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Executives

Enrique Martell – Corporate Communications

Richard Carrión – Chairman and Chief Executive Officer

Jorge Junquera – Chief Financial Officer

Lidio Soriano – Chief Risk Officer

Analysts

Joe Gladue – B. Riley

Robert Greene – Sterne Agee

Ken Zerbe – Morgan Stanley

Michael Sarcone – Sandler O'Neill

Derek Hewett – KBW

Popular, Inc. (BPOP) Q2 2012 Earnings Conference Call July 18, 2012 10:30 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Q2 2012 Popular Inc. Earnings Conference Call. My name is (Clara) and I’ll be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of the conference call. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the call over to Mr. Enrique Martell, Corporate Communications. Please proceed sir.

Enrique Martell

Good morning. Thank you for joining us on today’s call. Chairman and CEO, Richard Carrión; our CFO, Jorge Junquera; and our CRO, Lidio Soriano will review our second quarter results and then answer your questions. They will be joined in the Q&A session by other members of our management team.

Before we start, I would like to remind you that in today’s call, we may make forward-looking statements that are based on management’s current expectations and are subject to risks and uncertainties. Factors that could cause actual results to differ materially from these forward-looking statements are set forth within today’s earnings press release and are detailed in our SEC filings, our financial quarterly release, and supplements. You may find today’s press release and our SEC filings on our webpage, which you may visit by going to popular.com.

I will now turn the call over to Mr. Richard Carrión.

Richard Carrión

Good morning and thank you all for joining the call. Please turn to the second slide. For the second quarter, we reported net income of $66 million, compared with the profit of $48 million in first quarter, our sixth consecutive profitable quarter.

We remain on track in executing our strategy by improving credit, building our asset portfolios to maintain our strong revenues, optimizing operating expenses, and continuing improvements on our U.S. operations. Our revenue generating capacity was clearly displayed in the second quarter with a net interest margin of 4.33% that stands well above our peer average and gross revenues amounting to $435 million.

A major takeaway from the results of the second quarter is that credit metrics continued to improve. Excluding bulk sales, the quarterly decline of $120 million in non-performing loans is our largest quarterly decrease in this credit cycle, while charge-offs reached their lowest level since 2008. The decrease in NPLs was experienced across the board in both Puerto Rico and the U.S. mainland and NPLs inflows fell to their lowest level in four years. We continued to add high quality portfolios to our asset base by completing purchases of $273 million in U.S. mortgages and $225 million in Puerto Rico consumer loans. The pipeline of foreign portfolio opportunities remains active.

We continued to generate internal capital and boost liquidity. Higher cash flows from our covered portfolio are expected to boost our original net revenue assumptions for the entire life of their portfolio while in the second quarter we received the cash dividend of $131 million from EVERTEC, of which we own approximately 4.09%.

Our tangible common equity and Tier 1 common ratios are strong at 9.09% and 12.29% respectively. The economic situation in our markets have stabilized as evidenced by recent economic indicators and our credit trends, but we are still seeing weak loan demand both in Puerto Rico and the U.S. mainland. Combination of this weak loan demand, higher cost related to collection efforts, and the current negative accretion of the covered portfolio, which I will cover later are the three main challenges that we face as we move ahead.

Please turn to slide 3 for greater detail on the quarter’s main takeaways. The improvement in our credit metrics is quite evident. NPL commercial and construction inflows fell 63% from their peak to their lowest level in four years. The net charge ratio fell to 1.85% in Puerto Rico and to 2.15% in the U.S. Opportunistic portfolio acquisitions and another quarter of solid loan production by our Puerto Rico mortgage business, which originated $397 million in the quarter helped maintain our non-covered loan volume at $21 billion with a yield of 6%.

We continue exploring every opportunity to further reduce our cost base by streamlining our origination processes, lowering branch network expenses, and tackling inefficiencies in areas we have identified. However, our focus on accelerating the resolution on NPLs has increased costs associated with these benefits, legal fees, appraisals, collections, valuation adjustments among others. Meaningful reductions in these expenses will only be achieved through sustained improvements in NPL levels.

Credit quality improvements have already provided palpable results at our U.S. operations, where the current run rate for the provision it’s 40% lower than last year’s. Although earnings on U.S. mainland are still not at an acceptable level, the U.S. operations are contributing to our overall profitability.

Consolidated personnel costs decreased by $5 million in the quarter. We also paid off $350 million in expensive repos rebuilt that were scheduled to mature in 2014 and carried an average cost of 4.36%. The prepayment expense of $25 million will be recovered over the two year period by replacing the borrowings at substantially lower current market risks.

In June, we reached an agreement with the Puerto Rico Treasury Department to clarify that the Westernbank covered assets are capital assets subject to a capital gain tax of 15% instead of the ordinary tax rate of 30%. This reduction in our estimated future tax liability generated a gain of $73 million for the quarter. We continued to be actively engaged in pursing one-off transactions as well as bulk sales to further de-risk our balance sheet. Some of these negotiations and other recent market indicators led to a write-down of $27 million in held for sale commercial and construction loans which are now valued at $179 million.

The $131 million cash dividend from EVERTEC reduced book value of our equity investment in EVERTEC by the amount of the dividend and it now stands at $62 million. EVERTEC’s dividend payment reflects the strength of the business and its potential value going forward. I’ll return later to review the performance of our covered portfolio and the negative depletion on the related FDIC indemnity assets which lowered earnings by $8 million in this quarter.

Jorge will now take a dive into our second quarter variances and then Lidio will discuss credit trends. So, let me turn it over Jorge.

Jorge Junquera

Thank you, Richard. Good morning please turn to slide 4, as you can see our second quarter results has some unusual items that I will explain by going into the main changes in revenues and expenses versus the previous quarter. Starting off at the top net interest income of $341 million was $4 million over the previous quarter with our net interest margin raising by 6 basis points to 4.33%, this was a result of two items. First, the yield on the covered loan portfolio rose 69 basis points to 7.7% reflecting higher accretable yield principally due to accelerated recoveries in a single loan pool. Secondly, deposit costs fell by 5 basis points in the quarter to 0.89%. This decline demonstrates additional progress in bringing down deposit costs.

Year-over-year our costs of deposits have declined 40 basis points. On the asset side, yield on securities declined 9 basis points to 2.98%, while the yield on loans excluding the covered loans declined 5 basis points. This was principally due to growth during the quarter in residential mortgage loans, while higher yielding categories such as credit cards and personal loans declined modestly showing yet another strong quarter originations in our Puerto Rico markets business increased by $81 million to $397 million in the second quarter. While we have been able to offset weak loan demand with opportunistic portfolio acquisitions, we continued to face challenges in organic loan origination.

Let’s move to slide 5 for better detail of the quarter-over-quarter variances. Service fess and other operating income declined by $10 million in the second quarter mostly driven by the negative variation in the valuation of mortgage servicing rights which decreased slightly by $1 million in this quarter after reducing by $6 million in the previous one. There was also negative variance of $7 million in income from investments accounted for under the equity method and this reflects the fact that we had a $7 million gain in the first quarter.

Credit card fees rose by $2 million offsetting part of the overall decline in this category. Gain on sale of loans on trading declined by approximately $38 million in the quarter with $31 million due to valuation adjustments and resolution costs related to loans held for sale and $5 million in hedging costs related to the securitization of mortgage loans which are more than offset by gains on such securitization activity. There was a positive variance in FDIC lost share income of approximately $18 million. This increase includes the impact of the 80% reimbursement under the loss-share agreement from increases in provision for covered loans and other expenses reimbursable by the FDIC, which accounted for $26 million. This was partially offset by an $8 million increase in the negative accretion of the indemnity asset as a result of the most recent recasting. Richard will talk more about this later.

Credit metrics continued to improve. The provision for non-covered loans fell slightly to $81.7 million. The provision for covered loans rose $19 million. Although overall, expected losses from this portfolio continues to decline, there are certain loan pools that reflect higher loan losses than originally expected. Because of full accounting, these loan estimates are recognized immediately through the provision, but are offset by the 80% loss-share agreement.

Other operating expenses rose by approximately $32 million in the quarter primarily because of two items, the $25 million repayment expense of the high-cost repos and $13 million for management cost of the covered portfolio. Of which, 80% are reimbursed by the FDIC and reflected in other income. Excluding these two items, total operating expenses fell slightly to $290 million primarily because of lower salaries, benefits, and other personnel costs.

Various discussions with the Peurto Rico Treasury Department culminated in an agreement during the second quarter, which clarifies that the assets acquired in the Westernbank FDIC-assisted transaction are considered a capital asset for tax purposes. Therefore, any related gains will be taxed as the capital gains tax of 15% instead of the ordinary income tax rate of 30%. This allowed – this transaction allowed us to reduce our deferred tax liability by $73 million in the quarter because of the reduced tax rate, generating a tax benefit of an equal amount.

With that, I would like to turn the call over to Lidio who will discuss credit trends. Thank you.

Lidio Soriano

Thank you, Jorge. From a credit metric standpoint, the key observation for the quarter is continuing to improve. I would like to do two things today. First, I will highlight (credit trends) and then take a closer look at our Puerto Rico mortgage exposure.

Please turn to slide number 6. Total non-covered loans grew slightly to $21 billion aided by the previously mentioned purchases in consumer and mortgage loans. NPLs, excluding covered loans, declined by $120 million to $1.56 billion, down 7% from the first quarter and 33% from its peak in the third quarter of 2010. NPLs are at the lowest level since the first quarter of 2009. The linked quarter decrease was experienced across both regions and across all portfolios.

Net charge-offs declined for the third consecutive quarter. On a linked quarter basis, net charge-offs fell by $10 million to $98 million, the lowest level since the first quarter of 2008. The decrease was mainly due to lower losses in both Puerto Rico and U.S. commercial loans. The provision for loan losses amounted to $82 million. As you may recall, the enhancements of our allowance methodology in the first quarter had a positive effect on the results of that period. The provision in the second quarter reflects lower losses and improved credit metrics from the commercial, legacy, and consumer loan portfolios. This improvement in credit metrics were in part offset by increasing the reserve requirements for the Puerto Rico mortgage portfolio due to higher losses and specific reserve requirements for loans restructure on the loss mitigation program.

As explained in our previous webcast, the increase in mortgage loss trends was principally related to implementation of our revised charge-off policy during the first quarter of 2012. We remain very comfortable with the risk profile of this portfolio. I will provide further details later in the presentation. The improvement in credit quality led to a decrease of $16 million in the Corporation’s allowance for non-covered loan losses during the quarter. The combination of the small decrease in the allowance and the reduction in NPL led to a slight increase in our coverage ratio.

Please turn to slide number 7 for further insight into NPL trends. On the top half of the slide, we illustrate NPL trends for the last three years. As discussed before, NPL declined for the second consecutive quarter and are at the lowest level since the first quarter of 2009. The $120 million decrease in the quarter was mainly due to improvements from the commercial, legacy, and mortgage loan portfolios.

Commercial NPLs decreased by $52 million, $30 million in Puerto Rico, and $22 million in the U.S. Legacy NPL decreased by $24 million while mortgage NPL decreased by $34 million. The decrease in mortgage NPL was driven by improvements in the Puerto Rico portfolio due to higher levels of TDRs returning to accrual status and a slowdown in the inflows of non-performing loans, particularly from the Corporation’s recourse portfolio. On the bottom half of the slide, we illustrate the commercial and construction NPL inflows in the second quarter of 2010. Inflows of commercial and construction NPL declined by $31 million or 22% from Q1 of 2012 down for the third consecutive quarter and reaching the lowest level since 2009.

Please turn to slide number 8 to review NPA trends. On the top, we show OREOs and NPL held-for-sale trends for the last three years. On a combined basis, OREO and NPL held-for-sale have declined $427 million or 51% since the fourth quarter of 2010. The decrease is mainly driven by bulk sales of NPLs completed during the first quarter of 2010 and the third quarter of 2011. The linked quarterly decrease in NPL held-for-sale was mostly driven by the negative valuation adjustments as a result of recent appraisals and market indications received. The decrease in NPL held-for-sale was partly offset by increases in OREOs mainly due to property foreclosed from the Puerto Rico mortgage portfolio.

The bottom half of the slide shows trends in the disposition of Puerto Rico properties over the last year and a half. The key message from this slide is that over the last 18 months, we had realized 81% of the unpaid principal balance at default upon disposition of mortgage OREO. This is significantly better than peers in the U.S. and partly explained the variance in net charge-offs between our Puerto Rico mortgage portfolio and the typical U.S. based mortgage portfolio. This is one of the reasons we feel comfortable about our exposures and risk, notwithstanding the increase in OREO. The delinquency trends and NPL inflows in our Puerto Rico mortgage portfolio are also encouraging.

Please turn to slide number 9 for further details into the Puerto Rico mortgage loan portfolio. The top half of the slide shows the key credit metrics on an average basis for the Puerto Rico mortgage portfolio since 2007. The information is shown dividend between regular and repurchased portfolio. Over the last two years, the delinquency of our total mortgage portfolio has increased driven primarily by repurchase from our mortgage recourse portfolio.

Excluding these repurchases, credit trends for the regular portfolio have improved since 2010. This has been driven by a combination of portfolio growth, TDRs returning to accrual status, and a slowdown in the inflows of NPLs. The increase in net charge-offs for the regular portfolio is driven by the previously mentioned change in charge-off policy implemented during the first quarter of 2012. In 2010 and 2011, the Corporation experienced an increase in mortgage repurchase activity from recourse portfolio that led to the increase in NPLs. Prior to 2010, repurchase activity was not significant. These are mostly legacy securitizations into Fannie Mae pools sold with credit recourse. In 2009 we stopped this practice. These loans have an average seasoning of seven years and average loan size of approximately $100,000. Once we repurchase the loan, we put them through our loss mitigation programs.

Their bottom half of the slide shows the trends in this portfolio. Consistent with stopping the practice of selling with recourse, the blue bar graph shows a decreasing trend with portfolio balance, down $1 billion or 25% over the last two years. Repurchase activity peaked in 2011 with approximately $60 million per quarter. In the first two quarters of 2012, we have average approximately $40 million and I expect this decreasing trend to continue due to improved credit quality.

With that, I would like to turn the call over to Richard for details on the FDIC-assisted acquisition and his concluding remarks. Thank you.

Richard Carrión

Thanks, Lidio. The FDIC-assisted acquisition has exceeded expectations as we have consistently reported. Estimated cash flows are greater due to lower losses. The transaction has provided a solid income stream and created a one of a kind opportunity to add new clients to our base. As you are well aware, the accounting for this transaction is pretty complicated, but let me take a stab at explaining it.

On slide 10, you see a static depiction of our day 1 assumptions. The fair value of the covered portfolio balance amounted to $4.9 billion, net of estimated losses. Bear in mind, this is a portfolio that had an unpaid principal balance of $8.1 billion at the time of the acquisition.

An indemnity asset or receivable was created to reflect the present value of 80% of estimated losses to be reimbursed by the FDIC. On day 1 that asset was estimated at $2.4 billion. A liability was also recorded to reflect our obligation to reimburse the FDIC if actual losses are less than the FDIC’s original estimate. This liability is often referred to as a claw-back or a true-up. Present value of the claw-back amounted to $88 million on day 1.

Now, if everything would have turned out as planned on day 1, if we could have had laser precision on the estimate and timing of cash flows of an $8.1 billion impaired loan portfolio. This portfolio would have netted $1.7 billion in revenues by the time all loan payments and loss reimbursements from the FDIC had been collected. But as you all know, reality is a bit messier than that.

Please turn to slide 11. Again, we expect this transaction to perform better than we originally estimated, but let’s go through some of the ups and downs. As reflected in shaded area number one of the graph, midway through 2011, we received accelerated cash payments from a number of large borrowers, some of which we originally estimated to have significantly higher losses. These cash flows resulted in a faster recognition of the accretable yields exceeding the day 1 assumption line on the chart during the first few quarters.

Moving on to shaded area labeled number two, the recasting of loss estimates during the quarter ended June 2011 resulted in lower estimated loan losses than originally anticipated. Although the reduction of estimated losses increases the accretable yield to be recognized over the life of the loans, it also has the effect of lowering the realizable value of the indemnity assets since we are now going to collect fewer FDIC payments under the loss-share agreement.

While we were originally accreting to the future value of the indemnity assets, the lowered loss estimates require us to amortize the asset to expand lower expected collectable balance. Because of the shorter life of the indemnity asset vis-à-vis the expected life of the loan, this amortization temporarily offsets the benefits of higher cash flows accounted through the accretable yield. This amortization is what is sometimes referred to as negative accretion.

Let me clarify something else that maybe confusing. While overall loan losses are expected to be lower, there are certain loan pools that reflect higher loan losses than originally expected. Pool accounting required that these increased loss estimates for these particular pools be recognized immediately through the provision. They are also offset by the 80% loss-share agreement. Today, the impact of the negative accretion and the 20% of the provision expense has reduced day 1 estimated net revenues by $14 million.

Moving on to the third point in the graph, the negative accretion on the indemnity asset slows down compared with a contribution from the accretable yield since the balance of the indemnity asset is decreasing at a faster rate than the balance of the loans. As a result, net revenues will be pushed higher.

Let’s move to the shaded area number 4. Lower losses result in loans generating higher cash flows for a longer period of time. Since the bulk of the losses come from the commercial and construction loan pools and we expect to resolve them within terms of the non-single-family loss-share agreement that expires in 2015, future revenue streams from that point on should be more stable.

Key takeaway is that the Westernbank transaction is expected to produce $363 million more in net revenues than originally estimated, but be aware this will be a bumpy ride and keep in mind two things. The forecast we are showing you is as of June 30 and subject to subsequent quarterly recasting, also no additional provisions has been incorporated into these forecast. So, the recast process by definition contains all estimates of future losses. So what you see here will change next quarter. I can assure you that not all the benefits of the Westernbank transaction are fully embedded in the estimated revenues from the accretable yield. The model assumes full runoff of the portfolio. It assumes none of the more than 100,000 new clients that came by the way of the transaction has stayed or will stay beyond the life of the loans. Clearly, we’re actively expanding our relationships with these clients and retaining them.

Please turn to slide 12 for our concluding remarks. We’ve told you what our strategy is and what we are focused on. We made real progress in the second quarter with a reduction of $120 million in NPLs and purchases of $500 million in high quality loans. We are consistently showing lower NPL inflows, lower losses and strong revenues. We continued to build on our dominant position in Puerto Rico and on our consistent progress in our U.S. operations, which continued to contribute to the bottom line. We are exploring every opportunity to further reduce our cost base, however, a significant portion of our costs are dependent on sustained improvements in our NPL loans.

Regarding capital, our robust levels continued to increase. We are not wild about Basel III, we continue our analysis and we don’t anticipate needing to raise additional capital even on a full stress scenario. Although the economic situation in our markets are stabilized as evidenced by recent economic indicators in our credit trends, we are still seeing weak loan demand both in Puerto Rico and U.S. mainland.

Loan origination volume so far this year has been below expectations. We’ve been able to source quality portfolios in the market, but we’re depending on purchases to fully offset the effect of weak loan demand. The combination of this weak loan demand, higher costs related to collection efforts and the current negative accretion of the current portfolio I covered earlier is making it challenging to meet our targets. We now expect to earn between $210 million and $225 million in 2012.

While this is a higher nominal range that we expressed earlier, if you back out the unusual events of the second quarter that is that tax benefit and the after tax effect of the early repo termination and write-down of the HFS portfolio, you’ll get to a number that is $10 million less than our original range of $185 million to $200 million. While we continue to strength to make up this difference, we’re more interested in positioning ourselves for the future.

With that, I’d like to now open the call for questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Joe Gladue with B. Riley. Please proceed.

Joe Gladue – B. Riley

Hi.

Richard Carrión

Hi, Joe.

Joe Gladue – B. Riley

Richard, let me just follow-up on one of your last comments about Basel III, just wondering if you could touch on what you think some of the major impacts that will be on your business and if it caused you to change any of your business practices – types of loans or securities?

Richard Carrión

So, far I think the major impact will be felt in our mortgage business. We’re looking at waiting through these rules. It looks like the major impact will be on the mortgage side. Again we’re not crazy about it, but we don’t see anything in there that we can live with it will obviously require some adjustments about, but we haven’t seen anything that we can’t live with. I don’t know Jorge if you want to add?

Jorge Junquera

No, that’s correct. You mean that this is a process that it will be phased in through a period of time. And given that it will be increasing capital organically throughout this time, we conclude there is no reason we conclude that we will have to raise capital, because of Basel III we feel comfortable.

Joe Gladue – B. Riley

Okay. Let me ask a question or two to about I guess asset quality just I guess some numbers. Could you tell us where I guess the current TDRs and early stage delinquencies stood at quarter end?

Richard Carrión

I don’t have the numbers in front of me we’ll provide that information after the call, Joe.

Joe Gladue – B. Riley

Okay.

Richard Carrión

It’s something that we include in our regular package, its part of – will be part of the 10-Q, but we’ll provide you that after the call.

Joe Gladue – B. Riley

Okay. And I guess lastly, I’ll just ask in regards to the loan purchases just wondering one in a quarter they were when you made them and how much impact they might have won – still to come?

Richard Carrión

Yeah, the Puerto Rico when actually closed on June 28, the U.S. was in it throughout the quarter, they were a number of purchases. Carlos, you have different dates on it, but they were throughout the quarter.

Carlos Vázquez

The biggest part of the U.S. purchase was during the month of May.

Joe Gladue – B. Riley

Okay, alright. Thank you.

Operator

Your next question comes from the line of Robert Greene from Sterne Agee. Please proceed.

Robert Greene – Sterne Agee

Good morning. Just a couple of quick questions, I think first I just want to revisit your revised guidance expectations, I know there is obviously a lot of moving parts with the quarter and sort of going forward. But the $10 million reduction I guess in – with the guidance, I was wondering what was specifically attributable to that whether it’s slow in top line, higher than expected expenses or I guess higher than expected provision?

Richard Carrión

Well, it’s a combination of things. One is we are seeing very weak loan demand and we are depending on loan purchases to make better. And as you know these things sometimes come up or sometimes they don’t come up. So, there is some uncertainty to the downside there. Additionally, we are finding as we go through the cost reductions, we are finding a lot of costs that are associated with NPL and it’s very difficult to bring those down until we are – we bring all the NPLs that are down. We had in this quarter that negative amortization of FDIC asset which I explained so masterfully that was $8 million in cote, so that was in levels that we weren’t trying.

Robert Greene – Sterne Agee

Okay, it’s very helpful. And then I guess going over to credit quality on the commercial inflows big improvement in Puerto Rico looked a little bit more flat in the U.S. and I understand it’s lumpy, but do you expect sort of that $45 million run rate to improve or is that kind of status quo for the foreseeable future?

Lidio Soriano

I will say I mean in the U.S. business we are further along in terms of improving the credit quality. So, I think some of the dynamics of improvement in Puerto Rico versus improvement in U.S. are different in that regard I think you will see - continue to see improvement or I think you’ll continue to see improvement in Puerto Rico and improvement in the U.S. will be more leveled?

Robert Greene – Sterne Agee

Okay. And then just one last follow-up on credit quality, it looks like there was a modest reserve release in the non-covered portfolio. But overall, I’m sorry reserve coverage in mortgage went up. I’m just wondering how much of that is attributable to the change in charge-off policy versus the portfolio purchases or any of the sort of reevaluation of the portfolio loss content?

Lidio Soriano

I think the increases in the allowance for the mortgage portfolio driven by two factors as you mentioned. We changed the charge-off policy and that has implemented – it has an impact in the methodology and cumulative procedure we use in order to estimate losses. But in addition to that we have had significant activity in terms of loss mitigation programs and drove up their restructuring and that activity has also increased the level of research for our portfolio.

Robert Greene – Sterne Agee

Alright, I think that’s well do, thank you very much.

Richard Carrión

Thank you, Bob.

Operator

Your next question comes from the line of Ken Zerbe with Morgan Stanley. Please proceed.

Ken Zerbe – Morgan Stanley

In terms of the selling of the NPA – pieces of the NPA portfolio you mentioned a couple of times can you just give us sort of an update in terms of you’re – the likely ability you guys have to sell that reasonably soon or bring to that down including the willingness of buyers to purchase some of those NPAs? Thanks.

Richard Carrión

We have quite a few discussions going on and it’s difficult to predict when these reach fruition. There are a few deals that we think can happen certainly in the second-half of the year. Some individual deals and there are a few people looking at portfolios. But I just can’t give you assurance that we’ll get it done. We do think we will bring the level done considerably and we are very focused on that, because it’s not only bringing the NPA level down, it impacts a lot of other expenses that we’d like to come down.

Ken Zerbe – Morgan Stanley

And was there any other reduction this quarter in the NPAs related to sales or was that just that’s a broad question, but anything unusual on the reduction of NPAs this quarter or is that just very plain blocking and tackling and bringing it down?

Richard Carrión

It was blocking and tackling, but one or two did come in that we have been working on a while, but no sales, usually pay-off not sales, it’s kind of pay-offs on the sales.

Ken Zerbe – Morgan Stanley

Okay and just last question about a month…

Richard Carrión

I’m giving it to Lidio, so if I am telling the truth.

Lidio Soriano

You go ahead.

Ken Zerbe – Morgan Stanley

Okay, about a month ago when you guys were at our Conference I think Jorge gave an estimate for the impact of Basel given the higher risk weightings on the resi was about 100 to 200 basis points. I was just wondering if you guys had done any more work to get more precise estimate?

Richard Carrión

We are again calibrating that, but it’s not going to be more than that. And as I’ve told you, we don’t anticipate needing to raise any capital, any additional capital to comply with new things, it will make something from the business difficult, but we don’t anticipate the need to raise capital even in the full stress scenario.

Ken Zerbe – Morgan Stanley

Great. Thanks.

Operator

(Operator Instructions) Your next question comes from the line of Michael Sarcone from Sandler O'Neill. Please proceed.

Michael Sarcone – Sandler O'Neill

Hey, good morning guys.

Richard Carrión

Good morning.

Michael Sarcone – Sandler O'Neill

Thanks. As it relates to funding costs just on the repro agreement terminations, do you have an estimate to how beneficial it will be to the margin replacing that with lower cost repos?

Jorge Junquera

Certainly we would expect this to improve the margin point forward for recent developments on it. It’s within the entire amount it has a few basis points that sure will come handy in the future.

Richard Carrión

We’ll make it up over the next 24 months so…

Jorge Junquera

That’s right. It would be – the default will be coming in 2013

Michael Sarcone – Sandler O'Neill

Okay. And on deposit costs is there much more room to come down on those?

Richard Carrión

There is still some more room as I mentioned probably in the last couple of calls, it’s getting tighter. It’s getting more difficult as we have reached levels that really bottomed out, but there is probably another 5 to 10 basis points hopefully.

Michael Sarcone – Sandler O'Neill

Okay. And then switching to the mainland franchise, can you just refresh us on your outlook there and potential strategic alternatives?

Richard Carrión

Carlos is here, so let me – let him handle that, he has been quiet.

Carlos Vázquez

We made a lot of progress this year. And as Lidio referred to in the first quarter, the U.S. operation did benefit from some reserve releases. And in the second quarter, we also achieved the solution of some long-standing up from the loans, which have resulted a little bit. So, we continued to be positive. As Richard mentioned earlier, we expect contribute to overall the Corporation this year. So, I wouldn’t go out as far as multiplying the first six months by two, okay.

Unidentified Speaker

You bet.

Carlos Vázquez

And strategically, we are still focused on just continuing to improve the operation, our biggest operations in New York, which we just re-branded five weeks ago. So, we are focused on basics and blocking and tackling as we discussed earlier.

Michael Sarcone – Sandler O'Neill

Okay, thanks guys.

Richard Carrión

Okay.

Operator

Your next question comes from the line of Derek Hewett with KBW. Please proceed.

Derek Hewett – KBW

Good morning.

Richard Carrión

Good morning, Derek.

Derek Hewett – KBW

Hey, do you guys have the current cash balances held at the holding company as of the second quarter?

Richard Carrión

Size of the holding company?

Jorge Junquera

About $300 million.

Richard Carrión

Yeah.

Derek Hewett – KBW

And is that just cash or cash equivalents as does that include any of the – I think the holding company has some investments in the…

Jorge Junquera

No, that’s cash and cash equivalent.

Derek Hewett – KBW

Okay. And then moving on to the NPA balances that are held-for-sale, what percentage of unpaid principal balance are those loans currently marked at?

Lidio Soriano

37%, 37.5% more or less.

Derek Hewett – KBW

Okay, great. Thank you very much.

Operator

Your next question comes from the line of Jason O’Donnell with (indiscernible) Research. Please proceed.

Unidentified Analyst

Good morning.

Richard Carrión

Good morning, Jason.

Unidentified Analyst

Can you just comment maybe on your outlook for core non-interest income for the remainder of the year? It looks like the other service fees and other operating income lines were down linked quarter and maybe just remind us of what the key items are in the other operating income line that are driving those big linked quarter variances?

Richard Carrión

Bear in mind that – that other income is down for a couple of reasons. One is that write-down in held-for-sale comes off the gain on sale piece, which is part of other income. So, when you compare it, you got to bear that in mind. Other than that, I think it should remain fairly strong. I think we’re looking at fairly flat for the rest of the year.

Unidentified Analyst

Okay. So, you expect other service fees to that particular line to rebound for the remainder of the year?

Richard Carrión

Yeah. The thing that creates some volatility in that line is the FDIC stuff and that goes up and down depending on the covered loan provision expense and 80% of that in any expenses. We have, for example, this quarter I think we have $13 million in our operating expenses that they reimbursed up to us, so that’s $10 million. So, it jumps up and down with that kind of stuff. You got to take that out.

Unidentified Analyst

Okay, thanks guys.

Richard Carrión

Okay.

Operator

I would now like to turn the call over to management for closing remarks.

Richard Carrión

Okay. Well, thank you very much for joining us and see you next time.

Jorge Junquera

Thank you.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a great day.

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