Independent Bank Corp (Michigan) (IBCP) 2004 Q4 法說會逐字稿

Welcome to Independent Bank Corporation fourth-quarter earnings release conference call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded. This webcast may contain forward-looking statements as defined in section 27A, I 1 of the securities act of 1933 as amended. Including statements regarding, among other things, the Company's business strategy and growth strategy expressions which identify forward-looking statements speak only as of the date the statement is made. These forward-looking statements are based largely on this Company's expectations and are subject to a number of risks and uncertainties, some of which cannot be predicted or quantified and our beyond our control. Future developments and actual results could differ materially from those set forth and contemplated by or underlining the forward-looking statements.

In light of these risks and uncertainties there can no assurance that the forward-looking information will prove to be accurate. This webcast does not constitute an offer to purchase any securities nor solicitation of a proxy consent, authorization or agent designation with respect to a meeting of Company stockholders. It is now my pleasure to introduce your host Mr. Mike McGee, President and Chief Executive Officer of Independent Bank Corporation. Thank you Mr. McGee.

Thank you. Good afternoon. We are pleased that you could join us on our conference call to discuss fourth-quarter and full year 2004 results. Consistent with my appointment as President and CEO of Independent Bank Corporation on January 1 of 2005, I will now be participating in the earnings conference calls from this point forward. Also joining me is Rob Schuster, Independent Bank Corporation's CFO and Charles Van Loan, Independent Bank Corporation Chairman of the Board. All three of us will be available to answer your questions later in the call.

Our fourth-quarter 2004 net income of 10.8 million was up approximately 1.5 million or 16 percent from the fourth quarter of 2003. Our earnings per share of 50 cents this quarter was up 6.4 percent from the year ago comparative quarterly earnings per share of 47 cents. Our fourth-quarter 2004 results were slightly lower than the consensus market expectation due primarily to an other than temporary impairment charge and a severance pay charge that Rob Schuster, our CFO, will discuss a little later in greater detail.

On balance, when adjusting for these unusual items, we believe we had an excellent quarter with strong growth in our level of interest-earning assets and our net interest income. Over the year 2004 net income totaled 38.6 million, up slightly from the 37.6 million earned in 2003. However, earnings per share declined to $1.84 in 2004 compared to $1.87 in 2003, due primarily to an increase in the average shares outstanding because of our acquisitions of Midwest Guaranty Bancorp and North Bancorp in mid 2004.

Profitability measures remain strong in 2004 with a return on average equity of 19.42 percent and a return on average assets of 1.42 percent. In our press release we did provide earnings guidance for 2005 with an estimated range of $2.10 to $2.20 per earnings per share. We felt providing some guidance for 2005 was important and necessary because of some of the unusual items impacting 2004.

In addition, our 2005 guidance takes into account the impact of the pending requirement to expense stock options in 2005, as well as the fact on a comparative basis incentive compensation levels in 2004 were reduced because of earnings per share did not grow compared to 2003. Rob will provide greater details on our outlook for 2005 in just a moment.

As you know from a recent form 8-K that we filed in early January, we have made certain management changes at Mepco. In that release we announced that Rob Schuster had been appointed acting President and CEO of Mepco. I am pleased to announce that Rob has relinquished that role and that we have appointed Jack Swanton as the President and CEO of that subsidiary. Jack has approximately twenty-five years experience in the premium finance business including nearly twenty years as a CEO. Jack has been with Mepco for about five years with primary responsibility for management of the premium finance sales force. We are confident in Jack's ability as well as the management team now in place at Mepco. Rob will now provide some additional details on fourth-quarter results and our expectations for 2005.

Thanks, Mike, and good afternoon everyone. There were a few unusual items in the fourth quarter, and as I go through our operating results I will point these out. The primary driver of our earnings growth in the fourth quarter was a 7.4 million or 27 percent increase in tax equivalent net interest income on a comparative quarterly basis, and a 1.6 million or nearly 5 percent increase on a linked quarter basis. The comparative quarterly increase was primarily due to a $629 million rise in average interest-earning assets due primarily to the Midwest and North acquisitions in growth and commercial loans, finance receivables and investment securities.

A 6 basis point comparative quarterly decline in our net yield partially offset the rise in average interest-earning assets. On a linked quarter basis, the rise in tax equivalent net interest income was due to both the $64 million increase in average interest-earning assets and an 11 basis point jump in our net yield. The increase in the linked quarter net yield was due to several factors, including an increase in non-interest bearing deposits and other liabilities, the reduction of nonaccrual loans, most notably due to the sale of 11.2 million of nonperforming loans from North Bancorp at the end of the third quarter of 2004. And finally, a rise in our loan yields that was slightly faster than the rise in our cost of funds.

As we look ahead to 2005 overall we are expecting some downward pressure on our net interest margin due to a continued flattening of the yield curve. However, we would also expect that any margin pressure would be offset by earning asset growth. On a linked quarter basis loans outstanding at quarter end increased by 34.1 million, which represents an annualized growth rate of just over 6 percent. However, at the end of the fourth quarter of 2004 we securitized and retained in securities available for sale about 40 million of seasoned real estate mortgage loans. If you adjust for this securitization, linked fourth-quarter 2004 annualized loan growth was actually about 13.5 percent. This growth rate is consistent with our expected 10 to 15 percent range for loan growth in 2005.

Moving on to non-interest income, service charges on deposits were up 700,000 or 18 percent on a comparative quarterly basis but were pretty flat actually down just slightly on a linked quarter basis. For 2005 we would expect some more modest growth for this category of fee income with the rise of approximately 5 to 10 percent from 2004 full year levels. Gains on loan sales totaled 1.4 million in the fourth quarter of '04, which was down about 0.9 million from the fourth quarter of '03 but fairly consistent on a linked quarter basis.

In the fourth quarter of '04 mortgage loan origination volume was 165 million, which was actually up about 8 percent from the fourth quarter of '03. However, loan sales volumes were down due to both the amount of loans held for sale entering each quarter and the mix of loans being originated for sale compared to portfolio. The mix of refinances compared to purchase and new construction loans was 48 percent refis, 52 percent purchases for the fourth quarter of '04 and was 46 percent refis, 54 percent purchase for all of 2004. This compares to a 70 percent refi, 30 percent purchase mix for all of 2003.

Although our total loan origination volume was down 39 percent in 2004 compared to 2003, our purchase in new construction volume was actually up nearly 11 percent. We incurred securities losses of 1.2 million in the fourth quarter of '04. This was primarily due to a 1.4 million other than temporary impairment charge we recorded on our Fannie Mae Freddie Mac preferred stock portfolio. After taking this charge, the remaining book value of our portfolio at year end was approximately 25.9 million.

We have three fixed rate issues with a book balance of approximately 5.7 million, and the balance of our portfolio was adjustable rate preferred. About 4.6 million of our portfolio was Freddie Mac issues, and the rest were Fannie Mae issues. As most of you know, several banks have had similar charges for these preferred securities in the fourth quarter of 2004.

Real estate mortgage loan servicing fees in the fourth quarter of '04 included an impairment charge of about $200,000. Although short-term interest rates moved up during the fourth quarter, long-term mortgage rates actually declined a few basis points from September 30, 2004 to December 31, 2004. As a result, the year end valuation of our capitalized originated mortgage loan servicing rights indicated the need for this small increase in our impairment reserve.

Operating expenses in the fourth quarter of 2004 totaled 26.0 million and included a $2.3 million severance charge related to previously announced management changes at Mepco. For all of 2005 we would expect a quarterly run rate of 25 million to 26 million for non-interest expenses. Our assessment of the allowance for loan losses in the fourth quarter of '04 resulted in the provision of just over 300,000, which is down substantially on both a comparative and linked quarter basis. Although the provision for loan losses for the full year of 2004 was up about 7 percent from 2003.

Asset quality at year end improved with nonperforming loans at 15.1 million or .68 percent of portfolio loans. Other real estate and repossessed assets also dropped to 2.1 million at year end '04 versus 3.3 million at year end 2003. When you take into account all of the various unusual or non-recurring items in the fourth quarter of 2004, including the severance charge, securities losses, a lower provision for loan losses and reduced incentive compensation, you wind up with a net negative impact on earnings per share of about 6 cents for the quarter.

One final comment on all of 2004. When you take into account the $10.3 million decline in gains on mortgage loan sales, combined with all of the unusual charges and expenses, it amounts to about a 54 cent after-tax, per-share headwind that we had to overcome to maintain a relatively flat comparative earnings per share performance. So although 2004 has been a challenging year, we definitely feel it has made us stronger. As Mike McGee mentioned in his opening remarks, we provided guidance of $2.10 to $2.20 per diluted share for all of 2005.

In my discussion of fourth-quarter actual results, I provided some of our expectations for 2005 in certain specific areas, including loan growth of 10 to 15 percent, growth in service charges on deposits of 5 to 10 percent and a quarterly run rate for non-interest expenses of 25 million to 26 million. The 2005 non-interest expense run rate includes the impact of expensing stock options or whatever we may substitute for this long-term incentive, and also assumes a restoration and certain forms of incentive compensation, most notably the funding level of our ESOP compared to 2004 levels which were reduced because we did not have earnings per share growth.

The impact in 2005 of these specific items is expected to be about 10 cents per share. Further, our guidance assumes that the flattening yield curve does have an adverse impact on our net interest margin, which erodes a fair amount of the benefit we gained from the growth in our earning assets. Taking all of these into account, we are comfortable with the earnings per share guidance range that we have provided. I would now like to turn the call back over to Mike McGee.

Thank you, Rob. I would now like to open the call for any questions you may have.

(OPERATOR INSTRUCTIONS) Joseph Stieven with Stifel Nicolaus.

This is actually John Argas. Rob, this question is probably for you. You touched upon the margin right at the end of your presentation, and could you maybe talk a little bit how the margin performed on a month by month basis during the quarter?

I don't know if I could necessarily give it month by month. I don't have that right with me, John. Obviously it was up for the entire quarter versus where we were in the third quarter by 11 basis points. And although I think I am just here making somewhat of an assumption, I think it was up in the last month in December compared to where we started the quarter from. And I think what you are seeing there is in most of that growth came in the yield on loans where we were up on a linked quarter basis about 20 basis points. And we did benefit from the rising short-term rates. We have and this does not conclude adjustable rate mortgage loans but we have about 700 million of our portfolio which would be predominately either commercial loans or home equity loans that are tied to prime or LIBOR, some type of short-term rate. So we did get some benefit there.

And so we did see a nice lift on that. I think we are still concerned as we move forward even though we may have bucked the trend a little but in the fourth quarter of '04 I think we are concerned with additional flattening in the curve in '05 and the impact that that may have over the course of the year. I don't know if that specifically answered your question.

That definitely helps. I guess just my second question would be maybe if you could just talk about the economic conditions of some of your markets right now.

We definitely are impacted, you probably saw Michigan was just on the news I believe this week that we tied Alaska for the highest unemployment rate in the country at 7.3. However, with our entrance into Oakland County we have seen in the last couple of weeks we have actually seen a pickup in applications in both real estate, lending and commercial lending. That seems to be true across the company. However, we are not expecting any type of substantial economic growth in Michigan, but we don't believe it is going to get a lot worse than what it already is. So we're kind of optimistic we will be able to maintain asset quality going forward.

That makes sense. Thanks, guys.

Kevin Reevey with Ryan Beck.

Can you give us a little bit of color on the type of commercial loans that you've been booking because it looked like it grew pretty nicely on a linked quarter basis and kind of what your pipeline is looking like going forward and the types of loans you are looking to book.

Kevin, to this point our commercial loan portfolio has been heavily concentrated in commercial real estate. And when I say commercial real estate that will cover a lot of different type of properties, anywhere from rental properties as far as apartment complexes, low to moderate income housing. We have been doing quite a bit in the area of strip malls. But it has been primarily commercial real estate. We have added a couple C&I lenders to our organization, and we do want to diversify the portfolio a little bit as far as adding some C&I lending.

The advantage in Michigan of having real estate as collateral, it doesn't get up and leave during the night number one, and number two is Michigan has really never had a boom in real estate values so it is hard to have a bust. And it seems to be kind of our sweet spot when it comes to commercial lending and it also has helped us -- for the first time I think if you were to look at our balance sheet you would see that our commercial loan outstandings exceeds our mortgages, which we were kind of known as a mortgage corporation or mortgage bank for years. But commercial real estate lending has helped us increase our commercial balances significantly over the last year.

And then my second question is related to the MPL in your consumer loan portfolio, looks like it has been creeping up on a consecutive quarterly basis. Can you give us is this a trend, and what is your watch list looking like with respect to delinquencies?

The commercial loan creep up, Kevin, is predominately from the North Bancorp acquisition. That is where we are seeing -- I mean when you saw the creep up into the from I think the end of the second to the third, that was largely North Bancorp. Because we didn't conclude their consumer loans in the portfolio we sold because they tend to be smaller balances. And it just wasn't as efficient. So we are seeing a little creep up on that front, but nothing of any great significance or something that is causing us a lot of concern. But that is where most of that is coming from.

And then the watch list has been relatively steady. In fact, we saw some improvement in terms of our and that is where some of the decline in provision came from because we are just doing a calculation at every quarter end on what the allowance needs to be based on the model that we've been running consistently for several years. And that just results in what the provision is going to be required to bring the allowance to a level that is required. And we actually saw some improvements in commercial loan grades, some pay downs on some classified loans. So our watch list has been relatively steady or improving a little bit.

My final question is related to your preferred holdings of Freddie and Fannie Mae. Any -- what are your plans with respect to those holdings near-term?

Near-term our plans are to continue to hold them. We are, although you've seen a pretty significant trend on taking the other than temporary impairment charges -- I think Sovereign may have been the first guys out of the chute in terms of making an announcement, but certainly if you read their release, they strongly indicated they don't think it was reflective of a long-term economic value. The accounting in this area is really difficult because the guidance on the judgments you are making on what is other than temporary impairment are not that well defined. So everyone is sort of wrestling with this. It is very difficult to make an assertion that you're going to have a recovery in value over a reasonable period of time with a lot of certainty because there is a fair amount of unknowns. And the other issue with these is that they are perpetual preferred, so there is no maturity date like on a bond where you know it is going to mature at par.

But we really view the issue as a couple of things. One is particularly on the floaters where the rate has been adjusting, you know these are, there is a 70 percent dividend received deduction on these. So when interest rates are low, the volume of the tax efficiency on these is much less than say several years ago when the rate on it might have been 6 percent. So 70 percent of 6 was 4.2 percent with the rate adjusting to lower rates, 70 percent of 2 percent is only 1.4. So the tax benefit is a lot less. So that gets somewhat of an impact on the floaters.

And then the other recent phenomenon is I think as most of you're aware, Fannie Mae came out with a $5 billion preferred issuance in late 2004. The whole market prior to that time I think for all of the preferreds outstanding were somewhere between 8 and 9 billion. So they have put out an issue that was roughly half or more than half the size of the entire market in kind of -- I am not going to call it fire sale but it was certainly done quickly at pretty high spreads. And that sort of depressed the entire market.

So we really don't think it would be a good idea to sell these things at what we consider depressed prices. Certainly we do not see any long-term credit risk issues with Fannie Mae or Freddie Mac, and we are comfortable that over some period of time we hope to recover. But as I think you know, the way the accounting works for it is once you've taken another than temporary impairment that is your new basis so you can't write them back up, the only way to recover it is to sell it. So we would probably be more on the side of looking at whether adding at depressed levels makes sense as opposed to selling. But we think at 25.9 million we don't want to have a lot more of it in the portfolio just because of the volatility may create in earnings with the other than temporary impairment issue.

Thank you.

John Bergquist with Sandler O'Neill.

Finance receivables are now about 11 percent of total loans. How much do you expect to grow to finance receivable portfolio in '05, and so you see an upper limit for that portfolio?

Well we certainly had strong growth from '03 to '04. I would expect the percentage growth to slow just because of the lob (ph)of large numbers. But I do think we are going to get much higher growth continuing in that portfolio compared to the balance of our loan portfolio. I don't know that we have set any particular limit on it. But I do feel, and I think we discussed this internally when it gets into that 13 to 15 percent range I think we would feel like at that point either some form of securitization or maybe some form of sales similar to what Wintrust does, Wintrust sells, they don't actually securitize, they have a conduit where they are selling 50 to 100 million a quarter maybe or maybe a little bit more than that. But that would be an alternative or securitization would be an alternative.

It is not that we have any discomfort with the loans because our charge-off experience in that portfolio has been quite good. It is just the funding of it, it is not in the absence of creating some sort of securitization type of facility or a sale conduit we are largely looking at financing that with wholesale funds. So I think it is not the issue for us, John, is not how big it gets from a sense of credit concerns because A) we like the credits, B) we like the yields, C) they are short-term in nature. I think its more an issue of the funding pressure it puts on the other side of the balance sheet because we can't borrow Federal Home Loan Bank advances them. We can't do reverse repos on them. So it is more creating the liquidity on the liability side. So I think once we get to that level I think that is what we would be focusing in on.

Good. My next question, you know could you talk but your expansion plans for 2005? You mentioned a run rate for expenses of 25 million to 26 million or so. And does that imply some additional expansion or would your expansion plans actually exceed that or help that number to increase going forward?

As far as expansion we do have a couple new facilities planned for next year, a couple branches. A lot of the expansion is a couple areas is benefits has increased. The other is going back to full level hopefully of incentive in ESOP contributions. And third is the banks have added, which has been our success in the past, the banks have budgeted or are expecting to add both commercial and mortgage originators to generate additional revenue for mid 2005 and beyond and also to put these folks in place so that they are fully productive through year 2006. So most of our expansion is not going to come in the form of brick-and-mortar but it is going to be coming in the form of staff originator, C&I lenders and commercial lenders.

Thanks, Mike. That is it for me.

Eric Ross with (indiscernible) Capital.

Most of my questions have been answered; just a couple of additional ones so can you talk to us about your tax rate, your run rate going forward? I know in the past you talked around 28 percent; is that a good number to use. And also, what are your thoughts as far as what you are seeing on the deposit side? I know you looked like you had some weakness there this quarter and I just wanted to know what you are seeing from a competitive front, from pricing front and is that one of your bigger concerns for the year, or what is your real focus and what kind of concerns you most and conversely what excites you most going into '05?

Well, there's at least three questions in there so I will take the first one on the taxes. We ended the year at about a 26 percent effective tax rate. The main thing that is going to drive that is what is the mix between tax-exempt and taxable income. That's going to be the main issue there. I would say somewhere in that 26 on the low end to 27, 28, on the high end. The other thing that can affect it a little bit and drive it up a little bit more is at Mepco we do have a little bit higher effective tax rate because they are -- Michigan does not have an income tax, so Michigan, our taxes actually a value added type of tax, a single business tax. That is actually up another expense. But Mepco because it operates effectively in 50 states we are actually filing where we have income taxes in a number of states. So depending on their level of earnings, that could boost that up a little bit. But I think 26 to 28, somewhere in that range would be generally pretty reflective because I don't see any big changes in our mix of taxable and tax-exempt securities in the portfolio. I think that would remain relatively consistent.

On the deposit side, we are projecting growth in core deposits a little bit north of 5 percent. We do see where the, where more of the issue is would be on the retail time deposit front. We are seeing a little bit more competition, a little bit more advertising and rates coming up a little bit. We have not seen that as much on the core deposit side yet. And I doubt -- I don't think we are really concerned that you're going to see pricing pressure on what I call real core deposits like checking accounts and passbook and statement savings. Those just tend to be a lot more inelastic from a pricing perspective, but money markets although we haven't seen a lot of price competition there, that could be an area where you see some more just because short-term rates have come up quite a bit. But we have started to see it in the CD area, although I would say in general most banks in our markets tend to, and we do the same thing, lag the movement in rates.

But I think as you know, most of our CD business is shorter term, two years and less. So rises in short-term rates does put some upward pressure there. But I think we still feel pretty confident long-term on core deposits absent the retail CDs growing at a reasonable pace. But certainly not at a level equal to our loan growth. So that is going to be a continuing challenge is funding on the liability side and the wholesale funding component that will continue to wrestle with a little bit. Because we are going to we think going forward continue to see a loan growth rate higher than the core deposit growth rate.

I think your final question was what do we see as concerns, and what do we see as big potential benefits? Mike could draw a couple -- I will say and I said it in my comments, the concern, the biggest I think kind of unknown for us in terms of our forecast is what is the flattening curve going to do to the margin. That, and we are like a lot of you. We are modeling and projecting and trying to predict, and it is very difficult to be exact on that. But that would be the one thing that kind of is a concern is that on a long-term basis.

Eric, along with the flat yield curve of course maintaining asset quality is always a concern, and we spend a lot of time reviewing our portfolio and making sure we have a really good handle on the quality of the portfolio. But you never know if there is a surprise in there. However, we feel confident going into 2005 that we do have a have great asset quality. (indiscernible) spend a lot of time looking at -- you are seeing a lot of our -- at least we are seeing a lot of our competition doing a lot in the area of brick-and-mortar expansion. We have talked about it and we are not convinced that that is the best way for us to grow as far as the most cost-effective way I should say for us to grow in increasing deposits. As Rob pointed out, we have a 13 percent increase or budgeted increase in loans, and yet only 5 percent increase in deposits and we are already at 100 percent over 100 percent loan to deposits. We are going to whenever we have the opportunity to look at acquisitions -- I think this is an area that if we have an opportunity to purchase some branches from a large bank, we will definitely take a good long look at that. Because at some point we would like to see an increase in our core deposit base. And not so much reliance on our wholesale borrowed funding strategy. But I'm not sure that branch expansion brick-and-mortar is the way to go.

And what excites us about 2005 that is it was very difficult at 2003 was the mortgage refinance boom to recruit any type of mortgage originators. We also found that to be true a little bit in 2004 when we entered some growth markets such as Oakland County, we opened an office in downtown Grand Rapids. I guess the commercial lenders working for competitors in those markets kind of wanted to take a wait and see who we were and what we are all about. And since we've established a relationship and reputation in those markets we are starting to actually find some of those commercial lenders are calling us, asking us if we are interested in interviewing them for the possibility of coming to work for Independent Bank Corporation and originating loans. So it looks like a very bright 2005 in the area of recruiting some real strong originators. So we are excited about that. And we are also seeing a pickup again and I think we will have a good year in mortgage origination in 2005. Chuck, do you have anything?

I would just add two things. On the acquisition side of things, that is a very reactive business, and we tend to be out talking to people. But it is not the kind of business where you kick in the door and buy somebody. They have to be ready to sell. And banking is getting more difficult with the regulatory environment, especially some of the accounting issues, Sarbanes-Oxley and the like that is putting a lot of pressure on some of the smaller players. So we would hope that in the next several years we will have some opportunities for acquisition there. And then I guess the other thing that excites me about 2005 and beyond is we have a new President and CEO who is all energized and fired up to get out there and make a name for himself as well. That excites me.

If I could just follow up with one other question, not talking about credit quality again as you brought that up, can you give us a little update? I know the last quarter you talked about seven different commercial credits on 11 loans were about 10 million in total balances. Where does that stand today? Are any of them facing liquidation?

No, one of them are facing liquidation and some of our improvements -- I mean, and it wasn't just in that category. I think we said at the last conference call when we're going through them that we had in place plans for each of those credits. And in fact, our commercial lenders have executed on those plans. So either we have achieved the results we were looking for; in some instances we got some significant pay downs on some credits. So those were moving all in the direction that we had hoped for when we were talking to you at the third quarter conference call.

So we ended the year we think in pretty good shape on the asset quality front. I think like Mike said, it is always an area that we try to remain very vigilant but when you have a $2.2 billion loan portfolio there is a lot of loans, and that is where we spend an enormous amount of time and effort is really looking to see where there may be cracks and what do we need to do to get ahead of the curve on them. So we feel we ended the year in good shape there, and we feel confident at about how we are entering '05 on credit quality. But it is something we have to remain vigilant on because there can always be a surprise.

Thanks very much for answering all those questions.

Peter Mott with Deutsche Bank.

A couple questions. Have the Mepco problems to the best of your knowledge been resolved, and was there really evidence of criminal behavior here, or any likelihood there are going to be criminal charges filed? You obviously the reshuffling but is that sort of the end of it? Are we going to hear more about Mepco? Is it (indiscernible) event or is it pretty much resolved? That is the first one and I would like you to talk a little perhaps more in depth of the type of acquisition you might make, whether or not you would do anything on a contiguous state, issues along that lines.

First on the Mepco front there is nothing in there in the release because there is nothing new to report. And certainly you use the term criminal activity. There is certainly nothing of that sort whatsoever. So I mean, we described I think in one of our quarterly filings that it was a problem that predated the acquisition. And it is not anything of a nature of what you describe. So I would say it is behind us. We still need to work through some details, but we've got any of the issues in terms of a potential liability covered between what we have accrued for and what the former owners had put into an escrow account. So in that sense it is behind us and it is really at this point just a matter of working through the details as opposed to having some other adverse event occur related to that.

Regarding the type of acquisition, that is a tough question because as Chuck mentioned earlier, you just don't know when someone may decide to sell. And then when they do decide to sell you don't know exactly what kind of bank it is until you receive that phone call. We, I think to this point have been extremely disciplined in our acquisition strategy to make sure that whoever we acquire and how much we pay for it, it will end up almost immediately being accretive to earnings. So if I don't see us laboring from that strategy, I would anticipate that will be the same strategy we apply going forward. And so we will take a look at every opportunity, and if we can price it right and make it accretive to earnings, and then also feel very comfortable that we will be able to manage and integrate that acquisition into IBC and that it will in no way deteriorate the quality of this organization, I think then we would probably be very interested in that acquisition.

Peter, this is Chuck. I would add to that if you look at '04 and it may be a classic example of Independent Bank Corporation's acquisition strategy, tactic in that we bought two very different banks. One had a lot of troubled assets. We integrated that very quickly, sold off the bulk of the troubled assets, ended up with a very good franchise in a good market, one of the best markets in the northern part of the lower peninsula of Michigan. And bought it at the right price so that it was immediately accretive.

The other bank was almost a mirror image in many ways, a very strong bank in a great market, did not have asset quality problems. But just had the ownership issues that banks run into when (indiscernible) and the lack of liquidity they had in their shares. So neither of them were right in our markets, but they were both contiguous to our markets. That added some value to us of course because we were able to get some cost saves there that we would not be able to for instance that we were going to do the same acquisition in Indiana, Illinois, Ohio, somewhere like that. That is not to say we would not be interested in some other states, but it changes some of the numbers in the analysis.

It is just getting increasingly difficult to find franchises that are for sale that are going to have a meaningful impact on Independent because as Independent grows obviously they need to make bigger acquisitions it kind of goes up with it. And there aren't a whole lot of those properties left which argues for I think maybe having a look at contiguous states.

That is a very good point, Peter. It's hard to move the needle with a 200 million dollar acquisition to make for Independent Bank Corporation. Two $200 million deals last year (indiscernible) did have some impact. But those aren't falling out of trees at us either.

(OPERATOR INSTRUCTIONS) Kevin Reevey with Ryan Beck.

Chuck, Rob, can you quickly walk us through how you've got to your 54 cents per share core number because I am coming up with 57, (indiscernible) shy by 3 cents.

If you are that close, that is awfully good. My 54 cents and it could just be that I am using, I think I used the 35 percent incremental tax rate, and you probably may have used our effective tax rate. But to give you what I had in it, I had the $10.3 million change in the gains on loan sales, which obviously I started out with and when I was talking with that number. Then I get roughly about 7 million of unusual expenses or charges. And what I had in there was 2.7 million on the Mepco expense that we took in the second quarter, 2.3 million on the severance charge, so that's 5 million. Then I got $1 million for the write off of some uncompleted software that we took in the second quarter at Mepco. So that is up to 6. And then I had about 800,000 for the Mepco investigation costs. So that roughly gets me to about 7 million, and then I used a 35 percent effective tax rate. And I used I think 20,900,000 shares which was our year todate dilutive share account. So that should get you roughly 54 cents. I might be off a penny or so.

And then the cost of the Mepco investigation, the 100,000, which line item is that included in?

It is in the income statements, it is in other, and in the supplemental data where we break out more detail, it is in other as well. Some of it -- I take that back -- it is in legal and professional mostly, which is other in the basic income statement. But in the supplemental data in the 8-K it is largely in legal and professional. That is up about 1.1 million, and that is a combination of that and then the balance is predominately the Sarbanes-Oxley 404 external costs.

And the million dollars for the uncompleted software expenses for the second quarter, is that included in your equipment expense line item?

No, that is down in other again in the basic income statement, and then if you look in the 8-K in the supplemental data on non-interest expense, it sits in a separate line item write-off of uncompleted software.

Great. Thank you.

Gentlemen, there are no further questions at this time.

We would like to thank everyone for participating in today's conference call, and look forward to visiting with you. Thank you.

Thank you. This concludes today's conference. Thank you all for your participation.