Fifth Third Bancorp (FITBI) 2008 Q2 法說會逐字稿

Good morning. My name is Janice, and I will be your conference operator today. At this time I would like to welcome you to the Fifth Third Bancorp Second Quarter 2008 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer session. (OPERATOR INSTRUCTIONS) I'd now like to turn the call over to Jeff Richardson, Director of Investor Relations. Mr Richardson, you may begin your conference.

Hello and thanks for joining us this morning. We will be talking with you today about our second quarter 2008 results, a recent capital actions and our outlook for the remainder of 2008. As a result this call contains certain forward-looking statements about Fifth Third Bancorp pertaining to our financial condition, results of operations, plans and objectives. These statements involve certain risks and uncertainties. There are a number of factors that could cause results to differ materially from historical performance in these statements. Fifth Third undertakes no obligation to update these statements after the date of this call. I'm joined here in the room by Kevin Kabat, our Chairman and CEO, Chief Financial Officer Dan Poston, Chief Risk Officer Mary Tuuk, 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 will turn the call over to Kevin Kabat.

Good morning, everyone. Thanks for taking the time to join us on what I know is a very busy morning for everybody. I have a few opening comments about our core operating results, plus some perspective on the significant events of the quarter, including our capital actions and the impact of leverage lease litigation reserves on results. Then I will hand it over to Dan and Mary who will review in detail our financial performance, our credit trends and our outlook for the remainder of 2008. Let me start by saying that throughout this economic downturn we have not lost sight of our long-term goals and our objectives and it's showing up in our operating results. We believe that our earnings power, our higher and strengthened capital levels and our ability to generate capital are more than sufficient to allow us to manage through this cycle.

We are well positioned to maintain our focus on producing continued strong operating results. We continue to make investments in our businesses to grow, diversify and leverage our platform and we continue to support our customers in this difficult time. Strong operating results remain consistent with expectations and we are secure in our conviction that when this cycle turns, Fifth Third will be positioned to post bottom-line results out performing the industry. Now for a few highlights from the quarter. Fee income growth continued to be robust. Electronic payment processing revenue of $235 million increased 10% sequentially and 15% from a year ago, driven by continued strong merchant processing results where revenues were up 16%. Card issuer interchange revenue increased 20% from the previous year, driven by higher debit and credit card usage overall and higher dollars per use in debit.

Electronic funds transfer revenue from our financial institutions clients grew 10% from the second quarter of 2007. Other major fee drivers, deposit service charges, corporate banking, and mortgage banking revenue, were strong again as well. Net interest income growth and net interest margin remained very strong and continued to improve. Our focus on the customer experience and satisfaction continues to demonstrate progress. In the JD Power and Associates 2008 retail banking satisfaction study, we were one of only two banks to improve out of the largest 20 banks in the survey. Customer experience and satisfaction is something we have put a significant amount of effort into as we continue to see positive external validation. We closed two transactions this quarter. We acquired First Charter, which brings us branches in North Carolina and Georgia, and added nine branches in Atlanta following the close of the deal with First Horizon.

This further strengthened our presence in the southeast and the demographic growth profile of Fifth Third Banc. These examples are driving consistent progress in producing strong core operating performance, even in the tough environment of the past year. Excluding the leverage lease charge to NII and merger expenses, pre-tax, pre-provision earnings were up 16% and we expect to continue to produce strong performance of this nature. Now several significant items have impacted this quarter's core earnings, which I will touch on briefly. Clearly, the largest item of interest for the second quarter was credit, which drove the June announcement and our capital plans. The capital plan we announced in June involved four key elements. First, given recent trends and the potential for trends to remain negative for some time, we determined that we should raise our target range for tier one capital to the 8% to 9% range.

Second, we issued $1.1 billion in convertible preferred stock which increased our tier one ratio by 93 bps to 8.5% at June 30th. Third, we reduced our common dividend which conserves $1.2 billion in common equity by the end of 2009 relative to our prior dividend. And finally, we announced our intention to sell certain non-core businesses over the next several quarters. We expect these actions to generate over $1 billion on a after tax basis. Now on the sale of nonstrategic businesses, as you know, we can't and won't comment in any greater detail on what these businesses are or are not, other than to say that the decision to sell these assets is strategic and has been contemplated for sometime. While these businesses are valuable to us and perform very well, we believe they would be more valuable to a number of other buyers and we feel this is an opportune time to exit them, given the continued strong valuations and our desire to focus on our core businesses, as well as to bolster our capital position in addressing all reasonably possible credit scenarios.

We realize that you would like more clarity here and it creates some near-term uncertainty for you. However, we strongly believe this is the best course to follow in order to minimize disruption to their operations and to ensure that our shareholders receive full value as we negotiate and execute the sale of these businesses. I would tell you that we would expect them to represent less than 10% of the normalized earnings of Fifth Third. We don't expect these actions to alter the significant direction of our Company or the investment thesis in Fifth Third. And we are confident in the attractiveness of these businesses with a strong number of interested buyers. Now, with regard to our capital plan and credit. We evaluated a variety of possible outcomes for credit losses in 2009. Mary will discuss this more later.

But we provided the range of outcomes of those scenarios in the supplemental credit package we filed with our earnings release. We have also provided a description of the methodology we followed, our underlying assumptions and the key factors and drivers evaluated. This was a very significant exercise undertaken to conservatively model and evaluate long-term credit risk. Also in this package are numerous additional stratifications to supplement what we have traditionally provided regarding our portfolios and geographies, particularly those experiencing more stress. We believe this gives you more insight into where we arrive from a capital planning standpoint and assist your analysis given your own assumptions for the future direction of economic trends. Our capital plan was based upon the most negative scenarios modeled, which involves more stress than we currently believe is likely and maintains an expected tier one ratio above 8% throughout that scenario.

This down side scenario appears to conform with a variety of down side views we have seen from experts in the industry and from a number of you. Now of course trends could become worse than those modeled, though we believe that's unlikely. If that were to develop, though, we have more than 200 basis points of cushion in our tier one capital above the regulatory well capitalized level of 6%. We have also taken aggressive action to contain credit and stay ahead of emerging issues. As we have mentioned before, some of the actions include eliminate all brokered home equity production last year. We have suspended new lending to home builders and developers. We have suspended for the near-term new lending for nonowner occupied commercial real estate. We have expanded our consumer credit outreach program to ensure we are able to have conversations with our borrowers to intervene earlier in difficult situations and a whole lot more. Mary will talk more about credit in just a moment.

Another item affecting earnings is the $0.42 per share impact of charges and expenses related to leasing litigation. This resulted in a reported loss for the quarter. Dan will talk more about this charge in his remarks, but it removes the down side risk we have related to leverage leases and puts any potential negative outcome from this issue fully behind us. Final observation, while the environment is difficult, we do have strong core earnings power. We earned a profit this quarter before taking the leasing charge and we currently expect to report a profit in the third quarter. This is a strong well capitalized Company with good momentum in core businesses and we are determined to bring the bottom-line kind of results you should expect from us. With that I will turn things over to Dan and Mary to talk about these results, credit trends and the outlook for the remainder of 2008. Dan.

Thanks, Kevin and good morning, everyone. As Kevin highlighted, our core businesses continue to perform well in spite of the very challenging environment. But given the state of the industry, I'm sure that capital and credit are the areas most people are going to want us to focus on today. So I'm going to make just a few brief general comments before moving into those areas. I'll comment on capital actions and Mary will cover credit trends and then I will finish up with operating trends and the outlook. With that in mind, there were a couple of items that impacted our results this quarter. The first is a charge related to our dispute with the IRS about leases that were originated between 1997 and 2004. This charge totaled $229 million after tax or $0.42 per share. Now this was a little lower than we estimated it could be last month and the charge has two components. The first component is an increase to our tax expense of $140 million.

The second component is $130 million pre-tax charge that reduced net interest income. These charges completely removed the previously recorded tax benefits of the disputed leases from our financials, as well as providing for any interest we may be charged if we lose our case. We continue to believe that we entered into good leases that should be respected for tax purposes, as we described in our 8-K last month, and we are still pursuing our case in court. The second item impacting results would be the closing of the First Charter transaction. This transaction was relatively small, First Charter had about $5.5 billion in assets, but given the market for loan portfolios of June 6th when we closed the transaction, the purchasing accounting mark to market adjustments for loans were larger than normal. I will talk about the affect of this later in my remarks. Now to summarize the components of our EPS this quarter. We reported a loss of $202 million or $0.37 per share for the quarter.

This result included the $229 million after tax charge due to the leasing litigation or $0.42 per diluted share. We also incurred $13 million or $0.02 per share after tax of acquisition related expenses. Our provision expense this quarter exceeded net charge-offs by $375 million or $0.45 if looked at on a after tax per share basis. Overall our businesses continue to perform very well. Average loan balances were up 11% year-over-year, including the affect of acquisitions, and transaction deposits were up 6% year-over-year. Net interest income grew 6% sequentially and 17% on a year-over-year basis, excluding acquisitions and the lease charge. The accretion of fair value marks contributed about a quarter of those growth rates. Reported noninterest income of $722 million was down $142 million, but was up $18 million or 3% sequentially, excluding securities gains and losses, and the net $120 million, $121 million benefit from the VISA gain and BOLI charge we reported last quarter.

On the same basis fees were up about 8% from last year. Moving on to our capital actions from last month. As Kevin mentioned, we believe that our current capital levels and our strong earnings power are more than sufficient to deal with an environment that looks to remain difficult for at least the next several quarters. For purposes of our capital planning, we assumed trends would remain difficult for the next 18 months. In the quarter, we had two capital transactions. $400 million of trust preferred securities were issued in early May and $1.1billion of convertible preferred securities were issued last month. These transactions, when combined with the dividend reduction and the expected proceeds from the sale of our non-core businesses, form the core of our capital plan. We raised our target for tier one capital to the 8% to 9% range. And the security that we issued placed us squarely within the range at 8.5%.

Going forward, the dividend reduction conserves over $1 billion of equity through year-end 2009, and that's relative to our prior dividend, and the sale of nonstrategic assets is expected to provide more than $1 billion of additional equity in the next several quarters. These sources of capital are meant to allow for the absorption of credit costs that could be high if current treads are sustained throughout 2009. At 8.5% and with the leverage lease charge behind us, we believe that we have enough capital now and we would expect to maintain a tier one ratio north of 8% throughout the remainder of this year, even before the inclusion of gains from asset sales. We built our capital plan around reasonably possible downside scenarios for credit losses, with the intent that we would remain above an 8% tier one capital ratio throughout the 2009 capital planning horizon. The capital we expect to generate through earnings and asset sales provides us with a substantial cushion above acceptable capital levels.

The sequencing and the nature of the capital build was designed to provide capital that we could need and to provide it in relatively efficient forms and timed to provide it in advance of when we might need it. The dividend reduction conserves approximately $170 million per quarter or $1.2 billion through the end of 2009. That is about 15 basis points of tangible equity capital per quarter or over 100 basis points through the end of next year. The asset sales are expected to generate over $1 billion or more than 85 basis point of tangible equity capital. Those sales have been considered for some time and they are an efficient way to generate capital in advance of a currently unclear environment for next year. Our plan provides over 200 basis points of cushion above regulatory well capitalized levels should the credit or economic environment deteriorate significantly more than we anticipated.

Markets remain volatile and having this off the table was very important. There is uncertainty about the length of the credit cycle and when we will see a change in the direction of trends. As such, we believe that an [8% to 9%] tier one target range was the right target to set and that we should put ourselves above 8% now to address any market concerns about what an appropriate capital level might be. If we ultimately don't need it because credit costs and earnings normalize sooner, that capital will support our ability to reinvest in our core businesses, seek good business opportunities and manage our dividend policy. As a result of the developments during the quarter, our tier one ratio is up about 80 basis points, from 7.7% to 8.5%. Total capital is also up 80 basis points to 12.15% and tangible equity increased to 6.37%. All very positive and all within the targets we set for ourselves. Now let me turn it over to Mary to discuss some of our credit trends.

Thanks, Dan. I will start with charge-off. Net charge-offs were 166 basis points for the quarter. That's up 29 basis points from last quarter and in line with our expectations laid out last month. Of that, consumer net charge-offs were $167 million or 204 basis points, versus $135 million or 158 basis points in the first quarter. Real estate related lending continued to show the most weakness. Residential mortgage net charge-offs were up $29 million and home equity net charge-offs were up $13 million. These were offset by a $9 million decline in auto net charge-offs from the first quarter as expected due to seasonal trends. Mortgage losses of $63 million were driven by the affect of lower property values on foreclosures, a trend that we don't see changing in the near-term, as HPA indices from Case Shiller and OFHEO continue to fall. And again, those higher losses were concentrated in Michigan and Florida, which accounted for 72% of our second quarter mortgage net charge-offs.

The rate of increase slowed in Michigan this quarter, but we saw continued deterioration in Florida. Home equity losses continue to be high at $54 million or 183 basis points of loans, with brokered home equity accounting for about three quarters of those losses. The brokered portfolio totals $2.5 billion and represents about 20% of our home equity loans. This portfolio is currently running off and you'll recall that we shut down brokered home equity production last year. Brokered home equity annualized net losses were slightly more than 400 basis points of loans. This disproportionate slit of losses is expected to continue as the brokered portfolio winds down. Charge-offs in credit card were up $1 million. Card losses remain relatively benign and below peers, although we'd expect losses to continue to grow in a period of economic weakness and seasoning of the portfolio. Now, let's move to commercial. Commercial net charge-offs were $177 million or 141 basis points versus $141 million or 121 basis points in the first quarter. Residential developers and home builders continue to represent a significant challenge.

Over all, they represented 19% of commercial charge-offs and 10% of total charge-offs, with a charge-off ratio for that portfolio of over 4%. Going forward, we would expect to see elevated losses in this category in the near-term, as companies further deplete their cash reserves and the level of demand for new housing continues to be weak across most of the country. Home builder non-performers grew $238 million this quarter, taking the nonaccrual ratio for this portfolio up to 17% for this loan type. We have aggressively moved to deal with issues here and have taken either charge-offs, reserves or marks of close to 30% against our home builder NPA's. About 20% or $165 million of our commercial funded reserves are held against this portfolio to represent inherent losses already taken through the P&L but not yet charged off. We do expect losses among home builder credits to be higher in the second half than what we saw this quarter.

charge-offs in the commercial construction and commercial mortgage portfolio were down a combined $35 million from high levels in the first quarter, particularly in Michigan and Florida. We still have a large concentration of non-performing assets located in both of these geographies and, combined with the elevation of home builder developer NPAs, we would expect commercial real estate losses would be back up the next couple of quarters. C&I charges offs were up $71 million. Over three quarters of this growth came from a $23 million fraud loss and about $30 million in C&I losses from loans associated with the residential construction and development sector. We currently expect C&I losses to be lower in the third quarter. C&I won't be immune to the economy but it is holding up reasonably well. Dan will summarize our outlook further in a few moments.

Now moving on to NPAs. NPAs totaled $2.2 billion up 39% from last year and were 256 basis points of loans up from 196 basis points last quarter. Commercial NPAs of $1.5 billion were up approximately $465 million or 44%. Commercial construction NPAs grew $133 million and commercial mortgage NPAs were up $216 million. As with last quarter, Michigan and Florida represented about two-thirds of our total commercial real estate NPA growth. Home builders and developers accounted for more than half of the increase in commercial NPAs overall, up $238 million from last quarter. This category accounts for $547 million or 25% of total NPAs on $3.3 billion or 6% of our total loan portfolio . C&I NPAs increased $107 million sequentially, with nearly all of this increase in C&I loans tied to builder and developers, or otherwise associated with the residential construction and development sector. More than half of all C&I NPAs at present are associated with that sector.

Consumer NPAs of $674 million were up $141 million or 26%. Residential mortgage and home equity loans continue to account for nearly all of the growth. We restructured $138 million of consumer loans during the quarter for a total of $318 million since the second quarter of 2007. These TDRs accounted for virtually all of our consumer NPA growth in the quarter. Let me take a minute to share some of the characteristics of our NPAs in terms of write-downs that are already inherent in the carrying amounts that you see in our report. Total NPAs were $2.2 billion at the end of the second quarter. The total discount on our NPAs is about 25%, which has already hit our P&L either through being written down or reserved for. Of total NPAs, $210 million are OREO and other repossessed assets, which are carried at their expected realizable value and do not require additional reserves.

On the consumer side, $318 million are TDRs against which we hold specific reserves of approximately $39 million. The remaining $207 million of consumer non-performing loans have already been charged down by about $46 million and have approximately $74 million of additional reserves held against them. Now on to the commercial portfolio. $121million of non-performing loans are from acquisitions and have been marked in purchase accounting to fair value due to credit deterioration, therefore we don't hold reserves against those loans. $429 million of commercial non-performing loans have already been charged down by $289 million and have specific reserves of $56 million held against them. Another $343 million of non-performing loans haven't incurred charge-offs to date but have specific reserves of $106 million held against them. Finally, the last $593 million of non-performing loans are viewed as having sufficient collateral and guarantors such that no specific is required.

I would note that $291 million of our total commercial non-performing loans, or 21%, are less than 90 days past due. So, adding this all up, including charge-offs, marks and reserves, we're carrying these non-performing loans at approximately 75% of their original face value. Provision expense this quarter with $719 million and was a little more than two times charge-offs, resulting in an increase in the reserve to loan ratio from 1.49% to 1.85%. I would note that given the state of the market for fair market valuation of loans, we have a significant mark related to First Charter's loan portfolio. Credit marks on just NPAs totaled $77 million for the acquired portfolio, including $39 million for First Charter. If these marks, which are available to absorb losses on acquired loans, were added to our reserve, our reserve to loan ratio would go up about 10 basis points to 1.95%. We have an additional $734 million in liquidity related mark, largely for First Charter, of which we would expect to recapture a significant amount and would also be available to absorb potential losses.

Provision expenses quarter reflected significant additions, particularly related to home builders and residential developers reflecting the inherent losses in these loans. We would expect to recognize a substantial amount of charge-offs related to these loans in the second half of this year as they proceed to that stage. Now I would like to talk about our capital planning exercise and some of the key elements. We developed our capital plan around a range of outcomes that could happen through the end of 2009. The purpose of this process was not to forecast expected losses but instead to build a capital plan that could absorb credit losses in stress scenarios that could be viewed as reasonably possible. Our analysis is not meant to suggest that macro trends won't improve. But, given the uncertainty of future trends, until we see evidence that would point to an improvement, we believed it was prudent to assume for capital planning purposes that they wouldn't improve.

This was not a exercise in to any possible upside or downside scenario, only what is plausible given current trends and external leading indicators, most of which do have a negative slope to them over the past few quarters. We did shock those negative trends and we are comfortable that we took an appropriately conservative view of the range of loss outcome. Now the process of developing these scenarios was complex. We ran multiple scenarios on about 50 different portfolios. On the consumer side, as an example, we segmented the home equity portfolio by delivery channel, retail and broker, and also by LTD splits. For mortgage, we treated lot loans separately and we treated lot loans in Florida residential property as extinct from the rest of the footprint. We divided the commercial portfolio into ten industry segments and three geographic pools, Florida, Michigan and the remainder, to create 30 portfolio segments.

Let me start by describing the consumer modeling process. I'm going to spend my time discussing the most stress scenario, which is what we based our capital planning on. For home prices we used Moody'sEconomy.com forecast. Their expectation for national devaluation in what they term a severe recession is a further 25% from now until the end of 2009. That's on top of the devaluation experience to date. We took that national expectation and applied it to the majority of our residential real estate portfolio, excluding Florida which I will come back to. We believe that the use of the national data is pretty conservative. The rest of our footprint did not experience the run up in values or the extent of decline as the national index given the impact of California and Florida on it. It's important to note that midwestern markets are not forecasted to decline as much as the U.S. Index.

For Florida we used Moody's severe recession expectation for 27% home price depreciation from now through the end of 2009, beyond what has been seen thus far. We also applied roll rate unit stresses to all of the portfolios and bankruptcy forecast stress as appropriate. These stress components, severity, roll rate and bankruptcy, ultimately represent an increase of approximately 55% in additional losses incorporated into the high stress scenarios for the second half of 2008 and for 2009. We believe that this high stress scenario represents how the portfolio would perform in a severe recession. Again, we are not predicting a severe recession but we want to make sure that we are prepared for that. I would add that, as you'd probably assume, we would expect the real estate segments to drive most of the potential consumer losses that we would experience, about two-thirds.

Our commercial analysis was a little bit different. For each of the 30 portfolio segments that I mentioned we extrapolated the trends that we have experienced over the past three and six quarters to determine the slope of trends for criticized assets, nonaccrual loans and losses within each of these 30 segments. These historical trends generally have increasing slopes, as you know. We projected these trends forward and used them to create baseline levels for determining our loss rates, with the worst of those two trends representing what would clearly be a severe recession. For our 2008 scenarios we further shocked the real estate related segments with an incremental layer of loss to approximate a 35% to 50% reduction on our highest risk nonaccrual.

We also evaluated the lagged correlation between 15 leading economic indicators in our recent loss trends in these 30 segments to provide additional perspective in approximating losses in each of our scenarios. Building upon our 2008 work we extended this through 2009. We incorporated within the portfolio segments the recent trends for criticized assets to migrate into non-performing status and then to charge-off. We used Moody's 2009 net income forecast by industry to project the movement and levels of our criticized assets for all four quarters in each of the 30 segments. We supplemented this quantitative exercise with discussions with lending experts in the geographies and industries at hand. Based on the information gathered, we stressed growth in problem assets by up to 10% and migration trends by up to 20%. The most significant stress was assumed in Michigan and Florida and in the real estate related Industries.

The stress compounded from this exercise ultimately represented 35% in additional losses in our high stress scenario for the second half of this year and 2009 relative to our baseline. Similar to the consumer portfolio, we would expect real estate to account for about two-thirds of commercial losses under the range of scenarios evaluated. We have outlined our scenario modeling process further in a few slides in one of the credit supplements we provided with earnings. And as Kevin noted, we have also provided the range of outcomes that resulted from this exercise. You will find this in the package, but the output of our scenario modeling for 2009 losses was $1.5 billion to $2.2 billion or about 170 to 250 basis points. That compares with 152 basis points in the first half of 2008. As we have said, we do not view the high end of that range as likely, but we would expect to maintain a tier one capital ratio over 8% if it happened. During this exercise we developed a methodology that we believe provide a lot of additional support to us as we manage our actual ongoing forecasting process.

Our forecasting process has continued to be pretty accurate throughout this cycle from a unit default standpoint. Loss severity has been the issue and that's really been a function of residential real estate. Every month the predictions seem to have gotten worse and the reality has followed that. With the process that we have developed, while we can't forecast home price trends, we can forecast the effects of a variety of outcomes on our likely losses. This recalibration has given us more insight into what may happen in the future than traditional forecasting methods. Before I turn it over to Dan, I would also mention we have provided some expanded disclosure stratifying our portfolios by the characteristics that are driving differential loss experience. These stratifications are intended to provide you with some of the information that we have available in doing our own analysis. Now, let me turn it back over to Dan to discuss our operating trends and our outlook. He will touch on our credit expectations for the remainder of the year in his

Thanks, Mary. Now I want to walk through our results in a little greater detail and I will start with the balance sheet. It's worth noting, before I get going, that the results included First Charter beginning on June 6th, the date of the acquisition. So the effect on average balances is less than a full quarter's effect. On an average basis loans and leases increased 3% from the first quarter or 2% before the First Charter acquisition and 11% from a year ago or about 8% before acquisitions. End of period loans and leases were up 6% from the first quarter or 3% excluding First Charter. Breaking that down, average commercial loans excluding acquisitions, grew 7% sequentially and 19% versus a year ago. The majority of that growth was in C&I loans. Commercial loan growth included about $1 billion in high quality commercial loans that were held for sale but that we moved to the portfolio in early April given the state of the commercial paper markets.

Excluding that effect also, average commercial loan growth was 5% sequentially and 17% versus a year ago. Excluding acquisitions and held for sale activity, C&I loans grew 7% from the first quarter and 26% on a year-over-year basis, commercial mortgage loans grew 5% sequentially and 11% from last year, and commercial construction loans were flat versus both periods. On a consumer loan side, excluding acquisitions, average loans were down 4% sequentially and 5% from a year ago. This reflects the economic environment, improved underwriting practices and the sales and securitizations of loans in the first quarter. Excluding the affect of both securitizations and acquisitions, consumer loans were up 3% from a year ago. Breaking that down, auto loans were down 9% sequentially and down 20% compared with last year. This reflects the first quarter loan sales and securitizations, as well as increased spreads on new originations over the past nine months or so.

Spreads were increased to help ensure that the loans we originate can be sold as market conditions permit or provide an otherwise strong return. New volume is coming on to the balance sheet at spreads that are approximately 100 basis points wider than our historical results and with better credit performance characteristics. Credit card balances were up $455 million or 36% on a year-over-year basis. This continues to be a key strategic initiative for us and our model remains a relationship based one. Excluding the effect of acquisitions, residential mortgages were down 5% versus last year and up just 1% sequentially, while home equity loans were flat for both comparisons. Moving on to deposits. Average core deposits were down 2% from the first quarter, but up 3% year-over-year. Total transaction deposits were up 1% quarter over quarter and up 6% year-over-year, while DDAs were up 6% for the quarter and 5% from a year ago. And those all include about 1% from acquisitions.

Higher retail balances and higher commercial compensating balances contributed to the growth of both. Deposit account production remains strong, with new consumer DDA production up 18% from a year ago. The number of consumer DDA accounts was up 9% over the same period. Average balances per account however were down 5%, this reflecting a slowing economy. Other transaction deposits consisting of interest checking, money market accounts and savings accounts, were down 2% sequentially but up 4% from last year, excluding acquisitions. Consumer CD's were down 14% from last quarter and 17% from last year, excluding acquisitions. We generally chose not to match aggressive CD rates offered by competitors during the quarter, which we believe to be higher than warranted relative to the value of those deposits.

Moving on to revenue. As mentioned earlier, NII was impacted by the $130 million pre-tax leasing charge. If you exclude that charge, NII was up 6% sequentially and 17% from last year. If acquisitions and purchase accounting accretion are also excluded, NII growth was 2% from last quarter and 13% from a year ago. NII growth was riven by a steeper yield curve in the second quarter, which was partially offset by the effect of higher nonaccrual loans. Let me provide just a little more background on the purchase accounting impact. Net interest income for the quarter includes $31 million in accretion of discounts associated with a $663 million purchase accounting discount for First Charter. These discounts to par relate primarily to real, rather than specific loan level credit deterioration since origination.

These fair market value discounts are being accreted into net interest income over the remaining contractual terms of the loans. Based on currently anticipated portfolio activity, we expect that the accretion of these discounts will approximate $100 million each in the third and fourth quarters and will then decline substantially in 2009 as the portfolio is amortize. The overall net interest margin was down 37 basis points sequentially to 304 basis points, with the decrease driven primarily by the leverage lease charge. Excluding that charge, NIM for the quarter was 370, excuse me, 357 basis points compared to 341 basis points last quarter. That improvement included 13 basis points from purchase accounting accretion in the quarter. So the core margin expanded modestly, reflecting the benefit of a steeper yield curve, again offset by the affect of nonaccrual loans.

As noted above, our margin will continue to benefit from purchase accounting accretion in coming quarters and I will discuss that more in the outlook section. Let's move on to noninterest income. As I mentioned earlier, fee income was impacted by a number of items in the first quarter, most significantly the VISA gain of $273 million and the BOLI loss of $152 million. Additionally, securities gains were $27 million last quarter compared with losses of $10 million this quarter. On a core basis, fee income increased 2% sequentially and 8% year-over-year. We had continued strong growth in the payments processing revenue, which was up 15% compared with last year. As you would expect, this business is effected by the impact of higher food and energy prices on disposable income and consumer spending.

We still expect mid-teens growth for the year in spite of that, given our expectations for new merchant customer acquisition later in the year. Deposit service charges also remain strong, up 8% from the first quarter. Most of the $12 million sequential growth came from consumer service charges. Commercial deposit fees reflect strong sales in our expanded treasury management suite, which was offset to some extent by the effect of lower earnings credit rates on service charge income. Corporate banking revenue performed extremely well again this quarter, up 3% from a strong quarter in the first quarter and 26% year-over-year. The main driver of the strong growth year-over-year was foreign exchange, where revenues increased 79%. Investment advisory revenue decreased 1% sequentially and 5% from a year ago, largely reflecting lower market valuations and trading activity.

Mortgage banking net revenue totaled $86 million, which was down $11 million from a very strong first quarter. Originations were $3.3 billion, about $700 million lower than last quarter and that was driven by rising mortgage rates that led to lower application and origination volumes in the latter part of the quarter. Results for the quarter also included $9 million related to gains on the sale of portfolio loans and that compared with $11 million last quarter. You will recall that we adopted the fair value provisions of FAS 159 last quarter and that positively impacted second quarter year-over-year comparisons by about $17 million. I mentioned earlier that we recorded $10 million in securities losses this quarter compared with net gains of $27 million last quarter. The losses this quarter were driven by a $13 million other than temporary impairment charge on GSE preferred securities. We hold just $68 million in face value of these securities, which now have a carrying value of $55 million.

Moving on to expenses. You may recall that the first quarter results included the reversal of $152 million VISA litigation reserve, which lowered our expenses in the quarter. The first quarter also included $9 million in severance related costs, $7 million in acquisition related expenses due to RG Crown and about $18 million in seasonally higher FICA and unemployment expenses. In the second quarter we incurred $13 million in acquisition related expenses for First Charter and the inclusion of First Charter in last month's results also added about $7 million to the sequential growth. If you exclude the effect of these items, noninterest expense was relatively flat. On the same basis year-over-year expense growth was 7%, which reflects volume related processing expense and technology investments that more than offset lower compensation costs as a result of expense initiatives in the past year.

Now let me turn to the full year outlook. You will find this on page 13 of the earnings release. To give you a better sense of run rates, the outlook excludes unusual items, such as lease litigation, VISA, BOLI and merger and severance charges. I also want to point out that the outlook now includes the impact of acquisitions that we closed this quarter. First, our NII guidance is for mid-teens growth. That strong growth rate is driven by both continued solid organic growth and the affect of purchasing accounting accretion, which represents about half of the growth rate. The full year net interest margin outlook is approximately 350 to 360 basis points, probably more toward the high end of that range. Purchase accounting accretion is adding about 20 basis points to full year margin.

We expect the NIM to increase in the third quarter given the full quarter's affect of the accretion, but that some of that benefit will be offset during the remainder of the year from an assumed Fed rate increase and from what continues to be pretty stiff competition on the deposit front in a number of our markets. I would note that the guidance excludes the impact of the leverage lease litigation, which will lower our reported NIM for the year by about 15 basis points. Loan growth is expected to be in the high single-digits. Commercial growth will continue to be driven by C&I lending. We would expect consumer loan growth to be flat or fairly modest due to the current economic conditions, as well as from a continued focus on disciplined underwriting and pricing. We are expecting core deposit growth to be in the mid single-digits. We would expect transaction deposits, excluding consumer CDs, to grow in the mid single-digits as well. Turning to noninterest income. We are expecting a low to mid-teens growth rate overall. We still expect mid-teens growth in the payment processing revenue.

We continue to capture significant market share and overall we feel very good about our growth prospects, although we are cognizant of slower consumer spending and the potential impact that could have on volumes. Corporate banking looks to be up in the high-teens given the strong performance so far and we expect this to continue. Deposit fee growth should continue in the low-teens, as we've seen thus far. And while mortgage banking will post a strong year relative to 2007, we currently expect lower mortgage banking income over the next couple of quarters. Our expense growth expectations haven't changed much other than the effect of acquisitions. Core growth is still expected to be in the 3% range. Just to walk that forward, RG Crown and First Charter will add about 3% to expected expense growth, processing expense will add 1% to 2%, and we expect about 1% each from de novos and FDIC deposit insurance costs. And then finally, FAS 159 adds about 2%.

We've updated our full year net charge-off out look to be in the 160 to 170 basis point range. Now this is a little higher than we expected in our June 8-K, which is a reflection of market trends during the past month, which have been generally negative. We would still expect to be well within the capital planning cases that we developed. As Mary noted, we expect home builder charge-offs in the second half to be fairly high as we work through that portfolio. Right now we would expect the majority of those losses to come in the third quarter. If you exclude home builders, we expect losses to continue to trend upward somewhat but at a more moderate pace than we experienced over the last couple of quarters. We expect NPAs to continue to rise, although we currently expect both the growth rate and dollar growth to slow in the third quarter.

Provision expense was obviously high in the quarter and we expect provision expense to continue to exceed net charge-offs, although not at the second quarter level. Provision expense will ultimately be determined by our reserve model. However, I would reiterate that we expect the reserve to loan ratio to be above 2% by the end of the year and it would be pretty close to that by the end of the third quarter. For taxes we expect the effective tax rate to be approximately 27% to 28%. Finally, we outlined our revised capital targets last month and those are tier one capital of 8% to 9%, total capital ratio of 11.5% to 12.5% and tangible equity to tangible assets of 6% to 7%. I will now turn it over to Q&A at this point. Our management team is working very hard for you and our employees to continue to deliver for us. Our core business results remain very strong and we believe that the actions we are taking to address our credit concerns are the right steps. We feel very well positioned to deliver outstanding performance when the cycle turns. Operator, can you open the lines for questions now, please?

(OPERATOR INSTRUCTIONS) First question comes from the line of Brian Foran of Goldman Sachs.

Thank you for all this credit detail, this is actually extraordinarily helpful. I have a fairly specific question to kick off. I think we are trying to struggle with how to get our arms around auto risk x when I look at your detail it's surprising to me that the biggest differentiation is in the 100, less than a 100 greater than 100% advance rate and the less than 60 month term and the greater than 60 month term in terms of NPAs and charge-offs between those buckets, even more so than the SUV versus the auto, which is what we were all afraid of. Do you expect that to continue over time and are those two metrics we should start to think about when we think about the riskiness of your auto book versus everyone else's or do you think SUVs versus auto will over the long-term be the bigger differentiator.

This is Mary Tuuk. A couple of comments that I would make with respect to our auto portfolio. First of all, if you look at our mix of new and used it's very much in line with the industry. In addition, if you look at our mix of large trucks and SUVs, it's also very much in line with the industry. And as part of the modeling that we performed, particularly with respect to the proportion of the portfolio that is comprised of the large truck and large SUV portion, we did shock that more specifically in our various planning scenarios to be able to account for what we might see in a rise in energy costs or otherwise. If you look at some of the other portfolio characteristics that you described, we do feel very very good over all about the performance of the portfolio. And as we continue to provide more specific analysis into the different vintages of the portfolio, we do believe that it's performing very well and we continue to see that.

Brian, this is Kevin, too. The only thing that we continue to watch as we have stressed the portfolios, obviously out of the box from the portfolios perspective and the economy today, cost of gas becomes a bigger driver related to the larger vehicles. If that shifts in terms of a recession where unemployment become of greater concern, that can obviously have a broader impact. That's what we really added to the stress and some of the assumptions as we looked at the stress in that portfolios. So that's kind of the metrics that we are looking at as we go through the analysis.

Okay. Thank you, guys.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Mike Mayo of Deutsche Bank.

I'm just trying to understand the core trends a little more. Your alluded to this. If we exclude First Charter from the results and exclude one timers, I think you said net interest income went up 2%.

If you exclude First Charter and exclude the one timers we would have printed $0.05 in the quarter, which actually includes $0.02 of merger related charge, Mike.

I'm just trying to look at core revenue trends. Net interest income would have increased 2% sequentially?

Pardon me?

It's in the release.

It's right in the release, I don't have that right in front of me, Mike.

So just bottom-line is total revenues excluding First Charter and excluding the one timers increased how much and how much did expenses increase excluding First Charter and one timers.

I'll tell you what, Mike, we will do that calc. It can be calced out of what we disclosed in the release. So you are asking for revenue and we just need to do some quick math.

Deposits, they went down 2% including First Charter?

Correct and that is on a average balance basis and First Charter contributed very little to that because the acquisition occurred so late in the quarter.

So deposits down. Can you give some color on that.

Overall, Mike, it's really bifurcated if you take a look at the deposit growth. Transaction deposits were up 6% on a year-over-year basis. Good account production and really where you saw some of the mix change is really where we actually decided not to match the aggressive CD rates, which we believed were higher than warranted given the value of those deposits. Overall we are pleased with deposit production, we think we are doing it in the right way and we think we are doing it with relationships that we can build with value over time, as opposed to simply high cost of funds single relationship only deposits. It really goes back to the same type of conversation we have had regarding the every day great rate strategy over time. So again, we think that, we think the deposit and transaction growth is strong and continues to be strong in terms of its core production.

Let me get off that. Are you done with your capital raises and what gives you confidence that you're done with your capital raises.

Mike, as we went through and evaluated our capital situation and we tried to explain in terms of the extended information expressed today, we really evaluate all of our options, we didn't make the decision lightly. With the volatility in the market we wanted to be proactive and have the capital which allows us to weather a severe stress case in case that happens. Not that we are predicting it, but in case that happens. The strategy that we have developed we believe provides the most long-term value for our shareholders and gets us through a very severe stressed scenario that we have tried to outline for you in the call this morning.

Maybe some of it goes to your outlook here. I see you had 166 basis points loan losses and you're guiding to 160 to 170 for the year with First Charter, it's not really apples to apples, right? Maybe you can just give a little bit more color on your outlook compared to where you are in the second quarter.

I will be happy to answer that. If you look at our guidance for the remainder of the year, essentially, what we are guiding you to is the fact that we do expect a increase in home builder charge-offs for the remainder of the year. And of that increase, we would expect a larger proportion of that increase to occur within the third quarter. And we would give you that guidance based on our analysis of the migration of that portfolio. However, if you were to exclude home builder charge-offs, we would expect the remainder of losses to increase at a very modest pace.

The other thing, Mike, we would say, by and large the First Charter portfolio is performing as expected and really better than the overall portfolio, so it is a slight positive to us in terms of the magnitude of contribution.

Then just a little bit more color on your outlook, which is appreciated. So your core margin, I guess that would be excluding First Charter, your core margin should that go higher from here?

Core margin went up 4 basis points if you exclude the effects of First Charter. And again we are expecting that to as we -- as Dan said in the outlook, to stay relatively flat, maybe down slightly and toward the end of the year is really what our expectation is.

Mike, purchasing accounting is going to add about 20 basis points to the annual net interest margin. Exclusive of that we do see some pressure on margins in the second half, particularly from deposit competition as banks prepare for what may be a rising rate environment. There will be increased competition for deposits and to extend maturities. The other thing I would point out from the -- in terms of the impact of First Charter, while we have the pick up that we described relative to the purchase accounting accretion, before purchase accounting, First Charter actually has a slight drag on margin. Their margin was running about 3% right before the acquisition. And then lastly, LIBOR Fed funds spreads have been historically wide in the first half of the year and we benefited somewhat from that. We expect that to narrow somewhat in the second half, especially with an assumed Fed rate increase later in the year or so.

Mike, this is Jeff. I just done some quick math here and I think the information is in the release, so don't -- I might have forgotten something here. If you take NII and you add back the effect of the LILO charge, which is 130, you get to 874. If you subtract out the purchase accounting accretion and then First Charter if you think of they added some NII for the 24 days that they were with us, but there is funding costs associated with that, so there is not a lot of NII effect of First Charter overall. You end up with NII being up about 2%. Then fees, you got VISA, BOLI, and securities gains last quarter, you have securities losses this quarter. If you take those out, fees are up about 2%. First Charter added about a few million dollars, maybe $5 million in the quarter. So fees are up about 2% excluding First Charter also, so revenue is up about 2% sequentially.

And expenses under the same analysis.

You didn't ask for expenses so I haven't done the math on that. That is crystal clear in the release.

No, because you still have First Charter expenses.

It's in there. I think Dan mentioned that expenses are relatively flat excluding First Charter and the some of the other things that -- the VISA reversal last quarter and that sort of thing.

And the last question. Second bulletin in your release says pre-tax pre-provision earnings were basically $745 million on a core basis. Do you think about that, that future kind of earnings as being a cushion for your loan losses. Does that factor into your analysis of how much capital you need.

Yes, Mike, we did take that into consideration. Our expectation is we've really kind of expressed all along is that we do have strong core earnings in the Company. We have been able to continue that strong core growth and we expect to be able to continue that strong core growth. Absolutely that was taken into consideration as well.

Under analysis how much would you haircut that $745 million when you're doing your analysis for the next couple of years. Or do you not.

You will have to wait for the outlook, Mike, when we get to 2009. Again we did that relative to trying to put a good capital plan together. We won't give guidance for '09 until we get closer to that mark. We will give you more information as it becomes more transparent to us as we get closer, okay. All right, thank you.

The only thing I would add to that, Mike, is we have talked a bit about the degree to which we stressed our credit scenarios as we built our capital plan and while we did stress them quite significantly, the core earnings trends we did not apply the same level of stress to those because we didn't feel like the uncertainty surrounding those items was the same as it was with respect to credit.

All right, thank you.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Vivek Juneja with JPMorgan

Hi, this is Vivek. Couple of clarifications on that pre-tax, pre-provision earnings. Sorry, I think I may have missed some of your call. How much of that would go away from the business sale that you're incorporating into your $1 billion capital raise. Does that include any of that?

One of the things that we are very sensitive to, Vivek, and obviously you missed it, is kind of not pre-talking or commenting in greater detail on what businesses are involved or are not involved in terms of the sale. Our expectation in terms of the businesses evaluating in total is less than 10% of the Bancorp, as we mentioned in our script and our earnings up front, so that's about all the color I can give you on that right now, Vivek.

Then a second one on the same pre-tax pre-provision, you said you didn't measure the credit impact, and by that I'm presuming the credit related impact of additional non-performers or rising collection costs those are not factored in to that?

Right.

The expense impact of those is. The only thing that would be excluded is the provision. So to the extent that we have incurred additional collection expenses and so forth or we have lost NII because of nonaccruals, that would be impacting that overall result.

That's included. And then going back to the auto related question on SUVs and pickup trucks, what are you assuming in terms of recovery values. How much decline are you assuming in that.

In some cases we are seeing decline as much as 62% in that portfolio of the large trucks and large SUVs.

52%?

62%.

Thank you.

So, any more questions.

At this time there are no further questions. I would like to turn the call back over to Kevin for closing comments.

Great, thank you very much. We appreciate your time this morning. We know that everyone must be on the key call. It's a long earnings season and you have a busy day. We recognize that the steps that we took last month were difficult decisions that we don't take lightly. But stronger capital and stronger reserves are necessary in this environment to deal with any potential possibility of negative trends in the industry, which may continue for an extended time. It's our responsibility to ensure that's the case. Our people are focused in delivering and we are confident they will continue to do that. I'd like to thank those who are listening for their hard work during these difficult times. We are well positioned at this point and we are committed to delivering above industry performance. We continue to demonstrate that through strong operating results and the earnings power we continue to build will provide significant bottom-line earnings power when the cycle turns and it will. Thanks again for joining us and talk to you next quarter. This concludes today's conference, you may now disconnect

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