First Niagara Financial Group Inc. (FNFG) CEO Discusses Q2 2013 Results - Earnings Call Transcript

| About: First Niagara (FNFG)

First Niagara Financial Group Inc. (NASDAQ:FNFG)

Q2 2013 Earnings Call

July 19, 2013 10:00 AM ET

Executives

Ram Shankar - Director, IR

Gary Crosby - Interim President and Interim CEO

Greg Norwood - CFO and SVP

Analysts

Damon DelMonte - KBW

Dave Rochester - Deutsche Bank

Bob Ramsey - FBR

Casey Haire - Jefferies

Erika Penala - Bank of New York America

David Darst - Guggenheim

Operator

Welcome and thank you for standing by. All participants are in a listen only mode till the question-and-answer session of today's call. (Operator Instructions) Today’s conference is being recorded. If you have any objections, you may disconnect at this time.

Now I would like to turn the call over to your host Ram Shankar, Director of Investor Relations. Thank you sir, you may begin.

Ram Shankar

Thank you Ameka and good morning everyone. Thank you for joining us this morning. With me today are Gary Crosby, Interim 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.

A copy of the earnings release and an earning’s review deck are available under the investor relation section at firstniagara.com. With that, let me turn the call over to Gary. Gary?

Gary Crosby

Good morning everyone thanks for joining us. When we held our first quarter investor call in April, I began my remarks by saying that as Interim CEO my focus is on leveraging our footprint and franchise and translating our strong business fundamentals and the strong financial performance.

And ultimately value to our shareholders. 90 days later I am pleased to say that we continue to deliver on that promise in the second quarter, while the search progresses for permanent CEO and I will come back to that.

Our team remains focused and is not missing a beat when it comes to delivery and value to our customer, shareholders and communities. For the second quarter we delivered earnings per share results that were in line with our expectations. Our businesses continued to drive profitable organic growth across our entire footprint, while adhering to our long standing credit underwriting discipline.

We delivered strong growth in commercial loans as well as total loans. Key to our ability to deliver this industry leading loan performance is attracting new customers, maintaining our discipline and credit and leveraging our cost of approach to sell more to our growing customer base across our entire footprint.

Importantly we have hired several experienced commercial lending leaders in the first half of 2013. These industry veterans will help to further drive our loan growth and fee income initiatives and our value proposition across our geographies and products.

In fact we've seen immediate benefits to our pipelines with the hiring of these additional commercial lending leaders. Combining our footprint, talent and products we achieved our 14th consecutive quarter of double digit commercial loan growth. We also continued to selectively invest in new products, services and infrastructure to enhance our ability to serve our customers, drive earnings and increase shareholder value over the longer term. At the same time we are tightly managing our operating expenses and I am pleased with our progress to date.

We remain focused on delivering our full year expense goals generating positive operating leverage and net earnings. I am going to turn it over to Greg in a moment. However in anticipation of your questions around the CEO search, let me once again answer those questions I am prepared to answer. At this time last quarter the search committee was only weeks into kicking off its search. They have covered a lot of ground since then, and are far along in the interview process.

The committee is pleased with the quantity and the quality of candidates who are interested in leading for First Niagara. Committee is not working towards a specific deadline, but is moving expeditiously through the process. In the mean time we're not missing a beat, as evidenced by our second quarter results.

I can't provide any more incremental color about the process, timing or the candidates. The committee as I am sure you can appreciate is maintaining a very high degree of confidentiality around the search, for just the right CEO to continue to grow and operate a strong franchise the will deliver increasing shareholder value.

With that let me turn it over to Greg to provide you with the details on our second quarter performance.

Greg Norwood

Thanks Gary and good morning everybody. Let me start with some key highlights for the quarter. First we achieved positive operating leverage again this quarter as revenue growths exceeded our expense growth with a 10% increase in pre-tax, pre-provision income. How did we do this? First, a better than expected net interest margin and very strong fee income growth. We had strong fundamentals in the loan and deposit activity despite the competition. Continued our high quality sustained credit metrics, no surprises there.

Further our balance sheet rotation strategy executed as planned. finally expenses this quarter were higher, adjusted for the first quarter executive departure related charges primarily due to higher incentives and variable compensation expenses driven by the higher than expected fee income. Additionally branch consolidation and technology cost and some modest separation cost related to prior executive departures were also higher than expected.

We remained focused on both extracting positive operating leverage and achieving our year-end expense targets. Now if you detail highlights from the income statement. Our NIM was 3.36% down only 3 basis points from the prior quarter. Our NII this quarter improved slightly as the quarter benefited from additional day, 2 basis points decline in the cost of our interest bearing deposits and modestly higher prepayment income versus the first quarter.

There were no retro adjustments to our residential mortgage backed securities portfolio related to change in prepayment speed estimates.

Loan yields declined 6 basis points quarter-over-quarter, impacted by new production at lower yields partially offset by prepayment income. New production spreads on our commercial books were in line with recent quarters and consistent with our own expectations, so no unexpected shift in market pricing. More on structure and credit in a minute.

As shown on slide four a very strong quarter for fee income relative to what we had expected. Strong customer activity in wealth management, deposits service charges, insurance, merchant card income drove the outperformance beyond what is normal seasonality. Wealth management increased 16% over the prior quarter as annuity sales and overall sales productivity improved as investors rotated from bond funds into other investment.

Assets under management increased annualized 7% and revenues per financial advisor increased 15% quarter-over-quarter. Deposit service charges increased from first quarter driven by greater NSF incident rates and importantly lower waiver rates based on active management by our retail team. Merchant and card income benefitted from a 10% sequential increase in purchase volumes coupled with net growth in card member accounts.

On the mortgage side locked volumes were essentially flat over the prior quarter while slightly lower gain on sale income was offset by other mortgage revenues. Capital markets revenues decreased 17% from the linked-quarter, attributable to lower swap demand in syndication activities this quarter.

For operating expenses, on a reported basis, expanses were $235 million, above our guidance, due largely to $1.5 more in incentive and variable compensation expense tied to strong fee income this quarter, a $1 million in true up for our branch consolidation and exit cost, and $5,000 in separation cost related to prior executive departures.

Compared to last quarter salary and benefits expense increased $500,000 with an increase in incentives and variable cost, driven by strong fee income; partially offset by lower cost due to lower employee headcount and lower tax and benefit expenses. At another way, if not for incentive compensation tied to revenue growth, our salaries and benefit expense would have declined nicely quarter-over-quarter.

Amortization of quarter profit intangible decreased $3.3 million due to lower amortization primarily on HSBC related intangibles. Looking ahead, what does that mean for our $225 target for fourth quarter; our organization is committed to achieving our expense met with targets. Usually we remain focused on increasing revenue, both NII and fee income and maintaining positive operating leverage.

Let me talk about the key loan takeaways in slides 5 and 6. A very consistent and distinguishing story for us on loan growth; the growth in the commercial platform continued across all geographies. Our western and eastern Pennsylvania market as well as our New England increased loans at double digit, annualized basis, and across all product lines. Briefly on the competitive environment, both pricing and structures are increasingly competitive.

As we have noted we have no appetite for weaker structures that we see out in the market place and continue to walk such deals. For example, invoked $60 million in renewals in June in our eastern Pennsylvania market on three relationships due to structure and pricing. One such borrower who was refinanced away to a competitor who is prepared to double the leverage and rate demand restrictions. That’s not how we compete. What are we doing; stay in through to our current acquisition strategy.

In the first half of 2013 we significantly added to our commercial banking leadership by hiring some great talent in each of our geographies. These leaders have deep roots in their markets, have decades of banking experience and know the banking clients well. They came to us from larger regional and money sender banks. For example one of our newest leaders covering eastern PA market was a top 10 lender nationally at one of the top three banks in the country. Additionally while attracting new talent we also lowered our overall relationship manager complement thus increasing productivity.

Turning to consumer finance on page seven; another strong quarter for consumer finance group, from both a balanced growth and a fee income perspective. First on indirect business, originations totaled nearly $300 million this quarter. Our new origination net yields were 3.2% down from 3.3% in the first quarter. The remainder of this year we expect new growth originations at a pace of a $100 million each month, and net of normal maturing in this business, we expect yearend balances to approximately $1.5 billion versus $600 million at the end of 2012.

On cards a 10% increase in purchase volumes driven by both seasonality and the impact of over 6000 new card members that we acquired during our first quarter solicitation campaign of our existing depositor household base.

As we noted earlier, our mortgage lock application volumes were largely unchanged compared to the first quarter, consistent with what you’ve heard the gain on sale margins decreased given the increased mortgage rates especially in June. Walking in the industry trend, both our application volumes and closed volumes were up quarter-over-quarter by nice amounts. Our purchase originations volume increased a $100 million quarter-over-quarter to approximately $220 million. Clearly the opportunity in this business is our underpenetrated market share. We have added capacity, reduced our cycle time and increased mortgage lending officers. All of this will continue to help us maintain a strong position in the market going forward.

Moving to deposits on page eight; our cost of interest bearing deposits came down two basis points to 23 basis points driven by continued pricing actions that we took on non-transaction accounts like online savings and money market deposits. Average transaction deposits, which include interest bearing and noninterest bearing checking accounts increased in annualized 17% over the prior quarter and currently represents 34% of the company’s deposit base, up from 30% a year ago. DDA balances increased 22% driven by continued customer acquisitions especially in western New York market as well as higher balances held by customers.

As I noted earlier, we consolidated another five branches during the quarter, bringing our year-to-date total to nine. As we look ahead we continue to consolidate branches. Since 2011 we have consolidated over 60 branches.

Turning to slide nine and 10 on credit, we had another clean and simple credit quarter. Originated provision was approximately 24 million after reflecting charge-offs and the other half to support organic loan growth of $1 billion. Compared to the prior quarter, our originated loan growth provision was up 2 million to 11.7 million in the second quarter. Our classified and credit side loans both improved quarter-over-quarter.

Nonperforming loans decreased 1 basis point to 1.02% of originated loan while the dollar amount increased modestly compare to prior quarter due to one commercial real estate loan that is well secured. Last exposure on our nonperforming loan portfolio remains low as the mark on our NPO is 63% of customer obligation.

Finally our reserve for originated loans had remained consistent at around 1.2% and we remained comfortable with the allowance levels given the current mix in our portfolio.

For the acquired loan portfolio another benign quarter. Feel good about the credit marks against this portion of our portfolio and our remaining credit marks are approximately 141 million representing nearly 30 basis points of tangible capital and approximately 2.5% of the acquired balances up 10 basis points from the prior quarter. As you can see some strong improvements in the classified and credit side levels driven by favorable portfolio migration and payoffs. Let me quickly touch upon our investment book on page 11.

If you look at just the AFS component of our investment book, the unrealized net gain after tax was approximately 84 million down from 161 million at March 31 of this year. A couple of points I would like to highlight, the duration of our AFS book was 2.46 years compared to 2.49 years at March 31. As you know, in the first quarter we transferred roughly 3 billion of the CMOs from AFS to HPM, at 630, it has an amortizing OCI amount of approximately 35 million.

On our residential mortgage back security book within our AFS portfolio only 26% of them are pass-throughs with the rest being CMOs and REM structures. They’re not influenced as much by the QE3 purchases and therefore not subject to the pricing volatility that we saw in June. As noted we reduced the par amounts of the securities by roughly 200 million by quarter ended June 30.

From prior yearend 12-31-12, they’re down almost 500 million. About 1.9 billion or 25% of our 7.6 billion AFS book primarily CLO and ABS are variable rate and therefore not impacted by mark-to-market base on interest rate moves. About 58% of the OCI that gains we have in our CMBS book as duration of 2.9 years and finally our $550 million (inaudible) has atypically short duration of 2.8 years, so what does all that mean is the duration of the composition of our book as resulted in an OCI reduction that we talked about earlier.

On the bottom of page 11, we repeated the charge we laid out last quarter reflecting that we have been saying since July of 2011. Our overall commercial credit portfolio which will include our CNI and credit loan plus our CMBS, CLO, and corporate security balances express as a percentage of deposits are in line with our peer group, at another way while we may have larger portion and credit assets in our investment portfolio total commercial credit exposure whether it’s in our loans or investment securities it’s consistent with our peers.

Importantly 76% of our credit securities are rated AA or better presenting better credit exposure than a traditional middle market loan book.

In total measured this way, we would have a loan to deposit ratio of 95% consistent with our target we have given in the past and consistent with our peers. To close my investment discussion, our long term strategy is to focus on customer relationships, fee income generation and cross solving. We will continue to gradually rotate the investment portfolio to a targeted 20% to 25% of assets overtime.

Briefly on the Basal III final rules, we are evaluating every aspect of the final rule. Mainly like many of you surmised the bank our size there were some real positive. As you were aware the regulatory minimum requirement phase in did not change and start at 4.5% on the implementation date of January 2015 and gradually increases to the 7% by January 1, 2019.

Based on our preliminary review, we feel positive particularly about changes in the proposed provisions relating to the exclusion of the AOCI and more favorable treatment of junior liens and residential real estate assets from a risk waiting perspective. On the other hand, the rules remain punitive on some of our investment securities particularly for certain ABS and CLO where the risk ways increase from a significant factor and some are dollar per dollar deductions under Basal III versus Basal I.

While we like these assets in 2011 when we fed up our HSBC investment strategy and we like them today through the Basal III transition period the majority of capital treatment of these assets under Basal III makes them less attractive upon implementation. We have approximately 275 million in such ABS and CLOs that have an average risk weighting of 40% under Basel I but would be subject to more than 30X increase to 1250% risk weightings under Basel III. By rotating out of these assets which we have already planned to do under our HSBC balance sheet rotation strategy, it would benefit our capital ratios by approximately 40 basis points.

Based on our interpretation and our planned rotation of these assets totaling 275 million, we estimate that the tier one common ratio at June 30th under Basal III would be 5 to 10 basis points lower than the 765 we reported.

Now let me talk a little bit about our outlook for the third quarter for 2013. Bottom line the $0.19 consensus estimate for the third quarter is consistent with our expectations. Based on current interest rates, we believe the third quarter NIM will see low to mid-single digit basis point compression from the 3.36% we reported in the second quarter of 2013.

If you look at our asset sensitivity for a 200 basis point increase in rates gradually, net income will increase by approximately 4.5% over a 12 month period. Unlike some others, this does not assume a day one increase in rates based on the forward curve that would produce a noticeably higher number. Instead, we assume a 16 basis point increase in rates each month across the curve over the 12 month period. In a 200 basis point immediate increase scenario, our NII upside would be approximately 7% asset sensitive.

While the steeper yield curve is welcome for some asset classes as you have heard repeatedly over the last week that real benefit for bank comes when the short interest rates move. About two-thirds of our loan portfolio is variable tied to short term indices. Of the variable rate loans, 45% are tied to the three month LIBOR and 26% to prime rate. With the steepening yield curve recently the movement rates have been in the mid to long end of the range while the three month LIBOR has given up one basis point.

For securities, our reinvestment rates have increased from 90 days ago. For instance, our CMO purchases in June yield up approximately 2.5% compared to the 2.0% we were investing in in the first quarter. Finally, we expect GAAP net interest income to be up against slightly from second quarter levels.

Current fee income consensus 94 million is consistent with our expectations. Consistent with what you have heard so far from others, we expect moderating volumes coupled with lower gain on sales margins will reduce mortgage banking revenue which we will mitigate partially by gaining market share. Likewise, we expect capital market revenues to receive modestly from second quarter levels given higher interest rates, increased competition, offering of a long term fixed rate loans and continued impact of (inaudible).

On expenses, even though we expect revenue growth to be we expect a low single digit reduction and expenses from 2Q levels. Said another way that current (inaudible) 226 million estimate for third quarter operating expenses appears a bit low.

CDI amortization expense will decline again in 3Q. As I noted earlier, we remained focused on achieving our previously communicated year end targets.

Moving to credit, we expect net charge-offs and originated loans to average roughly 40 basis points plus or minus an excess provision expense consistent with the mix of an originative loan growth. If you recall starting in the third quarter, we will be charging our credit card losses to the allowance compared to our prior practice of charging-off credit losses to the purchase accounting credit mark related to HSBC. The reason for this is the case is because of the entire card book we acquired from HSBC and only the card book has been moved from acquired to originative bucket over the last 12 months since the acquisition. As we have said before, this is the change in geography from excess provision the charge-off.

Before we go to Q&A, let me reiterate that we are committed to executing on the strategy we have embarked on, to continue profitable growth without compromising credit, maintain a key focus on expenses and rotate the balance sheet profitably to improve return profile.

With that, (inaudible) can begin 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 is from Damon DelMonte of KBW. Your line is open.

Damon DelMonte - KBW

My first question deals with a comment you guys made about prepayment income from commercial loans being repaid during the quarter. Could you quantify what that was in the second quarter compared to the first quarter?

Unidentified Company Representative

Sure. As you know, with loans paying off many of them have prepayment penalty. So what we saw in the second quarter was a little over 2 million prepayment income reflected in NII and that’s compared to roughly 500,000 in the first quarter.

Damon DelMonte - KBW

Okay and is there a way that you can engage that as we look into the back half of this year or is that just a kind of see how it goes each quarter?

Unidentified Company Representative

It’s hard to predict that because you are predicting of all the loans and the customer competition which ones would be prepaid, so we estimate it and it moves plus or minus based on that estimate.

Damon DelMonte - KBW

Okay. And then just to kind of circle back on the commentary on expenses. So a large part of the movement this quarter had to do with variable rate compensation because of the growth on the fee income side of things. So you’re basically saying you are going to have lower fee income in the third quarter and thus that will benefit your expense base in the third quarter, is that correct?

Greg Norwood

Yeah, I think you’ve got it Damon I mean obviously we’re focused on expenses. That’s a key part of how we’re running the business. But certainly we’re focused on generating positive operating leverage and while we predict that going forward as we saw in the second quarter fee income was higher than we had expected and therefore that resulted in the expenses.

Damon DelMonte - KBW

Okay. And then kind of following up here on expenses, are there any other initiatives that you guys could look to undertake maybe more aggressive approach on branch rationalizations or some other areas of your expense base where you can maybe churn some items?

Greg Norwood

Well certainly we continue to focus on the three major areas we’ve talked about in the past which is salaries, vendor management and other expenses and being the CDI. And when we look forward we kind of look at the decline from here to the end of the year as being kind of evenly contributed by each of those. So further reduction in personnel cost, further reduction in vendor cost and then the CDI as we’ve laid out in the past. Around branches, we continue to look at that and we continue to look at both the profitability today, the profitability in the near-term and also how we want to position branches relative to particular markets. So while we’re not communicating today any additional plan cuts know that as we lookout 18 to 24 months that is certainly part of our operating perspective and how we think about rationalizing the footprint.

Operator

Our next question is from Dave Rochester of Deutsche Bank. Your line is open.

Dave Rochester - Deutsche Bank

On the loan portfolio you mentioned the pipeline remains strong, but if I remember correctly you generally see a little bit of softer growth due to seasonality in 3Q. Are you seeing any of that this year, do you think you can offset that seasonality with bigger market share gains?

Greg Norwood

Well, you’re right I mean when you think about it August typically is a slower month. I would say we don’t see right now a dip due to seasonality. As you mentioned our pipelines are strong and they were strong going into the quarter. So while it’s hard to predict exactly the seasonality I would say probably less impactful.

Dave Rochester - Deutsche Bank

Great, and switching to the margin, can you talk about in the way of premium amortization expense and the prepaid penalty income is baked into your margin guidance?

Greg Norwood

Well, first let me go back to the prepayment, our guidance has a more normal run rate prepayment income than we saw in the second quarter, so we’re focused on that. And then as we talk about NIM going forward, it remains still pretty volatile and in part in certain areas of loan originations, so it’s kind of hard to give much more guidance on that. But I would want to make sure that when we look into the forecast and you guys look into we don’t see the kind of prepayment income in the second quarter, we haven’t modeled their assume that in third and fourth quarter.

Dave Rochester - Deutsche Bank

Do you think that premium amortization expense continues to decline somewhat at the curve all is here?

Greg Norwood

Yeah, I think it declined about 1 million quarter-over-quarter from the premium amortization and that’s as good a number as any to think going forward.

Dave Rochester - Deutsche Bank

Okay. And you gave some very detail on the Auto business I was just wondering it seems like your FICO scores are decently higher than what you’re generally targeting for that business and that’s I guess has been the case the whole time. Is there a thought to drop those a bit to take up some more yield given you’re seeing a suppression on pricing there?

Greg Norwood

Well, I think you captured it right, when we did the business model back in 2011 we did assume a lower FICO and a higher yield and as we started into the business it consistently has created a slightly different opportunity where we though there was a better risk reward trade up as we grew the portfolio by keeping the higher FICO and being reasonably competitive on the price. So while we’ve thought about it, one; as you go down the FICO spectrum, it’s a smaller overall industry population and frankly when we look at the blip we like the lower loss content that the higher FICO gives us as we grow and mature the book.

Operator

Our next question is from Bob Ramsey of FBR. Your line is open.

Bob Ramsey - FBR

The earning asset guidance of 32.7 billion I guess applies only about 100 million growth quarter-over-quarter, which is a lot less than you guys have been doing. I am just curious is that a reflection of more of a mix shift out of securities into loans or does it say something about the loan growth outlook and the seasonal per quarter or what sort of the factors in there.

Unidentified company representative

Well, one I'm not sure I'd fly the plane quite that directly. It is consistent with where we are, I think the potential relative to the loan growth as we talked about earlier, also will continue the balance sheet rotation which you know will impact earning assets that obviously helps us in our NIM guidance. The other thing is as we go down, is I mentioned the payoffs we had in June where we did not like the structures. Obviously that will reduce the averages in the short term, so again I think, we're comfortable with looking into the third quarter on loan growth. You know there will be some impact from the June and we will continue to rotate the securities books.

Bob Ramsey - FBR

Okay that's all folks, and then I think I heard you correctly in the intro comments that the expectation for GAAP and net interest income is that that will be higher slightly from second quarter to third.

Unidentified company representative

Correct, and just you know to tie that to interest rate sensitivity I want to make sure when we look at the two ways that you commonly see it in the industry, we expect interest income in our way a gradual up 200 to be about four and a half, and as I said another way to look at it is an immediate up 200 and that where we would expect net interest income to be up the 7% that I mentioned.

Bob Ramsey - FBR

Okay, and I know Damon sort of asked you about expense expectations as we go into the back half of the hear, the last quarter you all had said, that you expected in the fourth quarter to do possibly little better than the 225 million run rate guidance you'd previously given. Are you still feeling good at being out or under that 225 level in the fourth quarter?

Unidentified company representative

That is clearly the focus of the entire organization I think as both Gary and I have said, we are clearly focused on expense management, but I said you know to the extent we create better than expected operating leverage that would have an impact on what just sheer absolute point in time expenses might be.

Bob Ramsey - FBR

On fee income you're obviously expecting lower fees next quarter. What are the primary areas where you're expecting a sequential drop quarter over quarter?

Unidentified company representative

I think it's simple, one's industry and one's probably more unique to us so certainly mortgage, we don't expect anywhere of the volume declines that maybe we've heard others talk about, yes that'll be softer but not for the magnitude related to volumes, a gain on sale as you know is very difficult to predict. The other aspect for us where we see challenges is in the capital markets area. Two things impacting that, one is, given competition is extended fixed rate both in duration as well as level that makes a swap transaction less competitive in the market place. To a lesser extent obviously Dodd Frank eligible participant rules, impact that and while we could still work with customers to meet their need it doesn't create swap income it creates NII going forward.

Operator

Thank you. Our next question is from Casey Haire of Jefferies, your line is open.

Casey Haire - Jefferies

Two part question on funding side of things, one deposit's down a little bit this quarter just wondering if you have a right color on that decline. You guys did come in, secondly you did back fill with tapping more short term borrowings, you used to talk about your appetite there and what strategy is there.

Unidentified company representative

Sure, (inaudible) on the deposits, I mean our focus in the decline has been what is the right pricing for online savings as well as our money market. And we continue to believe there's a positive trade there relative to lowering the cost of those versus planned attrition, and as we talked about it in the past, when we think of the moving parts we don't that absolute target for loans, securities, deposits or wholesale. Clearly we've focused on our loan growth perspective, the rotation will 200 million a quarter and then deposits where we manage relative to customer and then secondarily to treasury and overall funding and currently believe that a wholesale perspective to match all of those up is the right way to go and as we look forward in pricing and the value of the deposit base moves we'll look at that. I think it's also important to pull that all in the deposit side and to what we talked about as our transaction saver borrower and one of the things that we look at that there is how to increase that and also whether or not the saver piece money market in OSA is contributing to that. So we continue to look at that first as a customer acquisition perspective and then secondarily from a treasury or funding perspective.

Casey Haire - Jefferies

Okay and the NIM guide does that contemplate any further easing of funding costs.

Greg Norwood

From a deposit perspective I would say I think that is flat and wholesale borrowing is probably about the same.

Casey Haire - Jefferies

Okay. And then just to sum up on the efficiency ratio, I know you guys are talking about 61%. From what I am gathering it sounds as though before it was mostly coming on the expense side. But obviously the top line is showing up a little bit better. You can get there with a more balance mix of revenue improvement and expense cuts versus just expense cuts prior. Is that fair?

Greg Norwood

I think you are looking it at the right way and then obviously the 225 remains our target, and depending on the ratio and mix obviously revenue driven by customer behavior is a key goal of ours. So it's probably less precise than that Casey but again we continue to believe that creating operating leverage while managing expenses is the right way to balance that.

Operator

(Operator Instructions) Our next question is from Mike for Erika Penala, Bank of New York America. Your line is open.

Erika Penala - Bank of New York America

Hey good morning guys. Just a real quick one on the indirect auto book. I know you guys kind of gave a little bit of guidance out in terms of origination. But I know last quarter I think you were up 50 dealers for 900, I was just curious as to what perhaps the dealer increase you saw this quarter, kind of what you expect by the end of the year?

Greg Norwood

So this quarter we saw a little over 50 and as we have mentioned our business plan moving into Pennsylvania. And as we did do that beginning this quarter, I mean Pennsylvania is not going to be a needle mover but it was a market that in our business plan we thought it was positive one. And I would say certainly the increase in dealer will moderate over time. So only slightly think about it going up. So 51, 50sh more this quarter with decline in increase going forward.

Erika Penala - Bank of New York America

Then just another quick one kind of switching to C&I. I know yields look like they compress around 8 bps to around 366 basis points. Just curious what are the current originations yields that you are seeing on the C&I side. I know at the beginning you had indicated that you are seeing more pricing competition and also competition on structure. But kind of curious for the kind of rate credit, where you see kind of those yields come in.

Greg Norwood

Yeah we really haven't seen a big change this quarter and I would just give you some actual. So second quarter origination yields for the entire commercial book, we are at 243 and that's down 5 basis points from 248. CRE is more around an L plus 250 and again a little less than that, probably what from we saw in first quarter versus second quarter. But again right now in the second quarter in total we had basically a LIBOR plus 243 little bit higher in C&I in business banking and a little bit lower down into the L 250 for the CRE book.

Operator

Thank you. Our next question is from David Darst of Guggenheim.

David Darst - Guggenheim

Greg have given us details on the portfolio, what percentage is bearable rate? Could you give me those details again?

Greg Norwood

Sure, let me go back a little bit to the investment page in the deck. So when you think about it, what we said was our AFS book has about 2.46 years in duration. And that's down a little bit from 249 at 331. So again the duration overall hasn't really changed. And as you know that duration is by design from the HSBC strategy where part of that was to shorten the duration of the overall securities book. Also if you look at as I mentioned a couple other just discrete portfolios, the new portfolio, I think important to compare to others is it is a really short portfolio again by design of only 2.8 years for annuity. And then CMBS again a lot of our portfolios '06, '07 originations, so you can put that in the normal 10 year maturity and that's where we have the 2.5 for the CMBS. I think another piece that I would highlight is in our CLO and ABS there are variable rates. So with 25% of our 7.6 billion book is variable rate and obviously those are only impacted by credit spreads. So again a pretty variable against the book of CLOs, ABS' and CMBS as well as (inaudible).

David Darst - Guggenheim

As you discussed in the capital markets business and the changing down there, are you beginning to see better yields on what you're booking and are the origination volumes staying the same, even though the dynamics of the fee income associated with them are declining.

Gary Crosby

Well from our capital markets syndication, I think they’re reflective of the broad markets and what we are seeing in the commercial loan book. So in our syndications I think we are seeing kind of larger deals that for us would be the 100 plus type deal, where we would sell off. That’s where you are seeing the lower spreads because you have more competitors in the market. You know our sweet spot, more of the club sized deal in the 50 to 75, again less competition there, so the spreads aren't quite, and what I would tell you on the capital market swap business is our volumes or the number of transactions we have done are basically flat first to second quarter. So to your point there, there is more pricing competition in the swap market again consistent with what I would call as a very competitive overall commercial lending environment.

David Darst - Guggenheim

Would you say that as far as the commercial bank, your production force, say the number of lenders you have and, are you dinosaurs building your capacity where there are still areas within the commercial franchise that you need to add new lender segments over to the various markets.

Gary Crosby

I think we like our overall complement, as we said in the past, we actually believe we have capacity within our existing complement. The two things we wanted to highlight that we have really been focused on, for five plus years now, is talent acquisition. Talent brings talent. So when we focus, we find folks that like our business model of decentralized credit underwriting, more autonomy than some of the bigger, and so we started first by saying what are the leadership roles, and that’s where we have increased there and that’s the main focus. But what we have also done is, look at what are our RM complement, our relationship managers are in each of the footprints and we’ve undertaken kind of a best in bank perspective. So what is the productivity? Where are we seeing it done the best, reflecting obviously geographic differences, competition differences. So we are really looking at both the leadership roles and the productivity of our RMs as two discrete components of resources, but again as we said consistently for probably six or nine months now is we believe there is embedded capacity in what we have and we’ll manage that capacity, our delivery capabilities to the marketplace capacity.

Operator

Next question is from (inaudible) of Sterne Agee, your line is open.

Unidentified Analyst

Most of my questions have been answered, but just one quick one. You guys gave some really good color on managed income sensitivity and the (inaudible). Could you give us some idea of sensitivity and a steepening yield curve environment such as what we have seen recently?

Gary Crosby

We haven’t disclosed information around that and I think just to be specific to your question as the steepening in recent, you know the back end of the curve will have less to do with that, given its less impactful both to deposits which is the most difficult assumption in management and the short end. We do run, as you would guess, a lot of different scenarios when we look at our business strategies but really haven’t disclosed the number of different scenarios. What we wanted to do at this quarter, because, frankly we got a lot of questions is the simplest distinction between asset sensitivities, are those banks that do a gradual versus those that do an immediate. Not that one is better or worse than the other, but as you can see for ours gradual has a 4.5% increase to NII where an immediate would model a 7% increase in NII.

Operator

Thank you, no further questions at this time.

Gary Crosby

All right, well in wrapping up let me just say that we are really pleased with our second quarter results and we continue to demonstrate our ability to translate strong business fundamentals into strong financial performance. Our CEO search continues and in the meantime we have a very strong team that is focused on further enhancing our financial performance. Thanks again for joining today’s call. Have a great day!

Operator

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

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