Valley National Bancorp (VLY) 2012 Q3 法說會逐字稿

Good day ladies and gentlemen, and welcome to the Valley National Bank third quarter earnings conference call.

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

(Operator Instructions) As a reminder, this conference is being recorded.

I would now like to introduce your host for today's conference, Ms. Dianne Grenz.

You may begin.

Thank you.

Good morning.

Welcome to Valley's third quarter 2012 earnings conference call.

If you've not read the earnings release we issued earlier this morning, you may access it along with the financial tables and schedules for the third quarter from our website at valleynationalbank.com.

Comments made during this call may contain forward-looking statements relating to Valley National Bancorp and the banking industry.

Valley encourages participants to refer to our SEC filings, including those found on Forms 8-K, 10-K, and 10-Q for a complete discussion of forward-looking statements.

And, now I'd like to turn the call over to Valley's Chairman, President, and CEO, Gerald Lipkin.

Thank you, Dianne.

Good morning, and welcome to our third quarter earnings conference call.

In an industry which has never been immune to external intervention, today's fiscal and monetary policies represent the most severe challenge the industry has faced during my half-century long banking career.

The Federal Reserve's unprecedented influence on the level of market interest rates not only creates uncertainty about future inflation, but impedes bank earnings and also has a direct negative impact on an entire generation.

For many senior citizens who have practiced fiscal restraint, managing to save a modest sum during their lifetime, the current level of interest rates limits their ability to earn a reasonable return on their savings.

In other words, the nation's recovery is being disproportionately placed on the backs of our senior citizens.

These families are punished financially which severely affects their lives.

The long-term impact of the Federal Reserve's quantitative easing program will have many unintended consequences, which I fear will prolong the current muddle-through economy we are experiencing while negatively impacting our nation's future growth opportunities.

In particular for community banks, the artificially low interest rate environment has negative effect on net interest margin and, consequently, makes it very difficult to grow earnings.

Concurrent with the negative effects of the Fed's monetary policy, new and additional regulatory guidance surrounding the levels of capital and the risk-weighting of certain asset classes further threatens to curtail lending.

In today's difficult economic environment, the health and profitability of our industry will be closely tied to improving employment and economic conditions.

Basel III as proposed, in my opinion, will make it even more challenging to lend money and grow our economy.

As our nation continues to struggle with growth, the demands for more capital and liquidity can only result in more restrictive lending.

For many in the banking industry, the increased costs associated with the onslaught of regulations, accounting changes, and added pressure on net interest margin will pose an insurmountable hurdle eventually leading to further consolidation within the industry, while for banks like Valley with strong capital, experienced management teams, and conservative credit cultures, this environment should present a tremendous opportunity to expand their footprint and increase shareholder value.

However, for smaller community banks, the future will be much more difficult.

Until acquisition opportunities materialize, at Valley we intend to focus on enhancing non-interest income revenue and controlling non-interest expenses as a means to mitigate the net interest margin contraction impacting us.

This year, we have centered on several strategic initiatives in specific response to the low interest rate environment.

We have reviewed and adjusted many of our fees to better align them with the services rendered in light of the lower revenues generated by offsetting deposits.

In spite of the fact that the Durbin amendment is costing Valley several million dollars annually, our service charge modifications, including those implemented for the accounts assumed in the State Bancorp acquisition, have offset that lost revenue and enabled us to show a 16% increase in service charges on deposit account income, over the same quarter last year.

Also, we have reviewed each of our lines of business and have begun to exit those which fail to generate an adequate return for the capital they require.

Furthermore, we have begun evaluating our entire branch network.

Where possible, we will be right-sizing branches and their staff to better reflect the technological changes taking place in our delivery system as well as the amount of lobby traffic at each branch.

Where volumes can't justify the office, we are prepared to either shrink the size of the office or close it.

Most favorably during the quarter, we generated over $25 million of mortgage banking revenue, a significant increase over the $3.1 million recognized in the prior quarter and nearly 300% more than the total amount earned in the first six months of 2012.

Application volume during the quarter was nearly $1 billion, which equates to over a 20% increase compared to the applications received in the second quarter.

For the year to date, Valley has processed $2.7 billion at residential mortgage applications, all of which I might add through our centralized origination platform here in Wayne, New Jersey.

The $2.7 billion in applications already received exceeds the total amount processed in 2011 and, based on the volume we're seeing thus far this month, the fourth quarter prospects appears extremely promising.

In spite of our recent success in expanding our mortgage activity, we still hold only a tiny market share in New Jersey, New York City, Long Island, and eastern Pennsylvania.

With our State Bancorp acquisition that closed in the first quarter of 2012, we expanded our branch footprint to include Long Island.

Commencing in July, we introduced Valley's on-air media promotion to this market.

To date, the results have been encouraging, and we anticipate further market penetration as both Valley's brand and product recognition improve in the region.

Applications in the New York marketplace increased 41% from the prior quarter.

This geographic expansion provides a catalyst to future earnings growth without having to denigrate our current underwriting criteria.

As we like to say, we plan to fish in a bigger pond, not deeper in our existing pond.

Our mortgage banking platform is extremely scalable.

We have the infrastructure and experience presently in place to expand Valley's low fixed-cost residential mortgage refinance product to both neighboring and non-contiguous geographies.

As a result, mortgage application volume expands, so will Valley's secondary market activity, as we do not intend to change the asset composition of the Bank.

Valley's roots are that of a commercial bank, and we intend to maintain this posture.

Therefore, for over 15 years, Valley has actively sold loans to both Fannie Mae and Freddie Mac.

During this period, Valley has witnessed almost nonexistent repurchase requests from the agencies which is a testament to the strict underwriting and processes employed in this area.

We strive for similar results as the Bank's mortgage banking activities intensifies.

I'd like to add that our staff exercises the same underwriting criteria whether we plan to portfolio or sell the loan into the secondary market.

A key factor in Valley's residential mortgage loan quality is the simple fact that we deal directly with our applicant.

We do not presently source our mortgage business through third parties or mortgage bankers.

Also, we do not outsource loan processing, underwriting, loan documentation, or quality control functions.

We manage and directly supervise the process.

Another favorable aspect of Valley's strong residential mortgage program is the fact that we retain the servicing rights to approximately 99% of the loans we originate and sell.

Since the interest rates on these loans are extremely low, the long-term revenue enhancement from this growing $1.3 billion third-party servicing portfolio should prove to be an annuity for many years to come.

Although the highlight for the quarter was Valley's increased residential mortgage banking activity, total loan originations throughout the organization were strong, as Valley originated approximately $850 million of loans in the quarter.

Third quarter volume was nearly 60% greater than the same period one year ago.

While much of the growth in the quarter was attributable to mortgage banking activity, approximately $450 million -- we are ever mindful of the fact that we are -- excuse me -- were commercial loans.

Accordingly, commercial lending activity during the quarter received a high level of attention and, as a result, growth was strong.

Total commercial lending originations were approximately $330 million, an increase of over $90 million, or 37%, from the same period one year ago.

Total non-covered commercial real estate loans, including construction, grew approximately 2% annualized during the period, as both schedulized amortization and prepayments were largely offset by loan originations.

While customer sentiment has not fully shifted in a positive direction, we are beginning to see encouraging signs of economic improvement from some of our developers, as sales have begun to improve, albeit at very low levels [from] prior years.

The sequential quarter contraction of non-covered C&I loans was largely attributable to repayments from a few large borrowers, coupled with a decrease in line usage, when compared to the second quarter.

The decline in commercial activity was for the most part a result of seasonality and unto itself was larger than the entire late-quarter contraction in the C&I loan portfolio.

We anticipate usage to expand in the fourth quarter.

The competition for high-quality, low loan-to-value commercial loans remains intense in our marketplace.

The larger money center institutions have become much more aggressive in pricing smaller credit facilities which historically were of little interest to these size institutions.

Similarly, smaller, local community banks are equally assertive on rate and term and, in some instances, openly flexible on traditional standard loan covenants.

The banking environment is extremely challenging.

At times, competition reacts irrationally to external factors that negatively impact revenues.

Whether it be extending duration or failing to price for the underlying credit risk, these are avenues Valley will resist.

Our credit culture is the hallmark of the Bank.

Although challenging, we anticipate our initiatives and the current economic and regulatory environment will provide the conditions for future opportunities at Valley.

Alan Eskow will now provide some insight into the financial results.

Thank you, Gerry.

Total third quarter revenues increased to $162 million, approximately a 12% increase from the sequential quarter.

The growth, as Gerry referenced earlier, was largely driven by increases in gains on the sale of residential loans, which totaled $25 million compared to $3.1 million in the prior quarter.

The expansion of mortgage banking revenue is in large part due to macro asset/liability management strategies, and Valley's subsequent decision to originate and sell a larger percentage of production compared to prior periods.

During the quarter, Valley sold approximately $380 million of residential mortgages, compared to $75 million in the prior quarter and $118 million in the first quarter.

The $25 million of gains recognized in the quarter were comprised of approximately $17 million in income attributable to the actual loans sold during the quarter and approximately $8 million due to the mark-to-market valuation adjustment on the $149 million of loans held for sale at fair value.

Management's decision to originate and sell a larger percentage of mortgage originations than that recognized in prior periods is mainly a function of Valley's desired asset/liability sensitivity.

In addition, residential mortgage secondary market activity, at times, can lead to swings in the balance of loans held for sale and retained in portfolio.

We anticipate an increase in the portfolio balance of residential mortgages during the fourth quarter, as the balance in the held-for-sale portfolio contracts to reflect delivery of sales executed in the third quarter and a larger percentage of fourth quarter originations are retained in portfolio.

In managing the aggregate level of residential mortgages on the balance sheet, Valley combines the outstanding balance of certain residential mortgage-backed securities with its mortgage loan portfolio in determining the aggregate exposure desired on the balance sheet.

In addition, we actively manage Valley's interest rate risk exposure and utilize both on- and off-balance sheet instruments to manage the re-pricing volatility of cash flows.

Our risk tolerance for residential mortgage portfolio levels in conjunction with the very low interest rates on these loans has in part led to this higher level of sales activity than previously experienced.

However, we have always actively managed these risks and, as a result, we reported gains on sales of loans ranging from $8.9 million to $12.6 million during each of the three years prior to 2012.

We have demonstrated that these revenues and balance sheet management strategies are an integral facet of our mortgage banking philosophy which, as Gerry indicated, is very scalable.

Net interest income for the quarter was relatively in line with the prior quarter of $121.8 million, although the net interest margin contracted 6 bps.

The decline in net interest margin is due to several factors, none less important than the macro interest rate environment.

During the quarter, the weighted average coupon of new loan originations held in portfolio was less than 4.0%, which continues to drive net interest margin pressure.

The increase in aggregate loan yield, to 5.12% from 5.09% in the prior quarter, is attributable to approximately $2.1 million of interest accretion on fully-repaid, FDIC-covered loan pools which Valley accounts for under the pooled asset guidance of ASC 320.

The timing and recognition of this income is subject to a multitude of external factors and, therefore, we cannot predict with certainty whether Valley's net interest income will benefit from similar adjustments in future reporting periods.

Exclusive of the additional interest accretion, the yield on Valley's loan portfolio would have contracted by 5 bps from the prior quarter, to 5.04%.

Additionally, the sequential quarter net interest margin contraction of 6 bps would have been approximately 11 bps in total, exclusive of the interest accretion.

Valley's total cost of funds was 1.26%, and remained flat as compared to the second quarter of 2012.

Valley's funding portfolio includes both longer-duration borrowings and certificates of deposit which were originated to hedge interest rate risk exposure.

Approximately 25% of Valley's total funds have stated maturities in excess of one year, which from an asset/liability exposure limits net interest income volatility.

However, in today's current low level interest rate environment, the balances limit Valley's ability to reduce funding expenses in line with the continuing contraction in asset yields.

While we do not envision rising interest rates for the foreseeable future, we will remain vigilant in monitoring the composition of the balance sheet should unexpected rate shocks occur.

That being said, we have recently reduced the rates paid on our money market accounts and anticipate a benefit in the fourth quarter.

Additionally, nearly $1.8 billion of short-term certificate of deposit with a weighted average yield of 63 bps are maturing during the next 12 months.

We anticipate a decline in the cost of these deposits as Valley's current average interest rate being paid on short-term certificates is approximately 20 bps.

For the fourth quarter and into 2013, we anticipate continued margin pressure.

The contraction from the third quarter to the fourth quarter will likely be larger than the current sequential quarter decline, due to the aforementioned interest accretion benefit on covered loans in the third quarter.

To mitigate the margin compression, we will not alter either our credit or duration risk profile.

We have always operated the Bank with a steadfast belief in generating sustainable long-term earnings.

Today's difficult current interest rate environment does not alter this belief.

We intend to manage our interest rate risk profile in a manner to minimize net interest income exposure in varying interest rate environments.

Further, consistency and conservative underwriting has been a hallmark of the organization.

This will not and has not changed.

Non-interest income increased approximately $16 million from the prior quarter, almost entirely attributable to growth in mortgage banking revenue.

Additionally, during the period, Valley recognized other-than-temporary impairment totaling $4.7 million on the two investment securities, one a private-label mortgage-backed security and the other a single-issuer trust preferred security.

We have recognized prior impairment on each security and continue to closely monitor both the expected cash flows of the TMBSs and the financial condition of the trust preferred issuer.

Future impairment on each security is subject to issuer performance, as well as external market conditions.

Non-interest expense increased approximately $1.7 million from the prior period, largely due to increased FDIC insurance expense coupled with OREO expenses largely attributable to covered loans.

Partly mitigating the increase in other expenses during the quarter was a contraction in salary and benefit expense.

For the quarter, Valley's credit quality improved from the prior period.

Total non-accrual loans declined only slightly, from $126.2 million to $121.4 million, but include approximately $3 million of performing consumer loans classified as non-accrual as a result of new OCC guidance surrounding Chapter 7 bankruptcy filings.

Overall, Valley's non-performing assets declined approximately $10 million, largely attributable to the aforementioned decline in non-accrual loans coupled with a $5.1 million decline in non-accrual debt securities.

$4.5 million of the $5.1 million decline is directly attributable to the other-than-temporary impairment recognized on the trust preferred security during the quarter.

Net charge-offs for the period of approximately $8.2 million include $2.3 million of covered loan charge-offs, resulting in non-covered net charge-off figure of $5.9 million.

Exclusive of the covered loan net charge-offs, annualized total non-covered net charge-offs to average loans for the quarter equaled only 0.21%.

The provision charge for credit losses for the quarter was $7.3 million, which was approximately $1.3 million greater than non-covered net charge-offs.

As a result, Valley's allowance for non-covered loan losses, as a percent of non-covered loans, increased from 1.05% in the second quarter to 1.09% in the current period.

Capital ratios for the third quarter remain solid.

Valley's regulatory Tier 1 and total capital ratios increased from the prior quarter.

As of September 30, 2012, Valley's Tier 1 regulatory capital ratio was 10.87%, compared with 10.53% in the prior quarter.

The increase is due to both an increase in regulatory capital combined with a decrease in risk-weighted assets.

In addition to solid regulatory capital ratios, Valley's tangible common equity remains strong.

Tangible common equity to tangible assets increased from 6.78% in the second quarter to 6.94% in the current quarter.

However, more important was the increase in Valley's tangible common equity to risk-weighted asset ratio.

For the quarter, the ratio increased to 9.24%, from 8.97% in the sequential quarter.

This strong common equity ratio is favorable when analyzed in conjunction with the underlying credit quality of Valley as well as the proposed Basel III guidance.

This concludes my prepared remarks, and we will now open the conference call to questions.

(Operator Instructions) Ken Zerbe, Morgan Stanley.

Great, thanks.

Just a quick question on the gain on sale margins, just want to make sure I'm doing the calculation right or at least understanding what you're booking.

Using $17 million, I think you mentioned, on the gain on the loans sold over a $380 million balance, it seems that your gain on sale margins are incredibly high versus what we've seen.

Is there other adjustments that need to be made to that?

Or, are we actually getting that good?

That's the appropriate number.

So, over -- basically 450 bps.

Approximately that, yes.

Wow.

OK.

And, then, just a second question and, Alan, this is for you.

I just want to make sure I understand what you were saying on rising loan growth.

Obviously, end-of-period loan balances fell a little bit this quarter but, going forward, we should expect moderate growth?

Yes.

OK.

And, as a -- OK.

No, that's perfect.

All right.

Thank you.

You're welcome.

You're welcome.

Craig Siegenthaler, Credit Suisse.

Thank you.

Good morning, guys.

Good morning, Craig.

Good morning, Craig.

First, just a big picture question here for Gerry.

Just on your earlier comments on the call relating to the industry, just wondering, with loan growth now kind of weaker, steep NIM declines.

So, next year is really kind of reality for the industry.

How can banks cut core expenses enough to keep EPS from falling, especially now that, kind of, credit levers for most banks have been drying out?

Well, as I said, it's a multi-faceted attempt.

First, you have to look at generating additional fee income, which we have done through the mortgage banking activities.

We have several other initiatives, but nothing as great as that.

We have to look at right-sizing branches.

We have to look at the amount of square footage you have in a branch, the number of people you have in a branch, and whether or not the branch justifies itself.

It used to be you had one on every corner, and now you've got to say, well, maybe you've got to put them every other block.

I think some of that, you're going to start seeing more and more of within the industry.

And, again, I think everybody in the industry has to, as we have begun doing, looking at whether or not you're being compensated for the activity you're doing.

Free checking was wonderful when interest rates were 8% and 9%, and you could generate significant revenues off of the deposit base.

Today, those revenues are not being generated off the deposit base and, in many cases, you're just not making money on the deposit account, and you have to bite the bullet.

Somebody has to start it.

So, in maybe some cases, maybe it's us starting it, but I think the entire industry has to look at itself and say whether or not, you know, they're just losing money because they're giving away their products for nothing.

So, I think it's a many-faceted approach that we're taking, and I don't know of any other alternative for the industry, other than to take that type of an approach.

And, Gerry, isn't mortgage banking today --?

Today it's very strong, but going forward, isn't your view that it'll be more, kind of, a point of pressure when you think of the income statement, just because you're at peak gain on sale margins, you're at peak refi activity?

Of course, kind of, core origination volume could pick up, but with the amount of refi activity in the current quarter, that's probably turning lower.

So, wouldn't it be an area of pressure?

And, what are the other areas of fee income you're looking to, kind of, generate?

Well, let's focus on that.

I think as long as rates stay at their level, and certainly for the next 6 months to 1 year, we should be able to maintain high volumes of mortgage refi.

Our product is scalable.

We are looking to, as I said, expand our footprint.

We have a tiny portion of the New York City, Long Island marketplace.

So, I think for the foreseeable future this will be a fee-generating source for this Bank.

Now, I think that interest rates eventually are going to go back up again.

This is a product that helps us generate significant income while net interest margins are being plummeting.

Eventually, net interest margins come back.

This business will shrink.

It will dry up.

The refi market will go away, at least for the most part.

But, by then, hopefully, interest margins will have re-normalized, and we'll make our money back the way we used to, on our spreads.

Just let me add something to that, Craig, and that is that I went back and I did look, not just in the last couple of years, but as far back as to the very early 2000s.

We have always been an active seller when we need to manage our balance sheet.

And, I think going back to our 2003 year, I think I remember a number like $12.5 million of gains that we had.

So, this is not an anomaly in any way, shape, or form.

And, while we like the spread business, it certainly augments the entire bottom line of the Bank to be able to have the ability to do this, and get rid of some of the balance sheet exposure we may see, and still provide fee income.

And, also, I'd point out again, Craig, as I mentioned in my comment, when this business dries up, because rates went up, then the refi is going to dry up, because it's not going to be profitable to refi.

The consumer is not going to.

However, we're building at the same time a very significant servicing portfolio, and that will be an annuity when rates go up, because people are not going to refi those loans.

One of the reasons we don't want to put them on our books, because you don't want to be stuck with a 3%, 30-year mortgage on your books that will last, the duration, for perhaps 10, 12, 15 years.

So, that's the reason we're actively -- one of the reasons we're actively selling them.

[Later on], the other side of the coin, because rates went up and those are at low rates, they're going to be around for a very long time, and that servicing revenue should be very valuable.

Got it.

And, I have one more question.

Would you prefer me ask it now, or just jump back in the queue?

No, you can ask it.

All right.

Cool.

So, I wanted to hear your perspective on kind of small case, really the C&I market in New Jersey and metro New York City, because there's several banks this quarter that really started talking about softer demand in C&I.

And, I'm wondering if you are seeing, kind of, softer demand, if you could kind of maybe focus on what specific industries are sort of driving that, like manufacturing or equipment-related segments?

It's all over the place.

You really can't say one industry.

It is softer in many areas.

Listen, the economy is not strong.

It's showing signs of increased weakness.

Yes, basically, C&I originations were kind of flat with some of the prior quarters.

So, it's not like we're seeing the numbers go way down, but what it is is they're not growing.

And, that's maybe what you're hearing from others.

And, are they talking about, really, taxes or any healthcare costs, outlook for the US economy, election, fiscal cliff?

Is that what (multiple speakers) --?

All of the above.

All of the above.

OK.

Great.

All right, guys.

Thank you for taking my questions.

OK.

OK.

Steven Alexopoulos, J.P. Morgan.

Hey, good morning everyone.

Good morning.

Good morning.

I wanted to start -- it's interesting that the cost of deposits went up quarter over quarter.

And, I know -- I think Alan you mentioned that they went up.

I didn't catch the reason.

Can you just talk about why they went up, and maybe where you're putting new CDs on, and how we should think about that going forward?

Yes, I think the first reason, the biggest reason, is probably the fact that we did have a promotion early in the quarter.

We decided that we were going to try and raise some money.

We raised some rates.

We brought in some time deposits at a higher cost.

And, then, as we saw what was happening -- and, obviously, the ability to raise those deposits, all you have to do is [work] to pay for them -- of the market.

And, I don't know that we were much above, but we were certainly reasonably aggressive.

We backed off of that as we saw that the money was coming in and, obviously, the loan demand was not as good as we would like to have seen.

So, it caused some increase in CD cost during the quarter.

OK.

Alan, to follow up on your comments that you expect more margin pressure, I guess, in the fourth quarter than the third, if we adjust for the accelerated accretion from the PCI loans, how do you think about just the run rate of core margin pressure, here?

Yes, I don't know that -- it's certainly probably in the 7 bps to 10 bps range, I would say.

OK.

That's just a range.

Obviously, there's a lot of, as you know, a lot of moving parts to this thing.

What kind of prepayments are we going to get during the quarter?

We've seen prepayments certainly on the investment portfolio, on some of the trust preferreds we've had that paid us some fairly significant rates for a very long period of time, some of those have been called, and that has caused some pressure on that side.

On the borrowing side, I don't see a real lot happening, other than we did have some short-term borrowings that caused a little blip during the quarter in our cost of short-term borrowings.

That should move down during the fourth quarter as almost all, all of that as a matter of fact, has been paid back.

OK.

And, just a final one, Alan.

Given your comments on loan growth should pick up a bit here, should we expect enough growth that you can offset the margin pressure and at least keep NII flat?

Or, do you see NII under pressure, as well?

I think NII will be under pressure.

OK.

OK.

Thanks for answering my questions.

Yes.

Dan Werner, Morningstar Equity.

Good morning.

Good morning, Dan.

I was wondering if you could comment on, looking at the level of residential loans coming down on a link-quarter basis, how much of that was, for lack of a better word, cannibalized by your mortgage banking ops?

And, I guess, going forward, are you seeing most of the prepayments coming from that, coming through the mortgage?

Or, are other outside banks taking part in that, as well?

No, we're -- some of the coming down was people who refi'd their own mortgage, coming down.

Some of that was us, some of that elsewhere.

Most of that, hopefully, was with us.

A lot of payments, prepayments.

It's a --.

Gross, it came down about, $200 million?

Yes.

About $200 million.

That was not done as a cannibalization, at least not for the most part.

In fact, most of it was [planned].

It's one quarter to a quarter, which you were planning to sell in the next quarter.

Some of it may be in portfolio today.

You were just holding it for sale, planning to sell it anyway.

OK.

OK.

Dan, just, you know, we've said this before and I think it pretty much continues, that about 70% to 80% of the refi's are coming from other banks.

OK.

So, it's not the cannibalization issue I think you're talking about.

OK.

All right.

Thank you.

Yes.

Collyn Gilbert, Stifel Nicolaus.

Great.

Thanks.

Good morning, guys.

Good morning, Collyn.

Good morning, Collyn.

I may have missed this, because I'm kind of surprised it hasn't been asked.

But, what is your appetite for how big this mortgage business can get?

And, when I say mortgage business, I mean kind of the servicing portfolio.

And, just kind of how we should think about the mortgage banking revenues from here?

I think it's, as I said earlier, it's scalable.

We don't really have a ceiling on it.

It's, right now, it's a great opportunity for us to maintain our earnings, to build on our earnings.

We'd be foolish not to take advantage of it.

Aside from the short-term upfront earnings, we are building a servicing portfolio, as you know, that will be an annuity into the future.

So, I think it's a win-win for us.

We are very mindful of the quality of the paper that we put on.

We end up not approving about one-third --?

Yes.

About one-third of our applications.

We don't put them on simply to sell them and let somebody else worry about them.

That's not our philosophy.

It's not our approach.

That's probably why we have so few loans ever put back to us.

That's why we have so few loans that have filed for bankruptcy.

It's our underwriting approach.

That being the case, the sky's the limit for how much we would be comfortable putting on, because we're selling.

We're not distorting our balance sheet.

We're just selling them.

And, we have the ability to service many, many times what we presently serve.

Well, I guess that's the -- so, that the -- maybe, there's not limits on what you would sell, but then you had mentioned that you are servicing -- I forget, it's in here -- but, what percent again of what you're originating are you retaining for servicing?

18% this past quarter.

Oh, only 18%.

No, we service almost -- no, we service about 99%.

That's what I thought.

It's a very small group of loans that we do originate that we do sell servicing released.

Those are mostly -- what are they?

The FHAs?

Yes, basically, virtually what we originate, we like to service.

OK.

So, let's say that --.

And, by the way, I just want to add that our performance on the loans that we have sold that we are servicing is roughly the same quality as the loans that we put into portfolio.

OK.

So, the delinquencies are low.

I mean, it's very important, because we're not building a big problem of what we have to service.

OK.

So, the servicing portfolio, you said, is $1.3 billion, right now?

That's correct.

OK.

So, I mean, you could see that doubling?

Tripling?

Keep going.

As long as we can put on the loans, we'd be happy.

OK.

The only thing, Collyn, that we'll keep an eye on obviously is how it affects under the new requirements the deduction against Tier 1 capital.

So, we will watch that.

There is a 10% limit.

We're a long way, I think, from that number today, but that could be the only item that I can think of offhand that would affect how much of servicing rights we'd put on.

OK.

Yes, we have many times [within] that.

OK.

So, then, how --?

And, I know, Gerry, you mentioned the business is scalable, but just if there's a way we can, sort of, quantify what the expense associated to, sort of, growing this servicing business to that level would be?

The way we have been marketing it, the additional expense really isn't that significant, because we do it on television.

We've been doing it with this actor that looks just like me, sounds just like me, you know.

It covers -- we do it on Channels Two, Four, Five, Seven, the major channels here in the New York marketplace, which covers the New York and New Jersey marketplace at the same time.

In the past, where the coverage was spilled onto Long Island, it was just wasted, for want of a better term.

We didn't have the vehicle to take advantage of it.

We do have it now.

So, it's really your branch -- it's just your branch people that are originating these loans?

Are you not paying commissioned --?

I know you said you're not using brokers.

We do not use commissioned sales people running around.

We are not a typical mortgage bank.

All of the applications are either sourced by way of the media or by the branches themselves.

When they are sourced by the media, they come into our call center and, then, they are directed to a branch.

So, eventually, almost all of the applications are serviced, at least in New York, New Jersey, and Long Island, through our branch system.

All of the loans close in our branches, which gives us an opportunity to cross-sell the borrower at closing.

We have trained and cross-trained our branch staff, so that they're able to do this appropriately, and the results have been just outstanding.

OK.

I'm taking up so much time.

Let me just ask one more quick question.

So, explain again, Alan, sorry, why are residential mortgages going to actually grow in the fourth quarter?

Or, how do you --?

Why do you --?

Just based on the volume of loans that are coming through the door, the applications, that we're seeing at this point.

We have a very strong pipeline and, based upon what we believe we will likely sell in the fourth quarter, there will be obviously some that will get put on the books.

So, do you anticipate selling less in the fourth quarter than what you sold in the third quarter?

No.

OK.

Somewhat.

Somewhat.

But, you know what, that's a little bit sometimes on the fly, and we have to watch our volumes and see what we want to do with (multiple speakers).

OK.

OK.

I'll leave it there.

Thanks, guys.

OK.

OK.

Damon DelMonte, KBW.

Hi.

Good morning, guys.

How are you?

Good morning.

Question for you on expenses.

I think in your prepared remarks you commented on trying to right-size the branch structure.

I was just wondering if you could maybe quantify that and, maybe more bigger picture, give us a little perspective as to what a good run rate is for the expense base, kind of coming out of the third quarter?

There's not going to be an overnight change, even as we look at the branch structure.

This is not in the fourth quarter all of a sudden branches are going to disappear and costs are going to change.

We have a long-term commitment to our branches, but we will continually look at them.

And, I think that's the point Gerry was trying to make.

This is not something you're going to see in the fourth quarter.

I think our run rate for the fourth quarter is probably reasonably close to where we are today.

OK.

Already this year we have closed three of our offices.

I believe last year, we closed four or five of our offices.

And, we have several others that we are monitoring very closely as to whether or not we should keep them open.

It's something that I think that everybody has to do.

It's not just Valley.

The age of just constantly opening up more and more branches, I think is passe.

OK.

That's helpful.

Thank you.

And, then, with respect to your funding costs, are there any opportunities to, kind of, tweak the balance sheet to try to lower the cost of funds?

I know in the past you've adjusted the rates on some borrowings and extended the durations on those.

Any type of opportunities like that?

Look, there are opportunities to always do things.

The question is in managing again the balance sheet, what is the right thing to do?

How long --?

Would I extend borrowings?

Do I really want to extend them?

What are the things we want to do?

And, so, I think we're comfortable at the moment with where we stand, but that doesn't mean we couldn't do things further as we continue to monitor it and we monitor the interest rate environment, as well as what's happening with loans coming on the books.

OK.

That's helpful.

That's all that I had.

Thank you very much.

Matthew Kelley, Sterne, Agee.

Yes.

Hi.

As you build out the servicing book, how are you going to capitalize that?

Maybe, just give us a sense of some of the assumptions there?

And then, also, what should we be thinking about for servicing income going forward as that becomes larger?

Yes, we try to capitalize it as low as the accountants will allow us to.

At the present time, I believe it's somewhere around a 5?

It's 5-time multiple.

Yes.

5-times?

Yes.

Yes.

OK.

And, then, what should we be seeing in the securities book?

You know, down pretty hard the last two quarters.

Is that going to stabilize?

Or, still see some modest shifting from cash and securities into loans and (multiple speakers)?

No, I think you're going to continue to see it go down.

I mean, remember, we still have a lot of mortgage-backed securities.

And, as loans are paying off, that's what backs up the securities.

So, you're going to continue to see those come down over time.

It's --.

And, in addition to that, I think as I mentioned, we do have some trust preferreds that are still out there.

Over time, some more of those will likely be called and, again, I don't think we can predict it, but obviously as interest rates stay where they are, we'll continue to see --.

Yes, the other point also -- this is Gerry -- as we've said in the past, if our mortgage-backs are paying down, we'd rather replace them with our own residential mortgages that --.

The performance history on our residential mortgages has been outstanding.

Well, I'd rather keep my own 3.75% mortgage than go out and buy a mortgage-backed security that's going to pay us, you know, 2.5%.

I'm getting the same product, the same duration.

We have a much better rate of return, here.

Yes.

So, over the next year, from a $15.8 billion asset size this quarter, do you think you're flat, up, or down, just over the next year?

I think a lot of it is going to have to do with what happens in November, as far as election is concerned, and how the Fed reacts to the economy.

And, it's the economy in general.

You want to tell me where the economy is going to be a year from now, I'll tell you how much bigger or smaller we'll be.

I think that we've always gone by the adage that it's not how big we are, it's how much we earn.

Sure.

So, the fact that we may have had a little bit of shrinkage this quarter and we made some good numbers, we're very comfortable with that.

And, you wouldn't be upset with additional shrinkage if it improved, you know, returns on equity and assets?

Why not?

As long as we're making a lot more money for our shareholders, it's not how big we are.

Yes.

And, then, what should we be using for a tax rate going forward?

I think we indicated 33.something% for the full year, in the fourth quarter.

OK.

Actually, I want to come back to one last one.

You know, again, it was asked earlier in the call, but your gain on sale margins for the [four handle].

If you go back and look at where you were in the first quarter, I think you sold $3.2 million -- you had $3.2 million in gains, $108 million sold.

So, that was a 3% margin.

I mean, what do you anticipate for gain on sale margins?

You know, a lot of this is based on the Fed, what the Fed has been doing.

Yes, QE3.

That's one of the -- while we get hurt on our net interest margin, it helps us on the sale of the product, the mortgages.

Right.

So, you have to be responsive as management.

You have to look for where we have the best returns to our shareholders.

To some extent, what the Fed is taking away, they're giving us.

Sure.

OK.

All right.

Thank you.

Gerard Cassidy, RBC.

Hi, guys.

Good morning, Gerard.

Hi, Gerard.

Gerry, can you give us a little more color on the deposit pricing?

You mentioned you're raising some of your prices.

How does that compare --?

No.

No.

No.

No.

No.

We're raising our fees on deposits.

That's what I meant.

I misspoke.

I meant your fees.

How does that compare to some of your competitors?

Is it a real meaningful difference?

Or, a slight difference?

Can you give us some color?

It's not dramatic.

You can't price yourself out of the marketplace.

We're not at the very top of the fee scale.

We used to price ourselves probably in the middle, and now we're at the 75% level.

But, the whole industry has to face up to the fact that you can't give away your services for nothing.

Eventually --.

You can't give away your home banking.

You can't give away all your postage.

You can't give away your bill pay.

You can't give everything away and, then, expect to have reasonable returns for your shareholders.

I totally agree.

No, it's -- hopefully, others will follow suit.

Can you give us some color?

You've, obviously, over the years have been very active in mergers and acquisitions and as the smaller community banks feel these pressures that you're talking about, are you seeing more of them come to the table with an open mind of about maybe joining forces with you?

Or, is it very quiet right now?

Well, first of all, I can't -- my counsel will shoot me for talking about mergers and acquisitions, about anybody coming to the table.

But, I will say that I think the realization has got to be setting in when you look at the returns that they're generating and what their future prospects for those returns are.

I mean, it's got to be an active discussion in every boardroom.

Sure.

And, then, finally, as you look at your expenses, you pointed out looking at branches, if maybe a smaller size might be more appropriate.

If this interest rate environment stays as long as the Federal Reserve has suggested they're going to keep it at, meaning the middle of 2015, these margin pressures obviously are not going away for the industry.

Does it make sense at some point -- maybe, it's a year from now and rates are still this way, margin pressures are more intense -- to shrink the balance sheet, tying in to your point about shrinking branches, and then giving back the excess capital to shareholders with a more aggressive buyback?

Everything is of course always on the table, Gerard.

But, when I talk about shrinking branches, I'm really speaking about lobby traffic, traffic counts, how many people are coming into the branch.

I think we're seeing, and I'm sure every other bank is seeing, lower foot traffic coming into the branches, simply because you have more automated and home banking and things of this nature, that people don't have to come to the bank.

You have remote deposit capture.

You don't have companies coming in as often as they do.

You need fewer tellers.

That's something you have to shrink and monitor and something we are following closely.

You also have to look at locations of branches, how many you have in a particular area.

You still want to have a presence.

And, then, you have to look at the branches.

What else can you do in the branch?

In our case, we have converted the branch locations, in most cases, to mortgage origination and mortgage service processors, helping us get the mortgage product through the system.

So, we're using the lobby space for other purposes, whether it's to sell investments in the branches that heretofore was not aggressively pursued.

All these things are under consideration right now, because we have the investment in the branches.

Some of them, you own the building or you have a long-term lease.

You just simply can't shut the doors overnight, because you're going to still have a lot of expense.

I'd rather see us convert those locations into doing other things that justify their existence.

Gerard, just as I mentioned earlier --.

Maybe you were on, maybe you were not.

I'm not sure, because we talked about the fact that the bank shrunk a little bit during the third quarter.

We're not going to -- Gerry, I think, agrees very much with me -- we're not going to look at our asset size.

So, if the best way to run the business is to have a smaller asset base and we can make more money on that asset base, then that's what we should be doing.

And, that's what we'll be looking at.

So, it's always going to be based on returns, what the net income is, the EPS is, and what we can do for our shareholders.

Our Board and our shareholders are very closely attuned to what our bottom line is.

And, everybody around this place, we've always focused on our bottom line.

And, I think this quarter shows that we've taken steps to help fortify that.

Just one follow-up, and I apologize if you already addressed this.

On your expansion on the mortgage banking business, that you could scale up if you chose to do it, is there any geographic boundaries that you're not likely to go beyond?

Well, the key here, Gerard, at the present time is the market share that we presently hold in our existing market.

We only have a roughly 1% or 2% market share in New Jersey and even less than that in New York.

So, we have an enormous opportunity to grow right where we are.

So, I wouldn't expect us to be opening up mortgage banking operations in the Midwest or out on the west coast.

It'd be foolish.

Let's finish servicing what we have right where we have it.

We have this branch network which we can utilize to process the loans, and we're doing that.

So, just think, if we doubled our market share, we'd still have a miniscule market share and a humungous revenue.

So, it is scalable.

If we were to add another bank, we could train and utilize their staff in that regard to bring in more business.

We don't really have to leave this part of the country, so to speak, to do it.

And, that will drive our efficiencies, Gerard, the fact that we don't have to open offices all over the countryside or do all kinds of work around the country.

We're already here.

We already have a couple of hundred branches.

We have the resources in this part of the market.

And, to drive our efficiencies down again means we just make more money.

If you stayed just in the market and get a bit deeper penetration, as you guys just mentioned, what are the challenges to do --?

What do see as being the challenge of doing that, should you decide to do it?

The challenge was getting our staff trained.

All of the mortgages, all of them, are processed here in Wayne.

We have one location in Wayne that processes them.

It's a question of adding the people that we need as the volume increases.

And, so far, we've been able to meet that challenge.

And, one of the things -- and, I'm very, very proud of our branch staff, because many members of our branch network have volunteered and been crossed-trained so that they can come into Wayne to work in the processing center when volumes increase.

So, we have a source of -- out in the branches, when I talk about right-sizing the branches and reducing staffing in the branches, we're able to utilize some of those same people by simply transferring them into the mortgage operation.

Thank you for all the color.

Appreciate it.

OK.

Thank you.

There are no other callers in the queue.

I'll turn it back over to our host.

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