Independent Bank Corp (Michigan) (IBCP) 2005 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Independent Bank Corporation third 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. If anyone should require operator assistance during the conference, please press star, zero, on your telephone keypad. As a reminder, this conference is being recorded. This webcast may contain forward-looking statements as defined in section 27 AI 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 are beyond their control. Future developments and actual results could differ materially from those set forth in, contemplated by, or underlying the forward-looking statements. In light of these risks and uncertainties, there can be no assurance that the forward-looking information will prove to be accurate. This webcast does not constitute an offer to purchase any securities, nor a solicitation of a proxy, consent, authorization or agent designation with respect to a meeting of the Company's stockholders. It is now my pleasure to introduce your host, Mr. Michael Magee, President and Chief Executive Officer of Independent Bank Corporation. Thank you. Mr. Magee, you may begin.

Thank you. Good afternoon. We are pleased that you could join us on our conference call to discuss third quarter 2005 results. With me is Rob Shuster, the Corporation's Chief Financial Officer, and Charles Van Loan, Chairman of the Board. Earlier today we reported third quarter 2005 net income of $12 million, which was up 1.7 million or 17 percent from the third quarter of 2004, and essentially unchanged on a link quarter basis. Our diluted earnings per share of $0.53 this quarter was up 15 percent from the year-ago comparative quarterly earnings per share of $0.46. Per share data has been adjusted for the 5 percent stock dividend that we paid on September 30th of 2005. The third quarter reflects continued growth in our level of interest earnings assets, with linked quarter annualized loan growth of approximately 15 percent. However, the positive impact of the growth and interest earnings assets was offset by a decline in our interest -- net interest margin due primarily to the challenges of the flat yield curve environment. Rob Shuster, our CFO, will discuss our net interest margin in greater detail during his remarks.

Profitability measures remain strong in the third quarter of 2005, with a return on average equity of 19.3 percent and a return on average assets of 1.47 percent. Our amount of non-performing loans at September 30th, 2005, was essentially unchanged from the previous quarter end, and remains at a level higher than our historical norms. As detailed in our press release this morning, last Friday we closed on the sale of 5.5 million of non-performing and other loans of concern. Included in this sale was 3.1 million of non-accrual loans. In the fourth quarter of 2005, we will record a pretax loss of approximately $400,000, or $0.01 per share after tax as a result of this loan sale. I want to, again, emphasize our focus on reducing the level of non-performing loans. Based on our actual 2005 year-to-date results and our expectations for the last quarter of this year, I continue to believe that we can reach the higher end of our estimated range of $2 to $2.10 for full diluted earnings per share for the full year.

Finally, as you know, Chuck Van Loan recently announced his retirement at the end of this year. Chuck has been with Independent Bank Corporation for 25 years and served as our President and CEO from 1993 through 2004. During this time period, our total assets grew from about $400 million to over $3 billion, and our stock price increased by nearly 800 percent, compared to a rise in the S&L bank index of about 300 percent. Chuck will remain on our Board of Directors and serve as a non-executive Chairman in 2006. On behalf of all the employees of Independent Bank Corporation, we wish Chuck all the best in his retirement and thank him for his contributions and leadership. Rob will now provide some additional details on third quarter results.

Good afternoon, everyone. Mike covered the highlights for the quarter. And I will provide additional details on net interest income in our margin, certain components of non-interest income and non-interest expense, and make a few more comments regarding asset quality. Tax equivalent net interest income totaled $35.9 million in the third quarter of 2005, which was up $3 million or 9.2 percent on a comparative quarterly basis, but down $131,000 or four-tenths of 1 percent on a linked quarter basis. The increase in comparative quarterly tax equivalent net interest income was due to a $290 million increase in average interest earning assets, primarily as a result of growth in all categories of loans, but particularly commercial loans and finance receivables. Partially offsetting this was an 8 basis point decline in our net interest margin to 4.75 percent from 4.83 percent on a comparative quarterly basis. The slight decrease in linked quarter tax equivalent net interest income was due to a 14 basis point decline in our net interest margin that was largely offset by a $56 million increase in average interest earning assets, resulting from growth in all loan categories, but particularly commercial loans which grew by 20 percent on an annualized linked quarter basis. The increase in loans was partially offset by a $24 million decline in the average balance of investment securities. The decline in investment securities reflects the difficulty in replacing the paydown or maturing of existing investments with new trades that meet our return and risk objectives, given the flat yield curve environment. On a comparative quarterly basis, in a linked quarterly basis, our yield on average interest earning assets and our cost of funds both increased, due principally to the rise in short-term interest rates. However, the rise in the cost of funds has eclipsed the increase in the yield on interest-earning assets, reflecting both the flat yield curve, as well as competitive conditions, particularly in the lending area. In previous quarterly conference calls, I've indicated that we believed growth in average interest earning assets would offset the expected erosion in our net interest margin. On a linked quarter basis, the overall growth in average interest-earning assets was in line with our expectations, but the erosion in the net interest margin was greater than what we anticipated, due principally, again, to competitive conditions in the flat t yield curve.

The dollar decline in our net interest income actually occurred entirely at Mepco, which had a $278,000 decline on a linked quarter basis in their net interest income. This decline reflects a very competitive pricing environment in the premium finance market, some margin squeeze on the warranty finance receivables as yields on this portfolio are somewhat inelastic, and a higher than anticipated cancellation rate in the warranty finance receivables which resulted in some reversal of previously accreted discount, which adversely impacted their net interest income. Despite this margin pressure, Mepco had an excellent third quarter with net income of approximately 2.1 million. To give you some additional trend analysis, on a company-wide basis, the decline in the net interest margin was pretty much spread evenly over the entire third quarter. The decline was a little bit greater in July than August and September, but on balance it was pretty much spread evenly over the quarter. Looking ahead, we continue to be relatively balanced in terms of interest rate sensitivity. Further, despite the linked quarter modest decline in net interest income, we remain optimistic that growth in average interest earning assets will offset some further expected erosion in the net interest margin.

Moving on to non-interest income, service charges on deposit accounts were up 9.1 percent on a comparative quarterly basis, and were up about 2 percent on a linked quarter basis. These increases are primarily due to growth in checking accounts, and changes in the occurrence rate of NSF checks per account. Gains on real estate mortgage loans were up slightly on both a comparative and linked quarterly basis, due to an increase in the volume of loans sold. Our loan sales margin declined by about 23 basis points on a comparative quarterly basis, due primarily to a competitive pricing climate, but it did increase by 12 basis points on a linked quarter basis. We expect conditions to remain very competitive in the mortgage banking sector. In addition, we would also expect the normal seasonal slowdown in mortgage loan origination volumes as we move into the fourth quarter of 2005 and particularly the first quarter of 2006. Real estate mortgage loan servicing income was up on both a comparative and linked quarter basis. These increases primarily reflect changes in the impairment reserve on capitalized originated mortgage loan servicing rights. During the third quarter of 2005, we had a $378,000 recovery of previously recorded impairment charges. Excluding changes in the impairment reserve, we would expect real estate mortgage loan servicing income to run at about $450,000 on a quarterly basis. Since the impairment reserve declined to only $54,000 at September 30, 2005, there is little remaining recovery potential, but certainly the possibility of future impairment charges if longer-term interest rates were to decline.

Non-interest expense totaled $27 million in the third quarter of 2005, which is up $1.5 million on a comparative quarterly basis and up about $1 million on a linked quarter basis. Nearly all of the linked quarter increase was in the area of compensation and employee benefits. In particular, salaries were up $828,000 on a linked quarter basis. About $400,000 of this increase is due to a one-time charge for early retirement benefits related to our Chairman, and about $130,000 of the increase is due to the third quarter of 2005 having 1 more working day compared to the second quarter. The balance of the increase, or about $300,000, was due primarily to the addition of sales-related positions, in filling existing open positions on a company-wide basis. Our effective income tax rate was 27.4 percent in the third quarter of 2005, which was somewhat lower on both the comparative and linked quarter basis. This decline was primarily due to tax exempt earnings representing a higher percentage of pretax earnings, and due to a decline in some state income taxes. Our assessment of the allowance for loan losses resulted in a provision for loan losses of $1.6 million in the third quarter of 2005, compared to $2.5 million in both the comparative and linked quarters. The provisions in both the second quarter of 2005 and the third quarter of 2004 were elevated due primarily to allowances recorded on certain commercial loans. As Mike mentioned, non-performing loans declined slightly to $27.4 million or 1.1 percent of total portfolio loans at September 30, 2005 compared to $27.5 million at June 30, 2005. Again, as Mike mentioned earlier on the call, these levels remain higher than our historical norms. The rise since year-end 2004 is due primarily to a $7.9 million increase in non-performing commercial loans, a $2.9 million increase in non-performing real estate mortgage loans, and a $1.4 million increase in finance receivables.

As I mentioned in last quarter's conference call, the increase in finance receivables is due to portfolio loan growth and the timing of the receipt of return insurance premiums as nearly the entire balance of the $3.5 million in finance receivables is expected to be recovered upon the receipt of the return premiums. Last quarter we discussed the 2 largest non-performing commercial credits, both to the same borrower group, one with a gross balance of $3.2 million and the other with a gross balance of $3 million which are secured by 2 low to moderate-income apartment complexes. These 2 projects were financed with combination of our loans and the sale of tax credits. Although the occupancy rates have increased in these developments, cash flow remains inadequate to debt service our loans. Since our last conference call, we have been unable to negotiate a satisfactory forbearance agreement with these borrowers. We added an additional $400,000 specific allowance on these loans during the third quarter, bringing the total specific allowance to $1.7 million at September 30, 2005. We are in discussions with the firm that syndicated the tax credits regarding next steps. We also have one other loan with this same borrower group with a balance of just over $3.5 million on a low to moderate-income apartment complex located in Port Huron, Michigan. The occupancy levels in this apartment complex are much higher than in the other 2 developments, but they have dropped recently and the loan is now approximately 30 days past due. We are closely monitoring this situation. Total commercial loan delinquencies were actually down at September 30, 2005 compared to the prior quarter end and the overall level of watch credit loans has remained stable. Additionally, net loan charge-offs in the third quarter of 2005 declined on both a comparative and linked quarter basis and represented an annualized rate of 0.16 percent of average portfolio loans.

One final comment relative to our balance sheet. We do expect to complete a $150 million premium finance asset backed note transaction in the fourth quarter of 2005 or the first quarter of 2006. We expect to achieve off-balance sheet treatment which will reduce finance receivables by about $150 million. This structure is expected to free up approximately $8.7 million of capital, and the proceeds from the sale of the notes will be utilized to payoff short-term borrowings or brokered CDs, thereby improving our liquidity. This facility has an all-in cost that is expected to be approximately 30 basis points higher than our on-balance sheet cost. However, the impact on earnings per share can be offset either by using the freed up capital to repurchase our common stock, or by releveraging, or through a combination of these two. I would now like to turn the call back over to Mike Magee.

Thank you, Rob. Before we open the call up for questions, I did want to make a few comments regarding our outlook for 2006. First, we do not intend to provide specific earnings per share guidance for 2006. Second, as many of you know, we have established a long-term objective to achieve average annual earnings per share growth of 10 to 15 percent. At the present time we believe achieving these goals -- growth goals in 2006 will be extremely challenging given the current operating environment. However, despite the operating environment, we will diligently work towards achieving these targets. We believe that a combination of prudent earning asset growth, emphasis on non-interest income sources, and reductions in operating expenses that do not adversely impact customer service or employee morale provide the best opportunity to meet our objectives. At this point, I'd now like to open the call up for any questions that you may have.

Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session. (OPERATOR INSTRUCTIONS) Christopher Nolan, Oppenheimer and Company

2 quick questions. The first was for the non-performing loans which were sold on September 30th. Were they excluded from the third quarter non-performing loan tally in the press release, or were they included?

First of all, they were not sold at September 30th. They are included in the loan tally at September 30th, so they're included in the 27.4 million. 3.1 million is included in the 27.4 million. The balance of loans making up the 5.5 million, which is the difference between the 5.5 total and the 3.1 that were non-accrual, were performing loans, but they were other loans of concern. So the sale would reduce the 27.4 million by 3.1 million. We didn't make a determination to sell the loans until October 6th, and then we actually closed on the transaction on October 21st. So the -- those loans are included in the 27.4 million.

Okay.

Does that address that, Chris?

Yes, it does.

Okay.

And that would be a $0.01 charge in the fourth quarter.

That's correct.

That's correct.

Great. And the second question I had was on the balance sheet, I notice that the retained earnings declined to134 million from 157 million in the second quarter, and I was just kind of curious of what the mechanics were on that.

That -- that's the payment of the stock dividend.

Okay.

And when you pay a 5 percent stock dividend it results in a reclass that reduces your retained earnings and increases your common stock and additional paid in capital. So it is just a shift within the equity accounts.

Okay. Great. And I guess my final question, if I understood the outlook for 2006 was that's achieving a 10 to 15 percent EPS growth in 2006 will be extremely challenging, if -- I'm just trying to get the exact wording. Is that correct?

We believe it will be challenging. We're going to do everything we can to achieve on average our long-term objective of 10 to 15 percent growth. But, as you know, the flat end of the yield curve has had a negative impact on our balance sheet. Now, I will say our balance sheet is well positioned on a rate sensitivity basis for either a rise in interest rate or a decline in interest rate, we just need the slope to come back in the yield.

Okay. And I guess my final question would be, are you extending the maturity on the -- on your investment portfolio at all?

Well, we -- we really haven't done -- we haven't done -- we're not extending the maturity on the investment portfolio. In fact, we have been doing very little on the investment portfolio, which is why we've had the declines, simply because it's difficult. We're lent up 100 percent. So if we have a new investment transaction, we have to effectively borrow the money for that investment transaction. So it's very hard to construct an investment transaction that doesn't involve either credit risk that we are unwilling to take, or interest rate risk that we are unwilling to take that provides the kind of return on equity objectives that we would have for that transaction. So we really haven't had the opportunity to do much there.

We are, on the liability side, doing some extension of liabilities. One strategy that works relatively well in this kind of environment just as an example, is we can terminate an interest rate swap where we're receiving a variable rate and paying a fixed rate and replace it with a longer term cap. And the nice thing about the cap is we get protection if short term rates go up, but with the way the cap works, if rates go down we would get the benefit of the declining rate. So that's one strategy in a flat curve. Because in a flatter curve, caps become less expensive. So they've become a little bit more attractive. And so we've used that as a strategy where we could actually, with the cap, get a longer duration cap but still have the upside if short term rates were to drop. So that's probably the only strategy that we've been utilizing in this environment that involves any type of extension.

Okay.

What we've been doing, Chris, is using the runoff in the investment portfolio. Basically there's a shift taking place on the balance sheets. The runoff has been funding our loan asset growth.

I understand. Okay. Great. Well, thanks very much for taking my question.

Joe Stevens, Stevens Capital.

Listen, Mike I guess a couple of questions I had, and I appreciate you guys always trying to be conservative. But I look at 2 things. Number 1, your loan growth was very healthy again. And so I would guess that I -- especially on the commercial side and on the installment side. So I was going to ask for a little color commentary there, and a little bit on the healthier markets. That's number 1. And then number 2, is your non-income interest growth, especially your fee income growth was a little bit better than we expected. So can you sort of just comment on sort of the outlook for those 2 areas a little bit? And I'll sit back and listen. Thanks, guys.

Thanks, Joe. I'll let Rob talk about the fee income growth, but I will talk about the commercial and consumer loan growth that we've experienced at this point. I believe all of you know that we have a subsidiary called First Home Financial that specializes in the financing of mobile homes, manufactured homes, and the majority of those loans are sold into the secondary market. However Independent Bank does get the first opportunity to look at those credits before they are sold. And we have been able to more or less purchase the cream of the crop of those loans, and so a lot of our growth has come through our subsidiary of First Home Financial. Also, we have been emphasizing in the area of RV's, both watercraft, snowmobiles and just travel trailers. We have a travel trailer division. And we have been making great inroads in the area of indirect lending. And in those areas, we are able to also achieve a higher yield. We're not trying to compete on used or new autos, so that's why we go after basically these other types of indirect lending opportunities. So the consumer side has seen good growth because of our indirect division and also our First Home Financial subsidiary. Regarding fee income growth, that's more or less a by-product of the growth that we have experienced in DDA accounts and other accounts and I'll let Rob talk about that a little bit.

Okay. And Joe, one other thing on commercial, that's where we had our strongest growth, with 20 percent linked quarter, if you annualize it. And I think it's reflective of a couple of things. You know, certainly you can't typify the Michigan economy as booming so we don't have a 20 percent annual organic growth rate there. I wish we did. But I think it's largely due to 2 factors. 1 is the addition last yearly of a couple of bank franchises, particularly Midwest Guaranty, where we picked up a lot of seasoned commercial lenders. That was a de novo bank that had started in 1989 and had grown consistently and had a nice middle market niche in southeastern Michigan. So I think that's provided a good springboard for us in a new market essentially. And then the other thing is we've been aggressively trying to add seasoned lenders in all of our markets. And I think over time that's paid off. We felt going into the third quarter we had a pretty good pipeline going in, in terms of commercial lending opportunities and were able to close off on some of those. As Mike said, the fee income, there is kind of a mixed bag because there were a few areas where we were down, particularly in mutual fund and annuity commissions, and that just tends to be somewhat choppy. But there's a number of other areas that have consistently done well. Mostly service charges on deposit accounts.

And as Mike said, that just really reflects our concentration on building checking accounts. It's the one area in your deposit franchise that we view as, A, not quite as price sensitive. You know, with CDs and even money market accounts, it is pretty hard to differentiate those products other than through rate. And so we really work hard on the checking account side to differentiate by service, by diversity of product, by location, and I think we've gotten good over the last 10-plus years at really building that checking account franchise, and that's where we spend most of our advertising dollars as well. And most customers there's not going to be a tremendous difference on whether you're paying a quarter percent or a half a percent on a checking account with an average balance of $600. So that's one of the reasons we like that product so well, is because it is a little bit less price sensitive and you compete on things other than just what the rate is on the account. And so we think that that just reflects our emphasis. And that checking account growth has also helped us build on the Visa Check Card Interchange income, which has been growing consistently from one quarter to the next. And again we're also working hard to try and get our customer base to use those cards more. And then finally, the other area where we see some good opportunity is in title insurance fees. We're not capturing as much business internally as we think we can in that area. For example, we're probably on our commercial side only capturing about 20 percent of our own business in terms of title insurance. So we're really going to work hard as we move into '06 not just to capture some external business, but also to capture more of our own internal business. And hopefully, even in an environment where mortgage banking is tough, we can still push those title insurance fees up.

Joe, I'd also like to comment. I'm sorry, regarding the commercial loans, you kind of asked by markets. It has been kind of across the board as far as the commercial loan growth, but we -- especially in west Michigan and southeast Michigan, we shared with you I believe in the last couple of conference calls that we had several commercial loans that had been approved, actually closed. They were real estate development loans and they had yet to be funded because of where the project stood. And kind of a seasonality process for us in Michigan, is that as you enter the third quarter, you are finding that these real estate development projects are now being funded in the -- and the customers are utilizing their lines. So that also is -- and we shared with you we had a pretty strong pipeline, and that pipeline is starting to come to fruition. We continue to have a strong pipeline going into the fourth quarter. So I'm also hopeful that we will see commercial loan growth. And along with the fees, I'd just like to point out, you are probably seeing, especially the large banks, they are really pushing their customers to use debit cards. And this is great source of future fee income opportunities. Our customers, as a percentage of checking accounts, that's growing every day the number of customers using debit cards or their Visa which we receive interchange fees. And so we continue to emphasize that and we see great potential in the future to increase fee income through improvement in concentration levels of debit card use by our customers.

Guys, thank you.

Kenneth James, FTN Midwest Securities.

For the first 2 quarters of this year I was actually very impressed with how well the margin held up and we talked a lot about the disciplined use of your pricing model. And I was just wondering, given the competitive environment and pressures you're seeing, if you've had to make any concessions there to generate the strong growth we saw this quarter on the loan side?

You know, it depends a little bit by sector. And I'll kind of go into a little bit of detail. But one thing to think about in our model, our model is driven off of a return on equity, based on allocated capital. And I guess how I will illustrate that is, again, we're 100 percent lent up basically, in terms of loan to deposit ratio. So if you think about it, if we're adding incremental loans, we basically have to borrow the money. Short term rates are, let's say, approximately 4 percent. So if you were trying to maintain a 4.75 percent spread on an incremental basis, you would have to charge 8.75 percent, and I could tell you you probably would do little or no lending. So our model really works off of an ROE, where we say, okay, on an aftertax basis, we want at least - and this is what we're trying to achieve - a 20 percent after-tax return related to that asset. And, for example, a commercial loan, we're going to drive that off at least 10 percent capital, because it is 100 percent risk weighted asset. So our model isn't necessarily going to continually keep the 4.75 percent spread, or if you go back a quarter, or a 4.89 percent spread. That's very difficult for us to do. What we're trying to do is continue to achieve growth at at least a 20 percent ROE. So that's how the model works. And we have tried to continue to price and maintain the discipline relative to that model.

The other thing I'll say is in certain sectors, it can be difficult. And 1 illustration I would give you would be on the premium finance side of the business. We've been, for probably about 12 months, been in what we would call a soft market. And by that I mean insurance premium renewals, the dollar amounts are dropping. So the overall size of the market is somewhat smaller. We had real good years in 2002, 2003 and into the early part of '04, subsequent to the 9/11 event. But over the last 12 months the market softened somewhat. So the pricing there has become very competitive. And there your relationship is through agencies. That's where your business comes through, is with these agencies. And so you're trying in that business, as much as possible, to defend your turf and not have others sort of supplant you in those agency relationships. So that's a particular segment where we really do pay attention to the competitive pricing and try to defend those relationships we have with the insurance agencies. So that's why, I think, on a linked quarter basis you saw maybe a little bit more of the compression occur at Mepco where we were actually down $278,000 in net interest income. The banks, overall, were up in net interest income, even though they had some margin compression. They were over -- able to overcome it with earning asset growth. So that's what we want to continue to try and do, is really continue to grow the net interest income in terms of dollars, and continue to achieve those return on equity targets which, in turn, through capital management, we want to grow our earnings per share. So that's really what we're focused at, as opposed to defending, per se, a 475 or a 489 margin. Does that answer the question?

Oh, yes. Yes, thank you very much. Also one follow-up question. Can you kind of walk through the details again of the upcoming securities finance receivables transaction and its effects on the balance sheet?

Sure. We're looking at doing $150 million securitization, and the effect of it would be that it would take -- because the key for us is to get off-balance sheet treatment. And as you know, under today's accounting rules, there's a lot of -- there's a lot of standards you have to meet to achieve that. But we believe we'll under up with the structure to do that. So what it would do, is it would take $150 million off of your balance sheet and finance receivables, and we'd get $150 million in cash. We'd use the cash to pay down borrowings. The notes then would be issued out in the market. And there would be a rate relative to those notes, which we think the all-in cost is going to be maybe a little bit more than 30 basis points over LIBOR. So that's about 30 basis points more than what we're currently funding at. Any excess yield we would retain through our residual interest. So the bottom line in terms of sort of a P&L impact is our effective funding costs would go up about 30 basis points.

Now there would be some changes in line items, for example, because we'd be servicing the loans. Our net interest income would go down, and our servicing income would go up. But, again, the net impact would be about 30 basis points which, on 150 million is about $450,000 annually. Now, by getting the off-balance sheet treatment, it would free up for us about $8.7 million in capital. And it's the difference between how much capital we have to maintain with $150 million of loans on our books, versus what we have to maintain with the loans being off the books but we are going to have a residual, we have to maintain capital dollar for dollar on that. And then there's going to be a -- sort of a B tranche that is going to be 200 percent risk weighted, because we expect we're going to get a double-B rating on that. So it will free up the capital. And then we can take that capital and we could either by back shares or leverage or a combination of the two in order to offset that $450,000 impact or hopefully more than offset that $450,000 impact, and it is going to inject liquidity into our balance sheet.

Kevin Reevey, Ryan Beck & Co.

Rob, how much in borrowings would you look to pay off with the $150 million securitization?

We'd look to pay it either all borrowings off or all-brokered CDs, one of the two.

One of the two? Okay.

But it would all be used to do that initially. Right now, the thing with the leveraging versus the share repurchase, the share repurchase is relatively risk free. In other words buying back the shares, it is not like there is any risk associated with it. The only negative is that it is dilutive to our tangible book value, which a leveraging transaction would not. But with a flat curve it's tough on the leverage side. So, we'll probably look at maybe some combination, using that freed up capital. And hopefully, if the loan growth continues, that would be a great opportunity in terms of the releveraging of the capital.

And then, Rob, given I guess the continued expected strong loan growth, would it be safe to assume that your loan loss provisions should go up from here?

You know, we get asked that every quarter about the provision. And it's difficult to project because it's dependent to a large degree on where the growth comes from. An examples would be, growth in the finance receivable area doesn't push up the provision very much. We've had relatively low losses in that portfolio so the allowance related to it is relatively small. Similarly, in the mortgage loan portfolio, losses have been quite small, so the allowance related to that is quite small. Where the allowance tends to be somewhat higher is on the commercial side. So it really depends on where the growth comes from. And if you go back historically, we've probably gone from a range of about $700,000 for the provision for loan losses, has been about the lowest we've been in any quarter over the last 3 years or so, up to a high of about 2.5 million. So I don't expect it to probably go down to that low but, you know, where we were at this quarter, for example, that included what I would call sort of our normal provisioning plus another $400,000 related to adding a specific allowance onto 2 commercial credits I referred to earlier. So if you kind of divide this quarter, 1.1 million was kind of what our model generated based on our growth, based on our -- on all of our ratings, on our loans, based on our historical charge-off kind of regression analysis.

We do all the components that flow into that model, said 1.1 million of provision was needed. And then we added to that 400,000 which was a specific reserve that we felt we needed to add to on those 2 commercial credits I alluded to earlier. So that's -- I mean,we're doing that every quarter. You know, it goes into the model. It indicates what the allowance needs to be. And then we record a provision accordingly. So, it's very difficult to answer. You know, I don't know that it's going to be higher per se than where we've been this quarter. It just depends on all those components flowing in. It could be somewhat lower. It could be a little bit higher. Hopefully the range is not too vast within where we were this quarter.

And then I guess, given your recent experience with some commercial real estate loans that you've had to charge-off, is there any sense in the market that maybe the commercial real estate market could be softening a little bit? Is that something that concerns you? Is there anything that you are hearing at all?

No, we're not seeing it, really, that much in the portfolio, other than these -- sort of these concentration of these -- the low/moderate income apartment complex. And this is with one borrower group, so perhaps some of it relates to the management of the complexes, maybe some of it relates to the location of the complexes. We're certainly not seeing across the board problems and -- as you know, Kevin, I think probably the majority of our commercial portfolio is real estate-based and we're certainly not seeing that kind of issue across the board. In fact, as I mentioned, our delinquencies are actually down this quarter. And our watch list levels are stable. So we're not seeing that at the present time.

Peter Mott, Deutsche Bank.

Talk a little bit if you would please about my favorite subject, which is consolidation and acquisition opportunities for us.

Hi, Peter, this is Mike Magee.

Yes, hi Mike.

The M&A market, we're optimistic that that may heat up a little bit this winter or during 2006. In talking to the investment bankers and just bankers around the state of Michigan, a lot of small banks are really struggling with this flat yield curve environment. The challenge we have is we have so many of the small banks, their board of directors kind of view their role more as maybe sitting on the local hospital board than a fiduciary role as far as what's in the best interests of the stockholders. So it's -- it always has helped us in the past in our M&A opportunities when the regulators kind of help prod a board of directors who is -- whose financial institution is struggling a little bit to maybe consider selling the organization.

But they're only going to do that with a troubled institution, right?

They're only going to do that with a troubled. But the problem that some of the other bankers I've talked to has been corporate governance compliance and especially Sarbanes-Oxley. And of course they've been given a little bit of time in order to comply, but they're still -- they realize this year what's involved in order to comply with that Act and a lot of them don't have the manpower skills in order to do it.

You know, one thing, Peter, with troubled institutions, if it's priced right, sometimes that's your best opportunity. It's not always the easiest environment, but particularly now with purchase accounting, if it's priced properly and you have a really good handle on where the problems or issues are, you can really kind of clean it up, right at or just after the purchase. I mean, a good example of that was with our transaction in Gaylord. Right after we bought them, we sold off about 11 or $13 million of the non-performers. And -- so you can -- you know, the purchase accounting, at least allows you -- or let's say they have a really bad spread problem for some reason because they had those awful putable Federal Home Loan Bank advances or whatever. You could kind of correct some of those systematic problems and then get it to a point where it could really be a diamond in the rough for you. We've found historically those are some good opportunities.

No. I mean, I agree with you 100 percent. I wish there were more troubled institutions. Have you looked beyond -- well let me ask this question theoretically. What is your response to the notion that perhaps Independent ought to be more regional and a little less Michigan specific?

It is no secret, Peter. We've shared that with the investment bankers who would be willing to look outside the state of Michigan.

That's all I have.

Christopher Nolan, Oppenheimer & Co.

A quick follow-up and just a clarification on the securitization. If I understood your earlier comment, it would increase the funding cost for those assets about 30 basis points, but that would be offset by either retirement of debt or pay down brokerage CDs or -- ?

No, no, no. Think about it like this, we would be replacing the brokered CDs or the borrowings with this note that's -- it's not consolidated but effectively it's going to -- that note that gets sold is going to be about 30 basis point higher in cost than our existing brokered CDs or borrowings, okay?

Got it.

So the net impact when you swap those 2 , is it's going to reduce our net interest income by about $450,000. So then we've got to figure out how do we make that up? And the way we can make it up is that transaction also frees up about $8.7 million of capital, because of getting this off-balance sheet. So we use that capital to either buy back stock. So our earnings are lower, but we have less shares outstanding, so our EPS is the same or maybe slightly higher, or we can leverage some of it to make up the 450,000.

Got it. So the capital it frees up basically enables you to offset that impact on EPS?

That's exactly right.

Okay. Thank you.

John Rodis, Stifel Nicolaus.

Most of my questions were answered. But Rob, not to beat this residual securitization to death, but correct me if I'm wrong, but you will have a non-cash gain during the quarter when you realize that?

Well, yes. I mean, you're going to have a non -- you're going to have to value the residual and there's excess spread there. So, what we're hoping to do is -- and this has got to be done within all the correct accounting requirements and the like. But we're hoping to be able to minimize the gain. One thing that's a lot different, because no one like residuals or the residual accounting, it could create volatility and all that good stuff. One good thing about these assets, and I know people have had, like with home equity loan securitizations, problems with residuals. The one thing with the premium finance assets is they are very, very short. You've got an average 9 to 10 month maturity, the warranty receivables are a little bit longer. But you've got a duration of maybe 5, 6 months in there. So, the present valuing of the yield differential, is not that great. And if you have a fairly high service fee in your assumptions, and again it's got to be within reason, hopefully you could kind of hamper down the gain a little bit. And then the other thing is, there's very few prepayments in these portfolios because they're such short duration. So, the measurement on whatever gain we end up with, which we hope isn't that large, is we think going to be very predictable, because you're not going to have sort of to revisit it because your prepayment assumptions were way off. So, I guess the 2 points I want to make is we hope the gains aren't that high, instead we get it flowed through in servicing income and the like. And then the second thing is, we think whatever it is, it's not going to have a lot of volatility in it because it's a very predictable asset class.

Okay. Assuming that goes well, with the Mepco loans which you consider securitizing other loans, like manufactured housing or something?

Yes. I mean, one of the good things about going through this process is it's a very good learning process. I mean, we're A, having to kind of wrestle through all the accounting issues and B, understanding the way these structures work. So we think it's a great exercise. The premium finance assets lend themselves very much to it. But we'd look at other opportunities. I mean, we have maybe something in the installment loan category. The other thing might be to look at some of these loans called fractional unit loan, which are mortgage loans. So, yes, we'd look at other classes because it would certainly add liquidity to our balance sheet.

Could you say at this time who is doing the securitization, and with that in mind, do you have a buyer in mind, or -- ?

I'd rather not say. I mean, we're marching forward with somebody, but we're not done with it. So, until we're done -- but I think the company doing it has some arm that would actually be the buyer of the A rated notes. The double Bs that I talked about, we're actually going to retain those. Because the yield -- in our mind, the yield on them is too high relative to the risk. I mean, we already own these assets. We know them very well. We're very comfortable with them. So we don't want to be paying 450 over LIBOR on that B piece to some outside third party.

Correct. Just regarding credit quality, you talked about I guess one, the Port Huron property. The 3.5 million? You said is 30 days past due. Has anything been reserved for that?

We've got probably some general reserves because of the rating on the loan. But usually those would be about 5 percent. That development has got much, much higher occupancy rates. So, that's not to say something adverse can't develop there. But it's certainly not in the same category at all as the 2 other projects which have really suffered from a sharp decline in occupancy rates.

Okay. Just 2 final quick questions hopefully. One, is the level of brokerage CDs I guess was up during the quarter, and I guess it looks like it's about -- is 35 percent of total deposits. Is that kind of the upper end of the range for you guys? Or where do you see that going? And then just maybe the final question is what is, in your view, the appropriate tax rate for 2006? Or at least the fourth quarter?

Well, the brokerage CDs, we also had I think borrowings came down some. Fed funds came down from about 144 million down to 108 million. And other borrowings came down from about 355 million to about 269 million. So, the change in brokered CDs is actually I think a little less than the change in the other borrowings. We're just looking at what is our cheapest source of funds, number one. And the brokered CD rates -- I mean the thing with brokered CDs is when rates come down, they tend to lag. Sometimes rates come down, or when they get real low, you just can't market them. So when LIBOR was 1 percent, it was hard to market brokered CDs, except at a pretty wide spread to LIBOR. Now that rates have come up, the brokered CD rates are actually very good relative to a spread to LIBOR. So, A, they're just more attractive as a funding vehicle, and so we're sort of replacing some of the other borrowings with the brokered CDs. And the second thing with the brokered CDs is we could really create whatever duration we need with them. We could either do bullet CDs and get the maturity we want. Or we could do these things where we do callable brokered CDs, and then we swap them back short and we create sub-LIBOR funding if we need variable rate funding. So they're extremely flexible. So, we really like them. So we don't necessarily have some percentage limit where we say we don't them higher than this. And they did go up but largely because they're just a more attractive funding vehicle than what we were otherwise looking at. And You know, when terms of the effect of tax rate, we kind of been between, it's not bee a real wide range. We've been kind of 27.5 percent on the low side, and maybe 29 percent on the high side. So I don't see us breaking out of that range at all.

What kind of tugs us back and forth in the range would be a -- 1, the percent of tax exempt earnings to pretax earnings. So, that category is basically municipal securities and our bank owned life insurance are the 2 biggest tax exempt categories. So as they get -- as they grow more than our pretax earnings they become a higher percentage, that will drift the rate down. And then the percent of Mepco's earnings to the total also has somewhat of an impact because Mepco operates in a lot of states, so we have state income taxes related to Mepco's earnings. So, their earnings, relative to the total can also push that number around. The reason it doesn't have the same impact with our banks in Michigan, is the Michigan single business tax is an ad valorem tax, and that's up in other expenses. So the changes there don't show up in that line. So I still think we'll be in that range, but those are the dynamics that are going to change it. So if you want to, for modeling purposes, take the midpoint, you're probably not going to be too far off, one way or the other.

Okay. Rob, just real quick though, on the brokerage CDs, how much extra on average do you think you're paying versus say a normal CD in your market? I mean, it's probably not that much, is it?

There's no such thing as a normal CD in our market. I mean the credit unions are paying just these whopping rates, which we could probably pay if we didn't have to pay taxes either. But -- Their price, the brokerage CDs are better than Federal Home Loan Bank advances, and they're at very tight spreads to LIBOR. I mean, they're right at, for the shorter end CDs, they're right at LIBOR. So, they're probably a quarter to three-eighths of a percent higher than what you might see as sort of a midpoint rate in the marketplace, but there are certainly rates out in the marketplace that are higher than the broker -- I mean, retail rates higher than the brokerage CD rates. And more than just a few. We see them advertised in the newspapers all the time, where they're paying 4.25 percent on a short term CD. That's higher than what we have to pay for a brokerage CD.

Okay. That sounds good. Thanks guys.

Jason Werner, Howe Barnes.

I had another question regarding the securitization. I was just kind of curious what the term is on these notes. Obviously, the assets are very short term duration. How long do these notes last?

It's going to be a 3 to 5 year revolver. We're hoping for the 5 year revolver, but it's going to somewhere in between that. The reason obviously we want as long a term is there is a certain amount of upfront fixed costs, legal fees, placement fees and the like related to the facility. So the longer we can have it in place, the longer we can amortize those upfront fixed costs, and it just makes it more efficient. So it's going to somewhere in the 3 year at the short end, hopefully a 5 year revolver.

So, you'd essentially be replacing the security with new securities -- not new securities, new receivables.

Yes, it's kind of like the waterfall principle. It's going to be capturing all of the loans coming in and then that amount, the 150 million, should stay constant throughout that revolving period. At some point in time, you start into the, what we would call the amortization period. Where then it starts paying down, but that would be toward the end of the revolving period. And hopefully at that point we would start up a new one.

What do you guys anticipate (inaudible) receivable side. Obviously, initially it goes down 150 million, will it grow from there or will it stay kind of flat in there because new receivables are going into the pool?

Well, that facility though, is only 150 -- 150 million. So, I mean, it's going to -- the receivables would still continue to grow. We're not -- the facility, in terms of the outside note is 150 million. So, you're kind of -- it's kind of -- you're constantly feeding it. But it's not going to get higher than 150 million. So if you have -- if you go from 300 million -- if you start at 300 million in receivables, you have 150 million that's not effectively out there. And then if you went up to 350, you'd have 200 million that's not in there.

Okay.

It's going to very hard to continue to grow receivables, though at the pace we have in the past.

Yes, I mean you've seen -- you may have seen the finance receivables, the growth rate slowed a little bit in the third quarter. And part of it is at 375 million in receivables, that portfolio about 10 percent to 12 percent is paying down every month. So you're getting $40 million every month that's paying down. So just -- once you get to a certain size, you really have to ramp up your origination to continually grow it at the kind of pace we grew it at from back in 2003 to where we are at today. Our origination volumes are growing, but it's just not having as meaningful an impact in growing the balance because now the monthly paydowns are about $40 million.

Okay. Thank you.

Well, we would like to thank everyone for participating in our third quarter conference call. And if you have any further questions, don't hesitate to call Rob or myself. Thank you very much.

Thank you. This concludes today's teleconference. Thank you for your participation.