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Operator
Welcome to the Old National Bancorp's third-quarter 2007 earnings conference call. This call is being recorded and has been made accessible to the public in accordance with the SEC's Regulation FD. The call, along with corresponding presentation slides, will be archived for 12 months on the shareholder relations page at www.OldNational.com. A replay of the call will also be available beginning at 1 PM Central time today through November 12. To access the replay, dial 1-800-642-1687, conference ID code, 20645931. Those participating today will be analysts and members of the financial community.
At this time, all participants are in a listen-only mode. Then we will hold a question-and-answer session and instructions will follow at that time.
At this time the call will be turned over to Lynell Walton, Vice President of Investor Relations, for opening remarks. Ms. Walton?
Lynell Walton - VP, IR
Thank you, Laney and good morning to all of you on the call. We appreciate you joining us for Old National Bancorp's third-quarter 2007 earnings conference call.
With me today are our President and Chief Executive Officer, Bob Jones; our Chief Financial Officer, Chris Wolking and our Chief Credit Officer, Daryl Moore.
Before we begin, I would like to refer you to slide 3 and point out that the presentation today does contain certain forward-looking statements that are subject to certain risks and uncertainties that could cause the Company's actual future results to materially differ from those discussed. These risks and uncertainties included but are not limited to those which are contained in the slide deck and in the Company's filings with the SEC.
Slide 4 contains our non-GAAP financial measure information. Various numbers in this presentation have been adjusted for certain items to provide more comparable data between periods and as an aid to you in establishing more realistic trends going forward. Included in the appendix to this presentation are the reconciliations for such non-GAAP data. We feel that these adjusted metrics provide a meaningful look at our third-quarter performance as well as ongoing financial trends.
Slide 5 agenda for the call. First, Bob Jones will provide an overview of our improved third-quarter earnings results, which include a continuation of many of the positive trends that began in the second quarter. Daryl Moore will then lead the discussion of our improving credit quality metrics. Chris Wolking will discuss in detail our third-quarter financial analysis of certain segments of our third-quarter results. Chris will also discuss the anticipated impact of our most recent sale leaseback transactions. Bob Jones will conclude with our expectations for the remainder of 2007 and then we will open the call for questions.
With that, I will turn the call over to Bob.
Bob Jones - CEO, President
Great. Thank you, Lynell, and let me add my welcome to all of you that are joining us on the call this morning.
I will begin my comments with slide 7 on your presentation. As you all know, this morning we announced earnings of $0.34 per share, which represent a slightly over 13% increase over the prior quarter of 2007 and slightly over 6% over the third quarter of 2006.
The theme for the quarter is much the same as we discussed last quarter. We did see continued improvement in two of our key drivers, credit quality and our net interest margin. We did, once again, see a decline in our nonaccrual loans along with our classified and criticized loans. This decline in conjunction with our overall and continued improvement in the quality of our loan portfolio meant that our ALLL model showed no need for a loan loss provision for the quarter. Daryl, as usual, will give you a more in-depth review later on in the call.
We also did see a 17 basis point increase in our net interest margin for the quarter. This increase is due in part to our continued effort to reduce our dependency on high cost funding, an overall much more disciplined approach to pricing, all of which we have discussed with you in the past. Chris will give you a little more detail on that, particularly as it pertains to building your model for the next quarter.
While we are very pleased with the overall improvements in our earnings, most notably as shown in our ROE at 14.22% and our ROA at 1.15%, I want to assure all of you on the phone that we remain diligent in our outlook for the credit environment. That we're not arrogant enough to think that we can totally escape any of the issues that exist in today's turbulent markets.
While we firmly believe that we have been extremely aggressive in both the identification of weak credits and our proactive approach to caution in the real estate market, I think as all of you know we have no sub-prime lending and we've been amongst the first to limit our exposure to real estate development. We also do realize that we're not totally immune to these challenges and while we don't see any dark clouds on the horizon, we do remain appropriately cautious.
This cautious approach does create some additional challenge for us though and as it pertains to growth. Let me begin with a review of our balance sheet performance on slide 8. As a precursor and [a set] context for our balance sheet, in the categories of commercial loans and leases, which, along with commercial real estate, in the third quarter of 2007, we did see a combined paydown of $319.7 million. Of that, $103.6 million was grade 6 or below credit and these would be our worst-graded credits, 6, 7, 8, and 9, that we worked out of the bank. Again, that was $103.6 million.
Just to put these numbers into perspective, last quarter, we saw paydowns of only $259.6 million. Also on a year-to-date basis, we have seen paydowns in our category 6 loans and below, again representing our worst quality credits of $225 million. So the third quarter represented 46% of our total-year payoffs in these lower quality loans, again a prudent exercise on our part.
Let me give you some additional detail by market to further explain what happened with our balance sheet. We were very pleased that our Louisville and Indianapolis markets did show good growth for the quarter, 7.9% and 3.4%, respectively. These two markets along with Carbondale led the way from a growth perspective. I should also note that our newest market, northern Indiana, did show some slight growth. Albeit very small, it does give us some comfort that we're moving past the integration issues and getting back into the selling mode, and I won't make any jokes about Notre Dame football!
I would like to discuss on three of the markets that did not (technical difficulty) dollars of that decline was due to lines being paid down, the bulk of those lines being agriculture related. None of these relationships left the bank and we have every reason to believe they should borrow again at these levels next year as they prepare for their crops. [In turn], we did exit one credit for $2.3 million, which was on nonaccrual.
In Jasper, we have a slightly different story. $4.4 million of the decline is due to the normal amortization of a municipal lease portfolio, which is really a business that we're not very active in any more. This along with the exit of $4.2 million of those lower grade credits I referenced contribute to the decline in that market.
Bloomington saw the sale of three credits totaling $3.1 million; Daryl will cover those later; along with the unexpected payoff of a public sector credit of $1 million. The message I'm trying to deliver here is that we are in a balancing act in the field. We ask our relationship managers to understand and abide by our cautious approach to lending, many times working and moving credits out of the bank, which requires time.
At the same time, we do want them to appropriately build their balance sheets. Given the uncertainties that exist in the market today, we do believe this approach is prudent. We do not believe this is a time to add more risk to the portfolio, and, quite frankly, we believe just the opposite. Now is the time to remove risk from our balance sheet. We do not believe in growth for growth's sake and I hope you understand that.
Let me turn to slide 9 and take a quick look at our consumer loan portfolio. As a reminder, this slide reflects our traditional consumer loan portfolio. It does not include our home equity product. The vast majority of our consumer sales efforts have been aimed at this traditional product through both a direct-mail basis and the focus of our sales teams. Given that focus, we are pleased that this was the third straight quarter that we have grown our consumer loan portfolio. This growth is a result of the enhanced sales process that Barbara Murphy has put in place in our branches and it's a good indicator that we believe the processes are working.
Let me turn to slide 10 for a quick look at our demand deposits. What I believe we are seeing in our DDA balances is that companies are paying down their lines and loans, as I previously noted, and using their cash versus borrowings monies as the companies do react to the economic environment.
I would point out of particular note was, again, the positive growth in northern Indiana, which is, again, a good indication that our integration has gone well in this very important market. While we did not see growth in our outstandings for the quarter, we did see a net positive inflow for this quarter for account openings. We had a positive 56 for the quarter, which is against a negative 576 last quarter. On a year-to-date basis, we have seen a positive 607 of net new checking accounts, which, again, I believe reinforces the sales process that Barbara has put in place is beginning to work.
Let me turn to slide 11, and I'll give you our customary review of our new branches. As you look at slide 11, let me just point out a couple of key points. As I mentioned at the beginning of the call, we have worked very hard to reduce our high-cost funding and to move away from special accounts. This effort affects these branches particularly hard since many of the promotional accounts reside in our newer offices. Let me give you a brief overview of how the process works and Chris will give you more detail on the impact of these efforts during his discussion on the margin.
Looking at our Caramel, Indiana market, we saw an $11.1 million decline in total core deposits. $7.1 million of that was one account that moved to an off-balance product, which we offered through our treasury group. This is a product that we offer through a third party. It allows us to retain the relationship without having to pay a higher rate. Corporate-wide this has been a very concentrated effort by our sales staff of identifying these very special rate accounts and offering the off-balance sheet product, both as a means of retaining the relationship and serving the client needs. This effort is reflected in the expansion of our margin, as Chris will discuss later. Now it's my pleasure to turn the call over to Daryl Moore, more, our Chief Credit Officer.
Daryl Moore - EVP-Chief Credit Officer
Thank you, Bob. I would like to begin my part of this quarterly presentation reviewing the trends in our Class 5 criticized and nonaccrual loans. As slide 13 shows, classified loans fell during the quarter, showing a decline of slightly more than $1.5 million and the period now stands at approximately $130 million. Eliminating what now appears to be a temporary bump-up in the fourth quarter 2006 and the increase in classified loans associated with the acquisition of St. Joe Capital Bank at the end of the first quarter, this quarter continues our general trend of declining classified loans over the last 14 quarters. Year to date, we have reduced classified loans $23 million, representing a 15% reduction in those outstandings since the end of 2006.
Slide 14 shows our criticized loan trends over the last 14 quarters. As we have discussed in prior calls, our time lines showed good progress resulting from our efforts to reduce criticized loans up into the third and fourth quarters of 2006, where we posted elevated levels. We are pleased to be able to report to you that in the third quarter we continued the progress we made in the first two quarters of 2007 by reducing criticized loans by another $11 million in the period. Year to date we have reduced criticized loans by $41 million, representing a 34% reduction from 2006 year-end totals. As the next slide shows, 90 plus delinquencies in our portfolio were up in the quarter from 2 basis points to 5 basis points of total outstandings. The increase was reflected of roughly $1.1 million in additional outstandings in this category from the prior quarter. One credit in the amount of approximately $1 million accounted for much of the increase. As you can see, we have historically managed our 90 plus delinquencies well and our results compare very favorably to the peer group against which we measure our performance.
As you can see on slide 16, nonaccrual loans fell $9 million to roughly $49 million at quarter's end. During the quarter, we made very good progress with two of the three largest nonaccruals reported at the end of the second quarter. Last quarter's second largest nonaccrual totaled $5.7 million, was collected in full including principal, interest, late fees and costs.
Last quarter's third largest nonaccrual account was a loan in the amount of $5.2 million. In the third quarter we took title to the assets which secure this loan and will be marking these assets for sale before the end of the year. $3.9 million of the $4.3 million increase in OREO at the end of the quarter was related to this account, with an additional $1.3 million moved to the repossessed asset account.
With respect to our largest nonaccruals at the end of the third quarter, we now have only two loans with balances of $2 million or greater. As with any financial institution, we continue to closely monitor our criticized and classified loans. This is especially true in these more difficult economic times where banks are more likely to see a relatively higher incident of deterioration of these assets into the nonaccrual category.
Turning to slide 17, net charge-offs for the quarter were $3.3 million or an annualized 28 basis points of average loans. The net total were $1.4 million of write-downs associated with $4.7 million in loans sold in the quarter. The first nine months of the year, net charge-offs stand at $11.7 million or an annualized 32 basis points of average loans compared to $14.2 million or an annualized 39 basis points of average loans for the same period last year. With the reduction in classified, criticized and nonaccrual loans in the quarter coupled with our controlled net losses, our allowance for loan and lease loss analysis indicated that no provision expense in the quarter was warranted.
As we discussed previously, we continued our efforts to attempt to proactively manage and reduce risk in our lending portfolio and wanted to refresh your memory on some of the steps we have taken over the past several years that we believe will help us manage risk and losses through this next credit cycle.
First, as Bob discussed earlier, Old National does not have a sub-prime lending division nor do we actively seek these types of loans. Second, we have discussed over the last year our purposefully conservative stance on commercial real estate. We would not anticipate any change in this stance in the near future. Finally, we continue to review closely our consumer loan book to make sure we are prepared for any combination of economic weakness or setbacks that could have a detrimental effect on that portfolio.
While we seem to have, at least at the present time, somewhat bucked the trend of increasing credit risk, we are fully aware that we are not immune to the credit cycle which seems to be developing. There is no denying that the current disruption in the market related to the sub-prime mortgage melt-down is significant for our industry. We have and will continue to closely monitor the inevitable impact of this disruption on our bank's loan portfolios. With that, I will turn the call over to Chris Wolking.
Chris Wolking - Senior EVP, CFO
Thank you, Daryl. As I was preparing for our call today, I was struck by the similarities of this quarter's discussion with our presentation to you last quarter. The major trends we discussed in July, improvement in our credit metrics and improvement in our net interest margin, are still in place and drove our strong results in the third quarter. We will begin on slide 19.
Our reported net interest margin improved to 3.37% from 3.20% in the second quarter. In the third quarter, as Daryl explained, we recovered $1.6 million of interest related to a commercial real estate loan. As you may recall from our last conference call, we recovered $1 million in interest related to another loan in the second quarter. If we subtract the impact from both recoveries, net interest income increased to $58 million in the third quarter from $57.6 million in the second and net interest margin increased from 3.14% to 3.28%. The 14 basis point increase and the normalized net interest margin is our second consecutive quarterly improvement of 14 basis points. The normalized margin of 3.28% in the third quarter of 2007 is 13 basis points higher than our third-quarter 2006 margin.
On slide 20, we've broken down the components of our margin improvement. I will take you through these components in more detail. Starting with the 3.20% recorded net interest margin in the second quarter, I have subtracted the 6 basis point lift from our second-quarter interest recovery. As noted earlier, 9 basis points of our third-quarter reported margin was due to the recovery of interest on another commercial real estate loan.
The yield on the investment portfolio increased from 5.10% in the second quarter to 5.19% in the third quarter. Additionally, we reduced our average investment portfolio $184.4 million from second quarter 2007. Subtracting out the impact of the interest recoveries from both the second and third quarters, loan yields were flat at 7.38% quarter to quarter. The change in the investment portfolio, combined with flat loan yields, gave us a 3 basis point lift in the margin due to asset yield.
Interest-bearing deposit costs declined significantly from 3.52% in the second quarter to 3.38% in the third quarter. This reflects the continued deposit pricing discipline by our banking business line managers. The average rate on NOW accounts declined 27 basis points and the average rate on money market accounts declined 25 basis points in the third quarter compared to the second quarter 2007. While the cost of our borrowed funding also declined in the third quarter, the improvement in our net interest-bearing deposit cost was largely responsible for the 12 basis point improvement in our net interest margin related to interest-bearing liability costs.
Change in our liability mix was primarily responsible for the 2 basis point decline in margin due to mix, volume, other. Total core deposits were down $416.4 million on average compared to second-quarter 2007 while total borrowed funds increased $140.8 million on average compared to the second quarter.
The decline in core deposits, however, was concentrated in our higher cost core funding, including certificates of deposit, money market accounts, and public sector customer NOW accounts. We also terminated a relationship with Merrill Lynch, which reduced NOW balances by approximately $60 million during the third quarter. The cost of the Merrill deposit was at a premium to the federal funds rate.
The increase in borrowed funding was concentrated in federal funds purchased and repurchase agreements at rates generally lower than the cost of the core deposits they replaced. We did, however, experience a $15.9 million decline in non-interest-bearing demand deposits, offset partially by an increase in core equity of $8.4 million. We define core equity as total equity not including the adjusted adjustment for OCI. This significant change in the mix of funding contributed to the 2 basis point decrease in margin attributable to mix, volume and other.
The change in the liability mix I noted above, the Company's continued attention to deposit pricing, and the closing of the sale leaseback transactions in the third and fourth quarters of 2007, should provide continued modest margin expansion from the normalized margin of 3.28% during the fourth quarter.
Slide 21 shows the trend in our cost of interest-bearing deposits. When brokered CDs are included our deposit costs, deposit costs declined 12 basis points from second quarter 2007 to 3.47%. We expect that our third-quarter deposit costs will compare favorably to the deposit costs of our peer group.
On slide 22, you'll see that our tangible common equity to tangible assets and tangible equity to tangible assets ratios improved again in the third quarter of 2007. At 6.27%, our tangible common equity to tangible assets ratio is within our 6 to 7% target range. We did not repurchase shares during the third quarter.
We are pleased with the continued improvement in our noninterest revenue. On slide 23, you will note that fees, service charges and other revenue was at $2 million or 5.7% over third quarter 2006. Deposit service charges, investment product fees and mortgage revenue continued to show improvement over 2006.
Notably, on a year-to-date basis, investment product fees are up $2 million or 31% through September 2007 over the same period in 2006. Non-interest income was down $1.1 million from the second quarter of 2007, due primarily to lower insurance agency revenue. The third-quarter decline in agency revenue is consistent with that which we have experienced in previous years during the third quarter.
Moving to slide 24, non-interest expenses were $2.9 million lower than second quarter 2007 and $2.6 million higher than the third quarter of 2006. The third quarter of 2006 included the reversal of $1.5 million of accrued restricted stock expense. Additionally, third quarter 2007 included $1 million of operating expense from the northern Indiana region which we acquired in the first quarter of 2007. These factors contributed to the increase in salary and benefits costs over third quarter 2006.
Occupancy expense is up $400,000 from the second quarter 2007 because we had a partial quarter's lease expense for the branches that were sold and leased back in September.
Slight 25 details the results of the sale leaseback transactions we closed during 2006 and 2007. We've executed three separate transactions since the fourth quarter of 2006. On December 20, 2006, we closed on the sale and leaseback of three of our corporate headquarters facilities. On September 19th, 2007, we closed on the sale and leaseback of 26 financial centers and on October 19th of 2007, we closed on the sale and lease of an additional 40 centers. We expect to close on the sale and leaseback of nine more financial centers before the end of the year.
We lease these facilities for terms of 10 to 25 years. The total gain on the sale of these facilities is approximately $122 million. It is important to understand that the majority of this gain is deferred and will be amortized over the terms of the individual leases with only approximately $5.6 million to be recognized in 2007. We anticipate recognizing a gain of $3.8 million related to the October 19th transaction and a gain of approximately $1.2 million on the remaining nine financial centers that should close later in the fourth quarter.
I should note here that we expect to use these gains to offset other expenses in the quarter. Cumulatively, the three transactions that have already closed generated $213.9 million in cash, after tax and other selling expenses, which was used to retire wholesale borrowing during 2007. Most of the cash was used to call brokerage certificates of deposit with costs ranging from 5% to 5.5%. As I noted earlier, we also terminated a $60 million deposit relationship from Merrill Lynch, which cost about 5.5% at the time we terminated the relationship.
The remaining transaction that should close before the end of 2007 is expected to generate an additional $12.5 million in cash, which we also expect to use to reduce wholesale funding.
We've detailed the first full-year impact of these transactions and the remaining bullet points on slide 25. Amortization of the deferred gain of $6.4 million, the savings in depreciation expense of approximately $5 million and the earnings on the redeployed cash of approximately $11 million are the positive impacts of the transaction. Of course, this is partially offset by the new lease expense of $20 million for the full year.
It is important to note that we used an earnings rate of 4.75%, representing the current federal funds rate to calculate the expected earnings on the cash. We believe that this is conservative given the manner in which we've used the cash thus far, but we felt it was an appropriate rate for this illustration. Overall, the transaction should have a favorable impact on earnings of $2.4 million pretax or approximately $0.025 per share annually.
Finally, you'll note that we are still holding eight additional financial centers as available for sale that we expect to be subject to the future sale and leaseback transactions. While these transactions have obvious financial benefits for the Company, it is important to note that they allowed us to make $1.6 million of property improvements to several of our facilities. The improvements include new roofs, resurfaced parking lots and interior upgrades.
My financial managers, Joan Kissel, our Controller and Doug Gregurich, our Tax Manager, both of whom were instrumental in completing these transactions, and I, are available today after the call to answer any follow-up questions you may have on the sale leaseback.
With that, I will turn the call back to Bob Jones for final comments.
Bob Jones - CEO, President
Great. Thank you, Chris. I'm going to be brief in my closing and using slide 27. I just hope that everyone on the call gets the sense of our firm commitment to the three strategic imperatives that we have operated under for three years. At the base is our need to continue to improve and maintain a strong risk profile followed by the need to continue to enhance our management discipline, both of which will lead to our ultimate goal of providing a consistent quality return to our shareholders in terms of earnings. Simply stated, we would love to be known as being consistently boring. Clearly, we are not there yet but I think we've taken some major steps towards that goal. I also believe it would be very easy to deviate from that strategy during difficult times. We believe in just the opposite -- consistency is the key to better execution.
With that very short editorial, let me say that we still remain comfortable with the guidance we gave you for the full year. Our full year earnings should be between $1.11 and $1.17. As you begin to think about 2008, we will be giving guidance on our January call for the full year.
With that, we will happy to open up to any questions you might have.
Operator
(OPERATOR INSTRUCTIONS). Scott Siefers, Sandler O'Neill.
Scott Siefers - Analyst
I guess I had a couple of questions just on credit. First, the loan sales from this quarter -- were those all non-performing loans?
Bob Jones - CEO, President
Yes, they were.
Scott Siefers - Analyst
Okay. And how are you finding the market for secondary loan sales, just given all the dislocation that we saw during the second quarter?
Bob Jones - CEO, President
Scott, it's interesting what we have found as we continue to talk with our loan sale advisers is, that everything exclusive of 1 to 4 family residential loans, there still appears to be a fairly vibrant market for them. Pricing may be off slightly, but not materially. If you've got residential 1 to 4 family development acquisition, development projects, they are trading probably at about $0.50 on the dollar, so many banks are not even putting those into loan sales. But that seems to be today the only segment that's been hit very hard.
Scott Siefers - Analyst
Okay, excellent. And then, I might hop back on, but I think that should do it for now. Thank you.
Operator
Erika Penala, Merrill Lynch.
Erika Penala - Analyst
Daryl, I just wanted to pick your brain about how we should think about reserves going forward. I know that the formula didn't cause you to report a provision this quarter, but it seems like the tone is appropriately cautious going forward. So how should we think about reserves?
Bob Jones - CEO, President
Erika, if you don't mind, I might chime and then let Eric or Daryl fill in the blanks. But I think that's in part why we want to hold of till January to give guidance for 2008. And I want to assure everybody on the phone, we don't see any dark clouds. And again, as I think you all know, we've been conservative, but I think we are being appropriately cautious. We also would be naive to think that we won't return to some normalization of credit costs as we begin to think about 2008. Daryl?
Daryl Moore - EVP-Chief Credit Officer
I don't have anything to add in there.
Bob Jones - CEO, President
I hope that answers the question.
Erika Penala - Analyst
Okay.
Bob Jones - CEO, President
And we'll be able to give you a little more color as we move to the January call.
Erika Penala - Analyst
And also, my other question is on the expense line. Efficiency management was excellent this quarter and should we -- excluding the occupancy expenses that are going to come online because of the sale leaseback, is this a consistent run rate to look forward to?
Bob Jones - CEO, President
I think, Erika, it's a good first step. I think we realize that we need to continue to look at our expenses and continue to be more prudent with our spending. So again, in '08, in January, we'll give you a little more guidance. But we realize that while it was a good first step or a couple steps for efficiency, we've still got some opportunities there.
Erika Penala - Analyst
Okay. Thanks for taking my call.
Operator
Charlie Ernst, Sandler O'Neill.
Charlie Ernst - Analyst
Just to follow-up a little bit on the expenses, it looks like the communications expense was down $0.5 million or so in the quarter. Can you add any detail there?
Bob Jones - CEO, President
I would say some of that may be related to St. Joe in the second quarter. But again, it's just prudent watching of expenses. I think that -- remember in the first quarter we put in some pretty good tight controls and a lot of that begins to show its full commitment in the third and quarters beyond.
Charlie Ernst - Analyst
Okay, and then the "Other" expense line was also, had a pretty good quarter. And I might be including a bunch of different things in there, but I guess the bottom line is you feel like this is a decent number to run off of other than the increase in occupancy.
Chris Wolking - Senior EVP, CFO
Charlie, this is Chris Wolking. I think that too, when you look just a little bit, I think in quarters past we've talked about 40-ish, $40 million to a little bit higher than that for salary and benefits. So we had a little bit of a benefit here I think in the third quarter. But as Bob said, I think it's continued attention, continued management of those expenses and we feel pretty good about our continued ability to keep a lid on expenses, but there's always work to be done.
Charlie Ernst - Analyst
Okay, and then I think you guys touched on the margin briefly, saying that it would be -- you think it's going to be up some. Can you add some color, especially given the rate cuts?
Chris Wolking - Senior EVP, CFO
I'll tackle that one, too. As you've seen from our previous SEC releases, we are still slightly liability sensitive but not nearly what we have been in years past. So we feel like we will still have some incremental benefit here from rates declining, but not significantly. I think the real benefit to the margin and the fundamental changes that we've made in our deposit pricing, continued attention to keeping an efficient balance sheet, if you will; making sure we've deployed our funding appropriately and into good assets; and the benefit from the sale leaseback. When you look at the sale leaseback transaction and the impact on the margin, just on the margin itself, when you think of that significant redeployed cash, it will be a nice lift on the margin going forward. But of course, that's offset by a lot of the occupancy expenses related to the transaction, itself.
Bob Jones - CEO, President
We just add for modeling purposes, I think as Chris said, I would suggest to use the 328 for the third quarter, but as Chris and I both said, you should see modest expansion of that margin as you look at the fourth quarter.
Charlie Ernst - Analyst
Okay. And then lastly, can you just comment on the tax rate? It's been very volatile this year. What's a good tax rate to be thinking about for you guys?
Chris Wolking - Senior EVP, CFO
Taxes themselves, we don't expect significant changes going forward. It's -- I can't give you too much more color on that, Charlie.
I'll be happy to address that question off-line if we feel like it's appropriate. I'm not prepared to deal with -- to answer that question right now.
Bob Jones - CEO, President
I think for modeling purposes, '07, as you look forward, really is not an anomaly at least in the short-term.
Charlie Ernst - Analyst
So if I take kind of year-to-date you're around 30% on an FTE basis, then that's probably not too bad to be thinking about?
Chris Wolking - Senior EVP, CFO
Yes, that's not too bad at all.
Bob Jones - CEO, President
Yes, yes. Continue to benefit from previous year's losses and such.
Charlie Ernst - Analyst
Thanks a lot, you guys.
Operator
Michael [Cohen], [Sinova].
Michael Cohen - Analyst
Thank you for taking my question. I just had a couple of quick questions. You guys are sort of kind of taking a sort of dual-pronged approach to this sort of view of credit in a sense that all your hard work seems to continue to pay off, yet you're sort of mindful of kind of a good economy. Can you provide maybe any more color I mean in a sense of the nature of the types of loans that you guys have originated over the past year and a half to two years? The diversity of such, maybe that gives you some confidence or the sort of loan to value that says kind of okay yes, things are going to normalize. But you keep saying you don't see anything on the immediate horizon.
Bob Jones - CEO, President
We say we don't see major dark clouds. I don't want anybody to get the sense we're not going to have any challenges. But we do believe we've got the right controls. I think Daryl can give you a little more color.
Daryl Moore - EVP-Chief Credit Officer
Yes, Michael, let me tell you, as Bob said earlier and as we've said on prior calls, we, a year plus ago, decided that the commercial real estate area was really not something that we want to take a lot of risk in. And although we did originate some commercial real estate loans, our underwriting was if you'll just look at the deals that we lost, was a lot more conservative then what was going on in the market. So we didn't put a lot of commercial real estate loans on the books.
The stuff that we were putting on was mainly commercial and industrial. We had some consumer growth. It was really pretty plain vanilla stuff. We didn't do a lot of residential subdivision lending. We didn't do a lot of commercial real estate construction or land development lending. So we think that at least right now, those are segments that we see some weakness in, in the book that we've got, but we don't have a lot of new exposure and I think that's where a lot of banks are getting into problems is on the new exposure. So I think that's why you hear us saying we are -- we're glad we've got the portfolio we have. We're glad we addressed the risk when we did, but we are not immune because the existing projects we have, and some of those customers on the C&I side that have some sort of tangential exposure to the 1 to 4 family real estate markets, are probably going to show some weakening over the next couple of quarters. And we just realize that and understand that that's going to affect our portfolio.
Michael Cohen - Analyst
Sure, that's helpful. You had also mentioned, I think you said in terms of loan sales, was it NPAs of construction, development or trading at $0.50 on the $1.00 or just any construction and development loan for trading at $0.50 on the $1.00?
Daryl Moore - EVP-Chief Credit Officer
You know, what the guys are saying is the 1 to 4 family acquisition and development loans that are troubled are trading at $0.50 on the $1.00. Those, you have to keep in mind, are very interesting loans because when you have a residential acquisition development loan that is showing some weakness, you've got a lot of slow absorption. And when you've got slow absorption, you have to look at your interest reserves. And then that translates back to the value of the project. So if you've got a project like that that is significantly behind where you thought it was going to be, there aren't a lot of those projects that are going to have more than a couple of quarters on them that aren't going to go to non-performing. So I think when they talk about that, they are probably talking about the non-performing but there are going to be a lot of those types of loans that are going to slip to that category.
Michael Cohen - Analyst
And can you just refresh our memory as to sort of the total size of your [C&D] book and the NPAs in that book? And kind of where you -- you're sort of alluding, is that where, over the next two quarters or a few quarters you might expect to see the NPAs creep up?
Daryl Moore - EVP-Chief Credit Officer
I think that if you look at the riskiness of any bank's portfolio, I would say that, yes, that would be the first portfolio where you would show nonperformers probably creep into that risk profile. I don't have all our statistics today. We can follow back up with you on the total dollars on the NPA in that portfolio.
Michael Cohen - Analyst
Great. And then, I don't know if you guys have a kind of near-term outlook. There certainly have been banks buying in the Indiana market. Can you sort of give an update kind of on your thought process and your kind of appetite for M&A within Indiana? Or would you be looking to kind of go to contiguous markets outside of Indiana?
Bob Jones - CEO, President
Yes, we've been pretty forthright about really wanting to concentrate on Indiana and we would include the Louisville market as part of that, but Louisville north up by 65.
A lot of chatter in the market. We continue to do a lot of dating, but as my team has heard me say, much like my dating career in college, I wasn't very successful. So I'm still just doing a lot of conversations. Nothing imminent. We continue to be open to any opportunities, particularly as it pertains to the state of Indiana.
Michael Cohen - Analyst
Okay, great. Thank you so much for your time.
Operator
(OPERATOR INSTRUCTIONS). Stephen Geyen, Stifel Nicolaus.
Stephen Geyen - Analyst
Just a quick question on the insurance premiums. Looking at Q4 or going back to Q4 of 2006, there was a big jump. Is there something seasonal that occurs there or is something completely different?
Chris Wolking - Senior EVP, CFO
Yes, Stephen, there was a -- we used -- had a reclassification of certain income associated with our insurance operation that was classified from other income into insurance premium, so that accounted for that increase.
I think generally speaking, the insurance agency, the insurance market in the Midwest is still suffering through a fairly soft market. Pricing is difficult right now relative to previous years. Plus in 2006, we had a weather event through Indiana that reduced our contingency revenue for 2007. So generally speaking, 2007 has been a difficult year for our agency relative to previous years.
Stephen Geyen - Analyst
Okay. And just if you can give me some thoughts on local economies. The commercial -- certainly, commercial real estate is probably hurting all over Indiana. Just C&I, if C&I is particularly stronger into some areas versus others? And consumer -- how the consumer is behaving, looking at Evansville, Louisville, Indianapolis, northern Indiana.
Bob Jones - CEO, President
Sure. I would say that we are not immune to some of the challenges, but we are clearly not in the same state of an economy as our joining states of Ohio and Michigan, in particular. We do see moderate growth in most of our markets. We have not seen some of the challenges that we've seen again as I said in Ohio and Michigan.
Indianapolis has probably been a little more pressured in the housing and commercial real estate side. We are hearing and seeing some challenges there. Louisville has been just the opposite. Louisville continues to have a very good economy.
So I would just characterize the economy in our markets as okay, not robust, but again we don't have the significant challenges that we see in some of the other Midwest states.
Stephen Geyen - Analyst
Okay, thank you.
Operator
(OPERATOR INSTRUCTIONS). There are no further questions at this time.
Bob Jones - CEO, President
Great, Laney. Again, for all of you, if you have any further questions, call Lynell or Chris or myself and we thank you for your time and we look forward to talking to you in January.
Operator
This concludes Old National's call. Once again, a replay along with the presentation slides will be available for 12 months on the shareholder relations page of Old National's website at www.OldNational.com. A replay of the call will also be available by dialing 1-800-642-1687, conference ID code, 20645931. This replay will be available through November 12. If anyone has additional questions, please contact Lynell Walton at 812-464-1366. Thank you for your participation in today's conference call.