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Executives

Kirk Walters - EVP and CFO

Joe Campanelli - President and CEO

Bob Rose - Head of Risk Management

Thomas Cestare - Chief Accounting Officer

Tom Brugger - Treasurer

Analysts

James Abbot - FBR

Bruce Harting - Lehman Brothers

Collyn Gilbert - Stifel Nicolaus

Ken Usdin - Banc of America Securities

Gerard Cassidy - RBC Capital Market

Nick Elfner - Wellington Management

Sovereign Bancorp Inc. (SOV) Q2 2008 Earnings Call July 23, 2008 10:30 AM ET

Operator

Good morning. My name is Felicia and I will be your conference operator today. At this time, I would like to welcome everyone to the second quarter 2008 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]. Thank you. I would now like to turn the call over to Kirk Walters, Chief Financial Officer. Mr. Walters, you may begin.

Kirk Walters

Thank you, Felicia. Good morning, everyone. I would like to thank you for participating in Sovereign's earnings call for the second quarter of 2008. As a reminder, during this call, we will make statements that are forward-looking statements within the meaning of the Safe Harbor provisions of the United States Private Securities Litigation Reform Act of 1995. These statements include, but are not limited to, statements about strategies, plans and objectives as well as estimates of future operating performance.

These forward-looking statements include matters that involve significant known and unknown risk, uncertainties and other factors that may cause actual results, levels of activity your performance or achievements to differ materially from the results expressed or implied in this presentation. Factors that might result in such differences are outlined in our SEC reports including our annual report on Form 10-K. We refer you to these documents.

These factors include, but are not limited to, general economic conditions, changes in interest rates, deposit flows, loan demand, changes in accounting principles, changes in the competitive environment and market factors in industry and geographic areas in which we operate and other factors.

You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of today. Sovereign undertakes no obligation and does not intend to update these forward-looking statements to reflect events or circumstances occurring after the date of the call. During today's call, you will hear remarks from Joe Campanelli, our President and CEO, as well as myself. We will then follow with a question and answer period at which time Bob Rose our Head of Risk Management, Thomas Cestare our Chief Accounting Officer and Tom Brugger our Treasurer, will also be available for questions. With that, I would like to turn the call over to Joe.

Joe Campanelli

Thank you, Kirk and good morning everyone. I too would like to welcome you to our earnings call. Given the challenging operating environment, I am pleased with our results for the second quarter of 2008. They demonstrate the progress we’ve made to date in reducing our risk profile and improving the quality of our earnings stream, resulting in improved operating metrics.

We took proactive steps during the quarter to increase our capital level by raising 1.4 billion of common equity and $500 million subordinated debts. We believe the successful execution of the offering and the interest by investors in both the United States and Europe underscores their confidence in the future of our company. Even as this difficult economic environment continues, we feel we are now well equipped to handle any further deterioration.

Careful attention to the consistency of our earnings stream, building of the allowance for loan losses, stronger capital levels, ensure that Sovereign is on solid financial footing to manage through the current uncertain economic environment. As part of our effort to aggressively manage our credit exposure, improving operating results and drive growth in core market share, we assembled a strong executive team with a history of successfully managing through difficult economic downturns.

The new additions this year to our executive management team of our CFO Kirk Walters, and our head of retail banking, Roy lever, complement our existing team led by Pat Sullivan, Matt Karen, Bob Rose at Sovereign. With this team we’ve the financial and operational leadership necessary to successfully execute on our initiatives. One of our key initiatives focuses on reinvigorating our retail franchise.

At our annual meeting in May, we discussed some early results of our Customer First initiative. I would like to give you an update on those results today. We are currently generating on average 6,000 retail checking account sales per week. As compared to 3 to 4,000 per week in 2006 and 2007. For the first time in several years, we’ve experienced good momentum in growing our customer base and have deepened relationships with our customers.

Low cost core deposits, DDA’s now and saving accounts through an annualized rate of 15% in the first quarter of 2008. This is the first quarterly increase in at least six quarters and is directly attributable to our focused strategy.

Money market growth during the quarter was solid as well. CD volumes and spreads continue to be challenged as the market competes intensely for deposits. We are not pricing CDs at a loss but instead pricing intelligently to maximize contributions and returns. In the first quarter of 2007, we were selling 3.5 core products per FTE per week. This increased to 6.7 core products per FTE per week in the second quarter of 2008. 91% increase.

Our definition of core products only include retail and small business checking, savings and money market accounts, CDs, and home equity loans. It does not include secondary product sales such as debit card, online banking and bill pay, which have also grown considerably. We are encouraged by the increased improved productivity within retail banking in a relatively short period of time, leading to increased sales of other products; in particular, attractive fee based products such as investments and credit cards.

Obviously an initiative like Customer First will take sometime for the results to be reflected in the bottom line. However, this confirms we are on the right path. We will continue to update you quarterly on results of this important initiative, and future steps to leverage our attractive retail banking distribution channel. We also continue to expand our focus on the small business segment, and execute on cross-selling opportunities.

We remain prudent and conservative with respect to CNI and CRE lending and continue to be very disciplined in the real estate and building related segments. The Northeast region has a well-diversified employment base and represents a significant portion of the national economy. This region continues to hold up reasonably well in spite of the economic challenges faced in the country as a whole.

Unemployment in most of our footprint remains well below the national average of 5.5%. This region also did not experience the rapid growth in real estate inventory over the last economic cycle. There is limited access to land and long entitlement periods, all of which worked in our favor in a deteriorating credit environment. We are focused on the challenges ahead of us. We’ve a committed and experienced management team and Board of Directors, a disciplined in market strategy and are fortunate to be positioned in one of the most attractive markets in the country.

I would now like to turn things over to Kirk who will go through the financial details of our second quarter 2008.

Kirk Walters

Thanks, Joe. For the second quarter, net income was $127.4 million or $0.22 per diluted share, as compared to $100 million or $0.20 per diluted share in the first quarter of '08, and $147.5 million or $0.29 per diluted share in the second quarter of '07. One item I would like to quickly note is that the earnings per share for the current quarter does not reflect the full impact of the equity issuance. The new shares settle on May 16th of '08. Therefore, the 179.7 million shares issued were only included in our share count for half of the quarter. Our weighted average shares will increase by 88.9 million in the third quarter, to reflect the full impact of the common equity issuance.

For the current quarter, our net interest margin expanded 18 basis points, to 3.06% from 2.8% on a linked quarter basis and 2.71% in the second quarter of last year. The overall reduction in short-term market interest rates and the improved mix in our deposit have been important contributors to the margin increase. Average deposit decreased $1.1 billion on the on a linked quarter basis to $47.8 billion, driven by a reduction of $1.2 billion in wholesale and government deposits.

Average retail and commercial deposits increased $285 million during the second quarter, in spite of run-off in timed deposits of $670 million. The decrease in timed deposits was driven by the company's decision to not aggressively price the maturities of $2.45 billion 5.25 % nine month promotional CDs that we issued in 2007. The bank did retain 58% or 1.4 billion of these balances at an average rate of approximately 2.66% through strong sales efforts by our retail associates.

Earlier Joe shared some results of the Customer First initiative with you. We believe the growth that we’ve experienced in retail deposits is a result of our increased focus on reinvigorating the retail deposit franchise. Our total deposit costs declined 67 basis points during the quarter, which reflects a full quarter of the multiple Fed cuts early in the year while still seeing growth across all of the retail core deposit categories, excluding CDs.

Average commercial loan balances increased $896 million from the first quarter, as a result of high originations at commercial real estate, multi-family and CNI loans within our core markets. On a spot balance basis, commercial loans increased only $254 million, or 79 basis points from the first quarter of '08. Average CNI loans and other commercial loans increased $247 million to $14.8 billion on a linked quarter basis. In addition, CRE loans were up $459 million, to $13.1 billion multi-family loans increased $190 million to $4.5 billion.

Yields on the commercial portfolio decreased 65 basis points in the second quarter, primarily due to the re-pricing of variable rate loans driven by lower short-term market interest rates. Average consumer loans decreased $907 million during the quarter to $25.9 billion. On a spot balance basis, consumer loans decreased $1.7 billion or 6.4% from the first quarter of 2008. Within the consumer loan category, residential mortgages continued to decrease as we execute our strategy of selling the majority of our production in the secondary markets. Average balances are down $674 million, and period end balances are down $1.4 billion from the first quarter levels.

In May, the bank securitized $780 million of residential mortgages and transferred them to the investment portfolio to improve its liquidity and collateral position. The credit quality of the remaining portfolio at June 30th of '08 remained solid with an average FICO score of 732, and weighted average LTV of 52%. Although we’ve seen a large increase from historically low levels in non-performing residential loans throughout 2008, net charge-offs in this portfolio for the second quarter were down slightly at $4.6 million, as compared to net charge-offs in the first quarter of $4.8 million. In an effort to provide additional information on a residential portfolio, we’ve split out certain details of the Alt-A loans in both the financial schedules and investor presentation that was filed on a Form 8-K this morning.

The average FICO of the Alt-A portion of this portfolio is 714, and the weighted average LTV is 61%. On a linked quarter basis, the bank's direct home equity loan portfolio increased $197 million on average, and $244 million at period end to $6.1 billion. Yields in this portfolio decreased 62 basis points to 5.53% as a result of a full quarter impact on our short-term market interest rate on the 41% of this portfolio that is variable rate.

Direct home equity loans are generated through our branch network and are of high quality. Utilization rates on lines of credit are approximately 41%. Past due levels and net charge-offs for this portfolio continue to be stable with past due loans equal to 46 basis points at June 30th of '08, compared to 51 basis points at March 31st of '08 and 51 basis points at June 30th of '07. Net charge-offs of $4.4 million were down on a linked quarter basis from $5.4 million in the first quarter of '08 and up from $1.9 million in the similar quarter in '07.

Indirect auto loan average balances declined $398 million on a linked quarter basis to $6.6 billion, and on spot basis decreased $509 million or 7.5% to $6.3 billion. This decrease was due to a $264 million reduction in originations within our core franchise, and the decision in '07 to stop originating auto loans in out of footprint markets.

Current quarter originations totaled $239 million, compared to $503 million last quarter. With an average FICO score improving to 745 and 718 a year ago. Given the recent rise in gasoline prices, there have been a lot of questions about the SUV truck exposure in our auto portfolio. In order to be responsive to your concerns, we’ve provided fairly extensive disclosures in the investor presentation and financial schedules in this segment on the auto portfolio.

Of the total auto portfolio, 50% is in SUVs and light trucks, of which 57% were new and 43% used at the time of origination. Additionally, of the SUV truck origination, 60% is in footprint and 40% is out of footprint. Industry data shows that 51% of auto sales in '06 and '07 were SUV, light truck sales, so our portfolio mimics that trend. Sovereign's credit quality statistics on this segment are not much different than the portfolio as a whole. SUV truck delinquencies at June 30th of '08 were 2.18%, compared to the portfolio of 2.54%. During the second quarter, net charge-offs for the indirect auto portfolio were $36.6 million, with approximately 57% of these losses in the SUV truck segment. The recovery rates on the SUVs and trucks have been declining in recent months and at June 30th of '08, we’ve incorporated into our loss models lower recovery rates as well as further deterioration for the indirect auto portfolio.

We expect this segment of the portfolio to continue to experience decreases in recovery rates but do not believe the impact will be material to our financial statements. As part of our equity raise, we had provided credit loss expectations under various loan portfolios. The full year 2008 guidance provided for the auto portfolio range from the base case estimate of $147.8 million, to the stressed case estimate of $182.8 million. Year-to-date net charge-offs on this portfolio total $79.4 million and we remain comfortable with the aforementioned guidance.

While we saw 18 basis points of margin expansion this quarter, our outlook on the margin is relatively stable. As both our variable rate loans and deposits continue to reprise and fully reflect the reductions in short-term market interest rates. Fee income before investment gains was $205 million for the second quarter of 2008, as compared to $158 million on linked quarter basis, and $190 million in the similar period a year ago.

Year-over-year consumer banking fees grew $3.7 million or 4.8%, primarily as a result of increased deposit fees and investment services revenues. It should be noted that in the second quarter of 2007, the company recorded a gain of $2.7 million related to a student loan sale. So on an operating basis, consumer fees actually increased 8.6%.

On a linked quarter basis, consumer banking fees were up $7.8 million to $81.0 million, due to seasonality increases in deposit fees as well as strong investment services revenues driven by recent increase in demand for annuity products. Commercial banking fees were $53.7 million in the second quarter of '08, down slightly from $54.4 million in the first quarter of '08.

Included in the current quarter was a $1.2 million loss related to the sale of $82 million of non-core commercial loans during the quarter. Year-over-year, commercial banking fees grew 3% driven by an increase in deposit fees of $7.4 million, partially offset by declines in precious metals income of $4.4 million.

The decline in the precious metals income was driven by the company's decision to reduce outstanding volume in this business and only focus on target customers within our core franchise. Mortgage banking revenues were $37.9 million for the second quarter of '08 as compared to a loss of $5.1 million on a linked quarter basis and revenues of $26.5 million in the similar quarter a year ago.

The loss in the prior quarter was attributed to mortgage and multi-family servicing right impairments, $23.6 million, which were driven primarily by lower market interest rates and higher market prepayment speed assumptions.

Approximately $20.5 million of this impairment was reversed in the second quarter of '08 as a result of the normalization and market prepayment speeds to more accurately reflect the current economic conditions. Net investment gains of $1.9 million in the second quarter of '08 were due to a gain of $6.5 million related to the sale of the majority of our Master Card stock which was partially offset by a write-down of $4.6 million related to certain off balance sheet home equity securitizations that were completed 1998, 1999.

Sovereign's maximum risk to loss on the remaining retained interest for these home equity securitizations is $2 million.

The first quarter of '08 included a net investment gain of $14.1 million, related to the mandatory partial redemption of the Visa IPO shares. G&A expenses for the quarter with $382 million compared to $359 million on a linked quarter basis and $337 million for the similar quarter in 2007. The increase on a linked quarter basis was attributable to the following factors. Included in the first quarter of 2008 was a $6.4 million reversal in legal costs of the accrual related to the Visa IPO.

The second quarter of 2008 experienced higher compensation and benefits expense of $7.6 million, which was driven by severance costs of $5.3 million, in addition to merit increases are granted to team members on April 1st of each year of $3.8 million. Higher loan workout and other real estate owned expenses of $5.3 million, and increased marketing expenses primarily related to Customer First of $3.5 million.

The increase in general administrative expenses from the second quarter of 2007 of $45 million was primarily due to increased compensation and benefit expense of $21.2 million, driven by the aforementioned severance costs and merit increases in the second quarter of '08 as well as higher incentive compensation accruals as a result of changes in incentive compensation structure for retail and corporate plans to better align our plans to the marketplace.

The second quarter of 2007 included a $3.8 million reversal of incentive compensation as well. In addition, the company has incurred higher deposit insurance premiums of $7.7 million, increased marketing expense of $2.6 million, higher loan workout and OREO expenses of $8.7 million and increased legal expense of $2.4 million.

Other expenses totaled $42.8 million in the second quarter of '08 compared to $37.5 million in the first quarter of '08 and $79.5 million a year ago. Second quarter '08 results included a decline in the fair market value on one of our equity method investments of $6.4 million due to the impact of the current environment on market valuations. The second quarter 2007 results include a restructuring charge of $32.7 million related to branch closings, freezing the company's ESOP plan and severance charges.

Income tax expense for the three months and six months ended June 30th of '08 was $29.2 million $51.2 million, compared to $22.1 million and $23.6 million for '07. The income tax provision in the second quarter includes a $10.4 million provision to increase our reserves for income taxes based on recent court decisions and proposed legislation in certain states. Our effective tax rate for the six months ending June 30th of '08 was 18.3%.

We expect our effective tax rate for the remainder of '08 to be 16%. Our provision this quarter was $132 million, compared to $135 million last quarter, and $51 million a year ago. During the second quarter, we increased our allowance for credit losses by $45.1 million, to $843.5 million, and at June 30th the allowance to total loans was 1.47%, an increase of 11 basis points from 1.36% at March 31st, and up significantly from the prior year level of 92 basis points.

The increase in reserves is due primarily to continued deterioration in asset quality for the commercial loan portfolio, particularly in the for sale housing segment. Net charge-offs were $86.9 million or 60 basis points of average loans, compared to $74.3 million or 51 basis points of average loans in the first quarter of '08.

The increase in commercial loan net charge-offs of $18.1 million from the prior quarter was due to higher net charge-offs in the CNI and other commercial loan portfolio of $13.5 million. Increase in net charge-offs within this portfolio related to a variety of industries including housing related companies, mortgage company, electrical contractor, and precious metals.

Approximately 34% of net charge-offs this quarter related to losses on corresponding home equity of $6.2 million out of footprint indirect auto portfolio of $23.3 million. As you know, both of these portfolios are currently in runoff mode, consistent with our expectations net charge-offs related to the runoff auto portfolio decreased $4.9 million from the first quarter levels. The remaining balance in the out of footprint portfolio is $2.2 billion with reserves of $86.1 million at June 30th of '08.

The remaining balance in the corresponding home equity portfolio is $416 million, which consists of $308 million in first lien loans and $108 million in second lien loans with the reserves and discounts of $33.1 million $41.6 million respectively, at June 30th of '08. It should be noted that we’ve added new disclosures on these runoff portfolios in the financial tables and investor presentation relating to current FICO's portfolio manage and LTVs.

During the quarter, non-performing assets increased to $553.9million or 70 basis points with total assets from $484.4 million or 59 basis points of total assets at March 31st of '08. The increases in non-performing assets are primarily occurring in three categories. Commercial real estate, Alt-A residential loans and multi-family loans.

Non-performing commercial real estate increased $21.9 million to $117.3 million at June 30th of '08, from $95.4 million at March 31st of '08. The increases in non-performing assets are being driven by a residential construction or for sale housing portfolio. We continue to reduce this portfolio, which totaled $907 million at June 30th, compared to $982 million at March 31st of '08.

The $907 million portfolio is comprised of $499 million of home builder, $357 million of condominium, and the remaining $51 million is land. The geographic breakdown of the for sale housing portfolio is as follows. $776 million is in our core franchise. $80 million is in Florida; $23million is in Texas, $1.3 million in California. We’ve performed two extensive reviews of the entire for sale housing portfolio over the past few months to ensure all risks are identified and our reserve levels are sufficient.

Although we are seeing increases in non-performing assets, from commercial real estate, past due levels for this portfolio continue to be stable with past due loans equal to 48 basis points at June 30th of '08 compared to 42 basis points at March 31st of '08 and 45 basis points a year ago. Net charge-offs increased to $7.7 million for the second quarter compared to $3.3 million in the first quarter of '08, and $2.8 million in the second quarter of '07. The increase in net charge-offs was due to developer housing related issues.

Non-performing CNI and other commercial loans decreased $10.6 million on a linked quarter basis to $129.7 million, as a result of pay downs or liquidations on a number of credits in a variety of businesses. Total past due CNI and other commercial loans were 52 basis points at June 30th of '08 compared to 39 basis points at March 31st of '08 and 36 basis points a year ago, driven by late payments and renewals, many of which have since been resolved. Non-performing Alt-A residential loans increased $20.7 million to $85.4 million at June 30th of '08 from $64.8 million at March 31st of '08.

The increase in non-performing and past due loans within this portfolio are concentrated in geographies that are proportionate to the top five states exposure which are Massachusetts, Pennsylvania, New Jersey, California, and Florida. Although we are experiencing increases in non-performing assets and past due loans for Alt-A loans, net charge-offs for this portfolio continue to be stable, $2.2 million for the second quarter compared to $2.1 million in the first quarter of '08 and $362,000 for the similar quarter in '07. We would expect to see increases in losses in future periods for this portfolio dependent on the general economy and unemployment rates.

We continue to reduce this portfolio, which totaled $2.8 billion as of June 30th, compared to $3 billion at March 31st of '08 and $3.2 million in June 30th of ‘07. Non-performing multi-family loans increased $31.8 million to $42.2 million at June 30th of '08. This increase is primarily being driven by one large $23 million multi family loan on a property located in Florida to a customer within our core franchise. The loan has sufficient reserves against it and we expect resolution fairly quickly.

As I mentioned earlier, we’ve added to our loan reserves for this portfolios during this quarter and prior quarters to cover the associated risk with these loans. That being said continued deterioration in these asset classes in future periods could require additional reserves considering the current environment.

As you will recall last quarter we discussed that our capital ratios have been a concern to the investment community and one of the primary responsibilities for the Board of Directors and management is to be good stewards of the existing shareholders' capital. I had indicated that we are committed to focusing on the core franchise and reducing wholesale and non-core businesses. This process of aligning the balance sheet with our core franchise will result in a smaller institution that is very focused on our most profitable customers.

If you look at our second quarter results you will see we are addressing these concerns through the recent equity and subordinated debt issuances as well as by reducing our balance sheet by $2.7 billion, while generating net income of $127.4 million. We’ve also reduced our reliance on wholesale funding sources, improved our operating metrics, and increased our tangible book value per share from the prior quarter. As Joe mentioned earlier, we successfully raised $1.9 billion of capital, $1.4 billion of common equity and $500 million in subordinated debt on May 16th of ‘08, which significantly strengthened the capital levels of both the holding company and the bank.

We intend to hold the cash from the equity offering to Bancorp to satisfy debt maturities or support the bank if necessary. It should also be noted that the increase in retained earnings and reduction in the size of our balance sheet increased our tangible common capital ratio by 37 basis points, as well as our other capital ratios during the second quarter. As previously mentioned, we continue to build capital even in this difficult operating environment, through continued downsizing the balance sheet and increasing retained earnings.

Tangible equity to tangible assets excluding other comprehensive income was 7.18% at June 30th, of '08 compared to 4.97% last quarter and 4.84% a year ago. Tangible common equity to tangible assets excluding OCI was 6.92% compare to 4.72% last quarter a 4.59% a year ago. Including the other comprehensive income, tangible equity, and tangible assets was 6.29%, tangible common equity to tangible assets was 6.04% June 30th of '08. Sovereign's tier one leverage ratio is 8.34% at June 30th of '08 as compared to 6.21% at March 31st of '08 and 6.4% a year ago. The bank's tier one leverage ratio is 7.27%, compared to 6.85% at March 31, of '08 and total risk based capital was 11, compared to 10.24% at March 31st. The bank issued $500 million of subordinated debt as part of the capital raise in May, which qualifies as tier two capital and covers phase-outs of qualifying subdebt through December 31st of '09. The company's OCI decreased $25.5 million after tax, primarily due to the impact of higher interest rates on our derivatives portfolio. Consistent with my comments from last quarter, I would like to review certain components of our investment portfolio.

Our non-agency mortgage backed securities are AAA rated and are not backed by any sub-prime mortgage related loans. Unrealized losses on this portfolio have increased $31.3 million after tax since last quarter, due to the continued widening of credit spreads. The remaining average life of this portfolio is 4.2 years. Our municipal bond securities portfolio consists of 100% general obligation bonds of state, cities, and school districts.

The portfolio has a weighted average underlined credit risk rating of AA minus. All other bonds are insured as extra credit protection. Credit spreads improved during the second quarter on this portfolio but remain wide due to concerns with respect to third party insurers. However, even if we were to assume that the insurers could not honor their obligation, our underlying portfolio is highly rated and we expect that all scheduled principle and interest will be realized. During the second quarter, the unrealized losses on this portfolio declined from the end of the first quarter by $21.6 million after tax. The expected life for these securities is 14.6 years.

Unrealized losses in our CDO investment portfolio remain elevated and increased by $4.6 million after tax attend of the second quarter compared to March 31st of '08. Our CDO portfolio is backed entirely by corporate names and is comprised 15 since that, $50 million CDOs. We do not have any exposure to sub-prime or residential mortgages in this portfolio. Our CDOs have not experienced any losses to date and maintain high credit ratings. Based on the current subordination within the CDOs, Sovereign would not have any loss exposure until cumulative losses from the corporate names in the CDOs exceed 5.1%. Which is three times the historical average loss rate and just under two times the worst ten year period of investment grade bond losses over the last 30 years.

Average remaining maturity on this portfolio is 8.36 years. Sovereign holds preferred stock in Fannie Mae and Freddie Mac, which was originally purchased for $899.5 million through a series of write-downs, has a current book value of $622.6 million, of which $173.8 million are Fannie Maes and $448.8 million are Freddie Mac's.

The unrealized loss in this portfolio increased by $11.4 million to $22.4 million after tax at June 30. In July, recent news stories and concerns in the marketplace have resulted in significant volatility in the share price of the Fannie Mae and Freddie Mac. It is widely believed that the U.S. Government will support these two government sponsored entities if needed, and has publicly stated so but it is unclear whether the support would extend to their common and preferred shareholders.

Given the developments in the marketplace, the value of our Fannie Mae, Freddie Mac perpetual preferred stock has been very volatile with minimal liquidity. We continue to work diligently to get better clarity around the value of these securities which are largely be driven by current legislative proposals before Congress and the actions of the treasury and Federal Reserve.

To the extent that market conditions do not improve, and the values for these securities do not stabilize, it is possible that we could have a significant additional other than temporary impairment charge in future periods. All in all, this was a quarter that showed continued progress a brick at a time in a very difficult operating and economic environment.

With that, we will now open up the lines for Q&A on our second quarter '08 results.

Question-and-Answer Session

Operator

(Operator Instructions) We will pause for just a moment to compile the Q&A roster. Your first question comes from the line of James Abbott with FBR.

Kirk Walters

Good morning.

James Abbot - FBR

Hi, good morning. I looked at the non-interest bearing deposit line, which was up quite a bit. Hopefully I did not miss this part of your comments but did you go over why that was up quite so much and maybe is that growth sustainable, do you believe and perhaps, that was a big contributor to net interest margin expansion.

Kirk Walters

The non-interest bearing deposits we’ve continued to see growth in that coming from our retail and commercial side. That is obviously the linchpin and key point tied into the Customer First initiative with the new accounts and such being opened there. However, also, you know, for a practical standpoint we do see seasonality typically in commercial that will contribute to some of that growth as well. So it is under the heading of it is steady as she goes. We are pleased to see that growth and we are continuing to be promoting the efforts on Customer First there. I do not know if Joe has anything additional he wanted to add to that.

Joe Campanelli

Excuse me. Thanks, Kirk. We did discuss some of the improved productivity levels in our retail franchise year-over-year, significant improvements in net new account openings and more cross-sell which is all part of the Customer First initiative and we plan to continue to disclose those numbers on a quarter-over-quarter basis to track progress.

James Abbot - FBR

Okay and that was my primary question. I will circle back at the end if there are others.

Operator

Your next question comes from the line of Bruce Harting with Lehman Brothers.

Bruce Harting - Lehman Brothers

So it sounds like you are from when you did your offering, you are getting more positive on the credit outlook. I might have missed it. However, can you just refresh the outlook you gave in terms of the range of credit expectations and then to the degree that as you pointed out the Paulson plan, passes the House today and Senate within the week, you know, what is the process for marking up any of those preferred, is that just as market price improves, that comes through each quarter or how does that work. If one assumes those are all effectively money good at par over time? Thanks.

Kirk Walters

Well, let me address the two questions and I will have Bob Rose, our Chief Risk Officer, chime in as well. I think in terms of the credit outlook, I would not characterize that we are any more optimistic from the equity offering. We did give the different scenarios in the equity offering. I think when we did those scenarios, we indicated that the likelihood that charge-offs would come in higher or lower than the number that was originally within those proposals for the second quarter was to be more likely it may be a little lower. I think we continue to be very careful in this environment in terms of what we are looking at from a credit perspective. You can see that by how we are adding increase in our allowance for loan losses and trying to be thoughtful in terms of that front. So I do not know that I would say that our position has changed from where we were at with the equity and debt offerings when we did that. On the second item, anything to do with asset valuations broadly across the financials is really a facts and circumstances type of situation. So we will be watching closely what Congress and others do and obviously other economic factors that could impact whether it be the Fannie, Freddie or other items we’ve and, you know, factoring all that in as we think about impairments or OTTI or those types of issues for the quarter. With that, maybe, Bob, if you want to give a little color on the credit side. I should note that we are not updating the projections that we put out as part of the equity raise.

Bob Rose

Well, relative to that forecast, we had called for provision of about $114 million for the quarter and we did $132 million and that really reflected some of the deterioration that Kirk and Joe mentioned specifically in the for sale housing as well as our judgment reflected in changing some of our loss assumptions and other parts of the portfolio. However, that does not materially change the provision forecast for the rest of the year. On the charge-off side, if you took the three quarter forecast that we did and simply divided it by three, it was about a $98 million number for second quarter charge-offs. We actually had some adjustment for cresting the skew more towards the present than the latter part of the year. It would have brought the forecast to about 109 and we wrote off $87 million. So we beat that by $22 million, but that, we beat it in some places, we were under in a couple of others but that does not mean we are going to continue to beat that through the year. We will stick with what we put out there.

Kirk Walters

Thanks, Bob.

Operator

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

Kirk Walters

Good morning Collyn.

Collyn Gilbert - Stifel Nicolaus

Thanks good morning. Just a couple questions. Maybe it is semantics and it does not really matter. You are describing of the for sale housing portfolio does that mean there is not land loans on it and they are finished lots?

Bob Rose

The for sale housing includes a little over $50 million in land. However, depending on the project, there is some there are some land aspects to it that are being built out by developers.

Collyn Gilbert - Stifel Nicolaus

Okay. Okay.

Bob Rose

Stand alone land in that number is $52 million.

Collyn Gilbert - Stifel Nicolaus

All right. Then just in terms of the overall exposure to Florida, and I just want to make sure I have this right. Within the for sale housing portfolio, Kirk I think you said you had $80 million in Florida?

Kirk Walters

That is correct.

Collyn Gilbert - Stifel Nicolaus

Then, but then the $23 million that hit net charge-offs this quarter on or was it net charge-offs, delinquencies on the multi family within Florida, can you just give us the overall exposure to Florida?

Kirk Walters

The overall between all of our different portfolios to Florida?

Collyn Gilbert - Stifel Nicolaus

Yes, yes.

Bob Rose

The overall exposure including and there was a slide to this effect within the deck that was put out this morning, it is page 20. The overall exposure is 4% of our loan portfolio, which would be approximately $2.3 billion, about $860 million of that is automobile loans, and the balance would be $1.4 million that is pretty well spread out in no inordinate shares throughout the entire portfolio.

Collyn Gilbert - Stifel Nicolaus

Okay. Then just in terms of the one multi-family credit, again, Kirk, you had mentioned resolution and there are sufficient reserves. Can you give us a little bit more detail on that or what is it that, you know, in terms of the why you feel the reserve is sufficient and how quickly you feel that can be resolved.

Bob Rose

This is Bob. Collyn because we are negotiating with at least one party as to the sale or assumption of that transaction, you know, within the parameters of our reserves and expectations. So it is based on real live negotiations to get rid of it.

Collyn Gilbert - Stifel Nicolaus

Okay. Okay. Then just on the securitization that occurred this quarter, could you just give a little bit more detail on that and if you anticipate or plan on future securitization in coming quarters?

Kirk Walters

The $780 million was securitized in single-family residential loans and agency securities putting them into the investment portfolio. We will be continuing to look at the residential portfolio, and may do additional securitizations; it not only frees up certainly some allowance for us on the credits perspective but more importantly provides better liquidity and more collateral in relation to those single family loans. The one thing I would just add to Bob's comment on the multi-family property, and I noted in my commentary, is this loan was made to a borrower out of our core markets by the multi-family group, which has traditionally done these activities, just as a point of note.

Collyn Gilbert - Stifel Nicolaus

Okay. Okay. Then just on the securitization, Kirk, was there anything specific about this pool of loans that you decided to take them off balance sheet?

Kirk Walters

Well, I would not say I would really say it is a non-balance sheet.

Collyn Gilbert - Stifel Nicolaus

Yes, you are right, I did not mean that but move them into the securities.

Kirk Walters

No, I do not think there was anything specific to it other than what I stated before, which is that as we can, one of our goals is continue to reduce the risk profile of the company and this continues to do that.

Collyn Gilbert - Stifel Nicolaus

Okay great and just one final question. You said tax rate of 16%, so for each of the following two quarters the third and fourth quarter we should be looking for 16% tax rate?

Kirk Walters

That is our projection at this point. That is correct.

Collyn Gilbert - Stifel Nicolaus

Okay. Okay. Very good. Thank you.

Kirk Walters

You bet.

Operator

Your next question comes from the line of Ken Usdin with Banc of America Securities.

Kirk Walters

Good Morning

Ken Usdin - Banc of America Securities

Good morning, Kirk. Question about the balance sheet. First of all, could you tell us when during the quarter was the securitization done?

Kirk Walters

It was May 28.

Ken Usdin - Banc of America Securities

Okay. So two months in. Then that leads to my second question, which is how do you think, could you help us in how we think about the overall size of the balance sheet going forward meaning that I know you made broader comments about continuing to shrink and obviously some of those portfolios are running off. Could you give us some help on the magnitude of the overall portfolio shrinkage that we should expect as we move forward over the next year or so?

Kirk Walters

We’ve not put any numbers out as you know as projections and still not considering the nature of the markets and such. I do not think it would be prudent to put out any projections in the numbers. However, what I said earlier, I would stand by. I think the balance sheet at the end of '08 will be smaller than the balance sheet at the end of the second quarter and that by the end of '09 that we will be smaller than the balance sheet at the end of '08 and so part of that is not me trying to be cute but just the realities of what the markets are and as we downsize, want to do it in a careful, thoughtful and the way that is best for our shareholders.

Ken Usdin - Banc of America Securities

Is there any way you can help us through maybe just some mix perspective, like do you continue to expect that with the commercial bucket continuing to grow while the consumer shrinks, any help on how mix might look as far as how you move forward, rather than magnitude?

Kirk Walters

I think what we’ve indicated earlier is that if you exclude securitizations that one would expect the investment portfolio to continue to decline. On the commercial portfolio, even though we’ve seen growth in that, you can see on a spot basis that is pretty well slowed and that we would probably expect that to start declining a bit here as we go toward the end of '08 and into '09, particularly a little bit in some of the multi-family loans, the nature of that business tends to be that we tend to build the portfolio and then do some larger sales through to Fannie or Freddie, etcetera, on that. On the consumer portfolios, I think you can see the trend, whether we do securitizations or not, is that across the different portfolios, other than home equity, that we continue to see those declining, particularly the auto portfolio at a pretty rapid rate and certainly the single family residential as well.

Ken Usdin - Banc of America Securities

Okay.

Kirk Walters

Bob might add little bit of color towards where we are going.

Ken Usdin - Banc of America Securities

That is helpful. Thank you. My second question is just regards to the net interest margin, obviously you had mentioned the flattish outlook and I was just wondering if you could detail us a little bit deeper on why it would only be flattish, your thought process. I mean, the equity raise I us only in there for about half the quarter. I would think that would be a nice improvement. What are the factors that would hold back continued margin expansion?

Kirk Walters

If you look at the equity raise, you have to factor in the subordinated debt we issued at 8.75. Even though there is certainly some net positive impact of that on the margin for the second quarter, it would have been less than a basis point. So you do have a couple of offsetting factors there. I think the margin largely as we go forward here is going to be driven by the mix of our deposit and loan portfolios and our ability to continue through the various initiatives on the retail and commercial side to grow deposits and grow low cost bearing deposits and some of that is going to be a factor of what is going on in the economy and with the customers and deposit levels and such there as well. So as we continue to see how that progress develops, then that will have impact on our margin and hopefully expansion of our margin.

Ken Usdin - Banc of America Securities

Okay. Thanks a lot, Kirk.

Kirk Walters

You bet.

Operator

(Operator Instructions) Your next question comes from the line of Gerard Cassidy with RBC.

Kirk Walters

Hi Gerard.

Gerard Cassidy - RBC Capital Market

Hi, Kirk. Got a question, I do not know if you have the data, possibly if you do not maybe you could get it offline. In the appendix on Slide H or page H I should say where you give us the supplemental information on credit quality; the first row is commercial real estate and then you information on credit quality, the first row is commercial real estate and then you put down in there a note about the construction loans being $907 million at the end of '08. Do you have those numbers for the construction loans for the net charge-offs in the total past due excluding non-accruals?

Joe Campanelli

I do not think we’ve that right in front of us at the moment.

Kirk Walters

We do not have that right in front of us. You know, the construction portfolio we were referring to there is the for sale housing portfolio.

Gerard Cassidy - RBC Capital Market

Okay.

Kirk Walters

That, you know, we had broken down before in terms of the various pieces, how much is in the home builder, how much is in condo and how much is in land. However, I do not think we’ve specifically broken out charge-offs. Hold on a second.

Bob Rose

We have in that sector, Gerard, there are $49 million worth of non-performing loans. Do not have the charge-offs, though.

Gerard Cassidy - RBC Capital Market

Okay. So that is 49 out of the 907, is that a fair relationship, meaning is that 907 portfolio?

Bob Rose

Exactly.

Gerard Cassidy - RBC Capital Market

Okay. In the CNI area, you had up tick in the non-performers as well as charge-offs. Could you share with us where you are seeing, if you are seeing any real weakness in CNI in other commercial?

Kirk Walters

Let me initially we will turn it to Bob and then maybe Joe would want to add on some commentary there.

Bob Rose

Yes, the non-performers in CNI, they fell in the quarter. They fell by about $10 million. However, you know, the general flavor there is across the board. It is spread out to some things that have tentacles in housing. We had a large addition that was a precious metals related company, but it was offset by over $50 million in resolutions on a broad range of things. So the net-net number fell. So still it is a complete range of thick codes and industries that are causing some issues there with a little flavor to housing.

Joe Campanelli

I think that Bob's point, the general stress in the economy, a little bit of bias perhaps people are selling those building trades, building materials, electrical contractors, digesting the lower level of revenues that is available in the market. However, it is pretty much across the board.

Gerard Cassidy - RBC Capital Market

Okay. Do you have any shared national credits in your commercial portfolio?

Bob Rose

Yes, we do.

Gerard Cassidy - RBC Capital Market

What would that portfolio size be?

Bob Rose

About $5 billion.

Gerard Cassidy - RBC Capital Market

5 billion? Have you heard any color on the shared national credit exam that I think was recently completed?

Bob Rose

Not officially. There is been a real estate color and a leveraged loan color to it and we are anxious to receive the results. We’ve done little or nothing in the leveraged loan area but we have not received any letters or notifications on it.

Gerard Cassidy - RBC Capital Market

Great. Thank you.

Operator

Your next question comes from the line of Nick Elfner with Wellington management.

Kirk Walters

Good morning, Nick.

Nick Elfner - Wellington Management

Hi, there, good morning. As it relates from the bond holder perspective, obviously happy about where your capital's been trending and I think could you comment on any update on shifting potentially to a commercial bank charter from the thrift charter. I think you mentioned back at the time of the offerings that that was behind the thought process, building the capital ratios and perhaps changing the mix a little bit and maybe even down sizing the balance sheet. Do you have any comments on that or an update?

Kirk Walters

I think in terms of the time we did the subordinated debt, we commented that with the equity raise it did allow us from a capital perspective to meet the capital requirements of any of the regulatory agencies. That is something from a charter perspective; certainly no decisions have been made. We continue to be and work within the OTS charter and as we go forward and think about the future where the balance sheet goes, etcetera, I think what we are trying to indicate in the equity and debt offering was that we did have the alternatives, at least from a capital perspective and such, of looking at other charters if in fact we found the existing OTS charter to be difficult. We are encouraged by the legislation currently going through Congress, which would provide holder relief to us and others in this situation and something we are also watching closely.

Nick Elfner - Wellington Management

Great. Thanks for that.

Operator

There are no further questions at this time.

Kirk Walters

Well, thank you very much to all the folks for joining us today. We hope you have a good summer. Thanks.

Joe Campanelli

Thanks, everyone.

Bob Rose

Bye Now.

Operator

This concludes today's conference call. You may now disconnect.

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