Pinnacle Financial Partners Inc (PNFPP) 2010 Q2 法說會逐字稿

Good morning, everyone, and welcome to the Pinnacle Financial Partners second-quarter 2010 earnings conference call. Hosting the call today from Pinnacle Financial Partners is Mr. Terry Turner, Chief Executive Officer. He is joined by Harold Carpenter, Chief Financial Officer; and Harvey White, Chief Credit Officer.

Today's call is being recorded and will be available for replay this afternoon by calling 888-203-1112 and using the passcode 862-9958. Please note, Pinnacle's earnings release and this morning's presentation are available on the investor relations page of their website at www.PNFP.com. This webcast will be available on Pinnacle's website for the next 120 days.

At this time, all participants have been placed in a listen-only mode. The floor will be open for your questions following the presentation. (Operator Instructions).

Before we begin, Pinnacle does not provide earnings guidance or forecasts. During this presentation, we may make comments which may constitute forward-looking statements.

All forward-looking statements are subject to risks uncertainties and other factors that may cause the actual results, performance or achievements of Pinnacle Financial to differ materially from any results expressed or implied by such forward-looking statements. (technical difficulty) of such factors are beyond Pinnacle Financial's ability to control or predict and listeners are cautioned not to put undue reliance on such forward-looking statements.

A more detailed description of these and other risks is contained in Pinnacle Financial's most recent Annual Report on Form 10-K. Pinnacle Financial disclaims any obligation to update or revise any forward-looking statements contained in this presentation whether as a result of new information, future events or otherwise.

In addition, these remarks may include certain non-GAAP financial measures as defined by SEC Regulation G. A presentation of the most directly comparable GAAP financial measures and a reconciliation of the non-GAAP measures to the comparable GAAP measures will be available on Pinnacle Financial's website at www.PNFP.com. With that, I'm going to turn the presentation over to Mr. Terry Turner, Pinnacle's President and CEO.

All right, thank you, operator. Good morning. I want to start this morning at 30,000 feet in an effort to provide some context for this quarter's earnings.

We built a tremendously valuable franchise. We serve two attractive markets, Nashville and Knoxville; in my judgment, the most attractive markets in the state of Tennessee.

The foundation of the franchise is a strong organic growth model focused primarily on businesses and affluent consumers. Unfortunately, largely through acquisition, we ended up with a meaningful concentration of residential real estate loans and unfortunately there's no place to add Nashville, Tennessee if you have a Nashville Tennessee if you have meaningful volume land acquisition, construction and development loans.

We have been aggressively focused on credit issues for some time. But let me say in the second quarter, we ratcheted up our intensity on resolution still further which I think is reflective of my desire to return this firm to its normal earnings capacity sooner as opposed to later.

You know we released quarterly earnings last night and after the market closed, reflecting a net loss of $0.85 per share. Before I get too deep in the presentation, I should probably say the obvious which is that I'm disappointed in these results.

But at the same time, the actions that we have taken this quarter should benefit us over the longer term and speed our return to normalized profits. Secondly (inaudible) this quarter was very significantly impacted by a tax accounting entry.

It's a non-cash charge of approximately $0.53 in EPS and Harold will speak more about this here in a few minutes. So, from my perspective, priority one for Pinnacle is and has been we continue to aggressively deal with credit issues.

It's my belief that we will inevitably get those credit costs off of us. And so number two is to continue building the core earnings capacity of the firm. And as we walk through the presentation, I think you'll see that we're making meaningful progress on both of those fronts.

As it relates to dealing with credit issues, I think one of the most critical initiatives has really been our intentional reduction in our construction and land development portfolio, is down about $75 million this quarter, down roughly $234 million or more than 36% since year end 2008, in other words over the last 18 months while we have been focused on this.

And if you go back to my comments just a minute ago, I believe that shift away from construction and land development back to C&I which is really the wheelhouse of our Company is one of the most constructive things we can do not only to produce sustainable asset quality, but to drive up the normalized earnings capacity of the firm. In the second quarter, we increased our allowance slightly from 2.59% to 2.61% in the second quarter.

Second quarter net charge-offs was $33.5 million. That's more than we had originally anticipated. Harvey White, our Chief Credit Officer, will give a little more color commentary on that in just a minute.

I will say that we expect reduced credit costs next quarter. As a reflection of our more aggressive stance in the quarter at June 30, non-performing loans were down to $118.3 million. That's down from $131.4 million last quarter.

And as I anticipated and as we' said in the last quarter, OREO increased here in the quarter, going from 24.7 at March 31 to $42.6 million at the end of June. Again I think that's reflective of a desire to speed through these resolutions as expeditiously as possible. We do anticipate that OREO balances will continue to rise over the next quarter or two as we are aggressively pursuing several significant foreclosures during the last half of 2010.

As noted on the last bullet of the slide, we continue to invest in our workout group, loan review, compliance groups and so forth. Over the past several months, we have I think significantly upgraded the caliber of our workout personnel.

We've hired several seasoned workout professionals who have experience in larger, bulkier real estate related projects. They've made significant headway on several projects last quarter and we anticipate continued progress for the next several quarters.

Our goal is really not just to show gradual improvement over a very long period of time, but instead to return our Company to profitability as expeditiously as we can. The second major theme is that we continue to focus on increasing the core earnings capacity of the firm.

The two major subthemes if you will are growing core deposits and expanding the net interest margin. We continue to grow core deposits at a very dramatic pace. The year-over-year core funding growth rate was 33% over same quarter last year.

Consistent with our focus on growing core deposits, the last 12 months we've added four new branches, 39 FTEs and customer contacts roles. Again I think that goes back to this idea that we we're going to concentrate on eliminating credit costs, but at the same time we're going to continue to invest and build the core earnings capacity of the firm.

I don't want to digress too much, but I might just comment on the branches that we have added and the success we've had with those. We view those to be really deposit acquisition outlets. Just a quick rundown of those four offices about which I'm speaking in Fountain City.

We opened that in October of 2009. The total deposits in that office are $29 million. That is -- Fountain City is a Knoxville-based office in Nashville, the Belle Meade office. Total deposits are roughly $20 million. That was opened in just December of 2009.

We opened an office in Knoxville, Farragut, in the Farragut area, that was opened in December of 2009 also. $12 million in deposits in that location and 100 Oaks which was just opened in April, already at $14 million in deposits.

So again the pace of deposit acquisition through that investment is excellent, in my judgment. I will comment that we will continue to add offices in Knoxville over the next several years but we have pretty well finished the buildout of the national market now with 31 locations in this market. So again, we are satisfied with the distribution that we built here in Nashville and pretty well through with that but we will continue to invest in Knoxville.

Our year-over-year net interest income growth was 17% from second quarter of last year. Net interest margin finished the quarter at 3.23%. That's 48 basis points more than the same quarter last year. It is slightly less than anticipated. We'll talk about that more in just a minute.

But I'll go ahead and say that the margin was negatively impacted by roughly $1.2 million or 11 basis points in interest reversals on non-accrual loans. Loan balances are down $210 million from last year.

We expect that loan balances will continue to be flat and down through the rest of this year. There really are three primary influencers there.

Number one is our focus on problem loan resolution. Of course that is impactful in that not only are we moving loans out of the bank, collecting difficult credits and so forth, but we also have a large and extensive resource allocation to resolve those issues.

Number two is the intentional reduction in our construction and development portfolio which we're going to continue for the remainder of this year. Number three is that there is a significant weakness in loan demand broadly and I think I have said before that loan demand is probably as weak as I remember it. Harold will break that down further in just a minute but right now, Harvey White will discuss some of the credit issues.

Thank you, Terry. As Terry mentioned, we have put a lot of effort into reducing the construction, land acquisition and development book. But this slide -- this next slide addresses the commercial real estate book other than the A&D loans.

As you see in the pie chart, the largest segment by far is the owner-occupied segment. We view these loans more as C&I credits.

We're obviously financing [the businesses building] and securing it with real estate, but we're actually primarily underwriting the cash flows of the business and we feel this is the least risky of the CRE categories. As for the rest of the categories, we've included commercial construction loans for non-owner-occupied CRE as a segment as well as the retail, office, warehouse and other segments.

You'll notice that there is no distribution among these segments and although it's not shown on this slide, most of these categories are reducing. Owner-occupied is down 2% since 12/31, construction is down 46% and I'll reference that in a minute. Miscellaneous is down 26%, the office and warehouse segments are essentially flat and only retail and healthcare are up 4% and 17%, respectively.

Both of those increases come from projects that were previously in the construction book and then when construction was completed in the first half of the year, they converted into the -- out of the construction segment into those two segments which is why construction is down and those two are up. The increase in retail I will just note was due to one large build-to-suit for a nationally known credit tenant.

About 2.5% of our CRE book is on non-accrual which we believe is better than most peers. We do not have any high-rise office buildings, malls or trophy projects.

We feel we have scrubbed this portfolio thoroughly. At the end of last year, we adopted a risk rating methodology and a standard global cash flow model.

During the first quarter, we used these tools on every CRE loan over $0.5 million using the most current information available at that time. And then again in the second quarter we used these same tools to scrub that same CRE loans over $0.5 million with updated financial information.

Let me talk just a minute about the commercial real estate market in Nashville. In the table at the top of the slide are the market vacancy rates.

In general, we continue to believe that Nashville is [a decent performers]. There are a lot of markets that are better and some that are worse, but Nashville does beat the national averages in three of those four segments given.

On the next slide, we look at past dues and non-performing loans for each of the basic loan categories. The peer comparisons, our peers are the greater than $3 billion banks per the most recent uniform bank performance report as of first quarter 2010.

As you can see, total past dues between 30 and 90 days on the left-hand side of the table are better than the peers in every category. And actually we are fairly pleased with this number of 0.66% this quarter as we feel this is pretty good for this stage of the economic cycle.

On the right half of the chart you see a similar comparison for the greater than 90 day past dues and non-performing loans again with the peer comparisons. As you can see, in total our numbers are slightly better than peers with somewhat better performance in the C&I and in the CRE books. Up in the top in the construction and land development category, the 15.7% is very high for us but as you see is only slightly above peers.

The next slide speaks to the non-accruing loans and OREO. At 6/30, non-performing loans totaled $118 million. That is a reduction from last quarter of $13.1 million. The pie chart on the right of the slide contains a breakdown of these non-performing loans.

As you can see, by far the largest components remain land development and residential construction. Our OREO total is $42.6 million. So that brings the total non-performing assets to $161 million, just slightly above the $156 million we reported last quarter.

Although it is impossible to identify a peak until you are past it, we believe that we are near the top of our NPAs at June 30. We do believe that OREO balances should escalate for the remainder of this year as we are planning several meaningful foreclosures presently and are being generally more focused on speeding up the ultimate resolution of these problem credits.

Another reason I feel we are near the top of the NPAs is that I feel we have analyzed and risk-rated our portfolio very thoroughly in the first half. As I mentioned before, we used a new risk rating methodology and global cash flow and analyzed our CRE loans twice in the first half.

We also developed a more objective risk rating model for the C&I world and by this point of the year, we should have 2009 results and numbers on most of our C&I book. Another factor is that we have beefed up our internal loan review staff and have them reviewing more of our portfolio.

And as evidence that our FAs are getting the risk ratings right, our internal loan review has identified downgrades for less than 3% of the loans they have reviewed in the first half. We have also stressed risk rating accuracy and the identification of problem loans as a key element of our overall credit culture.

And finally, I'll just mention that our regular annual OCC safety and soundess exam normally is in July or August of each year, so our FAs are aware that having their risk ratings correct by 6/30 was a high-priority item for them. Next slide addresses net charge-off trend.

This chart shows our net charge-offs over the next six last six quarters. We are obviously over our 1.25% projections which we had for the year. And again, it is reflective of a number of more aggressive choices that we have made relative to the speed of resolution of problem loans.

In the first half of 2010, our charge-offs were at 2.84 on an annualized basis. We believe the second half of the year charge-offs will be well less than that.

One matter that we do believe is insightful as at the year end, we had $19.3 million in specific allocations for non-accruing loans in our allowance for loan losses. These allocations are reserved for those loans where we are exploring additional sources of repayment other than solely collateral such as guarantors, continuing operations, etc.

At March 31 that number was $17.2 million and at June 30 it had decreased a full $10 million down to $7.2 million. And the significance of that is that it reflects a significantly more conservative valuation of these assets by our workout personnel in that we had been charging off loans instead of leaving them on the books with a reserve.

On this next slide, there's some detail about the other real estate owned book. And the point of this slide is that OREO balances are broadly covered almost 112% by generally current appraised real estate values. You'll note that average appraisal age is 3.8 (technical difficulty) months.

As mentioned earlier, we anticipate continued increases in OREO over the next few quarters. This could be and probably will be impacted by the possibility that some of our borrowers will declare bankruptcy in order to avoid the foreclosure.

You can see the bullet points down in the lower bottom of the slide and so I won't read those to you. But I do want to point out one and that is that we have a little over $11 million of the $42 million of OREO or roughly 25% which is currently in OREO that we currently have under contract and with no additional loss based on those contracts.

Excluding any new additions to OREO, our normal internal goal is to dispose of at least one third of our prior quarter balances in the next quarter. Obviously with contracts on 25%, we feel good about that goal for the third quarter and we expect to be well ahead of that internal goal.

The next slide speaks to the non-performing asset disposition and you see it's sizably upwardly sloping and this slide is put in there just to reiterate the fact that we have a heightened aggressiveness with which we are pursuing the disposition of non-performing assets. Obviously the disposition can come from several sources, charge-offs, appraisal write-downs, credit rehabilitation as well as cash payments and paydowns and payoffs. Thank you, now I'll turn it over to Harold.

Thanks, Harvey. I will briefly cover capital funding and have some brief comments about our second-quarter operations.

As you can see by the chart, our capital ratios remain strong as of the end of June. With the increased level of charge-offs and the deferred tax valuation reserve, the holding company did inject $25 million into the bank as of the end of June, leaving the holding company with approximately $65 million in cash to support the ongoing operations of our holding company.

On the next slide as the funding sources, similar to what's been going on in our construction development book, we continue to be excited about the transition we made in our funding base over the last six quarters as we continue to reduce our reliance on wholesale funding sources.

Even though competitions for our deposits remained intense in our markets, our sales force has been very effective in gatherings core funding. As noted on the chart, core funding has gone from 47% at the end of the first quarter of 2009 to 56% currently.

Since the end of the '09, core funding is up almost $200 million. We believe we will continue to reduce our reliance on wholesale funding particularly broker deposits [and internal] home loan bank borrowings for the remainder of 2010.

Concerning margins, the chart details the quarterly trends of our net interest income and our net interest margin. As you can see, our linked quarter net interest income between the first quarter and the second quarter of this year fell by approximately $1 million.

This was due to the continued reversal of previously accrued interest income due to new non-accruals, increased non-performing balances and reduced loan volumes. During the second quarter, we reversed $1.2 million in accrued interest related to new non-performers compared to $475,000 in the first quarter, much more than we anticipated.

We have included a chart of pro forma net interest margin which adds back the impact of interest reversal and makes an assumption that NPAs are limited to 1.5% of loans in ORE. Along with that assumption, we have also assumed that the excess non-earning asset amount would earn the average earning asset yield for each quarter.

As you can see with elevated NPAs, the gap between actual and pro forma has widened which provides additional motivation to eliminate NPAs as soon as possible. The next chart we have shown at various times detail why we think we should be able to increase our loan yields over the short-term.

Our records show that we have about $275 million in loan balances that will mature or renew within the next three months which are currently priced at below 5.25%. Obviously our objective would be to take these loans currently priced in the high threes and low fours into more than 5.25% primarily by getting the appropriate floors on loans and increasing the spread [and the index] on variable rate credit.

As to the CD book, our second margin improvement opportunity continues to be with the upcoming maturities in CDs. The $208 million represents about 15.9% of our CD book and [as to client CDs] noted above, you can see mid to low twos would reprice into the mid to high ones. We will also continue to emphasize money market accounts in order to reduce our funding costs further and increase our core funding metrics.

This table details our quarterly trends and fees. Regarding our run rate (inaudible) fees overall we expect fee revenues to be fairly flat for the second half of the year.

Service charges made a modest comeback this quarter as we enter the second half of the year and the new Reg E rules. We're four weeks into our opt-in program which will not end for another four weeks.

Thus far with our target customers, we have received responses from approximately 50% of these target customers with better than a 90% opt-in rate. Investment services are having a good year while insurance is having an okay year thus far even though the insurance pipelines appear to be opening up somewhat.

Mortgage fees are the big wildcard as revenues from that line of business fluctuate meaningfully from quarter to quarter primarily based on the level of mortgage rates in the refinance market. At quarter end, mortgage did have one of the largest sales pipelines they have ever had, the revenues from which won't be reflected until third quarter.

Now, since inception of our mortgage operations, mortgage repurchases have not been an issue and do not appear to be an issue for us going forward. We are deliberate in our methods of delivering loans to the secondary market and intentionally have systems in place to mitigate and help eliminate mortgage repurchase risk.

As to expenses impacting our run rates is obviously the volatility of ORE expenses. Aside from ORE [contributing to lower expenses] this quarter from last quarter were a reversal of previously accrued incentives as noted in the second line of the chart and general reductions in various variable expense categories.

In comparison to the second quarter of '09, generally run rates are up primarily due to increased hires. As noted earlier, four new branches have come online in the last year and 39 or so new customer contact positions have been added since June 30 of '09. We have also increased our expense base in such areas of compliance, special assets and other related areas.

We currently believe that the second quarter is a proxy for a 2010 run rate. We will continue to have elevated ORE expenses as we believe we will continue to increase foreclosures for the remainder of the year.

Also, please note that we completed our usual procedures for impairment of goodwill and determined we did not have any impairment as of June 30. As is our usual annual process, we will be performing our formal assessment as of September 30 at the end of the third quarter.

Now taxes, during the second quarter we entered into a three-year cumulative loss position and as a result, we determined that it was appropriate to record a valuation allowance equal to the difference between our net deferred tax assets or $30.3 million in the aggregate amount of our carryback potential or $12.9 million.

The difference was a valuation allowance of $17.4 million. As the chart indicates, we have identified $10.0 million of losses that we will be able to get back and collect as of June 30 which leaves only about $2 million in net deferred tax exposure as of June 30 this year.

As many of you know as a result, we likely won't be recording any meaningful tax expense or benefit for the next several quarters and that once profitability can be sustained for several quarters and it is reasonable to forecast profitability that we will be in a position to reverse the allowance account thus the reversal will be subject to considerable judgment. As Terry mentioned, we are disappointed at the impact this particular event has had on our financials at this time. It's a non-cash event. We're also confident that this valuation allowance will be reversed within a reasonable time period once operating profits are restored and sustained. With that, I'll turn it back over to Terry to wrap up.

Okay, as many of you know, Nashville and much of Memphis, Tennessee suffered a devastating flood during the first part of May. Many Nashvillians experienced damage to their personal property with a lot of that damage occurring outside the flood zone which basically means many Nashvillians were caught without flood insurance.

This slide summarizes some of the public releases as to the damages relating to the flooding. I think all things considered, much repair work has been completed but much remains.

The mayor estimated the flood impact at $1.5 billion. He has a website for any of you that may want to review that if you're interested in flood damage and so forth. His website is www.Nashvillerecovery.com.

I don't have current numbers on funding for Corps of Engineers projects but have heard a number of estimates in the several hundreds of millions of dollars of projects. I think as it relates to Pinnacle specifically, while we were severely inconvenienced by the flood and the building we lease for our headquarters location in downtown Nashville took a great deal of water in its underground parking garage that had to be pumped out that caused the building to be without power, HVAC and so forth for about two weeks.

But in terms of actual damage or losses to our biggest assets, there were virtually none. So to determine the risk to our loan portfolio, we used a number of techniques including using mapping software to identify client addresses, collateral locations and so forth.

Basically we had our relationship managers contact every potentially impacted client in the counties that were identified as disaster areas and determined what the actual impact was for us. Potential concerns were the need for loan payment deferments, damage to collateral, client negotiations with insurance companies or FEMA or monies to repair or replace.

The initial assessment showed that only $18 billion in loans, of (inaudible) loans, were actually impacted in any way. And of that amount, today only $1.8 million in loans have potential impact due to this event that warrant our continued monitoring.

So we have set aside a specific allocation of $1.5 million for those. So while it's been a very impactful event for Nashville and for middle Tennessee, it does look like for Pinnacle, we have weathered that storm pretty well.

Clearly residential real estate has been the most significant economic issue in Nashville and most impactful relative to our loan losses. On this slide you see some encouraging news, I think.

On the bottom left you can see single family residence closings, that moved up meaningfully during the selling season while inventories are shrinking slightly. And on the top right, you can see the most current data for June shows an elevated median home price with meaningful reduction in the months of inventory.

I don't think that's enough information to really celebrate an end to any residential real estate issues, but it clearly does show some stabilization and actually improvement and more (inaudible) job growth which really enables real estate to be absorbed.

On that note on this slide, I think you can see good news to many of us here is that Nashville has been selected for several corporate relocations and expansions recently over the course of the last two decades. Really Nashville has been one of the hottest relocation markets in the United States which fueled outsized job growth here in the same period.

Altogether the four announcements on this slide represent 2300 jobs. We are aware of several potential relocations that are in the works. We hope they will be announced soon.

But I do believe that Tennessee and particularly Nashville continues to be a great place for business expansion and relocation. We are also excited about a new downtown music city convention center.

Construction is underway on that. It should substantially increase Nashville tourism base and while plans are still somewhat preliminary, we are expecting an announcement on an anchor hotel very soon that would go with that convention center.

To put a bow on all that we talked about here this morning, we continue to very aggressively address problem credits. We continue to pursue meaningful NPA resolutions. We are making good progress on that front and you should expect continued reductions in our exposure to construction and development.

We are fortunate to serve attractive markets. We are seeing some early signs of economic stabilization and recovery.

Nashville's employment rate and ability to attract new jobs is beginning to show signs of life and we continue to find great opportunities in terms of competitive vulnerabilities. We are particularly focused on growing the core earnings capacity of the Company and I believe within that specifically we can achieve double-digit core funding growth through 2010 and continued margin expansion throughout 2010 as well.

Operator, I think that we will stop there and take questions.

(Operator Instructions) Jefferson Harfalson, KBW.

I wanted to ask about the DTA and what types of if any kind of tax planning strategies, [fully sale] sale leasebacks or the ability to make profitability in future relatively near-term quarters, how if anything that played into that write-down?

Thanks for the question. Really essentially none. We had a lot of discussion about that.

We went through a lot of different accounting pronouncement materials to try to identify tax strategies in those. But at the end of the day we elected to just put up this reserve. So right now we don't have any specific strategies that we are using to reduce the amount of the allowance account.

Okay and I if understand page 19 right that there is probably just $2 million of potential loss ETA in the future that the 12.9 that is left is supported by the carry bag, so it's really not a risk at the current time?

Yes, that's true. At the end of June, that's the correct assertion. At the end of September, the DTA accounts could move around some and we will have that discussion at that time. Right now our focus is on returning this firm back to profitability as soon as possible.

Kevin Fitzsimmons, Sandler O'Neill.

I just wanted to clarify some of the forward-looking comments you made on credit. Just want to make sure I heard it right.

So you kind of showed that the net charge-off rate spiked considerably higher in second quarter but I believe you said that you expect that to go -- to be lower over the balance of the year. And I am just was hoping you could provide a little more context on that.

And then NPAs, I think you said that NPAs are at their peak but OREO could still increase further. So that seems to imply that non-accrual loans are going to keep declining from here. If you could just provide some color on that, thanks.

Yes, this is Harvey. On that second point, that is the point I was trying to make, that we are trying to move things through their normal progression of being identified as a problem going into non-performing loan to OREO to ultimate resolution. So the speed of that is what would cause that phenomenon.

As to the first one, I really don't have a number. I feel very confident that it's going to be lower for the second half, but I hesitate to put an absolute number out there. But I do believe for the reasons I cited that there was so much focus on identifying and lifting up problems in the first half that we have done a pretty good job of scrubbing the portfolio and know what we have to deal with and that is what is behind my comment.

If I could just follow up, how do -- the disposition efforts, how have the things that you have been removing off the balance sheet, how has it been going with the marks that you've put on? In other words, have you had to -- are you finding you're incurring a lower amount of additional write-downs or are you getting close -- probably getting close to having it right on the mark?

During the second quarter, we had about $15 million in ORE dispositions. I think the net loss on that was about $1.8 million or so. So the rest of the loss in the ORE book were due to valuation adjustments where new appraisals came in and we wrote them down.

Mac Hodgson, Suntrust Robinson Humphrey.

Just a couple questions on -- just again on the credit side. I know additions to non-performers increased fairly considerably this quarter. Just trying to get a sense of what changed in the market. Was it more an aggressive stance from management, just to recognize stuff more aggressively or did you see just more deterioration across the board?

I think I would characterize it as significantly a more aggressive stance. I would not say that we saw meaningful deterioration across the market.

As Harold has indicated, we do continue to get some appraisals that come in where valuations are less, so we do have some of those sorts of write-downs. Again it would be hard to say that the market is moving forward.

But I think it would be equally hard to say that we saw a meaningful deterioration of the market either. I think the most correct way to characterize the elevated charges would be a more conservative stance and a more aggressive stance as Harvey just said trying to move things through the cycle and get them off the balance sooner as opposed to later.

And I would just point out that there are some bright spots out there as I mentioned and it is a significant item. The OREO we had going into third quarter, 25% of it we have already have contracts on it and no additional loss. So it certainly isn't the same for every credit. It's a deal by deal basis.

Thanks and, Terry, on the kind of outlook for loan balances, I think you said you expect loans to be flat to down. I'm kind of surprised given the rate of the decline this quarter and charge-offs and dispositions and things like that, I'm kind of surprised loans could be flat at all the back half of the year given the pretty sharp decline this quarter. Are you expecting loan demand to pick up to offset some of that stuff or maybe flat loan balances is somewhat optimistic?

I would say it's in a range of flat to down, but clearly it won't be better than flat. It would likely be down.

I don't want to overplay it. I would say in terms of loan demand, I've indicated it is softer than I have ever seen it. It's not zero.

I think our gross loan production absent, the removal of problem credits, charge-offs, all of those kinds of things, gross monthly productions in a $15 million a month range or something like that. So, you know, I think -- I would say that in the near term, third quarter it will be down. I think in the fourth quarter as you hopefully get some of those accelerated write-downs out of the way that they will flatten out.

Thanks, just one last one. Harold, on the liquidity at the holding company, I know you mentioned $25 million was injected into the bank. Remind us what the kind of cash outlay of the holding company are on an annual basis I guess to pay for trust expense and TARP and things like that.

The quarterly run rate on that right now is about $2 million per quarter.

Kevin Reynolds, Wunderlich Securities.

I wanted to to sort of talk a little bit about asset quality and then kind of a bigger picture question after that. But we saw -- I saw modestly improved non-performing loans and then 30 day past dues down and I think those are the first times we have seen those in what may be four or five quarters.

That's correct.

Now, with that, with the front end of the pipeline slowing down considerably, how much longer do you think it will be maybe in terms of quarters before you see real meaningful declines in your non-performing balances before the non-performing loan balances? That's one question.

And the second question is, assume that you could fast forward to that point in time and you could say all right, we've made it to the other side of the credit cycle. What do you expect the competitive environment to look like in Middleton [and see] and how well will you be positioned in there? Another way of asking is has there been any damage to your franchise locally as a result of focusing so much on problem credit resolution?

That's a great question. I think -- you know, I'm very cautious about hanging another timeline out here about exactly when it will return to profitability, when all the problem loans will be behind us.

But I think your assessment is correct, that you are beginning to see a slowdown in some of these front-end indicators, the two you cited being important ones. I can say beyond that as we look at the portfolio, we are finding -- and if you look at dispositions, honestly on those problem loans, Harvey, I believe the number was $11 million and that was was really through paydowns and payoffs.

14, I think.

Excuse me, $14 million was through paydowns and payoffs which again indicates that you're getting rehabilitation of problem credits at a more dramatic pace and I would say, and this is impossible to quantify, it's just a sense of mine that we have a meaningful volume of loans that are graded in their most conservative stance and that there are facts and circumstances that are beginning to come to light, which I would expect to see upgrades in a number of problem loans over the next quarter or two based on information that's now coming to us.

So, while the absolute credit experience during the quarter was hard, I would say my own outlook about the softer things here is that there are a good number of reasons to be more positive about the credit environment going forward. I think, Kevin, on your question about the competitive landscape, I am so bullish on Nashville and Knoxville.

They are great markets for us to be in and they are that because of the size and growth dynamics. And specifically as we hit on in this presentation a little bit, Nashville in particular, the key here has been this dramatic job growth we had over two decades and it is already beginning to resurface with a number of exciting relocations and so forth which again is the key to solving real estate issues and those kinds of things. Now, the thing that I have always believed about the markets we serve is it's more about the competitive landscape than it is about the size and growth dynamics which are good.

And from a competitive standpoint, as you I think you may know, we utilize Greenwich Research. Greenwich is a probably the foremost research analyst of corporate market share trends, client satisfaction, client loyalty index and so forth.

We have got data that has been updated through the first quarter. This data just came out and was done during the first quarter of this year which would indicate that of all the top banks in this market, our reputation for financial stability is the strongest.

Our reputation for client satisfaction is the strongest. Our client loyalty index is the strongest by far.

And so again I would say that there's no doubt, at some point you could damage the reputation of the firm with either losses or difficult handling of credit issues. But my own belief is that the data would say that we're weathering that storm very well and still enjoy the best reputation in these markets.

Okay, I guess another question to follow up on the housing market. I mean did I see recently that the median home price in Nashville has risen to a level that's roughly the equivalent to mid 2008 and I think monthly inventory levels down to about eight to nine months, is that right?

That is exactly right. Both points, median home price and the months of inventory, just under nine months on the months of inventory.

I know you're not necessarily a politician or an economist primarily, but would you estimate or state or do you think that that has more to do with stimulus programming in the government or are you just starting to see some general firming now in the housing market there?

Kevin, that's a great question. I'm skeptical frankly of stimulus impact. I think again I would go back to what drives these markets. Frankly it's more about corporate relocations and job additions and I can't tie those to stimulus spending.

Peyton Green, Sterne Agee.

A question, kind of following up on what Kevin was asking. In thinking about the land book that you all now have, I think it's about $140 million is related to the residential side.

When would you start to see that move into the queue in terms of possibly being developed again? I know that's -- is it a year down the road, is it still kind of a two-year situation? Or how would you characterize that? Is there any anecdotal change in the last six months?

Well, it varies location by location. Obviously we look at listings, what's out there in terms of lots. And quite frankly there are some lots that -- or some counties and some areas that based on current lots out there, there is a current absorption rate [a 10 year] supply. There's no denying that.

There are some that are much better. And man, I'm not any better than Terry at predicting when that's going to pick up. But you're right, there's a lot of land and a lot of lots out there.

We feel in terms of our specific book that we have gone through and with our models tried to determine which A&D developers either through other sources of income or other activities can weather the storm and hang in there. I will say that almost half of that book is in our criticized categories and therefore handled by our special assets officers and therefore I think get as much scrutiny, get as much analysis about that the right way to resolve the problems as we can possibly do. But your underlying point is right, that there's areas of middle Tennessee that have a lot of land and a lot of lots.

Okay, but I guess would you be more optimistic that you'll see more payoffs in that book as opposed to just simply charge-offs, reducing the carrying values going forward?

Yes, so I mean again, part of what we go through particularly when we see there's a problem and it moves into special assets is reassess what is -- we get reappraisals and do those kind of things to try to look at our ultimate resolution and I think as Terry mentioned earlier, once we write it down from that initial write-down when we really start to look at it hard, our experience has been probably less than a 10% additional write-down when we really do for sale.

Okay and then maybe a quick question for Harold in terms of the margin outlook going forward. The low cost deposit growth has certainly been very strong over the past several quarters. Is there -- what kind of opportunity do you have to reprice the savings and money market balances lower now that you've kind of got the new branches open, you have got these deposit bases in those branches? Is there any opportunity to take the [1.40] cost down over the next six months as interest rates stay low?

I think there is some opportunity there. I don't think there's a lot of opportunity there. But we are pushing our sales force to try to get every nickel out of these transaction accounts.

So we are pleased with the growth in these new branches and what they have been able to generate in deposits. But I can't really -- I don't want to give you any kind of assurance that we're going to be able to reduce our money market rates down into the single digits -- I mean, below 1% but we are working on it.

Okay but I guess maybe the question is this. Are those rates more administered or are they tied to some kind of an index?

I think there's both. We've got some meaningful customers on the commercial side where they are administered and it's just an account by account basis. And then we have got other customers where we have tied it to an index.

I might just add, I think you know and understand our Company very well. So much of our book of business is a relationship managed book. And much like you build a commercial loan portfolio one negotiation and one deal at a time, that is not a dissimilar phenomenon to how we build our commercial deposit book. I guess, I'm just saying so much of that is one client, one negotiation at a time.

I understand, it's just with the market the way it is in terms of the interest rate market, I understand the teaser rate to get the money in. But I was just wondering if there was some time frame that's reasonable.

We're working on it and we understand that particularly the larger banks have a significant competitive advantage on those rates because they have money market rates down below 50% on the overall book.

That's what I was getting at. Good enough, thank you.

Michael Rose, Raymond James.

Sorry if I missed this, I jumped on the call a little bit late. Did you mention -- I know the 30 to 89 day past due loans went down but did you provide a ratio for what the potential problem loans were?

How much were past due?

Potential problem loans, they were 8.63% last quarter.

I don't have that number.

Do you have a sense if it's -- that portfolio grew?

(multiple speakers) we were at 9.3%. Are you just wanting to know what the number is, Michael?

Just what the ratio was. You typically include it in the press release and I was trying to get a sense if that ratio had gone down because it wasn't in the press release.

The reason we're confused is I think it's in the press release. It's 9.3%.

If it is, okay. I'm sorry I missed it.

And then just finally, when it comes to recapture the DTA, how quickly can you recapture that once you get back to profitability? Is it going to be a couple of quarters, is it going to be realized over a couple of years? Sorry if I missed it, can you explain how that works?

Yes, the way the language reads and the rules are interpreted in the rules is that profitability has to be restored and sustained. So it's very much a judgment issue as to how long that will be.

Steve Moss, Janney Montgomery Scott.

Two questions here, one with regard to the construction portfolio. Obviously had some very good movement and other than the stuff that's heading for OREO here this quarter, where would we expect -- or where do you expect the construction would end up by the end of the year?

I don't have a number, I think in previous quarters I wanted to throw out a number that we have already exceeded. I continue to expect that number to go down.

But I don't have an absolute number in mind, quite frankly. I'm glad with the progress we are making and have made and really we have already exceeded my expectations for where we would be as of June 30. So I want to keep going but I really haven't provided an absolute number.

Okay and then also, are there any thoughts or any plans for any bulk sales of OREO or loans?

We don't have any of those on the plan right now. I think our special asset manager, Jason West, he is looking at all kinds of options.

As Harvey mentioned, we've kind of got an internal target of disposition of 33% of the balance in the third quarter. We appear to be running maybe ahead of that right now. But I know Jason and I know that he is looking at all kinds of options but we don't have anything like that scheduled today.

Brian Martin, FIG Partners.

Just one thing, you guys talked about just on the OREO, going back to this, the $11 million that's under contract right now, how much of that is undeveloped land at this point? Undeveloped land is about $30 million of the $42 million. Are you seeing some good progress on the undeveloped land or is that still the challenge?

I don't know exactly how much is 11 but, yes, the undeveloped land is the challenge. [And that answers] to the question is yes.

So you can't quantify. I mean I guess is it everything but that (inaudible) I guess could be going out this quarter or is there still some undeveloped land in that $11 million?

There is some, I just don't have it in front of me the number. But there is some.

Okay and then just given how aggressive you guys were on the credit front this quarter, can you talk about any -- as far as how many of the non-performing loans are actually performing at this point?

Yes, at the end of the quarter, there were $24 million in non-performers that I'm assuming you're saying weren't past due.

Right. And then lastly, just Harvey talked about just kind of changing the risk ratings with regard to the commercial real estate portfolio and kind of the C&I book. Can you just maybe articulate what you have done there differently in your book?

You talked about looking at every loan and the commercial real estate book, over $0.5 million. What in particular on this is kind of giving you the confidence that maybe NPAs have peaked? What on the risk rating have you changed that makes you -- gives you some sense of that?

Well I think there's several things. As I mentioned, we really developed new models and new processes to analyze it.

And the guts of those were to be more objective, to do more projecting and looking forward on debt service coverage. And one biggie is to be more consistent looking at relationships on a global basis, taking into account all their loans at other institutions, taking into account all their other sources of revenues and looking at it globally.

And I would say that those would be sort of the two trying to look forward more and trying to look globally more that would be the difference. And also as we look forward, stress testing is part of that, looking at not just rates but cap rates and other things to do some what-if analysis and stress testing.

I would like to turn the call over to our speakers for any closing remarks.

Okay, as we have talked here, obviously we're disappointed in the second quarter financial results. But in context, we continue to believe we built a tremendously valuable franchise. Nashville and Knoxville markets have great size and growth dynamics, are showing signs of life in terms of employment, job growth, those kinds of things.

The foundation of this franchise is really the businesses of affluent consumers. It is unfortunate that largely through acquisition we ended up with concentration of residential real estate loans.

We have ratcheted up our aggressiveness in trying to push that stuff through the cycle sooner as opposed to later. And while we are doing that, we continue to work on and expand the core earnings capacity of the firm.

So we appreciate your time. Hopefully we have been able to communicate effectively where we are. Thanks so much.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may all disconnect. Everyone have a great day.