Independent Bank Corp (Michigan) (IBCP) 2006 Q4 法說會逐字稿

Greetings, ladies and gentlemen. Welcome to the Independent Bank Corporation fourth quarter 2006 earnings conference call. [OPERATOR INSTRUCTIONS] As a reminder, this webcast may contain forward-looking statements as defined in section 27A 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 development 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 stock holders. It is now my pleasure to introduce your host, Mr. Michael Magee, President and Chief Executive Officer. 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 fourth quarter and year end 2006 results. Earlier today we reported that fourth quarter 2006 income from continuing operations was $1 million or $0.04 per diluted share. A year earlier income from continuing operations totaled $11.2 million or $0.47 per diluted share. Our return on average equity and return on average assets from the continuing operations were 1.44% and 0.11% in the fourth quarter 2006 compared to 17.66% and 1.34% respectively in 2005.

Our income from continuing operations for all of 2006 totaled $33.8 million or $1.45 per diluted share compared to $45.7 million or $1.92 per diluted share in 2005. Return on average equity and return on average assets from continuing operations were 13.06% and 0.99% respectively in 2006 compared to 18.63% and 1.42% respectively in 2005.

The declines in the comparative quarterly income from continuing operations in 2006 compared to 2005 were primarily due to four factors. These are, number one, a fourth quarter decrease in net interest income of $2.8 million in 2006 compared to 2005. Number two, a fourth quarter loan loss provision of $8 million in 2006 compared to $2.4 million in 2005. Number three, a $2.4 million goodwill impairment charge at Mepco and a $600,000 goodwill impairment charge at First Home Financial our manufacturing home finance subsidiary. And number four, a $2.4 million loss associated with a write-up of a receivable from a counter party in Mepco's warranty payment plan business.

Rob Shuster, our Chief Financial Officer, will discuss these items in more detail during his remarks. As I stated in my remarks during the third quarter conference call, I had asked Robert Shuster to accept the additional responsibility of CEO of Mepco Insurance Premium Financing. During his tenure Rob negotiated the sale of Mepco's Insurance Premium Finance business. This transaction closed in January of 2007. Mepco can now focus solely on its warranty payment plan business where it enjoys a market leadership position. In addition, we believe this business line can generate high returns on both average assets and invested capital.

The other factor adversely impacting our fourth quarter results was the continued increase in non-performing assets. I stated last quarter that we were going to review our commercial loan relationships over $1 million. We completed that process in December of 2006. This review covered 52% of all commercial loans outstanding. We provided specific reserves on several loans during the review that we internally downgraded. We are working with the customers to liquidate the collateral as soon as possible or otherwise cure the loan default. Also, we have assigned Pete Graves our Senior Vice President of Commercial Lending Services the responsibility to review and realign our credit culture and processes to provide more consistency between the banks, improve asset quality, and integrate even greater accountability into our culture. This project will be completed the first quarter of 2007. Rob will now provide some additional details on fourth quarter results.

Good afternoon, everyone. I will focus my comments on net interest income and our margin, certain components of non-interest income and non-interest expense, asset quality, and conclude by reviewing some of the assumptions related to our earnings expectations for 2007.

Tax equivalent net interest income totaled $31.5 million in the fourth quarter of 2006 which was down $2.7 million or 8% on a comparative quarterly basis and was basically unchanged on a linked quarter basis. Our third quarter 2006 tax equivalent net interest income restated removed discontinued operations was $31.57 million, and our net interest margin was 4.26%. The decrease in the comparative quarterly tax equivalent net interest income was due to a 49 basis point decline in our net interest margin to 4.23% from 4.72%. Partially offsetting this was a $78.6 million increase in average interest earning assets, primarily as a result of growth in commercial, real estate, mortgage, and installment loans.

On a linked quarter basis our tax equivalent net interest income finally began to show some signs of stabilization despite the flat yield curve and continued competitive pricing conditions in our markets for both loans and deposits. The linked quarter net interest margin only declined 3 basis points to 4.23% from 4.26%, partially offsetting the slight decline in our net interest margin was a rise in average interest earning assets which increased by $16.5 million due to growth in loans. The increase in loans was partially offset by a $9.1 million decline in the average balance of investment securities.

The growth in loans has slowed during the second half of 2006. This slowing in growth reflects several factors including a relatively weak Michigan economy, competitive pricing conditions, and our caution in booking any new commercial real estate loans involving construction in development of residential property. On a comparative quarterly basis our yield on average interest earning assets in our cost of funds both increased due principally to the rise in short-term interest rates. On a linked quarter basis our yield on average interest earning assets was up by 9 basis points, and our cost of funds increased by 12 basis points.

The fourth quarter of 2006 included $474,000 in reversals of accrued, but uncollected interest on loans placed on non-accrual during the quarter. This compares to about $300,000 in the third quarter of 2006. As most of you know, we closed on the sale of Mepco's Insurance Premium Finance business on January 15, 2007. As a result of this transaction, Mepco received approximately $176 million in cash, and the buyer also assumed approximately $12 million in liabilities and acquired $180 million of insurance premium finance loans. The funds received were utilized to pay off maturing brokered CDs or short-term borrowings. This transaction freed up approximately $22.4 million of capital that will primarily be utilized to fund the core deposit premium related to our TCF branch purchase. The TCF branch purchase is expected to close in March 2007.

Moving onto some of the more significant categories of non-interest income, service charges on deposit accounts increased by $294,000, or 6% on a comparative quarterly basis and were down $133,000 on a linked quarter basis. Visa Check Card interchange income was up 19% on a comparative quarterly basis and was up 3.4% on a linked quarter basis. The comparative quarterly increase reflects growth in debit card usage.

As mentioned in last quarter's conference call, we piloted a rewards program in the second half of 2006 to further increase debit card transaction volume. This pilot program proved successful in increasing debit card transaction volume so the rewards program is being rolled out companywide in 2007.

Gains on real estate mortgage loans increased by about $100,000 on a comparative quarterly basis despite a $19.4 million decrease in the volume of loans sold. The decline in loan sales volume was more than offset by a 48-basis point increase in our loan sales profit margin. However, just over one half of this profit margin increase was due to FASB 133 related adjustments. These gains were up by $149,000 on a linked quarter basis even though the volume of loan sales decreased by $3.2 million as our net profit margin on loan sales increased by 27 basis points with FASB 133 adjustments comprising 20 basis points of the increase. We anticipate that conditions will continue to be highly competitive in the mortgage banking sector in 2007.

Real estate mortgage loans servicing income was up $52,000 on a comparative quarterly basis, and was up $44,000 on a linked quarter basis. These variances primarily reflect changes in the impairment reserve on and amortization of capitalized originated mortgage loan servicing rights. During the fourth quarter of 2006 we recorded $49,000 of impairment charges. In the fourth quarter of 2005 we recorded a $43,000 recovery on previously recognized impairment charges. In 2007, assuming relatively stable longer-term mortgage loan rates, we would expect real estate mortgage loan servicing income to run at about $550,000 to $650,000 on a quarterly basis.

On a comparative quarterly basis manufactured home loan origination fees and commissions fell by 41% and for all of 2006 fell by 27% compared to 2005. Conditions continue to be challenging in this business, and as a result we recorded an additional goodwill impairment charge of approximately $600,000 in the fourth quarter of 2006 related to First Home Financial which we acquired in 1998. First Home Financial is a loan origination company based in Grand Rapids, Michigan, that specializes in the financing of manufactured homes located in mobile home parks or communities. Based on the fair value of First Home Financial at year end 2006, the goodwill associated with this entity was reduced from approximately $900,000 to just under $300,000. We had previously recorded a goodwill impairment charge of $600,000 related to First Home Financial in the second quarter of 2006.

Non-interest expenses totaled $31.1 million in the fourth quarter of 2006 which is up $5.7 million or 22.6% on a comparative quarterly basis. A goodwill impairment charge of $3 million and a $2.4 million write off on a receivable due from one of Mepco's warranty counterparties comprised about 94% of the comparative quarterly increase in non-interest expenses. During the fourth quarter of 2006 a $2.4 million goodwill impairment charge was recorded at Mepco as a result of a valuation performed to allocate intangibles between the business Mepco is retaining and the business that was sold in January 2007. Approximately $4.4 million of intangibles was allocated to the insurance premium finance business and is included in assets of discontinued operations at year end 2006. After this allocation $19.5 million of intangibles remained at Mepco that were valued at at $17.1 million which resulted in the aforementioned goodwill impairment charge.

During the fourth quarter of 2006, Mepco also recorded a $2.4 million loss related to a receivable due from a warranty payment plan counterparty. The loss is comprised of a $1.6 million write off that represents a portion of the balance that is due and $800,000 in discount for imputed future interest. Although this counter-party has been making periodic payments on the balance owed to Mepco, a long-term agreement for the repayment of all sums due that is satisfactory to Mepco has not yet been reached. As a result of this development, along with the potential for future litigation, Mepco recorded the aforementioned loss. Mepco will vigorously pursue collection of the amounts due from this counter-party.

Compensation and benefits were up by $872,000 on a comparative quarterly basis. The fourth quarter of 2006 includes $542,000 more in incentive compensation than the fourth quarter of 2005. This rise in incentive compensation is due to the Company's Board of Directors approving a 3% ESOP contribution which added a little over $1.1 million of expense. As you will recall, we had previously eliminated the accrual for both bonuses and ESOP at the end of the third quarter.

In addition, there is about $200,000 less in compensation and benefits expense that is deferred as direct loan origination costs in the fourth quarter of 2006 because of lower mortgage loan origination volumes. Our assessment of the allowance for loan losses resulted in a provision for loan losses of nearly $8 million in the fourth quarter of 2006 which was substantially higher than the fourth quarter of 2005 and the linked quarter. Non-performing loans increased to $39.2 million or 1.58% of total portfolio loans at year end 2006 which represents a $22.7 million increase from the end of 2005. The rise in non-performing loans in 2006 was primarily concentrated in the commercial loan and real estate mortgage loan portfolios.

Non-performing commercial loans rose by $16.4 million in 2006. This is principally due to 19 commercial loans with balances totaling $18.1 million at the end of 2006 becoming non-performing during the year. The five largest non-performing commercial loans represent about two-thirds of the total increase. Charge-offs or specific allowances have been recorded on these loans based on current assessment of collateral values taking into account disposal costs. The substantive majority of these 19 aforementioned commercial loans are collateralized by real estate and several are development loans. The inability of many of these borrowers to perform under the terms of the loan agreement is often associated with slowing sales of real estate in the state of Michigan.

As we mentioned in last quarter's conference call, we initiated a review of commercial credits with balances in excess of $1 million. This review was in addition to our normal ongoing loan review procedures. As Mike mentioned in total, we reviewed approximately 52% of our commercial loan portfolio. Particular attention was paid to construction and development loans and nonowner occupied real estate loans.

A summary of our findings is as follows--approximately one third of our commercial loan portfolio is comprised of loans secured by nonowner occupied real estate. Although there has been a marginal increase in vacancy rates in certain sectors, delinquencies remain low in this portfolio and the portfolio appears to be stable. Approximately one fifth or roughly $200 million of our commercial loan portfolio is comprised of construction and development loans. Nearly all of the loans in this portfolio exhibit some form of stress such as slower than expected lot or home sales. Delinquency rates in this segment are at about double the overall commercial portfolio average.

The balance of the commercial loan portfolio did not exhibit any significant stress with the exception of approximately $26 million in loans secured by convenience stores at gas stations and about $6 million in loans to borrowers who have direct relationships with the big three auto companies. These two segments also have higher delinquency levels than the commercial loan portfolio average. As a result of this review, approximately $50 million of commercial loans were downgraded. In addition, the rise in non-performing loans also reflects increases in residential real estate mortgage loans. The increase in non-performing residential real estate mortgage loans reflects weak economic conditions in Michigan that are resulting in a rise in bankruptcies and foreclosures. Weak home sales volumes and a high inventory of homes for sale make it more difficult for borrowers who are experiencing financial stress to sell their home quickly and avoid foreclosure. Non-performing finance receivables now exclude insurance premium finance loans which are part of our discontinued operations.

Moving onto net loan charge-offs, they totaled $5.3 million in the fourth quarter of 2006 or 0.85% of average portfolio loans which is actually down slightly from the fourth quarter of 2005's total of $5.5 million or 0.93% of average portfolio loans. For all of 2006 net loan charge-offs were $11.8 million or 0.48% of average loans compared to $9.5 million or 0.43% of average loans during 2005. The increase in the level of net loan charge-offs in 2006 is primarily due to higher charge-offs of commercial loans and real estate mortgage loans. Our allowance for loan losses rose to $26.9 million or 1.08% of portfolio loans at December 31, 2006, compared to $22.4 million or 0.95% of portfolio loans at December 31, 2005.

An analysis of the components of the allowance is as follows--the portion of the allowance allocated to specific loans increased by $1.2 million since the end of 2005 due primarily to the specific reserves established on non-performing commercial loans primarily during the last half of 2006. The portion of the allowance allocated to other adversely rated loans increased by approximately $800,000 since year end 2005. As I mentioned on previous conference calls, we utilize a 12-point loan classification system with 1 being the best and 12 being the worst, and the total of loans rated 7 or higher which some might call watch credits was approximately $109 million at year end 2006 compared to $86 million at September 30, 2006, and to $78 million at December 31, 2005. The increase in watch credits in the fourth quarter of 2006 in part reflects the results of the commercial loan portfolio review that I discussed earlier.

A portion of the allowance related to historical losses increased by about $1.4 million since the end of '05 due primarily to loan growth and a rise in the level of net loan charge-offs during 2006. We utilize a 10-year rolling average in calculating this component of our allowance with the most recent 24-month period weighted the highest. Finally, the subjective or unallocated portion of our allowance increased by $1.1 million since year end 2005 due primarily to concerns about economic conditions in Michigan.

We closed 2006 with total shareholders equity of $258.2 million or $11.29 per share. Shareholders equity includes a positive beginning of the year adjustment of $2.1 million related to our implementation of Staff Accounting Bulletin 108. The $2.1 million represents net over accrual differences that accumulated over many years and that were considered immaterial to any particular year's operations or financial condition.

I now want to focus the balance of my remarks on our earnings outlook for 2007. As we indicated in this morning's press release we currently expect 2007 full year earnings to be in the range of $1.70 to $1.82 per diluted share. This estimate range takes into account the following primary assumptions--loan growth of 5 to 6%, a decline in investment securities of about 12%, thus overall interest earning assets are projected to increase by less than 3%. The tax equivalent net interest margin during 2007 is estimated to be about 23 basis points higher than the level experienced during the last half of 2006. This improvement is comprised of an expected 12 basis-point positive impact due to improving spreads at Mepco and an expected 11-basis point positive impact due to the TCF branch acquisition. The provision for loan losses is expected to be more in line with our 2005 full year level.

Net gains on the sale of real estate mortgage loans are expected to be more in line with our 2005 level which would represent about a 17% increase over 2006. This is partly due to the addition of the TCF branches in March 2007 and also due to the addition of mortgage loan originators in several of our markets. Service charges on deposits are expected to rise by approximately $5 million due primarily to the branch acquisition.

Compensation and benefits are expected to rise by about 14% in 2007 over 2006. This increase is due to the branch acquisition, merit increases instituted at the start of 2007 that are expected to average about 3%, the restoration of incentive compensation which currently is estimated to be about $2.9 million higher than 2006, and increases in healthcare benefits costs. Occupancy, furniture and equipment, data processing, communications, advertising and supplies expenses are expected collectively to rise about 12% in 2007 over 2006 due primarily to the branch acquisition as well as full-year costs associated with new branches opened in 2006 and partial-year costs for three new branches scheduled to be opened in 2007.

Intangibles amortization is expected to rise by about $2.3 million in 2007 compared to 2006 which includes core deposit intangible amortization related to the branch acquisition that is somewhat offset by reduced intangibles amortization at Mepco because of the sale of our Insurance Premium Finance business. Net income at Mepco is expected to be about $4.3 million in 2007. This compares to a loss of $2 million in 2006 which does include discontinued operations.

Finally, we expect our effective income tax rate to range between 27 and 28%. That concludes my remarks, and I would now like the turn the call back over to Mike Magee.

Thank you, Rob. Before we open the call up to questions, I want to make some closing remarks regarding 2006 and what we expect for 2007. As I stated in the press release, we have taken several actions to address the issues that adversely impacted our performance in 2006. As a company we have refocused our efforts and what we are really good at, and that is community banking. We need to continue to be diligent on cost control while enhancing the customer experience. For all of these reasons and my confidence in our management team and employees, we are giving guidance, earnings guidance for 2007 of $1.70 to $1.82 per diluted share. As Rob indicated in his remarks, these earnings expectations assume that our provision for loan losses returns to a more normalized level, and are able to achieve a single low-digit net loan growth while continuing to operate in a flat yield curve environment. At this point, I would now like to open the call up for any questions that you may have.

[OPERATOR INSTRUCTIONS] Our first question comes from the line of Terry McEvoy with Oppenheimer & Co.

Thanks. Good afternoon.

Hi, Terry.

Just looking at, I call it your confidence that the provision will go back to '05 levels, Rob, you talked about some stress in the construction and development portfolio, delinquencies up, and a few other data points that maybe would have -- I would have read into it as the provision maybe being a little bit higher than '05. Can you maybe help me out with your comfort level and watching the provision go down to where it was two years ago?

Well, first I would say '05 at least historically was certainly higher than our historical norm. It was, and I am just looking back at prior years, it was probably 2 to $3 million higher than where our historical norm had been, so I would view '05 as at least somewhat elevated. I guess, the other point I would make is we did through our review in the fourth quarter try to do as good a job as possible at picking up any of the loans that we saw that were potential for problems and tried to incorporate that in our provision as best we could estimate for losses that were reasonably probable in the portfolio at year end. So that certainly, Terry, I would be the first to say, that's the area where there is the potential for us to be off some, but that's our best guess at the current time.

Terry, I would also like to add to Rob's comments that $30 million was downgraded in 2006 creating additional provision of $3.1 million that Rob touched on in his remarks, and also we had a very -- we had a provision last year, Rob mentioned the net. We provided last year I think it was about $17 million, 16 million in loan loss provision. We believe that we have opportunity also for recoveries because of the amount that we've charged off the last couple years, so we believe on a net basis because of recoveries that we'll experience that's why we'll be able to provide back to the 2005 levels.

And if you look at the four banks that operate under the holding company, was there a concentration of problem loans within one of those four banks or was it evenly spread out among the franchise?

Well, there was -- the one concentration you definitely saw was in construction and development loans. There is no question that the majority of the non-performers in the commercial portfolio were in that category, and of the -- of that group, 39% of the non-performing commercial loans were in southeast Michigan. So -- now that wasn't all just necessarily at our bank in southeast Michigan because oftentimes we will either share credits or some of the banks may have credits in markets that the other banks operate in. So I can't really say that it was concentrated in any one bank, but certainly it was concentrated in construction and development loans with some tilt towards southeast Michigan. And just to carry on with that, just because this was asked at the last conference call, some statistical data on what we have in southeast Michigan, we have about 43 million of loans in a -- and these are by a category, industrial classification category, but in the land subdividers and developers we have about 43 million in southeastern Michigan, and then we have about 23 million in-housing construction, so in total you have about 66 million in southeast Michigan, and what we would term land development and residential construction loans.

Just a quick follow-on, would those be in the high-end communities, more modestly priced, or evenly distributed?

I would say we don't have any in any real high-end communities, so I would say they would tend to be more mid-priced. Our single largest which we talked about the last quarter, the single largest non-performer is a mix -- was a land development loan that was mixed use, so it was commercial and residential, but that wasn't going to be a real high-end kind of residential development.

Appreciate it. Thank you.

Our next question comes from the line of [Peter Mott] with Deutsche Bank.

I'm sorry, my question was already answered. It had to do with the physical location of the problems, and what I am hearing is the bulk of it tends to be in southeastern Michigan, and most of that was probably originated with the bank you bought in Oakland County. Is that a -- I know you spread credits around, and different areas take pieces of it, but is it fair to say most of those were originated in that acquisition?

No. I would say, Peter, more of the credits were originated after we acquired the bank. I wish I could say that, but that's not correct.

Our next question comes from the line of Brad Milsaps with Sandler O'Neill.

Hey, good afternoon.

Hi, Brad.

Hey, Rob, if you don't mind, can you sort of run through the review of the credits, what are your findings in the quarter and then in terms of the construction portfolio and the commercial portfolio? And then is there any theme that you see early on in terms of kind of what is the overriding cause for a lot of these credits to go sideways? Is it something you found in the underwriting process or is it really all economic related and are the folks that -- it sounds like these people that originated these loans after that deal, are they still with the bank? If you could just give us a little bit more color there.

Well, yes, I mean do you want me to read back through kind of what I--?

Let me just make sure I have it correct. You said one third of the commercial?

One third of our commercial loan portfolio is comprised of loans secured by nonowner occupied real estate, so that would be things like apartment buildings, and office buildings that it is not an owner-occupied, it is an investor that owns it and he's leased it out, and I said that portfolio was really stable. We've seen a little bit of a increase in vacancy rates in certain sectors, but delinquencies remain low, and like I said, that portfolio appears stable. Then approximately one fifth or about $200 million of our commercial loan portfolio was comprised of construction and development loans, and that's the group where I said nearly all the loans in that portfolio exhibit some form of stress.

And what we're seeing there is we'll have when you do the loan expected release schedules for lot sales or if it is condo development, unit sales or if it is residential construction home sales, and in almost all instances, what was originally projected and where they're currently at, there is a departure, and what you're seeing there is just a tremendous slowdown in sales of real estate, and so that's creating stress, and if you ask is there a theme involved, I would say the theme involved is we're seeing most of the pressure in that segment of the portfolio, and probably maybe a couple of characteristics that you might also see is where there is the use of an interest reserve, in other words there is a segment of the disbursements that early on is used to pay interest on the loan, it is a fairly common practice, but certainly that can result in maybe not detecting that there is an issue as soon as if the money was coming out of pocket from the developer, so that may be another theme. I don't know.

It is easy to look back and kind of second guess the underwriting, but I don't think there was anything that was pervasively functionally wrong in the process that came out of the review process, and they really took a critical look at that. I suppose the one thing you could say is 200 million of construction and development loans, is that too large of a concentration? Certainly it's caused our non-performers to go up more than we are comfortable about. Then the last piece is the balance of the commercial loan portfolio. I said we really didn't see any significant stress within the balance of the portfolio with the exception of just a couple of sort of smaller, unique segments, $26 million in loans secured by convenience stores at gas stations or the complex of the gas station and convenience store itself. We saw some stresses in that portfolio.

I don't know that there was anything in particular there because that's kind of spread out, and there is no real concentrations of borrower groups there. It just seemed to be that that portfolio had a higher delinquency rate, and then we had about $6 million in loans to borrowers who had direct relationships with big three auto companies, certainly a small segment of the portfolio, but that group was exhibiting stress as well.

And of those 200 million of construction loans, what would you say, what percentage of those are on non-accrual at this point? Are all those not on non-accrual yet?

Well, I mean, you could see how much we have in total non-accrual loans in commercial, and the vast majority of that are construction and development loans. I am just trying to see what that figure is, Brad. It is 21.6 million, and the majority of that is in that construction/development loan category. It is probably a little less than 10% of the portfolio.

Okay. Have you begun to see any stress on the consumer side in terms of more overdrafts, anything on that side yet based on what you're seeing in the economy? You've had a nice pickup in service charges and you talked about some of the other things you were doing but just kind of trying to get a sense is that related to some weakness in the consumer as well?

Actually, we have seen in the consumer portfolio itself our non-performers have stayed relatively consistent. Now, recognize that the cycle time there is much quicker. I mean one of the issues you run into with the real estate secured loans is once they get into non-performing they stay there for a year as you work your way through the for closure and redemption period and then liquidation. Consumer loans you cycle through and liquidate much quicker, but even our charge-offs in the consumer portfolio while they're up a little bit, they're not up significantly and overdrafts we've not seen any significant change there either.

Brad, the only comment I would add to Rob's is we do -- we are experiencing an increase in customers who are trying to commit fraud against the bank through the use of their checking account, and we implemented a new position during the year, that we have a full-time employee that's all she does is monitor our checking accounts, and has found several instances where we've closed accounts to avoid any type of losses, as you know, we had a loss earlier in the year, and basically we found that the position was needed because of the times that we're in a lot of customers are -- when their back is in a corner, they do some pretty unethical things, so we're watching our DDA customer base very closely.

Okay. Final question, and I will step back. Rob, how aggressive will you guys be in buying back stock? Shares are off 7% today. Do you kind of view that as a level where you would be more active with some of the capital you freed up with the sale of Mepco? I know you have the branch purchase coming, but can you kind of give us a little bit of color on your appetite for buybacks?

Well, I think the extent we're able to do it to be in the market we would certainly view that as an opportunity. I mean I think we're confident that things will rebound in '07. I laid out the twelve major assumptions related to that, so certainly if the stock continues to not perform well, that would be an opportunity from our perspective.

What do you have remaining on your authorization?

Well, we've historically always had a $750,000 authorization -- I mean, 750,000 shares authorization, and we haven't bought back anything obviously in 2007. That's what we would have under our ongoing authorization.

Okay. Great. Thank you.

[OPERATOR INSTRUCTIONS] Our next question comes from the line of Jason Werner with Howe Barnes.

Good afternoon, guys.

Hi, Jason.

I was curious regarding the guidance you gave for the net interest margin. You said 23 basis points higher than the second half '06 level. Just curious how we get there? Is that just kind of -- obviously part of that is the TCF branches so that won't happen unless that occurs, but is there a ramp up towards that or is there going to be a spike or what do you guys see going on with the margin progression?

Well, I think there is two pieces to that. Once the TCF transaction closes which as I indicated earlier we expect to be in March of 2007, we would expect to deploy those funds to retire, and we would align our maturities so we can do that to retire short-term borrowings and brokered CDs, so we're not looking at a period of time where we have to invest those funds. That will happen relatively quickly to immediately after we receive the funds related to assuming those deposit liabilities, so I said 11 basis points of the overall 23 -- and remember, Jason, this is average for the year, so TCF would -- that branch acquisition, that 11 basis points would occur relatively quickly, so you would see an improvement basically in cost of funds in the second quarter related to substituting brokered CDs and borrowings with that deposit base. The other piece is going to come largely in yield on earning assets, and that's going to be more gradual throughout the year with the majority of that concentrated at Mepco and I had indicated we expect about 12 basis points overall margin improvement related to Mepco's operations. Not 12 at Mepco, but 12 overall in the consolidated margin.

Okay. I guess this would be net of any potential repricing of CDs and that sort of thing?

Yes. Our model, it projects a stable balance sheet, so it projects a static that we're not changing other than the loan growth assumptions and deposit related assumptions, but anything that's repricing would be repricing at current rates, whether it is loans, deposits, borrowings, anything of that night. We continue to expect pretty much relatively the same interest right environment we're faced with today.

Okay. With respect to the loan growth guidance of 5 to 6%, I was curious in color where that might be coming from? Hopefully none of that is going to be in construction loans in southeast Michigan.

Well, Jason, as you know, we added some commercial lenders during 2006 that we will be able to receive the full benefit of their efforts in 2007. We added Jose Infante and two commercial lenders in Muskegon. We have plans for a couple branch -- full service branches there. We've also added some mortgage originators throughout our footprint, so we feel -- the other thing that I think is very important to know is that with the TCF branch acquisition we're going to receive 40,000 new customers. And TCF has made the decision to exit those markets, but they're selling us the branches as far as their loan production offices. We believe we have great opportunity to generate quite a bit of loan business out of the TCF customer base in 2007, so part of our loan growth is using that as an assumption, too.

Okay. Last question.

Jason, one other point. We did grow despite a pretty choppy year in 2006 we were up about 4.7% roughly, so it is not a real stretch to try to get to 5 to 6%.

How much growth do you anticipate out of the warranty business, what's left in Mepco?

Modest growth, about 5%.

Okay. And then I guess we've had a lot of disruption from Mepco since you guys acquired them over the years, and you guys pretty comfortable at this point that most of that disruption is now behind you and kind of looking forward to getting down to doing business?

Well, that's certainly our objective. We think we've with the sale of the Insurance Premium Finance business we are down to a single line of business that, as I stated or Mike stated in his comments we enjoy. It is a unique niche that we enjoy a leadership position in and we believe we can generate excellent returns in that business, returns north of 2% on assets and north of 20% on allocated capital, so we -- it is a much more straight forward business than insurance premium financing.

I would -- I guess another way to answer the question is, Rob, when we had the Insurance Premium Finance business how much time did you need to spend there versus how much time do you plan on spending there in the future?

Well, I mean, the relative businesses you spend probably about 85 to 90% on the Premium Finance business, and the other business just doesn't require the same day-to-day oversight because of the nature of it. Once you establish your contractual relationships with your counterparties, the flow of business is fairly perfunctory. When you're just servicing payment plans -- so you're really being paid for a service, and it is just a completely different type of business compared to the premium finance business which really requires intense day-to-day management of a number of different things from credit issues to pricing to customer relationships, so it is a vast difference in terms of time.

So if you'll be spending less time overseeing that, then will you remain as the CEO of that business or will you guys look for a more permanent head of that--?

Well, right now we have two remaining people. They're the Chief Operations Officer and the person who has been running the payment plan division since April, and we are very confident in their capabilities of handling the day-to-day, but I will remain as the CEO just to oversee the more strategic contractual larger business issues, but it certainly won't require the time commitment that I spent the last five months or so, so I could really return to my day-to-day responsibilities as CFO.

Okay. Thank you, guys.

Thanks, Jason.

We have one final question from the line of Jon Arfstrom with RBC Capital Markets.

Good afternoon, guys.

Hi, Jon.

Does this mean I only get one question?

No. You go right ahead.

Okay. Just following up on the counterparty question at Mepco, how much work have you done in terms of looking at scrubbing the counterparties, if you will, to make sure that something like this doesn't happen again? And can you give us a little more detail as to how many counterparties you have in that business?

Well, there is two types of counterparties. You have what I would call administrators and insurers, and then you have sellers and dealers. This counterparty exposure of a seller/dealer. In terms of administrators and insurance companies, there is really only a handful of counterparties there, and those counter-parties are insurance companies or they're administrators backed by insurance companies. So in that sense it is really the same as analyzing the -- your exposures that you have in the Insurance Premium Finance business where you have generally publicly traded companies that have S&P ratings and AM Best ratings, so you can very much understand the counterparty exposure and the relative risk there, and I think do a very good job of underwriting that exposure, so we've never had any issues there.

Where you run into the issues, Jon, is with your seller/dealer counterparty exposure, and when one of these payment plans cancel, there is two pieces we have to get returned to us. One is the unearned dealer profit, and the other is the, what I call administrator insurance costs which is the actual insurance or administrator piece of the pie and the unearned piece, and the balance though is that unearned seller profit. That's the piece that is much more challenging in terms of management because these companies tend to be smaller, they're often private, it could be anything from car dealers to large direct marketers, so that exposure is more challenging to underwrite, but the two-ways you really directly work at doing that is, one, you either have the seller administrator who is working with that dealer guarantee the unearned dealer profit, so you remove part of the exposure, and with the particular issue that we have, part of that exposure with that seller/dealer is guaranteed by an insurance company. So the write off wasn't of the entire balance. It was the part where we had relatively speaking an unguaranteed exposure.

Other ways you do it is you have funding holdbacks that go into he escrow accounts where you hold back a certain portion of the funding due to the dealer, and you deposit it into an escrow account and hold it. And then the third way is just the mechanics of how and when you fund. So if you address and manage those three pieces, you should reduce to a relatively low level the unearned dealer exposure that you have. Those three pieces were not well managed with this particular situation, and that's what resulted in this exposure.

You feel like this is really a one-off event?

I believe it, yes, this in particular is a one-off event. We say this in our annual report, you can always have a catastrophic type of event occur where you could have an exposure where you did manage all of those pieces well, but there was just some catastrophic event. Now, I would say that the risk of catastrophic events in this particular business are not that great because it is not like P&U insurance where you can have a hurricane come through and just create huge losses with these extended vehicle warranty contracts, you're not going to have that kind of catastrophic event, and historically the underwriting claims and the profit margins in the business are relatively stable. So in other words by catastrophic event an insurer going out of business at least in that segment certainly doesn't seem that likely although, like I said, that's where you could run the risk of that type of catastrophic event.

Okay. Mike, in your comments at the tail end you talked about getting back to community banking roots, and just wondering how you think about the manufactured housing business considering the recent two writedowns in the goodwill and just how do you think about that business and how does it fit in?

That's a fair question, Jon. It is a subsidiary of one of our four banks, and I have been speaking with the President of that bank, and strategically we're going to take a look at it. As you know we've driven it down so it has a balance of just $300,000. Their budget currently shows that they are going to make money, but budget and reality are sometimes not always aligned, so if we don't see an increase in applications and also production from that entity, one of the things that we probably would look at doing is just collapsing that subsidiary, rolling it into the bank, having it be a department more or less than just like an indirect lending function, and we would continue to look at financing that paper, because one of the points that I would like to make regarding our relationship or association with First Home Financial, it has provided that bank $30 million of consumer paper at a very decent yield.

Our independent bank gets the first crack at the credit before they put it out on the market to sell to someone else, so we're buying kind of the cream of the crop, and then if IB passes on it then they will take it outside and sell it to someone else. It's provided a very good loan portfolio for us at a high yield, but that -- unfortunately that entity doesn't get any benefit when you do the impairment analysis. So I think that if we do anything we would look at, Jon, just rolling it into the bank and having it be just a department within the bank.

Okay. Okay. That's helpful. Then just two more things here. You talked about writing down your non-performing loans including potential disposal costs, and just being completely up front when you look at the reserve level against the non-performing level, give most analyst investors a little bit of indigestion. So I just wondering if you could comment a little bit on the disposal costs included in there indicate that you would potentially entertain selling some of these loans to bring that ratio back in line?

Yes. Now, when we go through our FASB -- we call it FASB 114, but, impairment analysis, we will discount the current collateral value and we will estimate based on the time to dispose of the property what we would call carrying costs which can include anything from property taxes to brokers commissions plus, we'll also include a lost opportunity interest cost. So when we take that write down -- when we write it down we do think we write it down fairly aggressively. Mike said that's why perhaps we'll be fortunate and get some recoveries, but al lot of that is dependent on what -- until you sell it and you find a buyer willing to pay that price, you never know, but it is based on we think, very realistic and relatively conservative assumptions.

The other thing to recognize in our non-performers is about a third or better than a third of the balance is 1 to 4 family mortgage loans where we've historically had very low level of losses underneath. The idea you got 13 million, it is roughly a third in 1 to 4 family mortgages which are secured and which historically, like I said we've had relatively low levels of losses and then in addition out of the 21.6 million of commercial loans, they're not -- they're largely secured by real estate where we've already looked at and updated collateral values and including looking at disposal costs. So I think that puts a little different spin on it.

Then the final comment I would make just in terms of the relative percent of the allowance to loan portfolio is you've got a big chunk of the portfolio in 1 to 4 family mortgage loans which have a low reserve associated with them, and then you have about 184 million of finance receivables which are those warranty payment plans now which have a low reserve associated with them. If you were to break down the commercial portfolio, the reserve related to that is in excess of 1.5%. It would look much more like what you would see with the commercial bank. It is just I think our mix is a little different.

That's very helpful, that statistic, I appreciate that. Thanks, guys.

Thank you, Jon.

Showing no further questions at this time, do you have any closing remarks?

Just on behalf of Rob and myself, we would like to thank everyone for participating in our fourth quarter and 2006 earnings conference call. Thank you.

Ladies and gentlemen, this concludes today's teleconference. Thank you for your participation.