Associated Banc-Corp (ASB) 2005 Q3 法說會逐字稿

Good afternoon. At this time, I would like to welcome everyone to the Associated Banc-Corp’s Third Quarter Earnings Conference Call. [OPERATOR INSTRUCTIONS.] I would now like to turn the conference over to Mr. Paul Beideman, President and CEO. Sir, you may begin.

Thank you very much, and thank you all for coming on the call today. I’ll make a few comments here. Joe Selner is also here with me. And we’ll be happy to answer any questions that you may have. As you can see from the press release, we earned $0.63 a share, which is up about 10.5% over last year.

I’ll spend a few moments later talking about the margin dynamics. But let me make a couple of other points before going there, if I can. Our fee income in the quarter remains strong. Retail commissions were down in the quarter. That’s reflecting seasonality, and receipt of insurance revenue. And, if you look back last year, you can see basically those same trends from the second to the third quarter.

But, on a year over year comparison, this revenue stream for us is up over 25%. And we feel very good about that, and its prospects for growth in the future. Mortgage banking was a strong contributor for us here in the quarter. Fees from mortgage originations were up meaningfully. And the MSR asset for this quarter was a positive contributor. You will recall that last quarter it was a negative contributor by about $2.5 million, and a $4 million positive contributor this quarter.

Deposit fees are up. And they’ve been up nicely really on a year over year comparison. Trust fees were essentially flat, but up significantly again on a year over year comparison, when you look at year to date 2004 to 2005. So when you look at the business over that period of time, I think you can see how the momentum in each of these categories is generating some positive effects for us.

Asset quality remains very strong. And from our perspective, the trends indicate continued strength. We always are working on individual credits. But we feel good about our commercial and consumer portfolios, as well as the credit risk management processes that we have in place to manage asset quality going forward.

Expenses were essentially flat, with personnel expenses again down slightly from the second quarter. This is reflecting some of the staffing actions that we had taken to the quarter, and reaching a level of stability at this point, if you will, in staff line. But again, comparing back to the first quarter 2005, expenses are down meaningfully. And that’s creating, along with the revenue aspects of the performance, it’s creating positive operating leverage for us.

In terms of the balance sheet, we have seen growth in most of our core deposit categories -- demand, interest earning, money market and certificates -- as a result of initiatives that we’ve been running here, especially in the latter part of the third quarter. And we expect those initiatives to continue to create traction and momentum for us, creating, in my mind, positive momentum in terms of deposit growth, even in a very competitive environment, as we go into the fourth quarter.

On the asset side of things, our C&I loans are showing good growth. And our home equity loans are showing good growth. And, in both of these categories, we feel good about our momentum, again, going forward. We are continuing to originate a meaningful number of commercial real estate transactions, and in fact our origination of real estate business this year has already exceeded the entire amount of business that we originated last year.

But the growth is still being constrained by pay downs that we’re receiving, resulting from competitors that are offering rates, terms, and underwriting criteria that we are unwilling to match. Our risk management approach, and our pricing discipline in this business, really at this point just doesn’t allow us to reach for these kinds of deals.

We all know that the commercial real estate lending component of our business is different than other forms of commercial lending. It’s risk profile is different. It’s cyclicality is different. Historically, it’s impact on the industry and on the performance of individual companies is different. And, from my point of view, if you are growing this segment today by double digits, you’re doing things differently than you did them a year ago. And you are altering your risk profile as a result.

We feel very strongly about this. And we believe that, over the intermediate run, we’re going to benefit, both in terms of eventually seeing the growth begin to rekindle because of the strength of our core business, but also maintaining asset quality through different economic interest rate environments.

Maybe it’s important to understand what we’re not doing. What we’re not doing are large participations, brought to us by other institutions. We’re not doing out of market lending, unless our customers are involved. We’re not buying broker participated loans. And we’re not extending our terms past the leases on buildings. And we’re not extending terms for low fixed interest rates. Around those dynamics are the effects going through the commercial real estate portfolio.

Over the last few months, we’ve seen the pay downs begin to diminish. And we believe that because of the origination volume that we’ve been created, as you also know, it takes time to draw on these things. And we believe that the portfolios will begin to stabilize, and in 2006 we’ll begin to see some lift from the initiatives of the origination transactions that we’ve done this year. And we believe that over time this phenomenon around the pay downs will subside.

In regards to the margins, I’d like to spend a couple of minutes talking about these initiatives here as well if I could. There are several things that are impacting the margins, certainly. And the volume and balance sheet certainly is a major impact along those lines. And, as I said to you at the end of the second quarter, and also at the -- or at that time -- that we believe that the margins will -- well, we said that we thought that it would decline somewhat in the third quarter. And we’ve seen that occur.

But we also anticipate that it will begin to stabilize and increase as we move into the fourth quarter. And, as we look at where we are in this interest rate environment, we believe and are confident today that those trends are going to continue, and that we are going to see the stabilization in the fourth quarter.

To some extent, we’ve been the victim of our own success. If you go back and look a couple of years ago at our investment portfolio, it was among the top 10 in terms of its yield in the banking industry. And, over the last couple of years, we’ve seen the yield on that investment portfolio decline. So, one of the variables that’s going to impact this is that it’s reaching a point now of stability, and will begin to slowly increase as we pass through those investments maturing.

We are also going to be undertaking, beginning here in the fourth quarter, a new initiative that will basically reduce our wholesale borrowings, by applying the cash flows that we’re receiving from our maturing investment, to the tune of about a billion to a billion and a half dollars over the next 12 months, against those wholesale borrowings. And we believe that this initiative will also improve our margins going forward. And we intend to use the capital that’s freed up from the initiative to buy back shares during this period, so that this initiative remains accretive to our shareholders.

Given our duration, given the predictable nature, if you will, of how our investments are maturing, we believe that taking a measured approach to this type of initiative is best both for us and for our shareholders. And we believe that, as we do this, we’ll see a steady improvement in our margin, as this initiative takes hold.

Also, very important to us, obviously, is core deposit growth. It’s a strategy that I talked about over the last 2-1/2 years. And we are beginning to see some positive momentum there. And we also believe that, as we continue to see that momentum there, it’s a core factor in terms of us positioning ourselves for margin growth going forward.

So, those are my comments briefly. I’ll be happy to take any questions that you might have.

[OPERATOR INSTRUCTIONS.] Scott Siefers of Sandler O’Neill.

I wonder, Paul, you spent a fair amount of time on the margin, which I appreciate. Just as we’re looking at the third quarter, I wonder if you could kind of reconcile how much of the stabilization do you think will come from the, I guess, early stages of this mix shift in the balance sheet, and how much is just we’ve really worked through the effects of the flattening of the yield curve, number one. And then separately, I was wondering if you could talk about the increase in OREO from the second to the third quarter, if that’s anything we should be worried about, or just any dynamics.

If you will, let me take the second one first. I’m not very worried about it. It’s really one piece of property that we acquired through the first Federal acquisition, which we intend to sell.

Okay.

So it’s our own property that we picked up through the acquisition. It’s a large piece of land. And Scott, to be clear, it’s a piece of property that they had bought to expand their office.

Oh, okay.

We won’t be doing that. It’s not a piece of property we picked up through repossession.

Okay.

So we should be able to get back to what they paid for it at least, if not more.

And on the margin, if you look at the 7 basis point decline in the third quarter, you can look at competitive loan pricing, deposit rates, wholesale funding increases, small reductions in the yield of the investment portfolio. All of these dynamics sort of come into play.

If you look at the interest rate environment, the increases in the 10 year rates that have occurred just between the first quarter and the third quarter are going to be positive impacts for us. Interest rate movements through this cycle are going to help, as you said, sort of working its way through. The investment portfolio we believe is stabilizing, and will begin to show some increases.

So we’re confident as a result of these core things going on. Also, we believe State Financial will be a small positive contributor. It’s a relatively small transaction. But if you look at its margin, it’s a positive contributor for us. All of those things, coming together, are going to stabilize the margin, and perhaps even create some small positive upper momentum.

The reduction in wholesale borrowings added to that on a measured basis, over the next few quarters, will continue to -- will also add positive momentum, we think, to the margin. So to me, that’s sort of an additive thing.

Okay great. Thank you very much.

Kevin Reevey of Ryan Beck.

I was talking to one of your competitors early today. And they mentioned the paper industry has been going through some challenges. I was wondering if you could give us kind of your views on that, and if you have any exposure, indirect or direct, to the paper industry, and how you think that will impact you.

I can’t give you specific numbers right here Kevin. But we can call you back and give them to you about exposure in the paper industry. There are pockets here, sort of in the Fox Valley area, where the paper industry is pretty big. But we’re much more diverse than that now. Our Chicago presence and our Minneapolis up through other parts of Wisconsin. So I don’t view it as a major strategic risk for us.

And then I remember last quarter you talked about you were pretty positive on C&I loan growth. What are you doing specifically to get C&I loans up and running? Are you hiring loan officers from other banks? Are you doing aggressive marketing? What’s your game plan there?

Well, first of all, I think it’s been a core strength of the Company for some time. But we are beginning to be able to take advantage of the more attractive positions that we have in markets like Madison. And we have invested in hiring loan officers in those markets. We continue to beef up our lending capabilities in the Chicago market, and in Minneapolis as well.

So these core urban markets are really where we’re focusing our attention. And we think it’s a core strength of the Company, and has been. And we’re building on that capability in these enhanced markets. We’re also hopeful, once we get through the consolidation of State Financial and these Northern Illinois suburbs, and that -- the systems consolidation there should occur in early November, that we are confident, and again we’re going to build some capability into that area, that we’ll be able to bring our core strength into that market.

We’re also seeing some improved line utilization on the part of our existing customers as well. So, from all of those sources, we are -- we’re seeing momentum there. And I’ll say this again. We’re seeing very strong momentum in terms of the origination of our commercial real estate transactions. That’s -- in fact, it’s better than it’s been. And I think part of that is these attractive markets as well.

It’s this other dynamic that’s fogging the growth, if you will. And, to Scott’s earlier question, I didn’t really mention it, if we had had traditional 10% growth in commercial real estate lending, that’s creating a short-term drag on the margins, or on net interest income, if you will. But we believe, in the long run, that we’re better off taking that short-term reduction in net interest income, in order to preserve all of the valuables around risk management and origination of those loans.

Thank you.

Eric Grubelich of KBW.

Joe, FAS 133(R), option expense, is this something we need to worry about in terms of adjusting our estimates in ’06? Or not? In your view, for your bank of course.

I don’t have a number yet for ’06 Eric. We’re still working through that process.

Okay.

Our -- I think everyone realizes that our expense numbers weren’t that big to begin with. And our grant in 2005 had immediate vesting. So there will be no expense dragged from that into ’06. So, again, we expect there to be something. But I don’t have the right number -- the numbers right at this point.

Okay.

But it’s not -- I don’t think it’s going to be a big deal.

Okay. The other question I had was, Paul, you talked about the securities portfolio, and the presumed liquidation of at least part of it over the next year. And I think a number of people on this call probably heard First Merit about an hour and a half ago sort of talk about the same thing.

And I’m kind of wondering, when you look at doing this, is the implication here that when you liquidate or unwind the portfolio, through whatever, just normal cash flow, when you do that, are you actually losing that spread? Or are you taking lower yielding securities and paying off higher cost borrowing? Because in one case, there’s a bit of a pick-up. In another case, you’re losing spread income as you do it.

Right. Let’s think about it this way. The margin will be improving. But in essence, the income is -- in a stable interest rate environment, we’re giving up a small amount of net interest income as a result, because we’re shrinking the size of the balance sheet. So we’re giving something up. Others that have done this have reinvested. Alright?

And in that environment, you could say that you’re keeping an equal amount of net interest income, or actually potentially at least creating some. If you couple what we’re doing with a disciplined share buyback program, in the period, I think we’re creating a transaction here, or an initiative, that is neutral or accretive to shareholders, and actually, in my mind, reduces the potential volatility associated with what the ultimate performance of that reinvestment is going to be.

Also, from our point of view, we have -- from our perspective, this is an attractive approach, because of our short duration. And, in essence, our entire portfolio turns over in about a two year period.

Is that where the duration is right now? About two years? Or a little bit less than that?

Yeah. It’s a little less than two. So, from my point of view, a share buyback is more predictable. If rates go up, the impact on the net income gets neutralized. So the give-back, if you will, of the net interest income is smaller. And another point, if I can make it here -- we’ve been working strategically here at the Company to change the quality of the earnings stream away from mortgages and commercial real estate.

And we’ve been focusing on C&I. We’re focusing on home equity and core deposit growth to improve the quality of spread earnings. And we’ve been focusing very aggressively on wealth management and core fees to create quality of earnings. I would argue that we’re giving up here between -- the spread between the borrowed funds and the investment portfolios, lower value earnings, to the betterment of the margin, that allows higher quality earnings to have a more positive impact as they pass on to the income stream.

Okay. And then just one last question. There have been a couple of banks -- this hasn’t been huge numbers. But there’s been a couple of banks that have reported in the Midwest some deterioration in home equity loans or home equity lines of credit. In a couple of instances, they’ve been with higher net worth borrowers. Out of curiosity, have you looked at your portfolio? Any concern there?

Oh yes. We look at it. Our loan to value ratios are in the high 70s. And, again, we believe we’re relatively conservative in terms of our underwriting standards, both on the consumer and the commercial side. And we’re getting our growth, again, at trajectories that are different than the historical Associated Banc, which is good. But we’re getting it under a disciplined set of credit standards.

Okay. Thanks very much for all the answers.

I have one more answer, maybe to a question you didn’t ask me.

What’s that?

But on the portfolio, or on this whole reduction of investments in borrowed funds, we feel comfortable having an investment portfolio that’s maybe about 15-20% of our asset size. And we think we need to have one. And this is a balancing act. You know, you need liquidity. You need collateral. You need to balance yourself in interest rate environments.

If rates were falling aggressively, people might say, why would we undertake this type of an initiative? Why wouldn’t we leverage more? So there’s a balance here. And we think 15-20% is about right. This exercise of about a billion dollars, maybe a little more, gets us down into that range, which is where we want to be.

And I would argue that we’ve had too much wholesale borrowings in any environment, and core deposits are critically important to that. But this initiative allows us to get at that issue also, and to reduce the source of volatility in this rising rate environment, but also protect shareholders, linking it to the buyback program.

Okay. Thanks.

Young Im of Robert W. Baird.

Paul, could you provide us with some color on the decline in real estate construction loans?

Yeah. Basically, we’re not stretching to take the risks that we’re seeing other people take. And we believe --

Young, it’s very simple. We do a lot of construction lending. And when it comes to take off, the borrowers are looking for fixed rate, long term. It’s really the commercial real estate argument. It’s just that we do the construction piece, and then someone is taking us out at the back end.

Okay. So then it’s relatively slower to hit that particular segment then, the commercial real estate category.

That’s right. And it’s just that those payoffs, in this environment, are higher than they normally would be.

Okay. And then also, could you provide some detail on what’s in the other non-interest income line item?

What’s in there?

Yeah. Well, it’s up $6 million over the prior quarter or so.

Well that is --

That’s the derivative transaction. In fact, maybe I should -- I should probably comment on that. You’ll remember, we adjusted our earning statement for the second quarter, that as a result of the derivative transaction. And in the third quarter we have unwound those transactions, so that all volatility that could be associated with them have been eliminated from our balance sheet. And we lost hedge accounting on those two derivative transactions. And we have unwound them basically in the third quarter. So that’s the difference.

That was that $6 million one-time entry made right at the time our earnings were formally [inaudible].

Okay. Thanks for the clarification.

Terry McEvoy of Oppenheimer.

One question. Should we be expecting a near-term slow down in earnings growth, as net interest income declines? But, as you said, the quality of earnings improves? Or do you think you will be able to repurchase stock at a pace fast enough to offset the reduction in net interest income?

If you look at the levels of these things, we’re comfortable that we can repurchase the stock roughly in equivalent trajectory to overcome the income effect.

Okay.

And if interest rates were to continue to increase, that becomes easier and easier to do.

Sure. And then the seasonality in the insurance revenue seemed to be a little bit more, call it pronounced, this quarter. Was it simply seasonality? Or were there any other dynamics going on in the third quarter?

Well, if you go back and look at least year and this year, what you see is that a larger portion of the insurance revenue is front-end loaded. So, when you see it in the first half of the year, and then it falls off to a level, as you’re seeing it here, in the third quarter.

And Terry, some of the other parts of that, causing your comparability issue, was the fact that we added [Javis] [ph] in the second quarter of last year. And so some of that profit sharing income was in the pre-acquisition numbers versus the post-acquisition numbers. So you’ve got a lot of dynamic going on there. The insurance business itself is doing very well.

Yeah. And then one last question. The decision not to repurchase stock in the third quarter, was that connected to the acquisition of State Financial? That deal being closed?

We were blacked out.

Yeah. We were blacked out during that period.

That’s what I thought. Thank you.

And if I could, just one more comment on the insurance thing. If you look at it nine months over nine months, I don’t have the number -- I think it’s about 25% increase -- that’s the dynamic that we’re seeing in the business that Joe’s feeling good about.

Appreciate the help. Thank you.

Ben Crabtree of Piper Jaffray.

A couple questions. I’m trying to figure out how to think about this, basically the balance sheet shrink. And I’m assuming -- it should be fairly obvious that the assets that you’re going to get rid of, along with the borrowings, the spread on that is very narrow.

Correct.

But roughly what would we be talking about in terms of that spread? I mean would it be somewhere around one and a half or one and a quarter or something like that?

It’s probably even less than that. Let me just give you some rough kinds of numbers. But this is not massive in nature. It’s -- we’re looking at in the neighborhood of less than $0.03 all in, in terms of today. If interest rates go up 50 basis points, you’re talking a penny, penny and a half. So it’s not a massive amount of money we’re talking about.

I think the other point, Ben, that we have to keep in mind is since all of these securities are relatively short, the ones that we’re going to let roll off, the yields on those securities are lower also.

Right.

So the impact on the net interest income number, given no change, is, as Paul said, isn’t significant. And as rates go up, it will become -- it just continues to narrow that spread.

Right. And I guess this other -- my next question is something that you’ve probably already answered. But obviously a way to minimize the impact on earnings per share would be to buy back stock aggressively on the front end of this period, and then let your capital ratios rebuild. It didn’t sound like you were going to do that.

Well, it’s a balancing act. We want to make sure we can maintain our capital ratios where we want them to be. And we think that, as we go through this process, we can. Again, because of our short duration, and the way the investment portfolio has been laddered really with some discipline over time, we’ve got the ability to manage this in a measured, balanced sort of a way.

Final question would be on the mortgage banking number itself, which was an exceptionally good number. It’s certainly better than I was expecting. I would presume that where the 10-year is there would be some possibility of another positive adjustment on the MSR values going forward. But if we could kind of exclude from the discussion of mortgage banking the whole concept of MSR adjustments, what should we think of as being kind of a core number of mortgage banking fee business? I know you’re much more active in originations. And what’s that number?

Well, I would suggest that -- it’s hard for me to give you a precise number, because you’d have to tell me what the interest rate environment looks like when we talk about it. I would say that over the first half of this year, we were in somewhat of a transitional mode, moving from Associated’s traditional in-branch mortgage model, to more of an originator mortgage model that we acquired when we were with First Federal. And that required -- there was some staff transition in that, and transition to new systems and products and that whole thing.

So, even though interest rates did go up in the third quarter, we had some good positive momentum from the fee side of the business. So, I’d like to think that the core mortgage business for us in reasonable interest rate environments would be better than the performance that we saw in the first half of the year.

Okay. Great.

And the third quarter reflecting some of that momentum. Now, in the fourth quarter, there is seasonality associated with this business as well.

Right. Right. Right. Okay, thanks. That’s helpful.

Mark Kehoe of Merrill Lynch.

Just in terms of your core deposit growth going forward, can you give me details as to how you’re going to achieve that, and the rate going forward please? Thank you.

Well, we’re doing a whole series of things. We are revamping our product line. We’re coming out with a whole new set of core checking products. We’re creating packaged products. We’re focusing on indexed type products that provide customers long term value.

We are upgrading and enhancing our marketing programs. And we continue to focus on our sales management efforts, both in terms of what our commercial bankers are doing, as well as the consumer side. We’ve made really some major changes. For example, as we go through these cultural changes associated with sales management, I would suggest that approximately 40% of our branch managers have turned over in the last 12 months. And that’s a function of getting the right people in the right positions, to make sure that we can manage this thing properly.

So we’re pulling all those levers, if you will, to focus on deposit growth. And I’ve articulated that as a core strategy and a core need for the company, to overcome what has traditionally been a less than attractive, in my mind, loan to deposit ratio. And we’re working on fixing that. And we’re pulling all those levers to do it.

Brad Ness of FBR.

Reading between the lines in the text, I guess assuming that you guys feel comfortable hitting the consensus 2005 estimate, kind of implies $0.63 in the fourth quarter. Would a number like that generally include mortgage servicing rights, recovery, or any other security gains? Or when you give verbiage like that, does that typically exclude gains like mortgage servicing rights and security gains?

Well, I don’t know how you think about the business. The mortgage servicing rights can be positive. And they can be negative from quarter to quarter. From my point of view, mortgage servicing rights, core asset quality levels, all those things to me are core parts of the business. And some quarters, because of external factors, in some cases you benefit from them, and in other cases you don’t. But they’re still core, and they count. And there they are.

You can look at our history and see where, in some quarters, there was -- the mortgage servicing rights have been an aggressive drag. In other cases, they’ve been a positive. And we occasionally have small securities gains. That’s associated with how we manage our business and look at where those securities might be at the time, and if there’s an opportunity to balance later, to provide value for some shareholders.

We continue to work every day on improving the core aspects of our business. We’ve created some major operating leverage on the expense side of the equation. And we continue to focus on efficiency. So we’re looking at every aspect of it, to get to where we need to be, and where we want to be. And from my point of view, it all adds value.

Mmm-hmm.

And if you look at the third quarter last year, because of where we were, and where we evaluated our loan loss reserve, we took no provision. Right?

Right.

So if you compare that to the mortgage servicing rights this year, you could all count that stuff as one time. But it’s managing the business.

Sure. Now, absent the balance sheet restructuring, how do you think your net interest margin was positioned for 2006, assuming another 50 or 75 basis points of Fed Funds rate hikes, and the rather flat yield curve? Do you think you could have held a rather stable interest margin in that environment?

Well, I said at the end of the second quarter that we felt the margin was going to begin to stabilize in the fourth quarter of this year, because of a lot of these dynamics. And, given the way we’re looking at interest rates right today, I guess that statement still holds. That’s what we were saying.

We’re taking the initiative, because we believe that it better positions the organization in a rising interest rate environment, and also better positions our overall balance between these components of our balance sheet, in a way that’s going to be neutral or even potentially accretive to shareholders. So, again, we take all those things into consideration when we look at it.

Again, we are asset sensitive. And we’ve said that for a while. So therefore, in the absolute sense, assets re-price faster than liabilities. But there’s more than that, that goes on with your net interest margin. I mean there’s pricing, there’s mix, and then net interest income, there’s growth.

So there’s a whole lot of dynamics going on, that go around Paul’s statement, is guess is what I’m trying to say. But we believe that we were positioned and are positioned for rising rates.

Appreciate it.

Marsella Martino of KeyBanc Capital Markets.

I just have a question on the home equity, the growth that you’re seeing there. We’ve heard some commentary from other banks that consumers are shifting their purposes towards fixed rate products over variable rate. And I’m wondering what you’re seeing maybe in terms of your existing customers versus new production, if you’re seeing anything.

I would suggest we’re seeing some small shifts there.

Okay.

And that’s not a surprise, as interest rates go higher.

Okay. But not an overwhelming shift?

No. We haven’t seen any massive shift. But it’s a noticeable small shift.

Okay. Thank you.

Mmm-hmm.

[Andrea Jayo] of Lehman Brothers.

On the balance sheet, if you’re going to run off a billion or more, that’s roughly, year over year, a decrease of $500 million. With loan growth and deposit growth at current levels, 3Q and 4Q levels, do you think that will be enough to more than offset the average $500 million runoff? Or kind of just offset that? I guess what I’m getting at is how much will balance sheet growth slow? Or will the balance sheet even shrink on a year over year basis?

I see what you’re saying. Well, again, it depends on a lot of factors I guess. But if we -- I think the two things are unrelated to each other. Our core deposit and loan growth is one variable that we need to consider. And we believe that this commercial real estate thing will begin to normalize, and we’ll see traditional -- even probably better because of the markets that we’re in now -- commercial loan growth.

Our consumer loan growth is fixed as far as I’m concerned. We’ve been showing 20% growth there for some time. And we’re going to continue to focus on improving our deposit growth in a very competitive environment. The reduction of the borrowed funds is positioning our balance sheet to be higher quality. And I think it needs to be considered separately from that. It’s designed to allow the earnings from the core assets to pass through, and not be negated by these more narrow spread, lower quality types of earnings, and to bring the balance sheet components into the desired levels of assets and liabilities that we are more comfortable with.

[Andrea], I would have responded by saying, again, well, we don’t have any guidance for 2006. And we’re working through that process. But if we’re going to grow our earnings, our 10% target that we’re projecting we can, and 70% of our revenue is coming through net interest income, the volume growth on those parts of our balance sheet has to be greater than the $500 million you’re talking about.

And that’s our intention.

And I would -- I’m thinking you’re -- it may slow the growth, or get the growth percentage down a little bit. But it still has to be more than that.

Yeah. Okay. That helps. Did you quantify the amount of capital that will be freed?

No.

Okay. Understood. Oh, this is helpful. Thank you very much.

Peyton Green of FTN Midwest.

Several kind of unrelated questions. But first, what is your outlook regarding State Financial and what you think they can do for you at the margin, going into ’06? And then second, when you think about your loan and deposit growth goals going forward, the cultural change that you’re affecting through the sales training and the like -- where do you think you are in that process? Are you half way through it yet? And then when should we really expect to see a material change in the growth rates?

Well, there’s lots of variables that affect growth rates. But I believe that we have made substantive progress this year, as we have made these changes from a people perspective, have worked through the transition of the First Federal systems conversions in the late first quarter, early second quarter. And we’ve hired in -- it’s not just sales either. We’ve hired in resources into our marketing and product development area of the Company, to improve the effectiveness of those programs.

So I feel much better about 2006’s prospects from a deposit growth point of view, than the experience certainly that we’ve seen in 2005. And in relation to State Financial, we bought State Financial, frankly, because of its markets and its customer composition. It looks very much, on a smaller scale, like our commercial business culturally. And those markets are very attractive. And we can do much more with them than a billion and a half dollar State Financial could do.

So we’re, I guess maybe on both questions, we’re seeing real momentum and real lift around our Madison footprint that we’ve put into place there. And as we’ve gone through the transition, and the convergence and the hiring and all that sort of thing, we’re starting to see all that stuff begin to pay off. And I would like to see that we’ll see those same kinds of things out of the Northern Illinois side of it.

Okay. And then in terms of the wholesale issue, is there any scenario where you would take more of it off, instead of just doing it as cash flow comes in? I mean is there any consideration to taking it off sooner and working with the stock buy-back a little bit differently? Or why just wait for the cash flow and for the margins to get thinner? Why not take advantage of getting out of it better now?

We considered several scenarios around this whole thing, and landed on this one as the best one in terms of our ability to manage the transaction itself, but also managing the effective implementation of it in an environment that certainly, over time, will change.

We looked at the possibility of taking a one time charge to earnings, to be a catalyst for that. But, if you think about, really what you’re doing in that environment is taking the charge to sort of boost the earnings, if you will, over a fairly short period of time after that. But if you present value it, you really don’t get an adequate return. And the way we looked at it, it was below the cost of capital. So it’s not an economically sound transaction.

And, to some extent, that’s a fit. You do that, and interest rates start down on you aggressively, what have you done? You’ve already cooked it. So, from my point of view, doing this in a measured sort of a way allows us to get the highest quality results. And again, because of our short duration, and the way our investment portfolios are structured, we’re not in a position where we have to do this thing in large individual traunches.

And the point that Joe made earlier, the lowest yielding assets are the ones that are coming off right now. And so if you start to look at the assets past that, or the investments past that, you really start to hesitate to give up the yields that are associated with them.

Well, and I would think that those insulate you from a down tick in rates more than what you’re taking off.

Exactly. So my point is, we’ve looked at this thing from every angle. And you think we’ve come up with the right answer, given the nature of our investment portfolio, the nature of how it performs and reacts, and how it’s re-pricing, and how we want to manage the risks of all of this going forward.

Okay. Well, I guess if you allowed a billion to a billion and a half to come off, and you pay off the wholesale borrowings, that gets you down to, on today’s balance sheet, about 27% of your earning assets would be funded with wholesale, down from about 33%. Is there a further target that you would like to get the wholesale down to over time, based on what you’re trying to do on the deposit side?

Absolutely. The core deposit growth is very important in that whole arena. So yeah, we’re going to -- we obviously want to maximize the positive impacts that accrue from replacing the spot funds with core funds.

What do you think a realistic two to three year goal is?

If I were going to give you a number right now Peyton, I’d be just stabbing in the dark at it. It’s something we can talk about over time. But that’s a difficult number just to give you here on the call.

Okay. No, I just didn’t know if it had been thought through that far. Okay, good enough. Thank you very much.

[OPERATOR INSTRUCTIONS.] Eric Grubelich of KBW.

Hi. I had one more follow up for Joe. Joe, the 12 million bucks of mortgage banking income, you had a $4.5 million valuation recovery on it. The remainder there, what is that? That’s $7.5 million, right? How much of that was just from mortgage banking, gain on sale business, versus servicing?

Well, I don’t have the numbers in my head Eric. But let me -- you can calculate them. We have about $9.5 billion in servicing assets, loans to reservice. And we get a quarter.

Twenty five?

Twenty five. And you take that times -- and divide it by twelve, times three, and you can figure out how much of it was servicing, and the rest of it from the production side.

Is that 25 net of amortization, or not?

No. No, that’s gross.

Gross. Okay. Okay, thanks.

At this time, there are no further questions. Mr. Beideman, are there any closing remarks?

No. Thank you everyone for your time.