Fulton Financial Corp (FULT) 2012 Q2 法說會逐字稿

Good morning, ladies and gentlemen.

Welcome to the Fulton Financial Corporation announces second-quarter earnings conference call.

This call is being recorded.

I would now like to turn the call over to Laura Wakeley, Senior Vice President of Corporate Communications.

Thank you, and good morning.

Thank you for joining us for Fulton Financial Corporation's conference call and webcast to discuss our earnings for the second quarter of 2012.

The main presenter for today's conference call is Scott Smith, Chairman and Chief Executive Officer of Fulton Financial.

Joining him are Phil Wenger, President and Chief Operating Officer, and Charlie Nugent, Senior Executive Vice President and Chief Financial Officer.

Our comments today will refer to the financial information included with our earnings announcement, which we released at 4.30 yesterday afternoon.

These documents can be found on our website at fult.com by clicking on Investor Relations and then on Meetings.

On this call representatives of Fulton may make forward-looking statements with respect to Fulton's financial condition, results of operations and business.

These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are not in Fulton's control and difficult to predict, and which could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements.

Fulton undertakes no obligation other than required by law to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

In our earnings release we have included our Safe Harbor statement on forward-looking statements and we refer you to this section of that release, and we incorporate it into today's presentation.

For a more complete discussion of certain risks and uncertainties affecting Fulton, please see the sections entitled Risk Factors and Management's Discussion and Analysis of Financial Condition and Results of Operations set forth in Fulton's filings with the SEC.

Now I would like to turn the call over to your host, Scott Smith.

Thanks, Laura, and good morning everyone.

We are pleased you were able to join us today.

Before Phil Wenger discusses credit and Charlie Nugent covers the financial details, I have a few comments on the quarter.

When we conclude we will be happy to take your questions.

We reported diluted net earnings per share of $0.20 up 5.3% over the first quarter and up 11.1% over last year.

Our return on average assets also increased, and as you know from previous calls, ROA improvement is one of our key priorities.

While we experienced success on a number of fronts in the second quarter, two in particular stand out -- continued improvement in our credit quality and strong other income growth.

Looking first at credit, and Phil will provide more detail, we were pleased to see further decrease in the provision for credit losses.

Nonperforming loans also decreased due in part to the sale of a group of nonaccruing loans.

We continued to see overall improvement in our credit quality in what from our perspective is still a less than robust business environment.

Total loans outstanding increased modestly at the end of the quarter.

We would like to think this may be an indicator of a pickup in loan demand, but our expectations remain tempered by persistent customer uncertainty.

We continued to expand the foundation for potential future loans growth by growing our retail and commercial account base again in this quarter.

While we do not share actual account growth metrics for competitive reasons, our recently completed retail deposit promotion generated higher than normal new account activity when compared to the same period last year.

Turning to noninterest income.

Sales gains from residential mortgage loan activity were again strong.

And as long as interest rates remain low this area will likely continue to make a solid contribution to income.

We also saw a healthy increase in deposit account-related brokerage revenues linked quarter.

Earnings pressure came largely from two areas, net interest margin contraction and higher expenses.

While I would like to say that both items are specific to this quarter, I do not believe that to be the case.

Given the current and anticipated rate regulatory and competitive environment these areas will present continued challenges and will receive close management scrutiny.

On the margin, the lower interest rates produced another reduction from -- in our funding costs.

We have shown consistent decreases in our cost of funds over the last several quarters, as we adjusted our mix from time to lower-cost core deposits.

Those past actions have been effective; however, during the second quarter the rate of decline on earning asset yields accelerated and put greater downside pressure on the margin.

Expenses were up this quarter.

We are all aware of the increasing attention to enterprise risk management and compliance functions, both a primary focus of certain provisions of the Dodd-Frank Act.

We anticipate that the expectations for these areas and the resource commitment to them will continue to increase.

We have engaged outside consulting firms to help us evaluate and examine both areas.

They are providing us with broader insight into industry best practices.

This investment will help us be better prepared to meet the demands of a larger, more complex organization that will inevitably accompany our next phase of growth.

Overall operations continue to generate increasing levels of capital.

We have increased capital back -- we have reinvested capital back into the profitable business lines and increased our cash dividend.

With the acquisition front rather quiet, the Board approved a stock buyback of up to 5 million shares through the end of the year.

The last time we did a stock purchase was in 2007.

Our repurchase activity will be dependent on market conditions and when we feel that it will benefit our shareholders.

At this time I will turn the call over to Phil for an overview of credit and then to Charlie for a financial discussion.

Phil.

Thanks, Scott.

As we mentioned in our press release, we were pleased to announce improvement again in our overall credit metrics.

As we discussed, we sold a portfolio of nonperforming commercial loans that aided our overall improvement in credit quality.

I will give you the details on that sale in a moment.

We were also successful in reducing nonperforming loans through our individual resolution activities at a pace greater than that which we have seen in prior quarters.

Also, we have continued to reduce our exposure to problem loans, as I will discuss also in a moment.

Now let me give you the details.

Overall delinquency declined to the lowest it has been at quarter end since the end of 2008 at 2.81% of loans or $337 million.

Emergency delinquencies, those accounts under 90 days past due, picked up slightly since the end of the first quarter from 0.71% to 0.86% of loans.

This is not unexpected as there will continue to be some fluctuation in delinquency given general economic conditions.

We were able to reduce nonperforming loans by $50 million from $284 million to $234 million.

As we mentioned, we sold a portfolio of nonperforming loans, all of which were under $1 million in balances, with a total bank balance of $44 million.

We periodically evaluate loan sales, and again this quarter, as we did in the fourth quarter of last year, we performed the cost benefit of holding and collecting these loans over time versus selling to an investor.

Our analysis reflected the sale would be an appropriate strategy.

We sold the pool to one investor.

The pool was comprised of $11 million of C&I loans; $30 million of CRE loans; and $3 million of construction loans.

The charge-off associated with this sale was $21 million.

The amount of our allowance for credit losses allocated to these loans was $24 million, so we were able to execute the sale without a related loan loss provision expense.

As I mentioned, the loan sale, as well as our ongoing workout and collection efforts, reduced our nonaccrual exposure.

We generated $55 million in new nonaccruals this quarter versus $37 million in the first quarter of 2012.

However, we were able to resolve through payments and charge-offs $51 million, which in addition to the sale and a $5 million reduction in over 90 day occurring loans, drove the improvement in nonperforming loans.

Additions to nonaccrual for the first half of this year totaled $92 million versus $160 million for the same period last year.

We were able to reduce our problem loan levels for exposure to loan relationships rated special mention or worse by nearly $160 million.

Given these metrics, we were able to reduce our loan loss provision from $28 million to $25.5 million for the quarter.

The allowance to nonperforming loans ratio increased to 101% from 91% at the end of the first quarter of 2012.

Our allowance now stands at 1.98% of loans.

Total net charge-offs were $46 million or 1.55% of average loans on an annualized basis as compared to $28 million or 0.94% of average loans in the first quarter of 2012, and a 1.3% for the second quarter of 2011.

Troubled debt restructurings increased slightly from $103 million to $109 million.

Of this total, $81 million or 74% are accruing loans versus $71 million or 69% last quarter.

The $6 million increase to TDRs was primarily driven by two loans related to the hospitality industry that were restructured to reflect current market conditions.

Now moving to loan demand and activity, our ending balances increased despite the reductions from the loan sale and nonaccrual resolutions.

Our ending balances increased just over 1% from the same period last year, with that growth coming from our CRE and residential portfolios.

Although new loan demand remains very modest, we continue to have good success with gaining market share.

After a slight increase in the first quarter our construction portfolio did decline 4.4% in the second quarter.

And we expect we will continue to see quarterly fluctuations in this area until the market reaches a greater level of stabilization.

General market conditions and customer sentiment remained consistent with the first quarter.

Our customers have a generally positive outlook; however, they continue to be cautious on expanding or taking on additional debt.

Our Pennsylvania market shows the most strength, with Maryland, Virginia and Delaware close behind.

New Jersey continues to be the more challenged state in our footprint, although we are making good progress with asset quality there, as we have across the entire footprint.

Mortgage activity as we mentioned in the press release remains a highlight.

Applications are strong and increased slightly to $824 million versus $812 million in the first quarter and $477 million in the second quarter of 2011.

Application volume is up 72% over the second quarter of 2011.

The increasing trend in purchase versus refinance activity continued this quarter with purchases comprising 42% of our closed loans this quarter versus 31% in the first quarter.

We are seeing a shift in our current pipeline to an increasing position of refinance activity, given the yet again historically low rates.

Our current pipeline is $520 million versus $458 million last quarter and $215 million a year ago.

So to summarize, we made good progress this quarter in improving our credit metrics.

Ending loan balances increased modestly.

And with a gradually improving economy, our seasoned teams are working hard to take advantage of market opportunities.

Now we will turn the discussion over to Charlie Nugent for his comments.

Charlie.

Thank you, Phil.

Good morning everyone.

Thank you for joining us today.

As Scott mentioned, we reported net income of $0.20 per share for the second quarter, an improvement of $0.01 or 5% over the first quarter.

Net income also increased 5% to $39.9 million in the second quarter from $38.1 million for the first quarter.

Unless otherwise noted, comparisons are of this quarter's results to the first quarter of 2012.

The growth in our net income resulted primarily from an increase in other income and a decrease in the provision for credit losses.

These improvements were partially offset by slightly lower net interest income and an increase in other expenses.

Net interest income decreased $1.2 million or 1%, primarily as a result of a 7 basis point decline in the net interest margin to 3.78% in the second quarter from 3.85% in the first quarter.

The compression on net interest margin resulted from asset yields declining more than funding costs.

Yields on earning assets decreased 13 basis points to 4.48% in the second quarter from 4.61% in the first quarter.

Our cost of interest-bearing liabilities decreased 6 basis points to 0.93% in the second quarter from 0.99% in the first quarter.

The decline in yield on assets was largely driven by investment securities which yielded 3.19% in the second quarter as compared to 3.36% in the first quarter.

Prepayments on mortgage-backed securities and the resulting accelerated amortization of premiums were essentially unchanged from the first quarter.

However, the average portfolio yield continued to decline as reinvestments of cash flows were at rates lower than the overall portfolio yield.

Yields on loans decreased 9 basis points from 4.94% in the first quarter to 4.85% in the second quarter.

Competition continued to place downward pressure on loan yields.

The cost of interest-bearing deposits declined 6 basis points to 0.62% in the second quarter.

Time deposit costs decreased 6 basis points to 1.3% for the second quarter.

$725 million of time deposits matured at a weighted average rate of 0.88%, while $648 million of certificates of deposits were issued at a rate of 0.43%.

In the third quarter of 2012, $726 million of time deposits are scheduled to mature at a weighted average rate of 0.96%.

Average total interest-earning assets grew $141 million or 1%.

The growth was realized primarily in our investment portfolio, which grew $111 million or 4% as a result of purchases in the first quarter.

Additional increases were seen in short-term other interest-earning assets, which grew $28 million, and loans held for sale which grew $15 million.

Average loans decreased by $13 million in comparison to the first quarter.

Ending loan balances increased, as Phil discussed.

Average deposits declined $85 million, with a $161 million or a 4% decrease in time deposits being partially offset by a $76 million or 1% increase in demand and savings deposits.

Noninterest-bearing demand deposits increased $104 million, with a $70 million or 3% increase in business accounts, and a $30 million or a 5% increase in personal accounts.

Interest-bearing demand deposits increased slightly by $20 million or 0.8%.

Growth in personal and business accounts was offset by decreases of municipal accounts.

Savings deposits decreased $48 million or 1.4%, almost entirely in municipal accounts.

This decline resulted from a reduction in rates paid on municipal accounts.

Other income for the second quarter increased $1.4 million or 3%, excluding the impact of security gains.

Mortgage banking income increased $1.1 million or 11% as a result of a 6% increase in new loan commitments to $656 million and a 5% improvement in spreads.

The growth in volume was driven by persistent low interest rates.

Service charges on deposits improved $525 million -- I'm sorry, $525,000 -- sorry about that -- including a $204,000 or 8% increase in cash management fees, $193,000 or 4.5% improvement in deposit service charges, and $129,000 or 1.6% increase in overdraft fees.

Other service charges and fees increased $952,000 or 9%, primarily due to a $518,000 seasonal increase in merchant fees and a $280,000 increase in foreign exchange fee income as a result of higher transaction volumes.

Trust income grew $445,000 or 4.7%, almost entirely in brokerage income due to the strength of the equity markets and the enhancement of our recurring revenue model.

The $1.6 million decrease in the other noninterest income category resulted from gains on the disposition of two branches and one operations facility in the first quarter.

In the second quarter net security gains were $1.5 million as compared to $1.3 million in the first quarter.

Net security gains during the second quarter were almost entirely realized gains on bank stock sales.

Operating expenses increased $1.4 million or 1.3% to $112.1 million for the second quarter.

Salaries and benefits decreased $269,000 or 0.4% This decline reflected the net effect of a $1.1 million seasonal decrease in payroll taxes and an $830,000 decline in health insurance costs.

This decline was partially offset by a $1.6 million increase in stock compensation expense due to the annual grant of stock awards.

Operating risk loss decreased $1.3 million or 39% during the second quarter.

Provisions for potential losses of mortgage loans sold decreased to $680,000 in the second quarter from $2.6 million in the first quarter.

The other category of non-interest expenses increased $2.4 million or 15%.

This increase included $2.2 million in consulting expenses primarily related to the enterprise-wide risk management and compliance efforts that Scott discussed.

In prior quarters in response to questions we have provided estimates of quarterly expense run rates, but in our current operating environment with issues such as increasing regulatory and compliance demands, continuing loan workout costs and a pending core systems conversion that can contribute to expense volatility, we are reluctant to provide specific estimates of future expense levels.

Thank you for your attention and for your continued interest in Fulton Financial Corporation.

Now we will be glad to answer your questions.

(Operator Instructions).

Casey Haire, Jefferies.

Just a question, I guess, on the securities yields here.

What is the new -- what is new money getting in the securities book relative to the existing yields?

On the CMOs, the market rate right now for the CMOs we're buying, which are relatively short, is 1.4%.

And we didn't do a lot of buying in the second quarter, but the transactions -- the securities we bought in the first quarter are detailed on the analyst presentation on our website.

And the average yield on securities purchased in the first quarter was 1.81%.

Okay, so it is 1.4% today; it was 1.8% in the second quarter.

Yes.

No, 1.8% in the first quarter, in the second quarter it was 1.4%.

Okay, I got you.

Okay and then (multiple speakers).

I'm sorry, go ahead.

Just -- so on the deposit side how are you guys -- do you guys -- can you give us an update on how you are feeling around the flexibility on deposit costs going forward?

Yes, we think our deposits costs will continue to decline.

And we mentioned -- I mentioned, I think, that we have $726 million of time deposits scheduled to mature in the third quarter at a rate of 0.96%.

And we mentioned that we are holding CDs in the second quarter of 0.43%.

And we would expect to see continuing decline in our deposit costs, but it is not enough to offset the decline in asset yields.

Okay.

And then just last one, switching to credit.

Provision down $3 million here, but if you exclude the bulk sale provision was actually flat.

So I'm just wondering, there doesn't seem like there is a lot of loan growth here.

Why not -- you know, you have got the NPAs moving out -- why not push that -- why not more credit leverage in the quarter?

This is Phil.

And overall we continue to feel better about our credit and have seen declines in the provision, but at the same time we are seeing economic conditions that are not improving at any kind of rate, and some people think they might actually be declining.

And we are still headed into a period of time, I think, at the end of this year where a lot of decisions have to be made at a high level that could have an impact on the economy.

So we are trying to be as conservative as we can from a loan loss provision standpoint.

Okay, thank you.

Chris McGratty, KBW.

Given the outlook on growth and in context of margin, can you talk about your appetite to restructure some of your FHLB?

I know the prepayment penalties are significant, but what about a blend and extend to kind of mitigate some of the pressure here?

You know, we look at that all the time.

And our federal home loan bank advances are relatively short.

And the penalties can go from 10% to 15%, and it doesn't seem to make sense to take that significant penalty when the advances aren't that long.

And we would have to -- those penalties are pretty significant and it would be hard -- it just doesn't make economic sense to us to do that.

I guess I'm a little confused.

The penalties are large, but the duration is short.

Aren't the duration of these liabilities pretty far out in terms of maturity?

It depends.

Most of them are maturing in 2016 and 2017.

So they're longer duration liabilities, right?

Okay.

Well, it depends on what you think is long.

We don't think that is relatively long to take a significant penalty.

So you can extend those out, but you have to increase the rate on those, I think.

Well, there is a way -- I think there is a way to do it where you work the penalty into the rate and pick up some benefit without taking a hit to book.

You can take a penalty and it is considered in the new advance and it is extended out.

Right.

That doesn't seem to make a lot of sense to us either.

Okay.

Maybe switching to the -- maybe I missed this, I had to jump on a few minutes late.

The expenses -- is there a contemplation internally to go through another round of expense initiatives given where revenues are and given the growth picture you guys painted?

This is Scott.

Not at this point.

I think we still think our efficiency ratio is in pretty good shape.

And we are, as I mentioned, investing in the future because we are optimistic that this economy is going to turn around and we are going to be in a situation where we are going to need to absorb some pretty significant growth.

So we are investing in technology and systems and branches and other things.

And we think we need to keep doing that through this so that we are ready for that growth that is bound to come.

That doesn't say we won't continue to monitor -- we have always been very frugal about expenses and very careful about how we monitor all that.

So we will continue to do that, but I would say not expect an announcement from us that we are going to cut expenses by some dramatic number at least short-term.

Okay, I guess what I am struggling to marry the two -- that comment against the retracted expense guidance.

I am just trying to think about the expense run rate for the back half of the year.

It sounds like it is going to be higher than what you previously guided to, but should we expect growth from Q2 levels?

Well, we have been saying for many quarters now credit is going to be lumpy.

I think we have got to say expense is going to be lumpy, because there are -- the expenses associated with working out problem loans from quarter to quarter can jump around pretty significantly in how that all works out -- and other non-reoccurring items come up.

So I guess what we are saying to you is that rather than try to give you guidance that -- very specific guidance that we have the pressure coming from these increased expenses and we will continue to have some pressure on that.

We have the -- as you know, the IT conversion coming up, and that will continue to have some, again, quarter to quarter, maybe a little lumpy, but some expense issues around it.

So we are going to manage it very carefully, but to give you a run rate that we can say is fairly accurate is going to be difficult to do.

Okay.

Just one last one and I will jump back in the queue.

The buyback, I think -- I believe -- correct me if I'm wrong, it expires at year-end.

Two questions.

Do you expect to be able to get this done this year, and is there thoughts of re-upping it, I guess, next year?

Well, we have it in place in case we feel as though the price of the stock is in a situation where it makes sense to shareholders to buy some back.

That will depend on what opportunities present themselves to us or don't.

That will depend on where the market thinks the price ought to be and a lot of other factors.

So we are going to -- we have it in place, and we will make that decision here on almost a day-to-day basis based on how we see things unfolding and what other opportunities for capital we see out there.

Okay, thanks a lot.

Collyn Gilbert, Stifel Nicolaus.

Just to follow-up on the buyback question.

So I guess, Scott, it just still seems like you have a lot of capital, I mean, more than enough to sort of deploy in other ways, to get to the buyback or increasing your dividend.

How are you thinking about that?

I think -- we still don't have final resolution on capital, but we have a lot better feel for what the requirements are going to be than we did say six months ago.

And that is part of the reason we put the buyback in place.

I think we have talked in previous calls about the fact that many of our shareholders are very dividend conscious, so I think we will look, as earnings and our expectations about the economy provide the opportunity to increase the dividend, we will take advantage of that situation.

Acquisitions are still out there, and there is a little more noise around that then there was six months ago.

So I think we need to be prepared for those opportunities.

The buyback is there as well.

And as I said earlier, I am not predicting this economy will turn around quickly, but it could, and we could see a pretty significant growth curve if that happens, and we want to be prepared from a capital standpoint to absorb that and move on.

So that is the way we look at it.

I think we feel good about our capital base in terms of -- as you mentioned -- of it being certainly adequate.

And we will look at ways to -- ideally what we do is reinvest that in capital- and revenue-generating activities.

And as the economy provides those we will certainly want to do that.

Okay, okay.

Should I read into your order of your comments in terms of dividend acquisitions and then buybacks?

I didn't really -- I didn't think it through to do that, but as we said before, we very much -- the feedback we get from a lot of our owners if they like dividends.

So I think you can say we will do that when we feel appropriate, but there needs to be earnings and so forth to do it.

Between buybacks and acquisitions it is going to be opportunistic depending -- if the stock goes to $14, I don't think we will be buying that back.

If we get an acquisition -- if I get a call this afternoon and somebody is for sale, then we might go that route.

So I can't tell you because both of them are opportunistic.

And if we had an announcement I would make it, otherwise I have to keep my mouth shut.

Yes, okay, okay.

And then, Charlie, just a question for you.

Can you talk a little bit about what your strategy is at this point on the investment portfolio?

You know that had been growing a bit and then, obviously, you shrunk a bit this quarter.

How should we think about that and just the overall balance sheet going forward?

We evaluate additional purchases every day because we have strong cash flows coming from the portfolio.

And we made a significant addition to the investment portfolio in March; it was $585 million.

It worked out to our advantage, because at that time I think the ten-year went up to [1030 -- 235], so we got better yields.

Since that time we haven't been doing a lot of purchases.

We are a little apprehensive with where yields are and just the risk/reward in that.

Okay, so we will probably continue to see paydowns then as you're not going to reinvest, assuming no change in the rate environment?

At no change in the rate environment, yes.

Okay, okay.

And then just a question, which I guess you kind of answered it by withdrawing your expense guidance.

I am just trying to reconcile the $2.2 million in consulting fees that came in this quarter, seems like a big number that wasn't in your projection.

Is that why you're now withdrawing expense guidance is because you're anticipating things coming in that you can't predict or -- I'm just trying to still get my arms around that expense number and the direction that it is moving.

We project -- we were giving a normalized run rate -- we are trying to -- in response to questions.

And things are a little bit more -- it is harder to estimate that run rate.

So what we tried to do was on the call we went through each one of the expense categories and we tried to give you the exact detail for every line item, the reason for the change, and if there was anything unusual in there, so you could do a better job in projecting the run rate.

But it is -- the operating environment, like I mentioned, it is tough to project what quarterly earning -- quarterly expenses are going to be.

Okay, well, let me ask it a little bit differently.

So in terms of the additional regulatory expenses that could be coming down the pike, are you -- do you think you are 50% there for the stuff that is within your visibility over the next 12 months?

Do you think you're 25% there?

This is Scott.

I think I just read the other day that 70% of Dodd-Frank isn't written yet.

So it is going to be awfully hard to project where -- what the costs are going to be, because (multiple speakers).

No, I know.

I get that.

We are trying to anticipate some of that and put the systems, the software and the people in place to manage all this.

But we get interpretations almost weekly from all of that, and to expect what all is going to come out of that and tell you candidly what we think it is going to be down the road, it is hard to do.

No, I know.

I meant just with what you know now, given your exam cycle, given BSA, some of the issues that are facing you in the near term, I meant more from that perspective.

But if the answer is it is just too hard to quantify it, okay.

I am hearing from around the table here we think we are halfway through it.

So we will give you that and don't bet your life on it, but that is kind of where we are.

Okay.

That is a feel, if you will, rather than a quantitative analysis.

Okay, okay.

And then just one final question, maybe this is for Phil.

So the two loan sales you guys did, obviously this quarter, and then in the fourth quarter, you saw like about a 50% loss rate on those pools.

Is that where you think the portfolio is running or are you finding yourself tending to sell the lower-quality loans, or how should we think about loss severities of the portfolio that is currently left?

Well, again, that just fluctuates so much from loan to loan and type to type.

We feel good about the provision that we have in place for what is left, and I think this sale really bore that out.

Okay.

Okay.

Okay, that is all I had.

Thanks guys.

David Darst, Guggenheim Partners.

Could you maybe talk about how you plan to adjust to Basel III and if there is any opportunity for you to repay the Fulton Capital Trust loan?

We have $150 million in that trust.

The rate is a 6.29%, which we think is a good rate.

In Basel II the -- in Basel the common equity ratio -- that is the 8.5% and the total, 10.5%.

So we need 2% of capital -- would be our optimum capital to have 2% of our capital that is not common, and we see that trust preferred as cheap capital for that -- cheap capital for that.

Okay, so you -- that is somewhat permanent, not (multiple speakers)?

The 2% I am talking about is based on [no space] capital, and the Tier 1 ratio is 8.5% and the total is 10.5%, so there is 2% there.

And 2% on $12 million in risk-weighted average assets, which we have, is $240 million.

We think that is perfect for us.

That is cheaper capital than having common to come up with that ratio.

Okay.

And, Phil, could you go back over the reductions that you saw in the problem loan list this quarter?

The problem loans rated special mention or below decreased by $160 million.

Okay.

And then just on the expense side, and the OREO expense and the OREO pool, I guess you did not choose to include any of those in the loan sale.

And I guess we have just gone maybe through the spring selling season and that bucket didn't decline very much.

Could you give us an outlook of where you think that bucket may trend?

Yes, well, it is -- that is one of those expenses that is really hard to predict.

But those expenses in the quarter were just ongoing expenses, they were not related to the loan sale.

We are anticipating at some point as we continue to reduce these loans that those expenses will go down, but as you can see from the quarterly results, it hasn't happened yet.

Okay, are there any large pieces of OREO or is it mostly small pieces of residential properties?

It is all small.

Okay.

And would you consider doing another bulk sale of residential, including some of those?

We look at it every quarter, and we will continue to look at it.

So we may end up doing additional sales and we may not.

Did anything (multiple speakers).

We will continue to look at it as an option to reduce that portfolio.

Okay.

And how about on the new NPA generation, that number accelerated during the quarter, is there anything changing there or do you feel like you are at a point where that should decline?

Well, it is declining.

That is a number that is real lumpy from quarter to quarter.

So if you look at it more this six months -- the last six months, it has declined, we believe, significantly.

We did the first quarter at the $37 million was by far the lowest.

But, actually, then that number was the lowest that we had in any quarter since the beginning of 2008.

So it will continue to be lumpy, but we hope to continue to see improvement, but it may not necessarily be from quarter to quarter.

Got it.

Okay, thank you.

Frank Schiraldi, Sandler O'Neill.

Just a -- most of my questions have been answered, actually, but I just wanted to go back to the expense side, Charlie.

And I know you talked -- you broke it down line item by line item, but just wondering if maybe you could summarize what your thoughts are in what in the quarter -- what in the second quarter was either one-time in nature or seasonal in nature -- Seasonal to just the second quarter, such as maybe the stock grant you mentioned?

And, you know, excluding OREO costs, which I know are going to bounce around a lot and it is just tough to say what is one-time and what is not there.

That is exactly right.

It is tough to say what is one-time and what isn't.

We mentioned the $1.6 million in stock compensation expense.

We do that once a year.

Most of that is recognized -- that $1.2 million of the expense is recognized right away, so that would be reoccurring every year but not every quarter.

I talked about the consulting fees, whether that is going to go up and we have to do more or it is going to go down.

That is another one that it would be difficult to say if it is reoccurring or not.

We had -- in terms of mortgage -- we increased our mortgage reserve $800,000 for mortgage put-backs.

That is lower than it was the previous quarter.

Maybe it will be zero next quarter, maybe it will be more.

It is just difficult to go through these and say what is reoccurring and what isn't.

Okay, no, I understood.

So the consulting fees are -- you're not comfortable at this point saying maybe an increase in consulting fees -- you're not comfortable at this point saying whether that could go up, down, or stay the same?

I think Phil said that we -- and Scott said, we are trying to improve our compliance system and our enterprise risk management and we are not there yet.

Eventually that consulting costs will go down, but part of what we are doing is building systems that will add activities and people and so forth that will have some cost.

And so it might not be in consulting fees a couple quarters down the road, but it could be in other areas.

So that is where we are working our way through all of that.

But we don't have permanent consultants that are going to be here forever.

And we are just working through all that with them, and as I said, investing in the infrastructure to make sure that as this Company grows we have the infrastructure in place to work through all these issues around risk management, compliance and all of that.

When you go through all these items -- like our mortgage volume was way up, so our overtime cost in mortgages is up.

The temporary help was up.

And you go through that, what is normal and what isn't.

It is a judgment call.

And what we have been trying to do is just give you all that detail, so you can make -- use your judgment to figure out what is reoccurring and what isn't, because it is difficult to judge each one of these items.

Sure, understood.

And then -- so the consulting fees are really -- involve updating or upgrading maybe the systems, is that right?

Well, we are looking at all of that.

And this isn't unique to banking.

Enterprise-wide risk management, as I am reading, is a universal issue throughout all industry.

And I think regulators, shareholders, customers all expect the company they're doing business with to be able to manage risk appropriately.

And so I think we are all doing things to try to develop systems, to monitor activity, and from account opening through transactions through all the processes that happen to make sure -- and then predictive models that help us look at if the following assumptions change then what happens to the end result of all of that.

And so it is just -- it is a process that we're going through.

As I said, I think it is part of the new normal for any company, and particularly for banking, as we all improve our risk management activities.

Okay, this is -- just finally, just on the -- in terms of your -- in terms of guidance you have given before, there has been a steady increase in your expense guidance from 2Q to 3Q to 4Q.

So are there specific contracts involved -- increases in contracts in terms of upgrading your systems that you already know are coming in 3Q or 4Q that you could just basically talk about that is a known cost at this point that is going to come into 3Q that we haven't seen in the second quarter?

I don't think so.

There is some -- we will continue to, as I said, explore these activities, and as we see need to do some different things, -- you know, we are not -- I am not here to tell you we have got risk management done and we know exactly what it is going to be over the next decade and it is ready to go.

So I think as we get into this and get recommendations from folks that have experience throughout industry on these practices, which ones we will decide are appropriate for us or not that will impact all of that.

Okay, fair enough.

I don't want to --.

We will manage it as carefully as we can, but we do think we need to invest in the future even though we don't have robust earnings right now.

Okay.

Okay, and then just finally for Phil, I just -- in looking at the provision, I think prior someone else had asked the question earlier or talked about it earlier, if you include the reserve that you essentially pick up from the loans that you sold in the quarter the marks were lower than the actual reserves that you had in place.

It seems like the provision was equal to the first quarter.

I am wondering if throughout 2011 we saw the provision come down quarter-over-quarter, I'm wondering if you feel like we may be at the right levels right now here for maybe a bit of a more extended period, or can you foresee continued decreases in provision quarter-over-quarter, all else equal?

I would be hesitant to make any kind of predictions, but we do see credit continuing to improve.

And if that, in fact, continues I believe that there will be continued decreases in the provision.

Okay, great.

All right, thank you guys.

Rick Weiss, Janney Brokerage Firm.

A question regarding the loan growth or lack thereof, actually, are these loans that are going to other people, either for competitive reasons or pricing more aggressively than you, or is it just it is not even there?

This is Phil.

The demand on new loans or on new activity is still extremely modest.

There still is not a lot of new projects.

People are not investing in fixed assets, and sales growth is pretty small.

So growth comes from taking market share, and that is what we are trying to do.

Our ending balances did grow slightly.

And if you consider the fact that where we sold $44 million of nonaccrual loans, and we disposed or we got payments on a number of -- on another $51 million, we believe we were able to replace $95 million of loans that we aren't getting any income from with loans that we will get income from.

Okay.

So that will help a little bit on the margin to do that.

But even aside from that, then you still feel as if the margin -- I think you said the margin you still expect to see it under some pressure for the next couple of quarters.

Is that correct?

Yes, it is true, Rick.

Okay, and also I wonder if you could give a little bit of color on the mortgage banking -- it was very strong again this quarter -- and just kind of your best guess how do you think that plays out over the next near future?

Well, again, you know that mortgage banking can change very quickly.

But rates currently are incredibly low, and our backlog going into the quarter is stronger than our backlog was going into the second quarter.

So as of now it looks like we are going to have strong mortgage activity continuing.

But, again, if rates go up a little bit it changes very quickly.

Right, so if the Fed goes and continues its policies of very low interest rates or another more easing then we do expect that to be good for the mortgage banking part of your business?

Absolutely.

Okay, got it.

Okay, thank you.

Craig Siegenthaler, Credit Suisse.

This is actually [Nick Carzon] for Craig Siegenthaler.

A couple of questions.

First on the securities portfolio, I am just wondering if you can give us some color on the level of prepayments and maturities coming up over the next two quarters?

We filed that with our investor presentation, and our investment people are expecting the same level of prepayments that we have in that presentation.

And for the third quarter we expected cash flows coming from the investment portfolio to be $149 million and the weighted average yield 3.51%.

Okay, thanks, very helpful.

And then second question is going back to the capital return.

In your conversations with regulators how big is the 30% number?

What is the target in terms of the capital return level that we could see longer-term?

Are you talking the dividends, the payout ratio?

Yes, so dividends and then combine dividends and buyback.

Yes, there is some flexibility around that.

I think we have done a lot with stress testing with the regulators and capital planning with them.

And so that is a continuing and evolving process with them.

And I think as I said earlier, we are all getting a little more comfortable about what capital requirements are and are going to be, so I think there's a little more flexibility around it then there once was, but that is an ongoing process.

And as we contemplate moves in the capital we always talk with the regulators about their comfort level with it.

Okay, thank you.

Mike Shafir, Sterne Agee.

So a lot of my questions have been answered.

Just going back to the securities portfolio for a minute, it looks like you guys are predicting about $150 million in cash flows on a quarterly basis, and those outflows are coming out at a 3.51% rate?

Yes.

And you're probably looking for that securities book to stay relatively flat it seems like in the near term.

And the reinvestment rate is somewhere around that 1.40% on the CMOs that you are buying.

Yes.

Okay.

And then, also, just thinking about capital it looks like you guys are going to get to 10% TCE very quickly here organically.

So in your conversations with regulators, or just internally, if we think about a fully levered institution, where you guys feel like you are operating at maximum strength from a capital deployment standpoint, where is that level now?

If you're headed towards 10%, is it 8%?

Is it 8.5% on TCE?

And how do you guys think about that in context of -- and certainly you guys have been asked a lot of questions on M&A, buybacks, and I realize that it is all opportunistic in nature, but maybe you can give us a little context on if you were to go into the M&A market where would you like to go?

What kind of size institution would you be interested in?

Okay, a lot of questions there.

Obviously, any conversations with regulators is confidential, so we really can't talk about that.

As far as acquisitions are concerned, I think we have talked in the past about we have identified some geographies where we think critical mass would be very effective for us to gain.

But having said that, banks get -- they say banks gets sold, or not bought.

So we would have to look at who is for sale and then who else is interested and how rational they are going to be.

So I do think you can look to us to stay within the footprint we are in now, unless something very unique comes up, because we feel like we have opportunities within that footprint where critical mass can be very rewarding to our ability to capture market share and ultimately earnings.

So, yes, we are -- we will be looking at those kinds of things.

I mentioned earlier there is a little more noise now than there was, but it is certainly not an overwhelming onslaught of folks putting out for sale signs.

Okay, and then just on the capital level, it is there an internal goal that you could share with us?

I am not comfortable doing that.

Charlie, do you think that you --?

No, but -- we have our own capital plan.

We don't disclose what the targets are.

But you are right on the TCE, the tangible assets, we keep on building, and it went up to -- we don't have -- it is 9.49% at June 30.

It increased 24 basis points.

So we continue to build capital and it gives us a lot of flexibility, as Scott said.

Okay, and then just on the M&A front, I guess maybe I will ask this -- how big do you think you guys would be willing to go at, you know, a $14 billion institution right now or is it --?

$16 billion.

Pardon?

$16 billion.

You said $14 billion?

Well, I am saying you guys are $16 billion -- I'm sorry, I apologize for that.

Yes, yes.

You guys are $16 billion, so how big would you be willing to go on the M&A front in terms of increasing the franchise?

Would you look at something $5 billion plus?

Well, you never say never, but what we have said is our sweet spot is between $500 million and $2 billion.

But that is not to say we wouldn't look at a $5 billion company if it became available and the math all worked and it could -- we could create some real value for shareholders with it.

And that is not to say we wouldn't look at a smaller one if -- with very strategic locations where we need critical mass and we can work out the math to make it all work for everybody.

So ideally it is in that sweet spot and it is in the perfect locations.

But life isn't that easy, so we have to take what is available and do our analysis and decide whether it is right for us.

All right, thanks a lot guys.

I appreciate all the detail.

Bob Ramsey, to be our investment bank..

I know you gave it earlier on the call, but I missed it.

What was the pipeline for the mortgage bank at the end of the quarter?

Bob, this is Phil.

And at the end -- well, at the beginning of this quarter, $520 million.

Okay, and this quarter you mean third quarter, right?

To start the third quarter.

Yes, okay.

Got you.

And what was the gain on sale margin in the mortgage bank in this -- in the second quarter?

1.66%.

Okay.

And you think that is a good proxy for where we will be in this third quarter as well?

Well, that does move from quarter to quarter.

Our margins have been strong this year.

And I would just say I don't think we see anything that is moving them in either direction right now.

Okay.

And did you all do much in the way of HARP refinances this past quarter?

Of our current pipeline, 10% would be HARP and/or HAMP applications.

So that is about where we are running.

Okay.

Great.

And then last question.

Based on what you said you all expect in terms of security cash flows this coming quarter, rough math is telling me that your CPR rates are running in the low 20s.

Does that sound right to you?

What is -- I'm sorry -- what is the CPR rate?

CPR is the constant prepayment rate, or is it conditional prepayment rate?

I can't remember the exact --.

(multiple speakers) Well, I'm not sure.

I am not sure what would that would be.

Okay, all right.

Thank you guys.

Russell Gunther, Bank of America Merrill Lynch.

I just wanted to follow up on your comments that you would expect, all else being equal, the provision to continue to decline here.

You have got some decent visibility with where problem commercial entails might get resolved.

And I was just wondering if you have any increased comfort in being able to start providing below charge-offs, and for the releasing reserves, or would you expect to continue to (multiple speakers) charge-offs?

That is a tough question, and a lot of it will depend on what we see happening in the economy.

And you know how that is going right now.

So we would really like to get there, but I am not -- I can't say for sure that we are.

Okay, I appreciate that.

And then a follow up to comments on the loan side and competition.

How much do you think the loan production volume you're walking away from due to competitive pricing beyond your tolerance?

Well, I wouldn't say that we are walking away from it, but we are not getting some deals because of competitive pressures on both pricing and terms.

Got it, okay.

And then, lastly, on the expense side you mentioned that you were unlikely to have another round of significant efficiencies.

Would you consider -- is there any expectation that you might look to consolidate your remaining Pennsylvania charters and would there be some cost save opportunities there?

We look at that all the time.

And as you know, we have done, I think, 22 bank acquisitions and we are down to fixed charges now.

So that is constant -- we constantly look at that.

And I would follow up my previous comments.

We are in this lean process engineering mode, and have been for over five or six years now.

And that produces seven-figure reductions in cost for us continually on an annual basis.

So we'll continue to do that and that provides us ways of decreasing costs where it makes sense to do so.

So it is a combination of we need to spend some money in certain areas and we will be, as we have always been, very frugal about managing the expenses in other areas.

All right, guys, thanks for taking my questions.

That is it for me.

Mac Hodgson, SunTrust Robinson Humphrey.

Phil, I just had a couple of clarifying questions.

I didn't catch it when you mentioned earlier.

What is the level of new nonaccrual loans in the second quarter?

Well, the inflow was $55 million.

$55 million, okay.

And could you give any color on the loan sale, where those loans -- where the collateral was -- which markets they were in?

Was it Pennsylvania, New Jersey, et cetera, any detail there?

Yes, $26 million in New Jersey.

$15 million Pennsylvania, and then the balance was spread between Maryland, Virginia and a very small amount in Delaware.

Was it a surprise, given that the bulk was in New Jersey, and I know that is, I think, your weakest market?

Was it a surprise that you didn't have to take a larger loss or you had excess reserves there?

And does that tell you anything about your strategy for dispositions going forward?

Yes, we have been -- from day one we have tried to be very conservative with our provisions, and I think we will continue to be.

But I think this sale bore out that what we have tried to do, in fact, we have accomplished.

Okay.

Okay, thank you.

Blare Brantley, BB&T Capital Markets.

Just one bigger picture question.

Given where we are in the current rate environment and the regulatory expenses and things like that, you had mentioned previously about a targeted ROA in the 1.20% to 1.30% range.

Where does that stand today in your thoughts?

You mean where does the target stand?

Yes, do you feel comfortable with that being your target or has anything changed there from a longer-term perspective or -- because obviously we are going to be in a low rate environment for a while.

My target is 1.30% to 1.50%.

Okay.

And I think we can get there.

With a little bit of loan growth and some stabilization, some of those other issues, I think we can get there.

And I think there is a chart in our analyst presentation that shows it by banks.

And if you look at that you will see some of the banks are already there.

So we need to get some of these credit issues fixed and we need to get some loan growth.

You know, it is in the book -- we are looking at Lafayette Ambassador at 1.47%; FNB Bank at 1.44%; Fulton at 1.34%; Swineford at 1.60%, and then we have Columbia and Jersey which are -- you know, need to get fixed.

But that is -- that is -- I think, the lead bank is shown you we can do it.

Okay, thank you very much.

Russell Gunther, Bank of America Merrill Lynch.

Thanks for letting me hop back in.

Real quick, do you have any thoughts on tax rate going forward?

You know, the tax rate was lower in the second quarter; it was 25%.

We have a number of tax positions that are detailed in the 10-K.

And we settled one, which was $750,000 less than we had accrued, so that is $750,000 going through.

I would say the tax rate would be 26% to 27%.

All right, Charlie, thanks.

The second quarter is low because of that reversal of that -- something we had accrued for we didn't have to pay.

Okay, I appreciate the help.

Thank you.

And with no further questions in the queue, I would now like to turn the call over to Scott Smith for closing remarks.

Well, thank you all for participating in the phone call today.

We hope you will be able to be with us when we discuss third quarter on Wednesday, October 17.

We will talk to you then.

And, ladies and gentlemen, that does conclude the call.

We thank you for participating today.