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Executives

John Koelmel – CEO

Greg Norwood – CFO

Analysts

Jason O’Donnell – Boenning & Scattergood Securities

Erika Penala – Bank of America Merrill Lynch

David Rochester – Deutsche Bank

John Pancari – Evercore Partners

Aaron Brann – Stifel Nicolaus

Damon DelMonte – KBW

Mathew Kelley – Sterne Agee

Casey Haire – Jefferies & Company

Tom Alonso – Macquarie

Peter Kovaleff – Horowitz & Associates

Bob Ramsey – FBR

David Darst – Guggenheim Securities

First Niagara Financial Group Inc. (FNFG) Q4 2011 Earnings Call January 26, 2012 10:00 AM ET

Operator

Greetings and welcome to the First Niagara Financial Group 2011 Fourth Quarter Earnings Release. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

This presentation contains forward-looking information for First Niagara Financial Group Inc. Such information constitutes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 which involve significant risks and uncertainties. Actual results may differ materially from the results discussed in the forward-looking statements.

It is now my pleasure to introduce your host, John Koelmel, President and CEO for the First Niagara Financial Group. Thank you, Mr. Koelmel, you may begin.

John Koelmel

Thank you very much, Robin, and good morning, everyone. Before Greg Norwood, our CFO, walks you through the results for the quarter, let me start by recapping the outcomes of the last 90 days as well as highlighting our narrowed focus as we look ahead in 2012.

Over the last three months, we had three primary objectives. The first was margin management. Our third quarter actions on deposit pricing coupled with a nimble execution of our investment strategy and another quarter of sector-leading loan growth enabled us to minimize the impacts of the pressures created by a volatile and low interest rate environment, and we again delivered linked-quarter revenue growth.

Second was sustaining the business fundamentals. We further our commitment to continuously take an extra slice of the customer pie with differentiating loan and deposit growth. As you can see our talented team and relationship-based focused on the customer gained even more traction across all of our franchise.

And third was clearing the clouds of uncertainty around the HSBC branch transaction, obviously, worked decisively and creatively to successfully execute our capital and divestiture plans in support of that transaction. And we’re pleased and I would be solely focused on delivering another smooth and seamless conversion for customers and employees next quarter.

What did that mean for the fourth quarter results? Another ad expectation and outcome that was clean and straightforward, solid balance sheet and revenue growth, more best-in-class credit outcomes all while we continue to invest in our business, including the addition of two key leaders, Rich Barry, our new Chief Credit Officer will be working with Kevin O’Bryan in the months ahead to fully transition into that role and Larry Orsini, our new Wealth Management leader who came on board early from HSBC.

Whenever the macroeconomic challenges subside, our disciplined investments in people, process, systems and infrastructure put us in a very strong position to ensure our boat remains in the lead pack as the tide again rises for all.

As for the HSBC branch transaction, over the last few days, we’ve again had the opportunity to meet with the members of their team that will soon be joining us. The (inaudible), excitement and anticipation is tremendous. They’re very much looking forward to the opportunity to be part of our franchise and family, one that is committed to a winning community bank model in Upstate New York, just as they had under the Marine Midland banner for so many years. They also continue to receive very positive feedback from customers in the upstate New York community at large.

In addition to soon having access to the largest branch network across upstate, they know they will be banking with an organization that wins with local decision-making, a very nimble and responsive leadership style and a real sense of responsibility and commitment to every community we serve.

And with the financing in hand and divestiture agreements now in place, our focus is solely on completing the transaction in the second quarter. The outcome will virtually double our branch network across upstate, give us the number one retail market share in the region. And with this transaction in our own backyard, we’ve already hit the ground running and we’ll come out of the conversion with real pace and momentum. No doubt, our team will deliver a real seamless transition for all.

And given that, we’ll have added to the depth, breadth and efficiency of our four-state footprint along with an even lower risk balance sheet and best-in-class team, you can see why we’re very excited about our franchise and competitive positioning.

Let me now provide further clarity about what you’ll hear from us over the next 12 to 24 months. Simply put, it’s all about running the business that will have even more effectively and efficiently. We’re very proud of what we’ve delivered while concurrently staking out a regional footprint over the last three years. It’s time for us to hit the pause button on M&A and ensure we deliver on the promise. It’s all the more imperative given the strength of the headwinds the industry is up against today and we’ll obviously continue to face for the foreseeable future.

Our business plan for this year ensures that we have aligned the right resources in the back of the house to support best-in-class customer sales and service, all while continuing to invest in people, process, systems and infrastructure, albeit with a more measured pace.

That said we will have accelerated our commitment to selected businesses like credit card and indirect auto to capitalize on the opportunities that the HSBC transaction and other niche opportunities present. And we’re all very proud to be a Top 25 bank measured by size and market cap, that was never our objective. Our focus remains the same, to deliver consistent high-end performance for all of our constituents, customers, employees, communities and investors. And with the scale we now have, that will be our sole focus for at least the next 18 to 24 months.

Over the last 90 days, we’ve been very upfront in messaging that narrowing focus and the M&A pause. The communication reflects our recognition that in completing four deals in three years, increasing our footings by a factor of five; stretching our geographic reach across three additional states, we again need to narrowly focus on high performance operational execution of further building out all that we need to be one of the lead players when the economic tide again begin just to rise.

In the interim, with our strong profile and position across the footprint, we’ll continue to capitalize on the abundant opportunities to take more market share each and every day, and further enhance the value of our franchise. We’ll definitely keep playing offense and will certainly play a win, but that will be relatively small ball for the next couple of years.

So as we sit here today, we pushed away the clouds of uncertainty related to our pending branch acquisition. More importantly, we’re fully engaged in making the pivot across upstate New York to deliver on our promise for all of the customers and communities we serve.

It’s also now clear that it’s game on for everyone in our industry. And we’re certainly fully engaged, focused, decisive and moving with pace and conviction. And while many of my follow CEOs are expressing cautious optimism as to the near-term economic and macro outlook, I’ll reaffirm that we’re running our business with a much greater sense of caution than optimism about the world at large.

So, let me be clear. Our result remains to be one of the best in the business coming out of the other side of the current reality. So we’ll further sharpen our focus (inaudible) two or three years from now, invest smartly to ensure we’re positioned to do just that, optimize our near-term execution to minimize the downside exposure from the continuing headwinds and we are fully engaged and energized our team around the right business strategy. And that’s exactly what you’ll see from us in 2012.

With that, let me flip it over to Greg for a recap of the quarter.

Greg Norwood

Thanks, John. Good morning. Thank you for joining us today. Before I dive into the financials, let me highlight three key themes driving our financial results.

First, we continue to differentiate with strong business fundamentals. In the battle for customers, we are winning consistently quarter-over-quarter. Second, credit quality remains superior and because we are growing our business, we continue to build reserves as opposed to generating earnings through releasing reserves. Third, we have taken meaningful steps to lower deposit cost to better position us for today’s reality and we will continue to do so in the future.

These three themes are not new. First Niagara’s passion around winning with talent has been driving growth while maintaining our strong credit culture for some time now. Our experienced team has and will face any challenge aggressively, like low rates, and do what is best for the customers and shareholders over both the short and the long-term.

At a macro level, I want to comment on yesterday’s Fed actions. Going back to our October call, we’ve clearly stated that the industry would be challenged for the foreseeable future with the rate environment creating meaningful headwinds. The Fed’s affirmation keep rates low until late 2014 is really not a surprise to us and we have been running the business with this context since mid-August.

Having said that, rates have moved quite a bit since October and have been volatile. For example, since our last call just 90 days ago, the 10-year Treasury rate has ranged between a high of 2.4% and a low of 1.8%. Of late, the 10-year has moved down 20 basis points from mid-December to mid-January and remains volatile. This means it’s all the more important for us to be nimble and to react to the volatility and low rate environment. To be sure, we are focused on running the business to maximize our organic growth acquiring new customers over the next 18 to 24 months.

Now let’s turn to page four of the deck that was provided. We delivered another strong quarter recording operating earnings of $0.24 per diluted share. For the full year, we reported operating earnings of $0.98 per diluted share, up from $0.87 last year. Unlike peers, we did not grow the bottom line through reserve leases.

We grew pre-provision, pre-tax per share almost 10% in 2011 compared to 2010 versus the peer group medium of a minus 13%, very positive considering the headwinds we all faced in 2011.

Our total revenues grew 3% annualized from the linked-quarter and was negatively impacted by the immediate impact of Durbin. As we have said before, over time we expect to recover about 50% of the lost revenues related to Durbin.

We began where we left off last quarter, reporting strong volumes in commercial loans and our core deposit base. We delivered on the strong pipeline we saw at the end of the last quarter, reporting 28% annualized growth rate in C&I loans. Let me emphasize, that is our eighth consecutive quarter of double-digit organic growth in our C&I portfolio.

For our NIM, we delivered on our mid to low 3.40% guidance that we gave during the third quarter update, more on the moving parts of the NIM later.

Finally, our credit metrics continue to clearly differentiate us from our peers. Our losses narrowed to 14 basis points from 20 basis points last quarter.

Turning to slide five, this shows our year-over-year organic loan growth was 10% and again consistent growth across the footprint. Total fourth quarter originations were $2.7 billion, a 27% annualized increase compared to the linked-quarter. As in the third quarter, our newer capital markets and equipment leasing continue their momentum.

Looking to 2012, our proven ability to take market share and our improved product array will continue to yield benefit and translate into annualized commercial loan growth rates around 10%.

For those of you who know as well, we are consistently taking market share while maintaining our high underwriting standards for years and 2011 was no different, even with increased competition and more engaged players. How do we do it? We win with talent, plain and simple.

Slide six our deposit franchise once again had a very strong quarter. Core deposits grew 13% annualized over the linked-quarter. The increase in DDAs was driven by a combination of our recent marketing efforts, realignment of our checking account suite back in the third quarter and typical seasonal increases.

Account acquisition activity trends remain strong as well. We saw a 10% annualized increase quarter-over-quarter in the number of core checking accounts. Driving part of that growth in checking is our promotional money market campaign. Since its launch, we have cross-sold new core checking accounts to more than 40% of the new money market households. Compared to cross-sell norms across the industry, this is very strong performance.

Credit trends remain very positive as you can see on page seven. Net charge-offs totaled $5.8 million, averaging 14 basis points of loans, decreasing six basis points from the linked-quarter. Non-performing assets comprised a very modest 29 basis points of total assets, unchanged from the linked-quarter.

Legacy non-accrual loans were a modest 91 basis points of loans, up four basis points over the third quarter versus the peer medium in the fourth quarter closure to 2%. The increase in non-accruals resulted from relatively small increases in our single-family residential, C&I, and commercial real estate portfolios.

To give you some perspective, the small bump in non-accrual loans is not indicative of any increased risk in our view. Early-stage delinquencies roll-rate trends remain very stable across our commercial and consumer portfolio. Overall, we are very comfortable in the stability of our current credit quality.

Provision for credit losses totaled $13.4 million, down from $14.5 million in the third quarter. The decrease was driven by lower quarter-over-quarter charge-offs and the provision included $2.1 million related to consumer loans acquired due to the Harleysville transaction. I will come back to this later.

Let me point out that we are comfortable with the remaining marks on the acquired portfolio and this increased provision will have a small pool of non-mortgage consumer loans in Harleysville.

To put our 2011 provision for loan losses in perspective, we increased our allowance by almost $28 million through incremental provisioning. For 2012, we expect charge-offs to run between 25 and 35 basis points of total legacy loans, and we will continue to increase our reserves prudently as we did in 2011.

Turning to page eight on capital and liquidity, we are very pleased with our new execution on the capital raise completed in December. We continue to believe our pro forma capital positioning remains very solid, given the low risk nature of our balance sheet.

Post HSBC, our risk-weighted assets to total asset ratio will be approximately 55%. Some 20 percentage points below peer median and lower than our current 58%. As we have repeatedly noted, the HSBC transaction further de-risks both sides of our balance sheet, whether it is reducing wholesale borrowings and replacing them with core deposits or reducing the risk weighting of our pro forma book, our risk is lower.

When we think of capital, we also look at the amount of our credit marks on acquired loans. Today, about 40% of our loan book has a remaining fair value credit mark of approximately $205 million. This mark represents about 45 basis points of Tier 1 leveraged capital. Our liquidity position remains very strong at both the parent company and the bank, in line with guidance we gave in December as part of the capital raise.

Turning to slide nine, net interest income increased 12% annualized quarter-over-quarter to $243 million. During the quarter, we purchased $1.25 billion on investment securities with an average yield of approximately 3.2% as part of our pre-buy strategy ahead of the pending HSBC transaction.

Net of interest expense including the sub debt we issued in December, the pre-buy activity resulted in $1 million in net interest income, an increased average earning asset by about $450 million. Our fourth quarter net interest margin averaging 3.48%, unchanged from the prior quarter.

Let me break down the key drivers of our NIM. The NIM benefited approximately five basis points from the recognition of accretable yield income on acquired loans due to their better-than-expected credit performance.

Let me pause here for a minute and connect some dots. For the non-accountants, purchase accounting rules require the acquired portfolio to be put in homogeneous pools of loans to determine their fair value. And the pools have to be viewed independently. The accretable yield is created when the credit mark on any of the individual pools is too much and you expect to collect the cash and thus increase the yield.

In this quarter, we reduced the credit mark by $35 million and accreted a small portion of approximately $3.5 million. We have assumed the remaining $32 million will be accreted into interest income over the expected life, say roughly three years.

The other side of that equation I referenced earlier related to the provision where a small pool of non-mortgage consumer loans acquired through Harleysville had a decrease in fair value and we provisioned about $2.1 million. So net-net, the benefit was a positive $1.5 million in pre-tax income.

Back to the NIM, the excess liquidity from our capital raise and our pre-buy activity reduced our NIM by about four basis points. Our deposit pricing actions in August, immediately following the first Fed announcement reduced our cost of interest bearing deposits by eight basis points, which helped offset asset yield compression from pre-payments and refinancing. As you know, predicting rates in today’s volatile markets is challenging. Based on what we know now, we expect first quarter NIM to average around the 340 level.

Let me close the margin discussion with some update on net interest margin we expect from the HSBC acquisition. Recent rate moves will impact our estimates. We have purchased a fair amount already at good rates and we’ll continue to execute our strategy throughout 2012. When we look at current rate levels for both the securities book and the repricing of acquired assets, we estimate the all in NIM impact of the net acquired assets to be around 4%.

Now, let’s move to non-interest income and expense. The impact of the Durbin legislation on debit card exchange largely drove the 7% decline in total fee income. This reduction was largely offset by sustained strength in mortgage banking and capital markets revenue.

At $5.3 million mortgage banking revenues were essentially flat in prior quarter as closed loan mortgage volume approximated $500 million. Capital markets revenues in the fourth quarter were roughly $2.5 million. For the year, total capital markets revenue was approximately $9 million, which is really a nice number for the first full year of operations.

For example, we led three syndicated deals during the fourth quarter and a total of seven deals for the year. Looking into 2012, we have added more lending expertise in this area that will help drive future growth.

Finally in the fee income areas, this month we launched a branch staffing realignment effort, aimed at enhancing our sale capabilities in small business and wealth management. This realignment will put more small business bankers and financial advisors in our branches and will support our efforts to drive transaction account growth and greater fee income in the future.

Turning to expenses, normalized operating expenses excluding merger and restructuring charges were approximately $183 million for the fourth quarter, up 2.2% over prior quarter. As a result, our operating efficiency ratio in the fourth quarter was approximately 50.96% versus 58.7% last quarter. This increase is reflective of our continued investments to grow the business and in anticipation of closing of the HSBC branch transaction.

As we messaged in October, we will be prudent in 2012 to manage expense growth. Looking to 2012, we believe the fourth quarter expense run rate of roughly $185 million is a good jump off point for operating expenses for the legacy franchise, with typical seasonal increases in the first quarter due to payroll and FICO expenses.

Overall, efficiency ratios will be around 58% to 59% throughout 2012 from our legacy operations. Reported GAAP expenses of $202 million included approximately $20 million of restructuring and merger-related charge, attributable to our previously announced branch restructuring initiatives, the branch staffing realignment initiative I previously mentioned, as well as a HSBC-related merger costs.

Putting all that together, based on what we see today and mindful of the recent movement and volatility and interest rates, we think being around the average consensus EPS estimate of $0.98 make sense.

In closing, we are very pleased with the business fundamentals and trends that we saw this quarter and our overall competitive positioning. Our teams continue to perform very well against our competition big and small. We will remain a growth story that will allow us to offset some of the interest rate pressures with strong volumes. The HSBC opportunity has further integrated the momentum within our franchise and we are confident that the integration will be well executed.

With that Robin, we can begin the Q&A session.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions) Our first question comes from the line of Jason O’Donnell with Boenning & Scattergood. You may proceed with your question.

Jason O’Donnell – Boenning & Scattergood Securities

Good morning.

John Koelmel

Hey, Jason, how are you?

Jason O’Donnell – Boenning & Scattergood Securities

Good, doing well. Can you just talk a little bit about your expectations for the reserves to loans ratio here over the next year or two just assuming the status quo regarding credit quality and growth? Should we be looking for a steady increase from this level as acquired loans run off?

Greg Norwood

Jason, the way I look at it and the way we think about it going forward is the current level of about 1.20% is a reasonable place to be thinking. As you’ve said in your question, assuming no big changes in the economic environment, which we frankly don’t expect in our footprint, we think being around there, plus or minus, makes sense.

Jason O’Donnell – Boenning & Scattergood Securities

Any thoughts on how long it would take to get to that level?

Greg Norwood

Well, we’ve been at, in this quarter, at 1.2% of legacy loans and we consider that on a legacy loan basis. As I mentioned on the acquired loan marks, across that portfolio we are very confident that those marks will remain reasonable for the near future.

John Koelmel

In the 1.20% level, we’ve been sitting with for a while. So, that seat there is we’re comfortable in maintaining that kind of level as we look ahead, Jason.

Jason O’Donnell – Boenning & Scattergood Securities

Great, thanks a lot guys. That’s all I had.

John Koelmel

Yep, thank you.

Operator

Our next question comes from the line of Erika Penala with Bank of America Merrill Lynch. You may proceed with your question.

Erika Penala – Bank of America Merrill Lynch

Good morning, gentlemen.

John Koelmel

Good morning, Erika.

Greg Norwood

Good morning.

Erika Penala – Bank of America Merrill Lynch

My first question – and I apologize, Greg if I missed this during your prepared remarks. As I noticed a significant increase of almost 30 basis points quarter-over-quarter on your C&I yield. And I was wondering how much of that is – you’re getting better pricing on the market versus if the accretable went through that line?

Greg Norwood

The accretable went through that line Erika and that, as I said, was about five basis points.

Erika Penala – Bank of America Merrill Lynch

Got it. And so could you give us a sense of what the core trends, given that you’ve posted such great C&I growth. Could you give us a sense of the core trends in commercial pricing that you observed this quarter?

Greg Norwood

From third-quarter to fourth-quarter, I would say that the pricing trends are about the same. As we’ve said, there is margin compression, but we haven’t seen a big jump in that compression or increasing that compression significantly in the fourth quarter.

Erika Penala – Bank of America Merrill Lynch

And my last question is on the core non-interest expense levels. So as you think about a sort of a steady state environment in 2012, do you think that there would be potential savings from that 125.5 quarterly run rate, excluding of course the impact of HSBC? So I (inaudible) your thought on how you’re thinking about efficiencies in this environment?

Greg Norwood

Sure. Going back to the third quarter, we very clearly said that we will continue to invest in the franchise and as John mentioned whether it would be indirect or credit card. But we would do it at a much more measured pace considering the current environment. So as I mentioned in my remarks, when we look at next year and the non-interest expense relative to the efficiency ratio, we think it will be in that 58% to 59% ratio. Also if you include HSBC, we think over time that will definitely improve that number to a lower point. Clearly, our goal in a steady state environment to be in the mid-50s from an efficiency ratio perspective, that goal is unchanged.

Erika Penala – Bank of America Merrill Lynch

Okay. Thank you.

Operator

Our next question comes from the line Dave Rochester with Deutsche Bank. You may proceed with your question.

David Rochester – Deutsche Bank

Hey, good morning guys. Nice quarter.

John Koelmel

Hi Dave. Thank you.

David Rochester – Deutsche Bank

The 3.40% margin guidance, does that include any amortization of that remaining $32 million accretion you mentioned that you’re amortizing over the next three years?

Greg Norwood

Yes, it does. And if you think about that, it would be about a $10 million number in 2012 and that’s amortized on a level yield interest rate method.

David Rochester – Deutsche Bank

Okay great. And just another one on the margin, how much premium amortization was there in the NIM this quarter and can you give us last quarter’s number also?

Greg Norwood

The premium amortization has increased from the fourth quarter to third quarter. I guess the way we look at that is, our overall MBS position has about a 2.5% premium in it and interest – or pre-payment’s fees have increased about 25% – to about 25% in the fourth quarter. So the impact of the fourth quarter was a little bit greater than it was in the third quarter.

David Rochester – Deutsche Bank

Okay, great, thanks for that. And on the flip side, in terms of deposit costs, do you see more opportunities there? It seems like you have a little bit more room on the CDs as well as the money markets. Can you just provide a little color there in terms of lowering costs?

Greg Norwood

Sure, we do believe there is more potential there. And you’re right, it is both in the CD book, but also in the non-time deposits. We’ve continued since August to adjust pricing and we did so further in December and expect to do so in the first quarter. So I would agree, we do believe we’ve got some pick up in the first quarter.

David Rochester – Deutsche Bank

Great, thanks. And just one last one, how should we be thinking about loan growth going into the first quarter? You had nice growth in origination volume in 4Q. Can you talk about how the pipeline measured up at the end of the quarter versus maybe what it would like in third quarter and are you seeing any momentum going into January?

Greg Norwood

Well, clearly we posted a great quarter and just like the fourth quarter of 2010, there’s some cyclicality in that seasonality. When I look at the first quarter, being around that double-digit growth that we’ve been for eight consecutive quarters, I think it’s a reasonable place to be. With respect to the pipelines, they’re as strong as they were in the third quarter. So certainly the momentum remains just like it did in the third quarter going into the first quarter.

David Rochester – Deutsche Bank

Great. All right, thanks for the color guys. I appreciate it.

John Koelmel

Thank you.

Operator

Our next question comes from the line of John Pancari with Evercore Partners. You may proceed with your question.

John Pancari – Evercore Partners

Good morning.

John Koelmel

Hey, John.

Greg Norwood

Good morning, John.

John Pancari – Evercore Partners

Can you talk about the expected pace of the remaining pre-buy of the securities related to the HSBC liquidity? Just how we should think about the pace of the advances? Thanks.

Greg Norwood

Sure. When we think about closing in the second quarter, we were expected to invest about the total amount of the $3.5 billion. One of the things that we will do is to continue to refine the allocation among asset classes. One of the things we have taken a little more measured pace on is some of the corporate bonds. And over 2012, you will see us take some of the free cash flow and invest in the corporate bonds. But bottom line is, by the end of next year, we’ll have the securities allocation that we presented in December and consistently across those asset classes will be fully invested by the end of the year.

John Pancari – Evercore Partners

Okay, I got time for one more. And then what you’ve put on this quarter in terms of the investments, what was the average duration of what you’ve invested?

Greg Norwood

It’s around three years. Again our duration will be about what we’ve expected before, and the overall risk of the portfolio essentially will remain unchanged as we continue to execute the strategy.

John Pancari – Evercore Partners

Okay, all right. And then lastly, in terms of the loan growth you saw this quarter, can you give us a little bit more color in terms of what types of credits you see in the growth and is it in larger credits and anything by industry? Thanks.

Greg Norwood

Sure. Certainly in the C&I book, the growth, I think, was pretty evenly spread. We’ve been moving up market for several years now. So the average size is not appreciatively different in the fourth quarter than it was in the third quarter. And as far as the footprint, you can see the growth is across each of our major geographies. So I would say net-net, John, overall the growth is fairly consistent with what we’ve seen throughout 2011 in the C&I book.

John Pancari – Evercore Partners

Great, thank you.

John Koelmel

Thanks, John.

Operator

Our next question comes from the line of Collyn Gilbert with Stifel, Nicolaus. Please proceed with your question.

Aaron Brann – Stifel Nicolaus

Good morning. This is actually Aaron Brann calling in for Collyn. I had a question going back to the expenses. In the mid-part of the year, you took a fairly significant restructuring expense to (inaudible) integrate some of the acquisitions you had done previously. How much of the expenses have been captured and if you could estimate, how much of those expenses have been now reinvested back into the business?

Greg Norwood

Sure. You’re right. As we talk about, we estimate approximately $25 million in expenses from the planned branch restructuring. When we hit the end of this quarter, those savings will be fully realized. And I would tell you that by and large those dollars have been reinvested in very specifically some of our initiatives around small business, around indirect auto, growing those businesses as we’ve talked about in the last two quarters.

Aaron Brann – Stifel Nicolaus

Okay, okay. So almost a dollar for dollar has been reinvested?

Greg Norwood

Right.

Aaron Brann – Stifel Nicolaus

Is that the right way to think about it?

Greg Norwood

Yes.

Aaron Brann – Stifel Nicolaus

Okay, okay. And as it relates to, again the merger and the restructuring charges, the problems that’s occurring of term loans activity, when should we look for those again to go away, so the timeframe for when the interest, sorry, the non-interest expense will not have all these quarterly charges?

Greg Norwood

Sure, let me kind of break up the total. As we mentioned, there was about $3.5 million severance related to the retail branch realignment, which we think has a very positive impact for our ability to generate small business loans as well as wealth management fees.

Related to the second quarter restructuring around the branches, that will be completed in the first quarter in roughly $5 million related to that. Net-net, it will come in about $5 million less than our projection on the branch restructuring that we gave you in the second quarter of this year.

With respect to merger integration of HSBC, I would think about those expenses as being largely complete in the third quarter of this year with a significant amount of them in the second quarter given that when we anticipate closing.

Aaron Brann – Stifel Nicolaus

Thank you very much. I appreciate it.

Greg Norwood

Thank you.

John Koelmel

Thanks John.

Operator

Our next question comes from the line of Damon DelMonte with KBW. Please proceed with your question.

Damon DelMonte – KBW

Hi, good morning guys, how are you?

John Koelmel

Good, Damon. How about you?

Damon DelMonte – KBW

Good, thanks John. Greg, I just wanted to clarify, you said that there was $1.25 billion of securities that were pre-bought to the HSBC deal this quarter, the impact to average earning assets was about $450 million, is that correct?

Greg Norwood

Correct.

Damon DelMonte – KBW

Okay. And then my other question has to do with provisioning going forward. Given the continued strength in the credit quality, and your target for the 1.20% reserve level, I think you gave guidance of 25 basis points to 35 basis points of net charge-offs of legacy loans, so that would give us somewhere around $35 million of charge-offs for next year. And if you add about $12 million of provision for roughly, call it $1 billion of growth. That would kind of indicate that this quarter’s provision level is a fair run rate for 2012?

Greg Norwood

Well, I think I followed all of your math and would agree, but maybe we can check it offline, but I think you got all the moving parts, right?

Damon DelMonte – KBW

Okay, great. I just wanted to clarify that. That’s all that I had. Thank you very much.

John Koelmel

Thanks, Damon.

Operator

Our next question comes from the line of Matthew Kelley with Sterne Agee. Please proceed with your question.

Mathew Kelley – Sterne Agee

Yeah, just coming back to the margin discussion beyond the 3.40% guidance for the first quarter, if you take a look at the $11 billion net added 4%, are we still talking about combined margin determined at the mid 3.50s once HSBC is fully baked in?

Greg Norwood

That’s roughly the correct number, yes.

Mathew Kelley – Sterne Agee

Okay. And on HSBC, the expense guidance you provided there was I think 1.4% of the $11 billion net deposits acquired. Any updates at all or any additional clarity that you can give and what might have happened, what might have been going on from the time that the deal was announced through closing on that, on that piece of it?

Greg Norwood

Well, we remain comfortable with that, the right number to be using and as John mentioned, we’ve been very engaged with the integration and continue to believe that’s the best estimate we have.

Mathew Kelley – Sterne Agee

Okay. And the Durbin impact, is that fully baked into Q4 or are there additional, you expect to lose in the first quarter, is that a good number to work off of?

Greg Norwood

Yeah, the actual Durbin impact itself was about $3.5 million, and that’s, I would say, the starting point of the decline. And as we mentioned about 50% of that we expect to be able to reverse relative to other fee initiatives throughout 2012.

Mathew Kelley – Sterne Agee

Okay. All right, got it. Thank you very much.

Operator

Our next question comes from Casey Haire with Jefferies & Company. Please proceed with your question.

Casey Haire – Jefferies & Company

Thanks, good morning. Just another follow-up on the margin, you mentioned the pro forma NIM of 3.5% with HSBC, but that doesn’t include the benefit you’d get from the FHLB refi, correct?

Greg Norwood

So Casey, what I said relative to HSBC is, when we look at the incremental NIM, which would include the pre-buy, the acquired assets, it’s about 4%. And that does include the impact of the deposits coming over in eliminating the wholesale funding.

Casey Haire – Jefferies & Company

Okay. So, all right, so that is all in, okay. Okay. Switching to loans, just the resi real estate balances were obviously under pressure this quarter. I was just wondering is that just refi away from you and is that a trend that you kind of expect to continue into 2012?

Greg Norwood

Well, it is the refi away from us and I would say at a macro level it’s really hard to predict pre-pays. But when I think about it in the first quarter, I would say that the reduction is about what we would expect, maybe some leveling off in the refi activity. And that the absolute balance will be down quarter-over-quarter.

Casey Haire – Jefferies & Company

Okay. And then just lastly, tax payable high at 35.5%, is this the new level, what should we expect in 2012?

Greg Norwood

It’s not a new level. There is a little bit of clean-up there, maybe less than $1 million. But for 2012, it should be in the 33% to 34% range.

Casey Haire – Jefferies & Company

Okay, great. Thank you.

Operator

Our next question comes from the line of Tom Alonso with Macquarie. Please proceed with your question.

Tom Alonso – Macquarie

Good morning, gentlemen.

John Koelmel

Good morning, Tom.

Tom Alonso – Macquarie

Most of my questions have been – actually have been asked and answered. Just real quickly, do you guys actually you have a pro forma Tier 1 common number under Basel III, do you estimate that?

John Koelmel

I mean we look at Basel III obviously and we talked about our Tier 1 common leverage ratio in the capital raise, they’re really about the same when we think of Basel III versus where we are now.

Tom Alonso – Macquarie

Okay, fair enough. And then just, John, to your comments on sort of a slowdown on the M&A side, is that just because you feel like you’ve done enough or is that because you want to rebuild capital or is it a combination of the two? I just want to sort of hear your thoughts on that.

John Koelmel

So we looked ahead six months ago, Tom, as to where we would be coming out of the HSBC transaction anew. We needed to ensure we had our legs fully under us operationally and otherwise as we continued to build out the franchise. The capital point while very comfortable with pro forma levels in the backside of the transaction employing M&A offense, currently want to accelerate the capital accumulation process and confident we’ll be able to do that in the near-term as well. So, it’s yes and yes to your question in terms of ensuring we’re well poised and positioned for the next wave of opportunities that will sort itself out somewhere down the road.

Tom Alonso – Macquarie

Okay. Thanks very much.

John Koelmel

Yeah.

Operator

Our next question comes from Peter Kovaleff with Horowitz & Associates. Please proceed with your question.

Peter Kovaleff – Horowitz & Associates

Good morning. Hi.

John Koelmel

Hey, Peter.

Peter Kovaleff – Horowitz & Associates

Situation, I wanted to spin the calendar back just a little bit to ask you about the divestiture strategy. I know that you sold more branches in the Buffalo area than were required by Justice and I’m wondering what led you to doing that. And also why was the sale made to Key, which would make it a much more formidable competitor. Wouldn’t it have been odd, perhaps a better business strategy to have sold for perhaps a little less to a less strong entity?

John Koelmel

Well, we’ll take those two separately, Peter. In terms of Buffalo, the DoJ piece, we sold the 26 branches that were required to the extent you’re looking at some larger Western New York footprints. The incremental branches that were sold that might be attributed to Western New York worked in the greater metro Buffalo area, those that were sold to Key were just those that were required to be exited for the DoJ terms and conditions.

As for who we sell to, we knew going in last July, August that we have to assemble the pieces of that divestiture puzzle as best as we could. Just as we do each and every day, our focus isn’t frankly on the competition, we’re very comfortable with the team and the talent and our ability to execute.

Obviously, we were going to enable some combination of competitors as a result of this. We’re picking up $15 million, going to shed $4 million. We did divvied up $4 billion of deposits among in this case three competitors were left with a net $11 million, very, very comfortable with the relative market gains that we’ll have and the top tier position that has enabled, so very much of a mission accomplished, and know that our focus is our own execution and highly confident no matter the competitor.

Peter Kovaleff – Horowitz & Associates

Okay. Well, thank you.

John Koelmel

Thank you.

Operator

(Operator Instructions) Our next question comes from the line of Bob Ramsey with FBR. Please proceed with your question.

Bob Ramsey – FBR

Hey, good morning.

John Koelmel

Good morning, Bob.

Bob Ramsey – FBR

I just wanted to talk a little bit about expenses a little more maybe, I know you all said $185 million is a good sort of starting point for the first quarter, and then you add 1.4% of the HSBC deposits, in addition to the, I think it is $11 million for core deposit intangible amortization?

Greg Norwood

Yes, that’s about right.

Bob Ramsey – FBR

Okay. And then once you sort of baked out all in and you’re at that run rate, how are you all thinking about their trajectory of expenses after that as you work towards longer-term efficiency targets, how much of that comes from revenue growth versus either costs trending lower or at least staying flat?

Greg Norwood

Certainly our strategy is to grow revenue and particularly both growing NII through 2012 as well as growth across the fee income line. So relative to an efficiency ratio, our strategy as a growth company is to focus on the revenue. As we said, we’ll continue to monitor the expense run rate in 2012, again I don’t see it going down in 2012, but we’re going to manage it relative to the investments we make, really with the plan of being exactly where we want to be as the economy returns hopefully with better levels at the end of 2013 and early 2014.

Bob Ramsey – FBR

Got it. So not going down, but not materially higher in the back half of the year or I am thinking about...

Greg Norwood

Correct, not materially higher in the back half.

Bob Ramsey – FBR

Okay, thank you.

John Koelmel

Thanks, Bob.

Operator

Our next question comes from the line of David Darst with Guggenheim Securities. Please proceed with your question.

David Darst – Guggenheim Securities

Hi, good morning.

John Koelmel

Hey, David.

Greg Norwood

Good morning, David.

David Darst – Guggenheim Securities

Could you tell us what you think is the optimum mix is for residential loans as a percentage of the total? And do you have the flexibility to retain the residential loans unlike some of the MBS securities one-off?

Greg Norwood

Well, the balance sheet, we’re obviously interested in growing the balance sheet. And when we look at residential loans, we try to keep the loans that best fit our asset liability management. So when I look at retaining loans, I don’t think we’ll retain loans that we’ve historically sold. Certainly, as we refi particularly variable rate loans, those we tend to keep more than sell, so I don’t see a big change in our strategy.

David Darst – Guggenheim Securities

Okay. And then maybe could you highlight some specifics regarding what additional investments you think you need to make in the franchise at this time, is it in the people or facilities or anything else?

Greg Norwood

I’d say it’s certainly people. And as you can appreciate, one of the things that we’ve held dear in looking at 2012 is our investment in people, both in the development of them, acquiring the right talent, and retaining that talent. So we will continue to make investments in people, in development and our winning with talent strategy.

The other I would say is our mantra is to be even better. So the efficiency of our back of the house and our efficiency of our front of the house execution are things we will focus on, and it’s both inefficiency and ineffectiveness. And I think the sales staff realignment in the branches is a great example of how we look at investments going forward. We look at that very carefully. We see some significant upside in serving our customers both from the small business and wealth management. And we also think that’ll make our branches more effective and we can sell more of those products and services out of those branches.

John Koelmel

I think in addition, David, is the reference, we’ve got the credit card platform, we’ve got indirect auto, we’re continuing to invest in our distribution network. I think there is eight or nine new de novo branches planned for the back half of the year, et cetera. So we’re continuing to invest across the platform, across the franchise to ensure we’re nicely positioned to keep moving forward as the tide eventually turns.

David Darst – Guggenheim Securities

Okay, great. Thank you.

John Koelmel

Thank you.

Operator

There are no further questions at this time. I would like to turn the floor back over to management for closing comments.

John Koelmel

All right, thank you very much, Robin. And as always, appreciate everyone’s time this morning. We look forward to continuing our dialogue in the months ahead and we’ll be back at you again in another 90 days. In the interim, have a good one. Thanks so much.

Operator

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

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