Fifth Third Bancorp (FITBP) 2012 Q2 法說會逐字稿

Good morning. My name is Rebecca and I will be your conference operator today. At this time I would like to welcome everyone to the Fifth Third Bank earnings conference call. All lines have been placed on mute to prevent any background noise. After speakers' remarks there will be a question-and-answer session. (Operator Instructions)

Thank you. I would now like to turn the call over to Mr. Richardson. Sir, you may begin your conference.

Thanks, Rebecca. Good morning. Today we will be talking with you about our second-quarter 2012 results.

This call may contain certain forward-looking statements about Fifth Third pertaining to our financial condition, results of operations, plans, and objectives. These statements involve certain risks and uncertainties. There are a number of factors that could cause results to differ materially from historical performance in these statements. We have identified some of these factors in our forward-looking cautionary statement at the end of our earnings release and in other materials, and we encourage you to review them. Fifth Third undertakes no obligation and would not expect to update any such forward-looking statements after the date of this call.

I'm joined on the call by several people. Kevin Kabat, our President and CEO; Chief Financial Officer Dan Poston; Chief Credit Officer Bruce Lee; Treasurer Tayfun Tuzun; and Jim Eglseder of Investor Relations.

During the question-and-answer period, please provide your name and that of your firm to the operator. With that, I'll turn the call over to Kevin Kabat. Kevin?

Thanks, Jeff. Fifth Third reported strong second-quarter results that followed a very strong first quarter as well. Net income to common shareholders was $376 million, and earnings per diluted common share were $0.40, up 14% from a year ago.

As outlined in the release, EPS results included $0.04 of benefit from gains on the warrant we hold in Vantiv, as well as the effect of seasonally higher income tax expense, which reduced quarterly earnings by about $0.02. So earnings strength was also very evident underneath the headline result.

Second-quarter return on assets was 1.3% and return on tangible common equity was 14%.

Despite a sluggish economic environment, core trends in our operations remained favorable, as evidenced by solid loan growth, continued revenue strength, particularly in mortgage banking, and our ability to manage expenses during the quarter. In addition to mortgage, other revenue growth drivers included card and processing revenue, up 9% on higher transaction volumes, and corporate banking revenue, which was up 5% during the quarter as lending volumes and associated business production remained healthy.

We continue to generate solid loan growth, particularly in C&I loans, which were up 4% sequentially on an average basis. Average portfolio loans were up 6% from a year ago, driven by a 17% increase in both C&I and residential mortgage loans.

Expenses were down 4%, reflecting both continued careful expense management and the benefit of a couple of unusual items. As a result, PPNR results were again very strong and north of 2% of assets, despite the current interest-rate headwinds for the industry.

Credit trends also continued to improve. Quarterly chargeoffs of $181 million were down 18% sequentially and 40% from a year ago to the lowest level we have seen since the end of 2007.

The net charge-off ratio was 88 basis points, down 20 basis points from last quarter. That kind of reduction is both more than expected and sooner than expected.

Capital levels also continue to be very strong, with a Tier 1 common ratio of 9.8% and tangible common equity ratio of 9.5%. On June 8, we submitted our annual capital plan to the Federal Reserve, which we believe should address the basis for the Fed's objections.

Our resubmitted plan, like our original plan, included increasing our quarterly dividend and initiating common share repurchases beyond those in the amounts of gains from the sale of Vantiv shares. The plan was developed using updated macroeconomic scenarios as of March 31, which did not require substantial changes to our basic capital distribution plans.

As we have previously discussed, we did make certain adjustments to the assumed timing of distributions, given the changed timeline relative to the plan submitted in January. We currently expect a response from the Fed by late August, given our submission in early June. While I realize there is a high level of interest in this, we can't provide additional information, given the nature of this process.

Now, looking ahead to the second half of 2012, the overall economic picture remains about where it has been for the last year or so, and so we remain focused on blocking and tackling, making sure that we are out on the street talking to our customers and prospects person-to-person.

We remain focused on our customers and their needs, ensuring they have a valuable partner at the table offering real solutions, and it is paying off today. In fact, in a recent study the American Banker and Reputation Institute measured consumer perception of the top 30 US banks, and Fifth Third Bank was one of only eight banks to improve its reputation rating over the past year. Only two banks showed greater improvement than Fifth Third.

We are seeing the benefits of these actions in our production and our results. While Dan will discuss our outlook in more detail, we expect another set of strong results in the third quarter, with similar core revenue results, continued expense discipline, and continued credit improvement.

At this point I'll turn it over to Dan. Dan?

Thanks, Kevin. I'll start today with slide 4 of the presentation. As Kevin discussed, second-quarter results were strong, driven by favorable mortgage banking and corporate banking revenue results, continued expense discipline, and lower charge-offs and provision.

For the quarter, we reported net income of $385 million and recorded preferred dividends of $9 million. Net income to common shareholders was $376 million, and diluted earnings per share were $0.40.

Second-quarter results included $56 million in gains on Vantiv warrants, or about $0.04 per share on an after-tax basis. Earnings were reduced by $19 million or about $0.02 per share from the seasonal effect of stock options expirations on income taxes. There were a number of other unusual items which we outlined in our release, which more or less offset one another from an earnings perspective.

You'll recall that first-quarter earnings per share of $0.45 included several income items related to Vantiv that together contributed a total of $127 million in fee income for the quarter, or about $0.09 per share on an after-tax basis. All in all, we saw good momentum this quarter really across the whole Company, which was borne out in our earnings results.

Taking a look at slide 5, tax-equivalent net interest income decreased $4 million sequentially to $899 million; and the net interest margin decreased 5 basis points to 3.56%, both of those in line with our expectations. The decline in net interest income was primarily driven by asset yield compression in the securities portfolio and the loan book, but was partially offset by net loan growth. Vantiv's refinancing in March reduced NII by $2 million, and higher purchase accounting accretion increased NII by $2 million.

Interest expense declined as a result of lower hedge ineffectiveness and a deposit mix shift into lower-yielding products. You recall that hedge ineffectiveness increased interest expense last quarter, while we had a benefit of $1 million in the current quarter.

The 5 basis point decline in net interest margin during the quarter was in line with our expectations, despite the negative impact of the sharp drop in longer-term rates in late May and in June. Margin compression was driven by lower securities and loan yields, and partially offset by deposit mix shift and the impact of hedge ineffectiveness on the first quarter.

On the loan side, we see continued slow compression in yields driven by loan repricing, particularly in the C&I and auto portfolios. On the C&I side, portfolio average yield was down 7 basis points compared with last quarter. Yields on new originations have remained relatively stable, so the reduction in portfolio yields is largely due to the portfolio effects of repricing and a mix shift toward higher-quality loans.

On the indirect auto portfolio, the portfolio average yield also continued to decline, reflecting both increased competition in this space as well as the portfolio effect of replacing older, higher-yielding loans with new, lower-yielding loans. We will continue to closely manage pricing and loan volumes to ensure that the returns in this space remain appropriate.

Looking forward, we currently expect NII in the third quarter to be relatively stable in the $900 million range. On the plus side, our redemption of TruPS in August will benefit third-quarter NII by about $4 million, and day count will add another $5 million or so. Offsetting those benefits will be an estimated $5 million in lower purchase accounting accretion, with the remainder of the decline primarily related to the impact of repricing on the investment securities portfolio.

In terms of the margin, we currently expect NIM to decline 2 or 3 basis points in the third quarter. That would reflect about 2 basis points of benefit from the TruPS redemption, offset by 2 basis point detriment from lower purchase accounting accretion and 1 basis point negative effect of day count. The remaining decline is a couple of basis points which is largely due to repricing.

Our expectation today would be for NII to be stable or perhaps up modestly in the fourth quarter, with margin compression of a few basis points, similar to what we expect in the third quarter.

Turning to the balance sheet and slide 6. Average earning assets increased $1.2 billion sequentially, driven by $1.1 billion of growth in average portfolio loans and a $400 million increase in securities, partially offset by a reduction in loans held-for-sale. Average securities portfolio balances reflect the pre-investment of portfolio cash flows during the quarter, as well as higher cash balances held at the Fed, which are included in short-term investment balances. We would expect average securities to be down modestly in the third quarter but to remain fairly stable in light of the current rate environment and outlook.

Average portfolio loans and leases increased $1.1 billion sequentially, driven by higher C&I and residential mortgage balances. Average loans held-for-sale were down $337 million during the quarter, driven by decreased residential mortgage warehouse balances.

Looking at each portfolio, average commercial loans held for investment increased $973 million sequentially or 2%, and $3.3 billion or 8% year-over-year. C&I loans increased to $32.7 billion or a 4% increase from last quarter and a 17% increase from a year ago.

Our C&I production continues to be strong and has been broad-based across industries and sectors. Demand continues to be strongest in the large corporate and mid-corporate space, although refinance activity into the capital markets by these borrowers in the second quarter reduced growth somewhat. Commercial line utilization remained at 32% this quarter, which is consistent with last quarter.

Given our strong levels of production and pipelines, we expect continued solid C&I growth in the second half of the year. Commercial mortgage and commercial construction balances declined in the aggregate by $316 million sequentially or 3%. We have seen most of the runoff that we expect to see in these portfolios, and thus they shouldn't be much of a drag on commercial loan growth as we go forward.

Average consumer loans in the portfolio increased $113 million sequentially and $1.3 billion compared to a year ago. Residential mortgage loans held for investment were up 4% sequentially. The sequential growth reflected strong originations during the quarter due to the rate environment and the continued retention of jumbo loans and certain shorter-term, high-quality residential mortgages originated through our branch retail system.

Average auto loan balances declined 1% sequentially as we managed volume and pricing in that business over the last several months. As I mentioned earlier, we reduced our origination volumes for competitive reasons, where the profit potential wasn't there.

Home equity loans were down 2% sequentially. And average credit card balances were down slightly due to seasonality. Looking ahead in the third quarter, we expect loan growth to be driven by continued solid growth in C&I loans as well as the mortgage portfolio.

Moving on to deposits. We continue to manage our deposit book by focusing on higher-value transaction deposits while managing nonrelationship deposit accounts down. In total, average core deposits increased $294 million from the first quarter.

Average transaction deposits, which exclude consumer CDs, were up 1% sequentially, and 9% or $6 billion from a year ago. Growth in transaction deposits was largely driven by interest checking balances, which were up 6% from the prior quarter and 26% from a year ago.

Consumer CDs continued to decline, down $192 million in the quarter, driven by our continued disciplined approach to CD pricing. For the third quarter, we currently expect transaction deposits to be relatively stable compared to the second quarter and for consumer CD balances to continue to decline.

Turning to fees, which are outlined on slide 7, second quarter non-interest income was $678 million, a decrease of $91 million from last quarter, which benefited from the effect of Vantiv's IPO. There were a number of items that affected each quarter.

Second-quarter results included a $56 million positive valuation adjustment on Vantiv warrants as well as $17 million in charges related to the Visa total return swap, $17 million negative valuation adjustments on property held-for-sale. Net investment securities gains were $3 million in the quarter.

First-quarter results included $127 million in net benefits related to Vantiv's IPO and warrants, $19 million in Visa charges, and $9 million in securities gains. Excluding those items from both quarters, fee income of $653 million was up $1 million from a pretty strong first quarter. Underlying fee results included another strong quarter in mortgage banking revenue, which was down slightly from the first quarter; a 9% increase in card and processing revenue; and a 5% increase in corporate banking revenue.

Looking at each line item in detail, deposit service charges increased 1% sequentially and 4% from the prior year. Sequential comparison was driven by a 2% increase in commercial deposit fees and a 1% decline in consumer deposit fees.

The year-over-year comparison reflected a 7% increase in commercial deposit fees, largely due to new customer account growth, which was partially offset by a 1% decline in consumer deposit fees. For the third quarter, we expect to see a slight decline in deposit fees, which includes the effect of our elimination in June of daily overdraft fees on continuing customer overdraft positions.

Investment advisory revenue decreased 4% from last quarter and 2% on a year-over-year basis. Sequential decline is largely due to the first-quarter positive seasonality in trust tax preparation fees. Otherwise, revenues reflected overall market valuation trends and the effects of market volatility on customer activity. We currently expect investment advisory revenue to be stable to modestly higher in the third quarter.

Corporate banking revenue of $102 million increased 5% from the first quarter and 7% from last year. Sequential increase was driven by higher foreign exchange, institutional sales, and interest rate derivative revenue. We expect third-quarter corporate banking revenue of about $100 million, consistent with the strong second quarter [loans].

Card and processing revenue was $64 million, up $5 million from the first quarter and down $25 million from a year ago. The year-over-year decline was driven by the impact of debit interchange legislation, which cost us about $30 million on a quarterly basis. That was partially offset by increased transaction volumes and mitigation activity in this line item.

The sequential increase was driven by higher transaction volume, which is more reflective of the growth in this business. We expect transaction volumes to drive continued growth in card and processing revenue during the third quarter.

Mortgage banking net revenue of $183 million declined $21 million from the near-record levels in the first quarter, but increased $21 million from a year ago. Originations were $5.9 billion this quarter versus $6.4 billion in the first quarter.

Gain on sale margins were wider in the second quarter, reflecting market trends and a higher proportion of retail channel and HARP originations. As a result, gains on deliveries were $183 million, up $9 million from the previous quarter.

MSR valuation adjustments, including hedges, were a negative $22 million this quarter versus a positive $15 million in the first quarter. Currently, we would expect mortgage banking revenue to be up about $10 million or so in the second quarter, with gains on deliveries similar to our strong second-quarter levels and with lower MSR valuation adjustments. We expect deliveries to increase modestly and margins to be slightly lower.

Turning next to other income within fees. Other income was $103 million this quarter versus $175 million last quarter. Second-quarter results included the $56 million Vantiv warrants gain, the $17 million valuation adjustment on Visa total return swap, and the $17 million valuation adjustment on bank premises held-for-sale.

First-quarter results included net benefits related to Vantiv's IPO and warrants of $127 million and a $19 million charge on Visa total return swap. Exclude these items, other income was $81 million compared with $67 million in the first quarter.

Credit costs recorded in other non-interest income were $17 million in the second quarter compared with $14 million last quarter. We expect third-quarter credit costs and revenue to be down modestly.

Looking at overall fee income expectations for the third quarter, we currently expect fee income in the $670 million range, plus or minus, up about $15 million from the second quarter, excluding the significant items that I discussed earlier. Our outlook does not include any assumption with respect to the Vantiv warrant, which is a mark-to-market asset. The $56 million gain we recognized in the second quarter was driven primarily by a $3.60 dollar increase in Vantiv's stock price during the quarter; and that relationship should produce a decent estimate of changes in our valuation, if you would like to track that.

Turning to expenses on slide 8, noninterest expense of $937 million declined sequentially by $36 million or 4%. Current quarter expenses included a $9 million reduction to FDIC insurance expense and an $8 million benefit from the sale of affordable housing investments.

You will recall that expenses in the prior quarter included a tax-related benefit of $23 million, offset by $28 million in various other charges. If you exclude these items, noninterest expenses of $954 million were down $14 million.

That decrease reflected a $17 million decline in FICA and unemployment expense from seasonally high first-quarter levels, partially offset by a $12 million increase in initial marketing costs in support of our new branding campaign that we talked more about in April. Otherwise, expenses were down $9 million, primarily in compensation expense.

Credit-related costs and operating expense were $41 million, up $7 million from last quarter and in line with our expectations. Mortgage repurchase expense was $18 million this quarter compared with $15 million last quarter and reflected continued stable loss realization from GSE putbacks.

We expect that to generally continue, although I would note that the GSEs have indicated to us that toward the end of this year they plan to start requesting files for any loan that is nonperforming. That will likely lead to an increase in repurchase claims and some increase in repurchase expense. However, we expect that overall repurchase expense will continue to remain at relatively manageable levels for us.

In terms of the third quarter, we currently expect total credit-related costs recognized in expense to increase about $5 million from the second-quarter levels.

Overall for the third quarter we expect core operating expense of about $970 million to $975 million, up about $15 million to $20 million, from $954 million in core expenses this quarter. That increase reflects about $8 million in expected pension curtailment expense, which is a seasonal item. The remaining increase in branding-related marketing expense of about $6 million to $7 million, as well as higher mortgage incentive and fulfillment costs. As a reminder, we expect marketing expense to return to more normal levels in the fourth quarter, reducing expenses by about $15 million from third-quarter levels.

Additionally, due to our redemption of TruPS in August, we will incur about $27 million in net charges due to the hedge termination and the write-off of unamortized debt issuance costs. Those charges will also be recorded in noninterest expense.

Moving on to slide 9 and PPNR. Pre-provision net revenue was $636 million in the second quarter compared with $694 million in the first quarter. Excluding the items listed on the slide, which are also outlined in our release, PPNR in the second quarter was $594 million, up $12 million from the first quarter and about $25 million better than we were anticipating coming into the quarter. We expect third-quarter core PPNR to remain strong in the $585 million range, excluding the TruPS-related charge that I mentioned of $27 million.

The effective tax rate for the second quarter was 31.8% due to tax expense of $19 million associated with the expiration of employee stock options during the quarter. We currently expect the effective tax rate to be in the more normal 28.5% range for the third and fourth quarters.

Turning to capital, which is outlined on slide 10, capital levels continue to be very strong. Tier 1 common increased 13 basis points to 9.8%. Tier 1 capital was 12.3%, up 11 basis points from last quarter. And the total capital ratio was 16.2%, up 17 basis points from the first-quarter levels.

Tangible common equity was 9.5%, including unrealized gains of $454 million after-tax, and 9.2% if you exclude those.

During the quarter, we repurchased $75 million of common shares from our after-tax gains related to the sale of Vantiv shares. This reduced capital ratios by about 7 basis points during the quarter.

Looking forward, as we outlined in our release we are currently evaluating the regulator's Notices of Proposed Rulemaking for capital standards. The proposed rules for capital definitions and required ratios are in line with Basel III and our expectations.

The proposed standardized approach contains a number of elements that have not previously been proposed in the US or in Basel. We haven't completed our evaluation and interpretation of these rules, which are subject to comment and to change.

However, our initial evaluation suggests that the rules as proposed would increase our risk-weighted assets and that our pro forma Tier 1 common ratio would likely be lower than our current Tier 1 common ratio of 9.8%. Whatever the final shape of the rules, we are comfortable that we will continue to have significant excess capital and that our capital ratios will substantially exceed the new well-capitalized minimums and the new buffer minimums, including (technical difficulty) phase-in of those new regulations.

That wraps up my remarks. Now I will turn it over to Bruce to discuss credit results and trends. Bruce?

Thanks, Dan. As Kevin mentioned, we had a really good quarter in terms of continued credit improvement. Certainly it is the best overall level of credit performance for Fifth Third since 2007, prior to the financial crisis.

Starting with chargeoffs on slide 11, total net chargeoffs of $181 million declined $39 million or 18% from the first quarter, and $123 million or 40% from a year ago. Commercial net chargeoffs of $78 million declined 24% sequentially and 45% from last year.

67 basis points of losses was the lowest level reported since the fourth quarter of 2007. We saw improvement in C&I net chargeoffs, down $8 million sequentially, and in commercial net chargeoffs, down $5 million. However, the biggest improvement was in commercial construction net chargeoffs, which were a net zero compared with $18 million last quarter.

I would also note that our homebuilder portfolio balances are down to $376 million, less than 12% of peak levels and representing less than 1% of total loans. Commercial lease chargeoffs increased to $7 million due to one large chargeoff that accounted for the entire amount.

Total consumer net chargeoffs were $103 million, down 13% sequentially and 37% from a year ago. Improvement was broad-based and reflects underlying trends in overall consumer credit environment and the impact of our previous portfolio management actions.

All-in, it was a good quarter for us from a credit perspective and we continue to see steady improvement across our loan portfolios. Looking ahead to the third quarter, we currently expect net chargeoffs to be down about $10 million or so.

Now moving to nonperforming assets on slide 12. NPAs, including those held-for-sale, totaled $1.7 billion at quarter-end, down $111 million or 6% from the first quarter. Excluding held-for-sale, NPAs were $1.6 billion, down $54 million or 3%.

Commercial portfolio NPAs, $1.2 billion, and declined $43 million sequentially, driven by commercial OREO which was down $40 million. We saw improvement across most portfolio categories, with commercial construction NPAs down $30 million; commercial mortgage NPAs down $13 million; and commercial lease NPAs down $5 million. C&I NPAs were up $5 million, or 1%.

Within portfolio NPAs, commercial TDRs on nonaccrual status were down $10 million on a sequential basis. Commercial accruing TDRs were down $26 million and remained fairly low at $455 million. We expect to continue to selectively restructure commercial loans where it makes economic sense for the Bank.

In the consumer portfolio, NPAs declined $12 million to $437 million, or 122 basis points, with NPLs down $5 million and OREO down $7 million. Accruing consumer TDRs were flat sequentially, and nonaccruing consumer TDRs were down $8 million in the quarter.

The TDR book continues to perform in line with our expectations. The portfolio has been relatively stable the past several quarters, as opportunities for new restructurings have become more limited due to our past proactive practices and more stable residential real estate credit conditions.

Looking ahead to the third quarter, we currently expect NPAs to continue to decline, with the majority of the improvement in the commercial portfolio, which should be down about $100 million.

The next slide, slide 13, includes a roll-forward of nonperforming loans. Commercial inflows at $203 million were up $35 million in the second quarter. The increase is attributable to two or three larger credits that we expect to cure with no loss this quarter. We currently expect third-quarter inflows to be closer to first-quarter levels. Consumer inflows for the quarter were $182 million, down $2 million.

Moving to slide 14, which outlines delinquency trends. Loans 30 to 89 days past due totaled $370 million, up $3 million from last quarter, with consumer up $14 million and commercial down $11 million. Loans 90-plus days past due were $203 million, down $13 million from the first quarter.

Total delinquencies of $573 million were down $10 million from last quarter and remain at pre-crisis levels. I would also mention that our commercial criticized asset levels continued to improve in the second quarter, down over $400 million or about 6% sequentially.

On to provision and the allowance, which is outlined on slide 15. Provision expense for the quarter was $71 million and included a reduction in the loan-loss allowance of $110 million. Coverage of nonperforming assets remains strong at 125% and 2.8 times annualized chargeoffs. We expect to see continued declines in the reserve.

Slide 16 outlines our recent mortgage repurchase experience. The vast majority of our activity has been with the GSEs. And as Dan mentioned earlier, those claims and losses associated with them have remained fairly stable the past several quarters, although we expect this will likely increase some with increased file requests. We've provided a detailed breakout of loans sold by vintage and remaining balance.

Repurchase requests and losses have been concentrated, about 80%, in the 2005 to 2008 vintages, which represent just 14% of balances.

Overall results for the quarter demonstrated significant improvement in our credit metrics. And while we still have work to do, we remain headed in the right direction.

I'll turn it back over to Kevin now for the closing remarks. Kevin?

Thanks, Bruce. As Dan and Bruce outlined, it was another strong quarter for Fifth Third. Our core businesses continue to perform well and have good momentum as we head into the second half of the year. Credit results also continue to trend favorably, and I appreciate the focus and the hard work of employees this quarter as we move forward.

So, that wraps up our remarks. Rebecca, can you open the line for questions?

(Operator Instructions) Paul Miller.

Yes, hey. Thank you very much, guys. Yesterday there was -- a couple of your competitors on a call said that Ohio, the Midwest, has some of the most competitive pricing out there for commercial loans. I was wondering if you could add some color to that.

Morning, Paul. As we talked about last quarter, I think that comment was made by competitors as well. And from our standpoint, it is competitive, it continues to be competitive, although we feel like from our perspective and the growth that we've have that -- and as we mentioned in terms of our comments earlier, pricing on new production has been relatively stable, and we feel pretty good about the value we are getting for prices paid from that perspective.

So, again from our standpoint, it is competitive out there. We are being disciplined I think and sensible in terms of where we are targeted and where we are focused in competing.

I think you see that relative to our commentary on the indirect auto paper, for example. But we feel really good about the value we are creating long-term for shareholders with the new business we are putting on at this point.

Just a quick follow-up. Have you seen any slowdown in activity of loan demand, given the recent news reports about the fiscal clash and troubles in Europe? Or is the Midwest a little bit different?

What I would tell you, Paul, is that we still see good, solid growth. Our production continues to be good. Our pipelines continue to be good.

We have seen some of the higher-quality, larger credits going to the capital markets where they can refinance debt at historically low levels. But production continues to be good.

I think there is generally a consensus out there and a tone of cautiousness in the marketplace, and I think people are watching and paying attention to what is going to happen later this year and some of the resolution of some significant issues that will have consequences on the economy directly in the first part of next year. But again from our standpoint, we are still seeing good activity to drive the momentum that we've had continuing.

Hey, guys. Thank you very much.

Todd Hagerman, Sterne, Agee.

Bruce, just a question on credit and your outlook, if you will. Kevin, I think you mentioned that in terms of the credit quality improvement it seems to be accelerating more than what you had expected at this stage of the game.

As I look at the metrics, NPLs seem to be stabilizing a bit, the reserve release seems to be slowing down, and your new NPLs ticked up a bit this quarter. I'm just curious. Given that scenario, are we close to reaching an inflection point as it relates to provisions and the reserve release, which did slow this quarter relative to Q1?

Todd, thanks for the question. First of all, I think we are starting to see a little bit of an inflection between the NPLs, although we think they will continue to decline next quarter. Chargeoffs will continue to decline as well.

Reserve release is formula-driven. It clearly depends upon what our past history was, economic outlook; and we would expect to see continued release, although we do believe the pace will probably slow as the balance sheet continues to grow and we put more new loans on the sheet.

Okay.

This is Jeff. I'd just -- an inflection point suggests turning another way. And I think what you have seen over the last two years and I think what we expect is consistent with that, which is improvement continues. The pace can't -- the pace must slow. But I don't think we are near an inflection point so much as we are just seeing a continued improvement, but at a pace that reflects having gotten lots of problems behind us. But we have still got more that we will be able to get resolved in the future.

Right. Again, the point being, just in terms as I look at the balance sheet growth relative to the stabilization, some of the credit metrics, that it appears that -- again that reserve release would intuitively begin to slow at this stage of the game.

Yes, I think that is fair.

Okay. Then just quickly on the mortgage side, could you just quickly -- on the statistics in terms of just the gain on sale margins, again expanded at this quarter. Just curious if you can make the comparison Q1 to Q2, exactly what you are seeing relative to the production and the mix.

Sure. Overall, our mortgage results continue to be at near-record levels, driven by low interest rates and the HARP program. We saw really good results and we ramped up quickly to take advantage of the refi wave in the fourth and the first quarters.

This quarter, I think we saw a continuation of similar results. From a spread standpoint, I think our margins for the quarter were up probably 40 to 50 basis points.

That was driven by a number of things. The market conditions were very favorable, obviously. But we were also able to shift some of our capacity to the retail line of business, to the HARP program; and less of our capacity was allocated to the wholesale channel. So that had a positive impact on margins overall as we shifted some of that volume to the more profitable segment of the business.

As I mentioned earlier, we ramped up pretty quickly in the fourth and first quarters and probably captured more than our fair share of business during that period of time. I think the environment has gotten more competitive as rates have continued to move lower and others have ramped up their capacity. And that competition shows both in terms of competition for business as well as for personnel.

So, as we go forward I think we expect volumes in the third quarter as we mentioned to be slightly higher and perhaps that to have a slight dampening effect on the overall margins, but for margins to continue to remain very, very strong and for overall results to be slightly stronger in the third quarter than the second.

So I'm assuming that implies not much change in terms of rate environment in terms of your outlook.

That's correct.

Okay, great. Thanks very much for taking the questions.

Erika Penala, Bank of America.

Actually, [Steven Austin] on behalf of Erika. Just a couple questions. On your NIM I just wanted to just talk a little bit about big picture. I appreciate the guidance on the second half, and I know you've got some room on the CD repricing as well as the TruPS in the third quarter.

I am just wondering further out is there anything you are thinking about to offset some of the pressure that we are likely to see, given the likelihood of lower-for-longer on rates?

I think for the last two, three quarters, we have talked about the fact that it is difficult to fight yield compression with actions other than growing earning assets. And that remains the most powerful tool to keep NII stability.

We continue obviously to manage the liability side of the balance sheet, and there are always opportunities if this lower rate environment continues. We will see those opportunities. We have seen those in Q1. We have seen those in Q2. And I suspect that there will be further opportunities beyond just redemption of trust preferreds on the liabilities side.

On the asset side, clearly the fight is against repricing higher-coupon loans and higher-coupon investment securities. There, unfortunately, we don't expect the rate environment to change between now and year-end, as we see the continued Fed's commitment to keep rates low, potentially executing another QE, which may include keeping rates low beyond their current plan.

So in that environment, I think again the best tool remains growing loans, growing earning assets prudently, and managing NII.

Okay. Nothing else out there like swaps expiring or anything else we should be thinking about?

Nothing big.

Okay. Then just a quick question on post the Visa and MasterCard settlement and the temporary reduction on the interchange. Do you guys expect any impact from that?

Well, there will obviously be an impact that will apply to us as well as others in the industry. It is a relatively modest reduction; it's 10 basis points. And it relates only to credit card interchange, not debit card interchange.

Right.

So, it does have an impact on us, but we expect that to be relatively modest.

Okay, great. That's it for me. Thanks.

There are no more questions at this time.

Okay.

Thanks, everyone, for your call.

This concludes today's conference call. You may now disconnect.