Fifth Third Bancorp (FITBO) 2004 Q1 法說會逐字稿

Good morning. My name is Umiki [ph] and I will be your conference facilitator. At this time I would like to welcome everyone to the first quarter 2004 Fifth Third 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 period. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad. If you would like to withdraw your question, press star then the number two on your telephone keypad. Thank you.

I will now turn the call over to Brad Adams, Investor Relations Officer of Fifth Third Bancorp.

Good morning. Thanks for joining us. This conference call may contain certain forward-looking statements about Fifth Third Bancorp pertaining to the financial conditions, results of operation, plans and objectives of the Bancorp. These statements involve certain risks and uncertainties. There are a number of factors that could cause results to differ materially from historical performance and these statements. Fifth Third undertakes no obligation to update these statements after the date of this call.

At this time, I would like to introduce George Schaefer, President and CEO of Fifth Third Bancorp.

Thanks, Brad. And thanks all of you for joining us this morning. I will have a a few comments this morning on what I feel are the highlights of the quarter and then I will turn it over to Neal in a few minutes to go over the business line trends before we open it up to your questions. Typically, we are very cautious in our outlook at the beginning of the year, but the strength of this quarter's results gives us a great deal of optimism as we look forward to the remainder of 2004.

From my perspective the highlights for the quarter were: Number one, loan growth. Overall loan growth was very strong out there with $1.6 billion of balance sheet consumer and middle market commercial loan growth in the first quarter. Middle market commercial lending had period-end balances up over $800 million from last quarter. This was up 12% on an annualized basis during the quarter. And sum of lending remained very strong with originations of $1.5 billion.

Number two, the service income trends were very encouraging this quarter, with quickly improving results from Fifth Third processing, as well as from our Investment Advisors division.

Thirdly, operating expenses continue to be well controlled versus some of the trends we saw coming into this year. I will let Neal talk about some of the initiatives here and the opportunities we see for continued productivity improvements in 2004. As you know we've always been fairly efficient, but with the process improvements and automations that we're undertaking now, we really want to talk it to the next level while improving our customer satisfaction.

Fourth, our credit quality was substantially improved this quarter with losses declining by almost $25 million from the prior quarter. Consumer credit has continued to be very well behaved and we expect commercial credit quality to continue to show trend improvement, both in terms of charge-offs and nonaccruals. Our loan growth, spread revenues and service income trends feel very good for the remainder of 2004 and we are not overly concerned with the impacts of the declining outlook for mortgage banking compared to 2003 given the efficiency initiatives undertaken in this business.

Deposit growth this quarter was marked by very strong results on the demand deposit side, especially considering the seasonality typically seen in commercial in the first quarter. Some of the other categories are not where we would like them to be. Trends in deposits will become increasingly important to us as interest rates begin to rise and I think you'll see us put a great deal of focus and emphasis on growing core deposits in the next several quarters. Also the consolidation of several of our large competitors out here in the Midwest should help our deposit gathering.

Overall we feel like we overcame some significant challenges last year with a low level of rates and the regulatory environment and it is very gratifying to produce a good, clean quarter given this environment. We are still focused on a couple of things.

Number one, building our market share within each of our existing 17 markets by opening more checking accounts, by retaining more of our customers and by improving our distribution. We are continuing to invest in new banking centers and plan to open 75 net-new offices this year in high population, low market share affiliate areas. We are looking forward, also, to our acquisition and expansion in the Nashville market.

Number two, we are looking to improve our cross-selling in both our loan and fee-based products and taking advantage of our very large retail and commercial customer base. We have about 5.7 million customers here and not all of them are buying all of our products yet.

Number three, we want to maintain our low risk profile that we have in our balance sheet. Given the core loan and deposit trends we expect to see stable to modestly rising net interest margins in 2004.

Finally, on the productivity initiatives we want to stay focused there and we want to make sure our capital is invested in the business that offer us the best returns.

A couple of additional comments I'd like to make before turning it over to Neal. I think most of you saw the announcement regarding the termination of the written agreement. I understand it's probably natural for that to cause a fair amount of speculation out there regarding our appetite for acquisitions. I'd like to comment on that front.

First and foremost, we are investors when it comes to acquisitions and as such we will always approach any potential deals with an abundance of caution. Second, we are not in any hurry whatsoever. We feel like we have a great deal of opportunity in front of us with our retail expansion plans and the growth opportunities in the middle markets here in our market areas.

Second, with the announcement of Steve Schrantz's retirement, I've asked Bob Sullivan to step into his role, overseeing the commercial division. Neal Arnold will be assuming the responsibility for the Fifth Third Processing Solutions group, as well as the Investment Advisors group. Mark Graf, our treasurer, who joined us in 2001, will step into the CFO role, and Ron Marks will become treasurer and he'll report to Mark Graf.

With that I will turn it over to Neal for some additional review of our businesses and some trends that you can expect to see from us in future quarters.

Thank you, George. A couple of things as it relates to the line of business results I will touch on. As George said, on the fee business side we were pleasantly surprised by the strength in a number of categories, mix [ph] the mortgage results and I would say as expected.

First of all, in Fifth Third's Processing Solution side, I think Bob Sullivan and his team there has done an excellent job. They are up 14% year over year in typically a quieter quarter. If you exclude the impacts of the $7 million Visa/Master Card settlement, those numbers would be up 19 so those are very strong results. If you look underneath that, merchant revenue is up about 23% on new customer volume. And as everyone saw the retail sector had a pretty nice last couple of months in the quarter.

On the EFT side, results are up 4% and they should continue to accelerate. We see a lot of opportunity there, as well as Check 21 comes forward, we think the opportunity between our cash management and EFT area will only continue to accelerate. We also mentioned earlier in the quarter that we did close on a deal to sell third party small merchant contracts outside our footprint in the second quarter, and we are pleased to have that behind us. So I think a lot of good things done on the payments business and feel very good about the momentum.

On the Investment Advisor's side, as George said, very nice quarter, revenues up 17% year over year and I would say net income up even stronger. If you looked at the first quarter, we see a number of category growth rates, retirement plan services area, revenue up 33% on the brokerage side, Fifth Third Securities is up almost 100% on the revenue side, and I'd say on the institutional and personal trust side up double digits in most categories. So all categories contributing well on the Investment Advisor's side. Certainly a good market helps, but I would also say we've built the sales force on a number of our affiliate markets with private banking and wealth planning. I think that's starting to come through.

On the commercial side, we continue to see very strong momentum here in a number of our markets across the Midwest. The deposit growth side has been very strong. As George said, even though this would be a time of year where we would would expect some seasonality in balances, we continue to see very, very good deposit growth there. Fee products continue to expand nicely and I think you all saw the loan growth side of that.

On the retail side, the highlight clearly is consumer loan originations continued very strong at $1.5 billion in balances, up 15% over last year, and that's just continued branch effort by each of our banking centers and clearly one of the reasons we continue to open new branches.

On the deposit side, as George said, we continue to focus on that. We had a successful campaign on the deposit side here in the first quarter and I think we recognize the importance of deposits in today's rising rate environment.

Mortgage banking obviously affected by the movement in interest rates. During the quarter we had pretty severe ratchet down in interest rates in March. That picked up origination volumes there. That will carry over into April as well, but I would say obviously as rates have gone back up we expect slower activity and I think that's come through.

We had $35 million in write-downs and amortizations on the MSR portfolio with about $18 million in hedge gains. So we feel very good about where we stood on the servicing side. That's all retail originated mortgage activity, that's not wholesale activity, so we feel like we are in good stead. We think we've managed very well in the falling rate environment and we think we are prepared for a nice breather here as rates pop back up.

I would also mention on the mortgage side I think our folks did an excellent job as it related to the cost side, so as applications slowed down we think the expense side was very well behaved. We do continue to add new mortgage originators in some of our markets and we think that will continue to help us manage volume despite year-over-year slow down.

Maybe now we will turn to the operating expense side. I would say operating expense certainly is one of the areas we focused on all year given the kind of revenue year we thought we were staring at, so as we've seen stronger revenue we think that's going to fall through to the bottom line and expenses certainly sequentially very well controlled on almost all line categories. We continue to focus on processes. We continue to look at our business line productivity and we continue to exit those noncore businesses that don't fit middle market and retail franchises.

I would say in addition to that, it isn't just expense control. I will tell you our sales force adds have been accelerating in several markets and we expect to add significantly to personnel as we go throughout the year and essentially self-funded by the work we've done on the productivity side. So I think we'll be able to manage that quite nicely given the trends we are seeing right now.

Maybe spend a moment on the balance sheet and the trends we are seeing there. Obviously driven by continued good loan growth, net interest income was up 7% versus first quarter a year ago. Net interest margin was up 6 basis points, I'll repeat that, it was up and I think we are real happy with that. That obviously as rates have ratcheted up, we think coming up off of lows on net interest margins will continue to help us.

We expect the margin to continue to be at these levels or higher, I think obviously everybody is trying to forecast interest rates being in the Fed movement, but clearly with the retail balance sheet we think a steeper curve and higher interest rates only makes the run rate of net interest income stronger for 2004 versus 2003. We think we were a lot less optimistic a year ago with the flat curve and lower rates and we feel pretty good about that.

I will spend a moment on credit quality. Net charge-offs of average loans at 54 basis points versus 72 basis points last quarter, clearly last quarter was elevated a little. I would tell you we feel very good about the trends on the commercial side. We think nonperformers and charge-offs as George said to improve nicely through the remainder of the year. As it relates to nonperforming loans, I think our largest migration in the nonperformers was right at $5 million and they are only five credits over $2 million, so very, very well behaved and broad-based. I think credit quality continues to feel like it will improve for us.

Those are our comments. We would be happy to open it up to everyone for questions. Thank you.

At this time, I would like to remind everyone, if you would like to ask a question, please press star then one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from Tom McCandless of Deutsche Bank Securities.

Good morning, guys.

Good morning, Tom.

I have several questions, if I may, but if you have a quota on the number of questions just cut me off; and I will get back into the queue. Probably four, five questions. First one, can you delve a little deeper into your discussion about new deposit initiatives on a go-forward basis?

Yeah, let me tackle that one. Those of you that know us know that we run an awful lot of deposit campaigns in this company. We have, with lower rate environment, have been focusing a great deal on the direct loan campaigns and spent a great deal of effort there, because, obviously, they have been the highest coupon, best credit quality asset we can originate out of the branch network and have felt good about that performance.

As we saw rates bottom, we started and I think kicked off the end of last year a deposit campaign, that deposit campaign had very aggressive goals. Bob Niehaus and that group tend to set very aggressive goals that are up 20% and 30% of origination targets. We've clearly been swimming against, I would say outflows into the equity market of the savings variety, and it was a little hard to sell a CD with a zero in front of the decimal place, but I would say the checking account activity ought to show you that we are serious about deposits.

I think if you look on pure checking accounts, demand and interest checking, they are up $3.5 billion in just dollars of checking account deposits year over year. So, I think you'll see our deposit activity really driven through campaigns and a relentless focus on that side, so we probably put that at the top of the list of campaign priorities.

And, Tom, there has also been big campaigns on the commercial side as well. Our commercial demand deposits up there are up really significantly and we are finding great success there. And a lot of this is coming through various corporate treasury management services that we're also selling that have demand deposits that come with them.

Okay, great. Second question, related to Neal's comments around the processing business in particular, the EFT, funds transfer business and the notion that you think there's some opportunity for those revenues to pick up, particularly in light of Check 21. Could you elaborate a little bit on those comments and talk about your opportunities and why they present themselves to Fifth Third?

Yeah. Thanks, Tom, I am a two-day expert on EFT now. I would tell you that as it relates to the Check 21, we think the differentiation between moving a lot of checks, obviously the paper, and moving electronic debits and credits of business, we have a pretty long history, and as you well know, we think that that playing ground gets leveled pretty materially over the next couple years. We think we are well situated because, if you understand the electronics piece of the business, clearly Check 21 makes transportation a lot less element to people's clearing activity, be it large businesses, be it government enterprises, be it ECH and clearing house activities. So we think that the line gets blurred between the processors and the big cash management folks. We think we sit in a nice spot where we work very quickly on that part of the business.

Tom, we've also had some pretty good sized contracts with people like Sabra [ph] and the Armed Forces network out there that are just beginning to kick in now. But there's also, Tom, there's still 225 banks just in Ohio, there are 125 thrifts, there are 570 credit unions, and we still don't really have a really big market, so this is just Ohio now. If you spread that out, the customer base out there is really pretty good and so far we've only been in the U.S. All of our customers are really in the U.S. right now. We are also looking at some across the border stuff that may help us out and they are going forward.

Geography used to play a role in that you had to clear the checks overnight so there was some geographical constraints on the cash-flow business. I will tell you there aren't on the payments business and we think that's going to look better going forward.

Speaking of perhaps geographic opportunities, what are your thoughts about expanding your Investment Advisory business, particularly perhaps looking at fixed income, money managers in light of where we are in the rate cycle?

Are you selling something?

I'm sure the Street has a million of them for sale.

I would tell you, we feel very good about our product lineup. Under the Old Kent deal we bought a very solid fixed-income team based up in Grand Rapids, but I would say as relates to asset management, we think where we have done the best is selling our products into our footprint. We feel pretty good about the platform we have there, Tom, so there are a lot of asset management deals. They are fun to look at, fun to run numbers on, but they are hard to execute.

Last question if I may. Your comments on the net interest margin, net interest income should benefit as long as rates go up and the curves steep. What if the rates go up and the curve flattens? And could you talk to us a little bit more about your rate exposure and the balance sheet duration and held for sale, et cetera?

This is always a challenge. I think the world thinks that big retail banks mark their balance sheet to market every day. This is not Goldman Sachs, obviously, so we think a steeper curve and higher rates, if you are putting money out on loans in the four-year part of the curve, or whether you are putting them in the bond portfolio in the four-year part of the curve and you are funding them with deposits not just wholesale funding, I think you are going to see that those people sequentially make better revenue trends. The challenge is that doesn't happen overnight. It probably takes you, as I've said over and over, 18 months to reprice in a given rate and environment. I think we are up 40 or 50 basis points in the two- to five-year part of the curve versus a year ago.

Our company, it tends to be a short duration company and low rates, flat curve tend to be the hardest and I would tell you that was probably the biggest worry we had in 2003. First year falling rates are fun. It gets a lot more painful. I would tell you with our equity capital base and with our demand deposits we are about flat to spreads versus a year ago, but our margin is still down and 15 basis points to a year ago if you just look at a point in time. And that's really just driven by the level of rates. You have an awful lot of your balance sheet that needs to reprice and I would tell you while it's possible that the Fed snaps back quickly, I think it's more likely that the curve stays steeper than it did a year ago.

Okay. Thanks, guys.

Thanks, Tom.

Your next question comes Mike Mayo of Prudential.

Hi.

Good morning.

Could you comment a little bit more on the revenue growth? On the one hand, it looks like you had higher spread revenue growth in the past. On the other hand, you are talking about better growth going forward, specifically a higher margin. And it seems like your period-end loan balance were quite a bit better than the average balances. Can you help us, how we should think between what we saw in the reported results and what is going to happen in the future. Thanks.

I will take a shot at it, Mike. I would say I think you're right as it relates to end of period versus averages, January and half of February are a little slower on the loan growth side. I think spreads held up very nicely, but I would tell you that volume, March was a very strong loan growth month. Probably three categories I would point out. Commercial loan growth was the strongest, I think we've seen in the last five, six months. So very strong activity there and line draws. As relates to the retail side of the house, direct loans have continued strong. Indirect was softer later in the year. We are seeing March, April originations pick up very nicely. They are probably double what they were in January and February.

So loan growth feels good to us and I'd say as it relates to net interest income, we feel good about the kind of numbers that we had in the first quarter. I would tell you I think the whole industry was struggling with almost flat to down net interest income. The reason ours was better than that is because of the loan growth we've had clearly. And I would say given the line activity we think there's probably are more loan growth to follow into the second and third quarter at this point.

And the margin, you expect it to go up a lot or a little bit?

No. This is a retail balance sheet. I would tell you I would pay a lot of attention to repricing is not a ninety-day event here. This is not like I said a trading company. I think margin is going to be stable. A lot depends on whether or not overnight money gets expensive faster or whether it's more gradual. I will kind of let you guys put your own forecast for that. I think funding is going to be in good shape and I would pay attention to the funding side.

Thank you.

Thanks.

Your next question comes from Fred Cummings of Key Bank Capital Markets.

Yes, good morning, George and Neal.

Hey, Fred.

George, a question for you in the context of acquisitions. In reading the proxy this year it noted that the Board had established a 12% earnings per share growth for last year. In order for you guys to get back up to say 15% growth, which you've done in the past, how important will acquisitions be in helping to you attain that level or do you think you can get there just via organic growth and opening up branches de novo?

I think, Fred, if you look at last year it will probably give you a good proxy there. If you look at 2003 where we didn't do any acquisitions, the balance sheet grew by about $11 billion, $12 billion. Our loans were up just de novo $6 billion, deposits up $5 billion. So in 2003, without doing an acquisition, we grew the place, it was in effect $10 billion or $11 billion bank that we built just on our own through our own markets, people in Cleveland and Chicago and Detroit and Columbus, Ohio out hustling loans and just growing de novo. So I think we can do that.

Obviously, traditionally we have been in the acquisition business and we are always looking for opportunities there and we want to close this deal that we have on our plate down there in Nashville, and I'm sure there are going to be other opportunities out there. So I think mainly, Fred, we view ourselves as being opportunistic, we are not going to overpay for anything out there. And I think we've demonstrated that we can do de novo and at the same time we want to take advantage of any opportunities as they come down the road. So, like we've said in the preliminary comments, we do want to be very cautious here and we aren't in any hurry to do an acquisition out there. But as these markets change I think we are going to see some good opportunities.

I would say, too, that if you normalized our margin, I don't know what normalized means, but if you look at our historical margins we were a good 30 basis points lower last year, so as George said, We put out that volume, if you had another 30 basis points of margin on that we would have probably been up over 12/13s on an EPS kind of number. So I think we are a lot more comfortable with the kind of organic growth we are seeing out there. And I would say while people look like they've gotten in a lather, I'm not sure we are in a big hurry.

Fred, the other thing that we are doing, Neal mentioned this, in all of our lines of business, we are out there trying to hire some really good professional salespeople out there. On the commercial side, we are trying to higher some 200-plus different middle-market lenders throughout our markets. On the Investment Advisory side we are trying to hire brokers and people that can sell asset management. The same in the processing business. We are looking for really good salespeople out there. Those things don't require us to do an acquisition.

We found by going out and acquiring the good people and doing some fill in de novo branching, those seem to be much better returns than some of this acquisition stuff, we have to do a lot of clean up out there and you have to clean up the HR side of that. So we are in the acquisition business of good quality salespeople right now. If anybody is listening in and thinks they can sell anything, we have a job for you.

And, George, just one more question for you. You guys have had -- obviously, Steve Schrantz retiring and it looks like Neal is getting promoted here and you have some changes in the financial side of the bank. George, what are your thoughts, not specifically on succession planning, but I note that, will you ever hire or will you ever name someone as president even though if you keep the title of Chairman and CEO, or do you not think that you need to have that type of structure? I'm just kind of wondering where you are and where the Board is in the succession planning.

I think we talk about that pretty consistently, Fred, and I'm in my 16th year as President of this organization out there. I'm 58 out there right now, but I think things are going pretty well. But the one thing I do want to let everyone know, we have a very deep bench in all of our markets. The advantage of our affiliate system where we have 17 banks with 17 president's and 17 retail heads and 17 commercial lenders, gives us a lot of opportunities to see a lot of talent in a lot of markets out there. So myself, our management team and our Board feels really good about the bench strength that we have here right now. And at some point in time I will be moving along, and especially if we don't get these earnings going greatly, maybe it will be before I want. But I think everything is going pretty well now, but we talk about that pretty regularly.

Okay. Thanks, George.

Your next question comes from Gary Townsend of Friedman, Billings, Ramsey.

Good morning, gentlemen. How are you?

Good.

Could you discuss a specific market and your penetration of it in the Chicago area, particularly with regard to the branch expansion and your success with deposits there?

Yeah, I would say if you look at Chicago to date, I think Chicago is right now our third largest affiliate, or excuse me, second largest affiliate. They are right at about $9 billion in assets plus or minus a couple hundred million. I think one of the things that we've been most heartened, I guess we've been there about almost three years now and what we really see is the magnitude of the numbers. When we run a campaign up there it's almost like running a campaign in three of our affiliates just because of the magnitude of what we have.

Our loan growth on the commercial side has been up high teens. On the deposit side, I would say demand deposits alone are up north of 35% growth year over year, clearly benefitting from more branches hiring middle-market people up in that market. So our agenda is really to add, not only branches, but fill out the product line by adding people, as George mentioned, whether it's middle market, whether it's on the Investment Advisor side or even on the consumer lending side. So we are willing to fill in what others leave behind.

How many branches have you now in that market?

We are up to, we are opening I think five this last week but we have 114 plus four.

It's going to be plus five. I think it's going to be about 125, Gary, plus we've opened about, we put in ten new ATM machines up in that market recently there. And those new openings have really been, the deposit growth and the loan growth in those new offices have really been very, very good. I think they are the best we've had. They are almost like the Florida branches that we opened down there in Naples. They are really fast growers on the deposit side?

Are these all stand-alone branches?

Yes.

Yes, these aren't grocery stores. I would say, Gary, the number I think by May is that we are going to have nine more branches in the Chicago marketplace and so we clearly will continue to build there.

And so your total deposits there? If you have that number?

They are roughly, were three -- $7.5 billion.

Okay. Thank you.

Thank you.

Your next question comes from Joe Stieven of Stifel Nicolaus.

Good morning, guys. First of all good quarter.

Thank you.

Amazingly, most of the questions have already been answered, but let me ask about nonperformers. You guys had good trends literally across the board on your nonperformers. But the Midwest has sort of been soft. Can you give just sort of your color commentary on why your nonperformers are coming in that direction? Is it just changes that you guys are doing internally or is the economy starting to help you guys already? That's question number one.

Question number two is your charge-offs on a quarterly basis I think were the lowest I've seen in almost two years for you guys. Is this sort of a level that you guys feel is sustainable or is there anything in there that we should take note of? Thanks, guys. Good quarter.

I think it's really a combination of both points on your first question there. The economy out here is definitely, as you know, picking up out here. I think that's pretty well true. At the same time, though, we have been focused on this credit quality stuff as you know. Generally our charge-offs are less than the industry average and we don't do any sub prime and we are on the higher end of the spectrum out here when it comes to quality.

And at the same time, like I said, we've been at this now as soon as the cycle turned down we've got huge teams here focused on that, and I think you are going to see these kind of trends continue out here. Our target has always been for much lower commercial charge-offs out there and we don't think we get paid the -- the reward isn't worth the risk generally for these marginal credits out there, and we really have beefed up our credit area on the commercial side out there. So I think you are going to hopefully see that trend continue out there.

Joe, I would say if you look at just commercial nonperformers in our supplemental quarterly data, it's actually page 11 in there. I think our commercial MPAs peaked out in March of a year at $172 million. And this year we are at a $117 million number. So we've seen a very marked improvement in the commercial nonperforming area. And I would say I think everybody knew we were charging off some of the commercial lease aircraft stuff, but I would say as you look out forward, I think our focus has been that retail charge-offs will be pretty stable, but I think commercial has improved very nicely on the MPA front and certainly as the economy has done better and I think as the dollar is stronger, we are seeing businesses a lot more optimistic.

Joe, the other thing you have to recognize with Fifth Third is, during the down cycle and after 9/11 we didn't take the big flush. A lot of banks wrote off big numbers in commercial and flushed them out. We didn't do that. We typically work our loans a lot harder, stay with them, try to maximize the value going down. You have to consider that, that we didn't take a big $500 million/billion write down on loans or problems that occurred out there. So you always have to take that into consideration. A number of our peers out there will go ahead and write off big chunks of them, or sell huge pieces of them at a downturn and we think we maximize value by really working through these things and evaluating them on a quarter-by-quarter basis. So we hang with them a lot longer.

It's real money there, too. Good quarter, though. Thanks, guys. Thank you, Joe.

Your next question comes from Katherine Murray of Neuberger-Berman.

Hello. I have several questions on mortgage banking.

Yes.

I guess the first is just to make sure I understand the statement you have in the paragraph there about the mortgage net service revenue totaling $44 million, but when you make all the adjustments it's $78 million. Is that mostly the $26 million of securities gains or what else would be in there?

Predominantly it would be secondary market activity and service revenue.

But that would include the securities gains that you report on a different line, Neal?

Yes.

Okay. And just to confirm, the securities gains were mostly taken this quarter as part of the mortgage banking hedge.

Yeah. If you look and I think I pointed it out in my comments, I think we had a net write-down of $35 million.

Right.

And we had hedge gains of $18 million that were, if you will, off the balance sheet.

Mm-hmm.

So there's another $20 million, if you will, to be square as it relates to our hedging. I would tell you we've harped on this a lot. A lot of people don't hedge mortgage banking and probably got a nasty surprise in March. I would tell you that we are very happy with -- mortgage banking is volatile. What you thought March looked like, April was about the opposite. So it's bounced around and we think our position is in good standing there.

Right. And, Neal, that's where I wanted to go with the next question, which is, if longer rates continue to move up, just how will these numbers move, just to give us a sense of how the major pieces would be moving given what you are doing with your hedging?

Yeah. Clearly the biggest negative event in the servicing portfolio is low rates and prepayment speed. If you describe it the way you did, as loan rates move up, I would tell you that the predominant piece of our portfolio is fixed rate. So you are going to have slower prepayment speed into that and so you are going to have servicing on the books longer and you are going to slow down the amortization. So revenue pick up does come from the servicing portfolio. It isn't overnight but that's what's going to happen and I would tell you the excess of market to book there is probably going to move up nicely.

And where do you stand at this point on the cost structure associated with the mortgage banking?

Such as?

Are you downsizing as volumes come off? Are you done with that or aren't you going to do that because you never grew it? Just where do you stand on the cost structure?

Yeah. I would say when the volume hit we tended to do a lot of our processing with temporary labor, so those costs come out as volume changes pretty quickly and I think we highlighted that last quarter. I would tell you, Katherine, we are, though, hiring mortgage originators in many of our markets. We think it's one of the our best cross-sell products that we have, and so we will add originators to get the purchase side of the market. Clearly, re-fi is going to be a slower part of the business. But we still think mortgage banking is going to have a respectable, albeit down from a year ago, the last two years were 100-year storms in mortgage banking. Right. Okay, good. Thanks now.

Thanks.

Your next question comes from Denis LaPlante of KBW. Good morning, gentlemen.

Can you talk about the RFP backlog and how is it looking in the processing business?

We weren't quite sure what RFP you were talking about. I would tell you in the processing business, both areas I would say on the merchant side we focus on probably two real areas, the national business and the commercial business. The commercial business is sort of middle market a lot like our customer base. We have those sales forces out in each of the markets. Our volumes there continue to grow. Clearly, the last year we had slower retail sales.

One of the things you have to see in this quarter clearly, is that as retail sales ticked up, we get a nice pop. So I think the core franchise there is in good shape. We continue to like to add to that customer base. We think there's a lot of disruption gone on out in the industry right now. And so one of the things we bring to that market is a very reliable platform. So our platform we don't have hiccups, we don't charge customers three times for a debit transaction so I would say we feel pretty good about where we stand in that business.

I would say on the EFT side, George highlighted, we are seeing more customer opportunity there and I think the future looks pretty good. That's been a single-digit growth, but with Check 21 that could be stronger. So the pipelines are probably bigger deals than we've seen and we continue to work pretty hard there.

How would you characterize the pipeline in the retail side, though? Is it getting better given the terms of your opportunities to bid on business?

Yeah. I mean, as you've seen we have a lot of the big retailers and a lot of the drug stores and those kinds of clients. I would say we've tended to focus in a pretty narrow niche of retailers. Our opportunity is to go into some of the nearby businesses within that.

Can you talk about pricing in general? In both the wholesale and retail business?

I would say in general the last several years have been tougher as it relates to the margin. I think as the industry is consolidated a little and as we've seen some of the deals come into the market, I think we see the margins firming a little bit. We always think that's a tenuous part of the business, but I think margins have firmed a little. Clearly, lower technology or telecom cost have helped people as well.

Can you give me a better time line in terms of margins forming in the last three months, last six months, last 30 days, can you give us a sense?

This is a lumpy business, I would say on the larger merchant side, so it depends on what deal you are describing. But I would say the margins are firm, I wouldn't describe them as picking up.

Okay. Great. Thanks for the time.

I think at this time we have Mr. McCandless on the line for one additional follow-up question, then we will wrap things up. I know there's a lot of other calls this morning so go ahead if you would, Tom.

Thanks. Just the comments were made that you are trying to add to your sales force in many markets, many product areas, that would "hopefully be self-funded from increased efficiencies." Can you do a little deeper dive into where you are getting those cost savings to fund the expansion of your sales force, what type of activities are being eliminated, et cetera, et cetera?

I think a lot of that stuff, Tom, is straight automation of processes. I mean, one of the things I think we talked about maybe on a prior call was we used to have 30 or 40 people manually at one of our processing centers keeping track of the cash in the ATM machines for everybody we would process for. We put in a system now that automated that and now we have three or four people on that side. We've done a tremendous amount of automation. We are putting in a new reconciliation system now that automates a number of the transactions. We are putting in a new entry system now, instead of manual ticket entry, that's all key entry. We call it the ace system here. That is going to save 75, 100 kind of FTEs around here. So there's been a tremendous amount of process improvement going on.

We actually have some Six Sigma-type teams here not really into that depth, but doing work out on some of the efficiency projects coupled with our automation groups that are really saving a lot of people around here, FTEs in the process out here. So it's not any one big item, Tom, but it's a whole lot of different items.

Year over year, Tom, two big things obviously mortgage banking, and I talked about temporary labor that allow us to self-fund it. We also, year over year have gone out of both corporate trust and now this out of footprint small merchant, those contributed minimally to net income, but we had 50 to 75 bodies in each of those businesses and so that confirmed a lot of sales force adds as well.

Just one last follow up, in terms of your overall processing business, particularly as it relates to your merchant processing, how much of the processing volume in that business is debit card versus credit card?

I don't know the exact number there, Tom. I will get back to you, but I would say it has historically been 50/50, after we did the USB deal it was modestly more merchant on the credit side, but I think it's 60/40ish would probably be the outside.

Thank you.

Very good.

Thanks for listening in, everybody, this concludes the call.

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