Mercantile Bank Corp (MBWM) 2007 Q3 法說會逐字稿

Welcome to the Mercantile Bank Corporation third-quarter earnings conference call.

There will be a question-and-answer period at the end of the presentation. (OPERATOR INSTRUCTIONS)

Before we begin today's call, I would like to remind everyone that this call may involve certain forward-looking statements, such as projections of revenue, earnings and capital structure, as well as statements on the plans and objectives of the Company or its management, statements on economic performance and statements regarding the underlying assumptions of the Company's business. The company's actual results could differ materially from any forward-looking statements made today due to important factors described in the Company's latest Securities and Exchange Commission filings. The Company assumes no obligation to update any forward-looking statements made during this call.

If anyone does not already have a copy of the press release issued by Mercantile, you can access it at the Company's Web site, www.mercbank.com.

On the Conference today from Mercantile Bank Corporation, we have Michael H. Price, Chairman, President, and Chief Executive Officer; Bob Kaminski, Executive Vice President and Chief Operating Officer; and Chuck Christmas, Senior Vice President and Chief Financial Officer. We will begin the call with management's prepared remarks, and then open the call up to questions.

At this point, I would like to turn the call over to Mr. Price.

Thank you and good morning, everyone, and thank you for your interest in our company.

On the surface, the third-quarter results look very similar to our second-quarter results with earnings per share at $0.28 versus $0.26 for the second quarter. Margin compression continues to remain an ongoing issue and will be challenging for us in the short-term due to the recent Fed action. However, we should begin to see the benefits of the rate cuts starting in 2008. Chuck Christmas will have more detail on this issue during his remarks.

Loan growth for the quarter was $20 million, compared to $3 million and $27 million for the first and second quarters of the year, respectively. While this is fairly modest growth by Mercantile standards, given the number of loans we've been working off our balance sheet, we're gratified to see the continued growth in the loan portfolio.

Our big focus, however, continues to be on management on the nonperforming assets in our portfolio. While the comparison of quarter-end balances between the second and third quarters shows a 9 basis point increase in the level of nonperformers, there was significant activity during the quarter, which saw us remove over 5 million of the 24 million of June 30 NPAs. Unfortunately, one particular area, residential real estate development, continues to suffer extreme stress in our markets. Some additions to the nonperforming category during the quarter outweighed the eliminations that we were able to achieve. Bob Kaminski will give you more details during his remarks in a few minutes as well.

We think it's important to note that, while we were very conservative during the quarter and downgraded additional credits related to the residential real estate slowdown, the majority of the downgrades were applied to credits that were contractually current, which showed potential weaknesses that we believe will manifest themselves very, very shortly. Additionally, you can see that while during the past two quarters we have expensed over $5 million in loan-loss provision, charge-offs for the quarter were reasonable at 17 basis points or approximately $800,000.

While we certainly are disappointed that the success we achieved during the -- at reducing the nonperformers across the board was overshadowed by the continuation of a challenging residential real estate development market, we do see some encouraging signs for upcoming quarters.

At this time, I will turn it over to our CFO, Chuck Christmas.

Thanks, Mike, and good morning, everybody.

What I'd like to do is give you an overview of Mercantile's financial condition and operating results for the third quarter of 2007 as well as the year-to-date of 2007, highlighting the major financial condition, performance, balances and ratios.

Our net income for the third quarter totaled $2.4 million, a decrease of $2.8 million or about 54% from the $5.2 million we earned in the third quarter of last year. For the first nine months of 2007, we earned $8.9 million, a decrease of $6.3 million or about 42% from the $15.2 million we earned in the first nine months of 2006.

On a diluted earnings per share basis, we earned $0.28 in the third quarter of this year, a decrease of about 54% from what we earned in the third quarter of last year. For the first nine months of 2007, we earned $1.05, a decline of about 41% from what we earned in the first nine months of 2006.

The declines in 2007 earnings performance are primarily the result of an increased level of nonperforming assets, which necessitated a higher provision expense and higher operating expenses from the related collection efforts. The increase in nonperforming assets, along with a very competitive loan and deposit environment, also had a negative impact on the asset yield, which, when combined with the increasing cost of funds and a flat-to-inverted yield curve over the past 12 to 18 months, resulted in a lower level of net interest income, which more than offset the positive impact of growth in earning assets.

Our net interest income for the third quarter of this year was $14.1 million, a decline of $1.4 million or about 9% from the third quarter last year. For the first nine months of this year, we earned $42.5 million in net interest income, a decrease of $3.8 million or about 8% for the first nine months of last year.

Our average earning assets during the third quarter of this year totaled just under $2 billion, representing an increase of about $110 million or 6% over average earning assets in the third quarter of last year.

Our average loans increased $88 million or about 5% when you compare it on the average of the third quarter this year with the average of the third quarter of last year.

Our net interest margin for the third quarter of 2007 equaled 2.86%, down 5 basis points from the 2.91% in the second quarter of this year and down about 48 basis points from the third quarter of last year. The primary contributing factor of the 48 basis-point decline in the net interest margin during the past 12 months was a continuation of the increased cost of funds, reflecting the maturity and repricing of fixed-rate CDs and borrowed funds that were originally obtained in periods of lower interest-rate environments. The increased cost of funds, in corresponding decline in the net interest margin, for the most part reflects a reversal of an increasing net interest margin Mercantile enjoyed back in the latter part of 2004 through 2005 during an increasing interest-rate environment.

Other factors contributing to the declining net interest margin include a higher level of nonperforming assets, a very competitive loan and deposit environment, and a flat-to-inverted yield curve. Due to the recent 50-basis-point cut in the prime rate, we expect a further compressed net interest margin heading into the fourth quarter of this year. Approximately 50% of our loan portfolio has repriced as of late September with only about $1 in funding liabilities repricing downwards thus far for every $3 in loans. As we move forward into the fourth quarter and into 2008, we have fixed-rate CDs and borrowed funds that should reprice downwards, mitigating the initial impact of the recent 50-basis-point cut of the federal funds rate and prime rate.

Given the multitude of factors that impact the net interest margin -- for example, Federal Reserve decisions, corresponding changes in interest rates for deposits and borrowed funds, shape of the yield curve, loan and deposit competitive environment, changes in balance-sheet structure, level of nonperforming assets, and potential changes in interest-rate risk-management strategies, just to name a few -- under the current interest-rate environment and assuming no further Fed action, it appears it will be late first quarter or into the second quarter before our net interest margin recovers to the level recorded during the third quarter of 2007. We do have further fixed-rate CDs and borrowed funds repricing thereafter.

Our loan-loss provision expense in the third quarter of 2007 totaled $2.8 million, about double what we expensed in the third quarter of last year. For the first nine months of 2007, we've expensed $6.2 million, an increase of a little over 50% from what we expensed in the first nine months of last year. The increase in provision expense during 2007 primarily results from a higher level of nonperforming loans and other downgrades within our commercial loan portfolio, which has necessitated a higher reserve coverage ratio. Defined as the allowance for loan losses as a percent of total loans, the reserve coverage ratio was 1.38% as of September 30, 2007, compared to 1.28% as of June 30, 2007 and September 30, 2006.

Our non-interest income in the third quarter totaled $1.5 million, an increase of 11% from the third quarter of 2006. For the first nine months of 2007, our non-interest income totaled $4.3 million, up 12% from the first nine months of 2006. We recorded increases in virtually all fee income categories with the exception of a very modest decline in mortgage banking activity fee income.

Our non-interest expense in the third quarter of 2007 totaled $9.6 million, an increase of $1.6 million or 19% from the third quarter of last year. For the first nine months of 2007, we've expensed $28.3 million, an increase of $4.2 million or about 18% from what we did last year.

Adjusting for Gerry's, our former Chairman's, retirement package in the second quarter, on a year-to-date basis, our overhead costs have gone up $3 million or about 13%. Of the $3 million increase in core year-to-date -- over year-to-date increase, about $2 million or about 67% is in salaries and benefits primarily related to the continued growth in our FTEs, which have increased from 284 a year ago to 302, or an increase of about 6%.

Our occupancy and equipment costs are essentially unchanged. However, our other operating costs are up. Some of the reasons for that -- including an increased cost associated with the higher level of nonperforming assets, increased FDIC insurance premiums, software and system enhancements, and just the overall increased size of the Company.

As of September 30, our total assets were $2.11 billion, on a net basis up about $3 million for the quarter. However, during the third quarter, our loans were up $21 million. During the third quarter, we did experience a decline of about $19 million in our cash and due-from area -- two primary reasons for that. One, effective about June or July 1, we went to image exchange which provides us faster credit on our outgoing cash slider. We also, for Federal Reserve calculations, did a deposit reclassification program which eliminated about a $7 million required deposit at the Federal Reserve.

In the last 12 months, our loans are up $87 million or about 5%. There are no other major changes in our asset composition.

Our funding strategy has not changed significantly as we continue to grow local deposits and bridge any funding gap with wholesale funds, that being brokered CDs and federal [home] loan bank advances. During the third quarter of last year -- or this year, excuse me, average wholesale funds to total funds equaled 61%, unchanged from the second quarter of this year but down from the 65% during the third quarter of last year. I will note that we have been as high as 69%. The decline certainly reflects our continued growing of our local deposit base.

With regard to capital, we remain in a well-capitalized position per bank regulatory definitions with a total risk-based capital ratio as of September 30, 2007 of 11.4%.

That's my prepared remarks. I'd certainly be happy to answer any questions in the Q&A session. But I will now turn it over to Bob.

Thank you, Chuck, and good morning, everybody. For my prepared comments this morning, I wanted to focus on various aspects of the loan portfolio.

As Mike mentioned, loan growth during the quarter was about $20 million with about 49 million of that total generated by the Grand Rapids region. For the year-to-date, loan growth has been about $50 million with $21 million coming from the Lansing region and another $18 million generated by Grand Rapids.

While the nonperforming loan total did show an increase over the second quarter, an examination of the components reveals the definite velocity in turnover of these credits. Two residential real estate development construction relationships were added to nonaccrual status during the quarter. One of these relationships was about $4 million, while the other was about $2.8 million. These were the largest components of an NPA increase of about $8 million for the quarter. This increase was partially offset by a $5.2 million decrease in nonperforming assets. These reductions came from a variety of sources, including sale of other real estate owned and repossessed assets, refinancings by a borrower, borrower sale of assets with corresponding paydowns, etc.

To give some additional detail on the composition of the nonperforming list, of $26 million in nonperforming assets, about $7 million is to residential real estate developers. $1.3 million is for individual residential lots. $2.7 million is residential housing construction. $3.1 million is one to four-family non-construction residential housing. $10.3 million is commercial real estate, and about $1.4 is commercial and industrial.

In order to put the nonperforming numbers in some better perspective, I will give you some statistics on the composition of Mercantile's portfolio as of September 30. We had a portfolio of about $1.8 billion. Of that, construction comprised about $100 million; land development was about $114 million; residential real estate non-construction, secured, was $93 million; and commercial real estate non-construction was about $880 million.

Mercantile lending personnel continued to work closely with customers to identify struggling real estate projects and assess the ongoing risk to the Bank. We are also assessing closely the financial capacity of principles and guarantors, especially in those cases where those individuals are having to supplement the cash flow of their projects while moving quickly to attempt to obtain further support for their credit relationships if possible.

One final update -- progress continues to be made on the Oakland County regional office. A site has been selected in southern Oakland County in the city of Novi. City President [Al Plaflavus] and the Mercantile team are working hard to assemble a team of bankers to staff this office and opening is scheduled in late fall between Thanksgiving and Christmas.

That's it for my prepared comments. I'll turn it back over to Mike.

Thanks, Chuck. Thanks, Bob. At this time, we'd like to open up for the Q&A session.

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

Good morning, guys. The first question is what triggered the Company's ability to increase the loan loss provision? The reserve ended up at 168 above the first quarter, but if I look at the second quarter, nonperforming loans were up about 2.5 million to 10 million in the first quarter, and charge-offs I believe were lower as well. Maybe help me come up with kind of a fourth-quarter and '08 provision level, or how I should think about that, the provision.

Well, I think, when we look at with regards to the provision expense -- I'll tell you, this is Chuck -- obviously, you know, the level of nonperforming loans certainly drives that as we go through the process, and those loans are allocated a higher reserve factor. But we also look at all loans within our commercial loan portfolio that are graded. We also had some downgrades, say from a 2 to a 3, or a 3 to a 4, which also impacts the level of provision expense. So it's not just the level of nonperforming loans; it's the overall condition of the portfolio.

Maybe Bob, could you comments about home prices, the volume of home sales in western Michigan, just to give us a little color about the markets?

Well, Terry, what I think what you are seeing here is there's a tremendous stock in inventory right now in houses in the entire western Michigan area. What's causing it is obviously prices are not increasing as they had in recent years, and homesellers as well as builders are having a lot of trouble selling their stock right now. So it has been -- it's a typical case of supply and demand. The supply has been certainly strong last several years. I think the demand has struggled to catch up and the economy is certainly not helping that as we go through the last months of this year and certainly into next year.

Terry, this is Mike. Just to add a little color to both Chuck and Bob's comments, you know, I saw a statistic the other day that, nationwide, there's somewhere around 300,000 homes that are vacant right now, either through foreclosures, the subprime market blowing up, or new construction that just hasn't been able to be absorbed. Clearly, here in Michigan, we were one of the first to feel that, but I think you're starting to see that nationwide in heretofore markets that had never seen it before. It's just a matter of working through with time to get supply and demand back in focus.

As I said earlier, we really were happy during the quarter that $5 million of the $24 million that we had on nonperformers at June 30, we actually were reduced down, either off or had reductions in those loans. So there is activity going on; there is some movement.

Unfortunately, we had 2, especially 2 larger credits, again in the residential real estate development area that heretofore were contractually current. One is we had some pretty nice activity on it over the last course of the year, and they just have slowed way, way down to the point that we felt very prudent that we better put them on nonperformers, even though, contractually, they were current because we could see some issues down the road in this quarter if things don't pick up a little bit.

Mike, you had mentioned you are seeing some encouraging signs. Is that implying things are weakening less than they were in prior quarters, or you're actually talking about some stability in the residential market?

I think we are seeing finally some stability, but you know, it shaped my confidence a little bit from the standpoint of, you know, while we are sitting here saying gee, we have $5 million off this last quarter, that's really great but then to have two customers show up on your doorstep and say "You know, we were selling stuff pretty darn good in 2005 and 2006, but now 2007 is here, we're just having a real difficult time moving the lots and/or the homes that are under construction." But we're not seeing the number of credits that are showing weakness as much as we are -- you know, we're starting to see some slowdown in the downgrades, but last quarter was certainly a couple of large ones that we felt needed to go on the nonperforming list.

Thank you.

Brad Vander Ploeg, Raymond James & Associates.

Maybe just to follow up on that second, I guess qualitatively speaking, it sounds like it is hard to say sort of where we are in the cycle from your perspective. I mean, it sounds like you are a little bit more optimistic but if you were to say it is a nine-inning game, we can't really tell if we are in the second or third inning or the seventh or eighth at this point. Is that fair to say?

It sure feels that way. But again, sometimes it also feels like two steps forward and one step that, when you see some things, say, okay, finally we got some positive motions on these 4 credits and then we see a couple of downgrades in others. But I guess, when you look at it, and Bob gave you the overview of what we have on our portfolio in those areas -- residential real estate, construction and land development -- the portfolio isn't that large that we should have portrayed that this is in the second inning or third inning. We've been pretty diligent at going through and looking at everything we have in those portfolios, and trying to downgrade anything that we think shows any weakness. But that's a continuing process. The way it has been, it has been a really unusual market out there. Something -- I've been in the business about 30 years, but I've never seen. I've seen slowdowns, but this is just something where things have absolutely stopped in some cases and there have been no sales for three, four, six, eight months. That's pretty unusual. So we know that there could still be some stuff out there, but we are gratified with the little bit of progress we did make with some of the relatively large ones we had on the books as of June 30.

This is Bob. As Mike mentioned, it is a very fluid process. As you have downgrades, there's more provision that needs to be allocated towards those particular credits because of the increased risk. That doesn't necessarily mean that it's charge-offs (inaudible) though, and as some of these credits sell, their stock of inventory or the credit comes back a bit, both provisions can be decreased. So that's what you see going on continually in the portfolio with, as we mentioned, $5 million coming off a of nonperforming status. That did give us some relief in the provision and then obviously the downgrades hurt us. So, it is a very fluid ongoing process as we look to assess the risk and assign provision to compensate for that risk.

One of the hard things, too, Brad -- this is Mike again -- is that there are a number of these credits that the guarantors now have been carrying the debt. You know, we see that all the time, not just in this residential real estate but all sorts of different industries. But it has been a prolonged period now for some of these guarantors to carry the debt, and that part of the analysis is sometimes hard too, how long they are able to continue to go to the liquidity well. We can continue to try to assess that and analyze it, and a lot of guarantors are doing a very good job in carrying these things. But if this marketplace were to expand three, six more months with some of these projects having very little or no activity, even some of the strongest guarantors will certainly be challenged.

That's real hard to quantify, too.

Yes. Okay, thanks. Then, maybe -- it looks like about 40% of the nonperformers on the books right now I think you mentioned were commercial real estate, Bob. I was just wondering if you could -- if there's any more color or detail that you could give on that and kind of what's happening in that market. I remember, I think it was maybe at least a year ago that you guys started mentioning that there were some outside investors, outside the Grand Rapids area, that were coming in and buying properties because they seemed to be at attractive values. It sounds like maybe that is not the case any more and --.

Well, I think what you are seeing is those commercial real estate components of the NPA list are from a variety of different areas and industries, some of them are not owner-occupied, some of are owner-occupied, and a variety of different uses for the building. So I wouldn't say put your finger on any one particular segment of that list that's particularly troubling, but it is obviously a significant component of the NPA list itself.

In terms of an active market of buyers, if you were encouraging people to sell a distressed property, how is that these days for the non-owner-occupied (multiple speakers) ?

I think, Brad, there's certainly is still a lot of outside investors coming into the market, buying buildings but as you might imagine, unfortunately for us, they are buying and paying up really well for the fully leased and well-performing ones, so it's kind of a double-edged sword. Certainly, we have worked with the owners of the projects that are suffering a little bit, but that market is a little different than the ones that are full and performing well.

Then maybe lastly, just in terms of loan growth, I'm wondering how much of historically you've grown the balance sheet at a faster clip obviously. I'm just curious how much of the slowdown is by design, how much of it is because you are having to focus more on resolving some of the problem credits and what might be sort of a normalized rate in this environment and then hopefully coming out the other side of it.

Yes, I think that's a very good question, and it really is a multifaceted answer. Certainly, when lenders and management have to spend more time -- and we're spending a lot of time, as you can imagine, working out of credits, getting them off-balance sheet, doing what we have to do, there's less time to branch out and bring in new business., although we still do a fair amount of prospecting and that type of thing out there. But secondly, there's also a concerted effort to make sure that anything that goes on the books these days is as strong a credit as it can possibly be. Thirdly, banks like us, community banks, are strongly involved in the real estate market, both commercial and especially for us commercial. There isn't as much growth in that area over the last year, year or two. So I think all three of those areas have conspired to slow loan growth down a little bit.

At this point, when you say "What's going to be a normalized rate?" I don't know yet, because I think also it is also tied to the answer of when are the nonperformers going to get to a point where we can spend less time working on them and then more time back on the sales trail? Right now, I don't see us, at least for another quarter, not spending an awful lot of our time and energy getting these NPAs cleaned up.

Right, okay. Thanks very much.

[Vince Trand], Midwood Capital Partners.

Most of my questions have been answered; I just have one additional question. You guys mentioned stress in your real estate development portfolio. In terms of geographically, are you guys seeing weakness across the board or are you seeing it specifically in Holland or Grand Rapids?

The majority of the NPAs that we have on our books are in Grand Rapids, with two exceptions. We have a deal in Holland that was at June 30 a little over $5 million; it's been reduced down to $3.7 million. That was a commercial development that we are working on hard there. Then there was one new residential real estate developer that we put on for about $3 million in our Ann Arbor market. So you know, it's not just concentrated in one market, although certainly Grand Rapids and Kent County is a bigger concentration for us because that's where the bigger concentration of our assets are. But other than that, there's really no trend I guess you would say.

John Rowan, Sidoti & Co.

Chuck, just to go over one comment you made on the marketing guidance, you stated that the margin you expect to recover by the second quarter of 2008, after a dip in the fourth quarter and the first quarter -- but you expect it to recover to the third-quarter levels. Is that correct?

Yes, assuming that does not -- assuming that rates stay exactly where they are now, that prime doesn't change, and that rates especially on CD and federal home loan bank products don't change. So there's a lot of assumptions there, but just saying where we are today, if that just goes forward and doesn't change, that was kind of our estimated timeline.

Okay. Just on the expenses, obviously you had higher expenses from collecting on troubled debts. Do you see that going down in the coming quarters, or do you kind of see a push with increased operating expenses from the new branch?

Yes, you know, we put quite a bit through I think the third quarter for those types of expenses. It was about $300,000, which was just about equal to what we had done in the first six months.

Look at there components there. You know, there definitely is going to be some cost their. You know, we continue to reevaluate our foreclosed properties, and we are expecting some properties to come into ORE during fourth quarter because we have some reduction periods ending and we are always kind of taking a look at those [values] but again, we tried to reevaluate those on an ongoing basis. So it's very, very difficult to put your -- a finger on the exact number. We're certainly hopeful that it's not as high as 300,000, but there is definitely going to be some experiences there where we're going to have some costs.

Okay, and just one last question -- do you see the tax rates sticking around 26%, or is there a return up to 30% coming?

You know, as we go forward, it's probably going to be closer to 30 on a quarterly basis, but it certainly will be down below 30 for the year.

Ben Crabtree, Stifel Nicolaus & Co.

Yes, a couple of questions, one related to asset quality -- the way I interpret what you've said is, in terms of the movement in downgrades and performing status was fairly well concentrated in the housing-related part of your portfolio. I guess I'm curious about a couple of other sectors. Let's say the non-housing commercial real estate area, were there downgrades in deterioration there? Then how about the C&I part of your portfolio? How was the trend in credit quality in your pure C&I part?

I will try to answer that one. Bob or Chuck, if they want to amplify any answer.

I think the story in the third quarter was that almost all of the significant downgrades and almost all of the significant additions to NPAs were directly revolving around residential real estate development. That has been the story in the third quarter.

I guess if there's any good part, C&I portfolio, other parts of our portfolio have really been pretty steady to slightly improving. So we've got one concentrated, very focused area that's extremely stubborn right now that we're just going to have to walk through. Obviously, it's an issue throughout I think all across the country with banks at one level or another. We are certainly feeling it. But I think that's the one part we're starting to feel like okay, we are not seeing any downgrades of any size in any other types of loans, but boy, this one particular segment has been a real, real tough area for us to get where we want to be.

You know, that's good news because I guess a lot of people are wondering how much spread of infection is going to go from residential to the rest. So far, you're not really seeing it.

You know, we are. It affects people's confidence in other areas and that type of thing. But you know, obviously, we went through a period of time in this country a couple of years ago where we had incredibly low rates, and people were buying homes and people were building homes at a pace that we had never seen. The supply and demand, once the rates went the other way, got so far out of whack that we're just seeing the tidal wave of that right now, if you will. We are fighting our way through it as the supply/demand gets more in a proper adjustment.

Then an unrelated question -- could you talk and give us a little more color about your expansion into Oakland County? What is it about that market that appeals to you? How are you starting it in terms of personnel, where are the coming from and that sort of thing, just a perspective on that step out?

This is Bob. As we talked about in previous calls, regarding our philosophy on expansion into other areas, other markets, is it's all about the people. We've identified Mr. [Deflavus] as being someone who is very similar in terms of his approach to banking and lending, and very similar traits to the other city presidents that we've established in our regional expansion into other areas of Michigan. Really, that's where it all starts.

Oakland County is, as we mentioned in some of our other press material, is a good county. You've got some good, good commercial base there that is really our bread and butter for how we approach banking and the lending that we do, and so it's a good match. I think, in proximity to our (inaudible) region, which we've had for a few years now, I think it's a good fit there as well.

So I think all in all, it goes back to the people. We've identified a leader there to establish a Mercantile presence in the Oakland County market and build a team with that philosophy as we look to open here the fourth quarter.

In addition, we've already added, Bob and Al had added some good people to the staff. They are coming from generally larger banks in (inaudible) area. Most of them have had anywhere from 5 to 10 to 15 years experience. I believe we have a mortgage lender, a branch manager; we've got some other lending people that are about ready to join the team. So we are very happy with the team that we are assembling there and expect big things out of them.

You would expect, over time, their book of -- their loan portfolio to kind of resemble yours?

I would think so, knowing the people the we are hiring and knowing what our mission is at the Bank and the strengths of our bank, which is to really focus on commercial lending and especially in that medium-sized range where we are certainly not -- if the question is, are we looking at Oakland County to fly like a different duck, certainly not. We want to continue to use the same style of banking, the same values and the same focus.

Eric Grubelich, Keefe Bruyette & Woods.

I had a question just for Chuck LIBOR, Fed funds relationship is a lot wider than it has been. Is that much of a factor on your wholesale funding on the CD repricing? Does it matter? You know, if it tightens, does it help you out? Could you elaborate a little bit on that?

It's a really good question, because as you mentioned, we are seeing that spread that we haven't seen in a very, very long time, if ever.

As far as the loan portfolio, probably about 10% of our floating-rate loans are tied to LIBOR, so when the LIBOR went up a little bit and that spread has stayed a little bit above fed funds, it actually helped us a little bit. So a little bit of an impact there, and so far it has been positive.

Our trust preferred, which refinances actually next week, is tied to LIBOR, so there is a little bit of an issue there, too.

On the brokered CD side, definitely LIBOR rates drives a lot of those rates, and spreads are very, very tight because LIBOR, as you mentioned, is a little bit elevated. But I would say, from a LIBOR perspective, I don't see any huge impact on the brokered CD market. If there's a bigger impact on the brokered CD market, it has been over the last of couple of months. As you might imagine, some of the bigger mortgage players such as Countrywide and WaMu and those folks who I think have obviously seen some pressure on their ability to go to other banks and borrow off their lines of credit. They have always been in the brokered CD market, using that as part of their funding base, but it appears, just from the orders that are out there and just talking to our brokers, that they appear to be in that market much more regularly and with bigger orders than what they have in the past. To get the monies that they feel they need, they have elevated the rates up a little bit, just from your normal supply/demand and competitive issues. That's probably more about 5 to 10 basis points there.

Thanks.

[Michael Koven], [Senova].

I was wondering if you could just run through the NPAs in the portfolio composition. I just didn't get all the numbers. If you could just maybe run through those just a tad bit slower, and then I just had a follow-up question.

Yes, you bet. Let's see here. $7 million is to residential real estate developers; $1.3 million is individual residential lots; $2.7 million is residential housing construction; $3.1 million is one to four-family non-construction residential; $10.3 million is commercial real estate; and about $1.4 million is commercial and industrial.

Great. Then the compositions of the portfolio?

The composition of the portfolio -- about $100 million for construction; about 114 for land development; residential real estate is 93; and commercial real estate is about $880,000.

Then C&I would be how much? Just the balance?

Pretty much the balance.

Okay. Then can you talk about your outlook for the watch list? Then also, before you talk about the watch list, did the 4 million and the 2.8 million construction loans -- did those that you placed on NPA, did does hit towards the latter part of the quarter?

Actually, they did hit towards to the latter part of the quarter, the last month of the quarter, certainly. They're on the watch list, but I think what you're seeing there is a similar velocity that we are seeing on the nonperforming assets side. [Barry] is working hard to bring some dispositions to the credits that are stressed right now so they don't go into the NPA category. You see downgrades and upgrades happening in a very fluid fashion throughout the portfolio. Obviously, with the downgrades of a couple of the larger credits we talked about, the watch list has certainly increased.

[Stephen Guyan], Stifel Nicolaus & Co.

Just one question -- with previous nonperforming loans, I'm just wondering. You set up a reserve. I was just wondering if, as you've been working through those, they are on the books for awhile, if you had to set up additional reserves with property values declining, or has that first cut been [good] enough to kind of compensate for any additional decline in property values?

It is a very fluid process. Each month, we take a look at not only the NPAs but the credits as a whole to see whether they merit increased reserves or decreased reserves on those particular credits.

With some of the deals that had rolled off the NPA list, as we mentioned, that $5 million block this quarter, there were some there that we had some reserves that we were able to back away because of the sale of some of the assets and the training of those that gave us some relief that we hadn't built into the formula. So it goes both ways. You get some. As Chuck talked about, the other real estate part of the portfolio. As you assess the values of property, as you look at what property values are doing, you make adjustments there as needed, as well.

Jon Arfstrom, RBC Capital Markets.

A couple of questions here -- it seems like most of your peers have this rising NPA issue as well, so you're certainly not alone. But the question is, earlier you commented on the competitive loan-pricing environment. I'm just wondering if, over the past few months, you feel like you're getting better compensated for the risk you're taking. Or another way to ask it is are the competitors changing their behavior at all, given the rising NPLs and NPAs in Michigan?

I think, Jon, one of the things we are seeing is we are seeing some rationality come back into loan structure. For a while, it was both pricing and structure that were just getting totally out of whack and I think everyone has kind of taken a step back and realized that guarantee is a pretty good thing, you know, additional collateral is always a good thing, etc., etc. But the pricing remains pretty darn competitive out there, still. So I haven't really seen -- and I don't know, Bob, if you have -- but I haven't really seen too much change in that in the last couple of quarters.

No, it's still very competitive out there.

Okay. Another, just a follow-up question on the overall expense growth outlook -- I understand the increased expenses with some of the REO properties and some of the work-outs, but can you talk maybe a little bit about the overall expense growth outlook that you have for the Company, just going forward? I mean, I think the numbers were probably a little bit higher than most people were expecting.

Yes, you know, one of the things that kind of caught all banks a little off-guard with regard to budgeting this year was the increase in FDIC premiums. For us, we were paying $50,000 a quarter and now we are paying $250,000 a quarter, so an extra $200,000 a quarter. Hopefully, that will subside some day in the future, but certainly the FDIC has given no date as to when they can lessen those.

Another issue that we're going to be facing here in Michigan is we have a new business tax that goes into effect January 1. I haven't done all the hard calculations yet but that's probably going to add another, as we get into next year, another $250 million or so in tax that we are not currently paying.

You know, Oakland County is going to add some expenses certainly. Obviously, it depends on exactly what the team looks like as we go forward, but that would probably be somewhere in the $500,000 to $600,000 range. Obviously, they are already looking at loans; you know, they are going to the committee. And we obviously expect additional revenue to certainly start mitigating those initial start-up costs that we have.

We don't really have, as we are starting the budgeting process ourselves for 2008, don't have any really big projects planned that are going to cause any significant increases, say systems and those types of things, so that should be fairly benign in increases. But we certainly are a growing company. We do have plans to hire additional people next year, both on the sales force certainly as well as our backroom operations. It's really hard to try to put a specific number on it, though. But hopefully some of those details will help you out a little it.

Okay. The Oakland County, that was 500 to 600 a quarter?

No, a year.

A year, okay. That business tax seems like just a great way to strengthen the Michigan economy, right?!

(LAUGHTER) No comment!

We can talk about that at another time, you bet.

Okay, last question -- you know, your stock is trading almost $1 below your stated book value and you don't carry any goodwill. And loan growth is a bit slower. I know typically you haven't thought about buybacks, but I'm curious what the capital allocation thinking is internally. It looks like you have more than enough to cover the dividend. I'm just wondering, with the slower growth outlook, if there is any change in thinking.

Well, what we always say on that is we continually, as management and a board, continually assess where our capital position is, what our needs are. We will consider, as always, a stock repurchase program from time to time. So, it just doesn't change the fact that we are constantly looking at all the factors involved.

A follow-up question from Terry McEvoy, Oppenheimer.

I'm all set. Thank you.

There are no further questions at this time. I'd like to hand the floor back over to management for any closing comments.

Thanks very much. We appreciate everyone's interest in the Company. We continue to fight really hard through these difficult times at getting especially our asset quality back to where we want to be. If you have any further follow-up questions, please feel free to call any one of us on the management team. Thank you very much.

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