Independent Bank Corp (Michigan) (IBCP) 2008 Q1 法說會逐字稿

Hello, and welcome to the Independent Bank Corporation Q1 2008 earnings conference call. All participants will be in listen-only mode. There will be an opportunity for you to ask questions at the end of the today's presentation. (OPERATOR INSTRUCTIONS) Please note that the conference is being recorded.

Now I would like to turn the conference over to Michael Magee.

Thank you. Good afternoon. Welcome to our first quarter 2008 earnings conference call. I am Michael Magee, President and CEO of Independent Bank. Joining me on the call today are Robert Shuster, our Chief Financial Officer, and Stefanie Kimball, our Chief Lending Officer.

Following my introductory comments, Rob will provide a detailed review of our financial performance for the first quarter. Following Rob's comments, Stefanie will provide a progress report on our lending initiatives and risk management. We will conclude with a brief question and answer session, also please note that an accompanying PowerPoint presentation will be referenced throughout today's call. To access the presentation, please go to the Investor Relations section of our website at www.IBCP.com.

Please also note that this presentation may contain forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995. Please refer to our Safe Harbor Provision on slide 3 of the presentation for additional information on forward-looking statements.

I will begin today's discussion with a review of our first quarter financial results, which are summarized on slide 4 of the accompanying slide presentation. For the first quarter ended March 31, 2008, we reported income from continuing operations of $341,000, or $0.01per fully diluted share, compared to 3.9 million, or $0.17 per fully diluted share in the Q1 of 2007.

The year-over-year decline in the operating profitability is primarily attributed to a 3.2 million increase in provision for loan losses, and higher loan and collection expenses, as a result of several commercial real estate loans, moving from the watch list to nonperforming status during the quarter. These delinquencies are primarily the result of real estate developers experiencing cash flow difficulties, as they confront a significant decline in real estate values throughout various regions in Michigan.

While we are disappointed in the increase of nonperforming loans, it is important to know that these credits had already been identified as potential concerns when they were originally placed on the credit watch list. Throughout the course of the last year, we have on several occasions discussed our initiatives to improve our credit quality.

Under the guidance of our Chief Lending Officer, Stefanie Kimball, we have worked diligently to more accurately assess our loan portfolio, and enhance our underwriting policies going forward. While the actions taken will be effective in helping us avoid the situation in the future, Michigan's current economic conditions continue to create challenges for us. Particularly within the residential housing and commercial property markets, where real estate values and end market demand remain sluggish.

For a high level overview of the quarter please turn next to slides 5 and 6 of the presentation. Despite the increases in nonperforming loans and the credit cost associated with managing them throughout the course of last year, and the most recent quarter, we have remained profitable. Additionally our first quarter net interest margin increased on both the year-over-year basis and on a sequential quarterly basis, due primarily to our ability to reduce our funding cost at a faster pace than the decline in our yield in interest earning assets, resulting from the Federal Reserve Bank's aggressive action to cut short-term interest rates.

Another positive take away from the quarter is the growth in some of the categories of non-interest income. More specifically growth in deposit-related revenues on a year-over-year basis, and title insurance fees.

Looking ahead I remain encouraged by a number of strategic and operational initiatives that our team has implemented, that enable us to remain focused on measurable results, and assist us in remaining the community bank of choice in Michigan. These initiatives will guide us to continue to grow deposits, improve asset quality, and improve operating efficiencies through our disciplined cost containment. We are clearly not out of the woods yet, in terms of regional, economic challenges.

However I believe that we have better visibility in to the nonperforming assets in our portfolio, and are actively managing and monitoring credit quality. While our problem loans are clearly on our watch list, we are focused on managing what we can control. Mainly future loans and a more comprehensive credit review process, as well as branding and marketing to insure we increase our market share in this down cycle, and are hitting our stride when the market rebounds.

With that, I will now turn the call to our Chief Financial Officer, Robert Shuster, for a review of our financial performance during first period.

Thank you Mike. Good morning everyone. I am starting at page 9 of our PowerPoint presentation. 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 making a few comments about our current cash dividend.

As outlined on page 10, there were several unusual items impacting first quarter 2008 results. Our fair value election on preferred stocks, an incurment charge on capitalized mortgage loan servicing rights, the reversal of previously accrued and uncollected interest on loans placed on non-accrual, severance costs, and an elevated loan loss provision all negatively impacted the quarter.

Conversely, the VISA IPO, fair value election on loans held for sale, FAS 109 implementation for commitments to originate mortgage loans, and the release of a previously established income tax reserve, favorably impacted the quarter. We outline our implementation of FAS 59 and FAS 109 in greater detail on page 11.

Affective January 1, 2008, we elected fair value accounting for several preferred stocks that we owned. These preferred stocks were purchased long before the disclosure of any of the sub-prime mortgage problems that have impacted some of these issuers. The market values of these preferred stocks have declined sharply, due in large part to the general aversion to risk and liquidity challenges in the current market place.

Because these are perpetual securities, assessing these preferred stock for other than temporary impairment is very difficult, because there is no maturity date, and thus forecasting when the market value might recover is difficult. Further, OTI accounting is one-way. Once you write down a security for other than temporary impairment, you establish a new carrying value, or cost basis for accounting purposes, and cannot subsequently recover the impairment unless you sell the security.

As a result, we elected fair value accounting for these securities, and recorded a $2.2 million charge during the first quarter of 2008, which represents the change in market value between the beginning and end of the first quarter. Each quarter we will record the changes in fair value of these securities, as a component of non-interest income. Since the end of the first quarter, through about the middle of April the market value of these preferred stocks have increased by about $690,000.

We also elected fair value accounting for loans held for sale. Previously loans held for sale were accounted for at the lower of cost or market. The fair value accounting now aligns with the accounting for the related commitments to sell these loans. Additionally we implemented FAS 109, which resulted in recording the fair value of commitments to originate mortgage loans. Collectively these items added approximately $821,000 to gains on mortgage loan sales.

If you move to pages 12 and 13, tax equivalent net interest income totaled $31.8 million in the first quarter of 2008, which was up $576,000, or 1.8% on a comparative quarterly basis, and was up $264,000 on a linked-quarter basis. Average interest earning assets were down slightly, on both a comparative quarterly basis, and linked-quarter basis. On a linked-quarter basis average loan balances were flat, and average investment security balances were down a bit. This decline in average interest earning assets, partially offset the increase in our net interest margin.

As you can see on page 12, our net interest margin was 4.3% in the first quarter of '08, up 7 basis points year-over-year, and up 8 basis points on a linked-quarter basis. In the Q1 of 2008, non-accrual loans averaged $83 million, compared to $69.5 million in Q4 of ,07, and $39.5 million in Q1 of '07. We reversed $800,000 of accrued and unpaid interest on loans placed on non-accrual in Q1 of '08, compared to $300,000 during both Q4 of '07 and the Q1 of '07.

Our elevated level of non-accrual loans of approximately $95 million at quarter end, creates a drag of about 24 basis points on the net interest margin. Our ability to bring our cost of funds down at a pace equal to or faster than the decline in our yield on interest-earning assets has allowed us to improve our net interest margin.

Page 14 provides information on the sharp decline in our level of brokered CD's. Because we issued a lot of callable brokered CD's, we have been able to exercise our call rights and pay off the higher-costing brokered CD's, with lower cost borrowings from the Federal Home Loan Bank and the Federal Reserve Bank.

Moving on to some of the more significant categories of non-interest income, on page 15 of our presentation, service charges on deposit accounts increased by $759,000, or 15.5% on a comparative quarterly basis, and declined by $771,000, or 12% on a linked-quarter basis. VISA check card interchange income, was up 44.3% on a comparative quarterly basis, and was relatively flat on a linked-quarter basis. These large year-over-year increases, primarily reflect the acquisition of branches that we completed on March 23rd, 2007.

With respect to the linked-quarter decline in service charges on deposits, we have historically seen approximately a 7% decline from the Q4 to the Q1, due to seasonal variations, and the pattern of certain fees. However the 12% linked quarter decline experienced in Q1 of '08, does seem to point to some belt tightening by consumers, in avoiding certain fees such as NSF charges.

Gains on the sale of mortgage loans totaled $1.9 million in the first quarter of '08 on $84.4 million of loan sales. These gains were up on both a year-over-year and linked-quarter basis, due to the $821,000 adjustment I mentioned earlier, related to FAS 159 and FASB 109. Our volume of mortgage loan origination in the first quarter of '08 was $118.2 million, which is up slightly on a year-over-year basis. We experienced an increase in refinance volume in the first quarter of '08, due to lower mortgage rates, however this was largely offset by lower purchased money mortgage volume, as home sales levels declined in the majority of our markets.

Real estate mortgage loan servicing income declined, on both a comparative and linked-quarter basis. We recorded an impairment charge of $725,000 on capitalized mortgage loan servicing rights in Q1. The decline in mortgage loan interest rates, resulted in using higher prepayment speed, in the valuation of the capitalized mortgage loan servicing rights.

Moving on to page 16 of our presentation. Non-interest expenses totaled $30.3 million in the first quarter of '08, compared to $28 million in the first quarter of '07, and $29.6 million in the linked quarter. Several categories of expenses such as occupancy, data processing, communications, and the amortization of tangible assets were up year-over-year, due to the acquisition of branches, loan and collection expenses are substantially higher, due to the elevated level of nonperforming assets. Finally FDIC insurance expense increased significantly in the Q1 of '08, because of higher rates, and our full use of assessment credits in Q4 of '07.

As evidenced on page 17 of our presentation, the assessment of the allowance for loan losses, resulted in a provision for loan losses of $11.3 million in the Q1 of '08. This level is higher than the previous two quarters, and remains at a very high level of about 178 basis points of loans on an annualized basis. Non-performing loans, page 18, increased to $102.2 million, or 4.03% of total portfolio loans at March 31 '08.

The rise of nonperforming loans during the first quarter was primarily concentrated in the commercial loan portfolio. About 70% of the commercial loan increase, is due to certain land, land development, or construction and development loans, becoming non-performing. Stefanie will provide more information on our commercial loan portfolio during her comments. Further, the Form 8-K that we filed yesterday includes a table, that provides a breakdown of our commercial loan portfolio by loan category, and information on both performing and non-performing watch credits.

Page 19 of our presentation, provides information on the components of our allowance for loan losses, which rose to $49.9 million, or 1.97% of total loans. Excluding Mepco's financed receivables, and the portion of the allowance that relates to these receivables, the ratio of the remaining allowance goes up to 2.15% of loans. One statistic that gets a lot of attention is the ratio of the allowance for loan losses to non-performing loans, which for us was at 49% as of March 31, 2008.

In reviewing this statistic, it is important to note that nearly $50 million of our non-performing loans, have very little allowance associated with them, because they have already been charged down to the expected net realizable value, including considering estimated holding and liquidation costs. Thus the ratio of the remaining allowance to the remaining level of non-performing loans, would rise to about 100% in this scenario. Net loan charge-offs totaled $6.8 million in the first quarter of '08, or 1.07% of average portfolio loans.

Page 20 of our presentation breaks down the net charge-offs by loan type. Although down a bit in the first quarter, the elevated level of charge-offs in the mortgage and consumer loan portfolios, principally reflect lower residential real estate values. As I have outlined in previous conference calls, when we assess commercial loans for impairment we consider four factors, the amount of cash flows indicated from the current collateral values, the timing of those cash flows, the discount rate at which the cash flows should be present valued, and the liquidation and holding costs. In particular for real estate-related collateral, we continue to see new appraisals, with low expected sales prices, extended sales timeframes, and higher discount rates, to present value the cash flows due to risk.

Page 21 of our presentation has some historical balance sheet data. The $253 million decline in total deposits in the first quarter of '08, is entirely due to the reduction in brokered CD's, that I outlined earlier in my remarks. The total of our checking, savings, and money market accounts, or core deposits, increased by $14.4 million during the first quarter.

Our holding company tangible capital ratio increased slightly to 4.97%, at March 31, '08 from 4.96% at year end '07. A small decline in total assets was the primary factor leading to the increase in the tangible capital ratio. At the bank level, the tangible capital ratio was at 7.46% at March 31 of '08.

We remain well capitalized at March 31, '08. Our banks Tier 1 and total risk-based capital ratios were 7.40% and 10.62% at March 31, '08 respectively, compared to 7.35% and 10.5% at year end '07. Thus both ratios moved up during the first quarter.

As previously announced, and as outlined on page 22 of our presentation, we reduced our April 30th, '08 cash dividend to $0.11 per share, or about $2.5 million per quarter. Our after-tax interest cost on trust preferred securities outstanding is about $1.1 million per quarter. Thus the total current quarterly parent company cash requirement is approximately $3.6 million per quarter, which equates to about $0.16 per share of net income. Parent company liquidity was at $12.5 million as of March 31, '08.

We do not anticipate any need to downstream capital to the bank, and in fact, will be paying a $1.8 million cash dividend, from our bank to the parent company on April 29 of '08. Our Board of Directors will establish our July 31, 2008 cash dividend in late June, after considering our earnings in the first two months of the second quarter, our parent company tangible capital level, our liquidity, and our updated outlook for credit costs.

I stated in our last conference call, when discussing the outlook for the cash dividend, that earnings must be expected to exceed our dividend, and our tangible capital ratio must rise. Obviously we did not meet the first of these two objectives in our most recent quarter. We are committed to the concept of maintaining our current cash dividend level. However, we believe that the preservation of capital through a reduced dividend is much preferable, and in the long-term best interests of our shareholders, when compared to a highly dilutive new equity offering.

This concludes my remarks, I would now like to turn the call over to Stefanie Kimball.

Thanks Rob. As I make my comments regarding credit quality, I will be referencing the handout starting on page 24, starting with the commercial lending business. As a brief overview there are several encouraging signs, as we look at the details behind our first quarter results. The first is that the speed of the inflow, and the growth in the level of the watch credits has slowed. Secondly, as Mike noted, the new loans that we are adding to the portfolio are of a higher quality, and they are also related to our strategy to develop relationship-focused new clients, which will be in the best long-term profitability interest of the bank.

Third, we have recently rolled out a new risk base and relationship-focused pricing model, which is helping us redirect our commercial lending team to our target customer base. Like the rest of the industry, we continue to be faced with challenges, which include rising delinquency and non-accrual rates, charge-offs and collection expenses that are elevated, as Rob highlighted. Both of these have required significant investments in our time and our resources, to address each client's individual situation.

With that as a backdrop, I will now turn to some of the details of the commercial loan portfolio starting with page 25. Overall commercial loan outstandings have declined slightly, as we have been replacing our run-off, but also looking as well at some strategic exits. For example, During Q1 we did choose not to match the extended credit terms offered to one of our clients, for a $10 million real estate loan which we did not consider to be prudent. That customer paid us off, which accounted for most of the decline in the outstandings during the quarter.

As we turn to page 26, you can look at the segments that have been highlighted in the past. We do take comfort in the fact that the relative size of the land and land development segments of our portfolio is small in comparison to the whole. Further we have refocused the commercial lending team to pursue new loan volumes in the C&I and owner-occupied segments, while looking to decrease the land and land development. New loan volumes that we are pursuing is with relationship credits in these areas, which we believe position us well for future growth.

Turning to page 27, our credit watch process continues to be an effective way to manage our higher risk clients. In Q1, we conducted our fourth series of quarterly review meetings in each of our markets. Overall the watch credits increased by 5%, which is significantly less than the 15% average pace that we have seen in the last three quarters. Our internal watch grade is down actually 6%, and the substandard credits are down 8%.

With both of those declines as we saw credits migrate into the non-accrual levels, without a like amount of new credit moving in. We also do see an improvement of a few larger relationship. You can see on page 27 that the yellow and orange bars are declining, which are those two categories I mentioned.

Turning to page 28, the story behind our elevated problem loans have remained consistent. The Land and land development segment coupled with construction loans comprised 41% of our watch portfolio as illustrated. As we have highlighted in the past, these three segments of commercial real estate are particularly challenging, as they don't produce any income, which requires their investors to subsidize these projects. Given the slowdown in the market, in particular with the residential housing segment, these properties have required at least two to three years now of subsidy from owners, many of which have begun to run out of cash.

As we look at page 29, the commercial delinquency rate is shown. Delinquencies have increased during the quarter for a number of reasons. First of all, continued stress with our clients is being experienced, as you would expect. Secondly, we have seen a few clients approach the bank looking for deals or short sales, given that they have seen some of that in the market from some other organizations.

Then thirdly, we have seen a slowness in some of the renewals, where we have begun to tighten credit terms further. Educating our clients who can pay that they must pay have taken some additional time. Further, we have been tightening these credit terms in some cases with renewals which have contributed to the rise in delinquency, as it has taken longer to work through the details. These last two items are manageable, but they have been time consuming.

As we look at the non-accruals which are outlined on page 30, you can see that they continue to increase. As we have observed in the past, our concentration of residential real estate workouts, creates a higher and longer timeframe for credits in this category. This is very different than in past recessions where you seen C&I credits enter difficulty.

Specifically with the C&I, or a business credit, you have the benefit of quicker timeframes to collect receivables, liquidate inventory, auction and sell off equipment, where with a real estate loan 100% of the loan remains in the category for the full balance of the workout, as you go through a foreclosure process, and often a 1-year redemption period, plus credits stay in the category longer than we have seen in the past. As Rob highlighted, out of our 72 million in non-performing loans, about 50 million of them have already been charged down.

Turning to page 31, our commercial charge-offs are highlighted. They were 33 basis points on a annualized basis would be 132 basis points, up slightly from the Q4, but comparable to the periods that we experienced in Q3 2007, and the overall average for 2007. Charge-offs are processed according to our regulatory guidelines at 180-days past due, or when a loss is known, that is sooner. Rob has already talked about our trends for provisions and comments.

Next I will turn your attention on page 32, to a couple of background items regarding the environment, and the economic headwinds that continue to challenge us and our clients. Key is the prolonged weakness in our Michigan economy, weakness in the Automotive industry, and the structural changes taking place in our state, help to create a slowdown in the residential real estate market, which is impacted businesses now in multiple industries.

Residential real estate properties will take some time to be absorbed in many of our communities, given the negative population and job growth trends in our state. One potential future bright spot is the fact that there are some markets where new construction is very limited, and eventually that segment of the market set that would like a brand new home, will be forced to either buy existing homes, or concentrate in those few options that are available in the market. This hopefully will start to stabilize the market for new homes in some of our communities.

Turning to page 33, as we look at managing through this difficult economic environment, we are comforted by the fact that our credit Best Practices put in place in 2007, are a good foundation for us to weather this storm. In particular our special assets team is a key component, it allows us to professionally manage the weakest of the problem loans, moving the loans to a dedicated professional does free up our commercial lenders, to work with those clients that are in the earlier stages of challenges, and the performing portfolio, without being overwhelmed by the demand and pace and sense of urgency that is required for the substandard and the non-accrual loans.

Further at times a more objective or new set of eyes is important, in looking at a problem situation, and lessens the emotional challenges that we face in dealing with the problems of our clients that have been customers for many years. Our seasoned credit officers are also managing our credit quality review process, which allows us to apply the best available thinking to the entire watch portfolio that is managed by our lenders. Further, those credit officers are grading new loans, and assisting in the monitoring of the performance of the remaining clients.

Turning to page 34, the list of credit Best Practices implemented in 2007 is provided, many of which I highlighted here today, or certainly in past discussions. The organization has embraced the best practices given the challenges we face. And a significant amount of change has been able to be accomplished in a short period of time. I will now turn my remarks to the retail portfolio starting on page 35.

There are a number of positive factors, which include the long-term benefits of our tightening of our credit underwriting criteria, which are beginning to improve the overall quality of the performing loans, also we have seen a decline in the charge-offs for Q1. On the challenge side, in these business lines we continue to see delinquency and non-accrual rates rise, and that same focus on portfolio management in collections, as I mentioned on the commercial side is appropriate.

Turning to page 36, we will begin looking at some of the detailed metrics on the retail portfolios. You can see declining retail loan balances as we saw in the commercial businesses. On page 37, you can see the delinquency rate, in particular the delinquency rate for the mortgage portfolio, which did increase in the Q1 after declining in the Q4.

Turning to page 38, again similar to the commercial portfolio the non-performing assets in the mortgage business have begun to rise, as they move in to the workout stage. Again, the foreclosure and redemption processes do keep loans in this category for some time. On page 39, a positive point is a decline in the mortgage charge-offs experienced in the Q1, which is down from the peak experienced in Q4 2007.

I will now turn the call back to Michael Magee for closing comments.

Thank you Stef. Thank you Rob. With over a century of community banking experience, and one of the oldest, most established banking brands in Michigan, we have weathered a variety of markets and business trends over the years. Although the current credit cycle remains a challenging one, we have taken the appropriate measures to enhance our portfolio and risk management functions within the bank.

We are confident that these measures and our continued commitment to the fundamentals of the community bank are trusted relationships, reputation for excellence, and local knowledge and expertise, position us for improved performance in the future. That concludes our prepared comments, at this time we will open the line for questions.

(OPERATOR INSTRUCTIONS) First question, Terry McEvoy, Oppenheimer & Co.

Good morning. Stefanie, you mentioned that the inflow of watch credits slowed, and the internal watch for substandard loans declined, could you maybe break out the commercial portfolio, and make that same statement for the vacant land development construction, as opposed to the income-producing owner-occupied and C&I, did that happen in both portfolios, or is it just maybe fixed income success on those three stressed portfolios, that is overshadowing the increase in the other three?

As Rob highlighted in his comments, there is some additional detail in our financial statement that has been provided in those portfolios, I will let Rob highlight the specific balances.

Terry, just to give you some mix, we were down a fair amount in total watch credits in the categories of land and land development, we were flat in construction and owner occupied, owner occupied was actually down a bit. Where we did see some rise was in income producing.

So that is the mix of the change, although I will say within the income producing and owner occupied, I don't think we have seen anything way out of the ordinary, in terms of sort of the some of the historical issues, I think one of the questions is the soft economy beginning to gravitate into other areas, certainly we have not seen that in the owner occupied, we have seen a bit of an increase in the income producing. But I don't think at a level that would be way out of the ordinary, from what we may have seen in other historical timeframes.

The only thing I would add in terms of the income producing and the movement in, is that was driven by one large credit that is in the process of redoing some of the properties and does have some significant tother sources of income. It is not a trend we have seen yet in the portfolio.

Rob, you mentioned $50 million of NPLs, there is no reserve--?

There is little reserved. To give you an idea, for example when we charge down a commercial credit, based on that criteria I outlined, we will leave a de minimis allowance to cover holding and liquidation costs, so as you incur those expenses during the liquidation process, you have essentially accrued for some of them, so there is very little reserve-related, or allowance related to 50 million of the total of the 102 million.

So I know that ratio gets this enormous amount of attention, and at 49%, compared to historical levels, it looks very low. But I think the key there is, and you are seeing this trend in a lot of financial institutions, we have been actively charging down credits as they cycle in.

From a statutory basis under the bank regulations we are subject to, you are required to take a statutory charge-down on real estate secured collateral at 180-days past due, we will do it before then, if it is reasonably certain that we are going to incur a loss. The level of charge-downs that you are seeing over the last four quarters is that active process of charging down credits to net realizable values.

So my synopsis would be on 50 million of the 102 million, unless we are either wrong in our estimate of the net realizable value, and our estimate takes into account current conditions, very distressed conditions, and estimated liquidation and holding costs, or unless we see a continued downturn in prices, 50 million of the 102 million really ought to not create any additional losses for us.

It is going to take sometime to liquidate it as Stefanie said, but the point is, that in my mind when looking at the ratio, you kind of carve that out. Then you are looking at 50 million of remaining non-performers against 45 to $46 million of allowance, so you are around that 100% coverage rate.

Even within that remaining portfolio, most of, or a big chunk of that is secured with collateral, and we have evaluated it, or it is in categories like rating categories where we have done relatively recent estimates of probability of default, and the loss rate given the default in computed reserves based on the updated analysis.

The other thing I would add to Rob's comments, is that the although it is relatively early in our workout stage, the credits that we have gun to see move out of the portfolio, or resolve a credit that we have taken the charge down. Our process appears to be coming in right at those levels. So we take some comfort in the methodology from that.

What are you writing, you also have some [inaudible] --?

Currently, of our one to four family residential portfolio that are 90-days past due, or on a non-accrual status, we currently have written those down to a net book value of 60% of the original appraised value. So I feel we have been aggressive and conservative in what we have written down the 1 to 4-family non-accrual properties at.

I am also very optimistic about the future. I think especially in the 1 to 4-families, Commercial seems to take a little longer to work through the litigation process. But several of the one to four family mortgages that have been on non-accrual for a while, are starting to come out of the legal process, the redemption periods, we are starting to obtain titles on those properties, and are in a position to actually start selling them.

We are holding our first auction here in a few weeks on some mortgages one to four family, as one of the strategies we will use, or initiatives to liquidate, and start moving out some of these non-performing assets. Up to this point unfortunately, we have only been adding to the non-performing asset category, and starting the litigation process. But in several cases we have been now for several months, we have been foreclosing on properties, which is getting to the point now, where redemption periods are expiring, and we can obtain title to the property, and start moving it out of the non-performing asset category.

Rob, will you continue to bring down brokered CD balances, and will that provide some further support for the margin like we saw in the first quarter?

Yes, we still expect to see that going down, probably not ,because there is only 248 million, but I think you could over the next quarter that might come down again about 50%, so about in half, because of what we project is calls on the portfolio, so that will provide support, in terms of the migration out of the higher costing brokered CD's, and into lower costing borrowings, which we are predominately doing with the Federal Home Loan Bank and the Federal Reserve Bank, because borrowing rates there are at or sub-LIBOR, where as brokered CD rates remain at elevated levels. You are looking at 3.5% for a short-term brokered CD, and moving higher as you extend out of there.

Our next question comes from Tim [Fabrizik, Veronian].

Good morning. Stefanie, I think you said that your the inflow into the watch credit has declined. I am looking at the tables I guess on page 29, that shows commercial loans 30-days plus delinquent on accrual status, and that number as gone up. I am wondering if you can reconcile those two statements? Also on the month before as you indicated you wrote them down to 60% of original appraised value, I am wondering what those write-downs represent relative to current appraised value?

First of all, I will start with page 29 in the delinquent accounts. We do see a number of those delinquent accounts, the majority of them are in the watch category. But what we have been seeing is some of the non-watch credits also, are in a delinquent status as we try to renegotiate terms. So that is really the difference between what is given in the inflow. Generally we don't find commercial delinquency to be too predictive into the watch category. It seems to be more of a lagging than a leading indicator.

With regard to the residential real estate, in our practices of writing down the 60% of the original appraisal, would be writing the properties down to the current distressed values less all of our liquidation and holding costs.

We would often discount, depending on different attributes, we could discount that current distressed value as well. We would look at it, depending on what market it might be in, or the type of property we might write that down a little bit more.

They are written down to realize the value at this point. Not likely to be any recoveries?

Well, unless there is is a recovery in the market. It is spotty. You will get a few that sell at north of where we are valuing them. We have seen, as Stefanie had indicated, we have had some liquidations of some larger commercial properties, and we have been pretty much spot on what we valued them at. We have had a few modest recoveries there, where we have done a little bit better than what we anticipated.

But in this market, given the competition of more than just a few financial institutions, probably starting to liquidate collateral, it is probably not the type of market that is going to provide for a lot of recoveries, but we have been finding that our valuations have been very accurate, relative to where we have been able to dispose of these things at.

Thank you.

Our next question comes from David Scharf, FTN Midwest Research.

Thank you for taking my call. I wanted to go over the exhibit that you put in the press release. Talk about the total commercial loans. If we could talk about 1) are there in more lending going in these portfolios? Have you made a land development loan in the last year?

In terms of the land and land development, no, we are not making new loans in those categories. We have seen some of the existing commitments in those businesses that have been drawn upon. So what shows up in the information that you are referencing, is more of the balances as those loans have been drawn.

When did you stop extending credit to these sorts of projects?

That was in July of last year.

Okay. How old or how much would you say these portfolios are?

I would say probably the vintage would be somewhere in the '04 to '06 range, I would say by the end of '06 it really started to taper off.

When do they come up for renewal if you will?

I mean, most a lot of them that are a non-performing probably either have come up for renewal, or are not going to be renewed, because of the circumstances with the borrower. That was touched on earlier, that one of the things that has been cropping up like the 30-day delinquencies, is on some credits that do come up for renewal, we are demanding additional collateral, or other types of terms to better protect ourselves.

In some cases we have also been able to take additional collateral, if somebody has an investment that doesn't appear to be able to be moved in the short run, if there is some additional collateral that will shore up the loan, we will look at that as well, as looking for pay downs.

What would the haircut be on the non-performers that you had?

I would say generally the write-downs have been about 35 to 40%.

I am hearing that people are coming in and making offers at about $0.40 on the dollar. That kind of implies that there is more downside than fair value?

Although we have been able to liquidate more than just a couple of development loans at levels that we have written them down to. I do think there is some element, of if you are doing it in mass, we might have to look at those kind of valuations, but I think in a more orderly scenario, you are still able to get a little bit better execution than that.

When I referenced, 35 to 40% I am referencing the charge down that we would take on the loan. Obviously you wouldn't have a 100% loan when you made it. So what you would have advanced originally let's say it was 80%. For us to take a 40% write-down, is probably close to the numbers that you are referencing in the market.

I guess what I am looking at it too, unemployment is the highest the nation. You still have all of the properties coming on. There is no immigration of people in business. You look at this, and then balance that against the reserves, and the reserve methodology is at current appraisal, but you have to look a year to two years out and speculate. And I don't see how you don't incur another 20% write-down possibly on all of these? Do you not agree with that?

Well, one of the things that the appraisals and the current appraisals look at is exactly that issue. That is the absorption period. So very deep discounts are applied to the values to account for a very slow absorption.

I don't necessarily disagree with your premise, I think though, that the valuations are taking that into account.

Okay.

I will say there was a study recently done on the risk of further declines in residential real estate values on the 50 largest metropolitan areas, and this was looking at the percentage risk of further declines, moving our towards the end of '08 and into '09, and actually in Michigan, it was reasonably well, it was in the 14 to 16% chance of risk.

That is not the percent of decline, but the percent of risk of further declines, you had states such as Florida, California, Arizona, and Nevada, that were north of 80%, and then Texas was the lowest state at 1%. So that study at least would suggest, based on how much decline we have already seen here, that the risk is not that up there with some of these other states.

Do you agree with the 14% downside to this state?

Yes. What they are suggesting is there is 14 to 16% risk of further declines. That is not the percent of the decline, that is further decline. They are suggesting that it is relatively, on their study it was done by PMI is the name of the company, but they were suggesting that Michigan risk of further price declines, and this was mostly in southeast Michigan, is relatively low. Whether you agree with that or not, that is the study that I have seen most recently.

Could you give us color on the relative of inventory, since we are kind of focusing on the southeast, the southeast as far as homes? 50 months of inventory?

It varies so dramatically by price point. The higher price points your levels are well over a year, multiple years of absorption, if you are getting say $1.5 million. If you are down below $300,000, the absorption period, it just varies all over the map, depending on price point. I would say that our average loan balance in our portfolio is about $130,000. We don't have a lot of that high-end type of inventory. That would suggest that your outlook for absorption periods, relative to the size of our loans is better than is you had a portfolio that was heavily in the jumbo or super-jumbo loans.

In this smallest representation of our portfolio, total portfolio is from southeast Michigan in one to four family residential.

Yes, but you have a lot of land and land development construction loans down there.

We have remaining in southeast Michigan in land and land development, we have about $38 million, of which about 30 million is in watch credit. It strikes me that that is not relative to our size an enormous exposure even in that category in southeast Michigan.

What have you seen in your own mortgage business? You mentioned refis were a large driver of your mortgage volume. What are you underwriting now?

We are actually seeing, I mean the volumes are relatively flat, now we did in the first quarter, as I pointed out, it was more heavily skewed to refinanced volume, and the overall market is a little lower.

The other thing you are contending with on refinances, is in some instances, the appraised value of the property is lower. The customer is even eligible to refinance the loan. But offsetting that, is we have seen an enormous amount of people exit the market.

When the market was stronger, you always have a low barriered industry, you had a huge number of mortgage brokers and bankers entering the market, well many of those have gone away, even some more substantive mortgage bankers in this market have gone away. And what that has done is even though the market is smaller, institutions that have been able to remain in place in mortgage banking, like ourselves, are gathering a better market share. So you are still seeing reasonable activity there. I don't think it is going to be anything substantive, but I still think it will be steady.

Are you underwriting any loans where the LTVs were greater than 80%?

Well you are still doing loans above 80, if it meets Fannie and Freddie's criteria, and you can get PMI insurance. I can tell you just about every week, the PMI companies are coming out with changes in their underwriting matrices, and in addition to that, you also have changes on a pretty continuous basis from Fannie and Freddie on risk based pricing.

The other thing that we have had our mortgage banking arm is FHA lending, which is continuing to do well, and again those loans are sold, so we are not retaining that exposure, and then finally in the instance where we may do a portfolio loan above 80, we would get PMI insurance. In some instances, we have a wrapped insurance policy, that we have at our disposal, to also insure the exposure down well below 80%, outside of PMI.

So if it happens, we have put in place a wide variety of scenarios, to insure the risk well below that level. And I would add it is based on you know current valuations which are distressed.

That is all I wanted to touch on. I will just add it appears that clearly that real estate residential real estate is going to continue to fall. The reserves like you mentioned, obviously it does appear low. I would encourage you to increase that to a higher percentage to cover the problem assets.

I will respectively disagree.

Thanks for your time.

Our next question comes from [Curt Arbison, NPS].

Just a quick question on the preferreds, and if they are variable or fixed. And what the original rationale was?

They are variable. All of them I think are variable. The original rationale is these are preferreds where we get the dividends received reduction of 70%, and they had relatively high ROE's across the board, and obviously the market values have come down quite a bit, but we were comfortable with the names at the time.

Fannie and Freddie are holdings that we have had for a fairly lengthy period of time on the preferreds. The Merrill Lynch we added long before the sub-prime problems that had impacted them, and both Merrill and Goldman were very highly rated, and Goldman continues to be very highly rated, and so we felt comfortable with those investments.

Okay. One other comment on Board of Directors showing confidence in your stock would be a nice thing.

Okay.

Thanks.

Our next question comes from Jason Werner, Howe Barnes.

Good morning guys. My first question is bit of a clarification on one of Terry's questions on the brokered CD's, I just wanted to confirm that you do have room to continue borrowing from the Federal Home Loan Bank, or do you need to at some point increase your securities for collateral, and that sort of thing?

We have more modest capacity at the Federal Home Loan Bank. But we still have a fairly large capacity at the Federal Reserve Bank, probably in excess of $400 million there. So we have quite a bit of remaining capacity.

What is the rate difference between those two sources? Is there much of a difference?

Well, the Federal Reserve right now, we had been doing the term auctions, which that is doing twice a month. We have not done those lately, because the cover bid on the term auctions have been above the discount rate, or primary borrowing rate. So we have been borrowing at the discount window, which is at 2.5%, so it is just a little bit north of where the Fed funds rate is.

Federal Home Loan Bank advances would be generally a little bit below LIBOR rates. Sometimes it can be a little bit above, depending on the type of advance that we are doing. So they are probably a little bit higher than the discount window rates.

You can go longer term with the Federal Home Loan Bank advance rates. Or advances so you can get longer term funding, whereas at the discount window you could do I think the max is a 90-day borrowing, which is a variable rate borrowing, so you do have to turn those reserve window borrowings over on a regularly frequent basis, but we still have lots of capacity there, to be able to absorb further declines in the brokered CD's, which is down to 248 million.

How long are you going out with the Federal Home Loan Bank?

We will go out probably as far as 3 or 4 years, one thing we have also done is we have done 3-year, where we have a call at the end of one year. We have to pay up a little bit more for that, but it gives us a little bit more flexibility in the funding that we have, in case rates come down even more.

Jason, a similar example to that would be our strategy with the callable brokered CD's and then we hedge those with swaps, I mean that structure costs us a little bit more, but it gave us the ability, when we first did it, but it gave us the ability to do what we are doing right now, which is to call them as rates have come down, and not be saddled with a lot of termed, longer term funding, so we have always paid up probably a little more, to give ourselves more flexibility in the structure of our liability base. And that served us well in responding to changes in interest rates.

Okay. Given that you will continue to bring the brokered CD's down, are you looking for more margin expansion in the second quarter?

I would say we are still modeling, our modeling will suggest that we would benefit from lower short-term interest rates. So that we would expect depending on what the Fed does, to still have some upside potential in the margin, sort of the offset to that is the drag of the non-performers that I pointed out, although that is already in the margins. So as long as they don't grow a lot, we still should see some benefit there.

The other thing is, depending on how much in loans are migrating to non-accrual, if that slows or stays down, we won't get that reversal of interest like we saw in this first quarter, which would help the margin as well.

Another question on the credit quality, looking at that table in the press release that has the commercial loans broken out, when I combined the land and land development construction, and compared that to the previous quarter, I noticed it was down about 9.2 million. Obviously you didn't have that much in charge-offs in the quarter, I was curious if you could give some color as to what explains the rest of that difference? You mentioned you were able to get rid of a few things that could sell. Are you moving some stuff out then?

There was a couple of things in the first quarter, first of all we were able to sell one loan that was secured by land development, and then also we were able to negotiate a pay-off on another land development loan, that was partially secured by markover securities as well. A couple of those things moving out did help contribute to the decline.

I also noticed, and this is kind of ancillary, but I noticed that, I calculated the portion of those three categories that were non-watched still performing, and the land category actually went up about 4 million. Obviously the balance of outstanding loans didn't change, but performing went up, and I was wondering if something moved from the watch list back to the performing non-watched?

Yes. We did have one of the credits, that additional collateral was provided, and it moved back into the performing part of the portfolio.

Okay. My last question is, I was hoping to get color about the tax issue that resulted in the benefit in the quarter. Why was that accrual reversed?

Well, you saw the same thing on Citizens Republic. My guess is it was the same item. But it relates to a tax case that was held, and/or decided.

And what it relates to, there is something called a [shefler] adjustment, where you allocate, there is a calculation you have to do with allocating interest expense to tax exempt securities, and that renders that interest expense not tax deductible. The case related to whether you do that computation on a consolidated basis or an entity level basis, and because of what occurred there, and the facts involved, it allowed us to release the reserve that we had previously established on that issue.

Thank you.

We show no further questions, if you would like to make any closing remarks?

Thank you, with that, this concludes our conference call. Thank you for your interest in the Independent Bank Corporation, we look forward to speaking with you again next quarter. For an archived webcast of today's call, go to our website at www.IBCP.com under Investor Relations. This webcast will be archived on our website for approximately 90 days from the date of today's call. Thank you, and have a great day.

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