Truist Financial Corp (TFC) 2006 Q3 法說會逐字稿

Greetings, ladies and gentlemen.

And welcome to the BB&T third quarter 2006 earnings conference call, on Thursday, October 19th, 2006. [OPERATOR INSTRUCTIONS]

It is now my pleasure to introduce your host, Ms. Tamera Gjesdal, Manager of Investor Relations.

Thank you Ms. Gjesdal, you may begin.

Good morning everyone.

Thank you, Joe, and thanks to all of our listeners for joining us today.

This call is being broadcast on the internet from our web site at bbandt.com/investor.

Whether you are joining us this morning by webcast or by dialing in directly, we are very pleased to have you join us.

As is our normal practice, we have with us today John Allison, our Chairman and Chief Executive Officer, and Chris Henson, Chief Financial Officer.

They will review the financial results for the third quarter of 2006 as well as provide a look ahead.

After John and Chris have made their remarks, we'll pause to have Joe come back on the line and explain how those who have dialed into the call may participate in the question-and-answer session.

Before we begin, let me make a few preliminary comments.

BB&T does not make predictions or forecasts.

However, there may be statements made during the course of this call that express Management's intentions, beliefs, or expectations.

BB&T's actual results may differ materially from those contemplated by these forward looking statements.

Additional information concerning factors that could cause actual results to be materially different is contained in the Company's SEC filings, including but not limited to the Company's report on form 10K for the year ended December 31st, 2005.

Copies of this document may be obtained by contacting the Company or the SEC.

Now it is my pleasure to introduce, our Chairman and CEO, John Allison.

Thanks Tamera, and thanks all of you for joining us.

What I'd like to do is discuss with you the financial results for the third quarter and year-to-date, give you brief update on merger and acquisition activity, and then a few comments on our fundamental strategic focus areas.

Then I'll share you with some thoughts on the future.

After that, Chris will cover several areas in depth, and we will then open the floor for questions.

For the quarter, on a GAAP basis, we made net income of $417 million, which was down 5.7%.

Operating earnings were $429.8 million.

And that excluded 6.2 million in merger-related charges and $6.5 million in equity-based compensation.

And operating earnings were down 2.5%.

We did have an unusual item in the quarter.

We recorded a $15 million pretax charge related to an unforeseen legal matter.

On an after-tax basis the charge was 9.8 million or $0.02 per diluted share.

We did not characterize the charge as a nonrecurring in our earnings release.

However, it did result from a single legal issue that we think based on current facts will not result in additional losses in later periods.

Given the legal nature of the issue, unfortunately we can't be more specific than that.

But I would emphasize that it is we think a one-time event, and that we did not treat it as a nonrecurring earnings item.

If you look at GAAP EPS, we reported $0.77, down 3.8%.

Operating EPS was $0.79, down 1.3%.

If you add back the legal reserve, the $15 million before tax, then operating EPS would have been $0.81, up 1.3%.

The consensus estimate was $0.81.

We -- based on operating earnings, we were $0.02 under the estimate.

However, if you add back legal reserve, then we would have made $0.81.

I know some analysts don't -- or do take out equity-based compensation from operating earning.

We haven't been doing that because we're trying to get good comparisons.

Equity-based compensation is about $0.01.

So if you adjust for both the legal reserve and you take out equity-based compensation, then we would have made $0.80 a share or $0.01below the consensus estimate of $0.81.

Cash basis EPS was $0.82, down 2.4%.

However, if you add back the legal reserve, cash basis EPS would have been $0.84, which was the same as last quarter and the same as the same quarter last year.

Based on operating earning, we had a cash ROA of 159, a cash ROE of 2853, some still very strong returns.

Year-to-date numbers, GAAP net income was 1.7 billion-- 1.277.6 billion at 4.4%.

Operating earnings, 1.293.8 billion, up 3.7%.

If you add back the legal reserve, we made $1.303.5 billion, up 4.5%.

GAAP EPS for the nine months is 235, up 5.9%.

Operating EPS is 238, up 5.3%.

If you take operating EPS and add back the legal reserve for the first nine months, we'd have made 240, up 6.2%.

Cash EPS was 248, up 4.2%.

If you add back the legal reserve cash EPS would be 250, up 5%.

The nine-month earnings are similar in terms of returns on an operating basis, cash ROA was 167 and cash ROE 28.63.

So very strong returns.

Looking through the factors driving earnings by far, our primary challenge is our margin.

Our margin continues to decline.

It dropped from 376 in the second quarter to 368 in the third.

It is down from 388 last year.

The inverted yield curve is a big challenge for us.

Chris will give you some detail about the -- about what's happening in the margin and where we expect it to go.

Noninterest income was pretty good news.

Looking at annualized second-to-third and taking out any nonrecurring items, [inaudible] accounting, and also taking out the mortgage servicing rights impairments, a look at what I call true noninterest income growth rate annualized second-to-third was 8.9%.

Third-to-third was 8.3%, and year-to-date, 9.5%.

Pretty healthy noninterest income growth.

If you look at the items making that up and excluding nonrecurring items and purchases, insurance continued to be very strong.

Third-over-third, up 9.9%.

Down link quarters with that is a normal seasonal factor.

Year-to-date up 11.2%.

Insurance commissions are our largest noninterest income item.

I don't have the exact industry numbers, but every number I have seen through the first half of the year, we are clearly growing much more rapidly in our insurance business on a same-store sales basis, and -- than the industry is.

So we're moving market share there.

A little disappointment in our service charges, third of-- third down 4.1%, annualized link down 5.8%.

Basically flat year-to-date.

A couple factors driving that, as rates have gone up, commercial count analysis fees have gone down, so have higher earnings credits.

The other thing is, we have been over the years very tough on refunds.

We've become a little more willing to offer refunds on service charges in order to retain the account.

We think in the long term it'll actually increase our revenues, but in the short term there's a little transition going on.

We're still tough on refunds, but not as tough as we had been.

Very encouraged with new-- net new transaction accounts.

Up 30,000, third-to-third, and are due in the third quarter, and year-to-date up 115,000 net new transaction accounts.

Real good news there.

Nondeposit fees and commission, which is really basically our bank card and debit card look strong, third-to-third up 16.7%.

Annualized link 8.6%, year-to-date 21.1%, real healthy growth there.

Investment banking is doing better.

Third-to-third up 13.8, annualized link, 22.6, and year-to-date, 6.3%.

Trust is -- is doing okay, too.

Trust revenues is up 8.6% third-to-third, 20.6% annualized link, 4.5% year-to-date.

Mortgage origination business is struggling.

Mortgage banking income if you exclude mortgage servicing rights down 11% third-to-third, 41% annualized link, it's up 12% year-to-date.

If you take in and include mortgage servicing rights, third-to-third mortgage banking income's down 39%, annualized link down 91% and year-to-date up 3.4%.

So our mortgage origination business is slow.

It's interesting, part of it is volume in the third quarter of 2005, we originated $3.1 billion in mortgage funds.

We did 2.5 billion in the third quarter of 2006, the volume was down.

But even more than volume is that with excess competition in the industry, excess capacity, the spread on the originations have closed pretty dramatically.

Other noninterest income, third-to-third was up 25.9%.

That's primarily driven by client derivatives in the current kind of interest rate environment we're in.

And also we've added a new trading program in our capital markets area.

Tender option bond program that contributed to the increase in noninterest income.

That -- while there's going to be some fluctuation in that program, it is a permanent program which we had to staff to create.

And we should continue to get revenue in that business going forward.

Also on a link quarter basis we've got some benefit from restructuring part of our bank and life insurance which again should be a permanent benefit going forward.

Net revenue growth is interesting if you take out purchase accounting, non recurring items and the mortgage servicing impairment, annualized second-to-third, 3.5%, third-to-third, 3.4%, year-to-date, 5.3%.

So we're getting healthy volume growth, but it's not turned into revenue growth because of the margin decline.

If you just hold the margin flat you'd see some pretty excellent numbers in revenue growth.

So we're-- the volume side is doing well, and the margin side is under pressure.

The income ratio in the quarter was 40.8%.

Our-- that was a long-term goal to us.

We've now raised that to 45%.

If you consider that BB&T's largely a conglomerate of community banks that mostly had 20% fee income ratios over the last eight or 10 years, we've made a lot of progress in that regard.

Noninterest expenses, operating excluding purchases, and also excluding the $15 million legal reserve, second-to-third, up 6%, third-to-third up 7.4%, year-to-date up 7.8%.

The expense numbers are kind of high for us.

We've traditionally been very tight on controlling expenses.

We've been making a lot of investments for the future.

And Chris is going to give you some more insight on what's happening on the expense side.

Looking at the growth side, overall, pretty good numbers.

Average loan growth on a GAAP basis, annualized second-to-third, 15.6%, and third-to-third, 11.5%.

It's interesting to look at the second-to-third versus the third-to-third, in taking out purchase acquisitions and taking back securitization to see what's happening with our lending business.

If you look at second-to-third annualized, commercial loans grew 4.2%, sales finance 15.9%, direct retail 6.5%, revolving credit 8.8%, mortgage 11.5%, specialized lending, 23.6%, and total loans 7.6%.

Looking third-to-third, you see some interesting differences.

Commercial grew 7%, sales finance 2.6, direct retail 5%, revolving credit 4.3. mortgage 15.3, specialty lending, 24.3.

In total, 8.4.

Kind of looking at that analysis, obviously commercial slowed pretty significantly in the third quarter.

That was almost totally driven by a significant slowdown in our commercial real estate lending activity, primarily single-family residential construction.

We kind of hit a wall in July, and mostly client driven -- where our clients stopped building new homes.

Stopped -- starting as many subdivisions and reflecting slower activity in the residential markets.

So it's largely driven by what I call borrowed adjustments, we got a little tighter reflecting the slower activity particularly in the condo markets.

Part of it might have been driven by us.

We -- I'd be wary of anybody having great commercial real estate growth rates in this market.

They might be getting adverse selection.

It slowed quicker than we expected.

Interestingly enough, we're not having problems because most of our borrowers had made a lot of money over the last several years and they have a lot of liquidity, but they're slowing in production activity.

Our C&I lending picked up some.

It particularly picked up at the end of the quarter.

We'll see if that works in the fall quarter.

But we did have a pretty nice pickup in C&I lending late in the quarter.

We're not basically in the syndicated lending business, so we didn't get in these large credits that some of the bigger banks are in.

Direct retail actually saw some improvement in the quarter compared to where we've been, which is encouraging.

Sales finance had a great quarter, part of that is seasonal.

But I think we're also moving market share against the finance subsidiaries.

The automotive manufacturers, maybe get some of the banks right now for variety competitive factors.

Revolving credit did a little better.

Mortgage slowed for two reasons.

Our production slowed, but we also began to securitize ARMs, which we have traditionally held.

And that impacted the actual portfolio of mortgage loans.

We're debating whether we'll continue to do that because it's not been particularly profitable.

We maybe we'll go back to portfolio and ARMs.

Specialized lending businesses are growing rapidly in producing excellent returns.

And I'm not seeing material deterioration in credit quality.

Our subprime automobile business, regional [inaudible] is doing very well, as are our other specialized lending businesses.

Really pleased with the deposit growth numbers.

In fact, one of the best news, I think if you look at the whole area and what's happening with deposit growth, noninterest-bearing deposits weren't too spectacular.

We -- if you take out purchase acquisitions, third-over-third were basically flat.

Down 1.2% annualized length.

And year-to-date up 2.2%.

That does look, frankly, better than the numbers I've been preliminarily seeing in a number of our competitors.

We're seeing a pretty major movement out of DDA accounts into cash management on the commercial side, and into CDs on the retail side, which you would expect with this interest rate cycle.

Total deposit growth is -- is very strong.

You take out purchases, third-to-third, up 6.6% annualized link 10.2%, year-to-date 8.3%.

Maybe even more important than that is the composition of our growth.

If you look at just client deposits, take out [canemens] and brokers, which you can get all you want any time you want to, you take out purchase acquisitions, third-to-third, we're up 10.1%, annualized link 12.3%, year-to-date 8.6%.

So we've got some great momentum on our client deposit side.

That is not primarily driven by price.

We have been some -- we traditionally are probably low relative to the market on deposit rates.

We maybe move to market.

So we've been a little bit of price concessions, but they're still cheaper than national money market sources.

A lot of it's been the focus of our sales team based on the Gulf study we mentioned several times ago.

And -- that I think has produced better results.

The FDIC market share numbers for June 30 came out.

We maintained the leading market share in West Virginia.

And something we were very pleased with, we gained market share in every state, every other state we operate in, which we were real excited about. [ASA] quality which is obviously a biggie and an issue we're all focusing on, we were pleased with the results.

Our nonperformers went up from 319 million in the second quarter of the 331 million at the end of third quarter.

And ticked up slightly from 0.27 to 0.28 as a percentage of assets.

However, in dollars, the total increase in nonperformance was driven by the first citizens acquisition where we added 5.3 million in nonperformers and what I call the second wave of the main street acquisition, where post acquisition we identified some problems.

If you take out first citizens and main street, BB&T's nonperformers were essentially flat, and percentage wise actually would have been down a little bit.

So our core portfolio has not shown any deterioration so far.

Charge-offs were 0.27 in the third quarter.

Up from 0.23 in the second, but down from 0.30 in the third quarter.

And there is some seasonality there.

And charge-offs excluding specialized lending businesses were 0.14, compared to 0.19 last year.

Year-to-date total charge-offs, 0.25 compared to 0.28 last year in taking out specialized lending, 0.13 compared to 0.17 last year.

So we're still getting great credit quality numbers.

We think we provisioned appropriately, obviously.

Our provision was $7.6 million more than our charge-offs in the quarter.

And year-to-date has been -- we've provisioned 19.9 million more than charge-offs.

Our coverage remained very strong at the end of the quarter with 3.59, and we counted to the allowance to nonaccrual loans was 3.59.

And that's pretty much where we've -- we've been for a while.

So very, very excellent coverage.

In the reserve at the end of the quarter was 108 compared to 108 at the end of the second quarter and 111 at the end of the third quarter last year.

So in really good shape.

We are not seeing a material deterioration in credit quality.

Obviously if the [FED] pushes the economy into recession, then we'll have more problems.

The CRE, as I've mentioned earlier, we're having less activity.

We are having some problems, but frankly right now, we're not having material problems in CRE.

The numbers still look better than our C&I portfolio.

As we tend to be involved with people been in the business a long time that have done very well for the last several years, and obviously we might have more problems but we're not today, knock on wood.

We're not today seeing any material problems in CRE.

We do not expect nonperformers to increase materially in the fourth quarter.

And obviously we could have a negative surprise, in--as big as we are, things happen.

But we don't really see that right now.

We will have a higher level of charge-offs in the fourth quarter, and we've always done that.

For a long, long time.

We have some seasonality in our specialty finance and in our retail businesses that we've had for a long period of time.

But they shouldn't be different than the kind of increases we've traditionally had.

And right now as I said, we don't see any big increase in nonperformers unless something happens that we don't expect.

Also, I think it's always healthy to look at the long-term trends.

We kind of look at ourselves from our merger of equals we did in 1995, a little over 11 years ago now.

And the compound annual growth rate in earnings per share on the cash basis, as originally reported over that 11-year period is 10.1%, which remains very good.

Let me change the subject a little bit now and talk a little about mergers and acquisitions.

The Main Street acquisition, the $2.5 billion bank we acquired in Atlanta we did convert in August, the conversion went very well with very limited problems.

We've had excellent client retention.

We've lost some people, which you always do, mostly on the commercial side.

But overall, client retention had been very good.

They did have a national CD portfolio that we are running off and funding locally.

But overall the Main Street acquisition is going well.

We also closed our acquisition of First Citizens at $700 million bank in Cleveland, Tennessee in August.

We'll be converting First Citizens in November.

We've had excellent retention in both loan and deposit clients.

We have lost some people, which you do, in the merger process.

But overall, I think that merger is going very well.

In terms of other bank acquisitions, frankly we're just kind of amazed at what's going on.

We keep looking at the numbers, and there's some companies we certainly would have loved to maybe do something with.

But we simply can't make the pricing work in our models.

It just doesn't work.

And we've used the same model for a long period of time, and -- and we -- it don't make economic sense at the prices that are being paid to our shareholders.

And we're just not going to -- we might make a bad acquisition, but we aren't going to consciously make one, we're not going to do one that doesn't work from an economic perspective based on our traditional model.

So I don't know how many if any community bank acquisitions we'll do for a while until the -- the pricing gets more rational.

We continue to look for nonbank acquisitions.

We were very pleased with our announcement of our acquisition of AFCO-CAFO, which will take us to number two in the US and number one in Canada in the insurance premium finance business.

A clear, great bit with our insurance operations, and we can also send them some revenue out of our insurance business.

We continue to look for other nonbank acquisitions in the insurance asset management consumer finance, as we have been.

Let me now make a few comments about our strategic focal areas.

Particularly in light of the fact that over the years we've done a lot of mergers and acquisitions that aren't likely to do bank acquisitions of any magnitude in the near future, at least that's not something we see today.

We are very focused on organic growth.

Specifically on deposit growth.

We talked to you some time ago about the consulting study we had done by Galt that showed the real economic profitability in the driver of relationships was on the deposit side.

And we've had a great success and refocus in there, 115,000 net new house-- net new accounts, transaction accounts, the first nine months of this year, gain in market share at every state except West Virginia, where we had the number one market share.

We think we're continuing to accomplish that with a -- with our sales system that we've had for a long period of time, to be pass along our integrated relationship management strategy.

We continue to make more investments in distribution, primarily focused in growth markets, specifically Florida.

We started 50 location -- new branches, DeNovo branches last year.

We'll do-- start about 60 this year.

Next year, probably 50 or 60 in the same category.

We've been adding sales staff, that's one of the reason the expenses have gone up.

We've increased our advertising, another reason the expenses have gone up.

We're also strategically, again, based on this -- this consulting study beginning to try to refocus more on the corporate market.

Where traditionally BB&T has been a middle market, a small business retail organization because of our size and the fact that we've developed far more sophisticated treasury capital markets, etcetera, services over the years.

We think there's an opportunity for us in the corporate market.

Not really driven from the credit perspective which is basically a -- an economic profit destroyer, but driven from the treasury services and the asset management and -- and other capital market services.

And we think we have a -- the opportunity to go after some of that business as headquartered in our market area.

And we've had-- we know a lot of those companies and have had relationships with a lot of the people.

And we think that's an opportunity for us.

And hopefully we'll get that more aggressive effort in that area beginning next year.

We also continued to focus on service quality delivery.

We call the perfect client experienced.

We are a quality differentiated competitor.

That's really been our goal.

It's very interesting to me, frankly I've been reading some studies in newspapers, and other studies about client satisfaction.

And I wonder how statistically sound those studies are.

For probably 20 years, we have used outside research firms very objectively for our own information purposes to try to figure out where we were on the quality spectrum versus our major competitors.

We changed firms periodically frankly to be sure we keep it objective.

We just got back both our retail and commercial studies, and we continue to be based on what I think are scientifically sound studies versus some of the other studies that I would say you ought to look at the statistics in them.

We continue to be number one in service quality, in terms of our major competitors across our footprint.

Objectively the gap has closed.

We've actually gotten better in service quality, but some of our bigger competitors have gotten better faster.

And we're getting to the limits, in terms of our numbers are so good, I don't know how much higher you can drive them.

But we are still better.

We are particularly pleased with what we call the top box scores.

That's where on the scale of one to 10 somebody rates you a nine or 10.

And we continue to be way far ahead of many of our competitors in the top box scores.

And when somebody rates you a nine or 10, they're loyal and they're willing to recommend their friends.

And that continues to be a competitive advantage for us.

We did take a little bit of the pressure off of cost this year in order to drive revenue, as I described earlier.

As we head toward 2007, we're going to put some more pressure on costs while we continue the pressure on revenue.

With the part of that structurally, we are trying to take an objective look at the issue of doing some international outsourcing.

In fact, we've been experimenting.

We did the first -- we did the Main Street conversion using an Indian outsourcing firm.

We didn't lay off any of our people.

We would have had to add staff to do it.

So we -- instead of that, we're using an Indian outsourcing firm, and it was done extraordinarily well.

In fact, better than we've done them in the past frankly from a systems perspective.

And we did it for 40% less.

I don't think you'll hear anything dramatic from us, I don't -- in terms of international outsourcing.

But we will be looking at ways where we have opportunities like that to use international outsourcing.

And I think in a number of cases, can get anywhere from 20 to 40% cost savings.

We're also looking at our call centers.

We-- by our service quality numbers, we have some of the best call centers in the industry.

But they're not necessarily the most efficient ones.

We're looking at how we integrate our call center together and get some cost savings out of that.

Another thing which is kind of an industry phenomenon but maybe peculiar a little bit to us is how to use our teller line more productively.

We tend to have more, smaller locations where it's difficult to -- you have to have a certain minimum staff in those locations, particularly given our -- our rural histories and mid sized markets we're in.

Very interesting transitional thing is happening.

We're seeing more of our clients not coming to branches much, using debit cards.

And now, something I think is pretty major, where we are leading from a technology perspective, is the fact that our commercial clients can capture items at their own business site instead of coming and bringing the checks into the bank.

And that's going to change the activity in a number of our branches.

The interesting flip of that is our studies still show that from a huge percentage of our clients, the relationship with our tellers is very critical.

And we have to have then there and have good ones there and low turnover to be a quality-differentiated competitor.

So we're looking at how we take some of the activities, that we've centralized, and actually, literally put them back in the branch in order to fill in the time where the teller may be really busy at lunchtime but not so busy on Tuesday morning at 10:00.

And when I joined BB&T and this was true in the industry, back in 1971, everything was done in the branch.

And we need to figure out how to keep the productivity and having higher quality tellers.

So we're going to look at some improving our costs from a more of a structural perspective.

Let me make a few comments on the future results within the context of our third quarter performance.

I would reinforce that everything that -- that Tamera said about the truth-- the future is true, and that anything I say about the future might be wrong.

Frankly, this last quarter, we were certainly surprised with the speed with which CRE slowed down and of course this legal charge we're surprised, too.

So when we talk about the future, we obviously could be wrong, I could be wrong.

We were disappointed to some degree with the second quarter bottom line results due to a combination of negative factors.

Obviously the one-time legal charge, the more fundamentally we are struggling with the inverted yield curve and slowing in the CRE lending area, our challenges for us.

On the other hand, even though the bottom line was disappointing, I thought there were a lot of really good news in our numbers.

We've got very healthy deposit growth or moving deposit market share across our whole footprint.

And we've been gaining that by adding new clients.

And while we've been a little more price competitive, we're still no higher in the market -- we're not buying-- just buying relationships, we're creating relationships by focusing our sales system on deposits.

If you look, excluding the slowdown in CRE, our loan growth is pretty healthy.

Our specialized lending businesses are doing well, sales finance did well, retail's doing pretty well.

So pretty healthy nonCRE lending growth, and the opportunity, I think to drive faster growth rate in the commercial industrial segment.

Our credit quality remains very good.

For the immediate future we do not anticipate a significant increase in nonperformers, although quality's not going to get any better than this, it's probably-- given the economic environments.

Our statistically sound studies continue to indicate that we've got a client satisfaction advantage versus our primary competitors.

Several of our fee-based businesses, and particularly insurance, which is our largest fee-based business, continue to have pretty strong growth.

So we expect to have solid earnings going forward, although an invert in the yield curve is a very challenging environment for the whole industry.

With that said, now let me turn it over to Chris to give you some more in-depth analysis in some pretty critical areas.

Chris?

Thanks, John.

And good morning to everybody, as well.

I'd like to welcome each of you to the call.

As is customary I'm just going to speak briefly about net interest income, net interest margin, noninterest expenses, taxes and capital.

First looking at net interest income based on operating earnings, and I think John characterized it well.

It's a tough environment to generate net interest income given the yield curve.

But looking at link quarter, we generated $960 million in net interest income, down 0.1% annualized decrease over link quarter, adjusted for purchase acquisitions.

Reported by earning asset growth of 7.6%, adjusted for purchases.

Look at common quarter, also 960 million in net interest income, up 0.3% increase over the prior year quarter adjusted for purchases.

Supported by solid earning asset growth of 7%, adjusted for purchase accounting.

Year-to-date basis, we've generated 2.818 billion in net interest income up 2.7% over prior year adjusted for purchases, and supported by very healthy earning asset growth of 8% after purchases.

So obviously good earning asset growth challenges with the margin in the rate environment.

Looking at the margin based on operating earning, we're obviously as John pointed out still experiencing compression.

Link quarter we were down, margin was down 8 basis points.

Second quarter to third.

And common quarter we were down 20 basis points, 388 in third quarter of '05 to 368 third of '06.

Year-to-date, we were down 17 basis points, 375 in '05 down to 392 in 2006.

Just a few comments on kind of where we are with the margin.

During the third quarter our sensitivity moved from neutral to liability sensitive as we really believe that that is at the end of the tightening cycle.

Unless obviously there are more inflationary pressures than we've anticipated.

But our primary issue in the third quarter and -- and I think to some extent going forward is just a difficult interest rate environment caused by the inverted yield curve.

We experienced some increased level of loan pricing pressure, and rising liability costs associated with, in part, short-- increased short-term interest rates and a continued migration of existing clients from lower cost deposit products into higher cost deposit products.

Retail, we're experiencing really a pretty significant shift into CDs as the CD promotions kind of normalize in the 5 and 5.25 range.

Also, consumers look to equities for investment opportunities, as well.

Commercial as the economy potentially slows a little bit, they tend to use the cash on -- on balance sheet.

So we're experiencing more pressure in noninterest-bearing accounts as -- as they're using the cash, and also [opting] to take advantage of about a 200 basis point spread advantage by sweeping excess cash out of the checking accounts into the overnight investment opportunities.

We continue to focus on organic deposit growth.

This is very good stories, John alluded to.

We once again funded our loan growth with client deposits on a link quarter basis, if you look at average balances.

Decreased our dependence on short-term borrowed funds on average.

And that's worth about 100 basis points to be able to fund it internally as opposed to using borrowed funds.

So I think in summary we continue to experience a shift in overall mix with a deposit base toward high cost deposits.

The inverted yield curve continues to negatively impact loan and investment spreads.

We have seen some mix in the loan portfolios John pointed out from CRE to C&I, but really haven't seen huge impact to margin [inaudible] at this point.

Probably be more of a future sort of issue.

Looking at yields and rates, we continue to experience spread compression, and you can see that if you examine the link quarter.

You see total earning assets were up 22 basis points with interest earning liabilities total were up 30.

So generated 8 basis points of spread pressure, and the majority of that's being driven by the other interest-bearing deposits which were up 36 basis points in client CDs that were up 33.

Common quarter comparison, total earning assets were up 87 basis points while total interest bearing liabilities up 120.

Again you can see 33 basis points of spread pressure of the same categories.

Other interest-bearing deposits left 189 basis points, while CDs increased 129.

You look at our forecast for the fourth quarter 2006, [Alcoa] model projects the margin to be in the mid to low 360's, and for 2007 based on the most likely scenario, that the Fed will begin reducing rates sometime next year.

The margin should remain we think relatively flat during the first half of '07 and begin to show some improvement during the second half of the year.

The model assumes a 25 basis point reduction in Fed funds rate in May, with a flat to slightly inverted yield curve thereafter.

John commented on expenses, and I would agree if you look at our noninterest expenses initially it would appear that we experienced higher than normal, noninterest expense growth.

However, if you look at link quarter adjusted for purchases, if you -- our core expense growth in link quarter is really a more normalized 6% if you exclude the $15 million charge, the one-time charge that Johnny shared with you.

And I'll, I'll have more detail on link quarter comparison in just a minute.

Did want to comment on our cost savings and revenue enhancement initiatives.

As a reminder, we had achieved 75 million in savings and revenue enhancements as the plan-- plan to achieve additional 100 million in-- by early 2007.

And we are on target to do that.

We've achieved 48 million through nine month of 2006, bringing our total savings since we started this process to $128 million, September 30.

Third quarter, produced about $17 million in savings revenue enhancements.

And most of that was really just becoming much more effective in the vendor management across several broad areas.

That continues to be a real win for us.

And as previously mentioned, the savings are partially offset by increased regulatory legal, the marketing expense John referred to and some consulting costs, as well as investments for the future.

Again, the primary ones there, DeNovo branching, capital markets [inaudible], like the one John mentioned, and additional sales staff, all which was part of the purpose and consistent with our plan.

If you look down a bit, noninterest expense growth rates, operating earning, looking at year-to-date, we were up 8.4%, increase over prior year quarter adjusted for purchases.

If you exclude the 15 million year-to-date is-- falls to 7.8%.

If by-- look at common quarter comparison we were up 9.2% increase over prior year adjusted for purchases, and it falls to 7.4% excluding the $15 million charge.

On a link quarter basis, showed up 12.8% annualized, increase over link quarter adjusted for purchases, but really falls to 6%.

More normalized kind of rate, excluding the $15 million charge.

Well below both the year-to-date, and the common quarter comparisons that we just commented on.

If you kind of look in detail at that link quarter number, the 12.8% equates to about $28 million after purchases, and if you back out the $15 million charge, you've got about 13 million left.

And it really is a function of the increased salaries relative to higher new FDs from sales staff and some of the new programs John had mentioned, as well as the investment incentives and incentives for Laureate Capital, our commercial mortgage broker.

And just a small operating charge-off, less than $1 million.

And that really is the detail behind us.

It's really nothing new.

It's the same -- same focus as it has been the past quarters that we've talked about.

Primarily salaries related to new hires, and incentives, trying to drive the growth initiatives.

Also wanted just to give you an update on our expense savings progress with Main Street, especially since we just, as you know acquired them June 1 and then converted the middle of September.

As a reminder, we had targeted savings of 24.6 million.

Year-to-date we have achieved 4 million in savings, conversion just occurred this past month.

And we estimate about 5 million in the fourth quarter, and then moving more to about a 6 million per quarter run rate in 2007.

In terms of targeting expense growth for 2007, our preliminary target for next year would be in the 4.5% range.

I'll share that with you, as well.

Moving to taxes, I want to comment on the effective tax rate and what to expect going forward.

Our effective tax rate did decrease from second-to-third from 34.07% to 32.94% in the third.

And going forward we would expect effective tax rate to be in the 33 to 33.5% range for the fourth quarter of '06.

And the 33 to 34% range for the full year, 2007.

To hit on capital I wanted to make you aware of a change that we made to our capital policy during the past quarter.

As you know, our primary capital target has been to maintain leverage capital at 7%.

We've used that target as our primary criteria for share repurchases.

Going forward we're adding a minimum guideline for tangible equity, as well, which would be to maintain the tangible equity ratio of 5.5%.

And as in the past those targets would be used as criteria to trigger share repurchases.

We had done some trust preferred issues back in August and then in a second [branch] in June.

And our tangible got a little below where we wanted it to be and felt appropriate to more formalize that target going forward.

Overall, we continue to maintain a strong capital position.

Our equity to total assets that end the period was 9.9%.

Risk-based capital in the period on tier-one basis of 9.2%.

Total risk-based capital it appeared 14.6.

Leverage capital bumped up to 7.24%.

And tangible equity in the period was 568.

As for share repurchases on a year-to-date basis we've repurchased 22.3 million shares at an average cost of $41.69 a share.

And there were no shares repurchased during the third quarter.

As for future buybacks, we're going to continue to monitor our capital position given the equity adjustments required as result of the new pension accounting at the end of the year, as well as the tax accounting as [we send] first of the year 1048 and FAS 13-2.

Finally reminder our fourth quarter dividend, expected to be $0.42, which represents a 10.5% increase over the prior-year quarter.

That concludes my comments.

Thank you, Chris.

Before we move to the question-and-answer segment of this conference call, I'll ask that we use the same process as we have in the past to give fair access to all participants.

Please limit your questions to one primary inquiry and one follow up.

Then if you have further questions, please re-enter the queue so that others may have an opportunity to participate.

Now I'll ask Joe to come back on the line and explain how to submit your questions.

Thank you. [OPERATOR INSTRUCTIONS] Our first question is from Gary Townsend with Friedman, Billings, Ramsey.

Please proceed with your question.

Good morning, John and -- and Chris.

Good morning, Gary.

Hi, Gary.

I guess one thing you've talked a lot about your initiatives on the cost save side.

What could be done to -- or it seems as though relatively little has actually fallen to the bottom line or has gone into new -- new initiatives, which are obviously valuable, too.

But as you look into the latter part of the year in 2007, is there much likelihood for positive operating leverage and -- and just generally some of that cost save initiative falling to the bottom line?

That's a good question, Gary.

If you look at some of the type of investments that we've made, they do have-- it takes a while for them to pay back.

For years we were mostly in the branch consolidation business out of mergers, that worked very well in terms of cost saves.

But we were also losing some clients.

We kept closing branches down.

We changed that strategy a couple of years ago.

And particularly trying to fill in in markets that we had opened through merger, but we didn't have a good distribution system like Jacksonville, Florida, and Atlanta and places like that.

And so we've been doing fill-in very carefully focused DeNovo branches.

Well even when they do the best they do, they usually lose money for a year to maybe two years before they become profitable.

So you get some drag.

In fact, I think this year the drag from the new DeNovos is about $25 million.

That will go -- if they continue to do as well as they are doing, and the vast majority of our DeNovos are actually beating expectations, those will become positive sometime during the next half of next year, but we'll be adding new ones on top of that that will be diluted for a while.

So some of our investments do have a delusion for a couple of years.

We're following that very carefully.

When you add new sales people and this is-- when your supporting our integrated relationship management strategy, and again, let's take Jacksonville.

Then you need some asset management people, you need some investment salespeople.

You need maybe somebody from Laureate Capital, our commercial factoring-- commercial mortgage business.

Well typically those sales people, even if you get really good ones, and you're going to miss some, it takes nine months, a year, before they start paying for themselves.

I mentioned one reason our other income is up, we've been making some pretty big investments in our capital markets business.

And certain specialized areas where we've gone out and hired some teams that we think will make a pretty big profit contribution, but initially, you have to pay all their salaries and get all the systems in, etcetera.

So I think net-net by the second half of 2007, these pay back-- we'll be getting paybacks from the investments even though we're making new investments.

I think this early going from the merger activity to an organic growth activity, you get more of a negative.

And then going forward, it's going to turn into a positive.

And long term it turns into a pretty major positive based on the economic projections.

And I'll add even to, Gary, your point, is there any item out there that gives you an opportunity to create some additional [sale]-- I think John alluded to one, an outsourcing, that we're really taking a hard look at to see how the application would work in our business.

And have our -- had our toe in the water for the last 12 to 18 months in that.

Okay, thank you.

Sure.

The next question is from Tony Davis with Ryan Beck.

Please state your question.

Good morning, John, Chris.

Good morning.

Wondered if you could just give us some sense of-- if there has been any letup in the war of core deposits and loans since the August/September period, and -- and related to that, if you're seeing any variability in the pitch of competition by geography or size of competitor?

That's an interesting question.

I would say there has been no letup both on the deposit and the loan side except interestingly enough with exceptions.

I think that the community banks are a little less competitive, and the bigger banks are a little more competitive.

I think the community banks are getting a pretty tough beating in some cases on their spread.

They don't have the fee income businesses to pay for them.

Now that's not universal.

But I would say it's a very price competitive market.

Here's the -- [inaudible] you face.

If you have somebody on the variable price and they can get a lower fixed rate it's easy for a new competitor to come in and offer a lower fixed rate.

And so that's really creating a lot of commotion in the market.

It's not just intensity of the competition, it's the quirkiness of the yield curve that -- and we're -- we're -- our commercial mortgage business is doing phenomenally well, but it's hurting our regular commercial real estate lending business because all of our -- our shopping centers and everything are going long because long-term rates are under short-term rates.

So these people that might have played the spread for a while.

If the short-term rates were below the long-term rates, they're going long immediately.

And so you're not -- you don't just have bank competition, you've got a quirky kind of capital market situation that's creating extra -- and I would say that the yield curve by itself is more driving that than necessarily the capital markets participants have come up with some greater idea.

They're just willing to go long, at low rates, when banks try not to do that.

And that I think is a big factor that's impacting the whole competitive landscape.

Okay.

Thanks.

The next question is from Nancy Bush with NAB Research.

Please proceed with your question.

Good morning, John.

Hi, Nancy.

Just a question about your new capital or your new focus on tangible capital.

Can you give us just a little bit more of the background of why you've decided to focus on this, and 5.5% for a company with sort of your risk profile and the availability of deposits, etcetera, still seems like it's a pretty, pretty stringent.

If you could just give us a little color on that decision making process.

That's a good question, Nancy.

Traditionally we focused on leverage capital because we didn't do material amount of trust before.

We just basically had pure capital.

As Chris mentioned we started doing some trust preferred offerings.

And that started changing our tangible equity to asset ratio, but not our leveraged capital, because those count in your leverage capital computations.

We've always tried to be conservative in our capital position.

Every time we burn models, and I certainly won't say our models are perfect.

We do have quote excess capital, but we kind of like that.

And so we just wanted to continue what I think is a long-term conservative trend and maintain a strong -- a strong capital position.

Is there something about the 5.5% that's sort of debt rating related that you, that you want to keep it at that level?

It was more our decision -- I would assume that the rating agencies and bond investors will like it, but I don't think we had any -- any indication from them about that, the specific number or about the issue that I know of.

Chris, do you--?

It was not, it was historically we've been closer to 6, and we did the two offerings that took us down a little below the 5.5.

And that's where our comfort was.

Okay.

Chris, could you also just run through those numbers again on where you stand with regard to the cost saving program.

I'm afraid I got my numbers a little messed up.

Sure, happy to.

We started with a target of 175, and during the year '05, we actually achieved 75 million of that.

And then year-to-date '06 we have achieved 48.

So that puts us at a total of 128.

And this is to be completed by year end '07?

No, actually earlier -- by the first half of '07.

Great.

Thank you.

You're welcome.

Thank you, Nancy.

Your next question is from Chris Marinac with FIG Partners.

Hey, John, good morning.

Hi, Chris.

Wanted to ask about I guess employee retention at the acquisitions, whether you use the Main Straight and First Citizen as two recent examples or just in general.

Are you satisfied with the staff you're able to retain as you integrate the deals?

Chris, that's an interesting issue.

At Main Street, we have done great on the retail side, not so well on the commercial side.

We expected that.

We knew -- for example Main Street hired a lot of our people from us.

And we knew that a lot of the people they had hired in recent years were people that had come out of other banks and in today's world when you buy community banks, and particularly in a market like Atlanta, where there are a lot of community banks, there's kind of a group of people that float from one community bank to another hoping the bank they go to get bought so they can get some options and things like that.

And so we've had--we've lost some people on the commercial side.

We've done very well though on the client retention side and we've done pretty well on the retention of the retail staff.

I would say our loss of staffing in -- in Main Street is pretty much being kind of as we expected it.

And because we've really got a strong, talented team now in that marketplace, I -- it's not a -- it's not a material issue for us.

I still think we'll both probably beat the cost save goals and meet the revenue goals we had in Main Street.

Same thing-- a little bit of the same story in First Citizens.

We've lost some people on the commercial side but we've had great retention on the retail side that business.

I do think people doing community bank acquisition in today's world-- it used to be when we had employee meetings everybody was very, very worried about keeping their job.

Now they're -- they're trying to figure out where they go next.

And maybe that has made us more cautious in community bank acquisitions, frankly, and more cautious in running the revenue -- the early end revenue numbers.

And why we are not so happy -- or at least we are uncomfortable with some of the prices some of the people are paying because we think they're going to have more revenue attrition in small bank than they expect.

And I think it does--there is kind of a new world where people view themselves more as independent contractors, particularly on the commercial side of community banks.

Great, John.

That's helpful color.

Thank you.

Yes, sir.

Our next question is from David Pringle with [Sells Point].

Please state your question.

Good morning.

Sir?

If I-- I hope I can refrain from sounding obsequious in saying nice going on the deposit side.

Thank you.

If I look at your ending loan balance verses the average loans for the period, it looks like loan growth is slow a lot.

Is that correct?

We had an ironic thing, we had really strong loan growth right at the end of the quarter.

I think maybe you're picking up some numbers wrong.

But we had a lot -- we had a lot slower growth early in the quarter.

Well if I-- I'm looking at your average balances were 81 billion, and the ending loans were 82.

And if you go back, historically the -- the ending had been a lot higher than the average.

What happened is it dipped down in July and August, and early September which -- and then came back a little bit at the end of September.

Okay.

And then just a follow up--

And how much that means for the fourth quarter I don't know, I'm not-- but it actually did come back at the end of September.

Okay.

And then if I look at your call reports, they show that you have about -- at the end of the second quarter, had about $16 billion worth of construction loans.

And I was just wondering if you could give us a little bit of idea how much of that is commercial, how much of it is residential.

And what kind of growth rates you're looking in construction for the next couple of quarters, please?

The vast majority is residential construction.

We're a big residential construction lender.

We've actually in the third quarter had negative growth in a number of the residential construction categories.

I don't remember the exact numbers off the top of my -- my head.

Some of that being good in that our builder got more cautious, didn't start new houses, didn't get stuck with a bunch of inventory.

I don't know if I could put a percentage on it, but my own expectation is that the residential end will -- will be slow for at least another year.

I think that activity is -- the markets going to correct on that.

We still got -- it's interesting, it's very bifurcated in what I call traditional markets like the Riley's and Charlottes that haven't had the rapid price appreciation, where there's construction, it's still pretty good.

The places we're seeing much more slowdown in activities, metro D.C., the coast, where you've had, tremendous price appreciation and we're seeing a pretty significant slowdown in those markets.

So I got-- we've got partial mitigation of the slowdown in the growth markets because we're in a lot of places like Winston Salem, North Carolina, but if anything residential construction activity might actually pick up but pick up on-- it's not been very fast.

We haven't had that much appreciation in that market.

And we have a lot of those.

So I don't know if I could put a number on the growth rate, but it -- I think it's going to be pretty moderate, in the low single-digits for at least a year.

And when you refer to the coast, what do you mean by that?

East -- North Carolina, South Carolina, Virginia, Georgia, Florida, we've got pretty strong operations particularly along the Carolinas and Virginia coast.

But also growth in Florida.

And do you know -- would you share with us how much you have in sort of Florida condo stuff?

Not much.

Not much.

We are not a big condo lender.

We have a few condo projects, but we have -- we are scared of the Florida -- we have been scared of the condo market.

Now we -- we have a few projects, but we're not -- we're not even anywhere are we a big condo lender.

And I would say of the markets we're the most skittish of would be condos.

And I have one or two for the residential acquisition development and construction, sort of that whole combination, we're at about 7.5 to 8 billion of the total 16 that you mentioned, David.

Right.

And how much of that is land acquisition and development?

Land residential would be up 2 billion, development about 2 billion.

And what are you seeing the trends in the commercial construction market which really died in 2000, and I hear it's starting to come back a little bit?

It's still slow.

It's getting better, but it's still slow.

And also from a bank lending perspective it's become tougher because commercial projects are going to long market much faster.

Not seeing the three-year mini [perms] and trying to carry on the short term interest, and you also see more long-term lenders willing to take projects without full rental rates, where they used to be in the market on commercial projects you had to get full rental before you could take it long.

Sure.

Now a number of the long-term lenders are taking -- are willing to take it -- they usually don't do the construction.

But once you get it built even if you haven't got it leased up they'll take it.

So there's a pick-- more pickup in activity than there is pickup in bank funding because of the shift in the long-term market, and that's really accentuated by the negative yield curve.

And does that include the CMBS market, taken -- or is that just sort of insurance companies and other, the usual suspects?

Yes.

It's more insurance company, but it's CMBS would be doing it, too.

The hedge funds that are in the CMBS market.

Okay.

But I'd say they're all buying deeper.

That as they're taking more risk, they're taking a lot of risk now, but are taking more risk, yes.

Thank you.

David you also mentioned condo.

I don't have a number for Florida, but we-- our total condo exposure is less than 750 million total footprint.

Thank you very much.

Our next question is from [Michael O'Ryan] with Sun Life Investments.

Please state your question.

Good afternoon, gentlemen.

Just a quick question.

I know you guys touched on this probably indirectly in regards to the efficiency ratio with cost.

I'm assuming the -- the prime driver of why there was such a -- an uptick in that from quarter-to-quarter, it was because of the legal charge.

And also just your expansion efforts and hiring new staff and things of that nature.

So I would assume that that's probably going to go down in the coming quarters.

Is that right?

That's a valid assumption.

But remember the other thing in the efficiency ratio is the net interest income is not growing because of the margin.

Right.

Right.

If you looked at -- if you could -- if you could hold the margin flat you would not have had anywhere near significant deterioration in the efficiency ratio.

But it should improve because specifically because of the legal charge, which hopefully we won't ever have again.

Right.

But it -- it is being -- if you look at the long-term trend, one of the biggest factors has been lack of net interest income.

Right.

Okay, I'm assuming the legal -- I know you can't talk about the legal issue, but I mean, can you say if that's been settled at all or, can you even say?

I can't really say anything about it.

Okay.

Fair enough.

All right, thank you.

Yes, sir.

[OPERATOR INSTRUCTIONS] The next question is from Gary Tenner with SunTrust.

Please state your question.

This is actually [Lauren Thompson].

Gary had to step off the line.

Good morning.

Morning.

My first question, on the NPA increase, looks like about 6 million of that is from NSBK.

And just was wondering, you said these were found post closed so these weren't in addition to the known, nonperforming portfolio?

That's correct.

Any thoughts on any additional ones, if it was related to the "Rogue lender" they had?

I think we've-- you always get surprises, but I think we've had long enough to identify any problems.

That's why I think we're -- I certainly don't see any material increase from -- from here out of the Main Street portfolio.

Okay.

And what type of loans were those?

All commercial real estate.

Okay.

Secondly, you said in terms of the [expense reduction], you said 4.5% for 2007?

That would be our preliminary target now.

We're just at the beginning of the budget process.

And that's total year over total year?

Right.

Okay.

All right.

Thank you.

Thank you.

I'm showing no further questions in queue at this time.

All right.

Thank you for all those questions.

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Ladies and gentlemen, this does conclude today's teleconference.