First Merchants Corp (FRME) 2009 Q3 法說會逐字稿

Hello, and welcome to the First Merchants Corporation third quarter 2009 earnings call.

All participants will be in a listen-only mode for this event. (Operator Instructions). We will be using the user control slides for our webcast today. Slides may be used by following the URL instructions on page two of the First Merchants' news release dated November 2, 2009, or by visiting the First Merchants Corporation shareholder relations website and clicking on the webcast URL hyperlink.

During the call, Management may make forward-looking statements about the Company's relative business outlook. These forward-looking statements and all other statements made during the call that do not concern historical facts are subject to risks and uncertainties that may materially affect actual results. Specific forward-looking statements include, but are not limited to, any indications regarding the financial services industry, the economy, and future growth of the balance sheet or income statement.

After today's presentation there will be an opportunity for you to ask questions. (Operator Instructions). Please note this event is being recorded.

I would now like to turn the call over to Michael Rechin, President and Chief Executive Officer. Please go ahead.

Thank you, Andrea.

Welcome, everyone, to our earnings conference call and webcast for the nine months ending September 30, 2009. Joining me today are Mark Hardwick, our Chief Financial Officer, and John Martin, our Chief Credit Officer as well as Mike Stuart our Chief Banking Officer. Our press release, issued yesterday, reflects results of operations and priorities discussed last quarter. These priorities were and continue to be addressing credit and managing all aspects of our loan and investment portfolios, preserving capital to work through the credit cycle, and completing the combination of our charters into First Merchants Bank, N.A.

In regard to results, First Merchants Corporation posted a loss of $6.4 million, or $0.30 cents per diluted share for the most recently ended quarter. The loss is primarily driven by provision exceeding net charge offs by roughly $10 million. That same issue plays out in the bullet points below on slide four, where you can see the resultant increase in the reserve to 2.54% of loans, as well as the idea that our reserves increased significantly period-over-period, and while the bullet point references $35 million increase from earlier in the year, the reserve had actually increased $52 million on a year-over-year four quarter basis. The charge-offs for the year total $61 million, an annualize 2.24%, and nonperformers in the quarter grew 11%. We continue to work at increasing the coverage of the reserve to our non-accruing assets. John Martin will is speak to that issue later as well. It reached 70% coverage as of 9/30.

The strategy of operating with a smaller balance sheet, based on the environment we face, coupled with the margin opportunity available to us, did result in our ability to grow our capital ratios as well beyond well-capitalized levels and well beyond the level of the June period to include tangible common equity, despite our absence of earnings.

Moving to slide five, I referenced the efficiencies gained in capital liquidity and risk management in the bullet point. We also see significant impact in our ability to change quickly so the speed of our organization to move, as well as the cultural enhancements is being positive outcome. With one national bank charter we now operate primarily as First Merchant Bank. However, we also operate as Lafayette Bank and Trust and Commerce National Bank as divisions of First Merchants Bank in those markets reflecting heritage we enjoy in the greater Lafayette and Columbus markets.

In the center of the page our net interest margin growth is very satisfying. Our portfolio is smaller because of credit exits we've achieved, the sale of approximately $20 million in mortgage loans, and the run off in our indirect portfolio in combination with just a lesser overall loan demand. Our funding costs have benefited and are lower to take advantage of the interest rate environment and our ability to pay off some of our highest borrowing costs. We also benefit from an overall loan to deposit ratio below 100%. The last point on slide five is an additional key measure in my mind of our results. Mark will detail in a few moments, but our net interest income growth with a healthy stable non-interest income coupled with expense management continue to produce the true reflection of our customer mix and our market coverage.

At this point, I was going to ask Mark to get into our financials in greater detail.

Thanks, Mike. Good afternoon.

First Merchants is well-capitalized, well-reserved and well-positioned for the future. Our current period results continue to be a disappointment as our credit challenges continue to over shadow improvements in other sectors of the business. The third quarter reflects positive momentum with respect to net interest income expansion, expense reduction, and capital improvement.

Total assets, on slide eight, declined to $4.5 billion at quarter ends consistent with our second quarter guidance regarding our capital preservation plan. The reduction was driven by declines in loans and investments of $297 million linked quarter-over-quarter. The allowance for loan loss was increased by another $10 million during the quarter, pushing the totals to 2.54% of total loans. The increase is totally attributable to increases in the FAS 5 pools of $10.8 million as total specific impairment reserves declined by $971,000. Other assets increased to $421 million during the quarter as fed funds sold for the quarter increased from zero in the second quarter of 2009 to $53 million at the end of the third quarter.

The loan portfolio on slide nine totals 76% of the corporations assets and the composition remains evenly balanced as the various categories of Commercial Banking comprise 68% of the loan balances. The overall yield to the portfolio totals $592 or 5.92% and is also the primary asset driver of our 3.83% net interest margin. The investment portfolio on slide ten totals $489 million or 11% of assets. The duration of the portfolio is just 4.3 years and the average yield totals 5.1%. Our exposure to pooled bank trust preferred securities also -- or continues to remain a challenge. Our exposure declined to $9.9 million from $11.1 million last quarter as OTTI expense of $1.2 million was charged to the income statement. The current market value is $3.7 million. Even with the FAS 115 unrealized loss in the portfolio of $6.2 million related to trust preferred securities, the total FAS 115 portfolio of net gain is $9 million as of quarter end.

Our liability mix on slide eleven continues to significantly improve our overall liquidity position and bank level borrowing, driven by SLB advanced and Fed fund purchase reduction of $44 million. The $111 million of hybrid capital includes $61 million of trust preferred borrowing, which qualify as Tier 1 Capital with maturity date of 2037 and $50 million of sub-debt with a maturity date of 2015.

The preferred stock is 100% CPPP capital and qualifies as Tier 1 Regulatory Capital as it has no maturity date. Common stock totals $364 million, up from $361 million in the prior quarter despite a third quarter loss and a third quarter dividend as increases and other comprehensive income due to unrealized gains in the bond portfolio and fewer intangibles accounted for the increase.

Our deposit mix on slide twelve results in an average cost totaling just 1.95%. The changes in the deposit mix as detailed on the last page of the press release are very positive as DDA or least expensive category totals 33.5% of total deposits. Broker deposits, our most expensive category, will continue to decline in the coming quarters as we strategically preserve capital and focus on margin expansion. We have $34 million of brokered CDs maturing in the fourth quarter and another $44 million maturing in the first quarter of 2010.

Our regulatory capital ratios on slide thirteen are well above the OCC and the Federal reserves definition of well-capitalized, and we are pleased that total risk-based capital expanded 52 basis points to 13.08% during the quarter and that our TCE ratio improved by 33 basis points. Management and the Board of Directors understand the regulatory and market sensitivity to all capital ratios. We intend to continue reducing our non-relationship assets and wholesale or purchase funding while expanding our net interest margin to ensure that net interest income remains constant or increasing. During the quarter we were quite successful in executing on this strategy. On slide fourteen you can see our net interest margin improve to $383 million as our annualized net interest income improved by $3 million.

Our interest sensitivity model as reflective of balance sheet strategies and the fix of rising net interest income of just under $5.5 million given 100 basis points shift in key external driver rate. The point of this statement is just that Management is not putting future net interest income at risk to achieve the margin expansion you see on this page, as its positioned to perform in a more inflationary environment. The allowance for loan losses on slide fifteen has increased by 308% during the last seven quarters and now totals 2.54% of total loans. The allowance for loan losses began this cycle just under 1% of total loans and equaled $28.2 million. The allowance now totals $87 million and suggests that we are well-reserved for future quarters. During the quarter provision expense exceeded net charge-offs by $10 million as previously mentioned helped support higher FAS 5 pools or the historical and inherent reserve as they increase by almost $11 million.

Federal non-interest income on slide sixteen increased by $4.2 million over the second quarter of 2009. However, when adjusted for bond gains and losses and a small marketed mortgage sale gain, total non-interest income declined by 900,000. The reduction is accounted for in the other income category and is primarily attributable to minimal income related to hedging activities.

Total non-interest expense on slide seventeen also showed several areas of improvement during the quarter as salary and benefits expense declined by $1.8 million. Of the $1.8 million reduction, bonus accrual reversals accounted for $500,000. The company also prepared $119 million of Federal home loan bank advances costing $1.9 million as detailed on line seven of this slide.

We believe that First Merchants is well-positioned for the future and slide eighteen is reflective of that opinion. Our pretax pre-provision run rate of more than $17 million allows for approximately 200 basis points of annualized credit cost to break even on a go forward basis. We are pleased by our pretax pre-provision run rate expansion that remains the key to loan loss absorption and provides the solid foundation for future earnings power.

Now, John Martin, our Chief Credit Officer, will talk about structure of mix and the quality of our loan portfolio and will provide some incites into charge-offs for the quarter and year-to-date.

Thanks, Mark.

I'll be walking through our credit metrics on slides twenty through twenty-six of the presentation before turning the call back over to Mike.

Before I move to the detailed analysis I would like to turn your attention to the quarter end drivers of the portfolio begin on slide twenty. Non-performing loans plus OR E., other real estate own, totaled $151 million or 3.37% of assets for the quarter representing a $14 million increase. While I will detail individual changes in the following slide, suffice to it say we continue to feel the effects of the summer spike in unemployment rates rising to levels in our communities that exceeded 10%. That is, and continues to impact not only consumer loans, but also commercial mortgage and commercial and industrial loans. Other real estate owned ended the quarter at $21.8 million. While this account roses by roughly $1.6 million for the quarter, we liquidated or otherwise wrote down approximately $5.4 million in commercial properties, while adding approximately $6.9 million in new ORE.

Loans ninety days past due or greater totaled $5.4 million compared to $3.6 million. One relationship totaling $2 million was in the process of being extended at the end of the quarter and attributed to the increase. Absent this relationship, delinquent accounts plus ninety days past due, would have been decreased by a corresponding amount. We view thirty plus days past due as an indicator of future potential concerns. And although ninety plus days past due essentially remain flat for the quarter, when excluding the individual relationship just mentioned, we continue to follow the increase in the thirty plus days past due at the end of the quarter. Thirty plus days passed due increased from $47.4 million to $59.5 million spread across the one- to four-family residential construction and construction and land development portfolio, commercial mortgage and C&I portfolios.

Intentionally, we continue to experience run off in our one- to four-family residential construction and construction and land development portfolio. These balances declined by $61 million, since the quarter ended March 31 with a $16 million reduction for the quarter. Decreases in this category are coming from refinances and pay-offs as well as pay downs on existing relationships. Finally, the impaired loan portfolio has been marked down and specifically reserved by 30% from the customer balance. This is to say that from direct charge-offs and specific impairment reserves, we have written down or specifically reserved for losses of 30% of customer balance in our impaired loan portfolio.

Now turning to slide twenty-one. For the quarter, net charge-offs totaled $14.4 million down from $40 million in the second quarter, while provision expense totaled $24.2 million. The table in the middle of slide twenty-one represents charge-offs on loans greater than $500,000. Specifically, these five customers comprise $7.75 million or roughly 50% of total charge-offs for the quarter with one commercial loan relationship comprising $4.2 million. The two loans that comprise this relationships are related to the operations of a troubled commercial industrial borrower. From a geographic perspective, four of the five relationships were originated in our Muncie region.

Turning to slide twenty-two, I'll walk you through the year-to-date charge-off ratios by asset class. Commercial and industrial charge-offs were 5.03% of the portfolio on an annualized basis, commercial mortgage charge-offs were 1.55%, and one- to four-family residential construction and construction and land development loans were 8.36%, also on an annualized basis. We continue to see stress in the C&I and land and lot portfolios as a result of the slow down in the residential construction development sector. Our portfolio, our consumer portfolio continues to perform reasonably well from a loss perspective given the environment with year end to date annualized -- with year-to-date annualized charge-offs of less than 1% of consumer loans. In this category, the home equity and one- to four-family residential mortgage portfolio experienced annualized charge off ratios of .73% and .78% respectively.

In the charts, you can see the distribution of the portfolios and related charge-offs which helps to illustrate the balance of our charge-offs between asset classes. In particular, a disproportionate level of charge-offs, 21%, is coming from the land and lot loans, which would represent only 4.3% of our portfolio. Additionally the commercial industrial portfolio, which represents 23.8% of total loan is generating over half of the total charge-offs. We continue to be concerned about the difficulties we see our customers experiencing in the automotive manufacturing sector and closely monitor developments in this category. Finally, while the commercial mortgage portfolios 21% of total charge-offs, we are paying particular attention to this sector by closely tracking vacancy in our commercial real estate portfolio.

Turning to slide twenty-three, nonperforming assets, including ninety plus days past due, were $156 million. Non-accrual loans increased from $112 million to $123 million with increases occurring in the commercial mortgage and commercial and industrial portfolios of $4.9 and $5.6 million, respectively. Again, the pie chart shows a composition of the nonperforming assets as a percentage of the total portfolio. As you can see, a disproportionate amount of the portfolio is related to the land and lot development category, comprising 4.3% of total loans with 20% of the portfolio on non-accrual. In aggregate, nonperforming assets represent 4.56% of total loans. A summary of the top five nonperforming relationships is outlined on slide twenty-four. Geographically these, again, are similar to the distribution of our charge-offs with four or five relationships being originated out of our Muncie region.

Now, turning to slide twenty-five, we can see the effects of a jump in that non-accrual loans and are continued building of the allowance. Non-accrual loans were $37.9 million in the third quarter of 2008 and $87.5 million in the fourth quarter of 2008. Allowance coverage at that time fell from 92% of non-accrual loans to 57% of non-accrual loans in the related periods and has steadily improved since that time. Allowance coverage at September 30, 2009, increased to 70% as Mike mentioned, of total nonaccrual loans and shows significant improvement since the first quarter 2009 low of 54%. Since that time, we've increased the allowance to $87 million and we believe that the coverage gives us adequate protection.

Turn now to slide twenty-six for a brief review of our existing real estate owned portfolio. Total real estate owned was $21.8 million at the end of the quarter. As can be seen in the chart, 83% of the dollar amount of the portfolio is in the CRE and residential construction and land development portfolio. Eleven commercial properties moved into ORE, representing roughly $6.9 million, while we liquidated ten commercial properties representing $5.4 million. These properties are all now being actively marketed.

Let me now turn it back over to Mike.

Thank you, John.

Slide twenty-eight serves both as a summary and as a move into any questions that participants might have. Slide twenty-eight suggests our near term tactics will continue to prioritize management of credit and capital. We feel like the environment is unlikely to the change dramatically as we look forward into the fourth quarter or even into the first half of 2010 and as such the opportunistic reduction of our borrowing cost should allow for the margin expansion that we've seen in the third quarter that continue, as much of the payment activity that Mark highlighted took place in the second half of the third quarter. So between the coupon on the loan and investment portfolios and what we think of the run rate and the carrying cost we feel good about the continued ability to earn a margin similar to what we achieved last quarter.

Mark also referred to non-relationship asset reductions and will continue that. We've spoken for a couple of quarters now about getting out of the indirect business which amortizes at a $2.5 million a month kind of a rate on a portfolio that's about $85 million. Similarly, we refer to the mortgage business where we continue to be very active in an originate and sell model, taking opportunities as we did in the last quarter to find attractive virtually at par type pieces with which to generate funds to help offset credit costs. I'd also go on to mention that our overall exposure to shared national credit, which has been a category of some concern nationally, is modest. Our commitments are just over $90 million and our outstandings are just over half of that number, right around $50 million and that participations considered as a whole are not a driver of our business. Our near term tactics will continue to focus around credit and capital, our longer term strategy which hasn't been described at length in this presentation given the dominance of the environment that we are in, remains intact as well.

We have momentum coming out of the Lincoln transaction, now part of First Merchants Bank as our Indianapolis business grows, our customer counts and customer satisfaction work, which is not precise, nor perfect, gives us every indication to believe that we are retaining customers through providing high quality service. I like the momentum we have going into the fourth quarter, absent the unclear view we have as to the credit environment and at this point, Andrea, we would be happy to open the microphone for questions.

Thank you. We will now begin the question and answer session. (Operator Instructions.)

First question comes from Scott Siefers, Sandler O'Neill.

Hi, guys.

Hi, Scott, good afternoon to you.

Just have a couple of questions. I want to do start out on capital if possible and specifically the TCE ratio just given that that seems to be the area where investors have been placing the most emphasis, obviously pretty nice bump based on the balance sheet downsizing and the move in other comprehensive income. I guess maybe if you could expand a bit on how you're thinking about that TCE level, where it should be, where it needs to be just based on changing industry preferences.

Scott, this is Mark Hardwick. The continuation of our plan of shrinking the balance sheet in non-strategic areas and also just wholesale funding will continue forward, probably not as aggressive a pace as you saw this quarter as we actually took advantage of the pre-payment of some Federal Home Bank advances. We will see that pays slow slightly.

But internally, as I mentioned, we are having discussions between Management and the Board around the overall capital level. And our near term goal is to get our TCE capital ratio to 5% understanding that at least in today's environment as the TCE multiple increases, it appears that the market is rewarding companies for higher TCE ratios and obviously lower nonperformers. Our near term goal is 5% and longer term goals, if hybrids are not available into the future, ultimately the TCE starts to look more like the leverage ratio. But that's, at least at this stage, how Management and the Board is evaluating and thinking about our tangible capital ratio.

If I can jump over to credit just based on you guys comments, I sort of got the feel that charge-offs might remain maybe near this quarters level or so. Obviously, that's kind of a tough one to gauge. So, one, any comments you could share on that item and then, additionally, just in terms of reserving methodology as we look at some of the leading indicators, whether it's NPA's thirty days, ninety day delinquencies, which of those are going to be the biggest drivers in determining how much you guys will continue to build the reserve in coming quarters?

I'll speak to the -- it's Mike, Scott. I'll let John, in a moment here, speak to the leading indicators that his group primarily manages.

But to the earlier part of your question, the -- we look at both what is, we feel appropriate for the portfolio as well as what our peers are in that relationship of quarterly provision and charge-offs and our hope would be that we are getting towards the point at 2.5% of loans, where the reserve can begin to only grow to the extent or I should say that the provision can only reflect what the charge-offs would be and create a little bit more equilibrium where we've been at a plus $10 million growth for a couple of quarters consecutively now. All of the measures that you referred to in regard to where we pay attention, I guess non-performers is the one we pay closest attention to knowing that the exit of them and the secondary market for them have been so sluggish and so time consuming. As you can imagine there's a broader group of bankers that get involved at the past dues at the thirty-day level that gives us more input and hopefully more ability to manage them. John, do you have any additional thoughts there.

Yes, I think the only thing that I might say, Scott, is that we do, within particular asset categories, weigh out which indicator is more important. So, for example, say on the residential mortgage portfolio, thirty-day indicator in the delinquency category is something that we watch closely as it runs through the different buckets and progresses to the end. I agree with Mike that we pay a great deal of attention to the nonperformers as we settle out those accounts if they are nonperforming and we wind up either liquidating an asset or otherwise working with the borrower. We do see losses either through the charge-off of the specific reserve and we do see results out of the settlement of those assets in particular. But, I would say it's non-performers, past dues of particular attention with an additional eye towards obviously our classified asset level as well.

Thank you. Just one final question, Mark, do you have the total average earning assets level for the third quarter?

You know, I can get that for you in just a moment.

Okay.

I don't have that off the top of my head.

Okay. All right. Thank you.

Thanks, Scott. Thank you.

Our next question comes from Adam Klauber of Fox-Pitt.

Thanks, good afternoon everyone. As far as non-performers, I think in the call reports, it looked like you that $45 million of inflows. I'm not sure if that's right. I'm sure what is the difference between that and the $12 million that you show in the, that you break down.

Adam, could you repeat the question.

Sure. We did a quick check of a call report that looked like had you total NPA inflows of $45 million. Is that member around right.

I'm not sure I can reconcile exactly what, when you say the NPAs we went from, let me back up and I can build it for you.

On a gross basis.

We had the non-accruals went from $112 million to $123 million. The ORE essentially remained flat. I'm sorry. I know what you're talking about. You're looking at First Merchants Bank from last quarter and First Merchants Bank is the sum of all entities because we merged the charters of each bank and filed a call report this quarter that was all of our bank's combined.

So, in other words, there's some double counting when I'm looking at that way. Is that correct.

Well, if you try to compare this quarters call report versus last quarter's for First Merchants Bank, you also need to include the call report from the prior quarter of Lafayette and First Merchants Bank of Central Indiana.

That's helpful. I'm not sure if you said this. What was the flow on the watch list of problem loans? Was it in line with what we saw in NPAs, greater or less?

Can you help me define, Adam, when you say watch list, are you talking about our classified assets?

Yes.

They are in line with what we are seeing in the non-accrual dollars as a relative amount.

Okay. But the pace of acceleration or pace of increase or decrease -- is that increasing faster or is it increasing at the same pace as your NPAs?

I think it's probably increasing slightly higher than the NPAs.

Okay. Okay. Thank you.

At a rate slightly higher than the NPAs.

Okay. And then, Mike, more of a macro question. How are the economies doing in some of your different markets, Lafayette versus Muncie? Are they holding in or do you see them getting worse over the last three months?

I actually, Adam -- the employment levels across the different portions of the state to include central Ohio operating were mildly down, but they are down from elevated levels. The two metro markets we primarily operate in, greater Indianapolis market and greater Columbus, were flat and lowest in each of those states respectively.

Whereas, our most mature markets in places where we have sizeable share, the Anderson market, the Muncie market, have been 2% to 3% elevated from an unemployment against the state average. In other words, that is to say that they've been 11% to 13%. And they are also flat as the summer ended. Flat with their early, beginning of summer levels.

Okay. Okay. And finally as far as the margin goes, how much in deposits do you think can still be re-priced down over the next, say, two quarters?

We are very focused on a pool of about $300 million of transactional type accounts, non-maturity deposits where we know we continue to have room to price those deposits down. We've been surprised at the lack of aggression in terms of gathering public money in our marketplace that's changed dramatically over the last, really the last twelve months. As a reference point we've won a couple of public fund CD bids for 9 and 12 basis points. And those are just areas where we have a lot of opportunity to make some reductions in the balances or in the rates associated with those balances and communicate extremely well with our customers and ensure that we get the expense pick up, the reduction of the expense and still maintain the account.

And, Mark, if I'm not mistaken apart from the customer liabilities you were referencing we also have some near term maturities in Federal Home Loan Bank advances and brokers for that matter that are between 3% and 4% if I'm not mistaken.

Yes, that's correct. The maturities that I mentioned in my comments looking through -- the reduction of broker deposits where we have on an ongoing basis this fourth quarter and the first quarter are all around $370 million.

Okay. Okay. Thank you very much.

Thanks, Adam.

Thank you. Our next question comes from John Rodis of Howe Barnes.

Good afternoon, guys. Could you maybe just talk about your decision to go ahead of keep the dividend at $0.8 in the fourth quarter, in light of third quarter earnings?

Sure. We feel like dividend policy and philosophy at the Board level is clearly linked to our ability to earn it and earlier this year, first quarter began to just make sure that that correlation was consistent, if not absolute.

And, as you can see, in the seconds and third quarter we didn't earn it. However, we did, earlier in the year, reduce it from $0.23 a quarter to $0.8. In dollars, with 21 million shares relates to roughly about $1.6 million per quarter which we thought was appropriate to continue to pay based on the health of the run rate of the business as we measure it by pre-tax pre-provision. And an elongated stretch meaning, continued quarters of where we didn't earn it, is going to have that issue continue to be reconsidered, and it does get discussion from Executive Management and the Board.

Okay. Fair enough. As it relates to, in the second quarter, your largest charge off was a $10 million credit that you said potential could have involved fraud and I think you were taking legal actions potentially. Is there any update on that front there?

It's continued, it's a multi-party situation. It's not just First Merchants Bank and the borrower. It includes at least another senior lender and owners of the borrower. We don't anticipate a significant -- we do anticipate a recovery. We don't anticipate a significant recovery if would you refer to significant as 50% based on the absence of collateral that can be monetized.

Okay. Fair enough.

The legal action, the legal activity around that continues.

Okay. Fair enough. Maybe just final question for Mark. Mark, can you maybe just give us an update on that deferred tax asset, where that stands and your ability to use it?

I can. Mike has been working closely with DKD with deferred tax asset. Actually we just finished re-evaluating the goodness of that asset. And at this stage, we feel that 100% of the deferred asset is -- should remain on the books. It's about $59 million in total and $19 million applies back to refundable items, $43 million would be future and perspective.

We feel good about where we stand, although just as Mike mentioned with the dividend, it's a similar situation, the longer we go with, if the losses were to continue through another quarter or two, you start to run out of capacity to carry the deferred tax asset forward. Back to Scott Siefer's question, he had asked about average earning assets for the quarter and those were $4.2 billion, $4.236 billion.

do you have a follow up, sir?

No, I'm good. Thank you.

Our next question comes from Brian Martin of FIG Partners.

Hey, Mark. Hey, Mike.

Hi, Brian.

Quick question, Mark you talked about the asset reductions on a non-strategic side. Can you give a little color as far as what your expectations are over the next 12 months as far as what type of reductions you are looking at, given this quarters level of, sounds like a little bit greater than you thought?

Yes, I would say the best measure of that are the broker deposits. We have about $310 million of broker CDs on our books at the end of the quarter and it is certainly a non-strategic funding source. And as we continue to move through the cycle and focus on new approvals of credit adhering to all of our standards, we are continuing just to see natural run off in the loan portfolio, as well as Mike mentioned, a couple of key areas like indirect where we are just simply not in the business and in the mortgage area where it's a fee for service business where we are selling to a third party.

So as we move through the cycle we are anticipating that we can get close to having the broker deposits equal zero and have a balance sheet that's, that has a lower overall loan to core deposit ratio -- I'm sorry, a stronger -- lower loan to core deposit ratio and a little lower loan to overall asset ratio. So smaller balance sheet, more efficient, greater margin, producing a higher return on assets. And we think even with that improved return on assets, given a constant return on equity level that we can maintain an ROE at a constant level with normalized provisioning.

Okay. All right. Just a couple other questions, more of a housekeeping, maybe you said this on the call or I didn't hear it, the other income line linked quarter was down quite a bit. I'm just wondering if there's anything unusual in just that line item itself that stuck out.

Nothing unusual.

It's primarily the result of hedging activities both sales of our interest rate floors, the benefit that we were deriving from the sale of those floors. It was I'm not sure how many months ago, but we ran out of that $5 million that was amortizing through a couple different areas of the income statement.

And then just pure hedging activities, loan level hedge transactions where we are allowing the borrower to fix his loan and using a counter party to make the loan variable to us. The activity this quarter was just extremely low; I mean based on the numbers you can see here it was virtually nonexistent for the quarter.

I guess it's fair to say that I guess that number trends back up somewhat I guess from future quarters and maybe not the level it was at, but just upward from here.

Given the continued low interest rate environment that we are in, we believe that borrows are going to continue to look to fix their loan cost and given our asset sensitive position and our desire to stay that way we are going to continue to offset the risk in the -- with counter party.

Just two other questions. Do you have, do you know what the impaired loan balances were at quarter end? Yes. Total impaired loan balances were $148 million. Okay. And then just the, lastly you talked a little bit about, it was John that talked a little bit about the auto loans, and just continued stress in that category. Can you give a little bit of color of what your expectations are, just how those credits continue to hold up and if there are a significant concerns there or just you feel like they are treading water, or are okay at this point? I think as we see the unemployment statistics over the summer, the automotive-related companies that would otherwise supply the large auto manufacturers, have experienced stress. Their orders are down and Muncie being a fairly heavy manufacturing city, you can imagine the portfolio has our share of that in it and there are a number of credits that we have that are experiencing challenges related to that. And, we continue to work through those and see challenges ahead in that portfolio. Okay. That's all I have, guys. Thanks very much.

Thanks, Brian.

Thank you. This does conclude our question and answer session. Gentlemen, do you have any closing statements, today?

Only one of appreciation for the folks that took time this afternoon to listen to the update on our performance and as we look forward and the questions we received. That would be it, Andrea.

Thank you. This does conclude today's conference. You may now disconnect.