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Valley National Bancorp (NYSE:VLY)

Q22012 Earnings Call

July 26, 2012 11:00 am ET

Executives

Dianne Grenz - Senior Vice President of Investor Relations

Gerald Lipkin Chairman, President and Chief Executive Officer

Alan Eskow - Senior Executive Vice President and Chief Financial Officer

Analysts

Steven Alexopoulos - JPMorgan Chase

Craig Siegenthaler - Credit Suisse

Dan Werner - Morningstar

Travis Lan - Stifel Nicolaus

David Darst - Guggenheim Securities

Brian Kleinhanzl - KBW

Nancy Bush – Research, LLC

Matthew Breese - Sterne Agee

Ross Haberman – Haberman Management

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Valley National Banks’ second quarter earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time.

[Operator Instructions] As a reminder, this conference cal is being recorded. I would like to introduce your host for today’s conference Ms. Dianne Grenz. Madam, you may begin.

Dianne Grenz

Good morning. Welcome to Valley's second quarter 2012 earnings conference call. If you have not read the earnings release we issued earlier this morning, you may access it along with the financial tables and schedules for the second quarter from our website at valleynationalbank.com.

Comments made during this call may contain forward-looking statements relating to Valley National Bancorp and the banking industry. Valley encourages participants to refer to our SEC filings, including those found on Forms 8-K, 10-K and 10-Q for a complete discussion of forward-looking statements.

And now I would like to turn the call over to Valley's Chairman, President and CEO, Gerald Lipkin.

Gerald Lipkin

Thank you, Diane. Good Morning and welcome to our second quarter earnings conference call.

The banking industry continues to be besieged with a litany of external variables, ranging from additional regulatory expenses to the Federal Reserve’s direct intervention on market interest rates. Community Banks have historically been a catalyst to economic growth within the neighborhoods they operate. Banks and the communities they serve have a mutual interest in the prosperity of each other.

In today’s difficult economic environment, the health and profitability of our industry will be closely tied to improving employment and economic conditions. New and additional regulatory guidance surrounding the increased amount and form of capital held at every financial institution stands as an impediment to that expansion.

To further this disconnect, the new draft capital requirements, issued by the joint regulatory agencies, are inconsistent with the treatment of capital as outlined in the Collins amendment as they further limit the eligible forms of capital for many banks.

On the other hand, the proposed regulatory adjustments to the measurement of risk weighted assets, for certain loan categories is an improvement, as we have always believed every borrower needs skin in the game. Specifically, the proposed Basel III guidance provides an advantage to those institutions, like Valley, which have emphasized larger borrower equity in their underwriting standards.

Based on a recent third party review of Valley’s first lien conforming residential mortgage portfolio, the adjusted mark to market loan to value ratio was approximately 48%. As a result, under the proposed guidance, we anticipate a significant reduction in the calculation of risk weighted assets for that portfolio.

Therefore, based upon our initial review of the proposed Basel Three capital requirements, we believe we currently meet the enhanced 2019 well capitalized definition for all regulatory capital ratios, as defined under the new proposal. As the market level of interest rates remains constrained due to a multitude of factors, Valley’s emphasis on non-interest income revenue generating sources will continue to receive much greater focus.

The strength in Valley’s residential mortgage banking division has consistently generated positive returns for the organization and we anticipate continued benefits. During the second quarter, Valley closed nearly $0.5 billion of new residential mortgage loans. For the year, total closed residential loans exceeded $1.0 billion and we are on pace to surpass all of 2011’s actual volume by the end of this month.

We anticipate significant increases in mortgage banking revenue for the remainder of 2012, as we intend to sell a larger percentage of originations into the secondary market. For the first six months of 2012, Valley earned approximately $6.3 million in gains on sale of loans into the secondary market.

We expect to recognize a significantly greater amount in the third quarter than we generated in the entire first six month period. In spite of our recent success in expanding our mortgage activity we still hold only a tiny market share in New Jersey, New York City, Long Island and eastern Pennsylvania. Presently, approximately 73% of Valley’s residential mortgage refinance applications are coming from non-valley customers.

This not only presents a cross sell opportunity, but provides management with an indication as to the potential products acceptance when we began to expand the geography in which we market these loans. We emphasized the fact that we have no plans to lower our strict underwriting guidelines in this endeavor.

As we like to say, we plan to fish in a bigger pond, not deeper in our existing pond. For over 15 years, Valley has actively sold loans to both Fannie Mae and Freddie Mac. We have the infrastructure and experience presently in place to conduct this enhanced mortgage banking effort. Historically, Valley has witnessed minimal repurchase requests from the agency which is a testament to the strict underwriting and processes employed in this area.

At Valley, we have always retained the servicing rights to the loans we originate. Interestingly, the performance of the loans we sell closely mirror the performance of the loans we retain in portfolio. Furthermore, we believe that these servicing rights will become a more valuable source of fee income in the future, as the propensity to sell or refinance properties currently being refinanced are at today’s extremely low interest rates, and will likely be low in the future as market interest rates are likely to increase.

With our acquisition of State Bancorp in the first half of 2012, we expanded our branch franchise to Long Island. In part, as a result of the acquisition, we expect residential mortgage application volume from the former State branch locations to grow accordingly. State Bancorp was not an aggressive residential mortgage lender and we are seeing great enthusiasm on the part of the former State Bank branch staff to offer residential loans to their customers.

Valley’s TV and radio commercials, supporting the New York market were completed in early July and the on air media promotion has just begun. As a result, it is brisk and we anticipate a much expanded market penetration.

Total loan growth during the second quarter was extremely promising as Valley originated nearly $1.0 billion of loans. Total linked quarter annualized growth in Valley’s non-covered loan portfolio was 11.0%. The commercial lending portfolio grew 4.0% annualized during this period, while the consumer lending portfolio expanded 23%.

The growth in consumer loans is in large part attributable to new residential mortgages. However we are beginning to witness some signs of a sustainable expansion in Valley’s consumer auto portfolio. The portfolio grew over 7.0% annualized during the second quarter and the activity into July remains encouraging.

We continue to exercise extreme caution in underwriting these credits, focusing both on the borrowers FICO score and more importantly the equity component of the loan. As an example of Valley’s stringent underwriting criteria, for the first 6 months of 2012, we declined nearly $125 million of auto applications with borrower FICO scores in excess of 700, largely because we were uncomfortable with the amount of the borrowers equity in the deal in relation to the financing requested.

While we like to maintain significant residential and auto loan portfolios we are ever mindful of the fact that we are a commercial bank first and foremost. Accordingly, as mentioned earlier, commercial lending activity during the quarter received a high level of attention and as a result growth was strong.

Total new originations were approximately $375 million, an increase of 7.0% from total new originations in the first quarter. Specifically, total commercial real estate, including construction loans, grew over 6.0% annualized from the prior quarter as we continue to take customers away from our competitors and begin to recognize some early benefits associated with the State Bank transaction.

While customer sentiment has not fully shifted in a positive direction, we are beginning to see encouraging signs of economic improvement from a few developers, as sales have begun to improve, albeit from very low levels in prior periods. The competition for high quality low loan to value commercial projects remains intense in our marketplace.

Due to the low level of market interest rates, the origination rates on many of these projects are at rates considerably lower than similar originations in prior periods. We continuously monitor the duration and re-pricing characteristics of the entire loan portfolio and attempt to adjust our funding composition accordingly in an effort to maximize profits while mitigating excessive interest rate risk in the future.

We actively used interest rate swaps and longer term funding strategies in order to protect our balance sheet in changing interest rate environments. As a result, on many loans and investments, we routinely recognized less current net interest income in order to preserve a sustainable and predictable cash flow stream in future periods.

Similar to the manner in which we view credit, the interest rate risk at Valley is of the utmost concern and receives a tremendous amount of management’s time. We stress our portfolio under numerous economic and interest rate environments, managing for the long-term has always been a hallmark of the organization.

We are encouraged with the loan growth generated in the second quarter. Although the current interest rate environment is negatively impacting Valley’s net interest spread, the new relationships add tremendous franchise value to the organization, provide expanded growth opportunities into the future. Valley’s mortgage banking business can generate significant non-interest income for the Bank and we anticipate opportunities to increase revenues from this business line.

Although the economic environment is changing, Valley’s diversified balance sheet, strong capital position and credit culture provide many avenues to increase revenues. We are excited about the many new opportunities in the coming months.

Alan Eskow will now provide some more insight into the financial results.

Alan Eskow

Thank you, Gary. For the second quarter, Valley reported net income available to common shareholders of $32.8 million or $0.17 per diluted share, compared to $34.5 million in the prior period. The sequential quarter decline in net income is largely attributable to a contraction in net interest income of approximately $5.4 million.

During the same period, Valley’s net interest margin, on an FTE basis, declined from 3.70% to 3.52%. Approximately 11 basis points of the 18 basis points reduction in the margin is due to diminished accretion income attributable to Valley’s covered loan portfolio. The decline in accretion is in part due to a 41% annualized decline in the covered loan portfolio’s outstanding balance as compared to March 31, 2012.

Due to the nature of the underlying loans within each loan pool and the specific accounting treatment applied to the covered loan portfolio, accretion income is sometimes volatile and largely subject to actual cash flows received, which are often difficult to predict in each reporting period.

The decline in accretion during the second quarter is by no means attributable to additional deterioration in credit within the portfolio, but rather the timing of cash flows. Another variable negatively impacting Valley’s linked quarter margin is the absolute low level of market interest rates and the resulting pressure on both new and re-pricing loans.

During the quarter, the average loan yield was 5.09% compared to 5.42%in the prior period. Approximately 14 basis points of the decline is attributable to the aforementioned change in accretion on covered loans. The balance is principally the result of market interest rates.

During the quarter, the weighted average coupon of new loan originations held in portfolio was slightly less than 4.0%, which is consistent with the yield recognized in the first quarter. Loan yields for the first six months of 2012 have been negatively impacted by management’s decision to portfolio excess residential mortgage originations in lieu of purchasing lower yielding mortgage backed securities.

Total non-covered loan footings, as a percent of total earning assets equaled 80.3% as of June 30, 2012, compared to 73.5% in the same period one year ago. Valley views the cash flow sensitivity of Valley originated residential mortgages to be relatively equal to the sensitivity of mortgage backed securities.

Although the loan portfolio yield is negatively impacted, the effect on gross interest income is positive. The yield on taxable investments declined 15 basis points to 3.50%, as prepayments on higher yielding mortgage backed securities remain escalated. In addition, trust preferred securities issued by financial institutions and held in Valley’s investment portfolio declined, as issuers have begun to exercise call options subject to the change in regulatory capital treatment. The trust preferred portfolio currently yields approximately 5.0% and total book balances are equal to $337 million.

We anticipate continued pressure on earning asset yields, as Valley is mindful of the risk of extending duration in search of increased yield. While we do not envision rising interest rates for the foreseeable future, we must remain vigilant in monitoring the composition of the balance sheet, should unexpected rate shocks occur. Our focus continues to be on maximizing long term sustainable earnings.

On the funding side of the balance sheet, the cost of funds improved from 1.32% in the first quarter to 1.26% in the second quarter. Declines in every interest bearing funding category contributed to the linked quarter decline. Late in the quarter, we modified the terms on $100 million of FHLB advances, of which only a minor reduction in interest expense was recognized. We anticipate future annual savings to exceed $0.5 million as a result of this modification.

The rate on time deposits contracted 6 basis points from the prior period; a run rate which we believe is sustainable for the remainder of 2012. Additionally, we have the ability to reduce the rates paid on other deposit products, although the magnitude of such changes would be somewhat limited due to the absolute low level of current rates.

Non-interest bearing deposits comprise a major funding source for Valley, as many of the Bank’s commercial relationships maintain significant compensating balances. As of June 30, total non-interest bearing deposits comprised nearly 30% of all deposits, and 23%of total funds.

Unfortunately, in low market interest rate environments the value of this funding source is diminished and actually becomes a detriment in reducing funding costs, as the absolute rate paid is zero. That being said, the franchise value is considerably enhanced due to this stable inexpensive funding source.

Valley continues to aggressively manage its cost of funds, and we anticipate continued improvement in the cost of deposits. However, as interest rates remain near the current low levels and the reinvestment rate on loans originated and/or modified continue to be less than the current yield of our loan portfolio we anticipate continued pressure on the margin, exclusive of the potential impact due to infrequent items.

We do not anticipate the velocity of the contraction to parallel the current linked quarter decline, yet in the current interest rate environment it is very difficult to maintain a net interest margin above our current levels unless financial institutions are willing to either extend asset duration or change their risk profile.

Non-interest income increased approximately $1.4 million from the prior quarter as declines in insurance commissions were more than offset by increases in the gain on sale of securities transactions and trading gains largely attributable to the non-cash mark to marked gains on Valley’s debt related to its own Trust Preferred Securities carried at fair value.

Non-interest expense declined approximately $3 million from the prior period, largely due to the elimination of many expenses related to the acquisition of State Bancorp. Salary and benefit expense for the second quarter increased approximately $200,000, as gross health care expenses increased approximately $1.2 million. Health care expenses are at times volatile due to Valley’s election to self fund a large portion of the insurance plan.

The increase in benefit expenses obscured the contraction in salary expense attributable to cost cutting efforts made by Valley in conjunction with the State Bancorp transaction. Assuming health care expenses normalize in the third quarter, we anticipate a potential decline in salary expense for the remainder of 2012 as compared to the first half of 2012.

For the quarter, Valley’s credit quality remained relatively unchanged from the prior period. Total non-accrual loans were relatively flat at $126 million, while total accruing past due loans declined significantly to $31.5 million from $44.7 million in the first quarter.

Overall, Valley’s non-performing assets increased $15.8 million mostly due to an increase in market value of trust preferred securities issued by one bank holding company in which Valley recognized a large credit impairment in the fourth and subsequently placed on non-accrual. The linked quarter increase in reported non-accrual debt securities is not a sign of further deterioration in the securities, but rather the result of an increase in market value, which ultimately increases the balance of non-accrual debt securities.

Additionally, impacting the increase in non-performing assets was the reclassification of certain non-performing commercial assets in which Valley obtained title. We anticipate liquidating the majority of these assets by the end of 2012, for values in line with current carrying costs.

Net charge-offs for the period of approximately $10.5 million include $1.8 million of covered loan charge-offs. The resulting non-covered loan net charge-offs figure of $8.7 million was largely the result of a partial $4.6 million charge-off on one non-performing commercial real estate loan.

Inclusive of this charge, annualized total non-covered net charge-offs to average loans for the quarter equaled only 0.31%. We are comfortable with the credit quality of the balance sheet and do not foresee a material change in the level of net charge-offs for the remainder of 2012

This concludes my prepared remarks, and we will now open the conference call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from Ken Zerbe from Morgan Stanley. Your question please.

Ken Zerbe - Morgan Stanley

Gary, a question for you. On the whole push into mortgage banking, why is now the right time to get more aggressive and I ask that, I understand the pressure on NII, et cetera. It makes sense but if this is such a great business, and you could have been making a ton more money over the last six months or last two years, why not have started it a year ago and instead of waiting for today?

Gerald Lipkin

For one thing, we have been doing this, as I said, for 15 years. We just haven’t done it at the level we have been doing it at. With the low interest rates and particularly where they are currently, sub 4%, there is a huge demand for residential refinancing. That didn’t exist three years ago or four years ago, or even two years ago.

It just stated picking up in the last two years and we have been growing with it modestly. We recognize that we now have the infrastructure in place to do a lot more. We started in the last 24 months, advertising on TV, something we have never done before, using me as the spokesperson and I don’t know that it’s me, I think it’s the rates, but it has brought in a huge volume of applications and an ever growing volume of applications.

Enough so that we are convinced that we can do even a lot more by bringing that product aggressively on to Long Island and into New York City. Markets that we really never aggressively went after and it does produce the profits.

Now, we are not looking to hold most of the loans that we put on and particularly going forward, as we get more aggressive, we are looking to expand materially the size of our outstanding residential mortgage portfolio. Although, I will point out that when you combine our mortgage backed securities held in our investment portfolio with those the mortgages that were originating and the performance tends to be very close together.

On a combined basis, we are lower today than we were five years ago. So it looks like we are doing something more so of a change than we actually are when it comes to looking at the portfolio and we are generating good fees. We are originating at a price that we can sell and make the profits.

Ken Zerbe - Morgan Stanley

The only thing about that the loans that you are going to be writing going forward, third quarter, fourth quarter, should we be thinking about those as the amount of loans going on balance sheet is going to diminish because instead of holding we are going to selling them? Or are these new loans with different characteristics that you would not have written anyway?

Gerald Lipkin

We are not changing our underwriting criteria.

Ken Zerbe - Morgan Stanley

You are just holding less on balance sheet.

Gerald Lipkin

Well, we are maintaining our balance sheets. We want to hold that approximately our current level the number of mortgages that we have and we are seeing some prepayments on that portfolio taking place. So to the extent that we have prepayments taking place there, we will hold those into the portfolio.

We are very strict though in what we underwrite and sell. We don’t underwrite or sell mortgages that are above, for example, 80% loan for bag. We generally try not to go much above. Under some circumstances we will go to 90 but basically we don’t go above 80 and for us to hold it in portfolio, our threshold if generally at 70% loan to value.

Ken Zerbe - Morgan Stanley

Okay, so that will make sense. All right, thank you very much.

Operator

Our next question is comes from Steven Alexopoulos from JPMorgan Chase.

Steven Alexopoulos - JPMorgan Chase

Jerry, I want to start, we all know how conservatively you have run the bank, and with the dividend payout ratio now toward at or near 100%, how should we be thinking about the risk of a dividend cut?

Gerald Lipkin

It is a desire of our board to continue the dividend as long as practical. We are not under, because we meet our capital requirements, at the present time, regulatory pressured. That all being said, I can only speak of what has happened up until 11:29 this morning. Anything is possible to come down the pipe which would require action on our dividend in the future. I can’t say that we will never reduce our payout but we are going to strive to do whatever we can of course to raise our income. So that our payout ratio is low. So that everybody is happy.

Steven Alexopoulos - JPMorgan Chase

Jerry, given the different tools you have to manage capital, how do you prioritize the dividend versus other items such as limiting balance sheet growth or raising common. Just curious how you stack.

Gerald Lipkin

It is way up there, okay. We just said, we would not like to have to reduce our dividend but we are of course always mindful of our needs for capital and the needs to grow, so it’s a balancing act and our board looks very closely at this.

Literally, every quarter, when the dividend comes up, this is discussed in depth. Up until now, nobody as expressed a desire to lower that dividend but that could chance next quarter. I can’t go into the future. I don’t have a crystal ball as to the mindset of our board, the ones who actually sit there.

Steven Alexopoulos - JPMorgan Chase

Alan, the reduction on margin from the accretion, is this the run rate or is there some type of one time reduction that will reverse next quarter?

Gerald Lipkin

So, as we said, the cash flow is healthy from that and its very difficult to be able to say for sure whether is in a one rate that will continue or not. The reduction was fairly substantial this quarter. Once again, I don’t know that I could tell you that next quarter it’s going to run the same way. I don’t know that that will happen again but it did this quarter.

Steven Alexopoulos - JPMorgan Chase

Then just a final one, you guys talk about the significant improvements on loan sale. You talked about the first half maybe a little better than the third quarter. Are you thinking, does the $6 million, $7 million per quarter item or could it be even better than that.

Gerald Lipkin

Anything is possible right there. We are going to do, we have to do to make sure that we don’t take too much risk on our balance sheet. We don’t put things on there that we don’t want. So the volume is very strong and it could produce some large profits.

Alan Eskow

I did it my comments. The fact that we expect in the third quarter, at least as much as we generated in the first half.

Steven Alexopoulos - JPMorgan Chase

Operator

Our next question is comes from Craig Siegenthaler from Credit Suisse. Your question please.

Craig Siegenthaler - Credit Suisse

Just personal loan yield compression. These is a big three area it is coming from. One, the feeble yields, spread compression and then also a little bit of loan class mix shift. Maybe some swap, in fact. I am not sure, could you kind of go through those and it should be maybe roughly a third or half, where it is coming from?

Gerald Lipkin

Well, I think we said that for this particular quarter, 11 basis points came from the accretion issue. There is no doubt there is some thrust of swaps in there that also is impacting the margins. Not a large number but it is out there.

Then of course, what we said, growing it to the actual loan rates that we are dealing with. I mean you are seeing new finances. Everyday of the week, people want to refinance. That being said, rates are at that 4% level give or take and the average is at 509.

So I don’t know that I can give you a specific breakdown but I think what I can give is the 11 basis points and the 18.

Craig Siegenthaler - Credit Suisse

Then, one other thing that could benefit you that was that actually if you were growing loans faster than earning asset, deposits and securities within the balance sheet allowing mix shift to take over and one other thing that isn’t prominent is your CNI loan growth, it is actually fairly low versus the industry competitors. Can you give us, maybe, some reasons in terms of why you are seeing your loan growth is lower than competition?

Gerald Lipkin

Well, one of the reasons is our credit quality. Its one thing to run out, systematically grow the portfolio, it’s another to grow it under the lending criteria that we employ it badly. We are very tough. Listen, our loan growth in the residential mortgage area was a laagered in 2004, 2005, 2006, and 2007. That’s because we would do sub prime lending, okay. Same thing applies here.

If we can’t enough of a rate to cover the risk that we are taking in the loan for one thing, we are just not going to make it. It’s easy to do at the face lending at 100 basis points below prime and think you are going money on that but are not factoring in your loan losses.

One of the things in the credit card industry they learn, as long as they can charge 20% interest they can absorb a 5% loss but if they try to take put on credit cards at 6% or 7%, they are out of business. Same thing here.

Craig Siegenthaler - Credit Suisse

Got it, and Jerry, give some point. So your commentary is kind of like, CNI loans are actually getting underpriced relative to risk. I think many would argue it’s potentially underpriced relative to the NIM and the ROE that it translates to. There is just not a lot of (inaudible) there relative to funding cost but you actually saying there is actually some credit risk in the CNI that’s getting price to that. Is that fair?

Gerald Lipkin

That’s correct.

Craig Siegenthaler - Credit Suisse

Got it, thanks for taking my questions.

Operator

Our next question is comes from Dan Werner from Morningstar. Your question please.

Dan Werner - Morningstar

In looking at the balance sheet and the long term borrowing book beyond five years as well as the your own trust on the balance sheet, since those are not longer be counted as Tier 1 starting next year. Does is make any sense to do a perpetual preferred on cumulative or common issuance to replace the trust as well as absorb the prepayment laws that you would do on refinancing of those long term borrowings.

Gerald Lipkin

Well, first of all our trust preferred doesn’t go away next year. It goes down by 10%, so its capital each year starting next year. So it doesn’t go away overnight. The long term, obviously, are not going to have the value that they do. They track their call (inaudible), we can call on that anytime and as we have seen in the past in (inaudible) deal, our board is looking at all capital venues on a regular basis. We have a very comprehensive capital plan and we discuss in depth our capital needs with the board on a regular basis.

One of the topics that we have discussed is this perpetual preferred stock. There has been no decision made regarding any of these but our board is well aware of the scenarios, as I say and we discuss them all the time.

We have to make a change we will make a change.

Dan Werner - Morningstar

I guess, I was just commenting that it would make sense from a margin standpoint if you could refinance those long term borrowings and kill two birds with one stone. I guess that’s what I was, but that’s my comment.

Operator

Our next question is comes from Travis Lan from Stifel Nicolaus. Your question please.

Travis Lan - Stifel Nicolaus

Most of my questions have been answered but just quickly, to be clear, the reduced accretion from the PCI loans was due to accelerated prepayments from the Park Avenue and Liberty Point.

Gerald Lipkin

Yes. Part of it was definitely that.

Travis Lan - Stifel Nicolaus

Do you have sense of any of those borrowers refinanced back into the bank?

Gerald Lipkin

Very few, if anybody, I don’t think there are any of this.

Dan Werner - Morningstar

Alan, do you happen to blend in on yield for the covered portfolio?

Alan Eskow

For the covered portfolio? At 7%.

Operator

Our next question is comes from David Darst from Guggenheim Securities. Your question please.

David Darst - Guggenheim Securities

So you said that the loan pool from the climb in the accrete able yield was primarily those FDIC deals, nothing from stat yet or are you seeing faster prepayments in that portfolio as well?

Gerald Lipkin

No, not at this point.

David Darst - Guggenheim Securities

Should we treat as any kind of adjustment or should we think about the margin going forward at this 350 levels of starting off point?

Gerald Lipkin

Yes, I think that’s the way you would look at it.

David Darst - Guggenheim Securities

Okay, and Alan, do you have the expected increase in risk related assets under Basel III?

Alan Eskow

That’s actually going to be somewhat of a decrease. I think Jerry said that before the fact that our residential loans have such a low, low value relative to the way the bucket is full. We do expect that as likely to ramp.

David Darst - Guggenheim Securities

Do you have the pro forma capital ratios?

Alan Eskow

Not off the top of my head but we expect to meet the low capital rise certainly by, today, for 2019, but we have already been through rough estimates at this point, so I am not about release those ratios. You should just expect that we meet the reports.

David Darst - Guggenheim Securities

Okay, and then I guess that also falls under your point on the perpetual preferred, another types of capital that you can include in that? It might not be dilutive.

Alan Eskow

Exactly, right.

Operator

Our next question is comes from Brian Kleinhanzl from KBW. Your question please.

Brian Kleinhanzl - KBW

On the mortgage banking, can you give some color on what you are seeing on the gain on sale margins? That went up or down from the prior quarter?

Alan Eskow

Went up a little bit.

Brian Kleinhanzl - KBW

Then also you mentioned that the theory on accruals that you have met a relatively low carrying cost. Can you remind us what that carrying cost is and what that inflows and outflows were out of those buckets this quarter?

Alan Eskow

No, I don’t think we disclosed anything on that. Carrying forces, there is not a huge carrying force to those other than obviously taxes and a bunch of other items but I don’t have that.

Brian Kleinhanzl - KBW

So I mean, like we are at the mark relative to the original balance.

Gerald Lipkin

How many did we write down the property sale?

Alan Eskow

I am sorry, I didn’t understand your question. It’s hard. It’s all over the place and part of the problem comes in on the appraisals. What does carry that is what it now appraises that although some of the appraisals in my mind come in kind of crazy low today. Seems like the appraisers were all trying to cover their backside. So they are hiding those writing downs more than I understand but fortunately we don’t have a big part of it so it’s not material.

Just on that whole issue. Legal did pretty good with the analysis of every single loan that’s in care and whether it’s a new loan in this quarter or it’s a file loan that’s we continue to look at every quarter. We take into account whatever the current appraisals are, whatever the discounted cash flow are relative to cash flow loans and I think we made sure that we are covered as of this point in time and that’s why when you look at the reserve as an example, the reserve is reflective of everything.

So its not a matter of somebody might say leading reserve, I think its more a matter of what does our reserve need to be relative to what we already charged down, what we have already taken impairment on or any kind of other reserve we set up on those.

Operator

Our next question is comes from Nancy Bush – Research, LLC. Your question please.

Nancy Bush – Research, LLC

Obviously, a response to one response if you, the headwinds that you are hitting which are pretty considerable with, if you cut cost more aggressively. Has there been any sort of new initiative spread in motion this quarter and I realize it will be tough given that you are trying to expand in some areas, but what is your ability to go to other side and start cutting that a bit more?

Gerald Lipkin

We're always looking at where we can take cut course. Nancy you know the bank. We look at every expense on a regular basis. We have been hammered, as I said, repeatedly by the regulators with additional cost that seem to offset our core cities. Fortunately, we come up with enough core states till the end of the day that we look pretty flat, but you have things like the (Inaudible) Valley for $1 million and where you got to come up the clip phase to offset that $4 million.

The FDIC insurance today is high. It's closer to roughly $14 million, $15 million a year. If you looked back ten years ago, that number was zero. So pretty close to zero. So we have been able to cut other expenses to make up for to that. Health, of course, as Alan mentioned are reflecting a significant increase, so we are looking at those areas, where we can best deliver something to our staff without killing the bottom line.

Alan Eskow

Nancy, I think you will see some more, not huge, but some more additional sales based on the State acquisition, but that being said, we are in a mode now where we have increased our volume on loans. Loans are coming in across the board in each of our major areas. So we just wanted to reduce a lot of those types of course relative to putting on new norms when that's going on.

Alan Eskow

We try o gamble, we tried to manage the dispatch in our branches by using as many Park Avenue employees as we can. Throughout the whole log and envision we look at those things.

Nancy Bush – Research, LLC

So there would not be any kind of information though to delay or whatever, any kind of expansion plans that you may have as a result of this.

Gerald Lipkin

Well, we're looking a little bit harder at some new branch expansion right now, because that would create a course, then we have closed several of our branches in the last six months. We were looking at several others to make sure that they carry themselves.

Operator

Thank you. Our final question comes from Matthew Breese from Sterne Agee. Question, please?

Matthew Breese - Sterne Agee

Just to be clear, today let's call it another region 18 months the builds in the residential loan portfolio has been from booking excess from the mortgage origination platform. Is that correct?

Gerald Lipkin

Right.

Matthew Breese - Sterne Agee

Okay. Then you guys said that going forward, you are going to be booking more gain on sale, and so that portfolio should be flat?

Gerald Lipkin

Relatively, yes.

Matthew Breese - Sterne Agee

Okay. Then my last question is, there was some recent guidance from the FDIC, about ourselves and stress test. You guys are covered by the OCC. Has there been any further information on that, and any color or implications from it?

Gerald Lipkin

No, but I'd tell you Valley has been stress testing its portfolio for years. It's not something new. So whatever they want us to do, we're going to do.

Alan Eskow

Yes. We had to do stress test for a number of times whether it was to get out of TARP, or acquisition related stress test. Obviously, this will change but I think based on what the results were those days, we are obviously passed some of the stress test, so we don't anticipate an issue there.

I think as we said before, when you look at things like our residential loan portfolio, which has a loan LTV. When you look at our commercial real estate portfolio, there also probably has an LTV in the 15% range. We think that we'll be just fine.

Matthew Breese - Sterne Agee

You think you have the infrastructure in place to keep expense as it is?

Alan Eskow

Yes.

Operator

Thank you. We have one more that just came in. Ross Haberman, Haberman Management. Your question please.

Ross Haberman – Haberman Management

A quick question. I think it was BB&T issue to new trust preferred in the last or going to the last day or two five and change. Have you reconsidered your trust preferred and possibly issuing a new type soon?

Gerald Lipkin

You must have missed. That question was raised before. We are looking at everything all the time. There has been no decision made on anything. It's interesting to note the interest rates there it's a perpetual preferred stock has been issued have been coming down rather dramatically over the last 18 months. I guess that if interest rates fall, people are realizing that it's a good investment. So seem the longer we wait, maybe the cheaper it will be.

Ross Haberman – Haberman Management

Okay. At some point it might be virtual.

Gerald Lipkin

We look at that all the time.

Ross Haberman – Haberman Management

Okay. Thanks, guys.

Operator

I'm not showing any [audio].

Dianne Grenz

Okay. Thank you for joining our conference call. Have a nice day.

Operator

Ladies and gentlemen, the conference will be available for replay from July 26, 2012 at 1:00 pm, Eastern Standard Time. You may access teleconference replay system by anytime dialing 1-800-475-6701, entering the access code: 6701, entering the access code of 2359.

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