Fifth Third Bancorp (FITBP) 2011 Q2 法說會逐字稿

Good morning. My name is April and I will be your conference operator today. At this time, I would like to welcome everyone to the Fifth Third Bancorp Second Quarter 2011 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).

I would now like to turn the call over to Mr. Jeff Richardson. Sir, you may begin.

Thanks April. Good morning everyone. Today we will be talking with you about second 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 its historical performance in these statements. We have 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 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; Chief Risk Officer Mary Tuuk; Treasurer Mahesh Sankaran; and Jim Eglseder of investor relations.

During the question and answer period, please provide your name and state your firm to the operator. With that, I will turn the call over to Kevin Kabat.

Thanks Jeff. Good morning everyone and thanks for joining us. Today we reported second quarter 2011 net income to common shareholders of $328 million or $0.35 per share. That is up 120% from last year's EPS and up 30% from last quarter excluding the $0.17 write-off of TARP discount.

Trends continue to reflect broader aspects of the economy as it recovers, with positives including strong chart strong fee income results, controlled expense performance and improved credit trends. These trends generally offset the impact of a difficult interest rate environment and a competitive landscape which negatively affected alternatives for securities reinvestment as well as lending margins.

Loan demand continues to be lower than we would like, as deleveraging trends and economic uncertainty continue to weigh on customer demand for new financing. However, taken as a whole, this is an environment that we've been able to take advantage of.

We continue to build our relationships both in terms of retail households and commercial lead bank positioning. And we continue to be recognized for our customer experience, whether from our own customer surveys or those of third parties. So we continue to have success in deepening our own customer relationships and the building market share. That will drive value in the future and gives us confidence we can build upon current results.

Dan and Mary will provide more details in their remarks, but in terms of financial results, I will touch on a few high-level items here.

Average portfolio loans increased $300 million sequentially with C&I loans up about $600 million or 2%. Generally, pay downs remained high and that continued to impact loan growth. CRE loans were down about $400 million, although that runoff continues to slow. Consumer loans were up about $150 million with growth in the residential mortgage and auto portfolios offset by home-equity runoff.

Deposit growth continues to be strong. Transaction deposits increased 2% sequentially, partially offset by CD runoff and core deposits. While deposit costs decreased during the quarter, we expect a bigger benefit in the back half of the year from maturities of late 2008 vintage CDs.

Noninterest income results were strong in the second quarter. Mortgage banking revenue improved significantly from the first quarter and totaled $162 million. Deliveries were down, but gain on sale margins improved. And we recognized net gains on the MSR and related hedges given the low rate environment at the end of the quarter.

Card and processing revenue and corporate banking revenue were both up 10% or more.

Expenses were down 2% due to positive seasonality and good expense control. And finally, overall credit trends continue to improve.

Charge-offs were $304 million -- the lowest level since the first quarter of 2008 -- with a sequential reduction of $63 million. That was better than expected across essentially all of our loan portfolios. We expect similar improvement in the third quarter.

Total nonperforming assets decreased $78 million or 3%. And total delinquencies declined $70 million or 9% compared with last quarter.

All told, these results are the strongest we've reported since 2007. And I would like to thank our 21,000 employees for their hard work, dedication and focus on meeting our customers' needs and driving business results despite the many changes the industry has faced the past several years. Thank you all.

Let me turn to some of those changes. We have had a number of regulatory developments during the quarter. Perhaps the most notable being the release of final rules related to debit interchange under the Durbin Amendment.

The Fed's final proposal does not provide [for] full cost recovery, but the proposal at least covers most of our marginal costs and with a significant improvement from where it started. We still believe that this legislation was unwarranted and is regrettable as a precedent for private sector price controls. But at least we have some certainty and can begin to adapt to it.

Dan will talk about that effect in more detail. But we currently expect gross negative impact of about $30 million a quarter or approximately 50% of our $60 million in quarterly debit interchange revenue. We'd expect to mitigate about one-third to one-half of that in the fourth quarter of this year, which is the first quarter of implementation, something like two-thirds of it by the first half of next year and hopefully most of the rest as we fully adapt to the new rules.

In terms of capital, we remain hopeful that at some point in 2011 we will see final capital guidelines for the US. As you know the Basel Committee has published rules that will establish capital surcharges for globally systemically important banks of 1% to 2.5%. We are a fraction of the size and far less complex than any of the 28 banks that appear to meet that definition.

It is possible that the domestic US banks with over $50 billion and in assets would be ascribed a more modest surcharge as rulemaking and Dodd Frank are applied here in the US. We would hope and expect that our traditional business model and our lack of complexity will result in no surcharge, or a modest one, for regional banks like Fifth Third which do not pose a threat to the financial system.

Before turning it over to Dan, I would just like to sum up that the macroeconomic environment remain sluggish. But it is one in which we continue to post solid results. They are not yet at the levels we're our capable of, but at 1.22% ROA and a 14% tangible return on equity, are strong for this stage of the recovery and are relative to our peers.

While there is a lot of uncertainty facing the industry, there's a lot going right at Fifth Third, and we're confident we can build on these results in the second half of the year and thereafter.

With that, I will ask Dan to discuss operating results and give some comment about our outlook. Dan?

Thanks Kevin. Starting with slide four of the presentation, in the second quarter we reported net income of $337 million and recorded preferred dividends of $9 million. Net income to common was $328 million and earnings per share were $0.35. That compared with net income to common in the first quarter of $88 million or $0.10 per share.

Prior quarter results were reduced by $153 million or $0.17 per share that related to the accelerated write off of the TARP discount. If you exclude that, net income to common increased 36% sequentially and EPS increased 30%.

As Kevin mentioned, our return on assets was 1.22%, which is beginning to approach the lower end of our normalized ROA expectations. Return on equity was 11% and return on tangible common equity was 14%. Those are relatively strong returns for this point in the recovery, but we believe that they have room to improve further.

As we have discussed previously, we believe our return on assets should normalize in the 1.3% to 1.5% range with continued improvements in credit costs and a more favorable interest rate environment in the longer-term. Those would also drive improvement in our return on equity measures. Additionally, our current common equity levels exceed our targets by about 100 basis points.

We're obviously awaiting clarity on final capital standards for US banks, but still believe that a Tier 1 common ratio target in the 8% range should be an appropriate level in a normal operating environment for a bank of our size and business model.

That said, we don't have any information on that front other than what you have seen come from the Basel Committee, as well as from some public comments from the Fed that any incremental capital requirements would likely be modest for banks at the lower end of the Dodd Frank $50 billion threshold.

As we have discussed the last several quarters, we would expect to remain north of our targeted capital levels in the immediate term as we and regulators adapt to Basel III, and as distributions remain somewhat restricted by regulatory guidance.

Turning now to slide five and net interest income. Net interest income on a fully taxable equivalent basis declined $15 million sequentially to $869 million. And the net interest margin decreased 9 basis points to 3.62%.

Most of the decline in NII and NIM was attributable to lower mortgage warehouse balances, lower average spreads on commercial and consumer loans, lower LIBOR rates and a flatter yield curve. Growth in C&I, auto and residential mortgage loans offset these factors to some extent.

An extra day in the second quarter, relative to the first, added $6 million to net interest income comparisons. But that was offset by the impact of hedge ineffectiveness as well as a full quarter effect of our January debt issuance.

We experienced some additional yield compression during the quarter, primarily in the C&I and auto portfolios. On the C&I side, the portfolio average yield was down 10 basis points during the quarter. Of that, about one-quarter was simply due to the investment of excess cash in banker's acceptances, which were up about $140 million on an average balance basis.

As for the remainder, loan renewals and payoffs have tended to be on loans originated at wider spreads over the last several years. Much of the new borrowing activity that has characterized the recent quarters has been in the upper end of our portfolio, both in terms of size as well as credit quality. And so there is a mix effect that has also affected our reported yields. We did see origination yields spreads improve in June, which you would expect given market conditions.

In the indirect auto portfolio, lower yields are reflecting both lower reinvestment rates and additional competition as these assets are quite attractive from both a loss and a duration standpoint.

In general, loan growth and pricing were lower than we expected, particularly earlier in the quarter, with demand and refinancing activity continuing to skew to the higher end of the book and reflecting heightened concern among borrowers with recent economic and political developments.

On the funding side, deposit pricing discipline, ongoing CD runoff and deposit mix shift all benefited NII. But those were partially offset by higher interest expense that I mentioned earlier resulting from hedging ineffectiveness and a full quarter effect of our January debt issuance.

The net interest margin reflected the items I just discussed was about half of the decline driven by the higher day count, the hedge ineffectiveness and the increase in long-term debt.

Looking ahead to the third quarter, we currently expect NII to increase in the $20 million range. We expect the sequential increase to be driven by a number of factors.

CD runoff should reduce interest expense by about $8 million. Our second-quarter TruPS redemptions will add another $5 million and an extra day in the quarter adds about $6 million. Those three items produced something like $20 million in benefit.

Otherwise, we expect the benefit of loan growth, some continued compression in yields, as well as some other factors to largely offset one another.

The tailwind from CD runoff is pretty significant. We expect an additional $15 million of NII benefit from this in the fourth quarter on top of what we will see in the third. And that is due largely to maturities of CDs originated in the fourth quarter of 2008.

In terms of the margin, we currently expect NIM to expand about 5 basis points or so in the third quarter and to finish the year somewhere in the 3.7% range. Improvement will be driven by the factors I outlined in my discussion of net interest income, with day count reducing margin by about 2 basis points in the third quarter relative to the second.

With that context and turning to slide six, let's go through the balance sheet in a little more detail. Average earning assets were down $324 million sequentially, primarily driven by lower mortgage warehouse balances which were down $453 million, and investment securities balances which were down $98 million.

Average portfolio loans and leases increased about $300 million sequentially. We continue to experience positive balance trends within C&I, residential mortgage and auto loans, which were up a combined $1 billion this quarter. That was partially offset by the runoff in the commercial real estate and home equity books of about $635 million.

Looking at each portfolio, average commercial lines held for investment were up $160 million sequentially. C&I average loans increased $578 million or 2% from last quarter. C&I production continues to be a strong, although we're still seeing high levels of pay downs.

We've seen broad-based growth across a number of industries and sectors with particularly strong production within the manufacturing, healthcare and wholesale sectors. Given our strong levels of production and the strong pipelines, I expect we will see similar growth in the second half of the year.

Commercial line utilization remained at low levels this quarter at 33%, which is consistent with last quarter but up about one percentage point from a year ago. That is down from normal levels in the low to mid-40%s, and that would represent about $4 billion in balances if normalized.

We saw continued runoff in the commercial mortgage and commercial construction books, although the rate of decline continued to slow. Average CRE balances were down $403 million or 3% sequentially. We would expect to see continued runoff in these portfolios in the near to intermediate term, although at a continually slowing pace.

CRE loans for us are only about 15% of total loans. So, while the runoff is a drag on overall growth, it is not a big one and it is getting smaller. Significant decline in CRE charge-offs obviously helps as well.

We are not really originating much in the way of new CRE loans, though we do have the capacity to do so. We would not expect to see -- to have much of an appetite for non-owner occupied CRE until we see a better balance between the supply and demand for space.

Average consumer loans in the portfolio increased $141 million sequentially. The growth in consumer loans was driven by the residential mortgage book which was up $372 million sequentially, along with auto loan growth of $118 million. Those being partially offset by continued runoff in the home equity portfolio, which was down $232 million.

The sequential growth in mortgage loans reflects the continued retention of certain primarily shorter-term, high-quality residential mortgages that are originated through our branch retail system. We retained about $283 million of these mortgages during the second quarter.

Average auto loan balances increased 1% sequentially. The auto portfolio has continued to perform very well from a credit standpoint throughout the cycle, although as I mentioned, yields have come down due to increased competition.

Home equity loan bounces were down 2% sequentially. We have seen continued runoff in this portfolio for some time now. Given the lower equity levels among homeowners, I suspect it will still be a while before we see any growth there.

Average credit card balances were down 1% sequentially. We continue to increase credit card penetration within our customer base, although that's being offset by a general balance decline throughout the industry as customers reduce their indebtedness.

Looking ahead to the second half of the year, we would expect to see solid growth in C&I, mortgage and auto loans partially offset by continued attrition in CRE balances and home equity. That should result in continued modest overall portfolio loan growth in the second half of the year.

Moving on to deposits, average core deposits increased $720 million or 1% on a sequential basis, in line with our expectations. That net growth included the effect of $625 million of consumer CD runoff which is included in core deposits.

Average transaction deposits excluding CDs were up $1.3 billion or 2% sequentially, and are up $6 billion or 9% from a year ago. The majority of that growth is coming from our DDA and savings products.

Average retail transaction deposits increased 4% sequentially and 13% year over year, with growth across all categories. Our Relationship Savings product has now attracted over $12 billion of balances since its inception two years ago.

Given the current rate environment, we've continued to see customers moving funds and to liquid savings products when CDs mature.

Average commercial transaction deposits declined 2% from last quarter and increased 1% from a year ago. The sequential decline reflects seasonally higher balances in the first quarter, while annual growth was mitigated by about $650 million in intentional high cost public funds runoff.

We expect modest growth in transaction deposits in the second half of the year offset by continued CD runoff.

Moving on to fees, as are outlined on slide seven. Second quarter noninterest income was $656 million, an increase of $72 million from last quarter, with stronger mortgage banking revenue being the biggest driver.

Going line by line, deposit service charges increased 1% sequentially. Consumer deposit fees were flat, while commercial deposit fees increased 2%. Consumer deposit fees have reflected the implementation of overdraft regulations as well as overdraft policies, but most of that impact should now be behind us.

We have maintained commercial deposit fee growth despite a challenging business climate for our commercial customers. Overall, we expect about deposit fees to increase about $10 million in the third quarter due to the benefit of positive seasonality and commercial fees, as well as underlying growth from both consumer and commercial offerings. The fourth quarter should be at similar levels.

Investment advisory revenue decreased 3% from last quarter but increased 10% on a year-over-year basis. The sequential decline was largely driven by the seasonal tax preparation fees we received in the first quarter, as well as a less active securities trading environment in the second quarter. The year-over-year increase was driven by new customer acquisition and an overall lift in the equity and bond market. We currently expect to see low single-digit growth in investment advisory revenue during the second half of the year.

Corporate banking revenue of $95 million increased 11% from the first quarter and increased 2% from last year, consistent with our expectations. The sequential growth was driven by increased lease remarketing fees, loan syndication fees and institutional sales revenue. We would expect corporate banking revenues to sequentially decline about $5 million in the third quarter and then see results pick up in the fourth quarter due to typical seasonality.

Card processing revenue was $89 million, up 10% from the first quarter and up 5% from a year ago. Both periods benefited from growth in overall transaction volumes with sequential comparison also aided by seasonality.

As you know, the final interchange rates under the Durbin Amendment were established at the end of the quarter. The ultimate outcome of the Amendment will effectively reduce our debt that interchange revenue by about 50% on a gross basis beginning on October 1. That's a quarterly impact of roughly $30 million at current transaction volumes before any mitigating factors on debit interchange revenue of approximately $60 million per quarter.

In terms of mitigation, we expect to offset much of the effect over time through a variety of means. As Kevin has already mentioned, we have identified potential mitigants that would offset about one-third to one-half of the gross impact in the fourth quarter, about two-thirds of the impact in the first half of 2012 and hopefully most of the rest by the end of 2012.

Of that mitigation, about $5 million per quarter would come in the form of reduced expenses. Those expense reductions should be realized in the fourth quarter and in each quarter thereafter.

With that background, let's return to expectations for total reported card and processing revenue. We expect third quarter revenue to increase to the mid-$90 million range. For the fourth quarter, when the debit interchange rules take effect, our current expectation would be for card and processing revenue in the mid-$70 million range including the initial effect of mitigation activities on that line item.

Mortgage banking revenue of $162 million increased $60 million from the first quarter and $48 million from a year ago. Gains on deliveries were $64 million this quarter compared with $62 million last quarter, while servicing fees of $58 million were flat sequentially.

Net servicing asset valuation adjustments were a positive $40 million this quarter, reflecting MSR amortization of $25 million and a net MSR valuation adjustment including hedges of a positive $65 million. In the first quarter net servicing asset valuation adjustments were a negative $18 million. Right now we expect mortgage banking revenue to decline $40 million or so in the third quarter due to expectations for a lower contribution from MSR valuation items.

Turning next to other income within fees, other income was $83 million and increase 3% sequentially. Second quarter results included $29 million of positive valuation adjustments on warrants and puts related to our 2009 processing business sale. And that compares with $2 million in negative adjustments on those same measurements in the first quarter of 2011.

Equity method earnings from our 49% interest in Vantiv, the processing business, were $6 million this quarter compared with $9 million in the first quarter. As we have mentioned, Vantiv has been incurring expenses related to standing that business up as an independent company, as well as integrating its acquisition of National Processing Company which occurred in the fourth quarter of last year. And those have both impacted earnings.

In the second quarter, and Vantiv also refinanced its debt which resulted in the acceleration of deferred fees. Absent the impact of those costs, our equity method earnings would have been $14 million in the first quarter and $19 million in the second quarter. And we currently expect our equity method earnings in the third quarter to be within that range.

As expected, credit costs reported in fee income increased to $28 million in the second quarter compared with an unusually low $3 million last quarter. The largest driver of these increased credit costs were losses on the sale of OREO properties, which were $26 million this quarter compared with just $2 million last quarter.

Net losses on loans held for sale were $1 million, including realized net gains of $8 million offset by $9 million in fair value charges. That compared with a net gain of $1 million in the prior quarter.

We expect credit related costs within fee income to be around $20 million to $25 million per quarter in the second half of the year.

Overall, we expect fee income in the third quarter of about $600 million or perhaps a bit higher, with lower benefits from the MSR and warrant gains being the primary driver of the decline from this quarter's levels, offset by broad-based growth in most of our core fee lines.

Turning to expenses on slide eight, noninterest expense of $901 million was down $17 million or 2% sequentially. There were a couple of factors driving the sequential decline. We redeemed $452 million of trust preferred securities during the quarter and that resulted in a $5 million gain on the extinguishment of this debt, which reduced other noninterest expense.

Compensation expense was a bit higher than last quarter which reflected stronger results as well as annual merit increases that occurred in March. Those were offset by lower benefits expense due to the seasonally high payroll taxes we incurred in the first quarter.

Credit related costs within operating expense were lower than expected this quarter at $36 million compared with $32 million last quarter. Mortgage repurchase expense was $14 million compared with $8 million last quarter, with $7 million in net reductions to purchase reserves in the second quarter compared with $14 million last quarter.

Realized repurchase losses were $22 million this quarter versus $24 million last quarter.

We have seen lower levels of audit requests as well as a reduction in our overall repurchase demand inventory which peaked last summer. We have also seen a trend towards lower loss severities on the repurchases. We currently expect those general trends to continue as demands related to 2007 and prior years decline.

The other major driver of lower than expected credit costs was a reduction in OREO expense, which was about $6 million this quarter compared with $13 million last quarter. We currently expect total credit-related costs recognized in expense in the second half of the year to be in the $40 million per quarter range, as we're not currently forecasting additional repurchase reserve releases.

Overall we expect operating expenses in the third quarter to increase from an unusually low level in the second quarter up perhaps $25 million from this quarter's levels. The drivers there would be the benefit in the second quarter from the debt extinguishment gain and the repurchase reserves release, which are about $15 million of the increase, and then about a 1% expense growth otherwise.

Moving on to slide nine and taking a look at PPNR. Pre-provision net revenue was $619 million in the second quarter compared with $545 million in the first quarter. We expect PPNR in the $560 million to $570 million range in the third quarter based on our expectations for lower mortgage banking revenues and modest growth in expenses, partially offset by stronger NII results.

We would expect similar PPNR results in the fourth quarter as growth in NII and other fees are offset by the initial $15 million to $20 million in negative impact of the debit interchange rules.

The effective tax rate for the quarter was 33%. The higher rate was due to tax expense of $23 million associated with the expiration of employee stock options during the quarter. We expect the effective rate in the second half of the year to be in the 28% to 29% range and then the full-year effective rate to be about 30%.

Turning to capital on slide 10, our capital levels remain very strong. The Tier 1 common ratio increased 21 basis points to 9.2%. Tier 1 and total capital ratios at 11.9% and 16.0% both reflect the 45 basis point impact from the redemption of the trust preferred securities during the quarter, offset by retained earnings growth.

Tangible common equity was 8.6%, up 25 basis points from last quarter. We calculate that ratio excluding unrealized securities gains which totaled $396 million. Including those, TCE was 9.0%.

As I mentioned, this ratios are well above our targets with the common ratios exceeding target by about 100 basis points. Our current estimate for our Basel III Tier 1 common ratio would be about 9.6% based on what has been published thus far.

As we announced in March, our capital plan submitted to the Fed included the redemption of certain trust preferred securities which they did not object to. In May, upon receiving approval from the Fed, we called $400 million of retail TruPS and $52 million of floating-rate capital securities.

Under the Dodd Frank act, TruPS will be phased other Tier 1 capital over three years beginning in 2013. They are also to be phased out under the Basel III rules.

We have about 270 basis points of non-common Tier 1 capital in our capital structure currently. That is more than we would be warranted by the new capital rules and requirements that are coming out under Basel III, particularly given our high common equity ratios. We will continue to evaluate the role of these securities on our capital structure based on regulatory developments.

As Kevin mentioned earlier, we're generating capital at a pretty good clip -- roughly 20 to 25 basis points of tangible common equity and double-digit annualized growth in tangible book value. And we expect that to continue going forward.

That wraps up my remarks. So I will turn it over to Mary now to discuss credit results and trends. Mary?

Thanks Dan. Credit quality trends remained positive with NPAs, delinquencies and charge-offs all declining further during the quarter. While results can move around from quarter to quarter, we generally expect all key credit metrics to continue to improve during the second half.

Starting with charge-offs on slide 11. Total net charge-offs of $304 million decreased $63 million or 17% from the first quarter. That is 156 basis points of loans, down from 192 basis points in the first quarter and the lowest we have reported since the first quarter of 2008. Although they remain challenged, the biggest improvements came from Florida where charge-offs were down 17% sequentially, and from Michigan, down 32%.

Included within net charge-offs were $34 million in net losses recorded on a relationship that we have discussed the last couple of quarters. This was a foreclosed commercial credit collateralized with a number of individual consumer loans and it's carried in the other consumer loans line item.

In the first quarter, you will recall that we booked $23 million in charge-offs on that credit. We have no remaining loss exposure on this credit and we continue to work towards recovering previously charged off amounts.

Excluding that credit in both quarters, net charge-offs declined $74 million to $270 million or 139 basis points of loans.

Commercial net charge-offs were $141 million in the second quarter compared with commercial net charge-offs of $164 million in the first quarter. This marks the lowest level since 2007 and we saw improvement in all major portfolios.

C&I charge-offs were $76 million, down $7 million from the prior quarter. Commercial mortgage charge-offs were $47 million for the quarter, down $7 million sequentially. Commercial construction charge-offs were $20 million, down $6 million sequentially.

We have significantly reduced our exposure to the homebuilder portfolio. And balances are down to $597 million or less than 1% of total loans. This is significantly below the peak of $3.3 billion back in mid-2008, after we suspended originations to the sector.

Total consumer net charge-offs were $163 million compared with $203 million last quarter, including the impact of the $34 million charge-off I mentioned a minute ago. Excluding that credit, which again is shown in other consumer loans, total consumer net charge-offs were $129 million in the second quarter, down $51 million from the first quarter. We saw a significant improvement in most major consumer loan portfolios.

Residential mortgage charge-offs were $36 million, down $29 million. We expected significant improvement but this surpassed our expectations.

Home equity losses of $54 million were down $9 million from last quarter.

Auto net charge-offs fell $12 million to $8 million or just 29 basis points. We continue to see excellent credit performance from this product, driven by strong used car values and conservative lending standards.

Credit card net charge-offs were $28 million, down $3 million. We have had five consecutive quarters of improvement in this line which we expect to continue.

Looking ahead to the third quarter, we currently expect total net charge-offs to decline about $50 million or so. We expect consumer net charge-offs to be fairly consistent with second quarter, excluding the one credit, somewhere in the 150 basis point range with continued improvement and bank card as I mentioned.

I'm hopeful we will see card charge-offs down below 5% in the second half of the year.

In the commercial portfolio, we expect net charge-offs to be down $10 million to $50 million or about 115 to 120 basis points. Overall, we see continued improvement in underlying loss trends and currently expect total net charge-offs to trend below 125 basis points of loans by the end of the year.

We also continue to expect recoveries to begin to play a larger role in our net charge-off trends, which would further the improvement in our results down the road as realized.

Now moving to NPAs on slide 12. NPAs, including those held for sale, totaled $2.3 billion at quarter end, down $78 million or 3% from the first quarter. Excluding held for sale, NPAs in the loan portfolio were $2.1 billion, down $38 million.

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 40% of NPAs in the commercial and consumer portfolios. However, NPAs in those two states were down $37 million sequentially.

Commercial portfolio NPAs were $1.6 billion, up slightly, but overall consistent with the first quarter. Commercial construction NPAs declined $8 million while commercial mortgage NPAs increased by about $14 million. And C&I NPAs increased $18 million or about 3%.

Across the commercial portfolios, residential builder and developer NPAs of $243 million were down $6 million sequentially and represented 15% of total commercial NPAs.

NPA balances move around from quarter to quarter. But we expect a continued downward trajectory of commercial NPAs as we move into the second half of the year. Within portfolio NPAs, commercial TDRs on nonaccrual status increased to $188 million this quarter from $149 million last quarter. We expect to continue to selectively restructure commercial loans where it makes economic sense to the Bank.

On the consumer side, NPAs totaled $476 million at the end of the quarter for 1.37% of loans and were down $63 million from the first quarter. The largest driver of the decline was other consumer NPAs which declined $57 million from last quarter, driven by the large charge-off I mentioned earlier.

Residential mortgage NPAs were consistent with the first quarter and remained disproportionately concentrated in Florida. Home equity NPAs totaled $71 million at the end of the first quarter, also consistent with last quarter.

Auto NPAs were down $2 million and credit card NPAs were down $4 million.

Looking ahead to the third quarter, we expect both commercial and consumer NPAs to decline with total NPAs improving by $50 million give or take.

To give an update on the pool of commercial NPAs carried and held for sale, at the end of the second quarter of 2011 we had $176 million of nonaccrual commercial loans held for sale. These are largely credits remaining from actions we took in the third quarter of 2010, although we continue to periodically identify credits that we view as good candidates for sale.

Total portfolio NPAs, commercial and consumer, are being carried at about 63% of their original face value through the process of taking charge-offs, marks and specific reserves recorded through the first quarter. We've worked to be proactive in addressing problem loans and writing them down to realistic and realizable value.

The next slide, slide 13, includes a roll forward of nonperforming loans. Commercial inflows at $309 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 $140 million.

Total inflows of $449 million remain at the lowest levels we've experienced since before the crisis. You can see from slide 14 that the level of inflows as a proportion of our loan portfolio also remains relatively low versus peers.

Moving on 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 June 30. Only $211 million of those were nonaccrual.

Among the $1.6 billion of accruing TDRs, $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 $1.3 billion pool to stay current based on experience, particularly those that have seasoned.

More recent modification vintages have shown lower re-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.

As you know, the Financial Accounting Standards Board has issued new guidance related to TDRs that will be implemented with third-quarter results. That guidance is generally consistent with our practices and we therefore don't expect too much of an impact from the implementation.

Moving to slide 16, which outlines delinquency trends. Loans 30 to 89 days past due totaled $466 million, down $83 million or 15% from last quarter with consumer down $29 million and commercial down $54 million. On a year-over-year basis these early stage delinquencies were down 33%.

Loans 90-plus days past due were $279 million, up $13 million from the first quarter, with consumer down $16 million and commercial up $29 million. Total delinquencies of $745 million this quarter dropped $70 million or 9% from last quarter, and are at the lowest levels since 2006.

On the provision in the allowance which is outlined on slide 17, provision expense for the quarter was $113 million and reflected a reduction to the loan loss allowance of $191 million. Our allowance coverage ratios remain very strong, with coverage of nonperforming loans of 160%, nonperforming assets of 125% and coverage of annualized net charge-offs of over two times. Given anticipated trends and credits, we would expect the loan loss reserve to continue to decline in coming quarters.

Before I wrap up, there's been a lot of news on the mortgage front. We're not a party to the state's Attorney General discussions, but we expect that whatever standards develop for the larger banks will become standard for the rest of the industry. We expect that to be manageable for us.

In terms of mortgage put back risk, we don't have the same exposures as many of the larger banks. For example, unlike most of our larger peers, we have no exposure to private mortgage securitization with only $35 million in a well-performing 2003 HELOC securitization still out there. Most of our activity has been with GSEs, and as Dan mentioned, those requests or demands have moderated and seem to be improving.

That concludes my remarks. April, can you open up the line for questions?

(Operator Instructions). Brian Foran.

Good morning. I guess on the normalized ROA guidance, what I was trying to do was take the current credit-adjusted PPNR of $646 million -- I guess I have to add in the normalization of Vantiv earnings you referenced. Which those two things get you to like a 2.4% pre/pre ROA. And then backing into the provision rate, that would produce a 1.4% ROA as like 44 basis points.

Breaking down the ROA, is that kind of consistent on how you are thinking about it? Or is the normal provision higher but there's opportunities also expanded pre/pre ROA, maybe with the TruPS redemptions and stuff like that? Just any thought process on breaking it into the two would be helpful.

Yes, I think in general that is in the ballpark of what our expectations are. We have not been that granular in terms of discussing exactly how we get to our 1.3% to 1.5% expectations. But I don't think those are too far off.

I think -- we would think that there may be some additional PPNR upside as we get to a more normalized economic and interest rate environment, which should add to our growth and increase the size of our balance sheet and add NII.

And I guess also on Vantiv, if it were to go public, can you just remind us all the mechanics of how that would work in terms of revaluing the balance sheet to date, the equity method earnings that would come out? And if there is any adjustments that have to be made to the warrants and puts or if that happened this quarter?

Whether there will be an IPO in the future I guess is something that we aren't commenting on. Obviously that relates to another company and it is not something we would discuss anyway.

Relative to how that might work from an accounting perspective, I think there's a lot of different variables that would determine that. It would be determined in part by -- what would the makeup of an IPO be? Would it be all primary shares issued by Vantiv? Would it involve some of our shares? What would the resulting ownership percentage that we have be? And so forth.

But in general, I think we have a 49% interest in the company. That is on our books for something like $650 million. And one, we would need to compare our ownership percentage on a pre- and post-basis in order to determine what the overall P&L and balance sheet -- or P&L and capital impact of that would be. So, I'm not sure if that is getting to what you were driving at better.

Yes, it does. I guess it is proactive to think about it as -- let's assume the value that the paper talked about as somewhere in the reasonable ballpark. I guess with all of the expenses and the bond refinancing you talked about, right now it is a very modest part of your earnings stream.

But it actually seems like this could be a situation where if, they were to partly go public, your earnings relative to this quarter could actually be the same or higher because they are so understated right now. But then you would have almost like a book value understatement right now. Obviously it's correctly stated by accounting, but economically the book value might be not fully reflective of Vantiv's value and so there might be a situation where earnings don't necessarily change, but the book value goes up.

Is that -- I know you can't say guess that is correct because you don't know if it is going to go public and you don't know what the value would be. But is that like conceptually possible?

This is Jeff. I think all of those things sound conceptually right, but the premise is one that we cannot comment on. So there is a lot of complex accounting associated with this and we can't describe every iteration of that, particularly when we can't really discuss this to begin with. It's not -- it wouldn't be appropriate.

Got it. Okay.

Matt O'Connor.

Hi, guys. If we look at your expenses, even trying to back out some of the stuff that might have helped this quarter that is not sustainable, it still seems like the good trends there.

As we think out beyond the next quarter or two, how should we think about you managing your expense base for -- maybe there is no normal environment or this is normal. So that would mean loan growth a little bit less than all of us would have thought or hoped for, and fee volumes maybe a little bit less. What kind of levers can you pull on expenses looking out to 2012 and beyond?

Well, Matt, I think as we talk about frequently, we have what we believe is a very strong expense discipline at Fifth Third. We tend to manage expenses continually rather than to have large cost takeouts at any one point in time relative to headcount reductions and so forth.

We believe that in terms of the future we will continue to manage expenses aggressively. We have added to our expense base somewhat over the last couple of years, primarily associated with the addition of revenue-generating sales positions, and have funded a lot of that through expense discipline and reductions in other areas. So I think in general we would continue to plan to approach expense management in the same way as we go forward.

We would expect to see improvements in our overall efficiency ratio as we go forward. But frankly, we would expect a lot of that to be accomplished more through increases in revenue than through reductions in expense.

Okay. And then separately, there are some changes and the accounting for TDRs that the industry will have to reflect in third-quarter results. Any meaningful change to your TDRs when you adopt those?

No, Matt. We've gone through an analysis of those new -- or that new guidance and compared that to how we have been operating and really don't see any significant differences. And we wouldn't expect that it would have a significant impact on us going forward.

Okay, thank you very much.

Erika Penala.

I was wondering if you could walk us through the mechanics on how you were getting to the Durbin mitigation. So far this earnings season, your Durbin mitigation has been the most optimistic thus far. And if you could, take us through what the wholesale changes that you're making on the revenue side to get to that number?

Just I guess to kind of level set, I think what we said is that in the fourth quarter we would expect that we could mitigate about one-third to one-half. That is on a gross impact of $30 million. So you're looking at $10 million to $50 million of mitigation in the fourth quarter.

Of that, I think $5 million of it relates to expense reductions that have been specifically identified and we attach a pretty high degree of certainty to those. The remainder of that benefit would come from a variety of fee income categories, and relate to changes in fees that individually are not all that significant. And that is kind of the near-term view.

Going forward, I think the mitigation includes those items, perhaps some increase in the impact of some of those fee adjustments that we're talking about for the fourth quarter and then a larger impact as we go forward as we continue to look at our product offerings, reengineer those product offerings to be more consistent with what would make sense in the kind of environment we are in where debit interchange is going to be limited.

So, beyond that, those larger impacts from continuing to adjust our product offerings I think are things that are still being considered, still being designed. We feel comfortable with the estimates that we have made. And we have taken into consideration in making those estimates the fact that those aren't fully developed and baked yet and are subject to customer acceptance and so forth.

But those are the things that we are looking at as we give our guidance, so.

Okay. And on the NIM guidance, I appreciate the very specific color. And I was wondering on the loan yield side if your margin expectations bake in a similar type of decline, particularly in C&I and auto and yield, for the second half of the year in terms of pace?

Well, I think our expectations for the second half reflect an environment that is very similar to the environment that we're in right now. I think it reflects a low rate environment, one in which there is a fair amount of competition. So I think it reflects a continuation of the environment that we're in, not necessarily a worsening environment and not a significant drop-off in origination yields, but one in which we expect to see continued pressure on that side of the balance sheet.

This is Jeff. Obviously as we renew loans in this environment that were booked two years ago, let's say, where spreads were wider -- I mean, there was a portfolio impact that's going to affect yields that is predictable in the sense that we know where our loans are going to renew were priced originally.

Okay, and one last quick question. Could you share with us what you're earning in terms of ROE for Vantiv?

Yes. I think we mentioned that on the call. Our earnings in the second quarter, our equity method earnings were $6 million. That included about $13 million in costs that are related to integration costs and the refinancing of their debt in the second quarter, so about $19 million excluding that. So is that what you're asking?

Paul Miller.

On the auto side of the business, we're hearing a lot of national players in the indirect auto lending is really, really pushing pricing down on price competition. I'm just wondering; are you seeing that? And I'm also just wondering if you can walk us through a little bit how you are pricing the auto business?

This is Mahesh. We're definitely seeing competition in the auto business, no question about that. It continues to be a pretty attractive asset as a short duration asset. Even though pricing has been pushed down, it continues to be a pretty attractive asset which probably explains the competition to some extent.

In terms of pricing, we are very granular in our pricing. We risk-base price and we price at -- not just based on one or two risk categories. It's a whole matrix of risk categories and we price based on used versus new and so on. So it's tough to give you a general answer to that question. It's a very granular risk-based pricing system.

You know, you talk about how -- it's one of the few I think loan categories out there that is still attractive. But I'm just concerned about -- is that some of these big national players here struggling with balance sheet growth are really coming in hard in some regions. I don't know -- whereas some banks have told us they just pulled back completely. But I just guess in your areas you're not seeing that much of a cutthroat competition.

No. We're definitely seeing competition. I think we feel confident that the way we're pricing and the ability to risk-based price gives us the ability to create, at a portfolio level, a high credit quality portfolio that gives us good returns. So while those returns are definitely lower than they were two years ago, the returns still are pretty good relative to the credit quality of the portfolio.

This is Kevin. The other thing I would tell you is we never exited the business. We stayed right there all along. And the credit quality of the paper that we continue to book is exceptional and still very, very good, as well as particularly in terms of the in-footprint piece, we have strong relationships with our dealers and dealerships as well.

So we're positioned a little bit differently than obviously a national player from that perspective. And we think that is a business we can continue to stay in, and continue to contribute to our growth as we go forward, as we've given guidance to.

So, again, Mahesh is correct. We are seeing more competition. But again, we feel like we've got a pretty good spot in our place.

Guys, thank you very much.

Todd Hagerman.

Just a couple of capital questions. On the payment processor, I think Dan, Kevin, you have mentioned in the past the Basel III implication on the payments unit was fairly modest. And certainly with a [9.4] pro forma ratio, that seems to be the case. I'm just curious how the Basel III would possibly be affected by any potential IPO with Vantiv.

I'm sorry. I didn't get the last part of that.

I'm just trying to reconcile the Basel capital implications with the payments units in terms of how you guys are currently looking at it today, and your pro forma [9.4] ratio, and how that may possibly be influenced by any kind of a potential IPO in your capital thinking.

Well, I think right now our expectation would be and our understanding of the rules would be there is no impact on our capital, or no adjustment to our capital as a result of that investment.

In terms of how that is impacted by an IPO in general, I think the only impact would be whatever gain there might be, or whatever the results of that transaction is on our capital would come through. But no other adjustments other than just reflecting the impact of the transaction.

And it would come through the P&L, so it wouldn't have a Basel III effect.

Right. So at the end of the day, as you responded to the other question about -- again, conceptually, you improve your book value. But I'm just kind of wondering now, at the end of the day, Fifth Third is sitting on an extra 100 basis points of capital if you will under the new guidelines. And you have kind of suggested that acquisitions really aren't in the cards at least near-term.

So how should shareholders kind of think about capital management going forward? It seems like, as you've mentioned, you are generating a lot of capital internally. You're currently operating well in excess of kind of what you see as your long-term goal. How should we think about that capital management going forward, some of these puts and takes?

Well, as you indicated, we believe we have excess capital now. We are continuing to accrete capital at a pretty good clip. But fortunately, I think we're in an environment where we will likely have to maintain that excess capital level for some time into the future.

But as we go forward, certainly we are looking to deploy that excess capital both through organic growth, potential M&A activity as we go forward, but also through returning capital to our shareholders. And that -- our alternatives with respect to returning capital to shareholders, we believe will get better as we go forward. And we will consider things such as potential further dividend increases, potential share repurchases, etc. as we go forward.

Obviously those things will have to be considered within the context of the regulatory approval processes that have been put in place. But those are clearly things that are in our longer-term plans.

Great, thank you.

Ken Zerbe.

From Morgan Stanley. The -- just coming back to the interchange fee increases you guys plan to put in, have you guys looked at where your new or expected fee increases stack up relative to the rest of the industry? I guess I'm asking the question more from a consumer behavior perspective, that you are one of the more aggressive ones to try to offset interchange with higher fees.

But does that puts you at a competitive disadvantage, given where your prices may stack up at the end of the day?

This is Kevin. What I would tell you is obviously we're very sensitive in terms of how we position it. We are looking at and we have talked openly about a value-added proposition as we migrate really the model from a fee-based orientation.

So I will be looking at what is happening across the entire industry, but feel that confidently with what we have given in terms of guidance that not only will we be able to stay well-positioned competitively, but we will continue to grow in that space as we move forward or we wouldn't be considering those. So again, we feel quite comfortable. We don't feel like even some of the things that we have already indicated to you really push us far out on the edge or the leading edge of any of those areas.

The one thing I would tell you is we have had a long time to think about this. So it has been a year and we are continuing to evaluate kind of the value propositions for growth in that arena. And we will be adding those and making those changes in a comprehensive approach to that client segment, those client segments. And we think we have a very good offering from that standpoint going forward. So, we're pretty confident we can get there.

Okay. One more question on the resi mortgage portfolio, obviously you have seen a lot of growth there. Can you just remind us what your ultimate retention goals are, or your willingness to put on incremental growth from here?

Yes, I think we have talked about the fact that the additions that we are making to that portfolio are coming from -- at retail branch originated product that is higher-quality, shorter-term, and primarily a refi product that has lower LTVs and so forth.

And really the decision to put that on the balance sheet was one that was made within the context of evaluating our overall asset liability management position, our overall strategy for managing the investment portfolio. And at this point in time, the balance sheeting of those residential mortgages is in lieu of reinvestment of investment portfolio cash flows in mortgage-backed securities.

So, we looked at the relative values there and decided there was greater value in the mortgages that we were originating. So that will be an evaluation that we will revisit continuously as we go forward, depending upon what marketing conditions are, so forth. So, I think longer-term our general strategy and preference would be to sell most of the residential mortgages that we originate.

The other thing I would add is we look at that strategy very holistically. So we look at it from an asset liability perspective in terms of interest rate risk and such. But we also evaluate that in terms of our overall credit portfolio strategy and the need for diversification on our balance sheet, as well as the quality of the assets themselves.

Okay, great. Thank you.

Craig Siegenthaler.

Hey guys, good morning. It's Craig Siegenthaler, Credit Suisse. First question just on aggregate loan growth trends, how have balances trended in July, so Q3 to date and June relative to the earlier part of the second quarter, like in April and May?

This is Jeff. I don't think we have anything. There is nothing special happening in July that I -- we're also not prepared to talk about the third quarter in terms of weekly trends in loans.

Nothing, Craig, at this point we would change the guidance that we just gave five minutes ago. (laughter)

Got it. (laughter) But I guess my point is you didn't see stronger activity in the first half of the second quarter than in the second half; it was kind of steady and consistent.

It's true. I think that is really what we kind of see and continue to give guidance for in terms of our outlook.

Got it. And then just on capital management, you're generating a lot of capital generation here and your capital levels are quite robust. I'm just wondering when could we get back to a point when you start buying a significant amount of stock, really reducing your share count.

Well, I think we generally addressed that question earlier, which was given our capital levels, given our results and given the limitations that there are right now from a regulatory guidance perspective on dividend payouts, that certainly share repurchases would be something that we would consider in our overall capital management activities going forward. It is difficult to predict when that might occur due to the fact that there are regulatory processes that have been put in place to get approvals for those kinds of activities. So those aren't decisions that can be made and then executed upon quickly.

So I don't think we are giving any guidance as to when that might occur, other than to say it is certainly something that is on our minds.

Got it. Great, guys. Thanks for taking my questions.

At this time, we have reached our allotted time for today's call. Mr. Richardson do you have any closing remarks?

No. We appreciate everyone joining us this morning and I hope you have a good day.

This does conclude today's conference. You may now disconnect.