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Operator
Good morning, ladies and gentlemen, and welcome to today's Mercantile Bankshares' conference call. At this time, all parties have been placed on a listen-only mode, and the floor will be open for questions and comments following the presentation. (OPERATOR INSTRUCTIONS). It is now my pleasure to turn the floor over to David Borowy, Director of Investor Relations for Mercantile.
David Borowy - Director of Investor Relations
Thank you, Dina. Good morning, everyone, and thank you for joining us today. I would like to inform you that this call is being recorded and will be available for replay along with our earnings release at our Company's investor relations web site, www.Mercantile.com.
With me on the call this morning are Ned Kelly, Chairman, President and CEO of Mercantile Bankshares Corporation, Terry Troupe, our Treasurer and CFO, and Ellen Harvey, Sr. Vice President and Portfolio Manager. Before I turn the call over to Mr. Kelly, I'd like to address some housekeeping matters. The press release announcing our earnings was distributed via PRNewswire at 7:02 AM eastern daylight savings time. I'd like to remind you that t during the course of this conference call, we may make forward-looking statements within the meaning of and pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. A forward-looking statement may encompass any estimate, prediction, opinion or statement of belief and the underlying management assumptions. Forward-looking statements are based on current expectations and assessments of potential developments affecting market conditions, interest rates, and other economic conditions, and results may ultimately vary from the statements made during this call. In this call, we will discuss some non-GAAP measures in talking about our Company's performance. You can find the reconciliation of those measures to GAAP measures within our news release, which is posted in the investor relations section of our web site. I now present to you Mr. Ned Kelly.
Ned Kelly - Chairman, President and CEO
Thank you, David. This morning, I'd like to walk through the most important points in my view in the earnings release. I am then going to ask Ellen Harvey to discuss our securities portfolio for several minutes, just because there have been a number of questions that have arisen on an industry basis with respect to bank securities holdings, and I thought it might be helpful for us to walk through that. And then we would open it to questions. During my discussion, I also plan to talk a little bit about F&M because I know that's a source of interest to many of you.
As you know, this quarter's release includes a fair amount of noise from F&M; that's unavoidable in the context of the acquisition. We're going to do our best to be clear, going forward, and have done our best to be clear in the context of this release. As you know, the headline was that we reported 63 cents, which was a penny ahead of our preannouncement of September 22nd, and that was due principally to a bonus reversal of the holding company. Everything else was by and large in line with the pre-release. As you know, the factors that drove the decline in earnings this quarter was our decision not to take any securities gains, severance expenses and investment in wealth management, merger-related charges with respect to F&M, and margin compression.
In order to achieve some clarity and to cut through it, given some of the noise that we've got, we've actually reported an operating earnings number as well, which you can see in the press release. That number was 67 cents for the third quarter; it was 70 cents for the third quarter last year and 68 cents for the second quarter.
That operating earnings number, as you know, backs out amortization of intangibles, securities gains, and merger-related expenses. Embedded in that operating earnings number, however, is the severance charge. It is reconciled on Page 12 of the release because that is a non-GAAP number, but as I said, given the amount of -- or the number of unusual factors affecting our earnings this quarter, and potentially going forward, we thought it would be helpful to include it.
On a core gross basis, X-F&M, and this may be, frankly, the last time I do it because it's going to be extremely difficult to do going forward -- Mercantile's assets were up 11.1 percent year-over-year; they were up 2.28 percent on a linked-quarter basis; loans were up 6.88 percent year-over-year; they were up 1.79 percent on a linked-quarter basis; and deposits, which have grown 7.28 percent year-over-year, were by and large flat second to third quarter. And that connection, I might note that our loan to deposit ratio at the end of the period was 88 percent. And as we have discussed before, and to some extent discussed in the announcement, we are very liquid. We have lots of liquidity. The fact is that loan demand has not been as strong as I would like, although there has been growth; and we have not been aggressive in soliciting deposits, which explains the decline in the growth there. Although as you know, for the last several quarters, deposit growth has been beyond everyone's wildest dreams.
On the margin compression, we detailed the factors that drove the margin compression this quarter in connection with the pre-announcement. Frankly, based on some of the other releases that I have read recently, it doesn't seem to be out of line with banks that we think of as being similarly situated. The principal driver of it has been the fact that our low-cost liabilities are less valuable in this environment. The fact that we have as many demand deposits as we do and as much capital as we do, which serves us well in most contexts, is obviously not as big a benefit in an environment that involves historically low rates. Spreads have actually held up reasonably well, which I think is a testament to the strength of our clients' base and the efforts of our bankers.
The interesting thing is that the volatility in interest rates during the third quarter, and to some extent, as you all know, has continued, drove refinancings, not so much in the commercial portfolio in the third quarter as in the consumer and the residential real estate portfolios, which is not surprising. And that obviously contributed to the compression.
Based on current market conditions, and obviously, I am no soothsayer in this respect, we would expect the net interest margin to begin to stabilize during the fourth quarter.
On the credit quality front, there was there was some marginal deterioration. NPAs were up rough numbers $13.5 million; 3.5 million of that is from F&M. On a Mercantile-only basis, again on a core basis, they were up about $10 million. There was one loan which basically accounted for that, although I will say that there were some smaller loans that moved in and out; but one loan effectively accounted for the increase, which was a loan to the Air Pollution Control Systems Company which had been in monitored status in the second quarter, and which we had disclosed, but moved to nonperforming in the third.
Monitored loans were down $4 million. That was in large part because of the movement of that Air Pollution Control Company loan to nonperforming status. That migration was offset by some additions, the principal one being a loan to a nursing home by one of our affiliates in the amount of about $6.5 million. Charge-offs were consistent with our low historic levels. I believe they were 12 basis points for the third quarter.
The allowances at 1.73. That is lower than we reported historically. Not surprisingly, that is attributable to the inclusion of F&M, which had a lower allowance, and as you know, lower levels of nonperforming loans. It is down from close to 190 historically; it is now 1.73, as I said, with the consolidation of F&M. The coverage of NPAs, it is still at more than three times.
Thirty to 89 days, which is a number that we focused on in the past -- were up 12 million on a linked quarter basis. Just so everyone understands, 9 million of that was from F&M. So by and large, the number with respect to Mercantile was stable.
As you know from the release, non-interest income was up strongly. Investment and wealth management was up 20 percent year-over-year; up 2 percent on a linked-quarter basis. Non-interest expenses were also up. As you know, that was due largely to F&M, which we're now including and to the IWN (ph) severance. If you back out both the impact of F&M and the IWM severance, salaries and benefits in particular were very much controlled on a linked-quarter basis.
A few minutes on F&M, we believe that is going very well. We plan to integrate the acquisition operationally this coming weekend. We have run a few tests in connection with the operational integration; they have gone well. Absent and act of God, we expect no surprises in the coming weekend, and should be fully operationally integrated next week. We expect merger related charges of roughly 3 to 5 cents in the fourth quarter. At that stage, they should be over as a material matter; it may be that there are drips and drabs in the first quarter of 2004; but I think the merger-related expenses should be behind us in the fourth quarter. We expect to begin to realize cost-saves in the fourth quarter, and really predominantly into early next year. But we're very much on track for reaching the cost-save targets, and in my own mind at least, we are actually ahead of schedule in terms of how well the integration has gone.
As you know from the release, and as we said in the pre-release as well, on a shares basis, that is in terms of the shares that we issued to do the transaction, F&M is already non-dilutive. There is 1 cent of dilution associated with the debt that we issued to finance the cash portion of the acquisition; I think given F&M's -- the strength of F&M's earnings, which have not only been stronger than we predicted when we did the deal earlier this year, but also we're, from our standpoint, very strong during the third quarter. It is remarkable that in the absence of any cost-savings that there's only 1 cent dilutive, and that is attributable to the debt. If in fact we can realize the cost-saves, I don't think it takes much effort to do the math and conclude that all things being equal, we should be more than able to offset the dilution associated with that debt as we go forward.
With that, and as I said, I think there are very few surprises, if you will, in this release, given the pre-announcement, since there's a very close relationship between the two, I will stop, turn it over to Ellen, who will spend some time going through the securities portfolio. And then after that, we would be happy to open it to questions.
Ellen Harvey - Chief Financial Accountant
Thank you. In the fall of 2002, we initiated a review of the bank portfolio with the (indiscernible), looking at ways to enhance the return on it. As most everyone knows, we were in a low-rate, low-loan demand environment. and our holdings of mortgage-backed securities at that point in time were minimal versus peers that had as high as 65 percent in mortgage-backed securities. We're looking for a way to increase the yield on the portfolio without increasing the interest rate risk. As you know, the investment portfolio serves as a source of liquidity first and then as a provider of incremental income. We had set a target with that in mind of 40 percent in treasuries, 20 percent in agencies and 40 percent in mortgage-backed securities. Treasuries would be our first liquidity piece, that is they are the most liquid. Agencies, higher yielding, but settlement, taking a couple days more, and then mortgages. With this in mind, we set about implementing this target throughout our affiliate portfolios, but allowing the affiliates to modify this range slightly for their own needs.
Currently, the investment portfolio, with F&M is made up approximately of 29 in treasuries, 22 percent in agencies, 44 percent in mortgages, 4 percent in municipals and 1 percent in other. The mortgages are made up as follows -- 6 percent in pass-throughs, 19 percent in adjustable-rate mortgages, and 19 percent in collateralized mortgage obligations. This represents a change going back to the end of 2002, where mortgages were less than 15 percent of the portfolio, and the treasuries were 45 percent of the portfolio. We have attempted to make this change on a fairly even basis such that if you look at a picture of the history of the portfolio composition, you can see treasuries coming down incrementally quarter-by-quarter from the high of 45 percent to 29 percent -- now, mortgages increasing over that time period and agencies remaining about the same.
We've implemented guidelines for purchases of mortgages-backed securities to make sure that we protect the portfolio. In general, we're looking to buy securities that trade around par, that have a shorter duration, that have shorter types of collateral -- that is 15-year pass-throughs as opposed to 30-year, that are agency in nature, and that have limited extension risk, which we're trying to control, again, through the types of collateral and through the structure of the individual securities. Importantly, we're not using leverage in these -- in holding these securities. We did have leverage in the first quarter when we prepurchased mortgages against upcoming maturities. Since then, however, that is not the case.
With respect to the interest rate risk of the portfolio, we prefer to use duration as a better measure of interest rate risk than average life. And what we have done is to look at the current duration of the portfolio as well as what it should look like in changing interest rate environments. Currently, the duration of portfolio is about 2.3 years. If interest rates decline 50 basis points from here, the duration of the portfolio should go to 1.9 years. If interest rates move up 100 basis points, the duration should increase to 2.8 years; up 200 basis points, to 3.1 years. So if we have a 200 basis-point increase in interest rates, the duration of the portfolio should extend only 0.8 of a year. At the moment, the average life of the portfolio is 2.7 years. We have done some analysis to see what the addition of mortgage-backed securities has done to the portfolio; and it has generated incremental returns, overall, for the year-to-date. I repeat again that there is no leverage in using these mortgage-backed securities or holding these mortgage-backed securities. And currently, we are adding mortgage-backed securities only as more maturities and paydowns occur.
So those are my comments.
Ned Kelly - Chairman, President and CEO
Thanks, Ellen. The only thing that I would add to that, and frankly just highlighting points that Ellen made, are that the securities portfolio for us is 25 percent of interest-earning assets, which I think is relatively conservative -- with respect to peers.
As Ellen mentioned, we have 44 percent of our portfolio in mortgages, which is also relatively conservative with respect to peers. Just to stress again what Ellen has said -- we have no -- repeat -- no leverage, with respect to the portfolio. There was a brief period at the beginning of the year when we made some repurchases that leverage has since expired. We have in fact bought the mortgages by substituting them for securities that were previously held in the portfolio. My own view for what it's worth, and we have done this analysis, is that we are better off today -- having done what we did than we would have been had we continued to follow the policy of the past, which was basically (indiscernible) treasury.
The other thing I would mention is, and I think is in the release is, that the gain on the portfolio was $45 million at the end of the second quarter; it is 32 million at the end of third. As we mentioned in the pre-release, we did have, as everyone else did, mortgage prepayments, during the course of the third quarter. We believe we have continued to be short (ph), conservative, very attentive to the interest rate risk, and I think as with most other things at Mercantile, we're very conservatively positioned.
I would be happy to answer any questions at this point.
Operator
Thank you. (OPERATOR INSTRUCTIONS) Our first question is coming from Roz Looby of CSFB.
Roz Looby - Analyst
First, I'd like to thank you for providing more detail on the securities portfolio; it is extremely helpful. I wanted to follow up on your overall interest rate positioning after the end of the quarter and with the close of F&M.
Ned Kelly - Chairman, President and CEO
I think our overall interest rate positioning Ross, as you know, the good news and the bad news is that we continue to be very long (ph) liabilities. That obviously positions us well for a rising rate environment. It will continue frankly to make life more difficult than I would like it to be, if current interest rate conditions persist. As you know, there have been some signs of a long end moving, very little sign of the short end moving. Not clear to me, given the political and economic environment, when there might be a movement in the short end. So we are braced, if you will, for a continuation of the current environment. We do believe that if that continues, the net interest margin should begin to stabilize at this level. Having said that, if rates rise, we're all going to be extremely pleased.
Roz Looby - Analyst
That helps. One more question on the margin and then I have one on F&M. Last quarter, you did mention what the contribution was from the fund to funds (ph) to the net interest margin; I think it was 1.7 million. What was it this quarter?
Terry Troupe - Chief Financial Officer and Treasurer
Slightly under $1 million -- around that number.
Ned Kelly - Chairman, President and CEO
It was smaller, Ross.
Roz Looby - Analyst
Okay. Thanks. Regarding F&M, you mentioned that earnings having been coming in above your expectations there. What drove that in the most recent quarter?
Ned Kelly - Chairman, President and CEO
Ross, the interesting thing is that F&M provides us with a in some respects, a little bit of a hedge going forward and one indication of that is that they have a mortgage banking business and more of one than we ever had. And that clearly helped them during the course of the third quarter. Having said that, as you know from my previous comments, we see enormous opportunities given the complementarity of the two franchises. I think in general, they have done better on the retail and the consumer front than we have. I think we have done better on the commercial front than they have. I think early signs are, as we have integrated this thing and as you know, done our level best to make sure that we maintain the local touch with customers by dividing it up on a geographic approximate basis, that we should be able to realize those inherent synergies.
As you know, X- the synergies, as I said, if you just look at on a shared basis in connection with the debt we issued, we're already in my view, doing very, very well with it. The fact is that if we can realize the cost saves, even if we don't do another thing on the synergy front, we will be very well served.
Roz Looby - Analyst
Okay, great. Thanks, very much, guys.
Operator
Thank you. Our next question is coming from Gerard Cassidy with RBC Capital Markets.
Gerard Cassidy - Analyst
You may have touched on this, but I apologize if you did. On the duration numbers that you gave us in terms of rates going higher or lower and how the portfolio will extend out or shorten up, what interest rate are you guys referring to when you talk about rates going up or down 50 or 100 basis points? Is it the short-term rates?
Ellen Harvey - Chief Financial Accountant
We have been using a parallel shift in the curve; but for purpose of the portfolio, the five-year treasury is really the key rate.
Gerard Cassidy - Analyst
Great. Also, can you refresh my memory, Ned, on the cost savings, how much you a think you'll get in total? And then how much maybe in the fourth quarter and the rest in '04?
Ned Kelly - Chairman, President and CEO
Twenty-six-and-a-half million was the original number, Gerard. And with respect to the timing of it, that is a little bit difficult to predict. We will clearly realize some of it in the fourth quarter as we begin to roll off personnel, for lack of a more delicate term. And we will probably realize -- begin to realize -- the bulk of them in the first quarter of next year. And then I would have thought, frankly, based on everything I understand today, that by the second quarter, we should be pretty much there.
Gerard Cassidy - Analyst
Okay, and then finally going back to the investment portfolio, the targets that you guys established now that it seems to be out of kilter with your original targets -- do you expect to go back to that target level? If you do, when do you think you'll get there?
Unidentified Speaker
Gerard, you know distorted is too strong a word; but what changed the balance was the inclusion of F&M. And X-that, we had been pretty religious about in fact following the allocations. We are going to go back to the balance that we had in mind. The one confounding factor, and that is the municipals, and we're taking a hard look at those, we didn't hold any; they held a relatively substantial amount. As you know, that is 4 percent I think currently of the portfolio. But we are going to try to re-achieve the balance that we all agreed upon as a prudential (ph) matter. And my guess is that we will be able to do that relatively shortly.
Operator
Robert Lacoursiere of Lehman Brothers.
Robert Lacoursiere - Analyst
I was wondering if you could just announce -- I apologize if I wasn't paying attention on this -- on the asset quality -- on the inflow of non-performing assets. How much of it was directly the result of F&M?
Unidentified Speaker
Three-and-a-half, Robert.
Robert Lacoursiere - Analyst
Three-and-a-half million? And then, if you could comment on -- is there still aircraft leasing in the monitor?
Ned Kelly - Chairman, President and CEO
Yes, there is. That has been there now -- somebody will quickly correct me if I'm wrong -- for three quarters. My view, for what it's worth, it'll stay. It's been performing, it's fine; but I'm going to keep it there for obvious reasons. That is left numbers (indiscernible) $18 million of the 30 that's currently there.
Robert Lacoursiere - Analyst
Okay, has your view changed on expected loss rates on any of these things that have gone into monitored status or ultimately gone in NPAs?
Unidentified Speaker
No.
Robert Lacoursiere - Analyst
On the other income line, which you guys explained, apart from the bit that comes from insurance and F&M and other income, there was still a pretty good rise. Could you give us some color on that and the sustainability of it?
Ned Kelly - Chairman, President and CEO
I hope that it's going to be sustainable. As you know, the bulk of it essentially comes from investment and wealth management. And that becomes even more stark when you back out the securities gains. I think we're doing better there for a couple of different reasons. I think we have got increased focus; we've obviously been helped by the market; and the acquisitions that we did I think are performing very well. So I hope it is going to be sustainable. We obviously have got some more diversification as a result of F&M, in terms of the insurance business, which actually had made a contribution during the course of the quarter. But as you know, that has been a focus of mine and will continue to be a focus to in fact sustain that contribution. from non-interest income.
Robert Lacoursiere - Analyst
Thank you.
Operator
Our next question is coming from Todd Hagerman of Fox-Pitt, Kelton.
Todd Hagerman - Analyst
Good morning, everyone. Thank you. Ned, a question for you if I could on the staff and incentive compensation expense. One, could you just detail -- I think you mentioned the bonus accrual reversal in the quarter -- the amount there? Two, is there going to be any residual effect in terms of the severance related and wealth management? And then three, if you could just kind of maybe update us in terms of how you are thinking the incentive comp, particularly with the stock options. It's been a factor the last couple of quarters, and just how we should think about it, on a go forward basis as you start to recognize the cost saves on the incentive comp line.
Ned Kelly - Chairman, President and CEO
Let me take that in pieces. One is, as you know, our compensation system, by and large, with very few exceptions, is based on growth in earnings per share. That has been true historically; it has continued to be true. When I arrived, I drove that compensation down more deeply into the organization, changed certain facets of it. But the organizing principle continues to be growth in earnings per share, especially when you think about earnings this year in connection with the merger-related charges and some of the other things that we've had happen. It was clear that there were simply not going to be bonuses payable at the holding company. Terry will correct me if I'm wrong; but I think the reversal of those bonuses added a penny for purposes of the quarter, roughly $1 million year-to-date, terry if I'm not mistaken. That is a decision we made in the face of the facts. With respect to investment and wealth management, I can't tell you that there won't be any more severance charges because there may be. What I think I can tell you is that there are unlikely to be any more material severance charges. We have a team in place; my expectation is that it will remain in place. We may make changes to the margin that involve relatively immaterial severance charges; but I certainly don't expect any major ones going forward.
And I think with respect to the stock, as you know, the volatility that has been generated has been by the directors-deferred program, by and large. That has been the biggest number. My recollection is, there was 1,000,007 in the second quarter; I think it's $550,000 in the third quarter. That is something because of the structure of it that we're not really very able to control. Terry and I have looked at various points as to how we might insulate the P&L from that kind of volatility, you know, given the nature of it. We're still working on that. Until we figure out how to do it, unfortunately, it is still going to generate that volatility.
With respect to the mix, as you know, of equity and stock options, Mercantile has expensed stock options since 1994. We continue to do so. I have made it one of my interests to try to get as much equity into people's hands in the form of compensation as I can. And one of the other changes I made in the compensation plan is that beyond certain levels, people began to receive stock rather than cash. I think that's a good thing. If I had to bet going forward, based on conversations with the compensation committee and what I see elsewhere, there will be more emphasis on restricted stock than options than there has been in the past. But as you know, we have not been profligate with either.
Todd Hagerman - Analyst
Okay. That is very helpful. I appreciate that. If I could, is there anything -- you just assuming the stock price remains relatively stable, is there any more overhang that we should be aware of kind of near term, as it relates to any kind of lumpy expense within the next quarter or two?
Ned Kelly - Chairman, President and CEO
No, not that I'm aware of. I mean, the directors deferred, unfortunately, as I said, bounces around with the stock price and it bounces around based on where the stock price was at any given point, if you see what I'm saying. So that is what it is. With respect to anything else, no, I'm not aware of anything else unusual in that respect or that would otherwise be lumpy. The lumpiness this quarter, frankly, (indiscernible) generated by severance in investment and wealth management, which to be blunt about it, did not work out; was my mistake.
Todd Hagerman - Analyst
Okay. Thanks very much.
Operator
Thank you. Christopher Marinack with FIG Partners.
Chris Marinack - Analyst
Question on the reserve policy going forward, particularly as it pertains to provision expense. As the portfolio of loans grows, in hopefully a stronger economic environment in the future, will you simply cover the provision with charge-offs? Or will you intend to grow the reserve?
Ned Kelly - Chairman, President and CEO
Chris, with some exceptions that I can think of over the last few quarters that you all are always quick to point out, I think we have covered charge-offs with provisions, and in fact exceeded those charge-offs. There have been exceptions of that in the past in special circumstances. Chris, you know, I think we had 2 million rough charge-offs; we made a $3 million provision, which is by and large in line with what we've done. The provision each quarter has sort of been at the 3 million, 3.2 million kind of level. We had a debate actually, internally, Terry and I talked about this, because in fact we kept the provision constant. When we took on F&M, we added 3 million. Again, it was in excess to charge-offs. But because of the nature of F&M.'s balance sheet and our decision to do that, the coverage rate or the allowance went down to 1.73. The coverage ratio still remains in excess of 3. We have also talked in the past, as you know, both in these calls and otherwise, in conversations that I've had in larger groups, that there is some pressure from the regulators and from the accountants with respect to the levels of allowance generally. My druthers would be for more, rather than less. I think based on our historical experience, especially when you look the level of our charge-offs, notwithstanding what the level of our non-performers might be at any given point, maintaining the reserve levels at 2, which is where we were when I arrived, is extraordinarily difficult. I think given the nature of our portfolio, I'm certainly going to do my level best to keep our reserve levels at as robust a level as possible.
Chris Marinack - Analyst
Okay. That's fair. Ned, from a separate question, what are the trends that you and the team are seeing on pricing, particularly on commercial loans? Is pricing any better or worse than your footprint?
Ned Kelly - Chairman, President and CEO
I think pricing is pretty much the same, Chris. I don't think it's any better or worse. I think the fact is that it's become more or less binary. I don't think incremental declines in rates have frankly made much difference to people's decision whether to borrow or not. I think that decision involves around factors currently that are unrelated to rate, and depend heavily on their perception of the future -- of their own future prospects. The barrier that we've got, and I think a lot of other banks face -- and I've seen this in the reports of some of the others -- is that people are still somewhat uncertain about the future, and levels of capital investment, levels of investment for the future aren't as high as any of us would like. I don't think rate is going to drive that. I think if the last two years has demonstrated anything, it is that that decision is relatively insensitive to rate. It depends on other factors. So we don't see -- pricing is not what is driving this environment.
Chris Marinack - Analyst
Okay. And the last question, Ned, on the asset and the investment wealth management side, what would be the organic growth X the market impacts this quarter?
Ned Kelly - Chairman, President and CEO
I don't have that number off the top of my head, Chris. It may be that Terry and Dave can get it for you. If you check back with us, we can let you know. I think, given the gyrations in the market, my own sense was there was some addition from F&M, obviously, because they did have a small business. Having said that, I think the bulk of it, based on the reports that I've been seeing in terms of the net inflows, is that I suspect that most of it was organic. Remember it well that we are not as heavily equity-dependent as some others. We have a smaller proportion of our assets in equities, so we are going to be less sensitive at the end of the day to movements of the equity market.
Operator
Thank you. Casey Ambrecht (ph) with Millennium Partners.
Casey Ambrecht - Analyst
Not to beat a dead horse, but I was wondering if we could kind of go back to the earnings release on September 22nd when the Company preannounced. The Company basically states that they expect that the second quarter was closer to 67 cents than what was reported of 72 cents in the second quarter?
Ned Kelly - Chairman, President and CEO
As you know, what we did there, there was no magic; it was entirely formulaic. All we did was to back out the securities gains and add the merger related expense.
Casey Ambrecht - Analyst
Okay. That being said, I went back to the second quarter and actually pulled the transcript. And you were quoted saying that securities gains basically offset these onetime items during the course of the quarter. Meaning that 72 cents is a actually a good core clean number. I'm trying to true it up why it was clean in the second quarter and then fast forward to September 22nd why it wasn't clean?
Ned Kelly - Chairman, President and CEO
Well, let me tell you what we did. And I thought through that pretty carefully. And I think that's not an unfair point. There were certain factors in the second quarter -- and I don't have them in front of me -- that were also unusual, that were different from the prior year and from the prior quarter. My recollection is that there was directors' deferred comp, which was 1.7 million; there was an intangible amortization from Boyd Watterson which contributed to it; there was some merger-related expense, which was about a penny in the second quarter as I recall. And there's one other factor that I may be missing in there. (multiple speakers). Those were the three principal factors, as I recall. Now what happened -- I'm sorry -- the issuance of the debt. Because the debt had an impact as well of a penny or two. As you compare quarters, which is what I was trying to do -- in other words second versus third -- the fact is that those factors that I identified in the second quarter persisted in the third, right? So they are inherent in the third quarter numbers. So there was no need reason to back them out if you see what I'm saying. In other words, there was no lack of comparability (ph). So what I did for purposes of the second, for the prerelease, was to identify those items with respect to which there was no comparability.
Casey Ambrecht - Analyst
I have one comment. If you could kind of address it, that would be great. Historically, Mercantile (ph) Bank has been known as a very kind of plain, conservative, vanilla, asset-based -- asset-sensitive based bank. There's a lot of noise in this company right now for the last six quarters, even if you back out F&M with all that is going on with the balance sheet. And it seems like the company is actually diluting the asset-sensitivity of the balance sheet.
Ned Kelly - Chairman, President and CEO
Why would you conclude that, just as a matter of curiosity? I mean, part of the reason there has been noise in the numbers over the last six quarters has been precisely because we are asset-sensitive. And one of the reasons we walked through the securities portfolio in the way we did and highlighted the fact that it represents such a small portion of earning assets is for precisely that reason. I understand what you're saying, I've heard it. But to be blunt, it mystifies me.
Casey Ambrecht - Analyst
Okay. It's just a comment; that is how I perceive it.
Ned Kelly - Chairman, President and CEO
Obviously, I always appreciate your candor. But I'm being equally candid in response. I don't quite understand it.
Casey Ambrecht - Analyst
Well, the company continues to remix the balance sheet, take securities gains, and you know --
Ned Kelly - Chairman, President and CEO
Casey, hold on. The securities gains we took in the second quarter as you know, were predominantly equities, right? The securities gains that we've taken historically with respect to the bond portfolio in my recollection have generally been pretty small and have been a function of managing that portfolio. Five of the six cents in the second quarter was equities. Remixing the balance sheet, as you know, we did with an eye, obviously, to generating -- to maintaining -- interest rate risk, maintaining short duration, maintaining credit quality, trying to generate incremental earnings. Because if we had done nothing, in other words, if we had simply continued to roll treasuries, it would have been very adverse in the current environment.
Casey Ambrecht - Analyst
Exactly. But now we are coming out of the current environment. And people have been waiting for this rebound, this snapback in earnings, and it is going to be dilutive with the securities incumbents (ph) you've been buying the last few quarters.
Ned Kelly - Chairman, President and CEO
I don't know why, again, given Ellen's review of the profile, the securities portfolio -- as you know, we are much lower level mortgages than anybody else. We are still very short. The other thing I would point out, to be honest is that, I thought when I arrived 2.5 years ago -- not quite that long -- but I thought a year-and-a-half ago, I thought rates were going to rise. I think a lot of people thought rates were going to rise. We have been predicting a rise in rates for some time. It's yet to materialize. And frankly, in my own mind, I don't know when it's going to happen. But what I can tell you is when it does, we have diluted, in my view, in a very, very small way, consistent with trying to manage the company prudentially, whatever asset sensitivity we have in the currently out of the money option with respect to rising rates.
Casey Ambrecht - Analyst
Okay. Thanks very much for answering my questions.
Operator
Thank you. Our next question is coming from Gary Townsend with Friedman.
Gary Townsend - Analyst
Good morning, how's everyone? You predict something long enough, it'll happen.
Ned Kelly - Chairman, President and CEO
Well, the one thing you can't do, Gary, is change your mind.
Gary Townsend - Analyst
, Precisely. Just a couple of housekeeping things. What are the opportunities to further lower funding costs? You did a good job on the third quarter. But can you do more?
Ned Kelly - Chairman, President and CEO
Minimal, I'm afraid, Gary. I think they're minimal. We have done what we can. As you know, we've been trying to manage things as effectively as we can. But I think it's going to be hard.
Terry Troupe - Chief Financial Officer and Treasurer
One of the challenges we face, back to the prior question is, the long-term debt, for example. We have not swapped that to floating for the last 200 million of that. That would help us right now in the short run from the standpoint of our interest costs on the liability side. We have not elected to do that in order to maintain the structure of the balance sheet and our asset-sensitivity.
Gary Townsend - Analyst
Okay, thanks, Terry. Any stock or purchases in the quarter?
Ned Kelly - Chairman, President and CEO
No. Essentially, we were under rap. Given the (indiscernible) of the F&M acquisition.
Gary Townsend - Analyst
And the view for stock or purchases going forward?
Ned Kelly - Chairman, President and CEO
The fact is, as you know, part of what we discussed last time is that we've generated a fair amount of liquidities to holding company by virtue of the debt issue and the recapitalization of the affiliates. We are certainly positioned to do it if it makes sense.
Gary Townsend - Analyst
Okay, that's wonderfully obscure. I think there's another career for you. Finally, computing about 39,400,000 shares for average diluted share count in fourth quarter. Does that seem reasonable?
Ned Kelly - Chairman, President and CEO
Seventy-nine.
Gary Townsend - Analyst
Seventy-nine?
Ned Kelly - Chairman, President and CEO
I think you said 39; it's 79.
Terry Troupe - Chief Financial Officer and Treasurer
Roughly 80 million.
Gary Townsend - Analyst
79.4 was what I was trying to say, if I misspoke. Thank you.
Operator
Thank you. Our next question is from Jennifer Demba with SunTrust.
Jennifer Demba - Analyst
I was just wondering if you could give us some background on yesterday's announcement on Alex Mason.
Ned Kelly - Chairman, President and CEO
Alex, as you could tell from the release, has been a vice chairman at Deutsche Bank. He actually started his career at Banker's Trust 30 years ago. I've known him for more than 30 years. He started life as a commercial banker, had been at Banker's Trust his entire career and it successor firms. He moved to Baltimore when they bought Alex Brown, helped Banker's Trust integrate it, stayed on in Baltimore after the Deutsche Bank transaction. Alex as younger as he is -- he's 52 -- was in fact in a position to retire from Deutsche Bank because he had been at Banker's Trust for 30 years, and concluded for personal reasons that he'd like to stay in Baltimore. We've known each other for a long time. The fact is that he has an extraordinary breadth and depth of experience which I think could be helpful to us. And I and the board believe, for what it's worth, that as we have gotten larger, and as the world has gotten more complex, especially in the risk management front with respect to regulatory and legal risk, that it was important to buttress the senior management team.
Alex, when he gets here, is going to focus on risk management issues, new business development, H. R., strategic planning. He's going to be a partner to all of us, with respect to running the bank. It is also going to be part and parcel, frankly, of an announcement that I plan to make in the next couple days about a formal holding company management team. It will involve members that you all know, in other words, no new additions. It'll be composed of people from the inside as it were. But I think it's important, especially given the growth of our affiliates and how important they've become, and the fact that we've become a larger organization, to begin to focus on some of the underlying risk issues for the firm as a whole, just in terms of regulatory and compliance risk, interest rate risk, which Ellen was talking about, and to try to address them in a coherent basis. And Alex will be part and parcel of that.
Jennifer Demba Great. Thank you very much.
Operator
Thank you. Our next question is coming from Bob Hughes of KBW.
Bob Hughes - Analyst
Good morning, guys. A couple of quick questions. Ned, I was hoping you could just give us a quick progress report on the reorganization of investment and wealth management. I know you said that we should not expect severance charges to be material in future quarters. What can you tell us about the expense base? Is it inflated right now by charges or by expenses that would be onetime in nature, like technology expenses? Or have we built in an expense base that we now need to generate net new business and new revenues to really show an improvement in pretax margins?
Ned Kelly - Chairman, President and CEO
I think, Bob, it's a combination of all three of those. I think there is some inflation going on by virtue of severance. I think there has been some expansion of the expense base in order to generate new revenues. I do think there have been some technology charges that we are carefully reviewing, that we may reconsider going forward. And I know that's not a very crisp answer. But what I will say by and large is, that the reorganization from my standpoint by and large is, is finished. We have a team in place; John Pelagy (ph) is the CEO of Investment and Wealth Management, precisely the same people that were here with Wallace are here today. We are trying to add, incrementally, if you will, to our distribution in the form of additional people, only on a basis that makes sense economically. That is, people that we believe are going to be able to generate revenues that offset the expenses. They understand that that is our objective. But we are also going to look very hard at taking out some of the expenses that are currently embedded where they don't make sense given what we are trying to do.
Bob Hughes - Analyst
Okay. Can you tell us what your pretax profit margins look like in IW (ph) this quarter versus last quarter?
Ned Kelly - Chairman, President and CEO
If you take out the severance expenses, they were by and large flat.
Bob Hughes - Analyst
Okay. Final question, just on loan portfolio, can you give us a sense -- I recognize that there was some growth in combined portfolios, quarter-to-quarter. Can you tell us where you experienced that growth, number one. Secondly, M&T, in the third-quarter conference call, indicated that they had seen some shrinkage in the commercial real estate and construction pipelines in your region. Could you comment on that as well too?
Ned Kelly - Chairman, President and CEO
Yes. Terry, do you have the numbers on the portfolio growth (ph)?
Ned Kelly - Chairman, President and CEO
I don't think we've seen much shrinkage on that front, but I will let Terry address the growth. The fact is that my view is, there have been no outliers in that respect. Bear with us.
C&I loans, as you know, are, and again, it's difficult because of the inclusion of F&M, there's some confounding factors. And on a core basis, you know, I think I mentioned that we were essentially 1.79 percent on a linked quarter basis. I think it was pretty evenly spread, by and large. If you look at construction and land development loans, and take into account F&M, the fact is we were up marginally on a linked quarter basis. We don't see any particular shrinkage. My own experience, in going through these loans, which as you know, we do every week, has been that there has been no particular pattern to them. As I said, not as robust as I would like, but they seem to be sort of across the board.
Bob Hughes - Analyst
Okay. And your impression of the integration of the Allforce (ph) franchise to-date? Has that yielded some relationships for you? How is that integration going to be going from your perspective?
Ned Kelly - Chairman, President and CEO
As I've said before, I have great regard for M&P (ph) -- Bob Loomers (ph) and his management team in particular. They are likely be very good competitors. Has it yielded relationships for us? Yes. But I don't want to overstate that. I think the fact is that from where we sit, that integration seems to be going pretty well. But, disruption always generates opportunity. We're doing our level best to focus on it. But I'm not confused about the strength of the competition that they will offer.
Operator
(OPERATOR INSTRUCTIONS). Dawn Gilbert with Ryan Beck.
Dawn Gilbert - Analyst
But just a quick question on the charges -- the F&M merger-related charges -- can you just walk through the dollar amounts of those -- what we've seen so far? And I know you said incremental perhaps in the first quarter. But just I want a little bit more clarity on that.
Ned Kelly - Chairman, President and CEO
Terry will quickly correct me if I'm wrong. But essentially on a pretax basis, we've had 3.3 million in charges. And the fact is if you look at those, essentially the bulk of that is attributable at this stage to professional services. There's some in connection with salaries and benefits; and then there's some that is scattered across the other categories -- equipment software, travel membership, marketing, those sorts of things. As I said, we expect another 3 to 5 cents in charges, going forward, merger-related charges. As you know, in a purchase accounting regime, there are essentially three buckets. There are the merger-related charges, that run through the P&L; there are the purchase price adjustments, which relates to some aspects of the transaction. And then there are the purchase accounting adjustments themselves. We're in the process of going through the purchase accounting exercise, where we've asked B&Y (ph) to help us with that. I think we're about to complete that process. But with respect to the charges themselves, those items that affect the P&L, as I said, we've had 3 cents so far. We expect 3 to 5 cents in the fourth quarter, and that should be about it.
Terry Troupe - Chief Financial Officer and Treasurer
And the bulk of those were the consulting firm that we brought in to help us with the initial planning for the merger, and then the marketing firm that we brought in to deal with the customer communications.
Ned Kelly - Chairman, President and CEO
Which we felt was important, given our interest in not losing customers.
Operator
Thank you. Our next question is coming from Claire Percarpio with Janney Montgomery Scott.
Ned Kelly - Chairman, President and CEO
Claire, I wondered where you were.
Claire Percarpio - Analyst
I'm on simultaneous conference calls. But anyway, I'm here. I think one of the things that we would all love to hear, Ned, if you can, and you probably can't, is just, if interest rates rise, what kind of parameters do you expect on the net interest margin? And can you give us any more clarity -- I don't want you to box yourself in on this margin, but, you phrased that you expect the margins to begin to stabilize in the fourth quarter. Can you give us -- be a little more quan.-oriented on what you mean by that. Is it still going to go down a little? I apologize if I missed some of the comments.
Ned Kelly - Chairman, President and CEO
It's okay, Claire. I think the fact is -- the reason I'm hedging -- and clearly "begin to stabilize" is a hedge. No question about it. Is because I can't predict what rates are going to do. And during the -- the third quarter in my view was testimony to the hazard of prediction. As you know, it reached a trough in mid-June, spiked through July and August, stabilized in August, and I think it's gyrated to some extent in September, up and then down. That's clearly had an impact. And as you know, there is a lag associated with some of that, especially with respect to the consumer and residential portfolios. So part of the hedge that I am building in, when I say it should begin to stabilize is that I don't know what rates are going to do; I don't know what impact it's going to have on the consumer and mortgage portfolio. I don't know what impact it's going to have on mortgage prepayments.
What I can tell you is, that if current conditions persist in a relatively stable way, that the margin should begin to stabilize. If rates rise, my view, for what it's worth -- and we have not done a detailed analysis of this, frankly because we've been focused on trying to manage the firm in the context of the current rate environment, given the fact that we've got structural issues that serve us very well in a rising rate environment -- is that I wouldn't be surprised to see the increase or the expansion in the margins be more or less symmetrical with the decline in the margins as rates have fallen. In other words, that would be my expectation. I don't think that there's any inherent asymmetry based on what we've either done or the nature of our portfolio that we effect that.
Claire Percarpio - Analyst
I guess what I want to just ask about that is, when you first came on board, not initially, but at some point, you started to say, gee we're too asset sensitive. Let me reduce this a little because rates aren't turning around like we thought. I know you're still asset-sensitive. But are you less asset-sensitive than you were? And my mind, I'm thinking the margin doesn't go back to the starting point.
Ned Kelly - Chairman, President and CEO
Look, it may not go back to the starting point because I think it's going to be a long time before rates rise 550 basis points, right, frankly. But keep in mind, what a steep, long fall this has been. But I think that the things that we did to reduce asset-sensitivity -- and maybe I made too much of this, in fact in part because frankly, there were not all of you, but those of you who pounded on us for being that asset-sensitive. And when, as you know, I arrived, we had a balance sheet which was wonderful in the sense it had lots of demand deposits, lots of capital, and laddered (ph) treasuries in the investment portfolio. That is a prescription, as you know, for complete and other (ph) asset-sensitivity, and potential precipitous declines in earnings in an interest rate environment like we've found (ph). The only things we've done to try to manage that, as you know, were by eliminating some of the term liabilities that I saw were here when we arrived, right, which in fact, in some respects, made us more asset-sensitive because it made our liability pricing very sticky at the high end. We got rid of those. The second thing we did was to do a debt issue which I swapped back in order to generate some liability sensitivity, which was $200 million, which I think has actually served us pretty well. And the third thing we've done is to try to reconfigure the investment portfolio in such a way as to not affect duration or credit risk, but to generate earnings beyond those that would have been associated with a simple strategy to laddered treasuries. I think, frankly, in the context, those things have been prudent. Have they mitigated asset sensitivity? Yes. Hard for me to quantify how much, but given the numbers involved, you can tell it's not huge, given the nature of our balance sheet, which is now 13 billion. But one thing I'm absolutely sure of is that when you've got as much capital as we do, you have as much non-interest-bearing deposits as we do, if rates rise, you are going to do very well.
Claire Percarpio - Analyst
Thanks.
Operator
Ladies and gentlemen, I'm showing no further questions coming into queue. Do you have any closing comments at this time.
Ned Kelly - Chairman, President and CEO
No. Thank you, very much. I always appreciate the exchange.
Operator
Thank you, ladies and gentlemen. That does conclude today's teleconference., You, may disconnect your lines, and have a wonderful day.