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Executives

John Koelmel - CEO

Greg Norwood - CFO

Analysts

Bob Ramsey - FBR

Erika Penala - Bank of America Merrill Lynch

Josh Levin - Citi

John Pancari - Evercore Partners

Casey Haire - Jefferies

Dave Rochester - Deutsche Bank

Damon DelMonte - KBW

Collyn Gilbert - Stifel Nicolaus

Matthew Kelley - Sterne Agee

Tom Alonso - Macquarie

First Niagara Financial Group Inc. (FNFG) Q2 2012 Earnings Call July 27, 2012 8:30 AM ET

Operator

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

Welcome and thank you for standing by. All lines have been placed in a listen-only mode until the question-and-answer session. This call is being recorded. If anyone has any objections, you may disconnect at this time.

I would now like to turn the call over to Mr. John Koelmel, President and Chief Executive Officer. Sir, you may begin.

John Koelmel

Thank you very much, Teresa, and good morning everyone. It’s been a busy couple of weeks for many of you and that our being a week later than usual. Those put us on the back side of the earnings cycle, but all are moving parts and pieces around the HSBC Branch acquisition; want to make sure we got it right and we are able to give you the best possible clarity and transparency around the transaction and its early outcomes.

We are only four days away from the one year anniversary of the announced one of that deal. But it’s a much more important to us. The conversion of those customers and accounts is already more than 60 days in the rearview mirror. It means we are definitely an even better bank today than we were just one year ago.

But also not just because of the transactions now behind us, so over the last 12 months we also continue to do the hard work necessary to further build out our entire franchise across the Northeast and drive even sharper organizational focus on optimizing execution of our core business.

After four exciting and at times challenging years of creating and building a franchise of which we are very proud and are equally excited to be 100% on execution level; driving our franchise to be one of the best managed, most well run and high performing banks in the business. We’re completely focused on maximizing our organic platform; built to be all the more efficient in the fact that we’re delivering and differentiating customer experience and be equally effective in bringing to the bottomline the benefits of what we make happen for the customers and communities we serve.

Confident, you’ll again see the results of that focused and disciplined execution in the second quarter outcomes. Completing our largest and most complex transaction, to well know our fortune in three years, one of the best teams in the business is also delivering another consistent chapter in our continuing story of strong and consistent organic growth, solid credit quality and improving fee income, because we continue to invest both the financial and intellectual capital to optimize our delivery channels and product suite, keep the business model simple, execute where the winning relationship based and customer centric focus and ensure that our entire team top to bottom is empowered to drive growth and strengthen relationships.

And you see that we’re doing just that across all of our markets. That’s the punch-line. We’re increasingly winning the hearts and minds of the customers and communities we serve and the benefits are all the more real and evident.

As for the HSBC Branch transaction, one of my key takeaways at this early stage, one we have very effectively pulled off our biggest challenge yet and find ourselves in a even better than anticipated position just two months into it.

Two, over the last year, we validated not only the strengths of the franchise we acquired, also our own brand as our first major end market deal. Our ability not only to hold the base substantially and tack over and turned out to be an all too extended timeline between announcement and closing, but in fact win more than our share of pre-close attrition battles is noteworthy.

Many other former HSBC customers that moved in the interim period, weren’t running away from us, and really wanted to get a jump start on establishing a relationship with us. While it would have been awkward to be as crisp on that point over the last year, I want to be very clear now about the significance of the positive balance as they came away before the deal was completed in May, because even as competitors stepped up their efforts to take advantage of the dislocation in the market, our brand awareness is now stronger than ever.

That is showed that over the last six months is when at least 20 point approval in (inaudible) awareness in Western New York alone. Rochester, Syracuse and Albany awareness quotients doubled now, which is north of 50%, even better than the 85% awareness number is our 70% of favorability rating in Buffalo with the next best competitor at 62% and you can see the benefits of that in all of our results whether it be the strong retention statistics or the significant number of customers that we converted to us.

Last and most importantly, the new and expanded teams went playing off since Monday, May 28th and the execution and momentum is really evident. We’re opening mark, checking accounts in the former HSBC Branches and even in our legacy locations. Our new mortgage teammates have already made a significant contribution to increase origination volumes this past quarter; small business pipeline is growing with more than 20 relationship managers are further enhancing our success in all of our markets and our private client services team is moving accounts with real pace to ensure we maximize the opportunities presented by the expanded portfolio of assets under management. The sum of that’s an outcome of which I am very, very proud.

All of that said, one year later, it’s also very clear that we find ourselves on unfamiliar and unwanted territory when we look at share price, shareholder returns and the significant disconnect between the strength of our business and the valuation of our currency. The reality that’s very much in our face everyday. And while every bank CEO is playing their cards in a very different game than any of us could have anticipated five years ago, totally on me, my team and our organization to play a hand that much better. To really pull the cards we wanted over the last five years and now we like the hand we hold, but know that we have a winning combination when it’s playing very well today, and we will continue to do so over the next several years.

Consistently set, we run the business today for what we expect it to be the model and that’s still very true today. But now for the first time in my tenure potential for significant change in who we are, as well as the world around is just minimal. If you look ahead two to three years you can only assume the macro influences whether it’d be economic, regulatory or political or remain challenging and volatile and maybe even suboptimal. You have to presume that no forward curve for the foreseeable future literally or figuratively will be meaningfully better than the spot curve of today.

As I said earlier, we are fully completely a 100% (inaudible) running the business we have today and focused on delivering the performance results and returns that will create real and sustainable value for shareholders. You can be assured we will manage both our business and our capital to optimize those returns as we move forward. Always been about good, better, best for us and we are a much, much better bank today as a result. Now it’s all about being one of the best.

With that, let me flip it over to Greg and have him walk you through the quarter.

Greg Norwood

Thanks John and good morning. As John mentioned in his remarks, the HSBC conversion of the business execution have been very positive. But before I get into second quarter numbers let me give you some information supporting John’s comments on our HSBC success as outlined on slide three.

We have 1200 new team mates that are some of the best in the business with significant community and commercial bank experience going back to the Marine Midland days. I’ll note, net of divestitures and adjusting for an estimated $300 million of deposits that we captured during the HSBC market dislocation, we calculate the net deposit premium to be approximately 7.1%. Deposit attrition to date is less than 3% and running ahead of our expectations.

Certainly, there is a buzz within the market; so what does that mean for our customers and our performance? The number of new checking accounts opened today in the acquired branch is about 20% higher than we typically see in our established branches. Looking at interest cost, the average cost of the retail deposits acquired was 31 basis points or 2 basis points better than our own book.

We now have the footprint and the branch density we want across New York State we have the product sophistication to reach out to more existing and new customers. We are also on board $1.6 billion in loans that have a contractual yield of approximately 6.3%.

And finally, on middle market lending, we acquired only $300 million commercial loans from HSBC, most of which are branch based small business loans and as you recall, we did not acquire HSBC middle market loans within the footprint that they choose to retain.

As you’ve heard from us in the past, there is market opportunity in the core middle market segment. We have competed very well against HSBC in the past and we see that getting better with the greater market presence in New York State.

Last point on HSBC, earlier this month we facilitated the smooth transition of divestitures to KeyBanc, Community Bank Systems and Five Star. The third and final piece of the divestitures is to comprise our bank involve a total of seven branches and will be completed later this quarter.

Moving along let me start with some quick highlights from the quarter on slide four. Operating net income available to common shareholders of $0.17 per share versus $0.19 per share in the first quarter. Results include the positive impact of HSBC branch transaction completed in May 18. Our commercial banking franchise continues to produce strong organic growth extending that streak double digit annualized commercial loan growth to 10 quarters.

Excluding the increase due to loans acquired due to HSBC transaction, commercial loans grew at an annualized 17% over the prior quarter again at 17% in our 10th consecutive double digit growth quarter. It was also a stellar quarter for our new indirect auto business. The seasoned veterans we hired and their relationships with dealers are paying off and we expect to build on that traction in further in the year.

On the deposit side of the business, checking account growth was once again a very positive story. The average balance growth was strong within our Western New York and Eastern New York footprints at 45% and 28% respectively.

Let me repeat as 45% and 28% in Upstate New York, it really validates John’s comments about the power of our brand. The income growth was another highlight this quarter driven by strong mortgage banking activity, sustained strength in capital markets and growth in banking services and lending fees led by the HSBC branch acquisition.

I'll dive into credit in greater detail later, but the real story here is we had a very strong loan growth and unlike our peers we are not releasing prior period provisions from our allowance into earnings.

This quarter our provision exceeded charge-offs by $10 million resulting from significant organic growth. Additionally, we had one [unlaw] credit that charged off this quarter and is not indicative of decrease in credit quality trends across the portfolio.

Quite the contrary, our underlying metrics remained strong. Let me talk about loans covered on slide five to 10 for a minute. We are clearly delivering on the loan commitment growth. And we see that continuing through though even some say it will slow in the second half of 2012.

Our Pennsylvania markets continue to lead the pack with strong double digit annualized growth rates over the last quarter. Even in a slow growth Upstate New York market, we increased loans 8% excluding any impact to the loans acquired through HSBC.

New England saw a 5% decline quarter-over-quarter and let me give you some context around that. As you know the NewAlliance book was a lot more thrifty and in the current interest rate environment, solid growth in the commercial business in New England of 4% was more than offset by resi prepayments resulting in the overall decline.

However looking forward we definitely see more commercial growth in the back half of the year in New England. Overall, our pipeline across the franchise remains strong and is consistent with the first quarter supporting our continued strong loan production in the back half of the year.

We also increased our overall lines by almost 30% annualized while our utilization rate was essentially flat. This strong build will bode well when the economy does turn and credit demand builds. Irrespective of what timeframe you are looking at, the growth in the commercial platform is across all product lines. This is further proof that we match up very well with our customers' needs in the market at large and that the growth is sustainable as we continue to deliver multiple product lines to new and existing customer relationships.

On the consumer side, I would like to highlight our tremendous indirect auto story, our mortgage activity and our new credit card platform. A stellar quarter for the new direct auto business that originated $170 million in new business during the quarter. So that’s about $210 million in new loans that are yielding a net 3.6% at least source since we entered the market in early March, so one more growth engine that will drive asset growth in the future.

By year-end we expect that loan balances for our indirect auto portfolio to increase roughly 15% higher than our earlier expectations that we communicated in the first quarter, or about $600 million in balances by year end.

On the mortgage side, the pipeline for refinancing remains strong. The new team members that joined us from HSBC have made an immediate impact on the mortgage production business. In the first half of the year, over a third of our business in mortgage versus purchase volumes versus rebuy.

Our sales force has and will continue to drive mortgage business to take a larger share of the pie. In the second quarter, total closed volumes increased 19% to $565 million. Our gain on sale margin was about 43 basis points higher than the prior quarter or roughly 2.1%.

Concurrent with HSBC branch transaction, we migrated to a new more advanced product and servicing platform for credit cards. We continue to see additional opportunities to leverage this platform particularly across the entire legacy customer base by driving higher cross sales.

Moving to the retail and the deposit story on slide 11 to 13, excluding the impact of the acquired deposits, average core deposits in the second quarter of 2012 increased an annualized 6% over the prior quarter; driven by the noted strength in interest bearing checking accounts and account growth.

The number of new personal checking accounts increased 15% over the last quarter. In addition, personal checking account balances excluding the impact of the HSBC transaction were up 20% for the entire footprint.

Let me tie the deposit story and consumer lending story together. A key to our retail strategy is to increase our Transactor/Saver/Borrower penetration. Today only 19% of our households combined all three that is they are transactors, savers or investors in mutual fund products and borrowers.

Our research and analytic has shown that a customer who is a transaction saver and a borrower is four times more profitable than just a checking account customer. Likewise, a checking and savings customer is nearly twice as profitable than a checking customer.

Today less than 10% of our DEA customers have a credit card with us; best in class metric for this is around 30%. Through our newly rolled out caliber compensation program, we are gauging and rewarding branch team members to cross sell cards to checking account households. As a result, we already are seeing preliminary success and are processing about two times the number of credit card applications than we did in prior months. Combining the deposit growth and the credit card opportunities will enhance future profitability.

Turning to slide 14, this slide shows recent quarterly trends in our originated loan book. Our clarity is the originated book represents loans that have been underwritten under our watch versus acquired loans that have a credit mark on them when we (inaudible). The provision for originated loans was $25.4 million. On an end of period basis, total originated loans increased $875 million in the second quarter.

Consistent with our philosophy to provision at or about 1.2% of net loan growth, the excess provision over charge offs equaled $10.2 million in the second quarter. There is a key differentiation point for us versus the rest of the industry that is sometimes lost. We are and will remain an organic growth story. And as we grow, we will continue to provision for the net growth in loans, but strong organic loan growth serves as an initial headwind in the form of higher provision expense in the first year of the loans origination.

And track this to the rest of the peer group which for the most part is enjoying the tailwind effect of reserve releases that are under effect covering higher provisions for their loan growth.

Net charge-offs on the originated portfolio totaled $15.1 million or 55 basis points of originated loans up from 34 basis or $8.6 million last quarter. For context, approximately $7.7 million of net charge-offs this quarter related to one large commercial relationship.

Absent that charge the ratio for the quarter would have been roughly 27 basis points of total originated loans. The allowance for originated loans totaled $135 million or about 1.19% of total loans and unchanged from the prior quarter, a level that we are very comfortable with holding at over the near-term.

Non-performing originated loans declined consistent with the continued strong underlying credit quality of the originated book. To summarize, I want to be clear that we remained confident in our overall credit quality and expect charge-offs in the second half of the year to be only slightly higher than the normalized first half excluding the one significant charge-offs.

But we say, I would say roughly [35] basis points of charge-offs in the back half of the year. Our loan grading for commercial loans and delinquency trends for the consumer book this quarter were consistent with recent experience; again no change in credit quality.

Finally the results of the sneak review recently completed have been very favorable. The key takeaway here is because we are growing we will continue to provide an excessive charge offs but the industry is currently releasing reserves to cover the cost of loan growth.

Turning now to slide 15, this is a detail of the acquired book for each of our four acquisitions we've completed since 2009. At June 30, our acquired loan book was $7.6 billion compared to $6.5 billion at March 31st. The increase results from the addition of $1.6 billion of loans acquired through HSBC and pay offs from previous acquisitions.

In the second quarter we provisioned $2.4 million towards these acquired loans given our lifetime loss expectation on consumer loans acquired in past transactions. Our actual charge offs experienced was $700,000 in the second quarter.

Summarizing the activity on acquired loan book in the fourth quarter of 2011, we reversed $35 million from the credit market into accretive yield which we said would feed into net interest income at approximately $3 million. Partially offsetting this we have incurred a cumulative $9 million in provision for acquired loans and support quarter of 2011.

When combined, the NIM and acquired provision are about equal over that time period. As some of our peers have noted from time to time we may incur additional provisions on pools of acquired loans. Likewise as our acquired portfolio season we will be able to transfer additional non-accretable cash flows back into the earnings stream from that portfolio when credit in those pools are likely to form better than initially anticipated.

In our acquired loan portfolio we have changed our disclosure to include certain non-performing lines and credits. The total for the second quarter of 2012 is roughly $19 million largely unchanged from first quarter of 2012.

This new disclosure had no impact on our estimated probable loss and thus no impact on net income. This better disclosure is not indicative of changing credit quality of the loans and it represents only expanding disclosures we feel appropriate.

Turning to slide 16; let me turn to the income statement. Interest income increased $259 million from $250 million last quarter. The increase in the prior quarter was driven by the effects of the HSBC branch acquisition including the averaging effect of the pre-buy securities we brought in the first quarter, the loans we acquired from HSBC and the repayment of the more expensive wholesale funding that we had with proceeds from the HSBC deposits.

These benefits were partially negated by the impact of our mortgage-backed security portfolio and the effects of the continued repricing of assets. Commercial loan spreads narrowed only modestly over the first quarter.

Again, I want to be clear. The loan spreads were only a modest decline quarter-over-quarter. Our commercial loan yields decreased about 9 basis points quarter-over-quarter, as the positive benefits of the higher yielding HSBC loans was partially negated by spread compression.

Our total mortgage-backed security amortization in this quarter was $40 million versus $26 million last quarter. Our second quarter net interest margin averaged 3.26%, 8 basis points down from the first quarter level, consistent with the guidance we provided a few weeks ago. Absent the impact of the mortgage-backed portfolio in the second quarter, our NIM would be 17 basis points higher or approximately 3.43%.

Now let me breakdown the key drivers of the NIM compared to prior quarter. Loan yields declined only 3 basis points sequentially to 4.59%. The good news, while commercial loan spreads and yields continued to contrast modestly due to competition, they were exactly in line with our internal projections.

So we’re holding the line on maintaining spread in our new production. Yields on investment securities declined 43 basis points as I mentioned due to the mortgage-backed premium amortization.

Looking at the liability side, deposit cost decreased 4 basis points quarter-over-quarter, driven significantly by (inaudible) quarter impact of onboarding HSBC deposits that yield 31 basis points and to a lesser extent residual effects of repricing of our own deposits.

We have managed down the cost of the HSBC portfolio in response to the environment and we will continue to manage deposit costs to help offset some of the impact of the yield curve pressure.

Long-term and short-term wholesale borrowing costs decreased by 19 basis points from last quarter. You will recall last quarter as we executed the pre-buy strategy, we borrowed short-term money by pledging less liquid collateral. The deposit proceeds received from the HSBC branch acquisition and the late June investment portfolio repositioning, we take these borrowings, resulting in improved funding costs.

On the wholesale borrowings, what is left is essentially our longer-term public debt which has a higher cost associated with it, but a smaller impact on the overall NIM and customer repo obligation also remain.

On our non-interest income, overall another strong quarter for fees. Capital markets even better than the first quarter, a 61% increase in the number of derivative swap transactions, commensurate with commercial loan volumes we saw.

Mortgage banking revenues benefited from both higher volumes and improved gain on sales as I mentioned. The volumes also benefited from the onboarding of very experienced HSBC mortgage lenders. The pipeline remains in good shape from a mortgage banking perspective.

Let me round up the P&L discussion by discussing operating expenses. Operating expenses excluding merger and restructuring charges were roughly $210 million for the second quarter. The sequential increase was driven by partial impact of the branches acquired from HSBC, a $4.4 million increase in EIC premium expense due the impact of HSBC, both which were offset by some tempering and seasonal compensation cost.

Reported GAAP expenses of $345 million included approximately $135 million of restructuring at HSBC merger-related costs in line in what we had telegraphed before. The one-time cost represents the bulk of the charges anticipated with the HSBC transactions and include prepayment penalties on the Federal home loan bank borrowings, lease termination as in professional fees.

Now turning to slide 17. This slide gives you a view of the sell-side consensus information for the second half of 2012. Generally the amounts are in line with our thinking, so let me walk you through the table. The NIM consensus view is right in the middle of our guidance we gave a few weeks ago and the average earning asset amounts are pretty much where we see them in the $31 billion range for the back half of the year.

Fee income is also in this zone and we see that it may have some upside potential. Expenses are pretty consistent with our thinking, so no real change there. The one exception is the provision which appears light.

As I said earlier we expect charge offs to basically repeat the normalized range in the first half of the year to no deterioration in credit trends. So why do we think folks might be off? First the provision cost for loan growth. Also we think that is why some folks miss the second quarter provision expenses as well. We had great loan growths in the second quarter that cost us $10 million in provision over charge offs.

When I look at consensus number, it’s probably light by about 10 million plus or minus for the next six months as we expect to continue our strong growth in loans and given we do not have reserves to reverse we will provide dollar for dollar to fund future significant organic loan growth. Second as a requirement of purchase accounting for the credit cards associated with the HSBC branch acquisition. Given the accounting rules we've provide for credit cost for credit cards over the next four quarters at roughly $2.5 million per quarter.

This is different than the accounting for loans that are term or amortizing loans. So what does this mean for a consensus EPS of $0.39. We think net, net this might be high by $0.01 to $0.02.

In closing once again we delivered a very strong quarter driven by strong fundamental growth in our traditional banking businesses, a quarter in which we kept the eye on the ball while successfully converting an exciting opportunity with the HSBC branch acquisition. The quarter with commercial and capital markets teams continue to drive profitable growth, the quarter on which the retail and consumer finance team continue to open new checking accounts and originate consumer finance lending opportunities, a quarter in which our newly minted indirect auto team hit the road running and contributed to loan growth.

In summary, a really strong quarter. With that Teresa we can now begin the Q&A session.

Question-and-Answer Session

Operator

(Operator Instructions) Bob Ramsey of FBR, you may ask your question

Bob Ramsey - FBR

Obviously the loan growth isn't really tremendous. I know you all mentioned on the call that you are expecting even more commercial loan growth in the back half of the year out of the New England markets. What do you attribute that to and sort of also along the same lines across all of your markets what is sort of the sense you are getting from customers as you work through the second quarter, is there any pick up or slow down or change in customer behavior?

Greg Norwood

Bob, let me hit a couple of things here. First, just at a macro, we are not seeing slowdown across the geography. Our pipelines in the commercial lending perspective are pretty much in line with where they were at the end of first quarter which we mentioned were very strong. But we continue to see that momentum taking us through the end of the year.

With respect to what do we think drives this, I think it’s really two consistent themes that we've had. One is the relationship based approach and distributed credit decisioning for the vast majority of our credit. That community bank feel and decisioning and the speed of the decision is critical.

Also the consistency for being in need of through disruption and through the continued uncertainty I think is also a positive. I think its equally important, our newer product suite, the broader product suite, whether it would be our loan syndications, our healthcare specialty you know all those things allow us to bring more to a customer and the more we can bring to the customer, one the more likely we are to secure it and the more profitable to that customer.

In New England, I think the real benefit there is under David Ring who runs that group; we have a very strong commercial lending team. It’s now been in place for a couple of quarters and the traction is really quite positive. We did have a significant payoff in the second quarter of credit; we decided not to retain, but that's a little bit of a dip. Those things happen quarter-over-quarter, but we clearly feel that the back half of the year we will see more growth opportunities in New England.

John Koelmel

Just pulling off the talent point Bob, there is no question whether you look backwards or forwards, we just have tremendous traction. I use the phrase best team in the business; I don't intend to be glib with that at all. Our people are as good if not better than anyone and as Greg said, the activity and the traction continues to gain momentum; I won't deny it; I sat with the commercial group a week ago.

Competition is increasingly competitive; pricing in some cases those who were flush with liquidity, goofy aggressive with pricing, at least by our standards. We see frankly both the little guys and the bigger guys holding on or moving up market in terms of the size of deals that are pursing affirming everybody’s asset challenge, so whether its little guy stretching for a $30 million or $40 million deal that they wouldn't or couldn’t have worked out before whether it’s a bigger guys keeping all of the $30 million deal just because they are challenged on the asset generation front.

We don't deny the realities of the moment; don't deny what you are hearing from others in terms of their lot and life, but our guys just continue to knock it out and are incredibly well positioned with our customers and the communities at large to perpetuate the role we have been on.

Bob Ramsey - FBR

Okay, great, and then I’ll hop back out, but just real quick I was curious about the tax rate outlook, obviously this quarter there was noise around the one-time items that is 33.5, 34 sort of 33-34 sort of the right way just to go forward?

Greg Norwood

Yeah, 33.5, that's a good place to be.

Operator

Erika Penala of Bank of America Merrill Lynch. You may ask your question.

Erika Penala - Bank of America Merrill Lynch

I just wanted to ask a clarifying point on the margin guidance, does not include any expectation or any help that you may get in terms of the contractual yield and any adjustment from proven yield for the second half of the year on the HSBC loan portfolio?

Greg Norwood

It does not include any additional accretable yield for HSBC or prior acquisitions.

Erika Penala - Bank of America Merrill Lynch

Got it and my final question is on your Tier 1 common ratios; Greg, could you give us a sense of, I know you put in your press release Tier 1 common at 7.4%, what would it be under the new rules that we got or the NPR that we received in June and also are you including purchase accounting model and thinking about risk weight under this NPR?

Greg Norwood

Sure, Erika. I mean we all are looking at the NPR and the 80 questions, but when we look at it a high level and again making some assumptions that what we think might happen to residential mortgage etcetera. You know, we look at the Tier 1 you are talking about, 740, you know, maybe plus or minus 20 to 25 basis points decline.

The purchase marks from RWA will not really be significant relative to that analysis on a go-forward basis, but I think as we all know and have talked about and heard is there is a lot of work that have to go into getting the NPR finalized. And I think we feel very comfortable over the long-term being in a good spot relative to Basel III capital ratios and we’ll adjust our business model to provide the right return for the capital we need, but also providing the right products for the customer.

Operator

Josh Levin of Citi. You may ask your question.

Josh Levin - Citi

So you talked a lot about organic loan growth and taking market share; in those occasions when you actually missed out on the deal when you don’t win when you are competing for a loan, what do you think is the biggest single reason why you missed out?

Greg Norwood

I would say it’s by and large when people are just putting the spread way, way too narrow for the current and potential value of the customer. You will see structural things every once in a while and those are pretty easy you just walk because they fundamentally are against our policies and practices.

But as we look at people fighting to keep a loan or go after a loan as John said, it’s typically rate and that’s why I made the comment in my prepared remarks that we are not having to give up a spread and we feel that the benefit of as John mentioned, our products, our people, our geography means we don’t have to do every deal to get the kind of numbers we are getting. So I would say by and large it’s when the price (inaudible) and we say that’s not the right economic return for us relative to the customer.

Josh Levin - Citi

Okay. And John, you said that you are running the business on the assumption that the challenging environment remains challenging for quite a while. Along those lines one of your peers said he was going to close 5% of its branches; are you considering significant branch closings or other kinds of hard cost cut?

John Koelmel

Well, we’ll clearly continue to take an aggressive look at how we are running the business Josh, and what we can do to better position people, process, systems and infrastructure and include branches in that, specific to the branch component that you are quizzing and on the closures are as well relevant for us there is potentially divesting those components over a network that don’t mess with was our longer term view to ensure that the distribution system we have is most optimally aligned for what we think makes sense for us as we look longer term.

But parlaying that across the broader spectrum, they are expense based relative to revenue base where you won’t get efficiency ratio; you look at operating leverage that needs to be better. It’s not well all that complicated. The industry is challenged and is well structured and positioned and run as we think our business is there is no question this reality forces us to find ways to be even better.

So as good as we are with the front end execution we need to be even better; what the backend delivery and support that we provide to enable the continued growth there, so well the specific point may not be all that relevant to us, the directional question you are asking is applicable to anybody in the industry and certainly one we are continually focused on.

Operator

John Pancari of Evercore Partners. You may now ask your question.

John Pancari - Evercore Partners

Can you discuss loan pricing a little bit more detail, specifically what you are seeing in terms of new money yields on the indirect auto originations as well as in your commercial business and also maybe how the new money yields have been changing through the past couple of quarters?

Greg Norwood

Okay, sure, on the indirect as I mentioned I mean the current book is yielding 3.5 to 3.6 net to us and that hasn't changed from when we started in March. And I don't see it changing appreciably for the remainder of the year. From a commercial perspective, we see the spreads at 250 to 300 and while that might modestly move down, it won't increase. Again going back to our ability to not take the lower priced yields I mean we've locked deals that are LIBOR plus 50, and LIBOR plus 100 and as a credit only that's just not a good economic trade for us right now. So commercial would be in the 250 to 300 range.

John Koelmel

As I referenced earlier, I was listening to our guidance, the kind of numbers that Greg just referenced to we walk away from our I don’t want to call it commonplace but they are increasingly frequent and those of our competitors that are either asset challenged flushed with liquidity are clearly getting in from our standpoint, my standpoint relatively goofy, aggressive on pricing.

John Pancari - Evercore Partners

And then along the lines, the loan yield as you indicated held up relatively well this quarter, I mean is that down 3 to 5 bps type of range on a quarterly basis, something we should expect in the coming quarters?

Greg Norwood

Yeah, maybe in the, maybe 0 to 5, it bounces around a little bit over the back half of the year but I would say 3 to 5 a quarter is not a bad place to be John.

John Pancari - Evercore Partners

Okay, alright, then lastly, can you just talk a little bit about the potential risk for remaining premium amortization expense in the [bond] portfolio and what is your remaining unamortized premium balance as of the end of the quarter?

Greg Norwood

The unamortized premium balance is about $130 million, down from $141 million as I think we mentioned a couple of weeks ago. The risk hasn’t changed relative through the back half of the year and as we mentioned on the retain portfolio, that would be about $4 million of amortization in both the third quarter and the fourth quarter. Again baked into the guidance we gave. We feel very comfortable with the estimates we made and continued to feel like we have the right valuation for the remaining mortgage-backed securities book.

Operator

Casey Haire of Jefferies. You may ask your question.

Casey Haire - Jefferies

Just a question on couple of pieces of the guidance, starting off with the charge-offs on your originated loans. As 30 to 35 bps, it feels a little aggressive, I was just wondering how much acknowledgment for another lumpy item coming through, like on CRE $11 million for non-accrual this quarter and expecting resolution next quarter. You know, if you get a couple more lumpy items, you know, does that derail that 30 to 35 bps?

Greg Norwood

Let me start at a high level, Casey. When we look at over the next six months, and done extensive reviews to the credit portfolio, we don’t see any large lumpy activity. In fact, the $11 million that we referenced in the materials, we actually don’t see any expected loss around that or if any, very small. In the guidance 30 to 35 basis points. You know, that looks to kind of normal balances that we saw in the first half of the year and again we don’t see anything in the horizon that would cause us to have any lumpiness factors in the back half of the year.

John Koelmel

I mean that’s half of the year our natural experiences a little under 30 basis points, so I mean we are allowing for some movement in that backend. So Casey’s question is not fractionally incorrect but I agree with what you said. We've kicked the can harder Casey, the one that bid us in the back side question in a hurry and we've scrubbed the portfolio hard to make sure we could be responsive to this very question as to where we see it and where we have it and as Greg said a couple of times, feels really good about it.

The flip side is the continued growth and impact of that on provision. I want to make sure people understand the impact of that hanging up 120 basis points where we --- of our loan we originate, that’s clearly a run rate but you need to factor into your forward book.

Casey Haire - Jefferies

And then just switching to the net interest income guidance, you know, the earning assets of $31 billion, is it just to clarify, is it right to think as I think about the growth going forward to keep securities book flat, you know, the loan growth continues, you know, that earning asset is on an annual basis is kind of like a high single digit growth story annually?

John Koelmel

Yes.

Casey Haire - Jefferies

And assuming you hold back pricing I would imagine that hold the pricing on which you get for securities yields and new loans. What does that I would imagine that puts pressure on NIM, what do you see on a quarterly basis the NIM compression being going forward?

Greg Norwood

Well NIM, if you think about where we are in the second quarter 3.26, we believe the NIM is going to be in that 54 range that the (inaudible) has. So the compression really is reduced by the benefits of the full impact of the HSBC assets and as you said maintaining approximately the same spread on the commercial loan growth, I think also as the auto indirect rose to the $600 million level in the back half of the year that’s 3.5 range will continue to support the number of the 350s.

John Koelmel

The additional $40 million of premium were 16, 17 basis points, So really look at a 342, 343 on a normalized basis so as you said that only included half a quarter of the benefit of the run rate on the HSBC portfolio and as you said you continue to layer in the indirect at the more optimal rates. We are comfortable Casey with the --- we are great with the [wagons] again.

Casey Haire - Jefferies

Alright I get that I see that the benefits are lifted from this 326 level. I was looking more toward the 2013 and as the balance sheet rotates and loans grow the NIM still I would think we would be under pressure I was just wondering what you see as the magnitude going forward? Yeah I see a point in the second half.

John Koelmel

Well, you are little out in front on ‘13, we will be happy to talk with you progressively as year unfolds here but our efforts been to flame as best we can near of the range of forecast for us for the next six months.

Operator

Dave Rochester of Deutsche Bank. You may ask your question.

Dave Rochester - Deutsche Bank

You may have already answered this in your comments of the strong pipeline, but I was just wondering if there is any seasonality we should watch out for in the loan growth in 3Q or if you are expecting some momentum from 2Q to turn into Q3?

Greg Norwood

We expect similar momentum and what I mean by that is double digit loan growth, I think you are focused on summer bps, we don’t see that being material and again we think the pipeline we had going into the summer we like very much. So we feel real confident.

John Koelmel

You mean the pipeline coming out of second quarter is better than that was coming out of the first right?

Greg Norwood

Yes.

Dave Rochester – Deutsche Bank

Very good to hear and I was just watching the securities book, what kind of cash flow you are getting of for that on a monthly basis now?

Greg Norwood

Let me have Ron or some one call you on that. I don’t want to give you a bad number on that

Dave Rochester - Deutsche Bank

And just I guess generally how should we look at earning asset growth going forward? I know that it is going to primarily driven by loan growth but will you also be building the securities book a little bit or will that stay flat or how should we think about that?

Greg Norwood

I think about it as flat and I mean one of the things we said several weeks ago and now is that we believe that's the right level for the near-term. So I would kind of think it as that $12 billion as we referenced

Dave Rochester - Deutsche Bank

And I guess that will be some what depended on deposit growth if you start to tear it up even more on the core deposit growth may be we see that grow little bit more.

Greg Norwood

I think there will be a mix of deposit growth and loan growth and combining those relative to what we think the right mix for the securities book is.

Operator

Damon DelMonte of KBW. Your line is open.

Damon DelMonte - KBW

I was just wondering with regards to the expense base, Greg how much of the expected HSBC expenses were actually in the second quarter number. Just trying to get a feel from filing perspective as to what's going to pull through in the third.

Greg Norwood

Well, about half of it was in the second quarter.

Damon DelMonte - KBW

Okay. And when we are looking for, could you just remind us what the total amount of expenses we are expecting to come on? I know it’s a percentage of the, it was like 1.4% of the net deposits.

Greg Norwood

Well, if you think about it, the $210 million in expenses we have in the second quarter and you think about the impact of the HSBC that goes up about $25 million going into the third quarter. It remains pretty much flat.

Damon DelMonte - KBW

And then my second question deals with the indirect auto portfolio. Could you remind us what percentage is new versus used and what you are seeing for your average FICO scores?

Greg Norwood

Its predominantly used at about 60% and the FICO scores are in the 740 range and our target I would say is somewhere in the 720 to 740. We don't want to go higher because you get into the super prime, it doesn't carry the same economics or IRR and we want to stay in the north of 720. So think of 720 to 740 as a desired target range.

John Koelmel

I will add to that is that it further validates the runway that we think we have. We have been able to create some really nice volume at favorable rates with frankly even higher credit levels than we had anticipated Damon, so that further underscores the upside potential that we believe is there at the back half of the year.

Operator

Collyn Gilbert of Stifel Nicolaus. Your line is open.

Collyn Gilbert - Stifel Nicolaus

Just want to clarify one thing first. Greg, when you talked about the net charge off of 30 to 35 basis points, that was of originated loans. So on a whole number it's like $10 million to $11 million of net charge offs, is that right.

Greg Norwood

By quarter that sounds about right.

Collyn Gilbert - Stifel Nicolaus

Okay because it's just the total loans because it's just a little bit of a swing factor.

Greg Norwood

Well, again we've been real clear trying to separate originated from acquired, so yes the 30 to 35 is on originated.

Collyn Gilbert - Stifel Nicolaus

Is on like that 11.4 billion. Okay, just want to make sure. Okay. And then on the loan growth, I mean you guys have said a lot, obviously the momentum is there. If we just frame that, I mean thinking about it in the back half of the year, you know if you look at kind of, is it 6% loan growth? I know you said double digit Greg, and then do you carry that momentum kind of in through 2013. I mean are we looking at 10% to 12% loan growth all in, or just trying to get a sense of where that momentum goes?

Greg Norwood

Well, not really going too far into 2013, but in the kinds of numbers we've had when you look at total portfolio which includes the consumer book, we believe we will remain consistent through the back half of the year. So double digit on the commercial, one thing that helps the consumer side will be the continued improvement in the indirect balance growth and that will help offset some of the resi refi.

John Koelmel

Card as well.

Greg Norwood

Card as well will be a factor in the back half. We anticipate card to be a bigger element as we move in to 2013 and really leverage that capability. As we mentioned in the transaction saver borrower as well as taking that capability and leveraging it through the remainder of the footprint, outside of upstate New York.

Collyn Gilbert - Stifel Nicolaus

And then in terms of the 1.2 provision that you’re stocking away on newly originated loans, do you know how that would have compared to what you did say two to three years ago?

Greg Norwood

I would say it’s a little bit more if we go back, but we’ve been using that 1.2 for a while now. We think that’s a very good number, when you look at the mix of the commercial and the consumer book. So, it’s been pretty consistent I think for a while.

John Koelmel

I mean we went back a couple of years, we really talked about Collyn as a threshold, a bit of price of admission, deploy at the level that we’re at because our credit experience is a track record has been and continues to be so strong in the [last]. We need to ensure we’ve got an allowance, but holds up to– the scrutiny of multiple constituent. So that’s just all we've working with over the last couple of years.

Collyn Gilbert - Stifel Nicolaus

And just one last question. I know that you're not really giving guidance for 2013, but just from a sort of strategic standpoint of how you're managing the bank, as we look at the expense run rate by the end of the fourth quarter, and assuming that you're kind of thinking about like 468 million or so in the back half of the year, do you anticipate much growth from that in 2013? Do you think there's ways to cut expenses from here or just trying to understand kind of how you are thinking about the expense side going in to 2013?

John Koelmel

I will just play off, then Greg can add to. What I said earlier, there is no question that all industries are going to continue to be, their revenue challenged and operating leverage for us has always been a key driver and know that we are very focused on ensuring, we are all the more efficient with everything we do Collyn. So, I am not trying to encourage you to read between the lines there. I will just encourage you to read my lips. We are very, very focused on managing costs or continuing to grow revenues.

And being all the more effective, all the more creative, further optimizing the mix of products and services we do provide to ensure those that are more efficient become more predominant and drive operating leverage. So we are very much on top of that and hence it wouldn’t be directionally incorrect to assume that you are not going to see an expense run rate that’s going to accelerate going forward.

Collyn Gilbert - Stifel Nicolaus

Okay. So said differently do you think you can migrate close to like a 60% efficiency in or is that a target of you all?

John Koelmel

I have never liked the six handle. So you look back a year ago, when we announced the HSBC transaction you saw 52, 53 as targets as you looked out a few years. Acknowledging that the world is different 12 months later, I won't acquiesce on the need to be much more efficient and there is nothing about six handle that excites me in a positive way. So you can presume, we are very focused on ensuring our results are meaningfully better than that.

Operator

Matthew Kelley of Sterne Agee, your line is open.

Matthew Kelley - Sterne Agee

Yeah just wanted to clarify some thing that you mentioned, wanted to be sure. $10 million of incremental provisions to account for growth in the back half of the year each quarter, 10 million a quarter?

John Koelmel

I mean Greg was just trying to backfill Matt, relative to what appears to us to be the miss for the like of a better term, the general miss among the 14 or 16 of [dealership]. A look at provision, people seem to be very honed in on the charge off and the run rate and getting the math right. On the other hand it appears provisions been [late] throughout this quarter and as we look out, provisions like relative to the growth assumptions. So we've swagged that based on what we can tell what kind of the collective models to be in that kind of zone, the same kind of 10 million that we reported this quarter.

Matthew Kelley - Sterne Agee

You know I got that, it just basically implies that loans within the year up over $20 billion which should be little bit higher than consensus, just wanted to confirm that's kind of the year end number. It's basically baked into that type of guidance, if you are providing $20 million for growth at that 1.2% rate?

John Koelmel

The originations this quarter were what, 875. Just under 900 million and we always intend and expect more of ourselves every quarter, so you can work the math off of that.

Matthew Kelley - Sterne Agee

When you guys announces the deal a year ago, I believe the earn back period was 4 to 5 years, what do you think that is today? Just to get back to the 786 book you had last quarter?

John Koelmel

I don’t have a number sitting right off the top of my head Matt, in terms of ramifications of all moving parts and pieces. I will say my bad for not being able to give you more direct answer at the moment. I haven't said that. But we restructured the transaction to ensure the earn back period didn't become prolonged from the original target we had and you can interpret from everything we've said about the focus on running the business more efficiently et cetera and compensating for the realities of the macro environment et cetera that we are committed to perpetuating that. So we owe you and everyone a better answer than that, but directionally there is no let up on our end.

Matthew Kelley - Sterne Agee

And then last question. Is there any reason why there hasn't been more significant you know purchases by management, do you guys see such great long term value, why is the management don’t buy more stock?

John Koelmel

We've, the short answer been blacked out for the quarter. As you can -- I guess what the benefit of hindsight include when we announced the balance sheet repositioning, the security selling on the 27th of June, 25th of June, something like that. We didn't come to that conclusion in the week prior. We've been at that and looking at that for frankly most of the quarter and looking at it enough that we felt that it was imperative we black ourselves out.

You saw that on top of just the running blackouts with the sordid series of HSBC transactions and the typical quarter end stuff. We haven't been able to get in or haven't been able to get in any way, shape or form. So that window reopens next week.

Operator

Tom Alonso of Macquarie. Your line is open.

Tom Alonso - Macquarie

I will try to be brief here since we are pushing it. Just real quick, any more merger charges just from a modeling perspective, just to have them in there expected in the third quarter?

Greg Norwood

About 20 million.

Tom Alonso - Macquarie

And then just on and I think you may have covered this and I just missed it. On the increase in home equity NPLs, it looks like you've restated or you took the first quarter number up and you have in this slides here that 7 million of that is the inter-agency guidance. Is there anything else in there?

Greg Norwood

No, that’s the biggest piece in there.

Operator

There are no further questions at this time.

John Koelmel

Alright, Teresa, thanks very much. We appreciate everyone hopping on for St. Friday morning. Hope the rest of your day goes well. And we look forward to chatting with you in October. We will be back on our regular cycle. So a week earlier than this one turned out to be, but appreciate your patience and taking time for us this morning and we’ll be in touch. Have a great weekend.

Operator

This concludes today’s conference call. Thank you for your participation.

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