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People’s United Financial, Inc. (NASDAQ:PBCT)

Q2 2009 Earnings Call

July 17, 2009 11:00 am ET

Executives

Philip R. Sherringham – President & Chief Executive Officer

Paul D. Burner – Chief Financial Officer

Brian F. Dreyer – Senior Executive Vice President Commercial Banking Group

Analysts

Ken Zerbe – Morgan Stanley

Steven Alexopoulos – J. P. Morgan Securities

David Hochstim – Buckingham Research

Bob Ramsey – FBR Capital Markets

Mark Fitzgibbon – Sandler O’Neill

Damon DelMonte – Keefe, Bruyette & Woods

Christopher Nolan – Maxim Group

Richard Weiss – Janney Montgomery Scott

Collyn Gilbert – Stifel Nicolaus

Brian Harvey – CRM Funds

Amanda Larson – Raymond James

Operator

Welcome to People’s United Financial Incorporated second quarter earnings conference call. All participants will be in listen only mode for this event. (Operator Instructions) After today’s presentation there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the call over to Mr. Philip Sherringham, President and CEO.

Philip R. Sherringham

Welcome again to the second quarter 2009 earnings conference call for People’s United Financial. I’m Philip Sherringham, President and CEO and I will be presenting our results today with Paul Burner, our Chief Financial Officer. Other members or our management team are here with us and may answer questions as appropriate.

Before we move on to the presentation I’d like to remind you all to be sure to read our forward-looking statements on Slide Two. Now, I’d like to start with a few comments about the macro environment prior to discussing the quarter’s results. We began to hear some talk of [green shots early in the second quarter. While maybe the cool rainy weather in June here in the Northeast killed all the tender shoots but we haven’t seen the kind of sustained strengthening in the economy that we like.

National unemployment increased to 9.5% in June from 8.5% in March, stimulus funds have not been disbursed as quickly has hoped and consumer savings rate continue to grow. The economy, peering in the alphabet soup, remain undecided as to whether we should expect an L, U, V, W or square root shaped recovery. While the New England economy has held up better than the country as a whole, unemployment in the region increased to 8.3% in May, up from 7.6% in February. This compares to 9.4% for the US in May.

Since our first quarter call in April, we’ve all seen the results of the stress test and additionally several banks have paid back their TARP funds. I’d like to note again, we never took any TARP funds. Though we have seen some enhanced liquidity in the equity markets for financial institutions, we believe that it is still too early to call a turn in the economy.

Despite the ongoing turmoil, we believe that People’s United remains a very attractive investment. The continued strength of our capital, along with our liquidity, asset quality and earnings as well as the fact that our balance sheet continues to be funded almost entirely by deposits and stockholders’ equity are attributes that set us apart from most in the industry. Another distinguishing feature that we announced in May is the JD Power & Associates ranking of People’s United Bank as highest in customer satisfaction for the New England region in its 2009 retail banking satisfaction study.

This reward underscores our long term commitment to customer satisfaction. Our continued core business growth in these challenging times is of course the most tangible indication of our customers’ satisfaction. Our conservative underwriting standards coupled with a strong monitoring resolution and loss control practices act as a back stop to our credit discipline. Over the past two years we elected not to sacrifice credit quality and as a result we grew at a slower rate than our peers but today, continue to enjoy much lower net charge offs.

In the current environment, decreased competition in the lending markets along with our substantial capital resources allow us to grow where we want to in commercial and consumer lending as we benefit from wider spreads and more attractive terms. Our considerable excess capital is a unique strategic advantage. Additionally, given our asset sensitive position and the fact that the Fed cannot lower fed funds rate any further, we’re well positioned for the future as any increases in rates will have an immediate positive impact on our margin.

As we’ve said in the past, we remain convinced that the best use of our capital and that for the potential to most emphatically drive shareholder value is to have the patience to find and execute the right acquisitions. Now, I realize that our consistency in making these statements may sound like a broken record to some of you however, the facts are stubborn and we feel this is still a very good story.

Now, if you will please turn to Slide Three for some highlights of the quarter. Net income for the second quarter was $27.4 million or $0.08 per share. The quarter’s earnings reflect ongoing margin pressure associated with the historically lower interest rate environment, securities gain of $12 million and an FDIC special assessment charge of $8.4 million. The combined effect of this latter two factors was less than $0.01 a share. We continue to evaluate opportunities to enhance yield while not significantly extending our yield curve and not taking on credit risk.

Partly, due to this conservative stance on our part, the margin remained under pressure and was 3.12, down 13 basis points of 4% from the first quarter of 2009. We’ll speak to that in greater detail a bit later. Net loan charge offs for the quarter dropped to 16 basis points of average loans on an annualized basis compared to 18 basis points in the first quarter however, our NPAs to loans, REO and repossessed assets increased to 125.

While we saw some weakening of asset quality, we continue to see that the loss content of our non-performers is limited and that it will remain in better shape than industry and peer averages. We’re pleased that our industry leading tangible equity ratio remains strong at 18.7%. We’re also very pleased of course with our customer satisfaction levels demonstrated on Slide Four by the JD Power award for highest customer satisfaction in retail banking in the New England region which I mentioned earlier.

As some of you have heard us say, our retail and small business strategy is driven by convenience, excellence in delivery and a focus on gaining customer loyalty. The measure of our success is our ability to maintain disciplined deposit pricing and grow our lending portfolios while maintaining strong asset quality. Another measure is recognition by well regarded third parties like JD Powers & Associates.

With that I’ll hand it over to Paul to provide you details on the quarter.

PD

Slide Five illustrates the continued growth in our strategic commercial banking and home equity loans which combined were up 6% annualized in the quarter. Our core commercial portfolio continues to focus on middle market credits within our footprint. It’s a business line that cannot support commoditization and allows us to compete very effectively against the largest national players as well as the smaller regional banks throughout our franchise.

Our investments grew by $516 million due to deposit inflows during the quarter. All investments are in Fed funds or highly liquid, credit risk free, securities. You can see on Slide Six, we continue to be funded almost entirely by deposits and stockholders’ equity. Average deposits grew 15% annualized from the first quarter.

Turning to the income statement on Slide Seven you can see that the net interest income was essentially flat to the first quarter, declining $1.6 million. We’ll talk further about our asset quality and net interest margin in a moment. Our provision for loan losses at $14 million reflects an $8 million increase in the allowance for loan losses to $167 million at the end of the quarter which we feel is prudent in this period of economic uncertainty. Non-interest income was up $13 million or 18% over the first quarter, a $7 million increase in securities gains allow with increases in bank service charges and gains on sales of residential mortgages were primary contributors. Operating expense of $164.7 million excluding the $8.4 million FDIC special assessment met our expectations for the quarter.

Slide Eight shows the principle driver behind the decline in net interest income remains the margin. The red bar represents the core bank hit the well capitalized level and the barely visible grey one represents the yield on excess capital that we are maintaining. In the second quarter the core bank margin was 3.58, a decrease of eight basis points from the first quarter. Disciplined pricing has enabled us to partially mitigate the impact of falling rates. As you can see the yield on the completely asset sensitive asset capital which declined to 25 basis points has a significant impact on the blended margin.

Slide Nine breaks down the major components affecting the change in margin. Lower rates negatively affected asset yields by approximately seven basis points which was offset by an equivalent amount due to reduced deposit pricing. Netting the two, the second quarter would have been flat to the first at 3.25% however, we saw an increase in deposits during the quarter and this excess funding was temporarily invested in Fed funds. The aggregate impact in this growth and the negative carry was 13 basis points.

Total non-interest income as you can see on Slide 10 was $85 million, up $12.8 million from the first quarter. During the second quarter $723 million of mortgage backed securities were sold with a portion of the proceeds reinvested in mortgage backed securities with longer maturities and substantially equivalent yields. This investment portfolio repositioning undertaken to mitigate prepayment risk generated securities gains totaling $12 million. Excluding securities gains core non-interest income was $73 million, up $6.2 million from the first quarter. Bank service charges and gains on residential loan sales were up $2.5 and $1.9 million respectively from the prior quarter.

As you can see on Slide 11, operating non-interest expenses of $164.7 million excluded $8.4 million of onetime charges for the FDIC assessment. We continue to advance in our core banking systems conversion to Metavante and are still working towards converting Southern New England of 2010 and Northern New England in the third quarter of next year. This will enable us to fully combine our back office and increase efficiency, thereby further reducing expense.

Non-interest expense numbers are generally stabilized aside from any additional FDIC special assessments going forward. Additionally, while we cannot precisely forecast future regular assessments we expect the regular quarterly FDIC assessment to settle in at about $4 to $5 million, up from $1.8 million for the second quarter which reflected utilization of credits.

Given the macroeconomic trends and the growth in our nonperforming assets, we wanted to enhance our discussion on asset quality. We continue to feel comfortable with our asset quality even in the current environment because of the strength of our initial underwriting as well as our monitoring, resolution and loss control practices. As you can see on Slide 12, our NPAs increased from 97 basis points in the first quarter to 125 basis points this quarter. As we’ve said in the past, we will not be immune to significant and prolonged economic weakness of the kind that we’re currently experiencing but should fare better than others.

Our ratio compares very favorably to the top 50 banks which were at 266 basis points and our peer group at 314 basis points as of the first quarter. In fact, our second quarter NPAs are roughly a third of those of our peers as in the first quarter. We don’t of course, have the current quarter comparisons yet.

On the next slide we break out NPAs down by major product lines. Our increases for the quarter came primarily from commercial real estate $21.2 million, the C&I segment $12.5 million and residential mortgages $9 million therefore, we’ll describe these categories in more detail. Slide 14 provides a deeper dive in to our residential loan asset quality. As you can see on the left of the page, our NPAs of 138 basis points in the first quarter contrasts with that of our peer group that went 187 basis points and the top 50 banks at 237 basis points. The second quarter 174 basis points for us also compares favorably to both. Our net charge offs of seven basis points and 10 basis points respectively are at about 10% level of our peer group in the top 50.

Generally, we had low loan-to-value ratios at origination and we have current FICO scores of 726. These measures are significantly better than industry standards. I’d also remind you that we stopped portfolioing residential loans at the end of 2006. Finally, of our $51.4 million of residential NPAs, approximately 75% have current loan-to-values of less than 90% suggesting minimal loss content for the overall portfolio. Our practice is to obtain updated appraisals at 90 days past due.

Slide 15 provides a more detailed look at our home equity performance which continues to be better than that of our peers and actually improved for the quarter. Utilization rates remain relatively flat at 47.6% for the quarter. We continue to feel this portfolio will remain an excellent source of loan growth and is an important part of our retail customer relationships.

The next slide illustrates asset quality trends for our C&I portfolio. While the level of non-performers increased somewhat during the quarter it still remains at relatively low levels. We continue to feel that we will experience limited loss content from the non-performing loans due to our initial underwriting as well as ongoing credit administration practices. The portfolio is well diversified and continues to focus on core middle market customers where we’re able to provide better service than larger banks. Additionally, PCLC our equipment finance business finances mission critical equipment that maintains value. Coupled with our workout and resolution practices we’ve been able to limit losses in this portfolio.

As you can see on the left on Slide 17, in Q2 our NPAs as a percentage of loans for commercial real estate at 143 basis points compares favorably with our peer group at 238 basis points in the top 50 and 256 basis points for the first quarter. Our charge offs have consistently been much lower proportionately and we feel that this is due to the fact that we have underwritten our entire commercial real estate portfolio with a primary emphasis on cash flow as opposed to collateral. The portfolio is well diversified with limited exposure to construction.

I’m going to provide you some enhanced details on our shared national credit portfolio. Shared national credit balances and outstandings declined as expected since we’ve stopped booking new loans at the beginning of 2008. Outstandings dropped $55 million in the second quarter and $121 million since the end of 2007. Aggregate exposure dropped $57 million in the second quarter and $208 million from yearend 2007.

We disclosed in our first quarter results a $16 million shared national credit loan that moved to non-performing status. We also disclosed during the first quarter call in April that subsequent to first quarter end a $16.9 million credit migrated to non-performing status. This is part of our remaining $36 million exposure in Florida. The building is complete and partially occupied but the majority of presales that had 20% down payments have been unwilling or unable to close. Slide 19 shows our shared national credit exposure to geography on the real estate side and to industry sectors for the C&I component. As you can see both portfolios are well diversified.

The next slide reflects our charge off experience over the past couple of years. Our 16 basis points in the second quarter is about 10% of both the top 50 banks and our peer group as of last quarter. Due to our strong underwriting we do not expect significant increases in our loan loss levels. On Slide 21, we take a look at our Texas ratio which is the ratio of NPAs to tangible equity plus loans from loss reserves. If you look at us relative to the industry there is no comparison.

Now, I’ll hand it back over to Philip for closing comments.

Philip R. Sherringham

To conclude, I’d like to highlight our advantageous position. We have a very strong balance sheet with an enviable 19% tangible capital ratio and no sub borrowings. We have exceptional asset quality, low level of non-performing loans and very low loss content within that portfolio. We have a low cost, stable deposit base and loyal satisfied customers. We have excellent growth opportunities ahead of us both organically and through acquisitions.

To that point, we continue to focus on proactively seeking acquisition opportunities within our stated highly desirable Northeast region from Maine to Washington DC. We’re also open to the possibility of assisted transaction within potentially even other geographies to the extent that FDIC transactions may not be available in the Northeast and we’ll evaluate them as they come. In addition, given our asset sensitivity, we’re poised for leveraged earnings growth when the economy recovers and as interest rates begin to increase again.

That concludes our presentation and now we’ll be happy to answer any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Ken Zerbe – Morgan Stanley.

Ken Zerbe – Morgan Stanley

Two questions, first of all if you can take a longer term view of credit quality and the economy obviously, things are still very, very challenging for the industry, if you look six months, 12 months down the road, where do you think you’re going to see the biggest stresses in your own portfolio?

Philip R. Sherringham

I would say that possibly – two portfolios that we’re watching carefully obviously would be the equipment leasing portfolio and commercial real estate.

Ken Zerbe – Morgan Stanley

The second question I had was more of a request for your response but one of the criticisms that I do hear a lot about People’s is we have seen a sharp recovery in the bank valuations overall. Obviously, you’re very interested in making an acquisition but I guess at times people might get concerned that you’re sort of, I don’t want to say missing the bottom, but the stocks or your acquisition targets could run up a valuation long before you make an acquisition. Can you just respond to that please?

Philip R. Sherringham

Candidly, making acquisitions is easy, making acquisitions that make economic sense and make our shareholders happy is a different matter. I would say that as we all know bank valuations had dropped back in March to probably all time lows, if not all time lows, lows we haven’t seen in a very, very long time. Of course, ideally it would have been a great time to make an acquisition then. But frankly, that’s probably difficult at any rate since many of the banks involved obviously are not enthusiastic about selling at those levels as you might imagine, even at significant premiums above those levels.

I’d also like to remind you that you have to put things in perspective, yes stock prices have basically let’s say doubled since March for many of those banks but they’re still at very, very low levels compared to their recent highs of two or three years ago. So, we certainly don’t think we’re out of opportunities or somehow that we missed the boat.

Operator

Your next question comes from Steven Alexopoulos – J. P. Morgan Securities.

Steven Alexopoulos – J. P. Morgan Securities

Phil, I just wanted to follow up on a few of your comments on the FDIC deals. Now, have you looked at in the past how many deals so far? Have you bid on any? In terms of your comments on geography, would you go to a market like Georgia for instance where we’ve seen quite a few failures recently?

Philip R. Sherringham

Well, we’ve been looking at a few deals, we haven’t really bid on any of them yet. Part of this is of course, as I have stated, there haven’t been many deals in our preferred geography which remains of course the Northeast corridor which might lead us then to look at deals outside of that corridor. The deals would have to meet our [inaudible] stated acquisition criteria and I’d say especially if we’re talking about deals outside of our favored geography that have to meet certain size criteria, they can’t be too small. We’re not interested in a beachhead in a remote market or something like that obviously.

Frankly, the franchise has to make sense to us in general. When we’ve been comparing some open bank transaction metrics to some of the FDIC with loss sharing arrangement metrics frankly, some of those deals look very attractive and that’s why we sort of feel compelled to look at them and that’s all I’m stating here. It’s a possibility that we might do something outside of our favored geography but it’s not necessarily a strong possibility and it would have to be a fairly large deal that makes a lot of sense to us. I feel however, that over the next few months that we’ll be seeing more deals coming from the FDIC. So, that’s an option that we can’t ignore.

Steven Alexopoulos – J. P. Morgan Securities

Are you tempted at all to repurchase stock here given your almost 25% off from where you issued it in the second sale?

Philip R. Sherringham

We’re always evaluating that as an option. Frankly, at this point no, we’re still not tempted because we fee, in fact, we know that based on our analysis the rates of return we can gather from making acquisitions whether they are FDIC acquisitions or even not actually are still superior to repurchasing our stock. I’d like to remind you also of course, that we have a fairly significant dividend policy which we feel provides an adequate return of capital to our shareholders.

Steven Alexopoulos – J. P. Morgan Securities

Just for my final question, did you guys take any partial charge offs for a specific reserve on the shared national credit that moved in to non-accrual this quarter?

Philip R. Sherringham

Yes. I mean, by definition there’s some certain rating implications to those credits moving to non-performing status and we would evaluate them in the context of our overall methodology and take the appropriate specific reserves.

Steven Alexopoulos – J. P. Morgan Securities

Can you say what that amount was on that credit?

Philip R. Sherringham

No, I’d rather not.

Operator

Your next question comes from David Hochstim – Buckingham Research.

David Hochstim – Buckingham Research

A couple of things, could you talk about what you’re seeing in the commercial loan market in terms of growth opportunities and give a sense of how much margins have improved over the last few months?

Philip R. Sherringham

Yes, I could but I’ll past the discussion to Brian Dreyer, Head of Commercial Banking.

Brian F. Dreyer

There are some very good opportunities right now particularly in commercial real estate. Very high quality credits and spreads that are in many cases maybe two times what they were two or three quarters ago. Lots of well seasoned loans coming to maturity points in other people’s portfolios, people who would prefer to shrink because of capital considerations and we would prefer to grow. So, you are seeing some pretty good growth particularly in commercial real estate finance.

It’s not everywhere in our trade area and we don’t see those kinds of opportunities today in our northern markets but certainly in our Connecticut and New York markets we are seeing those opportunities. Also, greater Boston we are seeing those opportunities. Likewise but to a lesser extent, we see opportunity in commercial lending, C&I deals. For the same reason again, it takes a little longer, some of those companies are stressed at this point so you have to be very careful so you’re not seeing great growth from us but that’s partly because we have other customers that are shrinking and other customers that are hurting in this market but the combination of the two maintains a good earnings stream for that business and maintains the credit quality.

David Hochstim – Buckingham Research

In terms of credit quality could somebody give us a sense of how to think about the loss reserve relative to charge offs and expected charge offs indicating that you don’t expect a big increase in charge offs than the coverage seems very, very conservative. I wonder if the regulators have changed their policies and allow you and others to build reserves in a very conservative manner these days as opposed to the past where they took a pretty narrow view?

Philip R. Sherringham

I don’t think the regulators as far as I know have changed their policy or their approach; certainly, the accountants haven’t. The buildup you’re seeing this quarter was something prudent and warranted by the methodology and approach that we’re using traditionally and that hasn’t changed. So, we built up our provision because we thought it was the right thing to do given the increase we’ve seen in non-performing assets regardless of the loss content of those assets actually.

David Hochstim – Buckingham Research

So it’s not appropriate to think that that’s a forecast of 12 or 18 months forward charge offs?

Philip R. Sherringham

No, it’s not.

David Hochstim – Buckingham Research

Just the tax rate is there something there, should we think about the tax rate going forward as opposed to the 30%?

Philip R. Sherringham

The average tax rate is going to be about 31% for the rest of the year overall.

David Hochstim – Buckingham Research

Then finally if I might just ask you if you have a reacting to the administrations white paper for regulatory form and how you think about, and you obviously don’t have to do anything right away but, has it caused you to think about making changes?

Philip R. Sherringham

Well, that’s a topic worthy of a long conversation as you know. It’s very difficult frankly to react because we don’t know exactly what’s going to come of it, if anything actually. There’s some elements of the package that we think are frankly problematic and there are other elements of it that we think are probably alright. The creation of the consumer protection agency, I think is certainly a problem for the industry potentially because we feel that the current setup where regulators enforce consumer protection laws as well as safety and soundness provides a very necessary balance to the regulatory system.

If you separate the two you might end up with very unfavorable and unintended consequence in some situations; I can certainly sett that. That’s an example of concern. Obviously certain elements of the package don’t particular impact us, the determination that some larger interconnected complex organizations are going to have a special status and that’s probably fine too and warranted frankly given what’s happened recently.

The proposed changes to the regulatory systems is very difficult for us to comment on. Frankly, whether the OTS remains or is sort of merged along with the OCC in to a new regulator is something that we’ll watch with interest because we’re an OTS regulated institution. But, at the end of the day we don’t expect that to change our world that materially frankly. We have a certain business operating model, we’re going to stick to it regardless of what changes in the regulatory system in that sense.

I could go on but I think I’ve covered some of the key points here. Frankly, one last thing is that from our perspective and this is not directly related to your question but we would tend to be very supportive of the FDIC concerns or restrictions on the participation of private equity capital in the buyout of some failed banks. We feel that those constraints that the FDIC is suggesting should be in place are very legitimate.

Operator

Your next question comes from Bob Ramsey – FBR Capital Markets.

Bob Ramsey – FBR Capital Markets

Tell me would you all be more interested in a non-FDIC assisted transaction in your New England markets maybe of a company at or around a small premium to where they are trading now, or something that’s out of market FDIC assisted and is really more of a bargain price?

Philip R. Sherringham

You know, we’re an equal opportunity acquirer frankly. You have to be very opportunistic, it depends on what is available when and at what price frankly and it could be any of those situations. So, we don’t have a preference necessarily for anything.

Bob Ramsey – FBR Capital Markets

I know you mentioned you don’t want anything that’s too small if it’s not within your footprint. Where do you sort of, even if it’s a range, what is sizeable enough that it would be worth you moving out of market and what’s not?

Philip R. Sherringham

Let me put it to you this way, if it’s within our states in the Northeast corridor markets we could look at smaller acquisitions at the size of say $200 million and $400 million or something like that. If it’s out of territory they have to be at least I would say $2 to $4 to $5 million in assets doesn’t make any sense.

Bob Ramsey – FBR Capital Markets

I know you were already asked if you would go as far as Georgia earlier, would you really look at anything even on the west coast or do you kind of want to stay somewhat closer to home?

Philip R. Sherringham

I don’t think geography is a particular constraint. If we’re going to look at an acquisition out of territory it is going to depend a lot on the specifics of the company involved and the specifics of the markets. Frankly, yes there are very attractive markets on the west coast as I think everybody knows and the west coast may or may not be preferable to Georgia, I don’t want to make any judgments at this point. I’ll let you ponder that but, we’ll see what happens. But, it’s very much a function of opportunities.

Bob Ramsey – FBR Capital Markets

I know you also mentioned that you expect there to be more opportunities if you will the next few months coming from the FDIC. How are you thinking about timeframe? Obviously, it depends on what comes up but do you think something will be done before the end of the year?

Philip R. Sherringham

It’s certainly a possibility but again, there’s no certainty there. It’s very hard to judge the timeframe of those things but we feel we have good contacts with the FDIC and we think they’re aware of our interest, in fact, we know they are aware of our interest and we’ll see.

Operator

Your next question comes from Mark Fitzgibbon – Sandler O’Neill.

Mark Fitzgibbon – Sandler O’Neill

The first question I had is for Paul, Paul could you help us think about the margin going forward? Do you feel like given if rates stay where they are the margins bottomed or are we getting close to bottom?

Paul D. Burner

Yes Mark, it does feel as though the margin has bottomed. Actually last quarter we thought we were at a near bottom. We did have higher deposit growth than we were anticipating and as I described that’s what really brought us down but with loan spreads and very active deposit repricing we see prospectively the next couple of quarters the margin increasing. So, I think we’ve turned the corner there.

Mark Fitzgibbon – Sandler O’Neill

Secondly, you booked a fair amount of new home equity business this quarter. What are the FICO and LTVs on this new business your booking look like?

Paul D. Burner

We’ve continued to maintain our standards. We’re a solid prime lender well in to the 700s and we continue with our low loan-to-value ratios. I will say the volume has dropped off a little bit, our rate of growth has slow down a bit on home equity in the last quarter which we also think has something to do with the refi boom that started in the first quarter.

Philip R. Sherringham

Mark, just to add to this, I’m looking at some numbers here, the average FICO scores on our home equity portfolio is 751.

Mark Fitzgibbon – Sandler O’Neill

Then Philip also, I was curious how long would you be willing to wait for that ideal acquisition candidate? Obviously, there’s an opportunity cost on that capital that you’re sitting on, how long do you wait before you say, “You know what we’ve got to start deploying it either in small transactions and buybacks or other kinds of uses for the capital?”

Philip R. Sherringham

We’re willing to wait a while longer. I don’t want to be overly specific just because I think there are actually very good candidates for us in the months ahead. We’re not at a point yet where we’re ready to throw in the towel and start buying stock back or looking at small acquisitions but I mean exactly how long, I know you’ll hold it to it if I give you a date so I won’t.

Operator

Your next question comes from Damon DelMonte – Keefe, Bruyette & Woods.

Damon DelMonte – Keefe, Bruyette & Woods

Could you just provide a little color around the strong deposit growth that you had this quarter, like where in the franchise was it coming from? Was it new customer account or existing customers?

Philip R. Sherringham

It’s pretty much across the board there, there’s no particular geography. Of course, on the one hand we’re very happy at it to look at how stable our core funding is, on the other hand as we’ve just explained, temporarily it hurts our margin. But, we’ll live with that, that’s fine. Again, it’s pretty much across the franchise.

Damon DelMonte – Keefe, Bruyette & Woods

Then with respect to the increase in non-performers in the residential mortgage portfolio, how much of that is attributed to the Fairfield County area? And, could you also just give us an update on kind of what you’re seeing down in that market place?

Philip R. Sherringham

Yes, we can. Again, the way we look at this as I think you know, is we basically do a sort in our portfolio based on the employer of record based on the time the loan was made and we aggregated all those borrowers who stated at the time they were working for a company in the financial sector, I can give you a list actually, it’s Morgan Stanley, Greenwich Capital, RBS, UBS, Goldman, Merrill, Lehman, [inaudible] Group and GE Capital as well as GE. If we do that, as of the end of June we had a total of $156 million of mortgages balances outstanding to those borrowers and we’ve got about $1.6 million, or rounding it $1.7 million that’s delinquent on that portfolio.

On the home equity front we had about $15 million of loans outstanding of which only one totaling about $800,000 is delinquent. So overall, our exposure to this sector is about $171 million of which $2.4 million loans are delinquent so we’re not particularly concerned. I’ll remind you, as you know of course, that our overall mortgage portfolio is about $2.9 right now.

Damon DelMonte – Keefe, Bruyette & Woods

How much balance sheet growth do you think your $2.5 billion of excess capital can support?

Philip R. Sherringham

I’d say probably $30 billion.

Damon DelMonte – Keefe, Bruyette & Woods

Has your return criteria changed at all as far as like your IRR expectation on a deal?

Philip R. Sherringham

That’s a good question. Not, a whole lot, I mean we still are going to shoot for let’s say the high teens certainly, mid to high teens.

Operator

Your next question comes from Christopher Nolan – Maxim Group.

Christopher Nolan – Maxim Group

First question is for Paul, Paul on the shared national credit that you were discussing earlier you indicated, and maybe I misheard you, that where as many condo sales with deposits the buyers had backed out of the transactions, is that correct?

Paul D. Burner

That is correct.

Christopher Nolan – Maxim Group

That’s a change from the first quarter because as I recall on this particular credit which if memory serves is somewhere around $160 million I think, the overall loan, backs up by $250 million guarantee I think?

Philip R. Sherringham

I think you’re confusing the two credits Chris. The credit we’re talking about where the sale didn’t come through is the second one in Florida.

Christopher Nolan – Maxim Group

So it’s a different credit entirely?

Philip R. Sherringham

A different credit.

Christopher Nolan – Maxim Group

This is for Brian, on the commercial real estate what sort of LTVs are you seeing? Are we seeing lower LTVs on new deals?

Brian F. Dreyer

Actually yes, many of the deals as I mentioned are seasoned deals maybe with calls at five or seven and so they have been paid down a fair amount. It’s not unusual to see 60%, 65%, 55%, nothing up as high as 80%.

Christopher Nolan – Maxim Group

What is the debt coverage that you’re looking for? As I recall it was 1.2, 1.3 earlier, has that changed?

Brian F. Dreyer

It probably is but we’re seeing better debt service coverages than that. It depends on the quality of the credit too. Obviously, there are several factors that you balance when you do the underwriting but suffice it to say those are strong credits.

Christopher Nolan – Maxim Group

Are you writing shorter term credits? Are you going out five years, or seven years or 10 years on any of these?

Brian F. Dreyer

Yes, short absolutely. Some with floating rates some with swaps on them.

Christopher Nolan – Maxim Group

Okay but you’re keeping the duration, you’re trying to write shorter credits on the new originations?

Brian F. Dreyer

I think that’s true and I think we have a community of interested borrowers because they don’t expect that the situation in the credit markets will remain as it is and I think they’re hoping to refinance at lower spreads later.

Christopher Nolan – Maxim Group

My final question on commercial real estate, on prepayment penalties for the new deals that you’re writing are you able to secure more stringent prepayments or is that an area where you’re getting a lot of push back?

Brian F. Dreyer

Every case we have a prepayment penalty when we have a fixed rate, always, never an exception. It’s always at least the redeployment of funds.

Operator

Your next question comes from Richard Weiss – Janney Montgomery Scott.

Richard Weiss – Janney Montgomery Scott

I was wondering with respect to the shared national credits, how has the recession affected the initial plan when you went in to the runoff mode? Is it slowing things down or maybe you’re seeing better opportunities and maybe it’s time to revisit growing that portfolio again?

Philip R. Sherringham

Well clearly the recession has impacted the timing of our exiting the business. It’s very simple, most borrowers have seen other avenues evaporate and they’ve come back to their bank lines and they’ve drawn them down. So, to the extent that’s happened, it’s happened a lot especially on the C&I side. We’ve given you some perspective on the slides there, you can see how the portfolio has declined, it hasn’t declined as quickly as we thought and again, that’s the reason why I think.

Richard Weiss – Janney Montgomery Scott

But the plan still is to run it off?

Philip R. Sherringham

The plan is still to run it off.

Richard Weiss – Janney Montgomery Scott

With the problems in CIT, I know you’re not going to replace CIT but are there any kind of opportunities that you would see as a result of that?

Philip R. Sherringham

Yes, I mean hopefully. No one can get pleasure from what’s happening with CIT I think but obviously it may translates in to opportunities for us either directly frankly or indirectly.

Operator

Your next question comes from Collyn Gilbert – Stifel Nicolaus.

Collyn Gilbert – Stifel Nicolaus

Just a few sort of follow up questions, when you were talking about the home equity and Paul you had commented that the growth was slowing a bit, do you have a sense at all for what these borrowers are using the funds for on the home equity side?

Philip R. Sherringham

No, we really don’t Collyn. That is really difficult to determine. I don’t think anybody has good insight as to what they’re using it for. I think the point I’d like to make is that the growth you see in this sector, we’re very comfortable with and that’s not a given. The reason we’re comfortable with it is we’re still lending essentially all in footprint, we’re doing it all ourselves there are no brokers involved, we’re lending to our customer base, our existing customer base.

If we look at our home equity portfolio and we analyze the cross sell ratio in that portfolio compared to other parts of the bank home equity loan customers have the highest cross sell, it’s about six products on average, a little over that actually compared to other products. So, this is good stuff. The reason the portfolio is growing also is frankly we’re taking market share away from other banks.

Collyn Gilbert – Stifel Nicolaus

Just in terms on the credit side and why you’ve seen such low loss migration and you talk about sort of your credit administration practices, can you just give a little bit more color as to kind of what’s driving that? Is it a timing issue, are you finding yourselves working more with your borrowers and maybe sort of restructuring some loans? What is it specifically that’s helping you control the losses?

Philip R. Sherringham

As I’ve said many times before I think the secret formula is patented of course Collyn, I can’t actually give it to you. It’s a combination of facts, it’s not a silver bullet, I think the stability of our credit philosophy over time, the stability of our management team in the field, the fact that we know our customers very well. Yes, of course, we work with them very closely but we’re on top of things. We don’t let things deteriorate to where it becomes unmanageable or loss content can’t be controlled. Not to say that it wouldn’t happen once in a while but in general we try and avoid it.

We’re very proactive on managing this portfolio and I have to emphasize that again, the underwriting initially is good. It makes a huge difference over time what your underwriting was initially. We made sure that our borrowers have equity in the projects in terms of CRE, we make sure the companies have good solid cash flows in the case of C&I and over time that kind of approach clearly pays off. It’s the basics if you will, of the banking business.

Collyn Gilbert – Stifel Nicolaus

I know you talked briefly about the PCLC but maybe can you just give a little bit more color on kind of what your outlook is for that business? How much you want to grow it? Obviously, credit deteriorated in that segment this quarter, do you expect deterioration of that rate to continue? Just a little bit more color on the equipment finance business?

Philip R. Sherringham

Well, what we’ve done there is actually we’ve put the brakes on the growth frankly. We’re concerned about deterioration. We’ve tightened our standards quite a bit so you probably won’t see that portfolio growing at similar rates as you’ve seen in the past in the coming quarters. I think that’s a fair statement. The advantage you have in this business is that if something goes wrong you can grab the collateral pretty quickly and turn around and sell it. Remember, we’re basically lending on average on equipment that has already established secondary markets and we’ve been historically very, very successful at limiting the amount of repossessed assets because we turn it over very quickly. That’s a big advantage that we have here. I think that’s probably the answer to your question.

Collyn Gilbert – Stifel Nicolaus

Then just finally on M&A and I can’t wait for the day that we can all stop asking this question but, Philip obviously these banks are not anxious to sell at the bottom, you’re getting resistance or the market is resisting whatever the case may be. Is there maybe a creative structure that could be available to sort of facilitate these guys to move? You know, in the way a deal is structured or is there any other opportunity that you maybe see or potentially could explore to sort of drive the revelation that these banks really have to sell?

Philip R. Sherringham

I think every CEO has to basically, and I think we all do, ponder the future of their institutions given the environment, their potential, their access to capital markets, the quality of their franchise and their general outlook on life. It’s a one-on-one decision that every bank CEO has to make and I don’t think there are any magic elements to precipitating that either frankly. Hopefully everyone is thoughtful. Hopefully in some cases if shareholders aren’t happy and feel something should happen they’ll let management know.

Operator

Your next question comes from Brian Harvey – CRM Funds.

Brian Harvey – CRM Funds

Philip a question for you, as we are starting to approach the three year moratorium on you being acquired, do you feel any additional pressure to redeploy that capital between now and then? The second part of that question would be, if we get to that three year anniversary period do you and the board sit down and sort of reevaluate the situation and maybe sort of reevaluate where people fit within the banking industry?

Philip R. Sherringham

Well Brian, as you might imagine we’re constantly reevaluating our situation, it’s an ongoing analysis that we make. Yes, the calendar is indicating that some point in April of next year we’ll be beyond that three year horizon. I don’t think it puts more or less pressure in terms of deploying the capital. We’re anxious to deploy the capital period but we’re also anxious to deploy it smartly and that should be clear to everyone by now, otherwise we would have done it a long time ago.

There are any number of deals that we could probably do tomorrow if we just paid what we feel is an unreasonable price and what you would probably feel is an unreasonable price if we did it. So, that’s why it hasn’t happened yet. There’s no more or no less pressure and as far as we’re concerned there’s nothing magic about that particular data on the calendar. We intend to grow the company and run it as an independent company as long as our performance warrants it and frankly like every company in the universe, every public company, we’re shareholder owned and we’re responsible to those shareholders as you know. We’ll do whatever we think is right for the shareholders.

Operator

Your next question comes from Amanda Larson – Raymond James.

Amanda Larson – Raymond James

I see that you guys had a surge in mortgage banking income this quarter and I wanted to know what the pipeline was looking like and if you think that’s sustainable for next quarter?

Philip R. Sherringham

Well of course, as your question underscores, the jump in mortgage banking income is directly related to the huge increase we see in the pipeline in the first half of the year, particularly in the second quarter. Most recently, that has slowed down a little bit but it is picking up again. We’re very comfortable with our approach to the mortgage business at this point. As you know, we’re not booking anything on our own balance sheet essentially, or very little and we’re satisfying customer needs and borrower needs by making loans and then turning around and selling them. We’ve developed a very nice little income stream there we think.

Amanda Larson – Raymond James

Then also on non-interest income, since fees were up linked quarter, and I wanted to know if you thought that was a factor of seasonality or are you charging more for fees?

Philip R. Sherringham

It’s mostly seasonality.

Amanda Larson – Raymond James

Finally, wealth management was down linked quarter and I wanted to know if it was profitable overall during the quarter?

Philip R. Sherringham

Yes. I mean, the fees were up a little bit there in part because assets under management went up a little bit. That’s a business I think that’s under stress and under pressure for us and at most banks because of the equity markets as we all know. But, that’s a business that we’re committed to and we think it’s a valuable business as far as we’re concerned. It’s a logical business for us to be in, it’s an extension the way we look at it of our relationship with our customers.

Amanda Larson – Raymond James

Insurance revenues were down though right?

Philip R. Sherringham

Insurance revenues were down.

Amanda Larson – Raymond James

Could you speak to that at all? Is there anything going on there that is notable you think?

Philip R. Sherringham

Yes, I mean historically there’s more renewals in the first quarter of the year so there’s some seasonality involved I think.

Operator

We show no further questions. At this time I would like to turn the conference back over to management for any closing remarks.

Philip R. Sherringham

I just want to thank you all for your interest and we’ll see you all again for our third quarter results. Thank you very much and have a great weekend.

Operator

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.

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Source: People’s United Financial Inc. Q2 2009 Earnings Call Transcript
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