Fifth Third Bancorp (FITBI) 2010 Q3 法說會逐字稿

(Operator Instructions).

Good morning. My name is Tiffany and I will be your conference operator today. At this time, I'd like to welcome everyone to the Fifth Third Bancorp third quarter 2010 earnings call.

(Operator Instructions).

I will now turn the conference over to Jeff Richardson, Director of Investor Relations. Please go ahead.

Hello and thanks for joining us this morning. Today, we will be talking with you about our third quarter 2010 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 cause results to differ materially and historical performance in these statements. We have identified a number of those factors in our forward-looking Cautionary Statements in the end of our earnings release and in other materials, and we encourage you to review those factors. Fifth Third undertakes no obligation would not expect to update any such forward-looking statements after the date of this call. I'm joined on the call by several people: Kevin Kabat, our President and CEO; Chief Financial Officer, Dan Poston; Chief Risk Officer, Mary Tuuk; Treasurer, Mahesh Sankaran; and Jim Eglseder, of Investor Relations.

During the question and answer period, please provide your name and that of your firm to the operator. With that, I'll turn over to Kevin Kabat. Kevin?

Thanks, Jeff. Good morning and thanks for joining us, everyone. I will make some opening comments and then hand the call over to Dan and Mary for more detailed discussion of our financial and credit performance. We've again posted a presentation on our website to facilitate our discussion.

For the third quarter, we reported strong earnings results which built upon solid second quarter levels. Net income was $238 million, up 24% with $175 million or $0.22 available to common shareholders and that was up 38% sequentially. Third quarter results included the effective credit actions we took during the quarter to further reduce risk in our portfolio. Those actions reduced pre-tax earnings by approximately $175 million in the form of higher provision expenses. Results also included the positive effect of a net $127 million litigation settlement stemming from one of our BOLI policies that was announced during the quarter. Return on average assets was 84 basis points in the best performance we've posted since the first quarter 2008.

Let's talk a little bit about some high level operating results. Pre-provision net revenue of $760 million increased 34% compared with last quarter driven by very strong mortgage revenue in the BOLI settlement I just mentioned. Excluding the BOLI related benefit, PPNR was $633 million, 12% better than the second quarter. This was driven by strong mortgage revenue and growth in investment advisory revenue. Additionally, net interest income increased $29 million and the margin expanded 13 basis points to $370.

We continue to benefit from repricing of our CD book and the management of deposits, in general, given our significant excess liquidity. As expected, we also saw some loan growth during the quarter, particularly in higher-yielding C&I and consumer books which is a good sign. We've been pleased with our lending volumes throughout the year, particularly in C&I, which has always been one of our strengths.

Origination volumes were offset in the first half of the year with higher paydowns than normal. During the third quarter, our C&I origination volumes exceeded paydowns. In fact, C&I originations were more than $1.1 billion per month in the quarter, which is the highest we've ever seen. Up from just under $1 billion per month in originations last quarter. Paydowns remain high, but we seem to have reached a point of equilibrium.

We're hopeful we are beginning to see the first signs of sustained loan growth. I think this is a direct result of continued focus on core business activity by our loan officers and salespeople. Originations were broad-based, high-quality, and diversified, both geographically and by asset class, driven particularly by growth in healthcare and manufacturing, two industries that are recovering well. We aimed during the crisis to ensure that we were well-positioned when things began to turn. I believe we have done just that.

As a noted, third quarter fee income results were also very strong, driven by significantly higher mortgage banking revenue. Total non-interest income was up 33% sequentially, including the BOLI benefit, and excluding this benefit, non-interest income was up 9%. Mortgage banking net revenue of $232 million increased $118 million from last quarter, as historically low mortgage rates drove a high level of refinancing during the quarter. Our total originations were $5.6 billion, up nearly $2 billion from last quarter.

Deposit fees were down just 4% despite Reg E, which was a pretty good result. And, investment advisory revenue was up 4% from the second quarter, as improved sales production and better markets resulted in strong net asset and account growth. Average loans were flat on a percentage basis compared with the quarter. Period-end balances grew almost $1 billion before our credit action at the end of the quarter.

Growth in C&I contributed to positive loan momentum, as well as auto loans and mortgages. Average core deposits were down 2% sequentially and up 8% over 2009 levels. As expected, the sequential decline included $1.1 billion in CD runoff and a reduction in non-relationship public funds deposits of about $1.2 billion. Excluding public funds and CDs, transaction deposits increased 1% sequentially and increased 19% year-over-year.

Expenses were up $44 million from last quarter driven by $25 million of expenses related to the BOLI settlement, and higher mortgage repurchase costs, which included a $15 million billed in repurchase reserves. Otherwise expenses were consistent with last quarter and continue to reflect ongoing investments in our sales force and strategic initiatives.

Let me talk a little bit about credit, which Mary will go into more detail a little bit later. The end of the third quarter, we undertook two sets of actions that significantly affected credit quality trends, including net charge-offs, non-performing assets, and loan-loss allowance. First, we sold $228 million of residential mortgage loans, which resulted in $123 million in net charge-offs being recorded to reflect the sales. Additionally, we transferred $961 million of commercial loans, which resulted in $387 million of net charge-offs being recorded to reflect their estimated sales price. These loans represented situations where we believe near-term sale was a better solution than a long-term workout with the potential for rehabilitating relationship. Their disposition further reduces our exposure to future real estate losses and was anticipated to be a slow recovery.

I note that even before the sales and transfers during the quarter, our NPA balances were stable and net charge-offs were $446 million, both in-line with our expectations. These actions reduced non-performing loans by about 40%. The loans involved represented about half of our residential mortgage non-performing loans and over a third of our commercial non-performing loans. Excluding the effect of these credit actions, charge-offs of $446 million were relatively stable compared with last quarter at $434 million.

Portfolio NPAs were down almost $900 million, largely as a result of our credit actions. As a result, our third quarter NPA ratio was 2.7% and the NPL ratio was 2.1%, the lowest levels we've seen in two years. Our reserve position remains very strong at 4.2% of loans, with coverage increasing to almost 200% of NPLs. Dan and Mary will talk about our outlook in more detail, but we expect further earnings improvement in the fourth quarter.

We should see annualized charge-offs move south to 2% of loans and significantly lower provision expenses as a result. We also expect PPNR results to remain robust. As result, we expect our return on assets to move north of 1% and to post a return on common equity in the 10% vicinity. That's not where we want these numbers to be long-term, but they would be relatively strong for this environment.

Turning to capital, with the release of the new Basel proposals, there have been questions about that -- what that means in the TARP repayment context. Clearly, our capital position is very strong relative to the Basel proposals, with or without TARP. Common equity already exceeds the proposed buffered minimum and, if anything, we expect our common ratios to be a little higher, after adjusting for the BASEL common capital definitions.

We said we thought a TARP resolution in the second half of 2010 seemed reasonable for us. While that is still the case, we've also expressed that we've been willing to be patient. It has always been about the right result, rather than a particular timeframe. We believed, and continue to believe, that improvement in our results, continuing positive trends in our credit performance, and additional clarity on future capital requirements, provide us and our regulators with a better sense of what is an appropriate repayment plan. We also have a lot more clarity on the economy than in the early part of the year. All those have been constructive developments from a TARP context. That's the basis of our thinking. We certainly don't view TARP as cheap capital or funding. In spite of what you've read in the papers, we're paying 5% after-tax on it and essentially reinvesting it at a quarter percent before tax.

We'll continue to approach this thoughtfully and in the context of capital requirements and take appropriate steps for Fifth Third. We look forward to resolving this and putting it behind us. With that, let me turn it over to Dan to discuss operating results. Dan?

Thanks, Kevin. As Kevin discussed, we continue to see positive trends on a number of fronts, and I'd like to spend some time discussing our performance in a little more detail. If you turn to slide four in the presentation, in the third quarter we reported net income of $238 million and paid preferred dividends of $63 million, which resulted in $175 million of net income on an available per common share basis or $0.22 per share. Earnings per share were up 38% from last quarter. Our results included about $950 million in net charge-offs. Of that, $510 million was attributable to loans that were sold or moved to held-for-sale during the quarter.

Reserve reductions related to the loans sold or transferred were about $337 million. And, reserve reductions related to the health or investment portfolio were about $162 million. PPNR was $760 million, which included the $127 million net benefit of the BOLI settlement. Excluding that, PPNR was a strong $633 million, much better than we originally forecasted, and reflected strong fee and net interest income results.

If you turn to slide five, net interest income, on a fully taxable equivalent basis, increased $29 million sequentially to $916 million. While the net interest margin increased 13 basis points to 370 basis points. The increases in NII and NIM were attributable to a number of factors, including continued deposit pricing discipline, CD runoff and repricing, a mixed shift toward higher yielding loans and decline in excess cash balances held with the Fed. These benefits were partially offset by lower Libor and swap rates compared with the prior quarter, as well as a decline in the average investment securities.

Additionally, you'll remember that the GSE buyouts of delinquent loans for mortgage-backed securities resulted in elevated premium amortization expense in the second quarter. With that context, turning to slide six, let's go to through the balance sheet a little more detail. Average earning assets were down $1.5 billion sequentially or 2%, which was almost entirely driven by the decline in investment balances from the previous quarter.

Short-term investments declined about $800 million, primarily driven by lower cash balances held at the Fed, as we reduced access liquidity through runoff of CDs and public funds. Average taxable investment security balances declined about $680 million due to portfolio cash flows not being reinvested during the second quarter. The outlook for a longer period of low rates has become clear in the past several months. As a result, we have reinvested portfolio cash flows during the third quarter. But, we have chosen not to grow the portfolio, despite our capacity to do so.

We continue to be very careful about managing interest rate risks in our balance sheet. Obviously, maintaining a modestly asset-sensitive position in this kind of environment costs us current period earnings, but we believe that posture will serve us better with respect to long-term earnings quality and growth. Average total loan balances were flat sequentially. We're pleased with our core production, particularly in the C&I area. As Kevin mentioned, commercial originations were higher than previous quarters and that contributed to a more positive loan balance trend. But, paydowns do continue to be elevated. We continue to focus on developing deeper customer relationships and growing our customer base, which is driving our relative success in this environment and will benefit us going forward.

Average commercial loans were down 1% from last quarter which was driven by a 4% sequential decline in commercial real estate loans, partially offset by a 1% increase in the C&I loans. Period end commercial loans were down $785 million, but they were up about $200 million, if you exclude the transfers to held-for-sale. Period end C&I loans increased 1% sequentially and were up 2% prior to the transfers. That's the best organic growth and balances we've seen in a couple years. We're seeing particular strength in manufacturing and healthcare reflecting growth across the footprint in both sectors. Commercial line utilization remained stable this quarter, although still very low at 32.4%, compared with 32.1% last quarter. That's down from 36% a year ago and normal levels in the low to mid-40s.

We saw continued runoff in the commercial mortgage and commercial construction portfolios. In aggregate on a period end basis, those portfolios were down 8% sequentially and down 3% excluding the transfers. We would expect these balances to continue to trend down over the near-term.

Average consumer loans were flat sequentially, but increased 2% on a period end basis. Average residential mortgage balances were flat sequentially and up 3% on a period end basis. That increase was driven by higher jumbo mortgages which increase due to the high levels of production during the quarter and by branch originated mortgages. During the quarter, we began retaining simplified re-fied mortgages originated through our retail branch system. This is a product we have offered for several years and which has lower LTVs, shorter durations, and higher average rates than the conforming loans that we sell to agencies. We currently review -- view retaining these assets as a good way to re-extend the overall duration of our earning asset portfolio, in the face of higher prepayment speeds, as we work to maintain a balanced interest rate risk position. The retention of these loans contributed to about $400 million to period end loan balances.

Auto loan balances increased 3% sequentially and 19% from last year, due to continued strong originations. The loans we brought back on to the balance sheet in the first quarter contributed to the year-over-year increase. Our auto portfolio has continued to perform very well in spreads that remain attractive. We have been able to maintain high FICO scores on our originations, while improving spreads at the same time.

Credit card balances were down 1% from the second quarter and 6% year-over-year, while home equity loans were down 2% sequentially and 4% from a year ago. Looking ahead to the fourth quarter for loans, on a period end basis we would expect commercial loans to be relatively flat versus the third quarter levels, with growth of $500 million or more offset by the effect of an expected refinancing of our loan to FTPS. As you'll recall, the loan to FTPS included in the original transaction structure was about $1.25 billion. FTPS is acquiring national processing company with that acquisition expected to close sometime in the middle of the fourth quarter. In connection with that acquisition, FTPS is increasing the size of its loan facility which are being syndicated through a group of banks and which will result in the ultimate reduction in the size of our loan.

On the consumer side, loan balances should be up modestly on a period end basis. Net net period end loans should be relatively flat versus the third quarter, or perhaps up modestly, with good underlying growth trends. Average loans will reflect the timing of the FTPS refinancing, as well as the effect of the $1.2 billion in loans sold or transferred to held-for-sale at the end of this quarter. We currently expect solid organic growth trends to take over again as we move into 2011.

Moving on to deposits. Average core deposits were down 2% on a sequential basis but up 8% year-over-year. Consumer CDs included in core deposits declined 9% sequentially and 28% year-over-year. This reflects a continuation of the repricing of our CD portfolio, including higher rate CDs originated in the second half of 2008. We still have roughly 2 billion of those CDs which have rates in excess of 4% with half a billion maturing next quarter and another billion and a half maturing in 2011. Excluding consumer CDs, average transaction deposits were down 1% sequentially and up 17% year-over-year. The main driver of the sequential decline was public funds balances, as expected, which were down 19% from the previous quarter. Transaction deposits would have otherwise been up $648 million or 1%. Retail transaction deposits increased 1% sequentially and 13% year-over-year.

We continue to have great success with our Relationship Savings products, which now has attracted over $8 billion of balances since its inception. These balances have doubled in the last six months. Total commercial transaction deposits were down 4% from last quarter and up 25% from a year ago. Average public fund balances were down about $1.2 billion sequentially as we adjusted our pricing due to access liquidity position. If you exclude public funds balances, average commercial deposits increased 1% sequentially and 37% from a year ago, reflecting continued strong liquidity among commercial customers. We currently expect about a $1 billion -- $1.5 billion to $2 billion in total CD runoff in the fourth quarter partially offset by continued solid growth and transaction account balances.

With that background, let me circle back now to our overall outlook for NII and NIM. We expect NII to be relatively flat the fourth quarter compared to the pretty strong levels in the third quarter. We'd also expect NIM to be stable in the 370 basis point range.

Moving on to fees as outlined on slide seven. Third quarter noninterest income was $827 million, an increase of $207 million from last quarter. Fee income included $152 million gain from the settlement of the BOLI litigation. We also incurred about $25 million in expenses associated with that settlement which are reported in other expense. Excluding the BOLI gain, fee income was $675 million and increased 9%, largely driven by very strong mortgage results. Fee growth was 13% on an apples-to-apples basis, taking into account several items which are detailed in the release.

Deposit service charges decreased 4% sequentially. Commercial deposit fees were up 6%, reflecting lower customer attrition, while consumer deposit fees were down 13%. As you know, Reg E went into effect for all accounts in July and August. The effect on third quarter was about $10 million. We're seeing opt-in rates in line with our expectations and we still believe that a $15 to $20 million effect is a pretty good estimate on the impact of the fourth quarter and the ongoing run rate. We would expect fourth quarter deposit fees to be down about $5 million to $10 million with the full quarter impact of Reg E being partially offset by seasonally strong deposit fees.

Investment advisory revenue increased 4% sequentially and 10% on a year-over-year basis. The sequential increase was the result of improved production, particularly in brokerage and insurance. These also contributed to the increase over the prior year, as did an overall lift in the equity and bond markets. We expect investment advisory revenue to increase modestly in the fourth quarter.

Corporate banking revenue of $86 million was down 8% from a strong second quarter but up 11% from last year. The sequential decline was a result of strong lease remarketing results in the second quarter, as well as lower FX and institutional sales revenues this quarter. Those effects were partially offset by increased interest rate derivatives revenue potential to higher commercial loan origination volume during the third quarter. Compared with last year, revenue from interest rate derivatives sales and business lending fees were the primary drivers of the increase. For the fourth quarter, we expect corporate banking revenues to be consistent with the third quarter.

Mortgage banking revenue of $232 million increased $118 million sequentially. Gains on deliveries were $173 million this quarter, versus $89 million last quarter, due to the very strong origination volume from refinancing activity. Servicing fees of $56 million were up modestly. MSR hedge gains, net of MSR impairment, were $46 million for the quarter and offset the MSR amortization of $43 million. We'd expect mortgage revenue to remain strong in the fourth quarter but lower than the third. That would be driven by lower gains on deliveries, perhaps down $15 million to $20 million and, of course, we're not currently forecasting MSR hedge gains.

Payment processing revenue was $77 million, down 9% from last quarter. We expect processing revenue to increase to the mid $80 million range in the fourth quarter.

Turning to other income within fee income. I mentioned earlier the $152 million gain associated with the BOLI settlement, which is reported in other income. We also incurred $5 million in negative marks on the FTPS warrants and puts which last quarter was positive by $10 million. Equity income from our interest in the processing joint venture was $7 million, compared with $6 million in the second quarter, while revenue from a transition service agreement was $13 million during the quarter, the same level we saw last quarter and that offset the similar amount of expenses.

Credit-related costs reported in fee income were $40 million in the third quarter, compared with $14 million last quarter. This was mainly due to increased losses on OREO properties, which were about $29 million this quarter versus $13 last quarter. Losses on loans previously held-for-sale for about $10 million. We expect a more moderate level of credit cost in fee income in the fourth quarter, driven by continued OREO losses in the neighborhood of $20 million to $25 million. Overall, we currently expect fee income in the fourth quarter to be in the $650 million range, give or take, with the decline driven by lower mortgage revenue and, of course, the BOLI gains.

Turning to expenses on slide eight, noninterest expense of $979 million was up $44 million or 5% sequentially. Third quarter expense included $25 million in legal costs associated with the BOLI settlement. Also, as you would expect in this environment, we continue to see elevated credit-related costs. Third quarter credit-related cost within operating expense were $67 million versus $55 million last quarter. The increase was driven by higher expenses related to mortgage repurchases, which were $45 million this quarter, compared to $18 million last quarter.

About $15 million of that expense was related to a repurchase reserve billed, while actual realized repurchase losses were $30 million during the quarter versus $18 million last quarter. Total repurchase reserves are now about $100 million. File requests and repurchase demands have been volatile and very difficult to predict, although repurchase demand did come down this quarter from the high second quarter levels. We currently expect demand for repurchases as well as loss severities to remain high and the near-term mortgage repurchase expense will remain elevated as a result. Our current expectation for repurchase expense is about $30 million to $35 million for the fourth quarter.

Reserves related to unfunded commitments declined $23 million in the quarter, compared with a $6 million reduction in the second quarter. We currently expect total credit-related costs recognized in expense in the fourth quarter to be pretty consistent with a $68 million realized in the third quarter. In total, we expect fourth quarter expenses to be relatively stable with a $979 million we just reported. With higher revenue-based compensation expense offsetting the effect of the BOLI expense which would go away in the fourth quarter.

Turning to slide nine and looking at PPNR, pre-provision net revenue was $760 million in the second quarter. If you exclude the net gain we had from the BOLI settlement, PPNR was $633 million, up 12% from the second quarter. As I outlined, total credit cost within fess and expenses were $107 million, up $37 million from last quarter, but that was more than offset by very strong mortgage results, as well as our NII growth. Our current expectation is that fourth quarter PPNR would be in the $580 million range plus or minus, based on some of the moving parts I outlined earlier.

You'll see in the release that the effective tax rate was about 21%, which was consistent with last quarter, and as about what we would expect for the fourth quarter as well.

Moving on to capital, which is on slide ten. Capital levels remain very strong. Tangible common equity was 6.7%, up 15 basis point improvement from the end of the second quarter. That ratio, the way we calculated it, excludes unrealized securities gains, which totaled $432 million at the end of the quarter. All in, TC ratio was about 7.1%.

Tier 1 common increased 17 basis points to 7.3% and the Tier 1 ratio also increased 20 basis points to 13.9% while the total capital ratio was 18.3%, up 29 basis points. Kevin touched on some of the developments under Basel. I would just reiterate that we would expect Fifth Third to readily meet, if we don't already exceed, whatever standards are set for US banks and that going forward we will manage our capital and its composition appropriately given those capital requirements, as well as our expectation that capital will continue to build through profitable results.

That wraps up my remarks, so I'll turn over to Mary to discuss credit results and trends. Mary?

Thanks, Dan. I will get started with discussing the credit actions we took during the quarter, as summarized on slide 11. In terms of the residential mortgage nonperforming loans sales, we identified a pool of mortgage loans that were either nonperforming or delinquent but still accruing.

We continually monitor markets which have become more liquid and determined that pricing has become more realistic relative to expected real estate values, workout costs, and a reasonable return on results. The loans we've sold included $228 million in balances. $205 million of which were nonperforming with the remainder delinquent. Approximately 62% of the loans were located in Florida. We incurred charge-offs of $123 million on the sale. Reserves were reduced by approximately $44 million.

In terms of the nonperforming loans we retained, those will generally be loans with higher probability of loss mitigation or cure, higher levels of collateral support, or where market values were well below realizable value. On the commercial side, as you know, we have a workout group known as the Special Assets Group or SAG. That group has been very focused on higher risk portfolios, such as non-owner occupied real estate. They've worked hard over time to achieve the best solutions possible on troubled credit. As part of that process, they continually identified loans most likely to result a successful workout, given enough time, and which loans are less likely to result in an acceptable outcomes.

For that latter group of loans, our options include a long-term workout strategy or a shorter term solution. One of which is the possibility of selling a loan and redeploying the resources that would be devoted to a longer-term solution. We continually evaluate our short and long-term options, our view of economics, the resources devoted to workout, the probability of success in workout, legal costs, et cetera and other things.

In comparing those factors to potential values in the marketplace, we determined that the sale of those loans would produce a better overall short and long-term outcome for the company, all things considered. We're marketing these loans in several pools, targeted at particular buyer bases. Land loans in one pool, vertical CRE in another, syndicated loans in another, and a final pool that we intend to sell to investors, loan by loan. These loans, particularly the nonperforming ones, would generally represent the more troubled part of our commercial portfolio with a high content of commercial real estate in general, particularly land and construction.

Of the $961 million in balances transferred, $694 million were nonperforming and the remainder were accruing. About 19% or $181 million were related to residential real estate developers. $515 million was nonowner occupied real estate, $138 million was owner occupied real estate and $308 million was C&I. Geographically, about 27% of the loans were in Florida and 10% were Michigan.

We incurred $387 million in charge-offs of the transfers of these loans to held-for-sale; $202 million on commercial mortgages, $77 million on commercial construction, and $108 million on C&I. About $21 million of the C&I losses were in real estate related industries, with much of the remainder in sectors such as accommodations or retail where real estate trends are significant negative factors. The slide provides some additional cuts of the data.

Reserves were reduced by approximately $293 million with a transfer of these loans to held-for-sale status. We expect to sell most of these loans in the fourth quarter and believe that our marks are conservative and reflect near-term realizable market value of these properties.

Now, moving onto charge-offs. Except where I note otherwise, the following discussion will focus on the ongoing or held-for-investment portfolio, starting with net charge-offs on slide 12. Total net charge-offs for the third quarter were $956 million, $510 million related to the actions I just described, and we incurred $446 million in net charge-offs otherwise compared with $434 million in the second quarter. Total commercial net charge-offs were $627 million. They were $240 million, excluding the losses due to the held-for-sale transfers, compared to $225 million last quarter.

C&I portfolio net charge-offs were $129 million, up from $104 million in the second quarter. Commercial mortgage portfolios charge-offs were $66 million for the quarter, compared with $78 million in the second quarter. About two thirds of the $66 million was attributable to Michigan and Florida. Commercial construction portfolio net charge-offs were $44 million, essentially flat compared with the second quarter. I would note that commercial construction balances are down to $2.3 billion, compared with $4.1 billion a year ago.

Home builder losses totaled $32 million for the quarter, compared with $48 million last quarter. You will recall, that we suspended home builder originations over two years ago, have already recorded significant charge-offs against that portfolio, and have worked to reduce our exposure. Portfolio balances are now $824 million, which compares with a peak balance of $3.3 billion back in mid 2008. We continue to expect losses from this portfolio to decline over time.

Additionally, as you know, the third quarter is also when we receive SNIP exam annual results and, as we communicated previously, there were no significant surprises on that front. We currently anticipate that fourth quarter commercial net charge-offs will be in the $160 million to $175 million range, down about $70 million to $80 million from the third quarter charges realized before the effects of moving loans to held-for-sale.

Total consumer net charge-offs were $329 million, and were $206 million, excluding residential mortgage sales, compared to $209 million last quarter. Excluding losses from the sales, residential mortgage net charge-offs were $81 million, down $4 million from the second quarter. Home equity losses increased slightly to $66 million, with about 40% of that coming from the brokered portfolio, which represents 15% of the total home equity portfolio. The charge-off rate was 549 basis points for the brokered book and 147 basis points for the retail originated book. We discontinued brokered production in 2007.

Auto net charge-offs remained low and declined by $3 million sequentially to $17 million or 65 basis points. Credit card net charge-offs declined to $36 million or relatively low 7.7% compared with 9% in the second quarter. We currently expect consumer net charge-offs to be between $190 million and $200 million in the third quarter, down about $10 million to $15 million before the losses incurred from the sale.

Now, moving to NPAs on slide 13. NPAs, including held-for-sale, totaled $2.8 billion at quarter end, down $353 million or 11% from the second quarter. NPAs, excluding held-for-sale, totaled $2.1 billion or 2.72% of loans, down $887 million or 30% sequentially. NPLs were $1.6 billion, or 2.08% of loans, down $946 million or 37% sequentially.

My next comments will focus on the held-for-investment portfolio, unless otherwise noted. Overall, Florida and Michigan remain our most challenged geographies from an NPA standpoint and accounted for 44% of NPAs in the commercial and consumer portfolios. However, NPAs in those two states were down $430 million sequentially, due in large part to our portfolio actions. Commercial portfolio NPAs were $1.6 billion or 3.71% of loans and declined $670 million from the second quarter. NPAs were relatively flat prior to the effect of the sale.

Commercial construction NPAs declined $190 million, commercial mortgage NPAs declined $276 million and C&I NPAs declined $198 million. Across the commercial portfolios, residential builders and developer NPAs of $280 million were down 35% sequentially and represented about 10% of total commercial NPAs. Within NPAs, commercial, TDRs and nonaccrual status declined to $31 million this quarter from $48 million last quarter. We expect to continue to selectively restructure commercial loans where it makes good economic sense for the bank.

Looking ahead to the fourth quarter, we expect commercial portfolio NPAs to be stable versus current levels. Nonperforming loans inflows from the third quarter were $290 million, which is the lowest level since 2007. Given an outlook for continued gradual improvement in the economy, we expect inflows to continue to generally trend downward, which they have done now for four straight quarters. Obviously, outflows going forward, will be lower because of the removal of charge off content from our NPA pool due to transfers. On the consumer side, portfolio NPAs totaled $478 million at the end of this quarter or 1.44% of loans, a decrease of $217 million or 31% from the second quarter.

Residential mortgage NPAs decreased $221 million during the quarter to $328 million, driven by the sale which accounted for $205 million of that $221 million. Home equity NPAs totaled $74 million at the end of the third quarter, a $9 million increase from second quarter levels. Auto NPAs were up $2 million, and credit card NPAs were down $7 million. We expect fourth quarter consumer portfolio NPAs to be up modestly, compared with the third quarter, $30 million to $40 million, perhaps. We currently expect consumer nonperforming loan inflows to continue to trend down in the fourth quarter with lower outflows due to our credit actions.

To wrap up the NPA discussion, we've been proactive in addressing problem loans and righting them down to realistic and realizable values. Total portfolio NPAs, commercial and consumer, are being carried at approximately 58% of their original face value, through the process of taking charge-offs, marks, and specific reserves recorded through the third quarter. We believe that's appropriate and I think our recent charge-off trends continue to be indicative of lower severities on new NPAs.

The next slide, slide 14, includes a role forward of nonperforming loans. As I mentioned earlier, our commercial nonperforming loans inflows were the lowest that we've seen in quite some time, at $290 million. Consumer inflows decreased $157 million. Total inflows, commercial and consumer, were $447 million, down $68 million or 14% from last quarter and the lowest we have seen since 2008. I would note that this inflow data also includes loans that became nonperforming during the quarter that were sold or transferred to held-for-sale at the end of the quarter.

As you can see on slide 15, our level of inflows is relatively low versus peers after being higher than peers during 2008. I think that's a reflection of our geographies which were impacted earlier than others and aggressively recognizing issues as they occurred.

Turning to slide 16, we provide some data on our consumer troubled debt restructuring. We have $1.8 billion of consumer TDRs on the books as of September 30, of which $1.65 billion were accruing loans and $175 million were nonaccrual. Out of that $1.65 billion of accruing TDRs, approximately $1.3 billion were current. And, of current loans, about $1 billion were current and were restructured six months or more ago. Based on that experience and our re-default rates overall, we expect the vast majority of that billion dollar pool to stay current.

Over time, we've learned more about what works and what doesn't work in modifying loans. As result, more recent modification vintages have shown lower re-default rates than loans we restructured earlier in the cycle and also constitute a larger proportion of the aggregate TDR pool. As you can see from the slide, while 2008 vintages peaked at higher redefault levels, more recent vintages are trending toward the 20% to 25% range. Overall, we continue to be pleased with the result of our loss mitigation efforts and I think the information we've provided demonstrates that they're working and improving.

Moving to slide 17, which outlines delinquency trends. Loans, 30 to 89 days past due, were $666 million, down $26 million from last quarter with consumer down $1 million, commercial down $25 million. Loans, 90 days past due, were $316 million, down $80 million from the second quarter, with consumer down $1 million and commercial down $79 million. Total delinquencies this quarter were down 27% from last quarter and were at the lowest level since 2007. We believe we're seeing signs of stabilization and don't currently expect a lot of movement next quarter, although delinquencies can move around a bit given seasonality and timing issues.

Now, for a couple of comments on provision and allowance, which is outlined on slide 18. Provision expense for the quarter was $457 million and reflects a reduction to the allowance for loan and lease losses of $499 million. Our allowance coverage ratios remain very strong and increased sequentially despite the reduction in the dollar reserve. Coverage of nonperforming loans improved to 202%.

Slide 19 contains our expectations for charge-offs in 2010 relative to the S cap scenarios. As you can see, 2010 losses are expected to come in between $2.3 billion and $2.4 billion, below 2009 losses of $2.6 billion, and significantly below S cap assumptions. This is despite our recognition of more than $400 million of charge-offs this quarter, that likely would not have been recognized until 2011 as to our disposition plan.

Before I wrap up, I want to take a minute to comment on developments in the mortgage market. Namely, foreclosure process concerns and repurchases. With respect to foreclosures, as you all know, the focus has primarily been on the accuracy of affidavits and related documents utilized in affecting foreclosures through the judicial process. We have reviewed our processes and procedures in light of current industry issues and we are comfortable that those are sound. There's nothing at this point that would lead us to believe that this will be significant issue to Fifth Third. Also, to anticipate a question, at Fifth Third, our process is for foreclosure analysts to be assigned to account to prepare documents and affidavits for each foreclosure file.

There's a lot of additional concern about this issue in the context of private label mortgages, mortgage securitization, and CDOs. Fifth Third was never in the business of creating CDOs or securitizing mortgages on behalf of others. We don't have any first mortgage securitizations of our own outstanding and only one small securitization from 2003 further loans are performing well and which has less than $150 million remaining. We're not a complex company and we do not have complex businesses with opaque risks. We try to be as transparent as we can about our risks.

On repurchases, this is an ongoing issue for us the industry. However, as we have disclosed for a number of quarters, mortgage repurchase cost for us has been manageable and we expect that to remain the case. Repurchase losses have been $20 million or $30 million per quarter for us for the past several quarters. Losses have been subject to some volatility based on GSE activity but we don't have any reasons currently to believe this will change in terms of order of magnitude on an overall basis. Kevin, I will turn it back to you for any closing comments before we go to Q&A.

Thanks, Mary. I think this quarter demonstrated pretty clearly the earnings power of this Company and our positioning. Our PPNR results were very strong, up 12% sequentially and up 20% from a year ago, excluding the BOLI gains in the third quarters of this year and last. Credit trends remained stable with a positive outlook.

We marked a billion dollars in nonperforming loans for sale and earned through it. We expect the majority of those loans to be off our books by the end of next quarter. As a result of previous declines in NPAs in these actions, are problem asset levels are at relatively low levels from an industry perspective. Our reserves and coverage levels remain strong. And, we generated a ROA approaching 1% even while absorbing these losses and look for better bottom-line results moving forward.

I want to thank our employees for working hard during this time, in helping the Company deal with the challenges we face, and maintaining a strong focus on customers and providing good service to them and to developing new business. We're not yet generating the kind of results we can generate, but we're beginning to develop a lot more visibility on that. Admittedly, there are a lot of regulatory developments that require additional clarity. We're confident that we will be able to deal with those changes, adapt to them, and, ultimately, earn through them as well. So, at this point, let me open it up for questions. Operator?

(Operator Instructions).

Your first question is from Craig Seigenthaler from Credit Suisse.

Good morning everyone.

Good morning.

From your earlier comments on TARP repayment, it sounds like the probability of TARP repayment could be a little lower in 2010. I am just wondering is this correct and, if it is, what has changed in light of two profitable quarters here?

Craig, I'm not sure that I would say that the probability of it is less other than there's only one quarter remaining in the year. I think, as Kevin alluded to earlier, we've -- we've always been working towards getting an appropriate answer and we think we've made tremendous progress in doing the things that are necessary in order for that to happen. So, we will continue dialogue and we believe resolution in 2010 is still a possibility. But, again, I guess I would just reiterate that we are working to get to the right answer rather than to try to -- to hit a hard deadline of December 31. So, we continue to work diligently toward that goal.

And, then, just one follow-up. What is your originated balance outstanding of both private label and then also GSE sold mortgages?

Craig, when you say outstanding, do you mean what we've delivered?

What have you originated? And if you do not have the total number maybe you can say over the last four years or so because I do not have a private-label number.

Yes, that is fine. I've here what we originated over the last ten years, $43 billion, let me rephrase that. $50 billion to the GSEs and GMA and about $1.5 billion to private label, but I would note that the private labels, all of that was originated in 2007 and prior.

Great. Thanks for taking my questions.

Your next question is from Betsy Graseck with Morgan Stanley.

Thanks, good morning.

Good morning, Betsy.

I have just a question on credit. Tons of detail. I just wanted to follow-up on the comment you made regarding market value being less than realizable value. Does that suggest that there is income associated with the properties that you chose not to sell? Just trying to understand how that works.

I think, Betsy, what we were getting at there is we always go through, particularly in the commercial portfolio, a loan by loan assessment of the status of that particular credit. What are the workout opportunities? We also balance the maintenance costs going forward if we continue to hold onto that loan. It really comes down to, in the commercial portfolio, a loan by loan assessment of what our workout potential is, likelihood of a successful outcome, and balancing that, versus what a realizable value would look like today in market pricing.

Okay. So, you're expecting that market value will be increasing and that is why you're holding onto it, is that a fair conclusion?

I wouldn't necessarily say it quite in those terms. It really comes down to a loan by loan assessment of where we think we can get the greatest economic value as a whole.

Okay and just separate --

Betsy, not so much that the market value will increase but we think we can realize more value that the market value today.

Right. Through actions you are taking on, improving the properties or what have you.

Right.

Okay. And, then, for the next quarter I want to make sure -- did you say next quarter you are anticipating ROE of above ten and ROI of above 1%?

We did say that, Betsy.

So, above 10% ROE and above 1% ROI --

I think we said the vicinity of 10%.

Okay, thanks.

Yes.

Your next question is from Paul Miller with FBR Capital Market.

Thank you very much. Again, getting back to the loan sales, because I think we find that the most interesting. The -- the various states that you sold, were there different prices in different states? Is Florida getting the worst prices than say Michigan or is it just pretty much all down the board that you got the same prices?

Certainly, you would see variance in pricing, dependent on geography and obviously some of that comes down to what is happening in property values in each of the various geographies. Again, the assessment that we did, really came down to where can we get the best economic value in whole.

In the case of the commercial portfolio came to a loan by loan assessment. In the case of the consumer portfolio, we looked at it as well as the context of a number of things; How were the loans performing today? What kind of value could we get going forward based on what collateral values were and such. So, to answer your question, there was some dependence on geography, but there were also broader factors that we looked at.

And, my guess, following from Betsy's question, that you're going to continue to look to sell these -- sell some NPAs out to clear the books or is this the last of the sales?

We certainly don't declare any absolutes in that regard. We will continue to look at additional opportunities in the future and, again, it really comes down to where we think we can get economic value. So, we always keep that door open.

Okay. Thank you.

I think it's fair to say we -- we sold what we're -- we want to sell.

So, unless prices really for firm up over the next couple of months, we're not going to see anymore of these large sales anytime soon?

That's fair, Paul.

Hello, guys. Thank you very much.

Hello, Paul? This is Dan. The only thing I would point out relative to your question on geography. On page 11 of the presentation materials, there is a breakout that shows the -- the amount of charge-offs by states and so forth. The other thing I would point out that is perhaps implicit in your question is that, as we mark these loans, we look at these on a loan by loan basis it and determined an appropriate mark. We do not just take some average expected realization rate and spread over the entire portfolio. Each -- each loan was evaluated individually for a variety of items including geography to arrive at the appropriate mark.

I mean, is there anyway that -- that you could further give detail here like the par values of every state? I know this is the charge-offs but is there anyway we could back into the par values to see what the mark was for each state?

Paul, as you might appreciate, we're -- we're negotiating with counter parties and sharing our carrying values relative to -- to where we have the loans does that really help us in that negotiation.

Okay. Thank you very much. I understand.

We've marked these to where we believe they need to be marked.

Okay, thank you very much gentlemen.

Thank you, Paul.

Your next question is from Matt O'Connor with Deutsche Bank.

Hello guys.

Good morning, Matt.

How should we think about the pace of your capital build going forward? Obviously 10% ROE is fairly straightforward but I would assume the risk-weighting on these assets that you held -for-sale and are looking to sell is quite high so that could free up a fair amount of capital.

Yes, I think these do -- do carry higher risk weighting. Although, these, while significant, are less than 1% of our risk-weighted assets. I'm not sure that the loan sale itself would change the trajectory of our organic capital growth significantly. More important, I think will be the improving profitability that this loan sale would enable. I think Kevin's comments relative to income expectation would probably get to the answer you're looking for relative to how our organic capital growth changes. It's going to be driven more by income, then by risk-weighted assets.

Okay. And, just in general, is that they are as we look at over the next two, three, four quarters that your capital ratios will be mostly driven by the net income as opposed to actions on the RWA side or anything like that?

Yes, I think that's fair.

Okay. All right. Thank you.

Your next question is from Matt Burnell with Wells Fargo Securities.

Good morning folks. Perhaps -- perhaps first a -- a question for Mary. As you said in your prepared remarks, you started working on your asset quality issues a bit earlier than many of your peers. I'm just curious given that it appears you are further along in your actions on that than some of your other peers, are you getting any guidance from the regulators on their preference for the pace for the ultimate level of loan loss reserves?

No. I think it's certainly fair to characterize our -- our strategy as aggressive, but I would characterize it more the context of we want to make sure we acknowledge what our credit issues are, and that we deploy the best economic solutions for those within the context of the regulatory operating environment. So, I would tell you there is no specific mandate that we have received from the regulators directly addressing that strategy. What we've tried to do though is make sure we have credit practices that can withstand scrutiny, so, from that standpoint they are really inscrutable. We want to make sure going forward we continue that practice.

And, then, if I can just follow-up on commercial loan demand and I apologize if you've already addressed this. But, several banks have suggested that there is some demand for commercial loans over the past quarter presumably that or hopefully that will continue in the fourth quarter. I guess specifically my question is, are you seeing any signs of greater price or other levels of competition for commercial loans that in -- in any of your markets that might cause you to think that these loans are getting a little bit aggressive in terms of either the pricing or the other terms?

Matt, two things I would say to that question. One is we are -- we are as we mentioned seeing a pickup in terms of the loan demand we have seen in the marketplace. I would not call it robust but there is demand there. But -- and, as we mentioned, last quarter we have begun to see some pricing tension, but for the most part we had held the line from that standpoint and still been able to grow the balance sheet, so, we feel good about how well positioned we are, and we feel good about what the competitive landscape is to continue to produce the guidance that we gave. So, those will be the two things that I would comment on that.

And is that competition coming from smaller market players or some of the larger more regional players?

Definitely the larger, we are seeing that.

Okay, good. Thank you very much.

Thanks, Matt.

Your final question comes from Mike Mayo with the CLSA.

Good morning.

Good morning, Mike.

Just a question on Basel III, you have a Tier 1 common ratio of 7.3%. Where does that go under Basel III or any insight maybe on what happens with risk-weighted assets if anything.

Yes, Mike. Relative to Basel, obviously, at 7.3%, we're above the buffer minimum for Tier 1 common. Certainly, as we go forward, we would anticipate operating at some level above that requirement. We haven't really established specific targets at this particular point in time.

We're waiting to see a final regulations will look like and how US regulators will deal with the Basel proposals. I think at this point our expectation would be that we might be managing to something closer to an 8% level from Tier 1 common perspective. So, at 7.3% and generating capital organically, we feel very good about our capital position and our ability to manage within those kinds of parameters, relative to risk-weighted assets and the impact.

The equity definitions and the risk-weighted asset definitions and so forth embedded in Basel actually -- probably work to our benefit by a small amount probably adding 20, 30 basis points or so or perhaps a little more to our Tier 1 common ratio. Really, the only negative of any significance, with respect to -- to what's included in the Basel proposals, would be a repeat of what is already out with respect to the disallowance of trust. So, other than that impact, I think, generally, our capital ratio should benefit by the applications of the Basel proposal.

7.3% Tier 1 common goes may be goes to 7.6% or so under Basel III?

Yes, Mike. The Basel puzzles are quite complex. I think on the risk-weighted assets side, we should not be affected significantly. On the commons, we do not know how the Fed will interpret what the proposals are but we should not see any harm and depending on how they treat unrealized gains we can see the benefit.

And are you currently running on Basel II.

We are on Basel l.

You can run parallel to Basel ll for a few quarters. Have you started that process?

We are not an internationally active, record bank.

Then, at some point you go to Basel II. I understand the rules are different, it was intended for global banks and here you are implementing, a domestic bank.

We are not implementing it. We do what the Fed tells us to do and the Fed uses Basel as a framework for that. The Basel rules applied for -- at least in the US -- to record banks which have $250 billion in assets and internationally active banks, and we are neither one.

Thanks a lot.

Thanks, Mike. One quick thing I wanted to add obviously it's a big topic, and everyone has a different way to ask the question. We did get an e-mail on what our originations where from 2005 to 2007. Originations to GSEs and Ginnie Mae were about $9 billion for 2005 to 2007. In private label were about $900 million. Most of that $900 million private label being jumbos.

All right. Thanks everybody for joining us. Talk to you next quarter.

This does conclude today's conference call. (Operator Instructions)