Webster Financial Corp (WBS) 2007 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Webster Financial Corporation's third-quarter earnings conference call.

(OPERATOR INSTRUCTIONS).

As a reminder, ladies and gentlemen, this conference is being recorded.

Also, this presentation includes forward-looking statements within Safe Harbor provisions of the Private Securities Litigation and Reform Act of 1995 with respect to Webster Financial's condition, results of operations, and business and financial performance.

Webster has based these forward-looking statements on current expectations and projections about future events.

These forward-looking statements are subject to risks, uncertainties and assumptions as described in Webster Financial's public filings with the Securities and Exchange Commission, which could cause future results to differ materially from historical performance or future expectations.

I would now like to introduce your host for today's conference, Mr.

James C.

Smith, Chairman and CEO.

Good morning, everyone.

Welcome to Webster's third-quarter investor call and webcast.

Joining me today are Bill Bromage, our President; Jerry Plush, our CFO; and Terry Mangan, Investor Relations.

I'll provide some highlights and context for the third quarter results, and Jerry will provide details on our financial performance.

Our remarks will last for about 30 minutes, and then we will invite your questions.

In our earnings release, we reported $0.64 in diluted earnings per share in the third quarter, which includes the impact of $0.14 a share from an $11 million increase from Q2 to the allowance for credit losses, primarily in connection with home equity loans.

This compares to EPS of $0.63 in Q2 and $0.17 a year ago, and to adjusted EPS of $0.78 in Q2 and $0.77 a year ago.

I'll speak to trends in business activity in the quarter, and then provide a thorough update on our loan loss provision and on asset quality prior to handing off to Jerry for the financial review.

I want to say up front that we believe we have applied a conservative standard in determining the Q3 provision, attempting to reserve today against the losses we foresee based on a thorough analysis of trends in force.

As we have stated in prior calls, comparison to a year ago continued to show the benefits of the balance sheet repositioning actions that we implemented late last year and the beginning of this year.

While average earning assets in Q3 are $1.2 billion less than a year ago, a 37 basis point increase in the net interest margin to 3.38% contributed to a 4% increase in net interest income.

Securities were 14.9% of assets at September 30 compared to 18.3% a year ago.

Borrowings were 13.6% of assets compared to 21.9% a year ago.

The benefits of the balance sheet repositioning are now clearly reflected in high-quality earnings from loans and deposits, and our improved capital position has facilitated an aggressive stock repurchase program year-to-date.

Webster continues to show momentum in both commercial and consumer lending.

Aside from the NewMil acquisition in the fourth quarter of '06, total commercial loans and consumer loans grew over 4% from a year ago as we continue to place emphasis on building these portfolios.

Including the loans received in the NewMil transaction, commercial loans including commercial real estate loans totaled $5.5 billion and grew by 6% from a year ago, and now comprise 44% of the total loan portfolio compared to 39% a year ago.

Our C&I portfolio is by design about twice the size of our CRE portfolio.

The portfolio yielded 7.44% in the quarter, up six basis points from a year ago.

The C&I portfolio is balanced, diversified and granular.

These characteristics underpin our favorable charge-off experience and overall asset quality.

While we saw strong origination activity of $96 million in the third quarter, we also saw significantly higher levels of payoff activity connected to the capital markets.

We've seen CLOs, private equity and hedge funds aggressively moving into the lower end of the middle market, which has had the dual effect of either taking out bank debt or putting in a loan structure that doesn't meet our credit standards.

Payoffs in our C&I portfolio totaled an unusually high $111 million, which explains the relative flatness in the C&I portfolio from June 30 to September 30 despite strong originations.

Our commercial real estate portfolio remained essentially unchanged from the second quarter at $1.9 billion, as strong originations were again offset by high prepayment activity.

Originations of $56 million in the quarter were offset by payoffs of $60 million.

Total CRE portfolio yielded 7.13% in the quarter compared to 7.27% a year ago.

As with the C&I portfolio, credit performance has been strong, with virtually no CRE charge-offs in the past decade.

The consumer loan portfolio totals $3.3 billion, and grew 8% from a year ago, or almost 5%, excluding NewMil.

Consisting about equally of home equity loans and lines, the portfolio yielded 7.01% in the quarter, up 7 basis points from a year ago.

Consistent with the announcement we made upon completing our strategic review, our emphasis is on a direct to consumer and branch-oriented strategy.

We had branch originated home equity production of $112 million in Q3, or almost 50% of the total, compared to $100 million or 28% of the total a year ago.

Retail outstandings in the home equity portfolio increased $28 million at June 30.

This increase helped to offset a decline of $11 million in wholesale outstandings during the quarter, which reflects our previously reported decision to limit our wholesale originations to the northeast compared to nationally previously.

Excluding the $300 million of residential loans received from NewMil, resi loans declined 30% from a year ago, primarily due to the two securitizations that took place in Q4 '06 and Q1 '07, and consistent with our plan, as well as our decision in July '06 to sell all fixed-rate production.

Resi loans currently comprise slightly less than 30% of the loan portfolio compared to 37% a year ago.

We expect that further planned attrition in the resi portfolio will be more than offset by ongoing commercial and consumer loan growth.

We want to provide the details around the decision to increase the loan loss reserve by $11 million, primarily in connection with home equity loans, nonaccruals, and higher delinquencies.

In total, nonperforming assets increased to $104.2 million at September 30 compared to $78.7 million at June 30.

We had anticipated that NPAs would rise, and we've adjusted our quarterly provision accordingly in recent quarters to $4.25 million in Q3, up from $3 million a year ago.

All of the $11 million increase from Q2 levels was applied against emerging trends in Webster's $3.2 billion home equity portfolio, most especially against out-of-market, high combined loan-to-value ratio, no income verification loans which meet our definition of higher risk loans.

The spike in home equity related nonaccruals and delinquencies overall, but most particularly in September, coupled with our risk layering approach to analyzing the portfolio caused us to provide the additional $11 million.

Of our $3.2 billion home equity portfolio at September 30, $94 million meets our definition of higher risk -- out of market; high CLTV, but none over 100%; and no income verification.

We've been tracking this portfolio closely, and as you may have seen, including it in our investor presentation, most recently at the Lehman conference in September.

The delinquency rate for these loans rose from 2.38% at June 30 to 3.06% at September 30.

And the nonaccrual rate rose from 2.70% to 4.83%.

Given the trend and the anticipated high loss rate in the event of default, we concluded that the prudent course of action warranted a higher allowance.

To complete the home equity picture, we have another $189 million of no income verification loans, two-thirds of which are in footprint, and only $22 million of which have CLTVs greater than 90%.

The delinquency rate on this $189 million bucket rose from 1.84% at June 30 to 2.59%.

And the nonaccrual rate was reasonably stable, rising from 0.56% to 0.71%.

The balance of the home equity portfolio are $2.9 billion in outstandings performed within normalized provision levels with the delinquency rate rising from 0.57% to 0.59% and a nonaccrual rate from 0.34% to 0.46%.

Overall, consumer nonperforming assets were $19.5 million at September 30, $12.3 million at June 30, and $3.6 million a year ago, with the majority of the increase coming from the out-of-market loans I have described.

The annualized net charge-off ratio in the consumer portfolio was 18 basis points in the third quarter, down actually from the 24 basis points in Q2 and up from 2 basis points a year ago.

One other portfolio bears special mention, that being national residential construction loans, about which we've commented in the past two earnings calls.

The NCLC portfolio, as we call it, is reported as part of the residential mortgage portfolio.

Since last quarter, balances have declined $31 million or 26% to [$116] million], while delinquencies have risen as expected by $2.3 million to $11.9 million, and nonaccrual loans have risen $5.3 million to $18.5 million.

We allocated $10 million in reserves against this portfolio in Q1, in anticipation of related credit losses.

About $8.5 million of that reserve remains as we work out this portfolio.

As a reminder, we announced earlier this year that we discontinued all residential construction lending outside New England market area.

We continue to have good experience in retail construction lending in New England, where such loans totaled $110 million at September 30 compared to $130 million at June 30.

As loan quality is the focus of our report today, I'd like to provide information on other portfolios as well.

Total residential developer outstandings within our commercial real estate portfolio were $241 million across 257 individual loans at September 30.

Our portfolio actually has remained flat over the last several quarters.

As with our overall CRE portfolio, we had no net charge-offs in the res dev segment over many years now.

We lend only in the Northeast to established builders who have been in place for a long time and have seen the cycles themselves.

Our prudent underwriting standards have served us well in the res dev segment over the years.

We verify each developer's liquidity upfront as part of our underwriting, complete a global analysis to ensure that their other developments will not negatively impact our project.

Total nonperforming assets in the residential mortgage portfolio were $34.3 million at September 30 compared to $27.4 million at June 30 and $7.6 million a year ago, with the majority of the increase representing the residential construction loans that I described a couple of minutes ago, and that were originated by the NCLC unit.

NPAs represented 0.43% of the $3.5 billion core portfolio at September 30 compared to 0.38% at June 30.

Commercial nonperforming assets totaled $31.1 million at September 30 compared to $24.1 million at June 30, and $30.9 million a year ago.

The net increase of $7 million from June 30 primarily reflects one middle market credit.

Commercial NPAs to total commercial loans were 0.87% at September 30, 0.68% at June 30, and 0.92% a year ago.

Nonperforming assets in our equipment finance portfolio increased to just over $5 million at September 30 from $2.6 million at June 30.

Most of this increase reflects one loan where we are at a strong collateral position and we expect full realization in Q4.

Commercial real estate nonperforming assets were $14.2 million at September 30, $12.2 million at June 30, and $16.8 million a year ago.

CRE nonperforming assets to total CRE loans were 0.75% at September 30, 0.63% at June 30, and 0.95% a year ago.

The $2 million increase from June 30 reflects a single residential developer credit.

Turning now to deposits, total deposits amounted to $12.6 billion, $615 million of which came from the NewMil acquisition that closed in Q4 '06.

Excluding NewMil and the planned reduction in broker deposits, deposits grew 2% from a year ago.

Growth over the past year has been led by CDs, which reflects the consumer preference across the industry for higher-yielding deposit products and, to a slightly lesser extent, by relatively lower costing savings accounts.

Webster's overall cost of deposits increased 8 basis points from Q2.

The Q2 cost of [2.88%] was 18 basis points below the median for our peer group, clear proof that our above average market growth rate stems from execution, not price.

Our de novo banking program consists of 27 branches opened since 2002, or 15% of our total retail branches that had total deposits of $773 million at September 30 compared to $790 million at June 30 and $701 million a year ago as we've let some of our higher-costing deposits run off.

Our de novo branches continue to provide an improving mix of demand, NOW, and savings account deposits over time.

The de novo program is an essential part of our buy and build strategy, enabling us to expand our retail presence and creating opportunities for us to deliver our bankwide products and services to consumers and businesses in new market areas.

We opened two new locations in Q3, one in New Rochelle, New York, and the other one in the Springfield, Mass.

area.

We expect to open two locations during Q4, one more in the Springfield area and one in Woodbridge, Connecticut.

While we have slowed the pace of the de novo openings in the past 18 months, we continue to see de novo branching as integral to our plans for a longer-term organic growth.

Turning to HSA Bank, we now have $384 million in deposits in this division, an increase of $106 million or 39% from a year ago.

And we also have $55 million in linked brokerage accounts compared to $34 million a year ago.

HSA Bank's average cost of deposits for this fast-growing category was 2.97% in the third quarter, about the same as the cost of in-market deposits.

Strategically, we've expanded our reach for core deposits to fund our above-market loan growth, and we've tapped the deposit market poised for attractive growth over the next several years.

In the third quarter, HSA Bank acquired about 11,000 new accounts from enrollments and transfers from other banks, and more than 181,000 total accounts have an average balance of over $2,100 each, which we expect to increase over time, given the higher deposit limits allowed by recent legislation.

HSA Bank is expanding its salesforce, as market acceptance for health savings accounts continues to build among employers.

I'll now turn the program over to Jerry Plush, so he can provide full details on the financial performance in the third quarter.

I would like to update everyone on our continued progress in several key areas.

First, our tangible capital ratio, inclusive of the impact of repurchasing over 1.1 million shares in the third quarter, now stands in excess of 6%.

Our TCE ratio of 6.17% as of September 30, 2007 is a solid improvement over the 5.66% we recorded a year ago at September 30, 2006.

Our tangible capital ratio for the third quarter remains higher than the 6% we have stated as our target range, which allows for ongoing capital management flexibility.

Next, our loan to deposit ratio was 99% compared to 97% at June 30 of '07, and over 106% at September 30 of 2006.

The improvement in this ratio over the last year is due to an $860 million increase in core deposits, partially offset by a $610 million reduction in broker deposits and the completion of the balance sheet repositioning actions.

Our statement of financial condition shows that compared to June 30, 2007, our deposits increased $265 million and loans decreased $20 million.

Broker deposits declined $114 million by quarter end as well, as we continue to minimize the use of this source of funds.

Borrowings increased $202 million in the third quarter, but have declined 42% from the third quarter of last year.

Our net interest margin was 3.38% in the third quarter in comparison with 3.47% in the second quarter and [3.01%] for the third quarter of '06.

The 9 basis point decline from the second quarter to the third quarter is the result of an increase in share repurchase activity, which accounts for 3 basis points; a higher average level of trust preferred securities outstanding during the third quarter, which accounts for another 3 basis points, as the second quarter benefited from the retirement of $105 million of trust preferred securities as of 4/2/07, and issuance of $200 million in new trust notes in late June of 2007.

In addition, the effect of loan interest reversals on higher nonperformers also impacted the NIM as well.

Looking at the provision for credit losses, when taking into account the additional $11 million provision that Jim outlined earlier that was specifically set aside for the home equity portfolio, the provision for credit losses for the third quarter was $15.25 million compared to the second quarter at $4.25 million.

Our allowance for credit losses to total loans is now 1.32% as of September 30th in comparison with 1.23% at June 30 and 1.20% a year ago.

Charge-offs for the quarter were $3.9 million compared with $4.2 million for the second quarter and $3.1 million for the third quarter of 2006.

The $0.64 of diluted earnings per share for this quarter, or $0.78 if you [look to be] exclusive of the additional provision we just talked about, reflects the achievement of a return to positive operating leverage.

Earlier in the year, we noted that we expected to achieve positive operating leverage by the second half of the year.

I am pleased to state that we have achieved this, as adjusted revenues grew by 6.2% from a year ago, and adjusted expenses grew by 5.4%.

We continue to build our earning asset base with higher-yielding commercial and consumer loans that are funded by core deposit growth.

The yield on total loans was 6.8% compared to 6.81% for the second quarter, and was 15 basis points higher than the 6.65% we reported a year ago.

Commercial, including commercial real estate and consumer loan categories in aggregate, grew by 7% from a year ago or by $566 million, and are up $39 million for the second quarter.

Commercial and consumer loans now represent 70% of total loans compared to 63% a year ago.

The yield on securities for the third quarter was 5.79% compared to 5.78% for the second quarter and 5.06% a year ago.

It reflects the positive effect of the security repositioning steps that we took in the latter part of 2006.

On the funding side, our cost of deposits increased 8 basis points to 2.96% over the cost of deposits for the second quarter, and were 20 basis point higher than the 2.76% reported a year ago.

Seasonal municipal deposit inflows were the primary driver of the cost of deposit increase in the quarter.

The cost of FHLB advances was 4.58% in the third quarter, down 14 basis points from the prior quarter and down 40 basis points from a year ago.

Our total FHLB borrowings are now down by $1.2 billion from a year ago.

If we turn now to noninterest income, we reported $60.2 million for the third quarter compared to second quarter noninterest income of 64 (multiple speakers).

Note that the second quarter noninterest income included $2.1 million in gains on the Webster Capital Trust I and Trust II securities.

This also compares to a non-interest income of $6.8 million a year ago, which was reduced by the $48.9 million securities portfolio repositioning charge that we took.

Deposit service fees totaled $30 million compared to $28.8 million in the second quarter and $25.3 million a year ago.

The increase from a year ago reflects tiered retail pricing changes and the benefit of no longer charging the uncollected overdraft amounts, just the uncollected fees, to deposit service fees.

Our insurance revenue was $8.9 million in the third quarter compared to $9.1 million in the second quarter and $9.8 million from a year ago, while loan-related fees were $7.7 million in comparison with $7.9 million in the second quarter and $7.8 million from a year ago.

Wealth management fees were $7.1 million, down from the $7.6 million we've recorded in the second quarter and $6.7 million in the third quarter a year ago, while [another] -- our non-interest income was $1.6 million for the quarter compared to $1.4 million in the second quarter and $1.7 million a year ago.

Our mortgage banking activities that we've reported are $1.9 million for the third quarter compared to $4 million in the second quarter.

We have as previously announced scaled back our mortgage banking activities to the Northeast from a nationwide view previously.

We recorded $482,000 in net gains from the sale of securities in the third quarter compared to $503,000 recorded in the second quarter and $2.3 million a year ago.

Turning now to expense, our total non-interest expenses were $121.7 million compared to $138.1 million in the second quarter.

The second quarter included onetime items such as $8.9 million of capital trust securities redemption premium, and $5.3 million of severance and other onetime charges.

Total non-interest expenses were $115.9 million a year ago and do not include the additional expenses of the NewMil acquisition which occurred in the fourth quarter of 2006.

So excluding severance and other costs, and cost from the debt redemption during the second quarter of 2007, non-interest expenses declined $2.6 million during the third quarter.

Non-interest expenses, though, for the third quarter of '07 did increase by $5.4 million from the third quarter of 2006.

Looking ahead now to the balance of the year.

Let's first talk about our capital ratios.

They will be maintained at a level to provide ongoing capital management flexibility, including share repurchases.

We will see some continued pressure on the net interest margin in fourth quarter based on the recent Fed reduction, as loans reprice downward more quickly than deposits in the short term.

We would anticipate also going forward that our provision for credit losses could increase from the previous run rate that we've reported based on loan growth overall, and more specifically, based on the mix of that loan growth.

This will place increased emphasis on further reductions in expense and growth in higher yielding assets to offset these expected trends.

The achievement of positive operating leverage [this quota] was a goal we set earlier in the year, and we plan to continue this trend in the future periods.

In addition, we continue to be committed to driving down our operating efficiency to our stated target of 60% or lower by reducing expenses from low-contribution businesses identified in our strategic review and realizing efficiencies from the reasons completion of our organization review.

We continue to make forward progress in the process of centralizing all of our shared services functions with the objective of improved effectiveness and efficiency.

And we believe the consolidation of facilities represents more opportunity in future periods.

With that, I'll now turn it back to Jim.

Thank you, Jerry.

Putting the quarter in perspective, we made good progress in strategic focus, commercial loan originations, margin, management and organizational development.

While I'd like to think of the $11 million provision increase as an event, and that we've isolated and fortified this small portion of our loan portfolio that is under stress, we can only say that we've acted as aggressively as possible under the circumstances, given our experience and the trends we see.

We've adjusted our reserving model accordingly.

I'd like to reiterate that the higher-risk home equities that I described represent a very small portion of our portfolio.

There are many areas in which we have excelled.

Our balance sheet is strong, we have capital management flexibility, we're growing organically and we're beginning to show positive operating leverage.

We look for strong performance ahead.

Thank you very much for being with us today.

We would be happy to respond to your questions.

(OPERATOR INSTRUCTIONS).

Mark Fitzgibbon, Sandler O'Neill.

Gentlemen, you guys have had some pretty bad luck with your national lending businesses over time, whether it was a the Shared National [Credit book], or Florida construction, and now home equity.

Does it make sense to just exit those national lending businesses altogether and focus on Connecticut or sort of the footprint lending?

I would say, in a nutshell, you pretty well summarized our strategic review and our plan.

We actually exited the national construction lending program I think eight months ago or so.

We indicated in our earnings call after the last quarter that we were deemphasizing all of our national mortgage lending, as well as home equity lending, and that we would be focusing on the New England footprint.

And to the extent that we had originations beyond that, it would most likely be in the mid-Atlantic region.

Okay.

So we won't see you guys in any other national lending businesses in the future -- in the near future, anyway.

We can't say that exactly, because the question is national versus regional.

We have capabilities such as commercial real estate, where we originate within and outside of the market.

Our equipment finance direct lending business is on a broader scale as well, and we have our asset-based lending business that originates in a broader footprint.

But I think what we can say is that in our retail businesses, that in footprint would be the focus, and that overall, that Webster direct is the key.

And I will acknowledge that it has not gone well for us, and we have had some stress, both on the construction lending side and on the home equity loan side as well.

And then just to clarify, I think you had said that there was $94 million of out-of-market home equity loans, and none of those had greater than 100% loan to value.

I was curious if I got that right.

And also, if you could give us a sense for geographically where those loans are?

Sure.

Actually, $94 million is what we call the higher risk loans, which are out of market, no income verification, high combined loan to value ratio which we think of as between 90 and 100%.

We did not make any loan originations over 100%, and we thought that was a point worth noting.

Virtually all of those loans were made in and around the offices that we set up in Chicago and in Arizona and a couple of other places.

So we were actually -- we were in those markets around which those loans were originated.

And we have made plans to discontinue those offices, which is part of the deemphasis of the out-of-market lending program.

And I wondered if you could give us a sense for what you're seeing -- it looked like aside from the consumer stuff, C&I, equipment finance, commercial real estate nonperformers were also up linked quarter by a pretty decent percentage.

Are you seeing any additional troubling trends in sort of the 30- and 60-day buckets, or anything that we should be cognizant of?

In addition to the increase on the nonaccrual side, we have had some increase in delinquencies as well.

I stated -- and I thank you for letting me make this point again -- that we believe that the ratcheting up of our regular quarterly provision to the $4.25 million that we're at now is the appropriate measure against the rise, both in nonaccruals and delinquencies in those portfolios.

So you are seeing some rises in delinquencies in the over-30-day bucket and over-60-day buckets?

Yes.

30 to 90s --

Okay.

And then last question I have for you, Jim -- I wondered if you could update us on your plans for the sale of the insurance business.

We can't really make much comment about that right now, Mark, except to say that our plans to seek a strategic alliance are moving forward.

Jared Shaw, KBW.

Did you update the FICO stores on that highest-risk segment for September 30th -- what has that done?

The latest we have is that about 20% of those FICOs now are down to about under 650, I believe.

And I believe that that was as of September 30.

Is that 20% of the entire portfolio, or is that 20% of that highest-risk segment?

Its 20% of that highest risk segment, Jared.

In terms of the follow-up on Mark's question about the geography, where are you seeing the greatest geographic weakness as opposed to where you're seeing the most originations on the national portfolio?

The two areas where you'd see the most of it would be around the Chicago area, and then in the Arizona area.

Okay.

And then just looking at the information you had in your presentation from September, you're saying that the state concentrations for Illinois, Washington and Arizona -- those added up to about 8% of the non-footprint home equity loans?

Is there any other large area other than those three?

Those are the primary areas.

(multiple speakers) I think you said the whole portfolio -- did you say not just the footprint portfolio?

Pardon me?

Could you clarify that?

(multiple speakers) were you asking for the total, or were you asking on the 90?

Oh, I see, that's on the $95 million.

Right.

And then are you getting a higher yield on those loans that are out of market?

Very definitely, yes.

And then any change in the way you're looking at the allowance for the nonperforming loans?

That ratio has slipped.

Is there a target you have for that?

I think the allowance for loans, we're really looking at allowance against the need.

We focus significantly on the loan loss coverage, and I think that ratio is up right now over 1 30, although we do expect to reuse some of that.

We talk about wanting to be in a range of 1 20 or so, say, plus or minus a few basis points as far as that coverage is concerned.

We're not overly concerned that the coverage ratio of the nonaccruals themselves is under 200%

Okay.

And then finally, if you could comment on your outlook for consolidation in the market and your appetite for future transactions?

We believe there is going to be consolidation.

And that we're going to have an opportunity to expand through making partnerships with like-minded companies that share our vision of being New England's bank primarily.

Of course the fly in the ointment is the valuation of our own currency, and so to some degree our ability to acquire it is related to that.

But our sense is that there will be opportunities over the next 12 months or so, and more so than in the past.

James Abbott, FBR.

I just was -- see if I could ask -- drill down a little bit more on the FICO spectrum.

And I'm not talking just about the $94 million loans of concern, but are you seeing -- what can you tell us about delinquency trends across the FICO spectrum?

We heard on one conference call earlier this quarter that there is -- it seemed to be no respecter of FICO stores, that one company was seeing delinquencies across the spectrum, so I was curious to your vantage point on that.

Then I have a follow-up.

I'll just make the broad comment that delinquencies are higher across the spectrum in part because a lot of people were put in a situation where they were able to borrow more perhaps then they should have, regardless of what their FICO score was.

And so you see that there is a slice all the way through, right up into super prime, where people were borrowing more then they would have in a previous environment.

And the natural result of that will be higher delinquency and potential nonaccrual rates, although the higher the credit score, the lower the impact.

But it will be across the spectrum.

And we are seeing that too.

Okay.

I appreciate that candor.

When you look -- you mentioned you were providing as aggressively as possible for your home equity portfolio.

Two questions -- one is a housekeeping question on the reserve to high loan to value, out of footprint stuff -- $94 million high risk stuff.

Do you have the reserve to loan ratio on that at this point?

And then a follow-up question is more qualitative, which is what are the loss assumptions you're using?

What are the default assumptions?

What's the severity?

Have you actually -- in situations where the loans go bad, what are you seeing as far as the severity there?

This is Bill Bromage.

I think that we segment our portfolio, and that we don't -- and I think part of your question of the 94 gets a little granular for us to get down that far.

I will say that what we do is we have a model which we run in evaluating every one of our loan segments in every one of our loan categories.

And that is based on our experience with respect to delinquency rates and our experience with respect to loss in the event of default.

And in this environment, based on what we're seeing, particularly given the newness of this portfolio relative to other, more mature portfolios we've had, we've shortened the timeline; looked that timeline, if you will, to estimate what our expected loss might be.

So it is a computer model, if you will, and it's not driven by one specific loss assumption.

It's driven by a set of experiences over a period of time.

And we shorten that period of time, which has the impact given recent experience of increasing the level of loss potential we see in this portfolio today.

So that is the driver, if you will, for us pushing -- putting that -- posting that specific $11 million reserve.

And the balance of it, the portfolio -- and we evaluate all those portfolios.

And I think if you reflect back on the 120 basis point plus or minus that Jim referred to loans, that's an outcome of the risk profile we look to have in the portfolio when you take various asset categories and expected performance we might have from each one.

Okay.

So is the $11 million the only dollar amount of reserves set aside against that $94 million?

Or is it -- is that not the right way to look at it?

No, that's not the right way to look at it -- that the overall reserve is available against the loan portfolio; in this case, we decided that we should allocate additionally against this segment.

Okay.

My concern on the overall industry is that we haven't been here before, or at least we haven't been here in a long time, where the look-back periods may not really accurately reflect it, and the companies in general are not going to be able to get ahead of this trend, that it's going to be continued bad news for two or three quarters in a row because the models are rearview looking.

What can you tell us about your ability to get ahead of it and anticipate the losses, even though you may not be seeing any quantifiable situations or numbers, there's no numbers to support that.

But you know that there's loss or you know that there is default in the portfolio.

Is there any way to get ahead of that, or is it just -- we have to live with the GAAP accounting rules?

I think by significantly shortening the time period that you look back and taking into account with the greater weighting of more recent trends, that as you evaluate that then on a monthly and quarterly basis, and you're continually updating that, you are making a quantum step toward addressing the very thing that you're looking at, which is making it much more real-time.

And I think that's what's really appropriate, particularly with this product when you think about home equity and the potential stress that this product -- or the stress that we're seeing in this product right now, I think it's appropriate that we took very aggressive steps to shorten that lookback period.

So you're a seeing a much, much greater weighting the way that we're looking at our portfolio, and the reserves that we need to establish and maintain for our portfolio as a result.

And we think that is a very prudent step to be doing at this time.

Andrea Jao, Lehman Brothers.

Just want to follow-up on a couple of comments you made earlier.

First, you mentioned that you try to be very aggressive on the credit front.

Given delinquency trends in various portfolios, what exactly does this imply for loan loss provisioning in the fourth quarter and in 2008?

The comments that I made specifically in my remarks about the potential for the provision to increase in future periods is one that if you evaluate the specific comments of thinking about run rate, which is currently at 4.25, and looking at our charge-off levels, which have been in and around 3.9 to $4.25 million, that as the loan portfolio grows, and dependent on the mix that grows and the associated risk in that mix, we're stating very candidly that that will require an increase in the provision assuming the same level of charge-offs on a consistent basis going forward.

And we think it's important to note that we have been in a period of transition as an organization, in terms of when you take into account all the balance sheet restructuring actions that we've taken, the rebuild of our portfolio, the deemphasis on a larger percentage of residential, which went from 37% of receivables down to 30, and a greater percentage in commercial and consumer, which went from 63 up 70.

As our portfolio mix changes, as the risk associated with that -- which by the way, they are higher yielding assets, and we believe priced accordingly then for risk -- you'll see that the provision naturally would begin to be elevated again, assuming current charge-off levels.

And that was the specific comment.

Okay.

So would it be fair for me to interpret that as your loan loss provisioning, let's say, in coming quarters pulls in from third-quarter levels, but remains way above the 4.25?

I'm not sure I would confirm "way above." We believe that it will be above, given current charge-off experience.

Fair enough.

Then to another comment you made earlier, which is you're focused on generating positive operating leverage, and I think you mentioned good expense controls as well as balance sheet growth.

With respect to expense controls, how quickly do you think you can drive down your efficiency ratio to your targeted 60%?

And with respect to balance sheet growth, what is your propensity to add borrowings and securities to help balance sheet growth?

Great question.

Let me answer first the operating efficiency.

We stated at the beginning of the year that I think in the terms [were] the next frontier were positive operating leverage, achieving that, and consistently achieving it; and a significant reduction in operating efficiency ratio.

That operating efficiency ratio -- we believe, as we look at the lower contribution in lines of business and really basically take a significant look at the expenses that are incurred in those businesses, and prudently peel back those expenses, that that is the first step of many that we are planning to take, and actually that we're taking right now to reduce our overall expenses.

In addition, we believe that a combination of centralization steps, of various activities, particularly in the shared services area, coupled with on a little bit longer-term horizon, looking at centralization of facilities -- really going from the significant number that we have today, fewer facilities will have both an intangible benefit as well as a tangible one, the intangible of people being together and the tangible one being much lower expenses, as you would imagine, in all the other line items.

You would really see that showing up probably more in our [F&E] and occupancy lines.

Regarding the question on securities and borrowings, I would state that it is not our intent to go back to the days where we were much more dependent on wholesale.

However, we see that there are opportunities for us in the current environment to prudently add to our portfolio, nowhere near to the extent that we think we've seen in the past.

We really believe that we are focused on growing loans and growing deposits, and that's our core business.

And to the extent that we have some select opportunities on the securities side, we will take those opportunities.

Gerard Cassidy, RBC.

Regarding the home equity portfolio, can you guys share with us how you go about working out those delinquent loans?

If there's a $100,000 or [$150,000] home equity loan that's outstanding that goes delinquent, that's second to a first that's 3 or $400,000, would you guys take out the first to get to the property, or how do you work out those loans?

I'm sure as you can appreciate, that obviously is part of the art of the collection process when you're in a second position.

And I will state the obvious, that -- it's a case-by-case decision.

Will we do that?

Yes, we will do that.

But we do it based upon our sense of confidence in our understanding of the underlying collateral value, and its ability to hold if that collateral was in fact in the hands of a bank as opposed to an individual.

And properties tend to trade less when banks are the parties trying to sell them.

So we're very conscious of looking at what can we expect to net realize on a piece of property and make an individual decision if we think that there's coverage for all or a significant portion of our indebtedness.

What are you -- in the delinquencies that you're seeing in both the out-of-market portfolio as well as the in-market, what are you seeing in terms of the value of the collateral?

Are the value of the houses or multifamily units falling in value?

I think what we see -- I would say yes.

What we have seen is that the value when we have gone to realize has turned out to be less than the appraised value when we went into the loan.

I want to be careful here and point out that we're looking at a subset of loans here that's relatively small -- as it turns out, were the higher risk elements of the portfolio when we went into -- they're high loan to value to begin with.

The three prongs that Jim was articulating in terms of the higher-risk loan portfolio is a meaningful portion of the charge-offs we've shown in that book.

And they are a relatively high loan to value number.

Having said that, I'm not sure that's as fairly representative of the entire (inaudible) portfolio.

We have the retail book, if you will, which is what we have originated in the footprint that is a very strong loan to value ratio, and then we have ratios overall for the portfolio that don't have as much loan to value risk in them.

I'd just like to add to that if you get an opportunity to look through the presentation deck that we did in the third quarter of this year that's posted out on the web site, we've got a specific slide that takes -- in a pie chart, breaks up our home equity portfolio by CLTV.

And one of the positives you would see, that we're at 80% or less in about 60% of the portfolio.

Another 20-plus percent is in that 80 to 90 range, and another 10-plus percent in the 90 to 95.

So if you were to think of the potential impact of declining values in that underlying collateral, as Bill was stating, we're still in a huge portion of this portfolio in a positive position in collateral.

However, that's always of course dependent upon what the prevailing conditions are, given where housing prices have -- we've continued to see declines, as Bill stated.

You need to look at each and every one of these on a case-by-case basis.

And how often do you guys update the values of the collateral?

When you say loans values are 80% or 90%, are those up-to-date as of the third quarter or second quarter of this year?

We don't evaluate the entirety of the portfolio.

We're looking at those loans that we have a problem with and we will reorder, whether it's a full appraisal or a broker evaluation as we go through that process with problem credits.

And then finally, you guys indicated that it's likely that the loan loss provision would be greater than the $4.25 million.

What's your outlook that you guys are using for the economy in your footprint?

Do you expect -- what kind of growth are you guys looking for in '08?

We're looking for modest growth in the footprint.

I also would say that we think that the real estate values have held up pretty well in the footprint.

They didn't get quite as out-of-hand in the bulk of our primary market as they did in some other areas.

So that's a strong point.

We do think that there will be economic growth in our markets.

They have run a little bit behind the national average of growth over the past several years.

There is no reason that they would exceed the national rate, but we think that they will be close to it.

Thank you.

Collyn Gilbert, Stifel Nicolaus.

Maybe if we could just switch gears to the commercial side of the business for a minute.

Bill, could you just give us a little bit of color in terms of what that $7 million commercial credit that went on nonperformers this quarter -- what industry that was in?

And then just if you're seeing delinquency trends on the commercial side, if they're in any one segment?

And also, in terms of the pipeline, Jim, that you spoke to was strong on the C&I side -- if you could just talk about what types of credits those are?

And if you're taking market share away, from whom are you taking it -- and just give a little more color to those segments.

Okay.

The specific credit that you questioned is a Connecticut, middle-market, privately owned company.

It's in the retailing business, some of it supplying to the construction industry, but -- so it's a bread and butter classic middle-market company, if you will, not indicative of a trend.

With respect to pipeline, if you will, we have had very strong production this year in terms of our performance.

Our commercial origination book through nine months is in excess of $750 million in commitments.

Not all of that gets funded obviously at closing, Collyn.

But significant production -- probably 10 to 20% over what we did last year.

As Jim was mentioning in his opening remarks, the market earlier in the year had been so strong that we had a number of prepayments, and frankly a number of middle market companies that have elected to sell out to private equity firms, which has caused some higher prepayment levels than we had anticipated.

So we have seen a put and take, if you will, of a greater volume than we might normally see, which has caused our portfolio to grow -- probably, we estimate for this year, more into the 5 to 6% range than what we have gotten used to in terms of the double-digit range, in terms of commercial loan growth over time.

It is not, however, as I say, reflective of what we have seen in the market and our ability to source good quality transactions in and around our footprint.

We see the commercial real estate market.

Currently, we're seeing a flow of transactions there that are better quality transactions at a reasonable rate -- transactions that previously might have gone into the conduit market, we now see the opportunity to look at those.

So there is a potential there to see that this rate disruption that's taking place in the market may provide some further opportunity for us as we look into that market.

And our asset-based lending operation also, which has a very strong track record, continues to see good loan demand.

Okay.

Just a follow-up to the $7 million middle market credit.

And you said that there is some supply there, or there was some supply there to construction.

Have you gone through the portfolio and tried to comb through some of those business credits to assess who does have exposure to construction businesses, and maybe where you might see potential weakness?

I know you said it's not necessarily a trend, but where there is a slowdown in construction, maybe of your borrowers, who might be impacted?

Collyn, the answer to that is a qualified, yes, we have.

Combing through the portfolio implies perhaps a richer exercise, but we have certain buckets -- certain segments that lend into that industry.

Our equipment finance area, for example, has a construction subset.

They have very actively reviewed the entirety of the portfolio, and have seen some softness in that portfolio.

And we're working with our borrowers and monitoring that portfolio closely.

And our performance in that area continues to be strong, but we are cognizant that there's potential for weakness.

We've done that additionally in the small-business area.

But I don't want to leave the impression that we have sorted every single loan and done a thorough review of that.

But we are very cognizant of what is happening in the marketplace, the segments that are potentially negatively impacted, and having the leadership in each one of our own areas to take a good hard look at their portfolio.

Andrea Jao, Lehman Brothers.

Sorry about that.

Just wanted to step back a little -- now that you have finished your strategic review of your business, if you could talk about how over the years the Company has taken charges and essentially, these charges go against [capital] to restructure the balance sheet.

And then credit costs have been elevated in recent quarters.

What do you foresee in terms of managing capital that way, or avoiding charges again capital in the coming year?

Because obviously reducing charges against capital would be much better.

We agree with you that reducing the charges against capital would be better.

And I think that some of the steps that we have taken, particularly with the laserlike focus on the direct franchise businesses, would be a positive in that regard.

We will have less exposure to that out-of-market influence.

I think that ultimately, the capital is a cushion to some degree against potential loss, even though we don't really want to see it or use it that way.

We want to be able to use it to invest in our businesses, to capitalize our growth, to create flexibility, to have buyback programs or make acquisitions.

And of course the stability of the capital base is essential to be able to make that happen.

I believe that the focus that we have will make us less vulnerable to the range of issues that can affect us.

While we're focused on our core franchise, we also have the limited geographic span.

There always is the question of what will happen within the markets where you operate.

But I want to say that we don't take our responsibility to protect and increase our capital base lightly.

And we do our best to avoid any call on capital such as what we're seeing today.

Okay, that's good.

Now separately, I was hoping you could talk more about deposit trends.

I know deposits are seasonally strong this quarter.

But what else are you seeing in terms of customer migration to higher cost categories; your propensity not to compete in terms of pricing, or on the other hand, accommodate higher pricing?

If you could talk a bit more about that, that would be great.

I'll take a crack at it.

In the core market, we've been very successful at increasing our deposits faster than the market -- which has been relatively slow growth, by the way -- while also reducing our cost of deposits as compared to our peer group.

And I made the comment that that is clear proof that our execution is strong and we haven't relied on price.

In the meantime, as we open our de novo offices, we generally do use some promotional pricing, although we have scaled that back in recent quarters.

And that has had an impact on the growth of the de novos.

So overall, we have what I would call a highly responsible deposit pricing approach, and a very aggressive and successful marketing program that has enabled us to continue to grow deposits faster than the market.

I think one of the things we benefit from is that we have a very low attrition rate among our customers.

And we continue to pick up a higher share of churn in the market than is our existing market share.

When you combine that with very, very low attrition rates, you have the benefit of being able to continue to grow faster than the market.

I'll just make one other comment too, is that -- in terms of managing deposits by running off some of the broker deposits, we expect that will have a positive implication for cost of deposits as well for the net interest margin.

Philip Gutfleish, Elm Ridge Capital.

Just really quickly, why was the amortization lower in this quarter?

I don't recall you having actually sold anything during the quarter.

Could you just sort of -- explain that one?

I think that it's because CDI related to an acquisition made several years ago was complete.

And that resulted in a lower amortization of CDI.

$1.2 million on a 3.3 base?

That seems a bit high.

I would have thought that would have been coming down over time as opposed to just falling pretty big --

Generally, we will amortize a CDI over seven years.

And so at end -- and it's done ratably over that period of time.

So at the end of seven years, you cease amortizing.

Jerry may have more detail.

No, this is CDIs from branch acquisitions in the past, and -- that the period's expired.

We actually bought Mechanics Savings Bank back in the second quarter of 2000.

We had a seven-year amortization which ended in Q2.

Collyn Gilbert, Stifel Nicolaus.

Just a quick follow-up.

Could you give some color as to the percent of your loan portfolio that reprices with prime?

Yes.

Give me a second here.

I believe we're -- (multiple speakers) about 25%.

(multiple speakers)

James Abbott, FBR.

Also just a quick follow-up.

On the expenses, were there any contra-expenses or anything unusually low during the quarter?

Obviously, it was a very good change in expenses on a linked-quarter basis, and I'm just wondering if that's a good run rate to use going forward based on other comments you made in the conference call, or if there's anything unusual that might pop back up in the fourth quarter?

There's nothing unusual in the quarter.

We did record about [$700,000] worth of severance.

But as we have said before, we actually consider as we go through the process that that could be something that pops in and out of each quarter.

So I would actually tell you to keep that in the run rate.

Thank you again, and congratulations on the expenses.

That's good.

There are no further questions at this time.

I would like to turn the floor back over to management for closing comments.

Thank you very much for being with us today.

Good day.

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

You may disconnect your lines at this time.

Thank you for your participation.