First Horizon Corp (FHN) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the First Horizon National Corp second-quarter 2012 earnings conference call.

At this time all participants are in a listen-only mode.

Later we will conduct a question-and-answer session and instructions will follow at that time.

(Operator Instructions) As a reminder, today's conference is being recorded.

I would now like to introduce your host for today's conference call, Ms. Aarti Bowman.

You may begin, ma'am.

Thank you, operator.

Please note that the press release and financial supplement which announced our earnings, as well as the slide presentation we will use in this call this morning, are posted on the Investor Relations section of our website at www.FHNC.com.

In this call we will mention forward-looking and non-GAAP information.

Actual results may differ from the forward-looking information for a number of reasons outlined in our earnings announcement materials and our most recent annual and quarterly reports.

Our forward-looking statements reflect our views today and we are not obligated to update them.

The non-GAAP information is identified as such in our earnings announcement, materials, and in the slide presentation for this call, and is reconciled to GAAP information in those materials.

Also, please remember that this webcast on our website is the only authorized record of this call.

This morning's speakers include our CEO, Bryan Jordan, and our CFO, BJ Losch.

Additionally, our Chief Credit Officer, Greg Jardine, will be available with Bryan and BJ for questions.

I will now turn it over to Bryan.

Thanks, Aarti.

Good morning and thank you for joining our call.

Second quarter 2012 marked another period of successfully executing our strategic plan.

We achieved solid performance in our core businesses, asset quality continued to improve, and we purchased $37 million of our common stock leaving $74 million under our $200 million share buyback program.

Focus on our core businesses continued to pay off.

The Regional Bank's pre-tax pre-provision net revenue increased 16% from the year-ago level, driven by 9% higher net interest income and modestly lower expenses.

In capital markets, second-quarter fixed income average daily revenues were $1.1 million, within our expected range but down from last quarter's exceptionally high level due to more cautious buying behavior from our customers.

FTN Financial remains a major contributor to fee income and provides significant returns for us.

In the second quarter of 2012 FTN's return on assets was an annualized 2.1%.

Balance sheet trends were also positive in the second quarter.

We grew our Regional Bank loan portfolio while the nonstrategic loans continued to run off, improving our loan mix.

The Bank increased average loans by about $1.1 billion, or 10% year over year.

Although loan pricing and structure remained very competitive, average consolidated loan yields were flat at 4.09%.

Average core deposits in the Regional Bank grew 13% year over year and were up 3% from last quarter benefiting our funding costs.

Consolidated net interest margin was 3.16%, up from last quarter although slightly below a year ago.

Asset quality trends remain favorable.

Year-over-year net charge-offs declined 39% while nonperforming assets were down 38%.

In the second quarter consolidated loan-loss provision was $15 million versus $1 million a year ago.

While credit trends continued to be favorable, we are seeing the pace of improvement slow and we reserve for higher commercial and consumer loan balances in the Bank.

We are still seeing stable to improving loan portfolio credit quality trends over the remainder of 2012.

Consolidated expenses were up from a year ago, mostly driven by the $250 million addition to the mortgage repurchase reserve.

Our productivity efforts remain on track.

We saw declines in other areas of second-quarter expenses, such as compensation, occupancy, and foreclosed real estate costs.

Since we are better able to estimate and reserve for projected losses from mortgage repurchases, future environmental expenses should be lower helping drive our improvement in efficiency.

In fact, we now expect to achieve our annualized consolidated expense goal of approximately $1 billion by the end of 2012, a year ahead of our initial target.

In sum, we are making progress and are firmly committed to the continued successful execution of our strategic plan.

The current environment dictates patience since low interest rates and a sluggish economic recovery are likely to persist.

We are optimizing our business mix to well position First Horizon for when the economy momentum.

Right now we are focused on the successful execution of our strategic priorities.

We are entering new relationships, we are becoming more efficient, we are disciplined in execution opportunities, and we are focused on prudent capital deployment and achieving attractive long-term returns for our shareholders.

I will be back for some closing comments but now BJ will walk you through the detailed financial results.

BJ?

Thanks, Brian.

Good morning, everybody.

I will start on slide five.

Our second-quarter 2012 consolidated pretax income was a loss of $211 million, which included our previously announced pre-tax charges of $272 million.

Those $272 million of charges resulted in an after-tax impact of about $168 million, or roughly $0.67 a share.

The $250 million reflects an addition to the mortgage repurchase reserve and the other $22 million is for the litigation reserve.

Pretax income from our core businesses was $65 million.

And bottom line our net income available to shareholders was a loss of $125 million and diluted EPS a loss of $0.50.

As Brian mentioned, we bought back $37 million of common stock in the quarter, or roughly 4.5 million shares.

For our total buyback program to date we have purchased $126 million at $8.28 per share leaving $74 million still authorized to be repurchased under our program.

In terms of the consolidated balance sheet, average total assets were $25 billion, essentially flat to last quarter.

Average loans and core deposits were relatively stable as well.

Deposit rates declined by 3 basis points to 44 basis points in 2Q12 and were 20 basis points less than a year earlier.

As Brian mentioned, our consolidated net interest margin was 3.16% in the second quarter compared to 3.12% in the first.

Margin improved because of a reduction in our low yielding excess cash balances, higher commercial loan fees, and lower deposit costs.

The NIM improvement was somewhat offset by lower reinvestment rates in the securities portfolio as expected.

While we may see variability in quarterly net interest margin, we do currently forecast that consolidated net interest margins should be in the 3.10% to 3.15% range in the second half of 2012.

Turning to slide six and the Regional Bank, linked quarter our PPNR in the Regional Bank was up 5% and 16% year over year.

Net interest income was up slightly linked quarter due to higher loan fees and increased loan balances with nice year-over-year growth of 9%.

Fee income was up 8% linked quarter from a seasonal rebound in NSF and cash management fees, as well as increases in debit card, TRuPS, and other income.

Pre-tax income in the Bank was $65 million in 2Q 2012, down $9 million from the first quarter.

That decrease was driven by a higher, but still modest, loan-loss provision of $5 million in the second quarter compared to a credit of $7 million in the first.

We are seeing continued positive grade migration, but at a slower pace of reserve decrease.

Expenses in the Bank slightly increased linked quarter primarily due to technology investments that should result in more efficient processes going forward.

Turning to slide seven looking at the Regional Bank balance sheet trends.

Linked quarter Regional Bank period-end loans rose 3%, driven by loans to mortgage companies, corporate lending, and consumer loans and up 10% year over year, very solid performance.

While commercial loan yields declined slightly from last quarter, our ongoing focus remains on making higher return quality runs.

Linked-quarter spreads were stable and up year over year.

Our loan pipeline remains stable and commercial loan commitments increased by $100 million from last quarter.

Overall, quality loan demand remains modest and considerable competition, including pricing and structure pressures, persist.

Average core deposits in the Regional Bank were up 3% last quarter and up 14% year over year.

Average rate paid on those deposits declined 3 basis points to 36 basis points and was down from 54 basis points in 2Q 2011.

Turning to the next slide, slide eight, capital markets had another solid quarter with pre-tax income of $20 million.

Fixed income average daily revenues were $1.1 million, within our normalized range of $1 million to $1.5 million.

The decline in ADR from first quarter to above average level of $1.6 million reflects more cautious customer activity due to the uncertainty about both the macroeconomic environment and the interest rate outlook.

Expenses declined 24% from last quarter due to lower variable compensation, and looking ahead we anticipate ongoing variability with fixed income revenues.

We currently expect ADR to be in the lower half of our normalized range.

Fixed income product mix includes agency mortgages, corporate munis, and treasuries.

We continue to focus on further expanding our substantial distribution network by hiring talent and adding customer relationships.

For example, you probably saw we recently added several experienced sales specialist and traders to our Municipal Bond Group.

Additionally, our Capital Markets Group continues our long-standing position as a top underwriter of agency debt securities.

And for five consecutive years we have been the only non-primary dealer in the top 10.

Turning to slide nine, talking about our expenses and productivity initiatives.

As Brian mentioned, we should roughly achieve our targeted $1 billion annualized level of consolidated expenses by the end of 2012, a year ahead of our goal.

With the $250 million addition to the mortgage repurchase reserve we currently expect ongoing quarterly GSE-related repurchase provisions to be zero or very immaterial.

We are on track with our ongoing efficiency initiatives as well.

Core business expenses, excluding last year's capital markets litigation charge, are down 10% from last year.

Turning to slide 10 and a little bit on the mortgage repurchase reserve.

As you know, based on information we received from Fannie and extrapolated to Freddie, late in the quarter we added $250 million to the repurchase reserve for an ending balance of $360 million.

We had no change in our estimate or expected trend since our previous 8-K announcement.

On slide 11 you will see the second-quarter repurchase trends.

Linked quarter our operational pipeline increased to $431 million, driven by a higher number of GSE-related requests.

We did receive more repurchase requests from Fannie, which represented a backlog from prior quarters.

New requests were somewhat mitigated by a 6% linked-quarter increase in our resolutions, and our cumulative recision rates and loss severity continued to remain stable.

We had no repurchase requests from our first lien private securitization, and at this time, based on our private securitization's origination mix, deal size, and performance, we continue to believe that the risk here from private securitizations should be significantly less than what we have experienced with the GSEs.

On slide 12, asset quality trends, linked quarter our loan-loss reserve declined 7% to $321 million.

The reserve-to-loan coverage stands at 1.98%, a decline of 19 basis points from last quarter.

Net charge-offs decreased 14%, reflecting continued improvement in our consumer portfolios.

As you can see on slide 13, nonperforming assets declined 9% to $467 million from last quarter.

In-flows were stable and ORE balances declined through the continued disposition activity, mostly through single transactions.

Wrapping up on slide 14, we manage our company, as you know, to achieve long-term (technical difficulty) and profitability targets following our bonefish model.

Core business trends are good and we have made significant headway on resolving nonstrategic issues.

And even though we have made significant progress on our efficiency goal, we are constantly looking at ways to cut costs and become more productive and we will continue to do so.

Looking at slide 15, just a little bit on the potential impact of the recently announced NPR rules.

With the currently proposed Basel III capital rules we expect to manage our capital ratios within our bonefish range.

Right now we expect the NPR impact to our 10.6% 2Q 2012 Tier 1 common ratio, it would be about 240 basis points fully phased in or without any offsetting actions.

Putting it at a pro forma estimated 8.2% spot rate today.

However, assuming planned improvements and run-off actions, we would expect a positive approximately 260 basis point impact to the pro forma estimated 8.2% or a theoretical Tier 1 common ratio of over 10% under Basel III.

Now I will turn back over to Bryan for some final comments.

Thank you, BJ.

Second quarter 2012 demonstrated another quarter of successful execution.

We showed continue profitability in our core businesses, our efficiency initiatives are on track, and we return capital to our shareholders with our ongoing share buybacks.

For the second half of 2012 we will continue to work towards achieving our bonefish goals.

We will focus on improving -- we will focus on providing superior customer service that differentiates us from our competitors.

We are committed to becoming more efficient and productive through simplified processes and better technology.

We will continue to prudently manage the wind down of our nonstrategic assets.

With the addition to the mortgage repurchase reserves, we've taken a big step towards removing this distraction and allowing us to focus more on our core businesses.

Our balance sheet continues to strengthen, and we will proactively manage the mix and profitability of our portfolios in light of proposed changes to capital rules.

Finally, we will continue to manage capital smartly.

As I said earlier, navigating through this operating environment will take patience.

This is a marathon, not a sprint.

I am confident that continued successful execution of our strategic priorities will lead to higher profitability and improved returns for the long term.

Thank you and now we will take questions.

(Operator Instructions) Ken Zerbe, Morgan Stanley.

Thanks.

Maybe we can start off with the mortgage banking just a little bit.

Obviously big decline there given -- particularly in light of the strength that we have seen across the industry in mortgage banking.

Can you just go through the pieces a little bit?

I am just trying to understand what is sustainable, what were the big one-time items in there?

I think you had mentioned an adjustment on contingency related to something, the servicing that was sold.

Maybe a little more metrics on that would be helpful.

Thank you.

Ken, good morning.

It is BJ.

Couple things; remember that we have very little mortgage origination income, so when you are going to see strength or not out in the marketplace we are not going to necessarily participate in them.

Where you will see it is increase in our mortgage warehouse lending or loans to mortgage companies, and that is what I talked about when we saw loan growth.

We saw very solid strength there.

The biggest piece of our mortgage banking fee income is really related to our MSR hedging results and how effectively we hedge.

We had about $2 million of net positive results from hedging, which was down from about $9 million in the first quarter.

The other thing that you mentioned was just a modest adjustment of a couple million dollars related to a bulk sale receivable that we had had.

So that is more of a one-time item.

But really the main driver for our mortgage banking income is always going to be the MSR hedge results, and as I said, they were down about $8 million linked quarter.

Okay, that is helpful.

The other question I had was just on the mortgage repurchase.

I see that you are talking about requests of $431 million; has anything changed or what has changed between the time you announced the $250 million reserve build to today in terms of anything different, anything better or worse than your expectations back then?

No, Ken.

It is BJ.

As I said in my comments, we haven't seen any change in the trends or our estimate since we made the announcement.

When we had the call after the announcement we talked about having very significant visibility and very detailed information from Fannie Mae, which was extremely helpful.

It wasn't just historical information or current information, but it was expected future flow and so that really helps us understand what we are going to be seeing.

That obviously means that our views are going to be pretty good over the near to medium term at least.

Steven Alexopoulos, JPMorgan.

I wanted to start in terms of the initial hit to Tier 1 from the proposed capital rules, first should we think about the quarterly buybacks still in somewhere $40 million, $45 million range per quarter, or does that need to slow given the 240 basis points hit?

Then, secondly, are there any plans or options open to you to accelerate the runoff of the nonstrategic?

I guess that is where most of the RWA hit is coming from.

Steve, this is Bryan.

Couple thoughts.

One, we have got the $74 million, $75 million remaining under our authorization.

We don't think that these rules have any significant impact on that and we expect to continue to be opportunistic but look for opportunities to repurchase stock.

I would point out a couple of points about the proposed rules.

One, they are proposed.

You got to put emphasis on that and there is some things in them that I think, at least intuitively, seem like they will change, particularly around some of the capital levels maybe around home equity.

Two, I would say, and BJ pointed out, there are some opportunities for us to change the mix of the portfolio.

It is a long time between now and 2015 and even longer when they are fully phased in.

As in the past, we have adjusted our balance sheet to make sure, one, that we have capital efficiency and, two, that we have profitability driven by that.

So we will adjust appropriately to manage that.

So as BJ talked about it, and he gave a spot rate and then he gave a longer-term rate, we think more about where we will be at the end of 2014 and that is sort of what we manage towards.

So we think more about a 10%-plus Tier 1 rate on these pro forma rules, or proposed rules, and so we manage according to that.

Okay, that is helpful.

Bryan, one other question.

Looking at the bullet on slide 25, that all private-label deals will reach five years by the end of 2012, I think it is actually next month, is it still the view that five years is the statute of limitations on private label and this risk should be behind you by 2013?

BJ and I neither one are attorneys, so we will give you our interpretation of what we understand.

There are different rules around statutes of limitation and statutes of repose, and don't ask me to define the differences between the two.

And it varies by state.

As I understand it, the federal rules are different from the states and the federal statutes have run.

Then the states will run at various times.

But we think the vast majority of it would occur by the end of that five-year period based on our interpretation and understanding of it.

So it is not only that, but you go through five years of performance, five years of history, and if you look at the balances I think the balances outstanding on those private-label securities are down to about $11 billion or so in round numbers from the original $35 billion range.

So the passage of time and always we think is generally on our side.

Our balance sheet becomes stronger; the exposure to these risks becomes smaller with the passage of time.

Okay.

Thanks for all the color.

Thank you.

Craig Siegenthaler, Credit Suisse.

Good morning.

This is actually Nick Karzon standing in for Craig this morning.

I guess just to start, I noticed that TDRs looked like they increased about 11% quarter over quarter and I was wondering if there was a change in accounting here or what the driver was there.

Nick, this is Greg Jardine.

They increased similar to last quarter driven by firm mortgages primarily and then secondarily we had an increase in commercial loans about $10.5 million, which was driven by a [SNIC] credit that was -- primarily by a [SNIC] credit that went TDR last quarter.

So those were the primary drivers of the increase quarter over quarter.

Thanks.

Then I guess just looking at the compensation line I was wondering in terms of the quarter-over-quarter decline what piece of that was related to a decline in variable comp reductions versus the payroll taxes running off in the first quarter.

Nick, it is BJ.

I would say over half of it is probably related to the capital markets variable comp and the other half is the expected decline coming off the higher first-quarter levels.

Okay, great.

Thanks for taking my questions.

Matt O'Connor, Deutsche Bank.

Two unrelated questions.

I guess first on the expense management.

Obviously this was one of the things that you can control and it has been very good for several quarters.

As you think about making the $1 billion run rate target earlier, how much further can costs come down?

Is it trimming around the edges?

Are there some structural changes that can still be made?

Matt, this is Bryan.

We worked a lot on expenses and I would tell you we don't ever stop working on it.

It is something that we think is part of the business.

And a business that is changing like the financial services industry is today, we think there are additional opportunities for us to use technology, to use process changes, to use end-to-end looks at our business to gain efficiency.

We go back and forth internally about how do we continue to look at that.

As I have talked in the past, we try not to be goal oriented about it, simply because if you set a goal, you get to that goal, you quit.

We think it is a continuous process.

However, we do use goals to give people an order of magnitude.

So that is a long way of getting around to saying we will [forge] that $1 billion target, as BJ and I both said, by the end of this year but that doesn't mean we are stopping on expenses.

We are going to continue to look for additional opportunities to become more productive and more efficient.

To use technology and process to improve service, but do it in a more efficient way.

And that means that we continue to look at everything about the business day in, day out to drive that efficiency.

And then separate, just following up on the private-label putbacks.

Correct me if I am wrong, but there is -- a number of banks including you I don't think you have put a ton of reserves aside for that versus the GSE.

As we think about the timing of the statute of limitations expirations and maybe getting some more clarity next couple of quarters, is that something we could see a reserve boost for the next couple or few quarters?

Again, we have not had any requests, so it is kind of hard to build a reserve without actually any activity.

So until we see some activity coming through it is kind of hard to build the reserve.

Now we do look at reserving through litigation and so, as you know, we have a lot, five, lawsuits outstanding that are related to mortgage and so as appropriate we will add to litigation reserve on those types of things.

But we watch it very closely, but until we have any requests we can't really build reserves.

Okay.

I'm sorry I think I was combining the putback requests and the litigation on the private-label side.

Can you remind us what the litigation reserves are now, or at least how much you have put aside that you have disclosed?

Well, we increased the litigation reserve by $22 million as we announced in the 8-K.

You have put some in there before, I would assume, though too, right?

Yes, we had some other modest amounts in the litigation reserve, but that was the large increase to it.

Okay.

Erika Penala, Bank of America.

Good morning.

My first question was on your plan to improve your Tier 1 common under Basel III.

I guess what size balance sheet is in your model when you are thinking about getting to 10.5% by 2014 under Basel III?

Erika, it is BJ.

Couple of things I will expand on that Bryan talked about.

Number one, the balance sheet we don't particularly expect to change materially, but a little more color on what we think planned improvements would be.

Number one, first and foremost, is with the mortgage repurchase largely behind us in terms of an earnings drag we obviously have much higher amounts of retained earnings that we would expect over the next couple years that would significantly add to the numerator.

On RWA, obviously we have a big impact from residential real estate, particularly in our nonstrategic portfolio.

But as you have seen over the last several quarters and years that is running off anywhere from 15% to 20% a year.

So assuming that that continues to decline as expected, and there is no reason to believe that it shouldn't, as well as replacing that with better quality, lower risk-weighted assets in the Regional Bank will help materially.

Unfunded commitments are a big issue for us in the industry and I think there is going to be structural ways, for instance, that we change the way that we do business with our clients on booking those.

And so we expect to reduce RWA impacts on those types of things materially.

NPA reductions will continue to come down as our credit quality improves.

Our MSR is going to continue to run off and so there are a lot of things that we have been studying and looking at to improve.

And so we are confident that by the end of 2014, the first quarter of 2015 when the RWA impacts start to layer in, we will be well prepared and have a very solid capital position on which to grow.

Eric, this is Bryan.

You take something like the proposed rules around the capitalization on residential real estate and what that means to mortgage lending and the home equity lending, I don't think this is just a First Horizon question.

I think everybody is going to have to think very differently about how you use your balance sheet when it comes to residential real estate lending and/or the pricing of that product.

And so we are going to take this and process it.

We are already thinking, as BJ said, about how we take actions today and over the next several quarters to plan for 2015 and beyond.

We will also think about the nature of the business we are putting on the balance sheet and how that impacts it.

And so I think we need to sort out of let these rules settle down a little bit, let's see how they get finalized.

As I emphasized before, they are proposed.

The Fed and the OCC and the FDIC are asking for comment on them, and I suspect they are going to get a lot of comment on them.

They will go back and I am sure they will evaluate that, and we will get a final set of rules that we will all know how to adapt to over the next several quarters.

John Pancari, Evercore Partners.

Good morning.

Could you give us some more detail on the driver of the capital markets revenue this quarter?

The decline in that revenue was greater than we had expected.

Thanks.

John, it is BJ.

At this level what we are seeing in our business out there is as rates continue to grind lower it is just counterintuitive for our clients.

They expect that it is going to go up.

And so while there is not loan demand that means that there is still a lot of excess cash at the banks with which to invest, but they are very hesitant to invest and go out on the curve very far.

So they are staying very short.

And, frankly, the difference between investing in a short bond and putting your money at the Fed overnight is not significant enough, given the potential variability or volatility in rates.

And so we are just seeing our clients continue to remain on the sideline until we have a little bit more resolution than what is going on in Europe, a little bit more certainty about where the long rates are going to go, etc.

So we feel good that once there is a little bit more clarity and there is buying we are very well positioned to take advantage of that, but right now there is a lot of caution in our client business.

Okay, all right.

Thank you.

Lastly, Bryan, I know that you mentioned that your remaining buybacks should not be impacted by the NPR on the Basel III rules, but how about longer-term buybacks?

Any renewal of the program once that remaining amount is repurchased?

John, I would say, as I have said in the past, we will take this one step at a time.

We have got this authorization to continue to work on.

We will evaluate capital repatriation I am sure later in the year, early next year, and the mix of between dividend and stock buyback.

And we will work with the regulators at the appropriate time to work through that conversation, so it is premature at this point to speculate.

But as I said earlier when I was responding to Steve, we are thinking about our balance sheet and capital efficiency and all of these things coming together and we are thinking about where our capital ratios are targeted to be in 2014, 2015.

BJ talked about our bonefish ranges on capital.

One point that I would make is we talked about an 8% to 9% Tier 1 common ratio.

If the rules end up the way they are proposed today, given the significant increase in risk weighting of assets, I expect that range comes down and becomes lower over time, so I would have guessed that range would be in the low 8%s than a much wider range of 8% to 9%.

So you have to put all that together and let a little bit of this unfold, and we will evaluate it as we get into the latter part of the year.

But we expect to still have strong generation of capital and the ability to repatriate capital to our shareholders.

Josh Levin, Citigroup.

With regards to the potential exposure to the private-label litigation, you said you think the private-label exposure should be significantly less than the GSE exposure.

It does look like there was an additional lawsuit filed based on what is in your slides.

It also looks like you may have received claims from another underwriter.

Can you provide some additional color here at the margin?

Are you a bit more concerned about this issue than you were, say, last quarter?

Josh, it is BJ.

The answer to your last question is no.

We continue to see lawsuits out in the industry and we continue to see them here.

We continue to see activity on other whole loans, which are loans that we sold to others who then ultimately put it into private securitizations.

That is probably what you were referring to.

Again, there aren't any requests that we are seeing on our branded securitization.

So nothing much has really changed there.

We continue to actively monitor it, but like we said based on the mix of what we did and the size of our securitizations and the performance we continue to be comfortable that it is going to be significantly less than what we saw with the GSEs.

Okay.

On an unrelated topic, yesterday one of your peers said it was going to close up to 5% of its branches given how difficult the environment is.

As you think about going forward, we have low rate environment, regulatory costs; is reducing your footprint and closing branches is that a possibility?

Josh, this is Bryan.

Sure, if you look back over the last two or three years our branch totals declined from just under, say, 200 branches to the mid-170s or so now.

We continue to look at the size and nature of our branch footprint.

Our customer behavior in the branches has changed over the last five years.

It is likely to continue to change and decline over time as technology becomes more prevalent, the ability to bank on your cell phone or the Internet.

And so we expect to continue to look at our branch footprint, to look for opportunities to improve customer service, but at the same time be realistic about customer visits to branches, not only for us but across the industry, are dropping.

And so it is an important part of the distribution system, but it can be done in smaller or fewer branches over the long term.

So, yes, obviously we will continue to look at that as an opportunity to reduce our cost structure and at the same time improve service.

Kevin Fitzsimmons, Sandler O'Neill.

Good morning, guys.

There has been a lot of questions about the mortgage putback issue, but I just really want to verify here, you have said there is no a real change that has occurred since you preannounced the large charge and you said we have a reserve that you think is it for the GSEs.

So is it still a good assumption, reasonable assumption on our part that that repurchase provision line, which has been ranging before this quarter from $40 million to above $50 million per quarter, that that goes down to really an insignificant number when we model for coming quarters?

Thanks.

It is BJ.

Yes, we currently sit here today and expect it to be zero.

We think that we have fully reserved for what we can reasonably expect.

So I guess, BJ, we shouldn't -- I guess what we need to look at is when we see the quarter-to-quarter change in the request, change in the pipeline I guess it is a matter of if that came in in line with your own model when you calculated that reserve.

And so far it is, is that correct?

Yes, that is a good question.

We will continue to show that, because we believe it is important for you all and certainly helpful to you all to understand the flows there.

But as I have said on the call that we had around the 8-K and earlier, we got significant insight, not to just how historically our flows have worked, which helped us validate what we had been seeing, but also what is currently on the plate and what they expect to put back to us in the future.

And those latter two are extremely helpful.

So even as we see increases in our operational pipeline or increases in new requests, etc., that doesn't necessarily mean that that is any different from what they had already talked to us about.

And so, as I alluded to, those were all expected.

I actually said in my earlier comments that we had seen a backlog of requests which we believe drove the new requests.

And that was something, for instance, that we learned when we talked to Fannie Mae and what was going on.

So all of the trends that we have seen this quarter are ones that we fully expected and we expect to be able to have pretty good visibility going forward.

And things that we walked away with, as BJ alluded, is an understanding that this backlog.

We think we understand the sub-elements of the portfolio that drove that.

We think we have a much better sense of what that will play out like over the next now several quarters.

We may see another couple sub-elements of the portfolio lead to another surge later in the year.

But as you sort of summarize all of this what we will now be tracking is our understanding of that loss expectation in those portfolios with how those claims are coming in and looking for changes in GSE behaviors or the nature or type of requests that we are seeing.

And so, as BJ said, everything we have seen through the remainder of the quarter is consistent.

We don't have anything that has really changed our belief structure about what our remaining exposure is.

Matt Burnell, Wells Fargo.

Good morning.

Let me beat this topic a little bit more into the ground in terms of the mortgage repurchase numbers.

From your slide it looks like you are saying that recision rates remain in the 45% to 55% range, average loss severities really haven't changed over the last few quarters in the 50% to 60% range.

And I guess I am just curious as to -- I am presuming -- are those the assumptions that you are using for when you came up with the provision for this quarter?

Or are you assuming, as one of your competitors has recently said, that potentially the loss rates could come down a little bit over time?

Matt, it is BJ.

As I said on the announcement call for the 8-K, we didn't learn anything different about our recision rates or our loss severities from what we were expecting, and this was no different.

So, yes, we didn't see any change to how we came up with the reserve based on what our trends were here.

We did see in the second quarter a higher level of, quote, missing [doc] requests which we have much higher success rate on.

As you might imagine, they don't have lost content necessarily in them; they are just looking to clean up paperwork.

So that would drive a higher success rate in the quarter.

But what we always try to talk about is cumulative success rates and cumulative severities.

And so those haven't changed materially and we don't necessarily expect things to be outside of that range for the foreseeable future.

Let me use my follow-up to ask about the capital markets business.

Obviously that was down a bit quarter over quarter.

I noticed last year that you saw relatively strong levels of capital markets revenue in the second half of the year.

Maybe that is a little counterintuitive given the capital market's environment last year.

How are you thinking about the potential revenue opportunities relative to the second quarter in the second half of the year, given your earlier comments about clients being a bit more cautious in terms of how they are using their cash?

Sure.

As I said, I think we currently expect for the rest of the year to probably be in the lower half of our average daily revenue range.

So our range is $1 million to $1.5 million; we booked $1.1 million this quarter.

Keep in mind, last quarter -- I am sorry, last year this quarter we had $1.1 million, so roughly flat year over year.

So this business is always going to be what I call variable not volatile, so we will make a good amount of money and we will make some great amount of money in certain periods.

This was a period -- this was a quarter where we made a good amount of money, so we are very pleased with the quarter.

Looking forward we are generally assuming with my comments that we don't see a lot of buyers coming off the sideline.

We don't necessarily see improvement in the visibility in Europe or with where rates are going for the second half of the year but to the extent they do improve we could see better buying.

But right now we are staying a little bit more on the cautious side in terms of our outlook there.

If you go back -- this is Bryan.

If you go back and you play out, say, third quarter of 2011, what really picked up in the last half of the year is investor expectations changed.

So as we look at the remainder in the year there are a couple of the drivers.

One, there is a fair amount of cash that has been built up or not invested that in all likelihood is going to get invested at some level.

And, two, investor expectations are going to change.

It is going to depend on what the Fed may or may not do around quantitative easing or operation twist or any statement that may be made there or the long-term debt outlook for the US, etc.

So there are a lot of variables that could change it, but as BJ said, it will have some variability around it.

Even at the $1.1 million a day average daily revenue we are producing north of 2% ROA.

So it is a business that is very profitable to us and we'd obviously like to do more, but it is one that we feel like we can be very effective in and produce very good returns in.

Emlen Harmon, Jefferies.

Good morning.

If we could just wanted to hit on the Regional Bank commercial loan trends for a second if we could.

Saw a bit of a conflicting signal in that the pipeline was down quarter over quarter but you did see a pickup in fundings.

Just give us a sense of just what the dynamic is there and maybe what you guys are seeing kind of geographically within your footprint in terms of demand and lending trends.

Emlen, it is BJ.

I think there is a pretty tight correlation between pipeline and funding, so if you look -- for instance, if you remember fourth quarter to first quarter we actually saw the pipeline up but the fundings down.

And it just simply meant that the cycle time was different.

So our fundings didn't happen as much in the first quarter, but then we saw good fundings in the second and that means that those loans come out of the pipeline.

So pipeline and funding it's going to ebb and flow, but we still think both of them are very healthy, and it is showing up in our loan growth, period-end loan growth in the Regional Bank at 3%.

We have continued to see good growth in loans to mortgage companies, which is nice, but we have also seen good growth, solid growth, good return growth in corporate lending, which is pleasing to us.

Some modest growth in our core C&I lending and on the consumer side we have seen some healthy growth there in installment real estate.

Our bankers continue to be very disciplined and focused.

We talk to them all the time about getting the appropriate returns, appropriate credit quality and structure.

Even with that the activity that they are generating in a modest environment is very impressive and we are proud of the growth and the quality of the growth that we are seeing.

Emlen, this is Bryan.

I will add to what BJ said.

If you back away from the quantitative and focus on the qualitative aspects of it for a second, I am really proud of the calling efforts that our bankers are making.

They are doing a fantastic job calling on customers.

We are winning great relationships.

We are building strong relationships for the long term.

You see some real pockets where the pipeline, although it may be down slightly from quarter to quarter based on a number of factors, the quality number of customers that we think is going to close over the next several months is really improving.

I am really pleased with what our bankers have done over the last year and I like the momentum we have got going into the remainder of this year.

I think we are winning good relationships, we are picking up some market share and doing a great job executing in terms of discipline over the long term.

So it may ebb or flow a little bit from a pipeline perspective, but I think the momentum continues to be strong and I think, as you get to the end of this year it is going to look pretty good.

Marty Mosby, Guggenheim.

I wanted to focus on two things.

One is the capital again and then the other is going back to the some mortgage number this quarter.

First on the capital, I think what we are seeing is a spot rate problem that you took the charge this quarter drops your Basel I number, and then you're introducing the Basel III impact which then drops what last quarter was a 12% number kind of in a spot mine in the market down to about an 8% number.

However, when you look at what you are going to be doing going forward, the 10.6 under Basel I is really what matters in a sense of what you are going to be managing to.

And then you've got $200 million of roughly annual earnings that you have coming forward in the future.

So when you start looking at capacity to still repurchase, you really have to factor in the fact that you took that big charge this quarter, but that is really just accelerating and improving earnings in the future which then gives you more capacity to repurchase out of earnings versus the spot rate on capital.

Yes, makes sense.

In general, is that how you look at that in a sense of being able to utilize that hit this quarter does really free up, in the sense of $250 million, over time capital that you could repurchase?

Marty, this is Bryan.

There is no doubt that the $250 million charge and the $22 million around litigation reduces the starting point, and it does, assuming that that is a difference in when those losses would have been incurred from an accounting perspective, that does change the earnings trajectory in the out-years.

And so that does rebuild -- or out-quarters -- that does rebuild.

So I think that is a great way of describing it.

Then two, I would say, and it also incorporates the fact that we will look at the effective use of our balance sheet and the mix and the profitability of the product we are putting on.

The other spot rate issue was the hit to kind of Tier 1 common under Basel III, but when you look at that particular issue -- we had this happen last week, as well, with another company.

This is a temporary situation since between now and 2015, like you said, the portfolio changes, so you get to recapture that just on the natural runoff that would happen.

When you are doing discussions with regulators and they are talking about Basel III are they interested in what it is today or more interested in really what it is in 2015?

We are not having those discussions at this point, Marty.

These are proposed rules; they are in the comment period and so it is really not a regulatory discussion that we are really having much about.

We keep our regulators apprised of how things look like they might play out, but we are not at the point where we are focused on -- whether we are focused on end of 2014 or end of 2018, we are still working through how the rules finalize and developing our comments, in fact, for how we will respond to the request for comment.

Then, BJ, I wanted just to drill down to the mortgage number just one more time, given some of the information you gave early on.

Last quarter you had $23 million worth of mortgage banking fees.

Your hedge number was a positive 9 you said, your MSR value was constant at 68 basis points, so there wasn't really any shift in MSR value, which leaves $14 million in the other bucket which I am equating to the general fees that you get off the portfolio each quarter.

If you roll to this quarter at $10 million, hedge goes down to 2 but you actually increase the value of the servicing book from 68 basis points to 71, which means that that kind of middle part, or the operating part, would have had to drop from $14 million to $2 million.

So I understand the hedging doing a little less beneficial, but you also had that positive over in there in the value of the servicing portfolio.

So it seems like the core part is missing something and I was just try to get my hands around that.

Marty, it is BJ.

Yes, if you go to our financial supplement, we actually have a breakdown of all the ins and outs of our non-interest income related to mortgage.

It is in the nonstrategic.

But if you look at it, we had $10 million that is noninterest income 2Q versus $26 million 1Q.

The biggest changes were servicing fees were down a couple million dollars, we had $1 million change in the MSR value due to runoff, and then the biggest change being the net hedge results down from $9 million to about $1.8 million or so.

So it is all laid out back there on slide 19 as a supplement if you want to go through it.

And it looks like the other income is where a lot of that core came out of.

Is that something that would go back to something in the neighborhood of $3 million?

Is that kind of that modest adjustment you were talking about that was more of a one-timer this quarter?

Yes, yes.

If you look in the footnote there, it was a $2.3 million adjustment on a contingency related to prior servicing sales.

So that is a one-time type event, so you can assume that that [goes this] quarter.

And, BJ, if you would humor me with one more, the pension-related expenses that you are assuming are embedded in the $1 billion at the end of this year, how much benefit do you get out of that as you roll into 2013?

Let's see, let me do the math in my head.

It is about $25 million full-year cost.

I take that back, $25 million to $35 million.

Ryan Nash, Goldman Sachs.

Just one other question on the GSE putbacks.

In terms of commentary, one of your competitors noted that the GSEs have indicated that towards the end of the year they would start requesting files for I guess any loan that went nonperforming.

Was that the base case assumption that you assumed for your potential lifetime loss estimate?

Ryan, it is BJ.

Like I said, they give us visibility to -- not just what is currently selected but they broke it into two buckets for us actually.

One was current liquidated loans and the actual number of loans they expected to put back to us out of that bucket.

And the second was a bucket of seriously delinquent loans and the exact number of loans that they would expect to put back to us out of that population.

So the first one on liquidated loans, they gave us full visibility on what they would have expected to put back so we believe that we have got that captured.

Okay, that makes sense.

Then just in terms of the 10.5% Basel III number, can you give us a sense what type of assumptions were there made within that in terms of capital return or is that just all mitigation?

Won't go into very specific details, but we assumed a continued run rate on dividends.

We assumed some retained earnings from increased earnings over those time periods, so I don't want to get into particular capital actions but we assumed some.

Christopher Marinac, FIG Partners.

I wanted to ask about loan yields and just the ongoing stability that you have shown there.

Is there any reason that that would change in the next couple quarters, just given kind of what you see in terms of rollovers and the portfolio turning?

It is BJ.

We have worked really hard, or our bankers have, on trying to defend those yields as well as we could and it shows up in our numbers.

They have done an excellent job.

I don't particularly see any material change, though the longer the interest rate environment goes on the harder and harder it is to defend that.

I think we have talked about before that roughly 65% of our book is floating rate, 35% fixed.

That 35% is very hard to reprice and continue to keep yields up, so that is where we lose traction every time we see a payoff there.

But like I said earlier, our bankers are looking for every opportunity to appropriately price in today's environment for both risk and reward.

So we continue to believe that we will be able to defend our yields as well as we can.

BJ, if you look at the duration, maybe even just on the C&I piece of the portfolio or even real estate, is that going to evolve higher than you typically have or would you expect to manage it sort of similar in the past?

The duration risk?

Correct.

Chris, that really doesn't change much.

It will depend on what kind of loans you are putting on, whether you are putting on a real estate loan or a C&I loan.

But given that the vast majority of what we put on the balance sheet is floating rate, you have got longer -- you may have a difference in tenor, but in terms of sensitivity to interest rate risk it is really not changing a whole lot in terms of duration as it relates to interest rate risk.

Kevin Reynolds, Wunderlich Securities.

Good morning, everyone.

Bryan, I had a bigger picture question.

As we look at the bonefish and you look at 1.25% to 1.45% being your long-term ROA targets, I know that a prolonged interest rate environment or low interest rate environment is an impediment.

But beyond that what are the other things that you look at out there?

And now that you have fast forwarded your expense guidance a year, what else do you look at that could derail you a little bit there from achieving those goals?

I guess you can come up with a bunch of hypotheticals, Kevin.

I feel good about our ability to hit these targets.

As you said, not only us but everybody could benefit from a steeper and a higher nominal level of interest rates, but that is an industry-wide issue.

I guess you could see additional impact as it relates to fee revenues, related to changes in consumer banking in particular and maybe some on the commercial side.

But I don't think there is anything that really seemed like a looming threat out there on the horizon that causes us concern about our ability to hit these longer-term targets.

We feel like we are executing day in and day out.

Our bankers, our capital markets folks, our entire organization is focused on how we drive the profitability of the business.

They understand these targets and I think all (technical difficulty) we are on track towards hitting those.

And then I guess one other question on capital markets.

I know there is the uncertainty in the interest rate environment, but in years past if loan demand picked up your depository customers would use some of that excess liquidity and you would see daily activity fall.

Is there any of that going on?

Because I know there has been -- regardless of the type of loans that are being originated there have been stronger loan originations this quarter than many believed were coming.

Is there any of that going on or is that perhaps just wishful thinking?

Well, I would suggest that there is not a whole lot of pickup in loan demand.

All generalizations are wrong and there will be somebody out there that will have seen a big pickup.

I think what you're seeing right now in broad sense is loan demand that is consistent with an economy that is growing in the 1% to 2% range.

There is an awful lot of competition for the deals that are out there.

It manifested itself in pricing and structure.

So I am sure we have got some customers out there that are seeing some pickup in loan demand, but I think at the end of the day it is not a system-wide or economy-wide pickup in demand.

And I think these capital rules are going to have an impact on what that loan demand pickup looks like, because it is going to make it prohibitive to put mortgage product on the balance sheet, for example, with these capital rules.

So there is a lot of things that are going to impact what happens industry-wide in the balance sheet.

I think all of those give us some comfort that we will continue to see strength in the capital markets business and it is likely to be a steady business for us for the next several quarters.

Dave Bishop, Stifel Nicolaus.

Thank you.

Good morning, gentlemen.

In terms of the loan-loss provision relative to the commentary in regards to maybe the outlook for loan demand here, a near doubling from last quarter obviously reflecting some growth.

Should we expect that to sort of represent a sort of normalization of provision relative to revenues, or if we do see some diminution we should expect that to rein in a little bit?

This is BJ.

According to our bonefish targets our normalized provision would be around 50 basis points or so on loans, so that would be anywhere from $15 million to $25 million range.

We expect to be within that over the next several quarters.

As we have talked about, we expect to see continued improvement in net charge-offs.

We expect to continue to see improvement in grading and grade migration.

But with the reserve at 190 basis points we still see continued improvement there to be able to bring some reserve down appropriately, but it is going to happen at a slower pace.

So we are very mindful of having sound and adequate reserves and credit quality, but with continued improvement in our portfolios we will expect continued improvement in the provision.

Mike Turner, Compass Point.

When I look at what you have done so far, the new NPRs are a hit to capital, but at this point it is proposed so who knows how they ultimately shake out.

You are ahead of the game on your cost cuts and preparing as if the Basel III is going to happen as it stands today.

When I look out -- as it is today you probably have about $250 million in excess capital just based on the spot, the 8.2% Tier 1 common.

The amount for private-label put backs, at this point it is anybody's guess if you get any or what the dollar amounts could be, but if they do come they could be -- maybe they could be substantial.

Who knows what the dollar amount is.

In that scenario, why would you even want to buy back another dollar of stock like -- you are trying to build capital for the future.

Just thinking about that buyback, would it be more prudent just to hold back in terms of the unknown, or how do I think about that?

Mike, this is Bryan.

As we look at our capital actions, we do extensive stress testing.

We capture all of the known and we estimate even unknown exposures in our stress testing.

As we have said over the last several quarters, we factor in the impact of mortgage repurchase, both with the GSEs and any potential exposure that may exist with the private labels.

And so all of that is factored into our calculations.

We are comfortable in our analysis of the capital situation that we can be opportunistic, we can look for opportunities to repurchase stock, and we will continue to intend to do so.

I am not showing any further questions at this time.

I would like to turn the conference back over to Bryan for closing remarks.

Thank you, operator.

Thank you all for joining our call this morning.

Please let us know if you have any additional questions or follow-up that we can help with.

I hope everyone has a great weekend.

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

You may now disconnect and have a wonderful day.