Fifth Third Bancorp (FITBP) 2011 Q1 法說會逐字稿

Good morning. My name is Ms. Shea and I will be your conference operator today. At this time, I would like to welcome everyone to the Fifth Third Bancorp first-quarter 2011 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. Jeff Richardson, Director of Investor Relations, you may begin your conference.

Thanks, Ms. Shea. Hello, and thanks for joining us today. Today, we will be talking with you about our first-quarter 2011 results. This call may contain certain forward-looking statements about Fifth Third 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 the historical performance in these statements.

We've identified a number of those factors in our forward-looking cautionary statement at the end of our earnings release and in other materials. We encourage you to review 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 President and CEO; Chief Financial Officer, Dan Poston; Risk Officer, Mary Tuuk; Treasurer, Mahesh Sankaran; and Jim Eglseder of Investor Relations. During the question-and-answer period, please provide your name and that of your firm to the Operator.

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

Thanks, Jeff. Good morning, everyone, and thanks for joining us. Today, we reported first-quarter 2011 net income of $265 million, or net income to common shareholders of $88 million or $0.10. Net income to common included the effect of $153 million of discount accretion on the TARP preferred stock, which is in the preferred dividend line. Excluding this item, net income to common was $241 million or $0.27 per share.

It was an eventful quarter for Fifth Third. We completed and submitted our capital plan to the Federal Reserve at year-end. We issued $1.7 billion in common stock and $1 billion in senior debt in January, and in February, redeemed the US Treasury's $3.4 billion preferred stock investment in Fifth Third. In March, we repurchased the warrant issued to Treasury for $280 million. The warrant gave the Treasury the right to purchase 43.6 million shares at $11.72. This repurchase eliminates this potential future dilution at what we consider to be a reasonable cost.

Also in March, we increased our quarterly common stock dividend by $0.05 to $0.06 per share. We believe this is the first step toward beginning to normalize our dividend payout after two years of nominal dividends.

With no TLGP debt outstanding, Fifth Third has completely exited all crisis era government programs. We have a robust capital position with Tier 1 common of 9%; Tier 1 capital of 12.2%. We're confident we meet today any capital standards that will be set in the US under the Basel III framework.

Turning to quarterly results, overall, they were in line with our expectations, strengths and weaknesses, reflecting broader aspects of the economy as it recovers. The interest rate environment negatively affected mortgage production and results; loan demand, while improving, remains lower than would be typical at this stage of the cycle. However, debt capital markets have been very strong, which led to an elevated level of payoffs and refinancings during the quarter, and diminished loan growth in yields relative to what we were expecting.

Those effects were largely offset by the benefit of continued improving credit trends and lower credit costs. Dan and Mary will provide more details in their remarks, but I'll touch on a few high-level results.

Average loans increased $1.4 billion or 2% sequentially; C&I loans were up 4%, and we saw some modest improvement in line utilization. We're seeing cautious optimism from businesses, and believe that we'll have continued momentum in this category in coming quarters. Auto loan growth also continued to be solid. That said, we expected higher loan growth coming into the quarter.

While commercial loan originations have been exceptionally strong, payout activity was higher than we would have expected seasonally, as customers, particularly those in our syndicated loan and international books, took advantage of the historically low rate environment to refinance and lock in those rates, either through new financings or bond issues. This dynamic affected net interest income more than we've seen in previous quarters, in both inhibiting loan growth and in spreads realized on our own production.

Consumer yields declined as well, notably auto, where risk-adjusted spreads have been unusually attractive for the past couple of years. Deposit growth continues to be strong. Core deposits increased 1% sequentially, reflecting CD runoff; and transaction deposits, excluding CDs, increased 3%. This was stronger than we expected, which has been the case for a number of quarters.

Our excess liquidity and the low value of free funding, given the low rate environment, also continue to inhibit the net interest margin. We're seeing good household growth in transaction deposit accounts, which bodes well for added business and longer-term deposit stickiness. We expect some growth in NII in the second quarter, with improvement in the second half of the year. We'll reverse the $12 million impact of day count this quarter, half in each of the next two quarters.

High rate, three-year CDs placed in the second half of 2008, will experience additional maturities in the second half of 2011. Those factors will both add to NII in the next several quarters, which we expect to move back above $900 million in the third quarter. We also expect stronger loan growth, as we move forward in the year, as origination trends remain strong. We expect payoff activity to stabilize and subside over time, given our largely middle-market commercial portfolio.

Mortgage banking results is expected. We're down significantly from the fourth quarter. Mortgage-related revenue decreased $56 million. As mortgage rates increased, refinancing activity backed up and significantly reduced originations throughout the industry. We expect better results in the second quarter, given the seasonality.

Finally, credit trends continue to improve or were stable. Virtually all trends were quite favorable outside the effects of one larger credit that resulted in $22 million of charge-offs. We some positive results in most categories, and we also saw across-the-board improvements in all other early-stage metrics.

Total nonperforming assets decreased 5%. Loans 90-plus days past due declined 3% and loans 30 to 89 days past due declined 15%. We expect this general improvement to continue throughout the year, and Mary will further discuss our expectations in her remarks.

As far as for the environment, we continue to see slow but steady progress in business sentiment in most of our markets, which seems to be the experience of much of the country right now. Uncertainty around the Durbin Amendment remains an overhang for the entire industry, but recent developments suggest it's possible there may be a delay to permit a study of the impact of this bill on the debit business and banking customers.

I believe the study is appropriate in a situation when a business, which our industry and its customers have built over many years, is called upon to transfer $10 billion to $15 billion to another industry, without much discussion in Congress about the decision. We believe this bill would have a significant and negative impact on banking customers, and welcome the study.

When a customer shows up at a store, the debit card product makes that banking customer's checking account available to the merchant, with all the investment infrastructure we have built that make that possible, and at our risk for that payment being good funds. This bill would cause the merchant to receive that service at below cost, with either the customer or the bank paying for the benefit of that service to the merchant.

We should be able to earn a reasonable profit on our investments and costs related to this product, rather than conduct business at a loss. However, we'll be ready to implement mitigation strategies when and if a rule is implemented, and we'll continue to evaluate our plans and competitor reaction as we see developments from Congress and the Fed.

Another major topic surrounds last week's announcement of regulatory enforcement orders related to foreclosure practices directed at the 14 largest mortgage servicers. We are not one of the largest servicers and we're not one of the institutions included in this process. However, we do fully expect servicing requirements included in these orders to become industry standards for all banks.

We will evaluate the proposed standards and make any changes ultimately required, continue to serve our customers in the best way possible. We try to do that in all of our mitigation programs. We've consistently exceeded other servicers when it comes to conversions of HAMP modifications. Of GSE loans we service, our 77% conversion rate of trial to permanent mod as of December 2010 was more than double the national average of 35%. As Mary will discuss, we've actively modified loans within our own portfolio as well, and believe that program is working relatively well.

These activities are consistent with our efforts to continue to enhance our customer satisfaction and experience. Our most recent scores based on the University of Michigan's survey of Fifth Third's customers exceeded all named banks in their American Customer Satisfaction Index, as well as the industry average. We've also have been similarly recognized by organizations such as J.D. Power and Forrester.

So, to sum up, looking forward, we expect that operating results will generally continue to improve throughout 2011, as the first quarter tends to be seasonally weak. We have the capacity both in terms of capital and resources to grow our earnings in the balance sheet. Credit trends are improving, and we expect that to continue throughout the year, and we believe we are positioned well to generate overall stronger results as we move through 2011.

With that, I'll ask Dan to discuss operating results and give some comments about our outlook. Dan?

Okay, thanks, Kevin. Starting with slide four of the presentation, in the first quarter, we reported net income of $265 million and recorded preferred dividends of $177 million. Net income to common was $88 million. Of that $177 million of preferred dividends, $153 million of that was due to the accretion of the discount that was created at the time of the TARP investment, which was accelerated at the time of our repayment of TARP. Excluding that TARP discount accretion, net income to common would have been $241 million.

Our return on assets was 1%, which was in line with our expectations for the quarter. We reported diluted earnings per share of $0.10, but excluding the TARP discount accretion, diluted EPS would have been approximately $0.27.

Going forward, preferred dividends should be approximately $8.5 million per quarter, paid on the remaining $398 million of Series G convertible preferred securities that we have outstanding. These dividends were included in our EPS calculation this quarter, due to the impact on earnings of the TARP discount accretion.

Last quarter, the underlying shares were instead included in our fully diluted share count because the if-converted method was more dilutive. We would currently expect future quarters to generally follow the if-converted method, due to our expected level of earnings. This is discussed more fully at the end of the release. While I expect this is challenging for you to manage in your models, the current effect is pretty minor, and right now it's generally under $0.01 per share between methods.

Turning now to slide five and NII. Net interest income on a fully taxable equivalent basis declined $35 million sequentially to $884 million, and the net interest margin decreased 4 basis points to 3.71%. The sequential comparisons were driven by a number of factors, which are outlined in the release.

Day count was responsible for $12 million of the decline, as there were two fewer days in this quarter. We'll get back $6 million of that in the second quarter and another $6 million in the third. The full quarter effect of the refinancing of the FTPS loan that occurred in the fourth quarter reduced NII this quarter by about $8 million. That's now fully baked into our run rate. That represented nearly half of the decline in the reported C&I loan yields.

The mortgage warehouse balances were lower during the quarter, due to lower originations and delivery activity, and that cost us about $8 million in NII relative to the fourth quarter.

And finally, the issuance of senior debt in connection with TARP repayment increased interest expense about $7 million. While our bottom line funding costs are lower post-TARP, preferred stock is, of course, free funding to the NII and to the NIM, and that $3.4 billion in pre-funding was cut in half during the quarter.

Those factors reduced NII by $35 million. Otherwise, NII was flat with the number of puts and takes, whereas we were anticipating growth. Relative to the fourth quarter, on the positive side, average loans were up despite the FTPS refinancing, although we had expected more growth than we actually experienced. We had lower interest reversals on nonperforming loans and deposit interest costs were lower. Offsetting those sequential positives, loan purchase accounting accretion was lower sequentially, and yields on commercial and consumer loan originations were down from last quarter.

On that latter point, let me make a few additional comments. First, on the commercial side, for the past several quarters, we've seen robust origination activity, generally at record levels, but also relatively high paydowns and payoffs. In the first quarter, those trends continued, and refinancing and payoff activity increased, while typical seasonality would be for it to decrease.

As you know, capital market conditions have been quite strong this quarter, and a number of our larger clients with stronger access to capital markets alternatives -- whether that be bond issuance or syndicated loans -- have been able to take advantage of those conditions. High grade corporate bond yields, which are pretty attractive right now, were down something like 10 to 20 basis points from year-end, depending on the credit grade.

Also, interest rate expectations began to tick up in the first quarter, and that contributed to a desired access markets sooner rather than later. We are participating in customer bond activity and syndicated loans, but the effect of those alternatives has reduced loan balances relative to what we would otherwise expect to experience.

These alternatives also play a role in bank loan pricing, even if those alternatives are not pursued. Higher paydowns and lower origination yields together cost us $5 million to $10 million in NII, versus our expectations this quarter. That's excluding the effect of the FTPS loan, which I already mentioned. We expect commercial loan growth to pick up in the next several quarters, with origination activity remaining strong, and with the impact of refinancing activity lessening, although we recognize that that will continue to some degree.

On the consumer side, originations are generally being made at lower yields than the loans at which they are replacing. That's true in most categories, with auto loans being a notable example. Origination yields were lower and auto prepayments were higher than we were expecting for the quarter, which also negatively impacted NII by $5 million to $10 million. We think the compression in origination yields is beginning to run its course, so we should see some stabilization, although we don't expect them to actually improve in the near-term.

As I mentioned, core deposit costs were down, with a major [factor] being CD run-off. The lion's share of the benefit we see from CD maturities comes in the second half of each year, due to the annual maturities of CDs originated in the second half of 2008. I'll discuss that more in a moment with the outlook.

The net interest margin of 3.71% was down 4 basis points from the 3.75% last quarter. The FTPS refinancing costs and the TARP debt issuance each cost us about 3 basis points. That 6 basis points was partially offset by a 3 basis point benefit from day count. Otherwise, the margin was pretty flat. The factors I discussed a moment ago largely explained the main positives and negatives relative to the market.

Looking to the second quarter, we expect NII to be up, due to a higher day count, which should add about $6 million; but otherwise, to be relatively consistent with the first quarter. As I mentioned, we expect stronger net loan growth in the latter half of the year, as well as lower deposit costs. Repricing and run-off of CDs alone is expected to benefit NII by about $8 million in the third quarter and $15 million in the fourth quarter, relative to second quarter levels, with about three quarters of that benefit coming from the maturities in the second half of 2008 originated CDs.

Therefore, we anticipate solid growth in second-half NII versus second-quarter levels. As Kevin mentioned, we should be above $900 million by the third quarter, with additional growth in the fourth quarter. We currently expect the second-quarter NIM to be relatively stable in the 370 range, with improvement thereafter in the second half of the year, driven by lower deposit costs and loan growth.

With that context and turning to slide six, let's go through the balance sheet in more detail.

Average earning assets were down about $549 million sequentially, driven by lower short-term investments. That was largely cash held at the Fed. Average portfolio loans and leases increased $1.4 billion sequentially, which was largely offset by a $1.2 billion reduction in loans held for sale, primarily in the mortgage warehouse. Investment security balances were flat as we continue to be very careful about managing our interest rate risk profile, and continue to target a neutral to modestly asset-sensitive position.

As I mentioned earlier, average loans held for investment were up $1.4 billion or 2% sequentially. We experienced positive average balance trends within C&I, residential mortgage and auto loans, which were up a combined $2 billion. That was partially offset by run-off in the CRE and home equity books of about $700 million. And I already mentioned the $1.2 billion decline in mortgage loans held for sale.

Looking at each portfolio, average commercial loans increased $500 million or 1% from last quarter. C&I average loans increased $1 billion or 4% sequentially, including the effect of the FTPS refinancing, which reduced growth by almost $300 million. We've seen broad-based growth across a number of industries and sectors, with continued strong production within manufacturing and service sector industries.

As I mentioned earlier, we were expecting stronger growth this quarter. We had a good starting point in December, but the end of period balances grew only modestly.

Commercial line neutralization increased a bit this quarter, although it still remains at low levels at 33.3%, compared with 32.7% last quarter and 32.6% a year ago. Those are down from normal levels in the low to mid-40s, and that would represent about $4 billion in balances if that rate normalized.

C&I loan production has been very strong in the past several quarters. And as I mentioned earlier, refinancing activity has also been high. That dynamic should shift more in our favor in terms of net growth in coming quarters, given our strong origination trends and pipelines, and some moderation in the refi activity in the upper end of our loan book.

In the CRE portfolio, we saw continued run-off in the commercial mortgage and commercial construction books, although the rate of decline has slowed. Average CRE balances were down $440 million or 3% sequentially, and we'd expect to see continued run-off in these portfolios in the near to intermediate term.

Commercial real estate is only about 15% of loans, so while it's a drag on growth, it's not a big one, and the impact from that runoff is beginning to slow. While we have the capacity to add to the CRE book, we don't expect to have an appetite for net growth, at least until we see better balance between supply and demand for space, which we believe is still some time away.

Average consumer loans in the portfolio increased $800 million or 2% sequentially. Most of that growth was in the residential mortgage book, which was up $900 million. Mortgage originations were $3.9 billion in the first quarter, a little over half of the origination level of the fourth quarter, which was, of course, very, very strong.

Mortgage rates fluctuated throughout the first quarter but were generally higher, and that had a significant impact on refinancing activity. As we mentioned last quarter, we began retaining some mortgages we would normally deliver to agencies. The majority, of which were simplified refi mortgages, originated through our retail branch system. That is a product that has lower LTVs, shorter durations, and higher average rates than most of the conforming loans we sell to agencies.

We retained about $552 million of mortgages originated during the first quarter. We'll continually evaluate our appetite for retention of product versus investing in mortgage-backed securities.

Average auto loan balances increased 2% sequentially. Our auto portfolio has continued to perform very well from a credit perspective throughout the cycle, and yields have been relatively attractive, although we've seen some pressure there from a pricing standpoint, due to recent increases in competition. The increase in auto loans was offset by lower home equity loan balances, which were down 2% sequentially. I suspect it will be a while before we see growth here, given the lower equity levels among homeowners.

Average credit card balances were flat sequentially. We still have additional customer base penetration that's available to us, although that is being offset by general balance declines throughout the industry, as customers reduce their indebtedness.

Looking ahead to the second quarter, we'd expect to see solid growth in C&I and auto loans, partially offset by continued attrition in commercial real estate balances and home equity. We may see some growth in the mortgage balances, although as I mentioned earlier, as we reinvest investment portfolio cash flows, we are now more likely to invest in mortgage-backed securities than we have been in the past few quarters. Overall, portfolio loans are currently expected to be up modestly in the second quarter, with stronger results in the second half.

Moving on to deposits. Average core deposits increased $1.1 billion or 1% on a sequential basis, which was stronger than we expected. That net growth is after run-off in the consumer CDs, which are included in core deposits, which were down $1.1 billion sequentially. Average transaction deposits, excluding those CDs, were up $2.1 billion or 3% sequentially, and are up $6 billion or 9% from a year ago.

We saw pretty broad-based increases across DDA, interest checking, savings and money market account. Average retail transaction deposits increased 3% sequentially and 14% year-over-year, with growth across all categories. We've had great success with our relationship savings product, which has now attracted over $11 billion of the balances since its conception two years ago. Given the current rate environment, we're seeing customers moving funds into liquid savings products when CDs mature, and we expect that to continue for the near-term.

Average commercial transaction deposits increased 3% from last quarter and 2% from a year ago. The largest driver of the sequential increase was seasonally higher public funds DDA balances. We expect core deposits to be relatively stable in the second quarter, as continued solid growth in transaction deposits is offset by CD run-offs.

Moving on to fees, as outlined on slide seven. First-quarter non-interest income was $584 million, a decrease of $72 million from last quarter. Mortgage-related revenue represented $56 million of that decline. Deposit service charges decreased $16 million sequentially, with a $10 million decline in consumer deposit fees and a $6 million decline in commercial deposit fees.

First-quarter revenue is typically lower on a sequential basis, especially when compared with the seasonally strong fourth quarter, due to reduced activity and the effect of tax refunds on overdraft occurrences, although occurrences were lower this quarter than we expected. We expect the seasonal increase in deposit fees in the second quarter up 5% or so.

Investment advisory revenue increased 5% from last quarter and 8% on a year-over-year basis. The sequential growth was driven largely by seasonally higher tax preparation fees, and the year-over-year increase was driven by an overall lift in the equity in bond markets, as well as improved production in the private bank, institutional, and brokerage revenue. We currently expect to see low single-digit growth in IA revenue in the second quarter.

Corporate banking revenue of $86 million decreased 17% from the fourth quarter, but increased 6% over last year. The fourth quarter is typically seasonally strong for us, and we saw particularly strong results last quarter in lease remarketing fees and loan syndication fees. We're looking for growth in the 10% range in the second quarter.

Payment processing revenue was $80 million, consistent with the fourth quarter, and up 10% from a year ago on strong transaction growth. The first quarter is seasonally weak and we expect second-quarter processing revenue to increase by about $10 million.

Turning to mortgage banking -- revenue of $102 million decreased $47 million from a strong fourth quarter. Gains on deliveries were $62 million this quarter compared with $158 million last quarter, as we saw significantly lower origination volumes and narrower spreads. Servicing fees of $58 million were flat sequentially, while net servicing asset valuation adjustments were negative $18 million this quarter. That reflects MSR amortization of $28 million, offset by valuation adjustments of a positive $10 million.

In the fourth quarter, net servicing asset evaluation adjustments were a combined negative $67 million. Additionally, net securities gains on non-qualifying MSR hedges, which are recorded in a separate line item, were $5 million compared with $14 million in the fourth quarter. We currently expect seasonally stronger origination activity in the second quarter, and for total mortgage-related revenue to be up $10 million or so.

Turning next to other income within fees. Other income was $81 million and increased $26 million sequentially, driven by a $31 million reduction in credit-related costs included in this line item. Credit costs recorded in fee income were $3 million in the first quarter compared with $34 million last quarter. Net gains on loans held for sale were $1 million, including realized net gains of $17 million, offset by $16 million in fair value charges.

Last quarter, we recorded net losses of that nature of about $14 million. Additionally, losses on the sale of OREO properties were an unusually low $2 million this quarter, compared with $19 million last quarter. Overall, we expect credit-related costs within fee income to be around $25 million to $30 million in the second quarter.

Overall, we expect second-quarter fee income to be consistent with first-quarter levels, with seasonal rebounds in processing revenue, in deposit service charges and corporate banking revenue, as well as modestly higher mortgage banking revenue. Offsetting those improvements, we expect a decline in other income, due to higher credit-related costs, which, while generally declining over time, won't be sustained at the nearly $0 level that we experienced this quarter.

Turning to expenses, which are on slide eight. Non-interest expense of $918 million was down $69 million or 7% sequentially. The primary drivers were lower salary and benefits expense, and lower credit-related expenses. Compensation expense was lower, due to lower revenue-based incentives, which more than offset seasonally higher payroll taxes, as well as careful and disciplined management of expenses, which we will continue to calibrate to the revenue environment as it continues to unfold.

Credit-related costs within operating expense were $31 million in the first quarter compared with $53 million last quarter. One major driver of the decreased credit-related expenses related to mortgage repurchases, which were $8 million this quarter compared with $20 million last quarter, as the reserve associated with repurchases was reduced by about $14 million. We've seen a reduction in our repurchase demand inventory which peaked last summer, as well as a trend toward lower loss severities on repurchases.

Currently, we expect that general trend to continue, as demands related to 2007 and prior years continue to decline. The other major driver of lower credit costs was a reduction of reserves for unfunded commitments, which was a credit of $16 million this quarter compared with a credit of $4 million in the fourth quarter. We currently expect total credit-related costs recognized in expense for the second quarter to be approximately $45 million, with the increase related to the expected absence of a repurchase reserve release. In total, we expect second-quarter operating expenses to increase modestly from the first-quarter levels.

Moving on to slide nine and taking a look at pre-provision net revenue. PPNR was $545 million in the first quarter and we expect PPNR to be at similar levels in the second quarter, with modest increases in net interest income and expenses, and relatively stable fees. We currently expect growth in the second half, driven in part by stronger NII results. The effective tax rate for the quarter was 30%, which was consistent with last quarter, and we expect the full-year tax rate in that same vicinity.

Turning to capital on slide 10, capital levels are very strong. Tier 1 common ratio increased 150 basis points to 9%, reflecting our common issuance in conjunction with the repayment of TARP, as well as higher retained earnings, which were partially offset by the effect of our warrant repurchase. The Tier 1 ratio was 12.2%, down 180 basis points, and reflecting transactions related to the redemption of TARP preferred.

The total capital ratio was 16.3%. Tangible common equity was 8.4%. We calculate that ratio excluding unrealized securities gains, which totaled $263 million. All in, TCE was 8.6%.

Our capital position is obviously very strong and above the levels that we would target on a long-term basis. For instance, we continue to target Tier 1 common in the 8% range, and we expect organic capital generation to increase our capital ratios further. Raising the dividend this quarter was the first step toward returning more capital to our shareholders, and we'll continue to evaluate the dividend level as the year progresses.

In terms of further management of capital, we expect loan growth to pick up and absorb some of our organic capital generation. We would expect share repurchases to form part of our capital management activities at the appropriate point in time. Our capital position may be utilized to some extent through M&A, although we can't plan for that to be the case. We will be disciplined on that front and we don't expect anything in the near-term.

As we noted in our announcement last month, our capital plan incorporated the possible redemption of certain Trust Preferred Securities. We will continue to evaluate the role of trust within our capital structure, given the evolving rules, as our Tier 1 capital position is very strong with or without those instruments.

That wraps up my remarks, and I'll turn it over to Mary now to discuss credit results and trends. Mary?

Thanks, Dan. Credit quality trends continue to remain quite positive as we move into 2011. Looking at first-quarter results, charge-offs were negatively impacted by actions we took on a single credit relationship, resulting in a $22 million charge-off in the first quarter, which I'll discuss in a moment. However, all underlying credit trends are positive.

NPAs were down; nonperforming loans were down; nonperforming loan inflows were down; OREO was down; 90-plus delinquencies are down; 30-plus delinquencies are at their lowest levels since 2004; and charge-offs, excluding the one credit, were also down. While results can move around from quarter to quarter, we generally expect all key credit metrics to continue to improve during 2011, some substantially.

Starting with charge-offs on slide 11, total net charge-offs of $367 million increased $11 million from the fourth quarter. The increase was driven by the $22 million in losses recorded on the single relationship noted above, but otherwise results were slightly better than expected. We've seen improvements in most areas of the portfolio, and most geographies are stable to improving, although Florida remains challenged.

We've seen significant improvements in our results from Michigan, which was an early and significant source of credit stress in recent years. While I wouldn't say results in Michigan are where they ought to be, experience there has begun to converge with the overall portfolio performance, and we've seen that for a few quarters now.

Total commercial net charge-offs were $164 million in the first quarter compared with commercial net charge-offs of $173 million in the fourth quarter. C&I charge-offs were $83 million, down $2 million from the prior quarter. Commercial mortgage charge-offs were $54 million for the quarter, down $26 million sequentially. Commercial construction charge-offs were $26 million, up $15 million from last quarter. The construction losses were primarily related to two homebuilders, although homebuilder losses remained relatively low at $22 million in total compared with $19 million of portfolio losses last quarter.

You'll recall that we suspended homebuilder originations more than three years ago, have already recorded significant charge-offs against that portfolio, and have significantly reduced our exposure. Portfolio balances are down to $651 million or less than 1% of total loans, significantly below the peak of $3.3 billion back in mid-2008.

Total consumer net charge-offs were $203 million compared with $183 million last quarter, up $20 million, driven by the large charge-off I noted at the outset of my remarks. Regarding this credit, in the fourth quarter, we classified it as a C&I loan on nonaccrual and foreclosed on the collateral.

I spoke about this particular NPA in my remarks in January, where we foreclosed on our collateral, which is a modest number of consumer loans. We subsequently determined that the foreclosure resulted in the credit being more appropriately classified as consumer loans rather than commercial, which is how it was classified in the Annual Report. During the first quarter, we charged off $22 million of these loans, which are recorded in other consumer loans and leases, where you'll see charge-offs increase $20 million in the first order.

We expect we'll see some additional charge-offs on this in the second quarter, and we've incorporated that into our outlook for charge-offs that I'll discuss in a minute. Excluding this credit, consumer net charge-offs were $181 million versus $183 million in the fourth quarter. Residential mortgage charge-offs were $65 million, up $3 million, although we expect substantial improvement in the second quarter and also later in the year.

Home equity losses of $63 million were down $2 million from last quarter. We also expect results to improve here as well. Auto net charge-offs remained low at $20 million or 73 basis points. Credit card net charge-offs declined to $31 million or a relatively low 660 basis points. Trends in these portfolios are also positive.

Looking ahead to the second quarter, we currently expect consumer charge-offs to decline, driven by lower mortgage and auto charge-offs, which together, should be down $20 million or so. In commercial, we expect charge-offs to be down modestly. Total net charge-offs should be in the $330 million to $350 million range. We see continued good underlying loss trends, and currently expect charge-offs in the second half of the year below an annualized rate of 150 basis points. We also expect commercial recoveries to play a larger role in our net charge-off trends, which would further the improvement in our results down the road if realized.

Now moving to NPAs on slide 12. NPAs, including held for sale, totaled $2.3 billion at quarter-end, down $126 million or 5% from the fourth quarter. Excluding held for sale, NPAs in the loan portfolio were $2.1 billion or 2.7% of loans, down from 2.8% of loans in the fourth quarter. My remaining comments on NPAs will focus on the held for investment portfolio unless otherwise noted.

Overall, Florida and Michigan remain our most challenged geographies from an NPA standpoint, and accounted for 41% of NPAs in the commercial and consumer portfolios. However, NPAs in those two states were down $48 million sequentially. Commercial portfolio NPAs were $1.6 billion, or 3.6% of loans consistent with the fourth quarter. Commercial construction NPAs declined $11 million, while commercial mortgage NPAs increased by about $18 million.

C&I NPAs increased $8 million or about 1%. Across the commercial portfolios, residential builder and developer NPAs of $249 million were down $10 million or 4% sequentially, and represented about 16% of total commercial NPAs. Within portfolio NPAs, commercial TDRs on nonaccrual status increased modestly to $148 million this quarter from $141 million last quarter. We expect to continue to selectively restructure commercial loans where it makes economic sense for the Bank.

On the consumer side, NPAs totaled $538 million at the end of the quarter or 1.57% of loans, and were down $58 million from the fourth quarter. Residential mortgage NPAs decreased $29 million during the quarter to $338 million. About half of our mortgage NPAs are in Florida. Home equity NPAs totaled $71 million at the end of the first quarter, down $1 million from last quarter. Auto NPAs were down $2 million and credit card NPAs were down $2 million as well. Finally, other consumer NPAs declined $24 million from last quarter, driven by the large charge-off I discussed earlier.

Looking ahead to the second quarter, we expect both commercial and consumer NPAs to decline in continuation of the trends we've been seeing over time.

To give an update on the pool of commercial NPAs that are being held for sale -- you'll recall that in the third quarter of 2010, we moved commercial loans with the net value of $574 million into held for sale status, bringing the total at that time to $680 million.

At the end of the first quarter of 2011, we had $216 million of nonaccrual commercial loans held for sale, including $43 million of additions to the held for sale portfolio during the quarter. Additionally, we transferred approximately $10 million of loans from loans held for sale to OREO. During the quarter, we recorded negative valuation adjustments of $16 million on held for sale loans, and we recorded net gains of $17 million on loans that were sold or settled during the quarter. Gains, losses, and valuation adjustments have roughly netted out and our marks still feel appropriate.

Total portfolio NPAs, commercial and consumer, are being carried at about approximately 60% of their original face value, through the process of taking charge-offs marks and specific reserves recorded through the first quarter. We work to be proactive in addressing problem loans, and writing them down to realistic and realizable values.

The next slide, slide 13, includes a roll forward of nonperforming loans. Commercial inflows of $299 million were generally consistent with the last several quarters, and are less than half of levels realized in 2009. Consumer inflows for the quarter were the lowest we've seen since 2008. Total inflows of $412 million declined $55 million or 12%, also to a post-crisis low.

Turning to slide 14, the level of inflows as a proportion of our loan portfolio remains relatively low versus peers. A couple of years ago, we had higher relative inflows, and I think that's a reflection of our geographies, which were impacted earlier than others, and our aggressive recognition and resolution of issues as they occurred, which is benefiting us now.

Turning to slide 15, we provide some data on our consumer troubled debt restructuring. We have $1.8 billion of consumer TDRs on the books as of March 31, of which $1.6 billion were accruing loans and $209 million were nonaccruals. Among the accruing loans, $1.3 billion were current, and of those, about $1.1 billion were current and were restructured more than six months ago. We expect the vast majority of that $1.1 billion pool to stay current, based on experience.

More recent modification vintages have shown lower rate default rates than loans we restructured earlier in the cycle. Those recent vintages also constitute a larger proportion of the aggregate TDR pool. As you can see from the slide, while 2008 vintages experienced higher re-default levels, more recent vintages have trended toward a 12-month default frequency in the 25% range. Our modification activities continue to work relatively well, as I think vintage trends demonstrate.

Moving to slide 16, which outlines delinquency trends. Loans 30 to 89 days past due totaled $538 million, down $98 million, or 15% from last quarter, with consumer down $78 million and commercial down $20 million. On a year-over-year basis, these early-stage delinquencies were down 39%. Loans 90-plus days past due were $266 million, down $8 million from the fourth quarter, with consumer down $17 million and commercial up $9 million, although they were still just $39 million. Total delinquencies of $804 million this quarter were down $106 million, or 12% from last quarter and at the lowest level since 2006.

On to provision in the allowance, which is outlined on slide 17 -- provision expense for the quarter was $168 million and reflected a reduction to the loan loss allowance of $199 million. Our allowance coverage ratios remain very strong, with coverage of nonperforming loans of 170%; nonperforming assets of 132%; and coverage of annualized net charge-offs of nearly two times. Given the anticipated trends in credit, we'd expect the loan loss reserves to continue to come down in coming quarters.

That concludes my remarks. Operator, can you open up the line for questions at this time?

(Operator Instructions). Erika Penala, Bank of America.

I wanted to get an update of, first-hand, on the SEC inquiry and whether or not it made an impact on how you classified or categorized underperforming credit this quarter?

Yes, I think, overall, with respect to the SEC matter, we don't have any new information to report. I think we've said in our prior comments everything that we can say about that. We continue to provide the information that's requested and really don't have any additional insight in relationship to statements that we've made previously.

Relative to current reporting, it's had absolutely no impact on how we classify nonaccruals or how we account for or disclose any information in our financial statements.

Okay. And during your prepared remarks, you mentioned a propensity to both do M&A and buyback activity. I was wondering if you could give us a sense on what your priority levels are? Or is that really going to be dependent on whether or not the propensity to sell from properties where you're interested -- or in geographies that you're interested picks up?

Yes. I think, certainly, the relative priorities there or what the likelihood of what you might see there will probably be determined by the nature of the M&A environment that we see over the next six to 12 to 18 months. So I think that with the capital position that we have, we certainly think we're well-positioned to participate in M&A activity. We also think that share repurchases will likely become part of our capital planning activities as we go forward. So I would expect that you will probably see some of both over the next 12 to 24 months.

I guess -- this is Jeff. I would just add, there's not a lot of tension between those two, because we've got $1 billion of excess capital over our target now. We expect that to grow. That's $2 billion over the Basel III buffer standard. So we would expect to have excess capital in any instance.

(multiple speakers) And the final thing I would just mention, Erika, is, again, in terms of M&A, I think there's a -- there's kind of a growing expectation out there that that's imminent. And we just -- we don't see that as imminent, per se, particularly given relative valuations today. Banks are still sold. And I think that has to improve a little bit, and would probably take us into the latter part of this year or into next year even, relative to properties becoming available.

And from a size perspective, from an asset size perspective, what's your maximum tolerance?

I'm not sure we would have a maximum tolerance. I think we've indicated that one of our primary objectives in M&A, as well as in our organic growth, would be to densify our footprint and become more relevant in some of the markets where we don't have a stronger share as we have in some of our primary markets.

And therefore, I think the expectation would be that there would be acquisitions that might be on the smaller end, maybe in the $5 billion or so range, that might be acquisitions that fill in markets that we're in currently. Although, certainly, to the extent that larger acquisitions opportunities become available, I don't know that we would preclude ourselves from looking at those kinds of opportunities. But the focus would probably be more toward the smaller end.

Thank you.

Paul Miller, FBR Capital Markets.

Thank you very much and I was jumping in and off the call. But you talked -- somebody said that you talked about how you're seeing improvement credits in the Michigan market. Can you just add some color to that?

Yes, we're making that comment, I think, relative to the experience that we've had in the cycle over the last couple of years. So, as you'll recall, as we were in the earlier stages of the cycle, the biggest challenges we had from a geographic standpoint were in Michigan and in Florida. And in particular, in that Eastern Michigan region as we were working through some of our commercial real estate exposure.

We've been very aggressive in working through that exposure. We have a very, very good handle on our remaining exposure in that area, and feel very good about where we are in this point of the cycle. And as we've looked at the remaining real estate exposures in Michigan, we are seeing very much more of a convergence to an eventual operating environment that's more normalized.

That being said, we're still mindful, obviously, of our real estate exposures in Florida and we're seeing improvement, but perhaps not quite at the pace that we are in Michigan.

And then going back to the capital management question, because I don't think The Street completely understands the process that goes forward -- you announce a buyback; you can pay a dividend. To increase your dividend, do you have to go back to the Fed? And what's the process on that from here?

Well, in general, I think banks submitted capital plans that had baked into them expectations relative to dividends. So, the question as to, do you need to go back every time you have a dividend increase, I think depends upon what was baked into the plan.

Our plan had incorporated into it increasing levels of dividends that reflect our expectations that payout ratios would continue to increase over time, and that our earnings would tend to increase over time. So therefore, there are certain levels of increases that are incorporated in our plan would not necessarily require an additional capital plan to be filed with the regulators.

That being said, I think there is an expectation that, on an annual basis, banks would file capital plans with the regulators and refresh all of their expectations relative to their capital management activities, including dividends.

I guess or, if there's a change in the capital plan to resubmit a plan.

Yes. It's unclear to us for everything -- that helped out a lot. That really cleared up a lot of stuff for us, because we didn't -- some banks have said they have to resubmit to raise a dividend. But I guess for you guys, you don't have to. You show continued strong earnings and then you can, if you need to, you can raise that dividend.

There are some increases that have been incorporated into our plan, which was not objected to. So, within limits of what was incorporated in the plan, yes.

Hey, thank you very much, gentlemen.

Mike Mayo, CLSA.

In terms of the commercial loan growth, what percentage of the linked quarter improvement in the commercial loan growth is due to syndicated lending?

If you -- let me just (multiple speakers) --

I've got it right here.

Yes, if you've got that (multiple speakers) --

Syndicated loan balances were up about $300 million during the quarter. So that was probably a decent portion of our growth as you would expect in the environment that we're in, from a capital market standpoint.

And that -- just to put that in perspective, Mike, C&I loans grew about $1.4 billion in the first quarter. So -- and our, what you would consider probably syndicated loan book or deals where there are two banks or more in the credit, about 20% of our portfolio in total.

Okay. And what are you seeing in the syndicated lending area more generally? I guess it probably added to your fees this quarter too and it's, for the whole industry, it's up a lot year-over-year.

Yes, we've seen -- obviously, it's been very active and continues to be active. Typically what you see in those deals are larger deals, stronger credits, stronger companies really improving their position. And that's -- that activity we saw very much. So, in terms of actually the last few quarters, that continues from our standpoint. So -- and as you point out, Mike, you do tend, in participation, to get a good return, a fuller return of value with respect to some of the fees associated with that business.

And then, Mike, I would add from a credit quality perspective, that our overall credit metrics in that portfolio are actually stronger than in the other parts of our portfolio. And that's been the case for quite some time. So certainly, we look closely at that as we think about that business opportunity.

You seem to have the lowest percentage of non-investment grade syndicated loans, so it does seem like you have more of a quality emphasis. Is this a missed opportunity? Or are you concerned about the non-investment grade part of syndicated lending?

No, I think, Mike, that we continue to evaluate the right business for us to be in from that standpoint. Obviously, credit quality is something that we continue to be very mindful of from that perspective. So, as opportunity becomes more apparent or comfortable to us, we'll take advantage of that. We have the resource, the balance sheet and the capital to be able to do that, so.

And Mike -- sorry, I just -- one thing. I'm not sure what the non-investment grade thing is, but we're a middle-market bank. We have a lot of club deals where there are two or three banks in small credit, those tend not to be investment-grade types of borrowers. And we're not lenders to GE and -- we're just not -- we don't play in that space to a great extent with billion -- multi-billion-dollar Double-A credit facilities.

And to that point of Jeff's, as you think about our participation, particularly in the club deal portion of the space, we do have a very significant focus in thinking about it, in terms of overall relationship lending. So we look closely at not only the credit portion of the relationship, but also the noncredit portion of the relationship, to make sure we're getting the right level of returns.

All right. Thank you.

Todd Hagerman, Sterne, Agee.

Just wanted to follow up on the loan growth question. Kevin, it seems like a lot of the emphasis is the second half of the year in terms of the loan growth expectations. But there does seem to be several moving parts. Could you just kind of flesh out a little bit more in terms of, as you mentioned before, I think Dan, you mentioned, just the paydowns and the effect that they're having?

And then how the, in terms of your decision on the mortgage production as well as, again, this capital markets, syndicated lending, how that's influencing your loan growth expectations for the back half of the year.

Yes, I'll start, Todd, and then I'll turn it to Dan or Mary to chip in. Because I guess the things that we would emphasize is, we feel very good about our loan originations. That pipeline and that activity really has continued for us for the last several quarters, and we have high expectations that that will continue.

I think the thing that did surprise us was the capital markets activity and the level of paydowns. The good news is, we don't think -- we aren't seeing a migration of wholesale customers from that perspective. We are seeing a lot of activity on that basis in terms of paying down some of that debt.

We would have expected that to dip into some of the deposit framework. That hasn't happened at this stage, so we're still seeing that -- although the other positive from our standpoint is we did see a second quarter, albeit very slight, continued increase in line utilization.

So, those are the trends on a macro basis. I'll give it to Dan to talk a little bit about our orientation. Our expectation, as we've kind of indicated is, we feel very comfortable about what we control -- again, which is our originations and being front of the market in taking share. We assume that some of the speed with which those paydowns have occurred will begin to stabilize or slow. And that will be beneficial to us and our balance sheet going forward.

I don't know, Dan, if you've got anything else to kind of add as a flavor to that.

Probably not a lot. I guess I would just reemphasize from the perspective of paydowns and payoffs, we have seen that activity be fairly high in the last several quarters. Typically, we would see a drop in the level of refinancing types of activity in the first quarter. And we didn't see that in the first quarter.

That being said, I think capital markets conditions in the latter part of the quarter were not quite as strong as they were in the first part of the quarter. And I think, overall, we would expect that while refinancing activity will remain elevated, that it will lessen somewhat from what we saw in first quarter. I think that's one of the things that underlies our bullishness with respect to loan growth expectations for the second half.

And as Kevin said, the things that we can control relative to pipelines, our competitiveness in the marketplace, originations, and the fact that we're not losing a lot of customers are all things that we see as positive and underlie the positiveness of our outlook there.

So just so I'm clear, so the capital market facility is not expected to consume a larger portion of mix in the back half of the year necessarily; that you're still comfortable with kind of the -- what, as you say what you can control at your end on the origination side?

Yes, I guess the best way we can convey that to you, Todd, is that we would expect that those most capable and eligible to participate in that paydown and repricing of their debt have probably stepped forward, from that standpoint. So, if the environment changes dramatically, we'll let you know, but that's what we're foreseeing at this point.

Okay. And then if I may, just outside of that, with respect to just the underlying economic activity in the quarter, a number of institutions have talked about kind of that, the notable slowdown, particularly in the back half of the quarter. And you made some reference to it. But within your market, again, you talked about some of the positive macroeconomic drivers that you're seeing within the Midwest. Is that adding to the confidence? Or is it just kind of this hope and a dream that demand is going to once again pick up here after a slow start?

We have eliminated hope and dreaming from any forecasts, just to start with, Todd. I can't bear that, so (multiple speakers) --

Well, that's encouraging.

(laughter) But what I would tell you is, look -- a lot of our confidence comes really directly from the marketplace relative to our conversations with clients and their expectations. And I would tell you that we -- and maybe it is predicated or predominated because of the manufacturing orientation in our footprint, but we're hearing clients being cautiously optimistic -- nothing ridiculous or absurd, and I don't think we've given you guidance to that end, but as I think you've seen in terms of what we printed, our expectation is that continues at the slow and steady pace that it has started.

The other factor, as you might imagine, is getting more competitive out there. We're working hard to maintain our disciplines throughout the entire scheme of our asset classes. That's particularly probably relevant in auto today, because there are new players, new entrants coming back into that space where we've never left it.

So, those are the -- that's the battle of every day that we compete with. But I would tell you that our customers are feeling better than they were last quarter. And we think they'll feel better next quarter than they do this quarter. And that's where it comes from.

Terrific. I really appreciate the color. Thank you.

Ken Usdin, Jefferies.

Just a question on fees and a question on expenses. In terms of the outlook for fees, I was wondering if you could just kind of help us understand -- is mortgaged still reset further and that's offset by core growth on the other lines, like you mentioned, in processing? I guess the main question is, what do you expect the mortgage business to do and what does your pipeline look like?

Yes. I think, from a mortgage perspective, I think we did see things pick up a bit for the end of the quarter. We expect some seasonal increase in the level of mortgage activity, as we commented in our remarks. Overall, I think we expect mortgage revenues to be up maybe $10 million in the quarter. So, not a tremendous rebound in mortgage, but we don't see that declining further in the second quarter.

Okay. And on the expense side again, you're talking about also them to increase a little bit. Just -- not that you had any real one-timers in the first quarter, but can you just remind us again how much expenses were seasonally impacted by FICA tax-related stuff? And what areas do you expect to see growing within expenses? I think you typically do have more of a first and second decline.

Yes, I think, overall, we've been very pleased with expense performance. We were down about $70 million between quarters. Some of that is the credit-related piece of that, which I think was about $30 million. But that leaves about $40 million of decrease that's non-credit related. And as you point out, the seasonality of some of the payroll taxes probably cost us about $20 million or so in the first quarter. So other than that item, we've seen about $60 million of other declines.

And I think that's a combination of some items that are tied to revenue. So we do see some lower levels of incentive compensation and so forth, particularly with respect to the mortgage business. But also just good, broad-based expense discipline, which we continue to have, particularly in this environment.

So, I guess, so -- with $20 million of seasonal stuff in the first that you're still kind of -- at a good underlying cost number, but you're still expecting some growth in the second. I guess, what's replacing that seasonal decline, is my other question?

Maybe the simplest way -- this is Jeff -- this quarter, we had $30 million of credit-related costs. They've been running more in the $50 million, $55 million range. And we released $14 million, I think, in repurchase reserves this quarter; we wouldn't expect to replicate that. So that $14 million, if that goes to $0, that's $14 million of growth right there.

Right. Okay. And I'm sorry just to come back to the fee side, but if you're expecting mortgage to be up then, I guess what are the other things that would be coming down against on the fee side? Because usually you have also a better second quarter in service charges and the like as well as just in the core businesses?

Yes. Dan, I think, walked through and maybe I don't want to do it again, but in the transcript, we walked through every single fee line item and what our outlook is.

All right. I'll re-read that. Sorry about that.

Chris Gamaitoni, Compass Point.

Thanks for taking my call. Most have been answered. I guess, what do you view your normal reserve level? I'm a little surprised how high -- I mean, it's not high but relatively high compared to 170% coverage ratio [of] your provision each quarter and just where can we look at that going forward?

Yes. We've talked a bit about this in the past. And it's difficult, I think, to predict where reserve levels will end up overall. But I think one of the things we've talked about in the past is that from a historical perspective, reserve levels have been maybe 1% in the best of times, 1.5% in other times, and that we would expect that that would shift northward maybe to the 150 to 200 basis point range rather than 100 to 150.

A lot of that depends upon where loss rates settle out, what the new normal looks like, as well as potential changes in -- of accounting rules and regulatory interpretations and so forth. But I think we've talked about 200 basis points as being maybe what an expectation might be as to where the reserve might trend to, based on what we know now.

And there will be an expectation that seems as good as any, because we don't have clarity with any great degree on that.

Right. And then kind of a follow-up. Just as it relates to allowance to NPLs, do you think that's more indicative of keeping that balance high relative to loans? Or -- just in -- it's two to three times higher than the majority of your peers with similar books. So I'm always trying to wrap my head around why your ratio is so much higher than the rest of the industry.

Yes. You know, our reserving methodology takes into account a lot of factors. One is, I think that we have -- we were prudent in building reserves. We've seen some increase -- or excuse me, some improvements in our overall level of NPAs, which has impacted that. But by and large, other factors are what drives our reserve models and our expectations.

And I guess all I can say is that we feel that our reserves are conservative and prudently stated. And we take those things under consideration as we go through our models each and every quarter. And I can't really comment on what other people's models are and how they're arriving at their numbers, but we believe our reserve levels are appropriate.

(multiple speakers) The other thing I would add to that, when you think about that ratio in particular, keep in mind that, at least in recent quarters, we've also taken some special credit actions that had the effect of reducing our level of nonperforming loans. So that's also a factor, at least in recent quarters, to consider as you look at that ratio.

All right. Thanks.

Thanks, Chris. Thanks, everybody. Appreciate it. Talk to you next quarter.

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