Comerica Inc (CMA) 2009 Q3 法說會逐字稿

Good morning.

My name is Regina and I will be your conference operator today.

I would like to welcome everyone to the Comerica third quarter 2009 earnings results conference call.

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

After the speakers remarks there there be a question-and-answer session.

(Operator Instructions) Thank you.

I would now like to turn the call over to Miss Darlene Persons, Director of Investor Relations.

Miss Persons, you may begin the conference.

Thank you Regina.

Good morning, welcome to Comerica third quarter 2009 earnings conference call.

This is Darlene Persons, Director of Investor Relations.

I'm here with Chairman, Ralph Babb, our Chief Financial Officer, Beth Acton and Dale Greene, our Chief Credit Officer.

A copy of the earnings release, financial statements and supplemental information is available on the SEC's web site as well as on our web site.

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 the risks and uncertainties that could 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.

This conference call will reference non-GAAP financial measures and in that regard, I would direct you to the calculation of such measures within the earnings release and presentation.

Now I'll turn the call over the Ralph.

Good morning.

Our third quarter results were consistent with our prior outlook and reflect the many actions we have taken to position our Company for the slow economic recovery now underway.

These actions include the strengthening of our already strong liquidity and capital levels, quick identification of problem loans, the building of our reserves credit by credit and the careful management of expenses.

Coupled with our strong focus on customers we believe we are well positioned for the future with confidence in our strategy and a dedicated work force to deliver the results.

Net income in the third quarter was $19 million, up from $18 million in the second quarter and from $9 million in the first quarter.

After preferred stock dividends to the US Treasury Department of $34 million or $0.22 per share we had a net loss applicable to common stock of $15 million or $0.10 per share.

Loan demand continued to be weak and average core deposits continued to increase as businesses and consumers remained cautious in this economic environment.

New and renewed loan commitments totaled $11.8 billion in the third quarter, an increase of $1.6 billion from the second quarter.

Our lending efforts continue to be focused on new and existing relationship customers with the appropriate credit standards and return hurdles in place.

We are working hard to ensure we effectively manage credit particularly in this economic environment.

Early recognition of issues continues to be key.

We have moved credits to workout area at the first signs of significant stress.

The provision for loan losses was stable in the third quarter with chargeoffs similar to the second quarter as expected.

Over the past 15 months we have reduced by 46% our exposure to residential real estate development, the main focus of our credit issues.

Nonaccrual loans were charged down 41% as of September 30th versus 39% at June 30th.

Loans past due 90 days or more and still accruing decreased $49 million or 23%, from June 30th.

The allowance to total loans ratio increased 30 basis points to 2.19%, from June 30th.

All of these metrics are reflected in our outlook in which we expect to see a modest reduction in net chargeoffs in the fourth quarter assuming there is no significant deterioration of the economic environment.

As expected the net interest margin of 2.68% was relatively stable, reflecting improved loan spreads and the maturing of higher cost time deposits more than offset by a higher level of excess liquidity.

Excluding excess liquidity, represented by average balances deposited with the federal reserve bank, the net interest margin would have been 2.84%.

Our capital ratios once again increased from already strong levels as evidenced by a tangible common equity ratio of 7.96%, an increase of 41 basis points from June 30th of this year.

With regard to the $2.25 billion in preferred stock we still plan to redeem it at such time as feasible with careful consideration given to the economic environment.

It remain a top corporate priority.

We continue to focus on expense controls with year to date expenses down 9% from a year ago.

Looking at our footprint I will provide some comments on what we see in each of our primary markets.

Generally things seem to have bottomed.

Customers are speaking in more positive tones than they were just three months ago.

However they remain cautious and continue to hold the line on expenses, inventory levels and capital expansion plans.

In our western market the California economy is showing signs of strengthening, particularly in the middle markets and among small businesses.

The key and still missing ingredient to a healthy rebound there continues to be job growth.

However the housing situation appears to be stabilizing as evidenced by home sales which so far this year are running about 25% above last year's pace.

Also encouraging, the median existing home price in California has increased 18%, since bottoming in February.

We are hopeful that this leads to further stabilization of our residential real estate development portfolio in California.

While the economy has slowed in Texas it has consistently outperformed the national economy and will likely outperform again in 2009.

The state is less burdened than most by an overhang of unsold houses and with the unemployment rate in Texas running almost 2 percentage points below the national average, the state continues to attract businesses and people.

One of the reasons for Texas's success is the fact that the economy is well diversified.

In fact there are more Fortune 500 companies headquartered in Texas than in any other state.

We have a relationship with well over half of them today and that number continues to grow.

We recently announced the opening of our first lead certified banking center in Fort Worth, Texas and a new banking center in the southern sector of Dallas as a further demonstration of our commitment to the community.

We believe we are well positioned in our Texas market to develop new relationships and expand existing ones as the economy improves.

Michigan has been battling fierce economic head winds for many years in large part due to restructuring of the automotive industry for which we were prepared.

This is evidenced by our relatively low auto related nonperforming assets and chargeoffs throughout the cycle and the fact we no longer have any direct exposure to Chrysler or General Motors.

Our experience in dealing with Michigan's challenges over many cycles helped us weather the economic downturn in that state.

It remains an important market for us.

The annual FDIC summary of deposits report that came out last week shows us ranked number one in deposit market share in Michigan.

In Florida our customers have been able to manage through challenging market conditions in the state where we have limited land and single family housing exposure.

However the prolonged recession took its toll with respect to large condominium projects which have been delivered with substantial pre-sales but where there has been limited access to mortgage financing.

Our Florida condominium exposure is limited to about $127 million.

It is encouraging to see the Case-Shiller House Price Index show increasing prices in both Miami and Tampa in June and July.

Turning to our 2009 corporate outlook, we believe loan demand will be still be subdued as historically it has taken a couple of quarters after a recession ends for loan demand to return.

We expect to see continued net interest margin expansion.

We also expect to continue to diligently manage our credit issues.

Finally, we plan to maintain our strong focus on expense controls as we successfully manage through this phase of the economic cycle.

And now I will turn the call over to Beth and Dale who will discuss our third quarter results in more detail.

Thank you, Ralph.

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

Turning to slide three, we outline the major components of our third quarter results compared to prior periods.

Today we reported third quarter 2009 earnings of $19 million.

After preferred dividends of $34 million, the net loss applicable to common stock was $15 million or $0.10 per diluted share.

Slide four provides an overview of the financial results for the third quarter compared to the second quarter.

Average earning assets decreased $2 billion including a $2.9 billion decline in loan outstandings.

The continued slow economic environment has resulted in lower loan demand in all of our markets.

We have had very strong deposit generation again in the third quarter with core deposits excluding financial services division increasing $1.1 billion, including an $835 million increase in noninterest bearing deposits.

The net interest margin in the third quarter was relatively stable as expected.

Increased loan spreads, reduced deposit rates and the maturing of higher cost time deposits were more than offset by a low return on excess liquidity which I will discuss in more detail in a minute.

Credit quality metrics were stable, consistent with our outlook.

Net credit related chargeoffs decreased to $239 million and the provision of $311 million was consistent with the second quarter.

The allowance for loan losses to total loans increased in the third quarter to 2.19%, compared to 1.89% in the second quarter as we continue to reserve for loan losses substantially in excess of chargeoffs.

Noninterest income included securities gains.

As indicated last quarter we further reduced our investment securities portfolio as we no longer need down side interest rate protection and took advantage of favorable market conditions to sell mortgage backed government agency securities at a $102 million gain.

We continue to successfully control expenses.

The third quarter results reflected a decrease in salaries, incentives and share based compensation over year ago levels.

Our work force has been reduced by approximately 1000 positions or 9% since September 2008.

Year to date noninterest expenses decreased 9% from the same period last year.

Our capital position is strong, and was further enhanced in the third quarter.

The Tier One capital ratio increased to an estimated 12.18%, at September 30th.

In addition, the quality of our capital is solid as evidenced by our tangible common equity ratio of 7.96%.

Turning to slide five, average loan outstandings declined in the third quarter compared to the second quarter as a result of low demand in all of our markets.

We had $11.8 billion in new and renewed lending commitments in the third quarter, up from $10.2 billion in the second quarter.

Markets outside of the midwest comprised 63% of average loans.

Overall customers experienced lower sales volumes which resulted in lower accounts receivable financing requirements.

Also they continue decreased inventory levels as they cautiously manage their businesses in the weak environment.

The successful cash for clunkers program reduced dealer inventories and contributed to national dealer services average decline in outstandings of $514 million or 14% from the second quarter.

Decreases in the third quarter were also noted in middle market, global corporate banking, commercial real estate, and energy.

Line utilization was 47% in the third quarter, down almost 4 percentage points from the second quarter.

On slide six we provide details of our investment securities portfolio.

We pro actively sold $2.8 billion of mortgage backed government agency securities in the third quarter.

Over the last two years we had significantly increased the size of the portfolio to dampen the effect of the decline in interest rates.

It has served its purpose well -- we purchased the securities at very attractive prices and wide spreads relative to US treasuries.

Further interest rates reductions are unlikely so the need to hedge declining interest rate risk has diminished.

For these reasons it has been prudent to reduce the size of the portfolio.

Our guideline is to maintain the investment securities portfolio, excluding option rate securities to add about 10% of average assets.

As we reposition the portfolio, we temporarily increased holdings of short term US treasury securities resulting in a lower overall yield on the available for sale portfolio in the third quarter.

As shown on slide seven we had very strong deposit growth again in third quarter in all of our major markets and all commercial lines of business.

Average core deposits excluding the financial services division increased $1.1 billion, including a $835 million increase in noninterest bearing deposits.

I'm pleased to say that to date we've retained the majority of the balances of maturing customer CDs, many of which were put on a year ago at rates over 3%.

Deposit pricing conditions remain competitive in the third quarter and we believe we have hit rate floors on a number of our products.

However we were able to selectively decrease rates in certain deposit categories.

As outlined on slide eight, the net interest margin in the third quarter was relatively stable at 2.68% compared to 2.73% in the second quarter.

Excluding the impact of excess liquidity, the net interest margin would have been 2.84% in the third quarter, an increase of 3 basis points from 2.81% in the second quarter.

The increase was a result of our continued success in expanding loan spreads and selectively reducing deposit pricing combined with maturities of higher cost time deposits.

In the third quarter excess liquidity had an approximately 16 basis point negative affect on the margin compared to an 8 basis point impact in the first and second quarters..

The excess liquidity resulted from strong core deposit growth and the sale of mortgage backed government agency securities.

Excess liquidity was represented by an average of $3.5 billion, deposited with the Federal Reserve Bank in the third quarter up from an average $1.8 billion in the second quarter.

At the end of the third quarter this position had decreased to $2.2 billion, with the expectation that it will dissipate further in the fourth quarter.

This excess liquidity is above and beyond the investment securities portfolio which will continue to provide a large reservoir of liquidity.

On slide nine you can see we have consistently reduced personnel over the past several years, even while we were building new banking centers.

We focus on expense management on a daily basis.

Our largest expense item is salaries and therefore management of staff levels is key.

Full time equivalent staff decreased by approximately 100 employees from June 30 and 1000 employees or 9% from year ago levels.

We have been working hard to leverage technology and maximize productivity to support growth.

Now Dale Greene, our Chief Credit Officer will discuss credit quality starting on slide 10.

Good morning.

As expected third quarter net credit related chargeoffs and the provision for loan losses were similar to the second quarter.

Provision for credit related losses of $313 million, exceeded net charge offs by $74 million.

Economic conditions continue to be challenging, particularly in residential real estate development in the western market and middle market in the Midwest.

Net credit related chargeoffs were $239 million in the third quarter, a reduction from the second quarter.

Net chargeoffs included $91 million in the commercial real estate line of business, primarily related to residential real estate development, down from $108 million in the second quarter.

The decline in commercial real estate chargeoffs reflects the fact that we have been working hard to reduce the portfolio and have been taking the necessary charges to reflect declining values over the past 18 months to 24 months.

We have also seen value stabilize in select markets.

The commercial real estate exposure we have to commercial mortgages for owner occupied properties of our middle market and small business customers continues to perform in line with our C&I loans.

These mortgages are typically made in conjunction with the full relationship and are cross collateralized with the working capital lines of credit.

Turning to slide 11, total nonperforming assets were $1.3 billion or 2.99% of total loans and foreclosed property.

The growth in nonperforming assets decelerated in the third quarter.

Excluding the commercial real estate line of business nonperforming assets declined by $10 million, to $531 million.

Our watch list loans total $8.2 billion at the end of the third quarter, and reflect that we continue to proactively recognize issues and quickly move credit to our workout areas at the first sign of significant stress.

In line with the economic environment, the commercial real estate line of business and middle market particularly in Michigan continue to drive negative migration.

Compared to residential real estate development we believe that the loss severity will be substantially less for the remainder of the portfolio.

Loans past due 90 days or more and still accruing declined to $161 million, from $210 million in the second quarter.

The allowance for loan losses was 2.19% of total loans, an increase of 30 basis points from the second second.

The allowance for loan losses was 80% of nonperforming loans.

We written down our nonaccrual loans by 41%, which reflects current appraised values.

In addition it is important to note that Comerica's portfolio is heavily comprised of commercial loans which in the event of default are typically carried on the books as nonperforming assets for a longer period of time than our consumer loans which are typically charged off as soon as they become nonperforming.

Therefore banks with a heavier commercial loan mix in their portfolios tend to have lower NPA coverage ratios than do retail focused banks.

On slide 12 we provide information on the makeup of the nonaccrual loans.

A large portion of the nonaccrual loans continues to be commercial real estate, which consists primarily of residential real estate development loans.

Commercial real estate nonaccrual loans increased $75 million in the quarter, and will take longer to resolve than C&I problem loans due to the nature of the underlying collateral.

Nonaccruals decreased in global corporate banking by $26 million, small business $14 million, and energy which falls within other business lines declined by $14 million.

By geography, 42% of the nonaccruals are in the western market, which 31% are in the midwest market.

During the third quarter of 2009, $361 million of loan relationships greater than $2 million, were transferred to nonaccrual status, a reduction of $58 million from the second quarter.

Of these inflows commercial real estate line of business contributed $211 million and middle market had $89 million, both slight increases from the second quarter.

Leasing with $29 million in inflows and global corporate banking with $26 million in inflows both decreased.

Slide 13 provides further detail on our nonaccrual loans.

Collateral values on nonaccrual loans are reviewed every quarter as part of our credit quality review process.

We have written down nonperforming loans by 41% compared to 32% a year ago.

The carrying value plus the reserve reflected current market conditions.

Foreclosed property totaled $109 million, and reflected our efforts to work through the issues in the residential real estate development portfolio.

We had only $2 million in reduced rate loans and $10 million in troubled debt restructurings included in nonperforming assets.

We also had $8 million in trouble debt restructurings including in performing assets.

The total amount of TDRs was unchanged from the prior quarter.

When negotiating troubled credits we avoid situations that would result in granting below market terms unless the loan is going to be nonaccrual regardless of the outcome.

Therefore a few credits are reported as performing TDRs.

We had no held for sale loans.

In the third quarter we sold $65 million in loans.

10 loans totaling $41 million were nonperforming.

The average price was close to carrying values plus reserves.

These loans were distributed across several industries and geographies.

We have seen an increase in secondary market activity in the last several months.

On slide 14 we provide a breakdown of net credit related chargeoffs by office of loan origination.

Net chargeoffs for the midwest which made up 42% of the total were relatively stable compared to the second quarter.

About half of these chargeoffs or $50 million were from the middle market where we continued to see softness in a very challenging environment.

We saw a decline in commercial real estate line of business which accounted for $17 million.

And relative stability in small business with net chargeoffs of $14 million.

Western market chargeoffs made up 40% of the total.

The increase in the second quarter was driven by commercial real estate line of business which totaled $58 million, virtually all residential development related which I will discuss further in a moment.

Global corporate banking totaled $18 million, which was a small increase from the second quarter.

All of the lines of business were stable.

Texas had an increase in net chargeoffs from very low levels and we believe the issues remain manageable with no particular area of concentration.

As far as Florida, while net chargeoffs declined in the third quarter, we expect some lumpiness as issues continue to be concentrated in condo developments which totaled $127 million with continued difficulty closing unit sales.

Other markets net chargeoffs were down significantly and continue to be focused on real estate developments, which are more diversified by our geography and project type.

Slide 15 provides detail on net loan chargeoffs by line of business.

The commercial real estate line of business continues to drive the chargeoff levels.

Chargeoffs in Midwest middle market increased as expected in the current economic environment.

Chargeoffs for wealth and institutional management, small business and personal banking were relatively stable.

On slide 16, we provide a detailed breakdown by geography and project type of our commercial real estate line of business which declined $222 million from the prior quarter.

There is further detail provided in the appendix to these slides.

At September 30th, 25% of this portfolio consisted of loans made to residential real estate developers, secured by the underlying real estate.

Michigan outstandings of $656 million represented 13% of the portfolio, and were down $136 million or 17% from a year ago.

Florida outstandings of $589 million represented 12% of the portfolio.

As shown on slide 17, as of the end of the third quarter, we reduced residential real estate development exposure by $1.1 billion or 46% since June of 2008.

Total single family construction outstandings were down about $700 million or over 50% from June 2008.

Turning to slide 18, we display project type and geographic break down of net chargeoffs with the commercial real estate line of business.

Residential real estate development loans continue to account for the bulk of these chargeoffs in the third quarter.

Chargeoffs decreased in Florida and other markets.

Midwest was stable, and the western and Texas markets saw small increases in chargeoffs.

In the western market we have seen prices for single family homes stabilize and even increase in select areas.

However, land prices remain soft and in some locations continued to decline.

The increase in western chargeoffs in the third quarter largely reflects a single residential project which has a large land component.

As far as Florida we have limited land exposure, and single family exposure has been managed down for sometime.

The decline in chargeoffs in Florida can be attributed to the condos that were delivered to the market in the second quarter and the resulting chargeoffs we took at that time.

We expect some lumpiness in chargeoffs for this segment as condo closings are occuring, but at a very low level.

Many presales have been unable to close as buyers have had difficulty obtaining mortgages.

We continue to work to help resolve the issues.

While we continue to see softness in the nonresidential real estate segment as you can see on the slide, chargeoffs have been small and reflect that we have had far fewer defaults and much lower loss content than the residential construction segment.

Slide 19 provides an overview of our consumer loan portfolio which includes the consumer and residential mortgage loan categories on the balance sheet.

This portfolio is relatively small, representing just 9.5% of our total loans.

These loans are self originated and are part of a full service relationship.

The residential mortgages we hold on our balance sheet are primarily associated with our private banking customers.

Net chargeoffs for residential mortgages increased in the third quarter, as customers felt the stress of the prolonged weak economy.

The home equity loan portfolio has held up relatively well, with a decrease in chargeoffs in the third quarter, and 30 and 90 day delinquency rates were relatively stable.

On slide 20 we provide detail on our shared national credit relationships.

Shared national credit outstandings were $9.9 billion at the end of the third quarter, an $830 million decline from the second quarter, and $2 billion decrease from a year ago -- or from year end.

This category is very granular consisting of approximately 1000 borrowers.

Outside of global corporate banking where you would find larger syndicated facilities, the majority of our shared national credits have bank groups consisting of seven or fewer banks.

We work with small banks of banks -- we work with small groups of banks to mitigate concentration risk.

We do not compromise credit standards, return expectations or exposure guidelines in order to participate in a syndicated facility.

The credit issues we are seeing with shared national credits are similar to those we have seen in the bank as a whole, which are primarily driven by residential real estate development.

Based on the recently published results of the annual shared national credit review, our credit metrics are significantly better than the national average as measured by classified, criticized and nonaccruals as a percentage of total commitments.

Slide 21 outlines the recent performance of the nondealer automotive supplier portfolio.

We have reduced our loans outstandings by $1.5 billion, or 57% since the end of 2005.

This portfolio now represents less than 3% of our total loans and we plan to continue to reduce our loans to the sector.

The industry continues to be under stress but we believe the issues in our portfolio remain manageable.

Nonaccrual loans were steady at $32.8 million at the end of the third quarter.

Third quarter net chargeoffs were $22 million down from $27 million and were primarily related to one customer.

In our auto dealer exposure, average outstandings declined $1.5 billion, or 33% over the past year in line with falling sales volumes of new cars.

We continue to have excellent credit quality in this portfolio with no nonaccruals or chargeoffs in the third quarter.

In fact we have not had a significant loss in the dealer portfolio in many years.

A slide with further detail can be found within the appendix of this presentation.

To conclude on credit, we conduct in depth reviews of all of our watch list credits at least quarterly, to ensure that we have an appropriate workout strategy as well as reserves in carrying values that reflect our collateral assessment.

We continue to obtain current appraisals on residential and commercial properties and take chargeoffs and provide reserves to reflect those values.

This proactive action has resulted in the current carrying value of nonperforming loans of 59%.

While the US economy has bottomed we expect to continue to see the impact of the weak economy on our customers, particularly within residential real estate developers and Michigan middle market.

We are pleased that the inflow of nonperforming loans slowed in the third quarter.

Also noncommercial real estate nonperforming loans declined in the quarter.

Past due loans also decreased.

These metrics support our outlook for net credit related chargeoff to improve modestly in the fourth quarter.

We expect the provision for credit losses will continue to exceed net chargeoffs.

Now I will turn the call back to Beth.

Thanks Dale.

Turning to slide 22, our Tier One capital ratio is well in excess of the well capitalized threshold as defined by the regulators and it has increased in each of the past four quarters.

Turning to slide 23 in the tangible common equity ratio we have maintained a solid capital structure with a large component of common equity for many years.

Our tangible common equity ratio, which was 7.96% at the end of the third quarter increased from the second second and historically has been well above the average ratio of our peer group.

Slide 24 updates our expectations for 2009.

While the economic recovery appears to be underway, management expects subdued loan demand as loan growth typically lags other economic indicators.

We believe that the fourth quarter net interest margin will increase as result of maturities of higher cost CDs and wholesale funding and a reduction in excess liquidity.

In addition we expect the margin will continue to benefit from improved loan pricing.

While the economy -- with the economy beginning a recovery, our outlook is for net credit related chargeoffs to improve modestly in the fourth quarter.

Provision is expected to continue to exceed net chargeoffs.

A current topic of interest in the industry is deferred tax assets.

We paid significant taxes for 2008, and are paying taxes for 2009 so we do not believe there is risk of a deferred tax writeoff in the foreseeable future.

We believe that our strong capital position, vigilance in managing credit and building reserves as well as focus on controlling expenses will assist us in managing through the current economic environment and position us well as the economy improves.

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

(Operator Instructions) Our first question comes from the line of Steven Alexopoulos with JPMorgan.

Morning Steven.

Dale could we start with your outlook with calling for modest improvements in the chargeoff levels in the four quarter -- if we break that into two areas, one being real estate construction loans and two being C&I loans, is this outlook solely driven by expected improvement in the construction side, and what is the outlook for the C&I book?

I said a couple of things, I would say part of it is related to the fact that the construction loan portfolio continues to perform fairly well as you can see by some of our slides.

We've worked the resi way down as you can see.

And, if you look at the composition of the non-resi construction portfolio, nonaccruals and chargeoffs there, really it's all resi.

That continues -- the income producing side continues to look fairly good.

If you turn to C&I, while as we said we think we are going to be challenged on the C&I front particularly in Michigan and middle market.

I think the stability we've seen there is likely to continue and frankly unless there is some economic -- significant economic issues I would expect that would continue to be the case.

Is the bulk of the decline in the balance sheet now done and what's your best guess in terms of the timeline it will take to realize the [284 nim] without the excess liquidity.

Our expectation is that margin will improve in the fourth quarter because of dissipation of a lot of the excess liquidity.

I think I mentioned in the slides that we had $2.2 billion at September 30 on deposit with the fed.

That was down from the average level of $3.5 billion during the quarter.

We do have $1.8 billion of retail brokered CDs that mature in the fourth quarter that carry a 3.45% yield on them.

So we will soak up some of the excess liquidity with maturities in the quarter.

But part of it will be a function of how deposits go through the quarter as well as loans.

Loan demand I think will continue to be weak.

Our expectation is a lot of that excess liquidity will dissipate in the fourth quarter, and you will see a nice bounce back in the margin.

That would take the balance sheet down by another $2 billion or so?

Again it depends on what happens with loans and deposits, but in terms of liquidity yes.

In terms of deposits, our expectation is a substantial amount of that will be dissipated in the fourth quarter.

Perfect, thanks a lot.

Thank you.

Our next question comes from the line of Craig Siegenthaler with Credit Suisse.

Morning Craig.

Good morning.

Just asking the chargeoff question a different way.

I'm wondering what gives you confidence -- not by let's say loan mix -- but more is it a function of the improvement we have been seeing in the net inflows of NPLs and delinquencies, is that really a driver.

Or is it the more of a driver of the low valuation of your book.

What drives the confidence behind the lower net chargeoff level you expect in the fourth quarter.

Well, several things.

One is I think that while we are not out of the woods on the residential construction side if you segment residential from the old portfolio we have been talking about for a long time, startup piece, the starter home piece, that's way down below $300 million.

Really I think we managed that very effectively -- marked that book down fairly aggressively over time with the appraisals we've gotten.

So that piece, while still challenging, we feel pretty good about in terms of where we've got it marked.

If you look at the rest of the residential pieces while it's still challenged, if you look at the number of projects we have there -- not an enormous number -- we have great detail on every project, we feel pretty good about where those marks are and what is going on with those residential projects.

If you look at the rest of the nonresi construction book which is income producing and you look at the what is happening there -- the vast majority of the projects the construction risk is behind us, the large majority of those stabilized lease off and cash flows, so those look to be performing fairly well so far.

There'll be some issues there is of course, but I don't view them to be overwhelmingly negative.

If you turn back to the C&I book where clearly we in Michigan continue to fight the battle -- I think the battle has been fought fairly successfully, chargeoffs there are fairly stable.

I think even if the economy doesn't improve materially, if it continues to bounce along where it is, given the fact that we marked the book down so aggressively, and frankly given the evidence of some of the recent loan sales, what that suggests to us -- we feel pretty good about where we got it all positioned today and so those are the pieces in my judgment of the answer.

Dale does that mean you feel good we past the peak in net chargeoffs or do you think we can visit higher levels again in 2010?

I hope not.

I -- that's a tough one to answer.

As we said -- we said at the second quarter call that we thought the third quarter would be consistent with the second quarter -- it's actually a little better certainly on the chargeoff side.

We said the fourth quarter we think will be modestly better than that assuming no bad economic news.

And that's -- I believe that based on what I said.

So, if the trend continues, we may have in fact peaked, but I would not be bold as to say that -- things can happen, individual projects that you are working on, something can go awry, something unanticipated.

It's just difficult to make a blanket statement.

But I would hope generally we would see a declining trend.

Great.

Thanks for taking my questions.

Thank you.

Next question comes from the line of Gary Townsend with Hill Townsend Capital.

Morning Gary.

Good morning how are you all?

Good.

Could you discuss the -- your position vis-a-vis the government and willingness, ability to repay the TARP at present.

As we said earlier, Gary, we are looking at that, we review it based on where we think the economics are, where we think credit is, and the outlook is.

And we would like to pay it back as soon as feasible.

We will continue to review that and take the necessary steps accordingly.

If I could press you on that, are we looking at six months, three quarters, a full year.

We have not set a time frame Gary, but as I said it's a top corporate priority we would like to do it as soon as feasible.

And would it be fair to say you have ongoing discussions with the regulators on the same subject.

We have ongoing discussions as we said the past with the regulators on all of the things that are important based on where we are and those will continue.

This was the second consecutive quarter where the level of securities gains was high.

Could you just discuss the strategy there and perhaps the opportunities that the market is giving you?

Yes, as we said in our outlook, Gary, we are aren't expecting significant gains in the fourth quarter, so we are largely through the repositioning of that portfolio on its way to a smaller level than it was certainly a year ago.

And so I don't see that we will have significant securities gains in the fourth quarter.

Thank you.

Thank you, Gary.

Our next question comes from the line of Jeff Davis with FTN Equity Capital.

Good morning, Jeff.

Good morning, two questions -- one Beth in terms of the margin headed up in the next couple of quarters or 4Q -- does net interest income turn up rather than the margin or regardless of what the margin is.

Secondly, Ralph or Dale, I missed on the beginning of the call and you touched on it some -- but if you could talk a little bit more about is there any real pickup out there with the backdrop of your loans continue to decline and liquidity continues to build -- is the inventory story build for the economy is that real, are you really seeing early signs maybe within the dealer book or dealers moving to rebuild inventories or is it all just we are in holding pattern to wait and see.

On the first.

I'm sorry, if I could add, then also in relation to the reduction in loan if I've got it, if I'm correct -- what $1.3 billion between $830 million on the [snick book] and $500+ million on the dealer book -- did corporate bond issuances continually impact reduction in loans for you all this quarter or even last quarter?

Jeff, the first question I think was on net interest income what it would look like in the fourth quarter.

We certainly see the margin expanding in the fourth quarter -- obviously net interest income will be a function of what happens with loans.

I think loan demand remains weak, I think this will get covered a little-- we will see an uptick in the dealer loans outstanding in the fourth quarter but whether it will offset other potential further declines is not clear obviously at this juncture.

It's hard to answer without the loan question -- the net interest income.

But clearly we are positive about the expansion in the margin that will come in the fourth quarter.

Again, assuming liquidity dissipates at the level that we anticipate.

If you think about your question regarding loan growth, loan opportunities and so forth, I have a few responses.

One is that we are clearly seeing opportunities, we are clearly looking for those.

Yes it's -- the credit underwriting is more strict no question, certainly the pricing is important as well as the full relationship, that's part of it.

The dealer book will grow simply because inventories have fallen so far that they need to be replenished which helps not only dealers but our suppliers which have working capital needs.

My big issue is around capacity utilization, one is that there is a fair amount of capacity in the system that has to be utilized and that's happening gradually.

I think business people just generally while there may be a more positive feel there -- there is still a fair amount of caution out there right now and I think it will be a while until we see that change and I think that will also be a while until we see employment growth, which will be important to our recovery.

While we see opportunities I think it will be muted for a while.

That's not unusual in a recovery of a recession.

It usually lags a couple of quarters.

And, I would say, of our markets that we are seeing a little pick up of interest in California.

Obviously it went into the recession first and we are seeing a little more activity there than perhaps other markets.

You asked a question on corporate bond issuance, I don't think it had a big impact on either quarter frankly in terms of the loan decline.

Most of these customers are not -- are privately held , are not accessing the

Thank you.

Our next question comes from the line of Matt O'Connor of Deutsche Bank.

Good morning, Matt.

Liquidity is quite strong, the capital is strong and building, and you're managing credit better than many and better than frankly I had thought.

I guess I step back and think about what are the opportunities to go on the offensive in terms of FDIC deals or other things that you can do to help longer term earnings power besides what the environment will give you.

We are certainly looking at all of the opportunities and as I mentioned earlier in response and in my remarks or in response to Gary, certainly a top corporate priority is paying back the TARP.

We are always looking at opportunities that avail themselves as you mentioned in institutions that come through the FDIC, but again we are being very diligent, those need to fit our model, in our markets, and fit in culturally as well as otherwise.

But we are certainly looking at the opportunities.

From a mix point of view, obviously you are heavily concentrated on the commercial side, would you be more open to trying to balance it out from a retail banking point of view.

In the markets as I mention if we found an opportunity that fit that was more retail oriented than business oriented we certainly would.

The deposit and our products would fit together very well.

Just separately I know it's impossible to know, but I'll ask anyway.

Any thought on when loans will start to flatten out, at what level, obviously down quite a bit quarter to quarter because the weak demand and the stuff you mentioned.

Any guess on when that bottoms at what level.

As I think we mentioned as Dale and Beth were going through the previous question, typically in a recession and coming out of a recession, you find a lag of a couple of quarters before you see that begin to build.

And many have talked about this maybe slower because of the fact and Dale mentioned overcapacity that's out there that needs to fill and that will start to generate jobs which will then begin to -- in my opinion -- ramp up the acceleration in the economy.

Okay.

Thank you very much.

Thank you.

Our next question comes from the line of Chris Mutascio with Stifel Nicolaus.

Good morning all.

Thank you for taking my questions.

Beth if I look on page eight and I look at the margin, excluding liquidity impact, it looks like the core margin was up about 3 basis points.

I understand the margin guidance going forward is that the stated margin will go up as excess liquidity declines.

If I look at the core margin being up 3 basis points that's nice to see it up -- what is holding that back from expanding even more in the quarter, given the fact you've had noninterest income -- or noninterest bearing deposits growing, loan spreads are widening, what is perveying the core margin from going up more than it did.

We had an impact -- certainly nonaccruals have a very minor impact as well as just some of the repositioning of the investment portfolio during the quarter had an impact.

I think you will see -- I guess what I would focus you on is -- if you look at our loan yields our loan yields were up 17 basis points in the quarter.

I think that's pretty significant given one month LIBOR was down 10 basis points, and three month LIBOR was down 44 basis points.

So to be up 17 is a very positive thing.

At the same time our core interest bearing deposits were down 19 basis points in terms of cost.

So what held us back fundamentally is this excess liquidity and the mix of having some temporary holdings of treasury securities in the investment portfolio as we reposition the investment portfolio.

Fundamentally in the business loan yields are improving and spreads -- deposit cost decline, will decline further -- given I mentioned we had $1.8 billion in retailed brokered CDs maturing in the fourth quarter that yield 3.45%.

The key drivers there are well positioned to improve the margin as we go forward.

Can you provide on the guidance on your provision expense exceeding net chargeoffs will they exceed net chargeoffs at the same pace as we have seen the last couple of quarters.

That's very hard to predict.

That's a bottoms up process we go through.

It is our expectation that it will exceed it -- by how much is very difficult to predict at the moment.

If I could ask one extra question -- for Dale I've always enjoyed your macroview on credit.

When you look at the credit environment coming out of this recession and everyone is trying to look to get to -- what is the normalized earnings going to be, and when are we going to get there for all these banks.

Once we peak in credit losses, do we substantially fall from that peak like we have had seen after the 1991 recession and after the 2001 recession or is this different than that.

I don't know.

This is -- all of this is different so it's hard to predict.

I guess it was my view -- I don't think it's going to look quite like that -- my view is it's a gradual improvement.

I think it's going to take some time for this recovery to really take hold, I I think lit be a more modest recovery than past recoveries.

The unemployment question weighs heavily on me in terms of when that begins to reverse.

Which will be part of the answer.

My own view is I don't think it falls off a cliff and suddenly gets materially better right away.

I think it takes some time.

That's what I would expect would happen.

Thank you very much.

A lot of that will depends on the economy and the way as Dale prefaced we are all looking at a slow recovery.

Historically there has been the V recoveries in a lot of cases and I think that's what's driven the rapid increases in credit.

So it will really be tight.

Unemployment is going to be a key ingredient.

Unemployment and the economy will dictate that.

Our next question comes from the line of Heather Wolf with UBS.

Good morning Heather.

Hi, good morning.

Just a follow up to that last question, it seems that questions regarding the commercial real estate cycle will give us the answer, and some of your peers posted some pretty sharp deterioration in plain vanilla commercial mortgages.

You guys like like you are holding in well, can you talk about the underlying trends that you might be seeing.

Again Heather I think if you look at the composition -- if you look at the construction portfolios that we have and the various pieces of it, since we haven't really made a new construction loan whether it be resi or nonresi in some time, what you are really seeing is a lot of projects nearing completion or being completed so the construction risk becomes less of an issue.

You're seeing the resi component still being the key issue and we continue to deal with that and continue take the marks and so forth.

I think that will be a bit of a strain, a bit of a head wind.

In think on the income producing side when you look at what we've got there, again it's a fairly limited number of projects frankly.

These are projects that are largely completed, these are projects that are generating stabilized cash flow for the most part.

These projects have guarantees behind them.

Strong individuals who can and have stepped up to support the projects and so forth.

Has a lot to do with -- I think the type of underwriting we did back a few years ago.

When we put these on the books and the fact that we haven't added a lot to them -- I'm not saying that -- there will be issues clearly there are issues, it's within the realm of our expectations.

If I could add on that on the C&I side, both owner occupied as well as not owner occupied C&I, our metrics are very good -- except for middle market Michigan which has seen more stress.

If you look across the rest of your footprint middle market is good, stable, small business, wealth management, relatively stable not seeing any particular concerns there and certainly not on the owner occupied side.

Great.

Just a quick follow up on capital, I know you guys are materially above the well capitalized thresholds.

Are you having any conversations with your regulators about changes to that well capitalized threshold on Tier One.

There are have been no specific pronouncements or dialog related to changing the minimums or any particular changes in those.

There is a lot of rhetoric in terms of the US Treasury has made comments, international Basel regulators have made comments about capital, but there have been no specific discussions or pronouncements that would shed any light on that.

Okay.

Great, thanks so much.

Thank you.

Our next question comes from the line of Justin Maurer with Lord Abbett.

Just -- Dale we will keep picking on you here.

Relative to Steve's earlier question about what you envision as you guys talk about the fourth quarter credit being modestly better.

Do you have stats on -- you talk about the entire portfolio has got the 41% mark, what it is in resi construction.

Is that relevant in terms of the number?

Well I don't know what it is off the top of my head -- if you think about the fact that the bulk of the issues are in nonperforming, almost 60%, I think it's 58% are in residential construction, clearly you can tell from that it's much more heavily weighted in that direction.

You can tell by extrapolating that a big piece of the marks would be certainly related to residential construction.

So again is it the idea that that stuff should start to tail off pretty meaningfully as you guys -- as that portfolio has aged so much given the fact you guys exited that -- and weren't there in a meaningful way in the first place.

Is it a thought it's going to replaced by the later cycle credits that everybody is fearful of.

Well, I think that you're right.

As we said earlier we haven't added to the pile over the last few years, clearly you can see the slide that shows how much we worked the residential construction loan book down over the last 15 months which has been substantial.

And the nonresi piece is as I said earlier a lot of that construction is completed, we are dealing with that -- most of which has stabilized cash flow.

For us we don't since we don't have a heavy consumer presence the whole issue around late cycle for us not really a significant issue per se.

And the fact if you look at what we have in the consumer loan book, particularly home equity that's performing very well.

In fact, the delinquency statistics are better this quarter than last.

For us, it's just working through the general malaise in the economy primarily with our middle market and small business customers and I think so far we have done a pretty good job of managing through that.

If we truly are at the bottom and seeing some improvement that gives me some hope that the kinds of numbers we are looking at what will in fact materialize.

Then Beth quickly too, Jeff's questions about [NII] verses nim, I know it's all a function of where the loan portfolio stands at the end of the year, during the quarter.

Would you guys be hopeful that one could offset the other potentially given the pressure we saw in the last couple of quarters in earning assets?

It's very hard to know on the loan side.

As I described earlier related to the margin expansion will be -- we are pretty comfortable we will see a pretty nice expansion in the fourth quarter.

I can't say at this juncture whether that could offset -- I just don't know where loans are going to be.

Loans are a very difficult thing to predict.

If we had things to make projections about, that's one of the hard ones.

While we are seeing indications of interest as I mentioned earlier in California and I think we'll see some dealer be higher, it's not clear whether that will offset the other just conservatism that businesses are using to manage their businesses.

So it's a hard question to answer but I am confident we will see a nice expansion in the margin.

A lot will depend on confidence and where the economy is going as Beth said.

Thanks a lot, guys.

Good luck.

Thank you.

Our last question will come from the line of Brian Klock with KBW.

Obviously most of my questions have been answered but I have a couple of extra ones to throw at you.

Beth, with the tax rate there was a third quarter adjustment of tax credit in there.

The other noise with the return to provision adjustments usually takes place in the third quarter.

If we -- for modeling purposes -- do we go back to the normal guidance you the gave us last quarter that effectively a, say 35% effective tax rate, but you still have the $15 million low income housing tax credits in there quarterly.

That's it.

Dale I'm sorry if you've given this, did you give us the watch list balances for the third quarter.

Yes they -- we had them reported in here at $8.2 billion I believe was the number in the quarter.

Okay.

I guess within that watch list, obviously it doesn't look like there was much migration into lower grading because your provision levels didn't change much.

The impact of the exams and with the regulatory outlook looks like your credit is actually stable -- pretty stable.

I think that from the perspective of what we are seeing -- for us it's really identification, early action, moving stuff to the workout areas, all of our systems are geared particularly in this environment exactly to that point and that's exactly what we are doing.

That's one of the reasons at least to date we've seen somewhat better improvement in terms of the default characteristics.

Okay.

Thanks for taking my questions.

Thank you.

Would like to thank everyone for joining us today and we appreciate your continued interest.

Thank you very much.

Ladies and gentlemen, this does conclude today's conference call, thank you for your participation you may now disconnect