Webster Financial Corp (WBS) 2010 Q2 法說會逐字稿

Good morning, and welcome to Webster Financial Corporation's second quarter 2010 results conference call.

This conference is being recorded.

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

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

Actual results might differ materially from those projected in the forward-looking statements.

Additional information concerning risks, uncertainties, assumptions and other factors that could cause actual results to materially differ from those in the forward-looking statements is contained in Webster Financial's public filings with the Securities and Exchange Commission, including our Form 8-K containing earnings release for the second quarter of 2010.

I will now introduce it your host, Jim Smith, Chairman and CEO of Webster.

Please go ahead, sir.

Good morning everyone.

Welcome to Webster's second quarter earnings call and webcast.

You can find our earnings release that was issued earlier this morning in the slides and in-depth supplemental information that accompany the presentation in the investor relations section of our website at WBST.com.

I will provide an overview for the quarter and Jerry Plush, our Chief Financial Officer, will provide a more granular look at the quarter and then we'll invite your questions.

We continue to make progress in what I will characterize as a solid quarter as net income improved to diluted EPS of $0.15 per share.

Revenue grew by 6% year-over-year and by 1% on a linked quarter basis.

The net interest margin was essentially flat to the first quarter and a touch over our estimate, and core pretax pre-provision earnings held steady at $57 million.

The principal driver behind our second-quarter results was and is improving credit quality across all loan categories.

The provision for loan losses declined at the lowest level in two years while still covering net charge-offs, which were at the lowest level in five quarters.

Nonperforming loans continued their downward trend to less than 3% of the loan portfolio, registering their lowest level since Q1 2009.

The allowance for loan and lease losses rose slightly and is well in excess of nonperforming loans.

The quality of NPL coverage is especially strong considering that NPLs already have been charged down by 30% and fully one-third of NPLs are currently making payments.

At the front end, delinquencies declined to the lowest level in two years.

While we are ever reticent to predict future credit trends, we're encouraged by the stable to improving risk migration across the portfolio.

Our liquidating portfolio is now below $200 million compared to $424 million at year-end 2007, and carries reserve coverage of 25%.

91% of the loans in that portfolio are current.

Recognizing our progress on credit, Standard & Poor's recently upgraded its outlook for Webster to stable.

Should present trends continue it is likely we will provide reserves that are less than charge-offs in future periods.

The continuing improvement in our credit metrics is attributable in part to the focused multiyear effort to identify, manage, reserve for and resolve underperforming loans.

And we've done it in a way that has respected our customers and the challenges they have faced.

I expect that our approach will further strengthen customer relationships in the quarters ahead as we endeavor to help finance the regional economic recovery.

Underpinning our results is a slowly improving regional economy.

According to the June 5 Fed Beige Book, commercial real estate markets in New England are showing signs of improvement.

Most businesses in the region were reporting stable to increasing activity compared with a year earlier.

Most retailers and manufacturers generally report positive sales and revenue results.

In Connecticut, home foreclosures in June were down for the second consecutive month and unemployment dipped below 9%.

The improvements in the economy and our concerted efforts to boost originations can be seen in the Q2 numbers and in the pipeline.

Loan originations across our businesses rose by 46% from the first quarter to $579 million.

In-market commercial non-mortgage originations rose 72% to $200 million and we have a robust pipeline in place.

Our business and professional banking group in June reported its strongest month originations in a year and a half.

Originations in asset base lending, equipment finance and commercial real estate loans also increased in the quarter.

Our commercial loan volume and our pipeline give us confidence in our ability to achieve our goal of $850 million in new business loan originations in our markets in 2010.

Meanwhile, residential consumer originations rose 44% from Q1 to $275 million.

On the capital front, in slide 4, our ratios continue to track higher.

Tangible common equity rose 26 basis points to 5.79% and Tier 1 common equity rose 22 basis points to 8.12% in Q2.

Regarding CPP repayment our strategy remains the same.

We will continue to pursue orderly repayment on terms favorable to our shareholders in the quarters ahead, supported by our improving profitability and credit metrics.

Turning to slide five, let me briefly review our progress on the six strategic initiatives for 2010.

As I said before, our regional banking strategy is straightforward.

We'll build market share and wallet share among businesses and consumers through relentless improvement of our service quality to achieve best in class status.

Simply stated, we'll do better what we do best.

We have sharpened our competitive edge and vow to become the bank of choice in our markets.

Our overarching commitment to maximizing the growth of economic profit guides our strategic decisions and our allocation of capital and other resources.

One prong of our service quality strategy is competitive convenience.

During the second quarter we expanded hours at 89 of 181 branches and extended the service hours in the customer care center to 15 hours a day, seven days a week.

While it is only a one-month sample, May saw increased business in terms of sales and new accounts at branches with extended hours.

In these branches, small business loan applications rose 37%.

Business DDAs were up 23% and consumer DDAs climbed 17%.

In all three cases, these levels significantly exceeded the comparable numbers of branches without extended hours.

Even before the advent of extended hours, our progress toward best-in-class in service quality was bearing fruit.

The most recent JD Power survey, taken months before we extended branch hours, provided third-party verification that we're making major strides toward our goal of being number one in our footprint for service quality.

Delivering best-in-class service also meant reducing error rates, shortening the account opening process, simplifying product offerings, increasing speed of transactions, expediting workflows and improving the reliability of our ATMs.

These are the things that we're focusing on.

Investing in these service improvements is the best use of our capital, as we believe that improving service quality is the key to generating sustainable growth and economic profit.

Mobile banking and balance alerts will soon follow.

As you can see on slides five and six, we're making progress on our other initiatives as well, including 8% year-over-year growth in new business checking accounts, deposit growth in Boston and Westchester, and increasing income from our credit card referral program.

To sum up the quarter, it is clear that our performance is improving and the credit metrics are trending strongly positive.

But the bottom line is that our results are nowhere near our potential.

Webster is capable of earning well more than our cost of capital and that goal should be achievable in a reasonable timeframe.

Pretax pre-provision earnings $57 million are not nearly as sufficient to reach that goal.

I want to assure our shareholders that every strategic choice, every hiring decision, every loan we make, every dollar of capital and every precious resource we allocate bear this goal in mind.

I also want to be careful not to over promise.

Given the headwinds we face with overdraft fees and interchange, as well as higher FDIC premiums, it will be tough to move that needle over the near-term.

But look for is to improve that metric over the next several quarters as we exercise the strategic and financial discipline that will produce economic profit.

Before I turn it over to Jerry, I would like to discuss briefly financial regulatory reform and its potential impact on future results.

As you know, Reg E became effective July 1 for new customers and will apply to existing customers as of August 15.

Our strategy is to use the Reg E changes as tools to deepen engagement with existing customers and attract new ones.

For example, customers use debit cards differently from credit cards and checks.

We recognize this in our new schedule for opt-in customers, including lower fees for debit card overdrafts, and we believe our customers will reward us for giving them better banking services.

We continue to estimate that the changes to Reg E could impact our overdraft fee revenue by $5 million to $6 million a quarter before a planned product redesign, which will recover a portion of those fees across the broader base.

After the product changes, the hit will diminish.

And eventually most if not all of it will be priced more broadly into the business.

We simply don't have enough data from our opt-in activities to date to be more specific, but we'll have more to say in future calls.

Regarding the financial regulatory reform bill that is awaiting the President's signature, it is certainly the most sweeping piece of banking legislation since the National Bank Act of 1933.

We support the congressional intent inasmuch as it addresses "too big to fail," provides for an orderly liquidation of failed institutions, brings the shadow banking system under closer regulation, increases market transparency and retains the Fed as the primary regulator for bank holding companies.

Many of the objectionable aspects were mitigated from our perspective, including those dealing with preemption and derivatives.

As expansive and unchecked as the powers of the CFPB may be, the bureau will centralize oversight of consumer protection in a way we hope will serve consumers well.

These two features of the new law that affect us most directly are the Collins and Durbin amendments.

The Collins amendment signals a phaseout of trust preferred securities as Tier 1 regulatory capital.

All of our TruPS provide for early redemption at par in the face of a regulatory capital event, though TruPS redeemed prior to year-end 2011 could require regulatory approval.

One of our five issues, which represents over half of our outstandings, requires replacement capital if redeemed.

Since trusts will continue to qualify as Tier 2 capital, we may elect to leave some of or all of them outstanding based on cost-effectiveness.

We have no current plans to redeem the TruPS with cash, debt or capital.

And we anticipate that future earnings will be the primary means of replacing any capital loss through redemption or phaseout.

The Durbin amendment has the potential to reduce our income from interchange fees.

But before we venture an estimate of the impact, the Fed will have to complete an evaluation of the cost of delivering interchange services and set parameters for fees accordingly.

So it is too early to guess the amendment's impact on our estimated annual $20 million interchange revenue for debit transactions.

Finally, there many other elements of financial perform that will not be fully resolved for some time as the regulatory phase moves into the spotlight.

With that, I will turn it over to Jerry.

Thank you Jim.

Good morning everyone.

Turning to slide 8, as we have done in prior quarters we will provide a view of core earnings for the second quarter.

We're very pleased to report the positive results for Q2, and as Jim noted, the pretax pre-provision earnings of $57 million.

Please note that the $57 million includes the negative impact of Fannie Mae buyouts of $1.8 million.

We will provide some more detail on this and other items in a few minutes.

Adjustments in this slide include non-core items such as the $4.4 million in gains on the sale of investment securities, generated in large part to offset an incremental provision for loan purchases of $3.5 million.

, -- the loss of $1.2 million on the write-down of certain pooled trust preferred securities and $900,000 of severance we reported in the quarter.

We also exclude $900,000 in REO and repossessed equipment write-downs.

Lastly, we had the $19.7 million provision for litigation reserve and the $15 million Higher One IPO gains, each as previously announced.

The litigation reserve that was established stemmed from a judgment in an Ohio project involving the national construction lending business.

We believe we've fulfilled our obligations to the borrowers and respectfully disagree with the court's decision.

We also believe there were numerous reversible errors during the trial and we will ask the trial court and appellate courts if necessary to correct them.

Webster will take whatever steps are appropriate to vacate the court decision or otherwise resolve the case.

Also, the gain we realized in the quarter from our direct investment was Higher One, a New Haven-based provider payment system, for colleges and their students as they launch their IPO in June.

Let's turn now to slide nine and provide some more detail on our core earnings drivers in the quarter.

We compare it here to the first quarter of 2010 and also the second quarter of 2009.

The $57 million in pretax pre-provision earnings includes the Fannie Mae buyouts as well as a $1.6 million negative mark from off balance sheet hedges in the quarter.

The increase from a year ago in growth of over $5 million in the core earnings is driven by an increase of 23 basis points in the margin and a $557 million increase in average interest earning assets.

In comparison to Q1, the net interest margin decreased by one basis point while earning assets increased by $131 million.

This is several basis points better than we expected and the impact of the buyouts was nearly $1 million or two basis points better than we expected.

The quarter also reflects the positive impact of disciplined loan and deposit pricing.

It is worth noting here that the margin would've been 3.31% in Q2 if not for the $1.8 million of Fannie Mae buyouts from mortgage-backed securities, the result of a policy change which enables the GSEs to accelerate the repurchase of loans out of NBS or par.

The first quarter had a 3 basis point negative impact from similar Freddie Mac buyouts in that quarter.

So if you adjust both quarters for the respective Fannie and Freddie buyouts, you would have an adjusted margin of 3.31% at each.

The effect of these buyouts has now pretty much run its course as we head into the third quarter.

On an average basis, we had combined growth of $243 million in securities and short-term investments which offset a combined decline of $113 million in loans and loans held for sale.

The net impact was an increase of $1 million in net interest income quarter over quarter.

Our noninterest income increased by $900,000 as a rebound of deposit service fees from seasonally low first-quarter results and increases in loan and wealth fees somewhat offset a lower level of other income.

Other noninterest income in Q1 included proceeds from bank owned life insurance and some gains recognized on direct investments in that quarter.

While the second quarter reflects a $1.6 million mark-to-market loss related to the interest-rate hedging activities that were undertaken in Q1, and Q1 only included $150,000 mark-to-market adjustment.

The market is now expecting lower rates for a longer period of time than what was expected when these hedges were put on, and as such, these contracts experienced a loss.

We don't expect significant additional losses going forward, but there is volatility with these nonetheless.

Our core expenses increased by $2.2 million for Q1, and that is largely related to an expected increase in marketing and professional services.

While compensation expense remained relatively comparable to Q1, our Q2 results reflect lower than expected group insurance expense and a favorable pension valuation.

Our FDIC expense was higher, but will decline given lower levels of balances and the end of our participation in the TAG program.

Turning now to slide 10, we outline the activity in our investment portfolio for the quarter.

The slight increase in the portfolio occurred primarily to offset lower loan balances.

We continue to buy relatively shorter duration agency CMOs with limited extension risks.

During the quarter we sold some [10-1 high] premium agency MBS for a $4 million gain that would've had significant premium valuation risk in a falling rate scenario.

We also sold a truck for a $347,000 gain.

The portfolio's overall duration declined to 3.4 years from the mix changes in the portfolio.

It's important to note that 59% of the portfolio is in held to maturity, and that does include $1.1 billion of resi loans we securitized in the past and $675,000 in municipal securities.

The classification of longer duration securities in the HTM portfolio will provide protections for the TCE ratio should interest rates rise.

The $2.2 million in securities and AFS are shorter duration, they have excellent liquidity and should provide us with the flexibility that may be needed to manage the balance sheet going forward.

If we turn to slide 11, here you see the yields in the overall portfolio and they decreased by two basis points during the second quarter, which reflects the affect of fixed-rate maturities that are priced at higher levels being replaced by new originations at lower rates.

The resi yields declined by six basis points, and that reflects the impact of payoffs and paydowns on higher yielding loans compared to the new production that is being booked.

The consumer yields declined by one basis point and the commercial yield by nine basis points, while the eight basis point increase in the pre-yield of from [4 40 to 4 48] helped to moderate the effect of the declines in the other three segments.

Our average balances were up by $39 million in residential by $23 million in commercial non-mortgage, while all other categories saw declines.

The average balance increase in commercial non-mortgage, which represents our core middle-market small business lines, is encouraging and reflects the focus on growing in this segment.

We turn now to slide 12.

We'll take a look at some key asset quality progressions and here we provide a five quarter trend in total nonperforming loans, REO, repossessed equipment and past-due loans.

Like prior quarters, individual credit and other performance data for our principal loan segments is included in the supplemental information that is posted in the IR section of our website.

Our nonperforming loans declined by $31.5 million in the quarter through lower new non-accruals and continued [pures] and exits.

We'll review that in greater detail in the next slide.

Here again it is worth noting that one-third of our NPLs or $105 million are paying as we've been actively identifying and addressing problem situations.

The $317 million of NPLs at June 30 that have incurred charge-offs, that is over $135 million, or in other words Jim noted, that carry 70% of their original balance.

Our REO and repossessed equipment was relatively flat over the past year and that reflects the focus on remediation of problem loans and the resolution of repossessed property and equipment.

Our past-due loans remained in a fairly tight band at around 1% of total loans over the past year and they declined at June 30 to now represent 0.88% of total loans.

The $19.5 million decline of past-due loans during the second quarter includes a $12 million commercial credit that was resolved early in the quarter and that we mentioned in our first-quarter conference call.

We'll now turn to slide 13 and here we provided a reconciliation of NPLs over the past year.

A decline in new non-accruals, continued progress in [cures] and exits drove a lower level of nonperforming loans.

Also here you can see the favorable trend over the declining level of gross charge-offs since the third quarter of 2009.

Our redefault rate on modified resi loans is approximately 7% and that continues have a very favorable impact on our results.

This is reflected in our cure numbers once again this quarter.

We've seen and heard of industry redefault rates in the range of 40% plus, so our performance here has been very solid in comparison and reflects our approach to successfully work with at-risk borrowers.

Regarding the allowance for loan losses on slide 14, here we'll show the net charge-offs and provision for loan losses and they declined for the third consecutive quarter.

The provision totaled $32 million in Q2, which is right at net charge-offs of $31.8 million compared to the provisioning in excess of charge-offs that occurred in prior periods.

The $31.8 million in net charge-offs reflects $4.2 million worth of recoveries.

This compares to $2.8 million in Q1, evidence of improvement in recovery trends and problem loan resolutions.

The allowance for loan losses now represents 3.17% of total loans; provides a coverage ratio of 108% of our total NPLs.

The $8.5 million decline in net charge-offs from the first quarter comes from a number of individual segments, including a decline of $1.6 million in liquidating portfolio.

Again, please see our website for the supplemental slides that will include five quarter trend statistics and information for each loan segment.

Let's turn now to look at slide 15 and we will talk about deposits.

Our total deposits declined by $514 million in comparing June 30 to March 31.

Given ample liquidity, we employ pricing discipline to drive down the cost of deposits another seven basis points this quarter.

We expected there to be seasonal reductions in government deposits at quarter end, given that this is the fiscal year-end for municipalities.

And we also expected some reduction in concentrations in government given our election to exit the TAG program as of June 30.

So overall, government deposits declined by $648 million quarter over quarter.

Note that the decline in some large balance accounts provides us with the capacity, as we plan to add more new municipal and not-for-profit relationships that are more granular and will have volatility as we head into the second half of the year.

So we're keenly focused on growing our noninterest deposits and we showed solid performance year over year, as well as over the prior quarter, with growth of $169 million or 10.6% and $102 million or 6% respectively.

Our non-interest-bearing deposits are now 13% of the total deposit base and this has been a contributor to improvement (inaudible) the quarter total deposit ratio, which is 74% at June 30 compared to 65% one year ago.

Our core deposits have grown $1.4 million or 16.3% over the past year, while CDs declined $1.1 billion over this timeframe.

This improved mix has driven the 66 basis point reduction in the cost of deposits over the past year that you see on this slide.

We'll turn now to take a look at our deposit mix by line of business.

We believe it is a strong competitive advantage for us in deposit gathering, given we can gather deposits from the five lines of businesses that you see here on this slide.

With a particular note again our focus is on growing core accounts -- DDAs in every line of business as the key to strong customer relationships and profitability clearly starts there.

We've seen, as we talked to in the prior slide, solid growth in our non-interest-bearing accounts and balances.

We saw continued growth in HSA and commercial and small-business in the second quarter.

Retail stabilized even with continued CD declines in the quarter.

Our government business declined in the quarter with the expected reductions that we previously outlined.

But we continue to add new operating relationships in all four states that we serve.

So, in summary, we've seen overall growth of $1.4 billion, as I've mentioned, over the past year and $305 million in total deposits after a $1.1 billion decline in CDs, again while significantly reducing our costs.

We will turn now to slide 17.

We'll review the changes that have happened in borrowing mix and cost.

With the net deposit growth we covered in the last slide, this reduced the need for utilization of borrowings which are down $92 million from one year ago, though up quarter over quarter as we utilize some overnight funding to offset the expected decline in government deposits in the second quarter.

The ratio of borrowings to assets was 12% at June 30 and has been in a fairly tight band of 11 to 13% over the past year.

The slight increase that you see in the cost of borrowings of 3.1% reflects the liability lengthening strategies that we recently put in place and discussed at length on the first-quarter call.

So, before I turn things back over to Jim for his concluding remarks, let me provide some perspective on the third quarter.

So we will start with the margin.

We would clearly expect to see some improvement in Q3 given our lower levels of excess liquidity, better baseline results without the Fannie and Freddie buyouts that impacted Q1 and Q2, and from continued pricing discipline on deposits while recognizing that lower loan yields on new production will likely occur as well given the current market conditions.

We would think of a 3.30 to 3.35 margin as a likely range.

Regarding our interest-earning average balances, given the pipeline update and the increased business development workforce, we would expect with a continued strong effort we could turn the corner and could even begin to see some overall growth here in Q3.

We would expect to maintain at most, and not grow, our investment securities portfolio.

Regarding credit, the positive trends that began in late -- in 2009 and earlier this year continue to improve in Q2 as shown in TS and quality metrics.

So while we have to remain cautious due to economic uncertainty, including employment levels, and also note that the first half of this year did not have any lumpy commercial charge-offs which are always somewhat challenging to predict, we would still expect that lower provisioning in Q3 is likely assuming asset quality trends continue to hold up.

Our noninterest income will be down the given implementation of Reg E that takes effect this quarter.

We're assessing potential moves to offset this impact and will provide a more detailed update on our actions next quarter.

And for noninterest expense we would expect that comp would increase several million dollars quarter over quarter given hiring that we have referenced in our initiatives, and that Q2 benefited from favorable group insurance and pension valuations.

We think Q3 should also show significantly lower FDIC insurance premiums Q3 than Q2 given our exit from the TAG program and lower deposit levels at quarter and.

So I would say closer to $5.25 million or so.

We also estimate the effective tax rate should be around 19% for the quarter.

I will turn it now back to Jim for his

Thanks Jerry.

That concludes our prepared remarks.

We will be pleased to take your questions.

(Operator Instructions) Mark Fitzgibbon, Sandler O'Neill.

First, Jim, I think you mentioned your pipeline is really robust.

Could you give us a sense for how big that is and what types of loans it is concentrated in?

I would say -- I probably wouldn't give a number as to size of the pipeline, except to say it is at least as sizable as the originations that we're recording in terms of what we would expect to close in Q3.

And say that it is broadly across our business lines, and in particular in commercial and business and professional banking.

Okay.

Secondly, I know you said that earlier in your comments that you continue the orderly repayment of TARP.

Is it likely that you will need to raise capital to complete the repayment of TARP in your view?

I would say it is reasonably likely at some point down the line before we can complete the process that we would, but we're taking it a step at a time.

You saw that in the first quarter we were able to repay $100 million of it without having to raise any capital at all.

As our profitability and credit metrics continue to improve, we anticipate that we will have to raise less capital that might otherwise have been the case in order to ultimately complete the repayment.

I want to make it clear; we're not in a tearing rush to do it.

We're taking a balanced approach that very directly considers the best interest of our shareholders.

And our objective is to raise the absolute de minimis amount of capital that may be required to complete the repayment.

It's hard to say at this time, Mark.

Got you.

And then lastly, we've seen some deals in New England recently.

I'm wondering if you think that pace of consolidation is going to pickup in New England and if you think Webster is ready to get back on the acquisition trail.

We're not surprised that acquisitions are starting to perk up a little bit and we do expect that we'll see significant consolidation over the next couple of years.

From our perspective we are focused on our core model.

We're focused on increasing our market share and our wallet share in our markets by continually improving our service quality, and I hope that really came through loud and clear in my remarks today.

We're not likely to participate in auctions.

We're very interested, of course, in negotiated stock-based transactions with like-minded partners that share our view of what our institutions could be together.

At the same time, I would say that we think our currency would have to appreciate from here in order for us to want to use it in a transaction and we're really not interested in cash deals at this point.

So the focus is on internal activities.

And to the extent that there are like-minded partners that share our views, we would be very interested in that kind of a combination.

Thank you.

Damon DelMonte, KBW.

Good morning.

Jerry, could you remind us exactly how much you have in TruPS?

I think we've got a slide posted.

But I want to say it is around $55 million, $57 million or so.

Are you referring to the investment portfolio?

No, I'm sorry; (multiple speakers) refer to --

The capital?

Yes.

[232].

232?

And you said there was one issue --

I'm sorry; I had to think about both ends of the balance sheet.

I'm sorry.

I should have been a little clearer with my question.

And you said there was one security that's approximately 50% of that balance?

Right.

We've got roughly $132 million left of the issuance that we did in 2007.

Okay, great.

And then could you guys just give a little update on your flagship office in Boston?

Are you happy with the progress so far and do you have any additional plans to maybe support that branch with other de novos?

Yes.

The branch is right on target as it relates to what our planned results were.

We had good deposit growth again in the quarter.

We actually are seeing some very strong opportunities on the loan side.

We're fully staffed, so we would expect greater and greater contribution as you think about Q3, Q4, etc.

Again, our intent in the not-too-distant future is to begin to start to report out a little bit more about our activities in the seven regions.

So clearly we would focus in on performance related to Boston.

Regarding the expansion in the area, we're continuously evaluating what our next steps are.

I think we've made it clear that we established a flagship office there.

We wanted to conduct mostly small-business commercial and government municipal business sort of as the first step and follow it through with more on the retail and consumer side.

We'll continue to update you guys as we formalize our plans there.

Bob Ramsay, FBR Capital Markets.

Real quick, I didn't catch what you said; what tax rate should we expect next quarter?

Was it 25%?

19.

19, thank you.

And then, I appreciate the slide you include showing the new nonaccrual formation.

I see that the new non-accruals of $75 million and change are the lowest level we've seen in some time.

How much of that reflects sort of early action on the liquidating portfolios and how much of that are you really seeing some signs of stabilization in your core portfolios?

I would say that you're seeing stabilization as well -- it's a combination of both, rather than repeat everything.

I also think it's reflective of -- you can see the improvement that is taking place in the past dues, so the inflows are lower.

I think as you think about -- we continue to you to be very proactive in risk rating the portfolio in the commercial side clearly, and taking steps as necessary, so there hasn't been any change there.

I think you can take it as a positive sign of better performance both in the core and in the liquidating.

Okay.

How are you guys kind of thinking about reserve adequacy now that the allowances is well north of 3% of loans and your charge-offs seem to be rapidly approaching 1%?

I would say that we are evaluating what we should do in Q3 and Q4.

Again, we're going to take the approach of determining adequacy based on what we determine as the underlying risk in each of these segments, total it up.

If we don't need the provision to match the charge-offs or exceed the charge-offs, you guys will see charge-offs in excess of provision in those quarters.

If we, for some reason, were to see any type of uptick -- again, we have to be cautious given the economy, in particular employment rates.

I think it is important to note that there could be -- continued to -- you would see provision could be at those levels or greater.

But our view right now, we're very pleased with the performance to date.

Our thinking would be, as we said, that if these trends continue you will see us be able to charge off at whatever the levels are and just assess adequacy.

And we would assume that the provision would need to be either at or above the charge-off levels.

Collyn Gilbert, Stifel Nicolaus.

Thanks.

Good morning gentlemen.

Jerry, I just wanted to clarify couple of points you made in your concluding comments.

So the expectation was that you would see average earning asset growth in the third quarter.

But yet, you probably would at a minimum maintain the securities balances.

So then do we extrapolate from that, that there will be loan growth tying in also, Jim, to your comment on the pipeline?

What I stated was given the pipeline update, and with the increased number of business development officers, we expect that if we continue to see the kind of effort on top of the existing pipeline that we've got an opportunity to see some overall loan growth in the third quarter.

You should know that we have been boarding our residential loan production and you could see the uptick that occurred quarter over quarter there.

But we're really pleased to see that we've made some strong strides in the commercial non-mortgage area, in particular both in small business and middle-market.

So, think we're at the stage where we don't want to grow the investment portfolio.

I think the -- we've been talking about that.

I know there was slight growth quarter over quarter.

We may make some composition changes to the portfolio as we move forward, but our thoughts are to maintain at most and certainly not grow it.

That's very helpful.

Also on your comments with the expectation that noninterest income will be down just because of the regulatory concerns, issues, should we be thinking about in terms of quantifying how much of a decline when you commented on $20 million in the annual debit transactions?

Is that what we should be looking for?

I know the expectation probably is you're going to try to find out offsets to that, but just initially is that the kind of dollars we should be thinking about?

I think you should be thinking about a several million dollar impact, just given the timing of when things take place in the third quarter.

And our thoughts are to provide some additional clarity when we release some presentations we have scheduled late in the third quarter to provide an update of some of the other action steps.

I think as Jim noted, clearly we've got some repositioning of the product offering that we are seriously evaluating and expect to launch.

Also, we're going to do pretty much a full view of all of the fees that are assessed and also all of the expenses.

So, we're looking certainly very proactively for offsets.

Just to add a little bit to that, say -- one way to look at it is August 15 is the real date here.

So you could look at the impact of being about 50% in Q3.

The biggest gap is going to be in Q4.

There will be some response by Q1 into Q2 and we should come back up the other side of that by Q2.

That's very helpful.

And just a final question, and if you guys touched on this I apologize, but the $3.5 million provision for loan repurchases, could you give a little more color into that?

And is that a number we should expect could continue going forward?

Yes.

We've seen some repurchase activity.

It generally take somewhere between 24 to 36 months to come back.

So start to think about 2005, 2006, 2007 and even into 2008 loan production that was sold from the prior activities, the national wholesale and then also thereafter just from the activities we've had in the footprint of loans that are conforming and/or would go to private investors.

Most of this though is related to the 2006, 2007 and even into the 2008 timeframe.

And it is just based on the experience we've been having with having to reach settlements on some of that, with some of the investors that we've just determined it would be a prudent step to take that experience, with the volumes that are out there, and provide some level of reserve.

Generally speaking you provide several basis points off of your gains on sales as a reserve.

We felt that this point, given the level of activity -- and certainly this is something that all mortgage bankers and all banks that have sold or conduct mortgage banking activities are seeing -- our thoughts were it is better to estimate that and put up a reserve.

And then we will continue to monitor that and report on it.

But our expectations would not be that you would expect to see a charge like that of this size.

But then again, we're just going to continue to monitor the activity and continually assess where we stand with this.

So that was more of a proactive move as to what you might see coming down the pipe.

Yes.

It wasn't reflective of purchased loans that came on this quarter?

Correct.

Okay, that's hopeful.

I think that was all I had.

Thanks.

Gerard Cassidy, RBC Capital Markets.

Thank you.

Good morning guys.

To follow-up on the repurchase activity that might take place, have you guys done any work yet on what you think the demand might be that you might be required to repurchase?

Or have you -- it sounds like you haven't had to repurchase anything yet.

Is that correct?

No.

Gerard, we've been repurchasing or reaching settlements.

And generally speaking for clarity's sake, this is not a repurchasing of loans.

It's generally reaching settlements on that activity.

What to keep in mind is that the vast majority of this activity related to the long gone national wholesale business.

So there is some finite number, obviously, out there for that.

And we're just going to continue to -- and I would say 80% of our activity related specifically back to the production that that group generated and that was sold into the market.

So, we see most of our settlement amounts relate into that activity for 2006 and 2007.

As a percentage of sales we've got some statistics that we based how we extrapolated and came up with our reserves.

So, I think hopefully that gives you a little more perspective on it.

Okay.

What are you finding for every $100,000 mortgage that comes back that has to be settled or negotiated?

What is it costing you?

The dollar; for example, JPMorgan Chase is saying that for every dollar they have to take back, they are writing off $0.58 to settle that loan.

What are you guys seeing?

I think it is always going to be case-by-case.

But if you were to start to look at a range you could be probably in the range of 30.

Okay.

Regards to expenses and the way you guys look at expenses.

And by the way, just to clarify, that's when you look at it as a percentage of the sales of activity, too.

We look at this thing at lot of different ways, but hopefully that gives some flavor to that.

If we see the activity pick up, I think everyone knows we are incredibly transparent about these things.

We will certainly provide more detailed information in terms of monitoring the adequacy of that reserve and updating that on a quarterly basis going forward.

Sure.

Circling back actually to the capital, have you guys gotten any body language from your primary regulator where the Tier 1 common ratios will end up or the Tier 1 equity ratio?

(multiple speakers) To be more capitalized, that is.

I was going to say I don't think there's either been anything specifically stated or sort of framed there.

I think our view is based on where we see peer averages and peer medians and where some of the higher performers are in the sector.

Our view is that we've got a range around which we think we should be post all of the CPP.

But our view is that is going to be a combination of capital generation from obviously dropping earnings to the bottom line.

Coupled with the improved performance that we have it certainly should help us from a valuation standpoint.

When we ultimately do something that would help boost, as Jim referenced, we'd be in pretty good shape to try and do this with the minimum amount we would possibly have to raise.

We have been careful not to make any commitments as to what the changed levels might be, or even if they're going to change them at all.

But we think they look at each individual institution now and want to be sure that they have a particular level of capital based on what they deem their risk to be.

We think our Tier 1 comment at over 8% is at a very comfortable level.

It is within our target range of 8 to 8.5 or so.

And so we're pretty comparable where we are.

We think that even if they move what they call well-capitalized, they will not move it all the way up to that level.

They will still leave themselves significant latitude on an individual institution basis.

So 8 and 12 would be the key numbers, we think, that we would want to make sure we meet, even though well-capitalized will probably be less than that.

Right, right.

Regarding the nonperforming loan reconciliation table that you guys have, the new nonaccrual as you indicated were about $75 million, $76 million down obviously from the prior periods.

Is there any niche change?

Or what are you seeing in the new nonaccruals?

Is it more skewed to commercial real estate today versus resi or some sort of construction loan in second quarter 2009?

No, it is broad-based.

We see it across the portfolio, which is probably the most positive sign.

And are you finding that, when you look at these loans, is it because of poor underwriting or weaker underwriting versus just general economic problems that your borrower ran into because of the recession?

Is there any of that mix when you go and look at it over the last year that may be a year ago it was just more shoddy underwriting that was causing it, versus an economic problem whereas today is it more of an economic problem?

I think it's clearly the economy has affected borrowers, not only within the footprint but then also some of the other businesses that we have had that have been more national.

I think that is clearly the primary driver of all the issues that we've seen in the portfolio.

Thank you.

Bruce Harting, Barclays Capital.

On figure 8, the reconciliation of core earnings, the -- just maybe a clarification.

You've got foreclosed and repossessed asset expenses of $1 million, but I don't see that.

I see that in income statement but I don't see that in that table.

I do see the 900 -- the 0.9 foreclosure write-down.

I'm just wondering why that is not in there.

And then you also see the 3.5 on the loan repurchases.

Can you just -- in the last -- in Gerard's Q&A you talked about the provision for loan repurchases, but I haven't seen that accounting before.

So what is behind the new line item?

And will that be a recurring line item?

And how do we think about sizing those three line items -- the foreclosed and repossessed asset expense, the write-down and then this repurchase on a go forward basis?

Thanks.

We'll take those one at a time, thanks, Bruce.

We think clearly the write-downs are something that occurs within a period.

They're not -- they're true nonrecurring.

We think that the reason we split out the expenses related to the foreclosed property is that the vast majority of that activity is still ongoing.

So we've taken what we think is probably the most conservative way to look at this, split them apart.

So you can truly see what we're writing down and that the performance there is getting better and better because with the proactive management of -- before anything is going in, in terms of some valuation recovery that has happened to the existing portfolio.

I think that is really with the intent is there.

We also don't spike out all of our work out expenses.

We also continue to keep those in our core operations.

So I would say that I know that when you look at this table there's just an awful lot of items we're trying to explain.

But generally speaking we think we're taking what I think is probably a fairly conservative approach of trying to say hey, look, our core operations have to carry the expenses of that asset and foreclosure expense activity that takes place as well is our loan workout expenses.

So I hope that is helpful.

Regarding the reserving, our view was that based on what we do expect to see in terms of potential -- again based on what has been presented back to us, and taking a look at our total population of what is sold, this is a reserve.

And again, in fairness, Collyn Gilbert asked this question as well.

We look at this as much more of a one-time that we'll look at and determine on a quarter end basis, are we saying anything different from the assumptions that we made.

Our expectation is that would not have a material volatility, but we will be talking about it, because again from a transparency standpoint we want folks to know we conducted mortgage banking activities.

There are clearly loans that are being put back to us or asking for some level of settlement for whatever reason or another.

And that is being negotiated.

That has been done.

Most folks that have ongoing mortgage banking operations see this.

This is just from -- with the ramp up in activity that has taken place, our view is let's take a look at the total population, do our best estimate of what we think that reserve size should be, add this addition to the existing reserves that we have.

And then continue to monitor it on a go forward basis.

What are you and your peers in bank management level thinking about in terms of offsets to some of the regulatory actions on debit and over limit?

Can you give any indication?

Is it annual debit card fee likely?

Or -- I know you don't want to give away strategic plans, but if you could talk a little bit about that.

Thanks.

Let's say it's something, Bruce, but we have not been definitive about it yet.

There is, as you can imagine, a lot of ongoing review internally and we're reticent to discuss it until we have decided absolutely what it will be and what the timing will be.

But I think I tried to make the comment that the cost would be more broadly absorbed by the base than in the past, because you won't have a smaller portion of the base subsidizing others as a result of the fees that they pay.

So we're looking at the mitigators there.

On the Durbin amendment, we just don't know what the impact is going to be on that so we're not going to take any particular action on that until we do.

The biggest focus is on the Reg E changes right now, and first getting the maximum amount of people to opt in, then telling the market how favorable our program is in attracting new customers as a result of that.

And then when we go into Q1 and certainly into Q2, we will have rolled out our new program through product redesign.

And that will help to spread the cost across the base.

Okay, thanks Jim.

Ken Zerbe, Morgan Stanley.

Just given everything going on with financial reform and when you think about your business, I mean that does not change anything for you; but when you think about your business, broadly speaking what is your core run rate of return on equity, return on assets?

And obviously this is a couple of years out.

When do you really expect to get there?

Thanks.

I made a comment about -- we absolutely believe we ought to be able to earn our cost of capital.

Our cost of capital is probably somewhere in the 10%, maybe a little bit higher range or so.

If we were setting a number out there about what we think we ought to be able to do, we would say that we ought to be able to exceed a 12% return on shareholders' equity.

As I said in my remarks we're reticent to put a hard number out or put a timeline on it, except to say we know that's what we ought to be able to do and we believe we can.

And our focus on our service quality model and the way we invest our capital and our other resources to drive economic profit is what is going to take us there.

I'm reticent to say it's 2012 or sometime in 2013.

But you think out into that timeframe would be a reasonable time to be able to get to that level.

And I also gave the caveat that let's say remember there are headwinds out there, that there is a net negative impact on overall revenue as a result of regulatory reform, including the overdraft changes that are being made.

Plus, we have the impact of higher FDIC premiums for a long period of time.

So you would love to be able to say we'll do at least 1% return on assets, but I think is premature to be able to make that commitment.

And we would like to be able to suggest a higher return on shareholders' equity, but I don't think that would be the prudent thing to do right now either.

We have to see how it goes; the progress we've made with our particular service model which we think is the right model in this environment because were trying to deliver better banking to our consumers.

And time will tell how well we do.

But I think we've got the right plans.

We certainly have the right attitude.

We have the right strategic and financial discipline.

We're allocating our capital and resources appropriately, and so we're confident we are to be able to generate the kind of shareholder returns we have discussed.

Matthew Breese, Sterne, Agee & Leach.

I was just curious to hear what charge-off severity has been like this quarter compared to where it was three, six months ago -- preferably by loan buckets, if you could.

I think if you take a look at the breakouts we've given in the tables we give you charge-offs by quarter, by loan category.

And I don't know if you've had a chance to look through that, but that would give you -- I think your question of what charge-offs look like by bucket, by quarter, I think it is detailed there.

I'm just saying are you guys -- in terms of nonperformings, are you recovering $0.50, $0.60, $0.70, $0.80 on the dollar?

No.

Again, I'm not sure if I follow you question.

Okay.

I'm just curious as to, in terms of nonperforming recoveries, have they gotten better or worse over the past six months.

Recoveries clearly have gotten better and you can see that through the numbers.

I think though, just in terms of where we've seen in terms of loss content, I don't think it has gotten materially -- it certainly hasn't worsened whatsoever.

I think it's been fairly stable.

Okay, thank you.

Mr.

Smith, there are no further questions at this time.

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

Okay, thank you very much.

Before concluding I just want to remind everyone about our upcoming investor day at our flagship office in Boston.

We'll be hosting a dinner on the evening of September 22 and then we will have presentations on the 23rd.

Please contact Terry Mangan in our Investor Relations Group for further information.

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