Fifth Third Bancorp (FITB) 2008 Q4 法說會逐字稿

Good morning. My name is Tracy and I will be your conference operator today. At this time I would like to welcome everyone to the Fifth Third Bancorp fourth quarter 2008 earnings 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) Thank you.

Mr. Jeff Richardson, you may begin your conference.

Hello, and thanks for joining us this morning. We'll be talking with you today about our fourth quarter 2008 and full year results, as well as recent developments. This call may contain certain forward-looking statements about Fifth Third Bancorp pertaining to our financial condition, results of operations, plans and objectives. These statements involve certain risks and uncertainties. There are a number of factors that could cause results to differ materially from historical performance in these statements. We've identified a number of these factors in our forward-looking cautionary statement at the end of our earnings release and in other materials and we encourage you to review those factors. Fifth Third undertakes no obligation and does not expect to update any such forward-looking statements after the date of this call. I'm joined here in the room by several people: Kevin Kabat, our Chairman and CEO; Chief Financial Officer, Ross Kari; Chief Risk Officer, Mary Tuuk; our Controller, Dan Poston, and Jim Eglseder of Investor Relations. During the question and answer period, please provide your name and that of your firm to the operator. With that, I'll turn the call over to Kevin Kabat. Kevin?

Thanks, Jeff. Good morning, everyone, and thanks for joining us. We know it's a very busy morning for you this morning. I'll make a few comments about the environment for the industry and Fifth Third before talking about high level quarterly results. Then I'll turn things over to Mary and Ross, who will review and detail our financial performance during the quarter, our credit trends, and some of our expectations going forward.

Now, obviously the environment is extraordinarily difficult right now. Like last earnings season, the broader financial industry situation is again in turmoil. The US government and financial authorities have taken significant steps over the past several months that have created more stability in money markets. Equity markets are less settled and there seems to be less differentiation in institutions in the past couple weeks. We experienced credit challenges earlier than others, given our geography and I believe the actions we've taken will better position us for the remainder of this cycle.

The economy is very weak right now, not just in credit, but where consumer spending is important, such as deposit service charges and transaction processing. Trends in the economy are uncertain, which reduces visibility beyond the immediate future. We're intently focused on those things we control: expenses, getting in front of customers, modifying loans where appropriate, making difficult decisions, and evaluating our businesses. This company retained its underlying strengths and we will continue to manage through these issues and move the company forward.

Now, in terms of our results, some high level comments, we continue to produce strong operating metrics across many areas of the bank. That gives us confidence and evidence of our underlying strengths in an environment that's been difficult for the industry. That said, the industry environment is unusually challenging given the low rates, and that's put some pressure on the net interest margin, which we expect to persist into the first quarter. We took significant actions this quarter in selling and moving to held for sale our most problematic commercial real estate loans in Florida and Michigan. These sales and transfers resulted in losses being accelerated, as these losses were marked to liquidation values or to currently very depressed bid levels. These sales will allow us to focus our resources away from situations that we've determined have little upside potential and redeploy them towards those which have greater recovery potential.

We believe we've eliminated any significant potential loss content on these loans going forward. In the process, we have significantly improved our credit metrics and coverage ratios. Our capital position was strengthened considerably at the end of the quarter with the treasury's investment of $3.4 billion in preferred stock. Our regulatory capital ratios are well above our target levels and we expect that to remain the case for the foreseeable future. We continue to have significant flexibility that serves Fifth Third well as we move through this tough environment.

Let me spend a few minutes on the credit actions that we took. As we indicated, we intended to be very aggressive in dealing with problem credits during the fourth quarter, and we were. We undertook an extensive review of our loan portfolio, with a special focus on commercial real estate loans in Michigan and Florida, particularly home builder and nonowner occupied commercial real estate loans. As you know, we suspended originations of these loans beginning more than a year ago. Our goal was to identify those situations where we believe we had long and unfruitful workout processes in front of us, where we believed our potential for recovery was not significant relative to current market values and where we believe the sale within the next several quarters was feasible. $1.6 billion in contractual balance loans were sold or moved to held for sale. Approximately 90% of these loans were commercial real estate secured loans in Florida and Michigan.

These loans had a carrying value at September 30, 2008 net of prior charge-offs of $1.3 billion. That $1.3 billion was made up of $732 million of nonperforming loans and $609 million of performing loans at September 30th, although the latter were loans with significant potential issues. These loans in aggregate represent the deepest discount loans on our books. We sold $240 million of principal balance loans during the fourth quarter and have contracts to close an additional $180 million this quarter, most of those in January. The remaining loans identified for sale were transferred to held for sale with losses recorded down to either the level of bids we received or otherwise to their liquidation value based primarily on recent appraisals. Overall, loans sold or transferred to held for sale were reduced to a value of approximately $0.33 of their contractual balances. We continue to aggressively work on selling down the held for sale position, which we expect to accomplish without further losses.

During the fourth quarter, we incurred losses on loans either sold or moved to held for sale of $800 million. Over half of these losses, about $440 million, were on home builder loans with half of those losses in turn in the Detroit region. We believe this represents an important step in reducing the risk of further loss on the most problematic loans we had in our portfolio, and in particular, the eastern Michigan home builder book. That portfolio has been reduced down to $270 million, three quarters of which is performing. Of the quarter that's not -- of the quarter that's on nonaccrual, those loans have been charged down to a carrying value of about 40%.

Turning to the consumer portfolio, we also continued to be very aggressive in restructuring consumer loans, or TDRs, modifying over $200 million in the quarter. We believe restructuring loans where appropriate will result in significantly greater likelihood of payment and more value ultimately received by Fifth Third. These activities are beneficial not only to our shareholders, but are also consistent with the needs of our customers. As of year end, we had $574 million in troubled debt restructurings and MPAs, classified that way because they hadn't met the six-month consecutive performance threshold.

Fifth Third has been among the most active of banks in the US in restructuring loans for consumer borrowers, a process we began over a year ago. We've been among the most active among our peers in these restructurings only one of the 15 largest US banks reports a higher dollar amount of restructured loans among its nonaccrual loans, according to regulatory filings. We have taken and continue to take very significant steps to mitigate losses and have increased the quality of originations considerably. We saw early deterioration in consumer credit trends than others, given our footprint, and I believe our early and aggressive action on those issues is showing up in results now. Consumer trends will follow economic conditions, but we've seen a slowing of the pace of deterioration that reflects the benefits of our loss mitigation strategies.

We've taken steps to bring about similar mitigation in the commercial book from suspending home builder and nonowner occupied commercial real estate originations to the buildout of our commercial workout area to the actions we took this quarter, to get our most serious problem loans behind us, at least from a loss standpoint. We continue to be very aggressive in other areas, including actively seeking updated appraisals to insure that their loss recognition is as early as appropriate and that our credit grades are reflective of current and recent market conditions. At the same time, we conducted a very thorough analysis of our loan loss reserves to ensure that they fully reflected recent economic conditions in terms of inherent losses we would expect from the portfolio, and we built those reserves by over $700 million in addition to the actions we took to reduce risk in the loan portfolio. We believe we're very well positioned to deal with the 2009 environment, which will undoubtedly continue to produce higher losses than historical norms.

Now, in terms of credit metrics for the loan portfolio, they reflected the challenging environment. Nonperforming assets at year end were 296 basis points and losses were 381 bps on loans remaining in the portfolio. And we expect the credit environment to remain very difficult in the near term. We've been building our loan loss reserves to ensure they remain strong and sufficient to absorb inherent losses in the portfolio. The reserve to loan ratio at year end was 331 bps and that represented coverage of nonperforming loans in the portfolio of 123%. We would expect continued growth in the reserve to loan ratio and in nonaccruals in coming quarters, but not at the rate of build in 2008. Absent future decisions on credit actions not currently anticipated, first quarter losses in the range of $.5 billion seems probable at this point. That's taking a fairly pessimistic view of economic trends, roll rates and credit grade migration.

As I noted, the $3.4 billion investment made by the treasury boosted our regulatory and tangible equity ratios significantly. Our total capital ratio of 14.5%, tier one ratio of 10.5%, and tangible equity ratio of 7.9%, are all well above our targeted levels by approximately 200 to 300 basis points, even after the charges we took to get problems behind us. We believe these ranges are appropriate as long-term targets, and as a result, we don't have current plans to change them. We believe having capital in excess of our long-term targets is appropriate at this time. As the economy strengthens, that cushion provides us room to grow. I would hope some of it will ultimately end up being more than we need. Our tangible common equity ratio ended the quarter at 423 bps. This reflects the effect of our credit actions, which reduced risk and future credit costs. There's obviously a trade-off between reducing those risks and lower capital. We're comfortable with our TCE levels, given the risks we've taken out with these actions.

We would expect to remain above the 4% level going forward, although we don't expect much, if any organic growth in TCE during the next several quarters until economic conditions improve. And we have significant internal sources of potential common equity available to us. You know that we are unique in our mix of businesses and we've discussed our evaluation of these businesses and their value. This evaluation was part of our initial capital planning last summer. We indicated we were reevaluating our plans with a treasury investment a couple months ago and it would be fair to say that given the change in the environment over the past couple of months, these options remain very much an opportunity for us. Additionally, we also have convertible preferred stock outstanding and conversion could be another possibility for generating common equity. Longer term, we do expect to operate at higher TCE levels and we'll continue to take prudent actions toward that end.

Turning to goodwill. We've recorded impairment of $940 million after tax during the quarter, or $1.64 per share. This write-down resulted from good will impairment testing in preparation for year end financial statements. A key driver here was the decline in our stock price during the quarter and the comparison of our market cap to our book value. It's important to note, as I'm sure you are aware, that this charge is noncash in nature. Obviously it's a large number and affects reported earnings. However, it doesn't affect our cash flow or liquidity or any regulatory or other capital ratios, which are all based on tangible equity. I know there's a lot of noise in our numbers this quarter, but I do want to spend some time highlighting some positives within our core results as well.

Corporate banking fees have continued to be very strong, up mid double digits, both on a sequential and a year-over-year basis. Our focus on building up the team and product set here is producing the substantial improvement. For the year, our processing solution fees were up 11%. While transaction volumes slowed in the fourth quarter given recent consumer spending patterns, our payments business seems to have held up comparatively well. We expect double-digit growth in 2009 as well. Mortgage banking should remain fairly strong given the fed's actions and recent refi activity.

Loan growth was modest during the quarter reflecting weak demand among commercial and consumer borrowers. We know there's a tremendous focus on the availability of credit, and I can emphatically say we're still making loans to qualified borrowers in all of our markets. We and our customers are being cautious and that's being reflected in our core growth numbers. As we discussed during the quarter, while deposit pricing has eased, like other banks, we're experiencing the effects of low rates on our deposit spreads, particularly lower yield and transaction accounts. At the same time, asset yields respond more fully to the drop in market rates. That's reflected in our net interest income and margin. We've seen deposit competition ease somewhat toward the end of the quarter, with the exit of some of the market pricing leaders, although deposit competition still remains fairly stiff. Additionally, the weaker economy has resulted in lower average balances across many segments of the deposit base. However, deposit account production has remained strong with consumer deposit accounts on a same-store basis up 4% over last year and consumer DDA accounts up 7%. Additionally, total account openings were up 5% over last year.

We would expect over time to see competitive behavior change and depositors return to a focus on total value provided and not the rate chasing that's characterized markets over the last six months. In the long run, the combination of everyday great rates and our strong customer satisfaction performance will continue to prove a successful strategy as these results indicate. The expense line was effected by a number of items that Ross will talk more about in a minute. Reported expenses were up significantly from last quarter, but excluding the good will impairment and other items outlined in the release, the sequential growth and core expenses was about 8%. Expenses related to credit activity, things like legal, collection costs, provision for unfunded commitments, etc., represented virtually all of that sequential growth. We would expect expense levels to come down significantly next quarter, as we're managing expenses very closely in this environment. With that, let me turn things over to Mary to talk about our credit results. Mary?

Thanks, Kevin. As Kevin mentioned, we undertook a number of initiatives this quarter related to our commercial loan portfolio in order to deal with our most problematic loan pools, where we believe that our chances of recovery were the worst. This increased the level of net charge-offs in the fourth quarter. For purposes of this credit discussion, we're going to distinguish between loans remaining in the portfolio versus those loans sold or transferred to held for sale. During the fourth quarter, we incurred $800 million in losses on loans sold or moved to held for sale. These steps were intended to further reduce the risk of some of the more problematic loan portfolios, particularly real estate loans in Michigan and Florida, and with an emphasis on home builders and nonowner-occupied commercial real estate loans.

To give some more color on the loan types and geographies for the credit actions, let me walk through the components of the $1.6 billion of loans that were sold or moved to held for sale. We sold loans with $240 million of contractual balances' and a carrying value of $177 million at September 30, incurring losses in the fourth quarter of $120 million. We also moved loans with contractual balances of $1.4 billion and carrying values of $1.2 billion to held for sale, incurring losses of $680 million. Taken in aggregate, the loans we've sold are moved to held for sale were sold or marked to values averaging $0.33 on the dollar. We're confident that we can clear the loans remaining in held for sale at that level.

Let me give some additional color on the geographic distribution, industry concentration, and types of loans sold or moved to held for sale. For the $800 million of net charge-offs on loans sold or moved to held for sale, 44% were on loans in Michigan and 49% were on loans in Florida. Of those losses, $440 million were related to home builders and developer credits. This took care of the majority of our troubled developer loans in eastern Michigan, and we feel more comfortable on a go-forward basis about that geography. We took losses and write-downs of $159 million this quarter on this one segment in eastern Michigan. We have $270 million of home builder loans in eastern Michigan remaining in the loan portfolio, of which approximately a quarter are on nonaccrual, and this portfolio has been written down significantly through charge-offs.

From an industry perspective, 51% of the $800 million in losses came from companies in the construction industry and 40% came from companies in other real estate-related businesses. So over 91% came from real estate-related credits. Excluding the $800 million, total net charge-offs on our ongoing portfolio were $827 million, up $364 million from the third quarter. Virtually all of the growth in portfolio losses came from the commercial portfolio. Starting with the commercial portfolio, excluding held for sale, commercial net charge-offs totaled $626 million compared with $266 million in the third quarter. A lot of the real estate problems were dealt with in the actions that I described a moment ago. Therefore, the primary driver of remaining losses were C&I charge-offs totaling $383 million, a $298 million increase from last quarter. About half of the fourth quarter charge-offs were attributable to loans to companies in real estate-related industries, which represented $105 million of losses, and auto retailers, which accounted for $84 million of losses. We don't expect to see similar levels of C&I losses in the first quarter, although we would expect continued stress in these sectors due to weakness in consumer spending and rising unemployment.

Commercial mortgage losses were $94 million for the quarter, with 64% of losses coming from Michigan and Florida. Losses on commercial construction loans were $150 million compared to $88 million of losses in the third quarter. Of the $626 million in commercial portfolio losses, residential home builder and developer credits accounted for $128 million, with about half of that in Michigan. Moving on to the consumer book, consumer net charge-offs were $201 million, or 2.4%, only slightly higher than the $196 million we saw in the third quarter levels. Residential mortgage net charge-offs were down $9 million for the quarter and home equity net charge-offs were down $2 million. Auto loan net charge-offs rose $11 million from the third quarter, reflecting pressure on borrowers and lower values received at auction. And credit card net charge-offs were up $6 million from the prior quarter.

Trends in these products' performance will continue to be driven by the overall health of the economy. The driver of the decline in home equity net charge-offs was the brokered portfolio. That portfolio continues to run off, since we shut down production in 2007. The net charge-off ratio for our brokered portfolio fell to 4.5% from 5% in the third quarter, although that's still more than four times the loss rate of our branch generated portfolio. Losses in the direct portfolio were relatively stable at approximately 100 basis points for the quarter.

Now moving on to NPAs. NPAs, including held for sales, totaled $3 billion at quarter end. Excluding $473 million of NPAs related to our held for sale activities, where the loans have already been fully marked, NPAs totaled $2.5 billion, or 296 basis points of loans, down from $2.8 billion last quarter. As Kevin mentioned, $218 million of our NPA growth was due to troubled consumer debt restructurings in the quarter. The declines in commercial portfolio NPAs are the result of our loan sales and held for sale activities. Portfolio C&I NPAs were down $9 million from the third quarter. Portfolio commercial construction NPAs were down $259 million and commercial mortgage NPAs were down $247 million. At the end of the third quarter, Michigan and Florida accounted for 38% of our total commercial real estate portfolio and 37% of our commercial real estate NPAs.

Across the portfolios, residential builder and developer NPAs of $366 million are now about half of prior quarter levels. Consumer NPAs of $1 billion were up $186 million, or 22% from the third quarter, driven by $218 million in new TDRs during the quarter. I would note that we've modified about $770 million in consumer loans since the third quarter of 2007, of which $574 million are carried in NPAs currently. About a third of loans modified more than six months ago have cured, and about a third of the loans that we've restructured to date are currently more than 30 days past due. As Kevin noted, we've been unusually aggressive in this area. As I noted, these TDRs accounted for almost all consumer NPA growth in the quarter and for the year.

Turning to the allowance for loan and lease losses, it was $2.8 billion at the end of the quarter, up $729 million. Provision expense this quarter was $2.4 billion, and was 145% of net charge-offs, including credit actions resulting in an increase in the reserve to loan ratio from 2.41% to 3.31%. The allowance to nonperforming loan ratio increased from 79% in the third quarter to 123% as of the end of the fourth quarter. That ratio includes troubled debt restructuring, which has specific reserves associated with them as part of the revaluation process when they are modified. As you know, the other nonperforming assets are marked net of reserve as part of the ordinary process and thus do not have reserves held against them. These would include OREO, repossessed autos, and nonperforming assets in loans held for sale. Additionally, we have reserved in the form of purchase accounting marks of about $450 million that are available to absorb credit losses, but which are not included in our loan loss reserve metrics. So overall, we feel our reserves are very substantial to deal with losses that we may incur in the future.

Now, I'll turn it over to Ross, but before I do, I would like to remind you that we've again provided some additional disclosures concerning our earnings materials, stratifying our portfolios by the characteristics that are driving differential loss experience, as well as some presentation materials depicting trends and data about some of our key portfolios. Ross?

Thanks, Mary. First, I would like to say it's a pleasure to be here. I've been at Fifth Third for about two months now and it's been quite a couple months. The industry is facing a lot of challenges right now and I have found here at Fifth Third a great group of talented people, very focused on addressing the problems the environment has presented, while still ensuring we keep creating value in the company for long-term success. I look forward to getting reacquainted with those of you I haven't seen in several years and to meeting the rest of you. So let me start with the summary of earnings per share and some high level results. For the quarter, we reported a loss of $2.2 billion, or $3.82 per share. The primary driver of this loss was net charge-offs that totaled $1.6 billion, of which $800 million was attributable to the loans that were sold or moved to held for sale. Additionally, we increased our reserves by a very substantial $729 million to provide for higher inherent losses in the portfolio, given the deteriorating environment. The other major driver was goodwill impairment charge Kevin mentioned of $940 million after-tax.

This noncash charge was triggered by the recent decline in the market value of our common stock and the subsequent evaluation of goodwill from a line of business standpoint. The impairment was ultimately determined to be in the commercial and consumer lending lines of business and recorded there for segment reporting purposes. Obviously that's a big headline number. We believe we have significantly better positioned the company for dealing with what will remain a very difficult environment in the near term. We believe we should see lower credit costs going forward, given our expectations and positioning today.

Now, let me walk through our results in greater detail starting with the balance sheet. Average loans in the fourth quarter were up 2% sequentially and 10% year-over-year. Growth included $1.7 billion in activity and off-balance sheet programs related to the liquidity environment in the early part of the fourth quarter. These include $1.2 billion of commercial loans previously in conduits that were returned to the balance sheet and $484 million in draws on letters of credit related to VRDNs, the counter parties were unable to remarket. Excluding that $1.7 billion, average loans were up 8% on a year-over-year basis and essentially flat from the third quarter. Average commercial loans increased 3% sequentially and 19% from a year ago. Excluding the off-balance sheet activities I just mentioned, commercial loans were flat sequentially and up 16% on a year-over-year basis, with most of that C&I growth in the early part of 2008. Average portfolio consumer loans were flat sequentially and down 1% from a year ago. Year-over-year comparisons were effected by the sale and securitization of $2.7 billion of auto loans in the first quarter of 2008. Now, within consumer loans, auto loans were up 2% sequentially and down 11% compared with last year due to the loan sales and securitizations of prior quarters. Credit card balances were up 2% sequentially and up 20% on a year-over-year basis.

Balance growth has slowed as consumer spending weakened over the course of the year. This remains a relationship-oriented product, originated in footprint through our branch network, with high average FICOs. Residential mortgages were down 4% sequentially and down 6% from a year ago. We originate mortgages to conforming standards with the intent to sell 95% of our production. The lower volume of production we're putting on the balance sheet is the primary driver of the decline as our legacy book runs off. We did see an increase in origination volume in December, as lower rates prompted many people to refinance their mortgages, so we would expect to see further benefit when those loans closed in the first quarter. Home equity loans were up 1% sequentially and up 7% from a year ago. Growth has moderated significantly as we've adjusted our lending parameters.

New production reflects branch originated high quality loans generally at greater than 720 FICOs and below 80% combined LTVs across most of the footprint, with a max CLTV of 75% in our most distressed markets. We expect continued loan growth to remain moderate on an average basis in the near term, given customer caution and the effect of our $1.3 billion of sales and transfers to held for sale, which occurred at the end of the quarter. Period end loans should increase a couple billion dollars in the first quarter and we would expect more than $10 billion of originations in the first quarter offset by repayments and maturities.

Moving on to deposits, period end core deposits were up approximately $4 billion, or 6% over third quarter. Average core deposits were up 1% sequentially and up 2% on a year-over-year basis. Average consumer core deposits were up 4% on both the sequential and year-over-year basis. Excluding acquisitions, consumer DDA accounts increased 7% on a year-over-year basis, but that growth was partially offset by a 5% decline in average account balance. Total commercial core deposits were down 5% sequentially and 6% from a year ago. Commercial DDA balances increased 5% sequentially and 10% on a year-over-year basis and commercial interest checking increased 3% on both a year-over-year and sequential basis. A good part of that DDA growth was from companies moving balances from money market and savings, given the increased FDIC guarantee. The decline overall in commercial core deposits was driven by companies opting to pay for treasury management services through fees rather than compensating balances due to lower earnings credit rates, as market rates declined.

As Kevin noted, in October and November, we saw extremely aggressive deposit rates from a couple major competitors. We did see significant easing in deposit price competition in December and our CD rates are now about half what they were during the first two months of the fourth quarter. We've continued to grow core deposit balances during this quarter with account growth more than offsetting lower average balances. We would expect to see core deposit growth continue in that low to mid single-digit level in the first quarter.

Moving on now to net interest income, net interest income was down $171 million sequentially and rose 14% on a year-over-year basis. This quarter's NII included $81 million of loan discount accretion related to the June 1st charter acquisition compared with $215 million last quarter. Excluding the discount accretion, NII fell $37 million or 4% from the previous quarter. This was driven partially by interest reversals on nonperforming loans that increased about $10 million from the third quarter to the fourth. NII was also affected by narrower deposit spreads in the low rate environment and migration into higher rate products among our customer base, which more than offset the benefit of wider commercial and consumer loan spreads. Net interest margin for the quarter was 3.46%, down from 4.24% in the prior quarter, with 54 of that 78 basis point decline attributable to the lower loan discount accretion from first charter. Excluding these impacts, net interest margin for the quarter was 3.15% compared to 3.39% last quarter.

The 24 basis point decline in the core net interest margin was primarily related to narrower deposit spreads, deposit mix shift, and our shift of funding towards deposits and away from wholesale funding. We've been focused for sometime on growing deposit funding and reducing reliance on market funding in light of the continuing disruption in the liquidity markets. Our focus was particularly intense in the fourth quarter, given the substantial strains the credit markets experienced early in that period. Obviously this was expensive relative to cost of overnight funds. In addition, during the quarter, our competitors continued to be very aggressive with deposit rates. We didn't seek to match the highest rates in the market. However, we did defend our customer base by offering competitive rates on a number of savings and time deposit products. We expect these additional costs to move towards more normal levels as pricing rationalizes over time.

In the first quarter, however, we expect further compression in the core net interest margin as we absorb a full quarter's effect of the fed's rate cuts on deposit spreads, slightly less than we experienced this past quarter in the core margin. Loan discount accretion on first charter will also be about 1/2 the 31 basis point benefit in the fourth quarter. We would expect net interest margin and net interest income to bottom out in the first quarter. Moving on to noninterest income, reported noninterest income of $642 million was down $75 million sequentially and up $133 million from a year ago. Fourth quarter results include an estimated noncash charge of $34 million related to lower cash surrender value on one of our BOLI policies and $40 million of OTTI charges. Third quarter results included a $76 million gain related to our satisfactory settlement of goodwill litigation related to our 1998 acquisition of CitFed, $51 million in OTTI charges on GSC preferreds and a $27 million BOLI charge. Fourth quarter 2007 results included a $177 million charge in BOLI charges excluding all of those items, the core growth rate for noninterest income was 4% year-over-year and flat compared to the third quarter.

Payments processing revenue was down 2% sequentially and up 3% on a year-over-year basis. While the number of merchant transactions was flat sequentially, the average ticket size was down by approximately 6%, consistent with softer retail sales in the quarter. We would expect those fees to be lower in the first quarter with typical seasonality, but they should still be up somewhere in the mid to high single digits from a year ago. Corporate banking revenue was up 16% sequentially and 14% on a year-over-year basis, driven by exceptional growth in foreign exchange, which totaled $29 million in the fourth quarter, an $11 million increase, or 64% on a year-over-year basis. Those fees are also typically strongest in fourth quarter, but we do expect continued solid year-over-year growth this quarter. Deposit service charges were down 6% sequentially and up 2% on a year-over-year basis. Sequentially, consumer service charges declined $12 million, while commercial service charges rose $3 million. The decline in consumer deposit fees was driven by lower transaction volume, mostly related to lower debit card utilization.

Consumer growth was driven by strong sales of our expanded treasury management suite, as well as the effective lower earnings credit rates on service charge income. Those fees should be seasonally lower in the first quarter, but up high single digits from a year ago. Investment advisory revenue decreased 13% sequentially and 17% from a year ago, reflecting lower market valuations and reduced trading activity related to the decline in equity markets. Given where markets are right now, I wouldn't expect to see growth in this line in the first quarter. As you're aware, our mortgage banking revenue is split between two lines on the income statement. Mortgage banking net revenues, the main one, and securities gains on nonqualifying hedges on MSRs is the other. If you net these two lines against one another, mortgage banking related revenue was $67 million for the quarter compared to $67 million last quarter, and $32 million a year ago. On a year-over-year basis, the adoption of FAS 159 contributed about $12 million of the increase.

Originations were $2.1 billion, up modestly from $2 billion last quarter. We expect to see a significant increase in originations in the first quarter as we close and book loans that were applied for mid-December following the fed rate cut, which is one of the reasons our MSR evaluation declined. It's always difficult to predict mortgage banking revenue, but total mortgage revenue should be up a good bit in the first quarter, given the current pipeline. Turning to the securities line, we recorded $40 million in OTTI impairment charges on investment securities. Last quarter's securities losses were $63 million, largely a result of GSE preferred impairments. I'm not going to walk through other income, which is described in the release in detail, but fourth quarter results were $24 million, which included $34 million in BOLI writedowns, as well as $24 million in ORE writedowns, which was about double the level of the third quarter. The remaining carrying value on this BOLI policy is $290 million, but all but about $30 million is currently invested in cash equivalents or money market funds.

Moving on to expenses, noninterest expense increased $1.1 billion on both the sequential and year-over-year basis. The primary driver, of course, was a charge of $965 million pre-tax to record goodwill impairment. Excluding that charge, fourth quarter noninterest expense was up $90 million sequentially and $117 million from a year ago. Fourth quarter 2008 results included some unusually large items such as higher provision for unfunded commitments, which was $63 million this quarter versus $17 million last quarter, reinsurance reserve accruals on PMI, and reserves for derivative counter party losses. These expenses were nearly $100 million higher than in both the third quarter and the fourth quarter a year ago. Fourth quarter results also include an estimated $8 million charge due to a change in estimates of losses related to our indemnification obligation with Visa. Third quarter results included $88 million of unusual items, which are described in the release. On a year-over-year basis, acquisitions have added approximately $26 million of additional operating expense compared with prior year, while the impact of the adoption of FAS 159 on the classification mortgage origination costs has added approximately $12 million.

Expenses increased in the high single digits excluding the items outlined above from the third and year-ago quarters. That remaining growth was fully attributable to higher costs related to collections and workout activity into higher processing volumes. We would expect first quarter expenses to be down significantly, absent that goodwill charge, closer to the third quarter levels. And we expect efforts to restrain expense growth throughout the year to offset higher credit-related expenses.

Now moving on to capital, on December 31, we closed the investment with the US treasury, which added $3.4 billion of capital to our balance sheet. Our period end tangible equity ratio was 7.9%, tier one ratio was 10.5%, and total capital ratio was 14.6%, all well above targets, which we believe is appropriate given the current environment. Kevin discussed capital at length, and I will only add that we believe we have the earnings power to absorb losses from our portfolio, and as a result, we would expect the TCE ratio, which is lower than we would like at 4.25%, to be pretty close to the floor of what we would expect. We've taken a lot of risk off the books and have strong reserve levels. As Kevin mentioned, we have a number of avenues to get that ratio up on a longer-term basis that will continue to actively evaluate. On that note, I'll turn the call back over to Kevin for some closing remarks.

Thanks, Ross. These are challenging times and they will remain challenging for some period of time, but we retain the strength and the flexibility to manage through this and we'll continue to deal with our issues aggressively and as transparently as we can. Our employees are working extraordinarily hard for shareholders under trying circumstances, and I would like to thank them and to assure you that that will continue. At the same time, they are also remaining very focused on producing the core results that will underpin strong earnings power on the other side of the cycle. We appreciate your time this morning. We know it's been a long and difficult earnings season and you have a busy day, so we appreciate your attention. And with that, operator, we can now open it up for questions.

Tracy?

(Operator Instructions) We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Matthew O'Connor with UBS.

Good morning.

Good morning, Matt.

Appreciate the commentary regarding the tangible common equity, which seems like it matters during bad days and doesn't matter so much during the good days. But just trying to get our arms around, is there a magic number that if it dipped down to, would cause you to reconsider selling assets or asking the government for additional help? It's very tough from I think the investor and analyst community to figure out what number is kind of the floor before something happens.

I don't think we have a magic number. Clearly, as we said at 4.25%, we're below where we would like to stay long term. So it leads us to look at all of the avenues that we have, which may include some that you mentioned. So -- but there is no magic number. There is no absolute floor that we would consider.

Okay, and then separately, I think your expectations are implying another 20 basis points or so decline in the quarter and in 1Q. As we look forward to the rest of the year, lot of moving pieces. You said it would bottom, but do you think that stabilizes, or is there an opportunity for expansion? What's your best guess on the outlook further down the road?

I think clearly it's going to be driven by market pricing and opportunities and spreads on both asset and deposits side. But as we model it right now, we see it bottoming in the first quarter with some expansion opportunity going forward into 2009.

Matt, obviously in this environment, hard for the fed to get below 1/2%. And so, again, I think Ross kind of summarized our expectations in terms of where we are and what we can do in terms of an outlook perspective to try and really address that.

Okay. All right. Thank you very much.

Okay.

And your next question comes from the line of Betsy Graseck with Morgan Stanley.

With Morgan Stanley, I think. Hi. Thanks for all the detail that you gave this morning. Two questions. One is on how you assess the degree which you'll be moving future loan pools to held for sale. I mean what are the triggers that you look for to make that decision?

I think clearly it's a very detailed evaluation of markets, product sets the economy and where we feel that the opportunity to recover nonperforming assets through a workout is less than what may be available in the secondary market, we will seriously consider that. We don't have any other markets or product sets that we're focused on right now, but that's a quarter to quarter, month to month activity we're undertaking. Mary, do you want to add anything?

Yes, I would just add that for this particular quarter, we really focused on those assets that we thought were at the greatest risk for further deterioration, and in particular, looked at the feasibility or likelihood of a successful workout outcome in the future. And on that basis, in combination with a very rigorous and methodical review that we did of the markets and the asset classes, came up with those decisions.

And obviously you touched to the market for these interests in these assets, so do you anticipate that you'll be able to sell the assets during the quarter, 1Q '09?

Yes, the number of assets that we've moved to held for sale are already under contractual commitments and then we'll continue those other activities as we've previously described.

Right, okay. And then --

I'll just add that it's uncertain whether we will move all of the assets in the first quarter of '09. It's something that we'll -- activity that we'll be undergoing into the future perhaps for a few quarters, but as Mary said, we have found an active market for many of these assets are under contract and that list of loans that are under contract will continue to grow.

Okay. And then separate question is on new loans and making new loans. Can you give us a sense of how you are assessing the quality of the borrowers to make new loans in an environment where there is such deterioration in some of the core economies that you're dealing with?

I think it's first of all important to understand that we're in the lending business and so we continue to make loans in a very disciplined fashion to qualified borrowers. So to that end, we continue to review all of our underwriting standards to make sure that those standards meet the appropriate balance of risk and return.

Obviously, Betsy, you're exactly right. In this environment, both borrowers and ourselves are cautious and we've raised and changed a lot of expectations of standards in terms of those loans. But there is still good business to do out there and there's still a need, an important role for lending to play both in our business and in our customers' business. So that's really what we're focused on and that's really kind of the significance of some of the changes that we've made, both in terms of the business mix, and we've hopefully been pretty transparent in terms of the market relative to the changes we've implemented over this time period, as well as some of the businesses we've shut down and areas we don't do business anymore on a go-forward basis. So hope that's helpful.

There's a couple of different levers. Obviously pricing, collateral, and then covenants. And I'm sure that those levers you use differently for different customer types. And it's a delicate balance, because if you move too much, you're going to choke off demand.

And I would also add that obviously in any underwriting decision you evaluate stress scenarios for the customer, and clearly the types of stress scenarios we're looking at now are probably a little more severe than would have been evaluated in the past.

Okay. And sort of just lastly, how are you seeing demand for loans in your core customer footprint, both on the commercial and the consumer side?

I think we still have good demand, but I think as Kevin said earlier in his prepared remarks, a lot of customers are being cautious. So and the concern that banks are not lending, it's because a lot of customers are being very cautious and perhaps in many ways the demand may not be there as it had been in past years.

Okay.

(Operator Instructions) Your next question comes from the line of Mike Mayo from Deutsche Bank.

Good morning, Mike.

Just one general question, then a few specific ones. But in deciding to take the CFO position, this is for Ross, I -- this quarter Fifth Third didn't exceed its cost of capital and I'm sure you wouldn't have taken the position if you didn't think Fifth Third would be able to do that over some course of time. So why did you take the job and how do you think Fifth Third can eventually exceed its cost of capital?

I, clearly as you indicated, expect that in the long term, Fifth Third will be able to exceed its cost of capital. I think the support of the the TARP program and everything gives us even more confidence going forward that there's plenty of capital to absorb the potential long-term marks on the credit portfolio. The footprint and the franchise is still unique and very competitive in our markets and I think once we get through this credit bubble, I have full faith that we'll be able to return to a position where we will be more than covering our costs of capital.

All right. I guess that's the long-term question. The medium-term question, when you talk about you'll evaluate your options as it relates to capital, and you said the tangible common equity might not improve for a few quarters, so I guess that implies you don't expect to earn much money the next few quarters. So what are some of these options and haven't these been around for a few quarters now?

I think as I look back at the history of some of the discussions, certainly some have been around for a few quarters and those options are still there. I'm not sure that we had talked previously about the possibility of converting preferred shares to -- it doesn't impact total capital, but it would benefit tangible common equity, which is a major focus right now. So they are still there and still very much alive in terms of how we're evaluating them.

And Kevin, anything else for the options in terms of sales of businesses or business lines?

Yes, Mike, we've tried to be as transparent as we can be at this point. I don't think, I don't think there's really anything more to add at this point. To your point, again, we've tried to be transparent. It's now a matter of moving through the period and executing.

And then the short term. So you wrote down these $800 million of loans that you sold or transferred to $0.33 on the dollar, but you only sold $120 million of the $800 million. So is there a chance we would have any more losses on the $680 million that's been transferred, but not sold, or is that -- just we're not going to have anymore losses there?

No, we believe that the actions that we took were very prudent and conservative in the methodology that we employed for the writedown. So at this point, we don't see a future risk of loss.

And for the commercial charge-offs, which went up quite a bit, the real estate-related industries, so what is this? These are commercial loans that actually wind up being real estate-related after all, is that -- what are these real estate-related industries?

Yes, these would be industries that have a dependency to the real estate business. It could be rental and leasing kind of borrower, or it could be a borrower that would have some other dependency on the real estate industry, such as furniture or supplies or other types of activities.

And what percent of your commercial loans would you say would be somehow real estate-related, if you had to guess?

We would say if you were to look at both the nonowner occupied portfolio as well as other aspects of our commercial real estate portfolio, and then anything else outside of the commercial real estate portfolio that would have some connection to the real estate industry, we think it would be roughly in the range of about half of the portfolio.

I'm sorry. Half of -- I guess I asked the question differently, but I'm trying to understand your answer.

I'm just trying to make sure, Mike, we're understanding your question. If we look at the SIC codes or the [nics] codes within the commercial book, I don't have that number handy, but I think it's probably closer to 20%. I think Mary was really speaking of industries that are more [tangentially] related, retail has a Lowe's and Home Depot, for example. So the way we report our external SEC reports would be purpose-driven, so it's not collateral-driven. That's the way the regulatory reports are set up. These are C&I loans to companies, some of whom are in [nics] codes in the real estate industry or the construction industry and that's what we are suggesting when we talk about C&I having a real estate component, is that these are C&I loans to companies within the real estate industry.

Okay. It's not unique to Fifth Third.

Right.

This is for the industry, right?

Right, absolutely.

And then the last question, salaries were up 5%. Is there anything unusual in that figure?

No, there's nothing unusual in that figure. Ross, is there anything?

I don't think there's anything unusual. You have to look at the impact of acquisitions year-over-year, and -- but I think if you back out the impact of acquisitions, we have clearly invested in growth in some areas such as the credit workout area and the credit risk management. But all in all, beyond those we've been very efficient on the salaries and head count.

All right, thank you.

Thanks, Mike.

We've reached the allotted time for questions. Do you have any closing remarks?

No. Thank you very much, everybody, and have a good day.

This concludes today's conference call. You may now disconnect.