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Webster Financial Corporation (NYSE:WBS)

Q2 2010 Earnings Call

July 16, 2010 9:00 a.m. ET

Executives

Jim Smith - CEO

Jerry Plush - CFO

Analysts

Mark Fitzgibbon - Sandler O'Neill

Damon DelMonte - Keefe, Bruyette & Wood

Bob Ramsey - FBR Capital Markets

Collyn Gilbert - Stifel Nicolaus & Company

Gerard Cassidy - RBC Capital Markets

Bruce Harting - Barclays Capital

Ken Zerbe - Morgan Stanley

Matthew Kelley - Sterne, Agee & Leach

Operator

Good morning and welcome to Webster Financial Corporation's Second Quarter 2010 Results Conference Call. This conference is being recorded. Also this presentation includes forward-looking statements within the Safe Harbor Provision of the Private Securities Litigation Reform Act of 1995 with respect to Webster's financial condition, results of operations and business, and financial performance.

Webster has based these forward-looking statements on current expectations and projections about the future events. Actual results may defer materially from those projected in the forward-looking statements. Additional information concerning risks, uncertainties, assumptions and other factors that could cause actual results to materially differ from those in the forward-looking statement is contained in Webster Financial's public filings with the Securities and Exchange Commission including our Form 8-K containing our earnings releases for the second quarter of 2010.

I'll now introduce your host Jim Smith, Chairman and CEO of Webster. Please go ahead sir.

Jim Smith

Good morning and welcome to Webster's second quarter earnings call and webcast. You can find our earnings release that was issued earlier this morning and the slides and in depth supplemental information to accompany the presentation in the investor relations section of our website at wbst.com

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

We continue to make progress in what I will characterize as a solid quarter as net income improved to diluted EPS at $0.15 a share. Revenue grew by 6% year-over-year and by 1% on a linked quarter basis. The net interest margin was essentially flat to the first quarter and a touch over of our estimate and core pre-tax, pre-provision earnings held steady at $57 million.

The principle driver our second quarter results was and is improving credit quality across all loan categories. The provision for loan losses declined to the lowest level in two years while still covering net charge offs which were at the lowest level in five quarters.

Non-performing loans continued to downturn trend to less 3% of the loan portfolio registering their lowest levels since Q1, '09. The allowance for loan lease losses rose slightly and is well in excess of non-performing loans. The quality of NPL coverage is especially strong considering that NPLs already have been charged down by 30% and fully one third of NPLs are currently making payments.

At the front end delinquencies declined to the lowest level in two years. While we're resistant to predict future credit trends, we're encouraged by the stable to improving risk migration across the portfolio. Our liquidating portfolio is now below $200 million compared to $424 million at year end 2007, and carries reserve coverage of 25%, 91% of the loans in that portfolio are current.

Recognizing our progress on credit, Standard & Poor's recently upgraded its outlook for Webster to stable. Should present trends continue, it's likely that we'll provide reserves that are less than charge offs in future periods, the continuing improvement in our credit metric is attributable in part of the focused multi-year effort to identify, manage, reserve for and resolve underperforming loans, and we have done it in a way it has respected our customers and the challenges they have faced.

I expected our approach will further strengthen our customer relationships in the quarters ahead, as we endeavor to help finance the regional economic recovery. Underpinning our results is a slowly improving regional economy. According to the June Fed Beige Book commercial real estate markets in New England are showing signs of improvement. Most businesses in the region were reporting stable to increasing activity compared with a year earlier.

Most retailers and manufacturers generally report positive sales and revenue results. In Connecticut, home for closures in June were down for the second consecutive month and unemployment dipped below 9%. The improvements in the economy and our conservative efforts to boost originations can be seen in the Q2 numbers and in the pipeline. Loan originations across our business rose by 46% from the first quarter to 579 million. In market commercial non mortgage originations rose 72% to $200 million and we have a robust pipeline in place.

Our business and professional banking group in June reported its strongest month for originations in a year and a half. Originations in asset based lending, equipment finance and commercial real estate loans also increased in the quarter. Our commercial loans volume and our pipeline give us confidence in our ability to achieve our goal of $850 million and new business loan originations in our markets in 2010. Meanwhile residential and consumer originations rose 44% from Q1 to 275 million.

On the capital front in slide 4 our ratios continue to track higher. Tangible common equity rose 26 basis points to 5.79% and tier one common equity rose 22 basis points to 8.12% in Q2. Regarding CPP repayment, our strategy remains the same. We'll continue to pursue orderly repayment on terms favorable to our shareholders in the quarters ahead supported by our improving profitability and credit metrics.

Turning to slide five, let me briefly review our progress on the six strategic initiatives for 2010. As I said before, our regional banking strategy is straightforward. We'll build market and wallet share among businesses and consumers through relentless improvement of our service quality to achieve best in class status. Simply stated we'll do better what we do best.

We sharpened our competitive edge and wow to become the bank of choice in our markets. Our overarching commitment to maximizing the growth of economic profit guides our strategic decisions and our allocation of capital and other resources. One prong of our service quality strategy is competitive convenience. During the second quarter we expanded hours at 89 of 181 branches and extended the service hours in the customer care center to 15 hours a day, 7 days a week.

While it's only a one month sample, May saw increased business in terms of sales in new accounts at branches with extended hours. In these branches small business loan applications rose 37%. Business DDAs were up 23% and consumer DDAs climbed 17%. In all three cases, these levels significantly exceeded the comparable numbers at branches without extended hours.

Even before the advent of extended hours, our progress toward best in class in service quality was bearing fruit. The most recent JD Power survey, taken months before we extended branch hours provided third party verification that we're making major strides toward our goal of being number one in our footprint for service quality.

Delivering best in class service also means reducing error rates, shorting the account opening process, simplifying product offerings, increasing speed of transactions, expediting work flows and improving the reliability of our ATMs. These are the things that we're focusing on. Investing in these service improvements is the best use of our capital as we believe that improving service quality is the key to generating sustainable growth and economic profit. Mobile banking and balance alerts will soon follow.

As you can see on slides 5 and 6, we're making progress on our other initiatives as well, including 8% year-over-year growth in new business checking accounts, deposit growth in Boston and Westchester and increased income from our credit card referral program. To sum up the quarter, it's clear that our performance is improving and that credit metrics are trending strongly positive. But the bottom line is that our results are nowhere near our potential. Webster is capable of earning well more than our cost of capital and that goal should be achievable in a reasonable timeframe.

Pre-tax, pre-provision earnings of $57 million are not nearly sufficient to reach that goal. I want to assure our shareholders that every strategic choice, very hiring decision, every loan we make, every dollar of capital and every precious resource we allocate bare this goal in mind. I also want to be careful not to over promise. Given the headwinds we faced with over draftees and interchange, as well as higher FDIC premiums, it will be tough to move that needle to over the near term. But look for us to improve that metric over the next several quarters. As exertize this strategic and financial discipline, it will produce economic profit.

Before I turn it over to Jerry, I would like to discuss briefly, financial regulatory reform and its potential impact on future results. As you know Reg E became effective July 1 for new customers and will apply to existing customer as of August 15. Our strategy is to use the Reg E changes as tools to deepen engagement with existing customers and attract new ones. For example, customers use debit cards differently from credit cards and checks. We recognize this in our new schedule for opt-in customers, including lower fees for debit card overdrafts and we believe our customers will reward us for giving them better banking services.

We continue to estimate that the changes to Reg E could impact ours overdraft fee revenue by 5 to $6 million a quarter before a planed product redesign, which will recover a portion of those fees across the broader base. After the product changes the hit will diminish and eventually most, if not all of it will be priced more broadly into the business. We simply don't have enough data from our opt-in activities to date, to be more specific but will have more to say in future calls.

Regarding the financial regulatory reform bill that is awaiting the President's signature, is certainly the most sweeping piece of banking legislation since the National Bank Act of 1933. We support the congressional intent and as much as it addresses to big to fail, provides for an orderly liquidation of failed institutions, brings the shadow banking system under closer regulation, increases market transparency and retain the Fed as the primarily regulator for bank holding companies.

Many of the objectionable aspects were mitigated from our perspective, including those dealing with preemption and derivatives. As expensive and unchecked as the powers of the CFPB maybe, the bureau will centralize oversight of consumer protection in a way we hope will serve consumers well. The two features of the new law that affect us most directly are the Collins and Durbin amendments. The Collins Amendment signals a phase out of trust preferred securities as tier 1 regulatory capital. All of our TRUPs provide for early redemption at par in the face of a regulatory capital event, though TRUPs redeemed prior to year end 2011 could require regulatory approval.

One of our five issues, which represents over half of our outstandings, requires replacement capital, if redeemed. Since TRUPs will continue to quality as tier 2 capital, we may elect to leave some or all of them outstanding based on cost effectiveness. We have no current plans to redeem the TRUPs with cash, debt or capital and we anticipate that future earnings will be the primary means of replacing any capital lost through redemption or phase out.

The Durbin Amendment has the potential to reduce our income from interchange fees but before we venture an estimate of the impact the Fed will have to complete an evaluation of the cost of delivering interchange services and set parameters for fees accordingly. So it's too early to guess the amendment’s impact on our estimated annual $20 million interchange revenue from debit transactions. Finally, there are many other elements of financial reform that won't be fully resolved for sometime as the regulatory phase moves into the spotlight.

With that I'll turn it over to Jerry.

Jerry Plush

Thank you, Jim. Good morning everyone. Turning to slide 8, as we have done in prior quarters, we'll provide a view of core earnings for the second quarter. We're very pleased to report the positive results for Q2 as Jim noted the pre-tax, pre-provision earnings of 57 million. Please note that the 57 million includes the negative impact of Fannie Mae buyouts of 1.8 million. We will provide some more detail on this and other items in a few minutes.

Adjustments in the slide includes non-core items such as the 4.4 million in gains on the sale of investment securities generated in large part to offset an incremental provision for loan repurchases of 3.5 million, the loss of 1.2 million on the write-down of certain pool trust preferred securities and $900,000 of severance we recorded in the quarter.

We also exclude 900,000 in OREO and repossessed equipment write downs. Lastly, we have a $19.7 million provision for litigation reserve, and the $15 million Higher One IPO gain each as previously announced. The litigation reserve that was established stemmed from a judgment in Ohio project involving the National Construction Lending business.

We believe we’ve fulfilled our obligations to the borrowers, and respectfully disagree with the court’s decision. We also believe that there are numerous reversible errors during the trial, and we will ask the Trial Court and the Appellate Courts if necessary to correct them.

Webster will take whatever steps appropriate to vacate the court's decision or otherwise resolve the case. Also the gain, we realized in the quarter from our direct investment was Higher One, a New Haven based provider payment systems for colleges and their students as they launch their IPO in June.

Let's turn now to slide nine, and provide some more detail on our core earnings drivers in the quarter. We compare it here to the first quarter of 2010, and also the second quarter of 2009. The 57 million in pretax pre-provision earnings includes the Fannie Mae buyouts as well as a $1.6 million negative mark from off balance sheet hedges in the quarter.

The increase from the year ago in growth of over $5 million in the core earnings is driven by an increase of 23 basis points in the margin, and $557 million increase in average interest earning assets. In comparison to Q1, the net margin decreased by one basis point while earning assets increased by 131 million. This is several basis points better than expected as the impact of the buyouts was nearly $1 million or two basis points better than we expected.

The quarter also reflects the positive impacts of discipline loan and deposit price. It's worth noting here that the margin would have been 3.31% in Q2 if not for the 1.8 million of Fannie Mae buyouts from mortgage backed securities, the result of a policy change, which enables the GSEs to accelerate the repurchase of loans out of MBS at par.

The first quarter had a three basis point negative impact from similar Freddie Mac buyouts in that quarter. So, if you adjust both quarters for the respective Fannie and Freddie buyouts, you would have an adjusted margin of 331 in each. The effect of these buyouts has now pretty much run its course as we head into the third quarter.

On an average basis, we had combined growth of $243 million in securities and short-term investments, which offset a combined decline of 113 million in loans and loans held for sale. The net impact was an increase of $1 million in net interest income quarter-over-quarter. Our non-interest income increased by 900,000 as a rebound of deposit service fees from seasonally low first quarter results, and increases in loan and wealth [ph] fees somewhat offset a lower level of other income.

Other non-interest income in Q1 included proceeds from bank owned life insurance and some gains recognized on direct investments in that quarter while the second quarter reflects a $1.6 million mark-to-market loss related to the interest rate hedging activities that were undertaken in Q1, and Q1 only included $150,000 mark-to-market adjustment.

The market is now expecting lower rates for a longer period of time than what was expected when these hedges were put on, and as such these contracts experienced a loss. We don't expect significant additional losses going forward but there is volatility with these nonetheless. Our core expenses increased by 2.2 million from Q1 and that's largely related to an expected increase in marketing and professional services.

While compensation expense remained relatively comparable to Q1, our Q2 results reflect lower than expected group insurance expense and a favorable pension valuation. Our FDIC expense was higher but will decline given lower levels of balances in the end of our participation in the TAG program.

Turning now to slide 10, we outlined the activity in our investment portfolio for the quarter. The slight increase in the portfolio occurred primarily to offset lower loan balances. We continue to buy relatively short duration agency CMOs with limited extension risk. During the quarter we sold some [101] high premium agency MBS for a $4 million gain that would have had significant premium valuation risk in a falling rate scenario.

We also saw the TRUP for a $347 million. The portfolios overall duration declined to 3.4 years from the mix changes in the portfolio. It's important to note that 59% of the portfolios are held in maturity and that does include 1.1 million of resi loans that we have securitized in the past and 675 million of municipal securities. The classification of longer duration securities in the HTM portfolio will provide protection to the TCE ratio should interest rates rise. The 2.9 million in securities in AFS are shorter duration. They've got excellent liquidity and should provide us with the flexibility that maybe needed to manage the balance sheet going forward.

If we turn to slide 11, here you can see the yields in the overall portfolio and they have decreased by two basis point during the second quarter which reflects the effect of fixed rate maturities that are priced at higher levels being replaced by new originations at lower rates. The resi yields declined by six basis points and that reflects the impact of pay offs and pay downs on higher yielding loans compared to the new production that has been booked.

The consumer yields declined by a basis point and the commercial yield point by 9 basis points while the 8 basis point increase in the pre-yield from 440 to 448 helped to moderate the effect of the declines in the other three segments. Our average balances were up by 39 million in residential and by 23 million in commercial non-mortgage while all other category still declines.

The average balance increase in commercial non-mortgage which represents our core middle market and small business lines is encouraging and reflects the focus on growing in this segment. We turn now to slide 12, we will take a look at some key asset quality progressions. In here we provide a five quarter trend in total non-performing loans, REO, repossessed equipment and past due loans. Like prior quarters individual credit and other performance data for our principal loan segments is included in the supplemental information that's posted in the IR section of our website.

Our non-performing loans declined by 31.5 million in the quarter through lower new non-approvals and continued cures and exits. We will review that in greater detail in the next slide. Here again it's worth nothing that one third of our NPLs were 105 million are paying as we have been actively identifying and addressing problem situations. The 317 million of NPLs at June 30 they have incurred charge offs that's over a 735 million or in other words as Jim noted carry at 70% of their original balance.

Our REO and repossessed equipment was relatively flat over the past year and that reflects the focus on remediation of problem loans and resolution of repossessed property and equipment. Our past due loans remained in a fairly tight brand at around 1% of total loans over the past year and they declined at June 30 which now represents 0.88% of total loans. The 19.5 million in past due loans during the second quarter includes a $12 million commercial credit that was resolved early in the quarter and that we mentioned in our first quarter conference call.

We'll now turn to slide 13 and here we have provided a reconciliation of NPLs over the past year. A decline in new non accruals, continued progress in cures and exits drove a lower level of non performing loans. Also here you can see the favorable trend of the declining level of gross charge-offs since the third quarter of 2009. Our re-default rate on modified resi loans is approximately 7% and that continues to have a very favorable impact in our results. This is reflected in our cure numbers once again this quarter. We have seen and heard of industry re-default rates in the range of 40% plus. So our performance here has been very solid in comparison and reflects our approach to successfully without risk borrowers.

Regarding the allowance for loan losses on slide 14, here we'll show the net charge-offs and the provision for loan losses and they declined for the third consecutive quarter. The provision totaled 32 million in Q2 which is has rated net charge-offs at 31.8 million compared to the provisioning and excess of charge-offs that occurred in prior periods.

The 31.8 million in net charge-offs reflects $4.2 million worth of recoveries. This compares to 2.8 million in Q1, evidence of an improvement in recovery trends and problem loan resolutions. The allowance for loan losses now represents 3.17% of total loans and provides a coverage ratio of 108% of our total NPLs. The $8.5 million decline in net charge-offs from the first quarter comes from a number of individual segments including a decline of $1.6 million in liquidating portfolio. Again, please see our website for the supplemental slides that will include five quarter trend statistics and information for each loan segment.

Let's turn now to take a look at slide 15 and we'll talk about deposits. Our total deposits declined by 514 million in comparing June 30th to March 31st. Given ample liquidity we employed pricing discipline to drive down the costs of deposits another seven basis points this quarter. We expect there to be seasonal reductions in government deposits at quarter end given that this is the fiscal year end for municipalities and we also expected some reduction in concentration to government, given our election to exit the tag program as of June 30th.

So overall government deposits declined by $648 million quarter-over-quarter. Note that the decline in some large balance accounts provides us with capacity as we plan to add more new municipal and profitable relationships that are more granular and will have less volatility as we head into the second half of the year.

So we're keenly focused on growing our non interest deposits and we shoed solid performance year-over-year as well as over the prior quarter with growth of 169 million or 10.6% and 102 million or 6% respectively. Our non interest bearing deposits are now 13% of the total deposit base and this has been a contributor to improving the quarter total deposit ratio which is 74% at June 30th, compared to 65% a year ago. Our core deposits have grown 1.4 billion or 16.3% over the past year while CDs declined 1.1 billion over this timeframe. This improved mix has driven the 66 basis point reduction and the cost of deposits over the past year that you see on this slide.

We'll turn now to take a look at our deposit mix by line of business. We believe it's a strong competitive advantage for us in deposit gathering given we can gather deposits from the five lines of businesses that you see here on the slide. With a particular note again, our focus is on growing core accounts, DDAs in every line of business as the key to strong customer relationships and profitability clearly starts there and we have seen as we talked in the prior slide, solid growth in our non-interest bearing accounts and balances. We saw a continued growth in HAS in commercial and small business in the second quarter, and retail stabilized even with continued CD declines in the quarter. Our government business declined in the quarter with the expected reductions that we previously outlined. We continued to add new operating relationships in all four states that we serve.

So in summary, we've seen overall growth of 0.4 billion as I mentioned and over the past year 305 million in total deposits after a $1.1 billion decline in CDs, again while significantly reducing our cost.

We'll turn now to slide 17. We'll view the changes that have happened in borrowing and mixing cost. With the net deposit growth we've covered on the last slide, this reduce the need for the utilization of borrowings which are down 92 million from a year ago though up quarter-over-quarter as we utilized in overnight funding to offset the expected decline in government deposits in the second quarter.

The ratio of borrowings to assets was 12 percentage in 30th, and it's been in a fairly tight band of 11to 13% over the prior year, excuse me with the past year. A slight increase that you see in the cost of borrowings to 3.1% reflects the liability of lengthening strategy that we recently put in place, and discussed at length from the first quarter call.

So before I turn things back over to Jim for his concluding remarks, let me provide some perspective on the third quarter. So we'll start with the margin. We would clearly expect to see some improvement in Q3, given our lower levels of access liquidity better based on results without the Fannie and Freddie buyouts that impacted Q1 and Q2 and from continued pricing disciplined on deposits while recognizing their lower loan yields on new production will likely occur as well given the current market conditions.

We would think of a 330 to 335 margin as a likely range. Regarding our interest turning average balances, given the pipeline update and the increase business development workforce, we would expect with the continued strong effort we can turn the corner, and could even begin to see some overall growth here in Q3. We would expect to maintain at most to not grow our investment securities portfolio.

Regarding credit, the positive trends to began in late in '09 and early of this year continued to improve in Q2 as shown in all key asset quality metrics so while we have to remain cautious to the economic uncertainty including employment levels and also note that the first half of this year did not have any lumpy commercial charge-offs which are always somewhat challenging to predict. We would still expect that lower provisioning in Q3 is likely assuming after the quality trends continue to hold up.

Our non-interest income will be down, given the implementation of Reg E to take effect this quarter, we're assessing potential moves to offset this impact and we'll provide a more detail update on our actions next quarter. And for non-interest expense, we would expect to comp with the increased several million dollars quarter-over-quarter given hiring that we've referenced in our initiatives, and the Q2 had benefited from favorable group insurance and pension evaluations.

We think Q3 should also, at least show should also show significantly lower FDIC insurance premiums in Q3 and Q2, given our access from the tag programs and lower deposit levels at quarter end. So I would say closer to $5.25 million or so. We also estimate the effective tax rates should be around 19% for the quarter. I'll turn it now back to Jim for his concluding remarks.

Jim Smith

Thanks Jerry. That concludes our prepared remarks; we would be pleased to take your questions.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer-session. (Operators Instruction). Our first question is from Mark Fitzgibbon with Sandler O'Neill. Please proceed with your question.

Mark Fitzgibbon - Sandler O'Neill

Good morning gentlemen, first - you Jim - I think you had mentioned your pipeline is really robust. Could you give us a sense for how big that is and what types of loans it's concentrated in?

Jim Smith

I would say - I probably wouldn't give a number as to the size of the pipeline except to say that it's - it leads to a sizeable as the originations that we're reporting in terms of what we would expect to close in Q3 and say that it's broadly across our business lines and in particular in commercial and business and professional banking.

Mark Fitzgibbon - Sandler O'Neill

Okay and then secondly, I know you said that earlier in your comments, that you continue the orderly repayments of TARP, is it likely that you will need to raise capital to complete the repayment of TARP in your view?

Jim Smith

I'd say, it's reasonable likely at some point down the line before we complete the process that we would, but we're taking it a step at a time, you saw that in the first quarter we were able to repay a $100 million of it without having to raise any capital at all, as our profitability and credit matrix continue to improve, we anticipate that we will have to raise less capital, then might otherwise have been the case in order to ultimately complete the repayment.

But I want to make it clear; we are not in a tearing rush to do it. We are taking a balanced approach that very directly considers the best interest of our shareholders and our objective is to raise the absolute, de minims amount of capital, it's maybe requited to complete the repayment. It's hard to say at this time around.

Mark Fitzgibbon - Sandler O'Neill

Got you and then lastly, we've seen some deals in New England recently, I'm wondering if you think the pace of consolidation is going to pick up in New England and also if you think that Webster is ready to get back on the acquisition trail.

Jerry Plush

We are not surprised that acquisitions are starting to perk up a little bit and we do expect that we will see significant consolidation over the next couple of years. From our perspective, we are focused on our core model, we are focused on increasing our market share and our wallet share, in our markets by continuingly improving our service quality and I hope that really came though loud and clear in my remarks today.

We are not likely to participate in auctions; we are very interested of course in negotiated stock based transactions with likeminded partners that share our view of what our institutions could be together. At the same time I'd say that, I think that our currency would have to appreciate from here in order for us to want to use it in a transaction and we are really not interested in cash deals at this point, so the focus is on internal activities and to the extent that there are likeminded partners that share our views, we'll be very interested in that kind of a combination.

Mark Fitzgibbon - Sandler O'Neill

Thank you.

Operator

Thank you, our next question is from Damon DelMonte with Keefe, Bruyette & Wood. Please proceed with your question.

Damon DelMonte - Keefe, Bruyette & Wood

Hi, good morning how are you guys.

Jerry Plush

Good morning, Damon.

Damon DelMonte - Keefe, Bruyette & Wood

Jerry could you remind this - exactly how much you have in TRUPs?

Jerry Plush

Damon, there is a - I think we have a slide post of it, but I want to say it's around 55 - $57 million or so in - are you referring to the investment portfolio?

Damon DelMonte - Keefe, Bruyette & Wood

No, I didn't refer to -

Jerry Plush

The capital? 232.

Damon DelMonte - Keefe, Bruyette & Wood

232? Okay and you said that there was one issue.

Jerry Plush

Sorry I had to think about both ends of the balance sheet.

Damon DelMonte - Keefe, Bruyette & Wood

Sorry, I should have been a little bit more clear with my question and you said there is one security that's approximately 50% of that balance.

Jerry Plush

Right, there is the - we've got a - roughly a $132 million left of the issuance that we did in 2007.

Damon DelMonte - Keefe, Bruyette & Wood

Okay, okay, great and then could you guys just give us a little update on your flagship office in Boston. Are you happy with the progress so far, and do you have any additional plans maybe support that branch with other (inaudible).

Jerry Plush

Yeah Damon, the branch is right on target as it relates to where our plan results were. We had good deposit growth again in the quarter. We actually are saying some very strong opportunities on the loan side. We're fully staffed, so we would expect greater and greater contribution as you think about Q3, Q4 etcetera and again our intent in the not too distant future is to begin to start to report out a little bit more about our activities in the seven regions, so clearly we would focus in on performance related to Boston.

Regarding the expansion in the area, we're continuously evaluating what our next steps are. Again, I think we made it clear that we establish a flagship there. We wanted to conduct mostly small business, commercial and government municipal business sort of that's the first step and follow with through with more on the retail in consumer side, and we'll continue to update you guys as we formalize our plans there.

Damon DelMonte - Keefe, Bruyette & Wood

Great, thank you very much.

Jerry Plush

Sure.

Operator

Thank you. Our next question is from Bob Ramsey with FBR Capital Markets. Please proceed with your question.

Bob Ramsey - FBR Capital Markets

Hey, good morning.

Jerry Plush

Good morning, Bob.

Bob Ramsey - FBR Capital Markets

Hey real quick, I just, I didn't catch which is what tax rate should we expect to next quarter? Was it 25%?

Jerry Plush

19.

Bob Ramsey - FBR Capital Markets

19 thank you.

Jerry Plush

Sure.

Bob Ramsey - FBR Capital Markets

And then I appreciate the slide you will include showing the new non-accrual formation. I see that new non-accruals of 75 million in change are the lowest level we've seen in some time. How much of that reflects sort of early auction on the liquidating portfolios, and how much of that data you really seen some signs of stabilization kind of in your core portfolios?

Jerry Plush

Yeah. I would say that you're seeing stabilization as well. It's a combination of both rather than repeat everything. Then I also think that it's reflective of, you can see the improvement that's taken place in the past too, so the inflows are lower, so I think as you think about we continue to be pro-active in risk rating to portfolio in the commercial side clearly and taking steps as necessary so there has been any change there, so I think you can take it as a positive sign of better performance both in the quarter and in the liquidating.

Bob Ramsey - FBR Capital Markets

Okay, and how you guys kind of thinking about reserve adequacy, now that the allowances is more than over 3% of loans, and your charge-off seem to be rapidly approaching 1%.

Jerry Plush

Yeah. I would say that we are evaluating what we should do in Q3 and Q4. Again we're going to take the approach of determining adequacy based on what we determine is the underlying risk in each of the segments, totaled it up. if we don't need the provision to match the charge-offs or exceed the charge-offs, you guys will see charge-offs in excess provision in those quarters if we for some reason were to see any type of uptick, again we got to be cautious given the economy and particularly employment rates, I think it's important to know that there could be continue that, you would see that provision could be at those levels or greater but our view right now, we are very pleased with the performance to-date and our thinking would be as we said that if these trends continue you will see us be able to charge off at whatever the levels are and just access adequacy and we will assume that the provision would need to be either at or above the charge off levels.

Bob Ramsey - FBR Capital Markets

Okay. Thank you guys.

Jerry Plush

Sure.

Operator

Thank you. Our next question is from Collyn Gilbert with Stifel Nicolaus & Company. Please proceed with your question.

Collyn Gilbert - Stifel Nicolaus & Company

Thanks. Good morning gentlemen.

Jim Smith

Hi Collyn.

Jerry Plush

Hi Collyn.

Collyn Gilbert - Stifel Nicolaus & Company

Jerry, just wanted to clarify a couple of the points you made in kind of your concluding comments. So, the expectation was that you would see average earning asset growth in the third quarter but yet you would probably maintain the – at a minimum maintain the securities balances. So, then do we then extrapolate from that, that there will be loan growth tying in also Jim to your comment on the pipeline.

Jerry Plush

Yeah, Collyn, what I stated was given the pipeline update and with the increased number of business development officers, we expect that if we continue to see the kind of effort on top of the existing pipeline that we have got an opportunity to see some overall loan growth in the third quarter. You should know that we have been boarding our residential loan production and you could see that the uptick that occurred quarter-over-quarter there but we are really pleased to see that we have made some strong strides in the commercial non-mortgage area in particular both in small business and the middle market.

So, I think we are at the stage where we don't want to grow the investment portfolio, I think, we have been talking about that, I know there was slight growth quarter-over-quarter. We may make some composition changes to the portfolio as we move forward but our thoughts are to maintain it most and certainly not grow it.

Collyn Gilbert - Stifel Nicolaus & Company

Okay, that's very helpful. And then also on your comments with the expectation that non-interest income will be down just because of the regulatory concerns, issues. Should we be thinking about in terms of quantifying how much of a decline when you commented on 20 million in the annual debit transactions, I mean is that what we should be looking for? I know the expectation probably is you're going to try to find offsets to that but just initially is that the kind of the dollars we should be thinking about?

Jerry Plush

I think you should be thinking about a several million dollar impact just given the timing of when things take place in the third quarter and our thoughts are to provide some additional clarity when we release or at some presentations that we have scheduled late in the third quarter to provide an update of some of the other action steps. I think as Jim noted clearly we have got some repositioning of the product offering that we are seriously evaluating and expect to launch and also we are going to do pretty much a full view of all of the fees that are assessed and also all of the expenses. So, we're looking certainly very proactively for offsets.

Collyn Gilbert - Stifel Nicolaus & Company

Okay.

Jim Smith

And just to add a little bit to that say one way to look at it is August 15 is the real date here, so you could look at the impact being about 50% in Q3, the biggest gap is going to be in Q4. There will be some response by Q1 into Q2 and we should come back up the other side of that by Q2.

Collyn Gilbert - Stifel Nicolaus & Company

Okay, that's very helpful. And then just a final question and if you guys have touched on this I apologize but the $3.5 million provision for loan repurchases what - could you just give a little bit more color into that and then is that a number that we should expect could continue going forward.

Jim Smith

Yeah, Collyn, we have seen some repurchase activity. It generally takes somewhere between 24 to 36 months to comeback, so start to think about 2005, 06, 07 and even into 2008, loan production that was sold from the prior activities to national wholesale and then also thereafter just from the activities we have had and footprint of loans that are conforming and/or we go to private investors. Most of this though is related to say the '06, '07 and even into '08 timeframe. And it's just based on the experience that we have been having with having to reach settlements on some of that, with some of the investors that we have just determined that it would be a prudent step to take that experience, look at the volumes that are out there and provide some level of reserve.

Generally speaking, you provide several basis points off of your gains on sales as a reserve. We felt that at this point, just given the level of activity, and certainly this is something that all mortgage bankers and all banks that have sold or conduct mortgage banking activities are seeing. Our thoughts were it's better to estimate that and put up a reserve and then we will continue to monitor that and report on it. But our expectations would not be that you’d expect to see a charge like that of this size but then again we are just going to continue to monitor the activity and continually access where we stand with this.

Collyn Gilbert - Stifel Nicolaus & Company

Okay, so that was kind of a more of a proactive move as to what you might see coming down the pipe.

Jim Smith

Yes.

Collyn Gilbert - Stifel Nicolaus & Company

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

Jim Smith

Correct.

Collyn Gilbert - Stifel Nicolaus & Company

Okay, that's helpful. Okay, I think that was all I had. Thanks.

Jim Smith

Sure.

Operator

Thank you. Our next question is from Gerard Cassidy with RBC Capital Markets. Please proceed with your question.

Gerard Cassidy - RBC Capital Markets

Thank you. Good morning guys. The follow-up on the repurchase activity there might take place. Have you guys done any work on what you think the demand might be that you might be required to repurchase or have you -- it sounds like you haven't had to repurchase anything yet. Is that correct?

Jerry Plush

No, we have been, Gerald we have been repurchasing or reaching settlements. And generally speaking for clarity sake, this is not a repurchasing of loans, it's generally reaching settlements on that activity. What to keep in mind is that, the vast majority of this activity related to the long gone national wholesale business. So, there is some finite number obviously out there for that and we are just going to continue to -- and I would say 80% of our activity related back to, specifically back to the production that, that group had generated and that was sold into the market.

So we have seen most of our settlement amounts were laid into that activity for '06 and '07. And as a percentage of sale we have got some statistics that we have based, how we extrapolated and came up with our reserves. So, I think hopefully that gives you a little bit more perspective on it.

Gerard Cassidy - RBC Capital Markets

Okay. And what are you finding for every $100,000 mortgage that comes back that has to be settled or negotiated, what is it costing you on the dollar? For example, JPMorgan Chase is saying that for every dollar that they have to take back, they are writing off $0.58 to settle that loan. What are you guys seeing?

Jerry Plush

Yeah, I think it's always going to be case by case right? But if you were to start to look at a range, you could be probably in the range of 30.

Gerard Cassidy - RBC Capital Markets

Okay. Regards to expenses and the way you guys look at expenses going forward?

Jerry Plush

And by the way just to clarify, that's when you look at it as a percentage of the sales of activity too. We look at this thing in a lot of different ways, but hopefully I’d give some flavor to that. If we see the activity pick up I think everyone knows we are incredibly transparent about these things. We will certainly provide more detailed information in terms of monitoring the adequacy of that reserve and updating that on a quarterly basis going forward.

Gerard Cassidy - RBC Capital Markets

Sure. Circling back actually to the capital, have you guys got any body language from your primary regulator where the tier 1 common ratios will end up or the tier 1 equity ratios?

Jerry Plush

No, I don't think we have got it.

Gerard Cassidy - RBC Capital Markets

To be well capitalized, that is.

Jerry Plush

Right, I was going to say, I don't think there has either been anything specifically stated or sort of framed there. I think, our view is based on where we see peer averages and peer medians and where some of the higher performers are in the sector and our view is that we've got a range around which, that we think we should be post all of the CPP. But our view is that that's going to be a combination of capital generation from obviously dropping earnings to the bottom line coupled with the improved performance that we have that certainly should help us from a evaluation standpoint. When we ultimately do something that would help boost, as Jim referred, we would be pretty good shape to try and do this with a minimum amount that we possibly have to raise.

Jim Smith

They've been careful, Gerard, not to make any commitments as to what the changed levels might be or even if they're going to change them at all. But we think that they look at each individual institution now and want to be sure that they have a particular level of capital based on what they deem their risk to be. We think our tier 1 common at over 8% is at a very comfortable level. It's within our target range of 8 to 8.5 or so. And so we're pretty comfortable where we are and we think that even if they move what they call well capitalized, they won't move it all the way to that level. They will still leave themselves significant latitude on an individual institution basis. So 8 and 12 would be the key numbers we think that we would want to make sure we meet even though well capitalized will probably be less than that.

Gerard Cassidy - RBC Capital Markets

Right, right. Regarding the non performing loan reconciliation table that you guys have, new non accruals as you indicated were about 75, $76 million down obviously from the prior periods. Is there any mix change or what are you seeing in the new non accruals? Is it more skewed to commercial real estate today versus resi or some sort of construction loan into the second quarter of '09?

Jim Smith

No, it’s broad based. We see it across the portfolio which is probably the most positive sign.

Gerard Cassidy - RBC Capital Markets

And are you finding that when you look at these loans, is it because of poor underwriting or weaker underwriting versus just general economic problems that your borrower ran into because of the recession? Is there any of that mix when you go back and look at it over the last year that maybe a year ago it’s just more shoddy underwriting that was causing it versus an economic problem whereas today is it more an economic problem?

Jim Smith

Yeah, I think it’s -- clearly the economy has affected borrowers, not only within the footprint but then also in some of the other businesses that we've had that have been more national. And I think that that's clearly the primary driver of all the issues that we have seen in the portfolio.

Gerard Cassidy - RBC Capital Markets

Thank you.

Jim Smith

Sure.

Jerry Plush

Thanks Gerard.

Operator

Thank you. Our next question is from Bruce Harting with Barclays Capital. Please proceed with your question.

Bruce Harting - Barclays Capital

On figure 8, the reconciliation of core earnings, the -- just maybe clarification you've got for closed and repossessed asset expenses of 1 million but I don't see that. I see that in the income statement but I don't see that in that table. I do see the 900, the 0.9 foreclosure rate and I'm just wondering why that's not in there. And then you also see the 3.5 on the loan repurchases. Can you just, in the last, in Gerard’s Q&A, you talked about the provision for loan repurchases but I haven't seen that accounting before. So what's behind the new line item and will that be a recurring line item? And then how do we think about sizing those three line items, the foreclosed and repossessed asset expense, the write down and then this repurchase on a sort of go forward basis. Thanks.

Jerry Plush

Yeah. We'll take those one at a time. Thanks, Bruce. On the, we think clearly that the writedowns are something that occurs within the period. They're true non-recurring. We think that the reason that we split out the expenses related to the foreclosed property is that the vast majority of that activity is still ongoing. So we have taken what we think is probably the most conservative way to look at this, split them apart so you can truly see what we're writing down and that the performance there is getting better and better because with the proactive management before anything is going in or in terms of some valuation recovery that's happened to the existing portfolio. I think that's really what the intent is there. We also don't spike out all our workout expenses.

We also continue to keep those in our core operations. So I would say that, I know that when you look at this table there's just an awful lot of items we're trying to explain. But generally speaking we think we're taking a, what I think is probably a fairly conservative approach of trying to say, hey look, our core operations have to carry the expenses of that asset and foreclosure expense activity that takes place as well as our loan workout expenses. So I hope that's helpful.

Regarding the reserving, our view was that based on what we expect to see in terms of potential, again based on what's been presented back to us and taking a look at our total population of what's sold, this is a reserve. And again just Bruce, in fairness, Collyn Gilbert had asked this question as well, we look at this much more as a one line, as a one time, that we'll look at and determine on a quarter end basis are we seeing anything different from the assumptions that we made? Our expectation is that that wouldn't have material volatility but we will be talking about it because again, from a transparency standpoint we want folks to know. We conducted mortgage banking activities. There's clearly loans that are being put back to us or asking for some level of settlement for whatever reason or another, and that's being negotiated. That's been done. Most folks that have ongoing mortgage banking operations see this. This is just from, with the ramp up in activity that's taken place, our view is, let’s take a look at the total population, do our best estimate on what we think that reserve size should be, add this addition to the existing reserves that we have and then continue to monitor it on a go forward basis.

Bruce Harting - Barclays Capital

Okay. And what you and your peers, bank management level thinking about in terms of offsets to some of the regulatory actions on debit and over limit and can you give any indication? I mean is a annual debit card fee likely or I know you don't want to give away strategic plans but if you could just talk a little bit about that. Thanks.

Jim Smith

Well let's say it's something Bruce but we haven't been definitive about it yet. There's, you can imagine a lot of ongoing review internally that we're reminiscent to discuss it until we've decided absolutely what it will be and what the timing will be but I think I tried to make the comment that the costs will be more broadly absorbed by base than in the past because you won't have a smaller portion of the base subsidizing others as a result of the fees that they pay and so we are looking at the mitigators there.

On the Durbin Amendment we just don't know what the impact is going to be on that so we are not going to take any particular action on that until we do. The biggest focus is on the Reg E changes right now and first getting the maximum amount of people who have been then telling the market how favorable our program is and attracting new customers as a result of that and then when we go into Q1 and certainly into Q2 we would have rolled out our new program through product redesign and that will help spread the cost across the base.

Bruce Harting - Barclays Capital

Okay. Thanks Jim.

Operator

Thank you. Our next question is from Ken Zerbe with Morgan Stanley. Please proceed with your question.

Ken Zerbe - Morgan Stanley

Great thanks. I guess given our things going on with finance reform and when you think about your business, I mean that doesn't change I think for you, but when you think about your business I mean broadly speaking what is sort of your core run-rate of return on equity, return on assets and obviously this is couple of years out and then when do you really expect to get there? Thanks.

Jim Smith

Ken I made a comment about, we absolutely, we got to be able to earn our cost to capital. Our cost to capital is somewhere in the 10% maybe a little bit higher range or so. If we were setting a number out there but what we think ought to be able to do we would say that we would say that we ought to be able to exceed a 12% return on shareholders equity.

As I said in my remarks, we're reminiscent to put a hard number out or put a timeline on it expect to say we know that's what we ought to be able to do when we believe that we can and our focus on our service quality model and the way that we invest our capital and our other resources to drive economic profit, is what's going to take us there.

I am reminiscent to say it's 2012 or sometime in 2013 but you think that out into that timeframe would be a reasonable time to be able to get to that level and I also gave the caveat that let's remember that there are head wins out there that if it's a negative impact on overall revenue as a result of a regulatory reform including the overdraft changes that are been made, plus we have the impact of higher FDIC premiums for a long period of time.

So, you would love to be able to say that we do at least 1% return on assets but I think it's pretty mature to be able to make that commitment and we like to be able to suggest a higher return on shareholders equity but I think that would be the prudent thing to do right now either. We have got to see how it goes, the progress that we made with our particular service model which we think is the right model in this environment because we are trying to deliver better banking to our consumers and time will tell how well we will do but I think we have got the right plans, we certainly got the right attitude, we got the right strategic and financial discipline. We are allocating our capital and our resources appropriately and so we are confident we ought to be able to generate the kind of shareholder returns that we have discussed.

Ken Zerbe - Morgan Stanley

Okay great. Thank you very much.

Operator

Thank you. Our next question is from Matthew Kelley with Sterne, Agee & Leach.

Matthew Kelley - Sterne, Agee & Leach

How are you doing guys?

Jim Smith

Hey good morning.

Matthew Kelley - Sterne, Agee & Leach

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

Jerry Plush

I think that if you take a look at the breakouts that we have given in the tables, we give you charge-offs by quarter, by loan category and I don't know if you've had a chance to take a look through that but that would just give you, I think your question of what charge-offs look like by bucket by quarter, I think its detailed there.

Matthew Kelley - Sterne, Agee & Leach

I'm just saying are you guys in terms of the non-performing are you recovering 50, 60, 70, $0.80 on a dollar?

Jim Smith

No. And again I'm not sure I follow your question.

Matthew Kelley - Sterne, Agee & Leach

Okay. Well I'm just curious as to, in terms of non-performing recoveries, have they done better or worse over the past six months?

Jim Smith

Oh recoveries clearly have gotten better and you can see that through the numbers. I think that was just in terms of where we have seen in terms of lost content. I don't think it's gotten materially -- it certainly hasn't worsened whatsoever. I think it has been fairly stable.

Matthew Kelley - Sterne, Agee & Leach

Okay, thank you.

Operator

Thank you. Mr. Smith, there are no further questions at this time. I'd like to turn the floor back over to you for closing comments.

Jim Smith

Okay, thank you very much. Before concluding I just want to remind everyone about our upcoming investor day at our flagship office in Boston. We'll be hosting a dinner on the evening of September 22 and then we'll have presentations on the 23rd. Please contact Terry Mangan in our Investor Relations group for further information. Thank you all for joining us today.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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