Fifth Third Bancorp (FITBO) 2009 Q4 法說會逐字稿

Good morning. My name is Kenya and I will be your conference operator today. At this time, I would like to welcome everyone to the Fifth Third Bancorp fourth-quarter 2009 earnings conference call. (Operator Instructions)

Mr. Richardson, you may begin your conference.

Thanks. Hello, and thanks for joining us this morning. We'll be talking with you today about fourth-quarter 2009 and full year results. This call may contain certain forward-looking statements about Fifth Third Bancorp pertaining to our financial condition, results of operations, plans and objectives. These statements involve certain risks and uncertainties. There are a number of factors that could cause results to differ materially from historical performance in these statements. We've identified a number of those factors in our forward-looking cautionary statements at the end of our earnings release and in other materials and we encourage you to review those factors. Fifth Third undertakes no obligation and 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 Chairman, 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 the call over to Kevin Kabat.

Thanks, Jeff. Good morning, everyone, and thanks for joining us. I'll make some opening comments and then hand the call over to Mary and Dan for a more detailed discussion of our credit and financial performance.

For the past two years credit trends have dominated our results. They have obscured positive developments resulting from our continued focus on our strategic plans in core operations, and while credit remains difficult and its impact remains significant, I am very pleased with the improvement in trends we saw in the fourth quarter. Charge-offs were $708 million, down $48 million from last quarter and NPA's up just 1%. Total delinquencies were down 33%, including early and late stage. Those are welcomed improvements from recent trends. We saw a drop in commercial net charge-offs from the third quarter, which as you'll recall, included the effect of the annual Shared National Credit exam. We expect commercial charge-offs to decline significantly in the first quarter and overall improved performance for all of 2010, as new problem assets generally have lower loss content than what we've been dealing with the past 12 months or 18 months.

We also made great progress in dealing with commercial delinquencies this quarter. Loans 30 days to 89 days past due were down 46% sequentially and loans past due 90 days or more were down 68% sequentially. This represented both improved flows during the quarter, as well as the efforts of our commercial banking and special asset groups to address delinquencies, get them resolved and current or to further the workout process. Commercial nonperforming assets were down about 1% in the quarter, which was the first drop we've seen in quite some time. We do expect commercial NPA's to increase in the first quarter, but we continue to believe the general trend is slowing. NPA inflows are continuing to shift to products where loss severities are lower and work out options are greater, like CNI and income-producing real estate.

Consumer charge-offs also declined in most categories and were down for the second consecutive quarter. We expect first-quarter consumer charge-offs to increase modestly, given the effect of bringing consumer securitizations back on balance sheet and normal seasonality. We currently expect consumer charge-offs for the remainder of the year to remain relatively stable and below the levels we saw in mid-2009, based on migration trends and our current outlook for the economy.

Our reserve position remains strong at nearly 5% of loans and 127% of NPLs. We expect losses in 2010 to be below 2009's levels and given our current expectations, we don't expect any significant further reserve builds to be necessary. The implementation of FAS 166, 167 will result in a small increase to the reserve in the first quarter as we bring assets on balance sheet. Mary and Dan will talk about that more in their remarks. Overall, we feel good about where we are with the reserve and that's a good position to be in as we head into 2010.

Now, let me give you some high level operating results. The net interest margin increased 12 basis points sequentially, a little better than we expected, which reflects good discipline on rates and the rolling off of high cost CDs we put on last year. Net interest income was up modestly, about 1%, reflecting good net interest margin and deposit trends largely offset by a difficult environment for asset generation. Transaction deposits were up 6% from last quarter with $1.1 billion of growth in DDA balances and $1.5 billion of growth in interest checking.

Our strong deposit growth and muted asset trends have created a lot of liquidity and we've reduced wholesale funding by $17.5 billion on a year-over-year basis. The mortgage business continues to perform very well and we generated another $4.4 billion of originations during the quarter. This was a record year for both mortgage banking revenue and origination volume and we've been pleased with our ability to continue that momentum throughout the year even as the refinancing boom began to wane.

Finally, last quarter we discussed the significant impact of credit charges recorded in revenue and expenses. These totaled $145 million in the third quarter of which $45 million was a provision for unfunded commitments. This quarter, those charges dropped to $85 million with $10 million in unfunded provisions. While it's difficult to predict the impact from quarter to quarter, I believe this is a more representative starting place for those costs as we move into 2010. Dan will talk later about the impact of those charges and where they appear in more detail.

Finally, let me just make a couple of comments on the environment. We're starting to see some additional positive indicators in the economy. For example, recent data showing that economic conditions improved in 10 of the 12 fed Reserve Districts, home sales and GDP both showed positive growth in the latter part of 2009 and the competitive environment is also much more rational than we experienced a year ago, which creates a more stable operating environment. But economic activity is still mixed.

Many of our commercial clients are very nervous about investing in new projects. Commercial line utilization at 33% is the lowest I've seen in my career, as customers are being conservative at extending themselves, even when they have committed financing.

Retail customers are continuing to deleverage, which is healthy for the economy in the long-term, but will likely lead to a slower recovery than we've seen after other recent recessions. Housing prices remain well off their highs, and while we've seen a small recovery in prices in some markets, a 5% increase after double-digit decreases still leaves a lot of people under water.

All told, a much better operating environment than we've seen in sometime, but the economy is not yet firing on all cylinders. An improvement will likely be measured over the next several quarters. We continue to remain focused on our core operations and the things we can control, like customer satisfaction, deepening our relationships, and investing in the Company's future while remaining disciplined on expenses and driving higher revenue and profitability. We're confident these actions and those we've taken on the credit front will serve us well in 2010 and the future. With that, let me turn it over to Mary to discuss credit trends in more detail. Mary?

Thanks, Kevin. As Kevin mentioned, overall credit trends were better than expected. Let me walk through results, starting with charge-offs. Total net charge-offs of $708 million decreased $48 million sequentially. Commercial net charge-offs declined $32 million to $468 million from $500 million last quarter. As you'll recall, third-quarter charge-offs were elevated due to higher losses related to the Shared National Credit exam. Florida and Michigan continued to represent a disproportionate share of charge-offs. And while Florida will remain a challenging market for some time, parts of our Michigan portfolio have begun to show signs of bottoming out.

CNI net losses this quarter totaled $183 million, down $73 million, with a sequential decline attributable to a broad base of industry segments and the effect of the SNC exam in the third quarter. Michigan and Florida accounted for 52% of CNI losses during the quarter, while representing 23% of CNI loans.

Commercial construction net charge-offs were $135 million, up $9 million, with Michigan and Florida generating 61% of losses. Commercial mortgage losses of $142 million increased $24 million from the third quarter, with Michigan and Florida contributing 56% of losses. Across the portfolio, home builder developer losses totaled $110 million, which was flat versus the third quarter. You'll recall that we suspended home builder originations two years ago, have already recognized significant charge-offs in that portfolio and worked to reduce our exposure. Portfolio balances are $1.6 billion, less than half of their peak level. We expect losses there to come down, given the work we've done on that portfolio.

As Kevin touched on earlier, our current expectations are for commercial charge-offs to come down again in the first quarter. While commercial charge-offs can be somewhat lumpy, we believe they will be down about $100 million in the first quarter, give or take, from $468 million this quarter and that they should remain well below the levels we experienced in the latter part of 2009.

Turning to the consumer portfolio, consumer net charge-offs decreased $16 million during the quarter, totaling $240 million. Improvement was broad based. Net charge-offs on the residential mortgage portfolio were $78 million, a decrease of $14 million from the third quarter. Michigan and Florida accounted for 73% of losses from 42% of the total mortgage portfolio. Home equity losses increased $2 million sequentially to $82 million, including $34 million of losses in the brokered portfolio. The net charge-off rate on brokered home equity was about 7% annualized, which is almost four times the loss rate on our branch originated book. The brokered equity portfolio is $1.9 billion of outstanding, down from about $3.5 billion a couple of years ago, and continues to run off. Auto loan net charge-offs were down $2 million sequentially, reflecting higher values received at auction. Performance has been very good in this portfolio throughout the cycle and reflects a number of improvements in underwriting in the past couple of years.

Credit card losses were flat compared with the third and second quarters. Total card balances are about $2 billion and as we've discussed previously, this is a branch originated in-footprint relationship product for us. We would expect card charge-offs to trend with unemployment and bankruptcy filings over time. We expect first-quarter consumer charge-offs to increase modestly, about $10 million or so from the fourth quarter. That reflects the effect of bringing consumer securitizations on balance sheet due to FAS 166 and 167 and seasonality. Beyond that, current migration trends and expectations would suggest that consumer losses should remain pretty stable in the remainder of 2010.

We continually update our stress test models and have outlined the results of those scenarios, which I just described on one of the slides in our normal earnings presentation posted on the website. Taking our commercial and consumer charge-offs expectations together, we currently expect 2010 charge-offs to be lower than the $2.6 billion we experienced in 2009. To place that into a broader context, in our SCAP submissions, we submitted baseline credit losses of $2.9 billion for 2009 and $2.8 billion in 2010. Our actual charge-offs in 2009 were about $300 million lower than our baseline submission and as I've just noted, we currently expect charge-offs to be lower than $2.6 billion in 2010. And our revised current view of 2010 stress scenario losses, which we don't believe is likely, is actually much closer to our original SCAP baseline scenario than the SCAP adverse scenario published in May. We've also posted the extensive portfolio stratification we have traditionally published to provide as much transparency as we can into our credit results and expectations.

Now, moving on to NPAs. NPAs, including held for sale totaled $3.5 billion at quarter end, down 1% from the third quarter. Excluding $224 million of NPAs in our held for sale portfolio, where the loans have already been fully marked, portfolio NPAs totaled $3.2 billion. That represented growth of just $24 million, or 1%. Florida and Michigan remain the most challenged geographies and account for 44% of NPAs in the portfolio. Portfolio commercial NPAs declined by $20 million, or 1% from the third quarter, which was better than we originally expected. That was due to a variety of factors. Improved financial performance, less deterioration than we expected during the quarter, and higher paydowns than we expected. That's a reflection of improving migration trends and the effects of shifting from a period of high sustained growth to an environment that shows signs of beginning to stabilize.

Within NPAs, commercial TDRs on nonaccrual status increased to $47 million from $18 million last quarter. We expect to continue to selectively restructure commercial loans where it makes good economic sense for the bank, for credit where the cash flow support the rework structure. Commercial construction NPAs decreased $44 million. Florida and Michigan were down $50 million combined. Commercial mortgage NPAs were up $16 million. CNI NPAs were down $9 million from the third quarter, with Florida the biggest driver of the decrease. Across the portfolios, residential builder and developer NPAs of $548 million represented 22% of total commercial NPAs and were down $52 million sequentially.

As Kevin discussed, based on current migration expectations, we expect commercial NPAs to be up moderately in the first quarter, with commercial NPA inflows lower than fourth-quarter inflows. Of NPA inflows currently forecasted in the first quarter, a majority were current at year end and we believe that's indicative of a reasonable workout potential for these NPAs in many cases. We anticipate commercial NPAs over the course of the year to generally reflect the broader slowing trend that we've seen the past several quarters. Improved early stage delinquency results are encouraging in this respect and liquidity has improved for moving distressed assets and that adds another method of managing NPAs as we move into 2010.

Moving to consumer NPA trends, NPAs totaled $704 million at the end of the quarter, a $44 million, or 7% sequential increase from the third quarter. Nonaccrual consumer TDRs were $33 million of the increase. Residential mortgage NPAs increased $38 million during the quarter to $523 million, with TDRs representing $26 million of the sequential growth. Home equity NPAs totaled $71 million at the end of the fourth quarter, down $1 million from third-quarter levels. Auto NPAs were flat and credit card NPAs were up $7 million, with the increase attributable to TDRs.

In terms of overall consumer TDR activity, we've modified about $2.7 billion of loans since the third quarter of 2007, of which $258 million were carried as nonaccruals at December 31. A little over a quarter of the loans we've restructured to date have redefaulted. On a lag basis, as you would expect, redefault rates are higher, but remain below 40% of modified loans. We believe that experience is generally in line with the industry. As this portfolio matures, we would expect TDR redefaults to continue to increase due to seasoning.

Overall, we continue to be pleased with the results of our loss mitigation efforts. In the first quarter, we expect consumer NPAs to grow in the mid single digits, consistent with fourth-quarter trends or perhaps a little better. We would expect modest consumer NPA growth going forward, driven primarily by increased TDRs, the result of our active modification program.

To wrap up the NPA discussion, we believe we've been as aggressive as anyone in assuring we've written problem loans down to realistic and realizable values. Total NPAs, commercial and consumer, are being carried at approximately 59% of their original face value through the process of taking charge-offs, marks, and specific reserves recorded through the fourth quarter.

Moving to delinquency trends, commercial loans 30 days to 89 days past due were $367 million and declined by $318 million, or 46% from the third quarter. Commercial loans 90 days past due were about $200 million and dropped $414 million compared with the third quarter, a 68% decline. As noted last quarter, we had a number of delinquencies where the loan was past maturity, but still current which has since been resolved. Looking ahead to the first quarter, we expect the seasonal increase in delinquencies from these very low levels experienced in the fourth quarter, but for growth to be moderate.

As we discussed last quarter, consumer delinquency trends overall have continued to moderate. Three key drivers of those trends are the seasoning of loans made in 2005, significant underwriting improvements in home equity and auto portfolios, and the runoff of mortgages due to our 95% salability strategy. These factors are having an increasing impact on the performance of the portfolio. Consumer delinquencies 30 days to 89 days past due increased 4% sequentially to $528 million. Consumer loans over 90 days past due were $369 million, down $12 million, with Florida representing the largest decline for the second consecutive quarter. We expect delinquencies to be up modestly in the first quarter, with 30 to 89s relatively stable and over 90s reflecting the growth in early stage delinquencies in the fourth quarter.

A couple of comments on provision expense and the allowance. Provision expense for the quarter was $776 million and exceeded net charge-offs by $68 million. This increased the allowance to $3.75 billion. Our allowance coverage ratios remained strong, covering nonperforming loans by 127% and fourth-quarter annualized net charge-offs by 132%. And we feel we are well positioned here, absent unexpected developments.

Let me spend a moment on a couple of other topics. First, an update on the nonperforming loans we've moved to held for sale status. Those balances were originally $473 million in the fourth quarter of 2008 and they are down to $216 million at the end of 2009. In the fourth quarter, we also moved $9 million into held for sale from the portfolio. During the quarter, we received payments of $16 million and wrote down principal balances of retained loans by $13 million. We also sold, settled, or closed $61 million of these NPAs during the quarter and realized about $4 million of gains on those sales and transferred $3 million to OREO. Since we moved these loans, our realization of gains and write-downs largely offset and these values overall are consistent with our original marks. We currently carry the remaining loans in this pool at about $0.33 on the dollar of their original contractual balances.

To sum up, we're encouraged by recent trends, but we're also realistic about the environment. Unemployment is high, and is expected to remain high. Home prices have stopped declining as precipitously, but have not turned around yet. And in some markets, they continue to be under significant pressure. Those forces suggest that consumer losses will remain elevated for some time. Additionally, while we've been very pleased with the results of our consumer loan modification, not all of those modifications are going to be successful and we'll see some NPAs and losses develop from those loans, even as we see improvement in overall trends. But we've taken that into account in our outlook and believe these actions will reduce the losses the Company ultimately experiences.

On the commercial side, we've been through a part of the cycle where loss severity has been very high, due to the nature and type of products involved, namely commercial construction and residential development. Those areas dominated our NPA inflows and charge-offs through 2008 and 2009. Our current inflows have been more reflective of typical cycle development, including CNI and commercial mortgage.

There's been a lot of justified focus on commercial real estate at this stage of the cycle, so let me make a few comments on that front. Our commercial real estate loans are about $15.6 billion, or 20% of the loan portfolio, which is a relatively low percentage compared with other regional banks. Of that $15.6 billion, $11.8 billion is in commercial mortgage and $3.8 billion is in commercial construction. Obviously the construction portfolio has been under the most stress and we've been very proactive managing this portion of the loan portfolio. We suspended home builder and developer loans back in 2007 and nonowner occupied real estate lending in early 2008. While we expect to see continued stress in the area, these credits were affected earlier in the cycle, given the issues in residential real estate and shortfalls in adequate cash flow to bring projects to fruition.

The current stage of the cycle is marked by a shift in NPA inflows toward income-producing properties backed by mortgages. Of our $11.8 billion commercial mortgage portfolio, about half is nonowner occupied, but is income producing. The cash flow from these properties gives us a much greater ability to work these loans out and as a result, we tend to experience lower loss severities than the loans that created most of the issues earlier in the cycle. But they do typically take time to work out. And so like consumer, we expect commercial charge-offs to remain elevated in 2010. But we do expect to see significant improvement in loss experience during the year versus what we saw the past couple of quarters.

The burden of provisioning on earnings and on capital generation has been pretty material over the past couple of years. In 2008 and 2009, we incurred provision expense of almost $3 billion in excess of charge-offs. The elimination of that additional burden should have a significant positive effect on results, even as charge-offs remain higher than we would like. We experienced pain from this credit cycle earlier than others, given our geographies and given some product areas where we frankly made some loans we shouldn't have made. Brokered home equity and home builder lending were two areas that stand out, but there are others we've discussed over the past several years. Because of these factors, particularly the early cycles in Michigan and then Florida, we adjusted our underwriting earlier, we charged loans off earlier, and we built reserves earlier and more significantly than many of our peers. We've tried to be aggressive in recognizing issues and getting them resolved and behind us. As a result, we don't believe we have an overhang or any catch up to deal with and we feel well positioned as we move into 2010. With that, I'll turn things over to Dan to discuss operating trends. Dan?

Okay, thanks, Mary. As Kevin noted, while this quarter still reflects a difficult environment, we did see significant progress. Not only on the credit front, but in operating results as well.

For the quarter, we reported a net loss of $98 million and paid preferred dividends of $62 million, which resulted in a loss of $160 million on an available to common shareholders basis. Last quarter, our net loss was $97 million, or $159 million to common. Excluding the effects of Visa, on a core basis the net loss last quarter was $303 million compared with this quarter's $98 million net loss. That $200 million after tax improvement was driven by three factors. The first was a lower provision, which was down $176 million pretax, reflecting both lower charge-offs, as well as a lower reserve build. The second was lower credit-related costs and revenues and expenses, which was down $60 million pretax. And then the third was our favorable operating trends. As Kevin and Mary noted, we expect the first-quarter charge-offs to come down again and we don't expect much of a reserve build, if any next quarter, beyond the effect of FAS 166 and 167. So we're currently expecting earnings trends to improve again in the first quarter as we move closer to turning that bottom line positive.

Some of the major themes for the quarter outside of credit were continued net interest margin expansion, lower credit-related costs, and strong deposit growth. Net interest margin increased 12 basis points sequentially to 3.55%. As with previous quarters, the expansion was driven by maturities of high rate CDs put on the sheet in the fall of 2008. Net interest income was up $8 million, or 1%, with the margin benefit of strong deposit growth offset by asset growth head winds that we've been experiencing recently. Average core deposits grew by 3% sequentially and 11% on a year-over-year basis with strong growth in transaction accounts. Compared with last quarter, credit cost recognized through fee income and operating expense were down significantly, totaling $85 million in this quarter compared with $145 million last quarter. That positive variance was driven by a lower provision for unfunded commitments, lower credit-related derivative losses, and lower fair value adjustments on loans held for sale. I'll talk about the revenue and expense split of these charges in a moment. Going forward, we expect these costs to remain elevated, but this quarter's number is closer to a run rate that should improve over time.

Overall, it was a pretty clean quarter, although there were two significant items that largely offset one another. We recorded a mark to market gain on warrants we hold from the FTPS transactions, which are valued based on a set of publicly traded proxies. That gain was $20 million and was recorded in other income. We also recorded a $22 million reserve for litigation risks associated with one of our bank card association memberships and that was recorded in other expense.

With that context, let's go through the balance sheet in a bit more detail. Average earning assets were down about 2% compared with last quarter and 4% on a year-over-year basis. This trend continues to be driven by soft commercial loan demand and the continued impact of our strategy of targeting the sale of about 95% of our mortgage production.

Let me mention here the prospective effect on our balance sheet of FAS 166 and 167, which we implemented on January 1 of 2010. This was a fairly minor event for Fifth Third, but it will result in loans in the first quarter increasing by about $2.3 billion and securities being reduced by about $900 million. The loans come from the consolidation of approximately $1.5 billion in consumer loan securitizations and from $800 million of commercial loan conduit assets, which will be added to loans. Offsetting that will be our previous investments of $800 million in the conduits commercial paper and net of $100 million in other securities which will go away. Thus the net effect on earning assets overall will be about $1.4 billion.

Now, looking at the fourth quarter, average loans held for investment were down 3% sequentially and 10% on a year-over-year basis. In addition to the $2.3 billion effect of FAS 166 and 167, we believe that CNI balances are reaching a bottom and we'll begin to see some organic growth soon. CRE loans on the other hand will likely continue to decline for at least several more quarters. For the year, we would expect loan balances to begin to grow modestly, although it's a little early to say how much that growth may be over the course of the year.

Now, to give a little more detail by product types, in the fourth quarter, average commercial loans decreased 4%, or $2.1 billion, with the majority of that decline reflecting lower line utilization, as well as charge-offs. Line utilization was down $1 billion sequentially and is down $3.9 billion from a year ago. This lower line utilization reflects customer caution. We still have those relationships, and as their confidence returns, this will represent some built-in loan growth, as line usage returns. Average consumer loans were down 1% sequentially and 3% on a year-over-year basis. Auto loan balances increased 1% sequentially and 6% compared with the fourth quarter of 2008. We're pleased to see growth continue here beyond the third-quarter benefit from the Cash for Clunkers program. Auto loan demand remains solid and credit performance has been good. Going forward, loan balances will reflect the inclusion of about $1.2 billion in auto loans that will be consolidated on January 1 of 2010.

Credit card balances were up 1% on a sequential basis and 13% on a year-over-year basis. Residential mortgages were down 3% sequentially and 13% from a year ago, as we continue to sell most of our new production. Flow sales during the quarter were $4.2 billion. Home equity loans were down 1% sequentially and 3% on a year-over-year basis. We currently expect home equity loan balances to be relatively stable in 2010, which reflects relatively low demand, but some stabilization in home prices in a number of our markets. Average securities increased by about $800 million during the quarter, with proceeds primarily invested in agency mortgage backed securities. We'll continue to evaluate securities investments in the context of loan growth, in the context of excess funding, and of course the overall interest rate environment. We remain very thoughtful about taking these positions, given our expectation for future rate increases, although the risk/reward profile has improved recently. We've supplemented our balance sheet hedges to reflect these purchases and to maintain our overall relatively neutral interest rate risk position.

Moving on to deposits, we saw continued strong deposit growth momentum this quarter with a significant positive shift in mix toward lower cost deposits. Average core deposit growth was 3% sequentially and 11% on a year-over-year basis. Transaction accounts showed the strongest growth with DDA balances up 6% sequentially and 24% year-over-year. We also had significant growth in interest checking deposits, which increased 10% sequentially and 19% on a year-over-year basis.

Looking forward to the first quarter, we expect core deposit growth to be fairly similar to the fourth. Given the low rate environment, customers continue to value liquidity and we expect that will continue in the near term. Retail core deposits were flat sequentially and increased 6% on a year-over-year basis. Our new higher value and bundled product offerings are attracting higher average balances. We've gotten good feedback from customers on these new product offerings. That offsets a decline in net new account production, which was driven by our no longer offering the totally free checking product. Total commercial core deposits were up 12% sequentially and 28% from a year ago. Commercial DDAs increased 10% from the third quarter and 46% from last year, while commercial interest checking increased 22% sequentially and 47% from last year.

I would note that average public fund balances in interest checking increased by $1 billion on a sequential basis and as tax refunds are issued, we would expect some of that growth to reverse. Otherwise, the growth has been driven by higher average balances, which reflects cautiousness and excess liquidity among our customers. As I noted earlier, our liquidity remains very strong. Wholesale funding levels were reduced again this quarter by $3.8 billion, or 15% and we've now paid down $17.5 billion of wholesale funding since a year ago.

Let me give just a quick update on FTPS. The deconversion process continues and we've completed transitioning of a number of core HR functions over to the joint venture. Retained card and processing fee income was up modestly on a sequential basis, coming in at $76 million for the quarter compared with $74 million last quarter. Card and processing expense of $27 million compares to $25 million last quarter and includes about $10 million of retained expense, as well as $17 million in charges from FTPS related to their providing of processing services to the bank. We also had $39 million of revenue from the FTPS transition services agreement, or TSA, which covers costs of a similar amount incurred by Fifth Third in providing services to the processing JV. That revenue is recorded in other noninterest income. Last quarter we had about $38 million of TSA related revenue. We would expect approximately $12 million to $15 million of TSA revenue in the first quarter and between $45 million and $50 million for all of 2010. We would expect first quarter expenses to decline in a like fashion. Finally, we recognized equity method income of $8 million related to our 49% interest in the joint venture through the other income line. That compares with about $7 million last quarter and the $8 million did not include the warrant marked to market adjustment, which I talked about earlier.

Moving on now to the income statement, starting with net interest income. Net interest income on a fully taxable equivalent basis increased $8 million sequentially to $882 million. That was driven primarily by deposit repricing and partially offset by lower loan balances. Net interest margin increased 12 basis points to 3.55%, a little better than we expected on wider deposit and loan spreads. We currently expect margin to expand another 5 to 10 basis points in the first quarter, with solid growth in net interest income perhaps in the $15 million range, including about $10 million effect from adding the assets that we talked about earlier related to FAS 166 and 167. As we move further into the year, we would expect earning asset growth, driven by modest growth in loans and securities and a margin that is likely to be stable after the first quarter in the near term.

Moving on to fees, third-quarter net interest noninterest income was $651 million. Non-core items in noninterest income are outlined pretty thoroughly in the earnings release. I won't go through those in detail, but on a core basis, fee income increased $30 million or 5% from the third quarter and $73 million or 13% from the fourth quarter of 2008. Credit-related charges that roll through noninterest income fell in the quarter from $45 million last quarter to approximately $30 million this quarter. The strong year-over-year results come primarily from the increases in mortgage banking revenue.

Corporate banking revenue of $98 million for the quarter was up $12 million from a seasonally soft third quarter, or about 15%. Sequential growth was driven by institutional sales, interest rate derivatives revenue and business lending fees and partially offset by declines in foreign exchange revenue. We expect solid results again in the first quarter, although they will likely be lower than the seasonally strong fourth quarter. Deposit service charges were down 3% from the third quarter and 2% from a year ago. Consumer deposit fees were down approximately $6 million on a sequential basis, which more than offset a $1 million increase in commercial deposit fees.

We continue to position our checking account offerings for changes in the regulatory environment, which contributed to the lower consumer deposit fees this quarter, as well as to an anticipated similar decline in the first quarter. We would expect some positive seasonality in the second quarter and additional account growth to offset these effects after the first quarter. We've been proactive in adjusting our offerings and we believe we're well positioned in terms of regulatory developments and offering value to our customers. Investment advisory revenue increased 4% sequentially and declined 2% on a year-over-year basis. Recent market performance has benefited the trust asset management and brokerage groups and we're expecting strong growth again in the first quarter.

As mentioned earlier, mortgage origination volume remained robust during the quarter at about $4.4 billion. Net mortgage revenue of $132 million was down $8 million from last quarter. We continue to capture greater market share and purchase originations increased to 36% of our volume in the fourth quarter. Right now we expect net mortgage banking revenues to decline about $20 million or so in the first quarter. Obviously that could move significantly, but overall, we've been very pleased with the continued strength of this business.

We currently expect fee income for the first quarter to be about $580 million, give or take. Relative to the fourth quarter, that would reflect three main drivers. First, the decline in TSA revenue I outlined earlier, which is about $25 million. Second is the effect of the $20 million gain on warrants that was reported in the third quarter. And third, we expect mortgage banking revenue to be down about $20 million. Beyond the first quarter, which is a seasonally low quarter, we expect fee growth to pick up on positive seasonality in the second quarter and growth across our fee businesses through the remainder of the year.

Turning to expenses, noninterest expense of $967 million was up 10% sequentially. However, fourth-quarter results included the $22 million litigation reserve that I mentioned earlier, while third-quarter results included a net $73 million reduction in expense due to Visa. Exclude these items, expenses were $945 million in the fourth quarter, down just slightly from core expenses of $949 million in the third quarter. In the fourth quarter, total credit related costs within operating expenses, which includes the provision for unfunded commitments, were $55 million versus $100 million last quarter. This positive variance was partially offset by the effects of a $14 million tax-related accrual and $8 million in growth and marketing expense. We currently expect noninterest expense in the first quarter to be consistent with that $945 million in the fourth quarter of core expenses. An expected $20 million increase in seasonal FICA and unemployment expense will be offset by the reduction in FTPS support expenses I mentioned earlier, which is primarily personnel related.

Let me stop for a moment and just do a quick reconciliation of preprovision net revenue. Reported pretax preprovision earnings were $562 million in the fourth quarter. That's consistent with the core number. Last quarter, core PP&R was about $530 million. We would anticipate PP&R to be down about $20 million to $30 million in the first quarter, given the expectations for a reduction in mortgage banking revenue and the effect of the $20 million in seasonal benefits expense I mentioned just a minute ago. Offsetting those negative variances would be pretty solid growth in net interest income. We currently expect PP&R results in subsequent quarters to rebound and exceed fourth-quarter levels, driven by net interest income growth, growth in fee businesses, and lower credit related operating expenses.

Let me add to my comments on the implementation of FAS 166 and 167 this quarter. We will record a cumulative effective adjustment to retained earnings in the first quarter, which we currently estimate to be a charge of approximately $90 million. That will reflect the valuation marks and the net difference in the carrying value of assets recognized and derecognized as part of that adoption. That charge would include an addition to the loan loss reserve of approximately $10 million for loans that are being added to the balance sheet, as well as a portion of the reserve for unfunded commitments will also be reclassified to the reserve for loan losses to reflect the conduit assets that are being added to the loan portfolio.

Now, moving on to capital, our quarter end capital ratios remained strong. The TCE ratio excluding $240 million of unrealized securities gains was 6.5%. Tier 1 common equity was 7% and Tier 1 capital was 13.3%. The effect of incorporating the net $1.4 billion of assets onto the balance sheet and the charge to equity will reduce our TCE ratio by about 15 basis points. We already carry those assets in our risk weighted asset calculations for regulatory purposes and thus the effect on Tier 1 and total capital ratios will be less than 5 basis points. I think with that, I'll open it up for questions.

(Operator Instructions) The first question comes from Craig Siegenthaler.

Good morning, Craig. Craig?

-- more detail on the commercial side where we've seen a pick up in restructured loans and has this been a shift in strategy in terms of becoming more aggressive in restructured commercial loans, or is this really the lag nature of the CRE loss cycle?

Craig, sorry, we could not hear the first part of your question. Could you repeat that? I'm sorry.

Sure. Can you hear me better now? I just switched to speaker.

Yes.

What I was asking about is restructured loan trends. We have seen and kind of know what's going on on the commercial side, but on the consumer side, that's been picking up recently. And what I want to know is if that was really a function of regulatory pressure or maybe a change in strategy, if there's something more kind of near term, or is this just really the aging in the CRE loss cycle, meaning you have more potential problem loans on the commercial real estate side so it's more potential to restructure them?

Yes, Craig, I would characterize it really more in alignment with how we're working through the cycle. We continue to evaluate opportunities for restructuring on the commercial side on a case by case basis, where it makes economic sense. And one of the specific characteristics that's important to that decision is the amount of cash flow that's available behind that credit. So in earlier stages of the cycle where we had situations that were more purely collateral-dependent, it wouldn't make sense. As we move through the cycle, we will continue to see additional opportunities for that kind of restructuring on a case by case basis, given the characterization of the types of credit workout situations that we're working through right now. So there's no regulatory pressure behind it per se, it's just a general reflection of our business strategy.

Is there any capacity constraints in restructuring loans, like manpower, people power, workout teams or regulatory pressure hitting now is in favor of more CRE workouts we saw last quarter. Are there any constraints there?

The regulatory guidance that was issued last quarter, we felt was really in alignment with how we would view these situations anyway. So, again, no specific callouts from that perspective. In terms of our staffing and resources, we've been very aggressive in making sure that we've got appropriate staffing levels to work through our issues and we continue to evaluate and monitor that closely, as we continue to move through different stages of the cycle, but we're well positioned in terms of our overall staffing capabilities.

Great. Thanks for taking my questions.

Your next question comes from the line of Matthew O'Connor with Deutsche Bank.

Good morning.

Good morning, Matt.

You provided some commentary in terms of how you're thinking of the securities book and wanting to stay relatively neutral. I guess my question is, if you look on a period end basis, there's a big increase in the security book, and I know there's always a lot of excess deposits at quarter end. So is that more indicative of the securities level going forward, or is it kind of artificially high on a period end basis?

Hi, Matt. This is Dan. I think if you, if you look at the investment securities balances, there are some investment balances that are impacted by quarter end liquidity. Those would tend to show up in the line other short-term investments. And that primarily just represents excess cash, most of which is just held at the Fed. If you look at the available for sale and the held for maturity investment securities balances, those are up about $2.5 billion, and I think those are the increases that would tend to be more permanent and represent additional investment made during the quarter, along the lines of the comments we made in our prepared remarks.

Okay, and I guess one concern that a lot of us have is that some of the deposit growth in the industry isn't going to be as sticky as we've seen in the past so that the deposits were priced more than expected as rates rise and then some of these fixed rate assets that are being added, say within the securities book, all of a sudden the funding costs go up pretty meaningfully. I guess I'm just wondering how you think about deposit for pricing and how you balance some of those risks.

Yes, I think those are clearly risks that we're focused on as well. I think there are certain portions of the deposit gains that we've made that, that won't be sticky. We alluded to some of that with respect to public deposits in our comments. We're mindful of that. That's incorporated into our interest rate risk management, and on an overall basis, we remain in a fairly neutral to slightly asset sensitive position. We've done that very thoughtfully. We added to some hedge positions during the quarter, which offset some of the impact of the securities that we've added in order to make sure that we maintain that position. So we're very mindful of the risks you're talking about and we're proactively taking steps to make sure we address those risks.

Matt, this is Kevin. The other thing I would mention is we feel very good about being out in front of it strategically, both in terms of -- really on both sides of the business, from a retail standpoint, as well as a commercial standpoint, which really calls for a lot of focus from our people recognizing the full value of the deposit relationship as we go forward from that standpoint. As well as, as Dan talked about in his comments, some of the strategic shift we've already begun with the bundling offerings and the value added services that we're providing from that standpoint. I think that's a pretty good start for us in terms of anticipating exactly the concerns you have.

Okay. That's helpful. And then just separately, if I can, the regulatory impact on NSF and credit card, do you have a preliminary estimate of what that might be?

Well, obviously that situation's fairly fluid and there're a number of things that aren't final there. We did make some comments about the deposit fee trend this quarter and expectations next quarter and certainly that incorporates our views as to the impact of -- the anticipated impact of regulatory changes. And from a bigger picture perspective as we go forward, our thoughts on deposit fees are that beyond the impacts that we alluded to in the fourth quarter and first quarter, that any impacts would be offset by account growth going forward. So relative to a specific estimate of the overall impact of regulatory changes, I don't think we're -- we've made a specific estimate of that that we've disclosed. But I think we are incorporating that into the guidance that we've talked about in the comments that we've made.

Okay, all right. Thank you very much.

Thanks, Matt.

Your next question comes from the line of Todd Hagerman with Collins Stewart .

Good morning, everybody.

Good morning, Todd.

Kevin, I was just wondering if you could just give us an update in terms of your thoughts on capital levels and repayment of TARP. As you know, recently there's been seemingly a little bit more pressure from the government to have some of the banks return the treasury money. But I'm just curious, kind of given your more favorable outlook, particularly as it relates to credit and the healthy capital levels that you have now, as well as kind of your update on the SCAP results, kind of where you stand now in terms of capital and your thinking on repaying TARP and if it includes kind of a 2010 time line.

Todd, I guess from my standpoint, what I would tell you is we continue to evaluate our environment. We continue to have dialogue. We don't -- there is no -- I would tell you we don't feel any pressure, except that we have a number of constituents with differing objectives and we feel good about the continuing improvements in our results and our capital levels, the environment, as we kind of highlighted for you today. What our objectives continue to be is to resolve TARP in a way that's thoughtful and considers all of our constituents, including our shareholders, and it remains a corporate priority.

So from my standpoint in terms of what we've discussed late last year and even into -- at this point we still feel about in the same position from that perspective. And as we get better clarity on what expectations we feel would be the right way to handle it, we'll communicate that. But we don't feel a pressure at this stage really other than focus on continuing to do the things we know add value for the Company at this point.

Okay, but I mean is it fair to assume, though, again, assuming the trends that we saw this quarter continue, that it's certainly possible that the TARP would be repaid in 2010?

Yes, Todd, I think that's a fair statement. Again, if expectations continue and we continue to improve and the environment continues to improve, I think that's a fair assessment.

Terrific, thank you.

You bet. Thank you.

Your next question comes from the line of Chris Mutascio with Stifel Nicolaus.

Thanks for taking my question. You gave pretty explicit guidance and I appreciate that in terms of what fourth -- first quarter may look forward to in terms of margin, fee income, and revenue and getting to a pretax, preprovision line item of roughly 530. I know that's just for a first quarter and might be seasonally low. But that implies in order to break even that your loss rate would have to go from the 365 charge-off rate you had this quarter, almost down 100 points to about 265 in order for the pretax preprovision earnings to cover losses. Is that a reasonable target to get down to 26 in terms of net charge-offs in 2010?

I didn't quite follow all the math.

Well, I guess if you just apply -- you can back into what the loan loss provision expense to get below 530. And your loss rates, if you do a back of the envelope on $80 billion of loans, your charge-offs would have to drop to 2.6% of loans in order for provision expense to drop down and match charge-offs -- provision expense to get to 530. You've talked about improvement in 2010. Could we see that good of improvement in losses for 2010?

Yes, I think on an overall basis. Mary made some comments relative to our baseline expectations for the year, would be for charge-offs to be lower. And I think from a big picture perspective, I don't think that the levels that you're talking about there are something that would be unreasonable.

Okay.

As an expectation right now.

Can I follow with one question--

Just a minute. We indicated in our remarks we expect charge-offs to be below $2.6 billion.

Okay.

And the other thing I would just add is we also indicated that we expect PP&R to bounce back in the second quarter to above this quarter's levels, which were 560.

Right. I wasn't talking about $2.6 billion. I was talking about 2.6% in charge-offs. That's fine. Can you give more colour on the tax? It looks like there was a fairly significant tax benefit, and if you've talked about this in the call, forgive me. There's four different banks reporting this morning, but the tax benefit was pretty significant this quarter. Any more colour on that going forward?

Yes, I think that the quarterly tax calculations I think in an environment like the one that we're in can get to be a little complex in that the tax -- the taxes that are recorded each quarter really reflect an estimate of what the year end overall tax will be depending on levels of taxable income. And that's impacted by credits and permanent items, which have a bigger impact on the effective rate, depending on how much income you have.

So I think our overall tax provision this quarter, it was really reflective of just working through those year end calculations and is kind of the final true-up for the year. There was not any significant adjustments included in there. We did have some significant period items related to leasing litigation and bank-owned life insurance that were in the first quarter that impacted the overall effective rate for the year and contributed to a very low effective rate overall. I think as you look forward, the best way to look at our taxes is that we have about $100 million in tax credits that we would anticipate for 2010 and then our marginal tax rate on income that we earned is about 36%. So depending on the level of income, if you put that $100 million in tax credits with a provision of 36% of expected income, you would come up with a tax rate that won't be 36%, would likely be less than that given the impact of the credits. But exactly what that rate would end up being will be a function of what taxable income for the year would end up being.

That's great. Thank you very much for the insight.

Sure.

Your next question comes from the line of Paul Miller with FBR Capital Markets.

Thank you very much. And given the fact that your capital levels have improved and credit's getting better, and you have talked about in the past about doing FDIC-assisted transactions. Have you started to get more involved in that, have you studied that more, or you just haven't seen anything that's come out to interest you at this point?

Paul, this is Kevin. As we've talked about in the past, FDIC deals could be interesting, could make sense to us, as long as they fit with our existing franchise and financially. As we talked about in terms of kind of the internal qualitative measure is really, these transactions involve a significant amount of workout resources, and those folks for us, as we reported today, are doing important work for us right now. So as we see that balance load continue to improve and shift, which would give us capacity, that would be, in my mind, the driver in terms of increased appetite and interest from our standpoint. So that's really kind of the whole way we're looking at it right now, Paul.

And the other issue, I mean I don't want to put you on the spot here, but you definitely got great credit trends and you're in some of the toughest states, being Michigan and Florida, your operations in the country unfortunately. Have you seen improvement in the unemployment rate? Because that's some of the things that we like to look at and -- or is it just that you're seeing stabilization in businesses and stabilization with your customer base, but not necessarily stabilization with the job growth in the areas that you're in?

Yes, I guess, Paul, you would like to put me on the spot. The way I would respond to that, if you look at it across our footprint, we're not seeing improvement yet, but we are seeing some stabilization. And I think that's the key element for us in those markets specifically that you mentioned. So I think that's relevant to us at this point in the cycle.

Okay, thank you very much, gentlemen.

You bet. Thanks, Paul.

Our next question comes from the line of Dennis Klaeser with Raymond James.

Good morning.

Good morning.

Two related questions with regards to loan loss reserves. When you look further out into 2010, would you expect you would get to a point where the provision expense would be less than the charge-offs? And then secondly, longer term, what would you think would be a good ballpark estimate for your normalized level of loan loss reserve to total loans?

As we have indicated in our earlier prepared comments, what we're seeing at this point clearly would be significant improvement in the credit trends as we've discussed. We also talked about very large build that we've made to the reserve in prior quarters. So at this point, although there may be some build left to the reserve, we would see it as being much less significant and in terms of the actual timing of that, that's still to be determined. Clearly we have to look at that in the context of a number of different factors, but we do definitely see a trend of much less significant build and just don't have an exact time line for that yet.

Yes, the only thing I would add in response to the second part of the question relative to what we would anticipate reserve allowances being going forward on a more normalized basis, of course those determinations need to be made at the time based on the condition of the portfolio and economic conditions at the time. Historic -- historically I guess for some context, that figure in more normalized times has ranged from about 1% to maybe 1.4%, 1.5% in more normalized times. I know that's a pretty wide range, but I think that's probably pretty good historical perspective to base expectations of a normalized future on that.

And that, again, I know it's difficult to predict and you got to put yourself in that position at that point in time. But that level could be a 2012, 2013 type level?

Too early to call, Dennis. We would love to be able to tell you exactly, and I will once we're past it a quarter or two. But too early to call.

Okay. And you may have mentioned this earlier, but in terms of the composition of a loan loss reserve now, what portion of it is specific reserves versus the FAS 5 reserves?

I don't have those numbers in front of me. I think the specific reserve portion of that is a much lower portion, the lion's share of that reserve is the kind of FAS 5 kind of reserves. The 10-Q, when we file it, will have a fair amount of detail about the components of the reserve that frankly I just don't have with me right now. But it is -- the specific reserves are relatively small, probably 10% or less of the reserve.

Got it. Okay, all right. Thanks for taking my questions.

Our next question comes from the line of Heather Wolf with UBS.

Good morning.

Good morning.

Good morning.

Just a couple questions on credit. Mary, you mentioned that you do expect redefault rates on modifications to accelerate. Do you have any feel for where those might peak out or what you are forecasting for that level?

We haven't forecasted any specific peaks per se, but what we are looking at is general trends, particularly with respect to loan modification activity in our mortgage portfolio. So as we look at that, clearly we have done quite a bit of that activity really since inception of the program and we continue to make sure that our loan modifications make good business sense, but also meet the needs of the borrowers at the same time. As you would expect, there would be some natural reaging effect that would come out of that, and as we look at what that effect might be, we will continue to evaluate and analyze to make sure that the activity that we do continue to engage in would make best economic sense for the bank, as well as for the borrower.

Okay, and do you have a quantification regarding principal forgiveness on those modifications you've done?

We would very, very rarely forgive principal. It's highly unusual.

Okay.

And, Heather, just to be clear in terms of your question, we would expect our performance on a percentage basis to continue and we've been pleased with that. The dollars will be greater because the pool's greater.

Oh, I understand. So you don't expect the redefault rate to accelerate -- you don't expect the rate to accelerate; just the dollar value of redefault.

At this point, we do not.

Okay.

And just to give you some additional context on that, our redefault rates right now are in line with the industry, with a regard of different measures we employ to evaluate the effectiveness of the program.

Okay, and then one quick question on CNI, so excluding commercial real estate and commercial construction. I know that this is traditionally a pretty volatile category in terms of migration. What gives you the confidence in sort of the pipelines that you see that we won't see a, another pickup in CNI losses or nonperformers?

There's a couple of different factors that we look at. Clearly one factor would be the overall economic trends within the footprint. We also would evaluate whether we're seeing any particular themes in certain industry segments within the CNI portfolio, and actually in the past, we have called out a couple of segments of the portfolio more specifically as we saw those segments driving higher losses. The best examples of that being real estate-related industries within CNI, as well as the dealer portion of the portfolio. We've continued to see improvement in those areas and so as we look at the economic factors, as we look at the industry segments, we don't see any particular theme coming out from an industry standpoint. There's a fairly broad base that we look at. So at this point in time, that would be some of the consideration that would give rise to our comments.

The other thing I would point out in terms of loss severities, there's really kind of a descending priority, if you will, with respect to loss severities, starting first in the commercial portfolio with the nature of the construction product and/or the home builder portfolio, looking then at other elements of the nonowner occupied portfolio, going from there to the owner occupied portfolio, and then finally going to the CNI portion of the portfolio. And because of the characteristics of the CNI portfolio, even as we may still see some additional stress there, the expectation would be that the loss severities in that portion of the portfolio would be far less than what we experienced earlier in the cycle.

Okay, great. Thank you very much.

Thanks, everybody. I believe that ends our call, so we appreciate it and we'll talk to you next quarter. Thank you.

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