First Horizon Corporation (FHN) Q2 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. Welcome to the First Horizon National Corp. Second Quarter 2012 Earnings Call. [Operator Instructions] As a reminder, today's conference is being recorded. I would now like to introduce your host for today's conference call, Ms. Aarti Bowman. You may begin, ma'am.

Thank you, operator. Please note that the press release and financial supplement, which announced our earnings as well as the slide presentation we'll use in this call this morning, are posted on the Investor Relations section of our website at www.fhnc.com. In this call, we will mention forward-looking and non-GAAP information. Actual results may differ from the forward-looking information for a number of reasons outlined in our earnings announcement materials and our most recent annual and quarterly report. Our forward-looking statements reflect our views today, and we are not obligated to update them. The non-GAAP information is identified as such in our earnings announcement materials and in the slide presentation for this call and is reconciled to GAAP information in those materials. Also, please remember that this webcast on our website is the only authorized record of this call. This morning's speakers include our CEO, Bryan Jordan; and our CFO, BJ Losch. Additionally, our Chief Credit Officer, Greg Jardine, will be available with Bryan and BJ for questions. I'll now turn it over to Bryan.

Thanks, Aarti. Good morning, and thank you for joining in our call. Second quarter 2012 marked another period of successful executing our strategic plan. We achieved solid performance in our core businesses. Asset quality continued to improve, and we purchased $37 million of our common stock, leaving $74 million under our $200 million share buyback program. Focus on our core businesses continue to pay off. The regional banks pretax, pre-provision net revenue increased 16% from the year ago level, driven by 9% higher net interest income and modestly lower expenses. In capital markets, second quarter fixed income average daily revenues were $1.1 million within our expected range but down from last quarter's exceptionally high level due to more cautious buying behavior from our customers. FTN Financial remains a major contributor to fee income and provides significant returns for us. In the second quarter of 2012, FTN's return on assets was an annualized 2.1%. Balance sheet trends were also positive in the second quarter. We grew our Regional Bank loan portfolio, while the non-strategic loans continue to run off, improving our loan mix. The bank increased average loans by about $1.1 billion or 10% year-over-year. Although loan pricing and structure remain very competitive, average consolidated loan yields were flat at 4.09%. Average core deposits in the regional bank grew 13% year-over-year and were up 3% from last quarter, benefiting our funding cost. Consolidated net interest margin was 3.16%, up from last quarter slight, although slightly below a year ago. Asset quality trends remain favorable. Year-over-year, net charge-offs declined 39%, while nonperforming assets were down 38%. In the second quarter, consolidated loan loss provision was $15 million versus $1 million a year ago. While credit trends continue to be favorable, we're seeing the pace of improvement slow, and we reserve for higher commercial and consumer loan balances in the bank. We're still seeing stable to improving loan portfolio, credit quality trends over the remainder of 2012. Consolidated expenses were up from a year ago, mostly driven by the $250 million addition to the mortgage repurchase reserve. Our productivity efforts remain on track. We saw a decline in other areas of second quarter expenses such as compensation, occupancy and foreclosed real estate costs. Since we are better able to estimate and reserve for projected losses from mortgage repurchases, future environmental expenses should be lower, helping drive our improvement in inefficiency. In fact, we now expect to achieve our annualized consolidated expense goal of approximately $1 billion by the end of 2012, a year ahead of our initial target. In sum, we're making progress and are firmly committed to the continued successful execution of our strategic plan. The current environment dictates patience since lower interest rates in a sluggish economic recovery are likely to persist. We're optimizing our business mix to well position First Horizon for when the economy gains momentum. Right now, we're focused on the successful execution of our strategic priorities. We're in new relationships. We're becoming more efficient. We're disciplined in execution opportunities, and we're focused on prudent capital deployment and achieving attractive long-term returns for our shareholders. I'll be back for some closing comments. But now BJ will walk you through the detailed financial results. BJ?

Thanks, Bryan. Good morning, everybody. I'll start on Slide 5. Our second quarter 2012 consolidated pretax income was a loss of $211 million, which included our previously announced pretax charges of $272 million. Those $272 million of charges resulted in an after-tax impact of about $168 million or roughly $0.67 per share. The $250 million reflects an addition to the mortgage repurchase reserve, and the other $22 million is for the litigation reserve. Pretax income from our core businesses were $65 million. And bottom line, our net income available to shareholders was loss of $125 million and diluted EPS, a loss of $0.50. As Bryan mentioned, we bought back $37 million of common stock in the quarter or roughly 4.5 million shares. For our total buyback program to date, we've purchased $126 million at $8.28 a share, leaving $74 million still authorized to be repurchased under our program. In terms of the consolidated balance sheet, average total assets were $25 billion essentially flat to last quarter. Average loans and core deposits were relatively stable as well. Deposit rates declined by 3 basis points to 44 bps in 2Q '12 and were 20 basis points less than a year earlier. As Bryan mentioned, our consolidated net interest margin was 3.16% in the second quarter compared to 3.12% in the first. Margin improved because of a reduction in our low yielding excess cash balances, our commercial loans fees and lower deposit costs. The new improvement was somewhat offset by lower reinvestment rates in the securities portfolio as expected. While we may see variability in quarterly net interest margin, we do currently forecast the consolidated net interest margin should be in the 3.10 to 3.15 range in the second half of 2012. Turning to Slide 6, in the Regional Bank. Linked quarter, our CPNR in the Regional Bank was up 5% and 16% year-over-year. Net interest income was up slightly linked quarter due to higher loan fees and increased loan balances with nice year-over-year growth of 9%. Fee income was up 8% linked quarter from a seasonal rebound in NSF and cash management fees, as well as increases in debit card, trust and other income. Pretax income in the bank was $65 million in 2Q '12, down $9 million from the first quarter. That decrease was driven by higher but still modest loan loss provision of $5 million in the second quarter compared to a credit of $7 million in the first. We're seeing continued positive great migration but as a slower pace of reserve decrease. Expenses in the bank slightly increased linked quarter primarily due to technology investments that should result in more efficient processes going forward. Turning to Slide 7, looking at the regional bank balance sheet trends linked quarter, regional bank period end loans rose 3%, driven by loans to mortgage companies, corporate lending and consumer loans and up 10% year-over-year, very solid performance. While commercial loan yields declined slightly from last quarter, our ongoing focus remains on making higher return quality loans. Linked quarter spreads were stable and up year-over-year. Our loan pipeline remains stable, and commercial loan commitments increased by $100 million from last quarter. Overall, quality loan demand remains modest and considerable competition including pricing and structure pressures persist. Average core deposits in the regional bank were up 3% last quarter and up 14% year-over-year. The average rate paid on these deposits declined 3 basis points to 36 basis points and was down from 54 basis points in 2Q '11. Turning to the next slide, Slide 8. Capital markets had another solid quarter with pretax income of $20 million. Fixed income average daily revenues were $1.1 million within our normalized range of $1 million to $1.5 million. The decline in ADR from first quarter to above average level of $1.6 million reflects more cautious customer activity due to the uncertainty about both the macroeconomic environment and the interest rate outlook. Expenses declined 24% from last quarter due to lower variable compensation, and looking ahead, we anticipate ongoing variability with fixed income revenues. We currently expect ADR to be in the lower half of our normalized range. Income product mix includes agencies, mortgages, corporate munis and treasuries. We continue to focus on further expanding our substantial distribution network by hiring talent and adding customer relationships. For example, you probably saw we recently added several experienced sales specialists and traders to our municipal bond group. And additionally, our capital mortgage group continues our long-standing position at the top underwriter of agency debt securities, and for 5 consecutive years, we have been the only non-primary dealer in the top 10. Turning to Slide 9, talking about our expenses and productivity initiatives. As Bryan mentioned, we should roughly achieve our targeted $1 billion of annualized level of consolidated expenses by the end of 2012, a year ahead of our goal. With the $250 million addition to our mortgage repurchase reserve, we currently expect ongoing quarterly GSE-related repurchase provision to be 0 or very immaterial. We're on track with our ongoing efficiency initiatives as well. Core business expenses excluding last year's capital markets litigation charge are down 10% from last year. Turning to Slide 10 and a little bit on the mortgage repurchase reserve. As you know, based on information we received from Fannie and extrapolated to Freddie, late in the quarter, we added $250 million to the repurchase reserve for an ending balance of $360 million. We had no change in our estimate or expected trends since our previous 8-K announcement. On Slide 11, you will see the second quarter repurchase trends. Linked quarter, our operational pipeline increased to $431 million, driven by a higher number of GSE-related requests. We did receive more repurchase request from Fannie, which represented a backlog from prior quarters. New requests were somewhat mitigated by a 6% linked quarter increase in our resolution, and our cumulative rescission rates and loss severity continue to remain stable. We had no repurchase requests from our first lien private securitization. And at this time, based on our private securitizations origination mix, yields, size and performance, we continue to believe that the risk here from private securitization should be significantly less than what we've experienced with the GSE. On Slide 12, asset quality trends. Linked quarter our, loan loss reserve declined 7% to $321 million. The reserve to loan coverage stands at 1.98%, a decline of 19 basis points from last quarter. Net charge-offs decreased 14%, reflecting continued improvement in our consumer portfolios. As you can see on Slide 13, nonperforming assets declined 9% to $467 million from last quarter. Inflows were stable and ORE balances declined through the continued disposition activity, mostly through single transactions. Wrapping up on Slide 14. We managed our company, as you know, to achieve long-term funds and profitability targets following our bonefish model. Core business trends are good, and we've made significant headway, and we're building non-strategic issues. And even though we've made significant progress on our efficiency goal, we are constantly looking at ways to cut costs and become more productive, and we will continue to do so. Looking at Slide 15, just a little bit on the potential impact for the recently announced NPR rules. With the currently proposed Basel III capital rules, we expect to the manage our capital ratios within our bonefish range. And right now, we expect the NPR impact to our 10.6% 2Q '12 Tier 1 common ration, it would be about 240 basis points fully phased in but without any offsetting actions, putting it at a pro forma estimated 8.2% spot rate today. However, assuming planned improvements and runoff actions, we would expect the positive approximately 260-basis-point impact to the pro forma estimated 8.2% or a theoretical Tier 1 common ratio of over 10% under Basel III. Now I'll turn back over to Bryan for some final comments.

Thank you, BJ. Second quarter 2012 demonstrated another quarter of successful execution. We showed continued profitability in our core businesses. Our efficiency initiatives are on track, and we returned capital to our shareholders with our ongoing share buybacks. For the second half of 2012, we'll continue to work towards achieving our bonefish goals. We were focused on improving -- we were focused on providing superior customer service that differentiates us from our competitors. We're committed to becoming more efficient and productive through simplified processes and better technology. We will continue to prudently manage the wind down of our non-strategic assets. With the addition to the mortgage repurchase reserve, we've taken a big step towards removing this distraction and allowing us to focus more on our core businesses. Our balance sheet continues to strengthen, and we will proactively manage the mix and profitability of our portfolios in light of proposed changes to capital rules. Finally, we'll continue to manage capital smartly. As I said earlier, navigating through this operating environment will take patience. This is a marathon, not a sprint. I'm confident that continued successful execution of our strategic priorities will lead to higher profitability and improved returns for the long term. Thank you, and now we'll take questions.

[Operator Instructions] Our first question comes from Ken Zerbe with Morgan Stanley.

Maybe we can start for the mortgage banking just a little bit. Obviously, big decline there given -- particularly, in light to the strength that we've seen across the industry in mortgage banking. Could you just go through the pieces a little bit? I'm just to understand what is sort of sustainable -- what were the big one-time items that I think you had mentioned, an adjustment on contingency related to something, the servicing that was the sold? Maybe a little more metrics on that would be helpful.

BJ. Couple of different things. Remember that we have very little mortgage origination income, so when your going to see strength or not out in the marketplace, we're not going to necessarily participate in that. Where you will see it is increasing in our mortgage warehouse lending or loans to mortgage companies. And that's what I talked about when we saw loan growth. We saw very solid strength there. The biggest piece of our mortgage banking fee income is really related to our MSR hedging results and how effectively we hedge. And we had about $2 million of net positive results from hedging, which was down from about $9 million in the first quarter. The other thing that you mentioned was just a modest adjustment of a couple of million dollars related to a bulk sale receivable that we have had. So that's more of a onetime item. But really, the main driver for our mortgage banking income is always going to be the MSR hedge results. And as I said, they were down about $8 million linked quarter.

Okay. No, that's helpful. The other question I had was just on the mortgage repurchase. I see you're talking about requests of $431 million. Has anything changed? Or just -- or what has changed between the time you announced the $250 million reserve build to today? And in terms of what anything different, anything better or worse than your expectations back then?

No, Ken. It's BJ. As I said in my comments, we haven't seen any change in the trends or our estimates since we made the announcement. And when we had the call after the announcement, we talked about having very significant visibility and very detailed information from Fannie Mae, which was extremely helpful. And it wasn't just historical information or current information, but it was expected future flow. And so that really helps us understand what we're going to be seeing, and that obviously means that our views are going to be pretty good over the near to medium term at least.

Our next question comes from Steven Alexopoulos with JPMorgan. Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division: I wanted to start in terms of the initial hit to Tier 1 from the proposed capital rules, first, should we think about the quarterly buyback still in somewhere $40 million, $45 million range per quarter? Or does that need to slow, right, given the 240-basis-point hit? And then secondly, are there any plans or options open to you to accelerate the runoff of the non-strategic, right, I guess that's where most of the RWA hit's coming from?

Steven, this is Bryan. A couple of thoughts. One, we've got the $74 million, $75 million remaining under authorization. We don't think that these will have any significant impact on that, and we expect to continue to be opportunistic but look for opportunities to repurchase stock. I'd point out a couple of points about the proposed rules. One, they are proposed. You got to put emphasis on that, and there are some things in them that I think, at least, intuitively seem like they will change, particularly around home -- some of the capital levels, maybe around home equity. Two, I would say and BJ pointed out, there are some opportunities for us to change the mix of the portfolio. It's a long time between now and 2015 and even longer when they're fully phased in. And as in the past, we've adjusted our balance sheet to make sure, one, that we have capital efficiency and two, that we have profitability driven by that. So we will adjust appropriately to manage that. So as BJ talked about, and he gave a spot rate and then he gave a longer-term rate, and we think more about where we will be at the end of 2014. And that's sort of what we manage towards, so we think more about 10-plus-percent Tier 1 rate in this pro forma rules or proposed rules. And so we manage according to that. Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division: Okay. That's helpful. Bryan, one other question. Looking at the bullet on Slide 25, that all private label deals will reach 5 years by the end of 2012. I think it's actually next month. Is it still the view that 5 years is the statute of limitations on private label and this risk should be behind you by 2013?

Well, yes. BJ and I neither one are attorneys, so we'll give you our interpretation of what we understand. There are different rules around statutes of limitations and statutes of repose, and don't ask me to define the differences between the 2. And it varies by state. As I understand, it -- the federal rules are different from the states, and the federal statutes have run and then the states will run at various times. But we think the vast majority of it would occur by the end of that 5-year period based on our interpretation and our understanding of it. So it's not only that. But you go through 5 years of performance, 5 years of history, and if you look at the balances, I think the balances outstanding on those private label securities are down to about $11 billion or so and round numbers from the original $35 million range. So it's -- the passage of time and always, we think, is generally on our side. Our balance sheet becomes stronger. The exposure to these risks become smaller with the passage of time.

Our next question comes from Craig Siegenthaler with Credit Suisse.

It's actually Nick Karzon standing in for Craig this morning. I guess just to start, I noticed that TDRs look like they increased about 11% quarter-over-quarter. And I was wondering if there's a change in accounting here or what the driver was there?

This is Greg Jardine. They increased similar to last quarter driven by per mortgages primarily; and then secondarily, we had an increase in commercial loans of about $10.5 million, which was driven by a SNIT credit that was primarily by SNIT credit, the TDR this last quarter. So those where the primary drivers of the increase quarter-over-quarter.

And then I guess just looking at the compensation line, I was wondering kind of in terms of the quarter-over-quarter decline, what piece of that was related to a decline in variable comp productions versus kind of the payroll taxes running off from the first quarter?

Nick, it's BJ. I'd say over half of it is probably related to the capital markets variable comp, and the other half is the expected decline coming of the higher first quarter levels.

Our next question comes from Matt O'Connor with Deutsche Bank.

Two unrelated questions. I guess, first on the expense management. Obviously, this is one of the things that you can control, and it's been very good for several quarters. As you think about making the $1 billion run rate target earlier, how much further can cost come down? Is it trimming around the edges? Are there some structural changes that can still be made?

This is Bryan. That's -- we've -- we work a lot on expenses, and I would tell you, we don't ever stop working on it. It's something that we think is part of the business, and a business that's changing like the financial services industry is today, we think there are additional opportunities for us to use technology, to use process changes, to use end-to-end looks at our business to gain efficiency. We've -- we go back and forth internally about how do we continue, look. As I've talked in the past, we're trying not to be goal oriented about it simply because if you set a goal, you get to that goal, you quit. We think it's a continuous process. But we do use goals to give people sort of an order of magnitude. So that's a long way of getting around to say, and we're towards that $1 billion target, as BJ and I both said, by the end of this year. That doesn't mean we're stop on expenses. We're going to continue to look for additional opportunities to become more productive and more efficient to use technology and process to improve service but doing in a more efficient way. And that means that we continue to look at everything about the business day in, day out to drive that efficiency.

And then separate, just following up on the private label putbacks, I mean, correct me if I'm wrong, but there is, I mean, a number of banks, including you, I don't think have put a ton of reserves aside for that versus the GSE. As we think about the timing of the statute of limitations, expirations and maybe getting some more clarity the next couple of quarters, is that something that we could see reserve boost for the next couple or few quarters?

It's BJ. Well, again, we have -- we've not had any requests. So it's kind of hard to build a reserve without actually any activity. So we -- until we see some activity coming through, it's kind of hard to build the reserve. Now we do look at reserving through litigation, and so as you know, we have a lot -- 5 lawsuits outstanding that are related to mortgage. And so as appropriate, we will add the litigation reserve on those types of things, but we watch it very closely, but until we have any requests, we can't really build reserves.

Okay. And I'm sorry. I think thought I was combining the putback requests and the litigation on the private labels side. Can you remind us what the litigation reserves are now? Or at least, how much you've put aside that you've disclosed?

Well, we increased the litigation reserve by $22 million as we an announced in the 8-K.

You've put some in there before, I would assume that's right?

We had some other modest amounts in the litigation reserve, but that was a large increase to it.

Our next question comes from Erika Penala with Bank of America.

My first question was is on your plan to improve your Tier 1 common under Basel III. I guess what size balance sheet is in your model when you're thinking about getting to $10.5 million by 2014 under Basel III.

It's BJ. Yes, a couple of things I'll expand on that Bryan talked about. Number one, the balance sheet we don't particularly expect to change materially, but a couple little more color on what we think planned improvements would be. Number one, first and foremost is with the mortgage repurchase largely behind us in terms of an earnings drag, we obviously have much higher amounts of retained earnings that we would expect over the next couple of years that would significantly add to the numerator. On RWA, obviously we have a big impact from residential real estate, particularly in our non-strategic portfolio, but as you've seen over the last several quarters and years, that's running off anywhere from 15% to 20% a year. So assuming that, that continues to decline as expected and there's no reason to believe that it shouldn't, as well as replacing that with better quality, lower risk weighted assets in the regional bank will help materially. Un-funded commitments, our big issue for us and the industry and I think there's going to be structural ways, for instance, that we change the way that we do business with our clients on booking those. And so we expect to reduce our RWA impacts on those types of things materially. NPA reductions will continue to come down as our credit quality improves. Our MSR is going to continue to run off, so there are a lot of things that we've been studying and looking at to improve. And so we're confident that by the end of 2014 -- so first quarter of 2015 when the RWA impacts start to layer in -- we'll be well prepared and having a very solid capital position on which to grow.

Erika, this is Bryan. You take something like the capital -- the proposed rules around the capitalization on residential real estate and what that means to mortgage lending and the home equity lending. I don't think this is just a First Horizon question. I think everybody's going to have to think very differently about how you use your balance sheet when it comes to residential real estate lending and/or the pricing of that product. And so we're going to take this and process it. We're already thinking, as BJ said, about how we take actions today and over the next several quarters to plan for 2015 and beyond. We'll also think about the nature of the business we're putting on the balance sheet and how that impacts it. And so I think we need to sort of let these rules settle down a little bit. Let's see how it gets finalized. I emphasized before the proposed, the Fed and the OCC and FDIC are asking for comment on them. I suspect they're going to get a lot of comment on them. And they'll go back, and I'm sure they'll evaluate that. And I we'll get as final set of rule that we'll all know how to adopt to or adapt to over the next several quarters.

Our next question comes from John Pancari with Evercore Partners.

Could you give us some more detail on the driver of the impact -- the capital markets revenue this quarter? The decline in that revenue is greater than we had expected.

It's BJ. Yes. At this level, what we're seeing in our business out there is as rates continue to grind lower at -- its' just counterintuitive for our clients. They expect that it's going to go up, and so while there's not loan demand, there's -- that means that there's still a lot of excess cash at the banks, in which to invest. But they're very hesitant to invest and go out on a curve very far, so they're staying very short. And frankly, the difference between investing in a -- an insured bond and putting your money at the Fed overnight is not significant enough given the potential variability of or volatility in rates. And so we're just seeing our clients continue to remain on the sideline until we have a little bit more resolution in what's going on in Europe, a little bit more certainty about where the long rates are going to go, et cetera. So we feel good that once there's a little bit more clarity and there's buying, we are very well positioned to take advantage of that. But right now, there's a lot of caution in our current businesses.

And then lastly, Bryan, I know you mentioned that you're remaining buybacks should not be impacted by the NPR on the Basel III rules, but how about a longer-term buybacks? Any renewal of the program once that remaining amount is repurchased?

Well, John, I would say as I've said in the past, we'll take this one step at the time. We've got this authorization to continue to work on. We'll evaluate capital repatriation, I'm sure, later in the year, early next year, what -- and the mix of between dividend and stock buyback. And we'll work with the regulators at the appropriate time to work through that conversation. So it's pretty immature at this point to speculate. But as I said earlier and when I was responding to Steve, I mean, we're thinking about our balance sheet and capital efficiency and all of these things coming together. And we're thinking about where our capital ratios are targeted to be, in 2014, 2015. BJ talked about our bonefish ranges on our own capital. One point that I would make is we talked about an 8% to 9% Tier 1 common ratio. Given the -- if the rules end up the way they're proposed today, given the significant increase in risk weighting of assets, I expect that range comes down and becomes lower over time. So I would guess that range would be in the low 8% than much wider range of 8% and 9%. So you have to put all that together and let a little bit is unfold and we'll evaluate it as we get into the latter part of the year. PI believe, we expect this will have strong generation of capital and the ability to repatriate capital to our shareholders.

Our next question comes from Josh Levin with Citi Group.

With regards to the potential exposure to the private label litigation, you said you think the private label exposure should be significantly less than the GSE exposure. It does look like there was an additional lawsuit filed based on what's in your slides. Is also looks like you may have received claims from another underwriter. I mean can you provide some additional color here? At the margin, are you a bit more concerned about this issue than you were, say, last quarter?

It's BJ. The answer to your last question is no. We continue to see lawsuit down the industry, and we continue to see them here. We continue to see activity on other whole loans, which are loans that we sold to others, who then ultimately put it into private securitization. That's probably what you were referring to. Again, there aren't any request the were seeing on our branded securitization. So nothing much has really changed there. We continue to actively monitor it, but like we said, based on the mix of what we did and the size of our securitizations and the performance, we continue to be comfortable there's going to be significantly less than what we saw with the GSE.

Okay. On an unrelated topic, yesterday, one of your peers said it was going to close up to 5% of its branches, given how the difficult the environment is. As you think about -- going forward, we have low rate environment, regulatory costs, are -- is -- reducing your footprint and closing branches, is that a possibility?

Sure, Josh. this is Bryan. Sure, if you've looked back over last 2 or 3 years, our branch totals declined from just under 200 branches to the mid-170, or so now. We continue to look at the size of -- and nature of our branch footprint. Our consumer behavior and the branches has changed over the last 5 years is likely to continue to change and decline over time, as technology becomes more prevalent that they'll see the bank on your cellphone or the Internet. And so we expect to continue to look at our branch footprint, to look for opportunities to improve customer service. But at the same time, be realistic about customer visits to branches. Not only for us but across the industry are dropping. So it becomes -- it's an important part of the distribution system but, it can be done in smaller or fewer branches over the long term. So yes, we have -- obviously, we'll continue to look at that as an opportunity to reduce our cost structure and at the same time, improve service.

Our next question comes from Kevin Fitzsimmons with Sandler O'Neill. Kevin Fitzsimmons - Sandler O'Neill + Partners, L.P., Research Division: There's been a lot of questions about the mortgage putback issue, but I just wanted to -- really want to verify here. You've said there's no real change that has occurred since you preannounced the large charge, and you've said we have a reserve that you think is it for the GSEs. So should -- is it still a good assumption -- a reasonable assumption on our part that, that repurchase provision line, which has been ranging before this quarter from $40 million to above $50 million per quarter, that, that goes down to really an insignificant number when we model for coming quarters?

It's BJ. Yes. We currently sit here today and expect it to be 0. We think that we had fully reserved for what we can reasonably expect. Kevin Fitzsimmons - Sandler O'Neill + Partners, L.P., Research Division: So I guess, BJ, we shouldn't -- I guess, the -- what we need to look at is when we see the quarter-to-quarter change in the requests, change in the pipeline, I guess, it's a matter of, if that come in line with your own model when you calculated that reserve. And so far, it is. Is that correct?

Yes. That's a good question. We'll continue to show that because we believe it's important for you all and certainly helpful for you all to understand the flows there. But as I said on the call that we had around the 8-K and earlier, we got significant insight not to just how historically our flows have worked, which helped us validate what we had been seeing but also what's currently on the plate and what they expect to put back to us in the future. And those latter 2 are extremely helpful, so even as we see increases in our operational pipeline or increases in new requests, et cetera, that doesn't necessarily mean that that's any different from what they had already talked to us about. And so as I alluded to, those were all expected. And I actually said in my earlier comments that we assume a backlog of requests, which we believe drove the new requests, and that was something, for instance, that we learned when we talked to Fannie Mae. And what was going on. So all of the trends that we've seen this quarter are ones that we fully expected, and we expect to be able to have pretty good visibility going forward.

One of the thing that we walked away with -- and as BJ alluded to -- is the understanding of this backlog. And we have -- we think we understand the sub-elements of the portfolio that drove that. We think we have a much better sense of what that will play out like over the next several quarters and we may see another couple sub-elements to the portfolio lead to another surge later in the year. But as you sort of summarize all of this, what we'll now be tracking is our understanding of that loss expectation and those portfolios with how claims are coming in and looking for changes in GSE behaviors or the nature or the type of requests that we're seeing. And So as BJ said, everything we've seen through the remainder of the quarter is consistent, and we don't have anything that's really changed our belief structure about what our remaining exposure is.

Our next question comes from Matt Burnell with Wells Fargo.

Let me beat this topic a little bit more into the ground in terms of the mortgage repurchase numbers. It -- from your slide, it looks like you're saying that rescission rates remain in the 45% to 55%. Average loss severities really haven't changed over the last few quarters from the 50% to 60% range. And I guess I'm just curious as to -- I'm presuming are those the assumptions that you're using for when you came up with the provision for this quarter? Or are you assuming as one of your competitors has recently said that potentially the loss rates could come down a little bit over time?

It's BJ. Yes. As I said, on the announcement call Form 8-K, we didn't learn anything different about our rescission rates and what are our loss severities from what we were expecting, and this was no different. So yes, we didn't see any change to how we came up with the reserve based on what our trends were here. We did see in the second quarter a higher level of "missing that request," which are -- we have much higher with success rate on. As you might imagine, they don't have lost content necessarily in them. They're just looking to clean up paperwork. So that would drive a higher success rate in the quarter. What we always try to talk about is cumulative success rates and cumulative severities, and so those haven't changed materially, and we don't necessarily expect things to be outside that range for the foreseeable future.

Let me use my follow-up to ask about the capital markets business. Obviously, that was down a bit quarter-over-quarter. And I noticed last year, that we -- that you saw relatively strong levels of capital markets revenue in the second half of the year. Maybe that's a little counterintuitive given the capital markets environment last year. How are you thinking about the potential revenue opportunities relative to the second quarter in the second half of the year given your earlier comments about clients being a bit more cautious in terms of how their using their cash?

Sure. Yes, as I said, we currently expect for the rest of the year to probably be in the lower half of our average daily revenue range. There are -- our range is $1 million and $1.5 million. We booked $1.1 million this quarter. Keep in mind last quarter -- I'm sorry, last year this quarter, we had $1.1 million. They were roughly flat year-over-year. So this business is always going to be, what I call, variable not volatile. So we'll make a good amount of money, and we'll make some great amount of money in certain periods. This was a period -- this was a quarter where we good amount of money. So very pleased with the quarter. Looking forward, we're generally assuming with my comments, that we don't see a lot of virus coming off the sideline. We don't necessarily see improvements in the visibility in Europe or with where rates are going for the second half of the year. But to the extent they do improve, we think it'd better. But now we're staying a little bit more on the cautious side in terms of our outlook there.

If you go back -- this is Bryan. If you go back and you play out,say, third quarter of 2011, what really picked up in the last half of the year is investor expectations changed. So as we look at the remainder of the year, there are a couple of big drivers. One, there's this fair amount of cost that's been built up or not invested and in all likelihood is going to get invested at some level. And two, investor expectations are going to change, and it's going to depend on what the Fed may or may not do around quantitative easing or operation twist or any statements that may be made there or the long-term debt outlook in the U.S., et cetera. So there are a lot of variables that could change it. But as BJ said, we'll have some variability around it. But even at the $1.1 million a day. Average daily revenue we're producing north of 2% ROE, so it's a business that's very profitable to us. And we'd obviously would like to do more, but it's one that we feel like we can be very effective in and produce very good returns in.

Our next question comes from Emlen Harmon with Jefferies. Emlen B. Harmon - Jefferies & Company, Inc., Research Division: If we could -- I just wanted to hit on the regional bank commercial loan trends for a second if we could. It's all bit of a conflicting signal, and that the pipeline was down quarter-over-quarter, but you did see a pickup in fundings. Could you give us a sense of just kind of what the dynamic is there and maybe what you guys are seeing geographically within your footprint in terms of demand and lending trends?

It's BJ. I think it is a pretty tight correlation between pipeline and funding, so if you looked -- for instance, if you remember fourth quarter to first quarter, we actually saw the pipeline up but fundings down. And it just simply meant that the cycle time was not -- was different. So our fundings didn't happen as much in the first quarter, but then we saw good fundings in the second, and that means that there's loans coming out of the pipeline. So the pipeline of funding is going to have inflow, but we still think both of them are very healthy. And it's showing up in our loan growth, period-end loan growth in the regional bank of 3%. We have continued to see good growth in loans in mortgage companies, which is nice, but we've also seen good loans -- good growth, solid growth, good return growth in corporate lending, which is pleasing to us, a modest growth in our core C&I lending. On the consumer side, we've seen some healthy growth there in installment real estate. So our bankers continue to be very disciplined and focused. We talk to them all of the time about getting the appropriate returns, appropriate credit quality and structure. And even with that, the activity that they're generating in a modest environment is very impressive, and we're proud of the growth and the quality of the growth that we're seeing.

Emlen, this is Bryan. I'll add to what BJ said. If you back away from the quantitative and focus on the qualitative aspects of -- for a second, I think -- I'm really proud of the calling efforts that our bankers are making. They're doing a fantastic job calling on customers. We're winning great relationships. We're building strong relationships for the long term. You see some real pockets where the pipeline, although it may be down slightly from quarter-to-quarter based on a number of factors, the quality number of customers that we think is going to close over the next several months is really improving. Then, I'm really pleased with what our bankers have done over the last year, and I like the momentum we've got going into the remainder of this year. I think we're winning good relationships. We're picking up some market share and doing a great job executing in terms of discipline over the long term. So I -- it may ever flow a little bit from a pipeline perspective, but I think the momentum continues to be strong, and I think as you'll get to the end of this year that it's going to look pretty good.

Our next question comes from Marty Mosby with Guggenheim.

I wanted to focus on 2 things: One, is the capital again; and then the other is going back to the mortgage number this quarter. First on the capital, I think what we're seeing is a spot rate problem that you took the charge this quarter drops your Basel I number and then you're introducing the Basel III impact, which then drops -- what -- last quarter was a 12% number, kind of in a spot mine in the market down to about an 8% number. However, when you look at what you're going to be doing going forward, the 10.6 under Basel I is really what matters in the sense of what you're going to be managing to. And then you've got $200 million of roughly annual earnings that you have coming forward in the future. So when you start looking at capacity to still repurchase, you really have to factor in the fact that you took that big charge this quarter, but that's really just accelerating and improving earnings in the future, which then gives you more capacity to repurchase out of earnings versus the spot right on capital.

Yes, it makes sense.

So on this -- how do -- in general, is that how you look at that rein or in the sense of utilize that hit this quarter does really free up in the sense of $250 million over time capital that you could repurchase?

There is -- Marty, this is Bryan. There's no doubt that the $250 million charge and the $22 million around litigation reduces the starting point. And it does, assuming that's just a difference in when those losses would have been incurred from an accounting perspective, that does change the earnings trajectory in the out years. And so that does rebuild -- or out quarters -- that does rebuild. So I mean that's a great way of describing it. And two, I would say and it also incorporates the fact that we will look at the effective use of our balance sheet and the mix and the profitability, the product we're putting on.

The other spot right issue was hit kind of Tier 1 common under Basel III. But when you look at that particular issue -- we had this happen last week as well with another company. This is a temporary situation since between now and 2015. Like you said, the portfolio changes. So you get to recapture that just on the natural runoff that would happen. When you're doing discussions with the regulators and they're talking about Basel III, are they interested in what it is today or more interested in really what it is in 2015?

We're not having those discussions at this point, Marty. These are proposed rules. They're in the comment period, and so it's really -- it's not a regulatory discussion that we're really having much about. We keep our regulators apprised of how things look like they might play out. But we're not sort of at the point where we'd focus on -- whether we're focused on end of 2014 or end of 2018. We're still working through how the rule's finalizing and developing, our comments, in fact, for how we'll respond to the request for comment.

And then, BJ, I wanted just to drill down on the mortgage number just one more time given some of the information you gave early on. Last quarter, you had $23 million worth of mortgage banking fees. Your hedge number was a positive 9 you said. Your MSR value was constant at 68 basis points. So there wasn't really in any shift in MSR value, which leaves $14 million kind of in the other bucket, which is kind equating to the general fees that you get off the portfolio each quarter. If you roll to this quarter at $10 million, hedge goes down to $2 million, but you actually increase the value of the servicing book from 68 basis points to 71, which means that, that kind of middle part or the operating part would have had to drop from 14 to 2. So I understand the hedging doing a little less beneficial but you also had that positive over in there in the value of the servicing portfolio. So it seems like the core part is missing something, and I was just trying to get my hands around that.

It's BJ. Yes. If you have get our financial supplement, we actually have a breakdown of all the ins and outs of our noninterest income related to mortgage. It's in our -- it's in the non-strategic. But if you look at it, we had $10 million that is noninterest income 2Q versus $26 million in 1Q. The biggest changes were servicing fees were down a couple of million dollars. We had $1 million change in the MSR value due to runoff and then the biggest change being the net hedge results down from $9 million to about $1.8 million or so. So it's all laid out back there on Slide 19 as a supplement if you want to go through it.

And it looks like the other income is where a lot of that core came out of, and is that something that would go back to something in the neighborhood of $3 million? Is that kind of the -- that modest adjustment you were talking about that was more of a onetime in this quarter?

Yes, yes. If you look in the footnote there, it was a $2.3 million adjustment on a contingency related to prior servicing sales. So that is the onetime-type event, so you can assume that, that goes in the quarter.

And BJ, if you humor me with one more. Potentially, the expenses that you're assuming are embedded in the $1 billion at the end of this year, how much benefit do you get out of that as you roll into 2013?

Let's see. Let me do the math in my head. It's about $25 million full year cost. I take that back. $25 million to $35 million.

Our next question comes from Ryan Nash with Goldman Sachs.

Just one other question on the GSE putbacks, just in terms of commentary, one of your competitors noted that the GSEs have indicated that towards the end of the year, they would start requesting follow-ups for, I guess, any loan that went nonperforming. Was that the base case assumption that you assume for your potential lifetime loss estimate?

It's BJ. We -- like I said, they gave us visibility not just with currently selected, but they broke it into 2 buckets for us actually. One was current liquidated loans and that the actual number of loans they expected to put back to us out that bucket, and the second was the bucket of seriously delinquent loans and the exact number of loans that they would expect to put back to us out of that population. So the first one on liquidated loans, they give full visibility and what they would have expected to put back. So we believe that we've got that captured.

Okay. That make sense. And then just in terms of the 10.5% of Basel III number, can you give us a sense is there -- what type of assumptions were there, made within that in terms of capital return? Or is that just all mitigation?

Yes. We won't go into very specific details. But we assume continued run rate on dividends. We assumed some retained earnings from increased earnings over the time period. So I don't want to get into particular capital actions, but we assume some.

Our next question comes from Chris Marinac with FIG Partners.

I want to ask about loan yields and just the ongoing stability that you've shown there. Is there any reason that, that would change in the next couple of quarters just given kind of what you see in terms of rollovers and the portfolio turning?

It's BJ. We've worked really hard or our bankers have on trying to defend those yields as well as we could, and it shows up in our numbers. They've done an excellent job. I don't particularly see any material change, though, the longer the interest rate environment goes on, the harder and harder it is to defend that. I think we've talked about before that roughly 65% of our bucket floating rate, 35% fixed. That 35% is very hard to reprice and continue to keep yields up, so that's where we lose traction every time we see a payoff there. But like I said earlier, our bankers are looking for every opportunity to appropriately price in today's environment for both risk and rewards. So we continue to believe that we'll be able to defend our yields as well as we can.

BJ, if you look at the duration maybe even just on the C&I piece of the portfolio or even real estate, is that going to evolve higher than you typical have? Or you expect to manage it sort of similar in the past?

The duration risk?

Correct.

Chris, I don't -- that really doesn't change much. It'll depend on what kind of loans you're putting on, where you're putting on a real estate loan or a C&I loan, but given that the vast majority of what we put on the balance sheet is floating rate, you got longer -- you may have difference in tenure, but in terms of sensitivity to interest rate risk it's really not changing a whole lot in terms of duration to -- as it relate to interest rate risk.

Our next question comes from Kevin Reynolds with Wunderlich Securities.

Bryan, I guess I have a bigger picture question. As we look at the bonefish and you look at 125 to 145 being your long-term ROA targets, I know that a prolonged interest rate environment or low interest rate environment is an impediment. But beyond that, what are the other things that you look at out there? And now that you've fast forwarded your expense guidance of a year, what else do you look at that could derail you a little bit there from achieving those goals?

Well, I guess you can come up with a bunch of hypotheticals, Kevin. I feel good about our ability to hit these targets. As you said, not only us, but everybody could benefit from a steeper and higher nominal level of interest rates, but that's an industry-wide issue. I guess you could see additional impact as it relates to fee revenues related to changes in consumer banking in particular, and maybe some on the commercial side, but I don't think there's anything that really seems like a looming threat out there on the horizon that causes us concern about our ability to hit these longer-term targets. We feel like we're executing day in, day out. Our bankers, our capital, our entire organization is focused on how we drive the profitability of the business. They understand these targets and I think all 6 [indiscernible], and we're on track towards getting those.

Okay. and then I guess one other question on capital markets. I know there's the uncertainty in the interest rate environment, but in years past, if loan demand picked up, your depository customers would use some of that excess liquidity, and you'd see daily activity fall. Is there any of that going on? Because I know there's been -- regardless of the type of loans that are being originated, there have been stronger loan originations this quarter than many believed were coming. Is there any of that going on? Or is that perhaps just wishful thinking?

Well, I would suggest that there's not a whole lot of pickup in loan demand. All generalizations are wrong and it'll somebody out there that will have seen a big pickup. I think what you're seeing right in broad sense is loan demand. It's consistent with the economy. It's growing in the 1% to 2% range, and there is an awful lot of competition for the deals that are out there. It manifests itself in pricing and structure. So I'm sure we've got some customers out there that are seeing some pickup in loan demand, but I think at the end of the day, it's not the system-wide or economy-wide pickup in demand. And I think these capital rules are going to have an impact on what that loan demand pickup looks like. Because it's going to make it prohibitive to put mortgage product on the balance sheet, for example these capital rules. So there's a lot of things here that impact what happens industry-wide in the balance sheet, and I think all of those give us some comfort that what we will continue to see strength in the capital markets business, and it's likely to be a steady business for us for the next several quarters.

Our next question comes from Dave Bishop with Stifel, Nicolaus. David J. Bishop - Stifel, Nicolaus & Co., Inc., Research Division: In terms of the loan loss provision relative to the commentary and regards to maybe the outlook for loan demand here and you're doubling from last quarter, obviously, reflecting some growth, do you expect that to sort of represent a sort of a normalization of provision relative to revenues or if we do see some diminution growth, we should expect that to rein in a little bit.

Yes. This is BJ. According to our bonefish targets, our normalized provision would be around 50 basis points or so on loans. So that would be in the -- anywhere from $15 million to $25 million range. And we expect to be within that over the next several quarters. And as we've talked about, we expect to see continued improvement in net charge-offs. We expect to continue see improvement in grading and grade migration. But with the reserve at a 109 basis points, we still see continued improvement there to be able to bring the reserve down appropriately. But it's going to continue -- it's going to happen at a slow pace. So we're very mindful of having sound and adequate reserves and credit quality, but with continued improvement in our portfolios, we'll expect continued improvement in provisions.

Our next question comes from Mike Turner with Compass Point. Michael Turner - Compass Point Research & Trading, LLC, Research Division: When I look at what you've done so far, the new NPRs are a hit to capital, but at this point, it's proposed, so who knows how they ultimately shake out. You're ahead of the game on your cost cuts, and preparing as if the Basel III is going to happen as it stands today. When I look out -- as it is today, you probably have about $250 million in excess capital just based on the spot, the 8.2% Tier 1 common. The amount for private label putbacks, at this point, it's anybody's guess if you get any or what the dollar amounts could be. But if they do come, they could be -- maybe there could be substantials. Who knows what the dollar amount is. Why -- in that scenario, why would you even want to buy back another dollar of stock, like you're trying to build capital for the future. Just thinking about that buyback, would it be more prudent just to hold back in terms of the unknown? Or how do I think about that?

Well, Mike, this is Bryan. We -- as we look at our capital actions, we do extensive stress testing. We capture all of the known, and we estimate even unknown exposures in our stress testing. And as we've said over the last several quarters, we factor in the impact of mortgage repurchase both with the GSEs and any potential exposure that made just with the private labels. And so all that's factored into our calculations. We're comfortable in our analysis of the capital situation that we can be opportunistic. We can look for opportunities to repurchase stock, and we continue to intend to do so.

I'm not showing any further questions at this time. I'd like to turn the call conference back over to Bryan for closing remarks.

Thank you, operator. Thank you all for joining our call this morning. Please let us know if you have any additional questions or follow-up that we can help with. I hope everyone has a great weekend.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.