Huntington Bancshares Inc (HBAN) 2011 Q2 法說會逐字稿

Good morning.

My name is Michelle, and I will be your conference operator today.

At this time I would like to welcome everyone to the Huntington National Bank second-quarter earnings call.

(Operator Instructions).

Mr.

Jay Gould, please go ahead with your conference.

Thank you, Michelle, and welcome, everyone.

I'm Jay Gould, the Director of Investor Relations for Huntington.

Copies of the slides we will be reviewing today can be found on our website, Huntington.com.

This call is being recorded and will be available as a rebroadcast starting about one hour from the close of the call.

Please call the Investor Relations department at 614-480-5676 for more information on how to access the records or playback or should you have difficulty getting copies of the slides.

Slides two through four notes several aspects of the basis of today's presentation.

I encourage you to read these as always, but let me point out one key disclosure.

This presentation contains both GAAP and non-GAAP financial measures where we believe it is helpful to understanding Huntington's results of operations or financial position.

Where the non-GAAP financial measures are used, the comparable GAAP financial measure, as well as a reconciliation to it, can be found on the slide presentation in its appendix in the earnings press release, quarterly financial review, quarterly performance discussion or in the related Form 8-K filed today, all of which can be found on our website as well.

Turning now to slide five, today's discussion, including the Q&A period, may contain forward-looking statements.

Such statements are based on information and assumptions available at this time and are subject to changes, risks and uncertainties which may cause actual results to differ materially.

We assume no obligation to update such statements.

For a complete discussion of the risks and uncertainties, please refer to this slide and the material filed with the SEC, including our most recent Forms 10-K, 10-Q and 8-K filings.

Now turning to the today's presentation and slide six.

Participating today are Stephen Steinour, President and CEO; Don Kimble, Senior Executive Vice President and Chief Financial Officer; Dan Neumeyer, Senior Executive Vice President and Chief Credit Officer; Nick Stanutz, Senior Executive Vice President and head of Automobile Finance and Commercial Real Estate.

Also present is Todd Beekman, Senior Vice President and Assistant Director of Investor Relations.

Let's get started.

Turning to slide seven, Steve?

Welcome, everyone.

I will begin with a review of our second-quarter performance highlights.

After my overview, Don will follow with his recap of our financial performance.

Dan Neumeyer will provide an update on credit.

Nick Stanutz will provide an update on our indirect auto segment.

I will then return for an update on our Fair Play and OCR, our optimal customer relationship strategy and a discussion of our expectations for the remainder of the year.

Turning to slide eight, we reported $145.9 million or $0.16 a share.

For the quarter this represented a 15% improvement to net income from the first quarter.

We were also very pleased to announce that the board has approved an increase in the quarterly common stock dividend of $0.04 per share from $0.01 per share.

The dividend is payable October 3, 2011, to shareholders of record on September 19.

Based on yesterday's closing stock price of $6.31, this equates to an annual dividend yield of 2.5%.

The board and management have been evaluating the Company's capital position as we previously reported and its ability to organically generate capital.

As such, we are very pleased with our financial strength and performance have improved to the point that it enabled us to take this action.

We view dividends as an important component of generating overall shareholder returns have established a targeted payout ratio or range I should say of 20% to 30% of net income.

This is another step forward for our shareholders.

Overall we are pleased with the second-quarter results, representing our sixth consecutive quarterly increase in earnings, and it shows the progress were making on a number of financial and strategic fronts.

Ultimately it comes down to the level of returns we generate for the owners of the Company.

This quarter our ROA of 1.11% is at the low end of our long-term targeted range, but we entered that range this quarter.

Nevertheless, we are disappointed that our $242.6 million in pretax pre-provision income was lower than expected as we elected not to expand the balance sheet.

We elected not to expand the balance sheet due to our view of risk-adjusted returns, and impacting pretax pre-provision also were expenses that were higher than expected.

Don will provide some additional detail in a few minutes.

Fully taxable equivalent revenue increased to $17.7 million or 3%.

This reflected an $18.8 million, 8% increase in non-interest income as we saw increases in service charges on deposit accounts, electronic banking income and capital markets activity.

Net interest income increased only $1.1 million, meaningfully lower than what we had anticipated due to a balance sheet that was roughly $1 billion smaller than we previously expected.

We shrank the sheet as an absolute level of interest rates, and added competitive pressure on money market and CD rates did not allow us to find attractive spread on new securities.

As a result, average securities decreased $515 million or 21% annualized.

Mortgage originations remained at a relatively stable level with the first quarter, but we saw a $239 million decline in average loans available for sale.

The negative impact of these declines was partially offset by a $437 million or 5% annualized growth in average total loans and leases.

This was led by very strong growth in average C&I and indirect auto loans with annualized growth rates of 8% and 18% respectively.

The net interest margin decreased 2 basis points to 3.40%.

NIM contended to be positively impacted by the mix shift to lower-cost deposits with the primary negative influences on net interest margin where lower loan yields and lower income from hedging derivatives.

Non-interest expense declined $2.3 million or just under 1%.

Turning to slide nine, credit quality again showed improvement with a 41% linked-quarter decline in net charge-offs and a 3% decline in nonaccrual loans.

A provision for credit losses declined $13.6 million to $35.8 million, representing an annualized rate of 37 basis points of period-end loans.

Our reserve coverage of total loans and nonaccrual loans of 2.84% and 181% respectively remained at healthy levels given recent economic trends.

In May we first introduced to you some of our metrics around OCR and provided an update on some of the early successes of our Fair Play banking philosophy.

During the second quarter, we launched our Asterisk-Free and Huntington Plus Checking accounts.

We believe these represent the best checking account offerings in our markets if not the country.

Customers agree as we experienced accelerated consumer checking household growth to nearly 10% annualized for the first half of 2011.

These new households are not just focused around a single service.

Through the use of our new sales process and [MAX], our relationship management system, we have been able to continue to grow our share of wallet with new and existing customers.

Now more than 71% of our consumer checking household customers have four or more products or services.

The household growth and increased cross-sell increased total consumer checking household revenue by 5% from the first quarter of 2011.

We are now 6% above the levels from the second quarter last year and have overcome the impacts from both Fair Play and Reg E.

Internal capital generation continued to improve.

Our period-end tangible common ratio was 8.22%, up 41 basis points, and our Tier 1 common risk-based capital ratio increased to 9.92%, up 17 bps.

Our regulatory Tier 1 and total risk-based capital ratios ended the quarter at 12.14% and 14.89%.

Turning to slide 10, we continue to move forward with our positioning for growth with the implementation of strategic initiatives designed to accelerate customer growth, increased convenience and grow revenue.

As I just mentioned, in May we launched the Asterisk-free Checking and Huntington Plus accounts.

We continue to increase convenience and create the best experience for our customers.

We rolled out mobile applications for Android and iPhone.

We now have 19 Giant Eagle in-store branches open, and we will have over 30 open by the end of the year.

While it is still early, the initial in-store branches are ahead of plan and look to be on the path to break even before our goal of 24 months.

We also implemented extended hours in all of our banking markets.

Michigan is a key market for us, and we have been heavily investing in it for the last two years.

And, as a result or as part of our commitment to Michigan and to our Midwest footprints, we announced a groundbreaking public/private partnership with the state of Michigan and the Michigan Economic Development Corporation by committing $2 billion in commercial and small business lending throughout the state over the next four years.

Huntington's expertise in small business lending made it the number one SBA lender in our region inclusive of Michigan.

So now let me turn to Don to review the financial details.

Thanks, Steve.

Slide 11 provides a summary of our quarterly earnings trends.

Many of the performance metrics will be discussed later in the presentation, so let's move on.

As shown on slide 12, our net income for the second quarter was $145.9 million or $0.16 per share.

The $33.7 million increase in pretax income reflected the benefits of an $18.9 million increase in non-interest income, a $13.6 million decline in provision expense, and a $2.3 million decrease in noninterest expense, which are partially offset by a $1 million decrease in net interest income.

I will detail these changes in subsequent slides.

Turning to slide 13, we show the trends in our revenues and pretax pre-provision on the left-hand side of this slide.

Primarily reflecting the lack of growth in net interest income, our 2011 second-quarter pretax pre-provision performance did not improve as much as expected.

With interest rates continuing at their absolute low levels, reinvestment rates available to us barely exceeded the incremental costs to grow interest-bearing deposits.

Given this environment, our deposit growth efforts focused on low or no cost transaction accounts, allowing some of our interest-bearing deposit categories to decline.

This, combined with a slightly lower loan growth than originally expected, resulted in a smaller earning asset base of over $1 billion for the quarter.

Our expense levels did not decline as much as expected, reflecting a temporary increase in deposit and other insurance costs and higher levels of professional services.

Slide 14 depicts the trends of our net interest income and margins.

During the second quarter, our fully taxable equivalent net interest income declined by $1 million, reflecting a 2 basis point decrease in our net interest margin to 3.40% and a $0.3 billion decrease to our average earning asset base.

The two basis point decline in net interest margin reflected the impact of three primary factors.

First, an 8 basis point increase from the reduction in deposit rates and improvement in deposit mix.

Next, a 7 basis point reduction related to the impact of the extended low rate environment on loan yields.

This quarter on page nine of the quarterly financial review we provided the impact of swaps on our commercial loan yields.

This summary shows that our commercial loan yields absent the impact of swaps only declined by 1 basis point this past quarter, despite a 6 basis point decline in LIBOR.

So our pricing remains disciplined.

That is our C&I loan growth reflects our increased efforts of generating new loans, but this growth is not the result of discounted pricing.

Finally, a 5 basis point reduction coming from lower benefits from interest rate swaps.

This reduction reflected the impact of previous terminations of swaps.

Our forecast would show a very modest reduction in this line item going forward, assuming rates remain at their current levels.

Continuing on to slide 15, we showed continued improvement in our deposit mix over the last five quarters.

We have reduced our non-core and core CDs from 29% to 24% of total average deposits.

Perhaps more important is the increase in the DDA balances over the last three quarters as this category has increased from 30% to 34% of our total average deposits.

The improved deposit mix reflects the efforts of Fair Play banking for the consumer category and our treasury management focus for our commercial businesses.

Also of note, third quarter begins another round of higher rate time deposit maturities with $1.9 billion maturing at an average rate paid of 2.63%.

Turning to slide 16, we showed a $0.2 billion decline in average core deposits.

This was driven by our decision to run down some of our higher cost money market accounts and CD accounts and replace them with significantly lower cost demand deposits.

Slide 17 shows the trends in our loan and lease portfolio.

Total commercial loans were flat.

This reflected the anticipated growth in commercial and industrial loans offset by the decline in commercial real estate balances.

The $0.2 billion or 8% annualized increase in C&I loans came from several business segments, including business banking, large corporate, middle-market, asset-based lending and equipment finance.

Total consumer loans were up $0.5 billion from the previous quarter.

The $0.3 billion increase in average automobile loans and leases reflected continued strong originations of $1 billion this past quarter.

These originations continue to reflect very high credit quality and reasonable returns.

We did see a small linked-quarter increase in both home equity and residential real estate loans.

This growth reflected the stronger origination activities from our retail franchise.

Slide 18 showed the trends in our non-interest income, which increased $18.8 million or 8% from the prior quarter.

This reflected increases in service charges on deposit accounts and electronic banking income of $6.4 million and $2.9 million respectively, primarily due to the seasonal factors.

Other income increased $7.3 million or 19%, reflecting improvements in various capital markets related activities and revenues.

Electronic banking income in the third quarter is expected to increase modestly from the second-quarter levels, though we anticipate fourth-quarter levels will decline about 50% as the new debit interchange fee structure is implemented on October 1.

We also expect to see continued growth in earnings contributions from other key fee income activities, including capital markets, treasury management services, brokerage all reflecting the impact of our cross-sell and product penetration initiatives throughout the Company, as well as the positive impact from our strategic initiatives.

The next slide is a summary of our expense trends.

Total expenses were down $2.3 million from the prior quarter.

This reflected an $18.2 million decline in other expense as the first quarter included $17 million in additions to the litigation reserves.

For this reason and as Steve noted, we are disappointed that the decline was not greater.

The benefit of this decline was partially offset by increases in professional services of $6.6 million, deposit and other insurance expense of $5.9 million, outside data processing and other services of $3.6 million, and marketing costs of $3.2 million.

The increase to professional services was higher than originally expected and reflected the incremental cost to prepare for and evaluate the impact of Dodd-Frank and other regulatory changes.

The increase to deposit and other insurance was temporary and should return to levels consistent with that in the first quarter for the second half of this year.

Slide 20 reflects the trends in our capital position.

Each of our ratios improved over the prior quarter, reflecting the strong internal capital generation.

The PCE ratio increased by 41 basis points to 8.22%, and our Tier 1 common ratio improved by 17 basis points to 9.92%.

Both of these ratios reinforce our message of having a very strong capital position.

As Steve mentioned, the board has increased the quarterly common dividend to $0.04 per share.

Along with that increase, the board has established a targeted payout range of 20% to 30% of net income, and this declared dividend falls within the middle of that range.

Even with the targeted payout range, going forward we expect organic capital generation to drive continued growth from today's level of capital.

Let me turn the presentation over to Dan Neumeyer to review the credit trends.

Dan?

Thanks, Don.

Slide 21 provides an overview of our credit quality trends.

The second quarter continued to exhibit improved credit quality trends in both commercial and consumer loans.

Notably the net charge-off ratio fell significantly from 1.73% annualized in the first quarter to 1.01% in the second quarter.

This reflected the results of our proactive recognition of emerging problem loans and focused on aggressive resolution that has been underway for the past two years.

The improvement was broad-based, but was particularly evident in the commercial segments, which experienced significant reductions despite a still anemic economic environment.

Loans 90-day plus past-due and accruing continued to fall and were 15 basis points on total loans at the end of the quarter, the lowest level experienced in several years.

Delinquencies in general continued to show improvement in both the commercial and consumer segments in both 30- and 90-day categories.

There are slides in the appendix that detail these trends.

The nonaccrual loans, non-performing assets and criticized asset ratios all showed continued improvement in the quarter, although the improvement was slowed somewhat by an uptick in problem loan inflows.

The allowance for loan and lease loss and the allowance for credit loss ratios fell modestly to 2.74% and 2.84% from 2.96% and 3.07% respectively.

The coverage ratios remain very strong, however, as the lower allowance levels were offset with lower nonaccrual loans and nonperforming assets.

The ALLL and ACL to NPA ratios actually remained flat quarter over quarter.

Slide 22 shows the trends in our nonaccrual loans and nonperforming assets.

The chart on the left demonstrates the continued reduction in the level of both non-accrual loans and nonperforming assets.

Non-accrual loans fell 3.5% in the quarter.

With regard to nonaccrual inflows depicted on the right-hand slide, we did experience a small uptick in the quarter.

We view this increase as reflective of the uneven nature of commercial activity, including several unrelated credits that migrated in the quarter rather than a reversal of the positive trend that has been developing, and that is expected to continue.

Slide 23 provides a reconciliation of our nonperforming asset flows.

NPAs fell by 5% in the quarter.

The increased inflows were more than offset by a stable level of loans returning to accrual status, loan and lease losses, payments, along with a modest level of loan sales.

Turning to slide 24, we provide a similar flow analysis of our commercial criticized loans.

Over the past year, we have seen a consistent decline in the level of commercial criticized loans.

As already mentioned, criticized inflows were in the quarter, although this inflow was more than offset by the level of upgrades to "Pass" during that same period.

Along with paydowns and charge-offs, this resulted in an 11% reduction in criticized commercial loans from the prior quarter.

Viewing slide 25, the loan loss provision of $35.8 million was lower than net charge-offs by $61.7 million.

The ratio of ACLs to NALs fell slightly to 181% from 185%, although this level of coverage remains very strong, and we expect we will continue to compare favorably with our peer banks.

Given the continued improvement in the risk profile of the portfolio as evidenced by virtually all of our key credit metrics, we viewed the resulting ACL ratio of 2.84% as sufficient and appropriate.

Overall we remain very pleased with the direction of credit quality across the portfolio and expect continued improvement in subsequent quarters.

Now I will turn the presentation over to Nick Stanutz.

Thanks, Dan.

Turning to slide 26, for the last six months, there has been an increasing level of attention on Huntington's indirect automobile portfolio.

Today I want to provide additional data that should help clarify most of the questions and/or issues that are asked about this business.

In the next three slides, I will, one, show you Huntington has been able to hold pricing higher relative to the industry, while at the same time originating record production by expanding into Eastern Pennsylvania in the New England markets, all the while maintaining our strong underwriting standards; two, describe to you the current portfolio by vintages and rates so you can see that while pricing has mirrored the decline in the two-year swap rate, the rate of decline has significantly decelerated over the last year and a half, still leaving us with sufficient margin; and three, provide you with details that is banks, not the manufactured captive finance companies, that have a dominant market share position in the financing of new and used vehicles sold through franchise dealers, which is our core market focus.

Captives have minimal market share in the used segment, which is as large as the new segment and which accounts for over half of our auto loan production.

These captives mission is to support the manufacture of selling new vehicles to consumers.

They do not play in the used vehicle space where we do.

As you know, we originate Super Prime indirect automobile loans.

The chart on the left shows the industry rates for Super Prime new and used vehicles.

Our originations have an average FICO score of 760 and have been very stable for years.

Huntington's comparable rates are shown on the right, again segregated between new and used autos.

With regards to loans on new vehicles, the average rate in 2011 first quarter for Super Prime loans was 3.64%.

This rate was down 74 basis points from a year earlier.

For Huntington our average rate in 2011 first quarter was 4.27% or 63 basis points higher than the industry average.

Further, this was down 34 basis points from the prior year or less than half of the industry decline in similar Super Prime credit.

This story is similar for used car loans.

For the industry the average rate in the 2011 first quarter for Super Prime loans is 5.06%, a 95 basis point drop from a year earlier.

In contrast, our average rate in the 2011 first quarter was 5.86% or 80 basis points higher than the comparable industry average.

Further, this was only down 7 basis points from the prior year or 88 basis points less than the industry decline for similar Super Prime credit.

As shown in the table on the right, our combined yield is basically in line with the decline in the two-year swap rate.

The question I get asked most frequently is, how do we accomplish these metrics?

You have heard me say it starts with our long-standing unwavering history of support for the dealer community.

For over 60 years, we have been there for the dealers regardless of the cycle.

The 2009 auto industry uncertainties allowed us to once again demonstrate our support for dealers.

When companies like Allied could not provide their historical support, we were there.

Our business model is quite unique.

It is local, which is very different from our competition.

By having sales and underwriting in the local markets, we know our dealers, we know our economies and they know us.

The combination of longevity, commitment, being local and easy to do business with collectively drive our results.

Keep in mind that when the dealership uses our rates, which might be 20 to 50 basis points higher than the market, that only increases the monthly payment to the customer about $5 to $10.

Good experienced F&I managers can sell that all day long to applicants.

The bottom line is that for those banks that are in and out of this market who operate on the fringes, they can only compete on rates.

It is their only option.

On the other hand, for Huntington where we compete on a total relationship and total service provided basis, that is the difference.

This makes us best-in-class, and not only things like approval time like 4 seconds or less on 75% of our applications or on our same-day funding of loan contracts, our dealer-centric approach gives us pricing leverage and superior dealer loyalty.

Slide 27 shows automobile loan origination vintages that currently comprise our $6.2 billion automobile portfolio.

The average rate for our customers in this portfolio is 5.91%.

The key points are the decline in the yields for our entire portfolio over the last two and a half years has been slightly greater than 150 basis points.

Importantly, that decline is slowing as that over 70% of our current production has been originated in the last 18 months at an average rate of close to 5%, and while there continues to still be run-off of our older, higher yielding loans, the increased origination volumes and the resulting increase balanced levels more than offset the impact in dollars to the net interest income.

Turning to slide 28, I would like to dispel the notion that what banks do in the auto finance space is driven or dictated by the captives.

This graph shows the relative percentage of new and used vehicle financing markets allocated between the major players.

Banks are the largest player in this market with nearly 40% of the total volume and nearly double that of the manufacture.

This is because the market for new only includes that but not also the used vehicle market.

As a matter of fact, the used vehicle market sold through franchised dealers is just as large as the new market.

So whenever you hear the industry talk about the new vehicle seller rate being whatever, the used vehicle markets are just as large as the new.

Therefore, when you add the two markets together, the new and the used as shown here, banks dominate.

In fact, captives represent less than 10% of the used car market, and that is significant for us when you consider that over 50% of our originations are used vehicle loans.

Let me turn the presentation back to Steve.

Turning to slide 29, as I mentioned in my opening comments, our Fair Play banking philosophy has been strongly resonating in the market and driving new customers to Huntington.

Along with these new customers, we continue to benefit from higher retention rates.

In May we reported our consumer checking household growth.

At that time first-quarter 2011 growth was running at a 9.1% annualized rate or 1.6% above our initial plan.

Over the second quarter, several competitors announced they were adding fees or reducing product features to try to offset lost revenue.

Customers reacted.

Our consumer checking household growth further accelerated.

I'm very happy to report that our annualized growth rate for the first half was nearly 10%.

This is more than 30% above the initial goals we set last September and more than a threefold increase compared to what we were generating in 2009.

Turning to slide 30 where we show the product penetration trends, optimal customer relationships, what we refer to as OCRs, more than just getting new customers in the door and keeping the old ones happy.

Key to our strategy is to grow Huntington's share of wallet from the total base of customers.

Driving this is a broad array of services and products coupled with the rigorous and disciplined sales management process, all of which is supported by robust sales and cross referral technology.

Over the last four quarters, we have increased the percent of households with four or more products from just over 68% to now over 71%.

While it might seem like -- while it might not seem like a large number, remember that the entire customer base of over 1 million households is reflected in the number.

So even if you don't factor in the new accounts, this means that we sold over 30,000 new products and services just this quarter alone.

Turning to slide 31, you can see that this has resulted in a significant positive impact of customer checking account household revenue, household revenue.

Total customer checking account household revenue in the second quarter was $260 million.

That is an increase of $11 million or 5% from the first quarter.

What we believe is even more meaningful is that consumer checking household revenue is $15 million or 6% higher than the year ago quarter.

Growth in checking account households and deeper banking relationships has more than offset the impacts from our Fair Play action, our investments in Fair Play and Reg E.

Turning to slide 32, I just want to recap our current thinking.

The economy we expect to be stable but not to meaningfully improve, and this is an adjustment from our perspective just a quarter or so ago.

We expect this for the remainder of the year.

We are seeing fragility, early signs of it in borrower and consumer confidence in the second quarter that we a couple of quarters ago did not anticipate as well.

Our net interest margin should be stable, and with regard to loan growth, we expect the recent trends to continue with the overall modest loan growth driven by continued strong growth in auto loans, meaningful growth in commercial and industrial loans, modest growth in home equity being offset by expected declines, continuing declines in commercial real estate portfolio.

We anticipate fee income growth will be mixed as we see continued growth related to Fair Play banking, positioning, strategic initiatives and other key banking activities.

In the fourth quarter, we expect implementation of the new interchange fee structure to reduce electronic banking income by approximately 50% from the second-quarter levels.

Non-interest expense is expected to be relatively stable as continued investment and strategic initiatives should be offset by continued low credit costs, credit related costs and improved expense efficiencies.

Nonaccrual loans and net charge-offs are expected to continue to decline throughout the rest of the year.

The primary driver of net income growth throughout the rest of the year is the expected modest revenue growth coupled with disciplined expense control.

In closing, while there were many positive aspects of the quarter as we continue to drive for higher and more stable returns, there were some aspects where we can do better and we will do better.

So thank you for your interest.

Operator, we will now take questions.

(Operator Instructions).

Ken Usdin, Jefferies.

Steve, I just wanted to ask you about the rate of expenses versus the rate of revenue improvement.

You are obviously still -- I guess if you can just tell us your rate of incremental investment versus trying to hold the line against the flattening out in pretax pre-provision, what leverage do you have?

Have you changed at all the way you are thinking about investments versus letting some fall to the bottom line if revenues get a little tougher?

We are looking at that dynamically now.

Some of our expense increase in the second quarter was related to Dodd-Frank issues where we are, frankly, trying to get ahead.

An example would be hearing what some of the large mortgage servicers were working on.

We invested in looking at our shop based on what seemed to be emerging standards with outside consultants.

So there will be continued investments in the business segments as well, but at this point with the change in our economic outlook, we will be rationing those investments more dynamically than we had anticipated at the start of the year.

Okay.

My second quarter is just on the NIM.

With the swap income pretty much rolled off and pretty big deposit repricing still to come in the back half of the year, stable margin seems pretty conservative.

So can you give us the puts and takes with regards to what you are expecting on loan yields versus what you are expecting on liability costs?

That is a great question.

We do expect the loan yields to continue about the same level.

As we talked about, our commercial loan yields on average after you back out the swap impact are fairly flat and have been relatively consistent over the last five quarters.

If you take a look at that commercial loan yield and back out funding from, say, a money market account growth, you are not at that 340 plus type of margin.

And so that is why we think even though with the improved mix of the deposits, the growth will still maintain a relatively stable margin going forward.

So the delta would just be if loan growth keeps up with -- so could the margin go up if loan growth keeps up with deposit growth?

I'm sorry?

If the loan growth keeps up with --?

Could you ask that question again?

I'm sorry.

Yes, so I guess if loan growth kept up with deposit growth, could the margin go up?

What would be the scenario in which the margin can actually see some upside?

I'm just asking does the earning asset growth need to keep up with the deposit, or does the loan growth need to keep up with the deposit growth?

I think you need to see a continued shift of the balance sheet away from investments to loans to see the margin improve.

And so to your point, if deposit growth funds the loan growth and you keep the investment portfolio stable, there could be some opportunity there for some slight expansion.

Ken Zerbe, Morgan Stanley.

Just on the C&I guidance, you're talking about meaningful C&I or meaningful growth in C&I.

What is the sensitivity around that?

Obviously you have had some improvement in C&I so far, but are you looking at an acceleration in C&I, and how confident are you that you could actually get that given your initiatives versus a more cautious economic outlook?

As far as our outlook for each of the last three quarters, we have been growing C&I loans on an annualized basis 8% to 10%.

We would continue to expect to have growth rates in that range.

And so it has really been a reflection of the concerted effort we have had as far as the culling activities and the execution of our sales efforts throughout the organization.

And so we still believe that will continue.

Some of the challenges against that, to be honest, are just the potential concerns about the economy.

We have seen it slow in this past quarter, and as Steve said, we think it is a little bit more fragile.

And we are continuing to see more aggressive pricing from the competitors, and we want to maintain our pricing discipline.

But we are seeing more aggressive pricing on large corporate and large middle-market, but even going into the more regular middle-market lending and also on the floor plan lending.

And so we want to maintain our discipline.

At the same time, we believe because of our sales efforts can drive consistent growth from that 8% to 10% range.

Okay.

I understood.

And then just in terms of the CD portfolio, I think you mentioned $1.9 billion of higher rate CDs coming due.

As those continue to reprice lower and the customers are determining whether or not they want to stay with the bank or they leave the bank, are you comfortable shrinking the securities portfolio as a result of that such that your balance sheet shrinks, or do you think that loan growth could actually help offset the security reduction hence flattish balance sheet going forward?

Our expectation would be is that the balance sheet should be flat to up, and that is driven by the loan growth.

As you saw this past quarter, we were comfortable in allowing that CD book to decline and the investment portfolio to decline just because we did not think the risk/reward was in balance for us.

But if you look at where our alternative investment yields were for, say, a three-year rated type of asset, it did not provide enough margin for us to raise the rates on growing the deposit book and also concern in this rising rate environment that we did not want to put a lot of low rate or low yielding investments in our portfolio.

That is exactly what I was asking because it almost seems like the scenario is about the same again this quarter, but you are a little more confident in your ability to grow loans to offset the balance sheet reduction.

We are confident that then we can continue to grow commercial.

We have a good track record as far as the indirect.

And, as you can also see, if you look at the end of period deposit balances, they are flat with where we were for the average for the quarter.

And so that gives us some confidence we can maintain that as well prospectively.

We are also using a strategy of moving some of the CD maturities into our investment portfolio.

We've got a very strong broker dealer.

So there is a customer management retention element to this as well.

Paul Miller, FBR.

Steve, relative to competition out there, especially on some of your large competitors in your region have talked about very aggressively growing their loan book in somewhat of a I still think a flat environment.

Are you seeing increased competition from some of your bigger regionals in your footprint?

I know a year ago you thought that a lot of these other guys were focused on other regions.

I'm just wondering if that is still the case.

Well, the Midwest has performed relatively well over the last year.

A consequence of that is there is probably a little more competition today than there might have been a year ago.

The manufacturing sector of the US economy, for example, you would see performing again relatively well whether it is a combination of market circumstances, including foreign exchange and things like that for exporters, and we are in a -- our footprint is in a manufacturing zone.

So we are a little more competitive to bottom line your answer.

And on the price side, there are a couple of banks that we have talked to said, if the banks that are growing their portfolios are really being priced competitive, are you able -- I know you talked about the auto side of it that you're able to maintain your higher rates while also growing the book.

Are you finding that across the board on the C&I and commercial also with your relationships?

We are.

We had some noise in the first quarter number related to our derivative position and how we had allocated it into various books.

We have tried to with disclosures make it very clear what was price pressure flowing through versus hedging, and hopefully we have been able to do that.

Okay.

Thanks a lot --

Essentially we are flat within a couple of basis points year over year.

And Paul, if you want to take a look at page nine of that quarterly summary, it shows that in detail on the bottom of that page where we break out the commercial loan yield trends versus the impact of the swaps.

Yes, I'm just wondering are you continuing to seeing that favorable trend?

I mean we are just hearing a lot of anecdotal evidence of some people really coming into different areas and undercutting people, and I'm just wondering, I know relationship banking is your bread and butter.

I'm just wondering if that is starting to show itself in your region?

It is more competitive today, Paul.

It's not sort of at a feverish pitch.

It's likely to be more competitive in the future than less as well.

But there is not some massive sea change that has occurred over the last quarter or two from what we can tell.

Because of our forward pipeline management, we don't see a see change at least in the near term.

Brian Foran, Nomura.

Just following up on the auto detail, which was very helpful, on slide 83 you also have expected cumulative losses for each quarter of production currently running around 88 bps.

So if you have a weighted average new origination rate running just below 5% and 88 basis points of expected cumulative loss, what does that translate into in terms of incremental ROEs on new production?

This is Don, and I will ask Nick to jump in here as well.

But generally our credit adjusted spread is around 2.25.

And we have been maintaining that for some time.

As far as ROAs and ROEs, we are probably closer to the 1% type of ROA, and then we are also looking at the ROEs and being in the mid-teens.

Keep in mind that that cum loss estimate is for the life of the loan.

And so if you have got a two-year plus type of duration of that asset, the average credit cost would be in the 40 basis point range as opposed to the 88 basis points that we are showing.

And when you think about used-car pricing, which is, I guess, currently an all-time high, but maybe there is some argument that it should be at an all-time high, and that is sustainable.

Do you use the Manheim or whatever index you use where it is today, or do you haircut it down when you're thinking about that expected cumulative loss?

Brian, the way we think about our pricing model is that we do not take into account what is going on with Manheim.

We typically look at historically what the cars have brought at auction.

So today we have got a tailwind because obviously, as you point out, the Manheim is at record levels.

That does not influence our pricing model at all today because two years from today there is a chance that that is going to be different.

And so we do not use something we cannot control as we think about pricing, and that is obviously used-car prices.

Tony Davis, Stifel Nicolaus.

I guess to follow up on the credit demand issue here, Steve, you describe customers as fragile.

Could you give us a little color maybe about where you ended the C&I backlog at the end of the quarter as opposed to what it looked like during the quarter and sort of your sense as we sit here today in terms of incremental borrowing intentions vis-a-vis, say, a month or so ago?

Let's start with the outlook, Tony.

We expected we would have a steadily improving economy throughout the year, and that does not appear to be the case today at least from our opinion based on the information we can access.

Our pipeline to answer your question now was flat at the end of the quarter compared to where it began the quarter or ended the prior quarter.

And we have confidence in our near-term forecasting and disciplines around sales management in and of that pipeline (inaudible) over the last two years.

So that is in part why we projected confidence in being able to grow the book, notwithstanding we think we have a different economic outlook today than we would have in the fourth quarter for the second half of this year.

I just also wonder if you could give us a sense about your regulatory compliance costs?

You talked about professional services and Dodd-Frank.

Looking back a year ago when this thing passed, any sense of what the expense increment has been to date as you add staff, gear up for reporting purposes, etc.

that we could look at?

Tony, as far as the current quarter, I would say that we probably had about $5 million incremental spend this quarter because of the compliance Dodd-Frank review and other issues like that.

But more of that is just gearing up, understanding and relying on some external expertise there that we have continued to invest in our risk management activities and functions.

I think it would be hard for us to define how much is Dodd-Frank specific.

But we continue to support these initiatives as part of our objective of having an aggregate moderate to low risk profile.

So I think it would be very difficult for us to ascribe how much of that increase in risk management is attributed to just Dodd-Frank.

Understand, Don.

Finally, Asterix-free a little more color perhaps on that rollout, what your expectations were in terms of new account growth there and kind of what you have actually seen?

We had a quarter that exceeded expectations as we shared, Tony.

Frankly, we don't know.

We are challenging ourselves as to how far we can take this and whether we can sustain it.

Whether we are in the one-time sort of moment here.

But we are very pleased.

We are, as I reported, we are above what we communicated last September, and we had good growth quarter over quarter.

But it is early.

Asterix-free came out with marketing late mid second quarter, so we need another couple of quarters to be able to answer that question with confidence, I think.

I did think of one other one.

The 75 Giant Eagle branches that are under previous banking agreements, I was just wondering, Steve, about the timing of when the majority of those will switch over?

The majority will be 2013 and 2014.

I think there may be a dozen or so next year.

Now the situation is fluid.

A partner could elect to pull back.

One of their other partners could elect to pull back, in which case we would step in on an accelerated basis.

Erika Penala, Bank of America/Merrill Lynch.

I was just wondering and I apologize if you had already answered this in conjunction to Tony's question, but can you give us a sense of how your competitors have responded to your Asterisk-free Checking product, or is the response going to be it is still too early given that we just got the final Durbin rules?

I don't think -- I think it is too early to answer you directly just as a competitive reaction, if there is going to be any.

There was a lot of product change across the industry, and those product changes were just implemented if not the second or first quarter, late fourth quarter in most cases.

So I'm sure there is some further adjusting or I imagine there is some further adjusting that is going on, but I don't expect to see any wholesale response from our competition based on where we are.

Fair Play is going well from our perspective, very well, and it is benefiting both account acquisition and much stronger retention.

And so I believe we have got a couple of quarters before we will really -- and maybe longer -- before we will see any sort of competitive dynamics.

Okay.

And my second question was in regards to your resi and home equity credit quality.

I was just wondering if there was anything in particular that flowed down the improvement in these categories, or is it just generally the economic fragility that you mentioned during your prepared remarks?

Well, the increase in the non-accruals in the quarter was just due to a policy change.

We are more conservative on our non-accruals recognition.

We moved from 180 days to 150 days.

So that accounted for the addition there, and otherwise, we view the portfolio as pretty stable.

Okay.

Got it.

Thank you.

We announced that policy change last quarter.

So it is recent.

Craig Siegenthaler, Credit Suisse.

I do have one left.

I appreciate the outlooks on the C&I and auto segments.

However, I'm wondering if you can provide us some help or some expectation for loan growth in both the home equity and the residential mortgage portfolios?

Our outlook would assume some very modest growth in those categories, and we would expect to see over the next several quarters continued declines in the commercial real estate book.

So those would be the other categories that we did not comment on specifically.

And on the residential mortgage, with that new growth coming in, what is the composition there from conforming mortgages?

Most of what we keep on our balance sheet are either adjustable rate mortgages or some of our private banking type of mortgages.

And so I would say the private banking they would typically would not be the ones you would sell to Fannie or Freddie because they tend to be in the jumbo category.

But our ARMs generally are underwritten with similar underwriting standards to what you would have for conforming loans.

Bob Patten, Morgan Keegan.

Steve, big picture question.

I'm wondering following up Paul's question on pricing, obviously it is aggressive.

If you look back at any cycle back to the 80s, it has never been this aggressive coming out of a credit cycle, but there is no demand.

Do you think if we go forward a couple of quarters and the economy slowly gets better, with the pressure on ROEs for the larger banks, do you think this pricing is going to stabilize and start to normalize?

Great question.

I do think it will in part because I think what is happening is a combination of events will come together.

First of all, we don't have [SISE] ratios in the US yet.

At some point we have to get those.

The higher capital charges for the larger banks, I think, will cause a rationing, an allocation that will go even beyond where it is today.

And so to the extent pricing continues to heat a bit in some of these markets, I think it may cause a redistribution and reallocation.

It is not clear to me that some of the very large banks, in fact, will not try and manage their balance sheet size differently.

So I don't think there is going to be some kind of sea change that reverts to a norm.

I think it is going to be more challenging in the future, but the rate of pricing competitiveness may abate a bit.

(Operator Instructions).

Scott Siefers, Sandler O'Neill.

You guys have started to give some pretty good color on the consumer household revenues and stuff like that over the past couple of quarters, which I appreciate.

I was wondering if you can talk about maybe household profitability and how you are looking at that?

And I guess just as I look at things, the household acquisition has been very, very strong over the last several quarters basically since you changed the strategy last year.

But I think on a per household basis, the revenues are still below where they were prior, even though that metric has been improving.

Is there a point where you target that to be accretive relative to where you were before, or at what point do you think the change in strategy will be overall positive from a profitability standpoint?

As we would look at it, you are right.

The revenue per household is probably down slightly compared to where it was a year ago.

But you have got to take into consideration that the Reg E and other initiatives cost us probably 8% of that revenue base.

And so those were areas that were outside of our initial control.

We could have gone through and charged that an additional fee to our customers, but we feel that the strategy we have taken on is going to be better for us in the long run.

We think that you are seeing that flow through in the way that our low-cost demand deposit accounts are growing.

The non-interest-bearing demand deposit is up 26% on an annualized basis this past quarter.

Also, if you consider the household growth that we are picking up, there really is a very small incremental cost to bringing in that household.

And so we think that the profitability is going to be maintained and retained at an appropriate level, and the core piece here, too, is that we want to use the household relationship as a start point.

So we can deepen that relationship and cross-sell to that customer and get additional services that will differentiate us compared to what our competition may be seeing.

So we are very pleased with where we are.

It is still early in the process, and we think that we will have more to come as we continue to move it forward.

You know, Scott, fundamentally we have taken an approach to try and take advantage of this cycle, notwithstanding the complications of regulation and other things, and that attitude is not going to change.

So irrespective of the Durbin impact and setback that is going to provide to household profitability, we have taken a longer view, and it starts with market share and share of wallet.

We will keep coming back to that.

That is helpful.

And then, Don, I wanted to follow up on the comment you made about incremental costs for new customers.

Are you able to say roughly where you are in the process of the overall investment in the new strategy, kind of sixth, seventh, eighth inning, etc.?

I don't know that I would ever want to define our game as anything past about the third inning.

(multiple speakers) We are always looking at ways we can improve and enhance and deepen that relationship with a customer.

But each one of these are stages at this part of the development.

We rolled out 24-Hour Grace.

We rolled out Asterisk-free.

We made enhancements here recently to mobile and some of the electronic channels that we have available to us.

And so if we ever start get to that seventh or eighth inning, I think Steve is going to have a problem and start to force us to go into a new game.

So I would just say that we are always innovating and creating new solutions here.

Jack Micenko, SIG.

Maybe one for Dan, sort of a broader credit question.

Looking at relative to the names we look at, NPA ratios, charge-off ratios may be a little bit better than peers; reserve ratio, a little bit higher than peers.

Obviously you have been releasing back since 1Q 2010, and you are not privy to other credit meetings of your competitors.

But just thinking through, is there any reason your reserve is a little healthier and your reserve improvement or your decline in reserve ratios is a little slower?

Any specifics there, any thoughts to why that is?

Conservative management.

Okay.

Seriously, there is a lot of volatility.

Look, it seems like we go through multiple cycles last year, and we are in one this year.

Our outlook changed fundamentally over a couple of quarters.

We intend to stay on the conservative side of the spectrum.

Okay.

Fair enough.

Thank you.

Did I answer it okay for you?

You did a good job.

I have no further questions at this time.

Mr.

Gould, I will turn the call back over to you for closing remarks.

Thank you very much.

Everybody, thanks for participating in this quarter's call.

If you have other questions, you can always follow up with Todd or I, and we will be happy to take your questions.

Thank you, again.

We will see you next quarter.

This concludes today's conference call.

You may now disconnect.