First Merchants Corp (FRME) 2012 Q1 法說會逐字稿

Good day and welcome to the First Merchants Corporation first-quarter 2012 earnings conference call and webcast. 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.

I would now like to turn the conference over to Mr. Michael Rechin, President and Chief Executive Officer. Mr. Rechin, the floor is yours, sir.

Thank you, Mike. Welcome, everyone. Thank you for joining our earnings conference call webcast for the first quarter ending March 31 of 2012.

As in prior calls, joining me today are Mark Hardwick, our Chief Financial Officer, and John Martin, our Chief Credit Officer. They are going to be adding detail as well as myself to our press release which went out just after 10 o'clock this morning and our presentations speak to the material from that release, which is accessible on directions from the webcast contained at the back end of the release.

My initial comments will start from slide 4 titled first-quarter 2012 highlights. We are pleased to be with you today. We had a strong core first quarter, $0.25 earnings per share fully diluted, nearly a 50% core earnings performance over the first quarter last year, our best core banking quarter since mid-2008.

All of that within the $0.46 per share on an absolute reported basis, 171% increase year-over-year and a lot of that difference comes over an exciting happening for us. Second half of last year in September, we actually firmed up the repayment of our CPP obligation and I thought it put us in a position to be a little bit more outwardly focused and I think we have communicated on calls like this the last few times, our willingness to look at smart, nonorganic growth opportunities.

And so in the first quarter, we made a rapid assessment and I think a smart bid on an FDIC modified whole bank transaction and were successful in acquiring the loans and assuming the deposits of Shelby County Bank, which is referred to several times in this work as SCB.

So while the immediate impact is strong, as evidenced by the $0.21 kind of immediate accretion, I think we are more excited about the upside as we watch the acquired loan portfolio performance, watch our people interact with those of the bankers that joined us from SCB to put a first-class, First Merchants effort on the field in Shelby County, Indiana.

Outside of that, pleased to see revenue coming back at us, slow growth there but as the slide indicates, $1.7 million year-over-year kind of equally split between net interest income and non-interest income. I think while there is elements of the margin that are under pressure, our bankers are doing a great job in the value exchange in the field preserving that at a pretty high level. And then we have had some success in restoring fee levels across several service categories in the post-Reg E era.

Mark's here and is going to talk to you about a couple of these bullet points but we really feel like in the quarter we eclipsed a few capital targets that we had set for ourselves going back a couple of years, specifically as it relates to the common equity level, getting through the 7% level, and then the Tier 1 common at 9.20. We are pleased with that.

As Mark will talk about the composition of our funding, it really is core funded from our customers in almost every respect. And then the lower risk profile speaks to what will be John's remarks about his continued shepherding of not only our traditional loan portfolio but what our early findings are coming out of Shelby County.

At this point, I was going to turn the call over to Mark.

Thank you, Mike. My comments will begin on slide 6. Just in looking at our balance sheet, our interest-bearing assets increased year-over-year by about $144 million or nearly 4% due to increases in loans, investments, and bank-owned life insurance on lines one, two and five.

On the linked basis, our interest-bearing assets increased by $97 million as our purchase of certain loans from the FDIC as of quarter end totaled $89 million. Net of the $19.2 million fair value marks that we did put on the SCB loan portfolio as of quarter end.

Our allowance on line 3 totals 2.5% of loans or $70 million and specific reserves totaled just $5.9 million as of quarter end. That's the lowest level of specific reserves since mid-2007. The remaining $64.5 million of the allowance or 2.4% of loans are general allocations or ASC 450 reserves.

The composition of our loan portfolio on slide 7 is diversified. It's granular and allows for pricing power. Our Community Bank balance sheet produces a 5.17% yield on loans for the quarter, down 39 basis points from the first quarter of 2011.

As a commercial bank, our loans are predominantly C&I, owner-occupied, CRE, investment real estate, and agriculture production loans. Absent SCB growth, we were pleased to see core commercial loans increase by $21 million year-over-year -- I'm sorry, $21 million over year-end 2011.

On slide 8, our $960 million bond portfolio continues to perform well, producing higher than average yields with moderately longer duration than peers. Our 3.78% yield compares favorably to peer averages of approximately 3.14% and our duration remains just a year longer, at 4.1 years.

The net gain on the available-for-sale portfolio is identified on this slide is $29.3 million, but if you include our held to maturity portfolio, the total gain in the bond portfolio is $37.2 million. We have $99 million that will mature throughout 2012 with a yield of 3.50% and $113 million that will mature in 2013 with the yield of 3.14%. So the tax equivalent of 3.78% should hold in pretty nicely as we go through the remainder of this year and into 2013.

Now on slide nine, I am pleased by the progress that we have made with the right side of our balance sheet. Non-maturity deposits, line one, are up again and represent 70% of total deposits. Our broker deposits in Federal Home Loan Bank advances are only being used to inexpensively lengthen liabilities for alcove purposes as we work hard to continue to be asset-sensitive and prepared for rising interest rates down the road.

During the quarter, we repaid $79 million of TLGP borrowings and replaced them with longer maturity obligations at much lower rates, saving around 180 basis points. It is important to note that the SCB transaction actually self-funds from a liquidity standpoint and given the size of the gain, it also self-capitalizes.

Tangible common equity continues to grow nicely as tangible book value per share now totals $10.05 per share.

The mix of our deposits on slide 10 continues to improve and our total deposit expense is now just 66 basis points, down from 105 basis points as of the end of the first quarter of 2011. Shelby County or the SCB deposits totaled $99 million at quarter end, down from $126 million on the purchase date. The runoff was consistent with our M&A modeling as $21 million came from higher priced Internet CDs.

We really took advantage of the opportunity to reprice CDs through an FDIC transaction that you don't typically have or you do not have in a traditional merger, so we were pretty aggressive about modifying the interest rates on their CD portfolio to equate to market rates.

All regulatory capital ratios on slide 11 are well above the OCC and the Federal Reserve's definition of well-capitalized and the Basel III proposed minimums. We were especially pleased to cross a couple of key thresholds as Mike mentioned, with the Tier 1 common equity on line 4 growing -- now eclipsing 9% and the TCE on line 5 now greater than 7%.

The corporation's net interest margin on slide 12 totaled 3.96% for the quarter, a single basis point of improvement over the first quarter of 2011 and net interest income increased by $700,000 over the same period.

Total non-interest income on slide 13 always reflects some volatility due to line 6, securities gains and losses. Now this quarter we have also added or excluded line 8 from our totals given the one-time gain on the FDIC transaction. Even after excluding $9.9 million of gains on line 10, or line 10, still improved by $1 million over the prior year.

Non-interest expense on slide 14 totaled $34 million for the quarter, up just $100,000 from the prior year as employee benefit expense increased by $1.2 million. While higher than the first quarter of 2011, the run rate of salary and benefits is really very consistent with quarters two, three, and four of last year, but they do compare unfavorably with the first quarter of 2011.

Please turn to slide 15. This is a busy slide and we have tried to minimize the number of extraordinary items, however, we still have several. The pretax pre-provision run rate remains strong and continues to improve. And I think it's important to highlight the one-time gain from TARP, the exchange that we had back in 2010 and then the loss that we experienced on the repayment of TARP in 2011.

We have discussed and presented the one-time gain from our SCB transaction in a similar fashion; however -- or we've presented it; however, it's very different. The TARP gains and losses that we experienced in 2010 and 2011 were non-cash and were driven really by accounting treatment. For the gain on the modified whole bank deal with the FDIC, is the result of acquiring assets for a $29 million discount or a 25% discount.

We are hopeful that over time as we move forward and work through the loan portfolio that we have acquired that at least a nice portion of the remaining $19 million will find its way back into our income statement.

Now turn to slide 16. Our employees and management teams are very pleased with our adjusted or core trend lines and we hope that you as shareholders are as well.

Now John will discuss our satisfying credit quality trends.

Thanks, Mark. Please turn to slide 18, where I will begin by covering the asset quality summary. On line 1, non-accrual loans are down in the comparable quarter year-over-year from $87.7 million to $74.5 million. In the linked quarter, non-accrual loans were unchanged in the core folio.

With respect to the acquired portfolio, we performed an initial due diligence followed by a full commercial portfolio review, which resulted in an increase in $4.9 million of newly identified non-accrual loans. While these loans have been paying current due to well-defined weaknesses or well identified weaknesses and the high possibility of potential loss, we moved those loans to non-accrual.

On line 3, restructured loans decreased from $14.3 million to $6.7 million. As outlined in previous quarters, we primarily employ a strategy of restructuring loans to A-B restructures. As mentioned on previous calls, the A note is underwritten and structured to market terms and conditions while the B note is charged off. We account for these by classifying the A note as a TDR and once demonstrated repayment has been established, we no longer report the loan as a TDR.

If a loan is modified due to the borrower's financial situation other than in an A-B note restructured as outline, it is identified as a TDR for the entire life of that loan.

In targeted situations, we have found the A note -- excuse me the A-B note restructure to be effective in assisting the borrower in identifying the loss while returning the loan to performing status.

On line 4, 90-day delinquent loans continue to remain low with one-half of the total resulting from the fair value portfolio.

And on line 6, impaired loans were lower in the come portfolio both in the comparable quarter year-over-year and in the linked quarter declining from $116.8 million and $79.8 million to $78.9 million respectively. The $15.4 million of impaired loans from the fair value portfolio includes all loans that were individually identified in the fair value analysis.

Moving down to line 7, the allowance for loan and lease losses while $500,000 lower remains at 2.58% of the core loan portfolio and 2.5% of total loans. The change in the allowance remains directionally consistent with the improvement in the linked quarter and our core portfolio and classified assets on line 9.

We continue to see migration upward and would expect to see improvement in overall criticized assets in line with the improved performance in our customer financial results -- customers' financial results.

Before moving on to the NPA reconciliation, please turn to slide 19. The lower bar graph shows the impact of the newly identified fair value portfolio non-accrual loans. The core portfolio non-accrual loans were relatively unchanged in the linked quarter, while we had $4.9 million in loans identified post closing that have been adjusted for fair value accounting. If the fair value adjusted non-accrual loans are excluded, the overall coverage to non-accrual loans remains flat at 101%.

Now please turn to slide 20 where I'll walk through the NPA reconciliation.

Before I begin, I should point out that on this slide the migration results include fair value portfolio loans. Now beginning in the gold box, in Q4 2010, I once again highlighted the improvement in asset quality over the last year and a half. NPA and 90 days delinquents have decreased 25.8% and show significant improvements.

Then moving to the far right column, Q1 2012, I will now step through the migration changes. On line 2, new non-accruals of $16.4 million were impacted by the fair value portfolio this quarter. Absent the addition of the $4.9 million in new non-accrual fair value loans, new non-accruals were in line with expected migration. To provide color, there are eight customers greater than $250,000 comprising the total new non-accruals.

On line 3 and 4, we reduced $2.7 million in non-accruals and had $2.5 million in new other real estate owned. Then moving down to line 5, gross charge-offs were lower in the quarter at $6.3 million compared to $10.7 million. In the linked quarter as in the press release, the net charge-offs for the quarter were $5.4 million compared to $8 million in the linked quarter. All in all, our core non-accrual inflows were met with reductions and the driver and the increase was the addition of the newly identified fair value non-accrual loans.

Moving down the migration to lines 8, 9, and 10, we saw a $700,000 net reduction in other real estate owned. $745,000 of the write-down on line 9 resulted from the receipt of a current appraisal. While the $15.6 million ORE portfolio has roughly $7.5 million of real estate under letters of intent pending zoning or other issues impacting a potential sale. We continued towards resolving these issues. The progress is slow.

So jumping down to lines 13 and 14, nonperforming assets and 90-plus days delinquent loans declined $3.8 million, continuing the improvement in overall asset quality.

Then turning to slide 21, as mentioned, the migration analysis, net charge-offs were lower for the quarter with the allowance remaining relatively unchanged. Provision $4.9 million of the $5.4 million in net charge-offs, our allowance methodology continues to be directionally consistent and future improvement in asset quality will of course drive lower provisioning and overall allowance levels.

Now please turn to slide 22. In summary, asset quality trends continue to improve, as measured by the lower level of classified assets and lower delinquent loans. We continue to work our way through the non-accrual and ORE and we continue to have success restructuring loans while our chargeoffs and provisioning expense continues to remain at lower levels.

With respect to new business, the internal measurement of pipeline saw improvement at the quarter and finally through the initial due diligence, the post closing loan review and the ongoing discussions with the bankers in Shelbyville, we believe that we have a portfolio that is similar to our own composition and fairly marked based on our analysis.

I will turn the call back over to Mike Rechin.

Thank you, John. I was going to make a couple of closing thoughts on page 24 before opening the lines for questions. And I am pleased when I look at this slide with the consistency of the initiatives that we have quarter-to-quarter, our chief banking officer keeps our retail commercial mortgage line of business folks constant in what we are prioritizing. The one new item here I would mention before I get to the middle part of the page would be the integration that is in front of us.

We look to grow in Shelby County and a key component of that for customer satisfaction is to get them using our back office as quickly as possible. And so our integration of SCB is scheduled just after the first week of July, will have taken place by the time we speak next in this call following the end of our second quarter. We go into that with a full expectation that it will perform off of our core systems and product offerings as have our last integrations.

Going back to the middle of the page, market coverage tactics across all lines of business including SCB, as John referenced, the portfolio feel around the kind of middle market calling we do around the Company and SCB to us is more than a financial transaction. We viewed that as a core franchise community where we can excel in lieu of regional banks, which occupy that same market.

So the market coverage tactics we use in all the lines of business are being deployed there today. And I will reference our pipeline here in a minute to give you a snapshot as to how we think we are doing.

From an FTE standpoint in terms of sales folks, we are pretty much full at this point. I know we highlighted over the last couple of quarters the willingness and we thought the access to some high-performance individuals commercially oriented primarily both in investment real estate and C&I. We are towards the end of adding those in the beginnings of their efforts under First Merchants are beginning to show up. We are pleased with it.

One area where we will continue to add some people would be in business banking. It's that unit that we have linked to the retail bank less than $10 million in revenue with dedicated underwriting with a little higher velocity for the calling effort.

So what is it producing? Our balance -- I personally thought we might make a little bit more headway in terms of on balance sheet organic loan growth. On the commercial side we have. We had a good quarter. We grew at about a 2% annualized rate, $11 million in commercial, knowing that it's offset by the mortgage business whose volumes are huge but where we continue to maintain our originate and sell strategy that drives the size of the gain on sale noninterest income line.

The consumer part, we are still scratching our heads at. We're putting a huge amount of effort at making sure that our consumer customers know our willingness to use our balance sheet on their behalf. It doesn't have the traction we would have hoped to -- we're just going to be consistent with it.

Trying to quantify that a little bit more, I referenced our mortgage business. We made a decision almost a year ago to do a lift out of a team that would diversify our volumes and maybe take some of the interest sensitivity out of what is the refi market by owning a larger share of the purchase business especially in the growth markets we are in, Indianapolis and Columbus. That has worked out pretty well.

And so as we sit here early in the second quarter, our pipeline for the mortgage business is at $71 million is $15 million higher than last quarter and on a seasonal year-over-year basis, $25 million were almost 50% higher than it was a year ago.

Those same kind of numbers exist in our commercial side of our Company. I referenced the investment we have made in bankers, but even apart from that, the marketplace is mildly stronger. There's more business owners that are willing to hear our ideas and our market coverage is growing, and so our pipeline there -- and to be consistent definitionally on these calls, we have talked about a pipeline as opportunities where the credit has been approved in front of their customer and in most cases in some early stage of documentation.

That figure on the commercial side of the house at roughly $165 million is 60% over the first quarter of last year and about 33% over year-end. So that growth that I alluded to a moment ago, we would expect to continue at a single-digit rate. I don't think it's going to go through the roof any time soon. I think we're applying our appetite and our culling efforts prudently.

We have one more metric that I've shared with you in the past. It is our early-stage pipeline. It is less firm but it's also equally as strong as it was last quarter at $365 million and it's about 65% higher than it was a year ago. That's probably a less seasonal figure but I think as I compare it to last quarter as about flat, knowing that we harvested some of that onto the balance sheet. It is just another source of optimism for me.

I think we can do better there. I look for us to do better. We would like to grow as I referenced at the last call, own outstandings in all categories and this year we will because of Shelby County but I would like to do it above and beyond that meaningful addition to us.

Going back to my slide, the last point under growing revenue was this retail CRM. We're still very, very excited about it. It's a product that would go into our banking centers and support both traditional retail and the business banking unit. We're probably a quarter or two behind where we might have otherwise been and so that is kind of a late 2012 initiative for that installation, which we think has some upside.

The bullet points directly beneath it, there is one that I kind of think of differently than the way I write it. When I say banking center rationalization, I know what Mike Stewart, our Chief Banking Officer, is working on is really just a better understanding of banking center effectiveness or banking center profitability. We are 18 months now past full implementation of our staffing model that has produced some efficiency. The real purpose of that was not only to be smart from an expense standpoint but to try and glean a cleaner view of a given market's potential and how we perform in that market on a sequential basis.

So I would look for some decisions to be made around how we can best be aligned retail wise. Certainly by the second or third quarter of this year as we make some decisions.

The last bullet point there just to be more specific, our credit folks evaluated late last year the investment in some automated auto-dialer technology. We made that investment in the fourth quarter. We're fully trained on it and the two tangible results we have early for you, you might've seen them in John's work, our consumer delinquency really dipped based on the really rapid ability to get to our consumers and bring to bear the knowledge that they need to keep their obligations current.

And then there's some FTE savings associated with that technology as well that have already made their way into our headcount and our expense phase.

Last bullet point, beyond Shelby County, which is what appears to us to be very, very attractive, we want to continue to participate thoughtfully in the accelerating industry consolidation. We are confident in our integration execution, confident in our product offerings. Particularly I say that as we have kind of transitioned a lot of our retail formatting in the post-free checking world into products that we think offer great value and serve that deposit mix that Mark spoke to.

And then lastly our service level, we've been in a retail line of business now, which is perhaps our greatest customer facing business and the consistency and the way we approach our customers trying to add value is really in great shape. So we think we are a good candidate for that if we can find the right opportunities either in a traditional way or should other FDIC transactions be in geographies where we think we perform well.

I think you picked up in the tone of my colleagues, we feel good about -- guardedly good about where our Company is going. As the economy kind of continues in our footprint to evidence a little bit more strength. So I'm going to turn over the call back to Mike to take some questions.

(Operator Instructions). Stephen Geyen, Stifel Nicolaus.

Good afternoon. Mike, I appreciated the additional color at the end. Maybe some additional thoughts. I was looking at the loan portfolio and just the changes quarter-to-quarter and trying to get a sense of the different categories that are broken down there and the growth rate quarter-to-quarter and how we should look at that with the acquisition and the production that you had?

Sure, if you are looking at the five quarter trending of loans by type, it sounds like that's what you have, Steve. I would be happy to work with you on that. I thought that we could grow organically everywhere. If you take the $90 million, it is actually $89 million but if you back the $89 million out of the March numbers, you can see that we marginally shrank just about $10 million. Our consumer portfolio was down about $13 million. Our mortgage portfolio was down $9 million and again, that's mortgages that we keep on the balance sheet and our commercial banking business was up $11 million.

I think that's consistent with what I shared. If you look into the March 31 numbers with Shelby County included, as they are on this page, and if you broke down what's in that $89 million, they had -- we have I should better have said -- $22 million of home equities, $8 million in consumer, $10 million in first mortgages, and $50 million in a combination of investment real estate and C&I landing.

And you know the other thing I would mention about it is Mark talked about the transition on the deposit side out of that bank. We haven't had any movement given the fact that the most troublesome assets were left with the FDIC. We're pleased that we've had great stickiness around a portfolio that so far feels good to us.

Like a lot of other FDIC failed bank candidates, a lot of the things they probably wish they did different were outside their market and so the temperature of the customer we find is the way they treat them there has gone well for us.

That's helpful, thank you. Maybe a question for Mark or John. Looking at the general allocation for the reserves, just curious how you look at that with the economy slowly improving a little bit, if you might make some changes to that? And then also is there a look back period on net charge-offs as well? Is it like a two-year, three-year look back period on the charge-offs that go into that general allocation?

We do have a look back period on the historical allocation component and it's two years. At one point, it was a little longer but we have shortened it over time and our expectation is that we are likely to be able to provide similarly that we did this quarter to our net charge-offs and that as the portfolio continues to improve, and as the historical numbers continue to improve that we will be able to continue to reduce the amount of provisioning relative to charge-offs.

The only thing I would add is that at the end of my comments, which is as asset quality and the criticized assets come down, that obviously drives the model and will allow for us to provision less.

Great and last question. The salary employee benefits, you talked a little bit about that -- the expense management was really exceptional. And just curious if there's any one-time items in that or is this kind of a good number to work off of?

There were some one-time items that we didn't really highlight. They kind of offset -- there was a one-time item in the bank and life insurance portfolio. It was essentially offset in the expense categories. We did have a death claim in the bank on life insurance category and on the expense side, we had a handful of fixed asset write-downs.

The cost to continue to maintain the Shelby County systems and processes prior to integration and net of taxes all kind of equaled out to around $600,000 or so on the bottom line.

I think it's fair to say two Mark's expense side of that answer, Steve, we have got some ongoing expenses with Shelby County that will run through the integration because their Jack Henry system we continue to support. That will go away. That is a small six-figure number and then we have about $200,000 of what we call temporary expense for some of the employees involved in that same effort. Then we had some one-time investment banking costs that were just over $100,000 with the transaction itself.

Okay, thank you.

Scott Siefers, Sandler O'Neill.

Good afternoon, guys. I think the first question I had is probably most appropriate for Mark. Just curious on your ability to sustain the margin. It doesn't sound like you're necessarily too worried about the investment portfolio, but I would be curious to hear your thoughts on pricing pressure on the loan side. And any additional room you have on funding costs as well.

And then along those lines on the margin if you could talk about whether or not Shelby had any impact on the margin in the first quarter and then what you would have -- what you would anticipate it would do going forward.

We are fairly optimistic about our ability to maintain our margins through the remainder of this year. As we move our way into 2013, I think we will be under a little bit more pressure. The remainder of this year if you look at loans over a 12-quarter period, they declined 39 basis points. The yields in the bond portfolio were somewhere around 20 but our interest expense on the deposit side came down from 105 to 66.

Some of the optimism I have for the remainder of this year is just continuing to price down the CD portfolio as it runs off at about $50 million a month. And then some optimism around the ability to replace or reprice wholesale funding as we work through the year.

Just in the month of April, we had $16 million mature on the wholesale funding side at a [480]. We have another $26 million, almost $27 million in May at a [470] and over the next 12 months, those totals are $75 million. They cost [440] and we can replace all that funding even protecting the balance sheet for rising rates out longer-term and still pick up 200 to 250 basis points of cost savings.

I mentioned the TLGP that we just did on the last day of the month was a $79 million reduction of borrowings that were costing about 320 and we replaced those somewhere in the 140 or 150 range. And so we are keeping up on the wholesale funding side and on CDs and I think that will continue through the remainder of the year.

But as wholesale funds and deposits find more of a floor, it will be a little more challenging in '13 and it's more imperative that we achieve the loan growth or the balance sheet growth really either side, either loans or deposits to continue to make up for whatever margin compression we might see in '13.

Okay. Then that outlook for pretty stable through the course of this year, that includes any impact from Shelby in there?

Yes, I should have -- sorry I didn't answer that question. It looks like Shelby is going to -- I mentioned today that it self funds, that we have a little more in deposits than we have in loans and so far through our 50 days of experience or so, the margin is over 4% at Shelby County. So we are pleased with the way it's performing to date and then some of the yield accretion that we certainly hope happens over time I am sure will help enhance the spread of that transaction as well.

Okay, perfect. Thank you. Then along the lines of the Shelby deal, have you guys gotten any of the cost saves [out today]? I don't think any of the branches have officially been closed yet, if I'm recalling correctly, and then obviously you have the integration. So are the cost saves at this point still all prospective or is there any of anything that got in the run rate in the first quarter?

We did get a little bit on the run rate from an FTE standpoint -- there was -- but the two items you referenced are both in front of us. You're right, so we have some money that will be saved, the banking centers close next week actually, the ones on which we decided not to keep open. And then as I referenced, the integration and those have roughly the same amount of FTE and direct cost impact to them is right after the end of the second quarter around July 7.

Okay, that's perfect. Thanks a lot.

Daniel Cardenas, Raymond James.

Good afternoon, guys. Can you give us some color or I guess an update on how the Indianapolis market is looking for you guys? Are you seeing more growth opportunities? What is competition like now that a couple of other community banks are trying to move into the market?

We like our steady progress there. When I referenced business banking in my prepared comments, Dan, the core market and the peripheral markets in Indianapolis is where the majority, not all of those business bankers are being deployed, the deepest market for that sector.

On the core middle-market business, we have had the largest amount of growth there in 2011 and have a projected largest amount in 2012 as well.

To the extent the commercial real estate is resuscitating itself, that's where we have the best focus on the most capable developers and so that just is an added arrow in our quiver, if you will.

As it relates to the other banks that target that same market, that is not who we are taking share from, so I acknowledge their efforts there. They will probably do an adequate job but to the extent that we are taking share there, it's really from the regional banks.

In terms of total loans, how big is Indianapolis right now?

We combined it. Shelby County for instance would go into our Indianapolis market but it is just under $1 billion.

Great. And then as I look at your capital levels, kudos on breaking the 7% TCE ratio. What is kind of the lower end of your comfort zone now with that ratio?

As we mentioned, it's been a long time, I think 2001, since we're above 7%. We internally feel like 7% of TCE and 9% Tier 1 common is really kind of the lowest that we should operate at least based on the current environment and so those are big hurdles for us.

It gives us a little more flexibility as we evaluate the SBLF or our BofA relationship those types of things. So certainly if the right acquisition came along we would have to evaluate if the modest amount of dilution and what the payback period would be and whether any type of enhancement would be required. But we feel really good about these levels. We think this is really an optimal spot for us to operate.

Okay, good. And then just one quick question on the M&A front. Are you seeing more opportunities present themselves to you or is the market still a little slow?

I think the market is slow. Our efforts are outbound if you think of it like I am, Dan, meaning the companies and the franchises and the executives associated with the kind of targets that we think we could do a nice job with are effectively the same as they would have been two years ago. We just spend more time on it.

But in terms of things coming to us, I haven't noticed a difference especially if you take the kind of FTSE type of transaction out of the mix. In terms of feeling that people need to combine with another company based on the industry outlook or the costs of running a bank, we haven't seen that yet.

Great, thank you.

John Barber, KBW.

Good afternoon. You mentioned CD runoff would be about $50 million per month. What is your retention rate on that and where are you currently pricing one-year CDs?

We have been keeping probably -- the retention rate is improving early on in the cycle when we were -- when rates dropped so dramatically, we were seeing higher runoff as people were rate shopping kind of the single-purpose accounts that we happen to have. But it is worth somewhere in the 80% to 85% range of retention at this point.

Our offer rates are right around 1, the best rate we have is around 1%. So most of our customers that are coming through those buckets kind of kind of on an annual to 12 to 18 month basis and they are staying part in fairly short offerings that are priced less than 1%. So it's -- we are trying to extend. We think that ultimately would be smart for us and the performance of our margin over time, but the customers are still wanting to stay off of short.

Okay, thanks. Related to SBLF, how should we think about the coupon going forward and do you include the acquired loans?

No, our understanding of the program from the day we got in it was that acquired loans don't count and so that wouldn't accelerate our ability to enjoy or earn a lower rate and we still -- given we are in our -- wrapping up our third quarter, so measuring our outstandings underneath that definition will get done here in the next couple of weeks.

We would expect them to grow modestly but I don't think we are on a rate where we would realistically expect a coupon or a rate decrease on that capital component in the near term.

Thanks, and last one I had. You mentioned a payback period as one of the considerations in M&A. I guess what is a reasonable period, in your view?

We think 3 to 5 is probably the right place. I don't get outside of five years. I think it's pushing your company, it would have to be incredibly strategic to go that far out.

Thank you.

Brian Martin, FIG Partners.

I think just a couple more housekeeping things at this point. Mark maybe -- or just maybe John, can you talk about kind of your expectations for bringing down the OREO expense now that credit is starting to feel a bit better and still at a pretty healthy level? I'm just trying to get an idea of what your thoughts are there.

Brian, I mentioned in my remarks we had one fair value adjustment. So out of the $2.1 million in credit and other OREO and other credit-related expenses, that was a significant portion of it.

Then in the -- excuse me, that was one of that $1.4 million in total write-downs for the quarter. So if you look at it and you take that one out, you start to see that we are on a path really to again to see a reduction in those numbers. Obviously as we get appraisals back, we are subject to changes in market value. Our expectation has been and continues to be that with the firming in the real estate values that we have seen, the write-downs in that $2.1 million number is really under control.

So I think speaking to that was the other remark that I made about in that $15 million number, we've got $7.5 million of it under contract to sell and we have obviously with that written it down to those values. So --

Okay, so on the core portfolio on the OREO expense is $700,000 this quarter or somewhere in that range? Did I understand that right or did I miss that?

More like 1.4, probably. 1.4 probably was the number. More like the number if you take that 2.1 back out the 700 as --

I've got you, okay. And just you talked about the inflows, John, being also being impacted by the fair value. Is kind of the $10 million type of inflow number what you guys would see as more normal at this point?

I think we've said in previous quarters, Brian, that it's $10 million, $12 is the inflow although on any given quarter what flows in, what flows out might fluctuate, but that's what we have been seeing.

Okay, then just the last one maybe for Mark, on the income statement, the FDIC expense this quarter, I guess that has kind of bounced around but now with Shelby in there, I guess what does that number look like as you go forward?

We are anticipating I think we had in our budget -- what $1 million a quarter.

It was $1.1 million in the first quarter and I think that may be a tad higher based on the balance sheet that we bring from Shelby County but I would think first quarter looks pretty indicative, Brian. That's Mike speaking.

Okay, okay. And then lastly, just how are you guys thinking about SBLF and eventually exiting it or not exiting it? How are you thinking about that at this point?

As we have been building capital to achieve the 7% level, we've essentially been leaving the majority of the bank's earnings, which are near $40 million a year in the bank. This year we are upstreaming about $10 million. Our expectations are to consider next year to start being a little more aggressive about how much we upstream from the bank to the holding company. It just gives us more flexibility to pay off some of the higher cost capital components that we are carrying that may be in excess of what we necessarily need.

There's a pretty big gap between our tangible capital and the total risk-based capital and as we have said, we would like to over time see those start to come a little closer together with a little higher TC of which we have achieved and to see the total risk-based capital come down over time.

Okay, so, Mark, what was the cash at the parent and what did you upstream this quarter?

We started the year right around 20, maybe 19. And we did a $2.5 million upstream in the quarter from the bank. We are likely to do the same thing each quarter as we go through the year although we've thought about given the one-time gain that we have at the bank level, earnings are a little stronger than anticipated that we may put a little cushion by upstreaming that gain one of these quarters as we go through the remainder of the year. So it's going to be somewhere between $10 million and $20 million for the year.

$10 million and $20 million for the year, okay. That's all I have. Thanks, guys.

It appears that we have no further questions at this time. We will go ahead and conclude our question-and-answer session. I would now like to turn the conference back over to Mr. Michael Rechin for any closing remarks.

Thanks, Mike. I am going to close. We appreciate the interest. We appreciate the quality of questions. We look forward to continuing to have a prosperous 2012 and look forward to chatting with you again midsummer after the June 30 quarter. Thank you.

Thank you, sir, and to the rest of management for your time. The conference call is now concluded. We thank you all for attending. At this time you may disconnect your lines. Thank you and take care.