Fifth Third Bancorp (FITBP) 2009 Q2 法說會逐字稿

Good morning, my name is Nakesha, and I will be your conference operator. First I would like to welcome everyone to the Fifth Third Bancorp second quarter 2009 earnings call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you, I will now turn the conference over to Mr. Jeff Richardson, Director of Investor Relations. Sir, you may begin the conference.

Thanks. Hello and thanks for joining us this morning. We'll be talking with you today about our second quarter 2009 results.

This call may contain certain forward-looking statements about Fifth Third Bancorp pertaining to our financial condition, results of operations, plans and objectives. These statements involve certain risks and uncertainties. There are a number of factors that could cause results to differ materially from historical performance in these statements. We've identified a number of these factors in our forward-looking cautionary statement at the end of our earnings release and in other materials and we encourage you to look at those factors. Fifth Third undertakes no obligation and would not expect to update any such forward-looking statements after the date of this call.

I'm joined on the call by several people, Kevin Kabat, our Chairman, President and CEO, Chief Financial Officer, Ross Kari, Chief Risk Officer, Mary Tuuk, our Treasurer, Mahesh Sankaran and Jim Eglseder of Investor Relations. During the question and answer period, please provide your name and that of your firm to the operator.

With that I'll turn the call over to Kevin Kabat. Kevin?

Thanks Jeff. Good morning, everyone and thanks for joining us. A release went out a couple of hours ago, so hopefully you've had a chance to review it and we can address your questions during this call. Second quarter results were generally in line with the outlook we provided in April and we've had a lot of announcements this quarter.

With the SCAP results, capital actions and the completion of the processing joint venture, so I expect that our comments this morning won't be surprising to you. With that being said, I'd like to take the opportunity to provide some perspective on our actions and results before turning things over to Mary and Ross for a more detailed discussion of our credit and our financial performance.

For the first time in a while more questions were answered than raised during the quarter for the industry with the publication of the SCAP results and the capital raises that followed. The completion of the SCAP marked a critical turning point for the industry. Uncertainty about the levels and required quality of capital for large banks was addressed and new standards established. We've exceeded our Tier 1 common equity commitment under the more adverse scenario by 60% and we continue to attack credit and aggressively manage exposure to economic weakness and market volatility.

Total loan losses for the first half of 2009 came in at $1.1 billion and that compares to an assumption under our SCAP more adverse scenario submission of $1.6 billion for the same period. Net charge offs increased to $626 million in line with what we expected. As for the third quarter, we're not expecting a significant increase, but our current expectation is for loan losses in the third quarter to show a moderate increase from the second quarter, with higher commercial real estate charge offs partially offset by lower consumer real estate charge offs. At that point we'll be through three of the eight quarters of the SCAP assessment and would currently expect to have incurred something like 20% of the assumed losses, so we don't expect to incur anything like the losses incorporated into the SCAP assessment. Our pretax, preprovision net revenue is also tracking well ahead of the SCAP assumptions.

Fifth Third's capital position is very strong. During the quarter, we closed our processing joint venture with Advent International, generating a $1.1 billion after-tax gain and a $1.3 billion benefit to tangible common equity. We raised $1 billion in new common equity with the offering oversubscribed by three to four times. We also generated $441 million of common equity through the induced conversion of about two thirds of our Series G convertible preferreds. Finally, last week, we completed the sale of our Visa class B common shares generating about $200 million of additional common equity. The results of these actions is that we've generated common equity of $650 million in excess of the SCAP requirement and we expect future capital levels to significantly exceed those assumed in the SCAP.

We're currently at 7% on the Tier 1 common ratio, including the completed Visa transaction. Our capital levels significantly exceed all well capitalized levels as well as our own target levels. Our capital mix is rich with common equity and that mix feels about right relative to where we want to be going forward after repaying TARP. We also have one of the strongest reserve ratios in the industry at 4.28% of total loans and 135% of NPLs. The reserve covers current levels of annualized charge offs by 1.4 times.

The same time, our earnings power remains very strong and our earnings generation relative to risk-weighted assets is higher than most of our peers, which was a positive for us under the SCAP methodology. Results for the second quarter were in line with our expectations and continue to reflect healthy core trends, offset by elevated credit costs. We reported net income of $882 million compared with net income of $50 million in the first quarter. Reported results included the $1.8 billion processing gain and other one-time items that largely offset one another. Excluding those, we would have had a loss of about $200 million, which included the effect of providing $415 million in excess of net charge offs.

We continue to see good momentum in most of our businesses. Core preprovision net revenue of $680 million increased 14% sequentially, excluding the items mentioned in the front of the release. We saw a significant improvement in the net interest margin, better than expected, up 20 basis points from last quarter. That was driven by improved liability pricing and wider loan spreads, which drove 7% sequential growth in net interest income. We expect continued expansion in the net interest margin during the second half of the year.

Fee growth remains strong, up 5% on a core basis from the first quarter of 2009. It was a great quarter for deposit growth, average core deposits were up nearly $2 billion sequentially or 3% with very strong DDA growth, up a billion sequentially and up $2.7 billion or 19% from a year ago. Our focus on improving customer loyalty is bearing fruit and is reflected in these results. We're only halfway through the year, but our retail team has already achieved its customer loyalty goal for 2009 which we believe would put us in the top quartile. Our employees' continued hard work on both service and sales as well as our every day great rates strategy continue to position us well across our footprint.

We had another record quarter in the mortgage business, originating $6.9 billion of residential mortgage loans versus $4.9 billion in the first quarter. Mortgage banking net revenue was $188 million in the second quarter including MSR hedges compared with $150 million in the first quarter. Deposit service charges were stronger than expected, increasing 11% sequentially with especially strong growth in retail service charges. The increase was driven by strong growth in net new accounts and transaction activity. Again reflecting the success of our concentrated efforts to improve cross sell and enhance the customer experience.

Processing fees increased 9% sequentially and merchant revenue was up 20% sequentially. Advent's technical knowledge and international expertise will help accelerate growth in this business where we retain a 49% interest. There is a lot of disruption in the industry and our business hasn't changed. We've got the same people and the same platform as before and we believe we can take advantage of the current situation and environment.

Expense management remains a key focus. Core expenses were flat from the first quarter despite the strong revenue performance and base compensation was down 3% sequentially. We continue to aggressively manage expenses, even with heavy investments and loss mitigation and collections.

Mary will cover credit in detail, but at a high level, the environment remains difficult. We worked very hard to mitigate losses around decrease risks in our portfolios and we've seen some deceleration in negative credit trends on the consumer side. Although the environment remains difficult and signals are mixed, mixed is better than deteriorating everywhere. Housing prices remain under pressure, although recent data show a slowdown in the rate of decline in many markets. The flip side of this is that affordability continues to improve and that's important for reaching equilibrium. Housing inventories fell again this quarter, which is also a positive indicator.

However, unemployment remains an issue and until that peaks, it's going to overshadow a lot of other more positive economic indicators. Both consumers and companies are being cautious. Personal saving rates are higher than they've been in a decade. Those behaviors have increased our core deposit to loan ratio by nearly 700 basis points over the past year. So while things remain challenging, we've seen some signs that the environment may be beginning to stabilize somewhat, however, it's too early and there's too much uncertainty at this time to characterize exactly when trends will turn.

We've taken aggressive actions and we've taken a lot of losses already through charge offs. We have plenty of capital in reserves and our balance sheet is strong enough to handle anything we might reasonably expect and we certainly don't expect losses to be anything like those assumed in the SCAP stress test. Now it's a matter of beginning to generate consistent earnings and that's going to be dependent on loan losses trending lower which still may be a quarter or two away.

With that, I'll turn it over to Mary who will discuss credit results in more detail. Mary?

Thanks, Kevin. I'll start with charge offs. As Kevin mentioned, charge offs for the quarter were in line with our expectations.

Commercial net charge offs in the portfolio totaled $342 million or 281 basis points, up from $256 million or 208 basis points in the first quarter. C&I losses totaled $177 million with nearly 40% of the losses attributable to auto dealers and real estate related industries. We have a total of about $1.5 billion outstanding to auto dealers, which is fairly well distributed across the footprint. We've worked that down significantly over the past few years.

About half of our exposure is to nondomestic car dealerships. Of the 2,000 Chrysler and GM dealers, we have loans to only eight Chrysler dealers and 16 GM dealers that are on the closure list. Many of these are multi brand dealers and we don't expect significant problems from these relationships overall. Although our exposure to GM and Chrysler dealer actions is manageable, we did feel some affect with $28 million of charge offs in the dealer portfolio in the second quarter. We currently expect significantly lower auto dealer losses in the third quarter and for C&I losses to be lower, although they will remain elevated until the economy begins to improve.

Commercial mortgage losses of $85 million were up $8 million from the first quarter with Michigan and Florida contributing 45% of losses. Commercial construction net charge offs were $79 million with Michigan and Florida generating 54% of losses. We expect commercial real estate losses to increase again in the third quarter with Florida continuing to be a difficult market. We may be seeing losses starting to stabilize in Michigan which would be a welcome change from trends over the past couple of years.

Losses on home builder loans were $76 million during the quarter, a $12 million increase sequentially and we expect third quarter losses to be consistent with the second quarter. We suspended home builder originations in 2007 and have aggressively charged down loans in that portfolio and work to reduce our exposure. Portfolio balances of $2.1 billion are down over a billion dollars from a year ago.

We also suspended new originations for nonowner occupied commercial real estate in early 2008, which are down overall by $2.3 billion or 18% from this point last year. If you'll recall, most of our transfers to held for sale and writedowns in the fourth quarter were the most troubled loans in these two portfolios in Michigan and Florida. Net charge offs in the consumer portfolio were $284 million in the second quarter, a $50 million sequential increase. As with the commercial book, we saw continued pressure from Michigan and Florida, which constituted 52% of consumer losses on 29% of total consumer loans.

To give some more detail by product -- net charge offs on the residential mortgage portfolio were $112 million, an increase of $37 million from the first quarter. Michigan and Florida accounted for 75% of losses, despite representing only 44% of the mortgage portfolio. However, they are beginning to show some early signs of improvement from a mortgage loss standpoint.

Home equity losses rose $16 million sequentially to $88 million, including $39 million of losses on brokered home equity loans. The net charge off rate on brokered home equity was 7.4% annualized, which is about four times the level of loss experienced on our branch originated book. That brokered portfolio is down to $2.1 billion of outstanding balances and continues to run off. We're seeing favorable trends in the portfolio that could lead to more positive movement in future losses, depending on economic conditions.

Auto loan net charge offs were down $10 million sequentially, reflecting seasonality and higher values received at auction. And credit card losses were up $9 million compared with the first quarter. We expect auto losses to be seasonally higher in the third and fourth quarter and for higher levels of bankruptcy to continue to negatively affect card losses, although the card portfolio is relatively small at $1.9 billion. Looking at charge off expectations overall, as Kevin noted, we currently expect losses in the third quarter to increase from second quarter levels with higher charge offs on commercial real estate partially offset by lower charge offs on consumer real estate.

Now, moving to NPAs. NPAs, including held for sale, totaled $3.2 billion at quarter end. Excluding $352 million of NPAs related to our held for sale activities where the loans have already been fully marked, NPAs totaled $2.8 billion or 348 basis points of total loans. Florida and Michigan remain the most troubled geographies and account for 42% of NPAs in the portfolio.

Commercial NPAs in the loan portfolio increased by $193 million or 10% from the first quarter, better than expected. Although growth has decelerated, we don't expect growth to remain this low in the third quarter given general commercial credit trends and a couple of larger loans we have projected as possible nonaccruals next quarter. Particular areas of continued stress include Florida and nonowner occupied real estate.

In terms of second quarter commercial NPA inflows, they were concentrated in commercial real estate related categories. Commercial construction NPAs increased $138 million, driven by nonowner occupied properties where the NPA ratio is three times the owner occupied levels. Commercial mortgage NPAs were up $72 million, with Florida accounting for $38 million or 53% of the increase, again, with most stress in nonowner occupied properties.

C&I NPAs were down $42 million from the first quarter. Real estate related industries and auto dealers were disproportionately represented at 27% and 8% of C&I nonperformers respectively. Across the portfolios, residential builder and developer NPAs of $613 million or 28% of total commercial NPAs were up $59 million sequentially, which is similar to what we'd expect in the third quarter as well.

Moving to consumer NPA trends. Consumer NPAs in the portfolio totaled $628 million at the end of the quarter, a $2 million sequential decrease from the first quarter. During the quarter, we saw a $21 million or 13% increase in TDRs on nonaccrual status. We've modified about $1.4 billion since the third quarter of 2007 of which $188 million are carried in NPAs at June 30. About a third of the loans we've restructured to date have redefaulted, which we believe is generally in line with the industry.

Residential mortgage NPAs were flat at $475 million. We expect mortgage nonperformers to increase in the third quarter due to increases in second quarter mortgage 90 plus delinquencies that will flow into nonaccruals and the continued lack of movement out of NPAs driven by foreclosure delays and house price declines. I'd note that our loss expectations and forecasts are driven more by delinquency role rates than performing, nonperforming status. So this development does not signal higher near term losses.

Home equity NPAs were $73 million at the end of the second quarter, an $11 million decrease from the first quarter. Our expectations here are similar to those in the mortgage portfolio. In terms of delinquencies, we saw improvement in early stage delinquencies during the quarter. Consumer delinquencies in the 30 days to 89 days past due bucket were down again sequentially, partly reflecting seasonal trends. Most of the decrease came in mortgage and home equity.

In the 90 days past due category, delinquencies were up 4% sequentially, which is significant deceleration compared with the past few quarters. Along with the industry, we are seeing growth in late stage delinquencies, those over 180 days. This has been driven in part by foreclosure moratoria throughout the country. As these begin to expire, we'd expect to begin working down these delinquencies through the OREO process.

Let me spend a moment on a couple of other topics. First, I wanted to give you an update on the loans we moved to held for sale status in the fourth quarter. At the end of the second quarter, we had $352 million of commercial loans held for sale that were on nonaccrual status, compared with $403 million last quarter, a reduction of $51 million. We currently carry the remaining loans at $0.26 on the dollar. Purchasers of these types of assets have begun to come back to the market after a period of waiting to see how the [PCEP] would develop. Between sales, writedowns and taking possession of collateral, we had $11 million in gains attributable to the portfolio, providing further validation of our initial mark.

We've aggressively marked our portfolio NPAs as well, through the process of taking charge offs, purchase accounting marks and specific reserves recorded through the second quarter. NPAs, excluding held for sale, are being carried at approximately 61% of their original face value.

Given developments in the auto industry this quarter, I wanted to take a moment to size our exposure there. We have approximately $13 million in secured direct exposure outstanding to GM which is current. We also have $77 million of letters of credit with Chrysler and related companies, secured by cash and receivables. So overall, we have very little exposure on that front.

Finally, we have about $600 million of outstanding balances to auto suppliers. That's significantly less than peak levels three or four years ago. The majority of these suppliers participate in the government suppliers support program, utilized export development Canada or have been named a critical supplier in chapter 11 bankruptcy. Those programs provide important support to these companies and their stability.

Now, let me wrap up with provision expense in the allowance. Provision expense for quarter was $1 billion and was 167% of net charge offs. This increased the allowance to $3.5 billion, up $415 million from last quarter and boosted the reserve to loan ratio from 3.72% to 4.28%. Our allowance coverage ratios are also very strong, covering nonperforming loans by 135% and annualized loan losses by 140%. We feel good about that level of loss coverage given that we generally expect losses to begin to stabilize over the next several quarters. As a result, we currently expect necessary levels of reserve building to be lower going forward, absent significant additional deterioration in the environment.

With that, I'll turn it over to Ross. Ross?

Thanks, Mary. Net income available to common shareholders was $856 million or $1.15 per share for the quarter compared with the loss of $0.04 in the first quarter of 2009. One-time items this quarter include the $1.1 billion after-tax gain on our processing joint venture with Advent.

The other two noteworthy items approximately offset one another. One was our $36 million after-tax special assessment from the FDIC's deposit insurance fund and the other was $35 million reduction to preferred dividends expense. The latter essentially represents the gain on the convertible preferred exchange transactions. Excluding these items, the loss attributable to common shareholders was $198 million in the second quarter, driven by credit costs which included provision of $415 million in excess of charge offs.

Also our share count calculation is fairly complex this quarter. There's a reasonably lengthy discussion of it in today's release, but briefly, our average diluted share count is up 146 million shares. This reflects an average effect of 47 million shares related to the 158 million shares we issued in the common stock offering this quarter. Additionally, the "if converted" method used to calculate diluted EPS produced a more negative result this quarter due both to the higher level of earnings and the impact on preferred dividends associated with the exchange. As a result, all 96 million common shares underlying our convertible preferreds were included in the fully diluted share count for the second quarter.

Looking ahead to the next quarter, the simplest guidance I can give is that our diluted share count should approximate our period end share count of 795 million shares. Whether the "if converted" method impacts diluted earnings per share in future quarters will depend on the level of quarterly earnings. Just to give you a rule of thumb, the break point for using the "if converted" method will be about 200 million of quarterly earnings.

One last data point, the dilution from the common offering represented about 19% dilution to common shareholders using prior fully diluted shares, which were about 673 million, which included the 96 million convertible shares. The earnings dilution would be less than that due to the free funding associated with the cash received in the equity offerings. Now, I'll go through our results in greater detail starting with the balance sheet.

Average earning assets were down about 1%, primarily to sluggish commercial loan demand. Average loans held for investment were down 2% sequentially and on a year-over-year basis. We once again had extremely strong mortgage demand, although most of that flows through the warehouse and off the balance sheet. That will come down through the normal course of sales in the future. We're also seeing continued caution from commercial customers with many companies waiting for better visibility on the economy before investing in new capital projects.

After commercial loans decreased, our average commercial loans decreased 3% on both a sequential and year-over-year basis. On an end of period basis, commercial loans were down 1% primarily due to lower commercial line usage. Average consumer loans were down 2% sequentially and down 1% on a year-over-year basis. Average mortgage loans held for sale were up about $1.2 billion to $3 billion. We'd expect the size of the mortgage warehouse to decline significantly in the third quarter as we deliver mortgages to agencies and refi volumes come down.

Now, within consumer loans, auto loans were flat sequentially and up 3% on a year-over-year basis. Here we continue to focus on originating very high quality loans with attractive credit spreads. Credit card balances were up 2% sequentially and up 9% on a year-over-year basis. This remains a relationship product for us in footprint focused on high FICO in-branch originations.

Residential mortgages in the portfolio were down 5% sequentially and 12% from a year ago. We originate to sell more than 95% of our production, so we wouldn't expect the retained portfolio to grow. Low sales during the quarter were $6 billion. Home equity loans were down 1% sequentially and 5% from a year ago. We wouldn't expect much if any growth there in the near term given the state of housing markets. Overall portfolio loan growth will likely remain sluggish in the near term due to high personal savings rates and general caution by commercial and consumer borrowers.

Moving on to deposits, as Kevin mentioned, we had continued strong momentum in deposits this quarter with a significant positive shift in mix toward lower cost deposits. Average core deposit growth was 3% sequentially and 9% on a year-over-year basis. Transaction accounts showed the strongest growth with DDA balances of 7% sequentially and 19% on a year-over-year basis. Our deposit mix continues to improve as customers favor liquidity given the low rate environment where there is little advantage to seeking higher rate accounts. We remain committed to our everyday great rate strategy. We offer our customers fair, competitive rates reflecting our total value proposition.

Retail core deposits were up 3% sequentially and up 11% year over year. That included 6% sequential growth in of retail DDAs and 3% sequential growth in consumer savings deposits. Average retail account balances were up 2% and we continue to see good growth in retail households.

Total commercial deposits were up 2% sequentially and 3% versus a year ago. Commercial DDAs, however, increased 9% from the first quarter and 35% year over year while commercial interest checking increased 7% sequentially and 30% from last year.

In general deposit pricing has become much more rational. We expect rates paid on our deposit book to continue to trend downward as our higher rate CDs originated last year roll off and the mix shifts towards transaction deposits. Our liquidity position continues to be very strong. During the quarter, we reduced wholesale funding by nearly $7 billion.

Before I move to the income statement, let me spend a few minutes talking about the effect of the processing joint venture on results and how we plan to report these results going forward. There are two main line items where we report processing results, electronic payment processing revenue and payment processing expense.

This quarter we reported $243 million in that revenue line. That would have been approximately $66 million excluding revenue that goes with the joint venture, which represents ongoing credit and debit card issuer interchange. We expect roughly similar results in the third quarter. We reported $75 million in processing expense and that line item would have been approximately $10 million excluding expenses that go with the joint venture. We would also expect that line to be similar to that in the third quarter.

For the next several quarters, we will continue to incur G&A expenses related to the business while we permanently transition employees from Fifth Third to the joint venture. We will be reimbursed for those expenses by the joint venture. Those expenses are expected to be about $37 million in the third quarter, primarily compensation expense which will be offset by a similar amount of revenue and other income. Both sides of this equation will wind down over time.

Looking forward, we will report income from our 49% interest in the joint venture using the equity method which will be included in other income. We'll disclose that to you each quarter in our discussion. I can't give much third quarter guidance on that line item at the moment for two reasons. First, the joint venture is incurring initial costs related to establishing the business as an independent entity. Those costs will be disproportionately incurred early on.

Second, the joint venture is still working through the allocation of intangibles to good will and other identified intangibles. That allocation will influence its amortization expense. My best guidance right now is that third quarter earnings from the joint venture will be -- will not be significant. This is consistent with the pro forma provided with the announcement given the fact that the joint venture will pay interest expense on a note to Fifth Third in the effect of the intangibles amortization. We'll provide you better information when we get to the fourth quarter.

Over time, we'd expect that line to approximate 49% of the business' run rate earnings, less the impact of intangibles expense and the interest expense on the note. The note I'm referring to is the $1.25 billion note from the business as part of its capitalization prior to its sale, which earns 9.5% interest. That will generate approximately $30 million a quarter in net interest income to Fifth Third. As I mentioned, the note reduces the earnings of the joint venture and our 49% interest in those earnings, but we receive 100% of the interest income from the note.

To sum this up, as we noted in the original announcement, we expected the transition to result in pro forma earnings dilution of about $100 million annually or $25 million a quarter. We think that's still valid, although it will depend on the level of intangibles amortization. We are pretty conservative in our assumption, so if anything it may turn out a little better than that. I know this is a little hard to follow given the ins and outs, but as you are adjusting your models, I think this information will give you what you need.

Moving on now to the income statements starting with net interest income. Taxable equivalent net interest income increased $55 million sequentially to $836 million. We expect to see further positive momentum in the third quarter as the deposit look continues through pricing trend we've seen so far this year and the benefit of the joint venture note. Net interest margin increased 20 basis points to 3.26% during the second quarter, slightly ahead of our expectations on wider deposit and loan spreads. We'd expect net interest margin to increase by about 15 basis points in the third quarter given the current pricing environment and the impact of the JV note.

Moving on to fees, a reported noninterest income of $2.6 billion includes the $1.76 billion gain on the sale of the majority interest to -- in FTPS to Advent. We also note that first quarter results included $54 million in charges related to one of our BOLI policies. If you exclude these items as well as the investment security gains and losses for all periods, noninterest income increased 5% on a sequential basis and 11% year over year. That's a pretty strong result in a weak economy.

Payments processing revenue increased 9% from last quarter and 4% from last year. Credit card interchange was down 1% with an increase in sales volume and number of transactions offset by an 8% decline in average ticket. Debit card interchange was up 7% on a year-over-year basis. On the merchant side, we saw similar trends with strong growth in debit and gift card processing revenue, but relatively flat credit processing revenue. Credit transactions were up 5% year over year, and transaction dollar volume was down by the same amount.

Corporate banking revenue was down 5% sequentially and up 11% year over year. Compared with first quarter declines in foreign exchange and derivative fees more than offset growth in institutional sales. After a strong first quarter, lease remarketing fees return to more normal levels. We should see similar results next quarter.

Deposit service charges were up 11% from the first quarter and 2% from a year ago. Sequentially, consumer service charges were up 20% from a seasonally weak first quarter and were flat year over year. Commercial service charges were up 2% sequentially and 3% from the second quarter last year. We've introduced some new products throughout 2009, such it is secured checking, which comes bundled with identity protection services for a monthly fee. About 7.5% of new retail DDA originations came from this product. We've also seen retail transaction counts rise in both May and June. We expect deposit service charges to show further improvement in the third quarter, which is typically stronger seasonally.

Investment advisory revenue decreased 4% sequentially and 21% from a year ago, reflecting lower brokerage fees. Revenue increased 1% sequentially, adjusted for seasonal tax preparation fees. We continue to see customers moving into liquid investments with lower fees and don't expect that trend to reverse until the economy stabilizes. We had another record quarter in mortgage banking on $6.9 billion in origination. Net mortgage revenue of $147 million was up 13% -- or $13 million from last quarter. Additionally, income from nonqualifying hedges on MSRs increased $25 million sequentially. As a result, total revenue from mortgage banking rose $38 million or 25% from last quarter's record levels. We continue to capture greater market share.

Purchase originations increased 19% of volume in the second quarter compared with 14% last quarter. We also originated $2.1 billion under the HASP where demands remain strong. Mortgage rates rose over the quarter and as refi volume slows, we would expect originations to decline to still robust levels. New home purchase demand should remain strong given incentives for first time home buyers. We've had a noticeable increase in FHA loans which provide wider margins to us when sold. We would expect net mortgage banking revenue to be as strong as anything we saw last year, but to be lower than the past two quarters.

Pro forma for the processing transaction core fee income for the second quarter was about $635 million. For this purpose, I'm excluding the second quarter processing transaction gain, second quarter fees that are part of the processing JV now and investment securities gains and losses. We'd expect fee income on the same basis excluding the Visa gain to be down modestly due to more normalized mortgage banking revenue, but up otherwise.

Moving on to expenses. Noninterest expense for the second quarter increased $59 million sequentially and $163 million from the prior year. Second quarter results include the one-time FDIC special assessment of $55 million. Excluding one-time items in the first and second quarters outlined in the release, noninterest expense increased by $12 million or 1% sequentially. Pro forma for the processing transaction, core expenses would have been about $900 million in the second quarter. I'm excluding payment processing expense and FDIC special assessment here. We expect third quarter expenses to be consistent with that level.

Now, moving on to capital. Kevin already covered the high points on this topic. We more than met our SCAP commitment by raising $1 billion in common equity and $441 million from the exchange of our Series G convertible preferred. Additionally last week we sold our interest in Visa and recognized a pretax benefit of approximately $317 million. The entire pretax amount will count towards meeting the SCAP buffer requirement since the income generated will absorb a disallowed deferred tax asset in the final stress test result. So all in we've generated about $1.75 billion compared with our $1.1 billion requirement.

Our quarter end capital ratios were very strong. Tier 1 common equity was 7%, the Tier 1 capital was 12.9%. Those ratios will be increased by about 20 basis points by the Visa transaction. That strong capital position coupled with one of the stronger revenue reserve positions among our peers position us well to weather the rest of the cycle.

On that note, I'll turn it back to Kevin for his closing remarks.

Thanks, Ross. Okay. To wrap up, I'll say that core results remain strong. Our announced capital actions have been successfully executed and we've got a good handle on credit. Our management team and employees remain focused on our strategic initiatives, improving cross sells, optimizing market share, satisfying customers and engaging employees.

We're building our brand and delivering great value for our customers as we continue to introduce new products and offer competitive but reasonable rates. We've got the right tools to come out of this cycle in a strong position and I look forward to speaking more about the success of these initiatives on future earnings calls and presentations. So we appreciate your time this morning and with that we will open it up for questions.

(Operator Instructions) Your first question is from the line of Brian Foran with Goldman Sachs.

Good morning, guys, how are you?

Good morning.

I guess when I put together all your comments, the different comments you made about preprovision and I know there's a lot of moving parts without PPS and the net interest margin, but it seems like you're talking about preprovision could be like $700 million next quarter. Is that a reasonable range to think about or am I double counting somewhere or some offset that I'm missing?

Well, this quarter, Brian, our core pretax preprovision was 680 and we're not giving guidance on that, but we did indicate that mortgage revenue will be down, obviously, and also the joint venture, there's about $40 million of preprovision revenue that will go with that. So I don't think you would end up with that number. You wouldn't end up with a 700 kind of number.

Got it. And then on credit the trends were obviously very positive this quarter in terms of trajectory. I guess really the only thing to pick out is the TDR book and when you talk about a redefault rate of 33%, is that the redefault you've experienced so far or is that where it's tracking for a lifetime redefault rate and if it's the former, what does 33% translate to in terms of lifetime redefault?

Yes. That 33% is the rate that we've experienced pretty consistently since we've begun that program in the latter part of 2007. It's based on looking at 30 days past due and over trends and we also look at it on a number of different calculations.

We'll look at it in terms of overall modified loans. We also look at trends based on loans that are eligible for actual cure based on a prior modification and as we look at all of the different ways of calculation, we believe that we're absolutely in line with the rest of the industry.

That being said, we would expect that at some point as there's a little bit more aging of the modification activity that you'll see some of that trend reappear in some of our future mortgage trends, but we don't expect that it would be anything out of line with what the rest of the industry is seeing.

And if I could ask one last one, your reserve coverage and reserve adequacy screens very nicely relative to other regionals right now and a few of the other banks that are now over 4% are talking about the end of the reserve building process being in sight. Can you just give us a little bit more color where you see your reserve building cycle and what the triggers are based on your reserve methodology, what needs to happen to -- for reserve building to come to an end?

Well, our reserve build is driven off of a model which we've developed and certainly in conjunction -- or signed off by our auditor which projects future losses. We feel that our reserve is very strong right now and that going forward, based on our current conservative estimates for losses, we will not need to build reserves anywhere near the level that we've been building reserves over the past several quarters. I think it's too early to call when the reserve builds go to zero or even start to draw down reserves. That will take probably a bit more time before we get the visibility into when the credit losses start to come down.

But we are feeling like we're clearly very strong . We've been aggressive in building the reserve. We've been aggressive in dealing with bad credits over the last several quarters and we're feeling like it's too early to say we're ahead of the game, but we're certainly on top of it,

Thank you.

Your next question is from the line of Matt O'Connor with Deutsche Bank.

Good morning.

Good morning, Matt.

If I could just follow up on some of the outlook comments on credit. On the charge off side, I think you said up from here, but indicated being less than we've seen this quarter and recent periods. Just wondering if you can give a little more details on that and the same thing on the NPAs, just trying to frame the magnitude a little bit better.

With respect to charge offs, what we are anticipating for the next quarter is that we would see something largely in line with this quarter or perhaps a very moderate increase.

With respect to NPA trends, really what we're seeing there in terms of the expectation of an increase is that the increase in and of itself would be at a rate of increase which would be more in line with prior quarters or perhaps lower. In fact, significantly lower than prior quarters as opposed to this quarter.

In terms of what's driving that NPA increase, we're looking at the trends that would suggest that we are in the heart of the commercial credit cycle. That being said, we are also targeted and very focused on a couple of our larger credits that we're projecting for potential nonaccrual for the third quarter, so there is a little bit of lumpiness that also might be driving that.

Okay. So just to be clear, the charge off dollar amount you expect to be up modestly from 2Q level?

Right.

Yes.

And the NPAs, I think if I look at the last four or five quarters was increasing around 25% or 30% and it would be much less than that from what you can tell right now?

Yes.

And then separately, as we think about unemployment hopefully peaking here the next few quarters, do you guys have any sense of once unemployment peaks, what happens to consumer credit?

Does it start trending down or maybe as people run out of savings and benefits, there's still some elevated losses there? How do you think that plays out in terms of -- even if unemployment just stays high -- what that impacts your consumer book?

When we look at unemployment, we look at the consumer products of card and auto probably with greater focus. The trends that we've seen with respect to our real estate products are driven more by some of the legacy underwriting and some of the earlier deterioration that we saw because of the drop in home prices. So with respect to future increases in unemployment and the impact that that might have, we think it would have a larger impact for our card book and perhaps our auto book.

That being said, our card book is a very, very small proportion of our overall loan book, it's $1.9 billion and it's a portfolio that is really largely a relationship portfolio, it's all in footprint. So even as we perhaps may see some future impact of unemployment, the proportion of that impact would be much smaller because of the overall proportion of that card book to the overall loan book.

Clearly, Matt, though, if unemployment were to stop, we do believe you'd see a positive impact in terms of consumer book. I think that would be something very much aligned with our expectations. When that occurs in the future.

Okay. And then just lastly, if I may, on the income producing commercial real estate, it seems like there's a huge bifurcation of views out there -- the fixed income research folks seem to be very negative on it, the banks seem to say they've got the good stuff and aren't really concerned about it.

What's your view on it and how is your stuff maybe different from other banks or from what's in CMBS?

Yes, Matt, as we look at income producing, we look at that separate and apart really from our home builder book which is correlated to the residential portion of our commercial real estate book. And we've experienced quite a bit of stress in the last couple of quarters. We've been very aggressive in how we've dealt with those problems issues within the residential portion of the commercial real estate book.

So as we look at other portions of that book, the income producing or the nonowner occupied portion of the portfolio, although we're seeing some stress in some weakening, it's not nearly to the degree of stress that we saw in the residential portion of the book. That being said, it's something that we're monitoring very, very closely and in particular what we're looking at would be rent trends along with vacancy rates and although we might see some squeezing effective cash flows with respect to those trends, at this point in time, there's some moderate weakness, but nothing to the degree of what we had seen in the home builder book.

So from a standpoint of loss severity, even if there is more weakness in that book, the loss severity would be a lot less than what we saw in the residential portion of that book.

Okay. Thank you.

Thanks, Matt.

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

Thanks for taking my call. Mary, just quickly, I just want to make sure I clarified -- the modified lines you talk about, that's basically the restructure loans you reported on the earnings release?

True.

Correct.

Ross, on the preferred dividend outlook, can you give me a thought of what the preferred dividends on a quarterly basis will be going forward given some of the exchanges you took place in the second quarter?

Basically we eliminated 63% of the Series G preferred -- the Series G preferred dividend was about $23 million to $24 million per quarter prior to the exchange, so the -- you would eliminate 63% of that and then compare it to the -- say, the dividend that we -- the preferred dividend that we paid in the first quarter. So that's the adjustment that you would make.

Thank you very much.

You bet.

Your next question is from the line of Mike Mayo with [CLFA].

Good morning.

Hi, Mike.

Can you just elaborate more on the commercial trends, like when you said a few large credits out there, what industry, what geographies have you most concerned on the commercial side?

Yes, as we look at the commercial trends right now, we are still focused certainly on the real estate portion of the book and so from that standpoint, we would continue to monitor the construction and the mortgage products within that book.

In terms of geography, what we talked about is that we think we're seeing some earlier signs of improvement in the Michigan geography. Florida certainly continues to be more of a stress point for us and so we're very, very focused on that.

And with respect to the C&I portion of the book, as we look at some of the industries, we do expect that we would see a decrease in experience in the auto dealer portion of the book. We think that that's a pretty good story for us and beyond that, it would be a fairly diversified look at the book and it would really correlate more closely to just pressures that may pop up in a more diversified way.

Okay. And then just one very general question. You said you think mortgage goes down in the third quarter.

So I think just based on your own guidance starting the third quarter, the actual credit losses before any reserve building would be greater than your preprovision, pretax profits and I guess that's not a surprise, some other banks are there, too. But then the question is how long do you think credit losses would be above the preprovision, pretax profits? Do you have a sense of when you emerge from that?

Because this gap period, as you mentioned, you'll be home free three out of the eight quarters, but I'm just wondering if eight quarters is long enough for when you might be in that kind of deficit position when credit losses are above your ongoing ability to absorb them.

Just maybe a general response or specific, however you can comment.

I think it's really too early to call when the trends start to come down. We're very focused on getting as much visibility into our portfolio as far out as possible, but I'd say the next couple of quarters we're expecting losses that are somewhat stable with what they've been this past quarter. Beyond that, I think it's too early to call.

Okay. And just maybe since commercial real estate is a bigger deal now than it was before, just your best guess if that's what it is on how long that will take to play out.

The only thing we would say at this point, Mike, while we're looking at that, we have not seen anything that we would highlight to you in terms of a problem other than what's going on in terms of general deterioration of the economy. So hard for me to give you a different color on that.

Mary, if there's anything else you would add on that piece.

Yes. The only thing I would add is we've been very aggressive and transparent in talking through how we've been dealing with our problem issues and that residential portion of the commercial real estate book or what we would call our home builder book.

So certainly I think we've been aggressive and because of the geographies, we've seen an earlier deterioration with some of the exposure in Michigan and Florida, but with respect to the rest of the book, I would take it back to some of Kevin's comments.

All right. Thank you.

You bet.

Your next question is from the line of Betsy Graseck with Morgan Stanley.

Good morning, thanks.

Good morning, Betsy.

Hi. Two things. One is on auto and I greatly appreciate the detail you gave on the corporate side, that's very helpful and I think much lower than what some folks have been anticipating.

The other thing is just on auto, could you give us a sense as to how you think about how auto is going to impact your consumer portfolio and what you're doing to mitigate any risk there that you might see?

You're looking at our commercial auto exposure?

Yes. Just given the fact that there's going to be some changes in the industry, how are you thinking about how that's going to be impacting the communities where you operate and the degree of risk that you might have associated with those communities and how you're mitigating that risk.

Yes, I think the way that we would look at that is the increased unemployment for certain of our geographies that would be most directly impacted by that. That would be primarily certain parts of northern Ohio as well as eastern Michigan.

That being said, our overall exposure in eastern Michigan to some of the other card products that we talked about would be at a more mitigated point of exposure than perhaps what we've seen in some of our other geographies. We've also been well ahead of that in anticipating what the impact would be of increasing unemployment in those geographies.

So although we expect that there would be some impact, we do believe that we've been well out ahead of that.

Also, Betsy, we have taken a lot of action already in terms of that entire segment and that entire space. We've tried to be clear about what we've done in terms of what we've done in terms of lowering exposures, directly to OEMs as well as the dealers and the suppliers, et cetera, all the way down the chain. So if you would look at it just at a point in time from 18 months to 24 months ago to today, our total risk exposure is down significantly from that perspective. So.

Yes. So with respect to the commercial side of the book and the impacts there, we think that we're in a very strong position relative to others who have experienced those impacts and with respect to the consumer impacts, again, we think that we've been well out ahead of that in anticipating what that impact would be for those geographies.

Okay. That's great. Thanks very much.

Second question is just on liquidity and you indicated how you've been improving that, in particular in the most recent quarter. I should say not only improving, but strengthening. You've had strong liquidity for a while.

I'm just wondering how you think about your position today and is there any other changes that you would be anticipating making to bolster liquidity even further?

Well, I think that we feel like we're in very strong position from a liquidity perspective. There are some things that certainly would come in the future, not necessarily to bolster liquidity, but will have that impact and that would be when we step up and issue unsecured senior debt, which is going to be required to pay back the TARP preferreds, plus as soon as the pricing in the debt markets get back to where we end up with much more reasonable pricing, we want to get back and start to be a presence in terms of issuing debt.

But it's not necessarily from the need to generate additional liquidity right now. We see that over the next several quarters, at least right now it's looking like commercial loan demand is going to remain sluggish and deposit trends are very, very positive. So we see the improvements in liquidity just organically continuing. So.

And how are you thinking about the time line for TARP or what types of things are you looking for in your business model to occur to get you to a point where you'd start to be thinking about paying back TARP?

Well, obviously it's been in the back of our mind, but we don't see the improvement in the credit trends that we'd like to see quite yet. Things have stabilized. They haven't started to come down yet and really that's what I think we'd like to see.

Okay. And you're talking about MPL growth because that's improved obviously Q on Q?

That's improved dramatically. I think we're talking about charge off growth -- charge off levels, excuse me.

And general trends in the economy in general, Betsy. We want to make sure we're right on this decision.

Got it. Okay. That's helpful. Thanks.

You bet.

Your next question is from Bob patten with Morgan Keegan.

Most of my questions have been asked. Kevin, just strategically, what's your thoughts on FDIC activity and the opportunity. Do you guys have the resources at this time to engage in any FDIC assisted deals? Is there any discussions? How should we think of that over the next couple of quarters?

I think, Bob, for the most part, we continue to be active in consideration and looking, but we're very focused on doing the things we need to do relative to where we're taking the Company from that perspective. If something opportunistically were to come to us, we'd consider it from that standpoint, but it's not like we're -- we have that as a key part of our priorities or our strategies at this point.

So we have participated in some of the FDIC transactions -- assisted transactions or handed transactions in the past. They have to make sense to us given what our experience has been and given what is going on in the environment today, but we're staying focused in terms of driving value, really doing the things we've talked about today and continue to stay -- keep our people focused internally from that standpoint and not really counting on that being a key element of success for us.

Okay. Thanks. Are you sensing any increase in activity, though, from -- I think we've all been surprised that it's been a little quiet from the FDIC in terms of encouraging deals to happen?

Yes, again, our perspective has really been around staying focused on the things that really mean a lot to us and our shareholders. If you look at some of the geographies of where some of the biggest challenges from an FDIC perspective have come, they've fallen outside of our marketplace.

We don't see that as an opportunity or a strategy that would make sense to us in terms of bridging to new parts of geography through an FDIC transaction. So until they move a little bit closer to home, they really are off our radar.

Okay. Thank you very much.

You bet.

All right. Thanks everybody. I appreciate you spending time with us and we'll talk to you next quarter.

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