Fifth Third Bancorp (FITB) 2006 Q2 法說會逐字稿

Good morning. My name is Crystal, and I will be your conference operator today. At this time I would like to welcome everyone to the Fifth Third Bank second-quarter 2006 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 session. (OPERATOR INSTRUCTIONS) Mr. Adams, you may begin your conference.

Good morning. Thanks for joining us. I would like to remind everyone before we get started that this call contains certain forward-looking statements about Fifth Third Bancorp pertaining to the financial condition, results of operations, plans and objectives of the Bancorp. These statements involve certain risks and uncertainties. There are a number factors that could cause results to differ materially from historical performance and these statements. Fifth Third undertakes no obligation to update these statements after the date of this call. At this time I would like to turn the call over to George Schaefer, Chairman and CEO of Fifth Third.

Good morning, and thanks for taking the time to listen in. I will have a few comments, and then Chris Marshall will review some of the financial detail, and Kevin Kabat will review some of the other trends before we open it up to your questions. Regarding trends this quarter, first, earnings per diluted share were $0.69 compared to $0.65 last quarter. Special items impacting earnings this quarter included a $14 million securities gains, a slightly below normal effective tax rate and an accounting change that resulted in the recognition of approximately $9 million in expense related to stock compensation to retirement eligible employees.

Second, loan growth trends remained consistently strong with period end balances at 10% over the prior year. Third, deposit trends were good with average core deposits increasing by 7% over last year and 7% annualized. Average transaction deposit growth trends remain positive at 3% over the prior year, but below our expectations. We are optimistic about deposit trends in the second half of the year as we typically exceed first-half performance.

Next, net interest income was essentially unchanged on a sequential basis due to a 7 basis point contraction in the net interest margin and relatively modest average earning asset growth. Margin performance was in line with our mid quarter guidance and somewhat below our guidance in April. Chris will have more details on the margin in a moment.

Next, service income trends were very good in some areas and mixed in others. Considerable strength remains in our processing business and in corporate banking subcategories. We feel very good about the results in trends we see here.

Next, expenses were within the range our expectations at 4% over last year. We will remain diligent in 2006 on the expense side, given our overall revenue trends. The expectation is still for low to mid-single digit expense growth this year.

Next, net charge-offs were 37 basis points in the second quarter. Credit trends have continued to improve this year, and our outlook for the remainder of the year remains cautiously optimistic.

And finally, the tangible capital ratio was essentially unchanged at 6.92%. We remain committed to maintaining a prudent level of leverage given the interest rate environment and the outlook for sustained flatness to the curve. As we look forward in 2006, our earnings and balance sheet trends this quarter were largely in line with our expectations. A sustained flat curve is a difficult environment, but we feel very good about our competitive position, and the progress we have made improving the balance sheet.

Loan growth has been funded with core deposits and securities sales and runoff for a year and a half, and the risk profile of the balance sheet has been greatly improved. The continuation of current balance sheet trends will leave Fifth Third very well-positioned when the short end of the curve stabilizes.

During the second quarter we announced a couple of significant management appointments. First, Chris Marshall, who you will hear from in a moment, has joined Fifth Third as our Chief Financial Officer. In addition to his banking experience, Chris brings a great deal of leadership experience and broad business background having served as a CFO in both financial and nonfinancial companies.

Mahesh Sankaran was appointed Treasurer. Mahesh brings a wealth of experience and an impressive track record in balance sheet management. Kevin Kabat was appointed President of Bancorp in recognition of the focus and success achieved in implementing what we believe is a more sustainable deposit growth strategy. Kevin is also leading our efforts in terms of improving our level of customer service. Overall he has been extremely effective in working with the affiliate model and has a great deal of leadership experience at Fifth Third and in prior assignments.

Greg Carmichael was recently appointed Chief Operating Officer. Greg leads our operations and technology efforts and has been instrumental in infrastructure enhancements. Greg's appointment represents the importance we place on developing scalable, best-in-class technology and processes in order to improve the customer experience and drive positive operating leverage.

In short, I believe the team we have in place today is the best we've ever had, and I am proud of the efforts of all of our employees through what has been a difficult period of time. I am extremely optimistic about the opportunities ahead of us. With that I will turn things over to Chris to discuss a little more of the details.

Thanks, George. Good morning, everyone. Well, this is obviously my first call, and I recognize I am new to some of you but not surprisingly you're all well-known to me because I have been reading all of your reports for several years. As a result of that I have really been looking forward to participating in this call with you, but I am going to start by saying that after six weeks I still have a lot of work to do in terms of developing a real in-depth understanding of all the moving parts of our business. But hopefully I'm going to do that quickly and I am looking forward to meeting with each of you shortly and look forward to working together going forward.

Now in the last month and a half I have spent a lot of time looking at a variety of interest rate and deposits scenarios so that I can get a better feel for the relative position of the Company and to calibrate our plans for the rest of the year. So I'm going to start with some comments on general balance sheet trends and I'm going to move through some expectations in the third and fourth quarter.

Beginning with the balance sheet specifically the asset side, we felt good about our continued loan growth which increased $1.5 billion in the quarter or 8% annualized. Earning asset growth was more modest, increasing $980 million or 4% annualized due to the continued reduction in the securities portfolio. Now at this point we are becoming more comfortable with the size of the securities portfolio relative to the overall balance sheet and going forward, our appetite to selectively reinvest cash flows and enhance yield expansion will be more dependent on the strength and mix of our deposit growth, as well as our outlook for short-term rates.

At the same time, we're very clear that the primary purpose of our bond portfolio is to ensure liquidity and to manage our interest rate exposure. And with that in mind we're going to be much more disciplined about maintaining the size of the portfolio within an appropriate range.

Now on the credit side both charge-offs and NPAs improved sequentially in the quarter. But there have been some legitimate questions surfacing about potential loosening credit standards in the industry, so I thought it was appropriate for me to comment for a second about our standards. And just directly say that there have been no significant changes in our overall credit risk profile and no overall changes in our underwriting standards with the singular exception of our home equity business where we have selectively increased LTV limits so that we are more in line with our competitors, but again only for those competitors that meet our conservative standards. So in terms of our commercial portfolio, and in terms of risk ratings for either new or existing customers, those ratings are unchanged almost to a basis point from where they've been over the past few years. And in our consumer portfolio our FICO scores across everyone of our productlines are equal to or higher than they were in the past few years and historically I think those levels would all be considered conservative. Overall our credit performance generally experiences less volatility than our peers over a complete cycle. And we think it is going to continue to perform that way. Now we're not immune to cyclical changes but overall our credit outlook remains very solid.

In terms of expenses, our operating expenses remain very well controlled with costs rising 4% over last year; that increase has largely been driven by increasing salary expense, but it is also due to higher depreciation due to some strategic technology investments we've made as well as the startup costs of our de novo banking centers. And we're going to continue to make those investments, but we're very, very focused on carefully evaluating every investment to ensure that expense trends overall are in line with our long-term revenue outlook.

Moving on to our tax rate, we had a nice improvement in our rate which came down to 28.5 as a result of the faster than expected resolution of several prior year issues. At this point our expectation would be for the tax rate to increase slightly from second-quarter levels in both the third and fourth quarters. From a capital perspective I would say we remain comfortable at our current levels given our largely organic and de novo driven growth strategy, specifically in regards to our dividends and our payout policy we would expect that ratio to move closer to a 50% level over time. And I know our second-quarter payout at 58% was significantly higher than that, but we believe the ratio is going to naturally come down as the margin stabilizes and improves. Longer-term, we are committed to maintaining dividend growth in line with our earnings growth.

In terms of our share repurchases, our expectations are still very modest given our commitment as George said not to increase leverage into a flat curve. Moving on to our margin, as George said, we had 7 basis points of contraction. We came in at 301, and that compression was largely due to the speed of our liability repricing. Our core deposits repriced at 24 basis points which equated to 48% beta relative to the 50 basis points of Fed rated increases in the quarter. And that level of repricing is largely in line with our expectations and we think it represents a pretty solid volume to price trade-off in terms of deposit growth we're able to capture. A noncore funding repriced at 50 basis points, and that was well ahead of the expectations we communicated to you in our first-quarter call. As you know, our wholesale funding is nearly all short-term floating rate, and so our repricing was directly tied to the change in market expectations for short rates during the quarter, and the corresponding impact on LIBOR. As a result we have already experienced a portion of the expected future interest rate increases and our funding cost is reflected in the forward curve.

Overall we continue to be focused on growing deposits, maintaining strong quality loan growth and managing the level of the investment in the securities portfolio. We think success in these strategies is going to allow us to improve our mix of funding and enhance our asset yield expansion.

Now if we look backward for just a second, we all know that Fifth Third is experiencing above peer 28 basis points in margin contraction the last 12 months. However, in terms of loan and deposit growth, we have outperformed our peers while at the same time experiencing repricing that has remained largely in line with the industry. The difference in performance of our margin has really been driven by two largely isolated areas in the balance sheet. First, is the lack of yield expansion in securities portfolio, resulting from our consistent discipline of reducing the overall size of the portfolio and using cash flows to partially fund our loan growth. The second issue is the speed of the repricing of our wholesale funding that I just discussed. Both of those issues can largely be traced to the balance sheet activity and the nature of the assets and leverage that we added during 2002 and 2003. The good news is that Fifth Third's funding base with competitive core deposit rates and largely variable wholesale funding, is largely in line with current interest rate conditions. The funding costs should be much more controlled when short rates stabilize, even in a very competitive deposit environment.

Based on the forward interest rate curve and deposit loan trends similar to the ones we experienced this quarter, we expect to see continued modest margin contraction in the third quarter. However, we think continued balance sheet growth should offset any modest compression and should result in stable to slightly increasing spread revenues. At this point absent continued Fed tightening beyond the market expectations embedded in the forward curve are considerable slowdown in loan and deposit growth, a significant further contraction in net interest margin appears unlikely.

In summary, I would say we still have a lot of work to do on our balance sheet and we've got plenty of opportunities in the future to improve the overall matching of asset and liability ratios. But our comparisons do appear to be substantially easy. Over the long-term we are going to be very disciplined about taking the right steps to reduce the impact of interest rate volatility on spread revenues and hopefully do a much better job of ensuring that growth in core banking activities reach the bottom line.

Now with that I am going to turn it over to Kevin to discuss some of the detail of our individual business lines and talk about some recent strategic initiatives.

Thanks, Chris. Let me start with some of the line of business trends and then move through some of the things that we're focused on in the near-term. Within the business lines commercial banking performance continues to remain strong. Average loan growth was up 10% annualized, highlighted by 16% annualized C&I growth. We are continuing to maintain positive momentum in deposit revenues despite the impact of increased earnings credit rates. When rates stabilize the impact of customer additions should be reflected in this line.

Commercial deposit growth was modest in the second quarter, but we are expecting strength in the second half of the year with customer additions and customary seasonal strength. Corporate banking revenue increased by 10% over last year and 31% annualized; considerable strength continues in both loan fees and in international revenues. Overall we feel this business is performing very well, and our primary focus is on continuing to expand the contribution of our capital markets area and cross sell additional fee-based products across customer segments.

Fifth Third processing solutions had a good quarter with revenue up 15% over the same quarter last year and 30% annualized. Merchant revenues increased by 17% over last year and financial institution revenue increased by 14% over last year. New customer additions in both merchant and financial institution have been extremely strong of late, and we expect that revenue growth rates will improve in the near-term. Additionally, existing customer contract renewal terms have been encouraging to us, as well. We are continuing to differentiate ourselves from the competition for these clients by taking the consultative, full solution approach backed by reliable processing.

In the mortgage area mortgage banking revenues decreased by $6 million from the first quarter levels on originations of $2.6 billion. The breakdown on mortgage banking revenues is provided in the text of the release, and from a strategic standpoint the vast majority of Fifth Third originations are direct in nature. At this point in the cycle we believe we can maintain revenue momentum in this business by modestly increasing the level of wholesale production in and adjacent to our footprint. In the investment advisers business increased by 5% over last year and $5 million from last quarter on improved retail brokerage and personal trust revenues. The primary challenge here lies in continuing to improve existing Fifth Third customer penetration in both retail and commercial. This is the quickest route for us to improve performance as a key focus for us.

In retail banking, retail deposit growth was steady in the second quarter and pricing as Chris talked about, has remained well controlled. Overall deposit growth and loan growth in retail was approximately 7% over the prior year. Our net new account trends continue to be very positive with production up more than 50% year-to-date over the prior year. Deposit revenues increased by 3% over last year and 47% annualized from first quarter levels on a seasonal rebound and overdraft related revenues. We continue to be focused on improving service levels to improve attrition and maintaining enhancing new account production.

On an overall basis we are intently focused on three areas. First, improving the net interest margin. We recognize that 3% is both too low for our business mix and well below our potential. Chris mentioned some of the things that will benefit us going forward in terms of the repricing dynamics, and we can help that substantially with more success in low-cost deposits. We are measuring deposit flows on a daily basis by affiliate and by banking center and making sure that we're taking advantage of every opportunity to drive sustainable growth and profit improvement from both a volume and a rate perspective.

Second, we want to maintain our historically strong credit quality trends. Historically we have outperformed and exhibited greater consistency than our peers over a credit cycle, and we're focused on continuing that legacy. Better credit consistency has come from a more granular commercial portfolio and a super prime consumer portfolio. Banking is ultimately a risk management business, and we have historically been extremely risk averse in terms of reaching for credit. That philosophy continues today. We believe investors should understand a few important points, however. First our margin appetite for risk is highest on the consumer side when primary residences are involved. Second, we've increased commercial credit concentration exposure slowly over the last five years or so as illustrated on our loan portfolio disclosures, and we still remain well below our peers. This strategy is consistent both with growth in the overall bank and has resulted in significant growth for us in cash management and capital markets related revenues.

And finally the absolute level of risk is probably much lower at Fifth Third today than it was five years ago given the level of integration and execution risk in a more acquisition focused growth model. Today we believe we can deliver significantly more value to shareholders with a de novo organic focus that will be complemented by strategic fill in acquisitions. We remain extremely focused on quickly resolving credit problems as they arise. In the second quarter we sold $39 million in non-accrual loans with resulting charge-offs of approximately $6 million. There is substantial liquidity in the distress markets today, and we will continue to explore opportunities to move out of low rated credits if the economics are there. Overall our credit outlooks remain silent.

Finally, the third area that we stay focused on is remaining mindful of expenses. With recent margin challenges and the outlook for inflationary pressures expense discipline remains a very high priority. We continue to see opportunities to reduce manual processes in the back office, and we believe we can become even more efficient. Margin improvement will shed more light on the progress we've made in these areas over the last couple of years as spread revenue improvement will largely be unaccompanied by corresponding increases in expenses. We continue to target expense growth of between 3% and 5% in 2006.

To conclude I would just like to say that we feel very good about our affiliate model, the strength of our sales culture and the quality of our teams today. Thank you for your attention this morning, and we would be happy to answer any questions that you have.

(OPERATOR INSTRUCTIONS) Matthew O'Connor.

Could you just give a little more color on the margin assuming the Fed stops in August? Do you see stability in December and the quarter end then kind of a steady increase going forward, assuming stable rates, or just give a little more color on how you think that plays out.

First of all, we are assuming that there are two more increases in our forecast, and so if they stop in August, that is better for us obviously. But I'll give you two things to just think about, a little bit of context. Part of it is what the Fed does and the other part is what happens with our deposits. If we end up seeing the cyclical increase in deposits that we historically have always seen in the fourth quarter, then we may see two to three, maybe four basis points of compression in the year. And if somehow that doesn't materialize and/or the Fed, something happens in terms of market expectations for short rates, it could be seven or eight basis points. I don't think there is a realistic scenario out there that would indicate we would see margin erode more than 10 basis points. And when I say realistic I mean a relatively pessimistic but realistic scenario.

And not seven or eight basis points per quarter or you are just comparing the second half overall?

That would be over the second half.

And just related to the deposit side, number of banks have talked about consumers moving their deposits out of the lower-cost deposits to higher cost money market and CDs. But it sounds like they are not seeing too much of that and it is not too much of a concern of yours.

We are seeing that shift, as well, and you can see that in our numbers although we feel really good about the focus on new account production, which is helping us overall. But certainly consumers are aware of the rising rates and are placing their money in a better value for them from that perspective, but we seem to be managing through that through account production, which has really been our focus from the start.

If we look at that net checking account growth number, I don't think you mentioned what it was running linked quarter or year-over-year.

It's pretty significant. We talked about our account production being over 50%.

Okay. Thank you.

Mike Mayo.

Can you give more detail on the linked quarter processing growth? Is some of that seasonal?

What we would say, Michael, is we have been very pleased with the new accounts and new relationships that we've been doing it. So some of that does have some seasonality into it. But our new relationship and new volumes that we expect out of that is not seasonality. It is we are winning good business there.

And Chris, can you just comment on what is different than what you expected when you got to Fifth Third? You can read a lot of the reports, but now that you are on the inside, what was kind of better and worse than what you thought?

That is a great question, Mike. I guess we are further along -- there has been a lot of noise here in the last three years, but I think both in terms of the management team coming together it has been a big positive. I really feel good about the people I am working with and not that I didn't at [vivay] but given the number of people who have changed jobs recently, I think it seems to be a very solid, very cohesive team. And then the second thing is there is a lot dependent on rates, but I think a lot of the pain has already been felt in the business, and I guess I view us as further along then I probably would have guessed before I came.

The downside, Mike, is he doesn't like the age of the carpet in his office, and that has been a big surprise to him.

That rumor about Fifth Third is exactly correct.

Some of your predecessors mention not only what the Fed does and not only what deposits do, but also the flatness of the yield curve. And as we sit here now say if you look at the three-month five-year spread it has gotten worse than at the start of the second quarter, so how do you think about that when you think about margin guidance?

Obviously if we see an improvement in the short end that is even better for us; but even in a flat but stable curve I think we still will see our margin stabilizing and even begin to improve just as our assets reprice and our wholesale funding starts to stabilize. I mean we have really been hit by the steady, increasing borrowing costs we've had just because we've got almost an entirely short-term floating, wholesale funding composition. So for us even stability is a good, is a big improvement.

And are there any new expense reduction programs or anything like that that you are considering or delaying replacing the carpet for a little bit longer?

No, Mike. This is George. On the expense side a lot of this imaging technology, Check 21 electronic deposit, a lot of taking the paper and electronifying it, if you will, that is going to create some really good expense savings for us. We, because of our processing capabilities, we think we are out in front of that pretty well and we are putting some pretty heavy marketing efforts in that. We think that is going to be a bit of an advantage for us going forward, but it is also going to be a huge expense reducer.

All right. Thank you.

Betsy Graseck.

Chris, you mentioned during your comments that you would be looking to keep the securities portfolio in what you would consider an appropriate range. Could you just help us understand how you think about what an appropriate range is and how that would change over time?

Thanks for the question. I think it was the last call when someone got that question and we said that the overall size of the portfolio should probably stay in the 15% to 20% range, and I don't think there is any -- I don't think any differently. We are getting very close to that level. Now obviously that might change if the overall environment changes, but given our current environment I couldn't see any reason why it would ever grow beyond that 20% level.

Any reason you would bring it down to the lower end of that range? Or what would drive that?

There is a potential that we would do that, but I am not going to get too far into exactly predicting the exact percentage. I just say it will float between 15 and 20, and for now we are still very disciplined about letting the securities portfolio run off.

Okay, and then on operating leverage you've obviously been making, as you've highlighted several times investments in the operations, including branch buildouts, etc. Could you give us a sense as to how the investments have been tracking in terms of breakeven and meeting your cost of capital? And what kind of piece of change you've been seeing relative to investments made recently as opposed to maybe a couple years ago?

This is Kevin. As we've talked about, we have very high standards in terms of the expectations for our de novo strategy, and I would tell you with the investments that we've made we are meeting or exceeding those investment strategies for us. We expect our new banking centers to really do well for us and what we do is we model ROI about 18%, 17, 18%. We have expectations of what they should do relative to deposits and loans, very specific in the first year. And I tell you that we are again meeting or exceeding each of those from that perspective so we fill really good about the de novo investments we've been making.

And that ROI is over the life of the investment obviously, right?

Yes.

And so the breakevens, how have they been tracking?

Breakevens for us have been running at about the 13 month level, thereabouts, which is about on expectation for us. We are pleased with that.

Okay, and the investments on the de novos will those be ramping in the back half of this year or are you at steady state at this stage?

Yes, our banking centers are up 40 if you look at year-over-year, and up 20 this year and our expectation is that we are going to do about 50 this year, so we are right on base.

Okay, thank you.

David Pringle.

You've been talking about new acquisitions and checking accounts, and I am looking at your checking interest-bearing checking account balances being down 15% over the last six quarters. Can you talk a little bit about that?

Sure. What that is is we are seeing the mix shift that was referred to earlier. People are. One of the things and one of the disciplines we've put in place with the great rate strategy is really that differentiating value return to customers by product, which also takes into consideration the relative liquidity of the product. So you can see that shift as consumers are really moving it out into the savings and CD products from that standpoint, and we are experiencing that through our balances. So that is really what is happening, and that's what you are seeing.

Our orientation and our focus as we've talked a lot about it has been really about driving new relationships and driving deeper relationships, and that is where I think our real success continues to be from a deposit gathering perspective. Our production is very, very strong. We feel good about that, and we think we've got that right balance for volume and pricing from that standpoint, as well.

And would it be possible to give a little bit of color on what type and where you are seeing commercial C&I loan growth?

The commercial C&I growth has been very broadbased for us. There is nothing I would tell you that I would say that it is concentrated in any given industry or any given geography. We are seeing really good strong C&I growth everywhere.

Yes, there has been very good granularity across the entire portfolio, and as Kevin said, there really isn't any one major area of concentration.

And your ninety-day past dues were up quarter to quarter. Would you talk a little bit about that please?

Our ninety days, and really what we continue to look at as we talked about in the context of the messages we continually look at our portfolio, we continue to look at opportunities to really manage that. We feel good about where we stand from that perspective. I would say that we are at this point in the cycle feeling some stress in terms of portfolios, but nothing extraordinary or out of hand, really continuing to manage it as we've historically managed it from that standpoint. So there is no, in our minds no fire alarms from that perspective.

About half of that increase that you saw in the ninety-day past due number has been brought current. There were a few administrative items where notes did not get renewed on time. So over half of that increase has been now brought current.

Just to show you how granular we are, it was actually $18 million over that was brought current -- I want to say two days after the quarter ended. So there was a little bit of timing there; that doesn't mean that number is not going to fluctuate around.

Are there any specific asset classes in that ninety-day past due that are moving north?

No.

This is a very granular portfolio, and the obvious question here in the Midwest is, is the auto industry question here, and we're keeping a close on that and that is not a concentration in these past dues or non accruals anywhere. We are really keeping a very close eye on them.

Then earlier this week a certain CEO of another Midwest Bank was asked the very astute question about consolidation in the upper Midwest, and/or how they felt about a merger of equals. Would you be kind enough to comment on that?

I'm not sure who you are referring to there but I think given our present position and the success we've had in generating loans and deposits we feel very comfortable with our present position here.

We absolutely agree there should be less competitors out there, though.

Thank you.

Jason Goldberg.

Just to clarify, the 9 million on FAS 123, is that a one-time charge?

It's one-time in the quarter. We will have some charge going forward on an annual basis, but we felt the full effect for the year in the quarter.

Okay, so that's kind of every second quarter expect if your option plans stay the same expect a similar type of charge?

Ed Najarian.

A couple quick questions. Could you give us the impetus or the reason that you incurred $14 million of securities gains in the quarter, what drove that? Secondarily, what drove the below normal tax rate in the quarter? And third, it looked like the charge-off ratio came in lower than your guidance in the prior 8-K, and I guess just looking for some color on net charge-off ratio outlook for the second half. Thanks.

Let me start with the securities gains. The biggest piece of it was the proceeds from shares that were sold in the MasterCard IPO deal, that was about $25 million and we had at the same time we had about a $10 million loss as a result of a $250 million in bonds. So that netted out to 14, 14 and change.

So that was basically driven by the MasterCard IPO?

Yes.

Okay.

The tax rate there are really a number of one-time things, and the resolution of a prior tax audit amounted to about $3 million. There was a change in the tax law that impacted us. We had some reserves associated with that, about $3 million, and then we had an outstanding issue that the statute of limitations just expired on. So there were several pieces that contributed to that bringing it down to 28.5. Again, we do think we would see a slight increase in that tax rate going forward and -- I'm sorry -- on the charge-off -- charge-off was the last piece of your question?

Before you get to the charge-off, you were at 28.5 on the tax rate this quarter; I think you were about 30.5 in the first quarter. Should we expect this to go back to about 30.5 in the second half of the year?

I think it will be somewhere in between, Ed.

Okay.

I want to try to be that granular in the guidance, but I think it will be lower than it was in the first quarter but slightly up from where we are today, and that is for both the third and fourth quarter.

Okay.

And then charge-offs, they performed well. I think we saw that from a lot of companies reporting. We think charge-off number is going to stay pretty much where it is. We don't see, if you look at our credit performance, I think Kevin made this comment, that just over a full cycle we don't have a whole lot of volatility in our credit performance. We don't see much going on through the end of the year.

Okay.

Good. Thank you.

Chris Mutascio.

Good morning, all. Chris, I wanted to get some, well just kind of stole my question on the tax rate; I was looking for more I guess more specific guidance going forward and I think you handled that. So it's really been -- from a follow-up question would have been in your prepared remarks you talked about the margin being impacted by securities and the fact that you haven't been building -- you've been using the portfolio as a source of funds for loan growth if I understood that correctly. Are you talking about the percent margin being negatively impacted by that or the dollar margin being impacted by that? Because I would have thought if you're using cash flows from the low yielding securities portfolio and reinvesting them into the loan growth you've had, your actual or your earning asset yields on that part would actually go up, not down. Does that make sense?

Maybe you could just recap that quickly. I'm not sure I followed the whole question.

When you talk about some of the areas in which the margin has been impacted in the last several quarters you said they was two specific areas, one was the wholesale funding, but the other one was the use -- I thought you said the use of the securities portfolio.

I guess, what I was trying to get at is that the overall yield on the portfolio is about 4.5, and current yields if we were reinvesting those cash flows are 5.5 or higher. But that is really what I was trying to get at.

But aren't you reinvesting those cash flows into higher yielding loans than the 5.5% you get if you are just reinvesting them into securities?

Yes, but if you go back and look over the year those rates have gone up. And so that hasn't always -- I mean the current 5.5% opportunity were higher and reinvesting those cash flows into the portfolio are higher than some of the loans we funded earlier in the year.

Okay, all right. Thanks for the clarification.

Jon Balkind.

I know you handled the 90 days past due, so I will take a shot at the NPAs. You sold 39 million in the quarter but the overall was only down a bit, so I'm just wondering what is refilling there? Is there any geographical or asset class concentration within that? And then on the loan sales in the quarter, I guess the haircut was about 15% which seems a little high in a liquid secondary loan market. So I'm just wondering the process you guys use when you put loans into NPAs in terms of how they are marked, etc.

We felt that was a very reasonable price, and as you know, when we made that sale we went out to a number of different bidders, and so we felt that was very reasonable in terms of what was in that $39 million that we sold out there. What was the first part of the question?

Just the refill and NPAs in the quarter, is there any concentration geographically or within asset classes that sort of led to the NPAs staying about flat despite the sales?

No. There wasn't anything significant in there. Again that was very granular across the whole geography across our 21 markets. And there wasn't any particular asset class in there that was overly concentrated.

Great. Thanks, George.

I think I got cut off earlier. But just to clarify, the 9 million option expense, we shouldn't expect that in the back half of the year?

No.

Secondly, Chris, in your prepared remarks you made the comment a lot of work to do with respect to the balance sheet. Can you maybe be more specific is that in terms of maybe just using more kind of off balance sheet stuff to manage it or -- I don't, you can give more color there.

I don't want to be evasive, but I would -- I could spend a lot of time on this, but we just have a lot of work to do in terms of basic matching of durations. So there are some very simple things we need to do even before we begin thinking about off-balance sheet or on balance sheet. There is a big mismatch between on our balance sheet today, and we want to fix that. So I wasn't trying to imply anything beyond that.

Okay, and then I guess as you looked at the balance sheet I think last quarter someone on the call made the comment that a normalized margin was in the 350 area. I guess any kind of updated thoughts there?

Well actually I would say that over the long-term historically going back a while our normalized margin is probably closer to 375. And so when we think of getting out to a normalized margin at 350 over the next few years, we think that is completely doable.

And then just lastly I guess processing fees up 15% year-on-year and you talked about a good business, new business wins. I think the target at start of the year was 20% growth. Is it more price competitive, is there just new business wins or less transactions? Just maybe a bit more color there?

I think what we announced in the, Monday of this week, wins with the merchant Linens-n-Things, Uno the pizzeria place, Orkin, the chemical company Rollins there, those were three pretty big merchants and those are some of the things that we see coming online. Plus the pipeline is still very good in that business.

I guess I just add one slight comment, and that is that if there has been any impact that we've seen in the first half of the year it is a little bit of the consumer shift in spending because of the impact of high oil prices. The concentration of our merchants does not include the retail gas station kind of market. And so as people have been spending more money there we've seen a little bit lower interchange that may remain for a while, but overall we think the performance of the business is outstanding.

Okay. Thank you.

John McDonald.

Two quick questions. What is the outlook on the mortgage revenue line?

Our expectation is that we can continue to kind of maintain performance in our mortgage group. It is, as you know a tough environment out there. We've been able, if you look at originations, originations have been flat year-over-year from that perspective. We also have and are introducing some new products through that line of business, which we think will help us as well as some of the additional markets that we anticipate going. So again, our outlook is that we can maintain momentum in that business.

The second question was where do you see the best loan growth prospects in your business, and are you pulling back from any areas because of the competitive spreads?

No, in the commercial side of the business our spreads have held up very, very well. We continue to pay attention to pricing and actually the spreads have improved a little bit over the past six months for us here. And it is spread across the whole line. This isn't just coming out of one particular area.

And on the consumer side how would you characterize that, George, in terms of loan growth and demand?

John I would tell you on the consumer side again we don't really see anything from a competitive positioning from our perspective that we aren't engaged in. We feel good about the pricing and the discipline that we've had in terms of our pricing. Obviously there are some segments like the indirect segment that becomes a more challenging for us. We do see some softening in terms of the consumer in general and borrowing with the rising costs of borrowing today. But no segment that we see a retreat or something that is really different for us at this point that I would point out to you.

Okay.

Obviously it is still a very competitive environment here in our marketplace.

But you did see -- you are saying you did the improvement in spreads, George, a lot of the competitors --

I'd say we didn't see any decrease in spreads; maybe let me put it that way during the past six months, we have not seen that pressure at all.

Okay. Thank you.

Gary Townsend.

My questions have been asked. Chris, welcome aboard.

Thank you very much, Gary. Look forward to meeting you.

Are there anymore questions, operator?

At this time, sir, there are no more questions.

All right, we will let people move on. Thank you for everyone's attention this morning. We appreciate it, and we will talk to you soon.

This concludes today's Fifth Third Bank's second-quarter 2006 earnings release call. You may now disconnect.