Independent Bank Corp (Michigan) (IBCP) 2007 Q2 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the Independent Bank Corporation second quarter 2007 earnings conference call. At this time, all participants are in a listen only mode. A brief question and answer session with follow the formal presentation. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Michael Magee, President and Chief Executive Officer for 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 second quarter 2007 results. There is a power point presentation that we will be referring to during this conference call. If you have not yet accessed this presentation, it is available on our Web site at www.IBCP.com in the Investor Relations section. Beginning on page four of our power point presentation, we have a financial overview. Earlier today we reported second quarter 2007 net income from continuing operations of $108,000 compared to $10.4 million in the second quarter of 2006. Our diluted earnings per share from continuing operations rounded to zero this quarter compared to earnings per share of $0.45 in the second quarter of 2006. Page five of our presentation summarizes some of the factors that have made the first half of 2007 such a challenge.

As most of you are aware, on July 9, we issued a press release indicating that we expected to record a provision for loan losses in a range of $14 million to $16 million in the second quarter. Our second quarter provision for loan losses actually ended up at $14.9 million. The July 9 press release provided information on the reasons for this increase provision and both Rob Shuster and Stefanie Kimball will discuss asset quality and credit costs in some detail during their remarks later in this conference call. I want to emphasize that improving our asset quality and reducing credit costs continues to be our number one priority, despite the ongoing economic challenges evident in Michigan.

As you have seen in the second quarter results of several Michigan banks, these economic challenges are impacting many of us, resulting in rising levels of nonperforming loans, particularly those linked to residential real estate development. Despite our current asset quality challenges and the decline in earnings, we believe there were several positives in the second quarter, including growth at our net interest margin, which increased on a linked quarter basis for the first time since 2005; strong growth in several categories of non-interest income, reflecting our recent acquisition of branches; and continued progress with our bank charter consolidation process. Moving on to pages six and seven of our presentation, the bank charter consolidation that we announced in April of 2007 remains on track to be completed in September. Thus far, excluding the employees that were added because of the acquisition of branches, our staffing levels have declined by nearly 8%. The benefit of the reduced staffing levels was not reflected in the second quarter due to the timing of the reductions and because of the severance costs that we incurred.

At the end of the second quarter, we shut down the operations of First Home Financial, which was a manufactured home lender that we acquired several years ago. We just did not see any likely turnaround in this industry. I would now like to turn the call over to Rob Shuster, our Chief Financial Officer, to cover second quarter 2007 results in more detail, and then to Stefanie Kimball, our Chief Lending Officer, who will talk about credit quality as well as several of the initiatives she has underway. Rob.

Thank you, Mike. Good afternoon, everyone. I am starting at page nine of our power point presentation. I will focus my comments on net interest income in our margin, certain components of non-interest income and non-interest expense, asset quality, and conclude by making a few comments about our expectations for the last half of 2007. If you move to pages ten and 11, tax equivalent net interest income totalled $32.1 million in the second quarter of '07, which was down $1.2 million or 3.7% on a comparative quarterly basis, but was up $859,000 or 2.8% on a link quarter basis. The decrease in the comparative quarterly tax equivalent net interest income was due to a 26-basis point decline in our net interest margin to 4.27% from 4.53%. Partially offsetting this was a $60 million increase in average interest-earning assets, primarily as a result of growth in loans.

On a link quarter basis, our tax equivalent net interest margin increased for the first time since 2005 despite the relatively flat yield curve and continued competitive pricing conditions in our markets for both loans and deposits. The linked quarter net interest margin increased 4 basis points to 4.27%. Average interest earning assets increased $36 million on a link quarter basis due to a $14 million increase in average loans and a $17 million increase in average securities. The increase in average securities during the second quarter represents the temporary investment of funds from our recent acquisition of branches until such time as we could pay off brokered CDs or borrowed funds. In the second quarter of 2007, non-accrual loans averaged $44.5 million, which was up $5 million from the first quarter, and we reversed $446,000 of interest during the quarter compared to $289,000 in the first quarter.

The reversal of this interest reduced the yield on loans by 7 basis points and the net interest margin by 6 basis points. Just for comparison, in the second quarter of 2006, non-accrual loans averaged $17.8 million and we actually had a recovery of $49,000 in interest during that quarter. Looking ahead, we believe the net interest margin will be relatively stable to increasing slightly. The upward movement that we anticipate is due to the runoff of some lower yielding investment securities and some modest growth in loans. However, the growth in the net interest margin has been tempered by our elevated level of non-accrual loans, which at $45 million to $50 million creates a drag of about 12 basis points on the net interest margin. Moving on to some of the more significant categories of non-interest income or page 12 of our presentation, service charges on deposit accounts increased by $1.3 million or 26.8% on a comparative quarterly basis and by $1.5 million or 30.5% on a link quarter basis.

Similarly, Visa CheckCard interchange income was up 48.3% on a comparative quarterly basis and was up 36% on link quarter basis. These large increases reflect the acquisition of branches that we completed on March 23, 2007. Gains on real estate mortgage loans totalled $1.2 million in the second quarter of '07 on $77.9 million of loan sales. Total mortgage loan origination volume was $129.6 million in the second quarter of '07, down about 4.5% from the second quarter of '06, primarily due to lower levels of real estate sales in Michigan. Real estate mortgage loans servicing income increased by $91,000 on a comparative quarterly basis and by $185,000 on a link quarter basis. These increases primarily reflect changes in the impairment reserve on and amortization of capitalized mortgage loans servicing rights.

The second quarter of 2007 included a $138,000 recovery of previously-recorded impairment charges on capitalized mortgage loan servicing rights. Moving on to page 13 of our presentation, non-interest expenses totalled $29.8 million in the second quarter of '07. This includes $950,000 of severance expenses. In addition, when comparing to the second quarter of '06, that quarter included a much lower level of performance-based compensation as we reduced the year-to-date accrual for our ESOP contribution from 3% of eligible salaries to 1%. In 2007 we are still presently accruing at 3% of eligible salaries. Several other categories of expenses, such as amortization of intangible assets, were up due to the acquisition of the branches. Advertising was up due primarily to additional marketing that we did during the second quarter in the communities that included our newly acquired branches. In comparing data processing costs, the second quarter of 2007 included $127,000 of one-time expenses largely related to our acquisition of branches and the first quarter of 2007 included $95,000 of one-time credits. Finally, loan and collection expenses were up due to our elevated level of nonperforming loans.

As evidenced on page 14 of our presentation, the assessment of the allowance for loan losses resulted in a provision for loan losses of $14.9 million in the second quarter of '07, which was substantially higher than the comparative quarter in '06, as well as the first quarter of 2007. Nonperforming loans, page 15 of our presentation, increased to $54.9 million or 2.2% of total portfolio loans at June 30, 2007, which represents a $15.7 million increase since the end of '06. The rise in nonperforming loans in the first six months of '07 was primarily concentrated in the commercial loan and real estate mortgage loan portfolios. Nonperforming commercial loans increased to $32.7 million at June 30 of '07. This is principally due to certain land or land development loans becoming nonperforming.

Stefanie will provide more information on our commercial loan portfolio during her comments. In addition, our nonperforming real estate mortgage loans also increased by $5.4 million during the first six months of '07. This reflects increased foreclosures in the weak real estate market in the state. Page 16 of our presentation provides information on the components of our allowance for loan losses, which rose to $38.2 million or 1.53% of total loans. Excluding Mepco's Finance receivables in the portion of the allowance that relates to those receivables, the ratio of the remaining allowance goes up to 1.65% of loans. Net loan charge-offs totalled $7.4 million in the second quarter of 2007, or 1.18% of average portfolio loans. Page 17 of our presentation breaks down the net charge-offs by loan type. As you can see, the bulk of the increased charge-off occurred in the commercial loan portfolio. We had charge-offs of $4.1 million on four commercial credits in the second quarter. Page 18 of our presentation has some historical balance sheet data. In the first six months of 2007, we have reduced brokered CDs by $242.1 million, federal funds purchased by $66.6 million, and other borrowings by $108.5 million. This represents an overall reduction in wholesale funding of $417 million or 32% reflecting the deployment of funds from our sale of Mepco's insurance premium finance business and from our acquisition of branches.

A little bit more color on deposits, comparing March 31 balances to June 30 balances, you will see time deposits declined from about $1.55 billion to about $1.488 billion. That decline is due to a $69 million decrease in brokered CDs, retail CDs were actually up $5.4 million. non-interest bearing deposits actually increased from $318 million at March 31 of '07 to $322 million at June 30. The category with the large decline is savings and NOW accounts. They declined from about $1.034 billion at March 31 of '07 to $984 million at June 30 of '07. Some of this decline is due to the March 31 balances including some municipal moneys, as those balances tend to build up as they collect taxes, predominantly in the February time period, and so the average balances in the first quarter compared to the second quarter did not decline nearly as much as the spot balance at March 31 to the spot balance at June 30. In addition, though, we did see declines and some migration from NOW accounts and certain categories of money market accounts, and we did have some attrition in the deposits at the branches we acquired.

Since the end of March, we have seen about $13.5 million of attrition in the branches we acquired from about $240 million down to just under $230 million. The breakdown of that attrition is DDA accounts decline by about $5 million, savings and NOW accounts declined by about $5 million, and time deposits declined by about $3.5 million. This attrition is pretty much in-line with what our expectations were and we did see the balances stabilize between May and June with actually June deposits at the end of June being slightly higher than the deposit balances from the acquired branches at the end of May. In addition, the decline in number of accounts was significantly less than the decline, the percentage decline in the dollars. Going back to the balance sheet, because of the decline in total assets, our tangible capital ratio, excluding accumulated other comprehensive income, increased slightly to 5.03% at June 30 of '07 from 5.01% at March 31 of '07 despite a break even quarter and paying a $0.21 per share dividend.

We are committed to remaining well capitalized and protecting our dividend. If necessary, we'll be exploring opportunities to further deleverage our balance sheet in a manner that does not have a significant adverse impact on net interest income. Over the past few quarters, we have not met the level of earnings we expected based on our guidance. This guidance indicated the level of the provision for loan losses that we expected and the challenges in trying to forecast the provision. As we look at the last half of 2007, we believe that the results in the second quarter for net interest income and non-interest income as well as non-interest expense at a recurring level of $27 million to $28 million once the bank chatter consolidation is complete are reasonably indicative of our near-term expectations. We would also hope that the provision for loan losses that we recorded in the second quarter represents the very high point in that the future range is lower, but as mentioned, credit costs have been very difficult to predict because of both changing valuation metrics as well as loans quickly becoming nonperforming. This concludes my remarks and I would now like to turn the call over to Stefanie Kimball.

Thank you, Rob. Good afternoon, everyone. Please turn your attention to slide 20 in our presentation. And I will commence a discussion of credit quality. As Mike outlined, credit quality continues to be our top priority. The commercial loan portfolio at the end of June, the outstandings were flat at $1,000,080,000. Our loan growth this year has been equivalent to our planned runoff. Turning to page 21, and as illustrated on this slide, the level of internal watch credits continued to increase in the second quarter, reaching $160 million. These loans require extra attention and include the non-accruals that Rob mentioned, the substandard and other internal watch credits. Early identification of clients who might have difficulty making loan payments enables the bank to work with these borrowers to find solutions before default occurs. Therefore, the bank has several categories of watch credits that do proceed the non-accrual and substandard numbers that you would see as industry standards. In this bar graph represents all of those categories aggregated together.

Turning to the next page, page 21, as Mike mentioned earlier, clients impacted by the downturn in residential real estate have been particularly challenged. This graph illustrates the segments of the commercial real estate portfolio that have contributed disproportionately to the level of our watch credits. The vacant land, land development, and construction loans contributed to the watch category at a rate that's more than double their percentage of the portfolio and you can see from the slide that the vacant land category in particular only comprises 2.9% of our portfolio. However, it accounts for just over 13% of our watch loans. In particular, these segments that are highlighted of commercial real estate that are non-income producing have really struggled during this downturn, as investors have been challenged to provide cash flow from alternative sources for project time frames that have significantly exceeded original projections and plans due to the abrupt slowdown that has been experienced here in residential sales. And that has dramatically increased the cost of carry for these projects.

Turning now to page 23, I'd like to share my observations as to the key factors that have contributed to the current credit environment at Independent Bank. And the first factor, we have already discussed, which is the Michigan economic environment and the significant challenges in particularly with residential real estate. But this has been coupled with a number of other factors that I will highlight. A rapid growth in the commercial lending portfolio has occurred to include our acquisition of Midwest Guarantee Bank. This combined with our concentration in commercial real estate that developed as the bank grew and was comfortable with those types of loans, and also adding to the environment is an increase in loans to a select number of larger, more complex borrowers. All these factors have created an environment that resulted in the current elevated level of watch credit.

So I would now like to turn your attention to the things that are underway in terms of credit process changes on page 24. As Mike talked about earlier, our chatter consolidation is taking place and I believe this creates the perfect opportunity coupled with our credit quality challenges to establish a platform for change and continuous improvement. Page 24 outlines several key credit process changes that are underway. These include strategic initiatives to provide diversification, to balance the concentration in commercial real estate that we have, and a number of enhancements to our credit processes. In order to facilitate these strategic initiatives and the new credit processes, a new organizational structure is in the process of being put in place. Some of the key components of this structure are highlighted on page 25. Our new structure is designed to enable both business development and the repositioning of the portfolio as well as move forward with our credit quality initiative. With that, I will now turn it over to Mike Magee for our summary comments and questions. Mike.

Thank you, Rob and Stefanie. At this point, we would like to open the call up to any questions that you may have.

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

Good afternoon.

Hi, Terry.

Just a quick question. Looking at the internal watch credits on slide -- one of the slides in the presentation, we started to see it really go up in the fourth quarter of last year and that trend definitely continued right through to the second quarter. I'm wondering why, when you internally saw the directional move in watch credits, why you continued to be somewhat conservative on your guidance for the provision, which unfortunately proved to be wrong. Was there something else that gave you comfort in telling investment community that the provision was going to be much lower than it actually turned out to be.

Well, Terry, I think it's -- there's probably two primary pieces to that and I think we did say, although we talked about a range of $4 million to $5 million, I think we certainly indicated that it was extremely difficult to project and that $4 million to $5 million assumed probably a couple of potential problems of more than just an insignificant size in the commercial loan portfolio, but I think the two things that have occurred is one, the velocity at which credits have moved or migrated is been a lot quicker than what we would have indicated. If you go back to our fourth quarter call, we had talked about that we had looked in the fourth quarter call would have occurred in January of this year. We had looked at the portfolio that constitutes land, land development, and construction, which at that time was somewhere in the $200 million to $220 million. And although all of the credits we said exhibited some form of stress, we didn't expect to see the type of velocity of movement from that portfolio into higher levels of watch credit. And that may have been naive on our part, certainly we didn't expect to see that-that not been our historical experience. Our historical experience would have been more gradual movements through the portfolio and not the type of rapid changes that we've seen.

The other piece has been the severity of loss has been very significantly greater than what we anticipated and two factors are driving that in what we're seeing in valuations. One is the projected marketing periods on these projects have lengthened, not just a little, but just a huge amount and these projects are typically being valued based on a discounted cash flow model, so when you're significantly expanding the marketing time, that's driving down valuations quite a bit. So that's occurred and then we've seen an increase in the present value factor used to discount those cash flows. So the combination of those two items has really adversely impacted valuations. So those would be probably the two areas that we just didn't, I guess, understand or anticipate how significant an impact it would have on our provisioning. Stefanie, I don't know if you want to add to that.

Yea, Terry, the other thing I would add and highlight with Rob's comments about the loss given a default is that we have seen appraisals coming in significantly less than they would have been the year before or certainly two years. And I think one of the most challenging jobs in our market is going to be being a real estate appraiser in the state of Michigan. Because we are seeing some discounts, fire sales, if you will, of real estate, which then have to be factored in with the normal sales in the market and those plus the things that Rob highlighted with the longer marketing time have all resulted in a significantly lower level for certain types of collateral than we would have anticipated, even in the fourth quarter.

Could you maybe provide an example of a specific project and the degree in which appraisal values have come down, let's say over a one-year time period?

Yes, I could give you one. This is -- I don't want to get into real specific, but one example would be a condo project in Lansing where the original metrics would have been something in the range of, at the time when the loan was originated, a 90% loan to cost and somewhere in the range of around 70% to 75% loan to value. And so that was the original basis under which the loan was underwritten and I think the original time frame on that particular project for marketing time was 18 months and the original discount rate was about 12%. The revised valuation had a marking time frame of eight years and this is, I think, a 48-unit project. So you could debate whether the eight years is reasonable, but that's what an MAI appraiser was saying and the revised present value factor was 18%. And you can imagine when you're extending it out, that collapsed the value -- the valuation of that collateral just varied dramatically. That may be sort of a very severe example, but that's what we're seeing in some of these real estate development projects.

Terry, to add a little color regarding the appraisers, I had a conversation with an appraiser a couple weeks ago who basically told me, right now, he's being sued for appraised values he gave financial institutions a couple years ago. And now that the banks are getting these properties back or new appraisals and the new appraisals are coming in substantially less and with the increase of litigation against appraisers, there's no incentive right now for an appraiser to give the bank anything but an extremely conservative appraisal.

That's very helpful, as was the presentation you provided for all of us. Thank you.

Our next question comes from Steven Wieczynski with Stifel Nicolaus. Please proceed with your question.

Yes, good afternoon. Call you give us a quick update on the Mepco business, the warranty business, and kind of what you're expecting going forward, what you saw this quarter, and if it was pretty close to expectations, and margins are about where you are expecting them to be?

Sure. A, Mepco had some good growth this quarter. They were up from -- and this is net of discount, the gross balances are a fair amount higher, but they were up from the end of the first quarter, they were a little bit under $190 million and they were up to $200 million. So you had link quarter growth of about 5.3% or annualized growth of about 20%. So we're seeing that business perform well. Mepco, from a profitability standpoint had after-tax earnings of, I think, just above $1 million for the quarter or right around $1 million, which is return on assets getting close to 2% on an annualized basis and a good return on tangible equity, so that -- and we've seen the margins continue to improve in their business as well.

Part of it is short-term interest rates, which they're sensitive too and have been relatively stable and we've had decent growth in the portfolio, so that business has gone well. Looking ahead, we continue to expect reasonably good growth in their payment plans that they're administering and we expect the margin in that business to hold up well. We seem to be gaining good traction with just being able to focus on just that one piece of business and not have the distraction of trying to run the insurance premium finance business as well.

And last question, the share repurchase program, where you are with that and what we can expect going forward?

Well, as I said in my comments, the level of our tangible capital is still at the low end of the range that we try to manage it between. We try to stay between 5.5% and 6.5% with 5% kind of being the low end of it. As I mentioned in my comments, even with no earnings this quarter and paying a $0.21 or about 4 -- that's a little over $4.5 million in dividend, the tangible capital ratio bumped up a couple basis points because we shrank in assets. First and foremost, we want to protect our cash dividend. Secondly, we absolutely are going to remain well capitalized. Third, we want to build the capital back up into that 5.5% to 6.5% range.

Hopefully we can do that quicker with some better quarterly results over the next two quarters, as well as looking at opportunities to deleverage the balance sheet. One thing with the flat yield curve, there are some opportunities to deleverage in the securities portfolio and pay down brokered CDs. That really doesn't have much of an adverse impact on the margins, so we're going the look at those opportunities, but share repurchase, even though we're authorized up to 750,000 shares, that comes at the end of the line of those other two things, although we certainly view the opportunity at where we're priced at would be great if we can get there and hopefully it will be sooner rather than later.

Okay, thank you.

Our next question comes from John Rowan with Sidoti and Company.

Good afternoon.

Hey, John.

A couple of questions to kind of follow-up on the last one. First, what is your total risk-based capital ratio at the end of the quarter?

I -- we haven't filed all of our call reports, so I don't -- I don't have an exact figure. My guess is it's going to be somewhere in the 1015 to 1035 range.

Obviously, you're fairly close to the 10% range. Looking ahead, what level of charge-offs do you think you need to report in the second half of the year in order to pay your dividend and remain well capitalized and that's outside of deleveraging the balance sheet? How do you see the going forward in the second half of the year?

Well, to earn the dividend, we have to earn $0.21 diluted shares. So if you just do the math-- I mean, we have to earn $0.21. So let's use 22.8 million shares, that's earnings of about $4.7 million after-tax, so if you take that pretax, that's pretax earnings of about $7.3 million. And so you have to reasonably get the provision down in about -- I mean, the first quarter we came close to earning the dividend. If you get the provision down into that $7 million area, which would absorb a fair amount of charge-offs, you're going to be at -- you're going to be at a position where you're earning the dividend. Actually, this quarter, total charge-offs were about $7.4 million. So the provision was quite a bit higher then net charge-offs. If we had just had a provision equal to net charge-offs for the quarter, we would have been probably a little bit ahead of earning our dividend. What pushed up the provision in excess of net charge-offs is the way our model works. There's components of it like our historical allocations that take into account our current level of net charge-offs and use that as sort of a predictor of what might occur in the portfolio and pushes up those historical allocations.

In addition to that, we had migration of credits. You saw the increase in the number of watched credits, so that migration of credits would have pushed up predominantly two areas. One could have been specific reserves. In addition to that, it would have pushed up the portion of the allowance that relate to classified or adversely-rated loans. So those two factors went up. And then even the subjective went up. The subjective component really is really triggered off various economic metrics that are both Michigan-based and national. So we'd have to be down into that $8 million range, I think, to earn the dividend, but I don't think that's an unreasonable expectation. We're trying to avoid trying to predict precisely a provision for loan losses so the questions Terry McEvoy rightfully asks, we're saying it's a difficult thing to predict, but I don't think a $7 million to $8 million level is certainly unreasonable in terms of saying that's overly optimistic.

One last question. Maybe for Stefanie, do you have updated appraisals for all the [ inaudible ]?

No, not necessarily. In some instances, you're not in a position to always get an updated appraisal. It depends on the nature of the property and the nature of what you're doing from a collections standpoint. If we don't have an updated appraisal, we are looking at the assumptions used in the original appraisal and discounting it based on what we're seeing for similar current valuations. Stefanie, I don't know if if you want to --

The other thing I would add, certainly as you get in that workout stage where you're getting ready to foreclose and having to bid on property, you have to get a current appraisal, so we tried to manage that and tying getting appraisals as loans move into the workout in the watch stage and as you get close in that foreclosure category. As Rob said, we would then also update valuations based upon current metrics we're seeing in similar appraisals.

I think it's important to add, too, that we made part of our provision last quarter, we set aside some reserves, some substantial reserves on current loans. These loans aren't even passed due. They're loans of concern, we're watching them, we feel our collateral is underwater, but we set up reserves for loans that are current and it is our intention, hopefully some day, we will through the workout process, which, Stefanie, if you will won't you talk about, the special asset group that you formed, but how we're going to go after getting some of this provision back for these reserves that we're currently making and how we intend to get those -- want to get those back in the future.

Okay, yes I would be happy to, Mike. In terms of the special assets group, one of the things that our consolidation has afforded us is the ability to look across all four of the banks and markets and look for some economies of scale and one of those the handling of workout credits. Instead of having people at each of the banks handle those, we have formed a special asset groups, which is operating on behalf of all of the banks and that area is managing, certainly, the non-accrual credits as they move to that stage and some of the loans that are before the non-accrual. We have plans to expand that group so that they can handle more of watch credits and also serve in an advisory capacity for all of our lenders for the entire watch universe. But this increased focus has been coupled with some excellent support from a number of the law firms that we work with so that we can vigorously pursue collecting our loans and realizing the value of the collateral that we have and looking to personal guarantees. All of those things are going to be pursued with the special assets team.

Okay, thank you.

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

Hey, good afternoon.

Hi, Brad.

Good afternoon.

Just a couple questions on credit. Just kind of curious as to in your mind, I know every loan probably has its own story, but and you talked a little bit about your workout group, but what in your mind has to happen or what couple things have to play out for the situation to begin to improve in terms of real estate picking up, etc., just kind of what is sort of your best case scenario in terms of what has to happen in order for you guys to see some improvement on the non-accrual loan side?

Well, I'll start, first of all, with what we need to see in the market. We have continuing -- we have continuously seen declining real estate values. So one of the things that we're certainly going to be watching for is some stabilization of real estate values. So for non-accruals, where we're in the process of foreclosure and then taking back property, we go to market that property, having market that is a little bit more stable is one of the things that will be the sign of recovery for us as a state. So that's one of the things that we're going to be looking to do. Also, by trying to aggressively -- more aggressively work these loans, we're able to move them along through that life cycle more quickly. When you foreclose on real estate in the state of Michigan, you often have a one-year redemption period, and so that has loans sitting in that category for some time. So that will be -- to the extent we can move things along more quickly by getting cooperation from the borrowers, that will be another strategy that we use to manage the level of non-- of non-accrual loans.

Another thing will be also looking at some -- we did do two loan sales this quarter. So that would be another tool that we can use to manage that part of our balance sheet. One of the good news pieces of information, as we study the portfolio, and I've had a chance to do a lot of that, being new to the organization is we've done a lot of segmenting as we outlined in the pie chart of the non-accrual and the watch credits and some of the good news is we really have gone through and classified as watch most of the vacant land loans. We only have a handful that aren't in the watch category. So that's another thing that will slow the, obviously, the inflow of that particular type of loan into a watch and then workout category.

Of the watch list loans, and you can just ballpark the number, but what would you say in terms of personal guarantees, maybe the watch list and the non-accrual loans that you can possibly look for as another source of repayment, if it takes an extended amount of time for the collateral values to recover?

I would say most of our loans in general and certainly those in the watch category do have personal guarantees. What has been particularly challenging is those guarantors a couple years ago were very strong, lots of liquidity, and substantial investments in real estate because they're people that specialize in that business. Given what's happened to their investment portfolios, a lot of their liquidity has dried up and the value certainly of their investments have dried up. So one of the challenges is collecting on that guarantee and also determining what is is best timing for that, is it something that you want to collect on right away or something that you would want to look at collecting a little bit more down the road when perhaps real estate prices have stabilized. But I would say most of the loans do involve a guarantee, and that is certainly a key part of our analysis and collection effort.

Okay. Stefanie, final question. Obviously, good credit people are always in high demand and will probably even be more so over the next couple of years. Just kind of curious, as you sort of weighted your options as to where you were going to set up shop at your next bank. Obviously, you probably took a hard look at IBCP and some of the credit issues that they were having. Can you give us some more color on what attracted you to the bank and beyond that, maybe why their credit issues seemed, I won't see easier to work out, but obviously you saw some upside in terms of what they were dealing with maybe versus some other opportunities, or am I stretching a little bit too far? I would like to hear some of that background.

Okay, sure thing. Well, in terms of my decision to come to Independent Bank, I felt it was just an excellent opportunity with the consolidation and putting together all the banks from a commercial lending perspective and also putting in place like credit processes consistent across the organization and it's the kind of management and leadership challenge that I have enjoyed in previous positions. So it was an exciting opportunity to attract me to the organization. Certainly, I have witnessed a lot of credit cycles over the years, whether it be on the consumer side with personal bankruptcies skyrocketing or other kinds of stress with automotive-related portfolios and so forth and certainly see that the credit cycle that we're in here is another manageable challenge that those of us that have lived in the state of Michigan our whole lives see come and go. So I certainly see this economic environment as very similar to some of the things that we've seen and been managing through on the automotive side and in other challenges.

Okay. Final question, where does kind of rank in your experience in terms of economic cycles for Michigan, etc.? Thank you very much.

Okay. In terms of the economic cycles here, I think one of the things that is different about this downturn, as we've talked about, is the particular strap that has been placed on the residential real estate market in general, and I think that is a sector that has been particularly challenged and perhaps the whole rest of the economy is not suffering as much. So I think that's one of the things that I would say that is a little bit different about this economic downturn than some of the things that we've seen, at least in recent history. I don't know if Mike or Rob have anything to add to that in.

On the real estate side, it was interesting at our meeting yesterday in Detroit, the housing market -- we're talking more nationally than Michigan at the time, but it seems like it makes a lot of sense how deep cut its been in the housing market. We have several states around the country that are currently experiencing downturns in real estate values. It seems to be more psychological driven as far how fast and how deep its gone than it has been rate driven or unemployment when you look across the United States. I would say to a certain point that's even true in Michigan.

I guess what the consensus was is that they're expecting a little bit of a faster rebound than you've experienced historically in real estate values, only because there's a lot of people right now sitting on the sidelines, who are just saying, I'm not going to jump in until I know it's hit bottom. As long as we continue to try to sell repossessed assets and you have developers reducing their price, at some point we're our own worst enemy because we keep reducing the prices. At some point, when we stop reducing the price on what we'll see property for and the real estate developers,I think you're going to see it rebound as quickly, or at least that was the consensus yesterday at the meeting. But time will tell.

I think that exactly hits it in terms of what I'll just call the emotional factor of the price of real estate, when everybody is sitting on the sidelines, everybody is afraid because they don't want somebody else to get the best deal and they're afraid to jump in and that emotional piece has really stalled a lot of sales.

Our next question comes from Jason Werner with Howe Barnes Hoefer & Arnett, Inc.

Good afternoons, guys.

Hi, Jason.

Good afternoon.

Most of my questions have been answered, but I had one other one. I think you announced, Mike, that you shut down First Home Mortgage --

First Home Financial.

I'm sorry, First Home Financial. That was at the end of the second quarter.

Yes. It was actually dissolved on June 30.

What kind of impact did that have to results in the quarter, if any?

Well, we had -- they, I think for the quarter -- We had about $85,000 in severance costs and they probably lost during the quarter another $60,000 or so. We have pared down that operation over a long period of time. When we started the year, they had about 11 employees. We probably pared that down by half during the first quarter still trying to see if we could find some level of sales activity in that industry that they could make a go of it, but as we moved into the second quarter, we just -- it just continued to be stress, so the decision was made to close up the -- close it up. As you know, we had written off the remaining goodwill in the first quarter, so we shut it down. So it wasn't a big -- maybe $150,000 negative pretax between severance -- maybe it's a little higher, because that $50,000 to $60,000 loss was after-tax, but not anymore than $200,000 pretax adverse impact for the quarter. So it wasn't real material, but I think it's just one less distraction that's now behind us.

And kind of going forward then, on the fee income side, that line item will be gone, completely in.

Well, if you look at our 8-K, it was in the supplemental data. We took it out of the face of the income statement because it had become pretty immaterial. It was for the quarter $115,000. We'll probably still have a little bit because there's some residual, maybe a little bit of residual income that we'll get in, but that will fade down to about nothing, but the costs on the other side will go down as well. So net-net, it's going to have a positive impact. Okay.

Then, Rob, could you repeat -- I think you had mentioned in your comments a level of debt approximate costs that were nonrecurring associated with the branch purchase.

Yes. In the second quarter, we had one-time data processing costs of about $127,000. So in that $1.9 million, you can take out $127,000. The first quarter had a one-time $95,000 credit. So we still expect data processing costs compared to the first quarter to be up about $200,000 a quarter or so. And that's a combination of the new branches we added and in addition to that, we brought online a new online teller system and platform teller system, and so that bumped our costs up a bit. So the combination of those two, we still expect to see data processing costs roughly at a couple hundred thousand higher than where we were, say, in the first quarter normalized. Which would have been about $95,000 higher than that first quarter figure.

Okay. That's all I had. Thank you.

There are no further questions. I would now lie to turn the floor back over to Mr. Magee for closing comments.

Thank you. On behalf of Rob, Stefanie, and myself, I would like to thank you for participating in this afternoon's conference call. And again we're available to answer questions at any time if you have them. Thank you very much. Good-bye.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.