a 10-basis point negative impact, is more than explained by higher levels of low interest rate loans in the financial services division.

Slide 8 summarizes a change made to our warrant accounting.

We currently have a portfolio of approximately 800 warrants for non-marketable equity securities, which are primarily from high technology, non-public companies.

These warrants were obtained in a loan origination process.

We have historically recognized income on these warrants approximately 30 days prior to the warrant issuer's stock becoming publicly traded or when a publicly-traded company acquired the warrant issuer.

However, in the third quarter, it was determined that due to net exercise provisions embedded in the agreements, substantially all of the warrants must be accounted for at fair value on the grant date and then mark-to-market through non-interest income in each subsequent period.

The required adjustments to record the warrant portfolio at fair value were not material to the current or prior periods and have therefore been reflected as of September 30, 2005.

The net effect of the adjustments shown on the slide is an increase in net income of 9 million.

Slide 9 details the components of non-interest income, which was 232 million for the third quarter, a 13 million increase from the second quarter, due partially to increases in markets and activity-based fees.

In addition, other noninterest income in the third quarter included 13 million of income net of write-downs, recognized on unconsolidated venture capital and private equity investments compared to 5 million of write-downs net of income distributions in the second quarter.

Also included in the quarter were 3 million of risk management hedge in effectiveness losses compared to 5 million of gains in the previous quarter.

Non-interest expenses, as detailed on slide 10, were 422 million for the third quarter, an increase of 39 million from the second quarter.

Salaries expense was up 12 million in the third quarter, due primarily to an increase in business unit incentives, including a 4 million accrual related to warrant accounting change previously discussed.

Customer service expense increased 19 million from the second quarter, as a result of increased value paid for higher deposit volumes in the bank's financial services division in a rising rate environment.

Moving to the balance sheet and slide 11, average loans for the third quarter increased 1.4 billion, or 3%, from the previous quarter.

Loans were impacted by two primary factors: growth in financial services division loans of 1.2 billion, and a 300 million seasonal decline in our national dealer business.

Excluding these items, loans in the western and Texas markets experienced 3% growth from the prior quarter, while loans in the Midwest and other markets were stable.

Slide 12 provides detail on line of business loan growth.

The third quarter showed increases in many business lines, offset partially by a 300 million seasonal decline in national dealer services floor plan loans.

The increase in the specialty businesses was due to the growth in the financial services division, which increased 1.2 billion from the previous quarter.

Slide 13 takes us into the credit quality portion of our results.

Non-accrual loans were 186 million at the end of the third quarter, down 26 million from the previous quarter, and down 175 million from a year ago.

By line of business, middle markets, specialty businesses, principally leasing, and small business account for 81% of non-accrual loans.

For the quarter, airline and automotive represent the largest industry concentration of non-accrual loans at 39 million and 38 million respectively.

At September 30, our non-accrual loans have charged down to 51% of the original contractual value, compared to 47% in the second quarter.

Slide 14 walks you through the changes affecting the balance of non-accrual loans and reflects continued improvement in credit quality.

During the quarter, 81 million of loans were transferred to non-accruals, compared to 47 million in the second quarter.

There were two new non-accrual loans over 10 million, one in the airline industry for 36 million, and one in the automotive industry for 13 million.

During the quarter, we sold 19 credits with 13 of these loans on non-performing status.

Our watch list and non-accrual loans were down to 2.1 billion and represented about 5% of total loans.

Slide 15 depicts net charge-offs by geography, line of business, and industry.

Net charge-offs for the quarter were 21 million, including 26 million of recoveries.

By geography, the majority of net charge-offs were in Midwest and other markets, with 23 million, while the western and Texas markets were in net recovery positions of 2 million and 1 million respectively.

Net charge-offs for the specialty businesses totaled 13 million, all in the aircraft leasing portfolio.

Overall, credit quality metrics have continued to improve and as a result, the allowance for loan losses has declined from 609 million at the end of the second quarter to 558 million at the end of the third quarter.

The allowance for loan losses at September 30 stood at 1.33% of loans, down from 1.41% at June 30.

Slide 16 details average deposits by line of business, which increased approximately 1.3 billion, or 3%, from the second quarter, due to growth in middle markets, non-interest-bearing deposits in our financial services division, and institutional CD's.

Deposits for our financial service division averaged $9 billion for the quarter compared to 8.5 billion in the second quarter.

These deposits total 11 billion at September 30, down from 12.1 billion at June 30.

Non-interest bearing deposits account for 38% of our average total deposits.

Now on slide 17, I would like to provide an update to previously disclosed events surrounding the July departure of the financial services division department head and approximately 20 others from the division.

The financial services division serves the deposit processing needs of various segments of the real estate industry, including title, escrow, property exchange, and property management.

We moved quickly and aggressively to protect the FSD franchise, an important and profitable business for us.

Despite the loss of staff, we have continued to provide high quality customer service by quickly assembling a cross-functional team of professionals.

Within a week of the staff departures, we named a new business head with broad national experience, including work in the title and escrow business.

During the third quarter, we filled the majority of open positions.

Comerica executives immediately began to call on FSD customers to reinforce our commitment to the business.

We filed and were granted a temporary restraining order against the financial institution that now employs the departed staff.

On slide 18 we provide some additional details on our financial services division.

Customers are compensated for the value of their deposits in the following ways: Non-interest bearing deposits earn a crediting rate, which may be utilized to pay for customer services such as escrow accounting; some customers also utilize their deposit credits in the form of fully secured low rate loans.

Interest-bearing deposits receive a market rate that a sophisticated depositor would expect.

Because deposit levels are largely driven by underlying economic activity, principally real estate-related transactions, we expect these deposits to fluctuate over time.

As outlined in this slide, FSD deposit balances averaged 9 billion in the third quarter, up from an average of 8.5 billion in the second quarter.

Related loans and customer service expense were also up, reflecting rising interest rates, higher deposit balances, and an increasingly competitive operating environment.

We anticipate that FSD-related loans will continue to rise in the fourth quarter, while customer service expense will likely be lower in the fourth quarter.

Deposits from our financial services division customers continue to provide attractive funding for Comerica.

Slide 19 updates trends for the full year of 2005.

These trends exclude the previously announced sale of Comerica's indirect interest in the Framlington Group and the sale of Comerica's Mexican bank charter.

Both transactions are expected to close in the fourth quarter.

We expect average loan growth for the year to be in the high single-digit range, or excluding FSD, in the mid single-digit range.

On average, the full year net interest margin is expected to be between 4 and 4.05%.

Inherent in this outlook is a fourth quarter margin in the range of 3.75 to 3.95%.

The fourth quarter margin is dependent in part upon the level of non-interest bearing deposits and FSD-related loans.

As indicated previously, we anticipate that FSD-related loans will be higher in the fourth quarter when compared to the third.

We continue to expect low single-digit increase in non-interest income.

Growth in non-interest expenses will be in the mid single-digit range, including FSD customer service expenses.

Continued credit quality improvement led us, again, to lower our full year average net charge-off outlook, now at about 25 basis points.

During the quarter we repurchased approximately 2.4 million shares for 147 million.

We expect to continue to be an active capital manager.

Now we would be happy to answer any questions you might have.

[OPERATOR INSTRUCTIONS] Your first question is from Gary Townsend.

Good morning, Ralph.

Good morning, Gary.

Good morning, Gary.

I wasn't sure that we would get to talk.

We weren't sure either.

Sorry, we had a little bit of technical difficulties.

I think we're back.

Great.

My question has to do with the -- the first question, at least, with the net interest income in margin.

The recognition of the warrant gain or the contribution of warrants, is this more or less a true-up from all prior quarters that has been presented here?

It's a cumulative effect of valuing the warrants that we've had over a number of years, so it is -- all of that is recognized in the third quarter.

Okay, so in coming up with your guidance with respect to net interest margins from, I think it was 3.75 to 3.95 in the fourth quarter, can you provide a bit more with regard to just the dynamics that are apt to be bringing -- that would cause that level of compression?

First of all, you have to remember in the fourth quarter will be the non-recurrence of the warrant accounting, so that right there was 16 basis points in the third quarter, which will obviously not recur in the fourth.

Right.

And in addition, the other important driver in the quarter relates to what we indicated in our slides, was that we expected the financial services division, low rate loans will continue to rise in the quarter, in the fourth quarter, higher than the third, which has a negative impact on the margin.

So can we assume from that, then, that the level of deposits is likely to have grown as well?

I think you have to look at it in total to kind of the trends.

There may be-- it's not as clear what the deposit levels will be in the fourth quarter.

We do expect, based on the value of those deposits in this period so far, that the low rate loans will be higher as a result.

And what was the average yield in the quarter on those low rate loans?

We haven't disclosed what we charge on those low rate loans for competitive reasons.

Would it be slightly in excess of Fed funds, or what would be the-- just a--

Can't really say.

Yes.

Near low.

Thank you.

And with regard to just the temporary restraining order, any update on that?

We will be-- the temporary restraining order continues.

We are likely in the next couple of weeks to be back in the court to have an assessment of whether a permanent injunction would be granted to us.

Thanks very much.

Thank you.

Your next question is from Jeff Davis.

Good morning, Jeff.

Hey, good morning.

Following up on Gary's questions, is the -- Beth, is the margin-- I know you're not providing 2000 margin outlook, but to the extent there is some additional margin compression from the adjusted 3Q level at just under 4% excluding the warrant accounting adjustment, does -- what's your sense on how that plays through in the first half of next year?

Are these transitory issues, or are we looking at a new run rate on the margin in the -- in your revised range for 4Q?

I think you need to consider that also excluding the warrant accounting there was an impact, obviously, of higher financial services division loans in the third quarter, as well as we've indicated those levels are likely to be higher in the fourth.

So a lot of what happens to the margin next year, an important element of what happens to the margin next year will be a function of the levels of those loans going forward.

We will have certainly a better view on that when we give you our full-year '06 outlook in January.

Let me ask it a little bit differently, then, and I haven't reworked my own numbers.

Is -- margin's just a calculation.

Is net interest income still expected to show forward progress?

That is, sequentially higher?

Well, again, I think to the extent -- we will give you more color on all of our trends in January, but I think our expectation is we will continue to see loan growth and we'll, as I said, give you more flavor for that in January.

Okay.

Fair enough.

And if I missed it, I apologize: The low margin loan growth at FSD, what is the purpose of the loans?

The purpose of the loans is to provide compensation to depositors for their deposits, and we do that -- we provide financial services division customers compensation for their deposits in two ways: One is through paying customer service expenses on their behalf, like courier services or escrow accounting services, et cetera, and/or through low rate loans.

Now, this isn't a change in geography, though, where there was an interest -- where you had some interest expense in effect on FSD deposits down in op expense that's in effect had moved up through a reduction in credit rates, is it?

No, there really -- the impact from FSD flows in both in the customer service expenses on the income statement, which relates to these services I mentioned that we pay on their behalf.

Yes.

The other flows through net interest income.

Okay, and the ramp-up, then, in this lending volume here, Beth, is this new pricing or a new product push?

No, it's really a function of -- that deposit balances have continued this year to be significantly higher than the prior year for each quarter that we've gone through this year, and rates have been rising.

So the combination of rising balances and rising rates means that there's more value attributed to those balances that we are sharing with customers.

Okay.

Let me -- I'll follow up off-line.

Thanks.

Okay.

I think an important point there was Beth's comment earlier on the margin slide that the negative 10 basis points was more than explained by the FSD transactions.

Your next question is from Heather Wolf.

Hi, good morning.

Good morning.

Good morning.

Two questions: First, if I'm reading your financials correctly -- can you still hear me?

Yes.

If I'm reading your financials correctly, it looks like you've had fabulous deposit growth, but it looks like you've paid up for that in the form of a lower margin and also these higher expenses in FSD.

So I'm curious if you can give us sort of your feel for what the deposit pricing competition is going to look like in the fourth quarter and why you think that a lot of these expenses, particularly in FSD, might dissipate.

On the deposit environment, if you look at -- obviously, rates were up about 50 basis points in the quarter, and our -- the cost of our funding was up about 30 basis points, but -- and there was some additional compression between earning asset yields and deposit yields, but largely driven, I would say, more from the asset pricing side than the deposit pricing side.

There continues to be very competitive environment on the lending side in terms of spreads.

So I think the environment isn't worse than it was, I would say, in the prior quarter and I think we would continue to see a pretty competitive environment.

It varies by geography.

I'd say Michigan and Texas would tend to be more competitive than California has been.

And your second question was related to FSD.

We had indicated in our call that -- in the presentation that we anticipate in the fourth quarter that it's likely we will see lower customer service expenses in the quarter, higher loan levels that we indicated, but lower customer service expenses.

And there's a dynamic, as I mentioned, between those two, the level of low rate loans and the customer service expenses.

I'm sorry.

So you expect higher loans and lower expenses?

Correct.

Because customers have the option of taking the -- taking the loan option or getting some of these other concessions that you offer?

Right.

Exactly.

Some customers use both.

Some just use one.

Okay.

And as Beth said, it's a very good source of funding for us, but it is also very dependent on the market pricing today.

Okay.

And also, can you give us a feel for what, first of all, what the expenses associated with the VC gains were and also what you think the sustainable level of VC gains is, going forward?

That's a very difficult one to predict, because you look at the third quarter, we have 13 million of income compared with 5 million of write-downs in the prior quarter, so that's an $18 million swing.

The prior quarter was kind of flattish, 1 millionish, I think, around there.

So I think it is very difficult to kind of give you an ongoing run rate.

Okay, and what about the expenses associated with the gain this quarter?

There really aren't.

It's just a few people who managed the oversight of that, both the relationship aspect to it as well as the administrative, so it's very small in the scheme of things.

Okay, great.

Thank you very much.

Thank you.

Your next question is from Christopher Chouinard.

Hello, good morning.

Good morning.

Good morning.

A couple of quick questions.

First, if you could talk about the decline in floor plan business seasonally, I understand the seasonality here, but I was wondering if it was a little more than you had expected this year and if you're expecting maybe a lower rebound maybe than in other years, due to weaker demand for auto.

I don't think we view the change as abnormal.

If you look at prior times, it's not unusual to have a 5, 6, $700 million decline.

I think we continue to see and expect that there will still be pretty good sales volumes for the autos, in the high 16 million kind of levels or low 17 million, at least in the foreseeable future.

So we see this rebounding in a fairly typical fashion this quarter.

And our dealer backlogs are very good.

There's a lot of activity, primarily out on the West Coast.

So this is typically what we see seasonally.

I think to reinforce one of the things Beth said earlier, too, if you remove the effect of the decline in dealer and also remove FSD and look at the underlying growth rates in loans, the Midwest, as we mentioned earlier, was flattish.

It was about a 1% annualized rate.

Western, and this is from quarter to quarter annualized, Western was at about 11% and Texas was a little over 13%, so overall loans were just slightly under 5% annualized growth during the quarter.

And then if I could just follow up, Beth, I think you mentioned that FSD deposits were 11 billion at the end of the quarter.

Right.

Do you think that's just sort of a quarter end anomaly, or is that reflective of what you think they could do on average for the fourth quarter?

It's very typical for there to be a spike at quarter end.

You saw that in the prior quarter in excess of 12 billion, so we tend -- average is what counts.

Just the way business closes, they tend to be very high at month end and quarter end.

Okay.

So it's not -- it's very typical.

Okay.

Thank you.

[OPERATOR INSTRUCTIONS] Your next question is from Mike Mayo.

Good morning.

Good morning, Mike.

Good morning.

Three questions.

One, expenses really jumped a lot this quarter.

Is there anything in there that is nonpermanent?

I guess you're saying the increase in customer services from 10 million to 29 million will go back to that range of, what, like 6 to 11 million in the last few quarters?

We didn't say.

We just expect it's likely they will be lower.

Okay.

And that was an important driver.

There was also an incremental 4 million of expense in the quarter due to warrant accounting, accruals related to incentive comp.

It's not incentive compensation that would be paid today, but we need to accrue for it since we've accrued for the revenue.

So those were two items that were more outside than normal.

But expenses are still up quite a bit this quarter.

I was just wondering if there's anything else that might be a little outsized, or is there anything else going on there?

No, and I think if you look at year to date expenses and you take out the customer service and the warrant, we're -- our revenue is growing in excess of our expenses.

So we should take out some of the customer service as like a nonpermanent item?

Well, I'm just saying, if you look at -- I think of customer service expenses as really more related to interest rates than it is to operating performance.

It's not an underlying operating efficiency issue there.

It's really related to what's driving our business and interest rates.

So if you're looking at operating efficiency as a bank, it's not something that I would focus on as part of -- yes, it is in expenses, but it's really part of the dynamic of running that business in total, not the underlying efficiency of the bank.

Let me just be more direct, then.

I mean, if you take out the reserve benefit, your number's close to consensus and you get a $0.05 benefit from the accounting change.

Is there anything conceptually that offsets that $0.05 benefit from the accounting change, because otherwise, then you're a little bit below consensus?

Well, I don't really -- can't speak to the analysis of versus consensus, but I think we've laid out the pieces so that you can understand what the drivers are in the business and I think we feel good about credit quality and continuing to be very good loan growth continuing, and some pickup in, as the year has gone on, in non-interest income.

So I think those all make us feel like things, we're making progress.

And just to better understand the FSD, I guess you had a big group leave and then you see these extra expenses, either for customer services or, as you say, in the fourth quarter, of these low interest rate loans.

Is this simply one way for you to reward the customers that much more during a period when others might be trying to pick them off?

You know, I think if you look at the balances, the balances are up about $1.3 billion year-over-year and at a time when also interest rates are up a couple hundred -- more like 120 basis points, so if you look at the confluence of the higher balances and the higher interest rates, it would not be unexpected we would see more value being allocated back to the customer via either these low rate loans or the customer service expense.

And then on the positive side, commercial loan growth is great.

Could you elaborate a little bit more?

You gave us the loan growth by region in aggregate.

But in terms of commercial loan growth by region and what's the big driving force to these new commercial loans?

Is it inventory, is it capital expenditures?

What do you think is the driver here?

It's really spread across the businesses, as you looked at that one slide that Beth talked about.

The other thing we saw that reinforces that is commitments are up as well and usage is down a little over 1%.

So it appears to be a little bit of a -- these are my words and an editorial comment -- of a summer lull and as things move forward, is the way I would predict that.

And then lastly, since we're looking at such a big margin decline in the fourth quarter, NII in the fourth quarter, do you expect that to be up or down or getting away from this myopic focus just on the margin?

I think we need to address it in the context of we did give you an outlook related to loan growth and margin and we haven't given a net interest income outlook.

Thanks.

Thank you.

Your next question is from Tim Ryan.

Good morning, Tim.

Good morning.

I just wanted to try to get the expenses, if you can talk about it a little bit more, the rationale behind the suit against the competitor, the CRO.

Is it just a function of trying to make sure that they don't get any of your existing customers?

Is it -- can you talk about -- it seems like these people aren't going to come back to work for you.

Is it monetary?

Just any sort of color you can give there?

You know, our -- we're really focused on making sure that any trade secrets or proprietary information, that it's very important to running our business, that we make sure we protect it and preserve it.

So that is what the temporary restraining order is really directed to, is protecting both our customers as well as us running that business.

Okay, and you commented that, on the quarter end balances were I think 12 billion at the end of the second quarter and 11 billion at the end of the third quarter, but the averages were up and the averages related to more sort of I guess (inaudible).

That's an important element, is the average, and also, as we've indicated in the past, these deposit levels are a function of what's going on in the mortgage market business, mortgage market, and as a result of rising interest rates over the last few weeks anyway, you know, we could see some impact on that on refinancing and other mortgage activity.

So that is what we've been saying for a long time, is that as rates rise, we would expect from a secular standpoint that we would see these deposits decline over time.

But, still, maintaining a nice, positive contribution to our funding base that we didn't have before we really developed this business.

Have you lost any relationships as a result of the departures?

We have not lost relationships.

Okay, great.

Thank you very much.

Your next question is from Cameron Hurst.

Good morning.

Good morning.

A couple of questions.

First, on the FSD loans, you said you expect them to tick up again in the fourth quarter, but thinking into 2006, maybe it's a duration comment or just where do you see them going after the fourth quarter?

I think we'll-- we're in the midst, literally, as we speak, of doing our planning for '06 and we would provide that, some better guidance overall on the trends for the Company in total in our January call.

Okay.

So I really can't shed a lot of light on that at this point.

Okay.

But I think back to what Beth just said it, will track, by and large, where the mortgage industry is going.

That will have a great deal of impact on the amount of funds that will be there.

So if mortgage lending or housing sales slows, or resales slow, then you'll see those deposits slow as well.

And if the deposits slowed, then that's to say that the loans that are associated with them are equal or close to in duration, so they are short-term, so they will also slow or drop?

That's correct.

Yes.

Okay.

Okay.

The swap portfolio, could you just give an update on the size, if there was any significant change there this quarter?

No, we had -- as we've disclosed in our second quarter Q, 1.8 billion of -- well, we had 700 million of swaps mature in the third quarter and have another 1.4 billion maturing in the fourth quarter.

But we tend to replace those swaps on a regular basis, on a quarterly basis, so it would be typical that we would be adding back about $1 billion in swaps each quarter.

And so that continues.

You actually added to the portfolio this quarter?

Yes, we did.

Okay.

And lastly, on the credit side, first, to clarify, did you say there was a 15 million new formation in auto and a 44 million in the airline industry; is that right?

The inflows, you're talking about?

Yes, yes.

Right.

We talked about the inflows to airline and inflows to automotive.

So is it fair to assume that those are single credits based on what's happened in the last three months?

No.

I think it's not safe to assume it's any one particular credit.

Often times it's -- usually it's a granular portfolio or a segment.

So, no, not just one credit, necessarily.

But there would have been events that unfolded in this past quarter that would drive those two numbers, then?

Yes.

Okay.

Yes, we mentioned of the 81 that -- inflows in total, that 36 related to one in the airline industry and 13 related to one in the automotive industry.

The rest would have been, as Dale mentioned, very spread out.

I understand.

I'm sorry.

I must have missed that.

Great.

Thanks very much, guys.

Thank you.

Your next question is from Ros Looby.

Good morning.

Good morning, guys.

Actually, most of my questions have been asked and answered, but the one thing that strikes me here, if you X out FSD completely, it sounds like the core margin trend is fairly intact here, and assuming that the level of these low rate loans does subside somewhat in 2006, are you optimistic that the core margin trend will continue to be relatively stable?

Is that a good assumption?

I would say for looking at the third and fourth quarter, which we were focused on in our discussions, that the core underlying margin is okay.

It's that impacts have largely been through FSD.

All right.

Fair enough.

Thank you.

Thank you.

Your next question is from Dennis LaPlante.

Good morning, all.

Good morning, Dennis.

A few things.

I'll get my quarterly question in on watch list trends within that automotive business, Dale.

Okay.

Well, I fully expected that.

I mean, I would make an overview comment on the autos, just sort of as a backdrop to that, that we have obviously been in the auto business a long time.

We actively manage that portfolio, as you would expect, and watch loan credits within that portfolio have basically remained fairly stable.

The pace -- we keep talking about the pace of improvement in the Midwest having slowed and that's primarily a reflection of the auto portfolio in manufacturing, but it has remained very stable and it's at a satisfactory level for us.

And your comment on stability is, it's been stable since the end of the second quarter?

Yes.

Okay.

How about secondary and tertiary issues related to the automotive, their suppliers and so on, and keeping a close watch on that and are you seeing any deterioration there?

Well, a couple of things there as well, I think what you've seen in the last few weeks, particularly with General Motors being able to work with this many constituencies, I think it's a great first step, which I think ultimately can help the industry.

I think as it relates to the supplier base, there is a lot yet to unfold.

I think our supplier base will continue to be stressed.

I think we recognize that and we actively work that portfolio.

We exit certain deals when it makes sense, obviously, and there are good suppliers out there.

There are very good suppliers out there that are our customers and there are some others out there that, frankly, would be good customers.

So, yes, there's an impact.

I don't know how this latest arrangement that GM has announced and others will probably announce will effect it all, but clearly we recognize that our supplier base will continue to struggle, continue to be stressed, and we're aware of that.

Okay.

This kind of goes back to the escrow business.

What actually does the court injunction do, in terms of what does it restrict them from doing?

It restricts them from soliciting more of our employees for employment.

It restricts them from soliciting business from our customers, and it also, through the process, we will be insuring that there are no trade secrets or other proprietary information that is in their hands that is being used.

And so that -- those are kind of the areas that it is temporarily restraining.

What we will be waiting for from the judge later in October is whether we -- whether this is turned into, then, a permanent injunction.

Now, solicitation can be interpreted, I guess, a variety of different ways.

Does that mean they have no -- they cannot have any contact with any customers that they previously dealt with?

That's correct.

Using our information in order to facilitate that, whether it's trade secrets or other information.

Thank you.

Last question is, it looked like the FTE tax rate was up a little bit above where you've been.

Any special items that probably hurt earnings by a penny or two?

No, just some true-ups that happened and various kinds of things through the year, so nothing of significance.

So you would expect it to go back down in the fourth quarter?

I would expect -- well, we may have some impacts from the Framlington transaction that could cause it to be a little higher than 32, but we'll be able to share those with you.

But on an ongoing basis?

I haven't looked into next year.

Okay.

We'll give you an indication of that in January.

Great, thank you.

Your next question is from Fred Cummings.

Yes, good morning.

Good morning, Fred.

Good morning.

Couple quick questions.

One, in the FSD business, is there a significant fee income revenue component to that business line?

There is fee income, yes, non-interest income that we earn for various treasury management kinds of services.

It is not significant, but there is some that we use in our analysis of the business in understanding the profitability of the business.

And, Dale, a question for you with respect to the subdued loan growth you're seeing in the Midwest; can you speak to -- is that a function of just demand being weak?

Is it a function of Comerica having tightened its underwriting standards, or is it reflective of this heightened price competition?

I think it's -- quite frankly, I think it's prudent underwriting.

I think part of it is that obviously the economy in Michigan and in the Midwest to a certain extent has been more stressed, shall we say.

I don't think that we've changed our underwriting standards in any meaningful way whatsoever, but we're cautious.

There aren't that many, frankly, good opportunities that really meet our standards.

When we find them, obviously we pursue them.

So I think the environment is just a little less robust and if you go out west or you go down south, you go to Texas, obviously it's a lot more robust, a lot healthier, and that's where we're seeing a lot of our growth, as Ralph indicated.

I think, Fred, if you talk to Dana, our economist, he would say that he expects kind of flat to up slightly activity in the Michigan market versus at the national average or above when you talk about California or Texas.

Then lastly, Dale, or Ralph, can you speak to -- you've had -- you had pretty robust growth within your commercial real estate portfolio on a link quarter basis.

Can you speak to the types of properties you're seeing there?

You're financing?

Sure.

They are really the same types of things we have financed historically.

We've found, you know, again, we find great opportunities primarily in the West, in Texas and Florida, so that's just continued growth in a very good business for us and in primarily the markets I've indicated.

I think in that overall real estate portfolio, it's important to keep in mind about 65% of it is not primarily in that business line.

In other words, it's real estate taken as collateral in the commercial business.

And as Dale said, over 50% of the construction portfolio is for sale housing, a lot of which is in southern -- the Southern California market, and as well, is in a very -- the whole portfolio is very granular.

Right.

And as you know, we've been exhibiting -- had been experiencing a lot of paydowns in that business, doing a lot of new deals, but offset largely until recently with a lot of paydowns.

So I think we're getting a little traction here, which is good, but sticking to our underwriting standards that we've been applying all along.

Okay.

Thank you.

Thank you.

Thank you.

Your next question is from Steve Berman.

Yes, I'm sure I'm beating a dead horse with this one, but could you give us the FSD deposits, how they have averaged -- you say they have gone up every quarter this year.

Would you have rough averages what they've run?

Yes.

In the first quarter, total deposits were 7.8 billion.

In the second quarter, 8.5 billion.

And in the third quarter, 9.0 billion.

Now, are these interest-free completely, or is there a small rate paid on them, or what?

About 70% of these deposits are non-interest-bearing deposits.

They are DDA accounts, so about 5.8 billion year to date has been in DDA and 2.6 billion in interest bearing.

The interest bearing, as I mentioned earlier, pays a market rate.

The non-interest bearing, we do give value to those customers for deposits with us via the paying services on their behalf, expenses on their behalf.

Yes.

Or through these low rate loans.

So there is value passed back to the customer on the non-interest bearing deposits through those two mechanisms.

Right.

And there was an earlier question.

I wasn't sure you -- I don't know whether you answered it or you did and I just didn't get it, but something about what do you -- I mean, you seem to talk -- maybe there is a slowdown in real estate in the fourth quarter, too, but these levels -- what is your expectation for these deposits in the fourth quarter, roughly?

I think -- well, we'll have to see and that's an important element of what drives these low rate loans as well as the customer service expense, but I think with rates rising and a little steam coming out of real estate, I think it wouldn't be unlikely we would see some modest decline in those balances in the fourth quarter.

I see, okay.

Thank you very much.

Thank you.

Your next question is from Gary Townsend.

Hello, again.

Mike Mayo asked my follow-up.

Thank you.

Okay.

Thanks, Gary.

Your next question is from Chris Mutascio.

Good morning, Ralph and Beth.

Good morning.

Good morning.

Two quick questions: If I back out $20 million from net interest income and a like amount from customer service expenses, the operating leverage in the quarter slowed, I guess, significantly from the improvement we saw in second quarter.

Is that a fair assessment, and is that just a lull or temporary in nature?

And my second question would be, if I again back out FSD from the commercial, average commercial loans, there wasn't much commercial loan growth in the quarter.

And Beth, forgive me, you may have mentioned it.

How much of that would be due to seasonal implications in third quarter?

Okay.

Let me take the loan question first.

We -- if you take out the loans in FSD, we're up to 1.2 billion in the quarter, but our dealer business was down on average about 300 million.

If you factor those two big pieces out, and Ralph mentioned this earlier, we had annualized growth in the quarter of about 5%.

It was slow in the Midwest, about 1%, but 11% in western and 13% in Texas.

Those are annualized based off the quarterly run rate.

So we did see loan growth apart from -- separating out FSD and separating out the seasonal aspect of our dealer business, we did see good growth, particularly in Western and in Texas, not so much in the Midwest.

And the other question on operating leverage, I think the quarter is a bit different in the sense that there were a large increase in customer service expense.

In addition, there was expense related to the warrant accounting as well as revenue related to the warrant accounting.

I think if you look at kind of the year to date business, we are making progress on the revenue side, vis-a-vis expenses, if you exclude kind of those higher run rates on customer service expense.

So we are making progress.

This quarter was a bit of a confluence of a number of factors.

Right.

And that's why I was asking the question.

Because I didn't know how really to look at it, so I was trying to back out both of those, but I guess there are more line items that are affected that would call at the operating leverage to kind of slow down from second quarter levels.

Yes, and obviously we have longer-term objectives to insure that we have a difference, obviously, between our revenue growth and our expense growth.

We're also making sure we're making investments that we talked about earlier, particularly on the branch side, so that's driving expenses higher this year.

Once we get a lot of those going and have a consistent investment in those, we will not have a drag from that investment either, which is going on this year.

I appreciate the color.

Sorry for having you to regurgitate the loan information.

No problem.

Thank you.

Thank you.

Your next question is from Terry McEvoy.

Good morning.

Everything on my list has been asked and answered.

Thank you.

Okay, thank you.

Your next question is from Charley Ernst.

Good morning.

Good morning.

I think in the past you have given guidance on average earning asset growth as well and I was wondering if you have any -- and I guess basically it seems that your loan growth on a reported basis is assumed to be higher, so that would make me think that your average earning asset growth assumption would be a little bit higher as well.

Yes, I think we, in the past, said it might be slightly higher.

I think it's more like the low single-digit kind of growth for earning assets full year '05 compared with full year '04.

You did see that we are also -- we have added some available for sale securities during the quarter and looking at loan growth, so all of it factors into, I would say, low single-digit growth for earning assets, for the full year.

Thanks a lot.

Thank you.

At this time there, are no further questions.

Thank you very much, and have a good day.

This concludes today's conference call.

You may now disconnect.