Fifth Third Bancorp (FITB) 2013 Q3 法說會逐字稿

Good morning. My name is Frederick and I will be your conference operator today. At this time, I would like to welcome everyone to the Fifth Third Bank earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks there will be a question-and-answer session. (Operator Instructions).

Thank you. I would now like to turn the call over to Jeff Richardson, Director of Investor Relations. Mr. Richardson, you may begin.

Thanks, Frederick. Good morning. Today, we'll be talking with you about our third-quarter 2013 results.

This call may contain certain forward-looking statements about Fifth Third 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 have identified some 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 them.

Fifth Third undertakes no obligation and would not expect to update any such forward-looking statements after the date of this call.

I am joined on the call by several people -- our CEO, Kevin Kabat, and CFO Dan Poston; Frank Forrest, who joined us as Chief Risk Officer and Chief Credit Officer last month; Treasurer Tayfun Tuzun; and Jim Eglseder from Investor Relations.

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.

This morning, Fifth Third reported third-quarter net income to common shareholders of $421 million and earnings per diluted share of $0.47. Earnings this quarter included the benefit of $85 million in gains on the sale of Vantiv shares, $6 million of valuation gains on our Vantiv warrant, and a $15 million reduction in our mortgage rep and warranty reserve.

These benefits were offset by litigation reserve expense of $30 million, $5 million in severance expense, and $5 million in new Dodd-Frank large bank supervisory assessment fees.

In total, these items produced an after-tax net benefit of about $0.05 per share for the quarter.

Third-quarter EPS increased approximately 1% from a year ago, adjusting both quarters for similar items, despite significantly lower mortgage banking income. This reflects core growth across most of our other business lines, particularly deposit service charges, which were up 10%, and investment advisory fees and card processing revenue, which were each up 6%.

Returns on assets and equity remain strong and tangible book value per share increased 3% sequentially and 8% from a year ago.

Now turning to business activity, borrowers remain cautious and on the sidelines, which supported higher average deposit balances and led to some slowing in loan demand during the quarter. Average core deposits were up 6% from a year ago and included growth in transaction deposits of $5.7 billion.

The strength in our deposit franchise was also reflected in the FDIC's annual market-share data, in which we grew deposits in 15 of our 18 affiliates and gained market share in 14 affiliates.

As you know, we h have completely revamped the deposit products in our consumer bank (technical difficulty) recently in our business banking segment. Our new offerings were designed with a focus on building full and profitable customer relationships and to align value provided and value received, given changes in the profitability of retail products.

We are through that process and we are building upon this foundation to accelerate growth going forward. We are seeing higher balances with our new account structure, and we expect that to continue when rates eventually rise.

In the third quarter, average portfolio loans grew 1% sequentially and period-end portfolio loans increased about $200 million, reaching the highest levels of balance in the Company's history. Sequential growth was a bit lighter than prior quarters as payoffs and paydowns offset new production in the commercial portfolio and as higher interest rates reduced demand for mortgage loans and refinancing in our consumer lending business.

Fee income results were solid and reflected lower mortgage revenue, as expected. We have been preparing for a shift in market conditions for quite some time, and are in the middle of implementing changes to the business to reflect more normalized volume expectations.

At the same time, our other businesses are performing very well. As I just mentioned, we continue to optimize our retail banking platform, both in terms of our distribution strategy and in prioritizing key customer segments that add value for the bank.

For example, consumer deposit fees are up 17% from this time last year. Retail brokerage and private client fees have increased 12% and 10%, respectively, from a year ago. Credit card balances are up 8% year over year. And we continue to see the benefit of our investments in the mid-corporate space and in the energy and healthcare industries. Dan will discuss these trends further in his remarks.

We continue to manage expense in a disciplined way. Expenses declined 7% from abnormally high levels last quarter, driven by lower litigation costs, mortgage-related costs, and credit costs, as well as careful expense management overall, and that will continue, as you'd expect from Fifth Third.

Credit trends continued to show steady improvement, with net charge-offs below 50 basis points of loans for the first time since early 2007 and nonperforming assets down 12% to 116 basis points of loans.

Capital levels remain very strong, with a Tier 1 common ratio of 9.9% and a leverage ratio of 10.6%. Our current pro forma estimate for Basel III Tier 1 common equity is 9.5%. Our ability to generate capital and our strong capital levels under both Basel I and Basel III give us the ability to support balance sheet growth, while continuing to return capital to shareholders in a prudent manner.

We recently completed and settled the $539 million common stock repurchase agreement we initiated in May, and we have more than $600 million in remaining capacity over the next six months under our 2013 CCAR plan.

Now to wrap up my remarks, I tell you it continues to be a tough and uncertain environment, one that doesn't give you anything. You have to execute and take it. We continue to generate a relatively high level of profitability despite these challenges. That's due to our strong culture and focus on revenue results, on lending and deposit gathering, on continued expense discipline, and on improvement in credit. These give us a lot of confidence that our strategies are working and that we are well positioned to win going forward.

As you may have seen, we recently received upgrades with two rating agencies, which reflect in large part these strengths of Fifth Third.

Now finally, as always, I would like to thank our employees for their continued focus and drive and our customers for their continued business and partnership with Fifth Third.

With that, let me ask Dan to discuss operating results and give some comments about our outlook. Dan?

Okay, thanks, Kevin. Good morning, everyone. I will start with slide 4 of the presentation and will discuss the results for the third quarter, before turning to the outlook toward the end of my remarks.

Earnings per diluted share were $0.47, down $0.18 from last quarter, primarily due to lower Vantiv gains. Current-quarter results included a pretax $85 million gain on the sale of Vantiv shares and a $6 million positive valuation adjustment on the Vantiv warrant, whereas prior-quarter results included a $242 million gain on the sale of shares and a $76 million positive value -- valuation adjustment on the warrant.

Additionally, third-quarter results included $30 million in charges to increase litigation reserves, compared with $51 million in the second quarter. There were several other items that affected earnings in the quarter, which are outlined in our release, and I will note them throughout my comments. As Kevin noted, these items contributed a net $0.05 to earnings per share this quarter.

Turning over to slide 5, tax equivalent net interest income increased $13 million sequentially to $898 million and the net interest margin was 331 basis points versus 333 basis points last quarter.

During the quarter, we took advantage of higher interest rates to remix and add investments to our securities portfolio. The higher earnings from these securities, along with $6 million in benefit from higher quarterly day count, contributed to the increase in net interest income.

NII also benefited from lower interest expense, reflecting the full quarter impact of debt maturities in the second quarter, as well as lower CD costs due to the maturity of approximately $500 million of 2008-era CDs.

These benefits were partially offset by the negative effect of loan repricing, lower mortgage held for sale balances, and the full quarter impact of the interest rate floors that matured in the second quarter, which is now fully in our run rate.

The 2 basis-point decline in the net interest margin was primarily driven by repricing in the loan portfolio, the full quarter impact from the maturity of interest rate floors in the second quarter, and a 1 basis point reduction from the day count effect. These effects were partially offset by the impact of lower funding costs and higher securities yields.

Earning asset yields continued to compress, although to a lesser extent than in previous quarters. Loan and lease yields declined, driven by C&I and auto portfolios. The reported C&I portfolio yields declined 9 basis points. The core decline was 4 basis points, with an additional 5 basis points coming from the full quarter impact of last quarter's maturity of interest rate floors.

The 4 basis point core decline in yields was driven by repricing within the portfolio, combined with a continued mix shift toward higher-quality loans. This core decline in yields is substantially smaller than the trend we have seen over the past several quarters, as we continue to focus on pricing discipline in this current environment.

In the indirect auto portfolio, the average yield declined 14 basis point in the quarter, largely reflecting the continued portfolio effect of replacing older, higher-yielding loans with new, lower-yielding ones.

In the taxable securities portfolio, yields increased 11 basis points, reflecting the benefit from higher investment balances and higher securities yields.

Turning to the balance sheet, which is on slide 6, average earning assets increased $1.2 billion sequentially, driven by a $1.2 billion increase in investment securities and a $333 million increase in short-term investment balances.

We added a net $2 billion of securities this quarter as the movement in rates within the quarter allowed for attractive entry points for us to purchase securities. Despite these investments, the proportion of our assets in the securities portfolio continues to be on the lower end of our peer group, providing us with additional capacity as the rate environment improves and provides additional investment opportunities.

Average portfolio loans and leases were up $565 million, but were offset by an $884 million decline in average loans held for sale, reflecting the lower level of mortgages being originated for sale.

Looking at each loan portfolio, average commercial loans held for investment increased $258 million, or 1%, from the second quarter and increased $3.9 billion, or 8%, from last year. C&I loans of $38.1 billion increased $503 million, or 1%, from last quarter, and increased $5 billion, or 15%, from a year ago.

C&I production remained strong this quarter. However, we saw some acceleration in paydown and payoff activity, which resulted in softer loan growth than we were anticipating coming into the quarter. Production continues to be broad-based across industries, with particular strength in mid-corporate and healthcare lending and in leasing.

Commercial line utilization declined to 30% from 31% in the second quarter, as clients are exercising a high degree of caution and minimizing line usage. This is the lowest level of utilization we have seen historically.

Commercial mortgage balances declined $345 million sequentially, or 4%, while commercial construction balances increased $80 million. This is the third consecutive quarter we have seen an increase in construction balances. The CRE pipeline is beginning to fill, and we should see some growth in the coming quarters.

Average consumer loans of $36.5 billion increased $307 million, or 1%, sequentially and increased $514 million, or 1%, from a year ago. Residential mortgage loans held for investment were up 2% from the second quarter as we continue to retain shorter-term high-quality residential mortgages originated primarily through our retail branch system.

Average auto loans increased 2% sequentially and 2% from the prior year. Average home equity loan balances were down 2% sequentially, reflecting continued runoff in this portfolio. And average credit card balances were up 3% sequentially and 9% from a year ago, driven by account growth and stronger cross-sell activity.

Moving on to deposits, we continue to see solid deposit trends, with average core deposits up $1.4 billion, or 2%, from the second quarter. Transaction deposits, excluding CDs, increased $1.6 billion, or 2%, sequentially and $5.7 billion, or 7%, from a year ago. We are seeing particular strength in the commercial demand deposits, which were up 9% sequentially.

Consumer CDs declined 5% as a result of the high-priced CDs that rolled off during the quarter.

As Kevin noted, the recent FDIC deposit market-share data is favorable across almost all of our geographies.

Turning now to fees, which are outlined on slide 7, third-quarter non-interest income was $721 million, compared with $1.1 billion last quarter. As I mentioned earlier, current-quarter fee income results included an $85 million gain on the sale of Vantiv shares and the $6 million positive valuation adjustment on the Vantiv warrant.

Second-quarter fee income included a $242 million gain on the sale of Vantiv shares and $76 million in positive valuation adjustment on the Vantiv warrant, as well as a $10 million benefit from the settlement of one of our BOLI policies.

If you exclude these items, fee income of $630 million declined $102 million, primarily due to lower mortgage banking revenue.

Nonmortgage banking related fees grew 5% from a year ago, with solid growth in investment advisory revenue, card and processing revenue, and deposit fees.

Looking at each line item in detail, deposit service charges increased 3% sequentially and increased 10% from the prior year. The sequential increase reflected commercial deposit fee growth of 4% sequentially and 6% compared with last year. Consumer deposit fees were up 2% sequentially and 17% from -- on a year-over-year basis.

The increase from the prior year reflects the completion of our conversion to the new deposit product offerings. The full impact of that conversion is now reflected in our results and that gives us a good foundation to build on going forward.

Corporate banking revenue of $102 million decreased 4% sequentially and increased 1% from a year ago. The sequential decline from a strong second quarter reflected lower customer activity as a result of increased economic uncertainty. This led to lower foreign-exchange and derivatives fees, which was partially offset by higher syndication fees and business lending fees.

Mortgage banking net revenue of $121 million decreased $112 million from the second quarter and $79 million from a year ago. Mortgage originations were $4.8 billion this quarter, compared with a record $7.5 billion last quarter.

Gain on sale revenue was $74 million versus $150 million in the prior quarter, reflecting both lower gain on sale margins and lower originations during the quarter. MSR valuation adjustments, which includes the impact of hedges, were a positive $23 million in the third quarter, compared with a positive $72 million in the second quarter.

Purchase volume was $2 billion, or 43% of originations, up from $1.8 billion in the second quarter and 24% of originations. Investment advisory revenue of $97 million declined 2% from the second quarter, but increased 6% over the prior year. The sequential decline was driven by lower brokerage fees and private client services revenue. The year-over-year increase reflects 10% growth in private banking, as well as 10% growth in the brokerage business, which were partially offset by the impact of lower mutual fund revenue. As you'll recall, we sold our retail mutual fund assets in September of last year.

Card and processing revenue was $69 million, a 2% increase from the second quarter and a 6% increase from a year ago, reflecting higher transaction volumes and account growth. Net investment portfolio securities gains were $2 million this quarter. They were negligible in the second quarter and about $2 million a year ago. We also recognized $5 million in net securities gains related to nonqualified MSR hedges. Those were $6 million last quarter and $5 million in the third quarter of 2012.

Turning next to other income within fees, other income was $185 million this quarter versus $414 million last quarter, which included the Vantiv-related gains that I discussed earlier. Excluding the previously mentioned unusual items in each of the quarters, other non-interest income of $94 million in the third quarter increased $8 million sequentially.

Credit costs and other non-interest income were $5 million in the third quarter, compared with $6 million last quarter and $14 million a year ago, reflecting lower losses on the sale of OREO properties.

Turning now to expenses, which are on slide 8, noninterest expense was $959 million this quarter, compared with $1 billion in the second quarter. Expense results this quarter included $30 million in charges to increase litigation reserves, compared with $51 million last quarter. Current-quarter expenses also included $5 million in severance expense and large bank supervisory assessment fees of $5 million. The assessment was applied retroactively to 2012, so this quarter's amount included seven quarters of expense. On an ongoing basis, this should amount to less than $1 million per quarter.

Excluding these items from both quarters, noninterest expense of $919 million decreased $65 million, or 7%, from the second quarter. The primary drivers of the expense decrease were lower mortgage-related costs and lower mortgage rep and warranty expense, partially offset by $4 million of seasonal pension settlement charges, which last year was recorded in the fourth quarter.

Current-quarter results reflected a decline in mortgage production related expenses of approximately $25 million, mostly in compensation expenses. As we have discussed, this included the elimination of overtime and contract work, some further reduction in full-time employee costs, and lower incentive compensation due to the lower origination volumes.

We will continue to adapt to the refinance and purchase environment, but our plans to manage the business are going just about as expected.

Credit-related costs and noninterest expense of $16 million declined $19 million compared with last quarter. This decline was primarily driven by a $15 million reduction in the mortgage rep and warranty reserve as a result of improving underlying repurchase metrics, driven primarily by lower levels of new repurchase requests. Realized mortgage repurchase losses were $13 million this quarter versus $14 million in the second quarter.

Moving on to slide 9 and PPNR, pre-provision net revenue was $655 million in the third quarter, compared with $905 million in the second quarter. Excluding the items that are noted on this slide, adjusted PPNR in the third quarter was $603 million, down 5% from the prior quarter and up 1% from a year ago, in both cases largely due to lower mortgage revenue, offset by higher nonmortgage revenues and lower expenses.

As Kevin mentioned, our credit results continued to trend well in the third quarter. Starting with charge-offs on slide 10, total net charge-offs of $109 million declined $3 million, or 2%, from the second quarter and $47 million, or 31%, from a year ago. The net charge-off ratio was 49 basis points this quarter and is the lowest we've reported in more than five years.

Commercial net charge-offs of $44 million declined 2% sequentially and 29% from a year ago. The 35 basis points of losses was the lowest charge-off ratio since the third quarter of 2007. The sequential decrease was driven by a $10 million decline in commercial real estate net charge-offs, a $2 million decline in commercial lease charge-offs, and those were partially offset by an $11 million increase in C&I net charge-offs.

Consumer net charge-offs were $65 million, down 3% sequentially and 31% from a year ago. The 70 basis points of losses was the lowest charge-off ratio since the second quarter of 2007. The improvement continues to be driven by lower home equity and residential mortgage losses, with improvements across most geographies, particularly Florida.

Moving on to nonperforming assets on slide 11, NPAs of $1 billion at quarter-end were down $136 million, or 12%, from the second quarter, with commercial NPAs down 14% and consumer NPAs down 6%. The NPA ratio was 1.16%, which is down 57 basis points from a year ago.

Commercial portfolio NPAs were $680 million and declined $114 million sequentially. The decrease was driven by a $66 million decline in commercial real estate NPAs and a $40 million decline in C&I NPAs.

Commercial TDRs on nonaccrual status, which are included in NPAs, were $241 million, up $45 million on a sequential basis. Commercial accruing TDRs were up $24 million and remained fairly low at $499 million.

In the consumer portfolio, NPAs of $334 million declined $22 million, driven by improvement in the residential mortgage portfolio. Non-accruing consumer TDRs included in these results were $138 million, down $24 million from last quarter. Accruing consumer TDRs were $1.7 billion, relatively consistent with last quarter. As you know, performing TDRs, which are included -- which included an interest rate modification below market rates, cannot be reclassified out of TDR status until they are refinanced on market terms.

$1.4 billion of the accruing consumer TDRs are current and $1 billion of them are current and have seasoned for more than a year. We would expect this portfolio to decline gradually over time as the opportunity and the need to introduce new restructurings has declined with the improving residential real estate credit conditions.

Total delinquencies of $414 million were up $4 million, or 1%, from the second quarter. Loans 30 to 89 days past due were flat from the previous quarter, and loans over 90 days past due were up $4 million from the second quarter, although they remain near -- at near historical lows. Commercial criticized asset levels also continue to improve, down about $60 million, or 1%, sequentially, which represented the 10th consecutive quarter of decline.

The next slide, slide 12, includes a rollforward of nonperforming loans. Commercial inflows in the third quarter were $71 million, down 53% from the second quarter and down 41% from a year ago. Consumer inflows for the quarter were $95 million, down 41% from last year. Total inflows of $166 million were the lowest levels we have seen in recent history. We generally expect continued improvement in both the commercial and consumer portfolios.

The provision and the allowance are outlined on slide 13. Provision expense of $51 million for the quarter was down $13 million from the second quarter and included a reduction in the loan loss allowance of $58 million. Allowance coverage remains very strong at 218% of nonperforming loans and 165% of nonperforming assets.

Slide 14 outlines our recent mortgage repurchase experience. We saw a sequential decrease in GSE claims, which are down 33% from a year ago. As I mentioned, we reduced mortgage repurchase reserve in the quarter to reflect slowing inflows of new repurchase requests, which should ultimately be reflected in lower losses going forward.

We have provided a detailed breakout of remaining balances of loans sold by vintage. Repurchase requests and losses have been concentrated in the 2004 to 2008 vintages, about 84% of the total. Those vintages represent just 8% of the total remaining balances on sold loans.

Turning to capital, on slide 15, capital levels continue to be very strong. The Tier 1 common equity ratio was 9.9%, up 46 basis points from last quarter, which included a 37 basis-point benefit from the conversion of 398 million of convertible preferred stock into common shares during the quarter.

As you will recall, the share repurchase agreement we had in place over the second and third quarters was implemented in May, and therefore it was largely reflected in our June capital results. The Tier 1 capital ratio increased 8 basis points and the total risk-based capital was up 2 basis points, compared with last quarter.

Tangible equity ratios also continue to be strong, with a 9.4% TCE ratio, including unrealized after-tax gains of $218 million, and a 9.3% TCE ratio, if you exclude those gains.

Our current pro forma estimate for the Tier 1 common equity ratio under the final Basel III capital rules is 9.5%. That calculation assumes an exclusion of certain AOCI components from capital, which is subject to an election on our part in early 2015. That pro forma estimate would be about 9.7%, if you included AOCI. As a result, our capital position is well in excess of the minimum required ratios, including the capital conservation buffers.

Just as a reminder, our May preferred stock issuance carries a semiannual dividend, which will not be payable until the fourth quarter. That dividend will normally be about $15 million every other quarter. The fourth-quarter dividend will actually be $19 million because it will also include the stub period for the months of May and June. All told, that will impact earnings per share for the fourth quarter by about $0.02 per share.

Turning to the updated full-year 2013 outlook, which is on slide 16, starting with net interest income and net interest margin. We continue to expect full-year 2013 NII to be relatively consistent with 2012 NII of $3.6 billion, and we expect the full-year NIM to be in the 333 basis-point range, plus or minus.

We expect fourth-quarter NII to be modestly higher than the third, up about $5 million to $10 million or so. That reflects the benefit of the higher rate environment on the securities portfolio and the yields, as well as the effect of loan growth, offset by loan repricing. We currently expect fourth-quarter margin to be down a few basis points, which includes about 2 basis points of reduction due to higher cash balances that we expect to carry in the fourth quarter.

Otherwise, we would expect some modest compression from the effect of loan repricing, partially offset by the benefit of the remaining $300 million in maturing CDs that were issued in 2008.

We continue to expect full-year average loan growth versus 2012 in the mid-single digits range, primarily reflecting growth in C&I loans, as well as continued retention of mortgage loans. We continue to expect transaction and core deposits to grow in the mid-single digits range, compared with 2012 averages.

Moving on to the overall fee income and expense expectations for 2013. Just as a reminder, we have adjusted 2013 and 2012 comparative results on this slide to exclude all Vantiv-related impacts, as well as debt termination charges incurred in 2012. Those adjustments are all listed in the footnote.

Overall, we currently expect fee income to be relatively consistent with 2012 adjusted fee income. That would reflect generally mid to high single-digit growth across most major fee categories, other than mortgage, which is down from a record 2012 level.

Just a couple of additional comments. The change in the rate environment, obviously, continues to impact our expectations for mortgage banking revenue. For the full year, our current forecast for total mortgage banking revenue is in the $670 million range, which would be down about 20% from 2012 record levels. This reflects lower volumes, partially offset by lower servicing asset amortization and higher MSR valuation adjustments.

Fourth-quarter mortgage revenue is expected to be in the $90 million to $100 million range. Corporate banking revenue should be up about $10 million sequentially, which would put it in the same ballpark as last year's record results.

Our overall expectations for the fourth quarter are for fee income in the $620 million range, with the sequential reduction reflecting third-quarter Vantiv gains, as well as lower mortgage production revenue, largely offset by fee growth in our other core businesses.

Turning to expenses, we continue to expect full-year noninterest expense to be relatively consistent with adjusted 2012 expenses. We currently expect fourth-quarter noninterest expense to decline about $40 million from the third-quarter reported levels. That would reflect the impact on the third quarter of some of the significant items we discussed on the call, as well as lower mortgage-related expenses. We will continue to manage expenses in line with expected revenue results and the overall economic environment.

In terms of PPNR, as outlined in my remarks to this point, our overall expectation for the year is consistent with 2012 levels. That's despite comparisons with a record year for mortgage revenue and a rate environment that remains very challenging.

Turning to the credit outlook, we expect the overall credit trends to remain favorable in the fourth quarter, with full-year net charge-offs currently expected to be a bit down, about $225 million to $250 million or so. We currently expect the net charge-off ratio for 2013 to be slightly below 55 basis points, compared with the 85 basis points we reported in 2012.

We expect NPAs to decline about 25% for the year, with commercial NPAs being the largest driver of that reduction.

For the loan-loss allowance, we expect continued reductions in the fourth quarter, with the ongoing benefit of improvement in credit results being partially offset by new reserves related to loan growth.

In summary, we are generating solid results in most of our core businesses, despite the tough operating environment, and we expect that to remain the case as we move into 2014.

That wraps up my remarks. Frederick, can you open up the line now for questions?

(Operator Instructions). Paul Miller, FBR.

I wanted to touch base real quick on your reps and warrants, which is really coming in nicely, but we have seen some banks out there being able to enter agreements with Fannie and Freddie to clear the decks of future reps and warrants. Have you had any success or tried to do this at this point?

We have ongoing dialogue with all of the GSEs relative to current results, their expectations going forward, so we continue to have those discussions.

We reflect our expectations relative to the impact of what they're telling us on our reserves and expected future losses, but we can't really comment relative to dialogues relative to settlements and so forth.

But I think the expectation is across the industry that Freddie Mac, in particular, is attempting to reach settlements with a number of banks, and we have certainly seen that with some of the larger banks, and the expectation is that they may well continue to seek settlements with other banks as we go forward.

And if you do -- I mean this and I know -- we have seen some of these banks taking additional charges just to clear the decks. Do you think that your reserves right now is sufficient or would you might have to just up it just a little bit just to clean the decks out?

As I said, we reflect in our reserve all of the current information that we are able to obtain from the GSEs relative to what they are seeing and what their expectations are.

You saw in the recent quarter that we actually reduced reserves, because our experience is coming in a bit more favorable than we had accrued. So we feel very comfortable with the level of our reserves. Whether that reserve proves to be adequate or excessive in a settlement kind of scenario, I think, remains to be seen, but at this point, based on information that we have, we are very, very comfortable with the level of our reserves.

Okay, thank you very much, gentlemen.

Jon Arfstrom, RBC Capital Markets.

Maybe, Kevin, a question for you on the payoff and paydown commentary on lending. Is it a few specific deals or is it broad based, and how persistent do you think that will be over the next couple of quarters?

We saw it fairly broad, so it isn't concentrated; it isn't narrow from that perspective. It was really across a large swath.

Persistency, I would tell you that our expectations, as we mentioned in terms of our guidance today, is that we are seeing a typical increase in fourth-quarter pipelines. We would expect that, again, given what happened in the last few days in Washington, whether that has a similar impact in the fourth quarter as it did -- as we saw, and I think as the industry's talked about in the third quarter -- remains to be seen.

But our expectation is that we will get a pickup. We are seeing the pipelines fill back again, but there is still an awful lot of cautiousness out there. There's is still a lot of really looking at things other than simply the broad economy, from that perspective. So how much of an impact that has is really hard to say at this point, Jon.

Okay, that's helpful. And then, Dan, maybe if you can provide a little finer point on the expenses. Last quarter, you talked a little bit about mortgage banking expenses coming out and the lag in terms of timing. And I'm just curious if you could give us some thoughts in terms of how much more mortgage banking expenses could come out and when that might happen and where you are on that spectrum?

Yes, Jon, as you alluded to, as we talked about mortgage banking, I think our key messages have been, and I think continue to be, that we always try to anticipate where we might need to go with respect to mortgage banking expenses.

We build our capacity in a way that facilitates us, our adjusting that capacity fairly quickly, and as a result of that, we believe we are able to act very quickly in response to anticipated changes in volumes.

That being said, there is always a bit of a lag. I think we were very pleased with the expense reduction results in the mortgage business for this quarter. The $25 million reduction that we saw was in line with what we expected to do at the beginning of the quarter, so it was in line with the capacity that we wanted to carry into the quarter.

As mortgage volumes have continued to decline, and as we said this morning, our expectation is for further declines in the fourth quarter, you could expect that we would continue to work very diligently to keep our expenses in line with that revenue reduction.

So embedded in our expectations for the fourth quarter is that we will continue to aggressively take costs out of the mortgage business.

Okay. All right, thank you.

Erika Najarian, Bank of America.

Congratulations, Erika.

Thank you. Thank you so much. My first question is a follow-up to Jon's on the mortgage expense side, and maybe I will just take a step back. Your adjusted efficiency went up by a percentage point this quarter, and clearly mortgage banking revenues coming down had a lot to do with it.

As we look out in 2014, I know you want to be careful in terms of giving us a dollar number of expense that can come out of the mortgage side, but is there room for that efficiency ratio to come down from the levels that you posted in the third quarter, in light of what seems like a soft revenue outlook for the industry?

We would certainly believe that there is room; and as we build our plans for 2014, that will certainly be our objective.

I think relative to the mortgage business, I would point out a couple things. One, as I just mentioned, there are more costs to take out and there always is a bit of a lag, and that will have an impact of improving the overall efficiency ratio as we get those things completely rightsized.

The other thing I would point out is that particularly with respect to the efficiency ratio this quarter, in addition to dealing with declines in mortgage volumes, which the volume declines present the opportunities for taking expense out, we're also dealing in this quarter with declines in overall gain on sale margins, which were down fairly significantly for the quarter and a bit more than we expected. We expected some softening of mortgage margins, but we saw about -- almost 50 basis points of decline in mortgage margins, which is very significant.

Fortunately for us, I think we may have fared better than most in the industry, but still 50 basis points of margin decline is difficult to deal with from an expense perspective on a short-term basis. On a longer-term basis, obviously if you expect those margin declines to be of a more permanent nature or more sustained, you have the opportunity to do things from an expense perspective, but it's difficult to react to those kinds of changes in margins on a short-term basis.

So we believe that we have the ability to continue to work aggressively on our expenses. We have always had that mindset, and we do expect that our efficiency ratio, going into 2014, will reflect a better environment and show improvements from where we are in the third quarter.

Erika, this is Kevin. The only thing I would add to that is our expectations in terms of the way we manage the Company really haven't changed. We always have stated that we believe we can get to our goals and targets. That hasn't changed. We expected the turn in terms of mortgage as our most cyclical business.

As Dan states, there would be some timing effect of this, some lag, but our expectations for ourselves over the long run really haven't changed, going forward.

Got it. And my second question is on your comment during the prepared remarks with regards to the size of your bond portfolio and potentially taking advantage of higher long rates. Given that your core loan and deposit ratio is at 100%, and you expect loan growth to match transaction deposit growth, do you plan to potentially lever up the balance sheet to grow your bond portfolio and take advantage of higher rates or would you just use excess deposit growth to do that?

Erika, we have discussed the size of our portfolio quite frequently over the past couple of years. This quarter, we have seen good entry points and we took advantage of those opportunities to grow the size of the portfolio.

Going forward, we always intended to normalize the size of the portfolio back to a peer average. We're still below peer average, which leaves us with quite a bit more room to leverage the portfolio.

Our intent is not necessarily to make up for weakness in loan growth, but by itself determine whether there are good opportunities for us to grow the size of the portfolio.

In terms of how much we grow, if we do see opportunities, we clearly have a lot of room in terms of liquidity and funding because deposits continue to be very strong and we are very much underutilized in many of our wholesale funding items, as well.

So, we think that both from a funding and liquidity perspective, as well as from an opportunistic profitable growth perspective, we have future opportunities to utilize more -- the timing of it will depend on what the market really presents us. We're not going to be -- we're going to be patient. We have been patient for the last two or three years and we took advantage of that patience last quarter. We will do the same going forward.

Okay, thank you very much.

(Operator Instructions). Ken Usdin, Jefferies.

I would just -- just on the loan side, auto is growing a little bit, but it looks like the industry is growing a lot faster. I just maybe wanted to ask you to flush out how you are thinking about the auto business.

And then, also, just talk us through this use of the secure on-balance-sheet securitization and what that means for results and funding, if anything?

Sure. On the auto side, Ken, as we have always stated, we have a very strong origination engine, but we want to make sure that engine actually produces profitable results.

And we are very keen on maintaining that level of profitability. There may be strong growth, but if that growth does not meet our profit guidelines and targets, we will not go after that and the paper that we put on our balance sheet will meet our targets.

We are happy with where we are. We will continue to maintain our strong presence in that business.

With respect to the securitization, this is our second securitization this year. The first one was off-balance-sheet for a specific purpose, to manage our capital more efficiently. The one that we executed in August is a funding securitization. The ABS markets continue to be very strong, and it's a very efficient and cheap funding source.

So it just basically will be a tool that we will use going forward to supplement the liability side of our balance sheet and manage our funding costs efficiently. Beyond that, there really is not much else to say on that.

Okay, and my second question is just with regarding -- I heard you talk very clearly about the preferred dividend step-up for the fourth quarter, but can you just give us your updated thoughts on just the preferred structure relative to that extra issue you had been talking about earlier in the year? We hadn't seen that yet. Just could you talk to us about the setup around capital structure and if you would continue to anticipate putting more preferreds into the structure, including that one issue that you had put out there earlier?

We have disclosed that we had one more preferred issuance in our CCAR plan, which was not objected to. We plan to follow our CCAR plan, and preferred securities are very efficient sources of capital today.

We currently have a significant amount of room in order to utilize that bucket. This next transaction is just another step towards utilizing that bucket and manage our growing capital ratios efficiently. Right now we plan to execute a transaction, and we are watching the markets, obviously, and that still is coming up.

Okay, and then last one for me, just, Kevin, you mentioned that line utilization remains very low. I know, obviously, there's a lot of uncertainties that are still out there, but could you just give us just some thoughts on what customers are not doing and any tone change in terms of willingness to invest in businesses?

Yes, Ken, I think the theme has been pretty consistent. I think folks have really been cautious in terms of trying to look forward in terms of the investments they are making, so we have -- we did see in the latter half of the quarter some pullback and some delay in terms of some of the investments. I think that has been reflected in some of the utilization itself, as well as some of the pipeline and the activities.

Now we are beginning to see it fill back. Again, I just -- it's really difficult to predict what an impact will be once we approach the end of this quarter again, but as we gave guidance, we are hopeful that we see a little bit of a tick up from what we experienced.

Production was good. It was really all in the paydowns, payoffs, and deleveraging that has been going on, and I think, again, if you are managing a business today, in the uncertainty of today, that cautiousness is pervasive. And so, as we get better clarity, I think you'll see better activity.

Companies, on the other side of it, as I think we have seen demonstrated over and over again in the improving credit metrics, companies are making money. They are doing well. They are just not taking a lot of risk at this point. So that's really the feelings that we have and the things we are hearing directly from clients and prospects as well.

Okay, great. Thanks, guys. Appreciate it.

Ken Zerbe, Morgan Stanley.

A quick question on expenses. How much of the one-time expenses that you highlight on slide 3 were included in your prior expense guidance for the third quarter? And I ask because some of those items, like severance, it seems like that would have been expected, so I am trying to figure out if that was included or not?

Going back, I can't really think back to July that quickly, Ken. I don't think the large bank assessment fee had been finalized by then. Severance, I don't know what we would have known at that point.

But it sounds like broadly you are saying that they were not (multiple speakers)

(multiple speakers) obviously, if we had an expectation for reserve, that gets booked when you have the expectation. Warrants (multiple speakers) on that, we can't estimate. Those are (multiple speakers)

Yes, of course. Okay, no, I didn't notice any parts of that. That's fine.

The other question I had, just on the mortgage repurchase reserve, obviously you are comfortable with your reserve, but what is more of a normalized level, right? Presumably the reserve today is set up for, let's call it, some problem years in the past, but as we move forward, the quality of the portfolio gets much better. I'm just trying to figure out where the reserve ends up, and is there a metric to think about whether it's basis points of loans outstanding or loans sold that we should be thinking about on a normalized basis?

Ken, I think that's difficult to estimate at this point. Certainly, historically, that normalized level for repurchases was -- approached zero. The optimistic view would be that someday we will get back to that kind of environment. I think that's still possible, but I think that will take some time for us to get there.

We have got a combination here of standards being enforced that perhaps weren't enforced previously, losses at record levels. Those kind of things produce these results. Going forward, hopefully, the loss experiences will trend back toward normalized levels, and for us, at least, we would certainly believe that the improvements we have made in controls and processes would also contribute to there being far fewer defects on any losses that do result going forward.

So we will work diligently to manage that number to close to zero. But that's years away. That's (multiple speakers) quarters away.

All right, great. Thank you.

Scott Siefers.

I think most of my questions have been answered, but I guess I was just hoping you could touch on the overall reserve, generally. You guys have obviously benefited from drawing it down over the last couple of years, but by the same token, by most measures, you've have still got a very strong reserve. So just qualitatively, I was hoping you could give your thoughts on how much longer does that tailwind last? Where, ultimately, would you see it flushing out, et cetera?

Relative to the reserve, we have talked in the past about the fact that our reserve methodology is what drives our reserve levels, and the reserve methodology, by design, tends to produce incremental benefits in terms of the overall levels of reserves as credit continues to incrementally get better.

So we have continued to see improvements in credit quality. We have continued to see improvements in net charge-off rates and so forth. And as those things continue to improve, I think we will continue to see the impact of those improvements reflected in the reserve.

In terms of when that levels out, I think that remains to be seen. There are a number of forces, I guess I would say, that have an impact on that. There is the regulatory environment and what the -- the posture that the regulators adopt with respect to reserves. There is also, obviously, discussions of changes in allowance rules and so forth.

Absent changes in the rules, our best estimate at this point would be that we would be migrating toward about a 1.5% kind of reserve, but I think that's subject to change, based upon the accounting rules continuing to evolve, as well as regulator expectations and pressures.

Okay. All right, that sounds good. I think that does it for me. So I appreciate it.

Ladies and gentlemen, we have now reached our allotted time for Q&A. I would now like to turn the call back over to Mr. Richardson and our list of panelists to give any closing remarks.

I have no closing remarks, so thanks, everyone, for joining us this morning and have a good day.

Thanks, everyone.

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