PacWest Bancorp (PACW) 2012 Q2 法說會逐字稿

Good afternoon, and welcome to the CapitalSource second quarter 2012 earnings conference call.

All participants will be in listen-only mode.

(Operator Instructions)

After today's presentation there will be an opportunity to ask questions.

(Operator Instructions)

Please note, this event is being recorded.

I would now like to turn the conference over to Dennis Oakes.

Please, go ahead.

Thank you, Amy.

Good afternoon everyone, and thank you for joining the CapitalSource second quarter 2012 earnings call.

With me today are CapitalSource CEO, Jim Pieczynski, CapitalSource Bank Chairman and CEO, Tad Lowrey, and John Bogler, our Chief Financial Officer.

This call is being webcast live on the company website and a recording will be available later this evening.

Our earnings press release and website provide details when accessing the archived call.

We have also posted a presentation on the website.

It provides additional detail on certain topics which will be covered during our prepared remarks that we will not be making specific references to the presentation.

Investors are urged to carefully read the forward-looking statements language in our earnings release and investor presentation, but essentially they say the following.

Statements made on this call which are not historical facts may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

All forward-looking statements, including statements regarding future financial operating results, involve risks, uncertainties, and contingencies many of which are beyond the control of CapitalSource and which may cause actual results to differ materially from anticipated results.

CapitalSource is under no obligation to update or alter our forward-looking statements whether it is a result of new information, future events, or otherwise, and we expressly disclaim any obligation to do so.

And finally, more detailed information about risk factors can be found in our reports filed with the SEC.

Jim will now begin the prepared portion of our call.

Jim?

Thank you, Dennis, and good afternoon everyone.

For us, clearly, the earlier than expected reversal of $347 million of our deferred tax asset valuation allowance was a very positive development for us in the second quarter.

It substantially increased our tangible book value and moves us one step closer to applying for bank holding company status.

Additionally, our loan portfolio grew very nicely with growth of 5% since March 31.

And, growth of 30% based on where we were at a year ago level.

As we said earlier, our expectation for this year is to have 15% to 20% loan growth and we are still on track for that.

This growth is still being done at attractive rates which is resulting in our net interest margin for the second quarter of 4.95% which is at the high end of our projected range for the year of 4.75% to 5%.

Finally, we repurchased 12 million shares during the quarter which pushes the total repurchases to over 102 million shares since our buyback initiative began in December of 2010.

This has resulted in roughly a 30% reduction in our shares outstanding.

From an overall earnings perspective, excluding the tax benefit resulting from the valuation allowance reversal, our net income for the quarter was $0.17 per share.

As Tad will describe, some of the Bank metrics showed modest declines from the first quarter level, but that is generally explained by one time items and an unusually low net loan loss provision in the prior quarter.

For the first six months of the year, however, we are on plan, or slightly ahead of plan, on key financial performance metrics relating to growth, profitability, and credit performance.

After the quarter closed, as expected, we retired the remaining $23 million of our 7.25% convertible debentures that were outstanding.

Our recourse debt at the parent has now been reduced by two-thirds over the past 12 months.

And, the only remaining recourse debt we have at the parent is our long dated trust preferred securities which do not begin to mature until 2034.

Recognizing that reversal of the valuation allowance happened six months earlier than projected, I wanted to spend a moment explaining the process which lead us to conclude that doing so was appropriate this quarter.

As part of our normal quarterly review of the valuation allowance with our auditors, we mutually concluded that there was sufficient positive evidence to release the majority of the valuation allowance as of June 30.

That evidence included eight quarters of sustained profitability, meaningful improvement in the reliability of earnings, a significant reduction in impaired loans, and a dramatic decline in the size of the parent loan portfolio which gave rise to most of the historical credit losses.

The reversal resulted in a tax benefit of $1.49 per share and positively impacted the company's tangible book value which increased to $7.15 at the end of the quarter.

We have previously indicated that once this initial reversal takes place we would not expect any material reversal of the remaining valuation allowance which is now $166 million as of June 30.

Based on detailed analysis of the valuation allowance, which was undertaken prior to the action taken this quarter, we are not forecasting any additional tax benefit from the remaining allowance.

Our plan to file bank holding company application in the first quarter of next year is unchanged by the earlier than expected reversal of the valuation allowance.

Converting the bank to a commercial charter and operating as a commercial bank remains a long-term strategy, but there is no short-term urgency for the conversion.

We are very comfortable with our existing business model which relies on the California Industrial Bank Charter, particularly in the current very low interest rate environment which the Fed has suggested will persist at least through the end of 2014.

The prospect of filing our bank holding company application within the next six months or so influences our thinking about liquidity management and capital deployment strategies as a key consideration for the bank holding company review will be the regulatory capital levels and the related consolidated credit metrics.

The recent reversal of the valuation allowance, though helpful, does not have a dollar for dollar benefit on regulatory capital.

The amount of the unreserved DTA, which we included in our consolidated Tier 1 capital, is currently estimated to be in the range of $80 million to $90 million.

Our bias over the next 18 months -- over the past 18 months, which is unchanged, has been to return capital to shareholders via share repurchase since we have had ample liquidity and our shares have generally traded below our adjusted tangible book value.

Since inception of the buyback program we have purchased $654 million of our shares at an average price of $6.37, and remain committed to returning the balance of the excess parent capital to shareholders over a reasonable period of time.

As we approach the filing of our bank holding company application, we will balance the opportunities to buy back shares against the need to maintain regulatory capital, and consolidated credit ratios at the levels we anticipate will be needed for our application.

We do not see this as a barrier, however, to achieving our return of capital objectives.

Before concluding, I want to mention that we recently added a new lending group, Premium Finance, which made its first loans in the second quarter.

We established the group by hiring two very experienced individuals to lead a small team with many years of experience in commercial lending and life insurance premium financing.

Our new loan product provides funding alternatives to clients seeking to utilize permanent life insurance for estate planning, executive compensation, and other business purposes.

This traditional premium finance business will add to our existing speciality product groups, further diversify our national lending franchise, and make our overall portfolio more granular as these fully secured, Premium Finance loans are smaller than our overall average.

Tad is up next, and he will provide an overview of the second quarter performance at CapitalSource Bank.

Tad?

Thank you Jim, good afternoon.

We are very pleased with the overall financial performance at the Bank through the first six months of the year.

The second quarter financial results were mixed due principally to an increase in the quarterly loan loss provision and several one time items in the first quarter which make some of the linked quarter comparisons unfavorable.

However, we do not see any concerning trends in the current quarter credit quality numbers and expect the second half of 2012 to be strong.

Turning to the specifics, loan growth in the second quarter was $250 million, representing a 5% increase over the prior quarter and consistent with our full year projection of growth of 15% to 20%.

All of our lending groups contributed to second quarter production with significant growth in commercial real estate, technology cash flow, lender finance, and equipment finance accounted for nearly 60% of the total.

As Jim pointed out, we are very excited about the addition of Premium Finance lending to our speciality product lineup, and look forward to reporting their growth in future quarters.

We are seeing some pricing pressure across our lending groups, but so far it is more case specific than broad based.

All in yields for new funded loan production year-to-date have continued to hold up nicely with the exception of multi-family in California where we continue to see more intense price competition.

We successfully redeployed cash and investments into higher yielding loans again this quarter so deposits only increased by $33 million.

We expect to be more aggressive in raising deposits to fund projected loan growth during the second half of the year with our current expectations in the $250 million to $300 million range.

Our cost of interest bearing liabilities, which is both deposits and federal home loan bank borrowings declined again, and now is at 1.05%, down 6 basis points from the prior period.

And our new deposits added in this quarter averaged below 90 basis points.

Despite these very low interest rates, our retention of existing customers who rolled over their certificates of deposit at maturity remained above 90% this quarter.

Based on our current interest rate forecast, we expect our cost to funds will be at or below current levels for the balance of 2012.

As Jim also mentioned, our net interest margin at 4.95%, down from 5.12% last quarter, was at the high end of our projected range for the year of 4.75% to 5%.

As we talked about last quarter, certain one-time items, including a change in prepayment assumptions on our mortgage-backed securities in our investment portfolio based on pre-payment expectations and interest rate movements and the recapture of interest on a non-accrual loan which paid off at par, added 13 basis points in the first quarter net interest margin.

Our second quarter NIM does not contain any of these similar one-time benefits.

Our capital levels remain extremely strong with a total risk based capital at 16.2% and a Tier 1 leverage ratio of 12.7%.

Although the full implementation of Basel III is several years off and its final structure is still unknown, we believe application of the methodology to our current capital calculations would have a minimal impact on our capital ratios which are well in excess of the proposed Basel standards.

Total assets for the Bank at quarter end rose to $7.1 billion, an increase of almost $700 million or 11% over the last 12 months.

Loans held in the Bank now stand at 87% of total consolidated loans at June 30 as the Bank continues to grow and the parent loan portfolio continues to run off.

As I mentioned earlier, certain credit metrics in the quarter showed an up-tick compared to the prior period.

Our net loan loss provision was $13 million due principally to $9 million of new specific reserves combined with general provisions for new loan growth.

This compares to an unsustainably low $2 million in the first quarter which arose because a $4.5 million reduction in general reserves due to loan pay offs largely offset increases required for new loan originations which resulted in no net change in general reserves.

In addition, specific reserves were unusually low last quarter.

Our nonaccrual loans also increased in the second quarter up $19 million to $102 million.

But, we increased the total loan loss reserve by $5 million which still results in 100% coverage for the total of all non-accrual loans in the Bank.

80% of those loans remain current today.

We do not see any concerning trends in the second quarter credit charges, and we view our credit metrics, specifically nonperforming assets which stand at 1.53% of total assets, to be in line with our peer banks.

John is up next.

John?

Thank you, Tad.

Good afternoon to all those listening to our conference call today.

Excluding the valuation allowance reversal, consolidated earnings in the quarter were $40 million or $0.17 per share.

That amount included two one-time items.

A benefit of $8 million on debt extinguishment as a result of redeeming $25 million face value of our trust preferred securities in the quarter, which was partially offset by $4 million in charges related to the abandonment of a lease for excess space in our Chevy Chase office.

Focusing for a moment on the tax impact of the valuation allowance reversal in this quarter and future quarters, it is important to remember three things.

First, the reversal results in a tax benefit which resides on the parent company balance sheet and will be used in future quarters to offset consolidated federal and state tax payment obligations.

Secondly, the consolidated entity will reflect GAAP tax expense at approximately a 41% effective tax rate going forward.

And finally, the Bank income statement and balance sheet are unaffected by this reversal.

The Bank is also an approximate 41% taxpayer, but makes its tax payments to the parent under a tax sharing agreement.

Turning now to some of the income statement items in the quarter, there were small decreases on a consolidated basis in interest income and non-interest income reflecting the declines at the Bank, which Tad spoke about.

The timing of loan sales, loan repayments, and new originations in the quarter also negatively impacted interest income within the Bank as higher yielding loans rolled off early in the quarter and a large percentage of the new loans were at late in the quarter.

Combined with our expectations for strong production in July and lower loan repayments interest income should show an upswing in the third quarter.

Consolidated credit improved in the quarter with nonperforming assets down by 18%, including a 44% drop in the REO balance to $19 million.

As we continue to proactively move REO and other troubled loans off of our balance sheet we incurred somewhat higher professional fees this quarter for workout related expenses.

The quarterly loan loss provision, on a consolidated basis, was down slightly at $10.5 million compared to $11.1 million in the prior period.

That net provision includes a $12.6 million release of general reserves in the parent other commercial finance segment due principally to payoff at par of certain substandard loans.

Total operating expenses for the first half of the year were $98 million, which is consistent with our projected full year total of $190 million to $200 million representing a 5% to 10% decline from total 2011 operating expenses.

As we realize more of the benefits from efficiencies gained due to the elimination of duplicate functions following the move of approximately 200 parent employees into the Bank on January 1, we expect quarterly operating expenses to decline from the second quarter level.

Parent company cash at June 30, pro forma for the $23 million repurchase of the remaining 7.25% convertible debentures earlier this month was $168 million, an increase of $61 million from the prior quarter.

Second quarter loan sales and payouts were higher than expected and more than offset $78 million of share repurchases.

Due to repayments in the first half of the year totaling approximately $125 million we are now projecting incremental payoffs in the non-securitized portfolio of just $40 million to $50 million for the balance of the year.

One more quarterly tax payment from the Bank to the parent will occur in September, which we estimate will be in the $20 million range, bringing total incremental unrestricted cash generated at the parent to $60 million to $70 million between now and the end of the year.

In short, there was a bit of noise around certain of our interest income and expense items on both the Bank only and consolidated basis in the second quarter.

We have made good progress harboring all majors of profitability, credit, and capital deployment through the first six months of 2012, and feel very good about how we are positioned going into the second half of the year.

Jim will now have some brief concluding remarks before we take questions.

Jim?

Thanks, John.

Before closing the prepared portion of our call this afternoon, I want to touch on two remaining items.

First, I want to congratulate all CapitalSource Bank employees who just celebrated their 4th anniversary of the founding of the Bank on July 25, 2008.

I particularly want to single out Tad Lowrey for his leadership as CEO of the Bank since its inception.

Which was also recognized recently by the Board of CapitalSource Bank as it elevated Tad to the Chairman's role of the Bank.

Secondly, I want to touch briefly on the competitive environment in which we are making new loans.

There has been quite a bit written in recent weeks about a modest rebound in CNI lending which of course is the heart and soul of our national direct origination platform.

We remain confident in our ability to achieve projected loan growth this year of 15% to 20%, and have seen very modest signs of economic improvement in some of our markets and among some of our borrowers over the first half of this year.

We have also seen global economic and political events together with domestic uncertainty, particularly over the last six to eight weeks, putting a damper on economic activity.

Our niche businesses and the ability to add them on occasion, as we did this quarter with Premium Finance, continue, however, to position CapitalSource for strong and profitable growth.

Additionally, our speciality lending areas have only selectively been subject to the type of price competition which is occurring with some frequency in more commodity like businesses such as general cash flow or multi-family lending.

As a result, we continue to feel comfortable with our growth projections and the ability to maintain lending spreads and our net interest margin at enviable levels compared to banks of comparable size.

Operator, we are now ready for the first question.

Thank you.

(Operator Instructions)

Mark Devries, Barclays.

Yes, thanks.

First question would be for Tad.

Tad, I am trying to understand what is embedded in the NIM guidance.

What I am struggling with is why, I guess, it implies flattish to down NIM when you've got pretty robust asset growth?

Which is enabling you to switch from, at least some of our proceeds, from cash and securities into much higher yielding assets?

That, you would think, would provide some upward boost to your NIM.

Is there some type of offset there where loans were also repaying, running off at high yields and coming on at much lower yields that's offsetting the benefit you would think you would get from that?

You just hit the nail on the head, Mark.

There are two strong benefits.

And, that is the cost of funds should stay the same, or lessen slightly.

The investment mix -- the loan mix verses investments should continue to improve.

And, those are small up ticks.

But, we have a substantial -- every new loan that we book, even though we haven't seen the price competition we expect yet, we are modeling that to occur.

And, we continue to run off loans at 8% and 9% and 7%.

And, record new loans in the 5% to 6% raping.

So, that's the primary driver.

The other piece I would add to that is during the first quarter, as well as the second quarter, within the loan portfolio we recorded 65 basis points of benefit from the FAS 91 and discount amortization that was being accreted through.

A portion of that is related to loans that have prepaid.

There has been some acceleration of benefit.

In our forecast we assume that the level of repayments and prepayments declines back down to more of a sustainable level than we think for the long-term.

So, we would lose some of that accelerated amortization benefit.

Okay, thanks, that's helpful.

Then, next question for Jim.

I am just trying to get some thoughts on how you are thinking about buying back stock here.

I think you have talked about as you transition towards thinking about your bank holding company status acquisition and applying for that again next year.

When I look at the excess equity that seems to be implied at the holding company where you've got almost $575 million between your non-securitized loans and your securitization equity, but you only have about $131 million remaining in your existing repurchase authorization.

Would you look to ask for more if you went through that?

Are you going to want to retain a healthy amount of that equity?

Well right now, as you pointed out, we do have $131 million of remaining buy back authorization through the end of the year.

And, our forecast is that we will still be able to do that.

So, in terms of increasing the level of buy back activity over and above that, quite frankly that is going to be dictated a lot by the regulatory guidance we get.

Because we are going to want to file our bank holding company application with a strong regulatory capital level.

And, we've got to take that regulatory capital and balance that against the credit metrics that we have at the parent as well.

So, there is a lot of things that are moving on relative to that.

At this point, as I said, we are comfortable with completing the $130 million before the end of the year.

And then, we have to evaluate whether or not we can increase the authorization beyond that level based on where we are relative to regulatory capital and our credit metrics.

Okay.

Thank you.

Aaron Deer, Sandler O'Neill.

Good afternoon, guys.

Hello, Aaron.

It looks like most portfolios increased in the quarter.

But, healthcare asset baseline in was down.

I am just wondering if maybe you had a credit or two that had priced away in the quarter?

Or if the loan pricing that you are able to get is unsatisfactory?

Or what's going on there.

And, maybe just what the aggregate loan pipeline looks like currently relative to a few months ago?

I would say in the healthcare ABL space we actually have one large loan that was a $50 million loan that did pay off this quarter.

That actually was a cash secured loan.

So, as a result we had a deposit that flowed out in connection with that transaction as well.

So, that really accounts for the reduction in that balance.

In terms of the pipeline, I think the pipeline looks very good in the healthcare ABL space.

I think it was a little more challenged at the end of last year.

But, I feel that it's picked up a lot.

We've got a lot of good deals that we are working on in that space.

I would expect to see growth happening in this space going forward.

How about the pipeline in aggregate overall?

In aggregate, overall, I feel good.

As I said, our target for this year has been to do our $2.2 billion of originations.

We're on track to be doing that based on what we did in the first quarter and the second quarter.

And, the third quarter is starting off good.

I think, in terms of deals being brought to credit committee there is certainly a lot of volume and a lot of activity that's coming through.

So, there is nothing at all that I am seeing to indicate that we won't be doing a similar pace going forward.

So, I still feel comfortable about our total origination target for the year.

That's great.

Then, just as a follow up.

You mentioned having done some analysis on Basel III and didn't seem too concerned about the impact that might have, which I guess is not surprising given your heavy level of equity capital.

But, has it at all changed how you think about business lines you are serving?

And, how you price for that given what could be at higher risk weightings on some of those?

And then, it doesn't sound like that has affected at all your thoughts on timing for the bank holding company applications, is that correct?

No impact on the latter, no impact on the bank holding company.

It's too early to think about changes in products.

It's made us more appreciative that we don't have a consumer business.

It's made us more appreciative we don't have a single family residential business because the proposal clearly is somewhat punitive on that.

We have always risk rated most of our loans, or capital weighted most of our loans at the full amount of regulatory capital.

So, really not much impact there that we see in what we do except for commercial real estate.

And, the detail is there in the fine print, the type of commercial real estate that we've been doing for the last four years seems to be outside of the boundaries of the Basel add ons.

But, it's still too early to see what the final will be.

If they were to tighten screws on that we would have to look at the pricing there.

Okay, great.

Thanks for taking my questions.

Thank you.

Steven Alexopoulos, JPMorgan.

Hey, everyone.

I wanted to start -- looking at the loan yields, if you are getting, I think you said, 5% to 6% on new loans and I think the current yield is 7.09%, should we just continue to expect this to bleed down?

I don't know, if it will be at a 15 basis point rate or so per quarter.

And, what's the time line it should get to this 5% to 6% range?

I guess there are two components of it.

As John mentioned, when we are looking at the yields part of that includes -- when we were talking about the deals we are doing right now typically the rates are in that 5% to 6.5% type zone.

But, we also have some of this associated with prepayment penalties, and the like, that are also increasing yield somewhat.

So, I think the answer is you will probably start to see that declining.

It will be lower from where it is right now.

But, I think in terms of how low does it ultimately go it's probably going to be in that 6.5% type zone, something like that.

Right, so there is an element of that that obviously takes into consideration what your expectations are for the quarter and interest rate incurred.

If we just assume that interest rates remain flat from here until whenever, if you just think of our portfolio as having a four year life, you would expect over the next two, two and a half years that we would see the remainder of the higher yielding loans that would repay or refinance down to the current interest rates that we're originating at.

Then on the other side of the balance sheet.

Your cost of deposits were $95 million And, looking at that one slide you had, I think they were $80 million to $85 million range is where you added new retail funds this quarter.

Is that where we should think about your cost of deposits moving down to?

Because you did give some commentary that it might be flattish.

I am not sure if the rate went up a little bit on acquisition of new CDs.

No the rate didn't go up.

The reason we say that is A, to be conservative, and B, we are finally getting to the point where some of the CDs that we roll over are at lower rates.

You get spoiled by rolling over 2.5% to 3% CDs and financing those at $105 million to $95 million.

But, there are a few maturity buckets where we actually have lower than that.

When you crunch it all together there is no anticipated range in the market in our pricing.

We think it should continue to come down.

We are going to be more aggressive in the second half than we were in the first half, though, because we still see a lot of loan growth.

And, we want to finance that with deposits.

Okay.

Actually, to follow up on that with loan growth.

Can you give us some color on what drove the increase in the general real estate lines?

I don't know if it was a few larger transactions.

I think, it was just over 40% of the quarter's loan growth.

There were -- we did one industrial transaction, which I think was helpful in the quarter.

Then, there were several other deals that we had done.

So, I wouldn't say there was a general theme of where it was all coming from.

I think it's been pretty widespread across the spectrum between the industrial side, the commercial side, and, to a lesser extent, the hospitality side.

Okay.

And, I know you touched on this.

Some banks were also saying that some of their borrowers are getting more cautious given what's in the headlines, regarding fiscal cliff, etc.

Can you talk about what you are maybe seeing or hearing from your customers?

What segments we should think of as being a little more sensitive to that?

I would say probably in terms of our customers the area where I think you may have the most sensitivity may be in terms of the equipment area.

Where you are hearing -- seeing people talk about cutting back a little bit on capital expenditures and the like.

So, I would say that's -- from what is driven more by the economy.

I think that business may be more impacted by the economy where you are see a little bit of a pull back there.

We haven't really seen it in the other areas to be totally honest.

Okay.

Thanks, for taking my questions.

Thanks, Steve.

Jennifer Demba, Sun Trust.

Thank you, good evening.

Steve just actually asked most of my questions.

But, back to his question on the granularity of the loan growth.

Can you just give some more color on maybe some of your larger transaction sizes from the first quarter to the second quarter?

I don't have that detail on a -- in terms of the detail between the first quarter and the second quarter.

That's something that's probably -- we can get back, we can get with you offline on that to show the level of average loan size in the first quarter verses the second quarter.

I don't have that with me now.

But, largely the whole sizes are small and we have purposely been migrating down in that area.

I don't have that detail in front of me.

So, we'll have to get back to you on that.

Okay, thanks a lot.

Moshe Orenbuch, Credit Suisse.

Great, thanks.

You had -- I guess you still have had decent pay downs coming in the securitized loans.

Any update as to whether you would expect to see cash coming out of that at some point in 2013?

No, we don't expect anything to really come out of that portfolio in 2013.

We think that they will all -- the debt, inline debt will be fully repaid in 2014 on each of the three securitizations.

Okay.

As it relates to the bank holding company comments.

Is that a process that's underway now and can't be changed?

Or would you as -- if you looked at it could you push it out a period of time?

It might be easier to accelerate it than push it out because we have begun discussions with our regulators.

Certainly, nothing official.

We have tipped our hat a little bit there.

So, it might be easier to accelerate than push it out.

We are still thinking early next year.

But, it depends on two of the big factors.

There were three big factors.

One is the reversal of this tax asset.

We also need to continue to improve the credit metrics.

We gained a lot of ground in the second quarter.

We expect further improvement in the third and the fourth.

The other is the annual bank -- the bank regulatory exam needs to be complete before we file as well.

Timing of that exam is?

It is typically in the fall, early 4th quarter is when it typically begins.

Got you.

Okay.

Just last thing, just a -- the Premium Finance business, could you give us some sense as to what size you might be targeting over the next year or two?

I think, in terms of what that business can grow to, we're targeting to have roughly $50 million of originations in the first year.

The nice part about this business is that you typically have a deal that ultimately can have a five to seven year life.

So, you will do an origination in year one.

And, assuming everything is going the way it is supposed to, you will do a similar, a loan amount for a similar level in the second year and the third year and the fourth year and on.

While I expect our first year originations to be in the $50 million range I would expect that this is a portfolio that could grow to $300 million to $500 million over that next three years or so.

Great.

Thanks, very much.

Sameer Gokhale, Janney Capital Markets.

Hi, thank you.

My first question was for Jim.

Jim, I think you had talked about this -- the DPA allowance.

I believe, if I heard you correctly, you suggested that you are unlikely to be reversing anymore of the allowance beyond what you have taken this quarter.

Which looks like is roughly, I think, 67% or so of the overall valuation allowance.

I just wanted to get a little bit of color of that.

My understanding was that your initial idea was that you divert 60% of it.

And then, the rest wasn't a guaranteed reversal because you had state by state allowances.

So, it was a function of how much you earned on state by state basis.

Plus there was securities and you had to realize income related to the securities in order to use DPA.

If they were in loss positions you wouldn't be able to use them.

Has anything changed there related to what you were thinking before with respect to the DPA?

Or is it just the case of you have taken, say, 67% of the allowance back and so the rest of it you just basically said it's just highly unlikely a level to get it back.

Has anything changed there?

No, I would say nothing has changed at all.

Before, what we had said was that our expectation was that we would be able to reverse 60% by the end of the year.

And, as you pointed out, we reversed 67% this quarter.

The remaining valuation allowance there, which is the $166 million I talked about it, is really a valuation allowance that we don't have any expectation of reversing.

A lot of that is due to, as we said, state NOLs as well as capital losses that we do not currently foresee a way that we would be able to utilize those benefits.

As a result, those stay fully reserved.

And, it is our expectation that they will continue to be fully reserved.

Okay, that's helpful.

And then, the other question was on the use of your cash at the parent.

I know you suggested that you might want to wait, this bank hold company process is underway.

So, you want to see how that plays out before you maybe use the incremental cash beyond the authorization for buy backs, and the like.

But, you also bought back some trust preferreds.

It looks like you bought those back for about $0.68 on the dollar.

Buying those back at discounts obviously would add to capital.

You seem to have a lot of capital already.

But, you are just waiting for the bank hold company application to be approved.

Is it safe to say that, let's say, you get the bank hold company approval you are going to be less inclined to buy back any of these trust preferreds.

And, you would rather use the cash more for buy backs.

That would be your preference.

Because, you won't really need the capital.

I think the way that we look at it is we look our capital and we look at our liquidity.

We clearly have a significant level of liquidity now.

And, we clearly have a lot of capital.

I think we are, quite frankly, looking between both of those levers.

We think, as we said, we've got the ability to retire stock and continue to return capital to our shareholders that way.

However, at times, to the extent we can buy debt and buy debt at a discount which lowers, obviously, the debt we have outstanding but also does increase our level of capital, we view that as something that, clearly, is attractive from a regulatory perspective as well.

So, the answer is yes we will look at reducing our debt.

And, we will look at retiring our stock.

So, we'll consider all of that.

Okay.

And then, in terms of the mix shift of the assets and the yields coming down on some of the older loans, I know at one point you used to have loans that had significant prepayment penalties, or fees I should call them, as those loans paid down.

So, would your expectation be that as those loans paid down there would be an offsetting prepayment fee income element to it that you would also be recognizing over time?

And, helping offset some of the margin loss that you would have?

Yes, I think we will have that.

One of the things we try do when we are doing deals right now is we try to get lock outs, prepayment penalties and the like to the extent we can.

So, yes, we'll have some benefit associated with that.

And, John Bogler had alluded to some of that benefit earlier.

The reality is that in some markets it is difficult to get prepayment penalties.

Just, for example, when you're doing deals right now, because it is a competitive market out there.

So, the answer is yes we do try to get lock outs.

We do try to get prepayment penalties.

But, we can't do that at the same level we were able to do that years ago.

Okay.

And then, my last question, the $4 million of charges that related to some sort of abandonment of the lease.

This is something that was at the corporate level.

So, it isn't anything that went through any provisioning item, correct?

If you look at the other commercial finance segment there was a net, I think, draw down, or negative provision.

But, there were two components and there was some specific provisioning of $10 million or so.

This doesn't relate to that, right?

This is just something separate at the corporate level?

Where you have the charges of $4 million?

Yes, that's correct.

We had some excess space as part of some staff reductions last year.

And so, we were in position -- and we had planned do this during this year, it just occurred, of course, and had anticipated.

But, the $4 million just relates to abandoning some space.

Okay.

Terrific, thank you.

Henry Coffey, Sterne, Agee.

Good afternoon everyone, and congratulations.

From a very simplistic point of view, now that you have recaptured the DTA, you switch to being a GAAP taxpayer.

As we look at the existing run rate of earnings and try to project forward, you have given us pretty good insight into the various components of the Bank.

But, now we are dealing with something like a 35% or 40% tax burden.

Are there some obvious counter balances to that that we should be thinking in?

$60 million buy back, yes.

But, I was just wondering as you walk through the whole per share earnings equation what else should we be thinking about?

There is nothing unique to be thinking about it.

We would look as our effective tax rate of being 41% which would be a combination of our federal and state income tax.

I think it's as straightforward and simplistic as that.

So, in theory, if we're estimating $0.10 we should just reduce it by $0.40 going forward.

That's correct, you would reduce it by $0.04.

We keep talking to you about buying back stock.

You keep putting out cautious messages.

And then, you go out and buy back more than we thought, which is wonderful.

The additional buy backs that you did during this quarter -- really, just two questions.

The additional buy backs that you did this quarter were funded from unexpected sources?

Or was that just part of the plan?

And, should we be thinking about you potentially buying back more than $60 million of stock between now and year end?

No, that was part of our plan.

As I said, whenever we are buying back stock we are looking at our capital ratios and we are looking at our liquidity.

We had the ability to be able to do that.

So, going forward that's what we're going to continue to look at is what are our credit metrics looking like?

What's our capital level?

But, you've got $60 million of targeted cash flow coming to the holding company.

That's correct, but -- that's correct.

That's the inflows that we have coming in between now and the end of the year.

But, we also have a significant level of cash at the parent still, even pro form for the pay down of the debt.

Where we had $168 million of cash at the parent right now.

We'll add to our cash at that level over the rest of this year.

If we read you correctly becoming a bank holding company is very important.

But, of greater importance is the continue return of capital measures.

If that meant delaying the bank holding company process for six months, would that be an issue?

Yes.

We are now officially pregnant.

And, we're close enough after the reversal of this and close enough with our credit metrics.

That it's time to move forward.

It's time to move forward.

We feel like we're very close to the finish line.

We don't see any change in the financial metrics.

So, there is no rush to do it from that perspective.

It's just that we have been talking about it for four years.

And, we are close enough that we don't want do anything that would jeopardize that.

Listen, congratulations, it's been a long haul and a great year so far.

Thank you.

Thank you.

Scott Valentin, FBR capital markets.

Good afternoon.

Thanks, for taking my question.

I just wanted to get a little color on the credit side.

I know you guys had mentioned that non-accruals had increased at the Bank, but there was no real, I guess, trends that were giving you concern.

Just curious, maybe if you disclose the watch list, if that's increased at all or what you're seeing in delinquency buckets.

I know in the past you have had lumpy credits come through, some legacy credits from the holding company that were sold to the bank.

I was just wondering if that's the case or if it is more just a group of credits?

It is not the case, our credits still are a bit lumpier than our peer group.

But, much less than they used to be.

We think the non-performer -- let me stop and start over.

You called it the watch list.

We call them classified assets.

We had a very significant reduction in classified assets in the second quarter.

But, we also had some things going in both directions.

So, it's the new down grades that caused the increase in the non-accruals.

Again, we don't see anything from a geographic perspective, from a product line perspective, from a size perspective, from a bank verses legacy perspective.

We just think that's part of the normal noise in originating and carrying a $5 billion loan portfolio.

I think we'll be happy if our nonperforming assets, if we can manage that in the 1.5% level where it is today.

Okay.

And then, on --.

To get these kind of margins.

Okay, fair enough.

And then on the asset sales.

Any material differences between the book value and the sale price?

I think you sold some REO this quarter.

We had included in our numbers for this quarter was -- we did have some numbers in there for REO costs that weren't significant this quarter.

I think they were in the $2 million range.

So, it wasn't significant.

We've actually gotten our REO cost -- our REO balance down and down significantly.

And, our goal is to continue to reduce that level.

In terms of not seeing any pressure on write down value verses sale values coming in line?

No.

All right.

Thank you, very much.

Daniel Furtado, Jeffries.

Hi, thank you for the time.

I just had a real quick one.

And, that is I heard you on the 41% GAAP tax.

Do we think the same from a cash tax perspective for '13?

Or how should we be thinking of that from a cash perspective?

No, the cash tax is dependent on a number of factors.

And, how they would unwind from a book to tax difference.

It's very difficult for me to give you a percentages as to what that means.

I do believe in 2013 it will be less than 41% on a cash basis.

But, I really can't give you any better indication than that.

Understood.

Thank you.

There was one follow up question.

The REO loss that he had in the second quarter was $3.8 million.

I had mentioned $2 million.

$3.8 was the level.

And, that's a combination of expenses and holding these and the write downs to get them sold.

All right, everybody.

Thanks, very much, for your time.