Fifth Third Bancorp (FITBP) 2007 Q3 法說會逐字稿

Good morning. My name is Phyllis, and I will be yourself conference operator today. At this time I would like to welcome everyone to the Fifth Third Bancorp third 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) Thank you. Mr. Richardson, you may begin your conference.

Thanks, Phyllis. Hello, everybody, and thanks for joining us this morning. We'll be talking with you this morning about our third 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 condition, results of operations, plans, and objectives. These statements involve certain risks and uncertainties. There are a number of factors that could cause results to differ materially from historical performance in these statements. Fifth Third undertakes no obligation to update these statements after the date of this call.

I am 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 will turn the call over to Kevin Kabat. Kevin.

Thanks, Jeff. Good morning and thanks for joining us, everyone. I have a few comments and then I will turn things over to Chris who will review our financial statements, our credit trends, and also our outlook for the rest of 2007.

I would like to start off by saying that this was a solid quarter for us and we're pleased with the results, particularly given the macro environment that we're operating in. We showed strong revenue growth and expenses were well controlled. Fee growth was outstanding, and NII growth was also quite good, and we hope will continue to benefit from wider, more rational spreads. We do expect some further deterioration of credit as we manage our way through the cycle. However, we've been able to generate core performance that has allowed us to earn through a higher provision and still grow EPS. That will stand us in good stead when the cycle turns in the next year or so.

Our payments business had another strong quarter, up 16% year-over-year. Last quarter we mentioned the signing of Walgreens credit card processing business. They were converted to our system during the latter part of this quarter. The U.S. Treasury business is about halfway converted, and that will be coming on through the first quarter of 2008. Additionally, we just won the rest of the EFT business for our largest financial institution client. We continue to feel very good about this business as we significantly outpace all of our peers in organic growth and expect to maintain our strong mid-teens growth rate.

Results continue to exceed our expectations in the credit card business. We really focused our management team and resources from a lot of areas of the bank into this and it demonstrates the power of that focus. Credit card account originations were up 83% and balances were up 57% year-over-year despite having sold $89 million of nonstrategic receivables last quarter. We have an enormous opportunity here that we have just begun to tap into. We've grown to $1.5 billion in outstandings even after selling over $100 million in balances the last 15 months. We think we have $2 billion or $3 billion of runway ahead of us just in penetrating our own retail customer base beyond the current 14% to 15%. As one of our strategic growth initiatives that we promised to deliver on, we're pleased about the early success we've had here.

In commercial, C&I growth remained solid at 7% over last year. Commercial mortgage and construction continued to slow, driven by lower activity in the marketplace. We had another very good quarter in corporate banking fees as we were really seeing success from the buildout of our capital markets capabilities in loan syndications, asset backed products, and better execution and increased sales in international, foreign exchange, and interest rate derivatives.

Our investment advisors business grew 7% year-over-year with continued strong results in private banking and continued improving results in brokerage. The addition of new management and a focus on improving the quality, productivity, and number of our brokers is beginning to pay off here.

In retail banking we saw another strong quarter for deposit service charges with double-digit year-over-year growth. Retail DDA production was really good in a fairly tough environment, up 6% from a year ago with 7% DDA account growth. In fact, recent industry studies we've seen indicate that we're in the top quartile in retail core deposit growth and stack up very well in key deposit performance categories.

In our consumer lending business auto loan production was strong with balances up 14% year-over-year. For mortgage I am sure you're well aware of the challenges in that sector during the quarter, and as you can see from our results we're not immune to that. Chris will give you more detail on this in a moment. Home equity balances continue to come down a bit due to our tightening of underwriting standards over the course of the last 12 months.

Let me turn to credit. Charge-offs came in at 60 bps for the third quarter in line with expectations and up from 55 bps in the second quarter. NPAs were higher than expected, with the majority of the increase coming from eastern Michigan, northeastern Ohio, and southern Florida. About $22 million of the increase in consumer NPAs this quarter came from debt restructuring for our consumer borrowers. Like all banks, we've seen customers struggle to service their debt, particularly in more difficult geographic areas. We're being very proactive in approaching them to address potential problems before they miss payments or go into foreclosure. It's good for our customers and it's good business for us. We do think charge-offs will be up in the fourth quarter and Chris will walk through this in more detail in just a moment.

We feel very good about our de novo activity. During the quarter we added 14 net new branches and remain on track to add a net 59 branches to our network in 2007. De novo deposit growth remains on track to exceed our target deposit levels. I would also like to mention that we're on pace with our acquisitions of R-G Crown Bank, First Charter, and the First Horizon branches we purchased in Atlanta. We're still targeting a fourth quarter close for the R-G Crown conversion and a first quarter 2008 close on the First Charter and First Horizon branch acquisitions.

Finally, let me say that I have been CEO for six months now, and while we're in a very difficult environment, I am excited about a lot of the actions we're taking as a new management team that are bearing fruit and will continue to do so for years to come. We're delivering on our commitments. We said we were going to diversify our footprint into faster-growing areas and over a relatively short period of time we have made huge strides. We really transformed the demographic profile of Fifth Third. We'll have a third of our branches in growth markets, specifically the southeast and Chicago at the end of the first quarter of 2008. That's double the proportion of just three years ago. Most of that change has been through de novo activity, and I am proud of the activities here investing in our future, the analytical and site selection work that's gone into enabling our success and the fact that we've been able to absorb the initial impact into earnings.

Expected population growth and household income growth in our pro forma footprint weighted for deposits is now roughly the national average. That's a significant improvement and opportunity, and will probably surprise a lot of folks.

We told you we would fix our balance sheet issue last year, and we did. We made commitments to deliver on our growth initiatives like our card initiative and healthcare industry vertical, and we're doing that. We've also been completely transparent about our opportunities and our problems. For example, we've been very clear for a year that we expected home equity to be the most likely source of higher losses, not only for us but for the industry.

The management team, we've been very focused on addressing our issues, particularly as it relates to our credit quality. For example, we've consolidated consumer and home equity underwriting and approval into two regional credit centers. We have reduced exceptions to guidelines and eliminated channels that were producing home equity loans with poor credit performance. We're now delivering all alt-A production under an agency flow arrangement and we're proactively addressing problem loans in the making. We can't eliminate the effects of the market and the cycle, and though they have increased, charge-offs are in line with our forecast at the beginning of the year, though higher than we would like. The steps we're taking will take time to cycle through, but will produce better results in the future. You can expect that as a team we'll remain focused on executing our strategic plan, meeting our commitments, and building a stronger institution going forward even as we work through a fairly challenging time.

With that, I will turn things over to Chris to talk about third quarter results and the outlook for the remainder of the year. Chris.

Thanks, Kevin. Good morning, everyone. I would agree with Kevin that in a pretty tough quarter for the industry our financial results were pretty solid, and hopefully that is beginning to demonstrate to all of you that while we continue to suffer from the same issues as the rest of the industry, we also continue to make significant progress in improving productivity and the profitability of our businesses.

Now before I get to the details of the financial statements and our outlook, let me try to save you some trouble digging through our release by recapping the major drivers of our EPS. As you've seen, earnings per share were $0.71, which we feel reasonably good about. Our results were characterized by strong growth in revenue and pre-tax income before provision which was up 3% sequentially and 9% versus a year ago. Growth in provision obviously offset a good bit of the bottom line benefit, but we continue to show respectable EPS despite that. So while credit costs are masking some of the growth we're experiencing, we feel good about where we are because, as Kevin said, the credit cycle will turn and when it does we'll retain the benefit of having raised our earnings capacity.

I am going to discuss each of these items more fully in my remarks later. But in terms of the major items, third quarter results included a number of offsetting issues including -- starting with fee income. In fee income we had about $0.03 total benefit from securities gains which totaled about $13 million. We also had $15 million in gains from the sale of FDIC deposit insurance credits. Those gains offset losses of almost $0.01 or $6 million on auto loans held for sale that we were planning to securitize this quarter as well as significantly lower mortgage banking income. Mortgage banking income was down $15 million or $0.02 for the quarter, from the second quarter.

In terms of NII and expense items, we had a benefit in NII of about $6 million for dividend adjustments related to repurchase of our repreferred securities. That benefit offsets the $6 million in expenses we incurred in the quarter related to pension settlement expense. Neither of these items are going to reoccur in the fourth quarter.

Then in terms of tax items, we had a net benefit from a variety of items which totaled about $8 million after tax and they were the result of finalization of exams, expiration of statutes of limitations, and state income tax law changes specifically in Illinois which I mentioned to you last quarter. Our effective tax rate ended up at 28% which was right in line with our expectations and it's right in line with our full year outlook. So net-net we benefited to the tune of about $0.015 to $0.02 largely in the tax line from the items I just outlined and then provision exceeded charge-offs by $24 million which raised the reserve to loans to 1.08 from 1.06 but it cost us about $0.03 in the quarter.

Now, as a reminder in terms of comparing results to prior periods, second quarter results were $0.69 and they included $16 million in gains on the sale of single product credit card accounts as well as $7 million in one-time costs associated with our expense reduction initiative. So we netted about $0.01 of benefit there. And then third quarter results a year ago which were $0.68 included net securities gains of $19 million, an $11 million charge related to debt termination, an $8 million pension settlement charge, and finally $10.5 million in gains on the sale of branches and out of footprint credit cards, so all in all we had about $0.01 of net benefit there as well.

Let me move onto the details, starting with credit. It was obviously a difficult quarter from a credit standpoint. There is no getting around that. Charge-offs were 60 basis points for the quarter which was largely in line with our expectations. Though NPA growth at 34% was higher than we were projecting, and we had some upward pressure in the quarter in that market conditions were very poor for NPA and charged-off loan sales. That obviously raises our NPAs and lowers our recoveries. We continue to evaluate opportunities to sell NPAs at the right pricing and we'd expect to do so moving forward. Additionally, as Kevin noted, we did restructure consumer borrowings this quarter and that increased NPAs by $22 million.

Turning to charge-offs, gross charge-offs were 66 bps for the quarter, largely in line with the second quarter. However, lower recoveries resulted in a net charge-off ratio of 60 basis points which was a 5 basis point sequential increase. That puts us at 51 basis points year-to-date.

Now, consumer charge-offs were $79 million or 93 bps versus 68 bps in the second quarter, which was a $24 million increase. Lower recoveries accounted for 7 basis points of the increase. The largest quarterly increase of net charge-offs occurred in auto lending which was up about $10 million and then home equity was also up about $7 million.

The increase in auto losses largely reflected the impact of higher than normal originations in the latter part of 2005. Those vintages are now rolling in their peak charge-off period and we're finding that the 2005 vintage, as well as some of the 2006 vintage, are defaulting a little early and therefore we're seeing a little higher LTV. So the severity of loss on collections is a little bit higher than it has been.

And then, as you probably know, the used car auction market is seasonally weak in the third and fourth quarter, so that's also been a factor on our losses. The 2007 vintage, on the other hand, is performing better at this point in the life cycle than 2005 and 2006, so in terms of new originations we feel pretty good.

In home equity we're seeing most of the losses coming in the higher LTV and broker products, and I've been talking about that for the past year or so. So no surprise there. And, of course, distressed geographies you're all aware of continue to be a big factor. As an example, almost 40% of our year-to-date home equity charge-offs have been realized in Michigan which represents just about 20% of our home equity outstandings. In mortgage and credit card losses were relatively stable throughout the quarter.

Commercial net charge-offs were $36 million or 33 basis points versus 44 basis points in the second quarter. The 11 point decline was driven by a 16 basis point drop in gross commercial charge-offs, partially offset by 5 basis points in lower recoveries. Most of the improvement came in lower commercial real estate and the absence of high dollar write-offs. In fact, unlike the past few quarters, we had no charge-offs recorded this quarter greater than $2 million.

Moving onto provision, provision expense was $139 million and exceeded net charge-offs by $24 million, which as I said earlier increased the allowance ratio to 1.08. We would expect to see provision continue to exceed charge-offs for the near future given our expected loan growth and the expectation for continued growth in NPAs and criticized assets in the near term.

Let me mention just a few more points on NPAs to make sure I cover everything. Let's see. NPAs totaled $706 million or 92 basis points of loans, up 22 basis points from last quarter. That totals $178 million increase or 34%, as I just said. Commercial NPAs were $446 million. We had $106 million (sic -- see Press Release) increase in NPAs in commercial. Most of the increase came from commercial mortgage and construction, particularly in eastern Michigan, northeastern Ohio, and southern Florida. Home builders and developers accounted for about $50 million of the total which is up about $5 million from the second quarter.

Consumer NPAs of $276 million (sic -- see Press Release) were up $61 million (sic -- see Press Release), and they were driven by an increase in residential mortgage and home equity loans primarily in Florida and Michigan. As Kevin mentioned, of that increase $22 million related to proactively restructuring borrowers' debt to better enable them to service their loans, and we'd expect to do more of that in the next few quarters.

Now, again, credit is problematic, but we've made a lot of changes, as Kevin said, since the new team has been in place over the past 12 months in terms of identifying areas of potential and developing stress in the portfolio, tightening terms and guidelines to ensure that credit problems are mitigated, and it is going to take awhile as you would expect for these changes to fully take hold, so you're seeing higher levels of issues currently than we would expect longer term. Based on our analysis of the portfolio and credit conditions in the fourth quarter, we expect to see NPAs increase by a similar amount to the third, and we would expect charge-offs to be up probably in the 10 basis points range or so.

Let's see, let me turn to the balance sheet starting with -- let me start with loans. Loan growth remained solid this quarter, it's up 2% sequentially and 6% year-over-year. Breaking things down a little bit, average consumer loans also grew 2% sequentially and 6% versus the third quarter. C&I loans were up 4% sequentially and 7% compared with last year. Commercial mortgage loans were up about $90 million. That just reflects the perming out of construction loans which was down by about the same amount. Other than that there is very little deal activity going on in the COE (inaudible) sector as you would expect.

Average consumer loans were up 1% sequentially and 6% year-over-year. As Kevin said, we continue to see strong growth in auto loans, up 3% sequentially and 14% from last year and, as you know, we planned to do an auto securitization about $1 billion in the third quarter, but market conditions made that transaction very unattractive from a return prospective, so we pushed that out until pricing improves. Retail credit card balance growth was also very strong, it was up 9% sequentially and 57% year-over-year.

Now, that would have been 18% sequentially and 75% versus last year excluding the sale of $89 million of nonstrategic credit card accounts last quarter, and that's really pretty remarkable given that our card growth initiative has only been in place since January. As Kevin said, originations were up 83% year-over-year, and that translates into an increase in monthly card originations from just under 14 cards per month per store last year to more than 28 per banking center this year, and those sales continue to increase. We were actually at a monthly rate of 32 cards per store last week. We're confident that Charles Drucker and John Grock, our credit card executives, are going to have production at best in class levels by year end.

Moving on to deposits, average core deposits were down a little less than 1% sequentially and up 2% from a year ago. Transaction deposits excluding CDs were up 3% year-over-year, driven by 5% retail growth and 1% commercial growth. Looking at the key deposit lines, DDA balances were down 2% sequentially and 4% year-over-year. The decline continues to relate to lower commercial DDA balances, that's consistent with the last few quarters. Commercial accounts have grown. They're up about 1%, so we're holding onto our customers, they're just carrying lower balances. The retail DDA balances are up 6% from a year ago on 7% account growth offset by about a 2% reduction in average balance.

Interest checking balances declined 5% sequentially and are down 12% versus a year ago, also consistent with the last few quarters. Most of the run-off from this product relates to our customers moving balances into savings and money market products as we have brought our pricing and IBT in line with the market over the last couple of years. Now, as a result of this shift and also very good management of CD pricing, savings balances grew 5% sequentially and are up 25% versus a year ago. And then finally, retail CDs are down 5% year-over-year and 5% sequentially which is right in line with our expectations.

We've been very vigilant about our pricing on CDs as well as our pricing on PUB funds, and while that has caused some balance erosion, our average weighted rate paid for interest-bearing core deposits was 3.36%. That's down from 3.42% in the second quarter. So our everyday great rates pricing strategy is really doing a very good job of managing the trade-off between volume and rates and still providing the right value for our customers.

All right. Let's move onto revenue starting with NII. NII was up 2% from last quarter and 6% from the same quarter last year. Earning assets were up about 2% from last quarter but NIM was down 3 basis points to 3.34. Now our year-to-date NIMs now stands at 3.38 which is right in line with our full year forecast of 3.35 to 3.40. Last quarter we told you we expected the NIM to be down a few basis points this quarter due to a full quarter effect of our hybrid issuance and our share repurchases, and as I just said we ended up down 3 bps. Of course a lot changed in the quarter. Compared to our forecast, the repurchase of our repreferred stock helped the NIM this quarter and the behavior of rates obviously helped origination spreads and wholesale funding costs, but those benefits were offset by the impact of higher nonperforming loans and the decision to postpone our auto securitization. At the end of the day we ended up right where we expected to be, but we didn't necessarily get there the way we expected to. I am going to talk a little bit more about margin in the outlook, but we would expect fourth quarter NIM to be fairly stable with where we are right now.

Moving on to noninterest income, fee income growth was very strong driven by payments processing revenue, service charges on deposits, and corporate banking revenue. Our payments processing results continue to be exceptional. Processing fees were up 4% sequentially and 16% versus a year ago. As Kevin mentioned, we're substantially outpacing all of the large processing companies in organic growth. We have an incredibly strong competitive position in this business, and we see nothing on the horizon that would cause us to change our mid-teens growth expectation in the foreseeable future. That's particularly true given the disruption in the competitive marketplace.

Looking at the payments business in a little more detail, revenue from the merchant segment was up 8% sequentially and 23% from a year ago which is really fantastic. Financial institutions revenue was up 2% sequentially and 7% from a year ago, and finally, card related revenue was flat sequentially from a seasonally strong quarter for debit card usage and up 15% from a year ago.

As we've mentioned in the past, we believe our segment reporting makes it difficult for you to determine the real contribution from our processing business, and so we're really focused on adjusting our reporting, and I hope that we'll have that done in time for our 10-Q. I think it is really important that you all get a better look at FTPS as though it it were a stand-alone business, so we're hard at work on that. Switching to deposit service charges, we had another strong quarter, up 6% sequentially and 13% from a year ago. Consumer service charges drove the increase, growing 8% -- I am sorry, they are up 11% sequentially and 19% year-over-year. This income -- this increase reflects the higher levels of customer activity as well as an increase in the number of consumer DDA accounts which, as I just mentioned, are up 7% from the third quarter last year.

Commercial service charges grew much more modestly at 1% sequentially and were up 5% year-over-year. Investment and advisory revenue decreased 3% sequentially largely due to seasonality in the brokerage and private banking areas that's related to business that's typically driven by second quarter tax planning. Private banking revenue was up 3% sequentially and 10% year-over-year and that just reflects continued strong performance across the business as well as some nice new customer additions. Retail brokerage fees were seasonally down 9% sequentially but up 7% versus last year reflecting increased broker productivity as well as success we're having in terms of broker hiring during the last few quarters.

Corporate banking revenue was up 3% sequentially and 15% year-over-year. Bruce Lee and our affiliate teams deserve a lot of credit for the consistent strong growth we've seen across the business, particularly in syndications, asset backs, customer derivatives activities, as well as improving letter of credit fees. This is still an undersized business for us but, as Kevin mentioned, we're seeing real results from our investments and upgrading the talent here and this still remains a great opportunity for future growth.

Mortgage banking revenue was $26 million for the quarter, down from $41 million in the second quarter. This was a very disappointing quarter for us in mortgage, and we missed our forecast by a very wide margin. The good news is that we didn't have any huge write-downs. We don't have real -- a whole lot of capital market exposure given our business model, but execution of profitable transactions was especially difficult this quarter. We've got new leadership in our mortgage business, and they're very focused on identifying opportunities to earn our way through these conditions because we think it is going to remain tight for the next few quarters. The decline in mortgage revenue was largely due to significantly lower gain on sale margins which, as you know, was caused by widening credit spreads in the mortgage market. I am hopeful that gain on sale margins will start to return to more normal levels in the fourth quarter, but that hasn't happened yet and so it is premature to start to count on that.

As we note in the release, originations were down modestly from the second quarter, but they were still fairly strong. A big driver of the drop in originations is our elimination of a number of products and channels as Kevin mentioned. We've shut down our national brokered home equity origination channel due to the poor performance of that channel, and we're also -- we also have eliminated all of our Alt-A production except that which we're able to deliver under agency forward flow agreements.

During the quarter we also incurred $3 million in mark-to-market losses stemming from the transfer of $470 million of jumbo mortgages and $110 million of Alt-A mortgages that were held for sale. We've moved those loans to the portfolio. Now we have been originating jumbos for sale, but we'll be holding them in the portfolio going forward as they meet all of our criteria for portfolio and product and they are really one of the best relationship products, so that's the right decision for us. The loans we moved during the quarter had a weighted average FICO of 740 and an LTV of 72%.

In Alt-A, as we've told you, we've moved very aggressively to try to stay ahead of changing market conditions. We wanted to develop this product without risk of holding it. Now, we're one of a handful of banks that in the last quarter has been able to arrange for future Alt-A production to be delivered within flow sale agreements, and so we feel good about that, and we don't think you should expect any future warehouse risk from this product. The $110 million of loans we moved to the portfolio had a weighted average FICO of 700 and LTV of 72%.

All right. Other noninterest income decreased 3% sequentially and was up 6% year-over-year. As I said earlier in this quarter's results we had a $15 million gain on the sale of FDIC deposit insurance credits partially offset by a $6 million loss on auto loans that were held for securitization. Last quarter's results included the $16 million gain on the sale of credit card accounts, and third quarter of 2006 results included gains on the sale of branches and card accounts which I mentioned was accounted for $10.5 million.

Moving on to expenses, we had another quarter of well-managed expenses. Our reported expense growth was 2% sequentially driven by higher payments processing activity and 6% growth compared with last year, also due to higher payment processing activity as well as higher de novo related expenses and technology investments. Now, excluding payments processing, expense growth was flat sequentially and up 4% year-over-year. Compensation expense, salaries incentives, and benefits of $377 million was flat sequentially and up 4% year-over-year. Benefits included $6 million of pension settlement expense this quarter compared to $8 million last year. This tends to hit us in the third quarter each year and we would expect to see a similar or smaller number in the third quarter next year.

Second quarter salaries expense included $6 million of severance. Again, that was related to the expense initiative reduction we announced at the end of the first quarter. Otherwise incentives on strong fee growth in merit increases drove the year-over-year increase. Payments processing expense was up 9% sequentially and 25% year-over-year. This expense line is being driven by 22% growth in transaction volumes. As we mentioned last quarter, growth in this line will be a couple of percentage points higher this quarter -- in the fourth quarter due to the conversion of national merchants as well as the effect of mix shift. The merchant business is our largest one and continues to grow the fastest of the three segments and it also has the highest efficiency ratio of the three. I just note here that other expense in third quarter '06 included the $11 million charge for early termination of debt.

All right. In terms of capital, our tangible equity ratio was 6.88, down 4 basis points but still very strong. As we have told you we expect the TCE ratio to be about 6.5 at year end in line with our target due to the impact of R-G Crown which will reduce the TCE ratio by about 40 basis points. Regulatory ratios are up about 40 basis points sequentially and that reflects the retail hybrid issuance that we did in August. As we noted last month, the repurchase of our repreferred stock will reduce fourth quarter regulatory capital ratios by about 65 bps. However, we expect to do further capital securities issuance in the coming quarter or two to further bolster those capital ratios.

Okay. Let me turn to the full year outlook. You'll find that on page nine of the earnings release. As we've told you in the past, we're going to update this each quarter and, again, we've highlighted the line items where we've made an adjustment to the July outlook to save you some time. I do want to point out that these expectations are excluding the acquisition of R-G Crown which we plan to close sometime in the quarter. With three quarters in the books, though, at this point I would say I am fairly confident in our ability to meet these expectations and while there have been a couple of adjustments, I don't think there is any significant change overall.

Starting with NII, our NII growth outlook remains unchanged, and it is still in the mid-single digits. This reflects a couple of things. Our share repurchase activities and debt issuance, as you would know, have been replacing free funding with debt. That's lowering NII. Obviously, though, the offset there is in EPS. Commercial loan growth is still expected to be fairly sluggish given the uncertainty in the overall economy and specifically in the Midwest part of our footprint. C&I growth remains good, but we see very little COE demand, and in this environment we continue to feel very strongly that slower growth is a better option for us right now, and I think you'd agree with that. Consumer growth has been solid, in the 6% range, and that feels relatively sustainable.

In terms of core deposit growth, we expect it to be in line with expectations. Retail core deposits held up pretty well, but we still haven't seen any strengthening on commercial side, and so I don't want to start to bet on those results at this point, but we are hopeful we'll start to see that turn.

Turning to net interest margin, in July I told you that we expected the third quarter margin to be down a few basis points, and it ended up down 3, as I said. For the year we still expect the margin to be in the 3.35 to 3.40 range, and that's been our forecast all year. The fourth quarter should be stable. However, the addition of R-G Crown is going to reduce the NIM by about 3 bps given the composition of their balance sheet, so we would expect to be around 3.34 to 3.35 for the full year including Crown.

Let's see. Turning to noninterest income, again no change to the fee outlook, payments business continues to do very well, and we remain very, very confident with our mid-teens growth expectation there. We expect deposit service charge and corporate banking revenue growth to be consistent with the third quarter results, so we feel very good about that. While we expect that the mortgage business will rebound somewhat from the lows of the third quarter, we still see a lot of uncertainty there although we would expect originations to be consistent with where they were in the third quarter.

We see an increase in our outlook for expense growth to the mid-to high single-digits. As I have said all year, if revenue expectations developed as planned, we thought that expense growth would likely be in the 7% range. Revenue growth has continued to be good and was very good this quarter. Merchant processing revenue growth in particular has been exceptional though that business has an average efficiency ratio over 70% and that's the big driver pushing us into the high-end of our range. With Crown we'll probably end up at about 8% for the year.

I remind you that about half of our expense growth is in processing and de novo expense. Underlying expense growth we would expect -- we forecasted to be in the 3.5% to 4% range, and I still feel very good with that expectation. We've raised our net charge-off outlook from the low 50s to the mid-50s to reflect third quarter results and fourth quarter expectations. That's more in line with our expectations at the beginning of the year but it's a little bit higher than we told you last quarter. As I mentioned, we expect fourth quarter charge-offs to be upwards in the 70 basis points range. As I have already noted, we still expect NPAs and delinquencies to continue to trend upwards a little bit.

Our effective tax rate outlook remains between 28 and 29 for the full year, probably towards the high-end of that range for the fourth quarter. And then one final thing. We would expect R-G Crown to produce about $0.01 of dilution in the fourth quarter and an additional $0.01 in one time charges in the quarter.

Okay. To wrap things up, I know the results have some noise in them, but we feel pretty good about our underlying businesses, especially in light of the difficulties that we experienced in the third quarter. There is a lot going on, and it is a very, very tough environment as you all know, but our 21,000 employees we really feel are doing an incredible job in terms of implementing a lot of very, very positive change here at Fifth Third while at the same time building on our strength. From my perspective, morale is as high as it has been and it continues to grow. Everyone is very focused on executing our strategic plans, and we've got a lot of confidence in them, and we're very committed to delivering value to you as shareholders. So with that I would like to thank you for your attention this morning, 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, Mike.

Good morning.

Good morning, Mike.

First just on your vision here, you highlighted that your footprint is one-third in growth markets, and I thought you said that was double what it was not that long ago. Where do you want to take that fraction and how do you define growth markets?

Mike, we've defined the growth markets really relation to the demographic and population growth exceeding the rest of the footprint and exceeding national averages, so that's kind of a rough approximation of how we define it. Our expectation and our orientation is really kind of getting a mix to more of a 50/50 split, if you will or growth rate if you will. That's what we would expect to try and drive to through our growth and through the opportunities that we see before us, and probably not in the too distant future, in the relatively short-term. With the progress that we have made in the last two to three years we think we can continue that same type of expected progress, and as we mentioned as well, most of that has been through our de novo expansion, and we also believe that strategically we've set that up to continue to be able to invest in those high growth markets again through organic expansion and the de novo strategy very well. So hope that helps in terms of some of our perspective.

And in addition to the southeast and Chicago, any other growth markets that are on your radar screen?

Obviously we do spill and look into the mid-Atlantic arenas, but again, we're going to be opportunistic as it evolves over the next few years, but there is a lot of work to be done in terms of where our platform is today and we feel good about the positioning that we have the Company really ready to take on.

And so additional acquisitions possibly?

Yes. As I mentioned, obviously, Mike, it is a challenging environment out there. Pricing hasn't changed a heck of a lot from that perspective, but I think if you look at it overall, the combination of what we've done organically specifically through the de novo strategy has been a very effective approach for us, and so while we're open to that, we'll consider that and we'll continue to be opportunistic in that route, we have a good organic platform to drive off of that growth as well, so that's what you could expect us to continue to execute on.

And then one unrelated question over to credit quality, so NPAs were up one-third and they should go up another one-third in the fourth quarter, and I guess your NPAs to loans are kind of above peer average, at least what I am looking at, and I guess they'll go up higher still, and Fifth Third has a long history of having a good credit culture. How are you thinking about credit quality today versus history and also if you can just give a little more detail on the auto loans? You said some of the severity of loss was worse than you expected and at the same time you're kind of growing at 14% year-over-year.

Mike, this is Chris. Let's see. First of all, in terms of the NPA growth, I can't give you an exact number, but I think 34% is what we saw this quarter. I think that was, if you look at it in two pieces, the biggest piece obviously credit deterioration was probably about 25%, and 9 or 10% was due to the troubled debt restructuring and the lack of a NPA sale. I can't tell you what we're going to do in the fourth quarter, but I would expect that not having an NPA sale is going to be unusual for us. We would look to do those each quarter. That would offset some of the NPA growth.

Then the troubled debt restructuring, while it is a little too early to tell how those credits are going to perform once they're restructured, I put those in a slightly different category, so I might look at the underlying NPA growth as a little bit lower than the 34%, more in the 25% range. In terms of autos, I think the bigger -- while there was an increase in severity of loss just given the earlier charge-offs in the '05 vintages, and I think you would see some of that occurring in some of the other -- some of our competitors across the country for some reason. There is higher charge-offs in that vintage.

Why do you think that is? The big question is, is the consumer problems in mortgage spilling over to other areas, and now we have auto to add to that list or no?

It is a good question, but it is one I really couldn't give you a great answer on yet, but that's something we're very focused on trying to figure out exactly what happened in 2005 that would drive that. By comparison, if it was just a spillover from consumer, you would expect that the 2007 vintage would continue to deteriorate even at this point in its maturity, and in fact the opposite has happened. It has performed a little bit better. Then when we look at other consumer lending like credit card, we said balances are up, but in fact we don't see any stressing on credit card at all. In fact, that's performing very, very well, so I am not sure if there was a change in standards or something else in 2005 and we're very focused on trying to figure out why that's occurring. The bigger issue in the quarter is due to seasonality, and the market is always very weak in the third quarter, and it has been even weaker this quarter because of the influx of inventory. So I think that's the bigger driver. So if you look at the 2007 vintage, it is performing well. The growth is, we feel good about the stuff we're originating right now.

How long does it take for an auto loan usually to go bad? I mean, '07--?

Well, they begin charging off -- you see the charge-offs even at very low levels from the time you write the loans, and so you see 90 days out, you would see loans already starting to be delinquent and starting to fail. We don't see that as badly in this new vintage as we did in '05, and '06, too, at a lower level. Your questions are very good questions, and you're right on the right point. It is just I would not assume that just because '05 and '06 are poor vintages that that's going to continue through this year.

All right. Thank you.

Thanks, Mike.

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

Hi, Kevin and Chris.

Good morning, Matt.

Chris, when we met in September you had mentioned that if mortgage spreads remained wide which they have you might add some securities in the fourth quarter. Are you buying securities and if so, what type?

Well, if they remain wide, mortgages -- mortgage pools have actually come down a little bit. Securities are probably not where we want them to be before we started to add. If we saw spreads maybe widen by about another 30 or 40 basis points, then I think they would be at or about the point where we would want to start to add things. Right now the returns would still be a little tight for us.

Okay. Is this dependent on your view of what the Feds could do? So if you thought the Fed was going to cut one or two more times you would look to add now or is it a risk premium?

No. Exactly. It is that -- if the outlook for the Fed gets a little clearer, then things would look a little more appetizing.

Okay. Then just separately, you have talked about securitizing or selling some lower spread assets, I think from the auto book in the past. Obviously this couldn't get done in 3Q. What are the plans going forward there as you think about '08 and what do you intend to do with the freed up capital?

Well, first of all, it is not a tremendous amount of capital, and I am not sure we have a specific use for that capital other than staying at our 6.5% target given the 3 purchases we're going to have to make. This first securitization is already factored into completing those transactions and still staying at 6.5%. Long-term, as opposed to the next quarter or two, we are going to build out an auto securitization platform. We're very committed to that. We think that's the right way to run the business, and so we will do that. In the short-term, though, the timing of the transactions is going to be entirely dependent on market pricing.

Over time would you like to bring down your auto exposure relative to overall loans with a target in mind?

Yes. I would say while we don't talk a whole lot about a specific target, we would start at maybe half the size of what the book is today.

Okay. Just lastly, I am sorry if I missed it, but what percentage of your home equity is brokered?

Hang on. Let's see. I'm going to say it's about -- I don't have the exact number, but it is about somewhere between 20% in a quarter, maybe the low 20s.

Okay. Thanks very much.

Thanks, Matt.

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

Good morning, guys.

Good morning, John.

Good morning, John.

Chris, I was wondering if you can give us a little bit of color on what the drivers are of the level of reserve builds I guess with NPAs and charge-off ratio going up, why don't we see a growth in the ratio of reserve to loans?

Well, I will give you a general answer there, John. There is not a linear relationship as you know between NPAs and reserves. It really has to do with the expected loss from those loans that are moving into NPA status, and in our case the vast majority of them are commercial loans, and our loss expectation on those loans are all factored into the calculation. I mean, we looked at what our -- in fact, we not only look at what our loss experience has been over the last couple of quarters, we really tightened that up to make sure we're looking at what our loss experience has been in the immediately preceding quarter as opposed to looking over the average of a year or two. So I think we're looking very accurately at credit by credit or pool by pool what's flowing into NPA, what the cure rates have been, and what the expected losses are, and that's how the allowance is built.

Okay. I guess I just figured with the charge-offs forecast going up, as it is for everyone, you would see more in terms of reserve building, but you're just saying it's a bottoms up and that's what it spits out?

Yes, it is very much a bottoms up.

And just to clarify one of your other answers, did you say that the NPA sale market has gotten a little better from virtually slowing down over the summer?

I really don't know. You really can't tell until you put a portfolio out to market what the pricing is. It turned out that when we -- we waited, just happened to be the way it happened, is that we put a portfolio out. It was at the end of the quarter, and we expected to sell it, and I think everybody and their brother came to market in the same week, and so the pricing was poor, and we pulled it, and pricing could have improved by now, and maybe it hasn't. I don't know. But we will -- if we have to hold those loans, we'll hold them. If we can sell them at the right price, we will, but we're not going to give them away.

Okay. Thanks, Chris.

Thanks, John.

Sure.

Your next question comes from the line of Ed Najarian with Merrill Lynch.

Good morning.

Good morning, Ed.

First question has to do with credit quality and with respect to commercial mortgage loans and commercial construction loans. We saw that that was one of the biggest drivers of the increase in NPAs this quarter, yet when we look at the charge-off ratios, commercial mortgage loan charge-offs 26 basis points down from 56 basis points in the second quarter and commercial construction 35 basis points down from 48. So it would appear like potentially you're deferring some of the loss recognition of these NPAs in commercial mortgages and commercial construction. Can you just speak to the very low charge-off ratios that you recorded this quarter in those two categories?

Well, I guess I could talk to it, but, Ed, I guess I would respond initially that you can't defer loss recognition, and we're certainly not in any way doing that so if you specifically -- if you're trying to -- if you want me to reconcile the amount of NPA in-flow to the charge-off ratio, I don't think I could do that right at this moment. I would gladly try to get you some more data off line, but I think the loss recognition we had in the quarter is accurate, and our charge-off ratios in the rest of our lines have moved around quite a bit, and I don't think you can try to reconcile them one for one.

But I guess the one-way we should think about it is that a lot of the migration to NPA that we saw this quarter was not written down materially. Would that be correct because if it would have been we would have seen higher loss ratios in those categories?

The one thing I would say is had we done a charge-off sale which we expected to, we would have seen higher charge-offs. I am sorry, an NPA sale. We expected to to do an NPA sale of about $60 million, and that was the sale that didn't happen. If I had to have guessed it, the loss might have been 10% of that, and so, yes, we would have seen higher losses to a tune of $10 million on that stuff that we would have sold. The rest of the stuff that flowed in I couldn't reconcile what that would have done to charge-offs in the quarter.

Okay. And then secondarily you've spoken a lot about de novo branch expansion in '08, and I think you talked previously about opening 50 branches in Chicago next year, and then some other de novo expansion in some other markets. Could you just put color on how you expect that to impact the growth in your operating expenses, outside of sort of the typical growth in the core franchise?

Yes. Well, I will give you some top level numbers. As Kevin said we're going to bring on 59 stores this year. Next year our current planning would say we bring on about 80, so about 20 additional stores. In terms of the numbers, there wouldn't be 50 in Chicago, there would probably be about 50% of those stores in Florida and the southeast now. There is probably going to be 20 or so in Chicago and then 20 stores will probably be spread throughout other parts of the franchise like Tennessee and other areas. So there is probably a couple of cents of dilution maybe an extra $0.01 from the extra 20 stores, maybe $0.02.

So could you give us a sense of those 80 stores, what kind of operating costs that entails, opening those 80 stores on a year-over-year basis? Or on a percentage basis? How much the opening of the--?

On a percentage basis -- well, I am telling you that assuming that we've already got 60 -- or roughly 60 stores opening this year, so that's in our run rate, we'll have about 20 more next year, and that will cost us about $0.02 in incremental dilution next year from the expense drag from bringing those stores on.

Okay. And then last question, in terms of the First Charter acquisition, do you have the percentage of their loan portfolio that is in construction or residential and commercial construction and land development lending?

We do have it. I don't have it with me, Ed, but I would gladly, I will have someone follow-up with you off the -- after the call.

Okay. Thank you.

Sure.

Operator?

Your next question comes from the line of Andy Walker with New Age Capital.

Good morning, Andy. Is Andy still with us?

Andy Walker, your line is open.

Okay. Any other questions?

At this time, sir, there are no further questions.

Let me just close it down, then. Thanking everybody for joining us. As we said at the beginning of the call, there are a lot of really positive developments in a very tough quarter for the industry, and particularly in terms of the credit challenges before us, but we feel that, really good about the improvements we're making to the business are going to stay with us. So we thanks for your attention, and we'll talk to you next quarter.

This concludes today's Fifth Third Bancorp third quarter 2007 earnings conference call. You may now disconnect.