KeyCorp (KEY) 2008 Q3 法說會逐字稿

Good morning and welcome to KeyCorp's third quarter 2008 earnings results conference call.

Today's call is being recorded.

At this time, I would like to turn the call over to the Chairman and Chief Executive Officer, Mr.

Henry Meyer.

Please go ahead, sir.

Thank you, Operator.

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

Joining me for today's presentation is our CFO, Jeffrey Weeden.

Also joining me for the Q & A portion of our call are Vice Chairs Thomas Bunn and Beth Mooney our Chief Risk Officer, Chuck Hyle.

Slide 2 is our forward-looking disclosure statement.

It covers both our presentation and the Q & A session that will follow.

Now if you turn to slide 3.

Before Jeff covers our financial results, I want to comment on the way we are strategically positioning Key to deal with the current economic environment and the challenges facing the financial services industry.

In my 35 years in banking, we have successfully managed through a number of difficult credit cycles and as I reflect back on those past cycles, I can not recall a time when we were more prepared than today.

Key has continued to strengthen its balance sheet by maintaining strong capital levels and continuing to increase its loan loss reserves.

At the end of the third quarter, our tier 1 capital ratio was 8.48% and total risk-based capital ratio -- and we had a total risk-based capital ratio of 12.31%, both of which place us well above the well-capitalized regulatory standard and positions Key to respond to future business opportunities.

In the third quarter, Key's loan loss reserve increased by $133 million to $1.55 billion which represents 2.03% of total loans and 161% of our non-performing loans.

We believe we have been consistent in our conservative reserving philosophy which has and should continue to serve us well in this credit cycle.

Key has also continued to practice an active risk management.

As previously reported, Key is in the process of aggressively reducing our exposure to the homebuilders segment of our commercial real estate business.

As of the end of the third quarter, our total residential property exposure in commercial Real Estate, including loans held for sale, has been reduced by $1.3 billion or 34% from one year ago and most important, the majority of the reduction has come from the weakest part of the portfolio.

I would also emphasize that Key does not have a subprime mortgage portfolio, a credit card portfolio, or a consumer auto loan portfolio, the epicenters of consumer credit issues.

We've also continued to focus on our relationship businesses.

Our community bank had another solid quarter with year-over-year growth in revenues and deposits.

In fact, we saw revenue growth over the prior year in every one of our 23 districts.

This benefit -- this business benefits from its geographic diversity with approximately two-thirds of both loans and deposits being outside of our Great Lakes region.

We have also continued to invest in our community bank in areas such as branch modernization where we have completed 70 branches with a target of remodeling two-thirds of our almost 1,000 Key Centers over the next five years.

We have continued to invest in de novo branches to strengthen our positions in low share, higher growth markets and we have continued to invest in technology with the rollout of our new branch platform which we have named Teller 21.

Despite the market turmoil, we are building a relationship based, customer focused business model which we are confident will position us well as the economy ultimately recovers.

In our national banking business group, our focus remains on risk management and improving risk adjusted returns.

This includes aggressively reducing our exposure in targeted portfolios and pricing appropriately for the rest.

Another area of focus has been our asset management business, Victory Capital Management.

While equity markets have been volatile this year, Victory's investment performance compares very favorably to benchmarks and its peers.

And finally, our relationship based strategy is supported by the strategic allocation of capital to those businesses that generate appropriate risk adjusted returns over the long term.

We will continue to emphasize our relationship strategy and provide capital to the areas of our company that consistently demonstrate the ability to grow and show positive returns above the cost of capital.

We continue to take decisive steps at Key in the third quarter to exit low return, indirect businesses, so that the company can focus its capital and resources on its best relationship customers.

We are in the process of exiting direct and indirect retail and floor plan lending for marine and recreational vehicle products and will limit new student loans to those backed by a government guarantee.

Slide 4 shows the actions we have taken over the past several years to reshape our company.

Once again, consistent with our relationship approach.

In addition to our announcements this quarter, we have previously exited subprime mortgage, indirect automobile financing, and broker originated home equity lending and sold these portfolios some years ago.

Our most recent bank acquisition, USB Holding Company, the parent of the Union State Bank, was completed earlier this year.

This acquisition continues to perform as expected and doubled our branch penetration in the attractive lower Hudson Valley area of New York.

We will continue to take steps to further focus on our relationship strategy and use our capital where we have cross-sell opportunities within our franchise.

Before I turn the call over to Jeff to review our financial results, I want to make a couple more comments with respect to two of the governments' programs recently announced.

First, with respect to the TARP US Treasury Senior Preferred Capital program, subject to discussion and approval by our board, we do expect to apply under this program.

The appropriate range of amounts for Key would be that Key would be eligible is between $1.1 billion and $3.3 billion.

Our current expectation would be that we would apply for more than the minimum, but probably not the maximum.

We will be discussing the amount over the next week or two among our team and with the board, and we know of no reason why we would not receive approval if we do apply.

The additional capital from the TARP Senior Preferred program would allow us additional capacity for loan growth for our relationship customers and be good for the economy.

And finally, we are assuring our clients that Key is automatically included in the unlimited deposit insurance program with respect to balances held in non-interest bearing demand accounts and we will continue in this program after the initial 30 day period established by the FDIC.

Their money is safe at Key.

Now I'll turn the call over to Jeff to go over the financials.

Thank you, Henry.

I'll begin with the financial summary shown on slide 5.

Key reported a loss of $0.10 per common share in the third quarter compared to a profit of $0.57 for the same period one year ago.

Items impacting the third quarter results are shown on slide 6.

The most significant item identified on slide 6 is a continuation of the build of the loan loss reserve.

During the third quarter, we continued to add to our reserves as provisions exceeded net charge-offs by $134 million.

In addition, as we described in our earnings release this morning, the Lehman failure resulted in the cancellation of various derivative contracts leaving Key exposed to changes in market prices with respect to where we operate matchbook positions.

Because these markets moved quickly during the hours following the cancellation of the Lehman contracts, we incurred a loss of $54 million to cover exposures with other counter parties to restore the matchbooks we maintain for customer position.

I'll discuss in a minute the update on the previously announced commercial real estate loan sale.

The reversal of the litigation reserve relates to the Honsador case we settled in September.

This case was reserved for back in the second quarter of 2007 and was in our principal investing area.

This reversal almost fully offset the $24 million negative marks we incurred in principal investing during the third quarter.

And finally on this slide, we note the severance and other exit costs we incurred in the third quarter including those costs related to marine and educational lending areas that Henry covered in his remarks.

We expect to incur additional costs which we currently estimate in the range of $10 million to $15 million range related to these areas in the fourth quarter of 2008.

Turning to slide 7, on this slide we provide an update on the status of our leverage lease dispute with the IRS and our commercial real estate loan sale we announced in the second quarter.

With respect to the leverage lease dispute as we said in our earnings release, we have opted in to the IRS global settlement initiative and expect to sign a closing agreement as soon as the fourth quarter of this year.

As a result of this settlement agreement moving forward, we would also expect to record an after-tax recovery of previously accrued interest on the disputed balances of between $75 million and $100 million as soon as the fourth quarter of this year.

On the right hand side of this slide, we provide an update on the residential commercial real estate property loan sale during the third quarter.

Given this very difficult -- given the very difficult market conditions we face during the third quarter, we were pleased to have made as much progress as we did to monetize a number of these loans.

We still have $133 million recorded at September 30 in the held for sale category and an additional $35 million held in other real estate owned.

We also recognized realized and unrealized losses of $31 million in the third quarter with respect to these loans.

This amount was noted on the previous slide as an item impacting our third quarter results.

Our goal is to continue to work these credit balances down during the course of the remainder of the year.

Turning to slide 8.

The company's taxable equivalent net interest income for the third quarter of 2008 was $705 million, down $7 million from the same period one year ago.

For the third quarter of 2008, our net interest margin was 3.13%, down from 3.40% we reported for the same period one year ago and down from the adjusted 3.32% we reported for the second quarter of 2008.

Negatively impacting the margin by approximately 10 basis points in the third quarter compared to the second quarter was the perspective reduction in net interest income caused by the second quarter 2008 recalculation of income on our contested leverage lease portfolio.

In addition, tight spreads on draws related to older lines of credit and the competitive environment for deposits pressured the margin.

Our expectation for the net interest margin is for it to remain under pressure during the fourth quarter as we continue to see draws under existing lines of credit at old spreads, which out weighed the better spreads we are achieving on new and renewal credit facilities.

In addition, we expect deposit costs to remain elevated due to the lack of functional capital markets for financials.

Also, the prospects for our future Fed interest rate cut will limit the opportunity for a proportional reduction in deposit costs below a certain level.

Given this, we look for the net interest margin to decline to the 3.00% to 3.10% range for the fourth quarter.

Turning to slide 9.

Average loans from continuing operations increased approximately $8.5 billion from the same period last year and were down $0.5 billion compared to the second quarter of 2008.

Impacting average balance comparisons to the same period last year was the transfer of $3.3 billion of student loans at the end of the first quarter from a held for sale to the loan portfolio and the approximately $1.5 billion of loans acquired as part of the Union State Bank acquisition completed January 1 of this year.

Comparisons to the second quarter are impacted by the commercial real estate loans we transferred to a held for sale as well as those portfolios placed into a run-off mode.

In the appendix of today's slides, we have provided a break down of the portfolios we currently have on run-off status.

Our outlook for average total loan growth on a linked quarter basis for the fourth quarter is to be up low to mid-single digits as we expect to see commercial balances increase and consumer loans related to our run-off portfolios decline.

Turning to slide 10.

Average deposit balances are up $3.8 billion compared to the same period one year ago and increased $0.8 billion from the second quarter of 2008.

Included in this year's balances are approximately $1.8 billion of deposits associated with the Union State Bank acquisition.

As we have been saying for some time, competition for deposits in our markets remain strong.

We have experienced growth in personal DDA balances within the community bank throughout 2008 where we have seen the greatest increase in deposits during the third quarter and throughout the year has been in the CD categories.

As rates have declined for transaction related accounts, customers have been placing their money in higher yielding certificates of deposit accounts.

Corporate deposits are little change from both last year and the second quarter; however, activity charges as reflected in our deposit service charge income have increased significantly compared to those same periods a year ago as customers are paying for these fees rather than through balances as interest rates have declined.

Our expectation for deposit growth remains in the low to mid-single digit range for the fourth quarter.

Slide 11 shows our asset quality summary.

Net charge-offs in the quarter declined to $273 million or 1.43% of average loans on an annualized basis compared to $524 million or 2.75% in the second quarter of 2008.

Non-performing loans at September 30, 2008, totaled $967 million and represented 1.26% of total loans.

Total non-performing assets at September 30, 2008, were $1.239 billion or 1.61% of total loans, other real estate owned and other non-performing assets.

As you can see on this slide, non-performing loans increased $153 million and non-performing assets were up just $29 million from the June 30 balances.

Our total reserve for loan losses increased to $1.554 billion, up $133 million from June 30, 2008, and up $599 million from September 30, 2007.

Our allowance represented 2.03% of total loans and 161% of non-performing loans at September 30, 2008.

On the next several slides, we provide some additional information with respect to asset quality statistics for the third quarter.

In addition, we have included other slides in the appendix of today's materials.

On slide 12, we show non-performing asset trends and the changes in the various categories between the quarters.

The most significant movement during the third quarter versus the second quarter were the increase in non-performing loans and commercial real estate, primarily in the residential property segment and a reduction in non-performing loans held for sale which I've covered earlier.

In addition, we had a modest increase in commercial non-performing loans primarily related to the automobile floor plan lending.

Slide 13 provides a summary by asset size of our total non-performing commercial loans at September 30, 2008.

Again, commercial and industrial non-performing loans are tied closely to the residential real estate related exposures and what is new this quarter is an increase in automobile floor plan lending non-accrual loans with respect to commercial real estate loans on non-accruals, it is mostly residential real estate related.

Slide 14 is a breakdown of our credit statistics by portfolio for the third quarter of 2008.

With respect to net loan charge-offs by individual loan categories compared to the second quarter of this year, commercial and industrial loans were stable.

Commercial real estate loans improved significantly due to our second quarter action.

Community banking home equity loans continued to perform very well at only 36 basis points of loss and other consumer loans in total were stable compared to the second quarter with marine showing additional stress and educational loans improving.

As Henry commented on earlier, with the exception of the government guaranteed student loans, all other national banking consumer lending portfolios are currently in run-off status.

The balance of these portfolios at September 30, 2008, were $ 7.8 billion.

In addition, we have approximately $1 billion of residential construction loans and $1 billion of marine floor plan loans in run-off status at September 30, 2008.

In total, these run-off portfolios declined approximately $600 million from the June 30, 2008 balances.

We will continue to use the cash flow provided by these run-off portfolios to redeploy to other relationship businesses.

Turning to slide 15.

This is an updated summary of our commercial real estate portfolio by property type, by geographic location.

We continue to monitor this portfolio closely and expect to see some downward migration of credit outside of the residential properties category over time; however, through September 30, 2008, we have only seen a modest increase in near term delinquencies and an improvement in loans 90 day past due when compared to June 30, 2008.

Turning to slide 16, we provide some additional details on our residential properties portfolio.

Our total residential commercial real estate outstanding balances continued to decline in the third quarter.

Over the past 12 months, outstanding balances are down $1.3 billion.

Non-performing loans in this portfolio represent 76% of total commercial real estate NPLs and 36% of total NPLs for Key.

And the last slide I would like to cover before we move to the questions is slide 17.

All of the company's capital ratios remained in the upper half of our targeted ranges for the ratios as noted on this slide.

Our tangible capital to tangible asset ratio was 6.95% and our tier 1 capital ratio was 8.48% at September 30, 2008.

As Henry said in his remarks, our capital accounts are in good shape, well above the regulatory requirements for well capitalized banks and they provide us with the necessary strength and flexibility to serve our customers.

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) We'll go first to Matthew O'Conner with UBS.

Hi, guys.

Good morning.

Slide 29 in the appendix is very helpful.

It leaves out all of the exit portfolios totaling about $10 billion.

I'm just trying to get a sense -- it's a pretty big number relative to your loan portfolio and as you think about this rolling off, should we think about a pretty meaningful deleveraging of the balance sheet or would you look to replace some of these assets, and I'm thinking beyond some of the draw down of commercial loans that's just naturally happening because of the environment?

Matt, this is Jeff Weeden.

I think there's going to be opportunities for us for new lending relationships going forward in the markets that we serve, I think within the community bank and also within national banking.

So we would look for this particular portfolio longer term to provide us with additional liquidity to redeploy into those particular relationships in the markets.

The expectation would be somewhere also between $600 million a quarter that this would run-off, at least for the fourth quarter and looking out a little bit beyond that.

Okay, and then just related expense give ups as these assets roll off?

Well I think on the expense side, what we took was a severance and other exit costs in the third quarter, because it was about $19 million in total, about $10 million of that was related specifically to the marine and educational lending business and we expect that we're going to see an additional $10 million to $15 million of exit costs associated with that in the fourth quarter, and that's for not only severance, but we wrote off about $4 million of goodwill in the third quarter and then we'll have some occupancy costs that will go away and on a go forward basis, we would expect to see about $20 million to $25 million of annualized cost improvement as we get into 2009.

Jeff, if I might add, this is Thomas Bunn, if you look at our businesses and the changes that we've done in the real estate business, the realign -- the refocusing of those businesses plus the consumer finance business as Jeff has talked about, when you look from September of '07 through the announced changes which will take us into December of 08 , our headcount in national banking will be down about 20% point to point, so that supports the numbers that Jeff just

Okay, that's helpful.

And then just stepping back, very big picture, I think all of the large Midwest banks have come out with earnings.

We're seeing a couple of similar trends.

One, deposit pressures out there, two seems like everybody is shrinking the asset side of the balance sheet and there's still just margin pressure because of deposit pricing and just general liquidity issues.

I mean, in the kind of environment we're in right now, we finally get some consolidation among specifically the Ohio banks, and I guess I'm thinking the TARP capital, there's some thought out there that it will only be available related to acquisition, and I'm just wondering how you think about that and any commentary specifically on what Treasury incentives to the capital.

Matt, this is Henry.

There's no question that Treasury's intent for the capital is to make more loans, and it addresses sort of the comments that you started with which is the deposit raising is still expensive, especially as we continue to see downward movement from the Fed which lowers the prime rate, and we do run into sort of a floor on the deposit side.

I have said for some time, and I think this very unstable and unprecedented financial environment that we're in will lead to further consolidation in our industry at a time when the financial services industry, banking in particular, stabilizes.

I think there's still a lot of uncertainty about the future, about the state of credit quality, where it's going, how deep the recession might be, how long it might be, what that will mean for consumer portfolios, so I wouldn't expect to see a lot of M & A activity other than the troubled institution activity that we've seen that is much more rifle than shotgun, but I think we'll see more shotgun as the market stabilizes over the next 18-24 months.

Okay, so like behind the scenes there's not regulatory or government pressure to consolidate?

No.

That has not been an issue that we're aware of or that the banks that we're talking to.

I think -- more detail than you may want, but we have seen sort of an inverted PE where the bigger banks were in the 10 to 12, the medium sized banks were 12 to 14 and the community banks were running at PE's 16 to 18.

This access to capital and growth has brought a lot of those ratios down to where acquisitions and a more normal environment should be easier to do, so I think that we'll see more activity, but it isn't the government as much as it is, I think, boards and management from some banks realizing that there aren't enough companies still willing to pay four times book which is a number that we saw on a number of occasions in 2006 and 2007.

I think that rationalizing of where the buy-sell meet will help activity get done.

Okay, appreciate the color Henry.

Thanks.

We'll go next to Tony Davis with Stifel Nicolaus.

Good morning, Henry, Jeff, how are you?

Good, Tony.

Just a little more color here on the snick portfolio.

I just wondered, what's the size of it right now?

Maybe Chuck can answer this.

The percentage of those loans in non-accrual and how your internal grades compare with the results of the national?

Tony, the size of our snick portfolio hasn't changed dramatically.

In fact, it has hardly changed at all over the last number of quarters.

In terms of how we've come up on the ratings in this last go around, we actually compare quite favorably to the national averages.

We're running in some of the categories at about half of the national average, and I think the reason for this, Tony, is that we have very much stayed away from the large leverage loan business that we saw a lot of back in '06 and early '07.

We've stayed completely away from it, and I think that one of the focuses of the snick exam this year was on a lot of those large leverage loans, the so-called covenant light deals, and that's where the national averages have gone up quite dramatically.

So we stayed away from that and our snick portfolio reflects that.

Chuck, staying with you, the second largest component of CRE is retail behind residential construction, yet you're not showing any change in NPLs there.

Wonder if you could give us some color I guess on what you're seeing in terms of risk classification migration, it was 30 to 89 day delinquents, just about how you feel about that portfolio today.

Yes Tony, it's obviously a portfolio we have been scrutinizing a lot over the last six to nine months.

Thus far, the numbers have held up extremely well.

About a billion of the $2.6 billion is completed and the completed projects are very close to 100% leased.

The reminder the $1.6 billion of construction, the way we've underwritten that portfolio has been, we don't start construction until it's 50% leased and in most cases it's higher than that.

A very high proportion of the portfolio is underwritten to at least break even coverage on that service, probably two-thirds of it, a little bit higher than that.

It's very geographically diversified.

I think we have probably no MSA that accounts for more than 5% or 6% of that portfolio.

On the average size, it's about $10 million, so it's not a lot of big stuff but clearly, the retail side, given the changes in the economic outlook over the last month or so, we clearly are watching that very carefully, but thus far, any of the bankruptcies in the retail side have not had an impact on this portfolio.

We've not had any exposures to those names.

So we're watching and looking very carefully but thus far, I think we've underwritten the portfolio well and we're going to keep watching it and see how we get through Christmas.

Henry, one last one for you and that is across the company, you've got various types of relationship businesses here.

I wonder if you could talk a bit more about the attractiveness of the community banking versus the national banking relationships today and what that implies here for future strategy.

Well, as you know, Tony, we have been trying to exit the non-relationship businesses and I'm not sure that they fall perfectly on national versus the community bank.

We have in our national banking group some strong relationship businesses and we're continuing to put dollars there, as we've said, where the returns more than justify the cost of that capital.

What we're doing is getting out of a lot of the indirect businesses.

Those only recently in KeyBank history have become part of the national bank.

They're really consumer driven, but because of the way we classified where they were doing business -- and it's really the indirect.

It's really where there isn't a specific relationship, and the reason for that and I have people -- my people claim that there's a relationship if there's a loan.

That's not a relationship to me, and we do analysis that shows that those clients, corporate and retail, who do more business with us, have more services with us, that those returns are way above our cost of capital, so relationship means to us doing more than one thing.

I'd like it to be doing more than two or three things, but it's really that focus that we're continuing and this is not new.

We've been doing this for seven or eight years in trying to work our way towards more of the relationship to it really being the dominant strategy, philosophy and way we do business and this economic environment has just pushed us to say, hey, let's just exit these businesses that are commodity and indirect.

Thanks.

And we'll go next to Ed Najarian with Merill Lynch.

Good morning.

Good morning, Ed.

I guess two questions.

First, you alluded to a longer term, higher loss ratio on commercial real estate outside of the residential construction portfolio.

I was wondering if you could give a little more perspective on that from sort of a timing and magnitude standpoint, and then Henry, I wonder if you could address your comfort -- clearly strong capital ratios, but if you could address your comfort level with the dividend going forward.

Ed, this is Chuck Hyle.

Let me try to take your first question.

I think on the residential side, we do believe we have the worst of the portfolio pretty well behind us now, so I think those loss rates will come down, but given that we've seen virtually no charge off activity and the rest of the commercial real estate portfolio and given what I said earlier about the change in the outlook for the economy, we do expect to see some migration there.

We've seen very little in retail.

We've seen virtually none in other parts of the commercial real estate portfolio at this point, but given the potential severity of the economic shift, we do expect to see some migration over the next couple of quarters, and I guess that's the way that I would summarize our view on commercial real estate.

And Ed, on my comfort level with the dividend, as I think all of you know, the board reviews our dividend on a quarterly basis.

We were comfortable, I was comfortable recommending the $0.75 for the third quarter and we'll take a look at where we are in the fourth quarter, but our participation in the capital program, the reversal of some of the charges that we took related to the IRS and some of the reserve building and one-timers lead me to be very comfortable with where we are on this date.

Okay.

Thank you.

We'll go next to Mike Mayo with Deutsche Bank.

Good morning.

Good morning, Mike.

Could you elaborate more on the drawdowns?

You mentioned that it hurt the margin.

Why is that?

Are the terms just locked in stone and the borrowers are getting good rates, or is there something else going on?

Mike, this is Tom.

As we've all been in this business for awhile, we know in the cycles as you go into a very strong cycle, corporates renegotiate their revolvers, three to five year revolvers in very aggressive terms and unfortunately, the banks let them.

So what we're seeing is, as we go into this cycle and corporate to have established lines of credit and in some cases, have been shut out of the capital markets, either the CP markets or long term debt markets, they've turned to these revolvers and these revolvers have 2006, 2007, 2005 type pricing and are probably in place for another couple of three years, so what you're finding is while they are generally tied to ratings, they are still very aggressively priced and they certainly would not be priced, those revolvers would not be priced in those ranges if they were redone today and as we see revolvers mature and get repriced and restructured, not surprisingly, rates across the board and spreads, fees, etc, are all going up, but we are living with a legacy of established revolvers that corporates are using to draw, and we're seeing quite honestly utilization rates, as you can imagine, because of the capital markets, utilization rates going up and what we've seen in the institutional bank.

from a low of 24%, it's now right around 39%, so that's the spread compression that Jeff talked about against those revolvers.

And how much are we talking about here?

So we're saying 2006 pricing on new 2008 loans which you're mandated to do due to the lines of credit that have been in place, so are we talking -- well, how big is this?

Well,--

Are you talking about the draws on the facilities?

Yes.

How much --

Well, from a margin compression standpoint, it's a combination of things that we provided.

In my comments, were really these particular draws, we also have --

Really, the question -- how much is being drawn down?

The dollar amount?

The dollar amount of the draws?

It will vary and some of them come in hundred million dollar chunks, as you can imagine.

In aggregate, like is it bigger than a bread box?

Well it would be a billion dollars that we've seen in draws on them, so --

Probably right around a billion, Mike.

That was this quarter?

Yes.

That was this quarter.

And so you expect that to pick up or --?

It's hard to say what we would expect to see in actual pick up there.

Tom?

Do you have any other color on that at all?

Mike, our view is that you're seeing the markets loosen a little bit, as you're seeing LIBOR come in, not quite -- not nearly where it has been historically, but as it comes in, as you're seeing CP markets fall, it's our impression that we could be, or should be at a peak as we go through the fourth quarter and see this fall as you go into the first quarter.

Chuck, I think -- would you agree with that?

That's exactly where I would put it.

So again, this is all tied to liquidity in the capital markets, and I think it is every bank that you've talked to probably are having this situation happen and we think that it is a market driven phenomenon that will fall and we are already seeing some fall as we see rates tighten and the CP market fall.

Well that's real helpful on that information.

Just to clarify on the into NPA outlook, so what's your outlook for -- ahead for NPAs and loan losses in aggregate?

Yes, I think we are, certainly on NPAs, our general view is we are plateauing.

We expect then in certain subportfolios to see elevated levels of non-performance but in general, again, subject as always to the economic environment, that still is the wild card here.

Our expectation is that we are plateauing on the NPA side.

And Mike, with respect to losses, our guidance that we provided there would also -- for the fourth quarter would be in the 1.20% to 1.60% of annualized net charge-offs.

So same as last quarter?

Same as last quarter.

And anything else new besides the auto floor plan loans you want to highlight?

No.

Not really.

I guess we have seen a little bit of weakness in the middle market commercial side in the Great Lakes region, but very strong still in all of our other regions.

But really, the material one is -- the one that's most noticeable is the dealer -- auto dealer floor plan side.

All right, thank you.

We'll go next to Gerard Cassidy with RBC Capital Markets.

Thank you.

Good morning.

Good morning.

I may have missed this.

I was jumping on and off the call, so I apologize.

With the Fed funds rate cuts, where do you guys see your fourth quarter net interest margin and if the Fed cuts again another 50 basis points before the end of March of next year to help stimulate the economy, what would the margin look like under another Fed funds rate cut for 2009?

Well, Gerard, this is Jeff Weeden.

We haven't provided 2009 guidance at this particular juncture, but with respect to our fourth quarter guidance of 3.0% to 3.10% which would bring the margin down from the 313 that we were at at the end of -- or for the third quarter, we have in fact factored in an additional Fed cut in that particular margin forecast, so we're anticipating that the Fed funds could be in the 1% range as we go through the fourth quarter.

I think clearly, that would continue to pressure the margin into 2009 until you have such time as you have enough turnover in your loan portfolio to reprice credits at better spreads, but as you know, when the funds rate gets down around 1%, you end up with deposit rates that are below 1%, the ability to go down in the same proportion as any Fed cut becomes very limited.

Yes, we do recall that a couple years back.

Moving back to the comments about the plateauing in non-performing assets, what kind of economic outlook are you guys using to feel comfortable that NPAs have plateauing around this level?

Gerard, this is Chuck.

Until about two months or so ago, we had a mildly recessionary outlook and in the last three to four weeks, we've worsened that economic outlook to a more of a severe, not overly severe, but a recession over the next two to three quarters, unemployment going up, probably getting close to 8%, so we've been factoring that into our projections over the last two to three weeks.

Okay, so with a fairly severe recession then, you still think they are plateauing the no-performers at these levels?

We do at this point.

But clearly, we get new informational the time, some good, some bad.

We didn't know, haven't factored in the impact of any potential stimulus plan, so there's just a lot of uncertainty but we are, we certainly, from about September 15 took a more negative view on the economy in all of our projections.

Sure.

Moving over to the commercial real estate portfolio, excluding construction loans, not that part of it, on your investment or your income producing properties and the loans that support that, over the next 12 months, what dollar amount will come up for REIT financing in that portfolio?

Do you know?

I don't.

I can tell you though, Gerard, that we expect that portfolio to continue to reduce.

We are being exceptionally selective in any new business and we are taking exits and paydowns wherever we can, but I don't know the percent of that business that's going to.

I think in terms of the non-owner occupied portfolio that we have that's identified on slide 15, the $ 12.7 billion portfolio, the unfunded commitments have been coming down steadily over the past year so if we were to go back a year ago, there was approximately $6 billion in unfunded commitments on that particular portfolio, that's down to $3.9 billion, so it's been dropping.

The last quarter it dropped half a billion dollars between the second quarter and the third quarter on the unfunded portion of it.

So clearly there's movement in activity within that book of business that's happening right now.

Okay, but you don't -- because one of the concerns, as you guys know from what we read, is that a number of commercial real estate operators particularly mall operators that have debt coming and rolling over are unable to roll it and they 're running into problems and we're now focused on which -- and you guys have always been strong in this business on the retail side if you had a lot of properties coming up for refinancing in the next 12 months.

Well clearly we're having to look at those particular deals when they do come up Gerard.

Some of them, there are refinancing opportunities and others, we're going to have to look at.

It may take a year for them to get refinanced, but as you know, we've said in the past, we're not a permanent lender so when we go through that particular process, we will continue to look for the markets to free up and move those particular credits into the secondary market.

And we are still, Gerard, seeing some deals getting refinanced down in the permanent market.

The life insurance companies are still active.

They haven't increased their volumes from standard percentages, but they are still active and we are still getting some of them done in that market.

Okay, and then on page 14 of the slides, you guys give the credit quality by portfolio.

3Q '08 and you have your commercial real estate line and you put in there $453 million of NPLs.

In the prior quarter, you broke that line out into commercial mortgage and construction.

Commercial mortgage was $107 million in the second quarter and construction was $256 million.

Do you have that break out for that $453 million between the two categories?

It's in the press release, so you can go to the press release or on slide 32 also.

You can get it by percentages if you're looking at it, so just going back to slide 32, you'll see the breakout in terms of percentages.

So that probably helps a little bit.

Yes, great.

Okay, thank you.

(Operator Instructions.) Looks like that concludes our question and answer session .

I'd like to turn the conference back to Mr.

Meyer for any

Thank you, Operator.

Again, I want to thank you all for taking time from your schedule to participate in our call today.

If you have any follow-up questions on the items we discussed, please don't hesitate to call Vern Patterson, our Head of Investor Relations at 216-689-0520 or Chris Sikora at 216-689-3133.

That concludes our remarks.

Again, thank you and have a great day.

Thank you, everyone.

That does conclude today's conference.

You may now disconnect.