PNC Financial Services Group Inc (PNC) 2005 Q3 法說會逐字稿

Good morning.

And welcome to today's Mercantile Bankshares earnings conference call.

At this time, all parties have been placed on a listen-only mode, and the floor will be open for questions and comments following the presentation. (OPERATOR INSTRUCTIONS)

It is now my pleasure to turn the floor over to Dave Borowy, Director, Investor Relations for Mercantile.

Sir, the floor is yours.

Thank you.

Good morning, everyone, and thank you for joining us today.

I would like to inform you that this call is being recorded and will be available for replay along with our earnings release at our Company's investor relations website at www.mercantile.com.

With me on the call this morning are Mr. Ned Kelly, Chairman, President, and CEO of Mercantile Bankshares Corporation;

Mr. Terry Troupe, Executive Vice President and CFO;

Ms. Ellen Harvey, Senior Vice President and Portfolio Manager; and Ms. Kaye Simmons, Senior Vice President and Treasurer.

Before I turn the call over to Mr. Kelly, I would like to address some housekeeping matters.

The press release announcing our earnings was distributed via PR Newswire at 7 AM Eastern time.

I would like to remind you that during the course of this call, we may make forward-looking statements within the meaning of and pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

A forward-looking statement encompasses any estimate, prediction, opinion, or statement of belief and the underlying management assumptions.

Forward-looking statements are based on current expectations and assessments of potential developments affecting market conditions, interest rates, and other economic conditions, and results may ultimately vary from the statements made during this call.

In the call, we will discuss some non-GAAP measures in talking about our Company's performance.

And you can find the reconciliation of those measures to GAAP measures within our news release, which is posted in the investor relations section of our website.

I now present to you Mr. Ned Kelly.

Thank you, David.

Good morning.

Thank you for joining us.

I believe we had a very good quarter in the third quarter.

As you all know, the earnings were strong.

They were up 25% year over year and 4.5% on a linked quarter basis.

We had good loan and deposit growth, especially year over year.

Our credit quality was stable.

Our operating efficiency improved.

The net interest margin was up 7 basis points year over year.

It compressed 5 basis points on a linked quarter basis.

That was due largely to Community Bank of Northern Virginia, together with an additional $50 million investment in bank-owned life insurance which, as you know, shows up in non-interest income, and a linked quarter decline in the yield on the securities portfolio.

GAAP earnings were 25% year over year and 4.5% linked quarter.

GAAP diluted EPS of $0.86 was up 21.1% year over year and 2.4% on a linked quarter basis.

Cash operating earnings were up 23.1% year over year and 8.6% linked quarter.

Our diluted cash operating EPS was up to $0.89.

That reflects $0.01 in merger-related expense and $0.02 in non-cash amortization of intangibles.

CBNV is going well.

We have completed the operational conversion.

By our calculations, it was probably modestly dilutive, very modestly dilutive this quarter if you include the merger-related expenses.

On the net interest income front, we were up 15.2% from last year and 4.5% from the second quarter.

As I mentioned, the margin was up 7 basis points year over year.

It was down 5 basis points to 441 from 446 the last quarter.

The linked quarter decline is largely attributable to CBNV.

As I mentioned, we also had a negative impact from the additional BOLI investment fine (ph) and yield in the securities portfolio from 3 77 to 3 73 on a linked quarter basis.

Loan yields increased 22 basis points linked quarter.

The yields were up in C&I and commercial real estate construction and home equity.

There were up only marginally in residential real estate.

And in fact, they were down in consumer.

As I mentioned, the yield in the securities portfolio was down, and that generated an overall improvement in earning asset yields on a linked quarter basis of 16 basis points.

Our cost of interest-bearing deposits was up 25 basis points on a linked quarter basis.

That was driven principally by money markets, time deposits greater than 100,000, and other time deposits.

Our cost of total interest-bearing funds was up 28 basis points on a linked quarter basis.

That was driven both by the increase in deposit costs and the interest on short- and long-term borrowings, some of which, as you know, have been swapped short.

That generated a decline in the net interest flow (ph) basis points late quarter.

That was offset by a 7 basis point increase in the effect of (ph) non-interest-bearing funds.

The effect of the non-interest-bearing funds in the year-over-year basis was 23 basis points.

I think, as you have heard with some frequency, the flat yield curve does hurt.

That is evident in the yields on the residential real estate and consumer, and particularly in the securities portfolio.

But there are some signs of relief.

We continue to expect modest expansion of the margin going forward, having established a new baseline with a full quarter of CBNV.

Having said that, we recognize there are an awful lot of variables.

And at least to me, the bond market still seems fairly volatile.

On the loan front, the average balances were up nearly 16% year over year and 4.5% linked quarter.

There was growth in all categories except commercial and industrial on a linked quarter basis.

We spent a lot of time looking at C&I loans.

It seems to me that there is some seasonality in the numbers.

But we're also trying with a redoubled effort to separate competitive pressure from demand -- in other words, the extent to which we have declined to chase the competition versus some slackening in demand.

As you know, consumer was up very strong, due primarily to the inclusion of CBNV.

On an end-of-period basis, the loans were up 14.3% year over year and 70 basis points linked quarter.

C&I was up slightly linked quarter -- 3% year-over-year.

Construction was down linked quarter due to paydowns, which is not necessarily bad news.

And commercial real estate was up 1.5%.

Both construction and commercial real estate were up very strongly year over year, construction up nearly 32% and commercial real estate up slightly more than 20.

Consumer, as I mentioned, was up 3.9% linked quarter and 27% year over year, again, due largely to CBNV.

We're going to continue to work on loan growth, especially commercial and industrial, but as I'm sure you're aware, we're not inclined to chase the competition.

We're going to continue to balance the risks and rewards.

Certainly, the developing presence we've got in Virginia should help on that front.

We've had very strong growth there for a number of years.

That growth should be even stronger based on the acquisitions of platforms provided by CBNV.

Deposit growth is pretty good.

Average balances are up nearly 12% year over year and 4.2% linked quarter.

Non-interest-bearing is up 8.6% year over year and 3.3% linked quarter.

Not surprisingly, as a function of higher rates, money market was up 7.5% linked quarter and 8.8% year over year.

The end of period balances were up 12.3% year over year and 1.8% linked quarter.

As I mentioned, generally good growth; non-interest-bearing was up 1.1% linked quarter and 5.1% year-over-year.

Savings and checking plus interest were down, surprisingly, given the interest rate environment.

Money market was up.

Time deposits greater than $100,000 were up.

Our percentage of non-interest-bearing deposits was pretty stable.

It was down slightly from last year, but pretty stable with the second quarter on both an average and an end-of-period basis.

On the securities portfolio, the average balance was up 4.9% linked quarter, only 3% year over year.

The securities portfolio as a percentage of earning assets was stable with the second quarter.

It was down from 23% last year.

Composition has changed only slightly from the last quarter.

Agencies are up from 31% to 32%; mortgage-backeds up to 49% from 48.

Treasuries are down from 16 to 14, reflecting the 1% increase in the other two categories.

As mentioned, the yield is down 4 basis points linked quarter, 2 basis points year over year.

Those yields are down across the board -- treasury and agencies and mortgage-backeds.

The portfolio is very slightly longer.

The duration is two years versus 1.8 last quarter.

The average life is 2.3 versus 2.1 last quarter.

If rates go up 100, the duration goes to 2.3, the average life to 2.6.

That compares to 2.2 and 2.5 last quarter.

We had a loss of 40 million at September 30th versus the loss of 17.4 million at June 30th.

There are some signs of relief from the curve.

We did have higher yields on investments at the end of the quarter.

But as I mentioned earlier, the market still seems volatile to me.

On the interest sensitivity front, we are still asset sensitive.

We are less so than last quarter, due principally to the inclusion of CBNV which, as you know, generated -- changed the mix of the assets and liabilities on the balance sheet.

If rates move up gradually over the next six months by 100 basis points, we would expect net interest income to increase by 10.9 million, or 1.72%.

If they are up 200, net interest income would increase 21 million, or 3.29%.

If rates are down 100, it would hurt net interest income by 13.8 million, or 2.17%.

All of those numbers I just said reflect some lessened asset sensitivity than the second quarter, but we still remain asset sensitive.

Credit quality continues to be a very good story for us.

It's stable.

It continues to be very strong.

NPAs are 27.8 million for the quarter.

They were 39.3 million last year.

Nonperformers as a percentage of loans and OREO are 24 basis points, which is the same as last quarter and down from 39 basis points last year.

We had net charge-offs of 745,000 this quarter versus a recovery, as you know, last quarter of $1 million and a $568,000 recovery last year.

We took a provision this quarter of $820,000.

That's marginally in excess of the net charge-offs.

As you know, we did not take a provision in the second quarter.

The allowance is basically stable.

It's down 1 basis points from the second quarter and down from 161 last year.

The coverage of non-performing loans is also stable.

It's 582 this quarter versus 583 last.

It fell considerably from last year, when we were at 415.

On the non-interest income front, I think another good story.

We're up 17% year over year, 5% linked quarter.

Investment and wealth management revenue was up 5.7% year over year.

It was actually down marginally on a linked quarter basis.

I think we generally had a good quarter.

The revenues were affected somewhat by some of the previously disclosed general termination issues that we had.

But pretax income for the quarter was actually up to 6.3 million from 5.3 million last quarter and 5.4 million last year.

That drove our pretax margins up to roughly 27%, 29% cash, versus 22% and 25% last quarter.

That was driven not surprisingly by good expense control.

Expenses were down $1 million, principally attributable to reductions in personnel expense and operations expense.

Our assets under administration are at 46.4 billion which is down from 48.3 billion last quarter.

As I mentioned at the end of the second-quarter call or during the second-quarter call, that reflects the termination of a large custody account of roughly 2.9 million.

That custody account had some cash management associated with it.

Our assets under management are actually up.

They are up to 21.9 billion versus 21.7 last quarter.

That's broken out into 8.8 billion personal and 12.9 billion institutional.

Personal is actually up strongly from the second quarter as I said at 8.8 from 8.2 in the second quarter.

Net new sales were generally stronger this quarter in the core business, and particularly in personal.

As previously noted, we had a large institutional termination during the quarter, which relates to that custody account.

On the personal front, net annualized revenues were 737,000 versus 25,000 last quarter.

Sales were up strongly.

Terminations were down.

On the institutional front, we had a net annualized revenues loss of 713,000 versus a $47,000 gain last quarter.

Sales were down slightly.

The loss was driven by that large custody termination.

And that obviously will begin to affect fourth-quarter revenues.

Overall net annualized revenues of 24,000 positive for this quarter versus 72,000 last quarter, again, due to the institutional termination during the quarter.

Net new assets under management were down 60 million this quarter versus being up 16 million last quarter, but personal was up 123 million versus 4 million last quarter.

And our Baltimore institutional business was up 75 million versus $31 million last quarter.

The overall net decline was driven by terminations in our other institutional business, which amounted to about 259 million.

I continue to feel good about the prospects.

It's a good team.

I believe it's growing stronger.

It is a very competitive market.

But as I said, I'm optimistic about the prospects going forward.

On other non-interest income, just focused on the linked quarter, service charges were up 3.5%.

Mortgage banking was up 78%.

That was driven by a 95% increase in commercial.

Residential was also up 33%.

Our other income was up 3.5% and that was driven by strong growth in electronic banking fees and charges and fees on loans.

It was partially offset by a small decline in insurance on a linked quarter basis, but I would note that insurance was actually up 8% on a year-over-year basis.

And a larger decline in all other income, which is due principally to the inclusion of a branch sale in the second quarter.

Those positives are partially offset by a marginal decline in nonmarketable investments.

It's relatively small.

It is a very different mix from the second quarter, though, with private equity down 4.5 million, but hedge fund investments up 4.1 million, and with the bank-owned life insurance being up 356,000, which essentially gets you pretty much close to flat.

On the noninterest expense front, we were up 9% year-over-year and 4.3% from 103.9 million last quarter to 108.4 million this quarter.

But as I'm sure you are aware, we had a full quarter of CBNV.

We also had $743,000 of merger-related expenses, among other things.

One thing that I would note is that that brings us to a total of $312 million for the first nine months of this year.

And that includes roughly $6 million of CBNV expense, both in terms of operating expense and the merger-related expensed, which gives a net of roughly 306 million in a context where we've generated diluted EPS share growth, EPS growth of 17.5% for the first nine months.

In my view, given that and given the increased incentives that have been generated by that earnings performance, we're actually pretty close to where we wanted to be at the beginning of the year.

It continues to be a focus of ours.

Our operating leverage has continued to improve and we want to sustain that.

Core expenses were pretty good.

Salaries were up 3.1% or 1.6 million, but that's entirely attributable to increased incentives based on the performance that I mentioned.

Employee benefits are actually down.

Net occupancy expense is up 4%.

Furniture and equipment are up 50 basis points.

Communications and supplies were actually down 2%.

Our other expenses were up 13%.

That was driven by a nearly 27% increase in volume-driven electronic banking expenses.

There was a 30% increase in outsourcing.

That's both an absolute number, but also reflects the elimination of certain concessions that we had in the second quarter which drive the percentage increase.

We also had a 300-plus percent increase in minority interest expense.

And that's due to the performance of the mortgage banking stuff that I mentioned earlier.

So basically, more than the entire difference of 4.5 million between the third quarter and the second quarter essentially is explained by incremental community bank costs, the increased incentives, the electronic banking costs, the increased outsourcing costs, the merger-related expense, and the increased minority interest expense.

As you know, in large measure, all of those are attributable either to the acquisition or to improved performance.

We're going to continue to focus on costs.

We've made good progress on CBNV.

We're certainly going to keep at it.

But I think we're pleased with the way that acquisition is going today.

On the operating metrics fund, cash (ph) efficiency improved linked quarter from 48.54 to 48.36.

Our operating efficiencies similarly improved from 48.29 to 46.97.

The return on tangible equity essentially is flat the last quarter, down 2 basis points from 19.64 to 19.62.

The ROA was down marginally from 1.79 to 1.75, improved markedly from last year's 160, however.

Average tangible equity to tangible assets was 953 versus 967 last quarter and 967 last year.

Tangible book value was at 17.35 this past quarter and 17.05 last year.

Looking forward, we're looking forward to continuing to leverage the new Virginia platform.

We'll focus on prudent loan and deposit growth.

And I'm hoping for a steeper curve for Christmas.

Having said that, I'd be happy to answer any questions.

(OPERATOR INSTRUCTIONS).

Steven Alexopolous, Sandler O'Neill.

Ned, can you isolate how much of the margin compression came from the inclusion of the Community Bank deal and how much came from BOLI?

Are you able to do that?

Yes, Steve, it's easier to do it on BOLI than it is on CBNV.

The BOLI impact is about a basis point as we calculate it.

On CBNV, as you know, there are a host of variables associated with that, including whether you choose to push down essentially the acquisition financing, and obviously reconstructing a balance sheet, which we have now had for a quarter and a half.

But our best back-of-the-envelope on that is 4 basis points or thereabouts.

And then obviously, we have additional impacts from the decline in the yield and the securities portfolio.

That's helpful.

Ned, in the investment wealth management area, do you expect any large custody terminations in the fourth quarter from what you can see now?

No, not that I'm aware of, Steve.

But you know, that business by and large -- well, actually, it depends on one's point of view.

We do have some large accounts.

The rest of it's pretty granular.

I think the one that we'd lost in the second quarter -- as you know, we chose not to compete on price.

An historic customer who had gotten to be much larger had more sophisticated needs.

As I said, at the end of the second quarter, we believe that that business is best for us as a niche business, not surprisingly, given some of the competition.

But I'm not aware of any other large terminations in that front on the horizon.

Do you have the dollars in terms of the construction paydowns in the quarter?

I don't have those handy, actually.

I know that a client (ph) is attributable to paydowns, because that's what I was told, but I don't know the dollar number.

Just finally, can you comment on the pipeline here in the fourth quarter on C&I and commercial real estate as well?

Pipeline is always difficult for me because obviously, there are an awful lot of slips betwixt the cup and the lip.

I think anecdotally, we're doing okay.

Is loan growth necessarily as strong on the C&I front as I'd like to see it?

No, and I hinted at that.

We're trying to separate how much of it is reflective of a compromise in price and terms on the part of our competitors, and how much of it is just a slackening of demand.

As I said repeatedly before, I'm not inclined to compromise on terms.

I think the fact is that we do have some flexibility on price, especially for more highly-rated credits.

We're trying to discuss that more broadly within the organization.

It will continue to be a focus.

One of the reasons that I said there is some seasonality -- and as you know, we have affiliates that are spread across a variety of market in Maryland and Virginia.

Summer months tend to be slower for some and faster for others.

So there is some of that.

But C&I is certainly going to be a focus.

C&I is I think -- somebody will correct me quickly if I'm wrong -- is down to mid 20s I believe in terms of the overall share of the portfolio.

Historically, it's been somewhat north of 30.

I think that reflects both strength in commercial real estate and construction, but obviously also, as you know, over the past couple of years, frankly, not as strong a growth as we like to see at C&I.

So that's become a top-of-mind initiative for senior management around here to try and get at that, especially in the small middle market sector.

Fortunately, Virginia gives us an awful lot of fertile ground to till in that respect, and we're very much focused on that front.

And the growth that we've enjoyed in northern Virginia and in the immediate Washington, D.C. market over the past few years has actually been extraordinary.

Christopher Marinac, FIG Partners.

I wanted to ask about the watchlist for credits -- just observing on the 30 days past due, just the small little noise on commercial leasing and construction -- anything to say there?

Yes, there is, Chris.

There's one past due 30 to 89.

And I think we're up to 57.3 from 43.7 last quarter; 36.5 last year.

The truth is that's a few borrowers, and one large one in particular who has drifted in and out.

We are comfortable with the security we have with respect to that loan.

We're not concerned about it turning ultimately bad.

The fact is we feel that we are well covered.

But the noise in those numbers frankly is generated by the status in particular of that one large borrower.

Okay, great.

And separately, just looking at the change on the average balance sheet on the funding side, there was faster growth on borrowings and CDs than there was on other core accounts.

I was curious if that's going to be something we should expect just again in future quarters.

Well, I think part -- and Kaye will correct me quickly if I'm wrong.

I think a large part of that is probably just a difference in mix between ourselves and CBNV.

The fact is the core deposit growth, as you know, Chris, was still quite good as a relative matter.

I think the difference is largely explained by that.

So I think of that as a baseline going forward.

And I think that we think of ourselves as returning to our more traditional mix as we do move forward.

Okay.

So sequentially that bodes for positive changes elsewhere on the mix then?

One would have thought.

The other thing that I mentioned before is that at some point or another, it may make sense for us and others to lengthen somewhat on the reliability front.

I still don't have a clear picture, and it's not clear to me that anybody else does either, of where rates are going and what the curve is going to look like.

So frankly we have stayed our hand and stayed relatively short.

Great.

And the last question -- on the investment and wealth management area, do you make specific goals that you're holding that unit to, whether it be in '06 or just longer-term in terms of percentage growth of assets?

Well, the fact is that I've long have a goal of 10%.

I think that that's going to be difficult to achieve.

What I'm encouraged by is that we're able to sustain profitability, even in circumstances which are largely attributable to the terminations with respect to the legacy business -- is pretty good.

I think profitability frankly is the key for us.

We will continue to pursue growth, but growth that enhances that profitability.

So what we have tried to do is rather than to set, frankly, hard and firm goals, we have tried to think about it in terms of the total mix that makes sense as an economic matter for us.

Robert Rutschow, Prudential Securities.

Good morning.

Just a couple of quick questions.

I guess on the expenses, looking ahead, where would we expect to see benefits from cost saves in CBNV?

And are you going to get any help on, say, professional fees and things in that?

Yes, I would have thought -- because, you know, professional fees -- merger-related expenses are scattered throughout the category.

So there is some of the noise obviously as you go through the other expense items.

A couple of things on expenses.

One is, as you know, we've had a fairly considerable increase in incentive compensation, which is reflected -- which is linked to the 17.5% earnings per share growth that we've had.

Our programs are such that they cap out at a certain point.

So you wouldn't have expected necessarily the acceleration and the increase, given the fact that I believe -- Terry will correct me if I'm wrong -- they cap out at 12% earnings per share growth.

So essentially, if we're accruing ratably, there shouldn't be a linked quarter increase in that category.

With respect to CBNV, the fact is we've already gotten some costs out.

I think that those cost saves will be accelerated, obviously, in the fourth quarter and into next year.

But I think we're doing pretty well on that front.

Okay.

And separately, I was just wondering if you could tell us how big your hedge fund and private equity portfolios are, and what sort of returns you look for on those?

Well, the hedge funds, I think, were -- rough numbers;

Terry will, again, correct me if I'm wrong.

Aren't we still roughly at 70 -- somewhere in the mid 70s, basically, Terry? (multiple speakers) I think we have essentially achieved our gains.

We're down below the initial -- we are?

We're at 66 million.

Performance of those hedge funds, as you know, has actually been pretty good.

I hesitate to predict the target.

I can tell you that we've done very well with them and feel comfortable with them.

Will that balance decline over time?

Probably, although it's not likely to be an accelerated decline.

And on the private equity investments, my recollection is that we have 30 million principal amount private equity, Terry, rough numbers? -- with commitments probably for an additional 20 that have not yet been drawn.

Okay.

And lastly, I was just wondering how you're feeling about the commercial real estate market, especially in Baltimore.

I think you've got to separate two issues.

One, how I feel about it as a CEO of Mercantile and how I feel about it a sort of an independent observer.

As a CEO of Mercantile, I still feel pretty good about it, principally because I'm confident in our structuring and underwriting capabilities.

As you know, we've long had developers who have been clients of ours for quite a period of time.

I think we have been very good at structuring underwriting.

And I think we feel comfortable with the portfolio.

One might reasonably ask how you feel about it as an independent observer.

I think it's still -- as near as I can tell, just anecdotally -- in other words, observing what's going on, that it's still pretty strong.

Can it get stronger?

I doubt it.

But having said that, I haven't perceived any substantial weakening either.

Chris Mutascio, CSFB.

If I back out the three -- what? $3.4 million branch sale gain in second quarter, all other income would have increased about 2 million -- maybe 2.0 to $2.3 million in the third quarter.

What -- were there any one line items in there that would drive that growth during the quarter?

Yes, there's just -- there's one item -- Terry, why don't you address that?

We did receive -- as part of our arrangement with the check vendor, we received a rebate from them that's reflected in that line items that was about $1 million.

That will be something that will recur periodically if we hit sales goals with that vendor.

So it does recur periodically?

Yes, it does.

And the rest of it is scattered.

Okay.

That's fine.

Now could you also talk maybe a little bit about the sustainability of the commercial mortgage banking fees?

It was a very strong quarter for you all.

Yes, it was.

And those guys have done very well.

As you know, we in part paid for that, obviously, as I mentioned with the minority interest expense.

Having said that, they have done quite well.

There is a lumpiness to that business.

And one might in that respect question the sustainability of the number where it is.

The good news is, as you know, residential was up 33% as well.

As you know, we've never been particularly concentrated in residential.

The fact is, we have quietly tried to build that business over the last couple of years.

We are working off a relatively low base, so improvements are actually reflected in relatively large percentage increases.

I think the mix of that business is pretty good in terms of commercial and residential because we've got both.

But you're right that if commercial has an extraordinarily good quarter, I'd be loathe to predict that they could repeat that consistently.

But my suspicion is they'll repeat it from time to time.

Okay.

If I could ask one final follow-up -- Ned, if I look at the loan growth in the quarter, is it better for me to look at end of period to end of period versus averages because of -- the Community Bank merger took place in mid-May, which might skew downward the average balances in second quarter?

Yes, Chris, I can actually tell you -- I mean, I think I've got -- as a matter of fact, if you bear with me for one second, I can tell you -- if you look at 4.5% linked quarter in terms of the average balances, 1.3% of that is organic.

Okay.

That's great.

That gives better color than I thought.

Matthew Schultheis, FBW.

Quick question regarding merger-related expenses -- and you may have touched on this already, but do you see any into the fourth quarter?

Yes.

Not a lot.

There are probably 400,000 rough numbers I think is the current projection.

Okay.

And then on a -- kind of a follow-up to Chris's question there, on a linked-quarter period-end basis, you saw, it appears, good growth in your consumer lending.

What sort of categories are those going into specifically?

It's just the inclusion, essentially, of CBNV.

In other words, for their (ph) portfolio, that's what drives that.

I think that there will be some noise in those numbers, because there are certain businesses -- for example, at S&M (ph), as you know, we had a mobile home portfolio which has declined somewhat, and my suspicion is will continue to decline.

CBNV has a relatively large indirect auto portfolio which we inherited.

And obviously, if we look at it, we're pleased with it at this stage.

Whether that's necessarily a growth engine is a separate question.

I think the rest of it -- Terry, correct me if I'm wrong -- is relatively broad-based.

But again, it reflects CBNV by and large.

And it is the indirect portfolio, which shows up in the yields on -- that is very sensitive to where the yield curve is.

And pricing has been very competitive.

But that's businesses you have to stay in for the long-term.

And as I've mentioned, I believe the yields on consumer were actually down on a linked-quarter basis, which is reflective of that.

Gary Townsend, FBR.

Question with respect to your indirect auto.

Do you see any changes in that market with the weakness or the difficulties that the majors are having?

Has it affected you?

No, it's been okay for us.

I would imagine it might be helpful.

Yes. (laughter) Fair point.

Secondly, Ned, could you give us some of your conclusions with respect to C&I and whether it's seasonality, whether it's your pricing, whether you've been aggressive enough or -- just color between the lines, if you would?

Sure.

I think some of it, having looked at the numbers for all of our affiliates, each one individually, I think there is some seasonality.

Having said that, even if there is seasonality in the aggregate, do I think we're growing it to the extent that we should?

No.

Part of that may be less demand than I would otherwise like to see in some of the markets we're in.

But I think that's going to be offset going forward by, one hopes, if we increase our penetration in northern Virginia, more demand on that front.

As you have heard me say before, Gary, my intuition has always been that in some respects, we are too conservative on the price front, especially with respect to very good credit.

I am not inclined to -- just bear with me for one second.

I'm not inclined to compromise on terms.

I think we do have some room with respect to price -- as I said, especially with respect to more highly rated credits.

I've had meetings obviously with the person who runs the affiliates, the person who runs the lead bank in Baltimore, the person who is running our Virginia operation.

We have had extensive discussions about that.

And that is going to be a focus of ours going forward.

So in sum, I think part of it is seasonality.

I think part of it is lower demand than we might have seen before, because if you look at it over the past couple of years, it's actually been more slack than I would have guessed.

But I think that -- both of those issues may in fact be attributable to -- and I don't want to describe it as undue, but not as refined a conservatism as I would like to see us bring to bear.

Fair enough.

Lastly, loan-to-deposit ratio has been creeping up.

I think it was just under 97% on an average basis in the third quarter.

You had some plans to accelerate deposit growth?

Or how might you go about that or how are you looking at that particular metric?

Well, certainly, as part of -- as you know, one of the initiatives that we have had around for a year or so which is actually beginning to come to a head is what we have described as the retail initiative.

In fact, we just recently had a retail summit where we called together the CEOs (ph) of all the affiliate banks.

And as you know, historically, we have not necessarily thought of ourselves as a retail bank.

The fact is, we now have 240 branches.

I think we are the 30th largest branch network in the United States.

It's always instruct me struck me, at least as an intuitive matter, that ought to be able to leverage that better than we have.

We have got them very much focused on that front, and one of the things that I pointed out is that while I've been surprised during my tenure here about how strong deposit growth has been not only for us, but also for the industry, that that's likely to be a challenge for everybody going forward.

We're going to have to get much better at it, and we are teeing ourselves up to be able to do that.

Can you tell me what some of your tactics and strategies will be?

I think basically just trying to increase share of wallet with respect to our commercial customers where we have historically done well, but I think where we could do better.

And frankly, on the other front, I think it's just -- without necessarily suggesting that we're going to be as aggressive as some others, certainly more aggressive marketing, and more mindshare around people in the branches thinking about how it is that they can increase wallet share with our customers and generate more deposits.

It's pretty simple blocking and tackling, actually, and trying to set metrics for people as to what it is that we expect.

Andrea Jao, Lehman Brothers.

In terms of the institutional termination in your wealth management unit, could you give us a better idea about the revenues associated with that?

And then what happens to the expense (ph) base as well?

Expense base declines some, but not a lot, obviously, in the sense that we'd rather -- we have a custody (ph) business, as you know, by and large, that's systems- and operations-driven.

So the expense saves associated with that are not going to the big.

If you look at -- if I'd (ph) given you the numbers with respect to non-interest income in terms of the institutional.

Net annualized revenues, I think, were at negative 713,000.

I think basically about two-thirds of that is probably related to the custody relationship.

Okay.

That's helpful.

And then a housekeeping question.

What would be a good number to use for option expensing in 2006?

I don't know -- well, I do know.

Obviously, I know historically what it is.

Having said that, I don't know what it's going to be in 2006 with respect to awards we might make in 2006.

Because as you know, we don't do with those until March.

But I will let Terry address the historic number.

We have expensed options, as you know, since 19 -- the mid-19 --

1995.

We were one of only four companies in the U.S. to fully adopt FAS 123.

And we have footnoted in our financial statements the run rate for options and restricted stock expense.

So we do not have any restatement issues for prior years or anything like that.

And typically, it's been running in the 2 million range -- 1.5 to 2 million per annum.

That is what it is.

There's no impact as a result of change in the rules.

(OPERATOR INSTRUCTIONS).

David Bishop, Legg Mason.

Could you run through -- I hopped on late -- I heard the tail-end of some of the details regarding the growth in operating expense of the outsourcing and banking fees.

Could you just run through that real quickly?

Yes, growth in operating expense, as you know was -- rough numbers, 4.5 million on a linked quarter basis, David, which I assume is the number that you're interested in.

There -- basic (multiple speakers) kind of pointing (ph) that entire increase between the third quarter and the second quarter based on incremental Community Bank costs, because, you know, we had them in for a full-quarter rather than half a quarter as we did in the second.

We had increased incentive comp of 1.6 million which is frankly just directly linked to the increase in earnings per share year over year, which is 17.5%.

We had volume-driven electronic banking costs of about 850,000.

The outsourcing costs were up about 710,000.

That's partially attributable to swing factor -- in other words, the lower costs in the second quarter elimination of some concessions and the third, which may be marginal increase 710,000.

There were merger-related expenses of roughly 750.

And we had an increase minority interest expense of about 700,000, which was due to the performance of the mortgage banking sub.

So the incremental increase was essentially by and large performance driven or volume driven, as the case may be.

Got it.

Great.

Circling back to the retail deposit front, deposit growth initiative -- obviously, you have got a pretty strong competitor coming down from north Jersey in the likes of Commerce.

Having seen any sort of encroachment in terms of poaching (ph) in personnel or any other internal effect, so to speak, so far?

No.

And I asked about that expressly a couple of times.

Each year, I get together with all of the affiliate bank directors in three different meetings. (multiple speakers) talk to the CEOs from time to time.

But I guess actually last week, if I'm not mistaken, I had the meeting with our directors in Virginia, and have spent a couple of hours just the other day with the person who is responsible for our Virginia operation.

And I asked precisely that question on the theory that somebody would ask me.

I think his reaction was, as I stated, no.

Fair enough.

Andrea Jao, Lehman Brothers.

On net charge-offs, which have been essentially nonexistent for the past three quarters, do you have some expectations you can share for the fourth quarter?

Do you think there will be fourth-quarter cleanup?

And what do you think the impact of CBNV would be?

Well, CBNV -- as you know, we went through a detailed analysis when we did the deal.

And of course, we went through purchase accounting, as well.

So the fact is that at least with respect to CBNV, I wouldn't expect any huge surprises.

With respect to the rest of the portfolio, as you accurately (ph) point out, our net charge-off experience, not only under the last few quarters, but frankly, over the time that I've been here -- with an exception -- a few exceptions I'll get to in a second -- has been pretty remarkable.

When we had spikes in net charge-offs, it's generally been attributable to pick (ph) problems.

The leasing dunk (ph) was a big (ph) problem, which as you know, we wound down a few years ago.

And my recollection is, Terry, we probably took somewhere between 25 and $30 million for charge-offs associated with that.

And then we had two airplanes, ultimately, that we got rid of, which were an outlier, and frankly, related to the peaking (ph) business which we took care of, I believe, in the fourth quarter of last year.

That explains the spike.

It wasn't -- it was cleanup in one sense, but it was isolated rather than systemic.

And in general, I think we feel pretty comfortable with the quality of the loan portfolio going forward.

Having said that, it's hard to imagine that credit quality industrywide gets any better.

Sir, there seems to be no further questions at this time.

Thank you very much.

This does conclude today's teleconference.

You may now disconnect.