BankFinancial Corp (BFIN) 2011 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth-quarter and year-end 2011 BankFinancial Corporation earnings conference call. My name is Regina and I will be your conference operator for today. At this time all participants are in a listen-only mode. Later we will be conducting a question-and-answer session. (Operator Instructions). Today's event is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. F. Morgan Gasior, Chairman and Chief Executive Officer. Please go ahead, sir.

Good morning, thank you. At this time I'd like to have Jessica read our forward-looking statement.

The remarks made at this conference may include forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. We intend all forward-looking statements to be covered by the Safe Harbor provisions contained in the Private Securities Litigation Reform Act of 1995 and are including the statement for purposes of invoking these Safe Harbor provisions.

Forward-looking statements involve significant risks and uncertainties and are based on assumptions that may or may not occur. They are often identifiable by use of the words believe, expect, intend, anticipate, estimate, project, plan or similar expressions. Our ability to predict results or the actual effect of our plans and strategies is inherently uncertain and actual results may differ significantly from those predicted.

For further details on the risks and uncertainties that could impact our financial condition and results of operations please consult the forward-looking statements declarations and the risk factors we have included in our reports to the SEC. These risks and uncertainties should be considered in evaluating forward-looking statements.

We do not undertake any obligation to update any forward-looking statement in the future. And now I'll turn the call over to Chairman and CEO, F. Morgan Gasior.

Thank you, Jessica. Well, all filings are complete as of early this morning and therefore we're ready to answer any questions.

(Operator Instructions). Jon Burke, Amica Insurance.

Your K alludes to you're more willing to do accelerated non-performing dispositions including bulk sales. And you talked a little bit about that last quarter. Can you just allude to how you're thinking about that right now?

Sure. We started evaluating the participants in the market and some different methodologies that are out there, looking at both the nature of the assets we have and the nature of the assets that people are interested in and the disposition methods. We're still fairly early in the process and I think we'll have a much, much better idea at the next conference call.

But if you break down the process into two or three methods, the bulk sale note process, that market might be smaller than people think. There are a handful of participants in it. We've reached out to several of these participants and we started to gather what their interest levels are by asset type, sometimes by location, sometimes by status whether it's performing, classified, in litigation, OREO.

If I were to break out the different channels, we have a handful of loans on the commercial side where we might see some bulk sale, note sale type interest. And then there's a greater quantity of the smaller residential loans, two and four unit buildings for example, that might go through an auction type process in greater unit quantity but perhaps not hugely significant dollar quantities given the small balances on the loans.

Toward the latter point, we'd be doing that to eliminate the carrying expense since some of these assets have been written down rather significantly already. But like I say, we're just early in the process. Some of these vendors have extensive data requirements. One vendor has something like 80 data fields that need to be populated. So as we put all that together and get it out we'll be in a better position in the early second quarter to figure out what makes the most sense.

Do you have in your head saying I want to cut down on this balance by X amount or is it all going to be based on what you receive back on pricing and etc.?

Our overall goal, John, is to get back to the asset quality ratios we were at at or before the time of the Downers Grove acquisition. We knew Downers Grove would add some non-performings to it. Currently Downers Grove is about just under 20% of our non-accruals, just under 20% of our performing classifieds, and just under 30%, right around 28% of our REO.

So we need -- we'd like to get some of that weight off the books. We'd like to get some of the stuff that happened in the third quarter off the books as we described in the K. But getting those numbers on an aggregate basis well under 50% of tangible capital plus ALLL and as much as feasibly possible under 40, maybe even under 30 would be ideal. It's just a question of what bids we're going to see.

And in some cases these decisions are tough. You might see bids that represent five, six, seven years worth of carry even where they're marked down below where we've got them down on a bulk basis. So some of these decisions on the economics are tough, but again, we'd like to get the asset quality metrics back in line where we were before Downers Grove and that would probably be the target range I'd guide you to.

Okay. Charge-offs in the quarter were accelerated, is that just timing or is that deliberate?

No, and that was actually -- it wasn't deliberate. We had a couple of large resolutions that drove the bulk of those numbers and then the OCC doctrine on charge-offs is more specific than OTS. Historically what we would do on charge-offs is once we had exhausted all available collection litigation, whether it was guaranty litigation, foreclosure litigation or if the borrower had filed a bankruptcy for a discharge, then we would charge off an otherwise fully reserved loan.

And the OCC guidance moves that up some. So we basically are taking it within a 12-month cycle. And what happens is we will charge the loan off earlier and then we'll continue the litigation and if we book a recovery later on that will be the timing difference. So mostly it was resolution action in the two big loans that we had said we expected to resolve and to a lesser extent we're charging off fully reserved loans where we're still in the process of litigation but haven't concluded it yet.

Okay. All right, the substandard yet performing category had a little jump and you mentioned in the K contracting with an independent creditor review shop to review risk ratings and that led to a jump. Is that the full reason for the jump or is it things like that go in and out of that category?

That was the vast majority of the increase, was the second independent loan review we did for the year. That was a substantial quantity of loans and it piggybacked on the one we had done earlier in the year because we do one every year anyways.

We have -- I think we have a pretty clear understanding of what the OCC's expectations are. Our credit operations people recently attended a seminar in Dallas with the OCC for further confirmation. So there were loans that occurred as we got financial information in, we're starting to do renewal processing, we saw where the numbers came in and got classified.

And then of course the large review was done by four retired OCC examiners because we really needed the experience, the OCC doctrinal experience to infuse into our process. And it basically validated what we had learned through the exam and what we had done -- the research we had done in the guidance. So some of it was just our normal review process having adopted the OCC doctrine and then the bulk of it was the large portfolio review.

And that -- as we said in the K, that's going to be a volatile category. We started the term loan review outreach process for the 2011 financials. As we get information in you'll see loans move on to the category based on the results they had for last year. You'll see some loans move off because they had a better year. So you're going to see those numbers moving around based on the information we get.

The slight jump up in the performing TDRs, is that something new there that you're looking to do?

Well, TDRs are a function of two things, in some cases if a borrower requests a modification or in some cases if we process a renewal. In second quarter of '11 the TDR definitions were let's say tightened or clarified, but with the practical affect that what is -- what could be considerate a TDR is significantly expanded. And that is a feature every time we process a renewal.

The most significant part of that was the resolution we had for the multi-family project with the new borrowers that came in. That was considered a TDR when the old loan was paid off and they contributed the new equity for the new loan. That will remain a TDR for the next year. It will also remain a classified loan until we see sustained performance under the new loan.

So that was the biggest change in it, but TDRs generally -- they're not just a function of a modification. If you process a renewal and for some reason the renewal isn't exactly within policy, there might be an LTV exception, there might be a credit score exception, you can't necessarily conclude that that would always be the market rate. You don't know what the market rate is.

So generally speaking we're being pretty conservative about classifying TDRs. We know a matter of regulatory concern as well just like loan classification. So when in doubt we generally are going to call it a TDR.

Okay. All right, last one on credit. In the K, the second largest credit exposure, you mentioned it's proceeding to a formal collection. If you can talk about it, is that still the plan at this point in time? And how do you feel about the reserve that you put up against it?

That came off of fresh appraisals right at the end of fourth quarter. We had done an estimate at the end of third quarter based on what we knew about the lease. The appraisal included a vacancy component which for a credit tenant isn't always the case. But again, in this particular case we understood why. So that was the biggest variance in the valuations.

We would hope that the borrowers reconsider our proposal. We know some of their advisors had advised the borrowers to accept our proposal. It gave them time to stabilize the second property. Everything would work as well as it could for now and we could work with the borrowers on what they needed to do next.

But for whatever reason they have not been willing to come to the table, even though the structure we proposed didn't necessarily put new assets at risk unless there was a subsequent default. But we can't sit around and wait forever, we've got to get the stuff moved. So we are proceeding with a formal collection action to make sure we collect all the rents that are due under the leases and then also to move the resolution process along absent movement on their part.

Okay. All right. In the objectives for 2012 category, in the K you mentioned the statement, accelerating the evolution of the loan portfolio towards a configuration that permits better growth rates in multiple independent segments. If you kind of translate that, are you implying that you want to look outside of Chicago for more things?

Well, as you know, we've looked outside of Chicago for the last five or six years. That portfolio leveled off in the last 20 -- 12 to 18 months just because we were concerned about economic conditions generally whether they were in Chicago or otherwise.

But we'll continue to diversify a little bit out of Chicago and we have over 90% of our real estate loans concentrated in Chicago. And there are markets that are just doing better than Chicago from a valuation, occupancy and performance perspective and we think we should have a little more diversification.

On the C&I side, we've had several strong capabilities, we continue to grow the commercial leasing portfolio and do more business with the lessors in their own direct finance. We want that to continue. Our healthcare portfolio is doing well. We've disposed of all but one of the original real estate exposures that we wanted to get rid of, the last one will disappear in a HUD refinancing just under a year from now, HUD takes a while to do.

But the C&I components of healthcare is performing well. And one of the things we're thinking about, in fact we had one borrower that we ran an experiment with and the borrower grew something like $2 million to $12 million and ultimately they asked us for a much larger commitment that exceeded our loan as to one borrower limited. So we're going to have to let them go.

But that was an experiment doing healthcare in multiple jurisdictions. Illinois is 49th in reimbursements in Medicaid, we're kind of here at the bottom of the cellar. There are other jurisdictions that present as good or more favorable reimbursement rates, regulatory environment and competitive environment, so we're going to evaluate those. Our first experiment was very, very successful.

So I think what we're going to do is work on our core strengths, things we know, and diversify away from real estate a little bit, particularly in Chicago, and capitalize on some of the strengths we have. And some of these markets, healthcare, it's a niche, it's not something everybody does, you have to understand how it works, we have some very good bench strength in that. So we're going to work on further diversification within those types of categories.

Okay, but everything is within your current channels right, your current sales channels? It's not like taking on something totally new?

At the moment we haven't started anything new. We're going to continue to evaluate how much growth we can get out of what we're doing. If we do something new it will be small while we get our feet wet. An example, one of the things we're working on is reconfiguring the small-business channel we have.

We have a new small-business sales manager on board; we'll be putting more people on the street and that will be coupled with a potentially innovative approach to SBA lending. So for the most part we're working within the channels we have. We may look at other channels depending on what kind of growth rates we see from what we have already.

Okay. Noticeably absent in the objectives for 2012 was any talk of excess capital deployment. And I know dealing with the credit issues is kind of the here and now, but can you just talk about where you are with -- do you still look at acquisition opportunities and just how you're feeling about that?

Well, it goes back to what we said about asset quality levels generally. Recall that in the second- and third-quarter calls we had talked about acquisition opportunities we had looked at but we passed on. And one of the significant reasons we passed on it was we saw what it would do based on the ASC 310 classifications to our overall level of non-performing loans.

From a regulatory perspective non-performing loans are non-performing loans, whether they're yours or somebody else's. So given the posture of the candidates we see out there, we don't really want to get into more resolution activity until we get back to our original starting point. And when we do that, and assuming we've gotten back to a reasonable profitability level and we can look forward to more accretive activities from acquisition, that's when we'll probably do it.

So that's another reason for getting the asset quality levels back to our original starting point. It will create room both operationally and from a regulatory capital perspective to look at something. But we're not super eager to add any more resolution work to the table.

Okay. This question may be early, but assuming the credit issues do get behind and you start generating quarterly positive earnings, what's the DTA recovery process? Is it like a minimum on a quarter that you've got to put up or how does that work?

There's not a tremendous amount of guidance on that. We've seen people recover it in a relatively short period of time with relatively thin earnings. But I think again that will probably be a better question we can better answer in third quarter or fourth quarter. Obviously it's contingent on what we need to do on the NPA side.

And then sometimes there are some tax versus book accounting differences that affect the DTA recovery. But recently in Chicago we saw somebody recover it after three or four quarters and it didn't look like they made a whole lot of money, but their auditors were comfortable in the recovery. I think we'll go with -- it's theoretically possible that we would recover it in '12. I think it's more likely it will be sometime in '13.

Okay. One of the things that stuck out was ad expense took just kind of a large decline in the quarter. Is something going on there?

I'm sorry?

The ad expense, the line item on the --?

Advertising?

Yes.

Oh, I'm sure that was just a timing difference and also -- just checking a fact here, and then we discontinued a marketing program that dealt with a point system. It was something tied to retail and it was working, but it wasn't really working all that well so we decided not to continue it. But our run rate is going to be in the $1.2 million range per year and it will be kind of volatile depending on how billings go.

Okay. All right, and last one just on the earnings release in general. I don't know if you've ever spoken to this, but just your approach of not having an earnings release until the K comes out, which is counter to how everyone else does it. Can you just talk through why your approach is -- what's your rationale on that?

We want to get everything done and through the audit process before we release any information. We've noticed that other market participants will put information out, they didn't get fully through the audit process and then something changed. So our mission is to give you as accurate information as we possibly can and that's why we want to finish the process completely.

In this particular case goodwill testing took longer because of the two-step process and there's a tremendous amount of analysis involved in that and that was a development that was later than usual because of the two-step process.

Then when you get those goodwill results the auditors have to do their own testing. And it's probably worth noting that with the Advent of [peek-a-boo] the documentation involved on our side and on the auditor's side is a lot more extensive than it was before peek-a-boo.

So everybody spends a considerable amount of time supporting all the language that's in the 10-K and the related matters so it's just a longer process. And until we get through the process we don't really want to put data out that could even be possibly changed in any material way.

Okay. All right, I appreciate it, thanks.

Matthew Lindenbaum, Basswood.

Forgive me if I'm asking questions that are sort of obvious, but I'm sort of new to the name. I had sort of two general questions. One, can you talk about the characteristics of the multi-family portfolio? I'm from New York City, I'm just wondering are we talking about sort of rent stabilized, rent controlled apartments, what kind of loan to values, that kind of thing?

And then also it looks like your real estate -- commercial real estate to capital is over four times. And I know the OCC -- the general guidance is it should be below three times. So where do you stand on that issue? Thanks.

Two very good questions and welcome aboard. Let's do the multi first. Multi is a pretty seasoned product with us now. The vast majority of it is in Chicago and we typically focus on smaller buildings. Our average loan is in the $400,000 to $500,000 range. We wish it was rent stabilized, just to get that out there. That would be a material benefit.

And it's a product we've been in for about 15 years now. We would consider it one of our core competencies. And we've had our issues with it particularly in some of the Chicago submarkets. Valuations went from say in a range from 40,000 to 50,000 to 55,000 a unit for years, trending up and down a little bit with rents and demand.

But in the '04-'05-'06-'07 timeframe, particularly the latter part of that period, even the south side stuff, which is a market that's got a lot of volatility in it in certain pockets, started seeing some condo development activity that was really, really changing the premise of the valuations as inventory for turnarounds and conversions as opposed to income property.

So at that point we decided to diversify out of Chicago a little bit. That's been very successful for us and it continues to be. But again, we typically like the smaller deals. We've had one bad experience with a one larger deal and that deal was over and done with. And it just reinforced our preference for the smaller transactions.

We don't really do -- we a do a little bit with Section 8 housing as far as a rental component in the buildings. Again, you see that more on the lower [amount] census tracts. But we make sure that borrowers know what they're doing with Section 8. There are additional and sometimes helpful inspection requirements, but it's a sub specialty, we try not to have a concentration in it. Is there anything more you'd like to know?

Well, how about loan to values and debt service coverage when you do the loans?

Debt service coverage is typically 75, maybe for an extremely strong well located and a high debt service building we might go as high as 80. But valuations -- valuations are a function of cap rates too and we watch those cap rates pretty carefully to make sure that we don't get over invested in it at a particularly low cap rate (multiple speakers).

So you're -- just to interrupt, you're talking about 75% loan to value, right?

Right.

Okay. And what typically, when you made these things the cap rates in this cycle got to what?

It depends on the market, the sub market, because it can vary considerably. In some of the markets it got as low as 4% and 5%; we didn't really go below 6%. Typically in low MOD census tracts you might see it in the 8% 9% 10% range, but in this particular cycle and some of the sub markets we have seen cap rates coming in and that was the third-quarter and fourth-quarter appraisals; we saw cap rates coming in in the 15%, 16% and 18% range.

So that's part of why we saw some of the marks we saw in the fourth quarter is that these markets, the pendulum has swung way to the other side. And it just makes it a tough investment environment for us and certainly for borrowers. That's why we're not going to see much growth in those markets.

But why is that happening? Why is the rent -- I'm assuming that's because rent -- the rental market is weak.

In those sub markets where you have those kinds of cap rates, you are seeing vacancies of 15% to 18%.

And this is driven by what?

Unemployment in those localities. Chicago has an employment rate of slightly over 10%. Some of the sub markets that number is easily 15% to 20%. And I think for estimation purposes it's pretty reasonable to say that if you get an appraisal back that the vacancy rate is 15% to 18%, it's pretty reflective of the unemployment rate in that particular market.

Are these markets that you're talking about, the ones with those cap rates, how would you sort of describe the demographics of those markets? Are they sort of very inner-city or are they sort of generally okay markets, just going through a tough patch?

They've been stable markets for a long time, but they have gone through a very rough patch. There are some city markets, there are some suburban, markets. I grew up in these markets going back many, many years and the valuations were stable within a reasonable range for a long time.

But part of this is driven by the subprime stuff and part of this is driven by the fact that the Chicago -- some of these Chicago sub markets the unemployment rate skyrocketed. And part of our growth issue there is will work through the issues in the portfolio, it's already stabilizing, I'm sure we'll see some issues here and there as we go along.

But the real issue for us is there are significant chunks of the market that you're just not going to see many growth opportunities with investment propositions at those levels.

And Just going back to when you do these typically let's say 75% loan to value, the debt service coverage meaning sort of the NOR divided by the debt service is what typically?

120 or better.

120 or better. Okay, now what about the commercial real estate to capital issue?

Yes, that's been a concern. We had identified that back when we did the combination of the Citibank loan portfolio acquisition and the Downers Grove acquisition, because those two deals exceeded those thresholds. For years we had bumped right along with the right thresholds under the thresholds and within the growth rate.

So that's one of the reasons we said that we were about done at June 30 with growth in the multi and the commercial real estate categories. We continue to believe that. The OCC recently put out in December a concentration of credit update that we're working through right as we speak, as a matter of fact, it's due to the Board at the end of the month.

The Board has adopted June 30 balances as the freeze for now. Once we finish the portfolio segmentation I'm sure the segmentation is going to reinforce that. But we may also impose some supplements in different categories of loans based on things like trends in the market, classification data, loss data. Just look where we've had problems before and maybe limit our exposures to those subsections.

So specialty commercial real estate, industrial commercial real estate, those are areas that have had trouble in the market. There's no sense in continuing or increasing exposure to that, so those are all going to be factors. And that's another reason why we're looking at portfolio diversification, A, because we're at or near limits anyways; and B, because there's not as many growth opportunities even if we weren't at those limits.

But there's a bank around where I am, a $2.5 billion bank that's OCC regulated that basically was sort of forced to sell -- sort of sell a whole bunch of multi-family loans they had originated recently and do sort of a big bulk sale because of their heavy commercial real estate exposure. And so, I'm wondering if you're getting any pressure from the OCC to sort of accelerate all this or are they going to give you time to sort of grow into a new allocation?

Well, we're aware of the situation that you're describing. Their concentration was higher than ours and they also had a concentration in the construction sector I believe which of course we don't have. There's no question that when you exceed those limits it's a matter of supervisory concern. What we're working on now with a concentration of credit analysis. It was timely to get the guidance from OCC.

And I think what our mission is we're generally comfortable with where we were at June 30, we want to see if we can establish that to the OCC's satisfaction. And if we can then it will be a fairly predictable portfolio for us. We will see some shrinkage in certain segments of the portfolio that may be offset by growth in others.

For example, if some of the commercial real estate runs off because we want it to and we started that process already in fourth quarter by letting some maturing loans that we weren't particularly happy with in the industrial sector just run off, that's part of the reason you saw the balances decline. Eventually we'll offset that in some markets and some products that we like better.

But we have to finish the concentration analysis based on the brand-new guidance. The same people that were helping us on the risk rating doctrine are going to be doing a review of the concentration of credit analysis for the Board. And again, we can talk more about that in the quarter -- in the next conference call.

So I'm sure we're going to see some runoff in part of the portfolio. We expected to see it when we closed those deals. Some of the Citibank portfolio we're letting run off, that's why you see balances dropping. But we're hoping that about where we were at 12/31 is a good place for us to be and ideally to keep earnings and everything else in balance, that would be a good place for us to rest. But we have to finish the analysis to see how it comes out.

And what percentage of the commercial real estate book -- I'm just talking about excluding multi-family construction -- is owner occupied versus investor real estate?

It's about 20% to 22% is owner occupied.

Okay, great, thank you very much.

You're welcome, thanks for joining us.

Brian Martin, FIG Partners.

Can you just give a little color on the -- what the DTA and the tax rate -- the tax rate looking forward, how do we think about that with the valuation adjustment taken this quarter?

Brian, Paul Cloutier. In regards to going forward or for year or --?

Yes, just going forward. I mean that tax rate now that you've taken the adjustment this quarter?

Well, with the full impairment of DTA, until we recover we probably won't be providing any taxes --.

Okay, I just wanted to make certain of that. That's the way I understood it, but I've seen it treated different ways with different banks.

Yes, we agree with that, that's why we said there's not a lot of guidance on there, there seems to be people all over the place. But it's going to be a function of establishing quarterly profitability on a sustainable basis. And then there are some book and tax timing differences that you have to factor in there. It's just a difficult thing to predict. So that's why tax rate and deferred taxes are a pretty variable topic right now, it's hard to make any kind of rational predictions.

Right, okay. How about just on the margin side, can you just talk a little bit about what you're seeing on the cost of funds and how much more room you have to go down versus kind of the repricing of the assets and just how things are going to play out there over the next several quarters or I guess whatever color you can provide?

Well, I think the cost of funds has about run its course. There might be a little bit more room as the year goes on and we've been managing that fairly aggressively, letting single service CD balances run off where we didn't have a relationship with the borrower -- or with the customer otherwise. No sense in paying up for that type of deposit relationship when we're sitting on cash.

The C&I side and the leasing side -- the C&I side is about re-priced already because it's more or less indexed to prime. Leases, you'll see some of the leases that are rolling off on their two- and three-year amortization, so you'll see some compression there. Replacement volume is going to be less than those yields.

We were lucky in '08 and '09. We were among the few people left standing in commercial leasing at the time and there were some pretty attractive yields in those leases. But things don't last forever and that portfolio has a short duration, so you'll certain see some compression there.

We may be able to offset that to some degree with some growth in the other sectors of the leasing components. But leases are also very competitive these days. It's a hot asset class because it's not real estate, it's short duration and it kind of checks -- everybody had a very good credit quality, it checks everybody's boxes.

The real estate side, the Citibank portfolio will continue to reprice. Those yields were in the sixes and market yields now are somewhere between 375 and 425 depending on the credit. Some borrowers don't want to be bothered with refinancing, they're happy with what they have, we've been out talking to them. But we have some aggressive competitors in Chicago that are out hitting people with a 3-7/8 coupon flat fee refinance and it can be an attractive product for a customer who wants to cut their interest cost.

So in the real estate side some of it is already over with, some of it is yet to come and that's, again, why we're saying you know, we don't -- and we also have to be careful of interest rate risk at this level. We don't necessarily want to lock ourselves into long-duration assets at extremely low yields. So that's another reason for the portfolio diversification.

So we're going to see some compression; it's hard to predict who's going to do what. We don't necessarily want to encourage customers, disturb customers from where they're at, but we've got to be responsive to their needs. And we have to be out talking to them because we don't want to find out that somebody else was and we just get a big fat check with a zero coupon attached to it.

Right, okay. On the expense side, outside of the advertising, I guess just in general can you just -- from a credit cost perspective, the OREO and whatnot, what are your thoughts as far as reducing that cost in 2012 versus where it was at in 2011 and realistically what's possible there?

Well, we're in favor of reduction, just to get that on the record. Let's take REO. REO is a function of two things, the write-downs due to marks and then the carry cost. In the carry cost the biggest things you have are real estate taxes. Chicago real estate taxes, if anything, are going up. As valuations go down the tax rates go up, the municipalities still need the same amount of money so you're still stuck with that bill.

But those will decline as balances decline. We've been successful moving inventory third quarter, fourth quarter. We're going to move somewhere between $2 million and $3 million in the first quarter. And we're very targeted on moving inventory that seems to have a relatively high cost relative to the asset. So that is one of the drivers in making a decision of whether we're ready to move something is what is this going to cost us either from a repair perspective or a tax and insurance perspective.

Another factor in that decision is the local municipalities are getting increasingly aggressive on property management and conditions and ordinances that will make those costs go up which of course just wants us to accelerate the disposition.

So I guess the big picture -- we're hoping the balances go down during the course of the year, therefore the REO costs will go down. And as we get toward the latter part of the year, as the rate of inventory addition slows down, then your initial provision for taxes and receiverships and all that will decline as well.

Okay. And the sales and whatnot of OREO as you guys kind of look at them -- you talked about getting your arms around things and doing all this data. Is it fair to say that we wouldn't expect to see any resolution on that front or disposition sales here, bulk sales in the first quarter? It will probably be a second half of the year event or is that --?

I don't think it will be any sooner than something that occurs in the second quarter because we're just not enough far along in the process for first quarter. So the soonest it would happen is in second quarter and we've got to kind of understand how the processes work. Do we want to do one larger transaction, for example, on a note sale.

The smaller properties it may make sense to send some to the first -- if we're going to use an auction channel to send a representative handful through the auction channel to see how it goes. If it goes relatively well then you set yourself up for another one. But there may be a 45-, 60-, 90-day window in between the auctions that you have to get set up for.

So as I said earlier, we'll know more when we get to the conference call in May about what we're going to do and how we're going to do it. And if we wind up doing something material that will move numbers in a significant way we'll probably 8-K it and possibly even schedule a conference call as we did for the Citibank transaction on the purchase side just so that people can get a better handle on what we're doing and how we're doing it.

Okay. Perfect, thanks. And from a credit perspective, this process of going from the OTS to the OCC seems to have been a bit of a change mentality wise for you guys. You talked about the second review that was done from a credit perspective whereas there's normally one done. What was the rationale for doing a second review? Is that internal or was that external?

That was internal, it was something that we decided the asset quality and the Board decided that the sooner we completed a full transition to the OCC approach on a number of fronts, not just on credit but all fronts whether it's interest rate risk, liquidity management or REO management, that's why we made sure the appraisal aging was accelerated under 12 months.

Whatever the specific OCC expectations were we want to meet them and we want to meet them as soon as we can and we want to meet them as comprehensively as we can. So it made sense to have the portfolio review done, it gave the OCC a better clarity of what was in the portfolio and what issues were out there and it just got us on their page in a much more efficient manner than trying to do it ourselves over a period of time. And it also meant that as we go through our renewals and even when we went to new deals we made sure we're analyzing it the OCC way.

Okay. I guess from a credit perspective the numbers speak for themselves. But the NPAs look like -- obviously they were down a bit this quarter, but when you look at the other metrics and kind of the special mention bucket, the classified bucket and 30- to 89-day bucket are all still trending upward at least this quarter.

What's your outlook on how you look at credit absent some type of bulk sale I guess here, just resolving some of these credits and getting those trends directionally going the right way? And I guess maybe you said it earlier and I didn't hear it. If you did I apologize.

Just the classified ratios relative to the regulators being somewhere around the 70% level now, whereas it seems like the line in the sand seems to be closer to 50%. Just kind of what your expectations are -- is where you can get -- at what point in time can you get to that 50% type of threshold and move it lower?

Well, there's three or four different avenues to doing it. If you line them up and say that performing classifieds and non-accruals and OREO all add up to that classified number there are different avenues to take. The OREO and -- the OREO is a function of a more aggressive disposition strategy if you think you can execute it within a reasonable range of results.

The non-accruals are a function of getting the borrower to do the best thing for all concerned. And in some cases -- in most cases if the borrower isn't able to function in the business or manage the property correctly for any number of reasons, then get them to liquidate the property and solve the problem as quickly as we can.

But borrowers tend to want to resist that solution. They want us to sit there and wait for them to fix something or do something and then they want to either pay interest only or not pay anything at all for a while. We're not their equity partners; we cannot take those steps. So that will force us to get more aggressive in the litigation, that's why we have put receivers in and run it through there.

But if they do come up with a solution -- for example, if they sell the building at a short sale, we think that valuation is about as good as we're going to achieve, then in isolated cases we'll do what we need to do, for example, on releasing personal liability to get the job done.

We hesitate to do that because holding people accountable is an important part of the credit function and we don't necessarily want to be known as the bank that just lets everybody walk. But if that's what it takes to move the credit exposure off the books and have a definitive conclusion then that's what we'll do.

The performing classifieds get even more tricky because in a lot of cases the borrowers are current, the businesses or the properties are functioning, they may have a certain amount of liquidity or other income that they support a shortfall if that's what's going on. But again, we will liquidate that exposure or not renew it if we cannot get the borrower to help address the basis of the classification.

And that's where you're going to see some volatility in both the categories of performing classified and even in non-accruals. Because if we can get the borrower to do something that would solve the problem that's within their ability to solve the problems, they just refuse, then we are going to take the treatment that it's a non-performing asset and we're going to liquidate it even if they don't want us to.

And that happened for over $2 million worth of assets in the fourth quarter. The borrowers could have solved the problem, they chose not to, and not to mention our largest exposure, and we're going to have to go -- we're going to have to put the hammer down.

So all those numbers can move down. There is a variety of techniques. And the positive side is as the economy recovers some of the problems solve themselves. One of the larger classified loans that occurred in third and fourth quarter, we have their financials in, it looks like they had a successful year. They've resolved the basis of classification on the strength of their own business operations and we think that we'll be able to upgrade them sometime in first quarter once we get their final year-end financials.

So some of these problems will solve themselves either because the borrower continued to perform, the business did better, we gathered whatever information we need to document the file. Getting that from borrowers is sometimes a challenge because they think you're going to call the loan on them so they don't want to give it to you.

But all these things can be moved in the right direction, but each loan, each borrower sometimes needs its own strategy and that's why it's sometimes hard to make generalizations.

Okay, how big was that credit you just referred to, the largest one -- the larger one that happened on the classifieds as it could move to and I guess a special mention to be upgraded?

That's a little over $3 million.

Okay, all right. And last quarter I thought you mentioned how many of the non-performings were actually paying, it was kind of a large number. I mean, is that still the case or did I misunderstand that number last quarter?

No, it's still the case. That's borrowers that are current on their payments not really presenting a problem, but there's a challenge to the debt service in some way that they either have resolved or are in the process of resolving, but there's not been enough sustained performance time to be eligible for an upgrade.

And in some other cases the property is performing just fine from our perspective, but they have problems elsewhere in their portfolio. That's a basis of classification we cannot fix. They got into partnerships, the partnerships are in trouble. If you look at their personal side you would say, oh, my God, look what's going to happen here.

And that's part of the OCC doctrine. They look at global cash flow, so our loan might be performing fine, but the risk to the borrower is out there from another source and that's the basis of the classification.

And how big of a -- how much of the non-performers are in that camp right now?

Of the performing classifieds?

Yes.

I don't have good enough statistics to tell you, but I can tell you, for example, in some of the work that was done with the independent reviewer we probably had, oh, a good 20% to 30% of the loans that went on to performing, seven were due to cash flow issues in other places -- as opposed to a weakness in the rentals or in the business operations that they had with us.

And that number might be even a little higher. But I can think of at least two or three cases right off the top of my head that would add up to 20% to 30% pretty easily.

Okay, all right, thanks. And then on the losses in the quarter, it looked like there was -- most of them were concentrated in the one-to-four family and multi-family. I guess the multi-family, which you guys have had kind of an expertise and did the purchase with Citigroup, what is your expectation on?

I mean it didn't look like there was a big jump in the actual non-performers on the multi-family side, really just pretty minimal. But the losses were better -- were greater than they had been in other quarters. I guess is there any sign that that's deteriorating more than you expected or what's the general health there?

I think there's two answers to that question. The first answer for the quarter is we had the significant charge-offs related to the large disposition, the large resolution we had in fourth quarter. And remember also we're more aggressive about charging things off that are reserved even if we're not done with the litigation, that's again and OCC doctrinal change. So that's part of what drove it in the fourth quarter.

And then finally, as our earlier caller inquired, you're going to see variability in valuations in different parts of the market. Some sub markets are still struggling, there's a little bit more stabilization, but they are still struggling and they're really struggling under the weight of sales comps. Most of the sales comps of some of these sub markets are foreclosures, short sales, bulk sales, there's very little arm's-length activity.

In other parts of the market the markets are recovering nicely, vacancies are stabilizing, effective rents are coming up and now you're seeing some stabilization in valuations as well.

In Chicago we would not expect to see a big recovery in valuations, more than 3% to 5% and most of the market. And in some of the really hard hit areas you could see another 5% or 10%. It's really going to be a function of how these liquidation comparables affect valuations and --.

The other thing that's out there is we're watching what Fannie and Freddie do with rental properties of the single-family. We ran an analysis to see how that would affect our portfolios. There's not a great concentration anywhere near our stuff so we don't think it will have a huge effect. But that's something else to keep an eye on especially in the low MOD census tracts where most of that Fannie/Freddie inventory might be located.

Okay. Just from a loan portfolio perspective, how much of the loan book is outside of the Chicago market currently?

On the real estate side it's less than 10%. If you look in the wholesale commercial lending line item that's where you'll see it.

Okay. When you talk about these areas that have been hard hit in the Chicago market, so the south suburbs and whatnot, how much exposure in the loan book is there -- in your loan book is there to those particular markets?

We have a reasonable distribution of loans throughout Chicago, so I don't have exact numbers for you, but it would probably be somewhere around the $70 million to $80 million range just off the top of my head in the multi portfolio. But what's more important than that exposure is the per unit exposure and this is something we talked about in third quarter.

We ran an analysis based on as we saw these new appraisals coming in with these liquidation comps to look at the per unit exposure and say, okay, where do we have a potential exposure. And really when we looked at the entire thing and we said, okay, to the extent that the borrower might have negative equity that would be a potentially higher risk of default. And by the way, that's also part of the concentration of credit analysis we're doing.

That number was less than $10 million and therefore the hit -- if you had an indicated loss it's obviously less than that based on proportionality. In something like that if the borrower is experiencing an issue the first thing we'll do is work with them. Coupons have already reset, but if we have to work with them and do a split note we will, we'd just assume keep it functioning.

And also, we have a responsibility to the community, we just don't want to throw the thing on the heap. If the borrower can function with the building and manage it properly and we have to recognize that valuation issue through a split note structure we will. We're not super concerned about that exposure, it's out there, but it just speaks to the issue of there's not going to be a lot of growth and so that overhang is resolved.

Okay. And just to follow up on the question I asked earlier. As far as getting to that target classified ratio of 50%, is that a doable scenario in 2012 in your eyes at this point?

Yes.

Okay. Would that be -- that's through a combination of the methods you've talked about, not just -- if there's no bulk sale of the like I guess is that still a doable situation in your mind without a bulk sale?

Yes, it will depend on the disposition of that larger credit one way or another, that would obviously help -- with a $10.8 million exposure that would obviously help get the number down faster. So that's a fairly significant variable one way or the other. But, yes, it's still possible to get it down under 50 even if that one isn't fully resolved. We might have to get a little more aggressive in ordinary liquidations to do it, but, yes, it is still feasible.

Again, the one thing I want to caveat is the performing classifieds could improve based on what the borrowers do. But as we get through the term loan review for '11 we will see just how well the other borrowers did during the course of the year.

So getting it from 12/31 levels down under 50 is doable through a number of channels, but we're going to have to see what happens with the performing classifieds. That project is underway and that is a top priority for first quarter and second quarter is to get that number in and get as high of a response rate as we can to complete the loan review cycle once and for all.

Okay. And just -- I mean fair to say that your outlook on credit at this point, after going through these last two quarters and kind of getting on the new, I guess, doctrine of the OCC, do you feel like things are stabilized at this point?

I guess it looks like 40% of your non-performings are in that commercial real estate bucket. And I guess in particular does that portfolio appear to have stabilized? And I guess if so where are your concerns at this point as you look forward?

Part of it will be resolving what you've already got. But as far as are you comfortable that the inflows I guess in the commercial real estate portfolio in particular and any other areas that you still have some concerns about with have I guess started to stabilize if not decline at this point?

Well, there's a lot of sub questions to that. Let me try and hit it in a couple things. The first thing is let's just talk about inflows. As we said in fourth quarter, even a little bit in third quarter, the past-due trends, the amount of discussion we're having on new cases is down sharply and we're happy about that. Presumably the economy stays reasonably stable we would expect those trends to continue.

Where we do have issues are issues where a family or a business is having an individual issue. We just learned that a family member running a business was diagnosed with cancer. They are concerned about the cost of cancer treatment plus the business owner isn't going to be on the premises. Is that going to affect the performance of the business? It's very possible it will, that's about a $2 million loan.

So you get situations like that are completely unpredictable. The issue we had with the borrowers, the larger borrower with the lease reset in third quarter. We knew the reset was out there but we had to deal with it. So some things are just instantaneous, they happen. But in the larger segments we're fairly comfortable with what we're seeing on the new case inflows.

We'll have a better sense at the next conference call on how the data is coming in for 2011 and operating results for real estate operators and for business operators. But we see some definite trends in the positive of the existing classified borrowers, either because they're addressing their own problems through liquidating the asset or their business operations got stronger.

So I'm not super worried about a massive inflow of things that we see, that's why we've taken to writing about what we might see in the loans on non-accruals section just to give people a heads up, we think that's the best way to do transparency. And also as we resolve them we'll certainly let people know that we're done.

So the overall credit environment, I'm probably more worried about competitive underwriting and retaining loans than I am having big defaults just because of where the yield environment is and how aggressive people are getting for loans. We've seen some fairly aggressive underwriting on the commercial real estate side. In some cases we're happy for it because it was a loan we were ready to move anyways and it solved the problem.

But in other cases the pricing will get -- the pricing is getting aggressive, but we will not be under aggressive on the underwriting. If a competitor wants to go farther than we want to we will let them and that will occur from time to time.

I think that takes all my questions. Thanks for taking my questions, Morgan.

Of course, Brian.

Ladies and gentlemen, this does conclude the question-and-answer portion of today's conference. Mr. Gasior, would you like to make some closing remarks?

Yes. Well, first of all, we thank everyone for their attention, a very great level of preparation was put into this on your side. And we're hoping that the information and the level of detail we're providing is useful to you. Please let us know if there's more we could be doing that if we can do it we will do our best.

Second of all, we've been through a bit of a rough patch and a detour these last two quarters. But we thank everybody for their patience and their understanding. We are feeling more optimistic about the future, we've got to finish our OCC transition to their satisfaction and we're really looking forward to getting the loan portfolio and the core earnings to sustainable levels that get us back to normal.

So getting us back to normal in '12 is our priority. We'll look forward to 2013 assuming better days are ahead. But once again, we thank everyone for their interest and their patience.

Ladies and gentlemen, thank you so much for your participation today. This does conclude the presentation and you may now disconnect. Have a great day.