Fifth Third Bancorp (FITBO) 2010 Q2 法說會逐字稿

Good morning. My name is Ginger and I will be your conference operator today. At this time, I would like to welcome everyone to the Fifth Third Bancorp second quarter 2010 earnings call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions) Thank you. Mr. Jeff Richardson, Director of Investor Relations, you may begin your conference.

Thanks, Ginger. Thanks, everyone, for joining us this morning. We'll be talking with you today about our second quarter 2010 results. This call may contain certain forward-looking statements about Fifth Third Banc Corp pertaining to our financial condition, results of operation, 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 statement cautionary statement 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 such forward-looking statements after the date of this call. I'm going joined on the call by several people. Kevin Kabat, our President and CEO, Chief Financial Officer, Dan Poston, Chief Risk Officer, Mary Tuuk, Treasurer, Mahesh Sankaran and Jim Eglseder of Investor Relations. During the question and answer period, please provide your name and that of your firm to the operator. With that, I'll turn the call over to Kevin Kabat. Kevin?

Thanks, Jeff. Good morning, everyone. Thanks for joining us. I'll make some opening comments and then hand the call over to Dan and Mary for more detailed discussion of our financial and credit performance. We've also developed a presentation this quarter to facilitate that discussion which we hope you find helpful.

Obviously this quarter marks an important turning point for us. Although the first quarter's loss was very small, it was still a loss. But the second quarter, we reported significantly stronger results, particularly from a credit standpoint. That resulted in a profit of $192 million which was $130 million or $0.16 per common shareholder. The environment remains challenging but I'm pleased with the progress we've demonstrated in both credit trends and continued strong operating metrics. We've seen fairly sharp improvements in credit results which I believe is the result of our aggressive actions earlier in this cycle. And while the pace of that improvement is obviously not sustainable, we do believe that credit should trend favorably as we move forward.

Taking a look at a few trends in credit, we saw a very significant move in chargeoffs this quarter, down 25% or $148 million from last quarter to $434 million. That was better than expected and is the lowest level of chargeoffs we've seen since the second quarter of 2008. Chargeoffs peaked in the third quarter of last year at $756 million. We've seen a reduction of over 40% in just three quarters. NPAs were down $160 million or 5% sequentially and NPLs were down 7%. Delinquent loans 90 days past due were down another $39 million or 9%. So, problem loan levels and loss content in both moved solidly in the right direction. And this contributed to our reduction in loan loss reserves. Still, our reserve position remains very strong at 4.85% of loans. With coverage actually improving to 146% of NPLs and over two times annualized chargeoffs.

Looking forward to the third quarter, given the size of the decline in chargeoffs we just saw and have seen in the past several quarters, it will probably be difficult to beat the second quarter chargeoff level. Right now, our expectation would be for chargeoffs to be stable to a bit higher in the third quarter. We're probably looking at net chargeoffs of something like $450 million plus or minus $10 million or $15 million. Commercial will probably be up modestly and consumer losses should be flat or down a little. We continue to expect net chargeoffs to be significantly lower in the second half of the year than the first half of 2010 and for them generally to follow a stable to declining trend line.

NPAs and delinquencies have declined recently and we expect those to slowly improve over time. We don't currently expect a significant move one way or the other in the third quarter and finally, we would expect the reserve to continue to come down based upon our current views for credit trends in the economic environment.

Let me give some high level operating results. Preprovision net revenue of $567 million was consistent with that reported last quarter and was in line with expectations. Reflecting better than expected fee income results and lower expenses. That was partially offset by lower net interest income resulting from weaker than expected loan demand and the decline in market interest rates.

Fee income results were strong, partially offset by lower mortgage banking revenue as expected. Total noninterest income was down 1% sequentially. Corporate banking revenue and card and processing revenue both showed mid teens growth. Average core deposits were up 1% sequentially and 12% over 2009 levels. That included $1.8 billion in runoff of public funds deposits without significant other relationship aspects as expected. We'll continue to focus on gathering households and long-term core funding and we'll continue to manage our balance sheet and funding by minimizing our high cost nonrelationship deposits.

Average loans were down 2% from last quarter. We came into the quarter expecting better results than that but commercial borrowers became more cautious as the European crisis developed and the US equity markets declined in the middle part of the quarter. Loan production was up from last quarter and we continue to gain market share. However, that was more than offset by higher than expected prepayment levels as companies continue to deleverage and defer investments. Line utilization hasn't increased but it did remain stable. The economy seemed to take a pause during the quarter. Still growing but perhaps less than expected a quarter ago and borrowers have reacted to that.

Expenses were down $21 million from last quarter as expected, driven by lower credit related costs and lower FICA. We continue to invest in the business for the long-term which you can see in our FTE growth. Our strategic plan is focused on approving our core franchise and strengthening our financial performances to the end of the cycle.

Our strategic initiatives are focused on continuing to improve the customer experience at Fifth Third which will result in deeper customer relationships and improved retention. This includes the roll-out of new products like the relationship savings product and other new product bundles such as our secured checking package. But also includes additional investments in our sales force.

Since September of last year, we've added almost 200 personal bankers to our high traffic branches. We've expanded our branch hours on weeknights and weekends at most locations which has continued to improve customer service levels. We hired 125 new business banking officers and five affiliate market pilots with an expanded small business banking sales force focused on customers in the $1 million to $3 million revenue channel. We plan to open a number of new branches in the second half of 2010 as we selectively refresh and add to our network to improve our presence and delivery in those markets. We have brought in several commercial loan teams from competitors in recent months which we expect to better position us long-term in key markets.

We've seen early positive impact from these initiatives, specifically in better deposit account production, deposit growth balance for new and existing customers and solid loan production which is helping to offset weak loan demand otherwise. We think they're the right steps to take for our future although it will take some time and a better environment to see the payoff. We'll keep a close eye on the performance of these initiatives and the economy and we'll dial them up or back as appropriate.

We still see a lot of opportunity in our markets today and our sales force continues to do a good job winning new business and clients throughout our footprint. My expectation is that this should continue particularly as we add value to services and products. Dan and Mary will talk about our outlook in more detail. We expect bottom line results to remain favorable in the third quarter and to see continued organic growth in capital.

Our return to profitability is a major step in the progress of the Company after the events of the past couple of years. I would like to thank Fifth Third's employees for their focus and dedication in helping us turn the corner in our credit issues. And for staying focused on our customer relationships. The quality of work they've done has been fantastic and has enabled us to produce these solid results.

Our fee income businesses are performing well and expenses remain well-controlled. Despite that, market developments during the quarter particularly in Europe and the US equity markets resulted in some moderation of economic expectations and higher levels of caution among potential borrowers. We hope that greater certainty around legislative and regulatory developments and the general direction of the economy will begin to more fully translate in the customer comfort with borrowing and investing in their businesses again. Dan will walk through some of the key features of financial reform legislation the way we believe some of its elements may affect us and some of the things we expect to do in response. We're good business people and while this will certainly present some challenges as we adapt, we believe it will be manageable.

I really do think that the net result of these developments, most of which are supposed to be addressed toward reducing systemic risks, will play to Fifth Third's strengths. I've noted that we saw no key business at Fifth Third impaired or eliminated by the crisis. By the same token, there are no key businesses eliminated for us through financial reform. Business activity is fairly sluggish right now. But our balance sheet and expense base are under leverage relative to what they can support as things improve as they will. We'll have to adapt to new costs and ways of doing business but they're consistent with the ways we've always tried to do business and I expect us to be a winner as we move ahead. With that, let me turn it over to Dan and discuss operating results. Dan?

Thanks, Kevin. As Kevin discussed, we've seen positive trends on both the credit and the operational fronts and I would like to spend some time discussing our performance in a little more detail. Overall, we're very pleased with the results for the quarter. E results were significantly better than anticipated. Offset somewhat by lower than expected net interest income due to weak loan growth and higher than expected cash balances.

Turning to the presentation, page three just summarizes the quarter for you so if you'll turn to slide four, I'll start there. In the second quarter, we reported net income of $192 million and paid preferred dividends of $62 million, which resulted in $130 million of net income on an available per common share basis. Which is $0.16 per share. PPNR was $567 million consistent with strong first quarter levels. The reduction in our net chargeoffs in the overall stabilization and improvement of credit trends contributed to a reduction in the loan loss allowance of $109 million.

Let me start with NII which is shown on slide five. Net interest income on a fully taxable equivalent basis decreased $14 million sequentially to $887 million on net interest margin decreased 6 basis points to 3.57%. The decrease in NII was primarily balance sheet driven. Loans during the quarter were lower than we expected, particularly from mid quarter on. Commercial customers are also holding record levels of cash. As the Euro zone crisis and domestic policy uncertainty have led them to adopt or maintain a cautious posture.

Long-term investment securities were also lower than expected. We didn't reinvest portfolio cash flows which were elevated by the prepayment during the quarter driven by GSE buyouts out of mortgage backed securities, which also resulted in higher premium amortization. These factors led to an increase in excess liquidity where obviously we're not earning much right now. This was partially offset by the benefit of deposit mix shift and CD repricing as well as wider LIBOR spreads during the quarter and the impact of day count.

Net interest margin benefited from lower deposit rates as our mix continued to shift to lower cost deposits. That was largely offset by the drag created by low yielding excess liquidity. Outside of those factors, the six basis point decline was largely attributable to increased premium amortization resulting mainly from the impact of GSE repurchases, as well as day count and a reduction in purchase accounting accretion.

With that context, and turning to slide six, let's go through the balance sheet in a little more detail. Average earning assets were down about $1 billion sequentially or 1%. Taxable investment securities balances declined about $800 million on a sequential basis. We deferred reinvestment of cash flows as we were concerned about the impact of termination of the Feds mortgage-backed securities purchase program. We continue to be very careful about managing the interest rate risk profile of our balance sheet. Although maintaining a neutral position in this environment costs us in current period earnings, we believe that posture will serve us better with respect to long-term earnings quality and growth. Average total loan balances were down 2% sequentially. While we would like to see better net results, we are pleased with our core production. We've always been a seeing eye focused lender. We're growing share and seeing good business opportunities there.

We're also growing our customer base. And while paydowns and deleveraging continue, we know it will turn around and we'll benefit from better activity and growth.

Average commercial loans were down 2% from last quarter driven primarily by a 15% sequential decline in commercial construction loans. Loan production was up significantly from the first quarter but paydowns also increased. Let me make a few comments on specific components of the commercial portfolio. We suspended new homebuilder and nonowner occupied loans several years ago and we expect runoff in those portfolios to continue. Commercial mortgage balances were flat sequentially. And we would expect those balances to drift down in the near term as well.

We also have lower CRE concentrations than most of our peers so we do have some capacity. However, appetite there will remain limited in the near term as we wait for the absorption of overcapacity to take place.

C & I loans were flat sequentially where we have seen declines in the previous five quarters. So that was a positive development. Period and line utilization was 32.1% this quarter compared with 32.6% and 32.7% in the previous two quarters. So, still fairly stable there. But that is from about 39% a year ago and from normal levels in the low to mid-40s. Average consumer loans decreased 2% from the first quarter.

Auto loan balances were flat sequentially but we would expect some modest growth in the auto loan portfolio in the third quarter. Credit card balances were down 4% from the first quarter and flat year over year. Home equity loans were down 2% sequentially and 4% from a year ago. Residential mortgages were down 2% from the first quarter and 10% from last year as we continue to sell most of our new production. Deliveries during the quarter were $3.1 billion.

Looking forward, it is somewhat difficult to predict borrower behavior in this environment. Our loan pipelines remain intact in our building, indicating there is interest in investment but borrowers are watching and waiting and are willing to defer borrowing decisions. Continued economic growth will require further capital investments and working capital financing. So to seek continued economic growth, we believe the companies will need to start borrowing.

We're seeing reasonable stability in loan balances which is better than the industry trend. C & I loans and line utilization were relatively flat during the quarter as were most consumer loan categories.

Looking ahead, we would expect C & I loans to be fairly stable in the third quarter and auto loan balances to be up slightly. Mortgage balances should be flat to down reflecting our sales strategy. Commercial real estate loans will continue to decline in the near term due to lack of demand and tighter lending standards.

For us, all of that adds up to an expectation that loans will be relatively flat next quarter or perhaps down modestly. Our best guess currently is that the economy has enough momentum to start to generate some additional borrowing in the near term. We have been close enough to flat that it wouldn't take much in the way of increased originations or lower repayments to tip that balance.

Moving on to deposits, average core deposits were up 1% on a sequential basis and up 12% year over year. Consumer CDs included in core deposits declined 6% sequentially and 22% year over year. Excluding those consumer CDs, transaction deposits were up 2% sequentially and 21% year over year. The main driver there was demand deposits which were up 3% from last quarter and 16% from a year ago.

Retail transaction deposits increased 5% sequentially and 12% year over year. We continue to have great success with our relationship savings product which is now attracted over $6 billion of balances since inception. In total, net new account production increased 22% sequentially and 56% on a year-over-year basis.

Total commercial transaction deposits were down 2% from last quarter and up 41% from a year ago. Excluding public funds balances, average commercial transaction deposits increased 8% sequentially and 46% from a year ago reflecting excess liquidity among commercial customers and good account production. Average public funds balances were down about $1.8 billion sequentially as we adjusted our pricing due to our excess liquidity position. We expect public funds balances to continue to run down as we manage our nonrelationship account pricing given our liquidity in the current environment for investing that liquidity. As a result, we would expect deposit balances to be lower in the third quarter.

Overall, the number of commercial deposit accounts is up and average balances per account are up as well. With that background, our outlook for third quarter NII is for growth of $10 million to $20 million to the $900 million range. We would expect that to be driven by loan balances that are stable to modestly lower. CD runoff continued deposit pricing discipline and lower premium amortization expense.

Turning to NIM, we expect NIM to increase in the third quarter but how much depends on the composition of our balance sheet. As you know, NIMs in the industry right now are highly sensitive to the levels of liquidity. We currently expect our third quarter NIM to increase 10 to 15 basis points or so to around 370 basis points plus or minus a few basis points. The increase is expected to be driven by lower excess liquidity, primarily from public funds deposit runoff which is grossing up the balance sheet without really producing any NII. Those drivers should be in place in the fourth quarter as well although NIM improvement likely won't be as significant as in the third quarter.

Moving on to fees, as outlined on slide seven. Second quarter noninterest income was $620 million, down $7 million from last quarter but better than the $25 million decline we expected. Mortgage banking net revenue was down $38 million, a little more on this our outlook. The key driver of the sequential decline was a net positive MSR evaluation adjustment of $51 million last quarter. Fee income this quarter also benefited $10 million in gains on the FTPS warrants and puts. Last quarter, we had $11 million in losses on the warrants and the total return swap related to Visa litigation. If you exclude those items, fees were up $27 million and we're pleased with that.

Payment processing revenue was $84 million, up $11 million from last quarter which was driven by higher transaction volumes. That reflects some seasonality but was better than we expected off a pretty good first quarter result. We expect similar levels of processing revenue in the third quarter. Deposit service charges increased 5% sequentially. Commercial deposit fees were relatively flat while consumer deposit fees increased $8 million from the first quarter. As you know, REGE went into effect for all new accounts in July and will go into effect for existing accounts in August. So far we're seeing opt in rates in line with our expectations and we still feel that is $20 million quarterly run rate effect is a good estimate. We expect third quarter deposit fees to be down about $5 million with $10 million to $15 million in decline in electronic overdraft charges partially being offset by growth and commercial and other consumer account service fees. Then we would expect another $5 million to $10 million drop in electronic overdraft charges in the fourth quarter.

We've been proactive in developing deposit products that generate alternative revenue streams. We've eliminated free checking unless a customer has a sizable direct deposit or a minimum account balance and revenue from alternative products will also mitigate these changes over time.

Investment advisory revenue decreased 4% sequentially but increased 10% on a year over year basis. The sequential decline is attributable to a seasonal benefit from tax preparation fees that occurs in the first quarter and the effect of lower asset values during the second quarter. We're expecting modest investment advisory revenue growth in the third quarter.

Corporate banking revenue of $93 million was up $12 million or 14% from the first quarter. The sequential growth reflected strong syndication and lease-free marketing fees and higher FX and institutional sales revenue partially offset by declines in business lending fees and interest rate derivatives revenue. We're not likely to match that level of revenue in the third quarter which is typically seasonally soft. And we expect corporate banking revenue to be lower by about $5 million or so in the third quarter.

Mortgage banking revenue as I mentioned was down $38 million. The MSR hedge and evaluation adjustments produced revenue of $51 million in the first quarter compared to a $4 million negative adjustment this quarter. Gains on sales were $89 million this quarter versus $70 million last quarter due to the effect of rates on refinancing activity as well as the expiration of tax credits on new home purchases. We expect third quarter mortgage revenue to be strong as well given the deliveries of second quarter applications and the current rate environment up perhaps $10 million to $15 million.

Within other income, credit related costs recorded in fee income were $14 million in the second quarter up from $1 million in the first. That was better than we expected in April primarily due to lower negative evaluation adjustments on loan sell for sale and lower losses on sales of OREO properties. We currently expect higher credit-related costs to impact noninterest income in the third quarter with our current estimate being about $25 million. We recorded equity income of $6 million from our interest in the processing JV in the quarter compared with $5 million last quarter. Revenue from the transition services agreement was $13 million during the quarter. The same level as last quarter. And those offset similar amounts of expenses. As I mentioned earlier, we had $10 million in positive marks on FTPS warrants and puts. Last quarter, those marks were a negative $2 million and we also had a mark in the first quarter on the Visa total return swap which was a negative $9 million. We're projecting a repeat of this quarter's benefit in the third quarter.

Overall, we currently expect fee income in the third quarter to be down about $20 million to $25 million somewhere around the $600 million range or just below it. That includes the initial Reg E impact I talked about earlier.

Turning now to expenses on slide eight. Noninterest expense of $935 million was down $21 million or 2% sequentially. In the second quarter, credit-related costs within operating expense declined to $55 million from $91 million last quarter. The improvement came from lower mortgage repurchase expense which was $18 million down from $39 million in the first quarter. We currently expect credit-related operating expenses to be relatively flat in the third quarter with about $20 million or so in mortgage repurchase expense. In total, we expect third quarter expenses to be relatively stable compared with the $935 million we just reported.

A quick recap of PPNR, preprovision net revenue was $567 million in the second quarter consistent with the $568 million reported last quarter. Our current expectation is that third quarter PPNR will be down slightly but remain in the $560 million range. You'll see in the release that the effective tax rate this quarter was about 20%. That's a bit higher than we expected last quarter. The upward adjustment was really just driven by higher earnings than we had previously expected both for the quarter and for the remainder of the year.

Moving on to capital on slide nine. Our capital levels remain very strong. Tangible common equity was 6.55% and 18 basis point improvement from the end of the first quarter. That ratio, the way we calculate it, excludes unrealized securities gains which totaled about $440 million. TCE was 6.9% including those unrealized gains.

Tier one common increased about 25 basis points to 7.22% and the tier one ratio increased 35 basis points to 13.75% while a total capital ratio increased 56 basis points to 18.11%. We would expect those ratios to continue to grow with on-going profitability.

Regarding TARP, I don't really have any updates on TARP repayment. Obviously our results are progressing more favorably than we expected and we're building capital. We'll have discussions with the regulators as we move forward. Our aim is a result that is anchored to an appropriate level and composition of capital. And it makes sense for us and our shareholders as well as the regulators. We said that we thought a resolution in the second half of 2010 seemed reasonable and that remains the case.

That said, we are willing to be patient. We believe that continued clarity on our results through continued positive trends and on future capital requirements through Bossel 3 and other regulatory developments will provide us and the regulators with a better sense of what is an appropriate repayment plan.

Finally, turning to slide ten, the President just signed the financial reform legislation yesterday and we've outlined some of the key provisions here. Obviously, this is not an exhaustive list of all of the elements of the reform bill or their potential impacts, especially given that most of the regulations to implement this law are yet to be written but I do want to highlight two elements in my remarks here. One of the more significant potential issues, at least from a direct financial standpoint, is the debit interchange piece. Under the legislation, the Fed is to study the cost of providing debit services and then set rates that are reasonable and proportional to those costs. Obviously, we don't know and no one knows what those costs will include or what reasonable and proportional will mean.

We obviously expect rates to come down. That's what the legislation intends. But we don't have any evidence of that, for example, they will set rates where banks actually lose money providing debit card services. That's what pricing at marginal costs would do and that certainly wouldn't seem reasonable and proportional. No one would benefit from that kind of disruption in the debit services that that would cause. Not us, not consumers, not even major retailers. The Feds study will highlight the pros and cons of the legislation which will be used in determining the appropriate interchange rates. Until all of that takes place, we don't really know what we're dealing with.

We've disclosed our interchange revenue and also the part that's related to debit which is shown on slide ten. Every ten basis points reduction in interchange rates would cost us about $15 million annually. And now that's before any steps that we would take in mitigation and we do believe that much of this could be mitigated over time as we and our customers adapt to whatever rules are written. Another element of the bill is the Collins Amendment which calls for the phasing out of trust securities as a qualifying source of tier one capital. We currently have about 280 basis points of trust prefers within our tier one capital structure. Excluding TARP, total noncommon tier one capital at Fifth Third is about 320 basis points. Given the evolution in capital standards and expectations for higher common capital levels, that may be more than we need long-term in terms of noncommon tier one. We'll adjust our capital structure over time as the new operating rules become clearer.

We're comfortable with our ability to manage this change in a way that we don't really expect to be that costly or disruptive. So that in the end, we have a mix of common and noncommon capital that is appropriate under the new standards. We do have a healthy capital position and a fairly long phase-in period for the trust preferred rules.

Turning now to slide 11, as I noted earlier, a lot of financial reform is aimed at reducing or eliminating activities that aren't related to traditional banking. Activities that are inherently volatile and create systemic interconnections across financial companies and across borders. Fifth Third has a traditional banking model that includes very few of those activities or very small scales. To cite one fact that I think is pretty telling, our daily bar or value at risk is less than $500,000. That's because we just don't conduct the kinds of trading activities that are targeted by the legislation.

There are any number of more qualitative aspects of the bill and I can't begin to forecast how all of those will play out. The new Consumer Financial Protection Agency and the way the new preemption rules will work are both major unknowns at this point. That being said, we've never originated so-called exotic consumer loans like option arms or subprime mortgages. We aim to provide good products and services that are relatively straightforward and at a fair price. Which is what the legislation is supposed to ensure. As we develop more clarity on all of the issues, we will continue to share our thoughts with you. That wraps up my remarks. I will turn it over to Mary to discuss credit trends. Mary?

Thanks, Dan. Overall, credit results continue to show broad-based improvement. I'll get started with chargeoffs on slide 12. Total net chargeoffs of $434 million decreased $148 million sequentially with commercial chargeoffs accounting for $117 million of the improvements. Losses in Florida were significantly lower than in the first quarter. In losses in Michigan continue to show stabilization with chargeoffs relatively flat versus first quarter and fourth quarter levels. Commercial net chargeoffs for $225 million down $117 million. Florida and Michigan accounted for $42 million of the decline. C & I net losses this quarter totaled $104 million, down $57 million with a sequential decline attributable to a broad base of industry segments. C & I losses in Michigan and Florida fell $20 million sequentially.

Commercial mortgage and commercial construction losses both showed significant improvement this quarter which reflects several factors. First, the impact of the suspension of nonowner occupied commercial real estate and homebuilder lending two or three years ago. Second, we've burned through a lot of our more significant problems by dealing with problems problem credits aggressively during the cycle. Finally, loss severities in general have also improved with greater economic stability and more liquid markets. Commercial mortgage net chargeoffs of $78 million decreased $21 million from last quarter. Commercial construction net chargeoffs were $43 million down $35 million. I note that our commercial construction balances are down over 50% since this time two years ago. As we've reduced balances in the risks in that portfolio.

Across both commercial real estate portfolios, Michigan and Florida represented $20 million of the improvement but still produced 52% of losses. Total homebuilder developer losses were $48 million down $33 million from last quarter. You'll recall that we suspended homebuilder originations over two years ago, have already recorded significant chargeoffs against that portfolio and have worked to reduce our exposure. Portfolio balances declined $117 million sequentially to $1.2 billion which compares with a peak balance of $3.3 billion back in mid 2008. We continue to expect losses from this portfolio to generally decline over time.

Given the fairly dramatic decrease in commercial chargeoffs seen over the past three quarters, we currently expect commercial net chargeoffs to be flat to up modestly, given our out performance this quarter and a fairly stable outlook for trends. As you know, the results of the exam are also provided to banks in the third quarter. Based on our own exam, and the more stable credit environment during industry exams, we don't have any reason to expect any negative surprises and haven't assumed any in our outlook. Our outlook does include our own assessment of all portfolio credits including (indiscernible) by other banks.

Turning to the consumer portfolio, net chargeoffs of $209 million were down $31 million or 13% compared with the prior quarter. Net chargeoffs in the residential mortgage portfolio were $85 million, a $3 million sequential decline. This reflected improving early stage delinquencies seen late last year and through this year. Home equity losses decreased $12 million sequentially to $61 million which included $24 million of losses in the brokered portfolio. The net chargeoff rate on brokered home equity was about 5.3% annualized which is down from earlier peaks but is still almost four times the loss rate on our branch originated books. The brokered equity portfolio was $1.8 billion, down from about $3.5 billion a couple of years ago and continues to run off.

We saw improvement in both auto and credit card chargeoffs as well, with auto losses falling $11 million or 36% sequentially to $20 million. This is largely due to better values received at auction, underwriting improvements and seasonality. Credit card losses decreased $2 million or 5% sequentially to $42 million. We expect consumer losses to trend down slightly in the third quarter.

Now, moving to NPAs on slide 13. NPAs including health for sale totaled $3.1 billion at quarter end down $236 million or 7% from the first quarter. Portfolio NPAs excluding held for sale totaled $3 billion down $160 million or 5%. Nonperforming loans were down over $200 million sequentially over a 7% decline while OREO was up about $48 million largely commercial OREO. Overall, Florida and Michigan remain our most challenged geographies from an NPA standpoint and accounted for 46% of NPAs in the portfolio although NPAs in those two states were down $51 million sequentially.

Portfolio commercial NPAs were $2.3 billion and declined $140 million from the first quarter which was frankly better than we were expecting. Improvement in the commercial construction portfolio was the biggest driver with NPAs down $87 million or 15%. This follows the drop last quarter of $138 million. Lower NPAs in Florida and Michigan accounted for almost half the decline. Commercial mortgage NPAs were down $47 million with improvement broad-based across the entire footprint.

C & INPAs were stable up $4 million from the first quarter. Across the commercial portfolios, residential builder and developer NPAs of $431 million were down $90 million sequentially and represented about 19% of total commercial NPAs. Within NPAs, commercial TDRs on non-accrual status increased to $48 million from $39 million last quarter. We expect to continue to selectively restructure commercial loans where it makes good economic sense for the bank.

We currently expect commercial NPAs to remain relatively stable in the third quarter. We saw pretty significant improvement in delinquencies overall during the quarter which I'll talk about in a minute. And so we're pleased with overall trends.

On the consumer side, NPAs totaled $695 million at the end of the quarter, a decrease of $20 million or 3% from the first quarter. Nonaccrual consumer TDRs declined $25 million with a remainder of the consumer NPA portfolio increasing $5 million. Residential mortgage NPAs increased $28 million during the quarter to $549 million with TDRs up $11 million sequentially. That did include the effect of a change in our recognition of mortgage NPAs from after 150 days to 150 days which brought a month NPAs into the second quarter. This addresses a monthly day count issue that you'll recall last year caused a swing or increase in NPAs from the second to third quarter.

Home equity NPAs totaled $65 million at the end of the second quarter down $5 million in first quarter levels. Auto NPAs were down $5 million and credit card NPAs were down $37 million with the improvement in the card portfolio attributable to TDRs return to performing status. We expect third quarter consumer NPAs to be stable with the second quarter. Consumer NPA trends should continue to reflect the seasoning of more recent TDRs as well as the favorable delinquency and migration trends we've been seeing.

Turning to slide 14, we provide some data on our consumer trouble debt restructuring. We have $1.8 billion of TDRs on the books as of June 30 of which $1.6 billion were accruing loans and $246 million were nonaccrual. Of the $1.6 billion of accruing TDRs, $1.4 billion were current. And if current loans over $1 billion were current and were restructured six months ago or more. Based on that experience in our redefault rates overall, we expect the vast majority of that $1.4 billion pool to stay current.

In total, about a quarter of the loans we've restructured to date have redefaulted. On a lag basis, redefault rates are just under 30% on modified loans which is better than industry data. We've updated our vintage default rate curves on the slides so that you can see the tendencies toward default by vintage. More recent vintages have shown lower redefault rates than loans we restructured earlier in the cycle and also constitute a larger proportion of the aggregate TDR pool. Overall, we continue to be pleased with the results of our loss mitigation efforts and I think the information we've provided that they're working and improving.

Let me stop for a minute and point you to slide 15 which is the roll forward of our nonperforming loans that we've included in the material we released this morning. Our commercial nonperforming loan inflows were the lowest we've seen in quite some time at $310 million. Compared with $405 million last quarter and a quarterly range of about $550 million to $830 million in 2009. Consumer inflows increased to $200 million although we would expect that to be down in the third quarter. The increase this quarter included the acceleration of mortgage NPA recognition I mentioned earlier. Total inflows, commercial and consumer were $515 million down from $542 million last quarter and the lowest we've seen since 2008. To wrap up the NPA discussion, we've been proactive in addressing problem loans and writing them down to realistic and realizable values. Total NPAs, commercial and consumer are being carried at approximately 56% of their original face value through the process of taking chargeoffs, marks and specific reserves recorded through the second quarter. We believe that's appropriate and I think our recent chargeoff trends continue to be indicative of lower severities on new NPAs and reasonable caring values overall.

Moving to slide 16 which outlines delinquency trends. Commercial loans, 90 days past due were $142 million up $22 million from the first quarter. Last quarter's level was down $79 million to the lowest level we've seen in several years. And so we're pleased with the continuing low level of 90 day delinquencies. Commercial loans 30 to 89 days past due were $277 million and decreased by $124 million from the already low level experienced in the first quarter.

As we discussed last quarter, consumer delinquent is I trends overall have continued to improve. 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 saleability strategy. These factors are having an increasing impact on the performance of the portfolio. Consumer loans over 90 days past due were $255 million down $61 million. Consumer delinquencies 30 to 89 days past due decreased sequentially by 13% or $62 million to $416 million. Total delinquencies this quarter were down 17% from last quarter and we're at the lowest level since mid 2007. We believe we're seeing signs of stabilization and don't currently expect a lot of movement next quarter although delinquencies can move around a bit given seasonality and timing issues.

Now, for a couple of comments on provision and the allowance which is outlined on slide 17 . Provision expense for the quarter was $325 million and reflect the reduction to the allowance for the loan in loop losses of $109 million. Our allowance coverage ratios remain strong and actually increased sequentially despite the reduction in the dollar reserves. Coverage of nonperforming loans improved 146% and coverage of second quarter annualized net chargeoffs increased 212%.

We've also updated our stress test models on slide 18. The macro forecast are derived from the Moodyseconomy.com base pace and recession case scenarios. As you see, under the updated base case scenario, 2010 losses would be expected to come in below $2 billion significantly below our 2009 losses of $2.6 billion. Losses under the recession case would not only be much better than the S cap adverse scenario results but also better than our baseline S cap submission for 2010. While current levels of losses are elevated, they're much lower than a year ago and our expectations for losses continue to be materially better than we were modeling coming into the year. That wraps up my comments. I'll turn it back over to Kevin for closing remarks before we open the call up for Q&A.

Thanks, Mary. Just to wrap up, we've accomplished a lot and it really shows in this quarter's results. PPNR was consistent with strong first quarter results. Credit trends and chargeoffs again improved significantly. We wouldn't be surprised if our chargeoff and NPA ratios move below those of the top 15 bank medium in this quarter. We had a modest reserve release but we showed earnings growth excluding it. We moved solidly into profit territory. It may be uncertainties on the horizon but we're performing relatively well on this side of it. So, with that, operator, why don't we open it up for questions. Ginger? Operator?

(Operator Instructions) Your first question is from the line of Ken Astin.

Good morning. I just wanted to ask you two quick things. First of all, on the REGE impact, can you in any way size the total amount of overdraft revenues that you currently have and a run rate in the second quarter?

Ken, this is Jeff. We haven't disclosed that previously so no. We can't do that.

Ok. And then on the question of NPAs being relatively stable, again, is it more of just a mixed question of why, given the improvements in some of the forward-looking trends of why you won't see a near-term continued improvement on the NPA side?

Yes. We've said in our guidance that we expect them to be relatively stable and to your point, there is a couple of factors that really drive it. One is there is a mix shift overall so a lower effect coming from commercial real estate than what we've experienced earlier in the cycle. In addition, loss severities will make a difference in terms of our overall chargeoff performance as we go further through the cycle. So, in terms of our overall outlook, obviously NPAs and chargeoffs are part of that. There are a number of factors driving that relative to improvement in the cycle, mix shift as well as lower loss severities.

Ok. My third quick one is just contrary to a lot of other companies that reported mortgage banking was actually down this quarter for you guys versus up and a lot of others. Can you just walk us through some of the moving parts there and what were the incremental pressures if any for you guys? Thanks.

Yes, I think the overriding factor with respect to overall mortgage results was the gain, if you will, that we recorded relative to MSR evaluation and hedging results in the first quarter. In the first quarter, we had $51 million in net gains on valuation and hedging. We talked at the time about the fact that that was probably not something that we would replicate in the second quarter and therefore, we guided to fairly significant decrease in mortgage banking revenue overall. I think we talked about something in the $30 million range. It came in at $38. I think our hedging results for the second quarter are more in line with what one would normally expect. We had about $100 million in valuation, negative valuation adjustments on MSRs, our hedges operated the way one would think they would and offset virtually all of that. We had about a $4 million net MSR hedging valuation item in the fourth quarter. So, I think that was the key driver. The only thing I would point out is that core mortgage banking activity in terms of gains on sales, were actually up during the quarter which I think is probably more consistent with what you're referring to in terms of what other's performance has been.

Got you. Alright. Thanks a lot.

And your next question is from the line of Todd Hagerman from Collins Stewart.

Good morning, everybody. Just a couple of quick questions. Just first, kind of a follow-up on the REGE question. Dan, I'm just wondering, I know you guys have been diligently working on a number of new products and so forth in anticipation of some of these changes. I just noticed that again, net account growth was pretty good again this quarter. One thing that struck me was with the guidance that you've given, the $20 million kind of run rate, if you will, a number of companies narrowed their estimate in terms of the potential impact. I'm wondering if you can give a little bit more color in terms of what some of the assumptions might be and kind of a little bit more detail in terms of the success you've had in terms of the new products and so forth.

Well, first of all, relative to the impact of REGE and talking about assumptions and so forth, as Jeff indicated earlier, we haven't disclosed detail about overdraft charges nor our assumptions in terms of the specifics of assumptions relative to our REGE impact. I guess I would point out that we have commented today that our prior estimate of $20 million per quarter, our results are tracking to be in line with the $20 million per quarter impact that we previously discussed. Relative to development of other sources of revenue and mitigation impacts, we have had success with a lot of our new deposit product offerings. We discussed some of those in the call, in the script today. On an overall basis, I think it is useful to look at overall deposit service charges, trends and expectations. For instance, in the third quarter, we talked about the impact of electronic overdrafts being down $10 million to $15 million. Yet we expect deposit service charges on an overall basis to be down only $5 million. I think in those kinds of expectations, you can begin to see the impact of some of the things we've done in terms of the introduction of new products and alternative revenue streams.

That's helpful. Then just secondly, if I could just add, Kevin, maybe a little bit more perspective in terms of kind of the Midwest economy. One thing I've noticed is that the manufacturing data regionally has been encouraging over the last couple of months. And I'm just wondering if you could give a little bit more detail. As you tie that together with some of the deposit of comments whether that's on the stabilization rates on the CNI side, holding steady or the dramatic drop in kind of inflows on the CNI side. Just trying to get a better perspective of what kind of the underlying activity you're seeing particularly as it relates to the traditional commercial customers and how that may be a function of what's happening there in the Midwest.

Yes, Todd, I think, from our perspective and we tried to capture relative to tonality which is a difficult thing, as you might imagine in this environment. But we still are seeing particularly in the segment that you talked about which was the manufacturing segment has been holding up very, very strong. Our manufacturers feel good about how they're positioned and are seeing some slight growth in terms of their wares. And so they are well positioned. Their balance sheets are strong but we did see a pause, particularly more toward the middle of the quarter as things got a little more elevated relative to Europe and credit issues here. So, people really have stepped back from that standpoint but they still are in very sound position. We think that when there is a bit of confidence, that bleeds in, that they're going to be well-positioned to be able to take advantage of that. We'll be there to help them.

From our standpoint, while we are seeing still the effects of some of that deleveraging going on, we think we're expanding our core base. We're getting some good clients on board. Our core production has been good. I think it will show up in a couple of different ways that I think it will begin to contribute to us in terms of overall growth going forward.

So, we feel well positioned from that standpoint as does the market place. So, that's kind of the trends we're seeing. That's kind of the feelings that we're getting as we talk to our clients and prospects. And we try to put that in. But it just makes for a very difficult time to predict or to talk about how soon we're going to see some of the benefit to us.

That's helpful. Thank you.

And your next question is from the line of Paul Miller from FBR Capital.

Can you talk a little bit about your going forward, we got low rates. We've got low treasury rates, on why how you're viewing balance sheet growth and the trade-off between that and your securities portfolio? I know a lot of people are repositioning their balance sheets and selling their securities. How do you view what's going on in the world and how to deal with it going forward on balance sheets. On your balance sheets?

Yes, as we mentioned earlier we have -- we did during the second quarter, defer some of the reinvestment of cash flows off the portfolio and that was largely because of some of the things you just alluded to in terms of some of the risks that are in this environment. As we look at it, I think we focus primarily on making sure that we are appropriately managing our interest rate risk. We've talked in the past about maintaining an overall approximately neutral position from an interest rate risk perspective. That continues to be our objective and I think that continues to be how we're positioned.

That likely costs us somewhat in the short run in terms of current earnings but I think it positions us better for the future. And I think while we would expect that we would resume investment of portfolio cash flows in the third quarter and may well even invest some of the deferred cash flow from earlier quarters, that will be done with the overall objective in mind of maintaining a neutral position from an interest rate risk perspective.

And the other issue is your credit quality. I think a lot of people seeing credit quality stabilize here and a lot of people are guiding us including you guys, to a more stable decline in improvement in credit quality going forward. We're seeing some bad macro data which is spooking some investors out there. And what type of, where would the economy really have to hiccup. In other words, the unemployment rate would really have to jump to 11%, 12% to start seeing deterioration in credit quality. I don't think it's going there. I don't think investors are looking at what would have to happen for credit quality to start to take another dive.

I think a couple of factors are going to enter in there for that question. One is we've been very active in working through the portfolio for a long time now. We were aggressive on this already starting a number of years ago. Which included, at that point, a very forward-looking view on what with the economic trends play out to be in the next couple of years and what actions could we take in advance of that. And that kind of stress testing approach that we already started a couple of years ago, we continue to expand upon.

In fact, in today's deck, we have another page which shows you the impacts of some of our more recent stress testing. It is something that is a continual part of our process so that we can take into account not only unemployment trends but also other trends relative to property prices as well as GDP. So, I think your question is a good one in terms of unemployment and what kind of impact could that is. Certainly, that is a possibility but we feel that we're able to manage through that in a pretty good way because of all of this activities and strategies and approaches that we put in place. Starting a couple of years ago and how we continue to work through the issues in our relative loan book.

Paul, the thing that we feel right now again, it is just by visiting the market so it's not out of one of the surveys or out of specific data information but we would tend to agree with you and don't see a huge risk for a severe back fall, if you will. Or double dip, whatever you want to call it. So, we're seeing kind of stable and steady as she goes out there without a major change from that standpoint. Just a lot of cautiousness relative to the current environment. And we think that's more of an impact today than what's actually occurring in the market place.

Ok. Thanks a lot, gentlemen.

Thanks, Paul.

And your next question is from the line of Nancy Bush from NAB Research LLC.

Kevin, I have a question for you. Once again, related to the Midwest. And I take it that things are improving there. But one of the characteristics of the Midwest in previous has been when things start to improve, the deposit pricing and the credit pricing get more competitive there than anywhere else in the nation. Can you speak to if you're seeing that kind of pricing competition yet on either deposits or loans and what your expectations are as things continue to improve?

Yes, Nancy, you're exactly right. We have been anticipating that. But we have not actually seen that.

Now, I would bifurcate the comments in two ways. We've not seen it at all relative to deposit pricing. As you can imagine, banks are fairly flush and light and so we're not seeing a lot of competition or paying up from that standpoint.

On the asset side, by in large, still good discipline we see out there and still good asset class spreads and yields across the board. Obviously though we are seeing now some of the better credits shopping harder and we would expect a little bit more competition from that standpoint. And so we're just beginning to see that now, Nancy. It hasn't been prevalent. You can see in our yields, even on a sequential basis, we haven't seen major change, only down a point. So, we're watching that but so far, so good. But I think, I don't want to be naive as we kind of continue on in the improvement and the progress in terms of the economic recovery that we fully expect to go toe to toe in terms of the better client and the better customers.

I have one follow-up financial question. US Bancorp a couple of days ago put forth some numbers for increased FDIC expense based on the new base and the new pricing. Do you guys have any kind of similar numbers?

Nancy, I think from an assessment based standpoint, I think I can speak to that. The increase in our assessment base would be from about $80 billion to roughly $97 billion which is a little over a 20% increase. So if you make an assumption of no adjustment in the assessment rates, that would imply about a 20% increase in FDIC costs. I think it remains to be seen at what level those rates will be established. But I think that probably gives you the information you need.

I would add this is Jeff, I would add I think USB actually said that that would be the assessment if the assessment rate stayed the same. There's no information in the bill that suggests that that's what they'll do and obviously if they do leave the assessment rate alone that may lead to an increase revenue to FDIC. We don't know whether that's what they're trying to do either.

Great. Thank you very much.

And your next question is from the line of Brian Foran from Goldman Sachs.

Hi, good morning. Good morning. On debit interchange, I know it is too early to tell and you gave a lot of help with with dimensions. But just to follow up to make sure I'm thinking about it right, first, in the last 12 months, debit interchange data, should we use that as a base or do we have to account for some kind of underlying growth rate, maybe 10% or so. And then second, I know you're not giving a point estimate and you know with good reason, there's no regulation yet. But when you kind of think about the B of A guidance that was put out there and compare that to your comments, is it fair to interpret that maybe you're a little bit more optimistic. It won't come down to that kind of extent. And then third, how should we think about your signature versus pin mix. Can you remind me why your overweight signature relative to the industry and is that a risk factor given higher rates?

Yes. Brian, on an overall basis, as you indicated, you know, hopefully we have provided information that is useful. Relative to what some others have discussed as we look at the rules and try to anticipate what the future might hold certainly, we're not of the belief that we're going to lose 80%, 90%, 100% of our debit interchange revenue. On the other hand, we do anticipate that there will be significant impact of this.

I think it is just too early to tell what that impact will be because we don't know what will be considered costs, what an appropriate return over and above those costs will be baked into the rates that are set ultimately. And I think there's going to be lots of opportunity to mitigate whatever that impact is. Once we know how the rules are set and what the kind of what the challenge that's laid out in front of us.

So, on an overall basis, we would anticipate that it will be far less significant than what some others may have been estimating. So, I think there may have been a second part to your question. That I didn't answer.

The only other thing, Brian, just to add to your questions, you talked about sig signature versus pin, there's really nothing. Maybe geography is really a dominant factor from that perspective but there's nothing to read into our mix from that standpoint.

Thanks and then.

The other thing I think you asked was last 12 months. Last 12 months was about $185 million give or take. In terms of growth. I think taken our most recent quarter and annualizing it is probably closer to $200 million rather than the $185 million. You're right in that range.

As I think about offsets in the mitigation, again, it will be early but should we think more about fees and I'm talking REG and debit together since the offsets are going to be so overlapping. I mean is it fees on checking accounts? Are we headed for a branch rationalization cycle? You know, is it annual fees on the cards? Is it migrating people at different products or is it just we kind of have to test everything. I guess ultimately what I'm asking is are there opportunities to offset this stuff on the revenue side by charging consumers in other ways or is the consumer so ingrained with the free products that you have to really go through a cost rationalization exercise if we're going to mitigate it.

Brian, again, it is really early on this but our orientation, I think would be one that I think there's going to be a lot of different levers to pull relative to this particular issue and that, in fact, the industry and ourselves specifically have already begun changing out kind of the old orientation of free to value-added services. We've talked a lot about that since what we did and began literally about this time last year and we'll just continue on that. It has been successful for us, thus far. Our customers, prospects and new product production has been outstanding, continues to be. So, I think we've kind of as we will, going forward, continue to find the right combination of services, value creation, additional product offerings, as well as some pricing opportunities that all will be contributory to that mitigation strategy as we go forward. So, I think we've demonstrated to ourselves at least that there are value-added opportunities that we can migrate from where we've been to where we're going. And that may be what you're reading into our optimism about how we viewed the challenges ahead of us.

This is Jeff. I guess I would just add that debit is the most efficient form of payment there is. Credit cards, involve credit risks and floats so that has to be priced into interchange. Checks involve float and credit risk to get those cleared. And debit, we guarantee payment to merchants and debit is cheaper than credit. And that's all going to be recognized when studies are done and if we end up shifting toward credit cards because credit risks are being taken, that's, we'll adapt to all of that.

That's all very helpful. Thank you.

And your next question comes from the line of Betsy Graseck from Morgan Stanley.

Hi, thanks. Couple of questions. One follow-up. Does it matter the percentage to which your debit is signature versus pin?

In the legislation, it doesn't. There's no reference to signature versus pin.

Because you're more signature, is that right?

Right. That's correct.

Ok. And then separately on loan sales, could you just give us a sense as to how you feel your portfolio is set up for loan sales and I'm thinking about distressed loan sales. I know there was a little bit of what you did in the quarter and I'm wondering if that's kind of a part of your go forward strategy.

Yes. Betsy, we continue to evaluate loan sale opportunity and we do that on a very active basis. We did not engage in any large scale asset disposition transactions this quarter. What we did was more just along the ordinary course of business looking for more individual and selective opportunities that made economic sense for us. And we'll continue to evaluate all strategies as we continue forward in the cycle.

I will tell you that we do continue to see some signs of improved pricing and demand for properties which you would expect to see I think at this point in the cycle given some of the cash that's on the sidelines and some of the excess liquidity. So we'll continue to work through that strategy.

So no incremental rate of change expected in the coming quarters though?

Nothing anticipated at this point Betsy. Again, we're going to be opportunistic as it arrives.

You have a significant amount of reserves so more effectively, it might -- I'm wondering if you positioned like that in order to try to sell a little more aggressively.

We always like to tell you after we did it, Betsy.

I hear you. Thank you.

Thank you.

Thanks.

Ladies and gentlemen, thank you for participating in today's conference call. This does conclude today's conference call. You may now disconnect.