Oct 21, 2009
Executives
Henry L. Meyer III - Chairman of the Board, President, Chief Executive Officer Jeffrey B.
Weeden - Chief Financial Officer, Senior Executive Vice President Beth E. Mooney - Vice Chairman Peter D.
Hancock - Vice Chairman Charles S. Hyle - Executive Vice President, Chief Risk Officer Joseph M.
Vayda - Executive Vice President and Treasurer
Analysts
Craig Siegenthaler – Credit Suisse Brian Foran - Goldman Sachs Todd Hagerman - Collins Stewart Anand Krishnan - Fore Research & Management Paul Miller - FBR Capital Markets David George - Robert W. Baird Gerard Cassidy - RBC Capital Aaron Foley - Bank of America-Merrill Lynch Mike Holton - The Boston Company Matthew Burnell - Wells Fargo Bob Patten - Morgan Keegan
Operator
Good morning and welcome to KeyCorp's 2009 third quarter earnings results conference call. This call is being recorded.
At this time I would like to turn the call over to the Chairman and Chief Executive Officer, Mr. Henry Meyer.
Mr. Meyer, please go ahead, sir.
Henry L. Meyer III
Thank you, operator. Good morning and welcome to KeyCorp's third quarter 2009 earnings conference call.
Joining me in today's presentation is our CFO Jeff Weeden, and available for the Q&A portion of our call, our Vice Chairs Beth Mooney and Peter Hancock, Chief Risk Officer Chuck Hyle, and our Treasurer Joe Vayda. Slide two is our forward looking disclosure statement.
It covers our presentation materials and comments, as well as the question and answer segment of our call today. Now if you turn to slide three, today we announced a net loss from continuing operations attributable to key commons shareholders of $422 million of $0.50 per common share.
While our results continue to be impacted by the difficult operating environment we believe the aggressive actions we've taken to address credit quality, strengthen capital and liquidity, and reshape our business mix, position us to meet the challenges posed by the current environment and to emerge as a more competitive company as the economy rebounds. We are encouraged that the pace of deterioration in the economy appears to have slowed, however, we remain conservative on our outlook and expect conditions to remain challenging into next year.
One of our primary areas of focus has been on building and maintaining a strong balance sheet. In August we completed a series of capital raises and exchanges that in total have generated approximately $2.4 billion of new Tier 1 common equity.
At September 30th, 2009, our Tier 1 common equity ratio was a strong 7.63%, and our Tier 1 risk based capital ratio was also a strong 12.61%. During the third quarter we continue to build our loan loss reserve by taking a $733 million loan loss provision which exceeded our net charge-offs by $146 million.
At the end of the quarter, our allowance for loan losses was $2.5 billion and represent 4% of total loans. We have strengthened our liquidity and funding positions over the past year by reducing our reliance on wholesale funding and increasing the portion of earning assets invested in highly liquid securities.
Average deposits were up 6% from the year ago period with growth in both community banking and the national banking group. Proactively addressing credit quality continues as one of our top priorities.
In the third quarter we saw an increase in nonperforming assets, but at as lower pace than in recent quarters, and most of that increase was attributable to the commercial real estate portfolio. In the third quarter we continue to take aggressive steps to reduce exposure to our commercial real estate and institutional portfolios through the sale of selected assets.
Jeff will discuss the actions taken in his remarks and comment on the marks taken on the various assets during the third quarter. While we continue to make progress on reducing exposures in targeted portfolios, we expect that credit quality trends will likely remain under pressure until we see meaningful improvement in the economy.
Another priority has been continuing to sharpen our focus on our relationship businesses by investing in those areas where we can be most competitive and exiting businesses that have not generated appropriate risk-adjusted returns. In community banking we have installed new technology to improve the client experience and we have continued our multiyear investment in our 14 state branch network.
We've opened 32 branches in eight markets in 2009 and will have completed approximately 160 branch renovations by the end of the year. These investments have further enhanced our competitive position and improved service quality.
As I mentioned before, Business Week recognized Key as the top rated bank, 11th overall, in its customer service champ survey for 2009. I'm also very pleased that last month KeyBank was awarded an outstanding rating for the Community Reinvestment Act for serving the needs of low and moderate income communities .
Key is the only national bank among the 50 larges to be rated outstanding by the OCC seven review periods in a row dating back to when the act was created in the mid-1970s. Executing on our relationship strategies has also required us to make some difficult decisions to exit certain businesses.
Earlier this month we announced that we were exiting the government guaranteed education lending business. This followed our earlier actions to exit private student lending.
Key will continue to serve the education segment by leveraging our strength and payment processing and liquidity management. In our equipment leasing business re have realigned our resources with our most profitable business segments and will cease conducting business in both the commercial vehicle and office equipment leasing markets.
And we continue to make progress on Key-Volution, which is our corporate-wide initiative designed to simplify internal processes and improve both client service and speed to market. Slide four shows the opportunity that Key-Volution represents over the next couple of years.
Initiatives that have already been implemented will result in an annualized cost savings run rate of $121 million with an additional $60 million in flight. There are approximately $76 million in onetime costs and investments including severance associated with these savings opportunities.
We have identified additional targeted Key-Volution benefits of $119-$194 million, which, along with other implemented or in flight initiatives, will produce total annualized run-rate cost savings of $300-$375 million with a significant portion captured over the next two years and the full run rate achieved in 2012. We continue to make progress on the initiatives that we have discussed last quarter around sales force realignment and call center consolidation.
Recent actions include strengthening our procurement organizations and leveraging the risk that has been done in the community bak to develop robust sales tools and disciplines that can be used throughout the company. In a procurement area, we are managing demand more effectively and improving our purchasing practices while building deeper more strategic relationships with our vendors.
Cost savings will be derived in partnership with vendors who can help us identify ways of conducting business more efficiently and effectively and provide pricing benefits available through scale. Key-Volution remains a critical component of our strategy to improve profitability by streamlining our processes to improve responsiveness and efficiency.
Now I'll turn the call over to Jeff Weeden for a review of our financial results.
Jeffrey B. Weeden
Thank you, Henry. Slide five provides a summary of the company's third quarter 2009 results from continued operations.
Unless otherwise noted, our comments today will be with regard to our continuing operations which exclude our educational lending activities which Henry commented on earlier. For the third quarter, the company incurred a net loss of $0.50 per common share.
Earnings continued to be impacted by elevated credit costs as we continue to work our way through the current credit cycle. I'll comment in a moment on the credit quality as we review our asset quality slides.
In addition, we incurred negative marks which impacted non-interest income and costs related to certain holdings tied to commercial real estate during the third quarter. Some of these marks relate to CMBS bonds held in our trading account and carried at market values of approximately 44% of face value.
The remaining carrying value is now down to $45 million. We also have investments with remaining carrying values of approximately $138 million in our Funds Management Group within the real estate capital line of business.
These investments which represent direct as well as our portion of funds which we co manage, are now carried at approximately 60% of our original investment. While not listed here as a significant item, we incurred an increase in other real estate owned expense in the third quarter as we sold or aggressively marked down our holdings in these areas.
And we incurred a non-cash charge of $45 million during the third quarter related to impairment of intangible assets other than goodwill within our equipment-finance line of business. This charge is a result of our recent decision to cease lending in certain equipment leasing markets.
Turning to slide six, for the third quarter of 2009, the company's taxable equivalent net interest income adjusted for early terminations of certain leverage lease financing arrangements was $613 million compared with $591 million in the previous quarter. The adjusted net interest margin was 2.87% for the third quarter, up 10 basis points from the second quarter of this year.
The company benefited from an improved funding mix and pricing on interest bearing liabilities during the third quarter. We expect this trend to continue into the fourth quarter as we expend additional maturities in our CD book and repricing to current market rates which will benefit the net interest margin.
Turning to slide seven, during the third quarter the company experienced a $3.9 billion decrease in average total loan balances compared to the second quarter of 2009, and a $7.7 billion decline compared to the third quarter of 2008. The decline in average balances reflects the soft demand for credit on the part of commercial customers due to the weak economic conditions and continuing pay-downs on our portfolios.
The trend we experienced appears to be consistent with FED data we reviewed which shows that consumers and businesses are continuing to deliver. We have also identified on this slide our exit portfolios which we have updated for certain leasing portfolios and the educational lending portfolio which was moved to discontinued operations.
Compared to the third quarter of 2008, the average balance of our exit portfolios, including discontinued operations, has declined $2.8 billion. Also, in the appendix of today's materials, we have included for your review, additional information with respect to the exit portfolios including net charge-offs and nonperforming loans by portfolio.
Turning to slide eight, average deposits were up $600 million from the second quarter and increased $5.7 billion from the same period one year ago. With respect to the individual deposit categories, we continued to see increases in DDA balances given the low rate environment and the safety these accounts offer commercial clients.
In addition, we began to see money shifting back into now and MMDA deposits as higher rate CDs originated in 2008 matured and current CD rates looked less attractive to clients. As mentioned earlier, expect to see this trend with CD balances coming down in coming quarters as repricing of this portfolio continues.
This should continue to benefit the net interest margin. Turning to slide nine, over the past four quarters the company's liquidity position has significantly improved.
As discussed on the prior two slides, the company has experienced a significant shift in its balance sheet with loans declining and deposits increasing. The company has used this increased liquidity to grow its investment portfolio and reduce its wholesale borrowings.
Over the past four quarters, the company's average balance in investment securities has increased from $8.9 billion to $17.4 billion and our borrowed funds position has declined by almost $9 billion. As can be seen on this slide, our average balance loan to deposit ratio improved to 103% during the third quarter of 2009 from 126% one year ago.
We have also included in this ratio, the loans from discontinued operations as we believe this is a more conservative way to view the ratio. Turning to slide 10, our nonperforming loans stood at $2.3 billion at September 30th, 2009, and our nonperforming assets were $2.8 billion.
Nonperforming loans were up $105 million from the second quarter and nonperforming assets increased $251 million. As shown in the summary of changes in nonperforming loans on page 28 of the earnings release today, the net inflow of nonperforming loan slowed when compared to the prior two quarters, and we receive more payments on NPLs in the third quarter than the first quarter and second quarters combined.
During the third quarter we continued to aggressively deal with our problem assets. At the end of the quarter we had $304 million of nonperforming loans in a held for sale category with many of these contracted for sale as of September 30th and subsequently closed during October.
Overall, nonperforming loans are carried at 76% of their original face value and nonperforming loans held for sale are being carried at 67% of original face. With respect to other real estate owned, we sold a number of properties during the third quarter and we took additional marks on the remaining portfolio.
At September 30, 2009 we are carrying other real estate owned and other nonperforming assets at approximately 52% of their original face values. Turning to slide 11, net charge-offs in the third quarter remained elevated at $587 million or 3.59% of average total loans, which was up from $502 million or 2.93% experienced in the second quarter of 2009.
While net charge-offs in almost all loan categories remained elevated the increase from the second quarter was largely due to continued weakness in the commercial real estate construction portfolio. We also continued to build reserves during the third quarter, however, at a slower pace than the prior several quarters.
At September 30th, 2009, our reserve balances stood at approximately $2.5 billion and represented 4.0% of total loans and 109% of nonperforming loans. Slide 12 is a snapshot of our commercial real estate portfolio at September 30th, 2009, with a comparison to the second quarter of this year.
We have additional information with respect to our commercial real estate portfolio located in the appendix of today's materials. As shown on this slide, our total outstanding balances declined in all categories of CRE during the third quarter compared to June 30, 2009, while we experienced an increase in nonperforming loans and net charge-offs compared to the second quarter.
As we have been commenting on for several quarters now, we continue to see negative migration within the retail properties category with nonperforming assets eclipsing 10% of outstanding balances as of September 30th, 2009. At the same time, we saw a decrease in nonperforming loans within the residential properties category and we have significantly reduced risk in this portfolio over the past two years as can be seen on the next slide.
Since the first quarter of 2008, we have reduced our residential properties exposure by over $2.1 billion or almost 60%, to $1.5 billion at September 30, 2009. Also shown on this slide are the reductions achieved in California and Florida exposures, to states which experienced significant downturns in the residential real estate market early in the cycle.
The shaded portions of the bars represent the nonperforming loans within the totals. And finally, turning to our capital ratios on slide 14, at September 30th, 2009 our tangible common equity to tangible asset ratio was 7.58%.
And as Henry commented on earlier in his remarks, our Tier 1 common equity ratio was 7.63% and our Tier 1 risk-based capital ratio was 12.61%. All of our capita ratios remain strong, and along with the company's improved liquidity, positions us well to continue to attack the current credit cycle dealing with the challenges ahead and being able to serve our client's needs in the future.
That concludes our remarks. Now I'll turn the call back over to the operator to provide instructions for the Q&A segment of our call.
Operator
(Operator's Instructions) And we go first with Craig Siegenthaler with Credit Suisse.
Craig Siegenthaler – Credit Suisse
Thanks and good morning. Just a few questions here, first on the nonperforming loan roll forward in the press release, page 28.
I am looking at the inflow of NPLs which only decline modestly which mean the NPL growth deceleration was really caused by an increase in payments and dispositions. How easy is the current run rate above $300 million to reoccur in the fourth quarter?
Because it actually picked up a lot sequentially.
Jeffrey B. Weeden
Well, certainly Chuck can comment on this too, but I think we've seen improved liquidity in the market that started in the second quarter and really continued into the third quarter. It remains to be seen, obviously, how that liquidity continues on with all the rest of the assets that are obviously out there from other institutions as well as the FDIC, but we remain positive that liquidity will be there.
It's a question obviously then of price and we have been moving forward to seal a number of these loans, as well as working with our clients, and some of course of what's coming in on payment share payments from clients that also occurred during the current quarter. As to whether that remains, we've got to see kind of how the economy continues to progress here and while we're very, very cautious on it, the tone is better, but it's not what we would call back to a normal at this point in time.
Charles S. Hyle
I think Jeff has covered it well that the tone has definitely improved quarter over quarter and we're seeing it really in a slightly wider range of assets as well, both straight in loan sales as well as OREO sales. So, not a great torrent, but certainly an improved flow over the last quarter.
Craig Siegenthaler – Credit Suisse
And then just actually looking at your CF&A segment, really your C&I segment, I'm wondering what drove the pickup in the NPLs in the second quarter, and then this level continued to be really flat in the third quarter — I was wondering if there was several large loans in the second quarter balance? And if you look at it on a Y-9C filing basis, the growth rate was actually higher in the second quarter than I think you guys report here.
So I'm wondering if there's anything kind of unusual in that second quarter results which could have came out?
Jeffrey B. Weeden
Well, part of what you would see in the CF&A total, and I think if you're looking at the FRY-9, also looking at the equipment, what's classified here as commercial lease financing. That may be also driving part of what you're looking at there, so it's broken out as a separate line item here.
Henry L. Meyer III
I think the other comment I would make is that there were a couple of names on the institutional side that we referenced in the second quarter, several around the media space, and one or two other areas — pretty isolated, but that drove part of the second quarter. And the third quarter number, we took advantage of liquidity in the corporate loan market and sold probably about $160 plus million out of the corporate portfolio that were either NPL or heading towards NPL and we took the opportunity to clean those up probably at a weighted average price north of $0.85 on the dollar.
Craig Siegenthaler – Credit Suisse
Great. Thanks for taking my questions.
Operator
And our next question comes from Brian Foran with Goldman Sachs.
Brian Foran - Goldman Sachs
Good morning. As we think about pre-provision outlook, and I'm sorry if I missed any of this in the beginning, but you can just touch on three line items which would be whether this OREO expense is kind of a new run-rate of artificially elevated?
The trust and investment services line item, why was that down, and should we expect it to go further down or grow going forward? And then third, what should we look forward to make investment banking and cap markets turn back into a positive revenue contributor.
Is it commercial real estate prices, or what needs to happen to kind of stabilize those losses?
Jeffrey B. Weeden
Okay. Well, with respect to ORE expenses, we were very aggressive here in the third quarter.
We went through and we moved a lot of properties. If you look at the overall amount, I guess referring one other item back to that flow on page 28, we had $94 million of property that was moved to ORE out of nonperforming loans in the current quarter, and yet if you look above on that same page, you'll see that net other real estate owned actually declined in the current quarter from $171 million to $147 million in the prior quarter.
So we were very aggressive on dealing with other real estate in the third quarter. Now, as part of that, of course you saw other real estate expense increase to $51 million during the third quarter and that was up $36 million from the second quarter and also $46 million from the prior year.
I think in terms of what that run rate is, it's going to be elevated from where it was in the second quarter. I'm not sure I can predict exactly where it will be in the fourth quarter, but it will be higher obviously, than when it was a year ago, just because we are now seeing some liquidity in the marketplace and we need to move that property on through.
And it will be awhile before it will actually decline back down to perhaps that $5 million level which is where we were in 2008. So that's going to be some time.
With respect to the trust and investment services income, if you look at page 24 of our press release, you'll see in there that actually the institutional asset management and custody fees were up in the current quarter. Personal asset management and custody fees were down, but the biggest decline was really on the brokerage commissions and fee income and that's going to be driven a lot by the community bank and some of our key investment services sales.
So those were softer here in the third quarter, but again, the higher margin businesses that we're going to have are going to be on the other two line items that I talked about. And I guess the outlook is that assets under management actually showed improvement with the overall market here in the third quarter so the prospects for the fourth quarter are improved in that particular area.
And then the last area that you talked about and asked about was the investment banking and capital markets related income. We did have significant marks that we took in the current quarter.
There are about $58 million in marks that went through in the current quarter. There's $20 million for CMVS bonds, there was another $26 million with respect to the funds management area with respect to certain real estate investments, and then an additional $12 million that was for reserves on customer derivative positions, and those were resulting from just credit migration.
There was a reserve that was built and that actually incurred losses in that particular area. I think that in talking with, and Peter can comment on this, but talking with our people in the institutional bank, they feel better about the pipeline with respect to M&A related fees at this particular point in time and I think the outlook at least looks more positive than what it was in the third quarter.
Peter, anything else you would add to that?
Peter D. Hancock
No. I think you hit the highlights.
Brian Foran - Goldman Sachs
And if I could sneak in one followup, the high cost CD book added end of last year, can you just kind of remind us what the margin opportunity might be there and how much of that has been the third quarter run rate versus how much would start to come through in the fourth quarter?
Jeffrey B. Weeden
Well, I think you saw the improvement in the third quarter from the second quarter. The improvement in the margin was approximately 10 basis points and we have heavy flows of maturities that continue into the fourth quarter, that first, and the second quarter of next year, so we believe we still have opportunities for re-pricing of that particular book during the next three quarters.
I would estimate at this particular point in time that the direction of the margin is for improvement and it could be similar to the magnitude of improvement that we experienced here in the third quarter compared to the fourth.
Brian Foran - Goldman Sachs
Thank you. That's very helpful.
Operator
And our next question will come from Todd Hagerman with Collins Stewart.
Todd Hagerman - Collins Stewart
Good morning, everybody. Just a couple of questions in terms of the commercial real estate portfolio.
Chuck, I was just wondering if you could talk a little bit more about the asset disposition here in the third quarter as it relates to the commercial real estate, particularly in the retail multifamily? Any restructurings that may have come through in the quarter?
And then if you have any comments or thoughts in terms of the prospects for the regulatory guidance coming through on the CRE restructuring and how that may affect you guys and kind of how you're thinking about restructuring and disposition going forward on the CRE book?
Charles S. Hyle
Let me try to take the first one first. I think generally speaking the breaking of the commercial real estate portfolio down into pieces, as Jeff said in his comments, the residential part given its reduced size is showing better numbers and a reduction in NPLs, et cetera.
The retail side is, I think, still a little bit of an open question and largely tied to the economy and how the economy progresses over the next couple of quarters. While we've shown a bit of an uptake in NPLs and charge-offs in retail, we're modestly encouraged by the delinquency numbers which have stayed pretty flat.
And again as I've said in previous calls, the retail portfolio is more highly correlated to the residential markets and therefore we've seen somewhat more weakness in the four states that have been hardest hit on the residential side, namely Florida, Nevada, Arizona, and California. But we think that — I wouldn't call it necessarily turning the corner, but I do think we've seen a little bit of modest improvement in the early stage side on retail.
Multifamily is a sector that we continue to believe will have relatively modest loss content in it, but clearly there are higher NPLs and some migration there, again highly correlated to the four states that I mentioned earlier. But absorption rates continue to be decent in most parts of the country and while concessions abound, I think the general view is this is more of a timing issue, I think, than an ultimate loss situation.
Office is always a laggard and not a huge portfolio for us. A large portion, 30 plus percent, is in medical office building which we think currently is performing well and we expect to continue to perform well.
So I think in general as we said earlier — I don't want to make this sound too optimistic because there's still a lot of uncertainty out there and it's certainly true to say that the real estate fundamentals across most markets certainly haven't improved and remain challenged, and again, the economy is going to be a major factor in how the rest of this portfolio performs over time. So that’s a broad-brush description of where we see the commercial real estate portfolio.
As far as where the regulators are, we don't really have a lot of information at this point. Certainly there have been public statements by the regulators that they are very focused on commercial real estate, but in terms of what impact, how they might change what they're doing, is still very much an open question as far as we're concerned.
Todd Hagerman - Collins Stewart
Okay. Just to followup on that, I mean, in the quarter itself, have you seen or begun to do anything more in terms of restructuring your own existing portfolio?
Was that a meaningful part of the quarter or is that something you're thinking more about going forward?
Charles S. Hyle
Well, we've been thinking about it a lot for a long time and I think as we said in the second quarter call, we had restructured something like $2.3 billion of commitments in real estate across all aspects of our real estate portfolio. And that program continues in earnest, particularly as certain loan construction is complete and there's not a strong takeout market.
So as we've said in the past, we have a program whereby we re-underwrite those loans based on appropriate underwriting standards. These are not TDRs, these are not distress deals, but often require developers or others to put in more equity.
We also get improved returns in terms of interest rates and appropriate LTDs. And that program has continued.
We've done something like another $900 million during the third quarter and we will continue to do that on the basis that the underlying property is a bankable and appropriate property. If it's not it goes NPL and we delay with it in other ways.
We've done very little in terms of TDRs to date, although clearly our expectation is that number may migrate up a bit over the next couple of quarters.
Todd Hagerman - Collins Stewart
So just to clarify, the roughly $900 million in the third quarter, that generally is categorized as performing?
Charles S. Hyle
Yeah, absolutely. It would have to.
Otherwise it would go into the TDR column.
Todd Hagerman - Collins Stewart
Right. Thanks very much.
Operator
And we'll now go to Anand Krishnan with Fore Research & Management.
Anand Krishnan - Fore Research & Management
Hi, good morning. I had a clarification question on the reserve (inaudible).
So you mentioned the recurring values of your nonperforming loans. They are at $0.76 and then your REO is at $0.52 and (inaudible) that are nonperforming $0.67, and still, your coverage ratio is over 100.
So I'm just trying to see how you think about reserving and provisions on a go forward basis given that your troubled assets are already substantially carried below par? And is that a function of you expecting things to weaken over the next 12 months because typically reserves are carried for the losses that you expect to take over the next 12 months.
So if you can share your thoughts on how you think about this that would be helpful. Thanks.
Jeffrey B. Weeden
Well, certainly the reserve buildup, of course, is a process that we go through that not only identifies the nonperforming, but it also goes through the performing portfolio and each of the credit grades that are out there will have certain degrees of loss given default in all of our probabilities. And so it's a pretty elaborate process that we end up going through.
I think your observations are good in the sense that you see what we have already taken in the form of losses against those particular nonperformers. The reserve also looks at a number of different factors.
Now, with respect to how we look at reserves and provisions going forward, I think we've covered a lot of ground at this particular point in time and what you saw in the third quarter were actually the amount of reserves of provision in excess of charge-offs is down from what it was in the last three quarters. And so, the expectation as we've gone further into the credit cycle here and we start to see some leveling off of some of the nonperformers, as well as looking at those that are loans 30-89 day past due and 90-day past due credits, we would expect to see that given where we are in the cycle there would be probably fare less need for reserve build on a go forward basis, but it still remains to be seen obviously as to where the economy goes and so we remain cautious, but the picture is better in that regard.
Anand Krishnan - Fore Research & Management
Thanks. That's pretty helpful.
And I had one more clarification question related to the investment banking capital market activity. You mentioned 20 million relate to CMBS marks, generally the third quarter performance on the CMBS side has been positive for the most part so I'm curious as to why there has been a negative on CMBS for US?
Jeffrey B. Weeden
Well, that's a good observation. It has been as a general rule.
The particular bond pieces that we ended up holding in that portfolio were downgraded late in the quarter by the rating agencies, and as a result of that, we ended up taking marks on those particular bonds.
Charles S. Hyle
I would add that these bonds were highly rated initially, but also highly illiquid. So it was very hard to get an accurate read on them at the end of the second quarter.
So I think that helps explain the third quarter mark that was basically using matrix pricing based on rating and the rating changed significantly with very little trading activity.
Anand Krishnan - Fore Research & Management
Thanks, good luck.
Operator
And next is Paul Miller with FBR Capital Markets.
Paul Miller - FBR Capital Markets
Thank you very much. Just to change subjects here a little bit on loan demand, I mean, loans look like they declined about $5 billion in the quarter and they decline about $10 billion over the last year.
I know some of that's related to the discontinued operations as you exit some of these portfolios, but are you seeing any loan demand out there, especially from the small business and middle-market business class? And should we continue to see this line item decline outside of discontinued operations.
Beth E. Mooney
Yes, Paul. This is Beth Mooney and I would give you a few of what we are seeing in our community banking markets which is this is at the point in the cycle where small businesses and middle market companies tend to be very conservative.
The duration of the economic downturn — people are being incredibly cautious about expanding capital investments, plants, and equipment, and as you can see in the general buildup in noninterest bearing which has been heavily in our commercial customer base, powers tend to remain very, very liquid. So I would say that there's still much caution in the existing client base about expanding their borrowings or debt as well as very, very little new loan demands.
So I would say that this is the point in the cycle where businesses are not prepared to expand their borrowing capacity and as we see some economic growth potentially as we go into 2010, I think we would hope for increased demand, but right now it is very, very weak.
Paul Miller - FBR Capital Markets
And I guess will you continue to grow your securities portfolio to offset that loan drop-off?
Jeffrey B. Weeden
Well, certainly to the extent that we have liquidity continuing to come at us with loans paying down and deposit coming into the company. We will deploy those funds in the investment portfolio, but we'll also look at other forms as we have debt maturities that come up.
We just simply won't replace the debt as it matures.
Paul Miller - FBR Capital Markets
Okay. Thank you very much.
Operator
And we'll now go to David George with Robert W. Baird.
David George - Robert W. Baird
Good morning, guys. Thanks for taking the question.
I was going to ask about the securities book, but it looks like you just answered that. Can you talk about, Henry, your appetite for FDIC deals going forward?
Henry L. Meyer III
Yeah. We continue to look at opportunities.
We've been very clear that the opportunities that we're interested in are in footprint, in markets that we're currently in and we have looked at some details and we just haven't in this environment found that right opportunity. I am a little bit discouraged, I guess, which way is the glass half full or half empty.
But the vast majority of the 99 banks that have been taken over have not been in our footprint states so there hasn't been a lot of opportunity, but we are actively interested.
David George - Robert W. Baird
Okay. I appreciate it, guys.
Thanks.
Operator
(Operator's Instructions) And our next questions come from Gerard Cassidy, RBC Capital.
Gerard Cassidy - RBC Capital
Thank you. Hi, guys.
The question has to do with the decision to move the student loan into discontinued operations versus the other exit portfolio businesses. What is the factors that you used to do that and should we expect for example, the marine business or the commercial leasing business to be moved into discontinued operations at a later date?
Jeffrey B. Weeden
Hi, Gerard. It's strictly an accounting bright line that we have to look at.
With respect to the student lending, we are out of the student lending both on the private side as well as the government guaranteed side of the equation so we're no longer in that "business" from an origination standpoint. With respect to the other portfolios, and you brought up marine, we still make marine loans through our branch networks.
So if we have customers that come in and they want to buy a boat, we will finance a boat. And so the distinction really gets into are we making those particular types of loans some place?
It is just like on the leasing area. We're in the leasing business.
Leasing is a major part of this company and will be going forward. I think what you have to look at though are certain sub-lines of business that we're out of at this particular point in time within the various areas.
That's what the distinction happens to be from an accounting standpoint.
Gerard Cassidy - RBC Capital
Thank you. And then just quickly, on the commercial real estate construction charge-offs that you took in the quarter, what type of properties were they mostly in and were they in those four states that you reference as being the weaker states due to the housing markets?
Charles S. Hyle
Yeah, Gerard. That is the appropriate way to look at it.
I think in the retail side I would estimate that in those four states we've got about 25%-27% of the portfolio and in terms of charge-offs and NPLs it would be the opposite of that, the inverse of that. Close to 70 plus percent would be in those four states so there's definitely a correlation there.
Same in multifamily, again, largely driven by residential characteristics and the economies, and so that's very much the trend that we would see there.
Gerard Cassidy - RBC Capital
Thank you.
Operator
We'll now go to Ken Houston with Bank of America-Merrill Lynch.
Aaron Foley - Bank of America-Merrill Lynch
Hi, it's Aaron Foley for Ken Houston. I just wanted to kind of — did you guys give an explicit timeline as to kind of how you're planning to put the liquidity to work over the next couple of quarters and kind of what loan to security makeup you see the balance sheet having longer term?
Jeffrey B. Weeden
Well, we haven't specifically given targets with respect to the loan and security makeup of the organization. We are deploying the liquidity cautiously, is what I would say.
We continue to make investments or put money to work in the investment portfolio, but we also are mindful too of looking at both sides of the balance sheet, the deposit side as well as the asset side. And I think as we go through this, we're being perhaps more bringing rates down on our CD book.
We're remaining cautious to see what ends up taking place there over time. So far we've been very encouraged by the fact that the money seems to be flowing back into the now and MMDA accounts, but we'll continue to monitor that.
And of course as you know with the FDIC's unlimited deposits on transaction accounts for commercial customers we have to see how that all evolves over the foreseeable future.
Aaron Foley - Bank of America-Merrill Lynch
Gotcha. Sounds good, thanks.
Operator
And our next question comes from Mike Holton with The Boston Company.
Mike Holton - The Boston Company
Hey, good morning. I just wanted to see if you guys would clarify a couple of things you talked around a little bit.
On credit quality, tell me if this is the wrong interpretation, net charge-offs in NPA — especially net charge-offs, should continue to go up, maybe a little less than previously but they'll go up and you guys will likely continue to build reserves in Q4, although there's a chance it could be less than Q3. Would that be your interpretation?
Jeffrey B. Weeden
Well, Mike, it's difficult to say exactly where that will end up because we've basically talked about the fact that you could have an increase in nonperformers which may result in an increase in reserves, but you have to look at the overall migration of the portfolio. And we're seeing better signs in certain parts of the book.
So it's difficult at this particular time to say how much, if any, the reserve will change in the fourth quarter, but certainly we are getting further into the cycle here and there's less overall need from our perspective of a reserve build.
Mike Holton - The Boston Company
Okay. But you do think charge-offs will increase from Q3 levels, the question would be magnitude?
Jeffrey: I would say that charge-offs will remain at the elevated level and it means that that's a possibility that you just outlined.
Mike Holton - The Boston Company
Okay, thanks.
Operator
And we'll now go to Matthew Burnell with Wells Fargo.
Matthew Burnell - Wells Fargo
Good morning, thanks for taking my call. I know that account fees don't make a large percentage of your noninterest revenue, but I'm wondering if you can update us on any actions you have taken or may consider taking in the future, relative to overdraft fees or some of the other regulatory plans that have been floating around Washington that might negatively impact noninterest income.
Beth E. Mooney
Yes. We have been very mindful of the news that several of the peers have made and their assessment of specifically overdraft fees, as well as the current regulatory environment and we certainly are poised to do what's appropriate in our marketplaces and take guidance from peers as well as the regulators.
It would have an impact obviously in terms of lessening certain fee categories, but we have not given any specific guidance at this time to that magnitude.
Jeffrey B. Weeden
And I think you're correct in the sense that deposit service charges are not a large number for us, and part of what's depressed some of our deposit service charges here too are the high levels of transaction accounts that we have on the corporate side of the equation so that those particular balances or fees are offset from an account analysis perspective and so that's also depressed it a little bit as they've used balances rather than paying hard dollar charges at this time, even in a low-rate environment.
Matthew Burnell - Wells Fargo
And I guess just to followup, what's the sense of the pushback that you might get from regulators as you look to offset those, I guess nondiscretionary fees, with discretionary fees, specifically to the account fee side of things?
Beth E. Mooney
On that I would say that you would always balance appropriate disclosures and we are not necessarily looking at nay changes we would make to the overdraft policies or anything like that to look to offset those in other fee categories. That would not be the linkage we would make.
Matthew Burnell - Wells Fargo
Great. Thanks very much.
Operator
And next is Bob Patten with Morgan Keegan.
Bob Patten - Morgan Keegan
Good morning, everybody. Following up on Paul Miller's question to Beth, if you look at your average line borrowings at this time in the cycle versus historical, even to your best customers, what would you estimate the percentage of line outstanding versus historical?
Beth E. Mooney
We see a relative increase in our home equity portfolio in terms of average line outstanding. So we've seen some increase over the time in terms of outstandings and in our commercial book it has been relatively constant, slightly up, but constant.
Bob Patten - Morgan Keegan
So constant with historical?
Beth E. Mooney
Yes.
Bob Patten - Morgan Keegan
All right. Where do you think growth will come from both in terms of geography and in terms of industry type, when the economy starts to resume again, if you look at your portfolio.
Beth E. Mooney
Bob, I would say given the markets we serve that we would have the opportunity in my mind for, both by industry as well as by market, growth opportunities across our footprint. We have not seen any particular analogies in any of our particular markets other than manufacturing in our Great Lakes markets.
So I would tell you as I look out at 2010 and 2011 as the economy begins to recover that there would be geographic diversity in terms of growth opportunities both for types of loans and in our markets.
Bob Patten - Morgan Keegan
Okay. And then last I mean obviously with all the excess liquidity the company's building and the securities portfolio, if we get loan growth, what would you say for every dollar of securities that you swap into loans that the difference in spread is?
Jeffrey B. Weeden
I think at this particular point in time it's going to depend on when the growth comes back. Right now obviously we're getting very good spreads off of loan volume and activity so there should be an overall pickup.
And it's not just on the loan. We look at it from a total customer relationship perspective, so I think Henry commented on it, we're building relationships here so we're trying to do not just the loan, but do other activities with each of our clients and build that long-term relationship.
But there would be some degree of pickup obviously because what you're talking about doing is going out of a AAA rated government sponsored entity type of a security into something that would be less than AAA rated, obviously, from a client perspective.
Bob Patten - Morgan Keegan
Yeah. But the spread has to be 3%-3.5% pickup, wouldn't it be?
Jeffrey B. Weeden
Well, most of our investments that we've put on — obviously if you're talking about it coming out of short-term which is 25 basis points, it'd be well over 300 basis points pickup. If you're talking about coming out of the investment portfolios, it's probably far less than 300 basis points pickup.
Bob Patten - Morgan Keegan
Okay, thanks.
Operator
We'll take a followup question from Brian Foran with Goldman Sachs.
Brian Foran - Goldman Sachs
Going back to the comments on the pay-downs and the NPA sales and the comments about improved liquidity, can you just kind of give us a sense, is there certain geographies or certain properties types? Where are you seeing the investor demand come back to a level that's a little bit more palatable that's making you sell some of these loans?
Charles S. Hyle
I would say the overriding characteristic is underlying cash flow on the real estate side. I think things like residential land and A&D and things like that, as we conversely know, has improved in liquidity there.
But if it's a multifamily project or something that has at least reasonable cash flow and the prospect of reasonable cash flow, we're seeing some liquidity there. And then as I said earlier, we're seeing some increased liquidity in the secondary corporate loan market as well.
Brian Foran - Goldman Sachs
Thank you.
Operator
And with no further questions I'd like to turn the conference back over to Mr. Henry Meyer for any additional or closing remarks.
Henry L. Meyer III
Again we thank you for taking time from your schedule to participate in our call today. If you have any questions or followups that you'd like to discuss based on some of the comments that we've made, please don’t hesitate to call Vern Patterson, Key's Head of Investor Relations, at 216-689-0520.
That concludes our remarks. I hope everyone has a great day.
Operator
Ladies and gentlemen, that does conclude today's conference. We thank you for your participation.