Jul 20, 2010
Executives
James Abbott – SVP, IR and External Communications Harris Simmons – Chairman, President and CEO Doyle Arnold – Vice Chairman and CFO Ken Peterson – EVP and Chief Credit Officer
Analysts
David Rochester – FBR Capital Markets Bob Patten – Morgan Keegan Brian Foran – Goldman Sachs Craig Siegenthaler – Credit Suisse Steven Alexopoulos – JPMorgan Ken Zerbe – Morgan Stanley Brian Klock – Keefe, Bruyette, and Woods Todd Hagerman – Collins Stewart Jennifer Demba – SunTrust Robinson Humphrey Brian Zabora – Stifel Nicolaus Jason Goldberg – Barclays Capital Joe Morford – RBC Capital Markets
Operator
Good day ladies and gentlemen and thank you for standing by, and welcome to the Zions Bancorporation second quarter 2010 earnings conference call. Currently, all participants are in a listen-only mode.
Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator instructions) And as a reminder, this conference is being recorded.
I would now like to turn the time over to James Abbott. Sir, please go ahead.
James Abbott
Good evening and thank you. We welcome you to this conference call to discuss our second quarter 2010 earnings.
I would like to remind you that during this call we will be making forward-looking statements and that actual results may differ materially. We encourage you to review the disclaimer in the press release dealing with forward-looking information which applies equally to the statements made in this call.
We will be referring to several schedules in the press release during this call. If you do not yet have a copy of the press release, it is available as an Adobe Acrobat file at zionsbancorporation.com and can be easily downloaded and printed.
We will limit the length of this call to one hour, which will include the time for you to ask questions. During the Q&A section we will ask you to limit your questions to one primary and one follow-up question to enable other participants to ask questions.
I will now turn the time over to Harris Simmons, Chairman and Chief Executive Officer. Harris?
Harris Simmons
Thanks very much, James, and welcome all of you. This quarter is one in which we have continued to see some progress generally in credit quality trends, but it remains somewhat choppy in terms of the economy and the outlook for the economy in the near term.
We're seeing decidedly improved trends in some of our markets, Utah, Texas, perhaps most notably, but contain challenges in some of the southwestern markets, Nevada most especially, and California, Arizona as well. We view the quarter as one in which we made reasonably good progress on credit quality and we believe our visibility continues to improve in that area.
We were able to reduce non-accrual loans for the first time since the financial crisis began, and we believe that the improvement will continue into the third quarter, as other measures of problem credits also declined at encouraging rates during the quarter. This quarter wasn't without its challenges, as loan balances continued to decline at a strong rate.
Though the largest portion of that decrease came in construction and land development elements of the portfolio where we are actually encouraged to see them coming down and reducing our exposure in those areas. We are encouraged with a significant increase in gross loan originations and renewables compared to the first quarter, but it wasn't enough to offset paydowns, and to a smaller extent charge-offs, and we expect that net loan growth is going to remain a challenge in the near term, and particularly as a result as we've indicated before, the continued shrinkage in the construction and development portfolio.
Turning to our results, there were several noisy items that obscure some positive trends which we'll review on this call. We reported a loss of $0.84 per share to common shareholders in the second quarter.
Net income before taxes fell to a loss of a $136 million, which was down $44 million from the first quarter. This decline can be primarily attributed to the conversion of subordinated debt into preferred stock, which was a $49 million increase in expense from the second quarter compared to the prior quarter.
As we said in the prior quarter's call, we didn't expect to add significantly to the allowance for credit losses and during the quarter we note that the ratio, the allowance for credit losses to total loans only increased 6 basis points compared to a 24 basis point increase last quarter, an increase of more than 200 basis points in 2009. As you are aware, we raised about $600 million of capital during the quarter, which is responsible for a significant improvement in our GAAP and regulatory capital ratios.
Looking back at what has been accomplished during the past several quarters, the tangible common equity ratio increased 160 basis points from March 31, 2009 through the end of the second quarter of this year despite absorbing $1.5 billion of that charge-offs, $339 million of securities impairments, including both OCI and OTTI, $168 million of other real estate owned expense and enhancing the allowance for credit losses ratio by 200 basis points or the equivalent of $850 million. With these actions, our capital ratios have moved above the peer median.
We remain pleased with the performance of our core deposit franchise, which we continue to believe is among the best in the industry. Average noninterest bearing demand deposit balance growth remained very strong, rising an annualized 25% from the prior quarter.
It is up 25% compared to the year-ago level. We believe this is partially attributable to low absolute interest rates and the FDIC guarantee on demand deposits.
Nevertheless, we are encouraged that our demand deposit growth rate has significantly exceeded that of the industry.
Doyle Arnold
Thanks, Harris. Good afternoon, everyone.
As noted in the release, we posted a net loss applicable to common shareholders on a GAAP basis of $135.2 million or $0.84 loss per diluted common share. I'll highlight three main areas that drove that result.
Revenue, credit quality and cost, and capital, and then we’ll turn to your questions. First revenue drivers; the reported GAAP net interest margin compressed 45 basis points to 3.58% from 4.03% the prior quarter.
The core NIM, which excludes amortization of sub-debt and items related to FDIC loan outperformance fell 12 basis points to 4.14% from 4.26% due primarily to the increase in average cash balances on our balance sheet.
And on a core basis, comfortably above 4% still. Just the difference being – so I would really encourage you all to watch for our next 8-K, which will be in September in which time we will announce the amount of sub-debt that has converted into preferred and what the impact of that will be on the NIM.
We try to be as clear as we possibly can and it does appear that some of you have missed that or publishing numbers that are on a core basis and what have you. So I guess the bottom line from our perspective and, but for the growth and cash balances on the balance sheet, the NIM was fairly stable on a core run rate basis as we suggested I think last quarter that it would be.
We also – we did have couple of offsetting movements. We moved more than $1.1 billion of higher rate money market accounts out of the bank, and attempting to manage down cash.
But as you will note on the balance sheet disclosures we have strong inflows of nearly $1.3 billion in DDA, and this combined with loan runoff of nearly $1 billion basically prevented us from achieving a reduction in cash balances instead they grew – I would note prevented us from shrinking the balance sheet further this quarter, it also grew slightly with a negative impact on tangible common equity ratio, not so much on regulatory risk-based measures but on that. Yield on loans, excluding the effect of a writeup on FDIC loans due to favorable performance was stable at about 5.59%, but the yield on incremental loan production and renewals during the quarter was about 5.2%, somewhat lower than the average and I will talk a little bit more about that in a moment.
As a reminder for those who are contemplating potential levels of our long-term net interest margin, depending on how you want to calculate it, it is pressured by more than 30 basis points due to the level of nonaccrual assets and interest reversals as loans moves into non-accrual status. Other key component of revenues, the earning asset base.
As I mentioned, period end loans declined $977 million, or 2.5% from March 31 and average loans declined about $1.1 billion primarily due to continued soft loan demands although as Harris indicated we saw a little bit of a pickup in new originations, first time draws on lines, etcetera. Excluding construction, FDIC insured loans, end of period loans declined 1.1% sequentially.
So I think those numbers as a percentage declines are roughly in line with what I’ve seen so far at least around the industry and probably don’t come as a big surprise to you. What we have seen in the last couple of months is a fairly significant increase in price competition for better quality, larger commercial loans and perhaps more modest increase in competition for more typical smaller business funds.
We’ve been cautious in meeting those pricing in terms which probably has affected loan balances, but seems pretty clear that this price competition is real and that we have, as you can tell by the marginal pricing of new loans, begun to meet it in some instances and we will expect that we may have to continue to selectively meet that price competition again on larger, better quality commercial credits. The primary component of the loan attrition was construction loans, as it has been for a number of quarters now, which declined about $600 million and accounted for more than 60% of the total attrition in the quarter, and we do expect that that category will continue to decline due to charge-offs, completion of projects and little demand for new construction and development loans.
Commercial loans attrition slowed compared to the prior quarter falling $282 million compared with $663 million in the first quarter. The loan approval rates have improved meaningfully during the last few months as borrowers' financial health, commercial borrowers has begun to improve.
In general, however, we hear from our lenders that businesses remain skittish about expansion and hiring plans, taking a wait and see approach. The components of non-interest income and non-interest expense contain less noise than in the prior quarters.
The increase in other service charges and the fee income line as a result of several items improving many of which were related to higher transaction volume and interest rate risk management services that we provide to our borrowers. This quarter’s levels are more similar to the 2006 and 2007 period before the crisis.
In non-interest expense, OREO expense did increase meaningfully this quarter, while several of the banks within our franchise experienced a decline in OREO expense, Utah and Arizona in particular resolved significantly higher volumes of OREO during the quarter and took higher OREO expense in doing so. Finally, I'd note that for about I think the fourth quarter in a row had a meaningful decline in other than temporary impairment in the CDO portfolio.
It was down to $18 million from $31 million prior quarter and about $100 million if you go back a few more quarters. Barring a significant double dip recession, we would expect this expense to continue to be at very moderate levels and in general continue a declining trend.
Moving back to credit quality in the loan portfolio. We are encouraged by the lower level of non-accrual loans, down about 6% sequentially.
This order of magnitude of improvement is also true when examining our more adversely graded loans, and our delinquent loan level has also improved dropping by 14% or 20% depending upon whether you exclude or include the FDIC supported assets that we acquired last year. Construction and land development non-accrual loans fell by 7%.
Within construction, we experienced a fairly rapid decline in the commercial construction problem loans and a continued trend of declining residential construction problem loans. Term commercial real estate non-accrual loans fell by 13% compared to the March level and owner occupied commercial real estate non-accruals also fell but by more modest 5%.
In general, we continued to see a fairly strong market for term CRE with multiple bidders on properties and properties pricing at healthier levels. C&I non-accrual loans have been holding steady at about 3.3% of total C&I loans outstanding.
Net charge-offs increased $28 million compared to the prior quarter. Charge-offs are somewhat lumpy.
The five largest loan charge-offs in second quarter were $48 million compared to $25 million for the top five in the prior quarter. And we’ve noted that it’s – charge-offs are probably not going to be a straight line down and perhaps the provision numbers will be more consistently stable to declining.
But I would say the other way to look at the charge-offs is that most of the increase occurred again in the commercial real categories, both construction and development and in term CRE and there was no one category of term CRE or one geography that showed consistent deterioration. It just was a handful of $1.4 million [ph] and $2 million charge-offs.
I guess the general picture is we had a consistent decline in problem credits across most of our banks and most of the various loan types, and therefore we do expect losses to continue to trend lower over time. A related note, our provision for credit losses was about 90% of our net charge-off level.
However, because of the declines in loan balances, the allowance ratio actually increased and we maintain one of the highest ratios of all regional banks. Our quantitative models continue to show declining need for reserves but we actually are viewing with some degree of caution the possibility of an economic indicators deteriorating, possibility of double dip recession etcetera.
So we are still holding up the overall reserve in light of that possibility, although there's no indicators in our loan portfolio itself of that at this point. Next, migration; I'll review migration trends within the non-accrual loan and OREO categories.
Within non-accruals, we expected total new non-accruals of $590 million, down just slightly from $600 million in the prior quarter. We also experienced about $350 million of favorable resolutions, including paydowns, payoffs and upgrades compared to approximately $270 million in the past quarter.
Main difference came from payoffs which more than doubled from the first quarter. Let me briefly discuss capital.
During the quarter, we raised gross $615 million of tier 1 capital, the vast majority of that was common. Net of fees, we added just over $600 million of common and preferred through three methods that are delineated in the earnings release.
Our common equity distribution program, an offering of warrants to purchase common stock and a new Series E preferred shares. As noted in the release, our tangible equity ratio increased 56 basis points to 6.86% from 6.30% in the prior quarter.
That number would have increased significantly more except for the buildup of cash which held up the overall size of the balance sheet. If cash were more in line with historical proportions to loans, the TCE ratio would have been comfortably over 7%, probably around 7.3%.
So the higher concentration of cash is the primary reason that the regulatory ratios improved at a faster rate than the TCE ratio. Tier 1 common, for example, improved 77 basis points from the prior quarter to 7.91% from 7.14%.
Summary of guidance for the next quarter and then we'll turn to your questions. We do expect some continued but hopefully moderating somewhat decline in loan balances during the third quarter.
But I don’t know that that is going to translate into any change in the overall balance sheet size because we do continue even post quarter end to an experience an increase in DDA balances and in general an increase in deposits. So our ability to shrink the balance sheet a whole lot further is questionable at this point.
We therefore might expect a core NIM to decline a bit, due to those increased cash balances. And continued loan runoff, which basically converts loan balances earning between 5% and 6% into cash balances earning 25 basis points.
We continue to be positioned in a very asset-sensitive position on our interest rate risk management posture, which means we may well positioned for rising interest rates. With regard to credit quality, we expect charge-offs to follow a generally declining trend, but with some lumps and based on everything we are seeing now we do expect continued improvement in non-accrual loans and adversely graded loans in the coming quarters.
We may experience some modest decline in the allowance in part because loans are shrinking but a major reserve release is still not probably being contemplated until we get significantly more clarity on the outlook for the economy over the remainder of this year and into 2011 in particular, whether or not a double dip recession is on the table or off the table. With that I will I think turn it over to the operator to queue up your questions, which those of us in the room here will do our best to answer.
Operator
David Rochester – FBR Capital Markets
Hi, good evening guys.
Harris Simmons
Hi, Dave.
David Rochester – FBR Capital Markets
Doyle, it seems like you can get a decent amount of margin lift by running off CDs in the back half and shrinking those cash balances. Can you talk about your ability to do that?
Doyle Arnold
I don't dispute your point. We are going to be talking with our Executive Management team day after tomorrow about rates paid on CDs and the balances in CDs.
There is probably still about $0.5 billion of CDs around the company where that appears to be the only relationship and I'll put that in quotes that we have with that customer. So we're going to be taking a very close look at those.
But yes, there is still I think some incremental progress we can make both in deposit balances and in rates paid on deposits. But I have not attempted to quantify that.
But I don't disagree with your point.
David Rochester – FBR Capital Markets
Doyle Arnold
I am not going to give you a detailed update. I think you're referring to – we've talked about that the significant portions of the CDO portfolio carry very punitive risk weights.
Is that basically your question?
David Rochester – FBR Capital Markets
Yes, that’s it.
Doyle Arnold
We do continue to work on that and I think it’s increasingly likely that we will have something to say this quarter, probably in the first quarter of this quarter about that. And I think the improvement ratios will be quite noticeable if we pull it off, and I think we will.
And with that, I'd ask for your patience because I don't have anything to announce yet but I think we are on track to get something done.
David Rochester – FBR Capital Markets
Operator
Bob Patten – Morgan Keegan
Good morning, guys.
Harris Simmons
Hi, Bob.
Bob Patten – Morgan Keegan
Doyle, just on credit, can you give a little color on the grade migration on the worst part of the portfolio, only for the fact that the criticism isn't for the stuff we know about, it's for the stuff that we don't know, so I just wanted to get a feel for the performing portfolio, maybe a little change in the worst grading portfolio and so forth.
Doyle Arnold
I'll take a stab at what I think you're asking, but if I am not we will certainly give you an extra follow up for that. We have seen an actual significant decline over the last six months or so in special mention loans going to classified.
We’ve seen a pretty significant decline in the, sort of just in general but rate of new loans being downgraded to a classified status. So basically the healthier part of the portfolio at this point seems to be staying healthy and less and less of it each quarter is deteriorating.
I don’t happen to have specific numbers to give you but basically special mentioned loans are declining significantly around the franchise as a whole. Classified loans were down slightly, but they clearly appear to have peaked and the rate of in-flows of new problems is slowing a lot.
Is that directionally what you wanted to know?
Bob Patten – Morgan Keegan
That's exactly what I wanted to hear. And the other point was at what point do we see the reported NIM start to go back to the core NIM?
Doyle Arnold
Oh, golly. Not more than 4.5 years, because that’s when the sub-debt matures.
Bob Patten – Morgan Keegan
All right.
Doyle Arnold
Basically, again, to remind you Bob, two things are going on. One of which is fairly predictable and the other which is beyond our control and we can only report.
When we modified the sub-debt in June of last year, simplest way to think of it is we mark it to market. But if nothing else, we still owe the par amount in 2014 and 2015 on maturity, so we have to accrete that discount back and write the debt up over time.
That amount that happens quarterly is all scheduled out. What changes the schedule and more importantly make each quarter quite lumpy is any time a holder of sub-debt exercises its conversion right and converts it into preferred, that amortization is accelerated.
We write it off, that piece all up immediately and then stop amortizing it for that purpose. So I would expect that probably after another few quarters, certainly by the end of 2011 the rate of conversions would go down significantly if it doesn't go down sooner than that.
And the reason is, what these holders basically have to do is decide, look at the relative prices on the sub-debt and on the preferred they can exchange into and the relative yields and decide if it's worth it to convert and they're going to be looking at a maturity date in the case of the debt and a call date in the case of the preferred; the call date is about a year sooner than the maturity date. So there comes a point when yes, okay, even if I can get a bit of pick up by converting to preferred, I am going to get it for a year less than I would if I just settle my debt.
So it may continue – bottom line, we may have a few more quarters of lumps, but then it should I would think start to settle down.
Bob Patten – Morgan Keegan
Very clear. Thank you, Doyle.
Doyle Arnold
Thank you.
Operator
Thank you. Our next question in queue comes from Brian Foran with Goldman Sachs.
Your question please.
Harris Simmons
Hi, Brian.
Brian Foran – Goldman Sachs
Hi. My name almost sounded French there.
Harris Simmons
It did. I thought you were becoming very sophisticated.
Brian Foran – Goldman Sachs
Still pretty simple. I guess one housekeeping question.
The tax rate or I guess the level of the tax benefit, I missed it if you explained that, but why is that lower this quarter?
Doyle Arnold
And as we try to estimate couple of things what is the total for the year likely to be. How much of it have we already recognized and it's complicated by the discrete items that flow through.
We cancel the one BOLI policy this quarter and we will pay $9 million of tax related to that surrender, even if we made no money. We canceled a BOLI policy, a couple of them last quarter and a larger tax penalty.
I guess the best way I can – and then there are few other true-up items in there that went both directions this quarter. The best guidance that I think we can give you on taxes is that we currently expect the effective tax rate for the year to average around 30%.
And if you look at where it was in the first half of the year that means it’s going to be fairly quite a bit higher than that in the second half of the year. And again, we get to – as we start to get closer to break even that number will – the effective tax rate will go way up as you get to a point where you have a little bit of income and it's not easy to figure out.
That's about the best I can do, unless James can say it – he's supposed to be able to explain these things more clearly than I can. But I don’t know that if he can this time.
Is that at all helpful Brian?
Brian Foran – Goldman Sachs
It is. It is.
I guess the second one is maybe more straightforward. The C&I competition comments you made, I guess it's striking how similar it was to what First Horizon said last week and I guess the two follow-ups I would have are is it surprising to see competition reemerge to this level this early in the cycle, and then secondly, you guys had that chart a while ago talking about the incremental NIM on new originations.
When you look at C&I incremental origination NIMs today, is it just less good but still NIM accretive or has it gotten to the point where it's core NIM dilutive to put new C&I loans on?
Harris Simmons
This is Harris. Maybe I'll take a crack at the – in terms of C&I loan competition, my own view is actually that it's entirely logical what we're seeing right now and that is because the industry is awash in liquidity and in capital.
I mean, if you look at capital ratios for the largest banks relative to where they've been two or three years ago, there's a lot of capital there sitting in cash effectively and in the short term I think it’s actually to me it makes a lot of sense that you are going to see lot of price competition. This is a little like a fixed-cost kind of an industry where you have – it's like running an airline with empty seats.
Everybody's trying to fill seats. I think my own belief is that as the economy actually start to expand again, you'll see discipline return as companies – as banks start to see the portfolios grow and approach whatever they think is the longer term required level of capital and start to think in a very much more disciplined way about what pricing is going to have to be over the longer term.
And I think that’s why we are seeing it in larger high quality credits.
Doyle Arnold
James Abbott
Brian, this is James. I'll just add in talking to small business lenders across the company, we heard that maybe getting 10 basis points or so pressure, pricing pressure on your small business credits where the bigger pressure is occurring is in the larger credits.
Then the other question was whether it’s dilutive to NIM on an incremental basis, and it's probably not dilutive to net interest margin. It would be dilutive to the loan yield.
But the incremental loans that we put on had a yield of about 5.2% and if you look at what’s happened in the deposit line items, most of the growth came from non-interest bearing and we had run-off in interest bearing. So the net interest margin, which still be accretive on an incremental basis from new production.
Brian Foran – Goldman Sachs
Thank you.
James Abbott
You are welcome. Operator, next question.
Operator
Yes, sir. Our next question in queue comes from Craig Siegenthaler with Credit Suisse.
Your line is now open.
Craig Siegenthaler – Credit Suisse
Thanks. Good evening, everyone.
Harris Simmons
Hi, Craig.
Craig Siegenthaler – Credit Suisse
I am just wondering – I didn't see the breakout anywhere. Can you give us the mix between the consumer and commercial restructured loans?
Doyle Arnold
No. I think the vast majority of it’s probably commercial but I don't have the – by far, Jerry Dent's saying.
But I don't think we have hard data for you. I don’t know if we could even get that in an hour to follow up with, easily.
James Abbott
Actually, we could.
Doyle Arnold
We could.
Craig Siegenthaler – Credit Suisse
We can touch base after the call on that. Just a second question, though.
What level of charge-offs actually came from the restructured loan bucket this quarter?
Doyle Arnold
Stump the band twice. I don't think it was a lot.
Craig Siegenthaler – Credit Suisse
Small number?
Doyle Arnold
Ken Peterson
Craig Siegenthaler – Credit Suisse
Have you guys been using a lot of kind of AB restructured notes or kind of what's – I'm just wondering if you could change anything with I guess some of the refinancings coming a little bit higher over the last quarter or two.
Harris Simmons
Craig Siegenthaler – Credit Suisse
Great. Thanks for taking my question.
We can follow up after the call, if that's okay.
Doyle Arnold
All right, Craig, we don’t have the exact number but Jerry Dent is still kibbitzing here with us, even though he's passed his Chief Credit Officer. He is telling me that he is highly confident that the redefault rate on TDRs is under 15%, which is quite a bit lower than I think what you are hearing from rest of the industry.
Craig Siegenthaler – Credit Suisse
Great. Thanks for taking my questions.
Operator
Steven Alexopoulos – JPMorgan
Hi, good afternoon, everyone.
Doyle Arnold
Hi, Steve.
Steven Alexopoulos – JPMorgan
Maybe we could start, despite what I would call positive turn in NPAs and delinquent loans, the tone seems much more cautious on credit I would say than it was last quarter. How much of this is coming from what you're actually seeing in the loan book and what is it you're looking for before you're comfortable with a larger reserve release if it's not these two trends improving.
Doyle Arnold
I would say that essentially none of it’s coming from what we are actually seeing in our loan book and it’s all the – it's the economic news that makes us cautious. It's the Fed minutes, couple of meetings ago talking about how they would withdraw stimulus and the meetings most recently talking about whether and how they might inject additional monetary stimulus.
It's consumer confidence numbers and NFIB numbers and there are positives. There's private sector job growth as well.
But there is still a fair number of negative macro kind of numbers out there. We are actually quite pleased in general with what we are seeking in the specifics of our credit portfolio.
Steven Alexopoulos – JPMorgan
Doyle Arnold
Harris Simmons
Doyle Arnold
Steven Alexopoulos – JPMorgan
Okay. Thanks.
Operator
Thank you. Our next question in queue comes from Ken Zerbe with Morgan Stanley.
Your line is now open.
Ken Zerbe – Morgan Stanley
Doyle Arnold
NPA balances were down – in-flows were down a lot first quarter over fourth quarter. They were only down marginally this quarter.
Based on the trends in criticized and classified loans that I’ve discussed I think the trend of new inflows is going to continue to be down as well. But that's something that's just not very easy to forecast on a quarter to quarter basis.
But I think that everything we see says the trend there is improving as well.
Ken Zerbe – Morgan Stanley
Okay.
Doyle Arnold
So I am not going to try.
Ken Zerbe – Morgan Stanley
All right. That's fine.
And then just going back to the reserve in terms of the timing of the reserve release, I understand you increased your environmental because – but if your portfolio is not showing deterioration, I guess how long can you reasonably and legitimately wait before you start releasing reserves in a more material way? I know you said you wanted to wait until 2011, but is that possible if the model continues to show improving underlying core credit trends?
Harris Simmons
Well, if I talked to the regulators, I could wait a very long time and if I talk to my auditors, I could probably only wait a shorter time. But there is enough uncertainty that I think another quarter or possible two before you have – as long as – if there is a double dip, it's going to start to show up here in the next quarter or two and then we won’t be talking about releases for a while.
If the economy continues to limp along, improving, albeit at a slow rate, that's probably going to become more clear by the end of year as well. And so I don't know, I think somehow or another, we're most likely – we'll likely hit an inflection point by the end of this year, but you tell me what the economy is going to do and I will give you a better answer.
Ken Zerbe – Morgan Stanley
Understood. All right.
Thanks.
Harris Simmons
Okay.
Operator
Our next question in queue comes from Brian Klock with Keefe, Bruyette, and Woods. Your line is now open.
Brian Klock – Keefe, Bruyette, and Woods
Good afternoon, gentlemen.
Harris Simmons
Hi, Brian.
Brian Klock – Keefe, Bruyette, and Woods
Just a quick question and I guess everybody's just talking about the reserve releases. I guess thinking about the macro concerns, maybe you guys can update us on capital plans, exit from TARP, do you feel like all the capital actions you did in the second quarter are the end of the capital raising since the end of the year and I guess timing of TARP repayment.
Harris Simmons
I think it’s premature to talk about TARP repayment until we’ve seen a more sustained – not just leveling of credit quality but actual meaningful improvements in the credit quality trends. We’ve seen them improve.
I think it’s going to have to be sustained for at least a couple of quarters before we can start having any serious conversations with the regulators about that. We also need to get probably to at least break even or somewhat profitable and have an outlook that calls for sustaining that trend before – and that again is perhaps couple of quarters away before you can really demonstrate that opposed to project it.
And as for overall capital, I'm confident that to the extent that some things count toward TARP repayment and some things don't. I think everything we did in the second quarter counts.
I don't know that that is sufficient in and of itself, because that will happen when we look at our capital – that determination will be made when we have a discussion with the Fed after the first two conditions are met, profitability, sustained credit quality improvement. Both of which we think we are on track to achieve.
Are there any major capital plans in between now and then to load the gun to repay TARP? No, not at this time.
Could we still issue more modest amounts of capital to cover losses and make sure than capital ratios that we built up don’t deteriorate prior to having that conversation, that’s something on the table. We haven't made any clear decisions about that, but I'd say that that’s possible.
Brian Klock – Keefe, Bruyette, and Woods
Okay. And just one real quick follow-up.
Earlier Dave's question was about the potential to lower your risk weighting assets on the TARPs [ph]. I guess would the third quarter margin if you're able to do that successfully, would the cost of the wrap, would that lower the net interest margin?
Harris Simmons
Assuming there is a wrap, as you call it, there will be a cost to doing it that will affect expenses in the quarter in which it’s done. It’s not the NIM.
Doyle Arnold
And it’s not salary expense.
Brian Klock – Keefe, Bruyette, and Woods
So it's safe to say it will affect pretax, preprovision ROA –
Harris Simmons
There you go. Certainly that.
Brian Klock – Keefe, Bruyette, and Woods
All right. Thanks, guys.
Harris Simmons
Unfortunately, the lunch is not free.
Brian Klock – Keefe, Bruyette, and Woods
All right. Thanks for taking my questions.
Harris Simmons
Yes.
Operator
Thank you. Our next question in queue comes from Todd Hagerman with Collins Stewart.
Your line is now open.
Todd Hagerman – Collins Stewart
Hi, good afternoon, everybody.
Harris Simmons
Hi, Todd.
Todd Hagerman – Collins Stewart
Doyle, I just wanted to ask just in terms of the OREO this quarter, I mean it’s been running $360 million or so the last couple of quarters. You mentioned a couple of the banks were a little more aggressive this quarter in their disposal efforts.
What's your sense now as you look across the portfolio of things getting marginally better? Can you talk a little bit more just in terms of what was in that expense line and just your outlook in terms of OREO?
Is that something that we can get a little bit of relief here on going forward or is that something that should likely stay elevated for a period of time?
Harris Simmons
It’s Harris, Todd. I think my expectation is it probably stays somewhat elevated for another couple of quarters.
We are trying to be – we are pushing these banks to be reasonably aggressive in getting rid of this stuff. We have – one of these portfolios in which we have some of this product is SPA 504 portfolio of national real estate credits we call them.
And that’s a portfolio that accounts for roughly I think 30%, 40% of the total of the real estate owned. That's the – we're turning that out on average in about 90 days once it’s booked.
We don’t have anything in there that’s been there for more than a year. On average it’s getting in about 90 days.
We are trying to accelerate that even a little further. So this holds true for both loan losses well as other real estate owned expenses, charges we take there to the extent that we push a little harder it’s going to take – it results in a little more loss, typically and so I think with non-accrual levels still is elevated I think we are still going to see over the next couple of quarters higher other real estate owned expense.
Until those numbers really start to come down.
Todd Hagerman – Collins Stewart
Okay. And then I'm assuming – were there any meaningful gains in that number embedded in that number?
Is it mostly write-downs?
James Abbott
Todd, this is James. The net gain and loss on REO was basically very close zero on that.
There was about $1 million gain. The volume of loans that moves through the REO balance that you guys don’t see but the volume was significantly maybe 30%, 40% larger in the second quarter than it was in the first quarter, the dollar volume of assets moving through the python, so-to-speak.
Todd Hagerman – Collins Stewart
Okay. Terrific.
Thank you.
Operator
Thank you. Our next question in queue comes from Jennifer Demba with SunTrust Robinson.
Your line is now open.
Jennifer Demba – SunTrust Robinson Humphrey
Hi, good afternoon, everybody. If I missed this in earlier comments, I apologize, but Doyle, do you have any specific guidance for the third quarter reported net interest margin at this point?
Doyle Arnold
James Abbott
I was just going to highlight the fact that your cash – the end of period cash balance was $1 billion, maybe a little better, $1.1 billion over the average cash balance for the quarter and that probably will have – in the high single digit worth of basis points of compression. So the core NIM will compress all else being equal about 7 basis points to 10 basis points just from the cash balance unless we can do something about it aggressively in the next few days here.
But from a GAAP basis, we – it would be very hard to predict, but as to what – I would note there were two issues that converted, two Q-SIPs that had the eligibility to convert of sub-debt in the second quarter, almost all of the conversion came from one Q-SIP though. So that’s perhaps not indicative of that.
In the third quarter, it will only be one Q-SIP that is eligible to convert. But it’s hard to know at this point what that number will be.
Jennifer Demba – SunTrust Robinson Humphrey
Okay. Thank you.
Doyle Arnold
If people had to make that decision as they hadn't made it last week, the economics of converting or not converting to the holder of the debt would have been just about awash. So there is no particular incentive for them to convert.
Nonetheless, we know there are some holders that have called in and even though they don't have to tell us formally yet, they told us they plan to convert this quarter; so it just really hard to know, Jennifer. I am sorry.
Jennifer Demba – SunTrust Robinson Humphrey
That's okay. My second question relates to the problem asset disposition market.
Have you noticed any meaningful changes as the quarter progressed and as we've entered third quarter, as economic sentiment has kind of dropped?
Harris Simmons
I can tell you that if we look at basically the resolution rate on the problem loans during the quarter was about 22% of the beginning of the quarter balance. And so – I think the resolution rate on problem assets continues to be, we think, pretty good.
I think a little better in the second quarter than it was in the first. As you start to get lower flows into kind of the problem credit categories, into graded loans, classified, criticized loan categories that should really start to bring it down if you can keep the resolution rate reasonably high.
So far, I think we’ve seen a lot of good resolutions. We go through these kind of one by one on a larger deals and discussions we’ve had internally on the deals in the last couple of weeks I think continues to be reasonably encouraging.
Doyle Arnold
I think last in the quarter, we saw more positive surprises than negatives, particularly coming out of Texas, and as Harris said we talked to all of the CEOs and chief credit officers of all the banks once a month and go through loan by loan their larger credits and generally the outlook is still more improving than staying stable or declining.
Harris Simmons
Jennifer Demba – SunTrust Robinson Humphrey
That's helpful. Thank you very much.
James Abbott
Operator
Yes, sir. Our next question is queue comes from Brian Zabora with Stifel Nicolaus.
Please go ahead with your question.
Brian Zabora – Stifel Nicolaus
Thanks. Just a quick question on the regulatory side.
Could you detail how much you had as far as overdraft fees this quarter and debit interchange that might be impacted by the changing rules?
Doyle Arnold
I can tell you that we had about – you can see it on the service charges line. We had as I recall about $52 million of service charges and fees during the quarter.
I can’t tell you how much of that would have been attributable to debit card transactions, ATM transactions, which are really the subject of the Reg E changes. So I don’t know if anybody else around the table has that.
James Abbott
I mean, Brian, what we said is if all service charge income from debit and overdraft and so forth went to zero it would be about $30 million a year. It would be a little bit more than that.
From what I've heard, this is James, from what I’ve heard there are fairly high opt-in rates which is consistent with what we're hearing out of the industry as well. But probably a little bit too early to make a definitive statement on that.
Brian Zabora – Stifel Nicolaus
Okay. Thank you very much.
Operator
Thank you. Our next question in queue comes from Jason Goldberg with Barclays Capital.
Your line is now open.
Jason Goldberg – Barclays Capital
Super. I guess with respect to the increase in I guess commercial real estate charge-offs, was there any I guess loan sales and loan markdowns on loan sales that influenced those figures?
Doyle Arnold
We are selling loans every quarter. That’s our preferred first.
If we can’t get it paid off selling the note not for closing is generally the first – well, you probably maybe restructure the note if that's possible sell the note. The last thing you want to do is really foreclose.
So that’s just an ongoing tool and I don't think there was any particular noteworthy change in the overall mix of resolutions, note sales versus other things.
Jason Goldberg – Barclays Capital
Got you. I guess secondly, it sounds like I guess you're in a 36-month loss position and it sounds like return to profitability maybe gets pushed out a little bit here.
Any further thoughts on where you stand with respect to the DTA?
Doyle Arnold
Jason Goldberg – Barclays Capital
Got it. Thank you.
James Abbott
Jason Goldberg – Barclays Capital
For regulatory.
James Abbott
For regulatory purposes.
Jason Goldberg – Barclays Capital
And that compares to 130?
James Abbott
It was 129 last quarter, yes.
Jason Goldberg – Barclays Capital
Helpful. Thank you.
Operator
Thank you. And we have time for one final question.
And our final question comes from Joe Morford with RBC Capital Markets. Please go ahead.
Joe Morford – RBC Capital Markets
Thanks. I guess the only other follow-up would be just curious on this competition you're talking about from new loans, is it really coming from across the board or is it more big banks versus small?
And then taking that in combination with your real estate and construction concentration, does this affect at all about what you think a more normalized margin is achievable on a core basis longer term?
Harris Simmons
Well, the competition is generally coming from handful of the four or five largest banks in the country. That’s really what we are seeing most notably.
I think in terms of, again, my own view is that longer term, that margins are going to be healthier than they were coming into this cycle, simply because I think you are going to have a lot more price discipline from the larger banks as they start to contend with having materially higher equity capital positions and that will be helpful in kind of leveling the playing field somewhat in terms of pricing of various kinds of loans. So we'll see.
That's my hypothesis, I guess. I think it's notable, as we look at – if I go back and look at 2006, and look at our taxable equivalent net interest income, 2006 which was about $1.8 billion and if I adjust for the subordinated debt conversions we are experiencing today, we've got taxable equivalent net interest income, equivalent of about $1.980 billion, something like that.
It’s actually interesting that even with a runoff and pressure there, and we brought on a lot of assets out of Lockhart several quarters ago that had net pressured margins and the additional cash, we're still seeing really quite healthy pricing on loans. The yield on loans this quarter, total loans was up 10 basis points over last quarter, and as James pointed out, incremental pricing, new originations has remained in quite good shape.
So we will see. I think if loan demand remains really weak for a protracted period of time, I think that's going to really pressure loan pricing in the near term.
I think as things start to grow again, I think we're fundamentally we have a healthier environment in which to price going forward.
Joe Morford – RBC Capital Markets
Okay. That's really helpful.
Thanks, Harris.
James Abbott
Okay. Thanks everyone.
That will conclude our conference call for today. I will be – we have taken down the names of those who are still in the queue and I will give you a call back as soon as we can.
And thank you for your time and your interest in the story today. Thanks.
Operator
Thank you. Well, ladies and gentlemen this does conclude today’s program.
Thank you for your participation and have a wonderful day. Attendees, you may now disconnect.