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People's United Financial (NASDAQ:PBCT)

Q2 2012 Earnings Call

July 19, 2012 5:00 pm ET

Executives

Peter Goulding

John P. Barnes - Chief Executive Officer, President, Director, Member Of Executive Committee, Member Of Treasury & Finance Committee, Member Of Enterprise Risk Committee, Chief Executive Officer Of The People's United Bank, President Of The People's United Bank And Director Of The People's United Bank

Kirk W. Walters - Chief Financial Officer, Senior Executive Vice President, Director and Member of Enterprise Risk Committee

Analysts

Ken A. Zerbe - Morgan Stanley, Research Division

Collyn Bement Gilbert - Stifel, Nicolaus & Co., Inc., Research Division

Damon Paul DelMonte - Keefe, Bruyette, & Woods, Inc., Research Division

Matthew Brandon Kelley - Sterne Agee & Leach Inc., Research Division

Bob Ramsey - FBR Capital Markets & Co., Research Division

Casey Haire - Jefferies & Company, Inc., Research Division

Thomas Alonso - Macquarie Research

Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the People's United Financial Inc. Second Quarter Earnings Conference Call. My name is Jeff, and I'll be your coordinator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to Mr. Peter Goulding, Senior Vice President of Corporate Development and Investor Relations for People's United Financial Inc. Please proceed, sir.

Peter Goulding

Good afternoon, and thank you for joining us today. Jack Barnes, President and Chief Executive Officer; Kirk Walters, our Chief Financial Officer; along with Jeff Hoyt, our Controller, are here with me to review our second quarter results. Before we get started, please remember to refer to our forward-looking statements on Slide 1 from our presentation, which is posted on our website, peoples.com, under Investor Relations.

With that, I'll turn the call over to Jack.

John P. Barnes

Thank you, Peter, and good afternoon, everyone. We appreciate you joining us today. On Slide 2, we provide an overview of our second quarter results. For the quarter, operating earnings were $67.2 million or $0.20 per share, up from $60.6 million or $0.18 per share in the first quarter. Net income after -- net income for the quarter, including non-operating items, was $64.8 million or $0.19 per share. The net interest margin declined to 3.97% compared to the 4.01% in the first quarter. The decline in the margin is the result of lower loan yields and higher levels of securities purchased earlier in the quarter in anticipation of our receipt of the proceeds for the Citizens branch transaction late in the quarter. This is partially offset by cost recovery income related to negotiated settlements and payoffs in the acquired loan portfolio.

Loan growth, including runoff in the acquired portfolios, amounted to 2.3% on an annualized basis, which was entirely funded by deposit growth.

Originated loan growth was strong and amounted to 11.2% on an annualized basis. Noninterest income increased $3.3 million compared to the first quarter, reaching $75.7 million. This increase was primarily due to growth in cash management fees, operating lease income, prepayment fees and gain on sale of acquired loans.

The efficiency ratio improved to 61.5% from 63.2% in the first quarter. This is a result of improved operating leverage from higher revenues and lower expenses. Capital ratios remained strong with the tangible equity ratio at 11.5% for the second quarter. We continue to make progress deploying our capital through balance sheet growth and share repurchase activity.

On Slide 3, we discussed several recent initiatives. Most importantly, we continue to expand our presence in key growth markets such as the New York metro area. We recently completed the acquisition of 57 Citizens branches in the greater New York metro area and rebranded all of the acquired branches over the weekend of June 22. 53 of the branches are in Stop & Shop supermarkets and 4 are traditional branches.

Through these branches, we will be reaching approximately 900,000 weekly visitors to Stop & Shop stores, which will significantly strengthen our brand awareness in the country's largest MSA. We now serve customers in approximately 100 branches in the New York metro area. As is the case throughout our footprint, we strive to bank the market. As we continue to build our deposit footprint in the New York metro area, we are simultaneously adding asset generation capabilities.

First, as we have said about our Stop & Shop branches in Connecticut, we generate a substantial portion of our residential mortgage and home equity originations through these in-store branches. We also see significant commercial activity in these branches. In time, we expect the recently acquired branches will also become significant asset generators.

In addition, we have expanded our C&I and asset-based lending efforts in New York metro area, adding 5 seasoned in-market C&I lenders on Long Island and 2 ABL professionals.

Recently, we also added 3 senior New York commercial real estate professionals. These individuals have spent their careers focused on New York commercial real estate relationships and are well known to both the market and our management team. Further, within the last week, we added a senior private banking professional, who will lead our private banking business, including expansion in the New York metro and Boston.

Second, over the last few quarters, we have built upon the depth of our cash management talent, and we are now starting to see the benefit of their efforts. In addition, we've been working to deepen our brokerage penetration throughout the footprint.

Third, we repurchased 4.5 million shares or $53.7 million at a weighted average price of $11.93 per share in the second quarter. Year-to-date, we repurchased 9 million shares or $110 million at a weighted average price of $12.24 per share. This results in approximately $6 million of annual dividend savings. We have 9 million shares remaining in our existing share repurchase authorization.

Now I'd like to turn it over to Kirk.

Kirk W. Walters

Thank you, Jack. On Slide 4, you can see a breakdown of the elements contributing to our 3.97% net interest margin for the quarter. As you'll recall, our first quarter net interest margin was 4.01%. Lower loan yields and higher levels of securities negatively impacted the margin by 8 basis points and 5 basis points, respectively. The expanded securities portfolio relates to both the cash proceeds from the Citizens branch acquisition and deposit growth exceeding loan growth. This was partially offset by an 8-basis point improvement from cost recovery income related to settlements and payoffs in the acquired loan portfolio. Deposit costs, excluding fair value amortization, were 50 basis points, down from 55 basis points in the first quarter, which benefited the margin by 4 basis points.

The progress in reducing core deposit costs was offset by the expiration of the Bank of Smithtown and RiverBank fair value CD amortization, which negatively impacted the margin by approximately the same amount.

It is worth pointing out that the fair value amortization from the Danvers acquisition were run off in October 2012 and negatively impact our fourth quarter deposit cost by approximately 3 basis points.

Fair value amortization from the Citizens transaction is negligible with less than 1 basis point of positive impact on funding cost. In this rate environment, there continues to be opportunities to lower the deposit costs, particularly in the markets we have recently entered via acquisitions.

On Slide 5, you can see that our operating net interest margin declined to 3.89% in the quarter. The difference between GAAP and operating net interest margin is the cost recovery income, which we view as discrete and transactional in nature. Our strong margin is a product of our low-cost stable funding, loan mix and solid capital levels, all of which means that we do not need to stretch on credit. In addition, our margin is and will continue to be supported by $1.1 billion of accretable yield resulting from 5 acquisitions closed within the last 2.5 years. Let me provide you a little more detail on the next slide.

Slide 6 links closely with our discussion of the net interest margin. For the quarter, interest accretion on acquired loans totaled approximately $56 million, down from $60 million in the first quarter. The decline in accretion primarily related to Fin Fed, which accounted for $3 million of the difference. As we have said, we expect Fin Fed accretion is likely to expire at the end of this year, negatively impacting the net interest margin by approximately 5 basis points in 2013.

The carrying amount of acquired loans appeared in total $3 billion. During the quarter, there were reclassifications associated with our reassessments -- of the Butler and Smithtown portfolios. These reclassifications were driven by better-than-expected credit performance in these portfolios. For Butler, we reclassified $6.5 million from non-accretable to accretable. For Smithtown, we reclassified $2.4 million from non-accretable to accretable.

As with all prior reclasses, the amount of periodic accretion will be adjusted respectively over the remaining life of the underlying loans.

Slide 7 is a new slide that illustrates the amount of noncash accretion running through our income statement. If you go to the top left, you see we booked total accretion of $56 million this quarter, which when you annualize and divide by the average balance of the acquired loan portfolio, gives us an effective yield of 6.97%. The weighted average coupon in the acquired loan portfolio is 5.51%. This is the actual cash coming in from the acquired loans. The difference between the 6.97% effective yield and the weighted average coupon is 1.46%, which amounts to $11.7 million of additional interest income from the amortization of the original discount on the acquired loan portfolio. Annualizing this number and dividing it by the adjusted average earning assets in the second quarter shows the 19 basis points of our operating net interest margin during the quarter relates to noncash accretion.

So if you want to think about our core underlying margin excluding the noncash accretion, it would be our operating net interest margin of 3.89% less than 19 basis points to 3.7%. The noncash accretion is equivalent to $0.02 a share this quarter, which is similar to prior quarters as shown on the right-hand side of the page. There has been some confusion about this topic, but we believe this slide helps set the record straight. We will continue to update this slide in the quarters ahead.

Over time, as the acquired loans repay, mature or settled, the amortization original discount will dissipate. At the same time, it is possible that we may also experience reclassifications from the non-accretable difference bucket to accretable yield due to better-than-expected credit performance.

Slide 8 provides a breakdown of elements contributing to our net increase in loans. As Jack noted earlier, the loan portfolios produced 11.2% quarter-over-quarter annualized originated loan growth for a total loan growth of 2.3% quarter-over-quarter annualized on a period-end basis. We believe we operate in the best commercial banking market in the United States and are one of the few banks that can credibly offer the full product suite of a large bank while maintaining our outstanding customer service standards. Originated loan growth for the quarter totaled $477 million. As in prior quarters, growth came from a variety of products and geographic areas.

Originated commercial loans increased $374 million quarter-over-quarter, which included increases of $143 million, $119 million and $111 million from C&I, equipment financing and commercial real estate, respectively. Within C&I, we saw strength across all categories, but I would highlight a few businesses that continue to outperform. Our equipment finance businesses, PCLC and People's United Equipment Finance, grew originated loans $48 million and $71 million, respectively, in the quarter. Since the acquisition of Financial Federal, now known as People's United Equipment Finance, closed in early 2010, the loan outstanding within this portfolio had consistently declined. However, over the last 2 quarters, we have seen this portfolio begin to grow.

Originated residential mortgages grew by $104 million or 13% annualized. The residential mortgage originations, approximately 57% were hybrid adjustable-rate mortgages, and 55% of the pipeline is jumbo product. Second quarter 2012 originations average loan size is $574,000. Average FICO score for the second quarter originations was 755 with an average LTV of 65%.

Originated home equity loans increased by $11 million. Home equity loan closings totaled $164 million in commitments compared to $126 million in first quarter 2012. In terms of recent originations, the average line size the second quarter originations was $132,000. The average FICO score was 766 with an average combined loan-to-value of 58%. Consistent with our past practices, 100% of home equity loans are retail originated.

The acquired portfolio declined by $360 million or 43% on an annualized basis. Acquired loans are running off with a faster-than-anticipated rate for several reasons. First, the low interest rate environment is pushing customers to settle or pay off acquired loans relatively quickly. Second, the lack of prepayment fees in the acquired loan portfolios encouraged customers to refinance. This dynamic is due in part to the transactional nature of the acquired companies' portfolios, whereas our business is much more focused on building long-term relationships.

Further, there is a concentration of criticizing classified loans and runoffs that we are comfortable parting ways with. This decline in the acquired loan portfolio, coupled with a challenging economic and competitive environment, will likely pressure loan growth towards the mid-single digits for 2012.

You can see in Slide 9 a breakdown of the elements contributing to our net increase in deposits. We have witnessed steady growth in both retail and commercial -- in both the retail and commercial segments with annualized total deposit growth of 3.6% in the quarter. Deposit growth was positively impacted by the Citizens transaction, which closed late in the quarter, but was partially offset by seasonal swing in Vermont municipal deposits.

Excluding the seasonal swing in municipal deposits, commercial deposit growth was 12.6% on an annualized basis. We have also seen an improvement in deposit mix with increases in non-interest-bearing and savings deposits of $25 million and $150 million, respectively, and $114 million decrease in time deposits. Average total deposits were up $346 million quarter-over-quarter.

The larger deposit gathering opportunities in front of us relate to increasing our deposit mix in favor of both retail and commercial non-interest-bearing deposits with better utilization of the acquired Citizens branches.

Slide 10 shows that we continue to make progress on loan and deposit growth on a per share basis while maintaining excellent asset quality. We know that if we grow loans and deposits per share, increase fee income and continue to reduce costs, we will produce greater recurring earnings per share. Over the past 2 years, loans per share and deposits per share have grown at compound annual rates of 20% and 19%, respectively.

Slide 11 provides a breakout of noninterest income, which increased $3.3 million from the first quarter. The income areas that demonstrated momentum included cash management and operating lease income, which increased $1.8 million and $1 million, respectively. Loan prepayment fees and gains on the sales of acquired loans also contributed to quarterly fee income growth, increasing by $1.6 million and $700,000.

As a reminder, our insurance business is seasonal. The second and fourth quarters tend to be weaker than the first and third quarters.

On Slide 12, you can see that our noninterest expense based improved to $206 million from $209 million last quarter. During the quarter, we experienced $3.6 million of non-operating expenses, $2 million of which related to the Citizens transaction.

As we think about noninterest expense, we are focused on the operating noninterest expense base. The second quarter operating expense base was $202.1 million, which included $700,000 related to the newly acquired Citizens branches and was down from $205.6 million last quarter. The largest part of this decrease was attributable to compensation benefit reductions, which declined $5 million to $103 million in the current quarter. Approximately $3 million of this decline relates to lower payroll taxes, which are typically higher in the first quarter as a result of the timing of annual incentive payments.

The third quarter will contain a full quarter of expenses for the newly acquired Citizens branches, which we estimate to be $7.8 million or an increase of $7.1 million from the second quarter. We expect that during the course of 2012, we will be steadily walking the quarterly run rate down such that our targeted full year operating expense base should be in the range of $825 million to $830 million. In the quarters ahead, we are committed to continuing to bring the absolute expense levels down on a pro forma basis.

On Slide 13, we provide a historical perspective on our efficiency ratio. The efficiency ratio improved to 61.5% for the second quarter compared to 63.2% in the first quarter and 64.9% in the second quarter of 2011. Although exhibiting progress, the efficiency ratio has been negatively impacted by slower-than-anticipated loan growth and a decline in net interest margin. In particular, the reduction in the absolute level of interest rates from the end of last year was unexpected. And if interest rates remain at their current record low levels, we may see the timing of achieving our 55% efficiency ratio goal slipping into 2014.

As we discussed in the first quarter earnings call, the newly acquired Citizens branches are expected to cost us $0.01 per share in 2012, $0.02 per share in 2013 and breakeven in 2014. This transaction will also impact our reported efficiency ratio progress until we reach the breakeven point.

Next, we move on to an overview of recent expense initiatives. Given the difficult economic climate and the industry's increased regulatory and compliance burden, we established the expense management oversight committee in the fall of 2011. This committee is comprised of 3 senior executives: The Chief Financial Officer, Chief Administrative Officer and Chief Human Resources Officer, that enables us to operate with a much more rigorous approach to expense control. This table outlines several key initiatives for 2012, as well as the new ones from this quarter to provide us an update on their current status. One of the goals of expense management oversight committee has been to focus on a longer planning horizon. For example, we now begin negotiating contracts 1 to 3 years in advance of expiration, which gives us a stronger negotiating position since the vendors recognize with this much lead time, we have the ability to switch providers.

We will provide an update on our cost reduction progress and the latest expense initiatives every quarter. It is important to note that we are still investing in the business while continuing to reduce expenses. The revenue initiatives that we have funded over the last year include the additional commercial relationship officers and support staff in the New York metro area, as well as additional talent in several key growth areas, including asset-based lending, mortgage warehouse lending, wealth management and private banking.

We are pleased to say these initiatives have produced sufficient increased revenues to cover their expenses and contribute to the bottom line with the exception of wealth management, which we expect to break even next year; and the acquired Citizens branches, which we project to break even in 2014.

Slides 15 and 16 are a reminder of our excellent credit quality. We did see an improvement in nonperforming assets this quarter from already industry-leading levels. NPAs decreased approximately $22 million to $295 million. Nonperforming assets at 1.67% of originated loans and REO remain well below our peer group and Top 50 banks.

Looking at Slide 16, net charge-offs were 26 basis points compared to 22 basis points last quarter. Approximately 5 basis points of our charge-offs this quarter related to losses in acquired loans. Accordingly, net charge-offs and originated loan portfolio was effectively flat on a linked quarter basis. These levels continue to reflect the minimal loss content in our nonperforming assets that stand at approximately 50% of our peers.

Over the last 4 quarters, charge-offs against specific reserves represent approximately 48% of total charge-offs. As such, we understand our credit issues well and typically have very few new credit events each quarter.

On Slide 17, you can see the detail for the allowance for loan losses by loan category. A few items to note. Our allowance for loan losses to commercial loans is 1.28% with a coverage ratio of 82% of commercial NPLs. As we have stated previously, we have a strict loan loss allowance methodology, which is consistently applied. That said, mix shift and new originations can result in modest changes in the overall coverage ratio in any given quarter. Provision for loan losses reflects $13.5 million in charge-offs, including $7.5 million at the previously established specific reserves and $4.6 million of additional allowance billed in response to loan growth.

Now I'll pass it back to Jack.

John P. Barnes

Thank you, Kirk. On Slide 18, you can see our operating return on average assets for the second quarter was 97 basis points, up significantly from the first quarter. However, this includes approximately 6 basis points of improvement related to cost recovery income, which we regard as discrete and transactional. It's also worth noting that the operating return on average assets in the third quarter of 2011 was positively impacted by securities gains amounting to 8 basis points. You'll recall that we took this action to reduce the premium on our books and protect against amortization exposure.

Making both of these adjustments, the chart would then illustrate consistent returns on average assets over the last 5 quarters of approximately 90 basis points. With this in mind, it's important to reflect upon the progress that we have made over the past 3 years.

As we have strengthened the earnings power of the franchise through the additions of key personnel, the expansion of key business lines and through the thoughtful deployment of capital, we have also absorbed the negative impact of regulatory reform to related higher cost of compliance and the impact of a prolonged low interest rate environment. Through all of this, we have nearly doubled our return on average assets from 49 basis points in the second quarter of 2009 to consistently performing over 90 basis points.

On Slide 19, we expect to see an increase in return on average tangible equity as we improve profitability and thoughtfully deployed capital. Our significant capital levels remain approximately 350 basis points above peers, which produces below industry return on average tangible equity. Normalizing our equity base to be consistent with our peers shows that the bank is performing well with return on average tangible equity at 12.4%.

On Slide 20, consistent with the outline of our financial targets, we expect to see our operating dividend payout ratio trend lower throughout 2012. While we were aided by cost recovery income this quarter, steady loan and deposit growth, together with consistent share repurchase activity, has and will continue to reduce the dividend payout ratio.

On Slide 21, we see that capital levels at the holding company and the bank remain very strong with our tangible common equity ratio at 11.5% and Tier 1 common at 13.6%, which compares well to our peers at 8% and 11.3% as of the first quarter, respectively.

While our tangible common equity ratio remains much higher than peers, on a total risk-based capital basis, we are much closer to peers. This is the result of having a larger commercial loan portfolio, as well as smaller residential and securities portfolios than our peers. It is worth noting that we have spent some time with the Basel III proposal released on June 7, 2012. Given our strong capital levels, we do not anticipate any material impact when the new rules are implemented. However, it will take time to be precise about the impact on our capital levels because amongst other considerations, Basel III risk weighting will require loan specific risk-weighting adjustments.

Our game plan for successfully navigating the low interest rate environment includes growing loans and deposits, maintaining discipline on all asset repricing, lowering the cost of funds, lowering absolute expenses, growing fee income and maintaining excellent credit quality. Our robust pipelines and strong originated loan growth contribute to the continued momentum of our franchise. The strength of our platform continues to allow us to attract and retain exceptional talent and provides a sustainable competitive advantage.

This concludes our presentation. Now we'll be happy to answer any questions that you may have. Operator, we're ready for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Steven Alexopoulos with JPMorgan.

Unknown Analyst

This is actually [indiscernible] for Steve. Kirk, could you give us some more color on the amortization of the deposits that detracted from the margin this quarter? It sounds like from your prepared comments, this is more one-offs. Should we expect the deposit costs? I think there were 107 in the quarter to normalize? Or do they ran at these levels?

Kirk W. Walters

The amortization that ran off in the quarter, which related to Bank of Smithtown and such did cost us about 4 basis points. It's a one-off, it's gone at that point -- at this point. And the other item that we tried to highlight was the only remaining amortization we have in our deposits relates to the Danvers acquisition, and that will cease to be around -- it goes away in the fourth quarter, which will cost us about another 4 basis points. So after those -- after the Danvers piece is gone, which will be a onetime, then we have no more left.

Unknown Analyst

Okay. So -- and then we should expect that 107 to kind of trail down from there in terms of your time deposit costs?

Kirk W. Walters

Well, the -- remember this amortization is reducing the cost of the deposits, right? When we acquired the institutions, the time deposits were at a rate higher than where the market was so it's bringing it down. So like in this quarter, we actually brought our overall cost of deposits down 5 basis points, which was good progress, but the onetime basically offset it for this quarter.

Unknown Analyst

Okay. Okay. So this is a new level for us. Could you speak to the rates that securities were added on in the quarter? And then should we expect you to build cash from here? It seems like the balance is pretty low at the end of the period.

Kirk W. Walters

Yes. To the first question, we're investing predominantly in short tranche CMOs. They're coming on at about 140 basis points. So it's really a cash substitute, almost, that we're putting the money into. And we're keeping the duration of the securities portfolio right around 3 years. In terms of the second question, we do, on the deposit side, we do tend to hit sort of our seasonal lows during the summer as we come into the summer and then through August, and then it starts building from there.

Operator

Our next question comes from the line of Ken Zerbe with Morgan Stanley.

Ken A. Zerbe - Morgan Stanley, Research Division

Just hoping to get a little more color on this cost recovery income. I guess I heard you guys say it was discrete, transactional. I mean, is this something that was completely a one-off? Or, and if not, why would we see it again?

Kirk W. Walters

If look back in the fourth quarter, you'll see we had cost recovery income in that quarter as well. And this comes about when we do the reassessments, and it relates to loans that either are settled or paid off, and we in essence get proceeds in excess of the amount of the carrying value of the loans. So we've chosen the wording discrete and transactional carefully because it's not a case that it won't be -- that we won't see more of this as we go and the portfolios continued to run down. But it is erratic in terms of when it occurs and as it comes through.

Ken A. Zerbe - Morgan Stanley, Research Division

Okay. Now, that makes sense. And then maybe just more -- taking a broader approach to the margin. I guess when you think about all the items in terms of what runs off, what doesn't, the resetting of your loan and security yields, pretty big drop. And then down to the 389 ex the cost recovery item. When you look forward over the rest of the year, any reason to assume that might not fall as much as it did or sort of outlook on them, please?

Kirk W. Walters

Sure. I think this drop, the drop this quarter was a little bigger than what we would expect to see in the third and fourth quarters. As we have given guidance throughout the quarter, we do expect third and fourth quarter to continue to trickle down partially because of the rundown on the Fin Fed accretion and also the Danvers fair value amortization running off in the fourth quarter. But this quarter, we did lose about 8 basis points on loan repricings and another 5 on the securities side. And I would expect the securities side that we won't be probably adding as much to that portfolio as we go into the latter part of this year. So you wouldn't see the impact there. And on the loan side, we would certainly hope that, that would slow down from the level we experienced this quarter.

Ken A. Zerbe - Morgan Stanley, Research Division

Got you. But the 8 basis points talking about on the loan side does not have to do with acquisitions. That's just purely on -- originated loans?

Kirk W. Walters

That is strictly on originated loans. And remember, 40% of our loan portfolio floats. And as short LIBOR and short rates have come down, we've unfortunately had that pain.

Operator

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

Collyn Bement Gilbert - Stifel, Nicolaus & Co., Inc., Research Division

Kirk, just wanted to confirm, the $7.1 million of additional expenses that's coming on in the third quarter related to Citizens, the Citizens branches, is that -- did I hear that right? Is that just $7.1 million on a quarterly rate and we -- or how is that getting allocated? And did you give indication of that number in the past?

Kirk W. Walters

The first, the run rate which you can back into, because we did incur $700,000 expenses this quarter, is $7.8 million. We have given guidance in the past that we expect expenses to run in that range of probably $7.5 million to $8 million. And on the other side, obviously, we have revenues coming in from fees, the cash that we invested and as we're starting to generate loans, loans to the branches. So we have given the consistent guidance that we expected that it would cost us $0.01 a share this year, which includes the additional operating cost and $0.02 a share next. And by then, we would have built the deposit and asset generation capabilities to a place that we expected to break even in '14.

Collyn Bement Gilbert - Stifel, Nicolaus & Co., Inc., Research Division

Okay, okay. And just the $360 million of acquired loan runoff that you guys saw in this quarter, how does that break out between commercial, residential and CRE?

Kirk W. Walters

It is -- I mean, the biggest piece of -- and I don't have it right in front of me, but when you think about your runoff that occurs there, the biggest piece of it is in commercial. And it comes from Fin Fed, which rolls up into our C&I book. And in the commercial real estate, which is largely the Bank of Smithtown portfolios that are running down or we are in some cases pushing the loans out.

John P. Barnes

I think -- Collyn, Jack, I think, it's probably important to -- the perspective on that should be really is a mixed bag. We have interestingly, it's a competitive market, there are those that are paying off and refinancing, and our workout group continues to make very good progress on the troubled pieces as well. But definitely, the commercial real estate in the Smithtown portfolio is a big piece of that change.

Collyn Bement Gilbert - Stifel, Nicolaus & Co., Inc., Research Division

Okay, okay. And just a final question, on the mortgage banking line, I guess I was surprised it didn't go up more this quarter. What was the dynamic going on there? And what do you think we can expect for the remainder of the year?

Kirk W. Walters

Actually, the dynamic there is that we had a very good first quarter. And so I think activity was still very good in the quarter. Pipelines are at the same level and actually up a bit this quarter from where they were first. And so we, overall, have had good gains, good activity, and we would certainly expect to continue to see some strong quarters in the third and fourth in terms of activity there. But i think was more a function of first quarter being particularly strong and maybe a little better margins than anything in terms of this quarter.

Operator

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

Damon Paul DelMonte - Keefe, Bruyette, & Woods, Inc., Research Division

My first question has to deal with the provision outlook. This is the second quarter in a row, I think, where you've been slightly at or above the $10 million to $11 million range. How do you look at the provision in the upcoming quarters given your outlook for loan growth?

Kirk W. Walters

One of the things that we have tried to give a lot of color and detail on is sort of the building blocks of our provision, which, of course, includes charge-offs and charge-offs net of specifics and the loan growth. And so right now, we put away about $4.5 million for the loan build for this quarter. And certainly, as we hope for stronger loan growth in the third and fourth quarters, I would expect the provision to come up but could very conceivably run in that 10.5, 11 to 15 range depending on where the loan growth is. That's the biggest variability in the provision at this point.

Damon Paul DelMonte - Keefe, Bruyette, & Woods, Inc., Research Division

Okay, that's helpful. And then do you think you guys mentioned that the Fin Fed portfolio starting to show some growth. Could you talk a little bit about what you're seeing the way of growth, maybe the size of the loans and what the pipeline looks like and where your seeing -- geographically, where you're that growth?

John P. Barnes

Sure. This is Jack, Damon. From a -- without seeing all that detail in front of me, our discussions about that, we basically turned the corner several quarters ago and have started to grow the portfolio modestly and are really encouraged by that. Most of that growth is coming across their -- across the country and across their -- through their sales offices. And I'd say it's kind of modest within all their business lines. Construction had historically been the majority of their -- the biggest part of their portfolio and the majority of lending. That is why it had strong shrunk and run off at the pace that it did. Construction is not coming back in any strong way, but it's showing some increases in some of their longer-term relationships.

Kirk W. Walters

Yes. Probably the other couple of things to add there is the long-haul trucking, which was another piece has shown a little better legs than both PCLC and Fin Fed, and the waste management business, we've added some people there, which has seen a little better activity too.

Damon Paul DelMonte - Keefe, Bruyette, & Woods, Inc., Research Division

Okay, great. And my last question, just a point of clarification on the Citizens branch deal. So you expect to be breakeven, you said, in 2014? Does that mean that you have -- would have recovered the drag that you experienced in '12 and '13? Or that just mean that you will be in the black, so to speak?

Kirk W. Walters

That would just mean we'd be in the black for '14.

John P. Barnes

I just want to add. Can't help but add a little bit of color. We had a really great transition there and our focus coming off of that conversion and rebranding and the initial training in a very positive way, which we've already generated mortgage transactions and home equities and some really nice activity in our licensed sales brokerage group as well. So off to a great start.

Operator

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

Matthew Brandon Kelley - Sterne Agee & Leach Inc., Research Division

Just getting back to the margin discussion, if all the accretable yield is gone today and you had a 370 margin, what would your outlook for next year be? Trying to get your core margin dynamics excluding the impact of the transactions.

Kirk W. Walters

So let's make sure that we're all clear on terms because under the accounting, all accretable gone means literally those $3 billion of loans and all the income off them would've gone. So that's why you probably saw in our deck, Matt, that we put in a chart, it's on Page 7, that really looks at what this issue is because we have cash income that comes off the loan portfolio and we have noncash. So if you, the 370 reflects the fact that the noncash accretion or if you think about it, the purchase accounting mark, would have run off and be down at 370. Now, that's tied to the -- if you look at the underlying loans, it has some fairly -- it's going to take a while to get to that, but it would give you some clarity. So if you think about the 370, we would probably run in terms of the core margin because we do have some additional discount running off and a couple of other things in there. My guess would be somewhere between that 350 and 370 range depending on where interest rates are.

Matthew Brandon Kelley - Sterne Agee & Leach Inc., Research Division

Okay. And if you just annualize the accretion and compare that to the total accretable yield. I mean it's about 5 years of run rate. I mean, is it fair to think it's gone a straight-line? How does it -- how could it change or be accelerated over time just all due to rates? I mean, it seems like it would be at the fastest level now just given where we are on the rate environment.

Kirk W. Walters

Yes. I think you have a couple of things. First, you have to, which give you the accretion for Fin Fed. That piece pretty well runs out by the end of this year or early next. And then the rest of it is bank-like type assets and really will be driven off of, as you mentioned, driven off of refinances, settlements, et cetera. So that's the estimate that you just gave there is certainly in the ballpark.

Matthew Brandon Kelley - Sterne Agee & Leach Inc., Research Division

Okay. And then on the reserve coverage, I believe in the past, you guys have talked about keeping the reserves around on the originated loans, around 100 basis points. Is that still a good benchmark? And you want to maintain above 100 basis points of coverage on originated loans?

Kirk W. Walters

I think what I really focus on in the reserves, and that's why we give all the color here, back in the deck on Page 17 is how that splits out. And in particular, the coverage on the commercial loans and the coverage in the residential. So right now, they're sitting around 1%. Could it hover a little bit below, or a little bit above depending on mix? I think the answer is, yes. But it has been hovering right around that 1% level. But I could say, what I really focused on is that commercial coverage historically, we've had very little in terms of charge-offs in the residential loans.

Matthew Brandon Kelley - Sterne Agee & Leach Inc., Research Division

Okay. And as we're thinking about expenses, the guidance of $825 million to $830 million for full year '12, is that operating or total expenses?

Kirk W. Walters

That is operating expenses.

Matthew Brandon Kelley - Sterne Agee & Leach Inc., Research Division

Okay, got you. And last question, can you give us a little update on the mortgage warehouse business, kind of balances there, yields there? And also just your gain on sale business that runs through the fee income portion of your P&L?

Kirk W. Walters

Sure. So let me outstart on the gain on sale and then let Jack comment on the mortgage business. The gain on sale, I think we had another good solid quarter. It's down a little bit from the first quarter. A lot of that was that we had a very good first quarter. Spreads were a little wider than this quarter. But the pipelines itself remain very solid and, in fact, at this point, are up from where they were during the second quarter. So I think we'll continue to see good activity in the gain on sale of residential loans for -- as well as originating portfolio loans for the third and fourth quarters. In terms of the gain on sale of acquired loans, that's really sort of a hit or miss deal. This quarter, we happened to get some loan sales off and made a little money, but it can be fairly erratic. Let me turn it over to Jack to talk about the mortgage warehouse side.

John P. Barnes

So I think I would mention 2 things on the mortgage warehouse side. One is, we continue to see very steady good growth there. It is a little less than $350 million now as compared to a couple of hundred million dollars at the end of last year. So we're seeing a very, very nice pace in the buildout of the book. And we are enjoying the fact that they continue to maintain spreads in the most recent quarter, even saw a little bit of uptick.

Matthew Brandon Kelley - Sterne Agee & Leach Inc., Research Division

Okay, what were the spreads?

Kirk W. Walters

The spreads in that business tend to run between 3.25 to 3.75.

Matthew Brandon Kelley - Sterne Agee & Leach Inc., Research Division

Okay. And actually, one last question. Could you just update us on your appetite for multifamily lending in the metro New York area, some of the rent-stabilized, rent-controlled type of product? I know you made a hire there recently, commercial real estate. Just talk about your observation and what you're seeing from multifamily yields and business?

Kirk W. Walters

Yes. Let me, take a first crack and then Jack will chime in. I think it's important that what we have done is we've hired some experienced commercial real estate professionals, and we're not going into that market with just a bent that we're just doing multifamily. Certainly, multifamily will be in the mix. It'll be one of the things we'll be doing. But we will be doing all types of commercial real estate, and we have been doing that for quite a while in the market and have some fairly good footings in New York City, as well as the Metro areas as we sit here. The -- so overall, it's a business that we expect that we're going to build out. One that will be relationship-oriented and that we do have a good strong history on the commercial real estate side but also other products and offerings that we'll be able to lever in that market. So if you look at our commercial real estate as a whole, and the portfolio, the multifamily portion is relatively small when you consider it as a whole. So we do have some capacity if we find some interesting and good production to do. But I'd re-emphasize that we're looking at commercial real estate as a whole in the city.

Operator

[Operator Instructions] Up next, we have Bob Ramsey with FBR.

Bob Ramsey - FBR Capital Markets & Co., Research Division

Most of my questions have been asked, but I just want to be sure that I'm thinking about the margin correctly. I know we've talked on it. But as I think about the third quarter, basically, you start out of the gates losing the 8 basis points the was sort of non-core this quarter. And then beyond that, you all had about 8 basis points of core compression on the loan side and you're expecting something less than that in the third quarter. Is that the right way to think about the margin then? Is there any other impact from the Stop & Shop acquisition?

Kirk W. Walters

Well, I think as you start off the quarter. The 389 we've given as an operating already excludes the cost recovery income. That's already taken out. So you're basically starting with the 390 base. And as far as the third quarter goes, we don't have any headwinds of fair value adjustments. We are continuing to reduce our deposit cost. And the overall loan production and such, we obviously could continue to feel some repricing pressure. We had hoped it would be more similar to the first quarter where we weren't able to entirely offset it but at least got in the ballpark. As we get to the fourth quarter, we will give up 4 basis points with the Danvers fair value amortization running off. And so that could edge it down a bit more in terms of that portfolio. So a lot of that will continue to be our success in bringing the deposit cost down, and about 18% of our deposits are acquired deposits and the cost of those deposits is still around 90 basis points.

Bob Ramsey - FBR Capital Markets & Co., Research Division

Okay. And obviously the Stop & Shop branches don't have a material impact one way or the other?

Kirk W. Walters

No. They actually come in -- yes, it's going to be almost a little bit of a -- the mid-40s is where they're at.

Operator

Our next question comes from the line of Casey Haire with Jefferies.

Casey Haire - Jefferies & Company, Inc., Research Division

Just one question on capital management. And I was just wondering if you could give us a sense for any M&A opportunities in footprint that you're seeing. Obviously, it sounds like a pretty tough operating environment. I was wondering if you could give us a sense for what you expect in terms of M&A opportunities upcoming.

John P. Barnes

It's been -- I would say the environment has been very quiet, and we remain focused on building the company through organic growth and doing the things that we have been doing in terms of capital deployment. We are building relationships as we've said in the past. I definitely feel like our relationships across the Northeast are stronger than they have been in the past, which is great. But it is a difficult environment as you point out, and I certainly don't have a sense that there's going to be any big piece in M&A.

Operator

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

Thomas Alonso - Macquarie Research

I just want to just walk through the expense stuff because it's been a long day and a lot of numbers. So we start with the $202.1 million. That goes up for -- by 7.1% for Citizens and then it walked down from there and you wound up in that $825 million to $830 million run rate. That's the way we should look at it?

Kirk W. Walters

That's correct. Now I'm sure it's been a long day for you. You got it right on.

Operator

Our next question is a follow up that comes from the line of Steven Alexopoulos with JPMorgan.

Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division

I actually had 2 follow ups. First, regarding the comments, I don't want to beat a dead horse because there's a lot of talk about expenses. But you're going to push out the efficiency ratio because of the rate environment. I think we get that. Have you changed the expectation for dollars of cost saves? If you could maybe break it down for us in the dollar view and maybe what's in the run rate so far? I think that would be helpful.

Kirk W. Walters

The -- I think in terms of that analysis, it's one that we did in the second quarter investor book. We haven't put that out right here. But we gave a range before of expecting the Citizens deal closed that it would be toward the high end of the $830 million. And as we calculate based upon where our run rate and Citizens coming in at about 7.8%, that certainly translates into that range. As we have looked at this analysis before and thought about the level of expenses that we have taken out, if we had done nothing, and you may be referring to that one graph that we had in our investor book that we used during the second quarter, that when updated would indicate that if we had done nothing, we'd be at around $240 million. And obviously, we came in around $203 million. So a quarterly run rate which is a little over $30 million difference and -- or $38 million difference, which is well above what we thought we'd get in cost takeouts of the acquired entities. So we continue to work pretty hard, but we are obviously picking up these costs with the Citizens deal, which we strategically think is a very good transaction but one that is going to take us a little while to get it to a breakeven.

Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division

Got you. And Kirk, maybe just one follow up. How much of the C&I loan growth was asset-based lending? And how's the pricing looking in the asset-based book?

Kirk W. Walters

Sure. In the C&I loan growth, probably...

John P. Barnes

That book actually would be fairly modest growth during the quarter. We had, I think, as we pointed out in the commentary, good growth from our core markets, if you will, C&I lending across our footprint. We also had very nice growth in the PCLC unit and equipment finance. That was a nice pace. We had growth in the ABL unit, but I would say modest comparatively.

Kirk W. Walters

And, Steve, on the C&I side, probably the biggest contributor to the growth this quarter was the mortgage warehouse, which we had commented on earlier that had a pretty good quarter. In terms of the ABL business and the spreads in that business, they are -- they've continued to hang in really well from an overall standpoint, but we're looking at probably 250 to 300 basis points over, maybe 350.

Operator

Ladies and gentlemen, since there are no further questions in the queue, I'd now like to turn the call over to Mr. Goulding for closing remarks.

Peter Goulding

Thank you for joining us today. We appreciate your interest in People's United. If you have any additional questions, feel free to contact me at (203) 328-6799.

Operator

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

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