Fifth Third Bancorp (FITB) 2007 Q4 法說會逐字稿

Good morning. I will be your conference operator today. At this time I would like to welcome everyone to the Fifth Third Bancorp fourth quarter 2007 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. Richardson, you may begin your conference.

Hello, and thanks for joining us this morning.

We will be talking with you today about fourth quarter and 2007 - sorry, fourth quarter 2007 and full year results, as well as our outlook for 2008. As a result, this call contains certain forward-looking statements about Fifth Third Bancorp pertaining to our financial condition, results of operations, plans and objectives. These statements involve certain risks and uncertainties. There are a number of factors that could cause results to differ materially from the historical performance in these statements. Fifth Third undertakes no obligation to update these statements after the date of the call.

I am joined here in the room by Kevin Kabat, our President and CEO, and Chris Marshall, our CFO. During the question and answer period, please provide your name and that of your firm to the operator. With that, I will turn the call over to Kevin Kabat. Kevin?

Thanks, Jeff. Good morning, everyone, and thanks for taking the time to join us this morning. I have a few comments and then I will turn things over to Chris, who will review our financial statements, our credit trends and also our outlook for 2008.

This has obviously been a difficult quarter for Fifth Third and for the industry. On most of our key operating metrics we had good results results this quarter, but I would be the first to acknowledge that was overshadowed by what happened on the credit front. Credit deteriorated fairly sharply this quarter, and we saw that reflected in growth in MPAs and losses, as well as provision. As you know, we don't hold the kind of assets that have produced the huge losses some of our peers have seen. However, one of our BOLI policies is invested in assets that experienced market declines due to widening credit spreads. Chris will talk more about that in a minute.

The credit environment remains challenging, and we expect credit conditions in the performance of our portfolio to continue to deteriorate in the near term. As we have discussed with you since the middle of '06, we have been concerned about home equity lending and real estate loans in general, particularly in the upper Midwest and Florida more recently. We have been actively working to mitigate the impact of these problems. So though it is a tough environment, and we expect the near term to present further deterioration in credit metrics, Fifth Third is well positioned. Our tangible capital levels are relatively strong compared to most of our peers. Most of the problematic credit areas have been with us for a while, and we have taken action to fix them. We have a number of strategic initiatives that are positioning us well for the future. This environment should present opportunities on which to capitalize for a strong institution like Fifth Third.

Before I turn it over to Chris, I would like to take a moment to review 2007, which was a fundamentally solid year for us with improving metrics. We started the year by laying out our 3-year strategic plan, and promising to be as transparent as we could be about not only our strengths but our weaknesses, and what we have been doing to improve on them. We hope you would agree that we have maintained that transparency throughout the year. We have made significant investments to improve the future performance of our business, and we continue to remain focused on these things despite the current credit environment.

Let me recap our operating performance for full-year 2007. Full-year average loan growth was 5% and core deposit growth was 3%. Net interest income growth was 5% for the year and non-interest income growth was 9%, excluding non-operating items outlined in the release. Operating revenue growth was 7%. Efficiency ratio, excluding non-operating items, was 55% versus 54% last year, with the modest increase really driven by growth in our payments business, which has about a 70% efficiency ratio. Operating leverage created in 2007 versus 2006 was $97 million. It is good progress in a tough operating environment.

Let me summarize some of the highlights. Our payments business, Fifth Third Processing Solutions, posted another year of strong double-digit growth. We processed nearly 27 billion transactions in 2007, up 33% from last year. Solid results across the board from merchant, financial institutions and card-related revenue drove the success this year. We have a strong competitive position in this business which we continue to leverage, and we expect similar mid-teens organic growth for 2008.

Our credit card initiative, driven by FTPS and the retail line of business, significantly exceeded our goals in its first year. Account originations were up 82% and balances were up 65% year-over-year, despite having sold off $150 million of higher risk receivables this year. Our new cards per branch average 24 per month versus 14 in 2006, a 75% increase in productivity. There's still a lot of opportunity to further penetrate our customer base and deepen those relationships. We are very sensitive to potential erosion in the performance of the card sector, and continue to measure and monitor trends. We view the customers we're adding as high quality, and still view this as a high-return business overall.

In retail banking, we saw strong growth in our deposit service charges this year, and we continue to broaden and deepen our banking network. We added 15 banking centers in the fourth quarter, in addition to the 31 branches Crown brought us in Florida and Georgia. For the full year, we extended our branch network by 77 banking centers, of which 66 were in the southeast or Chicago. Corporate banking had an excellent year. Fees were up 15%, with revenue growth across the board, as was evident in both the capital markets areas and new Treasury managment products and services we deployed this year. We've had tremendous success with our health care initiative, which has added $1.4 billion in loan commitments and produced $15 million in incremental fee income for us in the 2007, and that is despite only being in place for part of the year.

We successfully closed and converted the acquisition of R-G Crown in early November, and things are going as planned there. As we noted last week, we are awaiting regulatory approval from the Federal Reserve for First Charter, and are now planning for a second quarter close. We've received all necessary approvals for the purchase of First Horizon branches in Atlanta, and expect to close that this quarter.

Looking back over the year, we accomplished a lot, and I am proud of that. The securities portfolio issues we had for several years are a thing of the past. We continue to diversify our franchise through selected acquisitions and de novos. Our activities over the past year have had a significant effect on the population growth characteristics of our footprint, which will help accelerate our already solid organic growth. We continue to produce good loan and deposit growth, net interest income growth and exceptional fee income growth. Our ability to execute on our strategies and our sales culture are standing us in good stead now, and will continue to do so when we emerge from the credit cycle.

It was a difficult year and a noisy quarter, and it is important to highlight these significant positives so they're not lost in what is happening on the credit front. But credit is a significant issue and will be for some time. We are well aware of that, and very focused on taking steps we can take to mitigate the effects of the environment.

With that, I will turn things over to Chris to talk about fourth quarter results and outlook for 2008. Chris?

Thanks, Kevin. Good morning everyone.

As Kevin said, it was a tough quarter, clearly one of the worst the industry has ever seen, and our results obviously reflect that tough environment. GAAP earnings of $0.07 per share and operating earnings of $0.49 per share were down from a strong $0.71 last quarter, due to the increase in charge-offs and a large provision expense we reported. Beyond that, our results were solid. Fees were up $27 million sequentially, or 4%, if you exclude this quarter's BOLI charge and the hedge losses on the auto portfolio of $22 million, which which was slightly better than we were expecting. Sequential loan growth continues in the upper mid-single digits on an annualized basis, and core deposit growth for the fourth quarter was also up in that same change. Those numbers exclude you the benefit of the R-G Crown transaction. Net interest income, also excluding Crown, was up about 5%, reflecting our loan and deposit growth, and a slightly better margin than we were expecting a month or so ago.

We announced last month, as did virtually all of our peers, that we experienced a rather significant level of deterioration in credit during the quarter. As a result, provision expense increased $145 million from the third quarter, reducing earnings on a [linked] quarter basis by $0.18. That was driven by charge-off growth of about $60 million, and then provision exceeding charge-offs by about $110 million. By comparison, last quarter we reported provision in excess of charge-offs of $24 million. The over-provision increased our reserve to loan ratio from 108 at the end of the third quarter to 117 at year end. That doesn't include an additional 11 basis points reflected in the credit marks we hold against acquired loan portfolios, which are primarily related to Crown. Adding those marks to the allowance would equate to coverage of about 128%.

The quarter had more moving parts than usual, so let me recap them for you. As I said, our reported EPS was $0.07 and operating EPS was $0.49. There were three material non-operating items reported in the quarter. The first was $155 million after tax or $0.29 per share estimated charge we took on the BOLI policy. I am going to talk a little more about that in just a second. The second item was the $94 million pretax charge, or $0.12 per share, related to potential VISA litigation settlements. The third item we were charged was associated with the Crown acquisition, and that accounted for about $0.01 of EPS. For comparison purposes, third quarter EPS was $0.61 reported, or $0.71 operating, excluding the $78 million pretax charge related to the VISA/AMEX settlement. Fourth quarter 2006 EPS was $0.12-cents reported, and $0.64 on an operating basis, and the difference there reflects the charges related to the balance sheet actions we took in November 2006 which reduced pretax earnings by about $454 million, or about $0.52 a share.

Now, not adjusted for in our operating results, though noteworthy, was $22 million in losses this quarter on hedges we terminated on a billion dollars of auto loans that we moved to held-for-sale in the third quarter. That cost us about $0.03 in the quarter. We also booked $13 million in provision expense for unfunded commitments, an increase of $11 million from the third quarter. e view these items as unusual, but we also view them as part of our core operations, and I assume you would as well.

Let me spend a moment or two on the most significant charges this quarter, before moving on to a discussion of our credit trends, first starting with the non-cash charge for BOLI. But we wrote down one of our BOLI policies by an estimated $155 million, to reflect this current estimated cash surrender value. As is common practice, we have stable value protection on our BOLI policies to protect against market volatility in the underlying investments. A stable value protection essentially protects against P&L risk, but unlike our other BOLI policies this particularly policy only has partial wrap protection, and the market value of the underlying assets are now below the level of protection afforded by the wrap. As a result, the cash surrender value of this policy will fluctuate with the market value of the underlying investments until the value once again exceeds the limit of the wrap protection. This charge is appropriate, given accounting for BOLI policies; however, it does not mean we've surrendered the policy or that we have any current intention of surrendering the policy. As we mention in the release, we base the estimated charge on the most recent valuation information provided by our insurance carrier after year end, and we would expect to receive audited financial information in mid-February, and that's what we will use in our 10-K.

Now, as for VISA, it has been announced VISA intends to fund any litigation settlements from the proceeds of their pending IPO, which we believe is currently scheduled for late in the first quarter. When that occurs, we would expect to reverse the $172 million in litigation reserves we reported.

Let me move on to the details, starting with credit. First, I note that we have added some more detail to our release, which we hope will assist you in understanding our trends. Those details include a table on page 10 that breaks down non-performing loans by loan type. Additionally, in our discussions we have provided additional information about the losses and MPA growth we are experiencing in our most stressed markets, most notably Michigan and Florida. And then finally we've outlined the impact of losses from the brokered home equity channel, which has been shut down.

Okay, let me start with charge-offs. Net charge-offs were 89 basis points for the quarter, which brought us to 61 basis points for the full year, which is some what higher than the mid-50s range we were expecting as we entered 2007. That obviously reflects the accelerating deterioration in the real estate sector. In the fourth quarter, consumer net charge-offs were $99 million or 118 basis points, versus $79 million or 93 basis points in the third quarter. The majority of that growth was housing-related. We had $9 million of increases in residential mortgage, and $5 million in home equity. The increase in mortgage losses was driven by the effect of lower property values on foreclosures, and higher losses were concentrated in Michigan and Florida, which account for 22% of our mortgage portfolio but accounted for 58% for our fourth quarter charge-offs.

We continue to see higher home equity losses, especially in the brokered home equity channel. This is particularly in the case with brokered second lien and high LPV home equity loans, although we are also seeing stress in the geographies I just mentioned in both the direct and brokered portfolios. Brokered home equity losses were $20 million, or 60% of our $32 million in home equity charge-offs. That's from 22% of our home equity portfolio. We began shutting down the brokered channel in April, when we closed the HEA business, which was our weakest performer; and HEA, as you may know, was the national brokered home equity operation we picked up through a 1999 acquisition. Since then, we have shut down all brokered home equity, both within and outside the footprint. However, although it's now in run-off mode, we would expect losses in this portfolio to continue to rise throughout 2008. For some added context, Michigan represented 31% of our home equity charge-offs, and HEA represented 30%.

In addition to housing, the auto portfolio had elevated losses of about $5 million, due primarily to seasonality, although we are seeing earlier losses - or continuing to see, I should say, some earlier losses within the 2005 and 2006 vintages. That's a period when terms and advance rates in the industry were somewhat extended.

All right, on the commercial side, net charge-offs were $75 million or 66 basis points, versus $36 million or 33 basis points in the third quarter. The $39 million increase was made up of $25 million in CNI, $7million in commercial mortgage and $7 million in commercial construction. Now most of the increase in CNI losses was due to a large $15 million loss on a fraud-related credit. This fraud accounted for more than 1/3 of the sequential increase in the total commercial charge-off ratio. We had commercial real estate losses of $27 million, of which Michigan and Florida represented half; and then loans to home builders produced $3 million of losses, although they represent a larger issue on MPAs, as I'm going to mention in just a second. The provision for loan and leases was $284 million, and exceeded net charge-offs by $110 million, pushing the allowance ratio up to 117. I already noted that with purchase accounting this underestimates the amount of conch coverage we have for our loan portfolio by about 11 basis points.

Moving on to MPAs, MPAs totaled $1.1 billion or 132 basis points alone, so up 40 basis points from the last quarter, and that represents an increase of $358 million or 51%. Of that increase, Crown contributed $68 million, and troubled debt restructurings contributed $58 million, $126 million in total. Excluding those, MPA growth was 33%, approximately what we experienced last quarter, although that's still very high. Like last quarter we didn't sell any MPAs this quarter, as pricing remains very unattractive, and obviously the absence of sales is also contributing to the very high levels of overall MPAs.

Commercial MPAs of $695 million accounted for $249 million of the MPA increase, of which Crown was $57 million. All of the increase in commercial MPAs came from commercial mortgage and construction, which was primarily concentrated in Michigan and Florida. CNI MPAs were basically flat at $178 million, but commercial construction MPAs grew $151 million, and commercial mortgage MPAs were up $99 million. Michigan and Florida represented 68% of the growth in commercial real estate MPAs, and accounted for 60% of CRE MPAs at year end. Home builders and developers accounted for $113 million of total MPAs, up $64 million from the third quarter. The addition of Crown added $20 million to these MPAs.

Consumer MPAs were $369 million, up $109 million, with virtually all of the growth in residential mortgage and home equity loans. Florida and Michigan represented 50% of consumer MPA growth, and R-G Crown contributed $11 million of that growth in Florida. Those two states combined accounted for 47% of our consumer MPAs. As I just mentioned, we restructured $58 million of consumer loans during the quarter, which accounted for over half of consumer MPA growth, for a total of $80 million during 2007.

There's no other way to say it, it was a tough quarter from a credit standpoint. Things did deteriorate faster than we expected, but the trends were in line with what we've been seeing for the past couple of quarters. The difference in the rate of change was primarily in home equity and commercial real estate. As we sit here today, we would expect the first quarter to show similar trends. We've got a good handle on where our issues are, and we're taking steps to ensure that our underwriting is disciplined, and we're making the right loans to the right borrowers, but given the nature of credit, it is going to take some time for those steps to show up in our results.

Let me turn to the balance sheet, starting with loans. Average loans and leases were up 2% from the third quarter and 6% year-over-year. Loans would have been up 7% from a year ago, excluding the transfer of auto loans, the held-for-sale, and the effect of R-G Crown. Now we transferred $1 billion of auto loans to held-for-sale in early August, and another billion in late October. Breaking things down, average commercial loans grew 5% sequentially, and 8% versus the fourth quarter. CNI [items] were up 7% from the third quarter, and 11% compared with last year, and commercial mortgage loans were up about $450 million, and commercial construction up $45 million from last quarter. Now, excluding Crown, construction would have been down and commercial mortgage would have been flat. Average consumer loans were flat sequentially and were up 2% year-over-year. So excluding Crown and the transfer of auto loans, consumer loans would have been up 4% from a year ago. Those aren't big numbers, but considering the amount of tightening we've done to underwriting standards, that number looks pretty good to us. Now, as Kevin said earlier, retail credit card balance growth was very strong in this quarter. It was up 7% from last quarter and 60% year-over-year.

All right, moving on to deposits, average core deposits were up 3% from both the third quarter and the fourth quarter last year, with about 1% of that growth contributed by R-G Crown. Transaction deposits were up 4% year-over-year on solid growth and savings, and in commercial sweep accounts, which are reported as [foreign] office core deposits. Looking at the key deposit lines, DBA balances up 2% from last quarter and down 4% year-over-year. Commercial DBA balances were seasonally higher in the fourth quarter, and that's what really drove our sequential increase. Interest checking balances were flat sequentially, while savings and money market balances grew from the third quarter by about 1 and 2% respectively. Finally, retail CDs were up about 7% from last quarter, with about half of that growth coming from Crown.

All right, let's move on to our revenue, starting with net interest income. NII was up 3% from last quarter and 6% from the same quarter last year, and I'd note that about 1% of the increase came from the addition of R-G Crown. Earning asset growth of 5% and core deposit growth of 3% were the main drivers, partially offset by the reversal of interest on MPAs and the effect of the trust [preference] we issued in the third and fourth quarter. The net interest margin was down 5 basis points sequentially to 329. Now, the addition of R-G Crown contributed three basis points to that deterioration, although that was exactly what we expected, and the remainder, also as expected with a reduction, was driven primarily by the MPA interest reversals and trust-preferred impact I just mentioned. The full year NIM was 336, which was right in line with our full-year forecast. I will talk more about the margin when we review the 2008 outlook.

Let's move on to non-interest income. Non-interest income was $576 million, down 20% sequentially, and primarily again due to the BOLI charge of $155 million and the $22 million loss on the hedges I mentioned earlier. Fourth quarter fee growth, excluding those items, was $31 million or 4%, which is a pretty strong sequential increase and reflected great growth in corporate banking, payments processing revenue and deposit service charges. Year-over-year growth on the same basis, excluding the balance sheet actions we took last year, was exceptionally strong at 19%. Our payments processing business had another impressive quarter, with processing fees up 6% from the third quarter and 16% from a year ago, which is exactly where we forecasted it would be.

We feel particularly good about this strong quarter, given the weak holiday sales data being reported by everyone else in the industry. Merchant revenue was up 9% from last quarter and 20% from a year ago. This segment continues to put up significantly better organic growth numbers than any of our peers. Financial institutions revenue was down 1% sequentially due to seasonality of billings, but was up 7% from a year ago on a higher card usage [line]. Finally, card issuer interchange, which is basically debit and credit card usage by our own customers, was up 9% from the third quarter, and an increase of 20% from a year ago, due to the success of our card initiative.

Moving on to deposit service charges, we had another strong quarter, up 6% from the third quarter and 30% from a year ago. Commercial service charges drove the sequential increase; they were up 10% from the third quarter and 19% year-over-year. The increase reflects lower earnings credits and better fees associated with new product and service offerings. Consumer service charges grew 3% sequentially and were up 41% year-over-year, driven by higher customer activity. Remember that in the fourth quarter last year we had - actually the industry in total had a fairly sizable decline in deposit fees, and that's making our year-over-year performance look much higher than our core growth rate really is. Corporate banking revenue was up 17% from last quarter and 29% year-over-year. The results were driven by strong growth in syndication fees, institutional sales, interest rate derivatives, and internation fees. We are really seeing a pay-off here on the talent we have hired in the past couple of years, as well as on our efforts to broaden our middle market corporate banking capabilities. Investment advisory revenue decreased 1% sequentially, but was up 4% year-over-year, and mortgage banking revenue was $26 million for the quarter, down 1% from the third quarter and 14% a year ago.

Now, gains on loan deliveries were $18 million, up $9 million from the third quarter, which is a pretty decent result but still lower than the 25 to $30 million level we were running at before the market tightened. The market valuation adjustment on the MSR was a negative $6 million, but that was offset by MSR hedges which, as you know, shows up in the securities line. Other non-interest income was a negative $91 million, compared to a positive $93 million in the third quarter. The results here included the BOLI charge, the auto hedge loss this quarter, and then $9 million in net gains from the FDIC credit sale and the auto loan mark to market in the third quarter. Last year's results included a $17 million loss on derivatives, related to securities sold as part of our fourth quarter balance sheet actions.

Okay, moving on to expenses, reported expense growth was 10% sequentially and 23% year-over-year. The sequential change is largely due to the non-cash expenses accrued for the potential VISA litigation settlements. That was $94 million for the fourth quarter and $78 million in the third quarter. Also included in the fourth quarter was the $13 million charge and provision expense for unfunded commitments, as well as $8 million in merger-related expenses. We also saw higher expense related to affordable housing, credit amortization, compensation expense driven by higher fees, and then finally higher loan and lease expense. Results from the fourth quarter last year included a $39 million charge on the termination of financing as part of our balance sheet actions.

Moving on to capital, our capital ratios came down from the third quarter due to the closing of the Crown acquisition, which cost us about 41 basis points of tangible equity, as well as the BOLI charge, which was another 13 basis points, and then the fourth quarter VISA charge cost us about 6 basis points. TCE was 607 at the end of the quarter. We would expect to see that go up to about 630 or so by the end of the first quarter. That assumes the VISA litigation accruals are reversed, and we do a securitization during the quarter, which currently looks pretty doable. I'm going to talk more about that in the outlook, but the TCE target remains at 6.5%, and I am confident we have a very sensible plan to get back to that level.

All right, let me turn to the full-year outlook now. You will find that on pages 12 and 13 of the earnings release. One macro comment here. With the exception of capital, the guidance below doesn't include the impact of any of our pending transactions, specifically First Horizon or First Charter, nor does it include any potential impact from VISA. First of all, starting with NII, we'd expect NII growth in the mid-single digits, driven by higher core deposits and loan growth, both of which we expect to grow in the mid- to high-single digits. Core deposit growth is going to be helped by the effect of a full year of Crown, as well as the effect of 2007 and 2008 de novos. Crown adds about 1.5 to 2% of the expected core deposit growth, and the de novo should add about 1%. For loan growth, we'd expect commercial growth to be driven by CNI, and to be stronger than consumer growth. Consumer growth is going to be tempered by the impact of planned auto loan sales, as well as the continued focus on disciplined underwriting.

In terms of the NIM, net interest margin is expected to be in the 320 to 330 range. In the first quarter, the NIM is probably going to be lower by about 5 basis points, just due to the [fourth] quarter impact of the Crown acquisition, as well as higher - seasonally higher deposit levels in the fourth quarter, and higher expected levels of MPAs. As we move throughout the year, we should begin to pick up some benefit, due to expected loan sales and securitization activity.

Turning to non-interest income, we are currently planning for high-single digit growth. We expect mid-teens growth in the payments business and we continue to gain market share here. We feel really good about our ability to maintain that market share growth throughout the year. The effects of market share growth could be mitigated somewhat by forecasts which call for weaker U.S. consumer spending in 2008. That may become a reality, but we are confident on a relative basis that no matter what the overall economy does, we are going to perform as we did in 2007. We are looking for deposit fee and corporate banking revenue growth in the low double digits or even a little bit higher. That is just basically carrying through the effect of our strong rising performance throughout 2007. We would expect continued success in new deposit account production, as well as in corporate banking activities. We also expect mortgage banking revenue to rebound towards more normalized levels, though it is - this is a business that's really somewhat difficult to forecast. We have seen a pick up in ReFi activity during the last 90 days or so, and if that continues we will see some benefit in our earnings. Just as a reminder, payments processing, corporate banking and consumer overdrafts all benefit from strong positive seasonality in the fourth quarter, and negative seasonality in the first, and we're expecting that to be the case in the first quarter of 2008.

Our outlook for expense growth is mid- to high-single digits, in line with our revenue growth. Now, given the environment, we are obviously going to very carefully monitor revenue growth and manage our expense growth accordingly. I would also note that our expense plan assumes a continuation of the current credit environment lasting through 2008. Now, if that credit environment worsens significantly, or if there's any indication that credit trends are going to extend into 2009, we are going to re-examine our expense plan and adjust it accordingly.

Let me break down our current expense growth chart just a little bit for you. Crown and de novos each add about 1% to our expected expense growth; and then FDIC deposit insurance costs, which are expected to rise to the industry, will add another 1%; and then finally processing expense growth, which is driven by revenue and volumes, is expected to add about 2% to our overall growth. So expense growth would be closer to about the 4% range, excluding those factors. I would remind you that during the first quarter we experienced negative expense seasonality. due to higher FICA and unemployment accruals, which will add about $20 million in our first quarter '08 expenses versus the fourth quarter.

Now, full-year credit outlook is for net charge-offs to be in the low to mid-90s basis point range. That's above what we posted in the fourth quarter. As a remainder, our results in the fourth quarter included that $15 million fraud, and excluding that charge-offs would have been closer to the 81 basis point range. First quarter charge-offs are likely to be somewhat higher in than fourth quarter in our full-year outlook. As we discussed earlier, we expect MPAs and delinquencies to continue to trend upwards, and we'd expect provision expense to continue to exceed charge-offs. The amount of provision is obviously going to be driven by our reserve model, and those models take a number of factors into consideration, and our levels of trends of net charge-offs and MPAs are obviously two of the more important factors. But the models also consider items such as trends in collateral values, the credit scoring of our consumer portfolios, credit grades in the commercial portfolio, as well as trends in the general economic and interest rate environment. So therefore it is much more difficult to estimate future provision requirements than it is charge-offs. Accordingly, while our general expectation would be that we'll continue to provide an excess of charge-offs, we can't offer any more specific guidance in that area.

All right, the last two items are taxes and capital. We'd expect the effective tax rate to be about 30% for the full year, which is a little higher than we saw in 2007, and then finally our long-term capital targets are largely unchanged. We continue to target a 6.5% TCE ratio, we'd expect to be about 630 at the end of the first quarter and somewhere in the 625 and 650 range the rest of the year. Now we are assuming we do an auto loan sale on the first quarter, and for this part of our guidance only, we do assume we'll see a reversal of the VISA litigation charges. We are targeting a 7.5 to 8% tier one ratio and and 11 to 11.5% total capital ratio. We are below that total capital target ratio now, but we expect to solve that very, very quickly.

To wrap things up, it was obviously a very difficult quarter, largely due to credit. While we expect credit to be problematic through the near term, as a management team we are very optimistic that we'll continue to deliver a strong operating performance in 2008, and that is reflected in the outlook I just went through. I know many of our teammates are listening in on this call, and I would like to thank all of you for your hard work in 2007, as well as for your efforts toward making this a better company. We have got a lot to do in 2008, and we've got a solid plan for creating value for our shareholders.

So with that, I am going to wrap up. I would like to thank you for your attention, and I would be happy to answer any questions you might have.

(OPERATOR INSTRUCTIONS)

Your first question comes from the line of Matthew O'Connor from UBS.

Morning, Matt.

Can you just give us a little more color on the timing of the charge-offs? You had mentioned 1Q would probably be a little bit +6higher. It sounds like you are assuming higher first half of the year and then improvement in the back half of the year?

We are. Unfortunately, Matt, I can't give it to you quarter by quarter, but we are expecting things to be a little higher in the first quarter and then level off a little for the rest of the year.

Okay, and which specific portfolio is driving the 1Q? I thought there was seasonality in 4Q that made it higher, just on the auto side?

I'm expecting to see a little bit more in the commercial real estate and commercial mortgage area in the first quarter, as well as in home equity.

All right. And then just separately, even though your capital ratios are below some of your targeted levels, you are still above many other banks out there. I am just wondering what your appetite now is for opportunistic deals, if there are some out there.

You know, we obviously watch what's going on in the industry, Matt, but we've got a lot on our plate. The environment is very, very tough and I would say, you know, deals would not be our higher priority. But I am going to let Kevin add to that.

Matt, I just want to echo that we are very focused now on really kind of concluding some of the integrations that we've got going on right now, and on the continued strong operating metrics of some of the key elements that I highlighted for you in my comments. So, that is where our focus is and that is what we are really concentrating on right now.

Okay, thank you.

You bet.

Your next question comes from the line of John McDonald with Banc of America Securities.

Hi buys. Chris, could you give us a little color, just kind of contrast some of the credit quality trends, the difference between what you are seeing in commercial real estate and then what you're seeing in CNI lending?

CNI actually looks pretty solid. We haven't seen, you know, a contagion, if you will, start to hit anywhere in that book. We remain pretty confident that the book will stay solid throughout the year. I guess we have talked over the last couple of quarters about softness in the rest of the commercial portfolio, so if that is what you mean by comparison or contrast?

Yeah, and even in the areas geographically where you are talk about weakness, on the commercial side it's really in commercial real estate?

Absolutely, yeah.

We have seen that also, John, in terms of tracking on MPAs, the CNI portfolio from a sequential basis was literally flat. So, again, we just - we see it more in the real estate sector than we do in CNI.

That's kind of embedded in your outlook, too, for - the further deterioration in the first half of '08 is commercial real estate and home equity driven, I assume?

Yeah, I guess in the outlook we do assume some softness in CNI. Now, that's not because we have seen any softness ourselves, but we do recognize that the economy is slowing. So we are assuming there will be some softness at some point during the year. But in terms of our own metrics up until now, CNI looks pretty solid.

Okay. Then on the capital, did you give a timeframe, Chris, for when you thought you would get to your target TCE? Did you say by the first half of the year you should get there?

I think the TCE is going to move around during the year because of a few transactions that we have got planned. So I don't want to give you an exact target but we are - all I can say, John, is we're very focused on the 6.5% target and we're committed to getting back there.

Okay. Thank you.

Sure.

Your next question comes from the line of Michael Mayo with Deutsche Bank.

Morning, Mike.

Good morning. First question, the Fed cut rates 75 basis points this morning. What's the impact for you guys?

Yeah, we saw that, Mike. We are largely neutral to changes in interest rates, although I would tell you that the cut is very welcome, while we hedge our income for changes in rates, and by that, that is what I mean by we are largely neutral, cutting the rates is obviously very welcome by our customers, and it is something that we hope is going to pick up overall activity. We have been somewhat hampered this year by our customers sort of hesitating to go forward with things, sort of in anticipation of further rate cuts. We are hopeful - we think what the Fed did this this morning was the right thing, and we are hopeful it is going to start to spur some economic activity in our customer base.

As Chris mentioned earlier, we had seen some of the ReFi activity. This, we hope, will only accelerate that. We would anticipate that it will, and again that will be beneficial, particularly in terms of the consumer side and some of the stresses that we have experienced and highlighted for you on that book.

To the extent that some of your borrowing costs have gone up, I mean do you look to pass on those higher borrowing costs, which means the impact of the Fed move is somewhat muted?

Our borrowing costs -- let's see, I guess I would go back and answer that overall the Fed cuts are somewhat muted to us in terms of being - overall our income is not going to be largely affected by the Fed cuts.

Okay. First Charter, what's going on with that right now, since you need to obtain more stock? Do you still want to do that deal or what are your options to get out of it, even if you wanted to?

Well, we don't want to get out of it. First Charter was a very attractive strategic acquisition for us. While we obviously are not pleased with our stock price, we will see where that stock is when we eventually close. But in terms of where it is, we are awaiting Fed approval. With we had originally hoped to have that approval in the first quarter and that, you know, just from the passage of time, clearly does not look like it is going to happen, and so we are hopeful that we will get that approval sometime in the second quarter. But we still - you know, still view First Charter as a very attractive acquisition.

The FDIC insurance costs you said were going higher this year?

Yes.

Remind me, what's going on there?

There's a proposal to increase insurance rates, and it is - I will be honest with you, I can't remember the exact timing of when that occurs, and I know there's a proposal to delay it, but right now there's a scheduled increase in deposit rates that should affect everybody, you know, all banks.

It is scheduled, Mike, in the second half of the year right now, unless something changes.

You are already factoring that into your expense guidance for the year?

Yes.

Okay. So you consider this pretty much a done deal?

Right now, it is scheduled to occur. If the proposal to extend it goes through, then we will obviously have an improvement by that amount in our expenses.

Last question. On problem loans you said 81 basis points core charge-offs in the fourth quarter, and your guidance was just kind of to the low-90s, low- to mid-90s. Is being conservative enough?

I obviously feel that it is, you know, a balanced view in that I don't - I am not sure I would say it is conservative enough or aggressive enough. It is what we expect it to be. The increase is again expected to be a little bit higher from the first quarter, and then we expect things to level out a little bit.

And you said on the commercial side, it is really just commercial mortgage. Is it really just home builders or is it, you know, expanding more broadly?

No. It is - I do think it is broader. It is housing-related, and anything related to housing, which is pretty consistent with what we have been seeing for the last couple of quarters. In terms of home builders, charge-offs actually in the quarter were quite low. We do expect that to pick up a little bit as we get into the year.

All right. Thank you.

Thank you, Mike.

Your next question comes from the line of Casey [Embrick] with Millenium.

Good morning. Thanks very much for taking you for taking my questions. Looking through the press release, I don't see it. Can you just kind of walk - because I have a couple of questions. First, could you walk us through your Florida and Michigan exposures by some of the more problem - like size of the problem parts of the books, like the ELOCs, LTD and the appraisals, and what are the migration trends for both states?

Let's see. Would you mind, Casey, just going back and saying that one more time?

Sure. So I was looking for a little more detailed exposure, particularly on the Florida and Michigan. Would you cite that as like a 50% of your problems? Like for example, could you go through your ELOC book and what are the LTDs? What is the size of the book, what are the appraisals? When were they last appraised?

I am not sure I can reel through all of that on the call. We have got that data here. We can go through that. I am not going to be able to pull all of those numbers together instantaneously.

Okay. I think that would be a good - okay, how big is your Florida book, just in general? How many of the loans are in Florida?

$8.3 billion.

$8.3 billion. And of the amount, how much of the loans were acquired through deals in the last four deal years?

I mean, most of it.

Most of it right, in the thrifts you bought?

No, for the Florida National - sorry, FMB deal and the Crown deal, Crown being about a little over 2 and FMB about $4 billion, maybe.

Do you have a general LTD on Florida?

Because the portfolio, it includes everything, I don't know that an LTD would mean anything.

Okay. I mean additional exposure like that, it might be gad to get out there. Because just saying that Florida is melting down is tough for us to see.

No, we've got it all in there, but in the Qs, Casey, we disclose our portfolio by state, and then in the release we talk about the effect that Florida and Michigan are having on [obviously] all portfolios.

Okay. What about the capital, I mean do you expect anymore buy back now? That 6.07%?

No, we don't expect buy backs currently.

Okay. And then any updates on First Charter? I am sorry if you have answered this, I've been on a few calls, why is it taking so long to close this?

We just did answer that. I don't know if it is taking long or not, it's taking longer than we had hoped. But we are awaiting Fed approval and beyond that, there's not really a lot we can say.

Why is the Fed being held up?

I'm not sure the Fed is being held up, Casey, it's just the Fed is going through its normal process and we really can't comment on it beyond that.

Okay. One last question on the LTD, just going back to Florida, or maybe just talk about your ELOC book in general, what percent of your ELOC book was brokered?

Brokered ELOC is about 25%, 20 to 25% of the overall book.

Of the overall.

Right. There's about $11 billion in book, about 2 of it came through brokered, what you would normally considered brokered sales, and then $1 billion came through the HEA business or maybe 1.2 or $1.3 billion, so about $3 billion in total out of the $11 billion.

All right. Thanks very much.

Thank you, Casey.

Your next question comes from the line of Don Jones with Credit Suisse.

Good morning.

Looking at your capital ratios, it looks like the total capital ratio is getting a little bit close to the capitalized threshold. Do you have any contingency plans for if something happens between now and the end of the first quarter, you know something unforeseen of course, that would drop that below the 10% limit? And given that idea, it looks as though you guys are fairly filled up on tier 1 type of securities, so are there other types of things you might consider issuing?

The answer to that is yes. I am not going to go into the individual things we have planned but we clearly don't have any plan to go below 10%. As I have tried to do, or point out, we expect the total capital ratio issue to be resolved very, very quickly.

Okay. And then more broadly on the asset quality, the non-performing assets in the book, it looks as though the commercial mortgage and commercial construction was the source of major decline in MPAs or bump up in the nominal MPAs. What is -- I know you have already characterized this in some broad strokes; is that mostly Michigan and Florida? And again, mostly related to the home builders and whatnot?

Not home builders necessarily, but housing or real estate in general. Yes, you are correct, it is largely concentrated in Michigan and Florida.

What would you say your outlook is? I mean, how do you anticipate dealing with that in a way that won't further impair capital or hopefully earnings? Is there a way to sell or just ride it out? What happens with something of that size that's already coming under that much pressure?

Our outlook takes into account the stress we are feeling there and expects some further deterioration, specifically in those geographies and in those business segments. If terms of what we are going to do, there's a number of things that we are doing, including aggressive workouts. We do expect some level of MPA sales, but all that's included in our outlook, and our outlook for capital does include the expectation that there will be some deterioration in credit during the year.

Okay. Thank you very much.

Thank you.

Operator?

At this time, there are no further questions.

All right, let me wrap things up then.

Thanks for joining us for this call this morning. Again, while it was a difficult quarter we do feel good about the developments within the operations of the company and core results. The bottom line results are disappointing, given the impact of the credit trends this quarter. We have a strong management team acting to implement sound strategy against a very tough environment, and we're continuing to focus on executing the basics that distinguish outstanding companies and drive value. On a weekly basis, I can tell you we are score-carding all of our affiliates and lines of businesses on loan and deposit growth, fee growth and efficiency, and we are performing well on these metrics. We intend to be at the head of the class in every category, and that includes credit as well. We are able to see the improvements we have made show up in core performance, and credit actions, shutting down business lines, restricting credit, raising standards takes longer to show up current results, but it is happening.

So, remember we are a prime underwriter in every credit class with a strong customer base. Our geography is not cooperating on the credit side, but those geographies will stabilize, and the steps that we're taking across the company will increase future earnings base and produce better results when the cycle turns, which it will. So thanks for joining us today. We appreciate your continued interest in Fifth Third.

The this concludes today's Fifth Third Bancorp fourth quarter 2007 earnings conference call. You may now disconnect.