KeyCorp (KEY) 2007 Q3 法說會逐字稿

Good morning, everyone, welcome to the KeyCorp's third quarter 2007 earnings results conference call.

This call is being recorded.

At this time I'd like to turn the conference over to your host, to the Chairman and Chief Executive Officer, Mr.

Henry Meyer.

Mr.

Meyer, please go ahead.

Thank you, Operator.

Good morning and welcome to KeyCorp's third quarter earnings conference call.

We appreciate you taking the time to be a part of our discussion today.

Joining me for today's presentation is our CFO, Jeff Weeden, also joining us for the Q&A portion of our call our Vice Chair's, Tom Bunn and Beth Mooney.

Chuck Hyle, our Chief Risk Officer is unavailable to participate today due to a family emergency which called him out of town.

I'd now like to turn your attention to Slide 2, which is our forward-looking disclosure statement.

As you know it covers our presentation and the Q&A portion that will follow.

Before Jeff reviews our third quarter financial results, I want to make a few comments with respect to the points noted on Slide 3.

During the third quarter, the fixed income markets experienced one of the most volatile periods in a long, long time.

As an industry, we saw credit spreads widen rapidly and financial markets come to a near halt for a number of weeks as markets reprice for risk.

This repricing of the financial assets in the third quarter resulted in a write-downs in our Commercial Real Estate held-for-sale portfolio, our loan trading book, and other investments impacted by the changing market conditions.

While the fixed income markets continue to remain under some pressure as we head into the fourth quarter they certainly feel better to us today than they did just a few short weeks ago.

As a result, we believe most of the financial impact of our held-for-sale portfolios is behind us and we expect to see improved results from these portfolios over the remainder of the year.

Business activity outside of the fixed income markets remained fairly good during the quarter.

We experienced better growth in both loans and core deposits than we had for several quarters and we also saw growth in our Institutional Asset Management business.

Given the revenue challenges related to the fixed income markets and increased credit costs we have focused on controlling our expenses and will continue to manage our expenses closely while still making investments in our franchise for the future.

As you saw in our earnings release, we experienced an increase in our non-performing assets during the current quarter resulting from several projects in the residential property segment of our Real Estate capital line of business moving to non-accrual.

The two geographic areas of the country that we have been watching for some time and have taken action to reduce our exposure in are Florida and Southern California.

These are the two parts of the country where we experienced an increase in non-performing assets.

As you may recall, we started reducing our condo exposure in Florida over two years ago by not making any new commitments.

There are a number of projects we financed in Florida that are coming to completion in the next two quarters which will further reduce our exposure to this market.

During the third quarter, we continued to pursue opportunities to grow our franchise through targeted acquisitions.

In late July, we announced our plans to acquire U.S.B.

Holding Company, the holding company for Union State Bank, headquartered in Orangeburg, New York.

We remain on track with this acquisition and expect to close the transaction in early 2008, subject to approval by the U.S.B.

Holding Company shareholders and banking regulators.

The addition of Union State Bank to our community bank operations in the lower Hudson Valley will double our presence in this market to 64 branches.

Another transaction to another addition to our operations we announced in the third quarter and just recently closed on earlier this month was the acquisition of Tuition Management Systems, one of the leading providers of education related financial services.

With this addition to Key, we now operate one of the largest educational payment plan providers in the nation.

As we said in the past, we will continue to look at opportunities to build our Community Bank as well as to add strength to our National Banking businesses to further leverage our capabilities.

Now I'll turn the call over to Jeff for a review of our financial results.

Jeff?

Thank you, Henry.

I'll begin with with the Financial Summary shown on Slide 4.

My comments today will be with respect to Key's results from continuing operations; however, before I begin, I will comment on the $.03 loss from discontinued operations.

This amount relates to the write-down of the lease on the former Champion Mortgage Headquarters building in the third quarter.

Now, from Third Quarter continuing operations, we earned $0.57 per share compared to $0.74 per share for the same period one year ago and $0.85 in the second quarter of 2007.

Our ROE in the third quarter of 2007 was 11.50%, down from 15.52% in the third quarter of 2006.

The disruptions in the fixed income markets and higher credit costs had an impact on our year-over-year quarterly comparison.

I'll comment further on our third quarter results and our fourth quarter outlook as we review the remaining slides in our presentation.

Turning to Slide 5, the companies taxable equivalent net interest income for the third quarter increased $6 million from the second quarter and decreased $14 million from the same period one year ago.

For the third quarter of 2007, our net interest margin remained under pressure declining 6 basis points to 3.40% from the second quarter level and down 21 basis points from the same period one year ago.

We did experience good growth in our core deposits during the third quarter compared to the second quarter; however, the cost of these deposits continued to rise.

With the rate cut by the Fed in September, we have subsequently made adjustments in a number of our deposit rates; however, due to competitive pressures, the full amount of the adjustment has yet to be made in the rates paid for these funds.

This normal lag effect on consumer deposit rates and increase in the line utilization on the part of commercial customers and higher levels of non-performing assets will continue to place pressure on the net interest margin until wider credit spreads can work their way through the balance sheet.

On the other hand, higher earning asset levels should offset the margin pressure impact on net interest income.

Our outlook for the net interest margin in the fourth quarter is to be in the low to mid 3.30% range.

Slide 6 highlights the changes in our non-interest income between the third quarter of 2007, the second quarter of 2007 and the third quarter of 2006.

As we stated in our earnings release, in our earlier comments, the volatility of the fixed income markets had a significant impact on our third quarter non-interest income.

For the quarter, our non-interest income was down $211 million from the very strong second quarter of this year and down $105 million from the same period one year ago.

During the third quarter, we recognized $77 million in net losses in our held-for-sale loan portfolio, trading assets and other investments primarily related to Commercial Real Estate.

This total reflects both realized and unrealized losses as we mark these portfolios to market at the end of September.

Another area of non-interest income that was down in the third quarter was principal investing.

In this case we had comparison to very strong prior quarter results.

We did experience growth in several other non-interest income categories during the quarter including deposit service charge income which grew from both the second quarter and prior year level as we continue to add more transaction deposit accounts in our community banking operations.

In addition, income from trusted investment services showed growth over the second quarter and the prior year results adjusting for the sale of McDonald Investments Branch Network.

In the third quarter of 2006, we had brokerage income of $33 million from the McDonald's Branch Investment operations recorded in this category.

Also in the third quarter, we realized a $27 million gain related to the sale of MasterCard shares compared to $40 million in the second quarter.

With this third quarter sale we have no additional MasterCard shares remaining.

Turning to Slide 7, we have prepared a similar comparison of the increase/decrease in non-interest expense between the third quarter of 2007 and the second quarter of this year and the third quarter of last year.

Overall, we maintain control of our expenses and reduced incentive accruals to reflect the decline in revenue we experienced in the third quarter.

Turning to Slide 8, our average loans from continuing operations increased $1.4 billion or 2.1% unannualized from the second quarter of 2007 and were up 2.5 billion or 3.8% compared to the same period one year ago.

Average commercial loan balances were up 4.5% in the current quarter versus one year ago and up 1.9% unannualized from the second quarter of 2007.

Average consumer loans were up 2.1% from the same period one year ago and up 2.4% unannualized from the second quarter level.

Our outlook for commercial loans is an annualized growth rate in the mid to upper single-digit range for the balance of 2007 and for consumer loans, an annualized growth rate in the low to mid single-digit range on a linked quarter basis.

Turning to Slide 9, I'll speak to the growth we experienced in our average core deposits in the third quarter versus the second quarter.

Comparison to the first quarter and prior quarter shown are impacted by the sale of the McDonald Investment branch network.

Comparison to the second quarter are not impacted by this sale.

The dotted line on this chart represents the adjusted year-over-year percentage growth comparison excluding the impact of the McDonald deposits sold.

We experienced good growth in average core deposits during the third quarter compared to the second quarter of this year, as we priced our NOW and money-market deposit accounts more competitively in the markets in which we compete.

Our NOW and money-market deposit accounts were up 1.2 billion or 5.4% unannualized.

In addition our DDA balances increased 497 million or 3.6% unannualized compared to the second quarter.

The growth we experienced in our DDA balances came from our commercial mortgage servicing area.

As of the end of the third quarter, our commercial mortgage servicing portfolio had grown to over 134 billion and had 4.5 billion of escrow balances associated with this business.

Our CD balances were down $0.5 billion compared to the second quarter of this year as consumers continued to move money back into the NOW and money-market deposit accounts.

Our expectation for the fourth quarter 2007 is to see an annualized core deposit growth rate in the low to mid single-digit range on a linked quarter basis.

Slide 10 shows our asset quality summary.

Net charge-offs in the quarter were 59 million or 35 basis points compared to 53 million or 32 basis points in the second quarter and 43 million or 26 basis points in the same period one year ago.

While not shown on this slide, our provision for loan losses was 69 million in the current quarter compared to 53 million in the second quarter and 35 million in the third quarter of 2006.

Non-performing assets at September 30, 2007, totaled 570 million and represented 83 basis points of total loans, other Real Estate owned and other non-performing assets.

This compares with 378 million or 57 basis points in the second quarter and 329 million or 50 basis points one year ago.

As we stated in our earnings release, the increase in non-performing assets was primarily related to the residential property segment of our Commercial Real Estate construction portfolio.

The majority of this increase in this segment came from loans outstanding in Florida and California.

We have included in the appendix of this slide, of the slide's today a [breakdown] by property type and geographic location of our entire Commercial Real Estate book.

In addition we have included additional information with respect to the Residential construction portfolio.

Outside of the Residential Real Estate construction portfolio, we experienced only modest increases in non- performing loans during the current quarter.

The loan loss reserve at September 30, 2007, represented 1.38% of total loans and our coverage ratio of our allowance to non-performing loans stood at 192%.

Our outlook for net charge-offs for the fourth quarter is in the 35 to 45 basis point range.

Looking at Slide 11, the Company's tangible capital to tangible asset ratio was 6.78% and our Tier 1 capital ratio was 7.92% at September 30, 2007.

During the third quarter, we repurchased 2 million of our common shares and reissued 1.3 million shares under employee benefit plans.

At September 30, 2007, we had 14 million shares remaining under our current board repurchase authorization.

Again, our capital levels allow us for future growth opportunities both organically and through acquisitions.

In addition we will use share repurchase activities in the overall management of our capital levels.

Slide 12 summarizes my comments on our outlook for the fourth quarter of 2007.

Included on this slide is our fourth quarter earnings outlook of $0.68 to $0.74 per share.

That concludes our remarks and now I'll turn the call back over to the Operator to provide instructions for the Q&A segment of our call.

Operator?

Thank you.

(OPERATOR INSTRUCTIONS).

Let's begin with begin with Brent Erensel from Portales Partners.

Please go ahead,sir.

Thanks, good morning.

A question on your pre announcement in August you talked about Capital Markets dislocations and what kind of surprised me was the $200 million jump in the Real Estate Residential construction portfolio, non-performers.

I was hoping you could address that given that KeyCorp traditionally has been broad with a diversified product and geographic category, a very conservative underwriting national skills in local Markets, and now we're seeing a reflection of national ills.

Can you comment on this and give us some guidance in terms of what's in the pipeline and how far and how long you think this thing will go on?

Well, this is Jeff Weeden.

I'll comment with respect to the portfolio and Tom Bunn may also add some additional comments in a few minutes.

I think with respect to the home builder segment, specifically within this Residential Real Estate segment, we saw the deterioration really happened in August and September, so it was after we had already filed our second quarter 10-Q, and it really happened, we were seeing it more in the latter part of September, the disruptions caused by some of the financing activities related to the residential mortgage activities, so as those particular financing activities started to tighten up and the jumbo market became kind of dislocated at that time, a number of these projects, some of which are still current, we just have taken an activity, a proactive activity of placing those particular loans on non-accrual and putting them under additional scrutiny.

Our expectation, I think as we look at migration through the credit cycle here, some of it has been on how quickly the residential mortgage market comes back in some of these particular markets.

There weren't a large number of credits that related to that particular increase.

There were only a handful of credits but they were concentrated in two markets, those being Southern California and also in Florida.

Brent, the only thing I would add to that is we have not added a new client to our home builder segment in the last 12 months and so as you probably see in these numbers, our home builder exposure has declined.

Additionally, we feel the loan to value on these specific loans is good and we're working through them.

Okay, I don't want to seem too morbid here but you saw that I guest Horton today just got slaughtered with cancellations , 48%, and I'm just wondering how you guys can protect yourselves going

Well, I think in terms of cancellations that are out there certainly have an impact on the home builder segment of the marketplace.

As Tom was talking about, we originally under wrote these particular transactions, they were generally done at 65 to 75% loan to value.

We've had some degradation in values in the marketplace.

We believe that we still have some protection out there, but we can't guarantee that there won't be an additional write-downs in the market values that are out there associated with the underlying properties.

So we'll continue to monitor appraisals and ultimate sale of those particular properties that we are financing.

Thank you.

We'll take our next question from Matthew O'Connor with UBS.

Please go ahead, sir.

Good morning.

Good morning.

If you could just elaborate a little bit on how you guys decide when to write-down loans as they move into non- performing and I guess it just jumps out you had a big increase in non-performers.

The charge-offs were relatively stable.

Is it just you have a lost content or you take initial stab at estimated charge-offs and there's probably more to come related to those loans.

Well, Matt, this is Jeff Weeden.

As we go through and we place a loan on non-performing, we'll take the charge off at that particular point in time.

We also have, of course to continue to monitor the asset values over time and we'll continue to adjust if necessary and put charge-offs through at subsequent time periods.

Okay, so you're pretty confident that the increase in NPA 's this quarter, you've written them down to values that you'll recover?

Well as of the end of September, Matt, I don't think any of us can have a crystal ball to look out into the future on that.

Matt the one thing I would add to that is that an example is we have a piece of property where we have a conservative loan to value and we have an offer on the table for our loan value for that piece of property, and we will obviously execute that contract, so I think going back to Jeff's comment is we feel like the carry value of these properties is currently written to where we think we can get at them.

Okay, and will that sale occur in the fourth quarter, meaning non-performers will decline?

We don't have a crystal ball on that.

We would expect some of this to occur but we're not sure.

And Matt, I think it's a dynamic portfolio, so while this particular transaction may, that Tom referred to may close and have a positive impact on non-performers I don't think of us can clearly say that there won't be additional migration of credit over time, as we go through the credit cycle.

Okay, and then just separately, your core deposit growth and I'm just looking at deposits ex-CD's was very good this quarter but the rates rose a lot and you talked about some migration from CD's to the money-market.

Was that sort of an active campaign that you had going on or just trying to reconcile the increase in rates would obviously lower rates in the market overall.

Yes, Matt, this is Beth Mooney.

Third quarter is typically a historically strong quarter for the acquisition of new clients and we did position two new products into the marketplace that were in our NOW and money-market account.

Both were relationship based, required a core checking account along with it and across our geography carried relatively premium rates.

We were successful in generating, as you can see, some strong account as well as deposit growth was part of that and really repopulated some of our CD book into what we consider more core accounts.

We feel like those were cost effective deposits in this current rate environment and if you think about we're going into a period of declining rates, that is a managed rate book and we feel like not only were attractive client segments and new deposits but also something we'll be able to cost effectively manage over the cycle.

Okay.

Thank you very much.

We'll take our next question from John McDonald with Banc of America Securities.

Please go ahead, sir.

Hi, good morning.

Quick question for Jeff.

Could you give a little color, Jeff, on what kind of capital markets fee revenue assumptions are embedded in your fourth quarter EPS outlook?

Sorry if you covered that already.

Well, John, what we had in the basically in the second or the third quarter, we reported losses of $77 million between all of the various capital markets related activities net losses.

We would expect that we would have obviously a rebound in the fourth quarter, I think what we are looking at now a number of the marks that we took in the fourth quarter we've been able to clear some of that product through the market, in addition some of the credit spreads have tightened up somewhat here as we've gone into October, so I think that bodes better for profitability, so it bounced back from where we were but not necessarily going back to what we experienced in the second quarter but certainly a more normal related activity for us.

How about on just in terms of private equity activity and then maybe if you can comment on student securitization?

Yes.

With respect to the private equity activity, we had $9 million in gains in the third quarter and we were coming off some pretty strong comps.

Obviously I think as we go into the fourth quarter private equity gains are difficult to forecast but we would expect that we would be at least at the third quarter level in the fourth quarter and may do better than that, and then as far as the student loan securitization, those particular markets are still fairly tight at this point in time, and we are not currently planning on a securitization in the fourth quarter that will probably carryover into the first quarter of next year.

Okay.

Thank you.

We'll take our next question with Terry McEvoy with Oppenheimer.

Please go ahead.

Thanks, good morning.

Looking at the Community Banking line of business, the provision had been running about $20 million a quarter.

I was kind of surprised to see it dip down to a $1 million, just given the size of that portfolio, about $27 billion.

Could you just talk about that line of business and the provision in the third quarter?

Yes.

As far as the provision goes, we had an overall provision of 69 million compared to net charge-offs of 59 million, and we went through our book of business and we reallocated some of our reserves over to the Commercial side, you saw Commercial Real Estates provision for loan losses was much increased this quarter as we saw migration of credit.

The Community Bank book of business, the credit quality has held up very well there so we move some of our reserves over into some of the other lines of business.

And then just a question on the Indirect Marine portfolio was up about 19% from last year, about 5% of the loan portfolio.

Could you just talk about the quality of the borrower and maybe a geographic break down of the portfolio?

Hi, this is Tom.

We kept a close eye on the quality of that borrower.

We've increased expected credit scores there.

The credit quality of that portfolio has remained good.

It is predominantly a [water] related portfolio obviously, water related portfolio obviously so you have exposures in Florida and California but the credit qualities remain very good and the credit scores, we've pushed credit scores up and we're working to improve spreads.

Thank you.

We'll take our next question from Tony Davis with Stifel Nicolaus.

Please go ahead.

Good morning, gentlemen.

Just a few things.

Jeff, do you actually have an aggregate loan to value for the entire CRE portfolio today, and could you also identify the remaining exposure to Florida condos?

I do not have, Tony, an overall loan to value for the entire Commercial Real Estate book of business with me today.

With respect to the Florida condo exposure around $360 million is what's remaining.

Okay.

And I wondered about the size, Tom, of the Real Estate Capital Markets, the private equity investment pools that you have there and I guess your basis for confidence as you revert back to gains this quarter.

Well, we're talking about two different portfolios.

There's a Real Estate private equity portfolio and Jeff answered a question regarding our broad corporate (inaudible).

Yes, I understand.

Our portfolio is $238 million total in the private equity side for Real Estate.

That consists of $134 million which is mezzanine, so it's not equity debt.

Right.

And 104 million in equity, and a large majority of that is in Commercial Real Estate rather than Residential Real Estate.

And one final question here is the trend you're seeing in risk classification migrations outside of commercial Real Estate, I gather, Jeff, that they're reasonably stable?

They are reasonably stable.

I mean, we continue to watch the migration but it's been very stable.

And if I might add one other comment here, even within the Real Estate portfolio, outside the home builder sector, the Commercial Real Estate has had solid credit performance with very low migration.

Thanks.

We'll take our next question with Paul Delaney with Morgan Stanley.

Good morning.

Most of my questions have been answered but just had one on the allowance of non-performers that's come down very significantly, (inaudible) in the last three quarters and I guess is that really just a function of the loss content that you see in those construction non-performers being pretty low?

Just trying to reconcile that ratio going down while all of the other credit ratios are sort of going up.

Yes, I think any time, Paul, that you look over a credit cycle, there are going to be times when you see the allowance, the non-performing loans get down to a lower percentage.

It's not necessarily, your non-performing loans you aren't indicating that there is massive loss content in those particular credits.

Just like when you look at non-performing drop and you have a very high percentage coverage, you are really reserving for the entire portfolio including non-performing loans.

We've already, as we go through our non-performing assets, we'll take the charge-offs when we place them into non- performing and we'll continue to monitor those credits obviously for any further degradation or final liquidation and there may be additional charges that go through subsequent to that particular placement on non-accrual.

And can you just tell us a little bit more about how you are all sort of doing the appraisals on the construction book?

Is that a rolling process or will we have to sort of wait until the Spring selling season next year to get a better understanding of how those appraisals will shake out?

This is Tom Bunn.

We are very actively monitoring this portfolio.

We are actively reappraising and relooking at every loan in the home builder, specifically the home builder condo portfolio so no, we are not waiting around for the Spring selling season.

Okay.

Great.

Thank you.

We'll take our next question with Ed Najarian with Merrill Lynn.

Please, go ahead.

Good morning, it's Ed Najarian.

I guess most of my questions have been asked and answered, but back to residential Real Estate.

Could you provide any color on how that might impact or the jump in non-accrual status might impact net interest income in terms of not generating interest revenue on those loans or potentially having reverse out prior interest revenue, and then could you also potentially provide some color on how this increase in NPA's might affect your future CMBS securitization revenue?

Thanks.

Yes, Ed, with respect to the net interest income and net interest margin, it did have an impact on the third quarter, probably reduced our margin by a basis point, and so as we look at the fourth quarter, our guidance that we provided of low to mid 3.30% range incorporates in the higher level of non-performing assets that we have on our books.

Are there any reversals of interest income happening because of this?

For the most part, the loans when we put on non-accrual, they were relatively current so there was very little in the reversal of net interest income, and those reversals happened in the third quarter, so if there are new loans placed on non-accrual in the fourth quarter, there may be some reversals of income but that's very difficult to project at this point.

And then secondarily, could you make some comments about the CMBS securitization revenue going forward?

Ed, we think, this is Tom.

We think the adjustment that occurred in the third quarter, was an extraordinary adjustment.

We have seen spreads tighten as we've talked about earlier which has improved the outlook for the CMBS book.

The CMBS origination has slowed not surprisingly given the overall cost of that business now, but we are optimistic that it's going to return to the normal profitability of the business as early as the fourth quarter and we're very optimistic about the business going into 08.

It's a very core business to our originate distribute model and it's a business that has been profitable for as long as we've been in it and we expect that to continue.

Ed, I'll make one additional comment on that.

With respect to about 25% of what we is in our warehouse currently, it's locked in with a total return hedge, so we're very comfortable with that.

We've hedged the rest of the portfolio with respect to interest rate risks and we'll have to see how credit spreads continue through the process.

I think as we look into 2008, activity for origination has certainly slowed down so we'll probably have less activity in 2008 associated with this particular business just because those loans are not being originated at the present time.

So we should look at that business going forward, as a somewhat slower business from an origination standpoint versus where it was prior to Q3, as well as a business that should have or could have potentially tighter spreads on securitization for you as the bank?

Correct.

Okay, thank you.

We'll take our next question from Gerard Cassidy with RBC Capital Markets.

Thank you and good morning.

A couple of questions coming back to the Commercial Real Estate loans, I think you indicated you had $360 million of condominium loans still in Florida.

Could you tell us what the non-performing asset number is attached to that portfolio?

Yes.

I think I've got that here with me.

I just have to look to the schedule.

On the non-performing assets associated with condos, we really, there are no non-performers in the condo portfolio in Florida as of the end of September.

Okay.

In the Commercial Real Estate detail, you give us about $2 billion of retail properties.

Could you tell us what dollar amount or percentages in strip malls versus large malls or other types of retail properties ?

Tom, do you have that?

Strip center total is about $390 million.

Great.

And then finally, in the past credit cycles that we've had, the regulators tend to become a little more focused on credit and in fact they've even used specific targeted Commercial Real Estate exams.

Have you guys heard anything from the OCC about that maybe starting or have you experienced that already?

This is Henry.

We have not been notified by either of our regulators, the OCC and the Fed, although we hear talk of that, we can't confirm anything.

Okay, thank you, and finally since you're there, Henry, in terms of acquisitions, obviously you guys are always looking to enhance the franchise.

Are you sensing that smaller regional/community banks are more interested in coming together and possibly selling to you guys or to others because of some of the challenges on the horizon?

Well, I hope that that starts but no, I can't tell you that we've been either better received or had regional banks calling us, Community Banks in particular, but I think that this environment is not unique to Key in terms of what spreads are doing and what's happening, and I think that as all of us in this industry are in some stage of our process for 2008 planning, I think 2008 will be a more difficult year, Bernanke was saying yesterday that this market disruption isn't going to work its way through until maybe late in 2008.

One hopes at least from my perspective that there will be some banks and boards that come to the conclusion that maybe the capabilities of a company like Key would benefit them and their clients and their markets, but no, I haven't seen it yet.

Thank you.

We'll take our next question with [Girav] [Patankar] with Synovia Capital.

Please go ahead.

Yes, I had a question that in terms of allowance to total loans, you said that going through a cycle, 192% might not be that much but I was wondering, what is the comfort level of operating at those levels versus providing a little more in the coming quarters?

Can you give us some color on how the management team has been thinking of that?

Well certainly.

I think as we go through and look at our build up of our loan loss reserve, it's something that we have to go through and document each and every quarter.

As non-performers increase, as you see just normal migration credit, I think there's the normal expectation that as charge-offs go up this time of the cycle that provision will also end up going up and then just like it did in the third quarter, we've ended up providing more than what we've charged off.

So that particular pattern could exist in future periods as we continue to go through the cycle.

Okay, and one real quick question on the 77 million in losses that you had and I think this is both a combination of a gain on sale losses as well as markdowns.

With the market kind of as you alluded to with the market coming back toward the end of the third quarter and beginning of the fourth quarter, would you expect some write backs in the fourth quarter?

Well, we would have to see what is actually realized on those particular portfolios that we're just taking on marks on, so as those particular loans are securitized through the CMBS structures and they're placed into the marketplace, we'll have to judge what we receive versus what the marks are on those particular bonds.

We feel comfortable with our marks as of the end of the third quarter but it's very difficult to project out what credit spreads are going to do for the balance of the year.

Thank you.

We'll take our next question with John Boland with Maple Capital Management.

Good morning.

Thank you for taking my call.

We've had a lot of questions about the loan loss provisions, but it just seems to me you should have been a lot more aggressive this quarter and I'm just wondering, what might I be missing?

Are you seeing some trends moderating that have given you the comfort to not take bigger charges this quarter?

Well, I think we have to, when we look at the charge-offs we have to look at the actual loss content in the specific loans and we were able to either sell particular loans or we wrote them down to realizable net realizable values, so it's not something that you can just go through and start charging off.

I'm sorry, I meant provision.

Excuse me, I may have missspoken.

Well provision again, we go through a very elaborate build up process and it's going to be specifically related to the credit grades.

I believe there was an earlier question that asked about what are we seeing outside of the Residential Property portfolio and those particular portfolios seem to be performing fine, even within Commercial Real Estate as well as other portfolios.

We are seeing normal migration of credit but we've factored that in when we do our reserve analysis and I think if you compare our reserve levels we maintain as a Company, they would compare favorably to some of our other peers.

Okay, then just one follow-up then, given the trends out there that seem to be developing on credit and given the fact that you seem to be somewhat under reserved right now at 192, do you have any comment or can you give us any guidance on what might be happening to the balance of your 14 million share repurchase program?

Can we assume that's on hold?

Let me take a stab at this.

This is Henry.

First of all, I take a little bit of exception with your under reserved at 192.

You're focusing on one number which is reserved to non- performers.

We talked about a little bit of a jump in the non-performers in the Commercial Real Estate area, some of which we indicated, maybe you didn't hear it but that they are current, so it has to do with what's the quality and what's the loss content on those non-accruals.

That's one ratio.

Our reserve to total loans is one of the strongest in the industry and we've added more than we charged-off and we've talked about the rest of the portfolio being stable, so you can focus on anything you want.

I would tell you that's one ratio but it's only one of a number of ratios that you really need to look at, and on the stock buyback, we have been very consistent in talking about how we use stock repurchase as a Capital Management tool and we'll continue to do that.

There is no question that we will use a little bit of our capital when we close the Union State Bank deal in the first quarter of 2008, so we want to build to that point where after that deal is completed, we still have the flexibility on our balance sheet that we strive to retain.

Okay, so we can assume that buybacks will moderate a little bit in the next quarter or two, until the deal closes ?

I think you can look at share repurchase activity to be comparable to what we experienced in the third quarter which was just nominal activity to offset primarily what was reissued under employee benefit plans.

Okay, thank you.

We'll take our next question with Gary Townsend with FBR Capital Markets.

Hi, good morning, gentlemen.

On another subject, deposit growth seemed to be very good in the quarter.

Can you discuss what was helping with that success and are you doing anything different?

What are your competitors doing?

Yes, Gary, this is Beth Mooney, as I've stated earlier, we did have some very targeted and focused marketing and new client acquisitions in the third quarter centered both around core transactional DDA accounts as well as money-market and NOW accounts, and those were programmatic in the third quarter.

They were successful.

We increased the average number of accounts in both money-market and core transactional, as well as our balances , as you saw grew nicely in the money-market and NOW.

Competitive priced on the interest bearing book but as I said in a declining interest rate environment, that will serve us well versus continued CD's which a lot of our competitors put in the market and we had a solid acquisition of new accounts and new deposit dollars in the third

Oftentimes, these new accounts don't stick, but how do you assess that issue?

One, they were relationship accounts, they were paired to a core transactional or DDA account and you are right, there are always some ebbs and flows but we monitor that in the quality of the average balances and the profile of the client look strong and part of what we do in the fourth quarter is a very robust on boarding where we contact and follow back up with those new households for additional products and services.

Geographically any particular areas of special strength?

The western markets were the strongest.

That rate environment seems to be the most rational from a competitive point of view so we saw probably on a percentage basis the strongest growth and the weakest would be in the Great Lakes where you have the most competitive rates in the market.

Thank you for your time.

We'll take our next question with Mr.

David Pringle with Sales Point Research.

Please go ahead.

Good morning, all.

How much of the --

You're on speaker phone.

Sorry, doing my Jimmy Hendrix impression.

Let me try speaker, just a second.

How is this?

Better, thank you.

Better.

How much of your loan growth this quarter came from sort of slower Capital Markets activity in the C&I book and the Commercial Real Estate book?

I don't think we can exactly quantify dollar for dollar, this is Tom Bunn, but it is clear to us the institutional side of both Real Estate and corporate, we saw some clients who normally would have Capital Markets use their lines either because they didn't have the access or didn't like the pricing of that access.

We don't expect that to continue and in Jeff's estimates for loan growth for the fourth quarter as we expected that activity to be flat to down, so we think it's an aberration of the market and those clients will go back to the Capital Market and have already in some cases.

Well say in the Commercial Real Estate book, you're up about 600 million in the third quarter.

How much of that, if the markets had been open would have been securitized?

Well, the securitization side of the equation would be in the held-for-sale portfolio, so not in the what you're seeing in the other book.

Those are going to be just new construction loans and mortgage loans that are being made by the company.

Okay, and then you had a pretty substantial reduction in expenses, sorry, in the third quarter.

Can you do that in the fourth quarter again?

Well, I think, David, if you recall, the third quarter versus the second quarter, the most substantial portion of the reduction, there were two areas, one related to the incentive compensation accruals coming down and the second area was the litigation reserve that we had in the second quarter, which did not repeat in the third quarter, so I would not anticipate that type of reduction as we go into the fourth quarter and we may see some expenses tied directly to revenue go back up slightly in the fourth quarter.

And then finally, thank you, Jeff, how many people do you have in loan work out at this point and how does that compare to say six months ago?

I don't have the exact number of FTE's that we have in the loan specifically in the loan work out area, but clearly we continue to look at, do we ship additional resources into that group and we have less need on some of the line side of the equation moving resources around in the organization, so that's how we're going to try to manage some of those costs is the redistribution of some of the resources to collecting versus the origination.

Thank you.

This does conclude our question and answer session.

I'd like to turn it back over to Mr.

Henry Meyer for any additional or closing remarks.

Thank you, Operator, and again, we thank all of you for taking time out of your busy schedule to participate in our call today.

If you have any follow-up questions on the items we discussed, please call Vern Patterson in our Investor Relation's Department at 216-689-0520.

That concludes our remarks.

I hope everyone has a great day and we are adjourned.

Once again, ladies and gentlemen, that will conclude today's conference.

We thank you for your participation.

You may now disconnect.