Columbia Banking System Inc (COLB) 2010 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Columbia Banking System's fourth-quarter and year 2010 earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Instructions will be given at that time. (Operator Instructions).As a reminder, this conference is being recorded. I would now like to turn the call over to your host, Melanie Dressel, President and Chief Executive Officer of Columbia Banking System.

Thank you, Nicole. Good afternoon, or good morning, everyone. I'd like to thank you for joining us on today's call to discuss our fourth-quarter and year 2010 results. I hope you've had a chance to review our earnings press release that was issued this morning. With me on the call today are Gary Schminkey, our Chief Financial Officer, and Andy McDonald, our Chief Credit Officer. Mark Nelson, our Chief Operating Officer, will also be available for questions following our formal presentation. After my few brief comments, Gary will provide a summary of our results for the quarter, including our capital position, net interest margin, and core deposits. Andy will review our credit quality information, including trends in our allowance for loan losses, charge-offs, and our loan mix. I will conclude by briefly giving you our take on the economy in our region and discussing -- discuss our ongoing strategies for the rest of this year and beyond. We'll be happy to answer any questions.

And before we begin, I need to remind you that we will be making some forward-looking statements today, which are subject to economic and other factors. For a full discussion of the risks and uncertainties associated with the forward-looking statements, please refer to our securities filings, and in particular, our Form 10-K filed with the SECfor the year 2009.

In our press release this morning, we reported net income for the fourth quarter of $12.6 million, and $25.8 million for the full-year 2010. These results are reflective of a year of extraordinary growth for us. We began 2010 with the two FDIC-assisted acquisitions of Columbia River and American Marine Bank, growing our assets by about 40% in less than two weeks. We made real strides in extending our geographic footprint as we moved into both eastern Oregon and eastern Washington for the first time, as well as moving up the Olympic Peninsula in western Washington. The acquisitions are fully integrated, both technically and culturally, and I'm delighted with the wonderful addition of nearly 300 new Columbia team members.

We were also able to take advantage of other opportunities to increase our presence in the Pacific Northwest and enhance our market share. We opened the Fox Tower office in downtown Portland, as well as the Salem, Oregon branch toward the end of the year, and we invested in experienced local teams of bankers in both states in which we do business. We definitely have not forgotten our commitment to our legacy markets. For example, we recently moved our Redmond, Washington office to a much more convenient location for our customers. And just a few days ago, we opened our new branch on Evergreen Way in Everett, Washington, which is about 30 miles north of Seattle, which augments our loan production office, which was opened last fall.

While these strategic investments in buildings and people do increase expenses, they put us in a great position to increase our revenue and market share. We have seen an improvement in our credit quality, and as I mentioned in our release, our criticized and classified assets are at their lowest levels since December 2008. We did add $3.8 million to our provision for loan losses to reflect the risk of a slow economic recovery. However, it is down significantly from prior quarters. You will hear more about our credit quality from Andy a bit later, and Gary will review our results for the quarter in more depth.

This commitment to our customers and our communities has also resulted in an exceptional level of core deposits, an important factor for a stable net interest margin. At the end of 2010, our core deposits were over 90% of our total deposits, up from 89% last quarter, and 85% at the end of the first quarter of 2010. I mentioned during the last conference call that the FDIC's most recent deposit market share analysis showed that as of June 30th, 2010, our ranking rose to ninth from eleventh among banks in Washington state, and we now rank twelfth in Oregon, up from 27th. These results reflect our acquisitions, as well as a higher share in our more traditional markets. We have been able to take advantage of the disruption in the financial industry by focusing externally and providing an extraordinary level of customer service for which we are known.

Gary will give you more detail on our strong capital and liquidity position, but I want to mention again that we were very pleased to redeem all of our preferred stock issued to the US Treasury as a part of the capital purchase program, and we've also retired the related warrants. Now, I will turn the call over to Gary to talk about our financial performance.

Thanks, Melanie. Hello, everyone. First, let me explain the delay in announcing our fourth-quarter earnings. The complexities of calculating the income accretion, loan impairments, and the associated effect on the FDIC indemnification asset for our acquired loan portfolio and our desire to test the accuracy of the results prompted a time-consuming review and a reconciliation of the final model results.

So, this morning, we announced net income of $12.6 million for the fourth quarter of 2010, or $0.32 per diluted common share. This compares to net income applicable to common shareholders of $447,000, or $0.02 per diluted common share for the same quarter last year. For the year, net income applicable to common shareholders was $25.8 million, or $0.72 per diluted common share, compared to a net loss of $8.4 million for 2009, or $0.38 per diluted common share. During the fourth quarter of 2010, the Company completed the final settlement process with the FDIC, relating to our acquisitions of Columbia River Bank and American Marine Bank. Our payment of $23.9 million to the FDIC, transferred ownership of 18 branch locations and the related fixed assets.

From an income statement perspective, on a covered loan portfolio, we recorded some impairment due to a decrease between expected and realized cash flows within a few pools. As a result, we recorded $5.6 million in provision on the covered portfolio. This is substantially offset by an increase of $4.5 million in the indemnification asset. The indemnification asset increased $6 million during the fourth quarter. As we forecast changes to the cash flow estimates for the acquired portfolio, the yield on that portfolio and the value of the FDIC indemnification asset will also reflect those changes.

The variables that drive the yield on the acquired portfolio, the provision for covered loan losses, and the FDIC indemnification asset are driven by cash flow expectations. Cash flows are influenced by the asset's accrual or non accrual status, the amount and timing of loan payments, loss expectation, the timing of asset liquidation, as well as the maturity of the loss share agreements. Significant changes may occur as a result of changes in any of these assumptions.

Investment securities increased about $71 million during the fourth quarter. The increase is primarily as a result of purchases of mortgage-backed securities with a 10-year stated final maturity. Our goal is to pick up additional income versus the overnight rate, but also to receive more cash flow from these investments as interest rates rise over time. Loan generation continues to be a challenge. Our non covered loans ended the quarter at $1.92 billion, down $93 million from year-end 2009, and down $18 million from the third quarter of this year. Although loan totals declined from year-end 2009, our commercial business loan totals grew 7% from December 2009, to end the year at $795 million. Commercial real estate loans are down $794 million -- excuse me are $794 million, down $62 million, or 7% from year-end 2009, while consumer loans are down about $18 million or 9%. Our real-estate construction loans have declined by about $51 million, or 34% compared to year-end 2009.

As Melanie mentioned earlier, core deposits continued to be a real strength for us. At the end of the fourth quarter, they were 90% of our total deposits. Core deposits rose about 45% from $2.1 billion at the end of 2009, to $3 billion at the end of 2010, mostly due to the FDIC acquisition. As compared to March 2010, after the FDIC acquisitions have been included, core deposits increased by $142 million, or 5%. Since March, core deposit increases are most notable in demand and other non-interest-bearing accounts, accounting for almost all of the net increase, with declines in certificates of deposit. As compared to the third quarter of this year, core deposits rose about 2%.

After our full repayment of the capital purchase program funds, and warrants in the third quarter of 2010, our total risk-based capital ratio at December 31st was 24.5%, as compared to 24.4% at September 30th of this year, and 19.6% at December 31st, 2009. Our excess capital is about 2.5 times the 10% minimum to be considered well-capitalized. Excess capital amounts to roughly $369 million at the end of the year. We also measure our tangible common equity to tangible assets. At the end of the fourth quarter this ratio stood at 14%, unchanged from September 30th, and 11.4% at December 31st, 2009.

Our liquidity ratio is a measure to track the funds available to meet the needs of our customers and for the general operations of the Company. We are very pleased to have a liquidity ratio of about 49% or over $2 billion, slightly down from 51% at the end of the fourth quarter of last year. Our tax-equivalent net interest margin for the fourth quarter was 4.35%, down from 5.24% from the third quarter of 2010, and up from 4.3% at December 31st, 2009. During the fourth quarter, interest reversals related to non-accrual loans were $469,000, reducing the margin by five basis points. As discussed earlier, variables that drive the yield on the acquired loan portfolio also introduce volatility in the margin. As a result, the effect of the accretion of income from the acquired portfolio on a net interest margin for the fourth quarter was nominal.

Net interest margin was also affected by holding larger levels of interest earnings, cash invested at relatively low yields. Traditional opportunities to deploy excess cash into higher-yielding assets are a challenge, as in the near term, we expect cash will be used to take advantage of strategic opportunities, but we will seek attractive shorter-term investment opportunities. Average interest-earning assets have increased -- decreased 28 basis points to 4.84% from 5.12% for the same quarter in 2009. During the same period, average interest-bearing liability costs have decreased 47 basis points to 0.69%.

Non-interest income for the fourth quarter increased $7.4 million to $15.9 million, up from $8.5 million at December 31st of last year. The increase was due to the change in the FDIC indemnification asset for the quarter of $6 million. Removing the change in the indemnification asset, non-interest income totals $9.8 million, representing an increase of 15% over last year. Service charges and other fees for the quarter increased by $2.1 million, primarily from the addition of the two FDIC-assisted acquisitions.

Our efficiency ratio was 65.3% for the fourth quarter of 2010, compared to 58.12% for December 31st, 2009. While we have been successfully managing our expenses, the efficiency ratio increased, due to increased expenses associated with managing our problem assets, increased regulatory premiums, and expenses resulting from our FDIC-assisted transactions. Our conversion-related expenses during 2010 been about $1.9 million. We have also invested in the future growth of the Bank by adding teams of bankers and opening new offices. For these reasons, we still expect total expenses reported to continue at these levels for the foreseeable future.

Decreases in the efficiency ratio will be as a result of increasing revenue. Compensation and benefit costs for the fourth quarter are flat, as compared to the third quarter of this year. As compared to last year, compensation and benefits increased, due to the additional staff added as a result of our acquisitions, an increase of over 30 branch locations, hiring new teams of bankers, and our de novo branch expansion in 2010.

We recorded a tax benefit of $2.3 million for the fourth quarter. The tax benefit is primarily a result of earnings from our tax-exempt municipal securities, along with other tax-exempt investments such as bank-owned life insurance and affordable housing partnerships, as well a true-up of our effective tax rate on a year-to-date basis. Historically, we have had an effective tax rate in the range of 20% to 24%. While it's difficulties to provide an effective tax rate range for the coming year, because we do not know the ratio of tax-exempt income to total income in advance, but as we move into 2011, we would expect our traditional historical rates to continue.

Lastly, our Board Of Directors declared a $0.03 dividend for the fourth quarter, an increase of $0.02. We are certainly pleased to be able to increase our dividend this quarter. We had previously paid a $0.01 dividend over the last eight quarters. The Board reviewed our dividend, in light of our current market valuation, dividend yield, payout ratio, and our desire to retain capital. At this point, I would like to turn the call over to Andy McDonald, our Chief Credit Officer. Andy?

Thanks, Gary. My comments this afternoon will be primarily focused on our loans not covered under FDIC loss share agreement. As of December 31st, we had approximately $1.9 billion in loans not covered by loss share agreements, and a little over $500 million covered by loss share agreements. For the quarter, loans not covered under loss share agreements were down about 1% from the prior quarter. Similar to the last few quarters, our construction book continues to contract, as resolution of troubled credits exceeds new production. Given that the cost to build these days is more than the cost to buy, new origination opportunities are fairly limited.

Our term commercial real estate portfolio has also contracted, thanks partly to the resolution of challenged borrowers, but also due to competitive pressures where we have seen non-bank competitors willing to refinance commercial real estate at rates below where we are comfortable from an ALCO perspective. Our emphasis on commercial banking relationships, though, continues to pay dividends. Commercial business loans were up about 4.5% for the quarter, or roughly $34 million. We continue to keep this portfolio well-diversified with no industry segment comprising more than 15%.

Some of our largest industry segments would include healthcare and social services, at around 15% of commercial business loans. This reflects our focus on professional practices such as doctors, dentists, and medical clinics. Finance and insurance follows next at around 12.5%, then manufacturing at around 12%, and finally agriculture and construction, both comprised about 9.5% of commercial business loans.

Non-performing assets in this portfolio increased to about 4.3% of the portfolio, compared to 2.4% last quarter. The increase is attributable to one large credit, which while not 90 days past due, has exhibited signs of significant stress and in Management's estimation, will likely lead to a protracted workout. Past dues were about $1.6 million or roughly 20 BPs for the quarter in this portfolio. In total, the portfolio continues to demonstrate relatively stable credit metrics, reflecting the slow economic recovery we are in.

At year-end, we had $794 million in term commercial real estate loans, down from $819 million last quarter. Approximately $328 million are owner-occupied commercial real estate loans. As of December 31st, 2010, we had approximately $38 million in nonperforming term commercial real estate assets, which is essentially unchanged from the prior quarter. As I have discussed before, included in this total is a little over $5 million in TDRs that are on accrual and performing to our expectation. Excluding these performing TDRs, our NPAs account for about 4.1% of total term commercial real estate loans.

Past dues for the quarter were 90 BPs, and looking forward into 2011, we have about $46 million, which will be maturing this year. One-to-four family residential construction loans continue to decline, and we are beginning to see a change in the mix in this portfolio, due to the conversion of A&D loans into lots, lots into houses, which are then ultimately sold. Vertical construction this time last year accounted for about 42% of the portfolio, and now it accounts for 47%. Conversely, A&D in lots accounted for 48% of the portfolio last year and now account for 39%. The change in mix is consistent with our strategy for problem loan resolutions, and we would expect it to continue as we take builders vertical in order to sell completed homes. We began the year with $63 million in NPAs and ended with about $32 million, so we were able to cut non-performing assets in this bucket in half.

Okay, we ended the year with approximately $30 million in commercial real-estate construction loans. The portfolio is comprised of 15 loans, of which three are on non-accrual, accounting for $7.5 million, or 25% of the portfolio. We did not add any new non-accrual loans into this portfolio this past quarter. The non-accrual loans are comprised of two condo projects and one retail project. Non-performing assets in this bucket were down modestly from $15.5 million to $13.9 million for the quarter.

We ended the year with about $182 million in consumer loans, down from $200 million at year-end 2009. Approximately two-thirds of this portfolio is secured by home equity. Much of the decline in this portfolio we attribute to the low interest rate environment for first home mortgages. This has encouraged borrowers to refinance their home equity loans into first mortgages. On average, our home equity portfolio has been underwritten to an average Beacon score of 731, with a loan-to-value at origination of 59%. As of the end of the year, the consumer portfolio had past dues of 64 basis points, which was essentially unchanged from the prior quarter's level of 60 basis points. Non-accruals were also essentially unchanged, at around $5 million.

Concerning the covered portfolio, it contracted $192 million since acquisition on a UPB basis, due in large part to problem asset resolution and charge-offs. Non-performing loans represent about 22% of the portfolio, and are, of course, covered under FDIC loss sharing agreements. Past dues within the covered portfolio were around 150 basis points at year-end. The majority of the portfolio is real estate-related, with both construction and permanent loans accounting for about 68% of the portfolio. Commercial business loans account for 23%, and the balance is in consumer loans. In general, the portfolio has performed pretty much as we expected. However, given the concentration in commercial real estate, our experience is, these assets will take some time to bring to resolution.

In looking at the past year, it unfolded pretty much as we expected. As we have moved through the credit cycle, we have seen a shift away from the issues which impacted the construction segments of our loan portfolio to issues which are really primarily driven by the depth and length of the current economic cycle. These influences have primarily impacted our commercial business loan portfolio, and to a lesser extent, our term commercial real estate portfolio. As a result, we saw a modest uptick of roughly $5 million or 10 basis points in our non-performing assets this past quarter. While we had envisioned a stronger recovery than what has materialized, the overall pattern and migration through the portfolio continues to play out as expected. And as expected, our overall credit costs have continued to decline, representing what we believe is a better metric of the overall trend in credit quality. With that, I would like to turn over the call to Melanie Dressel.

Thanks, Andy. At this point I would like to give you a very brief update on how we see the economy and the markets we serve here in the Pacific Northwest. While we're all certainly ready for a strong recovery in 2011, most economists are predicting only modest growth.

Washington State's Chief Economist recently said, things are looking up but it's still too early to declare victory. He believes that 2011 will be a year of transition, and that we should be growing at a respectable rate by the end of the year. Unfortunately, unemployment here in the Pacific Northwest, as well as the rest of the country, is predicted to improve only slightly and remain high throughout the rest of the year. While more jobs are being created and filled each month, there haven't been enough jobs added to cover the new entrants into the labor force, as more people are beginning to job hunt again. Of course, the unemployment rate considers only people actually looking for work.

Washington State's unemployment rate for December 2010 was 9.3%, up slightly from 9.2% in November. This is still lower than the national rate of 9.4%. King County had a better employment situation, with a rate of 8.4%, and Seattle, Bellevue, and Everett areas held steady at 9.1%. The Tacoma metropolitan area's unemployment hit 9.2% in December, and this figure was down from 9.5% in December 2009. The Puget Sound region, which is made up of King, Snohomish, Pierce, and Kitsap counties lost more than 138,000 jobs in the recession and 7.4% of work -- 7.4% total non-farm employment. By contrast, the nation lost 6% of its employment.

On a positive note, last month marked the first time since September 2008 that Washington State saw a net gain in jobs. The largest number of jobs created were in manufacturing, retail, and professional and business services. Economists believe much of this year's job growth will come from smaller companies. We're seeing definite signs of progress, however, and our economy is expected to gradually improve, driven by investments and exports. In Washington State, we are export-driven and are fortunate to have Boeing, Microsoft, Ports, and the military.

Most businesses are continuing to hesitate to hire and spend their capital due to the economic uncertainties. That being said, a survey by consulting firm Robert Half found that 90% of Washington executives surveyed, expressed confidence that their companies would grow this year, boding well for our employment rate. The Ports of Seattle and Portland continue to do very well. Both are up over 40% in container volume from 2009. The Port of Tacoma is continuing its slow recovery from the loss of a major shipping line to Seattle, finishing 2010 down 6% from 2009 container volume. However, the Port's second half performance outpaced its first half by 7%, and they expect 2011 container volume to increase by at least 4%.

Oregon's unemployment rate remained flat at 10.6%, essentially unchanged for more than a year. In fact, Oregon's unemployment rate has been between 10.5% and 10.7% for the past 14 months. However, the Oregon employment department has some encouraging results from their first Future Hiring Survey of Employers. One in three private sector employers in Oregon expects to hire workers over the next six months. Interestingly, Oregon's labor force grew quite rapidly in 2010, after contracting in 2009. For the 23rd year, United Van Lines once again has looked at Oregon as one of the high destination states, indicating that people are continuing to move to the state.

New home inventories continue to decline in the Pacific Northwest, and it's taking less time to sell a home than did it a year ago, about three months. We actually saw some year-over-year price increases for new construction in King and Thurston Counties in December. However, in general, prices are still flat or declining slightly in most of our market areas. In the metro Portland area of Oregon, median prices for new construction are continuing to decline, but at a relatively modest rate. It appears the steep declines may be behind us.

The economies of both Washington and Oregon are showing signs of slow improvement. There's certainly more optimism in terms of job growth, and there are signs of improvement in the housing market. Both states have diverse economic drivers, which should help us recover more quickly than some other areas of the country that lack the economic diversity of the Pacific Northwest.

So what are we going to emphasize during 2011? As you can hear from Andy's comments, proactive management of our loan portfolio will continue to be one of our highest priorities, and we're continuing to focus on improvement in our credit quality. We believe the actions we took in 2010 have positioned us well for the opportunities we expect in 2011. Our capital levels allow us to consider growth through additional FDIC acquisitions, although we do anticipate that the size of the remaining banks that could fail will be fairly small. We believe that by year-end we will see some semblance of a return to open bank transactions, but I want to assure you that our interest in considering whole bank transactions will be tempered by our disciplined approach to acquisitions.

As always, expense control is very important to our success. We will continue, however, to take steps with the long term in mind to increase our market share and further our position as a strong regional community bank. When it makes strategic and financial sense for us, we will add experienced bankers and branch locations to help us penetrate markets in areas important to our growth. We have a proven track record of assimilating new teams of bankers.

One of the bigger challenges I think we will face is a lackluster loan growth. Although we are continually making new loans, particularly in the commercial lending arena, line usage and demand for capital improvement loans remains weak. There are some signs of optimism in economic expansion, but we don't expect a sharp increase in loan growth in 2011. We feel very good about the position we're in today, and despite the current slow economy, we operate in a part of the country that has strong economic diversity, and we're in a position to take advantage of the many opportunities provided by the disruption in our marketplace. This is a period of time in which we believe we can make investments that will position the Company for strength as a more normalized economy emerges.

This concludes our prepared comments this afternoon. And as a reminder, Gary Schminkey, our Chief Financial Officer, Andy McDonald, our Chief Credit Officer, and Mark Nelson, our Chief Operating Officer, are with me today to answer questions. And now, Nicole, we're ready for questions.

(Operator Instructions).Your first question comes from the line of Jeff Rulis with D.A. Davidson.

Good morning, Jeff.

Hi. I wanted to know about the sequential increase in commercial loans, a pretty big jump. Was anything reclassified, or what led to that?

I'll let Mark talk about that, but I will just say that a lot of it is just good old-fashioned calling efforts.

Yes, that's basically -- we've seen growth in our middle market. In our incremental loan production year-over-year has gone up, but particularly in that category, we haven't reclassified anything. I think where we're still seeing softness is in the smaller business sector in the consumer side. So and as Andy mentioned, that's offset by our resolutions of some of our credit problems and the reduction of our construction lending.

Okay. But I guess, Melanie, you talk about lackluster loan growth. Within the C&I category, however, does that seem sustainable, some good growth in that segment, at least?

Well, we're certainly hopeful of that, and, of course, we brought on a couple of new teams of commercial bankers, and they're beginning to get some real traction. I think that the lackluster loan growth, that we will see good growth in commercial loans, but it is going to be offset by drops in other categories in the loan portfolio.

Just one other observation. Our professional lending area continues to do very well, and we expect to be able to capture more of that as we overlay that in our new footprint, and we're also taking a real close look on the ag side about what opportunities we have there. So there's some momentum in certain segments, that will certainly help offset some of the resolutions that we've got going forward.

And a question on the loan-loss provision. This looks like the first reserve release in this cycle for you, and I guess I'm trying to get to a normalized provision, if there is such a thing. Q1's non-covered provision was quite a bit lower. Any sort of comments on what to expect in coming quarters on the level of provision?

Andy?

Well, as you pointed out, this is the first quarter where we've released provision, and so I think that the next few quarters could be kind of a little bumpy, just in terms of the charge-off activity, but certainly our provision levels going into 2011 will be substantially less than what you saw in both 2009 and 2010.

Okay. Thank you.

Your next question comes from the line of Joe Morford with RBC Capital Markets.

Good morning, Joe.

Thanks. Good morning, everyone. I guess, Andy, would you please give us a little more color on this large C&I credit that came into non-accrual this quarter. How large is it, the type of business, prospects for resolution, including any of the expected loss content, things like that.

Yes. Well, without getting into too much privacy concern, it's a large C&I credit, and the issues with the credit really underlie its customers. They have rather large concentrations to a number of other businesses, which did not do well in the last half of 2010. And so when we look at the credit, and we look at their underlying, basically receivables, we feel that there is a fairly high likelihood that those will be difficult for them to collect, given the issues that are faced by their customers.

The credit itself is around $13 million in outstandings. We -- because of its movement to non-accrual, we have conducted an impairment analysis as of the fourth quarter. There was no impairment associated with that loan, but I would be somewhat cautious in that we do need to get a number of -- we do have real estate, for example, as collateral, which is securing a large portion of this loan. The appraisals on that are approximately a year old, and we do have to get those updated so we will continue to evaluate that into the first quarter.

Okay. And so there was no charge-off taken on the credit in the quarter?

That's correct. The loan itself is actually not 90 days past due. It's really -- when we became aware of some additional information, actually during the month of January, is when we decided to put the loan on non-accrual.

Okay. And then the only other question was the $1.6 million of OREO expense this quarter, was that due to valuation write-downs with updated appraisals, or some kind of loss on sale, or is it just reflective of the current ongoing carry costs?

The majority of that expense was due to valuation adjustments, and then a smaller portion of that is just ongoing expenses associated with OREO, which includes real estate taxes and utilities and all the normal stuff.

So was that just with updated appraisals and any comment in terms of trends you're seeing there as those roll through?

The two properties -- we've basically isolated that most of it was associated with two properties. One is a large lot development loan, so we did see continued decline in lot prices in the Oregon market. The other one had more to do with a condo project which is getting converted to an apartment, and as you know, when you convert those projects from condos to apartments, there's generally a large impairment because of the difference in valuation.

Perfect.

But we believe converting it to an apartment project will allow us to resolve the loan more quickly.

Okay. Appreciate the color.

Your next question comes from the line of Aaron Deer with Sandler O'Neill.

Hi, Aaron.

Good morning, everyone. Andy, just following up on Joe's question, can you give what industry the C&I credit was tied to?

It's in the finance and insurance industry segment.

Okay. And then, Gary, can you provide what the discount is, where that stands on the covered loan book?

The -- I don't have that number. Are you talking about its effect on the margin?

Well, not specifically, though. Just in terms of what the discount is, relative value versus what -- where it's being carried.

Our average, I can give you the average. I don't have the number in front of me. But our average discount hovers in the mid-70s as far as the loan book that's consolidated for the acquired loans.

Okay, I'll follow up with you after the call and we can talk about that.

Okay.

And then on the margin, I guess the core margin has continued to hold up quite well. When you're looking at, I guess, new assets coming on the balance sheet versus kind of where your average earning asset is, yield is, and opportunities for reducing your cost of funds going forward, what's your thought on the margin going forward? It seems like maybe we should expect to see some pressure I guess, as we go through the year, at least until rates eventually rise. What are your thoughts there?

And we're talking about the core margin, correct?

Correct. Correct.

Okay. Well we still feel that we have some opportunities in our core deposit base. I mean, that has always been a real strength for us as far as keeping that price competitively, but also provides us a very strong margin. Where I see some -- as we've had some weakness in the past, is our non-interest bearing balances that we have, and we did increase our investment portfolio, and I think you'd see some pressure on that yield as we reinvest those funds, as we move forward. But I think we're still seeing stability in our margin. I think we're able to make it up on the loan side, as we book the new relationships and so on, and ours you go back year and years, our margin seems to hover in the same range, since we opened the Bank. So I wouldn't expect it to move materially.

Okay. Lastly, Melanie, you mentioned that there's not an eagerness, per se, to do deals, but I'm curious, given that you are clearly viewed as a potential consolidator in the market, given your capital levels, if you have been approached by banks that might be looking to sell, or if you've heard conversations or what kind of chatter might be in the market.

Well, we are actually. We would love to acquire other banks. My comments were more intended to let you know that we're not going to do anything crazy. We're going to maintain our discipline, whether it's an FDIC deal or an open bank transaction. There is a lot more discussion right now with banks. There are Boards who are just very, very tired. And that, more than anything, I think, is an indicator that there will be some deals done this year. I mean, we're already seeing, I think that more deals have been announced in the last month probably than all of last year. So it's just a matter of really understanding and believing in the loan portfolio that you're acquiring. That's the biggest concern.

Thanks for taking my questions.

Sure, thank you.

Your next question comes from the line of Matthew Clark with KBW.

Good morning, Matt.

Hey, good morning, guys. Hey, how are you?First, on the criticized classified list, can you give us a sense of magnitude as to how much that may have come down this quarter and how much it might be down from the peak?

Yes. Hang on a second. It's down roughly 30% from the peak.

Okay. And the incremental improvement this quarter, would you say, roughly?

We achieved about 26% of that this quarter. Of the total decrease.

Okay.

So it was a very strong quarter for us.

Is it just a function of upgrades, a function of things moving off the books?

Actually, most of it was due to upgrades, Matt, as a lot of our customers that we've been able to work with over the last couple of years are finally turning the corner. They've got their balance sheets now appropriately-positioned. They've right sized their companies and they're beginning to return to profitability.

Okay. And on the C & I front, can you give us a sense for what -- it sounds like usage is still treading water, but in terms of what you saw this quarter from the sales efforts, how much of that might have been -- did you see market share pick up in a certain market from a certain bank, and how does the pipeline look going into 2011?

Matt, this is Mark. We're not seeing utilization rates go up, and that's partly impacted because of drawdowns on construction lines. We've got less construction lending, so that's a little bit of it. But we're not seeing businesses aggressively drawing their lines down. So we continue to hover pretty much where we have over the last couple of quarters there. I'm certainly hoping that does give us a bump as 2011 progresses. But we haven't seen it yet.

Again, I think where we're seeing some activity today is in our core professional lending and the turnaround of some of our C&I clients, adding some new business in the C&I category, and our focus in the year is going to be continue to try to expand in the other areas as well. But pretty soft.

Matt, I can't draw a direct line to this, but I think anecdotally that we're seeing customers that went to large banks kind of at the beginning of the financial crisis, and not because we necessarily felt that their best option was a big bank long-term, but they were looking for safety and soundness, too big to fail, and as we're out with our calling efforts, we're calling on customers who really like the community bank service, more than the big bank level of service, and I think that we'll see more and more of that this year, as people feel comfortable moving back into the community bank arena.

Just a little bit more color, Matt. Line usage actually has declined since June of this year when it peaked around 56%. And we're about 2% to 3% down now, we're around 53%, high 52% range.

Okay. And then just finally on the dividend, you increased to $0.03 from $0.01, could you argue from a core earnings perspective this quarter that's still only a 15% payout ratio. Is that fair to assume that we're going to see more increases here throughout -- whether it be this year into next, is that going to take a conservative approach to be able to increase over time?

Hey, Matt, this is Gary. I think we will certainly evaluate that on a quarter-by-quarter basis. But I think that certainly would be the trend going forward, as earnings increase. We would, of course, look to provide higher dividends, payout ratio.

Matt, that's certainly our hope.

Great. Thanks, guys.

Thank you.

Your next question comes from the line of Chris Dalton with Halpern.

Hi, Chris.

Hello. Good morning. I have one remaining question from my list. That's basically the -- I guess the competition that you mentioned from non-banks in your area on commercial real-estate interest rates. Are you seeing any competition from banks in your region that are coming in much lower than what you feel comfortable, maybe even larger institutions within the region?

Mark?

Yes, we have seen it. Where we've seen it most aggressive is on some really long-term fixed rates. We're not going to go way out on the end of that curve, and so we have seen some competition there. We've been able to do a really good job of countering some of those pricing initiatives where we are comfortable on maturity levels. We've used swaps and done some other things off balance sheet to help our clients. We've got a conduit, a couple of folks that do -- that have connections through the commercial real-estate conduits, and that's starting to come back a little bit. So we think we're in pretty good position to defend our clients.

What we've lost has been a fairly large credit to a life company. And they were willing to go out on the yield curve maturity, and price down in order to get some earning assets, because their options were pretty limited, and we chose not to do that. And also, we won't give up on covenant issues, either. So we're pretty disciplined around what we will and won't do.

Okay. Great. Thank you very much.

Thanks, Chris.

Sure.

Your next question comes from the line of Brett Robinson with Sterne Agee.

It's Brett Rabatin. Wanted to ask Melanie, as you're thinking about M&A, I was curious, you indicated you weren't going to do anything crazy, could you give us maybe some thoughts on how you evaluate potential candidates? Are you looking at an IRR basis? Are you thinking about payback on any dilution on tangible book, accretive to EPS, GAAP, year one? How do you evaluate potential transactions?

It's all of the above. All of those different factors weigh into how we analyze the potential acquisition, and, of course, having to fair-value the loan portfolio is one of the biggest obstacles that you look at a lot of these potential banks, but we still use the same factors that -- we look at whether it's an FDIC deal or not. And, first of all, has to make financial sense. The second thing is that it needs to extend our geographic footprint, and then it has to be culturally compatible. They have to have core deposits and commercial business accounts, and those kind of things, because otherwise, it's just too much of a transition.

Okay. And -

Gary, do you want to add anything?

Yes. Yes, Brett, it's Gary. Melanie is absolutely right as far as the modeling for these transactions. The fair valuation does put up a roadblock, but also, as we look at these, it's the loss that's inherent in their loan portfolios, could be tremendous that could -- that you have to kind of pull it out, and try to estimate that going forward, and that's a much larger variable as well, as we look at these. But in addition to that, it's a capital perspective, in terms of looking at the coverage ratio. The FDIC looks at the coverage ratio very closely, and also, as they approve these kind of deals. So looking at that the credit quality becomes very important in ensuring that we have enough capital today and going forward.

Okay. And then, Melanie, with your assumption that there will be open bank M&A in your area this year, does that mean given everything that's been said, that you expect it to be on healthy institutions with relatively modest loan marks, as opposed to more distressed transactions?

Yes, on an open bank transaction, that certainly would be the case. There are still going to be FDIC deals that are going to get done, but when we compare them to the ones that we did last year, the FDIC, the P&A agreements are much different, and the loss share is much different. So that adds a different dimension to the metrics, and the banks that are pretty much left are very small, but we would look at each and every one of the potential deals, and we model things proactively as well. With the idea of, how could we make this work, because we do feel as though there are going to be some tremendous opportunities. We have a wish list that we have identified, and so I think that the open bank, healthier bank could be an interesting possibility for us this year.

Okay. And then I had one follow-up on the covered portfolio. Excluding the impact of any loan dispositions or amortization of the indemnification asset, can you talk about the credit discount, how that's trended the past two quarters and if that might -- if a decrease in the credit discount might positively impact EPS in the next few quarters, based on what you're seeing?

Well, for the fourth quarter, I don't believe the -- well, we had -- we did have a discount, but it was related to the timing of the cash flows. I mean it was all related to cash flows. But as far as the credit issues, I believe Andy can confirm this, but our portfolio is performing better than we had expected, than when we -- initialled from day one.

So if you had a decrease in the credit discount, would that not have a more positive impact potentially? I mean, obviously, there's a give up there in the fee income side, but the credit discount improving would have a positive impact.

That's correct. And as far as running this model, we are learning more and more as we go through each of the quarters. And we've developed some tools to refine the way we look at the model and to test the model this quarter, and there was some, and we booked some adjustments proactively, and I think going forward, you might very well see that, what you just mentioned.

The only thing I would add is the complexity in terms of modeling cash flows is that the portfolio getting healthier could actually extend the life of the portfolio and the life in which those cash flows will be received. And so then when you net present value that, it could actually end up with a lower value. So there's -- it's difficult to isolate to one component and say, if that got better, would it necessarily increase income for the bank.

Okay. Yes. That's a good point. Thank you.

Your next question comes from the line of Jonathan Elmi with Macquarie.

Hey, good morning, guys. Thanks for taking my questions.

Good morning.

Just a couple of quick housekeeping items at this point. Any color on the securities portfolio, just in terms of what you guys are buying and where the duration stands as of the fourth quarter?

In terms of what we purchased in the fourth quarter, we did look for some mortgage-backed securities that are government-guaranteed, and we look for 10 years dated final. We are -- we don't want to go too long, so average lives, into the three to four years, three to four-year range, we did have some opportunity to buy some municipal obligations as well, in some very strong locations. And we did -- we've actually upped our criteria for buying municipals. We're looking at underlying ratings of AA or above, or if they have state guarantees or other insurance.

Of course, what we add today, of course, would bring the overall yield down on the portfolio in total, but certainly in terms of dollars to the bottom line, it certainly helps that. I think we have the position now where we feel that, and we have felt this over the last several years, that if we wait for rates to go up, we miss a lot of income. So we have invested over the last several years, and including last year, but we do look at it in terms of cash flow.

Okay. And then do you have an estimate for what the weighted average life of the portfolio is roughly?

Weighted average life of the portfolio runs between four and five years.

Okay. And then just one other quick follow-up question, too. Do you have the inflows into non-performing loans for this quarter? What the gross in flows were?

Andy is looking.

For the quarter. I've got year stuff. Can I get back to you, Jonathan?

Yes, of course. That's all I've got. Thanks very much, guys.

Thank you.

And there are no further questions at this time.

Okay. Well, thank you all, and we'll look forward to talking with you next quarter.

Thank you for participating in today's conference call. You may now disconnect.