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First Niagara Financial Group Inc. (NASDAQ:FNFG)

Q4 2012 Earnings Call

January 23, 2013 8:30 am ET

Executives

John Koelmel – President, Chief Executive Officer

Greg Norwood – Chief Financial Officer

Ram Shankar – Director, Investor Relations

Analysts

Dave Rochester – Deutsche Bank

Erika Penala – Bank of America Merrill Lynch

John Pancari – Evercore Partners

Josh Levin – Citigroup

Casey Haire – Jefferies

Tom – FBR Capital Markets

Damon Delmonte – KBW

Matt Kelley – Sterne Agee

Collyn Gilbert – Stifel Nicolaus

Theodore Kovalac (sp) – Informed Sources Service Group

David Darst – Guggenheim Securities

Tom Alonso – Macquarie

Operator

Welcome and thank you for standing by. At this time, all participants are in a listen-only mode. After the presentation, there will be a question and answer session. To ask your question, you may press star, one. This call is being recorded. If you have any objections, you may disconnect at this point.

I will turn the meeting over to your host, Mr. Ram Shankar. Sir, you may proceed.

Ram Shankar

Thank you and good morning everyone. Thank you for joining me this morning. With me today are John Koelmel, President and CEO, and Greg Norwood, our Chief Financial Officer.

Before we begin, this presentation contains forward-looking information for First Niagara Financial Group. Such information constitutes forward-looking statements which involve significant risks and uncertainties. Actual results may differ materially from the results discussed on these forward-looking statements.

With that, let me turn the call over to John. John?

John Koelmel

Thank you, Ram, and good morning everyone. 2012 – it finished a challenging 18 months for us during which we completed the HSBC branch transaction, repositioned our balance sheet, and otherwise navigated a very dynamic external environment. But with all of that now behind us, we start the year in a much better position than where we were just 12 short months ago. This time, with a simpler and sharper focus than in any time in my tenure, solely on effectively and efficiently running the business we have today to again create real value for shareholders. We’ve obviously been challenged to do just that for the last year and a half, and therefore our focus in 2013 is to deliver consistent and predictable performance in outcomes and see that in turn translate to increased shareholder value. To do that, by continuing to be forward-looking to ensure we most effectively navigate the challenging economic, regulatory and political environment but be very focused on the present and execute with the discipline needed to make more clear this year the real value of the business we have built over the last four years.

Clear away all the clutter of the HSBC transaction and the balance sheet repositioning, you see that our results in 2012, the last six months in particular, make evident that we have a very well positioned franchise with a terrific brand, a fabulous team, and very positive momentum across all business lines and in every market we serve. We’ve already started 2013 with a clear resolve to build on that momentum and deliver a solid operating performance.

I realize the continuing clutter is a distraction we can’t perpetuate. I’ve done all I can to make clear throughout the last year that we look ahead with only one focus – running the business we have today. I understand that continuing noise, such as last week’s announcement about our outsized securities book and CMO portfolio in particular perpetuates questions about our ability to manage the balance sheet, to anticipate what will happen next, as well as to take the right actions to minimize any additional downside exposure until the economic and rate environment stabilizes. I’m confident we’ve now done just that relative to the CMO book, albeit with the pain of six more months of reality. I’ve again provided full transparency as to our expected outcomes for that portfolio and its anticipated future financial impacts.

The business momentum that we continued to build as we ended 2012 is evidenced by the new customer acquisition trends across all of our markets, along with deepening relationships, in particular with our best customers, as well as the improved execution in delivering all of our products and services as we more fully leverage our teammates, systems, processes, and infrastructure to facilitate efficient customer sales and service. While we can’t control what happens around us and while forecasting future events, given today’s realities, are challenging for everyone, our sole focus is to better bring the benefits of those continuing improvements in execution, effectiveness and efficiency to the bottom line.

So looking ahead, what can you expect from us this year, 2013? We presented the key elements of our refreshed business model at our last two conference appearances – no dramatic right or left turn, continue to keep it simple, maintain a constant eye on the customer, make it simple, easy, fast and very satisfying to do business with us. More specifically, accelerate the balance sheet rotation with disciplined loan growth that improves our earning asset mix, be smart in doing that to maintain our top quartile credit performance, increase relationship profitability by deepening share of wallet, and more effectively delivering our full array of fee-based products and services to our best customers; and be very disciplined in managing and controlling costs and the continuing investments we make to ensure we deliver more efficient results and outcomes.

The sum of that will create positive operating leverage and with that progressively improve returns, better than 1% ROA returns over the next several years. As I said earlier, we’ll do all of that with an increased sense of pace and urgency to deliver steady, consistent, positive results and performance to make clear we are in fact capable and proven operators.

A key to delivering on that promise is leadership. That’s why Dan Cantara was elevated last month to the newly created position of Chief Banking Officer. In his expanded role, all the customer-facing businesses will report to him. Dan will lead the front of the house in executing our business plan, and he and his team will have the support of the entire organization with no distractions. Given his stellar track record with the commercial services group over the last five years, you can be confident in his ability to deliver similar results across the full spectrum of customer-facing businesses.

As noted at the Merrill conference in November, we need to more fully absorb the capacity we created with our growth spurt over the last four years and further leverage our increased and improved competencies across all business units. It’s particularly true in our newer markets where there is so much more opportunity to extract value this year and beyond. That means you’ll continue to see double-digit commercial loan growth (inaudible) and further expansion of our indirect auto business and even better execution and performance from our fee-based businesses – capital markets, mortgage, insurance. We’re very proud of the continuing progress and momentum we’ve created over the last couple of years in retail. Mark Rendulic and his team are now even better positioned to support the integration of all of our businesses with the benefit of Dan’s leadership.

In referencing positive operating leverage a few minutes ago, let me underscore that we get it in terms of managing, controlling, and when necessary reducing costs. As so often stated, we’ve built a growth platform and remain committed to driving organic growth to take more than our share of the market wherever we do business. Be assured it’s very clear to us that increasing share of market or wallet doesn’t inherently translate to revenue growth in this rate environment, and given that there is no reason to believe that the world around us will change for the better in the foreseeable future, we’ve already adapted accordingly.

Expense management is obviously critical – you’re hearing it from everyone. In our case, we must see revenue growth from what we’ve already invested ahead of any additional spend, and we must spend less where the potential for revenue growth is compromised. While we will not look to damage our longer term opportunities, we fully understand and embrace the need to run today’s business more effectively and efficiently. An efficiency ratio in the mid-50s remains our expectation longer term, and to make a meaningful move in that direction we need to be extra disciplined this year in ’13 and reduce overall costs until revenues begin to more predictably rise. Our expense run rate coming out of the HSBC transaction was 240 million per quarter. We took actions during the back half of 2012 to reduce that level of spend, including the workforce optimization in Q3, and we’ll further bring that down to a targeted 225 million by the fourth quarter of this year.

So in summary, executing very, very well, being operationally excellent with all that is within our control, better minimizing the downside exposure of our unique balance sheet given a volatile environment we obviously can’t control, being fully and completely focused with absolutely no distractions on running the business we’ve already built, and driving improved results and performance. That’s our commitment for 2013 and that’s what you can hold me accountable to do.

With that, let me turn it over to Greg to review the just-completed quarter and give you our views on the outlook ahead the rest of the year.

Greg Norwood

Thanks John, and good morning. Let me start with some color on key income statement trends and then move to the balance sheet, credit, some perspective on our CMO adjustment, and close with the 2013 outlook, as John mentioned.

Fourth quarter operating net income available for common shareholders was $0.19 per diluted share, consistent with third quarter. This excludes the $16 million pre-tax adjustment or $0.03 a share to accelerate premium amortization on our collateralized mortgage obligations that we announced last week as well as 3.7 million in final merger-related and restructuring charges. Quarter-over-quarter operating net income, excluding the previously announced CMO charge, was flat to third quarter as a 13% increase in average earning assets negated re-pricing pressure on both our investments and, to a lesser amount, our loan book. Excluding the total CMO fourth quarter impact on our core NIM, continued downward re-pricing of core earning assets reduced our run rate by 8 basis points to 346. It’s what we anticipated when we gave you our guidance in the third quarter earnings call.

As with everyone in the industry, the decline in load yields continues to be driven by elevated refinancing or repayment activity in both our commercial and residential real estate books, and for us the significant growth in our new loans at lower current yields. Our fourth quarter C&I spreads continue to be in line with our expectations. Pricing on new C&I production is approximately LIBOR plus 250, plus or minus, and about 40 to 50 basis points higher on the business banking side. On the CRE side, we are seeing more churn in the marketplace and very competition pricing.

Total interest income declined by 5% from the linked quarter driven by lower mortgage banking revenues and seasonality in our insurance business. Those impacts were partially offset by continued strength in capital markets and in our wealth management businesses. Mortgage banking revenue declined 2.9 million from a very strong third quarter. When we last talked in October, we looked at our own expectations and that of the industry and believed that due to historically low mortgage rates, that volumes would remain high throughout the fourth quarter. Clearly as we look back, after a strong early fourth quarter, borrowers took December off and drove our application volumes down lower by 23% quarter-over-quarter, causing us to underperform on the revenue side relative to our guidance last quarter.

Another contributing factor to the quarter-over-quarter decline for us was a business decision we made to further improve customer experience, increase capacity, and clear pipeline backlogs. As a result, during the early part of the quarter we managed our application pipeline through pricing to accomplish these objectives. As a result, our closed volumes increased 12% to an all-time high of 610 million.

Looking forward, we opened our third new processing facility in Syracuse. As the mortgage business is a strategic focus for us, we are building capacity to meet long-term goals. We are well positioned in this business and much better than even a year ago. By clearing our backlog and adding capacity, we have reduced our cycle time from application to closing by 30%, and we expect to be even more efficient through the first half of 2013. In addition, we hired a very senior mortgage banking leader from a competitor, Gary Sease (sp). We also significantly increased our upstate New York presence with the mortgage lenders who joined us from HSBC. As we look into 2013, these actions that we have taken in 2012 will drive our strategic focus to take a bigger share of the refi volumes and be positioned in each of our markets to increase our new purchase volumes.

Capital markets revenue increased 11% from the linked quarter as we hit an all-time high of over 90 completed swap transactions. We also closed three syndication deals during the quarter, consistent with previous quarters. Insurance commissions declined 3 million from the third quarter, as expected and consistent with seasonal trends. We expect this to rebound consistent with prior trends as well.

Wealth management improved nicely for the quarter as well. Assets under management increased 9%, driving wealth management fees higher by 8%. The completion of the repapering of the HSBC customers, our focus on increasing branch sales, and the build-out of our advisory business all contributed to this growth.

Let me round out our P&L discussion by discussing operating expenses, which include our final merger and restructuring charges, roughly 235 million in the fourth quarter, in line with our guidance. The 2 million improvement linked quarter was driven entirely by a 4.5 million reduction in salary and benefits resulting from our workforce efficiency and effectiveness review that we completed in the third quarter, partially offset by seasonal increases in facility costs.

Let me talk about the key loan takeaways on Slides 4 through 6. The growth in the commercial platform continues across all geographies and all product lines. Our newer markets in western Pennsylvania and eastern Pennsylvania, as well as New England, delivered on a strong pipeline and increased loans at a double-digit clip. The healthcare lenders we hired in eastern Pennsylvania and New England recently continue to gain traction in that segment, while equipment financing continued its rapid growth driven by leveraging synergies with other lines of businesses. Since closing the HSBC transaction, our growth in New York in the second half of 2012 has been 11% annualized. This further demonstrates the continuing opportunity in our legacy markets as well as the HSBC benefits.

Finally and importantly, our year-end commercial loan pipelines and January activity remain strong. How do we keep doing this? Over the last few years, we’ve been building our competencies in products and services. Just looking at 2012, we added or significantly enhanced our business banking lending, pre-syndications, and improved product capabilities in foreign exchange. All of these we either did not have or emphasize previously – clear growth opportunities for us. Combine these new product capabilities with our greater capacity and our new geographies and greater presence in upstate New York, we have even more potential.

On the consumer side, in 2012 indirect auto was a real value proposition for us. By strategically bringing over experienced sales and support teams who know the business and our marketplace, we jumpstarted this business. Key to this is the ability loans at attractive yields. We have originated about 640 million in auto loans that are yielding net 3.5% with an average FICO of 740. All of these exceed our first year stretch business case goals.

On the mortgage side, as I noted earlier, the fourth quarter saw applications fall while close volumes reached an all-time high. Retail mortgage production increased again this quarter by 17% and was 90% of the total 610 million close volume – very important as we look to the post-refi period. Finally, credit card will be an emerging story for us. Purchase levels remained strong this quarter and grew to almost 260 million, up from third quarter. With our enhanced product and service capabilities, our card offering will begin to be a bigger part of our transaction saver borrow efforts going forward.

Moving to deposits on Page 7, we saw double-digit growth in average transactional balances in each of our regions, especially in our eastern Pennsylvania and New England markets. This increase came from higher balances with existing customers in our mass affluent segment. Our deposit mix also continues to improve. Today, transactional deposits are five percentage points higher than a year ago.

We continue to prudently invest in our retail franchise. Yesterday, we announced the launch of our online mobile banking app. We also announced our plans to launch our remote deposit capture and P2P capabilities later in 2013. We will be one of the few regional banks our size that offer the remote deposit capture and P2P product capabilities to our customers, further enhancing our value proposition. We’re really excited about the opportunity. During the soft launch without any marketing or notice, the app store had over 25,000 downloads – really exciting time to increase our product penetration.

Turning to Slides 8 and 9 on credit, we had a very good, clean, simple credit quarter. First, the originated book – overall a good quarter compared to third quarter with lower charge-offs set by a higher provision for new originated loans, resulting in a flat loan loss provision quarter-over-quarter. Non-performing loans as a percent of originated loans rose 14 basis points from the prior quarter but essentially flat with the first quarter of this year. Roughly a third of this increase was due to industry guidance from the OCC related to Chapter 7 residential loans; however, given stable home prices in our markets, there was no impact of this new guidance on charge-offs. Additionally, over half of the increase in commercial non-performing loans, or 7 basis points, resulted from one commercial credit and thus is not indicative of worsening trends across the broader portfolio. Again, our credit culture remains very strong and a core competency of ours. For the acquired loan portfolio, a pretty benign quarter. We still feel good about the credit marks against this portion of our book. Acquired NPLs increased only modestly quarter-over-quarter.

Let me give some context on the CMO adjustment we took and our current view of expected prepayments. What we are assuming now is significantly above the worst case scenario presented in our analysis when we announced the June sale. While we thought then we had taken a conservative view of prepayment speeds by assuming a CPR of 26 for the first year with a peak of 33 versus May levels of approximately 20, prepayment activity since the repositioning, and particularly in the fourth quarter, has made clear that speeds will be much higher, averaging 32 CPR for the last six months of 2012. As we looked at that activity and the range of possible prepayment speeds during our review process, we evaluated a range of possible prepayment assumptions. In addition to using our own ADCO model, we also used two advisors and their models to get the best possible perspective.

Looking at Slides 10 and 11, let me focus you on the portion of the residential mortgage-backed security portfolio that we are closely monitoring. Of the 12 billion securities portfolio, approximately 5.7 are residential mortgage-backed securities, including 800 million in mortgage-backed securities that have performed as planned for some time now. CMOs totaled 4.9 billion with 1 billion of those CMOs purchase post-the June 2012 repositioning at low or no premiums. The remaining 3.8 of this balance is the portion of the CMO portfolio that we retained post-June and that drove the $16 million adjustment we recorded.

So let me give you some additional color on that 3.8 billion. In terms of cash flows, we are assuming that roughly 45% of the 3.8 billion prepays in Year 1 and 80% over the first three years. We estimated the unamortized premium on the 3.8 billion will be reduced from 65 million today to 31 million on December 31, 2013. In the chart at the bottom of Slide 11, we show the impact of 10% and 20% increase in cash flows from our adjusted case I just gave you. This implies that 55% of the bonds are over 2 billion prepay in one year and 90% over the next three years.

Now let me talk about the outlook for 2013. First on the balance sheet, we expect commercial and consumer loan trends to continue pretty much as they have been. The card business, while not currently a needle mover in balances, will become a bigger part of our transaction saver borrower strategy progressively throughout 2013. We are committed to rotate out of investment securities, balancing return, margin and income metrics. We see balances moderating down beginning in the second quarter, again in a balanced way.

Net interest margin – we see a pretty predictable NIM for the first quarter, given the adjustment we have taken in our CMO book. The loan book will be impacted by compression from both fourth quarter and first quarter refinancing with just a slight benefit from lower deposit costs. As we look at rotating the balance sheet, we see this benefiting margin throughout 2013 and we will only see a very modest negative impact of the CMO cash flows re-pricing lower in the remainder of the year.

On credit, we expect originated charge-offs to originated loans to be approximately 35 basis points, plus or minus, in Q1 of 2013. Over the rest of the year, we expect our credit costs in total to continue to reflect our strong credit culture. For those of you with detailed models, I’ll remind you that the credit card purchase accounting we discussed in the second quarter earnings call will have about 3 million of originated provision in each of Q1 and Q2, and that will flip to charge-offs of a similar amount in Q3 and Q4. Net-net, no impact overall, just a shift in some of your models.

We’ve included in the appendix our methodology to calculate what we call the growth provision, or excess provision over charge-offs, for loan growth. We expect our originated book to grow by a net 1 billion, plus or minus, a quarter; so our growth provision would be roughly about 1.2% of that net growth. First quarter fee income should improve modestly over fourth quarter levels. Fee income later in the year will begin to benefit from our digital online banking and treasury management product enhancement efforts. Specifically on mortgage, as our Syracuse facility ramps up, we should see greater benefit over the course of the year as we pursue our growth initiative in this business and build capacity. The increased capacity will help offset the continued margin pressures we expect.

Closing with expenses, Q1 will be at or below 4Q levels, which means efficiency will otherwise cover seasonal increases. We know managing expense is the most controllable lever in what is otherwise a very unpredictable world. Looking at the fourth quarter of 2013, we are committed to running the business by lowering the annual run rate approximately 40 million compared to fourth quarter 2012. We think this is achievable while still investing prudently.

With that, I’ll conclude and turn it over to Stan to being the Q&A session.

Question and Answer Session

Operator

Thank you. We will now begin the question and answer session. [Operator instructions]

Our first question comes from Dave Rochester from Deutsche Bank. Sir, you may proceed.

Dave Rochester – Deutsche Bank

Hey, good morning guys. Can you just update us on what your interest rate assumptions are that are embedded in those prepayment speed models?

Greg Norwood

Sure. We assumed a flat or spot interest rate environment versus a forward in predicting the borrower behavior relative to refinancing patterns.

Dave Rochester – Deutsche Bank

Okay, so just the current curve projected out for the next two to three years?

Greg Norwood

The current spot curve, correct.

Dave Rochester – Deutsche Bank

The current spot curve – okay. And so at this point, I guess you’re comfortable that you’re finished with any other prepayment speed adjustments to the portfolio going forward?

Greg Norwood

Yes, we took a very conservative approach, David, even looking at the spot curve. We looked at that and made some overlay adjustments to reflect even higher prepayments, and while certainly you can never predict the future, I think when we talk about the cash flows, we’re very confident that we did the right thing in the fourth quarter in the right amount.

Dave Rochester – Deutsche Bank

Okay, great. And just switching to expenses, can you talk about how you’re going to get to that lower operating expense level by 4Q, where the biggest cost take-outs will be?

Greg Norwood

Sure. First of all, let me start with we’ll continue to do what we’ve been doing, whether it be the third quarter review we did or the restructuring in the first quarter of last year around the branch staffing. And while we’re not announcing any particular program, we will continue to focus on salary expenses, vendor expenses, and see other fixed cost expenses coming down over the period.

Dave Rochester – Deutsche Bank

Should we see a gradual reduction in expenses, or will it be more lumpy?

Greg Norwood

It will be more gradual.

Dave Rochester – Deutsche Bank

Right. And lastly on the margin, you talked about pricing on commercial real estate getting more competitive. How much have yields come down, or spreads come down from last quarter?

Greg Norwood

I would say the re-pricing on the commercial real estate, spread have tightened. Yields—the yield curve has been basically the same. The biggest impact there, David, is generally re-pricing higher rate fixed rate loans into lower fixed or to lower variable rate loans. So it’s the re-pricing of fixed into low rate variable.

Dave Rochester – Deutsche Bank

Got you. And what are the yields on the variable right now?

Greg Norwood

Generally around LIBOR plus 280, plus or minus.

Dave Rochester – Deutsche Bank

Okay. Great, thanks guys.

Operator

Thank you. Our next question comes from Erika Penala from Bank of America Merrill Lynch. Ma’am, you may proceed.

Erika Penala – Bank of America Merrill Lynch

Good morning. My first question, I just wanted to refer back to Slide 8. So I noticed there was an uptick in criticized and classified loans this quarter, and I was wondering—I appreciate the commentary on the NPLs with regards to Chapter 7, but does that have anything to do with the new OCC guidance, or if not, could you give us a bit more color on the uptick?

Greg Norwood

Sure. Directly there would be a modest impact from the guidance. I think as we looked at the overall portfolio, we didn’t really see that uptick evidencing any trends, so it wasn’t something that evidenced a broad-based credit deterioration. Even in our NPLs, I think it’s important to note that the one credit was the biggest mover there; and again, we didn’t see any negative trends across the portfolio.

Erika Penala – Bank of America Merrill Lynch

Okay. Could you give us a little bit more color on that one credit? Was it C&I, commercial real estate?

Greg Norwood

It was C&I from our eastern franchise.

Erika Penala – Bank of America Merrill Lynch

Okay. And just wanted to clarify some of your guidance on Slide 12. You mention that to be able to preserve the margin, you’re going to rotate some of your bond investments or bond cash flows into loan growth. In that case, should we expect earning asset growth to (inaudible) the 10% loan growth that you guided towards?

Greg Norwood

Well first of all, we’ve continued to rotate the balance sheet with loan to deposit ratio increasing this quarter up to 71%. From an earning asset perspective, the driver will be the average loans plus or minus, and where we see the investment securities starting to migrate down would be more in the second quarter and beyond, where we would anticipate loan growth to remain strong to keep the balance sheet essentially flat.

Erika Penala – Bank of America Merrill Lynch

Got it. And if I could just sneak one more in on credit, this is more of a long-term question. Have you gotten a chance to review the new FASBY guidance on the change in terms of migrating to lifetime loss analysis on reserving?

Greg Norwood

Certainly we’ve followed it and tracked it. I think there’s a lot to understand in the lifetime and models to be used, so we haven’t really quantified a range relative to how that would impact us going forward. But clearly from an industry perspective, it’s going to be an area where I think we all have to focus to ensure consistent application and clear discussions around that application so analysts and investors can understand nuances and differences between issuers.

Erika Penala – Bank of America Merrill Lynch

Got it. Thank you for taking my questions.

Operator

Thank you. Our next question comes from John Pancari from Evercore Partners. Sir, you may proceed.

John Pancari – Evercore Partners

Good morning. Can you give us some more color on the strategy for your securities portfolio here over the past—or what you’ve employed, really, over the past couple quarters. It looks like you levered up again this quarter. Last quarter when you did it, you pointed to the likelihood of elevated deposit inflows that you were pre-investing for that you had expected out of the fourth quarter, but we didn’t see that this quarter. So I’m just trying to get some color on what the strategy has been here around the levering up of the balance sheet.

Greg Norwood

Yeah, let me—when we think about the investment portfolio, we’ve tried to target a range of 11.5 to 12 billion, kind of a par balance, excluding government, federal bank, FRB type investments. So that’s been our target zone, and when you look at average balances we’re on the high side of that, but in that zone. Certainly we’re looking at, as we said last time, we wouldn’t make any huge shifts in the investment portfolio in the near term but would continue to look at balancing return metrics, NIM, and income relative to rotating that out as we would expect loan growth to begin to pick up relative to continued market share, as well as indirect. So we see that continuing and to have a more meaningful impact beginning in the second quarter and the remainder of 2013, and again that will help moderate the NIM compression with growth in other earnings assets continuing to allow for modest growth in NII.

John Koelmel

In terms of the wholesale leverage versus the retail play—

Greg Norwood

Yeah, one of the things that we’re focused on, too, is in our deposit platform, the key focus is on checking accounts and transactional accounts and not an aggressive push for money market or CDs. So when we look at funding the balance sheet, we’re looking at the cost benefit of the wholesale borrowings versus CD or money market in customer acquisitions and really trying to focus on the transactional accounts, and because currently the wholesale borrowing is a cheaper source of funds than money market or CDs from customers, and those aren’t the most valued customers, that’s why our focus is on balancing that.

John Pancari – Evercore Partners

Okay. And then on that front also, can you give us some color of what you’re putting on, what types of securities, what yields you’re putting on the securities?

Greg Norwood

Yeah, in the mortgage backed scenario, we’re generally in what I would say the 170-ish range in re-pricing, which I think is pretty common across the market. The investments we’re putting on most recently roll-on, roll-off of about a billion, has come on at a net yield of about 2.1%, and that’s spread across the mortgage-backed and CMBS platform.

John Koelmel

No premiums.

Greg Norwood

No premiums on the mortgage backs, as I mentioned, relative to acquisitions.

John Pancari – Evercore Partners

Okay. And then lastly, can you give us additional color on your outlook for growth in the indirect auto book, and also what yields are you currently getting on your new paper there? Thanks.

Greg Norwood

Sure. We continue to see the growth at paces we’ve seen. It is getting more competitive, so the yields are coming down a little bit; but they’re still in the positive range of 340 to 350 net of dealer. One of the things we are focused there in the rotating the balance sheet is opening up more of our geography, contiguous geography to existing dealerships and continue to sign the dealership. So while the rates are coming down a little bit, we still see a pretty positive trade there, and certainly that’s an element of how we look at rotating from investment securities and that alternative at 170 versus a risk-adjusted spread on the originated indirect book.

John Pancari – Evercore Partners

Okay, thank you.

Operator

Thank you. Our next question comes from Josh Levin from Citigroup. Sir, you may proceed.

Josh Levin – Citigroup

Thank you. Good morning. You had very strong loan growth but you also talked about a very competitive pricing environment. What metrics do you use to make that you are being properly compensated for the risk you are taking in extending credit in the current environment?

Greg Norwood

Sure. We’ve consistently deployed an IRR model and look at that at a portfolio level, a loan-by-loan level, and from a product perspective. So we continue to use that, and I would say we continue to focus on the hurdle rates appreciating that for the best customers, we look at an all-in fee and rate IRR to make sure that we’re balancing both the short term and the near term. As we said in our strategic discussion at the last two conferences, we clearly are a return-based shop and one of the benefits, I think, our franchise affords us is because we have the volume capability, we don’t have to take low IRRs just to see volume growth. So we’re not dropping down our hurdle rates, and we don’t have to see that going forward relative to being able to continue our loan growth that we’re talking about.

John Koelmel

We’re talking about spreads being relatively consistent with what we’ve anticipated, although absolute yields are coming down, so.

Greg Norwood

Yeah, I think John’s point around spreads and particularly the C&I book is important, because throughout 2012, even in the back half and in the fourth quarter, we did not see a lot of spread tightening on the C&I book. As we talked about in one of, I think, Erika’s questions, was on the CRE book that is where the market is seeing the most re-pricing risk because you’re typically taking adjustable or fixed rate loans and re-pricing them into variable rate loans, and that’s where you see the biggest impact in the NIM.

Josh Levin – Citigroup

Okay. And on the C&I loan front, you’re taking market share. If we were to ask a customer who used to borrow from Bank X or Bank Y but has since become a customer of First Niagara, why did you switch to First Niagara? Why are you borrowing money from them now? What would they say? I mean, what is it about First Niagara that is making customers switch, and why are you able to take market share?

Greg Norwood

Let me take a stab at that, and John can probably speak to it as well. One of the things that we see as an advantage to us in we’re in the middle sweet spot, and what we’ve been doing to really capitalize on that is building the product and service feature functionality. We’ve also built the talent around that, so what that allows us to do is in our PT metaphor, we also have a very regional, decentralized approach to servicing the customer. So when you think about it, we’ve got the products, service and talent to compete up-market with the bigger guys, but we’ve got the PT capability to be very quick, very decisive.

Clearly on the other side with smaller bank customers, we have product, service and talent that we think clearly differentiates us, so the whole moving up-market strategy with talent, product and service is a key for us. The other is in our newer geographies, we’ve got a lot of room to penetrate, so clearly that’s part of the acquisition strategy. And even in our legacy, the 11% growth in the back half of 2012 in upstate New York clearly shows that in our legacy franchise we can grow.

So Josh, it really is being in the middle and being able to more aggressively compete on either end of the customer spectrum.

John Koelmel

That can only underscore progressively we’ve gone from leading solely with talent and the strength of the relationships our seasoned team has, has long had, and our ability to execute and deliver, to a progressively sophisticated ability to respond to virtually any customer’s need. So whether it be Diego Tobon and his team or the rest of the tools that Dan Cantara’s group can bring to the table, we can compete with anybody; and as Greg said, we’re able to make it happen and get it done. So to the extent you’ve got a bankable transaction, we can more readily and consistently deliver for the benefit of our customer than most, if any of the competition. And as always, we lead with talent and the relationships and their ability to make good things happen for the customer.

Josh Levin – Citigroup

Thank you for taking my questions.

Operator

Thank you. Our next question comes from Casey Haire from Jefferies. Sir, you may proceed.

Casey Haire – Jefferies

Good morning, guys. How are you doing?

John Koelmel

Casey – good. How about you?

Casey Haire – Jefferies

Good, good. So just a question on the NIM guide. You mentioned moderating benefit from lowering deposit costs. Just curious how low you think you can take it from this 29 BP level and how quickly you get there.

Greg Norwood

One, I think we’d do it in the first half of 2013, and I think realistically when we think about it even six months ago, we continue to see a customer that’s inelastic to deposit pricing, so we’ll continue to do that and lead the market. But it’s a couple of BPs, Casey. It’s not an additional huge move going forward.

John Koelmel

At this point, it will just—you know, we’ll keep stepping into it where the opportunities present. So yeah, yet to be determined, Casey, but don’t quarrel with Greg. There is less than more, but frankly we’ve been saying that for a number of years and there has turned out to be more than less, so.

Casey Haire – Jefferies

Got you, okay. And just one question on earning asset trajectory sort of longer term. Obviously the earning assets are kind of running in place as you rotate out of securities, but when do you see that sort of inflecting where you have the securities portfolio sort of right-sized and the earning assets growth picking up, so to speak?

Greg Norwood

Casey, that’s a tough one to answer. Clearly as we move forward, the economic environment will determine the degree of loan growth. When we look at the target range for investments, we see that in the 20 to 25% range, and we’ll continue to move towards that. But to give a specific date, we don’t have that from our vantage point.

I’ll go back to the strategic perspective – I mean, clearly getting a loan to deposit ratio of 95% and getting to an investment book coverage of about 20%, those are our goals over the next three to four years.

Casey Haire – Jefferies

Okay, I guess said another way, if all goes well, where do you see that loan deposit ratio ending the year from that 71% level currently?

Greg Norwood

What I would tell you relative to outlook, we really focus on the first quarter, and I think the 71% is probably a good number with some improvement. As we move forward into 2013, again it’s harder to predict that at this point in time.

Casey Haire – Jefferies

Okay. Thanks for taking the questions.

Operator

Thank you. Our next question comes from Bob Ramsey from FBR. Sir, you may proceed.

Tom – FBR

Good morning guys. This is Tom for Bob. I just had one quick question for you. I wanted to go back to expenses. So if I’m thinking about this right, you’re expecting annual expense saves of about 40 million. Does that imply you expect to get the total operating expenses down to $225 million level by 4Q13?

Greg Norwood

Yeah, from a run rate perspective, all-in expenses – salaries, vendor, other fixed charges – is how we’re focused on that.

Tom – FBR

Okay, and does that suggest an efficiency of somewhere between 62 and 63%?

Greg Norwood

It should be a little lower than that. If you think in our guidance, we said we’re looking at a decline of 300 to 400 basis points, so closer to a six handle.

Tom – FBR

Okay, got you. And then on commercial loan growth, or on loan growth in general, some of your peers commented that loan growth might have been pulled forward this quarter as a result of potential tax policy changes and increasing capital gains. Did you see any of that in your markets?

Greg Norwood

I would say not a lot, and we’ve heard those stories about people selling businesses sooner. I think the key we wanted to highlight in my remarks is the January activity remains strong, so we had a lot of spillover even though we had a very strong December. We had a lot move into January as well.

Tom – FBR

Okay, great. And then one last thing. I see mortgage banking revenues, you’re expecting to be up 5 to 10%. Does that assume an extension of this refi boom, or are you expecting kind of purchase volume to kind of take over in 2013?

Greg Norwood

Well, the guidance we gave for first quarter will clearly continue to be a lot of refi volume. I think our expectations track the industry that certainly for the foreseeable future, and I would say maybe through the third quarter for sure, we’ll continue to see refi.

One of the keys we’re focused on strategically in the talent we’re hiring, the mortgage lenders, and leveraging the branch sales network, improving the incentive comp around mortgage referrals is we’re really focused on building for the post-refi, so the purchase book is a real important part of our strategy.

Tom – FBR

Okay, great. Thank you for taking my questions.

Operator

Thank you. Our next question comes from Damon Delmonte from KBW. Sir, you may proceed.

Damon Delmonte – KBW

Hi, good morning guys. How are you?

John Koelmel

Good, Damon. How about you?

Damon Delmonte – KBW

Good, thanks. My first question – Greg, could you just recap what you said about the provision related to the credit cards in the first and second quarter for ’13?

Greg Norwood

Yeah, and we can have Ram chat with you. But as we talked in the second quarter, there is a couple ways to do that accounting, and what we did is rotate the existing book into originated, so every quarter about one quarter of the 300 million rotates into an originated and we provide at a 2.75 or 3%. Once we do that and the whole book rotates in, we will take the charge-offs that are being recorded against the mark-to-market at acquisition and those will start to flow through. So again, they’re pretty much the same amount when you think about how a credit card book would work, and it would just flip depending on how you model from provision to charge-offs.

Damon Delmonte – KBW

Okay. And again, you said it was about 3 million for the first and second quarter?

Greg Norwood

Yes.

Damon Delmonte – KBW

Okay. That’s helpful, thanks. And then can you just reconcile between the 346 margin that you had in your press release and the 342?

Greg Norwood

Yeah, sure. The 342 reflects the run rate in our core book, including the CMO and exclusive of the 16. On a monthly basis, we record premium amortization based on that month’s cash flows, so as the cash flows increased in the fourth quarter, there were incremental amortization of about 3 million-plus. So when you look at the impact of the CMO for the quarter, it’s the combination of the two; so when we look at the NIM from our perspective and what we were thinking from a core bank, that’s what the 346 number would be.

John Koelmel

And my simple summary there, Damon, is the 346 excludes the full incremental drag, quarter-over-quarter. The 342 only excludes the $16 million adjustment we announced last week.

Damon Delmonte – KBW

Okay, great. That’s helpful, thanks. And then I guess my last question, just kind of based on the guidance that was provided, what does that translate into an ROE target for the full year for 2013?

Greg Norwood

Well, let me speak to the first quarter because that’s where we’ve really given more guidance versus outlook. I would expect the ROEs to remain relatively flat in the first quarter, and as I would probably bring back, Damon, is the strategic perspective we talk about at conferences. We’re really focused on ROA and increasing that, and we would expect that to also stay in the same zone in the first quarter. As we continue to rotate the balance sheet, increase fee income, we see that driving ROA and ROE up.

Damon Delmonte – KBW

Okay, that’s all I had. All my other questions were answered. Thank you very much.

Operator

Thank you. Our next question comes from Matt Kelley from Sterne Agee. Sir, you may proceed.

Matt Kelley – Sterne Agee

Yeah, just coming back to the expense save guidance here, the 40 million. How would you break that down between salary, headcount, and then other synergies and vendor and other operating expenses? How does it break down?

Greg Norwood

We haven’t really disclosed that, and we don’t have a particular program. It’s a continuation of doing what we do every day, Matt. I mean, clearly the benefits of the efforts in 2012 will help us period-over-period, and we’ll see expenses focus on discretionary spending and stay focused on things like digital and treasury management services, and defer other discretionary spending for more of a recovery market versus focus on controlling what you can control.

Matt Kelley – Sterne Agee

Okay, and where do you think we end the year on the branch count versus the 430 at year-end ’12?

Greg Norwood

We have modest consolidations, maybe in the zone of 5 to 10 over the course of the year.

Matt Kelley – Sterne Agee

Okay. And have you contemplated any additional branch divestitures across the footprint?

Greg Norwood

Certainly maintaining the franchise we have and focusing on our strategy, there are some areas that we might look at over time. But we really have no specific plans at this time.

John Koelmel

We’ve done our best, Matt, to make clear we’re very focused in ’13 on optimizing what we have, rather than reconfiguring or repositioning that. So expect that we’ll execute and deliver with the complement that we have in place.

Matt Kelley – Sterne Agee

Okay. And then just shifting gears to the mortgage banking business, can you just comment a little bit on the gain on sale margins you experienced during the quarter and what you’ve been seeing early on in the year, you know, the first couple weeks of the year in terms of volumes and gain on sale margins?

Greg Norwood

Sure. Gain on sales in the quarter, I would say were flat to maybe a slight tick down, and as you’ve heard and we would believe that that kind of trend is what we would expect in the first quarter. Volumes clearly have rebounded from—what, December was the lowest month in all of 2012, so volumes have kicked back up; and certainly from a volume perspective we would expect to see a rebound in the first quarter. And when we look at the rate volume, that’s where we get the 5 to 10% increase over fourth quarter.

Matt Kelley – Sterne Agee

Okay, and then just last question – how big is the mortgage banking unit in terms of headcount, and where was that a year ago?

Greg Norwood

Right now it’s about 130, and I would say that’s up pretty significantly. I mean, we brought in with HSBC about 30 mortgage lenders. We’ve been increasing capacity from just an overall perspective. I think we’ve mentioned before the Syracuse facility opening, and that’s increased 20 people already. So pretty significant increase, up to about 130, and we would expect that to be reflective and look at that on a go-forward basis as well.

Matt Kelley – Sterne Agee

Okay, thank you.

Operator

Thank you. Our next question comes from Ms. Collyn Gilbert from Stifel Nicolaus. Ma’am, you may proceed.

Collyn Gilbert – Stifel Nicolaus

Great, thanks. Good morning, gentlemen. Greg, to follow up on the comment that you made in terms of the expectation for loan growth will be contingent on the economic environment, how do your capital levels weigh into how you’re thinking about the overall growth of the business and the balance sheet positioning?

Greg Norwood

When we look out in the future, we feel very comfortable with our capital accumulation and supporting the rotating of the balance sheet from securities to loans. I mean, certainly we are focused on accumulating capital as we talked about during the HSBC transaction. We remain very comfortable that we have the right capital for the risk in the balance sheet today and will continue to manage that as we move through the next couple of years.

John Koelmel

And on that point, it remains a very low risk-weighted balance sheet, so.

Collyn Gilbert – Stifel Nicolaus

Okay, okay. And then just a quick question – you mentioned on the CMOs, the 1.1 billion was bought post-June, sitting with virtually no premium. The 3.8 that’s remaining, or the other bucket, when were those purchased?

Greg Norwood

They were purchased earlier than this year. There were some purchases in 2012, but most of the book was purchased prior to 2012.

Collyn Gilbert – Stifel Nicolaus

Okay, okay. And then just a final question – what are the performance metrics that you guys are kind of really honing in on this year; and I guess specifically, what are the metrics that are going to drive executive incentive comp this year?

John Koelmel

In terms of what you’ve seen us, Collyn, talk about, keys to our success, whether it be rotating the balance sheet, whether it be maintaining the strength of credit, whether it be our ability to, say, drive relationship profitability, improve that fee income story. Obviously operating excellence, operating efficiency, overall profitability, the level of performance, continuing to drive franchise value – those have long been and continue to be the parameters on which we’re compensated and what we otherwise focus to drive the business. We’ve consistently talked about our return driven shop and the need in the current year to further and continue to sharpen our focus.

So what you’ve heard from us is consistent with how we’re evaluating and consistent with how we look to drive the business near-term and beyond.

Collyn Gilbert – Stifel Nicolaus

Okay. Okay, so no hard numbers that you’re targeting for this year as it relates to a specific ROA. And I know when the question was asked about ROE, you’re honing in on first quarter. Will there be greater profitability targets or goals offered to us post-the first quarter number, or is it just something you’re going to maybe do quarter-to-quarter?

John Koelmel

I’ll put in all of the above. Clearly we’ll take it quarter-to-quarter, and as there’s improved clarity and improved probability of one’s ability to look ahead, we’ll be as transparent as we always in the past. Right now, it’s just difficult to get too far ahead of ourselves.

Collyn Gilbert – Stifel Nicolaus

Okay, that’s helpful. That’s all I had. Thanks.

Operator

Thank you. Our next question comes from the Theodore Kovalac from Informed Sources Service Group. Sir, you may proceed.

Theodore Kovalac – Informed Sources Service Group

Yes, good morning. I was wondering if you could give us a little bit more insight into the net interest margin, which seems to have been a little rocky.

Greg Norwood

Sure. Let me talk quarter-over-quarter. As we talked about, it was down about 8 basis points when you exclude the total impact of the CMO, and as we looked to the future when we talked last quarter, at the end of the third quarter call, I think we came in pretty much in line with what our guidance was. I mean, clearly the CMO book is the most volatile impact on the overall NIM, and key to looking forward is we’ve taken a significant portion of that volatility out of the 2013 outlook. And as we mentioned, over the total 2013 period, it has a very modest potential drag on NIM. So the rockiness that you refer to is almost solely the CMO, which we don’t expect to see that volatility going forward in 2013.

Theodore Kovalac – Informed Sources Service Group

So can we model it being essentially level or a slight erosion, or what?

Greg Norwood

Well, what I would suggest when you’re modeling is look at the guidance we’re giving in first quarter; and as we said, going forward we expect the balance sheet rotation to help mitigate some of the pressure and decline at a more modest pace overall during the year than in the first quarter.

Theodore Kovalac – Informed Sources Service Group

Okay, thank you.

Operator

Thank you. Our next question comes from David Darst of Guggenheim Securities. Sir, you may proceed.

David Darst – Guggenheim Securities

Good morning. Greg, would you go over the pace of the decline for the intangible amortization for the year, and is that included in the $40 million once you get to the fourth quarter number?

Greg Norwood

It is included, and it does decline over the year in addition to how we’re going to manage operating expenses.

David Darst – Guggenheim Securities

Should that number be around 8 million a quarter in the second half of the year?

Greg Norwood

That’s probably a good guess.

David Darst – Guggenheim Securities

Okay. And then in your 35 basis points for charge-off expectations for the first quarter, does that include the 3 million for credit card?

Greg Norwood

No, in the first quarter it would not, because there are no charge-offs. That’s going against the purchase accounting mark.

David Darst – Guggenheim Securities

Okay. And should we consider the 35 basis points something kind of for the full year as a run rate as well, or do you think you’ll see a decline?

Greg Norwood

Well again, right now as John said, we’re really focused on trying to give a clear view of first quarter. When we look out beyond that, our credit culture we think will help continue to keep charge-offs at a low percentage, depending on how you model charge-offs or how you model it. That’s why I made reference to the credit card, because that would reduce the, quote, provision growth and increase the charge-offs for the credit card component. So that would be one thing you would want to consider in your models.

David Darst – Guggenheim Securities

Okay. Do you think for the full year your provisioning could be around 60 basis points?

Greg Norwood

We haven’t commented on that, David.

David Darst – Guggenheim Securities

Okay, great. Well, thanks a lot.

Operator

Thank you. Our next question comes from Tom Alonso from Macquarie. Sir, you may proceed.

Tom Alonso – Macquarie

Hey, good morning guys. Thanks for taking all the time here. Just real quick on the balance sheet remix – just kind of listening to some of the numbers, if we’re taking your billion a quarter in originated loans, and there’s about 500 million in runoff in the acquired book – that’s a net 500 million increase. Should we be thinking later this year that that’s the same sort of level of decline in the securities book that we should be considering as a run rate?

Greg Norwood

Maybe Ram can help a little bit in the modeling offline, but I think the originated book and the runoff that you have is about right. I think for the investment securities runoff, that’s a little bit more difficult to predict at this point.

Tom Alonso – Macquarie

Okay, fair enough. Thanks, guys.

Operator

Thank you. At this time, we have no further questions in queue.

John Koelmel

All right, well thanks very much, Stan, for facilitating. As always, thank you everyone for your interest and attention and joining us today. Make the best of the rest of earnings season, and we’ll talk to you in another 90 days. Have a great day.

Operator

That concludes today’s conference. Thank you for participating. You may now disconnect.

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