BankFinancial Corp (BFIN) 2013 Q2 法說會逐字稿

Good day ladies and gentlemen, and welcome to the Second Quarter 2013 BankFinancial Corporation Earnings Conference Call. My name is Debra and I will be your operator for today. At this time all participants are on listen-only mode. We will conduct a question-and-answer session towards the end of the conference.

(Operator Instructions)

As a reminder, this call is being recorded for replay purposes, and I'd now like to turn the call over to Mr. F. Morgan Gasior, Chairman and CEO. Please proceed, sir.

Good morning and thank you. Welcome to our second quarter investor conference call. At this time I would like to have our forward statement read.

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 this statement of purpose 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. These 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 operation, 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 statements in the future.

And now I will turn the call over to Chairman and CEO, F. Morgan Gasior.

Thank you. As all filings are complete as of yesterday, I will turn the call open to questions.

Thank you. (Operator Instructions). And your first your question comes from the line of Jon Burke, Amica Insurance. Please proceed.

Hey, Morgan, can you provide us an update on the plan outlined last quarter to reduce expenses, add loans and get the institutions earning a return above your cost of capital?

Sure, Jon, good morning. Well let's take a look at our activity during the quarter, we'll start with loans. You will see that the loan origination track continues to improve and when we look at the five quarter supplements, the activity on a year-over-year basis increased dramatically.

But again, the trend is moving on the right direction, so we achieved positive loan growth this quarter. Underlying that you also saw that the rate of payoffs are reduced but the rate of resolution of five, six or seven rated credits stayed about the same.

So, that spread is widening, so to speak. The rate on payoffs is declining, the rate on loan origination is increasing, and that bodes well for stabilizing and increasing the net interest margin.

On the expense side, two things to observe; as we had indicated previous quarter, we did our operational reviews for the 2013 business plan and continue to implement those during the quarter.

And as I had outlined, looked at different layers of management capability, transaction processing capability as well as the back office functions, and accordingly processed the reductions in staff that we felt were appropriate. But having done so, we took two additional steps, we added some depth in capability in loan originations particularly in the C&I sector. We also took some steps to add some resources in credit operations and portfolio management.

So, we felt pretty good about the realignment of resources. There is always some additional consideration of things that we could do, and align resources a little bit better. But when you look at the reduction in the headcount we'll stabilize around the 310, 315, 320, 325 level depending on who's out there generating assets.

We're also looking at ways to supplement the fee income through additional revenue production. And a greater continued focused on revenue generation whether it's from fee income or loan origination will continue to be the focus going forward in terms of deploying resources.

So, on the comp line, I noticed there is 143 of severance expense in the Q, so net that out, you are at 6.4. Is that a good number going forward?

That's a high number Jon, most of our severances occurred towards the end of the quarter as we ramped up the assessments and realigned the functions, so we'll have a run rate for you at the end of next quarter, but that number is high.

Okay, and last call, you spoke of $3 million to $4 million of the expenses as you kind of, as we exit this year? What was that? Was that off the 13.2 expense, quarterly expense that you put out there last quarter? What was the number off?

Yeah, you have got, it's off of 12/31 numbers more so than 3/31 numbers, and you're looking at 3 or 4 components of that, all of which are in motion, one was the comp number, and we've achieved most of those goals already as of the end of the second quarter, and you'll see that starting to flow through in the third quarter and in the fourth quarter. But, already, it's already taken place in the third quarter as of the end of second quarter to third quarter.

Second of all, we're starting to bring down the NPA expenses. We actually thought we'd do better in the second quarter, but we saw some trailing litigation on a couple of cases, borrowers that have filed a somewhat misguided bankruptcy case that we're pursuing aggressively. But those cases are starting to reach their termination and those expenses will start coming down.

Resolution cases, you saw our OREO results, we did have a few marks some smaller parcels in the normal course of appraising. But the disposition activity continues to move forward and disposing at or above or close to book value.

So again I think the NPA expenses are starting to trend down obviously compared to year-over-year or even quarter-to-quarter, those will continue to trend down through the end of the year, that's more of, I think you'll see a floor, you'll see more of the run rate on that towards the end of the fourth quarter than I think third quarter.

And then finally, just with the completion of technology projects and the maturation of the technology processes, the depreciation curve on some of the IT equipment, IT equipment you depreciate over one year, two years, three years it's fairly short-term stuff, when we put stuff in like remote deposit capture, we put stuff in like teller item capture, you upfront those technology depreciation expenses. And those are starting to run-off the balance sheet.

There will be one facility that a lease expires that was kind of an experimental for customer service in the Hyde Park area that rolls off towards the end of the year. So that $4 million number, we might be able to beat it, but you'll see it come to full force and effect in the first quarter of 2014.

Okay. And just, again to confirm that was of the fourth quarter of last year?

Yes, that was our baseline for planning. First quarter numbers were consistent with fourth quarter. Remember first quarter too was a little bit weird, because we tend to have somewhat higher benefits expenses in the first quarter based on payroll tax rates that tend to trail off over the rest of the year.

Okay. Flipping over to the loan side, so we passed the inflection point here, I mean, net is what kind of what I care about, only grew modestly in the quarter. So the expectation is that originations will grow from the 115 level and payoffs will decline from the 106?

Yes, I would agree with that statement.

Do you have an expectation in your head of how big of a spread that will be?

It's tough to make specific predictions on quarter-by-quarter basis. We have a few closings, for example, in the nonresidential category that got deferred into third quarter instead of second quarter. One deal dropped out because an appraisal didn't come in as the borrowers thought it would.

But I would generally say that if we can put at least $20 million to $30 million worth of net loan growth per quarter on a performing loans basis, reduced by whatever resolutions of either six, seven or non-accrual loans that would be a good number for us for the reminder of 2013. And to keep that spread, if you will, that differential, that delta accelerating in the latter part of 2013 and 2014.

So in appropriate world in 2014, we're growing at $30 million to $40 million, maybe even as high as $50 million a quarter. In 2013, if we're growing at $20 million to $25million to $30 million, that's a good ramp up.

And then we already saw, most of our payoffs in the second quarter occurred in the first part of the quarter. Most of our originations occurred in the latter part of the quarter. So that was particularly helpful for net interest margin for the quarter, but we closed something along the lines of $30 million in the last two weeks of the quarter, if you take a 3.5% coupon on that, that will boost the net interest margin going forward.

So our idea is close as many loans as we can during the quarter and boost that absolute net interest margin. But we were pleased with the portfolio retention as the quarter ended and going into third quarter, that's not to say that there is always competition out there and there's deals that we may not win for underwriting or pricing.

To give you a quick example, right at the end of the quarter we had $1.5 million payoff in a multi-family borrower. It was a borrower we had in the portfolio and we acquired three more loans in the Citibank portfolio transaction.

That borrower paid off on the last day of the month for $1.5 million. So we at least we got the benefit of the earnings for the quarter. But the competition gave him a 2.99% coupon on a 10-year fixed. And when you look at the risk and interest rate risk characteristics of that loan, it doesn't make sense for us to follow the competition there.

So, we will have situations like that happening, but we were pleased with the rate of portfolio retention and it's also probably worth noting that the move in interest rates during the quarter in the medium-term, the five, seven and even 10 years has created a situation where one - the repricing elements were a little more favorable to us, market rates moved up modestly during the quarter.

And that plus our own portfolio retention activities should help us continue to move those payoffs down and the originations up. So, we would be pleased with 25 to 30 at least for the quarter - for the third and fourth quarter, whether we achieve it is going to be a function of what happens, but we like our originations pipelines right now.

The payoff is that if we can keep that trend going, we should be able to achieve that $25 million to $30 million or as close to it as we can and then continue those trends into the $40 million to $45 million range for 2014.

Last one, you've $300 million of almost non-earning assets, you've had a big move up here in yield securities, have you thought to deploy any of that into some short-term securities?

Yes, we have in fact, I'm glad you asked that question. We did a pretty thorough study in the second quarter of what security options are available to us. And we've already started to deploy it in some fairly short-term. And some of it might be some [CDs], there's -- FDIC insured CDs that are hitting the market.

There is a little more appetite for liquidity on the outer bound country. So we're just putting some cash to work in some short-term CDs, it's not like it earns a ton of money, but if you're picking up 25 basis points, 50 basis points, 60 basis points along the way it's a good thing.

Same thing, short duration, either variable raiser short duration, CMO type securities, top tranche securities. We don't really want to take any credit risk in the portfolio and we want to take as little interest rate risk in the mortgage portfolio as we can, but there are opportunities there for some incremental improvements. And it builds cash flow for a while for either redeployment into loans or redeployment back into securities that will ride the curve up, if in fact the curve goes up.

So yes, we've already started that and that's why you'll see the cash account down on two fronts. We'll probably do on a steady state basis, $25 million, $30 million, $35 million, $40 million a quarter in CDs and short-term mortgage securities, if we can also grow the loan portfolio by $25 million or $30 million, we are taking some meaningful dents in that cash account.

But you should also note that we will probably keep somewhere between $50 million and $75 million in cash as on balance sheet active liquidity account. We have enough activity in lines of credit going on and growing lines of credit. Also, nobody really knows what's going to happen to depositors and deposit competition when rates finally start moving up. So we want to make sure we have a pretty strong active liquidity portfolio and right now $50 million to $75 million of cash is earmarked for that.

We don't really see much benefit in putting it in any kind of securities that might earn 2 basis points more, 5 basis points more in treasuries, possibly even a negative return. So, the floor on the cash accounts probably is going to be around $75 million.

Okay. All right. Thanks.

Thanks, Tom.

Your next question comes from the line of Brian Martin of FIG Partners. Please proceed.

Hi, Morgan.

Hello, Brian.

Hey Morgan, just a follow-up to Jon's question on the liquidity, that the 75 floor you are talking about, I mean do you think that you can get to that level by the end of the third quarter? I guess how long does it take to kind of get to that level where you're at a baseline?

I think if you look and say we are consuming $50 million a quarter for each of the remaining quarters for 2013, and then it's 100 delta for 2013, and if we can. I really don't want to predict the mortgage stuff and the CD stuff, because it's a function of what's in the market.

But again if you said we did that over $40 million to $50 million for each of the quarters in 2013, that's $80 million to $100 million, and therefore we chew it up by the second quarter of 2014 at that rate. And we might be able to improve that on the loan side if the payoff numbers keep coming down as they have been.

Okay, all right. And just on the payoffs in the loan portfolio, I guess with credit that the work you guys have done bringing the non-performings down and the classifieds down. And what, it doesn't seem like there is a lot there that still has yet to payoff. I guess, what's driving the payoffs this quarter, when you look at, I know they're down from $125 million in the quarter to around a 100-ish if you will. But what level do you think the payoffs ultimately drop to here?

Yeah, it's a good question. I don't know that I have a particularly clear answer for you, because there are so many variables in it, but let me give you a couple of senses.

First, and as we've discussed before, I think we're coming to the end of this particular story. But we are pretty vulnerable between the Citibank acquisition and our own portfolio of having a pretty high quality portfolio at a very good coupon.

And accordingly, when rates dropped as aggressively as they did late last year and into this year, we were vulnerable to a great deal of competition. And our loans were good loans; they had good equity positions in the collateral, and therefore they were desired by a lot of competition. We've been able to fight that off and reduce that rate.

So if for example, if you said, let's just take a given month and say that may be at the end of the day, the payoff rate was $15 million to $20 million for the month, and maybe that was $5 million, $6 million, $7 million of transactions where the building was sold, we let a deal go because a competitor was more aggressive.

The real number to watch is are we moving the sixes and sevens out. And for example in the quarter we did about $16 million. That we can continue that $16 million to $20 million to $25 million for the remainder of the year, that will reduce those balances down to a very reasonable if not de minimis level, and then it's just a question of what happens with the end portfolio.

But we know that especially in active markets, people are starting to sell buildings. We are doing our best to capture those opportunities through the portfolio retention activities, but it will really be a function of what happens in the market. That's why the loan origination function is so important. Because that's something that we can see the pipeline growing, we'll do our best to retain what's out there. But we don't always control that outcome.

Some people have signed a contract, they already have their financing lined up. We don't really get into the deal until very late. They've already paid their due diligence fees. They don't really want to walk away from those due diligence fees. So you lose the opportunity of pretty much before you even started.

So, I don't, it's a hard one to give you as precise estimates, and given the activity in the first and second quarter, I don't want to predict a run rate. But I think what I'd be able to do for you is, by the time we get to the end of the third quarter, I'll have a much better idea of what the run rate is going to for obviously the remainder of the year and for 2014, and we'll try to give you some better guidance on those numbers in our next discussion.

Okay, that's helpful, and the loan pipelines you're talking about, if maybe can you please give a little color on what areas are progressing or at least accelerating more on the volume side, and maybe can you just talk a little bit about the yields you're getting on the new business or what type of yields do you expect to get in that area?

Let's start with something that's probably a better opportunity than we thought we were going to have, which is the residential ARM portfolio, with the backup in rates, we're seeing a significantly, well, significant is the wrong word, we are seeing a greater interest in ARM loans than we have in the past four or five years, and that's going to do two things for us. It's going to reduce the rate of the loan payoffs in the residential portfolio, and it's going to create some cash deployment opportunities in ARMs.

Those are going to go in the 2.5% to 2.75% range. We really can't offer a three-year ARM anymore due to a variety of regulatory constraints on qualification and it's just is not a product where many people are interested in for a variety of reasons, but the 5/1, and 7/1 ARMs are out there, and that's 2 3/8% on the low side, 2.75% on the high side, and if rates tick up a little bit during the remainder of the year and those will probably start snuggling up to 3, especially if the 30 year goes over 4.75%, north of 5%.

But that delta between the coupon on a five one and the coupon on the 30 year is widening and that's creating a significant amount of interest in the ARMs compared to where we were six months ago.

We have people deployed in the field for origination purposes for that, we have been preparing for this day. We were hoping it got here soon, and the fact that it's here now is a good thing. So we might be able to improve our net portfolio retention and our loan originations in that, it's a little too early to give you a run rate, again we will know more as our people get out there, and see how the market reacts to it.

But I can tell you now that our ARM pipeline is growing in the third quarter at a rate we didn't quite expect when we got to the beginning of the year. Now the question is, how fast and how far we can get that to grow.

Second of all, the multi-family area, it's obviously from the second quarter results growing at a pretty nice clip. Yields in there are anywhere between 3.5% to 4 3/8% depending on the structure, the qualification of the loan and the term, mostly five one and seven one ARMs. There is a temple of ten one ARMs out there. Very few people are interested in three years, but we have a handful of those too, but the vast majority is in the 3.5% to 3.75% range in the five one and then 4 to 4 3/8 in the seven one.

Those rates will also probably snuggle up towards the end of the year. We're being as competitive as we need to be to get our volumes. Therefore we're probably leading the market on the best qualified loans right now in all of our markets. There's probably room to tighten those rates up as we go into the fourth quarter without really hurting volumes, but right going back to Jon's point, we've got to get the delta on the portfolio growth going and we'll take an eighth off or a quarter off to get the best deal on the street and put in the portfolio.

So I think in the multi-family if you went with 3.75% number, 3 5/8, 3.75 average for this quarter production and you'll probably see that snuggle up an eighth, maybe a quarter as we get into the fourth quarter of 2014.

Nonresidential, that is the one that is the hardest to predict because we are still seeing qualification issues both in terms of lease resets. We're seeing it a little bit in valuations. We've had a couple of deals that dropped out because of valuation issues. It's less predictable. So I - on those loans you're probably in the low - the 3.75 level at the low-end to the 4.25% level, 4.5% level.

But as I said, we are interested in growing that. We have relatively modest growth goals. If we could grow the portfolio $5 million a quarter to $10 million a quarter for the next couple of quarters that would be just fine with us. But yields are right around high 3s to low 4s.

We're seeing competition in that as there are more and more people moving it out to 80% LTVs. But you really have to look at your cap rate. You've got to look at the stability of the net operating income. And then there are some people that aren't paying as much attention to global debt service coverage as we are. So we lose a few deals along those lines where people are less concerned about it than we are. But on the yields there, call it right around very high 3s to low 4s and again that will probably stay fairly stable for the remainder of the year.

Next big growth area was commercial leasing. We're seeing growth in that in two dimensions, one in discounted leases. That's our third consecutive $30 million quarter, which for this time of the year was pretty good for us. That pipeline remains strong, yields in the 3 - mid to high 3s. Sometimes they get to be low 3s that we're talking about or even high 2s, if we're talking about a very short-term lease, three-year lease to a very high investment grade company, General Electric comes to mind.

But generally you are talking mid-3s for three to five-year fully amortizing high grade commercial leases. You'll see in our C&I totals we're also doing better business on the direct lessor front with lending directly to the lessors, primarily bridge and warehouse credit opportunities there, but we're starting to see some greater interest in volume usage as their volumes pickup. They've got more assets deployed to the less - the lessees.

We've also deepened our penetration to our lessor base. That was a big focus for the first half, and we are hopeful, I don't want to promise it, but we're hopeful we'll see both better origination volumes and better line usage as we go for the remainder of the year. Also we're seeing in that context a continued shift where we're still doing a fair amount of technology work, but we are also seeing harder goods, fork lifts, material handling equipment, some medical equipment being part of the mix.

The good news about that is it tends to give you a slightly longer duration, and therefore stabilizes the portfolio. It also goes a bit farther out the yield curves. You pick up a little yield, still an attractive interest rate risk combination. We haven't done enough deals in the bridge and the warehouse space yet in the material handling side to know what our line usage will be. I think given the lead times of that, there might be some pleasant surprises there, but on the other hand, that's probably delivering a fork lift, it doesn't take a whole lot of setup. So it might not sit on the bridge line very long at all.

So some projects are longer term. We are doing a mail processing equipment for a top five commercial bank in the United States. To get that equipment running and interfaced to the systems is a longer lead time. If something like that asset is on the bridges, it's going to promote utilization.

So longer lead time assets are part of the mix, shorter lead time assets are probably a bigger part of the mix right now. But we're good with commercial leasing in both of those dimensions. We think we'll continue the momentum and we actually think we can build on the momentum a little bit going in to the 2014 - the rest of the year and into 2014.

Finally C&I, probably one area we are still frustrated with, we're growing the number of customers gradually, but the usage is just not there, is in the healthcare space. Historically, we averaged 40% to 45%, 50% may then 60% usage. The state of Illinois is pretty well caught up on their bills. We are not exactly sure how they are doing it, but they are, and our line usage is down under 25%.

So, something that should be producing $15 million and $20 million worth of cash usage every quarter is just not everywhere right now. So even if we had customers, their line usage is still the same. That may or may not change. You look at the finances of Illinois and you wonder how long they can keep this up, but at the end of the day, that is probably a lagging item for us.

And the general C&I and transportation side, it's kind of hit or miss right now. I would say that's the area we need to spend the most time in terms of promoting growth and especially predictable growth. So I would invite questions on that in the third and especially fourth quarter. But if you look at what we've done the leasing side and the real estate side, the steps we took in the fourth quarter, third and fourth quarter, first quarter are starting to pay off rather nicely.

The steps we're taking now for C&I, we hope to demonstrate similar results in the coming quarters to match that growth activity in the real estate and the leasing side.

Okay, perfect. That's helpful. And my sense is that, you've talked a little bit earlier about the margin, but the margin probably bottomed this quarter, it probably trends higher and I guess maybe to think about it more toward the big picture, and out into 2014, Morgan, I guess if we are able to put let's say $200 million of that liquidity to work it, let's call it a 3.5% pickup, you can potentially see a 50 basis point lift in the margin. I guess if you are at $330 million now, I guess, does a $380 million type of margin number if you execute like you think you do, like you think you can sometime later in 2014, that seems to be a realistic target for you guys at this point?

Yeah, I think, I'm glad you asked that because it has a couple different components to it. But let me answer your question at the high level as directly as I can. I think that somewhere between $350 million and your 389 number be a little high, but $350 million to $375 million, $380 million is possible.

If we get a little more help and repricing of loans, then I think that higher number that you are talking about is doable because we won't be repricing quite down to the floor and that was kind of the story of second quarter. We had a significant quantity of loan repricing in the first half of the year. That story is largely behind us.

What is renewing in the second half of the year are either shorter term renewals because we are ramping up the underwriting and documenting the file with current financials, but we have already agreed on the pricing with the borrower and those have essentially been reset to market already in the first half.

So I think I agree with your assessment of the net interest margin. We put a floor under it in the second quarter, I would have been a little happier had we had fewer payoffs to begin with and then had our originations close earlier in the quarter, I think you would have seen a somewhat better more predictable margin at the end of the quarter, but I think we have put a floor under it and the question now is expanding it.

So one, I think $350 million, $375 million is a fairly safe range for now. I think we could get a little bit better than that if we get a little more help on repricing, and if the curve moves up a little bit, so that we are coming out of the mid threes to high threes and we are closer to four on say the multi and very strong commercial real estate.

Also, I think on the leasing side is still extremely competitive, but to the extent that the curve moves up a little bit in the five and seven where our longer term leases are going, we will obviously pickup some yield there, because we're pricing off of light term swap curve.

So $350 million, $375 million it seems like a good medium term number to get to a year from now. We could be that number if we get a little lucky on the curve and we get lucky on the remainder of the pricing.

Okay.

The only thing I want to caution you, Brian, is as we wrap up the remainder of the risk rating five assets and sixes and the sevens, we will see some yield compression by taking those loans, we pricing for the risk. So if they have issues in the credit, they are still performing, the borrower's trying to work their way to an gain, we price for the risk.

So to the extent of those are removed from the equation, it will introduce some margin compression. But I think generally between the portfolio retention and the portfolio growth, we'll overcome that, especially as we get in to 2014 because it just won't be a factor anymore.

Right. Okay, perfect. And just maybe two last things, you talked earlier about the expenses, and I guess, just so I understand it, when you are talking about the fourth quarter kind of base line, and then that being similar to the first quarter, I guess maybe I was confused if that could have seemed like first quarter was a fair amount below fourth quarter.

But I guess, maybe the real question is if you look at the fourth quarter run rate, let's call it round numbers $15 million, the target that you talked about, $3 million to $4 million reduction, if we think about the high-end of that reduction of $4 million, the run rate might be somewhere in the $11 million-ish range as you look at 2014, and that's kind of what you are suggesting is reasonable?

Actually, we'd like to get below $11 million.

Okay.

So that's where again, I'll have a little more guidance for you as we get to the third quarter and the fourth quarter. But some of the things that haven't hit yet are improvements in the NPA that's still couple of million dollars a quarter in a variety of contexts and we also haven't seen the appreciation, the improvement in some of the technology depreciation and roll-off expenses.

So realistic, if you look at it in a different context, to the extent that we can get at or below $40 million a year, if you look at where, go back to your point on where yields are going to settle in, figure you're going to do if you can do 50 points a year on non-interest income.

We need to get the expense level at or below $40 million and the better below $40 million it is, the better it is, the only thing I don't want to sacrifice is the asset and revenue generation capability, and we also have to have the investment in the credit operations in the portfolio management to support it.

Right, okay. And the maybe couple of final things, the gain on sale line in the quarter. I know you had the one-time gain last quarter, it zeroed out this quarter, was there something in that line item that was unusual this quarter, or was that just the where we should think about it prospectively?

I really wouldn't try to baseline or run that, it is going to be lumpy. It depends on the process of litigation and recovery. We spend the litigation money and put as much pressure on the borrower as we can to achieve the results that we desire. And eventually we result in maybe we'll look at recovery, and maybe we'll sell a note at a gain or a loss to resolve the situation.

And the first quarter was an unusual situation where it was a trailing item from the fourth quarter sale that we wound up booking as a gain. So, gain on sale of loans is primarily going to be residential loans. It will be affected by a sale of a note if that's the best way to get out of a credit. The recoveries in the GVA are another function of how we're doing on resolving credits, and that will also be a factor in the non interest income or the results for the quarter.

Okay. And just with the health of the portfolio and all the cleanup you guys have done, it seems like the outlook on future losses if you will ought to be pretty modest suggesting, you can probably keep your credit costs at a pretty low level. Is that a fair way to think about it as you go forward, I guess there is not much more in the portfolio you have concerns with on the loss side, or are there still things out there that will make that a bit lumpy?

I would say as the general matter, we agree with that. If you look at the migration in the risk ratings, you're seeing that move in the right direction, we're always going to be subject to appraisal risk and even sometimes on performing loans.

As I said, we had a loan in the pipeline that was expected to be a valuation of $2.9 million. The appraisal actually came in at $2.1 million and now there is no more loan opportunity. So you still see a certain amount of valuation risk in almost any kind of asset, but particularly in commercial real estate. The multifamily areas are more stable.

We're also seeing more stability in the residential side. Again, it is spotty but the zone of stability in Chicago is expanding. So I generally think that very much the worst is behind us. I would say as we resolve the last couple of credits that are in the non-accruals, that we may make a decision to move something out because it's the right thing to do. We kind of did that in the second quarter, one of the commercial real estate parcels had been with us for over two years.

We got a bid that was a closeable bid. We didn't really like it, but I think we took a hit of 150 on that and that was off of a relatively recent '12 appraisal, but it was the right decision. And if that's what we have to do and once and for all move one or two of these items off the books, we'll do it.

But in the very big picture and as a best trend, I very much think those credit costs are continuing to decline and we will get down to a baseline. Our mission has always been to get back to historical levels and I think that we'll do what we need to do in the remainder of 2013 to get there, but we are very comfortable with the fact that trends are moving in the right direction.

We're also being fairly, I guess I'll say objective about assessing the prospects of a credit. So, just yesterday, for example, small loan that the borrower has a 92% LTV in their small little investment property, the loan's under $200,000.

They have cash to put down to work and they could get it into lower LTV. But we looked at the asset, we looked at the borrower, we looked at the return on the asset that they've been producing, we said, you know what, we're just not really interested in keeping this. We don't want to engage in a discussion about whether you're only going to pay down a little bit and then you'll do something later. So we just exited the credit and ultimately that reduces the risk of future credit costs. It does complicate the payoffs a little bit, but it's the right thing to do.

That's how we get back to historical levels on credit costs. That's how we get back to under 1% of non-accruals. That's how we get under 30% or less on classified and total capital and we'll take the cash, put it back to work in better prospects now that we're generating better prospects and that sets us up where we should be.

Okay. So that kind of my last question was just on the classified. It seems like you're still comfortable getting sub-$30 million if you will by year-end and then just further reducing it thereafter.

Yes.

Okay. Perfect. That's all my questions. Thanks for taking the time.

Always. Our pleasure. Thank you for the questions, Brian. Good questions.

Sir, you have no questions at this time. (Operator Instructions).

Going once, going twice. We thank everyone for their questions and their continuing interest. We look forward to speaking to you, and we'll take note of these items to provide better information and guidance for our third quarter call. And in the mean time, we wish you a good summer and early fall.

Thank you for joining today's conference. This concludes the presentation. You may now disconnect. Good day.