Fifth Third Bancorp (FITBP) 2004 Q2 法說會逐字稿

Good morning. My name is Christie and I will be your conference facilitator. At this time, I would like to welcome everyone to the second quarter 2004 Fifth Third conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period.

If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press star, then the number two on your telephone keypad.

I would now like to introduce Mr. Brad Adams, Investor Relations Officer of Fifth Third Bancorp. Please go ahead, sir.

Good morning. Thanks for joining us.

With me here today are George Schaefer, Neal Arnold, the executive Vice President and joining us also is Mark Graft, the Chief Financial Officer.

I would like to remind you that this conference call may contain certain forward-looking statements about Fifth Third Bancorp, pertaining to the financial condition, results of operations, plans and objectives of the Bancorp. These statements involve certain risks and uncertainties. There are a number of factors that could cause results to differ materially from historical performance and these statements.

Fifth Third undertakes no obligation to update these statements after the date of this call.

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

Good morning, everyone. Thanks for taking the time to listen in.

I have a few comments this morning on what I feel are the highlights of the quarter and then Mark will review some of the balance sheet items and Neal will take a few minutes to review some of the business line trends before we open it up for your questions.

From my perspective, the highlights for the quarter were number one loan growth. Overall loan growth was very strong with 1.8 billion of balance sheet consumer and middle market commercial loan growth in the second quarter, excluding residential mortgages.

Consumer lending remained very strong, with originations totaling $2 billion. That's our best quarter ever. But even more encouraging is the 1.3 billion in period end commercial loan growth. I think our loans are up some about $5 billion from last June period end.

Number two, the non-interest income trends continue to build on the momentum we saw in the first quarter. We've had strong sales results from Fifth Third processing and our investment advisors divisions are helping to overcome some of the falloff in the mortgage business, as you know we had a record year like most people did last year.

Number three, our expenses continue to be very well controlled. We've put a at lot of time and effort in improving our processes and watching the expenses. And on a core basis, expenses were essentially flat versus a year ago. You can read about some of the factors effecting those comparisons in the release.

And finally, number four, the credit quality. We were very pleased with the credit quality this quarter. Credit quality was improved, with losses declines by almost 19 million from last year. Consumer credit has continued to be very well behaved and we expect commercial losses to moderate around the current levels. Overall non-accruals should come down further as we continue to work through resolving some of these credits, but the absolute losses will probably bounce around the low 40 basis point level. Still, way below our historical average.

A couple of additional comments I would like to make before turning things over to Mark, deposit growth this quarter was somewhat mixed. Our demand deposits increased significantly, as we continue to welcome new commercial relationships, but some of the other captions were not as strong as we would like. We will be aggressively pursuing new customer relationships and looking to be much more competitive on the deposit side, and we just kicked off a new deposit campaign on June the 21st, that's really running way ahead of its goal. We hope to generate about 2 billion in new transaction account balances by the end of September.

Secondly, we closed on our Franklin financial acquisition during the quarter. Our newest affiliate down in Nashville will operate under a national bank charter and now has 11 branches and about 1.6 billion in assets and 840 million in total deposits in the Nashville market. We have an additional six branches to complete down there, that are on the drawing board. Those should be done by this time next year. So we're going continue to build out that franchise.

We've also been seeing some really pretty positive loan growth down in that Nashville market. And we're still focused on building market share within each of our existing markets by opening more checking accounts, doing a better job on account retention and improving our distribution.

We are continuing to invest in new banking centers. So far, we've opened a net of 40 offices this year. I think at the end of the year with had 952. As of the end of the quarter we were up to 992.

In addition, we've refurbished or relocated or built 16 other new offices out there, but have consolidated some in that process out there. So we continue to invest in our banking centers and probably in the next six months, we'll open another 50 or 60 net new offices. The returns thus far on our ennoble efforts, these new offices have been exceptionally strong and continue to be our most attractive growth opportunity.

With that, I'll turn it over to Mark to go over some of the balance sheet detail. Mark?

Thanks, George. Net interest income on a fully taxable equivalent basis was up 3% over the second quarter of last year and 7% over the prior quarter.

The linked quarter growth was in part impacted by a difficult comparable as a result of a leveraging strategy and significant deposit rate cuts in last year's quarter that resulted in the second quarter of last year being the high water mark for NII in 2003. Net interest margin was down 6 basis points from a seasonally high first quarter due to very strong loan growth that was primarily funded with wholesale borrowings.

In addition we pushed out the maturities of about 5 billion of those wholesale borrowings and reduced our period end fed funds from approximately 7 billion to just under $4 billion. We terminated approximately 1 billion in FHLB advances during the quarter resulting in an after tax charge of approximately $51 million. This action will enhance our performance going forward and allowed us the flexibility to address our shorter term funding mix, as I mentioned a moment ago.

Looking forward to the third quarter, we feel comfortable with our current forecast for improved NII growth and would guide you to a linked quarter number in the mid single digits. Current outlook for a measured pace of rate increases will be generally positive for our balance sheet, given the level of free funding we have. George spoke earlier about our deposit growth results for the quarter.

Insuring we drive sufficient deposit growth to fund the strong levels of earning asset growth we continue to generate, is clearly job one for us at this point. The early results for the third quarter campaign that George mentioned earlier, to date, point to some very good successes. We're running very well ahead of pace on that $2 billion campaign.

Couple of words about several of our lines of businesses. Our commercial business continued to show great momentum with DDA balances up over 20% linked quarter, deposit service fees up 21%, and commercial loans up over 11%, all of those excluding the impact of the Franklin acquisition. Consumer loans originations were up sharply at $2 billion this quarter compared to 1.5 billion last quarter. Those balances are absent the effective securtizations in both 2003 and 2004 increased over 21% year over year.

Retail deposit growth moderated, primarily in higher balance interest-bearing accounts and as both George and I mentioned previously, this is the key area of focus for us in the third quarter. Our mortgage business like the industry in general, continues to be impacted by difficult comparables to last year's refi boom.

That being said, the comparables in the second half of the year are much less difficult than the first two quarters. We remain very comfortable with our MSR hedging strategy, and are confidant that the conservative approach we've taken will allow us to participate in the upside in the market.

On the credit quality front, overall credit trends improved considerably from last quarter. Net charge offs as a percentage of average loans and leases were 43 basis points versus 54 basis points last quarter.

And we would expect charge-offs to moderate around this level, possibly slightly lower for the near term. On a sequential basis, NPA improved by over $25 million, dropping from 308 to 283 million and non accrual loans and leases improved by 17 million falling from 233 to $216 million. Commercial represented the bulk of the improvement.

However our consumer area also participated significantly. Overall, we feel very positive about the credit outlook at this point in time.

On that note, I'll let Neal talk about some the fee business trends.

Thanks, Mark. I'm going to highlight just the two areas that I've been working with.

First of all, on the Fifth Third processing side, we are up 5% year over year, but 25% on a comparable basis if you factor in the comparables of the U.S. B deal a year ago. Couple of items of color around the processing business, our merchant business year over year looked reasonably flat, but up a little over 25% if you look at the net of the sold contracts that we had in that category.

I would tell you based on revenue volumes coming out of our merchants, we see retail sales continuing to hold quite strong in the second quarter. Transaction volumes were up about the 26-28% level.

On the EFT side, we're up 14% year over year and really that's driven by a number of larger EFT wins that we've started to have in the last three quarters in this business. We signed up a number of larger financial institutions and those conversions by and large were completed in the second quarter and we'll see that show up in numbers strongly in the next couple of quarters.

As Mark pointed out, in the quarter we did close on the sale of auto footprint and iso small merchant contracts that we acquire indeed in a number of deals over the last couple of years. That did contribute 85 million in after tax gain that we were, that we put in in the quarter.

Turning to the investment advisors area, up 17% year over year. Three areas of strength there, our institutional asset management business is up 34% versus a year ago. That's really being driven by several victories we've had in winning new business in a variety of our large cap products, both on the large cap growth and the large cap value side. And we feel very positive about the momentum in that particular area. Brokerage contributed about 15% versus a year ago.

We continue to add brokers and we see continued momentum in that particular category,driven predominantly by mutual fund sales across the footprint.

Thirdly, on the private client and personal trust area, we're up 18% versus a year ago, driven by new products as well as additions to sales force, predominantly in our newer footprint markets. Indianapolis, Columbus, Chicago and Detroit, and we have seen very significant adds to staff in those areas and we think that momentum should continue as well.

With that, I'll turn it back to George or Mark.

I think we'll take your questions now if anyone has any.

At this time, I would lining to remind everyone in order to ask a question, please press star, then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from Gary Townsend, Friedman Billing.

Good morning fellows.

Good morning.

Good morning.

The deposit campaign that you described, you said that you would be more competitive, is that-- are you after certificates of deposits primarily?

No, these are, these are primarily transaction accounts, checking account demand deposits is the primary goal there. these are on the, our main campaign is really on the retail side with our almost thousand branches out there, the real leaders in this campaign.

And when you say you'll be more competitive, can you explain that a little bit more fully?

Yeah, I think Gary, what we did, is realized on some of the IBT products we may have shaved the rates a little bit too much in recent history and we're giving those lines of business a little bit more pricing power and flexibility going forward to attract those deposits.

Thanks very much.

Your next question comes from David George, AG Edwards.

Good morning, thanks for taking the question. I had a couple questions, it really revolves around the balance sheet.

It looks like if you look at, particularly the liability side, both on an average and period end basis, it looked like there was some movement on the borrowing side. I was wondering if you could touch on that for a moment as well as the margin outlook for the balance of 2004.

Yeah, absolutely. On the balance sheet side, we did push out about $5 billion give or take into some longer-term borrowings. The bulk of that came out of the overnight category really to position ourselves better for a rising rate environment was the primary thought process there in doing that.

In terms of the outlook for NII, going forward, I would say, again, I take you back to my mid single digit link quarter for the third quarter formed I would say looking beyond that, it's really dependent on our ability to grow deposits and the pace with which the fed moves.

That being said, we feel really good about a lot of the balance sheet repositioning actions we've taken and, again, as George and I both mentioned, the early, early take on that deposit campaign that has a $2 billion goal associated with it is that we're running well ahead of pace thus far in the quarter so we're very encouraged there as well.

Mark, would you say that you're closer to being neutral than higher rates relative to the end of the first quarter or there has been any fundamental change as it relates to your sensitivity towards higher rates.

I would say we feel better about it than the numbers at the end of the first quarter would have shown.

Okay. Thanks.

Your next question comes from Betsy Graseck, Morgan Stanley.

Two questions, just one. When you say you feel better about it, are you implying that you're a little bit more asset sensitive?

I think that's a reasonable interpretation.

Okay. And then on the new branches that you are in the process of putting out there, could you just give us a sense of your expectation for when you're going to see some acceleration in the top line growth coming from that?

Yeah. I think that with the new branches that we've been opening, we've been able to hit profitability in less than a year on those offices, and we're seeing really good deposit growth coming out of the offices that we opened.

For example, down in the Florida markets, some of our newer Chicago offices are showing particularly good deposit growth out there, and I think that's a gradual, you know, that's a gradual process. But generally that's been, that's been a lot better than historically we've done out there in terms of the, in terms of the growth. It's both on the deposit side and the loan side.

And pricing in the new branches, are you doing anything on the pricing side to draw people in?

We'll do occasionally, special promotions out there or have gifts.

We opened a new branch down in Nashville and we had Darryl Waltrip, the race car driver down there, there were 1,100 people at a branch opening there that created a lot of excitement. We opened a lot of new accounts there. We usually let the local people decide that.

Right.

The other thing, I think Betsy, that's going on here in terms of the deposit side, there is going be a lot of sign changes with our competitors in this market. As you know, the bank one signs here are going to be changing their names to New York bank.

Sure.

And the Providence has signs in our market are going to be changed out and the Charter One signs are changing to Citizens and even Union Planters over in Indianapolis is changing to Regions. That's several hundred of our competitors that are going to be changing their names and their signs.

I think that's going to have a positive impact on us also and we hope to be more competitive and a little bit more aggressive when those signs change. I think that shouldn't hurt our deposit growth.

Okay.

Betsy, I would also echo kind of to your point about the promos most, we do tend to use promos in new branch opens occasionally. I would tell you we track very closely the retention on those accounts. It's exceptionally, exceptionally good, and right now our new branches break even in about seven months.

Seven months, that's very fast. Just lastly on the float advances that you paid down, do you know what portion of those were put, were float advances that had putable options on them?

There were, there were a few of them did have putable options associated with them. They did not all have them.

Okay. Thanks.

Your next question comes from Carol Burger of Crest Investments.

Hi, guys.

Good morning, Carol.

Good morning.

It looks like your tax rate went up a little, is that true and what caused it and what do you expect going forward?

The tax rate was primarily driven by the, the out of market merchant sale that Neal and I mentioned earlier. Because of the tax treatment that we had elected on several of the different acquisitions that basically built up that portfolio, the tax on the sale was higher than you would normally expect to see, so our tax rate will moderate and return to the normal levels you're used to seeing next quarter.

Thank you.

You know how we love to pay taxes, Carol.

Yeah.

Your next question is from Joe Stieven of Stifel Nicholas.

Good morning, guys. First of all, good quarter.

Thank you.

Thank you.

Can we drill down a little bit on the margin, can you gives your margin on a month by month basis during the second quarter. Obviously we just got the 25 bips from the fed right at the end of the quarter. I just wanted to make sure I got your statement correctly. I think you talked about mid single digit linked quarter NII growth and I'm assuming that's on an annualized basis.

I just want to talk about those two things.

I would say again on the margin side, I would take you back to the earlier guidance to the mid single digit link quarter and I think that's a correct interpretation.

The 25 basis points at the end of the quarter was very much expected and we had clearly positioned ourselves for that, and that as well as the other increase in the quarter are clearly factored into the guidance I've giving to you.

So you are including another increase in the quarter?

That's correct.

Okay. Another 25 bips or what are you guys assuming?

I wish I were smart enough to know exactly. The current forecast has 25.

Okay. Okay. Fair enough. Thanks, guys. Good quarter.

Thank you.

Thanks, Joe.

Your next question comes from John Balkind of Fox Pitt.

Good morning, everyone. Just a quick question on tangible capital. Obviously the swing in FAS 115 impacted your tangible capital numbers in the quarter and you've typically run in that 9-10% range. Are you sort of targeting on an ongoing basis a certain range for tangible capital?

John, I would say our goal is to maintain that strong AA rating we've got, so we'll always maintain tangible capital that's consist with a AA profile. That being said, that 9% number feels reasonably good, somewhere in that range for right now.

Given the, given our current valuation and our own outlook right now, though it's probably fair for you to assume we would be buying back shares at a slightly accelerated pace from where we've been buying, so that may have a little bit of impact on that number.

Sounds good. Thank you very much.

You bet.

Your next question comes from Viveck Dijujah of J.P. Morgan.

Mark, hi. I wonder a clarification. When you answered the question earlier, you said you're more asset sensitive than you were. At the end of the first quarter you were liability sensitive. Were you trying to say you're less liability sensitive or have you actually switched to being asset sensitive?

No, I would say we have not totally switched to being asset sensitive. I would say we are significantly less liability sensitive.

A lot of that has to do with the magnitude of the rate move, Viveck.

Okay. Just wanted that clarification. Then loan loss provisionsing, could you talk a little bit that, obviously your provisions exceeded net charge of this quarter, can you talk about your outlook for that.

Absolutely. The reserve moderated a little bit this quarter down from 145 last quarter to 143 this quarter. I would say going forward we're keeping a real close eye, Viveck, on the credit trends we're seeing.

You know, we're not going to-- while we feel good about the decrease we saw this quarter, one quarter doesn't make a trend from a decision-making standpoint shall we say, with respect to reserves, so we're going to be watching it very, very carefully. The other thing we're watching carefully is the level of unallocated reserve we have. We do evaluation on that on a quarterly basis and very cautious and conscious on that as well.

I think you can safely assume we'll be taking a good hard look at those levels again as we move into the third quarter.

Yeah, and I think, Viveck, this is George. That will be, you know, sort of a gradual smoothing effect there as we look at that unallocated, unallocated reserve out there, which we're paying close attention to, but with the improvement in the, in the credit quality, I think you might see some lowering there.

Thanks.

Your next question comes from Tom McCandless of Deutsche Bank Securities.

Good morning, guys.

Hi, Tom.

Good morning.

I got a few questions.

One, with respect to your deposit growth, I think Fifth Third has been in a class by itself for a long period of time with respect to growing deposits. In listening closely to the call, it sounds like there were some issues with respect to what rate you are paying, but I'm trying to understand, it doesn't seem like the origination process is, is at issue.

It's more retention and perhaps pricing and I'm wondering if, you know, what's your analysis as to why the deposit, core deposit growth was, has been a little weaker than what you had thought?

Let me take a shot at that first, Tom. I think our retention rates, and we benchmark with at lot of people on retention. Our retention rates are equal to or better than our peers out there. And we go out and really check that. My, my reaction is it's a little bit more price sensitive out there. We can grow deposits like crazy if we're paying 5% overnight. We'll grow them by 100 billion tonight. As you know, we've been pretty conservative on the pricing side there and, Mark, you might want to fill in there.

Yeah, George, I would echo those comments 100%. At the end of the day we will continue to be to be best in class in deposit gathering, I feel very comfortable making that statement. I would say, to George's point on the rates, and to my earlier comment, I think we probably got a little bit overzealous in terms of lowering some of the rates, particularly in the IBT product, over the course of the last several months, and I think we're providing the lines of business with an opportunity to get some of that back and put the engine back on track.

I think the equity market took some of the steam out of a lot of folks' IBT accounts of the higher balance, not in the lower balance.

And increasing rate environment won't hurt us on that front either obviously.

We've also heard a little bit about increased pricing competition too in the Midwest.

I think it's a fair statement.

Yeah, at the same time, Tom, though, as some of these acquisitions occur, some of the people that had been paying higher rates are being acquired by more rational pricers out there also.

Right.

Again you have to remember we have 225 small banks, 570 Credit unions, 125 thrifts, and on any given day, you can borrow money cheaper out here and invest it at a spread just in Ohio among our competitors out here.

And you have known us for a long time, know us well enough to know that we're not perfect, there's plenty of things we could do better, but shying away from competition is not something that's ever bothered us.

I understand that. Could I follow up with a few other questions?

Sure. Absolutely.

With respect to your commercial loan growth, the period end numbers are up about 3/4 of a billion dollars. We've heard from a few banks that said cash and market was pretty active this quarter. I'm kind of curious as to whether or not how much of your 3/4 billion dollars of growth in period end C&I loans is attributable to syndications.

We're not playing in that, in that game out there. I think most of our loan growth came out of middle market. We did see our line utilization jump a bit. I think we're up from 43 to 44.5%, which is as big a growth kind of number in that line utilization as we have seen in a while. So this is just customers that are taking down their lines.

That increased pretty well, but I think we've seen good growth across all the markets, whether it's Chicago, Detroit, Cleveland, Indianapolis, Nashville, it's been pretty broad spread and it's not the syndication market. As you know, we do do some leasing out there and that was up a little bit also.

Middle markets so far hasn't been referred to as syndicate.

Okay.

It's core customer business is the real answer to your question.

Right. Next question is did first Franklin have any EPS impact this quarter?

No.

Closing was mid June, so obviously not.

There wasn't enough time.

All right. The next question is, I think I'm missing something, but if I read the press release closely, it seems like there is $148 million of gains you would like to sell to business and only $78 million of charges this quarter led to the early retirement of the float advances resulting in $70 million of pretax gains. Am I missing something? Should there not be something else offsetting that or did 70 million fall to the bottom line?

I would tell you we can chat about that off line. There were a significant number of other activities that we utilized. At the end of the day, suffice it to say a significant amount of repositioning of the balance sheet, in order to prepare us for the rate environment ahead and a few other issues as well.

Well, seems like the repositioning of the balance sheet would be considered normal operating exercises, correct?

Tom, this is Neal. There was a loss of revenue. Some of that out of the expense side of the sale of the auto footprint as well, so it's not pure gain. There was revenue and so you would have to net margin the revenue lost out of the sale of those assets as well.

And the other piece you need to keep in mind is there will be an expense pickup going forward because you lost the revenue from the FDPS business immediately. You've not lost all the expense associated with that. And as that comes out, there's wind at the back going forward as well.

Great. I would love a more detailed follow-up.

There is also the tax impact that you shouldn't forget about as well that I mentioned earlier.

I've already worked through that. Thank you.

The last question is, I don't know if you have had time to think about it, but do you have any thoughts about the competitive environment in the merchant processing business now that B of A has decided they want to be a bigger player?

Yeah, I think that-- this is George. Just like the sale of a lot of our competitors on the retail banking side, we think's going to help us, I think this latest sale of MPC, we contributed there and I don't think we're going to be hurt by that. I think that's going to give us some opportunities in our business any time a competitor departs out there, I think that's beneficial to us. But let me let Neal who has been on top of it.

Yeah, I would say, Tom, and you've spent a lot of time on that side, I can't remember another time, say, for the era when all these companies were going through their first IPO, the amount of competitor disruption we've had out in the marketplace, and I think one of the Hallmarks of our FTPS business is we have best in class reliability. We're known-- the reason we get the large retailers is because people know our systems work all day every day and I think that's been a significant advantage to us for a long time.

I also think we're certainly going to be aggressive in hiring people that certainly will be out in the marketplace. I think you'll also see us continuing to broaden our product areas there. So I feel pretty good.

Certainly I think we announced in the quarter that we've hired a new leader for that business who has deep experience both at Wells Fargo and more recently at First Data. So we think we have some opportunity to continue to grow that business.

Terrific. Thanks so much.

Okay. Thanks, Tom.

Your next question comes from Mike Mayo, Prudential Equity Group.

Hi.

Good morning, Mike.

Just a couple of nitpick questions here. How much in expenses went away due to the sale of the processing contracts?

I think roughly the revenue side of that was in the range of 20 some odd million. If you assume the margins in this business, some are in the 20% area, that's going be something that you'll see flow through this, but in the first quarter of the sale, we had some deal expenses that came through that, Mike, so net-net, they're probably $18 million -$19 million of expenses that we had in the quarter as well.

That went away?

That, that are in the deal.

And there will be a significant revenue expense going away going forward, Mike. As I mentioned, the revenue from that sale obviously came out with the sale closing April 1st. The revenue came out very quickly, due to a couple repositioning things and some short-term serviceing we agreed to do for the purchaser and the like, that expense didn't come out right away. That will start coming out in the third quarter.

Okay, and then the impact of the acquisition only one month's worth, but what was the impact on revenues and expenses this quarter?

On Franklin?

Yeah.

On the Franklin side? I think Franklin, if you looked at Franklin is running total expenses about $3 million a month.

You're talking about their income line, Mike?

Revenues and expenses.

Yeah, I think on a net basis, Franklin was reporting about a million dollars a month bottom line before we acquired them and we had them in that period, so that's about the number.

Yeah, and for roughly half a month.

The revenue and expense numbers?

Mike, it was not a helpful thing to the numbers this quarter.

The reason I'm asking all these questions, my general question is, it looks like you had some negative operating leverage from the first quarter to the second quarter.

I know you don't like having that situation, and, you know, is that simply partly the extra cost of getting more conservative on the liability side of your balance sheet?

I would say that would be a piece of it, Mike. The other piece of it is, you know, that is the primary piece, that $78 million pretax.

Mike, I would also say there is a significant amount of noise that's in the operating leases coming on through those numbers on year over year. This is the last quarter of that, so I think you have had some year over year comparison challenges in there. We certainly are mindful of that.

Okay, and lastly, was the higher tax rate for the corporation due almost exclusively to the sale of the processing contracts?

Yes, completely.

Okay. Thank you.

Your next question comes from Fred Cummings of KeyBanc.

Yes, good morning. Just one question on the loan growth by kind of your major metro part markets. Has there been a major difference anywhere on the plus side or the minus side in the various markets in which you operate?

I think generally, Fred, that was spread throughout the markets. I mean, up in your backyard up there, our Cleveland afilliate had good growth up there, Bob King and his people had some really good growth there, but Detroit had-- had some very strong loan growth.

Over in Indianapolis, they had some very good growth over there, so it was pretty spread. There wasn't any, there wasn't any one area here. Cincinnati, as you know, continues to show good loan growth.

And the other thing we've done, Fred, is we are hiring a number of good middle market lenders out here.

We continue to add people, you know, we're trying to bring another 100 middle market lenders on there, probably brought 40 or 50 on already, and that is helping us in all of our markets.

Okay. Thanks, George.

Okay, Fred.

Your next question comes from Denis LaPlante of KBW.

Yes, good morning. Two things. The first is given the recent rate hike, what did you do with deposit rates on the 25-basis point hike?

We have on the commercial side had about a 50-55% correlation on that. On the retail side, we are still in the process of making those adjustments.

And so far, what adjustments have you made? Have you made any adjustments on retail yet?

Nothing significant.

Okay. So that's lagging. In your anticipation basically, despite the fact that you're kind of tinkering with deposit rates to try to get the right balance to make sure that the volumes stay strong, going forward, what would you think that rate, those-- say rates go up 200 basis points. Are we going to have an elasticity of .7, or is it going be 1-1 or what would your best guess be right now?

I think at this point in time it's too early to call that one is the honest answer. It won't be 1:1.

The second thing related to asset liability, you've become a little less liability sensitive based on the disclosures that you provide. Can you be more specific related to however you want to put it, for a given say 100-basis point move in rates, what is the impact on spread and how does that number compare to what your last disclosure was?

You mean short rates or the entire interest rate period? (laughter)

I realize there is a lot of, you know, a lot has to go in the assumptions and you could come up with almost any number, but I'm just looking for an apples to apples comparison between where you were at the end of the first quarter.

Reality, exactly.

I guess I would answer the question as follows. And it would talk a little bit, you know, further to just the end of the quarter too so I'm going to be real cautious here. At the end of the day, I would say my own personal perspective is we are very close to neutral as we sit here today.

Okay. And that-- and that's including all of the impacts of the federal home loan bank borrowing impact and also the lengthening of the liabilities as well?

That is correct. And looking out to another increase this quarter as well.

Okay. That's great. And--

Asset side repricing has something to do with those that are tied to prime, but it also has a fair amount of term assets. Deposit rates will move at some pace, so I think people think there is more precision in here than there is.

I understand, but all I'm trying do is trying to get an apples to apples comparison in terms of how you guys look at it.

Denis, that's a big factor in here. The competitive position out there. It depends on what our competitors are doing as to how we behave out there. It isn't a static, we sit in here in the morning and plug it in the model. We're pretty sensitive to what's going on in the markets.

I understand. And I guess last question, which is more of, the other income line also looked a little light. I missed some of the opening comments so you may have covered it. Can you talk about that?

Yeah, there is a number of components in that one. The biggest one would be a negative mark on some freestanding derivative contracts that are out there, Denis.

Can you explain the negative mark on, this is related to what? Some hedging?

Yeah, that's correct.

Rising rates.

I'm sorry? What was that, Neal?

Hedgng of rising rates, that's correct.

Okay. Very good, thank you.

You bet.

Okay, Denis.

And your final question comes from the line of Kevin St. Pierre of Sanford Bernstein.

Good morning, guys. I just have a quick question on the mortgage servicing rights. The valuation on the servicing rights appeared to jump from about 114 basis points end of Q1 to about 143 basis points end of Q2. I was just wondering if you could tell me where the impairment reserve stands now and how you anticipate -- where you see valuation going as rates continue to rise.

Hey, Kevin, this is Brad. Right now, certainly the components are disclosed in the release in terms of what the hedging impacts were and also the actual write offs on the servicing rights. That line was also impacted by some additions from the Franklin financial acquisition as well.

So there is a lot of moving pieces. I would tell from you a hedging standpoint we're certainly positioned fairly well to see that asset move up with rates. We have moved that hedging down as some of the risk has gone out with just the overall write downs in the last 18 months.

A broad statement is obviously that we're very comfortable with where we are relative to that positioning.

In terms of how much potential recapture is there, I don't think that's something we can broadly comment on in terms of dollars.

Okay. Thank you.

We have been pretty conservative there.

Very much so.

Thanks.

I think that's all the time we have for questions today. Certainly we're available for any follow-ups that you may have, but thank you for taking time to listen in and we'll talk to you soon.

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