Good day, ladies and gentlemen, and welcome to the Valley National Bank’s third quarter earnings conference call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to introduce your host for today’s conference Ms. Dianne Grenz. You may begin.

Thank you. Good morning. Welcome to Valley's third quarter 2012 earnings conference call. If you have not read the earnings release we issued earlier this morning, you may access it along with the financial tables and schedules for the third quarter from our website at valleynationalbank.com. Comments made during this call may contain forward-looking statements relating to Valley National Bancorp and the banking industry. Valley encourages participants to refer to our SEC filings, including those found on Forms 8-K, 10-K and 10-Q, for a complete discussion of forward-looking statements. And now I would like to turn the call over to Valley's Chairman, President and CEO, Gerald Lipkin.

Thank you Dianne. Good morning and welcome to our third quarter earnings conference call. In an industry which has never been immune to external intervention, today’s fiscal and monetary policies represent the most severe challenge the industry has faced during my half century long banking career. The Federal Reserve’s unprecedented influence on the level of market interest rates not only creates uncertainty about future inflation, but impedes bank earnings and also has a direct negative impact on an entire generation. For many senior citizens who have practiced fiscal restraint, managing to save a modest sum during their lifetime, the current level of interest rates limits their ability to earn a reasonable return on their savings. In other words, the nation’s recovery is being disproportionately placed on the backs of our senior citizens. These families are punished financially, which severely affects their lives. The long term impact of the federal reserve’s quantitative easing program will have many unintended consequences, which I fear will prolong the current muddle-through economy we are experiencing while negatively impacting our nation’s future growth opportunities. In particular, for community banks, the artificially low interest rate environment has negative effect on net interest margin, and consequently makes it very difficult to grow earnings. Concurrent with the negative effects of the Fed’s monetary policy, new and additional regulatory guidance surrounding the levels of capital, and the risk weighting of certain asset classes further threatens to curtail lending. In today’s difficult economic environment, the health and profitability of our industry will be closely tied to improving employment and economic conditions. Basel III as proposed, in my opinion, will make it even more challenging to lend money and grow our economy. As our nation continues to struggle with growth, the demand for more capital and liquidity can only result in more…

Thank you Jerry. Total third quarter revenues increased to $162 million, approximately a 12% increase from the sequential quarter. The growth, as Jerry referenced earlier, was largely driven by increases in gains on the sale of residents loans, which totaled $25 million compared to $3.1 million in the prior quarter. The expansion of mortgage banking revenue is in large part due to macroasset liability management strategies and Valley’s subsequent decision to originate and sell a larger percentage of production compared to prior periods. During the quarter, Valley sold approximately $380 million of residential mortgages compared to $75 million in the prior quarter and $118 million in the first quarter. The $25 million of gains recognized in the quarter were comprised of approximately $17 million in income attributable to the actual loans sold during the quarter and approximately $8 million due to the mark-to-market valuation adjustment on the $149 million of loans held for sale at fair value. Management’s decision to originate and sell a larger percentage of mortgage originations than that recognized in prior periods is mainly a function of Valley’s desired asset liability sensitivity. In addition, residential mortgage secondary market activity at times can lead to swings in the balance of loans held for sale and retained in portfolio. We anticipate an increase in the portfolio balance of residents mortgages during the fourth quarter as the balance in the held for sale portfolio contracts to reflect delivery of sales executed in the third quarter and a larger percentage of fourth quarter originations are retained in the portfolio. In managing the aggregate level of residential mortgages on the balance sheet, Valley combines the outstanding balance of certain residential mortgage backed securities with its mortgage loan portfolio in determining the aggregate exposure desired on the balance sheet. In addition, we actively…

[Operator instructions.] Our first question comes from Ken Zerbe from Morgan Stanley. Your line is open.

Just a quick question on the gain on sale margins. Just want to make sure I’m doing the calculation right, or at least understanding what you’re booking. Using $17 million I think you mentioned on the gain on the loans sold, over a $380 million balance, it seems like your gain on sale margins are incredibly high versus what we’ve seen. Are there other adjustments that need to be made to that? Or are we actually getting that good?

That’s the appropriate number.

So basically 450 basis points?

Approximately that, yes.

Wow. And then just second question, Alan this is for you. Just want to make sure I understand what you were saying on rising loan growth. Obviously end of period loan balances fell a little bit this quarter but going forward, we should expect moderate growth?

Yes.

Our next question comes from Craig Siegenthaler of Credit Suisse. Your line is open.

First, just a big picture question for Jerry. Just on your earlier comments in the call relating to the industry, just wondering, with loan growth now kind of weaker, steep NIM declines, so next year’s really kind of reality for the industry, how can banks cut core expenses enough to keep EPS from falling, especially now that credit levers for most banks have been drying up?

Well, as I said, it’s a multifaceted attempt. First, you have to look at generating additional fee income, which we have done through the mortgage banking activities. We have several other initiatives, but nothing as great as that. We have to look at rightsizing branches. We have to look at the amount of square footage you have in a branch, and the number of people you have in a branch, and whether or not the branch justifies itself. It used to be you had one on every corner, and now you’ve got to say, well, maybe you’ve got to put them every other block. I think some of that you’re going to start seeing more and more within the industry. And again, I think everybody in the industry has to, as we have begun doing, looking at whether or not you’re being compensated for the activity you’re doing. Free checking was wonderful when interest rates were 8-9%, and you could generate significant revenues off the deposit base. But today, those revenues are not being generated off the deposit base, and in many cases you’re just not making money on the deposit account. And you have to bite the bullet. Somebody has to start it, so in many cases it’s us starting it, but I think the entire industry has to look at itself and say whether or not they’re just losing money, because they’re giving away their product for nothing. So I think it’s a many-faceted approach that we’re taking, and I don’t know of any other alternative for the industry other than to take that type of an approach.

And Jerry, mortgage banking, today is very strong, but going forward, isn’t it your view that it will be more a point of pressure when you think of the income statement, just because you’re at peak now on sale margins, your peak refi activity. Of course core origination volumes could pick up, but with the amount of refi activity in the current quarter, that’s probably trending lower. So wouldn’t it be an area of pressure? And what are the other areas of fee income you’re looking to kind of generate?

Let’s focus on this. I think as long as rates stay at their level, and certainly for the next six months to a year, we should be able to maintain high volumes of mortgage refi. Our product is scalable, we are looking to, as I said, expand our footprint. We have a tiny portion of the New York City/Long Island marketplace. So I think for the foreseeable future, this will be a fee-generating source for this bank. Now, I think that interest rates eventually are going to go back up again. This is a product that helps us generate significant income while net interest margins are plummeting. Eventually net interest margins come back. This business will shrink. It will dry up. The refi market will go away, at least for the most part. But by then, hopefully interest margins will have renormalized and we’ll make our money back the way we used to, on our spreads.

Just let me add something to that Craig, and that is that I went back and I did look, not just in the last couple of years, but as far back as to the very early 2000s. We have always been an active seller when we need to manage our balance sheet, and I think going back to our 2003 year, I think I remember a number like $12.5 million of gains that we had. So this is not an anomaly in any way shape or form, and while we like the spread business, it certainly augments the entire bottom line of the bank to be able to have the ability to do this and get rid of some of the balance sheet exposure we may see, and still provide fee income.

And also, I point out again, as I mentioned in my comments, when this business dries up, because rates went up, then the refi is going to dry up, because it’s not going to be profitable to refi. The consumer’s not going to. However, we’re building, at the same time, a very significant servicing portfolio, and that will be an annuity when rates go up, because people are not going to refi those loans. One of the reasons we don’t want to put them on our books is because you don’t want to be stuck with a 3% 30-year mortgage on your books that will last the duration for perhaps 10, 12, 15 years. So that’s one of the reasons we’re actively selling them. But on the other side of the coin, because rates went up, and those are at low rates, they’re going to be around for a very long time, and that servicing revenue should be very valuable.

I wanted to hear your perspective on small case, really the C&I market in New Jersey and metro New York City. Because there’s several banks this quarter that really started talking about softer demand in C&I. And I’m wondering if you are seeing softer demand, if you can kind of focus on what specific industries are sort of driving that, like manufacturing or equipment relate segments.

It’s all over the place. You really can’t say one industry. It is softer in many areas. Listen, the economy is not strong. It’s showing signs of increased weakness.

You know, basically C&I originations were kind of flat with some of the prior quarters, so it’s not like we’re seeing the numbers go way down, but what it is is they’re not growing, and that’s maybe what you’re hearing from others.

And are they talking about tax uncertainty, healthcare costs, outlook for the U.S. economy, election, fiscal cliff?

All of the above.

Our next question is from Steven Alexopoulos from JPMorgan. Your line is open.

It’s interesting that the cost of deposits went up quarter-over-quarter. And Alan, I think you mentioned that they went up. I didn’t catch the reason. Can you just talk about why they went up, and maybe where you’re putting new CDs on, and how we should think about that going forward?

I think the biggest reason is probably the fact that we did have a promotion early in the quarter. We decided that we were going to try and raise some money. We raised some rates. We brought in some time deposits at a higher cost. And then as we saw what was happening, and obviously the ability to raise those deposits. All you have to do is learn to pay for them, of the market. And I don’t know that we were much above, but we were certainly reasonably aggressive. We backed off of that as we saw that the money was coming in, and obviously the loan demand was not as good as we would like to have seen. So it caused some increase in CD costs during the quarter.

Alan, to follow up on your comments that you expect more margin pressure in the fourth quarter than in the third, if we adjust for the accelerated accretion from the PCI loans, how do you think about just the run rate of core margin pressure here.

It’s certainly probably in the 7-10 basis point range I would say. That’s just a range. Obviously there’s a lot of moving parts to this thing. You know, what kind of prepayments are we going to get during the quarter? We’ve seen prepayments certainly on the investment portfolio, on some of the trust preferred we’ve had that pay us fairly significant rates, for a very long period of time. Some of those have been called, and that has caused some pressure on that side. You know, on the borrowing side, I don’t see a real lot happening other than we did have some short term borrowings that caused a little bit of lift during the quarter in our cost of short term borrowings. That should move down during the fourth quarter as almost all of that has been paid back.

Given your comments on loan growth should pick up a bit here, should we expect enough growth that you can offset the margin pressure and at least keep NII flat? Or do you see NII under pressure as well?

I think NII will be under pressure.

Our next question comes from Dan Werner of Morningstar Equity. Your line is open.

I was wondering if you could comment on, looking at the level of residential loans coming down on a linked quarter basis, how much of that was, for lack of a better word, cannibalized by your mortgage banking ops? And I guess going forward, are you seeing most of the prepayments coming through the mortgage, or other outside banks taking part in that as well.

Some of the coming down was people who refied their own mortgage coming down. Some of that with us, some of that elsewhere. Most of it, hopefully, was with us. A lot of prepayments. Gross it came down about $200 million. That was not done as a cannibalization, at least not for the most part. In fact, most of it was [plain]. It’s going quarter to quarter. What you were planning to sell in the next quarter some of it may be in the portfolio today. You were just holding it for sale, planning to sell it anyway.

Dan, we’ve said this before and I think it pretty much continues. About 70-80% of the refis are coming from other banks. So it’s not the cannibalization issue that you’re talking about.

Our next question comes from Collyn Gilbert of Stifel Nicolaus. Your line is open.

I may have missed this, because I’m kind of surprised it hasn’t been asked, but what is your appetite for how big this mortgage business can get? And when I say mortgage business, I mean kind of the servicing portfolio and just kind of how we should think about the mortgage banking revenues from here?

As I said earlier, I think it’s scalable. We don’t really have a ceiling on it. Right now it’s a great opportunity for us to maintain our earnings. To build on our earnings. We’d be foolish not to take advantage of it. Aside from the short term up-front earnings, we are building a servicing portfolio as you know. That will be an annuity into the future. So I think it’s a win-win for us. We are very mindful of the quality of the paper that we put on. We end up not approving about a third of our applications. We don’t put them on simply to sell them and let somebody else worry about them. That’s not our philosophy. It’s not our approach. That’s probably why we have so few loans ever put back to us. That’s why we have so few loans that have filed for bankruptcy. It’s our underwriting approach. That being the case, the sky’s the limit for how much we would be comfortable putting on, because we’re selling. We’re not distorting our balance sheet. We’re just selling them. And we have the ability to service many, many times what we presently serve.

So maybe there’s not limits on what you would sell, but then you had mentioned that you servicing what percent again? Of what you’re originating?

18% this past quarter.

Oh, only 18%?

No, we service about 99%. It is a very small group of loans that we do originate that we do sell servicing release. Those are mostly the FHAs. Basically virtually what we originate we like to service.

And by the way, I just want to add that our performance on the loans that we have sold, that we are servicing, is roughly the same quality as the loans that we put into portfolio. The delinquencies are low. It’s very important, because we’re not building a big problem of what we have to service.

Okay, so the servicing portfolio you said is $1.3 billion right now?

That’s correct.

So you could see that doubling? Tripling?

Keep going. As long as we can put on the loans, we’ll be happy.

The only thing that we’ll keep an eye on, obviously is how it affects, under the new requirements, the deduction against tier one capital. So we will watch that. There is a 10% limit. We’re a long way, I think, from that number, but that could be the only item that I can think of offhand that would affect how much of servicing rights we put on.

[Yeah, we have many times what we’ve done there. ]

And I know, Jerry, you mentioned the business is scalable, but if there’s a way we can sort of quantify what the expense associated to sort of growing the services business to that level would be?

The way we have been marketing it, the additional expense really isn’t that significant, because we do it on television. We’ve doing it with this actor that looks just like me, sounds just like me. We do it on channels 2, 4, 5, 7. The major channels here in the New York marketplace, which covers the New York and New Jersey marketplace at the same time. In the past, where the coverage was spilled onto Long Island, it was just wasted, for want of a better term. You know, we didn’t have the vehicle to take advantage of it. We do have it now.

So it’s just your branch people that are originating these loans? I know you said you’re not using brokers.

We do not use commissioned sales people running around. We are not a typical mortgage bank. All of the apps are either sourced by way of the media or by the branches themselves. When they are sourced by the media, they come into our call center and they are directed to a branch. So eventually almost all of the applications are serviced, at least in New York, New Jersey, and Long Island, through our branch system. All of the loans close in our branches, which gives us an opportunity to cross sell the borrower at closing. We have trained and cross trained our branch staff so that they’re able to do this appropriately, and the results have been just outstanding.

Explain again, Alan, why are residential mortgages going to actually grow in the fourth quarter?

It’s going to be the volume of loans that are coming through the door. The applications that we’re seeing at this point. We have a very strong pipeline, and based upon what we believe we will likely sell in the fourth quarter, there will be obviously some that will get put on the books.

So do you anticipate selling less in the fourth quarter than what you sold in the third quarter?

No.

Somewhat. But you know what? That’s a little bit sometimes on the fly, and we have to watch our volumes and see what we want to do with them.

Our next question comes from Damon Delmonte of KBW. Your line is open.

Question for you on expenses. I think in your prepared remarks you commented on trying to rightsize the branch structure. I’m just wondering if you could maybe quantify that and maybe more bigger picture give us a little perspective as to what a good run rate is for the expense base kind of coming out of the third quarter.

You know, there’s not going to be an overnight change, even as we look at the branch structure. This is not, in the fourth quarter all of a sudden branches are going to disappear and costs are going to change. We have a long term commitment to our branches, but we will continually look at them. And I think that’s the point Jerry was trying to make. This is not something you’re going to see in the fourth quarter. I think our run rate for the fourth quarter is probably reasonably close to where we are today.

We’ve already, this year, closed three of our offices. I believe last year we closed four or five of our offices. And we have several others that we are monitoring very closely as to whether or not we should keep them open. It’s something that I think everybody has to do. It’s not just Valley. The age of just constantly opening up more and more branches I think is passé.

And then with respect to your funding costs, are there any opportunities to kind of tweak the balance sheet to try to lower the cost of funds? I know in the past you’ve adjusted the rates on some borrowings and extended the durations on those. Any type of opportunity like that?

Look, there are opportunities to always do things. The question is, in managing, again, the balance sheet, what is the right thing to do? How long would I extend borrowings? Do I really want to extend them? What are the things we want to do? And so I think we’re comfortable at the moment with where we stand. But that doesn’t mean we couldn’t do things further as we continue to monitor it, and we monitor the interest rate environment as well as what’s happening with loans coming on the books.

Our next question comes from Matthew Kelley of Sterne Agee. Your line is open.

As you fill out the servicing book, how are you going to capitalize that? Maybe just give us a sense of some of the assumptions there? And then also, what we should be thinking about for servicing income going forward as that becomes larger?

We try to capitalize it as low as the accountants will allow us to. At the present time, I believe it’s somewhere around five.

It’s a five-time multiple.

And then what should we be seeing in the securities book? Down pretty hard the last two quarters. Is that going to stabilize? Or still see some modest shifting from cash and securities into loans?

No, I think you’re going to continue to see it go down. Remember, we still have a lot of mortgage backed securities, and as loans are paying off, that’s what backs up the security. So you’re going to continue to see those come down all the time. And in addition to that, I think as I mentioned, we do have some trust prefers that are still out there. Over time, some more of those will likely be called. Again, I don’t think we can predict it, but obviously as interest rates stay where they are, we’ll continue to see..

The other point, also, as we’ve said in the past, if our mortgage backs are paying down, we’d rather replace them with our own residential mortgages. The performance history on our residential mortgages has been outstanding. Well, I’d rather keep my own 3.75% mortgage than go out and buy a mortgage backed security that’s going to pay us 2.5%. I’ve got the same product, the same duration. We have a much better rate of return here.

Over the next year, from a $15.8 billion asset size this quarter, do you think you’re flat, up, or down over the next year?

I think a lot of it is going to have to do with what happens in November as far as the election is concerned, and how the Fed reacts to the economy. And the economy in general. Do you want to tell me where the economy’s going to be a year from now? I’ll tell you how much bigger or smaller.

You know, I think we’ve always gone by the adage that it’s not how big we are, it’s how much we earn. So the fact that we may have had a little bit of shrinkage this quarter and we’ve made some good numbers, we’re very comfortable with that.

And you wouldn’t be upset with additional shrinkage if it improved returns on equity and assets?

Yeah, why not? As long as we’re making more money for our shareholders, it’s not how big we are.

And then what should we be using for a tax rate going forward?

I think we indicated 33 point something for the [full year and the fourth quarter].

Actually, I want to come back to one last one. Again, it was asked earlier in the call, but your gain on sale margins for the four handle. If you go back and look at where you were in the first quarter, I think you sold $3.2 million in gains and $108 million sold. So that was a 3% margin. What do you anticipate for gain on sale margins?

You know, a lot of this is based on what the Fed is going to do.

QE3, while we get hurt on our net interest margin, it helps on the sale of the mortgages. So you have to be responsive as management. You have to look for where we have the best returns to our shareholders.

To some extent, what the Fed is taking away they’re giving this though.

Our next question comes from Gerard Cassidy of RBC. Your line is open.

Jerry, can you give us a little more color on the positive pricing? You mentioned you’re raising some of your prices.

No, raising our fees on deposits.

That’s what I meant. How does that compare to some of your competitors? Is it a real meaningful difference or a slight difference?

It’s not dramatic. You can’t price yourself out of the marketplace. We’re not at the very top of the fee scale. We used to price ourselves probably in the middle, and now we’re at the 75% level. But the whole industry has to face up to the fact that you can’t give away your services for nothing. You can’t give away your home banking. You can’t give away all your postage. You can’t give away your bill pay. You can’t give everything away and then expect to have reasonable returns for your shareholders.

I totally agree. Hopefully others will follow suit. Can you give us some color? You obviously over the years have been very active in mergers and acquisitions and as the smaller community banks feel these pressures that you’re talking about, are you seeing more of them come to the table with an open mind about maybe joining forces with you? Or is it very quiet right now?

First of all, my counsel will shoot me for talking about mergers and acquisitions, about anybody coming to the table. But I will say that I think the realization has got to be setting in. When you look at the returns they’re generating, what their future prospects for those returns are, it’s got to be an active discussion in every board room.

And then finally, as you look at your expenses, you pointed out, looking at branches of maybe a smaller size might be more appropriate. If this interest rate environment stays as long as the Federal Reserve has suggested they’re going to keep it at, meaning through the middle of 15, these margin pressures, obviously, are not going away for the industry. Does it make sense at some point, maybe it’s a year from now and rates are still this way, margin pressures are more intense, where, to shrink the balance sheet, and tying into your point about shrinking branches, and then giving back the excess capital to shareholders with a more aggressive buyback?

Everything is, of course, always on the table. But when I talk about shrinking branches, I’m really speaking about lobby traffic. Traffic counts. How many people are coming into the branch? We’re seeing it, I’m sure every other bank is seeing lower foot traffic coming into the branches, simply because you have more automated and home banking and things of this nature that people don’t have to come to the bank. You have remote deposit capture. You don’t have companies coming in as often as they do. You need fewer tellers. That’s something you have to shrink, and monitor, and something we are following closely. You also have to look at locations of branches, how many you have in a particular area. You still want to have a presence. And then you have to look at the branches. What else can you do in the branch? In our case, we have converted the branch locations in most cases to mortgage origination and mortgage service processors, helping us get the mortgage product through the system. So we’re using the lobby space for other purposes. Whether it’s to sell investments in the branches that heretofore was not aggressively pursued. All these things are under consideration right now, because we have the investment in the branches. Some of them you own the building or you have a long term lease. You just simply can’t shut the doors overnight, because you still have a lot of expense. I’d rather see us convert those locations into doing other things that justify their existence.

We talked about the fact that the banks shrunk a little bit during the third quarter. We’re not going to look at our asset size. So if the best way to run the business is to have a smaller asset base, and we can make more money on that asset base, then that’s what we should be doing, and that’s what we’ll be looking at. So it’s always going to be based on returns, what the net income is, the EPS is, and what we can do for our shareholders.

Our board and our shareholders are very closely attuned to what our bottom line is. And everybody around this place, we’ve always focused on our bottom line. And I think this quarter shows that we’ve taken steps to help [afford a buyback].

On your expansion on the mortgage banking business, you could scale up if you choose to do it. Is there any geographic boundaries that you’re not likely to go beyond?

The key here, at the present time, is the market share that we presently hold in our existing market. We only had a roughly 1% or 2% market share in New Jersey and even less than that in New York. So we have an enormous opportunity to grow right where we are. So I wouldn’t expect us to be opening up mortgage banking operations in the Midwest or out on the West Coast. It would be foolish. Let’s finish servicing what we have right where we have it, if we have this branch network, which we can utilize to process the loans, and we’re doing that. So just think, if we doubled our market share, we’d still have a minuscule market share and a humongous revenue. So it is scalable. If we were to add another bank, we could train and utilize their staff in that regard to bring in more business. We don’t really have to leave this part of the country, so to speak, to do it.

And that will drive our efficiencies. You know, the fact that we don’t have to open offices all over the countryside, or do all kinds of work around the country. We’re already here. We already have a couple hundred branches. We have the resources in this part of the market, and to drive our efficiencies down, again, means we just make more money.

If you stayed just in the market and got a bit deeper penetration, as you guys just mentioned, what are the challenges? What do you see as being the challenge of doing that, should you decide to do it?

The challenge was getting our staff trained. All of the mortgages are processed here in Wayne. We have one location in Wayne that processes them. It’s a question of adding the people we need as the volume increases. And so far, we’ve been able to meet that challenge. I’m very proud of our branch staff, because many members of our branch network have volunteered and been cross trained so that they can come into Wayne to work in the processing center when volumes increase. So we have a source out in the branches. When I talk about rightsizing the branches, and reducing staffing in the branches, we’re able to utilize some of those same people by simply transferring them into the mortgage operation.

There are no other callers in the queue. I’ll turn it back over to our host.