First Financial Bancorp (FFBC) 2010 Q1 法說會逐字稿

Good morning and welcome to the First Financial Bancorp first quarter 2010 earnings conference call and webcast. All participants will be in a listen only mode. (Operator Instructions). Please note this event is being recorded. I would now like to turn the conference over to Mr. Ken Lovik. Sir, please go ahead, sir.

Thank you, BJ. Good morning, everyone and thank you for joining us on today's conference call to discuss First Financial Bancorp's first quarter 2010 financial results.

Discussing our operating and financial results today will be Claude Davis, President and Chief Executive Office; Frank Hall, Executive Vice President and Chief Financial Officer; and Richard Barbercheck, Executive Vice President and Chief Credit Officer.

Before we get started, I would like to mention that both the press release we issued yesterday announcing our financial results for the quarter and the accompanying supplemental presentation are available on our website at www.Bankatfirst.com under the investor relations section.

Please refer to the forward looking statement disclosure contained in the first quarter 2010 earnings release as well as our SEC filings for a full discussion of the Company's risk factors. The information we will provide today is accurate as of March 31st, 2010 and we will not be updating any forward looking statements to reflect facts or circumstances after this call.

I will now turn the call over to Claude Davis.

Thanks, Ken. And thanks to all of you for joining our call today. Once again this has been an eventful quarter for First Financial. We are pleased with our overall performance and Frank and Richard will provide more color on specific drivers related to financial and credit quality topics.

We have provided a tremendous amount of information today on the Company's performance, but I would like to highlight a few areas before we get into the details. As we discussed in our fourth quarter call, we concluded a common equity raise in early February, raising a net $91 million in new equity. On February 24th, we fully redeemed the $80 million of CPP preferred shares issued to the US Treasury. The net impact of these transactions improved our GAAP and regulatory capital ratios, and at March 31, we had a tangible common equity and tangible assets ratio of 9.7% and a total capital ratio of 19.2%. Our tangible book value per common share increased from $10.43 per share at year end to $10.96 per share at the end of the first quarter.

We believe our capital strength combined with the experience we have gained in our recent acquisitions positions us well to evaluate new opportunities. As we have said before, we adhere to strict internal requirements regarding long term strategic value and we will not compromise on those.

In addition, we continue to build our risk management systems to better manage our larger organization and prepare us for the future. The operational and core technology integration for Irwin was successfully completed during the first quarter, although some final integration efforts will be completed throughout 2010.

You will recall that our integration efforts for the Peoples Community transaction were concluded in the fourth quarter. All First Financial clients can now transact their business at any of our 115 locations in our strategic operating markets.

Successful integrations certainly speak to First Financial's ability to maximize shareholder value and also to the skill and dedication of our staff. Again I thank them for their efforts.

Liquidity also remains very strong as we have retained in excess of $700 million of cash invested short term on our balance sheet, and our new deposit generation and client retention efforts are proving successful. Our retail staff has aggressively embraced our sales initiatives and we are seeing the positive results. We continue to prudently price in all markets and believe depositors recognize the strength of our balance sheet, client service capabilities and ability to creatively meet their needs. Excluding the planned deposit runoff of the Western markets as well as the repriced broker deposits, linked quarter annualized deposit growth was approximately 5%.

One quick comment on credit quality. While certain economic indicators have been trending up recently, the overall economic environment remains uncertain and we believe consistent with many in the industry continued stress in the commercial real estate portfolio is probable. Not only does the economic uncertainty potentially impact the existing portfolio, it mutes the willingness to borrow and the quality of potential deals. Even though we continue to lend in our strategic markets, we experienced a 2.7% linked quarter decline in our legacy loan portfolio. Strength of capital, a solid liquidity position, strong sales culture, and skilled credit management are just a few of the factors that we believe will continue to propel our company forward.

With that, I'll turn the call over to Richard for further discussion on our credit quality and related topics for the first quarter. Richard.

Thanks, Claude. I'd like to make a few comments regarding our overall credit quality, some specifics on the quarter, the competitive environment and its impact on our lending activities, and finally, the management of our covered loan portfolio.

Let me remind you that when we talk about credit quality, the allowance for loan loss and other metrics, we're referring to the legacy portfolio, which is not covered by FDIC lost share agreements. The covered loan portfolio does not have an allowance for loan loss, but we are indemnified by the FDIC for losses in accordance with those lost share agreements.

Credit quality remains challenging but we are encouraged by recent economic news and what appears to be rising consumer confidence and spending. Commercial and commercial construction categories are still experiencing the most stress, but we continue to work closely with borrowers. Our 30 to 89 day total delinquency levels have remained relatively stable over the past few quarters, and we aggressively monitor our larger relationships.

We have 39 relationships greater than $10 million, and they've totaled approximately $500 million in outstanding balances. A contributing factor for recent volatility in our credit quality metrics has been the loan size and we stay on top of those credits.

First quarter net charge offs of $14 million or an annualized 2% of average loans included an $8.8 million relationship that was a result of alleged fraud. The majority of this relationship was in fact reserved for in the fourth quarter and as more information became available, it was charged off during the first quarter. This charge off represented 1.25% of average loans for approximately 60% of the charge offs in the quarter. Our allowance for loan loss -- loan of lease loss at 2.01% period end loans was relatively stable at the end of the first quarter as compared to 2.05% at the end of our fourth quarter.

Coverage ratios as compared to the fourth quarter remain stable as well with the allowance to nonperforming loans of approximately 85%. Total nonaccrual loans declined on a net basis during the quarter, primarily due to the previously mentioned alleged fraud related charge off and the transfer of four commercial land development properties, one relationship, totaling about $15 million into our REO. The most recent appraisal to the properties indicate that we're fully secured, although, until the land is liquidated, the actual value realization may differ.

Several acquisition and land development loans were transferred to nonaccrual status during the quarter, but our overall land development portfolio of approximately $71 million remains a small segment of our loan portfolio.

Loan demand remains muted and we experienced a slight net decline in the uncovered portfolio, but we're still lending when opportunities fit our underwriting requirements. Included in the Irwin acquisition was a specialty lending business that caters to the quick service and casual dining franchises. Again, this is a business that we had previously purchased participations in, and there is a very experienced team in place for that activity. It provides a risk appropriate geographically diverse earning asset that has a strong history of performance. We intend to support this business and manage it to a size that is commensurate with the risk appetite of First Financial.

As we manage our loan portfolio in the future, it's important to recognize that approximately 39% of our loan portfolio will be covered by an FDIC loss share agreement. As such, we have dedicated considerable resources to building the appropriate compliance and management infrastructure to support this now significant component of our franchise. First Financial has established separate and dedicated teams of credit specialists to deal with the covered portfolio both by product and geography. They are provided extensive support by our legal, finance and technology resources in order to execute and monitor all activity related to the loss share agreement. As you would expect, we manage these credits as we would our legacy portfolio, which is to maximize their value.

With that, I'll turn the call over to Frank for our discussion on financial performance for the quarter. Frank.

Thank you, Richard. First I will provide a quick overview of the quarter and the major components of performance and then I will discuss the supplemental information that was furnished separately and is available both on our website bankatfirst.com in the investor relations section and as part of the FNL webcast support and also in an 8-K filed this morning. This supplement is crucial to establishing a clear understanding of our reported results and an understanding the concepts that have a material effect on our current and future performance.

First quarter 2010 earnings per diluted share were $0.17. When taking into account adjustments consistent with our guidance provided in the fourth quarter 2009, earnings for the first quarter 2010 were approximately $0.33 per diluted common share. These adjustments include only a $2.3 million reduction in non-interest income and a $14 million reduction in non-interest expense. These items include expenses associated with transition, support of non-strategic locations and other items not expected to recur offset only by gains associated with sales of covered loans. This estimate also includes the $0.02 for diluted common share impact of a higher share count relative to the fourth quarter 2009.

First Financial will no longer provide guidance on the components of earnings as it has in the past. This decision is driven by the unpredictability of certain material items which we will discuss. As noted in both the tables and section 2 of the earnings release, we will isolate these material components and speak to our experience and provide insights, but will not guide to a specific number.

As Claude noted, our results were in line with our expectations and there is considerable detail provided in the earnings release in the accompanying tables. I will highlight a few items from the earnings release tables and then, in the interest of time, move quickly to the supplemental information to provide a clearer picture on what has emerged as a widely misunderstood topic in the industry.

One quick item of note is on our net interest margin increase of 24 basis points over the linked quarter. The improvement was due to the combined impact of a linked earning asset base and a 9 basis point impact of the linked quarter loan fee adjustments largely attributable to the acquisition. Covered loan runoff accounted for a 12 basis point decline, largely offset by an 11 basis point improvement in certain brokered and retailed CD costs.

Table 1 in the earnings release highlights some significant items specific to the other non-interest income category. Table 2 highlights significant items related to non-interest expense which are generally included in the other expense category unless classified further in Table 9. Table 9 lists both income and expense items that are specific to acquired businesses and the related support costs.

I will note that the timing of these income items is unpredictable, but the expense items notes will diminish over time as our integration concludes. It is expected that virtually all integration costs will not extend beyond the second quarter of 2010 and the ongoing support costs too, will diminish over time, but over a longer time horizon. And lastly, Table 10 presents a progression of our covered loans, which is a declining portfolio. As we will discuss later, the source of the decline is an important item to note.

I will now invite you to turn your attention to the separate presentation titled First Quarter 2010 Earnings Release Supplemental Information, Covered Assets and Acquisition Related Items. If you would turn to slide 3 in the supplemental information, we have illustrated our revenue by source, strategic, acquired, non-strategic, and the accelerated discount on loan prepayments and dispositions. The strategic portion is the part of our franchise that we intend to support and grow and includes both our legacy businesses and a portion of the acquired businesses. This represents approximately 81% of our total first quarter revenue.

The second category is the acquired non-strategic, which represents the portion of the acquired businesses that we will manage for maximum value upon disposition, but will not seek to replace. This represents approximately 12% of our first quarter revenue.

And lastly, the accelerated discount on loan prepayments and dispositions. Just as the realization of the rates and/or credit valuation mark that was reported at the acquisition date, this acceleration can be driven by full or partial prepayment, charge off, loan sales, et cetera--in other words, anything that will reduce the carrying value of the loan faster than what was originally projected. This repesents approximately 7% of our first quarter revenue.

Illustrated on slide 4 is the percentage of our loan deposit portfolios that we currently consider strategic versus acquired non-strategic. Approximately $539 million or 10% of our total deposits are considered non-strategic and are expected to run off during 2010. These include approximately $300 million in brokered CDs. The balance of the deposits are in our Western markets which we intend to exit. All deposit runoff will be funded with the cash that we have retained on our balance sheet.

Approximately $716 million or 15% of our total loan portfolio is considered non-strategic. We have a separate group of credit personnel that are working with each of these borrowers to establish the appropriate exit strategy. The acquired non-strategic loans may be on our balance sheet for several years producing income and the pace of disposition at this point is not easily predictable.

Slide 5 is perhaps the most constructive in illustrating the concepts and the materiality of First Financial's acquired covered loans. The pie charts illustrates at acquisition, the total valuation allowance recorded on acquired covered loans. The rate based evaluation component represents the carrying value adjustment required to establish the appropriate effective yield for acquired loans. This component of discount will be recognized into earnings through net interest income if the borrower pays according to the expected time horizon. If, however, any event occurs that reduces the carrying amount of the loan faster than what was originally projected, such as full or partial prepayments, charge off, loan sale, et cetera, then the full or proportional share of the rate based discount is accelerated and is recognized in non-interest income.

It is important to note that this component of future value will be recognized regardless of any future change in experience or assumptions. The only uncertainty related to this value is timing and the classification on the income statement. Additionally, the credit based valuation component is determined by establishing an initial estimate of future losses on the acquired portfolio.

The cost of these loans are covered under FDIC loss sharing agreements. There is an offset to the overall credit [march] to account for this expected indemnification. Therefore, the total credit based valuation component is split between First Financial and the FDIC. This component will not be recognized in the earnings if our credit experience occurs as originally estimated or worse than originally estimated. However, as our actual credit experience differs from original assumptions, there will be additional non-interest income if our experience is better than original projections or non-interest expense if a loss is greater than projected.

As our credit outlook on remaining covered loans may change over time, any adjustments to that outlook will be reflected in prospective yield adjustments on both the covered assets in the indemnification assets. Approximate dollar values of each component at acquisition date are noted below the pie chart.

On slide 6, I have illustrated two examples of early disposition. Scenario 1 illustrates a no loss scenario, which is similar to our loan sales in the Western markets where actual credit losses are below expected losses, and scenario 2 illustrates higher losses than expected. Both scenarios assume an unpaid principal balance of $1 million in a rate basis and credit based valuation adjustments similar to our get one valuation, where there is a total valuation adjustment of 21.8% comprised of a $56,680 rate based adjustment and a $161,320 total credit based valuation adjustments of which $129,056 is expected to be indemnified by the FDIC.

In scenario one, there is no loss, and as a result we recapture the full rate based and credit based discounts offset by a $129,056 FDIC indemnification asset impairment. The FDIC indemnification is impaired due to the adjustment in expected future cash flows due to the payoff of this loan. Both the rate and net credit based entries recorded as additional non-interest income.

In scenario two, there is a total credit loss of $500,000, which is $338,680 worse than the originally estimated $161,320. As a result of the greater credit loss, the FDIC will indemnify First Financial for 80% of the additional loss or $270,944. But we have to absorb the 20% share as an additional non-interest expense. As you can see on the lower right portion of the slide, we still receive full value for the rate-based discount reversal, but it will be more than offset by our share of the additional loss producing a net negative impact to earnings of $11,056.

The actual recognition of these components for First Financial is summarized on slide seven. The additional non-interest income from better than expected credit performance was $2.8 million and $1.8 million for the fourth quarter 2009 and the first quarter of 2010 respectively. And the acceleration of the rate based valuation adjustment was $5.4 million and a $4.3 million for the fourth quarter 2009 in the first quarter 2010 respectively.

Noted on table nine in the earnings release and later on slide 18 of the supplement, non-interest expense related to our promotional share of additional credit losses in $763,000 and $1.9 million for the fourth quarter 2009 in the first quarter 2010 respectively.

Overall our credit performance has been slightly better than original expectations--however, not significant enough to prospectively adjust the accretible yield on covered loans.

The pie chart on slide 7 is an approximation of the remaining valuation adjustments as of March 31, 2010. There are approximately $130 million or a $1.46 per share remaining in unrealized rate based valuation adjustments. Again the timing of this recognition is unpredictable.

On slide 8, we have summarized our components of non-interest expense and highlight that approximately 76% of our period expenses are for the ongoing support of our strategic operations. This is consistent with our expectations and we will remain committed to managing to between a 55% and 60% efficiency ration for our strategic businesses going forward.

Also noted on this page is the trend of FDIC indemnification support costs. As the level of covered assets decrease, so should the support costs. However, the agreements with the FDIC cover a maximum period of service of ten years and there will remain some level of support cost for that time arising.

For the first quarter of 2010, the FDIC indemnification support costs were $605,000. Remaining in the supplemental information are reprints of the tables from our earnings release.

This concludes the prepared comments for the call. And I will now open up the call for questions.

(Operator Instructions). Our first question comes from Scott Siefers from Sandler O'Neill Asset Management. Please go ahead.

Good morning, guys. Let's see I just -- I guess I want to make sure that I understand all the ins and outs, so most of my questions will relate to kind of Table 9 on page 11 of the release. So I guess I want to make sure that the $10.9 million of NII that's associated, I think with the $716 million o non-strategic loans. Do you guys feel like you can keep that $10.9 million or some high level of NII up for a period of years? Because those loans are going to stay on the balance sheet -- on the balance sheet even though the deposits will be going away this year. Is that a correct statement?

That's correct, Scott.

Okay. So and that's basically why when we pull out some of the things but leave in others, you -- that $10.9 million sticks with us whereas the cost that you guys are pulling out, those will go to zero pretty quickly. Is that fair as well?

That's correct. And if you think about in the slide when we talk about the expenses and components of them, in many of the expenses that we're currently incurring are transition related or integration related. So those have a pretty short lifespan to them. But he cost associated with the ongoing support of the non-strategic components is relatively small, but it will be around for awhile.

Okay. And then that actually segues right into the follow up that I had if we've got kind of the four main components of unusual expenses, the $2.2 million non-strategic operating, $2.6 million acquisition related, $6.3 million transition related and $1.9 million related to the mark. So the $2.2 million, those will go away pretty quickly. Was that correct?

There's a portion of them that should transition fairly quickly, yes. So when we're talking about for instance the occupancy expense there, we don't expect to have that after we've closed the offices.

Okay. And so that would be sometime in 2010, I guess, right?

That's correct.

Okay. And then the $2.6 million, those will go away in the same kind of time frame?

That's correct. We don't expect to have those types of expenses in a material way beyond the end of the second quarter.

Okay. And then the $6.2 million is that -- or excuse me $6.3 million that's the piece that will stick with us for a little bit longer but trend toward zero?

Yes. And I would say that the timeline on that should be relatively fast as well included in that salary and benefit line item by way of example is temporary help associated with the data processing integration, which has completed.

Okay. Okay. And then how you -- switch gears for just a second. So it's a little noise in the margin this quarter. Do you have a sense for where we should anticipate that's a trend and then as well, a little noise in that charge off number. It would been around 75 basis points. Is that something you think is sustainable or I guess, where is the run rate charge off level going to be upwards of the level including the fraud related or down towards the ex-fraud?

Okay. I'll answer the margin question and then Claude will take the credit question. On the margin, I would expect it to be -- I'll call it noise similar to what we saw this quarter, albeit the loan fee related items should not recur. But depending on the pace of the runoff of the deposits and depending on how the covered loans runoff over time, there will be a mixed shift in both of those categories. But overall I don't expect tremendous volatility in what I'll call the core margin number going forward.

Okay.

And, Scott, this is Claude. On the charge off issue, clearly this quarter's were elevated due to the fraud and the significance of that to our overall charge off. We're not, obviously, providing guidance on charge offs. And what I would say is we were pleased that excluding the fraud, we saw some moderation of the charge off number.

But I still think until we can get through this period of commercial real estate stress and the unemployment begins to decline, what I would suggest is that charge off number will be a volatile. I think we'll have some good quarters, but also some challenging quarters. So I wouldn't want to predict a stabilization of 75 basis points, but I think you're going to see some continued volatility in that number.

Okay. Great. Thank you very much.

You bet.

Our next question comes from Dennis Klaeser from Raymond James. Please go ahead.

I'm sure my first question is just a technical accounting question for you Frank. And you itemized this in Table 1 of the press release. When it comes to the accelerated discount of related to risk based valuation marks, you explained in your prepared remarks that if it comes through sale or prepayment, that is going to be recorded in non-interest income rather than in the margin. I thought the valuation mark related to rate, would always come through margin. Is that something unique for covered assets?

I don't believe it's unique for covered assets but that is how we are recording that item.

Sure. Okay. So I'd assume that was going to come through margin and so if it's -- since it's not in margin, your core margin trend is much stronger than I had expected and I may have missed this in your response to Scott's comments. But --

And Dennis, if I could maybe clarify a point on that. There's a difference between when a loan is no longer on our books or there's a reduction in the carrying value versus a change in the rate outlook. And the latter of those, the changes in the rate outlook is something that will impact the prospective yield of the portfolio. So when there's an actual disposition, that's when you see the recognition through non-interest.

Okay. Okay. And, again, I'm sorry. In terms of the outlook for the margin I -- and you may have responded to Scott on this, but are there components of the margin that you experienced in the first quarter that would not be continued going forward.

Well, again, I'm going to avoid offering margin guidance here, but the -- certainly the impact of the nine basis points fee adjustment I would not expect to recur and then I would just say the rest of the change would be attributable to the repricing characteristics of the balance sheet.

Okay. Got you. And maybe just the big picture question for Claude. Could you give us maybe an update on if there's any changes to your outlook for potential and timing of FDIC assisted deals that you might have an interest in and/or unassisted deals and have your -- has your view on sort of the geography that you're going to be looking at. Has that changed at all?

Dennis, we are still committed to our core kind of four-state market area. We think that's the right market of us. It's what we know well and we don't, at least at this point, have not -- no plans to extend beyond that.

As it relates to other consolidation, as I mentioned in my remarks, I think we have proven our ability to do deals, to do them quickly and to integrate them effectively. And I feel very good about the staff's readiness to do that not just kind of from a data perspective, you know, which are operations and IT staff is doing a tremendous job in getting that accomplished, but I'm most pleased with the cultural integration that's occurred and with how quickly the staff that had joined us from the Peoples and Irwin have embraced kind of our approach to the business and the sales approach most specifically. As it relates to future, I obviously won't comment other than to say that I think we have the balance sheet capability. I think we have the operational capability. We're certainly working on things since we are a larger organization today to make sure that we're ready in case that opportunity would present itself and things like making sure that we're making investments in good risk management systems and that we're able to effectively manage what would even be a larger organization if that opportunity would present itself. I wouldn't comment whether future FDIC deals are non-FDIC deals are in our future other than we're just trying to do our job to make sure we're ready in the even a good opportunity presents itself.

Okay. Great. Thanks, guys and thanks for the very detailed disclosure in your release. Thanks.

You bet.

Our next question comes from Joe Stieven from Stieven Capital. Please go ahead.

Good morning, Frank. Morning, Claude.

Hi, Joe.

Listen, Dennis just actually had my got my last question. But I would also commend you. Your disclosures are by far the best of anybody in the country. So thank you.

You bet.

Thanks, Joe.

Do you need to ask any other questions, Mr. Stieven?

No. I'm fine.

Okay. Would we'll go to our next question which is Eileen Rooney from KBW. Thank you. Please go ahead.

Good morning, everyone. I just had one follow up question. I guess it relates to the balance sheet side going forward. It seems like the loans goes non-strategic loans, they're not moving off anytime soon. But those deposits, that $539 million, we should expect that to come down. And assuming securities are liquidated, that your maintaining will come down by a like amount. That's really kind of the move in the balance sheet we should expect going forward?

That's correct.

Yeah. And I know what we've done is we've specifically as I mentioned to Mike how we've retained a lot of excess cash, which obviously hurts our short term margin, but for the express intent of being able to liquidate those non-strategic deposits.

And that will be in the near term?

Throughout 2010.

That's right.

Okay.

There's a bulk of that that we mentioned that's about $300 million of brokered CDs that we will in effect redeem at maturity.

Okay. And timing wise are they in any specific quarter of this year? Can you give us any guidance on that?

No. Nothing specific to quarters.

It's really spread throughout.

Okay. Okay. That's all I had. Thanks.

Great. Thank you.

Thank you, Eileen.

Thank you. Our next question comes from [Greg Rolle] from Robert W. Baird. Please go ahead.

Thanks. Good morning.

Hi, Greg.

Also echo the comments about the disclosure, very good stuff there, but as we sit now it sounds like the Western market offices have been closed except for two that are still open. Is that correct?

That's correct.

Okay. And Frank on the -- I see as get the net interest income and tax from the -- I guess from the covered assets that you disclosed. Anyway you could break that down to the interest income. Is that an interest expense that we have what's going through the yield and through the funding costs?

Oh, you're saying that the $10 million or what's interest income versus interest expense?

Yeah. We have not disclosed that. But the yields on the loan -- or excuse me, yields on the deposits that we have identified are not -- they're not dissimilar from like categories on the legacy portfolio.

Okay.

It's just heavier weight toward broker CDs than the rest of the portfolio would be.

Right. Okay. Yeah. Just trying to understand kind of what the yield on the covered loan portion of the portfolio is.

That's in net interest income.

Sure. And if you refer back to the 8-KA that we filed in December of last year, we disclosed what the yields on the discovered loans were.

Okay. Thank you.

Thank you.

Our next question comes from Jay Willadsen from Lee Munder Capital. Please go ahead.

Hi, guys. Longer term to you -- if I look at your ROA over history, it's bounced around from 1 to 1.5 and I guess once kind of all the noise dies down, what do you see this franchise -- what do you think it can do on ROA basis and possible an ROE basis and just trying to get to a true normalized level for you guys?

Sure. This is Frank. You know on the ROE I would tell you that that would be a difficult answer for anyone only because I don't think anyone knows what the equity requirements are going to be going forward. But on the ROA as we look at this, we certainly think that a one percent or better ROA is achievable. As interest rates would increase, certainly that helps but in that 1-ish and 1+ range, it's certainly what we're targeting.

Okay. Thank you.

Thanks, Jay.

Our next question comes from Daniel Cardenas from Howe Barnes. Please go ahead.

Good morning, guys. Just a couple quick clarifications here in terms of the FDIC-assisted transactions, if I'm understanding correctly, sounds like you guys are ready to go quickly here?

We are.

Yeah. We feel good about what that as it relates to the integration and so we have a little bit more work to do but we're in a good position.

In terms of size of potential institutions you would acquire is there any limitation that you wouldn't go above?

Well, what we have always said is that we really evaluate three key criteria, and we've stuck to those as we've evaluated any opportunities including the two we did last year and that is first, is it strategic and in our market area? Second, can we manage it operationally and we put lots of things in that operational questions including our risk management infrastructure and ability to manage it effectively. And then third is it -- can we price it appropriately? And we stick very kind of firmly to all three of those principles. So to the extent we saw an opportunity that said all three in that order, then we would certainly consider it.

And just in terms of your TC ratio maybe you're near 10% now. How low would you feel or how comfortable would you feel going down -- pulling down that ratio?

Certainly we'd feel like it's very strong and with a potential opportunity, there'd be some ability for that to decline. We're not going to give a specific number, because it will be deal specific or situation specific, and it's as Frank said, we're also eagerly awaiting any new regulatory guidance on any new capital expectations that are out there. So I think that it's a good thing for us in our balance sheet both from a capital liquidity in we feel like we are positioned to both deal with any new capital standards, but also to evaluate new opportunities.

Okay. And then just one quick question on credit quality. As I look at your restructured loan portfolio here, can you talk a little bit about how that's performing and then can you maybe shed some light in to see as to how you see that portion of your non-performers trending over the near term?

Sure. Thus far I would say, you know, that that portfolio is relatively small, and a lot of that has happened in the relatively near term. Thus far they've performed as we expected them to, but I would also say that as we go forward and we work with clients, especially if the economy begins to improve, you may see us do some more restructurings because we think it's the right thing to do for our clients and a term value for us. So I would expect that number to increase over time. We can't give a guidance number on that because we don't know. It becomes very loan specific.

All right. Thank you.

You bet.

Thank you. (Operator Instructions). Our next question comes from Justin Maurer from Lloyd Abbott. Please go ahead.

Morning guys. Just a quick follow up on Dennis's accretible yield question. Frank, I have the 8-K in front of me where you laid out kind of the [loan] portfolio—what the [yield] was. But just kind of in rough terms, since on prepayments and such that you're taking through non-interest income, how much just kind of roughly -- is the margin higher as a function of mix of assets with higher yields versus any kind of accretible yield component? I mean it's vastly a function of just Irwin's asset yield is higher?

No. It's the weighted average effective yields on the acquired portfolio. That acquisition was a 922. And in the fourth quarter release I believe we disclosed a 78 basis point contribution of that higher earning asset rate. But as we've talked about over time and I think to your point, as those covered loans at that higher yield run off, that is going to impact our margin.

Yeah. But it's more a function of the runoff as opposed to any artificial boost you're getting just through accretible yield discount, right? Or?

I'm not sure I understand your question.

Well, just I understand you're saying, hey don't expect the margin to stay this high. It should run down over time as some of those assets run off. That's clear. But is there any additional boost that you're getting from any accretible discount. The fact that if you mark that loan to $0.80 and the guy's still paying you the contract rate on an assumed 100 cents, does the math work such that that yield, stated yield is even higher, effective yield is even higher because you --

No. No. No. I understand your question. The 922 captures what you just described.

Got you.

The contractual payment on a discounted carrying value.

Okay. So it comes down or it moderates just as those loans run off, but that's it. Okay. Just next question Table 9 and the three components of what runs off. How much of that just generally is a function of the couple branches whatever that remain open versus corporate expense, if you will?

I would say the -- well, it's noted somewhat specifically on there so the operating expenses for acquired non-strategic office of the $2.2 million in the period. Again the bulk of that is related to the Western markets, the rent expense out there. So as those close, those go away. And then the professional service and the acquisition related costs, that should have a pretty quick exit period. And the transition related items, again, should run off fairly quickly. It should stop fairly quickly.

But shouldn't that $605,000 indemnification support that you expect to stay on?

That's correct and it's similar to the chart that we had in the back. There's a trend line to expect around that.

So I guess just on that $605,000, that seems like a pretty modest amount given like you said, in the last six months have been talking a lot about, hey we've got a lot of people that we're throwing at this thing to make sure we got all I's dotted, T's crossed and we have support from legal, operations, IT and that some of that would be shared services so it's not necessarily an incremental cost. But I guess I'm somewhat surprised that it would be that modest of a cost going forward because of the tail on these assets up to ten years, although it's obviously not going to be that significant then. But--

Right. And we're still building there. So I wouldn't expect that to be the high point.

And then just lastly on commercial real estate or just credit in general to Rich's points. You mentioned that the construction piece is pretty small, $70 million, I think and Presley Stephens says that that was down. Inflows were down. What components or asset classes or what have you do you guys still feel a little bit queasy about?

I think there probably too many banks out there wanting to claim victory so far that that the commercial real estate problems are behind us. But it just seems like relative to your size of troubled assets vis a vis other banks that are -- that were giving them fits. Yours is smaller and yet, it seems like others are inflecting maybe a little bit sooner than yours. Are there just a couple lumpy credits in there or certain property classes and [sense] that your otherwise are being problematic or what?

I'll start and then I'll let Richard kind of fill in too his thoughts on some of the other asset classes. But yes, Some of the charge offs we have seen and I've mentioned on I believe that last quarters' calls about the lumpiness of individual larger credits that tend to inflate either both nonperforming and or charge offs similar to the fraud we had this quarter. So I would say that's what you've been seeing around and that's when I talk about volatility. That tends to be what drives the volatility of those numbers are one or two kind of larger deals.

At the same time from my perspective the biggest area of concern continues to be commercial real estate and anything associated with consumer -- at least until we see a somewhat of a moderation and decline in the unemployment levels.

I don't know, Richard if you had anything specific in terms of categories.

Yes. I think the experience we've got in the portfolio as far as quality probably isn't that much different than ours. We continue to see some stress in that commercial real estate segment include the retail, the office, some of the multifamily stuff. But it's not growing at a rate that would cause us any real concern at this point.

The land acquisition and development future reference to $70 million has been proactively managed throughout the whole downturn recessionary period. And I think our experience to some of those -- some of that stress was somewhat delayed by just being proactive. But at the same token we're pretty comfortable we've got that just where we need to have it.

Okay. And just Claude on the -- it's asking about further opportunity should they come your way. How much now that you guys have a nice platform to maybe roll these in vis of vis others because you spent a lot of time dealing with this the last nine months. Clearly it seems like the prices of assets will go up as people certainty around -- there's certainly more liquidity in the market, but just as asset values have stabilized and maybe have risen in some cases that folks are feeling more confident about what they can pay. So I just -- I don't know what your thoughts are on another Irwin type of opportunity coming by you is probably less likely at this point, but what are your thoughts about -- (inaudible) are now talking about 80/20 all the way through or maybe in some cases like [DeSong Ford] a 50/50 is being a function of the number of bids and you've got a lot of banks out there who have promised their constituents that they be participating and have yet to do so, so that there's probably some pressure on those folks that -- to kind of put their money where there mouth is. There's a lot to deal with it seems and versus the opportunity you guys had last summer.

I think that's exactly right, Justin, and I, we, I think stuck to our disciplines when we priced the Peoples and Irwin deals and especially in the Irwin deal, we felt like we priced it very attractive for shareholders, but yet fair considering the complexity of that deal, and as we've disclosed this quarter, you can see the significance of the operational issues that we're having to work through. So it's like the price was justified in that context.

Going forward, you're right. I think pricing has improved for the sellers whether that be FDIC or non-FDIC. We're going to stick to the three principles that we feel strongly about and make sure we adhere to those and not feel pressure to do anything unless it fits those three criteria.

Okay. Thanks a lot. Appreciate all the detail.

Thank you.

Ladies and gentlemen this concludes the question and answer session for today. I'll turn it back over to Mr. Davis for any closing remarks.

Thanks, BJ. And I again thank everyone for joining us today. Again, we know that our detail was a lot, but we felt it appropriate based on the kind of the complications of this type of a deal and certainly the significance of it to our company. So I hopefully that's helpful and we look forward to talking in future quarters. Thank you.

Thank you. The conference is now concluded. Thank you for attending today presentation. You may now disconnect.