First Merchants Corp (FRME) 2009 Q4 法說會逐字稿

Good afternoon. And welcome to the First Merchants Corporation fourth quarter 2009 earnings conference call. All participants will be in listen-only mode. (Operator Instructions). After today's presentation, there will be an opportunity to ask questions. (Operator Instructions). Please note, this event is being recorded.

We will be using user controlled slides for our webcast today. Slides may be viewed by following the URL instructions noted in the First Merchants news release dated February 1, 2010. 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.

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

Thank you, Amy. Welcome, everyone, to our earnings conference call and webcast for the 12 months ending December 31, 2009. Joining me today are Mark Hardwick, our Chief Financial Officer, and John Martin, our Chief Credit Officer.

My comments will begin on page four for listeners that have access to the webcast. Our press release issued earlier today reflects results of operations and priorities discussed last quarter. Our priorities remain addressing credit in the management of all aspects of our loan and investment portfolios, preserving capital to work through the credit cycle, and implementing efficiencies available from our charter consolidation completed at the end of the third quarter.

Speaking to results, First Merchants Corp posted a loss of $11.7 million or $0.55 per diluted share for the quarter ending December 31. The loss was primarily driven by a provision of $26 million. The provision level, $5 million in excess of our net charge-offs, is the driver of our year-end increase in the loan loss reserve to 2.81% of our loans. Overall, our reserves increased $43 million at year-end 2009, over year-end 2008 level.

We were pleased with our ability to grow core deposits, allowing for reduced reliance on external funding. Our net interest margin grew in the quarter, despite having Fed funds sold greater than $100 million, and their negligible return.

Later in this call, John Martin will speak in detail to our credit metrics and trends. In advance of his comments however, we were pleased to be able to halt our 2009 experience of weakening credit.

Our press release references a decline of 6% in total non-performing loans. While the level of fourth quarter charge-offs accounts for a portion of the NPA decline, the improvement is more broad-based and satisfying.

Our delinquency improved in all agings, and our classified assets and OAM assets fell for the first time since the onset of the current credit cycle early in 2008. Our liquidity, coupled with modest loan demand, reflects an actively managed balance sheet. We ended the year with all regulatory ratios healthy and in excess of well-capitalized levels, despite our net loss.

Moving to page five, our summary thoughts for the full year 2009. Our year-over-year revenues and expenses reflect the acquisition and integration of Lincoln Bancorp into our franchise. The Lincoln integration as well as the charter combinations will provide for ongoing service and efficiency gains. For example, we began 2009 with 1,380 FTE, and begin this year, 2010, with 1,195, a reduction of 185 or 13%.

I referenced our credit metric improvement earlier, and view the declines that we achieved in the fourth quarter as predictive for at least the early portion of 2010, based on the environment we're currently operating in.

And lastly, on page five, as our press release states, our Board of Directors approved a reduced dividend of $0.01 per share for the upcoming quarter, understanding the need to preserve capital until the operating environment and our earnings improve. The dividend level approved would save nearly $6 million on an annualized basis over our previous level of $0.08 per share.

At this point, Mark, would you speak to the financial statements for the full year 2009?

Sure, thanks, Mike. Thanks everyone for joining our call this afternoon. I need to admit that I'm happy to be talking about 2009 for the last time. I have worked at First Merchants Corporation since 1997, and I've been the Chief Financial Officer since 2002. During my tenure with First Merchants, I've been privileged enough to report positive earnings in every year but one. From 1997 to 2008, on a cumulative basis, we earned a total of $293 million. Unfortunately for us all, we lost $45.7 million in 2009, and our stock has suffered an uncharacteristic decline in value. Our heightened level of credit expense is temporary, and we will soon begin to enjoy the earnings power of our historical core franchise.

I'm confident that 2010 will prove to be more productive and more profitable despite continued challenges in the economy, both locally and nationally. The fiscal prudence required by First Merchants and all of its customers, provides an opportunity for 1,195 employees to live our vision and mission statement, by providing the financial advice necessary during this tenuous time.

Several assets on slide eight, declined by -- or totaled $4.5 billion at year end, consistent with August guidance regarding our capital preservation plan. The reduction was driven by declines in loans of $444 million during the year, and offsetting declines in borrowings and broker deposits of $371 million. Given the positive growth in core deposits during the year, and the decline in loans in excess of our borrowings, the bond portfolio and on hand liquidity increased by $145 million.

The loan portfolio on slide nine totals 73% of the corporation's assets, and the composition remains evenly balanced as the various categories of Commercial Banking comprise 68% of loan balances. The overall yield of the portfolio totals 5.78%, and is the primary driver of our 3.86% fourth quarter net interest margin.

The investment portfolio on slide 10 totals $563 million, or 13% of total assets. The duration of the portfolio is just 4.5 years, and the average yield totals 4.86%. Our exposure to pooled bank trust preferred securities continues to be a challenge, as the market for bank CDOs remains very illiquid. Our year-end exposure totals $7 million, with an estimated market value of $2.4 million.

Total OTTI write-downs or expense for 2009 was $8 million, including $3 million in the fourth quarter. Even with the FAS 115 unrealized loss in the portfolio of $4.6 million related to trust preferred securities, the total portfolio has a net gain of $8.4 million as of quarter end. Or said another way, the remaining portfolio has net gains totaling $13 million.

Our liability mix on slide 11 continues to significantly improve our overall liquidity position, as bank level borrowings driven by federal home bank advances and Fed funds purchased declined $371 million. The $111 million or hybrid capital includes $61 million of trust preferred borrowings, which qualify as tier one capital with a maturity date of 2037, and $50 million of subdebt with a maturity date of 2015.

The preferred stock is 100% CPP capital, and qualifies as tier one regulatory capital as it has no maturity date. Common stock totaled $352 million, a decline from $396 million in the prior year, as current year losses are charged against retained earnings.

Our deposit mix on slide 12 results in an average cost totaling just 1.87% of total deposits. The changes in the deposit mix, as detailed on the last page of our press release, are very positive as DDA, our least expensive deposit category, totals 37% of our 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.

Our maturity schedule in 2010 by quarter for broker deposits totals $38 million, $34 million, $24 million, and $26 million in the first, second, third and fourth quarters respectively, totaling $122 million for the entire year of 2010.

We are pleased that our total risk based capital expanded during the year from a 10.24% in 2008 to 13.04% in 2009, through the addition of $16 million of preferred stock obtained through the US Treasury Department CPP program. Tangible common equity, the tangible common assets declined from 5.01% to 4.54%, or 4.54% during the year, as the Corporation's capital mix remained a challenge.

Management continues to explore the least dilutive alternatives to improving the common equity component of our capital mix, including dividend reduction and the possible conversion of trust preferreds to common equity and preferred stock to trust preferred debt.

Net interest income on slide 14 increased to $159 million during the year, and net interest margin declined by 10 basis points. However, this slide doesn't tell the entire story. The detail in the press release on the trailing five quarter income statement is very useful information.

Remember that we closed our acquisition of Lincoln Bank on 12/31 of 2009, and subsequently produced a net interest margin decline from 3.88% in the fourth quarter of 2008, to 3.68% in the first quarter of 2009, as Lincoln's sub-3% preacquisition net interest margin diluted the First Merchants run rate. After improvements in both loan and deposit pricing throughout First Merchants 80 locations footprint, combined with our capital preservation plan, we are back to 3.86% in the fourth quarter.

John, can you cover? Excuse me.

All right. Thanks, Mark. I'll be walking through our credit metrics on slides 20 through 27 of the presentation, before turning the call back over to Mike. Please turn to slide 20. The fourth quarter of 2009 exhibited a number of encouraging trends, which are highlighted on this slide. Starting with delinquency, loans that were 30 to 89 days delinquent declined from $59.4 million, or 1.7% of total loans, to $40.5 million, or 1.2% of total loans.

Additionally, loans that were 90 plus days delinquent declined from $5.4 million to $4 million. While the pass through category was elevated in the third quarter, nonetheless the percentage past due in the fourth quarter declined to levels that were more in line with historical delinquency.

Other real estate owned declined from $21.8 million to $14.9 million, and non-performing assets declined from $150.7 million to $142 million. Later we will walk through the reconciliation of our non-performing assets and 90 days past due, but suffice it to say progress is being made in reducing non-performers.

Finally, the relative strength in the allowance is a percentage of non-accrual loans continues to increase and is now at 78% of non-accrual loans, the highest level it has been in four quarters.

Please turn to slide 21. While there was improvement in a number of our credit metrics for the quarter, there were also a number of items that negatively impacted our credit results. Net charge-offs increased from $14.4 million to $20.8 million, with the top 10 charge-offs representing 60% of fourth quarter net charge-offs. Fourth quarter provision expense totaled $26 million, and gross and net charge-offs totaled $25.9 million and $20.8 million respectively.

Our largest charge-off for the quarter resulted from the restructure of a loan to a fuel distributor. We continue to work with customers where it is in the best interest of both the bank and the borrower to restructure loans while prudently recognizing losses as they become apparent.

Finally, ORE write-downs totaled $2.7 million for the quarter. Roughly $1.5 million of the total was taken on an individual property, a utility related to a commercial industrial park, where we marketed and attempted to auction the property. It became apparent that despite a supported appraised value, the remaining book balance was higher than what we could reasonably expect to realize given market conditions.

Okay. I will walk through the portfolio and credit metrics in more detail. Please turn to slide 22. On slide 22, you can see that we continue to recognize charge-offs coming from the land and lot development portfolio. While we have seen some encouraging signs in the market, generally the land and construction development portfolio continues to experience slow absorption of lots.

In the fourth quarter, we charged off $5.1 million in development related loans as we both moved loans to ORE and recognized losses on non-performing assets. As just mentioned, within our C&I portfolio, we recognized losses this quarter related to a specific borrower that was a part of a troubled debt restructure, and we continue to restructure loans in certain situations.

Now, turning to slide 23. Non-accrual loans declined for the first time since the first quarter of 2008, despite an individual relationship which is in excess of $21 million, moving to non-accrual. The chart on the top of slide 23 shows the impact of this relationship on NPAs, plus 90 days past due, for C&I, which increased from 4.02% in the third quarter to 6.02% in the fourth quarter. I will provide additional color around this relationship when we turn to slide 24.

In contrast to the commercial NPAs plus 90 days past due, one to four family secured loans and all other consumer loans resulted in an NPA plus 90 day ratio of 2.30%, in line with the prior quarter of 2.36%. Despite high unemployment in many of our communities, our consumer portfolio continues to perform reasonably well.

Please turn to slide 24. As mentioned on slide 23, one commercial and industrial relationship was moved to non-accrual, as it became apparent that the customer, who was severely impacted by last summer's bankruptcies in the automobile industry, would not be able to continue to meet its obligations under the original contractual terms. While we continue to work with this customer and believe that we have established a sufficient specific impairment reserve, the appropriateness of subsequent charge-offs will be evaluated as we work through the issues surrounding this credit.

Finally, the balance of new additions to non-accrual names included a real estate investor for $6.8 million, as well as other relationships that are typical of the loans we have in our portfolio.

Please turn to slide 25. Other real estate owned decreased for the quarter from $21.8 million to $14.9 million. There were three primary drivers impacting the results for the quarter. First, auctions were held for most all one to four family properties last quarter, resulting in a sale of approximately 45 properties. Secondly, commercial ORE declined as a result of the sale or auction of approximately 12 commercial properties. And third, as mentioned above, through the write-down of properties remaining in ORE.

Moving onto slide 26. Given the movement in the individual categories, the table on slide 26 reconciles the components I just discussed in order to highlight how the change in non-performing assets declined for the quarter. Let me walk through those changes now. Previous quarter NPAs and 90 plus days past due totaled $156 million for the quarter.

New non-accrual loans for the quarter were $40.2 million, which includes the significant non-accrual loans listed on slide 24. We were able to return to accrual or were refinanced out of $18 million of loans, and restructured or moved to ORE another $5.7 million. Finally, we charged off $21.3 million of non-accrual loans.

Recapping, ORE for the quarter, new other real estate owned increased by $2.5 million. We sold $6.7 million and wrote down another $2.7 million for a quarterly net decrease of $6.9 million. As mentioned previously, 90 days past due decreased by $1.5 million, and we restructured $3.2 million of existing balance for a net quarterly change in non-performing assets and 90 plus days past due of $9.9 million, reducing overall NPA and 90 plus days past due to $146 million.

Now before turning the presentation back over to Mike for his closing comments, I would like to highlight the progress we've made in our overall allowance coverage. Turning now to slide 27, we can see the effects of the current quarter decline in non-accrual loans and our continued building of the allowance. Allowance coverage at year-end 2009 increased to 78% of total non-accrual loans, and showed significant improvement from the first quarter 2009 low of 54%. Since that time, we have increased the allowance to $92 million, and we believe that the coverage gives us adequate protection against future losses.

I'll now turn the presentation back over to Mike for his closing comments.

Thanks, John, and I see in the last minute or two I got my CFO back, who is going to pick up kind of from where he left, just to cover some of what we think are the salient elements of non-interest income and non-interest expense that kind of drives our, in combination, drives our pretax, preprovision run rate. Mark?

Thanks, Mike. I'll try this again. If you turn to slide 16, on non-interest income, John's really covered slide 15 I think well around credit. On slide 16 our total non-interest income increased by $14.8 million during the year, reflecting the impact of Lincoln, which was approximately $7 million. And then you can see on line six we had about a $6.5 million shift from bond losses to bond gains. So another $1.7 million would really classify as core organic growth in the core, original First Merchants franchise.

If you turn to slide 17, you'll see that total non-interest expense did have pockets of improvement during the year, offset by increases in other categories from the acquisition and from just the operating environment. But I wanted to highlight for a moment, salary and benefits. Salary and benefit expense totaled $63 million in 2008 for First Merchants, while Lincoln totaled $19.2 million. Our combined numbers for 2009 were $76.3 million.

That reduction of $5.9 million would derive really throughout our entire footprint throughout the year. The salary and benefit reductions in total dollars is consistent with the 185 FTE decline that we saw during the year, and about 60 of the 185 were directly as a result of the acquisition of Lincoln and their back office operation, while the remaining 125 FTEs were in the core franchise. And again, that was a $5.9 million reduction.

Other categories that offset the improvement that we saw in salary and benefit negatively, through the expense categories, were FDIC expense that increased by $8.7 million during the year, OREO expense increased by $7 million, and DP costs increased by $2.1 million as we maintained Lincoln's legacy system until our DP conversion in April of 2009.

If you turn to slide 18, we believe that First Merchants is positioned to return to profitability in 2010, and that we will again begin to enjoy the bottom line benefits of our $70 million plus pretax, preprovision earnings run rate that you see here on this slide. As credit quality improves and as credit costs begin to decline, there will be little valuation rationale for First Merchants stock to trade at a discount to its $9 plus tangible book value.

Hey, thanks, Mark. I have a few additional thoughts regarding 2010 that are on slides 29 and 30, before we take questions. Credit, capital and customer service receive our primary management attention. With the economy and our overall footprint showing some modest improvement, and our credit indicators trending better, we look to demonstrate sequential improvements in credit quality, and to reduce our 2010 provisioning. At our current reserve level as Mark and John cited, we feel our provision should reflect net charge-offs, absent an economic reversal of size in our markets.

We also want to assure consistent market coverage to safely deploy the liquidity we've built into profitable growth. Our credit area, which has been centralized now for nearly a full year, and our 2010 that complements it, clearly frame our small business and middle market goals in terms of credit extension, structure and return expectations.

We're actively reviewing our capital structure for the risk in the portfolio, as well as the opportunity cost of our current tangible common equity level in reviewing potential FDIC acquisitions. Management and our Board of Directors are actively assessing the capital options available to protect our balance sheet and execute on potential growth opportunities.

Page 30 refers to tactics to take advantage of our simpler organizational structure. While credit's a focus, we know that we operate in attractive markets. Indianapolis and Columbus present ongoing opportunity and will rebound early vis-a-vis our other primary markets.

During 2009, we had an internal integration focus. In 2010, we'll expand our external brand building to assist our growth.

Lastly, we understand the path to profitability. Our expectation is straightforward. Our expenses, credit related and non-credit related, will decline. We do not feel we've optimized our expense levels, and we target an efficiency ratio towards our 2007 level, beneath 60%.

Our net interest margin should remain at its current level or grow modestly. Our expectation is that loan demand will remain modest, but that we have the ability to grow our nonbanking subsidiary revenues in our stronger markets and throughout the entire franchise.

At this point, Amy, could you please open the lines for questions?

Thank you. (Operator Instructions). Our first question comes from Scott Siefers at Sandler O'Neill.

Good afternoon, guys.

Good afternoon, Scott. How are you.

Good, thanks, how are you guys doing?

Good, thank you.

Good. Just given the markets, the focus on TCE, just wanted to expand a bit on some of the capital comments that you made. Mark, you had made the comment about potentially moving the -- I think you suggested potentially moving the TARP capital up to trust preferred. And obviously, there's an accounting benefit with that. I guess, can you talk about, one, some of the other things you might be thinking about. Two, sort of the rationale behind moving the TARP equity up? And then three, how adverse would you be to potentially issuing just new common shares, in light of the kind of changing market and regulatory standards?

Thanks, Scott. I think the best way to classify where we are from a capital perspective is that management and the Board is exploring the least dilutive alternatives to improving the common equity component of our capital mix. One way to help preserve capital or to improve that mix was the dividend reduction that we just announced. And we are actively pursuing the possible conversion of our trust preferred, a small piece of it to common equity. And we're also actively pursuing the possibility of converting some of our preferred CPP stock into trust preferred, and terming that debt out for an extended -- well, for the remaining 29 years. Have to have a 30 year life for the trust preferred treatment.

And when that transaction, if and when it could occur, does create some tangible common equity by shifting from preferred stock to common equity through retained earnings. So, I would say those are the items that we're evaluating and actively working on at this time. We have clearly had discussions about the possibility of raising common shares in the open market, and at this stage, we do not feel that that's in the best interest of our shareholders or a necessity at this point in time. So --

Okay. Sounds good. Thank you.

Sure. Thanks, Scott.

Our next question comes from Adam Klauber at Macquarie.

Thanks, good afternoon.

Hi, Adam.

Hi. A couple of different questions. That tool and die, how large is that total credit? And what sort of shape is the business in? I mean, are they close to not being around?

Well, Adam, I would -- this is John Martin. I would start by saying the total relationship is in the $21 million range. In terms of their ongoing survival, I don't think I'd venture a guess or be able to respond to the projection as to their ongoing viability.

Okay. Do you have collateral? What type of collateral do you have?

It's our typical C&I type structure. We've got real estate, as well as operating accounts and equipment.

Okay. And are they paying at all or have they totally stopped paying?

Well, I don't think I really want to get into that level of detail necessarily, but would say that we are working with the customer as it relates to their payments, and are basically trying to work through the issue with them as we go on.

Adam, it's Mike Rechin. It is an ongoing, out-of-bankruptcy entity that is where we have sized and measured the combination of collaterals that John referenced, current assets, fixed assets, real estate, to assess our degree of collateral coverage, and have identified specific reserves for gaps that we feel like exist.

Okay. That's helpful. And by the way, that's a very helpful chart, the non-performing asset reconciliation. As far as the $18 million in payoffs to accrual, is that a couple large credits or is that -- could you give maybe some detail on that?

There were a number of credits, I'd say probably a third of those just as a general guideline, we moved to accrual. The other were names that we otherwise were paid out of, either through the liquidation of some form of collateral or through a refinance from another institution.

Your question, Adam, in my mind speaks to units, and it's one of the reasons I'm encouraged about what we've begun to see really over the last two quarters in terms of -- our average commercial loan size is beneath $1 million. And so when you talk about the kind of dollar amounts that are going in and going out, the fourth quarter we view to be an aberration, in that the $21 million name that moved to non-performing is greatly disproportionately large to what our next largest non-performing credits are, and disproportionate as I mentioned to the average size of our exposures.

I would also add that it is the same entity that we referred to in each of the last two calls, in being a large exposure in the automotive sector of our C&I book. So while it's unfortunate that it took a turn negatively, it didn't catch us by surprise.

Okay. And you mentioned on the call and also the release that you think there's a reasonable chance that provisions could peak out. One, do you think that's -- is that next quarter, next two quarters? Or is it pretty close? And I guess underlying that, how's the movement in the watch list? Has that also been coming down?

John can speak to the watch list in a moment. In my comments on the front end of the call I referred to some of the earlier measures of migration, specifically OEM loans and unimpaired classified loans. And those came down by a somewhat significant, in our mind, degree, about 28% from the third quarter to the fourth quarter. So we were pleased with that.

It's about $55 million in total, so you can kind of back into the numbers, but it was kind of equally split in each of those two categories as to the source of the decline, and the grading criteria are consistent. I'd love to say that that would continue. When you get into it, it has that same flavor that speaks to your earlier question, in that the average unit size is somewhat small, certainly seven figure numbers, not eight figure numbers, so it speaks to series of individual obligations improving and not one or two.

Okay. On the DTA, I guess how large is that at this point, and I guess what's your outlook for it?

Would you restate your question? Did you say DTA?

Yes, I'm sorry, the deferred tax asset.

I'm sorry. Your question, specifically?

How large is your deferred tax asset right now, and what's the outlook for needing to write that down?

I can't give you the exact amount. I should know that off the top of my head. We've completed all of our deferred tax work for the end of the year. We have used the 2008 earnings. We still have room on 2007 earnings, and we're very confident in the carry-forward because of the strength of our pretax, preprovision run rate. So at this stage, we feel very good about the goodness of that number and our ability to use it, either on a carry-back or carry-forward basis, but I don't have the dollar amount for you.

Okay. Thanks a lot.

Thanks, Adam.

Our next question comes from John Rodis, Howe Barnes.

Good afternoon, guys.

Hey, John.

I don't know, Mike or John or I'm not sure who, but could you just talk a little bit about the health of your other kind of larger relationships, and is there any issues with those right now?

Yes, we actually on a annual basis, as you would imagine, go through the portfolio and review our relationships, and likewise, all the relationships greater than $1 million within the institution we're looking at quarterly. And I think in terms of large dollar potential problems, clearly the one that we just described is one of the most or one of the largest, and would say that we don't have others in that range. Many of them, many additional relationships that we have that are experiencing some difficulties are much lower than that dollar figure, and is probably far more representative of the granularity within our portfolio and the types of issues that we'd be experiencing.

So again, the one large one is kind of an aberration in terms of size, in terms of total aggregation, but the remaining issues are, again, far lower than that.

John, if I'm not mistaken, the $8 million overall relationship that also went non-accrual in the fourth quarter, is our largest -- is our second largest non-accrual, is that correct?

That is correct.

Okay. The $21 million credit, was that a long-time relationship with the bank?

Not that long. It's an established company that has not been our client for more than a couple of years.

Okay. If we look at operating expenses, is there a lot more room for improvement, or kind of look at the fourth quarter levels, is that a good run rate to kind of go from, and can you just talk about what sort of efficiency ratio you kind of see going forward?

Sure. John, it's Mark. We're encouraged about some of the efficiencies that we can continue to gain, and it's really, when I highlighted some of the areas where we've had significant increases this year, a number of them are credit-related. So as we look at reductions of ORE costs, and as we look at reductions of our professional and legal services, we think there's also a reduction in our overall FDIC expense, barring any one-time assessments.

And as a Company, we expect to continue to become even more efficient. So, there are opportunities, just on the expense side. Margin, we may -- there may be a little more room to expand margin, and we're continuing the cross-sell initiative, the non-interest income that are helping drive additional fee income. So, we certainly feel like there's still more capacity in our current footprint to maximize value for our shareholders.

Is the Lincoln acquisition, has that pretty much run its course as far as cost saves and stuff like that?

I think that one has. I would offer that, consistent with your question, that there's more opportunity for us in the legacy portion of the company as we continue to take advantage of centralization in the hub of our Company and our operation center. I thought we did a pretty thorough and quick job on Lincoln. I don't see a significant amount of additional expense savings in that particular unit. But as we offer new technologies available through vendors primarily, that's where some of our efficiencies have come. As Mark referenced, only slightly more than a third, about a third of the FTE savings came out of the Lincoln franchise.

Okay. Thanks, guys.

Thanks, John.

Our next question comes from Brian Martin at FIG Partners.

Hey, guys.

Hi, Brian.

Just one question, Mike. On the -- you guys talked about a few auctions you did this quarter on the one to four family. Can you talk a little bit about, would you expect to do more of those. And then just as it relates to commercial credits, do you see any auctions on those or is it just going to stick with the one to four family? Well, Brian, this is John. I would say that we're probably looking at, and we continuously look at that one to four family real estate book and OREOs and obviously we don't want them, so we're looking at auctions as one of the ways to dispose of those. So that's kind of an ongoing process, probably a little bit more formalized last quarter but I suspect we'll probably have a number of those again in the fourth -- or in the first quarter and forward.

As it relates to loan sales or the sale of or auction of more commercial ORE, it's kind of a part of a multi-pronged strategy. I think we look at auctions, we look at listing, and in terms of loan sales, we continue to look at that and evaluate, given where we are, as to the appropriateness of potentially selling off notes. I mean, does the bias seem to be more towards the sales side or is it more kind of I guess work through these on a maybe more of a lengthy workout type of process, given what pricing you're seeing out there? I would say it's -- again, it's a two-pronged approach. At the lower end we're probably more inclined to look at ways to dispose of those quickly. At the higher end of the spectrum, we're probably more inclined to work through those, given the loss, so at the lower end obviously it's more expensive. We do have a dedicated team of workout individuals, and have found success compared to some of the valuations we've gotten back on the high end to working them out ourselves. So, we do both-- we look at both. Okay. How about maybe just for Mark, the balance sheet expectation this year as far as shrinkage, kind of what your expectations are. I mean, have they changed much from last quarter? Still seem pretty consistent, maybe just kind of outline what your thoughts are as far as that goes.

I think it's pretty consistent with what we outlined last quarter. I would anticipate the reduction of the broker deposits that I mentioned in my section of the call, if you could hear me.

Yes.

Which I think was -- it was $122 million. So we would expect to see a runoff of the broker deposits, or expecting some continuation of decline in the loan portfolio through the first six months, fairly modest. And with the growth that we would see in our non-maturity deposits, we do anticipate that the overall balance sheet will not be shrinking dramatically from this point forward because the excess liquidity will be deployed in the bond portfolio.

So it really is a function of reducing the broker deposits, growing core retail deposits, and some runoff in the loan portfolio that feeds the bond portfolio. So I think we've probably neared the bottom in terms of how much shrink we could have in the loan portfolio or in our overall balance sheet without getting to the point where we're losing the type of relationships that we want to grow, our non-relationship assets. Really we've already primarily dealt with what was available to us in the portfolio.

Okay. And then just lastly, on the -- some of the legislation with regard to the NSF fees, can you just give a little bit of color as to what your expectations are and how that will impact you or what you guys are doing to offset that?

We're kind of formulating our strategy now. We're looking at some of the alternatives that other institutions have chosen, and while we haven't picked a direction yet that we feel like setting, we're evaluating what allowing a de minimus level of overdraft on a no fee basis would do for us. We haven't yet fully analyzed exactly where all of the sources of the revenue have come from in terms of the end source, but we're going to have a strategy in place here before the spring gets too close to us, knowing we have to act by July the first.

So it's a significant dollar item for us, service charges as a whole as you can see are just under $4 million, and we feel about a third of that is at risk based on some of the definitional work in the regulation as drafted. So we're trying to come up with a community friendly win-win proposition that gives our customers an optimal flexibility in choosing how they want to be treated without putting too much revenue at risk.

Okay. All right. That's all I had, guys. Thank you very much.

Thanks, Brian.

There are no further questions. I would like to turn the conference back over to Mike Rechin for any closing remarks.

Thanks, Amy. My only remark would be one of appreciation for the listeners on the call, appreciate the chance to speak to the progress we feel like we're making, particularly encouraged at the early indications of credit complexion getting a little clearer. Mark referenced in his answer to the capital question, the benefit of patience, and I think that our Board and our management team have been patiently evaluating our choices, trying to fully understand the gap or the hole that the credit losses create. We're somewhat pleased with that and we'll continue to act on that somewhat through the year. Appreciate the time and look forward to talking with you at the end of the first quarter. Thank you, Amy.

Thank you. That does conclude today's conference. You may now disconnect. Thank you for attending.