Fifth Third Bancorp (FITBP) 2007 Q2 法說會逐字稿

Good morning, my name is Deshanta and I will be your conference operator today. At this time I would like to welcome everyone to the Fifth Third second quarter 2007 earnings 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 session. (Operator Instructions)

Jeff Richardson, Director of Investor Relations of Fifth Third, you may begin.

Hello and thanks for joining us this morning. We'll be talking with you this morning about our second quarter 2007 results as well as our outlook for the remainder of 2007. As a result, this call contains certain forward-looking statements about Fifth Third Bancorp pertaining to our financial conditions, results of operations, plans and objectives. These statements involve certain risks and uncertainties. There are a number of factors that could cause results to differ materially from historical performance and these statements. Fifth Third undertakes no obligation to update these statements after the date of this call. Now I'm joined here in the room by Kevin Kabat, our President and CEO, and Chris Marshall, our CFO. 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 and thanks for joining us. I have a few comments and then I will turn it over to Chris, who will review our balance sheet, revenue and expense trends and also talk about our outlook for 2007. First of all, we posted a good quarter, especially in this tough operating environment. We showed strong revenue and net income growth and expenses were well controlled. So there's a lot to feel positive about in our operating results during the quarter. I'll let Chris walk through our reported results, so let me focus on our lines of business. In our payments business, as you probably know, we landed the U.S. Treasury account several quarters ago and we brought about half of the relationship online in the latter part of this quarter. We expect the remainder to come on over the next six to 12 months. Additionally, we signed Walgreens credit card processing business a couple of weeks ago and we expect that to convert to our systems in the second half of the third quarter. As you know, Walgreens is one of the largest retailers in the country and we now process for most of the large pharmacy chains in the U.S.

We continue to feel very good about this business and expect to maintain our strong mid-teens growth rate here? The credit card business is one of main strategic initiatives. We continue to see great results in terms of credit card account originations, which are up about 50% versus a year ago and balances are up 22% sequentially and 57% versus a year ago. In Commercial, our C&I growth remains solid at 6% over last year. This was mitigated by an absence of growth in our Commercial real estate lending, which reflects both our appetite as well as softening demand. Corporate banking fees were very strong as we continue to see increased capital markets produce sales, particularly in customer derivatives activities and loan syndications. Our investment advisors business turned in a record quarter and, as you will recall, last quarter we were able to complete and file trust tax returns earlier then in previous years. This moved a few million in fees into the first quarter that we would have normally realized in the second quarter.

Brokerage results were very strong with fees up 11% sequentially. We've talked about improving the quality and productivity of our brokers and we're beginning to see the results from our strategies and new management here. And of course, strong equity markets have helped across all of IA. In retail banking, we saw a strong bounce back in deposit service charges. Retail BDA production and balance growth remained very solid in a fairly tough environment. Pricing remains fairly rational in our markets and we continue to see the benefit in deposit pricing of our everyday great rates deposit strategy, as Chris will discuss. We feel very good about our de novo activity. We added six net new branches during the quarter and remain on track to add a net 45 to 50 branches to our network in 2007. Our consumer lending business saw better results then we expected coming into the quarter. Mortgage originations were strong though margins narrowed on loans we sold. As you know, the volatility of the first quarter made predicting second quarter activity fairly difficult and we were pretty happy with where we ended up.

We also saw continued growth in solid spreads in the auto business. Let me turn to credit. Charge-offs came in at 55 bps and NPAs were up 7%, both largely in line with our expectations. Clearly these levels are elevated from last year and we expect credit issues to remain on the front burner for a while. The midwest, where economic conditions are weak, and Florida, which is enjoying solid economic growth, are both working through some commercial and residential real estate issues. That said, credit remains manageable. We have the controls, processes and staff in place to manage through this cycle. Chris will talk more about what we're looking for the rest of the year in a few minutes, but generally our expectations haven't changed. Just because we're prepared for this, doesn't make it easier on our customers. They're experiencing very tough times here in the Heartland.

I know when you look at national economic statistics, the U.S. economy is still strong, but significant parts of the midwest have been in recession-like conditions for several years. This particularly applies to eastern Michigan and northern parts of Ohio and Indiana, where the domestic auto belt is centered. We don't expect to rebound in a quarter or two, but we do expect things to turnaround and we remain committed to doing everything we reasonably can to help our customers through this, that's our business. The last thing I would mention is that we're feeling very good at this point about our acquisition of R-G Crown Bank down in Florida. We announced this transaction in May and we're still targeting a closing sometime in the fourth quarter. It's early, but so far integration activities are proceeding as planned and we have found nothing thus far that's a negative surprise. With that, I'll turn things over to Chris to talk about second quarter results and the 2007 outlook. Chris?

Thanks, Kevin, and good morning, everyone. First, I'd agree with Kevin that our financial results were pretty good for the second quarter. I'm going to go through the details of the income statement and the balance sheet and then I am going to wrap up with our updated outlook for the full year. But first let me just take a second here and summarize our EPS. As you've seen earnings per share were $0.69. That included $0.02 of benefit from the sale of single product credit card accounts. All of the accounts we sold were single product relationships, either because we were unable to effectively cross sale them or because of natural customer attrition. As we've said before, strategically, we're focused on building our credit card business by growing multi-product relationships through our retail distribution network. Those accounts, as you know, are cheaper to originate, tend to be more profitable and have significantly lower risk. In fact, the portfolio that we just sold had a charge-off rate of the more then double our overall average charge-off rate.

So given that strategy, you can expect us to continually sell these kinds of account going forward as they develop due to normal attrition, although estimating potential volumes would be very, very difficult for us. Now offsetting that $0.02 was a $0.01 of onetime cost associated with the expense initiatives I discussed with you last quarter. I'm going to say a little bit more about expenses in a minute, but in general I'm very pleased with the progress we've made. By comparison we had $0.65 of EPS last quarter and $0.69 in the second quarter a year ago. And you remember that last year's results included a $0.02 net gain associated with the sale of MasterCard shares. All right, let me move on now to revenue starting with net interest income. NII was up $3 million from last quarter, which was flat on a percentage basis. Earning assets were up a slightly, about 1%.

But NIM was down 7 basis points to 3.37%, which was right in line with our forecast. NII growth was driven by consumer deposit production and modest reductions in consumer deposit rates, as well as some loan growth and the additional day count -- an additional day in the quarter. These benefits were offset by the impact of the first quarter issuance of trust preferred securities, as well as our share repurchase activities during the first and second quarters? As I just mentioned, the net interest margin was down 7 bps sequentially. And as I told you last quarter, we expected the margin to be down six due to the full impact of our March hybrid issuance and share repurchases as well as the effected day count. The additional basis point was do to share repurchased that were higher in the quarter then we forecasted in April. Other then that, there was no significant change in the margin. Turning to the balance sheet, starting with loans, I categorize loan growth as pretty solid. It was up 2% sequentially and 5% year-over-year. It would have been 6% if we had excluded the runoff of our consumer lease portfolio.

Obviously our growth has slowed, particularly in commercial and residential real estate sectors, as I'm sure you all would have expected. Now breaking things down a little bit. Average commercial loans grew 2% sequentially and 5% versus the second quarter. C&I loans were up 3% sequentially and 6% compared with last year and commercial mortgage loans were up about $500 million and that just reflects the [perming] out of construction loans which were down by just about the same amount. Overall, given the state of the economy, and specifically the difficulties that Kevin just mentioned in certain parts of the midwest, as well as just general credit conditions, we feel pretty good about our loan results. Growth is slower then we expected at the beginning of the year, but given the realities of the market I'm pretty comfortable with how we've been performing. Average consumer loans were up 1% sequentially and 6% year-over-year or 2% sequentially and 8% excluding the lease runoff.

We continue to see strong growth in auto loans, which were up 3% sequentially and, as Kevin just mentioned, credit card balance growth was also very strong. It was up 22% sequentially and 57% year-over-year. As I'm sure you remember, the credit card growth initiative was just kicked off in January so we've got a long way to go with it, but our results to date have clearly exceeded our expectations. And really, due to the successful deployment of point-of-sale technology that lets us officially sell cards to our existing customers when they're in their branches conducting transactions. Now we're just beginning to leverage that same technology in our call centers. We're in the process of training our call center staff to effectively sell cards proactively when customers call in with service issues, so we expect more upside there. And then finally, we are in the process of enhancing the technology so that it is going to work really effectively through our online bank channel and we'll be rolling out upgrades to that channel very, very soon.

Offsetting those strong results to some extent was residential lending, particularly in the home equity area. As you know, these loans are largely prime-based and with higher rates, borrowers are tending to opt for traditional fixed rate mortgages. Our mortgage business, obviously, benefits from that but that shows up as mortgage banking fee income instead of loan balances. By moving onto deposits. Average core deposits were up 2% annualized from the first quarter and up 1% from a year ago. We saw continued good retail core deposit growth offset by modestly lower commercial balances, which I'm going to elaborate on in just a second. Retail core deposit growth was about 2%. Increases in savings, demand and money market balances more then offsetting modest declines in interest checking and retail CDs. Now that's exactly the mix shift we've been targeting and that we've discussed with you in the past, specifically last quarter. In general, we continue to see good consumer DDA momentum.

The retail DDA balances were up 2%, which I feel really good about given the normal seasonality of customer tax payments in the second quarter. Now on the commercial side, core deposits were down about 3% sequentially and about 7% from a year ago. Now our reported core deposits don't include about a 1.4 billion in Euro dollar sweep balances, which a number of our peers do include. These are classified as foreign deposits on our balance sheet and if we were to include those, commercial core deposits would have been pretty much flat from last year. It's important to consider those Euro sweep balances. They've got real value to us. We pay about 16 basis points higher rate on them then money markets, but we avoid collateral cost and FDIC insurance cost, so the economic benefit to us is really the same as money market balances? We're obviously not doing ourselves any favor in the way we've been reporting these balances and we're going to take a little bit closer look at the classification and decide whether or not we should change that going forward.

We're seeing most of the money coming into those Euro sweeps coming out of commercial money market balances and as you can see those are down $650 million from a year ago. Overall, commercial DDAs remain a little soft. They're down about 0.5% from last quarter. We've got more opportunity here. We've got a lot of focused effort but we really need to pick up the pace in the third quarter and I expect we will. Now looking at some of our reported deposit line items. Second quarter is a traditionally weak one from an IBT standpoint as customers have historically used these balances to pay their taxes. Our interest checking balances declined 3% sequentially and we're down 12% from a year ago, but most of that drop happened last year. We're still seeing some shift from IBT to other higher rate paying products, but it continues to slow and I consider this to be largely stabilized at this point.

Now our savings balances grew 7% sequentially and they're up 21% from a year ago. And as we've told you in the past, we try to price this product so that rates are attractive enough to draw some natural CD investors and that strategy seems to be working very well. Retail CDs were up 3% year-over-year but down 3% sequentially, in line with our plans and our expectations. Looked at as a whole, our weighted average rate paid for interest-bearing core deposits was 3.39%, down from 3.43% in the first quarter. As Kevin said, we continue to price deposits in line with our everyday great rate strategy, which as you know is designed to find the point for each product where the customer value proposition is strong but that we're really optimizing the tradeoff between volume and rates. And that seems to be working very well for us. Moving on to non-interest income, fee trends were very good for the second quarter really in every category. Our payments processing results continue to be outstanding, processing fees were up 8% sequentially and 15% from a year ago, right in line with our expectations.

Sequential growth was driven by the comparison to the seasonally weak first quarter, we talked about on our last call, as well as the impact from the U.S. Treasury business that Kevin just mentioned. Looking at the payment's business in a little bit more detail. Merchant revenue is about half of our processing business and it was up 12% sequentially and 19% from a year ago. This business is doing exceptionally well and we expect that to continue in light of the Walgreens' win we just mentioned, as well as several other large merchants that are now in the process of converting. The U.S. Treasure business is going to come on, come on line over the course of the next 12 months, though as Kevin mentioned, about half of that converted in the second quarter. We think we've got a real advantage right now in the merchant space. We've got arguably the best platform in the industry.

We process for some of the largest, many of the largest merchants in the country and given the transition several of our competitors are going through, we feel really well poised and positioned to take -- continue to take share here. Financial institutions revenue is about 30% of the business. It was up 2% sequentially and 11% from a year ago. As you know, this is a volume-driven business and volumes were good this quarter. As we've mentioned, we'll continue to experience some margin compression in this space as contracts continue to rollover, but bottom-line, this is and will continue to be a very attractive business for us, despite that margin compression. And then finally, a card related revenue, which represents a little less then a quarter of our business, was up 10% sequentially and 13% from a year ago.

Now that's driven by interchange among our own credit and debit card customers. Debit interchange is about two thirds of our overall card fee revenue, but our credit card interchange has grown 43% from a year ago. So we're really seeing the impact of our card initiative here and we expect that to continue. Now let's look at deposit service charges were up a really strong 13% sequentially and 6% from a year ago. That was obviously a welcome development for us, given the soft results we've talked about in the last two quarters. Consumer service charges drove the increase, growing 23% sequentially and 11% year-over-year. Now, this increase reflects the typical upswing we see from the seasonally weak first quarter as well as very solid retail DDA production. And at this point you can now assume that we fully recovered from the unusual weakness we experienced just this past fourth quarter. Commercial service charges grew 2% sequentially.

They were down 1% year-over-year, which is largely reflecting the residual affect of the Fed rate hikes the second quarter of 2006, as well as, candidly, the relatively sluggish DDA growth we've had over the past year. Let's see. Investment advisory revenue increased 2% sequentially and 1% versus a year ago. As Kevin mentioned, this was a record quarter for us despite the $3 million in trust tax fees being earned earlier in the first quarter of the year. Adjusting for the timing of those fees, IA revenue would have been up 8% sequentially, which was a bit better then we were expecting. In the private bank, which is about a third of IA revenue, fees were down 8% sequentially and 5% year-over-year due to that same trust tax fee timing issue. Otherwise results would have been up 11% sequentially and 4% from a year ago. Retail brokerage constitutes about 30% of our IA revenue. Brokerage fees were up 11% sequentially and 6% versus last year.

And then finally, institutionally trust and mutual funds are each about 15% of the business and there we saw solid 3% to 4% growth sequentially and mid-single digits year-over-year growth. And that was really just driven by the strong performance in the markets. Corporate banking revenue was up 6% sequentially and 8% year-over-year. We continue to experience really strong growth in institutional sales, customer derivatives activities as well as in our loan syndication activity. Mortgage banking revenue rose $1 million from the first quarter. Now that's not much, obviously. But as Kevin mentioned, we didn't have a lot of visibility into mortgage banking revenue coming into the quarter, so we feel relatively satisfied with where we finished. Originations were very strong, but gain-on-sale margins were tighter. So gains on our sales and deliveries were fairly flat sequentially. Mortgage servicing revenue were up on our origination volume and, given the back up in rates, we picked up about $3 million from the MSR evaluation.

Last quarter there were several questions about our all day production, so it's worth mentioning here that we successfully cleared our quarter-end all day warehouse in April right at the pricing levels we were expecting. We now hold about 45 days of production, which is what we planned to hold in a steady state going forward, so there's really no story here in terms of all day. And then finally, I want to mention, given all the folks on subprime, I want to remind you, and I'll probably keep reminding you for the next few quarters, that we don't originate any subprime loans and we don't have any intention to do that. Finally in other non-interest income. The variance there was, from last quarter was solely due to the $60 million gain on the sale of credit card receivables. That was $89 million of balances that I've already mentioned. All right, moving on to expenses. I characterize our expenses as really well managed this quarter. Our reported expense growth was 1% sequentially and 6% compared to last year.

But when you adjust for the $7 million in onetime costs from our expense reduction initiative this quarter, expenses were fairly flat sequentially and were up 5% versus last year, which is exactly what we were looking for. Now salaries, wages and incentives expense were up 6% sequentially, including the severance expenses I just mentioned, which was about 2% of that increase. Others drivers there were the effect of our normal annual merit increases and stock awards, as well as higher revenue based incentives in the quarter. Year-over-year growth was really well contained at 2%. Our benefits expense was down 19% sequentially, due almost entirely to the seasonally high FICA and unemployment expenses that I talked about with you about last quarter. Payments processing expense, I should mention that reflects FTPS in bank card processing. It was up 20% year-over-year. Now this expense line is obviously volume-driven and our transaction activity is growing about 20%.

We expect growth in this line to be a couple of percentage points higher in the next two quarters due to the conversion of national merchants and the effect of product mix shift. Now, our merchant acquiring business is our most processing expense intensive business and it is also our largest and fastest growing payments business, so that's the main driver of the optical relationship you see here. Our merchant margins are stable and very attractive. So this isn't in any way something to be concerned about. And looked at as a whole, our dollar growth in revenue year-over-year is almost double the growth in processing expenses. As we mentioned in April, our expense growth overall, which was at 8%, was clearly higher then we were comfortable with and couldn't really be justified given the revenue environment we were seeing develop for 2007. And as a result of that we undertook a very, very focused effort to identify areas where we could reduce expenses and expense growth without impacting in any way revenue growth or customer service or our ability to continue funding our growth initiatives.

We've largely completed those activities. And as a result, we've reduced our work force by about 650 positions across the entirety of our franchise. Now that reflects both reduction of current positions as well as open positions that we were due to fill over the remainder of the year. The breakdown there would have been about 400 and 250 in terms of future positions. We may see a little bit of further onetime expense in the third quarter, just bleed over due to timing, but I don't expect that is going to be very significant. Those actions are going to reduce annualized expenses by about $45 million, which is what we had forecast, $40 million to $50 million. We're going to end up right in the middle of that. About 80% of that will show up in the salaries line and the remainder in the benefits expense line. You are going to see that play out in lower expense growth then we would have seen otherwise, rather then lower absolute expenses in dollars because, as we've said, we're going to continue to fund our growth initiatives throughout the business.

You're going to see in our outlook that we continue to expect mid-single digit expense growth for the year, in line with the expectations we shared with you in April. Payments processing growth and de novo expense growth are two of our key value drivers are going to continue to represent a disproportion part of our expense growth. We feel pretty good about expenses right now. So let's see, moving on, taxes, looking at our effective tax rate, which was 28.1%. That was a little bit lower then we were expecting. We feel good about that. Unfortunately, we're watching a legislative development right now in Illinois that has been signed by the governor is going to effect everyone doing business in the state, including us. And if there's no change in developments there, it's going to cost us a onetime about $0.02 in the third quarter. And then ongoing the effect will be about $0.005 each year starting in 2008. Now, as you'll see in our outlook, we expect our tax rate for the full year to be in the 28.5% to 29% range.

That outlook includes the effect of this Illinois legislative change, which we, at this point, we fully expect is going to happen. I think you're going to be hearing more about this from other banks that have big businesses in that region or in that state. Now turning to credit. Starting with charge-offs, they were 55 basis points for the quarter, largely in line with our expectations, maybe a couple of basis points higher then we were forecasting in April. Charge-offs were up as expected from a very low 39 basis points that we saw in the first quarter. That puts us at 47 basis points year-to-date and our full year outlook, which you'll remember is for charge-offs to be in the low 50 basis points for the full year and that outlook remains completely unchanged. I'll talk a little bit more about that, but commercial net charge-offs where $47 million or 44 basis points versus a low of 27 basis points in the first quarter. Commercial net charge-offs were $47 million or 44 basis points versus a low of 27 basis points in the first quarter.

Sequential increase there was evenly split between C&I and commercial real estate categories, so our C&I book is obviously a good bit larger then our real estate book, so we're feeling much more pressure on the real estate side. In terms of size, we had three charge-offs in the $4 million to $6 million range, which you as you know are fairly large for us, two of which were real estate related. One, as a matter of fact, was the $19 million Florida commercial developer that I mentioned on the call last quarter. And I think I mentioned or estimated at that time, we thought the charge-off might be $6 million and it ended up being $4 million. And then the remainder of our charge-offs were in the $2 million range and below. During the quarter, we sold $27 million in commercial NPA's, representing $3 million of losses and as a comparison we sold $39 million in NPAs at a loss of $5 million last quarter. The consumer charge-offs were $55 million or 68 basis points versus 53 bps in the first quarter and an increase of $13 million.

$10 million of that increase resulted from first quarter recoveries on the sale of charged-off loans that we discussed last quarter. But home equity losses were up $3 million and residential mortgage losses were up $2 million, largely due to housing market conditions in the northern part of our franchise. Let's see here, provision expense was up $121 million and exceeded net charge-offs by $19 million, which increased the allowance ratio to 106. We would expect to see provision continue to exceed charge-offs for the near future as we reserve for our expected loan growth and we expect to see continued growth in NPAs and criticized assets as we continue to move through the cycle. And I'll talk a little bit more about that. Moving on to NPAs and delinquencies. NPAs were $528 million or 70 basis points of loan, up four basis points from last quarter. This increased $34 million or 7% from the first quarter, which was right in line with what we were expecting. Consumer NPAs were up $22 million.

This was driven by continued growth in OREO, which increased just about $10 million, primarily in Michigan, and also higher levels of repossessed autos, which were up about $8 million. As we noted last quarter, we implemented an accelerated repossession cycle and that's resulting or has resulted in a higher level of repossessed autos that we hold in inventory. That's been about 20% higher then typical. While this tightening in credit policies has increased NPAs, we think it will reduce our losses going forward, so it's the right thing for us to be doing at this point in the cycle. A commercial NPAs accounted for $12 million of the NPA increase. They were about evenly divided between the commercial mortgage and commercial construction books and it was largely concentrated in eastern Michigan. Just a note that we had four NPA inflows over $5 million in the quarter and the largest one was about $9 million, $9.5 million. Loans 90 days past due were up $59 million to $302 million. That growth was a little bit higher then we were expecting, is partially due to timing.

To give you a little bit more color here, about two thirds of the delinquency growth was in commercial. Again, largely in commercial real estate and construction and primary in Michigan as well as in south Florida. Now consumer delinquencies were also largely in residential real estate, about half of which of those losses, those delinquencies were in south Florida as well. I'm going to talk about credit in terms of our outlook in just a second, but for now I would say that our credit -- our outlook for credit losses and general credit trends really hasn't changed. We don't expect things to improve anytime soon. Conditions are tough for everyone and they're particularly tough in certain parts of the midwest. But we were expecting the environment to be tough and we just need to continue to work through it the way we have been.

I'm going to wrap up the balance sheet with capital. Our tangible equity ratio was 693, down 73 basis points but still very strong compared to our peers. The decrease here reflected share repurchases of $693 million during the quarter, which is higher then we had forecasted last quarter. We would expect repurchases over the next couple of quarters to continue, driven by excess capital generation. Just as a reference point, we generate about 10 bps in excess TCE each quarter, depending on asset growth. Now, let me turn to the outlook for the full year. You'll find that on page eight of the earnings release. We're going to continue to update this each quarter and you'll see that we've highlighted the line items where we've made an adjustment to the April outlook. And there have been a few tweaks here and there, but I don't think there's anything really significant overall with the exception of the tax legislation hit in the third quarter that I just mentioned.

First of all, we lowered our NII outlook from the mid to high-single digits to mid-single digits. And this reflects a couple of things. Our share repurchase activities and debt issuance are replacing free funding with debt and that's obviously lowering NII and the offset is obviously in EPS. We continue to expect some sluggishness in commercial loan growth. C&I growth remains good, but we see very little CRE demand and in this environment we feel that slower loan growth is a better option then for us to start chasing credits. Consumer growth has been running in the 6% to 8% range and that feels sustainable for us, although the shift to fixed rate mortgages, as I just mentioned, reduces our balance sheet growth compared with home equity. As a result of those developments, we brought our loan growth forecast down to the mid-single digits from mid to high. Core deposit growth is clearly not going to make it up to the mid-single digits. We're seeing good retail core deposit growth, but we have less visibility at this point for strengthening on the commercial side.

We do have a lot of focused effort there, particularly on DDAs, as I mentioned. But for now, our outlook is low to mid-single digits for core deposits rather then mid. And again, this excludes the growth in our Euro dollar sweeps, which would add something like 2% to our full year core deposit growth rate and put us back toward that mid-single digit range. Now the net interest margin was lower then the first quarter, as we expected. Now that we have two quarters in, I feel comfortable with a tighter range of 3.35% to 3.40% for the year. The full impact of our hybrid issuance and share repurchases, as well as lower core deposit growth, are pushing the margin into the lower half of the range we provided early in the year. At that point we said the range was 3.35% to 3.45%. Our underlying margin behavior is pretty stable and I expect it to continue that way, though I would expect the carry through effect of second quarter share repurchases to reduce the margin a few more basis points in the third quarter.

Turning to noninterest income, overall, no change to the fee outlook. The payments business continues to perform very, very well. And we still feel good about our mid-teens growth expectation there. We expect deposit service revenue growth in the mid to high-single digits after the nice rebound we talked about in the second quarter. Corporate banking revenue is expected to grow in the high-single digits as the production from our capital markets activities is going to continue to provide a greater relative contribution. But there's still some uncertainty in the mortgage area. We expect originations to be consistent but spreads have compressed some and we expect that to continue in the near-term and we'll have to see how that goes. Outlook for expense growth remains in the mid-single digits. We're at 7% year-to-date and I would expect that the 5% growth we saw in the second quarter to be sort of the low-end of the remaining quarters and we're probably going to end up in the 6% to 7% kind of range for the full year, depending on revenue performance.

Almost half of that growth will be in processing and de novo expense growth. So all of in all, I think 6% to 7% is okay. I want to point out that we'll incur about $7 million in pension settlement expense in the third quarter. As a reminder, we had $8 million in the third quarter of last year. Now net charge-offs were higher this quarter then in the first and that was completely expected. We continue to expect charge-offs for the full year to be in the low 50 basis points area. That suggests they'll be somewhere in the mid 50s for the second half compared with the 47 basis points we saw in the first half. Right now we're pretty comfortable with our outlook. We still expect NPAs and delinquencies to continue to trend upwards. And, of course, we may well see some volatility in charge-off and NPA trends from quarter to quarter, but otherwise we're comfortable with our outlook. Finally, we reduced our effective tax rate outlook to 28.5% to 29% for the full year.

Right, at that point -- at this point, I guess I want to wrap up, looking at time here. I hope you all agree that this was -- the quarter was pretty good in what continues to be a very tough environment for the industry. Our businesses are performing well and under the circumstances we feel good about that. We're obviously very focused, appropriately so, on doing the right things to stay on top of credit, as well as on executing the strategic plans that we discussed with you early in the year. So I'm going to stop here and thank you for your attention and we would be happy to answer any questions you have.

(Operator Instructions) Your first question comes from the line of Mike Mayo with Deutsche Bank.

Good morning,.

Good morning, Mike.

It's been six months now with the new leadership and I was just wondering any tweaks or evolution to the strategy overall and if you can give us an update on merger appetite?

Mike, it feels like six years not six months. But, again, I think in terms of our focus, we continue to really look at our focus on continued productivity improvements in terms of the strategies. The strategies feel good to us and we're getting good, as Chris and I mentioned in terms of the course of our comments, we think we're getting good traction in those -- in those initiatives. Again, our focus has been on improving productivity and focus there. And that will be on going, Mike. I don't know if we ever will ever stop from that standpoint. So you can expect us to continue to tweak both our models and our strategies as we go forward continuing to expand and look for opportunities for improvement as we move down the pike from that perspective.

And deals?

And deals? Yes, we continue to look aggressively in terms of the marketplace. Again, we're -- nothing's changed strategically that we've discussed with you, Mike, in terms of wanting to expand the footprint and some of the diversity as well as opportunities that may exist within the footprint of taking out competitors. Nothing's changed from our standpoint. Obviously, pricings continue to be a challenge, but we are always on the lookout.

And then you got it lower in a few line items there offset by the tax rate. So, are you guiding lower for earnings overall or -- ?

Mike, this is Chris. No, we feel the lower guidance is really a reflection of what we've seen year-to-date in most of those categories and maybe a little more prudence in terms of commercial real estate growth then we were expecting at the beginning of the year. Other then that, we feel pretty good about the guidance we've given. In terms of earnings we're pretty comfortable.

On that last topic, the commercial real estate growth. I guess there's been some banks who said they initiated new appraisals for Michigan and that led them to more significantly increase their reserves for potential problem loans. Have you done any recent appraisals in that market or what's that process? Thanks.

Yes and that's a good question, very timely for us. We just completed a extremely thorough review of our Michigan businesses, specifically went through loan by loan in certain areas like Detroit. We also had our -- just went through a regulatory review of those same portfolios and there were no adjustments. So we feel good about. I think we're being very, very careful about those areas, that we're very focussed on them. And that review, I felt good that -- we've had an ongoing effort there, but the review that we just went through didn't result in any need to change any of our treatment of any of those portfolios.

All right, thank you.

(Operator Instructions) Your next question comes from the line of Brent Erensel with Portales Partners.

Good morning. Brent Erensel, Portales Partners. I've got a question on the margin. You mentioned a lot of times that the share repurchase is effecting the margin, but you seem to ignore the impact to the yield curve and the non-performing asset increase. Could you talk about those dynamics and a second question unrelated on the U.S. Treasury business. Could you talk about the revenue metrics there and possible profit dynamics?

Yes, Brent, thanks for the question. Look, I'm not sure what to say on the yield curve. It's tough. It's tough for everybody. We don't expect big changes, so I'm not sure how to respond to the question other then we're as eagerly awaiting some steepening, just like any other bank would tell you. With regard to NPAs. There's obviously growth in NPAs. We're at $528 million dollars. I guess to allay any, or not any, but some concern in that growth, I guess I would say of those NPAs, 75% to 80% of them are fully collateralized in terms of being backed by real estate or, to some much smaller level, autos. And the vast majority of those have been charged down, are already charged down to what their fair market value is. So, I think we're carrying them at the right amount and I don't -- we don't expect there to be significant hit to charge-offs as a result of that growth. I think that was the essence of your question.

Actually, if I could followup right there. Margins were down 7 basis points and you said that most of that was due to the share repurchases. But I'm wondering, when you have an increase in NPAs sometimes there are interest reversals and I'm wondering if that had any impact on the margin.

No. I guess what we were -- the only thing I was trying to tell you in the margin was the difference in our expectations from last quarter. Most of the other stuff we had already expected and forecasted for.

Great, okay. That's helpful.

And then in terms of the -- last part of your question had to do with the U.S. Treasury business and -- I'm sorry, Brent, would you --.

Just if you could talk about the revenue and profitability.

Oh, specific revenue for that business? We couldn't -- I'm not sure we could provide that to you account by account. So I apologize. It's a big account but we can't breakout the revenue from each one of those accounts.

Fair enough, thank you.

Your next question comes from the line of John McDonald with Banc of America Securities.

Good morning, John.

Good morning, guys. Chris, I think you kind of just answered the NPA question I had. Your outlook there is just for some kind of modest increases in NPAs, consistent with kind of what we saw this quarter, I guess?

Yes, that's what I would say today. Now, it is a little bit harder for us to predict NPAs and over 90s and that stuff does move around a little bit more in a little bit more lumpy fashion than charge-offs but that's what we're predicting now.

Okay. And I know this is hard to predict as well, but any insight into kind of what charge-off range might look like over the cycle for you guys have been able to kind of have any insight on that. Sounds like pretty stable for the second half of the year this year. But as we go through the cycle any thoughts about what the range might be?

No, I wouldn't forecast beyond that at this point. I can't elaborate on that at this point, John.

Okay. That's great. Thanks.

Bye.

(Operator Instructions) At this time there are no further questions. Mr. Richardson, are this any closing remarks?

Yes, I'll just -- this is Kevin, I just want to take a moment to thank everybody for your attention this morning. Tell you that we feel good about the quarter. We feel good about the efforts that were really approaching the strategies that we're attacking and really doing well in a very tough environment and we'll keep our focus and keep working on the things that we think will add long-term value for the Company. So appreciate your attention and have a great day. Thanks, everybody.

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