WaFd Inc (WAFDP) 2004 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the First Mutual Bancshares second quarter 2004 conference call. At this time, all participants are in a listen-only mode. Following today's presentation, instructions will be given for the question and answer session. If anyone needs any assistance at any time during today's conference, please press the star followed by the zero on your push-button phone. As a reminder, this conference is being recorded today, Wednesday, July 21, 2004. I would now like to turn the conference over to Mr. John Valaas. Please go ahead, sir.

Thank you. Also joining me today are Roger Mandery, our Chief Financial Officer; and Scott Harlan, who runs our Residential and Consumer Lending Operations. Let me begin by reading the forward-looking statements disclaimer. This presentation will primarily contain historical information but will also include some statements regarding the bank's trends, strategic objectives, anticipated growth and other expectations which will be forward-looking statements for purposes of the Safe Harbor Provisions of Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from those expressed or implied in this presentation. Factors that could affect actual results include local, national, economic conditions; changes in interest rates, and the affects on our net interest rate margin, credit risk management, the effects of branch expansion, the success of our marketing initiatives, and other economic, competitive and operational factors. Additional information concerning these, and other risks and uncertainties are discussed from time to time in filings made by the Company with Securities and Exchange Commission. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. First Mutual Bancshares does not have any obligation to update any such forward-looking statements.

I thought I would begin with just a few comments and highlights, and then open this to questions. But before I talk about highlights of our results for the second quarter, I just might mention a few things that have been going on in the local economy that maybe of interest to those of you who are calling in, and the fall of Pacific Northwest economy. The most signaled one, is the announcement few days ago by Boeing, as they actually expect their employment in the Puget Sound area to increase by about 3000 people by year-end, is that -- after several years, 2.5 or 3 years of continuing declines of their employment from, in the 80,000 plus range to about 56,000 people employed by Boeing today, this is an interesting turnaround, and frankly was not expected by most economists, who follow the labor scene here in Puget Sound. So encouraging. I also note that although as a lender, we don't lend on Class A commercial office-based, either anywhere, office vacancy, Class A office vacancy in both Seattle CBD and the W , seems to - vacancy rate seem to be declining and that's another encouraging sign, and in fact Class A office vacancies and W peaked in around 27%, 28% here, year or so ago and if one particular tenant that's going to take about 250,000 seating downtown, vaguely, it appears and if they do or if they can see here in CVD, it declined about 10%. So a couple of encouraging signs in the economy. Now to First Mutual Bancs. Just some highlights - very, very pleased with continued growth in our loan portfolio, gross loans excluding loans held for sale were up 18% year-over-year. We continued to have excellent core deposit growth up 39% year-over-year, and I just point out again as I did in the last earnings conference call, the continued strong growth in checking balances in both business and consumer accounts. Consumer checking balances are up 61% year-over-year. So we're very pleased with what's happening in the core deposit area. Couple of other comments, non-performing assets, 12 basis points, credit portfolio continues to perform very well and we finished the quarter at about $964m in total assets. So, very, very pleased with the quality of the earnings for the quarter and the continued core growth in the bank, in the loan portfolio. With those highlights, I will conclude my comments and open the call up to questions.

Thank you. Ladies and gentlemen, at this time we will begin the question and answer session. If you have a question, please press the star, followed by the one on your push-button phone. If you would like to decline from the polling process, please press the star, followed by the two. You will hear a three-tone prompt acknowledging your selection and your questions will be polled in the order they are received. As a reminder, if you are using a speaker equipment, we do ask that you please lift the handset before pressing the numbers. The first question comes from Ken Bradshaw. Please state your company name followed by your question.

Good morning guys. D.A. Davidson. Couple of questions, John. First, are there implications to the insurance component of the sales finance division from the increase in the contractual -- the potential increase I guess of the contractual insurance rate on some of the loans (Audio Gap) and by that I mean that your - the stepping up of the rates, is there a probability or possibility that you end up losing this, and sure overtime if the fall rates don't slow down?

My guess is, always that possibility we can grab a good relationship with the Company, the insurer. And we are satisfied with the step up in rates that -- solves their concerns over the current insurance goals. I might ask Scott Harlan to add a comment or two on that because he is the one that's most in contact with the insurers.

And might I clarify something too, the -- should that happen in the -- at some point in the future, the relationship terminated with the insurance company. The insurance on all of the loans that have been insured to date would continue to be employed as long as you continue to pay the premium. So, there is not a risk from that point of view of, if that relationship terminated having uninsured -- having loans in our portfolio that we have tagged as insured becoming uninsured, assuming again that we continue to pay the premiums and do the things we are supposed to do for the insurance company, but on an ongoing basis, again that, could get -- may or may not happen.

And Scott or John, is -- have you thought about, if the insurance company comes back in the next year or so, whatever the time frame is -- a higher rate, say it goes to 3%, instead of 2.7% or whatever the number is, you know, how much pain do you threshold do you have to continue the program with a different insurance percentage?

I'll let Scott respond to that.

The, if the insurance came - company came back and -- again based on the history, decided to adjust the ongoing -- the future premium, that is again -- that is just something we will have to work at, in terms of overall possibility of the program, the yields that we were receiving on the loans, the expected -- again the expected insurance cost and all that. In other words, I can't, you know, speculate at this point on what that -- what our conclusion may or may not be, based on our increasing premium.

And Scott, contractually when can they -- when could they come in and propose -- something like that?

End of the current policy year -- ends -- the end of September 2004.

Okay

Jim, this is John, there will be a variety of possible courses that we would look at and would consider. One would be adjusting pricing and retaining without insurance or proceeding without insurance. Discussions, number two would be discussions with other insurers and number three would be looking at sales of more loans to other investors, not generally speaking other banks on a flow basis of some sort. So, I think in the eventuality that they came back with something that was unacceptable. I think we have got several avenues to look at.

But the changes you made in the collection processes, it's still too early to say whether that's had any impact on the spot rates either, I guess?

Yes, though, you know, on page 12 of the press release, if you look at, near the bottom of the page, typed something insured portfolio and claims as a percentage of the insured portfolio, you see that we did have a spike in the first quarter, but it is dropped from where it was in the first quarter and delinquencies have also dropped. So, it's too early to tell, but we are encouraged by what we see.

I see. It's actually dropped. Okay, good. Down to 51 basis points in the June quarter. Is that what you were referring to there? Oh, that's the uninsured portfolio. Excuse me, I am looking at got it. Yes, there you go 151. Okay, perfect. The other question, I am sorry to ramble on, the other question I had was regarding recovery history after charge-offs. Have you got enough of a database yet to suggest to me what recovery rate is after charge-off for these loans? I'm really talking about the uninsured portfolio here obviously instead of the insured.

The uninsured portfolio is the program that we have had the longest history on over seven years and I'd say, you know, not knowing the numbers exactly, but the recovery history hasn't changed, in many loans they do, we make a recovery at some point after appropriate legal action is initiated by the collections asset management area, but there really haven't been any serious change in terms of that. Now, this is different than in the past where we used to finance more motorcycles, that type of vehicles where we actually repossess the assets and then sell them, attempt to sell them, the whole improvement has been more consistent in terms of the recoveries that we've had in our program.

Okay. Great. Thanks a lot guys. I appreciate it.

Thank you. Our next question comes from Louis Feldman. Please take your company name followed by your question.

Hoefer & Arnett, and Jim got most of them. Following along, I guess, can you provide more color on the differentiation in terms of your collection program at this point in time and what your objectives are with this?

Well, I think the differentiation is, we are looking at a higher ratio of collectors per X number of millions of outstanding balances in consumer loans.

Would that impact your FTE or is that some -- is that an outside contract?

That impacts FTE.

Okay.

That's something that we do internally, but the bottom line is just -- more aggressive, pursue it, we continue to evaluate, you know, different approaches in pursuit of delinquencies stratified by credit scores and things like that.

Okay. For Scott, is the -- last quarter you talked about the fact that the trend was moving lower in terms of overall FICO scores. Is that a trend that is continuing because those are loans but are more likely to fall under the insurance and therefore would be more at risk if something happened with insurance company?

I don't remember talking about the credit scores dropping. I guess, in a forward contact, I think they stayed pretty much the same, last quarter to this quarter.

What is the average score on these loans?

On the uninsured loans, which are about, pretty 41 out of the $67m and before average scores were 727. And the insured portfolio, which I believe, is about $27m. Now again, I am talking about just the loans that are on the bank's book, this does not include the loans that have been sold to other institutions. The average score on that loan is 666. I think I am remembering now what you were referring to last quarter, in that our underwriting criteria haven't changed such that we are still buying the same loans that we -- on the same underwriting criteria that we have purchased for the last 2 or 3 years although we have tightened up a bit in some places. But as we expanded nationally to areas that have, geographic areas that typically have lower credit scores than the Pacific-Northwest, just by nature of that expansion, the average credit scores will drop -- will drop over time. And when we compare the credit scores on the portfolio from first quarter to second quarter, there was essentially no change.

And I would say, Louis, this is John here. One of the difference is that we have made recently in underwriting is a more stringent test on disposable income.

Okay. On the general portfolio can you talk about the increase in the overall charge-offs and is this a trend that you think is going to -- I mean, certainly within the list on page 11, there are minimal charge-offs. Was the 161 something that occurred or you were cleaning house or is this more of a level because you also made a mention in here, that a significant portion of the charge-offs that you were incurring were coming from this consumer portfolio.

Hi, and this is Roger.

Hi Roger. How is the back?

Yes, it's getting better, thank you. Of the 161,000 we charged off this quarter, most of that continues to be the sales finance loan, 84% of that were the sales finance loans, so that's a little different than last year which in the same quarter was like 97%, but I think that same trend is such that most of our charge-offs are coming from the sales finance portfolio. So --

As the balance increases, are we likely to see higher charge-offs from the year-ago higher provisions?

Yes, certainly. Yes, I mean we are hoping that slowing that portfolio, although, we'll just add the notes that the growth in the sales finance portfolio will slow down because we will show -- check that on our quarter-to-quarter basis show. It's continuing to grow but it is in a slower pace than we saw in 2003 for example. I think that's right now that's probably the trend that we will see in terms of slow growth in that portfolio with us selling most of the loans off. But again, just the nature of Consumer Lending, it tends to have a very very high delinquency rate compared to the rest of the portfolio, and a very high charge-off rate. So, even though it's only about $70m of approximately of $795m in loans, it constitutes most of out charge-offs. And we are starting to get paid very high rate of return on that. The note on that loan portfolio widely exceeds any other portfolio that they have for bank.

Okay, I'll sit back for now.

Thank you. Our next question comes Bill . Please state your Company name, followed by your question.

Thank you Davidson Investment Advisors. You began to touch on some of the changes that you have made relative to the process fees, in terms of the front-end underwriting. What about on the collection front, and any additional detail that you can share relative to the underwriting front, in terms of what's different today versus in the past.

On the origination front, again was -- I spent a lot of time ongoing analyzing the loans that go to the insurance company for claims or loans that end up being charged off, try to find any trend within those loans that we can work -- we can appropriately tighten the portfolio for the underwriting guidelines and have ways such as John pointed out, have instituted some disposable -- minimal disposable income guidelines which was in response to the trend that we saw later in the third and fourth quarter of 2003 also changed up some required documentation, additional proof of income, types of criteria for lower credit stores. Again as you probably point out to the underwriting especially at lower credit scores is done by underwriters, not by a strict score card, and they are evaluating every credit, then I know for a fact that they have tightened their review of those loans especially at the lower-end of the credit spectrum. On the collection, I think, just kind of getting back to something John said earlier it's looking -- continuing to look at the portfolio more like a finance company would look at its portfolio and collecting on that portfolio aggressively especially and really particularly stratifying, a little bit of coming up on delinquency by credit store and being more aggressive on the lower credit storage and being much more proactive on those, I believe, than what we have done in the past and just it's a progression for the collections for the asset management folks. And I think the trend that we have seen in the last four months in terms of delinquencies and on charge off, particularly claims have been an indication that we are going in the right direction.

I'd also going to take on Bill and say that we also had -- we've retained consulting operation for a third-party review, this really in the second quarter, so, we have some observations from them that, well, we are not signaling any major changes and the way we do things were helpful to us. And thinking about how we, folks evaluate risk and then manage it in that portfolio.

Great. And then relative to the 2.7% that the insurance company, let's just assume that is what the premium is. How does that compare to their losses meaning are they still over time cash positive, I mean, they are paying out less than 2.7%. And I am actually wondering if we can appropriately compare that 2.7% to the same table on page 12 that you had referenced earlier there at the bottom on the insured portfolio that shows the claims as a percentage of the insured balance. So, it's 2.7% compared to the 0.89 in the last quarter and assuming that this is the case I guess is a whole another question that comes up which is, I mean, does it makes sense to dump the insurance and simply put 2.7% of each of these aside and dedicate it or allocate it loan loss provision and just expect that you might do it internally rather than these insurances. Sorry for the multiple questions there.

Hi Bill, let me take a stab at answering that. Roger. I'll just state where the numbers come from and you could kind of see where the insurance company is. The 300 issues that peaks there, March 31, 2004 the claims that were paid by the insurance company in that quarter were $351,000 which is 118 basis points of the balances at that point in time. So, if you annualize that it would be well in excess of 4% and we are paying them 270 basis points. So as to see why that certainly caught your attention. If you go back a quarter at 89,000 at the end of the year, it was only 38 basis points. So, at that point in time they were very happy with relationship. 38 basis points time score was obviously less than what we are paying them. And then you can see where we stand at the end of June at 89 basis points time score would be the annualized rate and again we are paying them -- we expect to pay them the maximum of 270 basis points. Although, I just add the note that we sort of settle up on all of this on September 30 at the end of the contract year if you will, but that sort of the issue and I think why I accept them here is if we can get all of these claims back down to a level that makes them a lot happier, then probably life goes on as we have always known it. If we don't resolve that issue then the new pools that we might be talking about insuring into last part of this year and next year might get some adjustments on the premium and that's kind of what we are looking at right now. But anyway it is kind of shuttling back to answer your question. That's a sort of number that the insurance company is looking at right now.

And Bill, John. I think, part three or four of your question was would we look at not doing insurance and just increasing our loan loss provision that's always something that we are looking at, I think, that as time goes on the more experienced with -- I am talking about experience in the insurance sense. what we have and the more comfortable we would be in making that final decision on an approach like that, probably premature data.

Alright. Thank you both.

The next question comes from comes from Roth . Please state your company name followed by your question.

How are you gentlemen? It's Roth Haberman, Haberman's . Roger, I just wanted to focus in on your GAAP and interest rates sensitivity number. I think you said it was positive 2.66 as of the end of the quarter. Was that a one-year -- that was just your one-year number?

That's a one-year GAAP, right.

Specifically, how much of your loans are tied to prime today, and how much will immediately adjust? Or are there are a number floors on them and it'll take two or three increases in rates to get above the ?

Roth, I don't think we mentioned where we stood on June 30 as on the floors and stuff. But if I just kind of jump back into some of the previous 10-Qs, where we've had little more time to discuss that issue, we do have a number of loans well in excess of a $100m that have floors of 7.5%. So we are long ways for getting to the point where those floors will work for our advantage. The only thing I can point to that's a little bit reassuring is that when we run the income simulations, net interest income simulations, and ramp that up 200 basis points from where we stood at the end of June there, the impact is nil. It's only one basis point. And that takes into consideration; we've got a ton of loans that won't respond until we get well above 7.5%.

Over and above the $100, which you are talking about?

No, no. I'm just talking about -- if you look at the entire portfolio, it includes roughly $800m in loans plus $100m plus in securities. I'm sure if you look at the whole plot, and then look at what's going on the liability side of it, one ingredient in that whole combination happens to be the loans of floors, and in the case of that little specific subset there, those loans won't respond positively because until the end excess -- the one-year end excess, they are above 7.5% plus our margin. Then they were not going to get any benefit from rising rates. But the rest of the portfolio is sensitive enough, and the liabilities are such fixed in many cases that at least for the next 12 months the impact of the rising rates, we don't' think will affect us one way or the other.

I don't think Roger meant to leave you with the impression that we have a ton of loans with floors. In the context of a $800m loan portfolio and the securities, it's not that. It's over a $100m, which is -- it is enough get our attention, but it's not a situation we are in a rising rate environment, but we don't think that's going to negatively affect us right now.

A number of companies who we've been hearing from the last couple days and as of last quarter are all basically saying they are spending out their maturities of their deposits and the CDs. Are you doing much of that and as your competitors and I'll throw out the de like Sound I guess who is in your markets. That de novo and others like that sort of forcing you to raise your deposit rates on a premature basis, you might say?

Well, there's certainly been a fairly aggressive deposit rate environment here in Puget Sound area. I don't think that Sound bank, the way they are called, is open yet. I don't know. Maybe I have never seen them.

I'm just using them. As much more example, I think you have across the street from you have a two or three old de novo. I'm just saying using them as my example. Channel that de novos.

We are seeing certainly -- and weekly, we look at competitor's rates on the deposits side, and we are seeing fairly aggressive rates being posted out in two and three and four, and five- year maturity range. But frankly I don't think consumers aren't idiots, and generally speaking they have been pretty reluctant to go out long because their expectation is that rate will rise and nobody is really keen on untying up money for very long periods of time, I think so, and I don't think it's lengthening maturity is not -- I haven't seen significant consumer movement yet. Well many people are obviously posturing themselves from a pricing point of view, to try and encourage people into longer maturity, but overall, the price and rates have become a little more competitive and that's been going on for the last six months or so I think it's partly a combination of that pricing rates and partly a combination of -- it leads to an okay stock market.

But, you don't see it, do you? Let me ask you specifically. Over the second half, I think you've seemed to imply your margins are going to be, sort of flattish compared to what they were this past quarter. You're not seeing your self having beginning to spend out the maturities having to pay out, pay up for more on, say the advances, then you have them.

Yes, Roth, well we did, that should encompass to step process for us. At the end of last year, we saw it reflected in first quarter, as the bank advances came due, we extended them out well beyond what we normally would have done, and that kind of, actually worked to our disadvantage in first quarter, and it kind of got flat in the margin down little bit. In second quarter here, we did something that was slightly different, because of the CPO , and because of the extremely low federal fund trade and all the short in rate, we went ahead and picked up about $37m worth of securities of the 3-year mortgage back securities and we went ahead and funded that with term bank advances that match that . So the combination of extending longer, and first quarter and second quarter is kind of blocked in some of our money if you will, which is why 200 basis points rise in rates doesn't seem to have much effect for us right now. It also flattens our margin over that, probably the downside if we hadn't extended sum of our wholesale money out longer on the curve. We might have had a little bump up in our margin in second, third quarter.

Okay, thank you.

Thank you. Next question comes from Darius Brown. Please state your Company name, followed by your question.

Hi gentlemen, the Group. Just want to say first, great quarter, and if we could a little bit about loan and deposit growth you mentioned. Can you just, sort of, characterize it for us? One thing I'm wondering about is if you're seeing as much commercial loan growth as it seems like you are, maybe these home improvement loans can be paired backed and is that your intentions, just I would like to know about that, please?

Actually, we are seeing decent growth on the business banking, our commercial side pretty much flat in commercial real estate and the growth has been in residential to include custom-constructing, which has been a very, very good business for us. And on the consumer's side and we remain committed to that consumer's segments, particularly the sales finance that we talked about earlier this year; don't look at any strategic change there in terms of turning back. On the deposit side, particularly the growth in check-in accounts, we've just had particularly at the small business end, we define we have a business segment we call community business, which is Companies with their credit needs of less than $200,000, and extremely good check-in accounts growth there and on the consumer side as we continue to change the make-up in our bank centers and, I think, that is due to both a change in management and with focus on the consumer side as well; its incentive systems where they are more focused on rewarding employees in the banking bringing consumer deposits. So, very, very good growth on the consumer's side again in just a result of focus calling at consumer level and the small business level.

Okay, great. Thank you.

Thank you. Our next question is a follow-up question from Louis Feldman. Please go ahead.

Yes, you talk about, following Darius' question, you talk about slower loan-growth in the back half. Is this you pulling back or are you actually seeing a change here in terms of what the demand is like?

Well I think that we are recalling back, consciously no, we are interested in continuing to exploit opportunities but this is --we are looking at the second half of the year. Certainly, we are not forecasting the second half but certainly in the next quarter, we are thinking that we may see slightly slower overall loan growth in the market place, at least at the pricing levels with and risk profiles that we want to take on.

Okay.

Let me make a differentiation between that and point back to manage asset growth or something. It's more a question of risk and pricing profiles.

You want to might be just add, this is Roger, we had such torrid growth, I mean, at least for us 20% roughly annually growth in the first half of this year and it just seemed to me that we probably won't continue to see that rapid growth and I think that's sort of a general observation more than anything else and as John points out, certainly not have changed the strategy if we could, continue to have extremely rapid loan growth. We would love to accommodate it, about its just not likely that, we will contain that-- continue at that pace.

If you achieve that loan growth, how would you fund it? Can you talk about what your plans are for your overall deposit gains, I mean certainly you are starting to get some decent traction on the DDA side and your time deposits are finally dropping below the 70% level, but what are your objectives at this point in time for continuing to build this at this point, going forward?

Well, first of all is to make sure that we don't think that the asset growth is going to be as strong in the second half as we saw in the first half. I guess things tend to average out over the years and I think probably 2004 will be the same. But if we were fortunate enough to continue at that pace, then we would probably have to equally bear wholesale funds to make up the difference. If you just look at year-over-year, our deposits are up almost a $120m, again looking at June to June and our loan growth in the first half of the year was about $70m. So, I -- if we had something akin to that in the second half, we would probably be able to fund probably 60% to 70% of that with deposit growth. That would certainly be around 10 and then we could probably very easily make up the difference with wholesale money.

But I don't think that, likely on the other hand if you may have noted from prior press releases, I have been surprised from quarter-to-quarter on terms of what asset growth has been.

And then, just one last question, somewhat complicated. Would you lay out what your strategy is in terms of these bond moves and what is your overall objective is and in terms of the investment portfolio at this point in time?

First of all, our investment portfolio as a percentage asset is on the --

Very small--

Compared to even the peers in this area and certainly compared to national average. So, for us to add another 30m to our securities portfolios is, kind of bringing up to the tail end to what other people offer on a routine basis or carry on routine basis. Secondly, the CPO curve was such that we thought that this was as close to golden opportunity as where we are going to get, so we're able to pick up some with the full bump up in rates that we saw in the second quarter and then turn around and match that off on duration with some Federal Home Loan Bank advances and in effect lock in for the next three years a margin adjusted for capital usage and risk and anything else, widely exceeds anything else we could do in the lending area, so, although that's not our core business. But it was just a golden opportunity and so I think as far as that piece is concerned that is taken care of, and we will come back and revisit it at the end of three years when these loans will overall become adjustable rate loans but in the mean time that was an opportunity that which I am sure, above the way, we won't see it again certainly in the next few years.

The inference in the press release was that part of the margin contraction was due to the fact that you would purchase the securities and have the carrying cost on the wholesale funds, but we were not getting any yields from the securities. Is that correct and to what extent did that impact the overall margin?

Yes. You are right. There is a timing difference there. When we took down the securities, we didn't actually take the liberty of settlement on that until late June, but we made the trade in April and May, but we didn't have the courage of our convictions to wait and max that off, when we actually settled. So we want to head in and lock it in for the next three years by digging down the funds in advance. And unfortunately, we had to carry it out a little bit during the second quarter and that depresses the margin. We never did; we went and actually figured it out, but I am sure it was matter of, you know, a number of basis points there.

Can we assume that, since they will -- these will now start yielding that that will be offset?

Yes. We will see the pick up in net income; in third quarter, we will get the full benefit of that trade.

Okay. Thank you.

Thank you. Ladies and gentlemen, if you have an additional question, please press the star followed by the one and if you are using speaker equipment, you will need to lift the handset before pressing the numbers. And next question is a follow up question from Louis Feldman. Please go ahead.

Yes. I am here. John can you talk about what your plans are in terms of the overall efficiency? Certainly you have been making a number of capital investments, the new Sammamish Plateau branch and the slow increase in the number of FTEs, but your efficiency ratio has been trending up over the last couple of years, you know, now moving into the 60% range. Can you touch on what your objectives would be going forward to try and bring that back down?

Well Louis, would it be disappointing to you if I said we don't have any specific objectives to bring that back down in the near-term future?

I am heart broken, go ahead.

Let me talk about that a little bit. We want to be on a phase to open a couple of banking centers a year. We have skipped that this year and our remodeling for those banking centers in the same retail style is our newest one. So, everything will look the same now by the end of this year or early next year. I would expect it to be back on the phase of couple of banking centers a year beginning in 2005. We've got a couple of sites identified -- at least one site pretty much identified that we will be ready in 2005. So, there will be continued capital expenditures there. Again the goal is to continue to build a strong franchise here in the east side of Lake Washington including that physical presence. In the area of business banking, we continued to invest both on the origination side and the operations and support side, you know, although I think the peak investment in terms of human resources is over and we continued additional investments there that will probably prop up the efficiency ratio realistically the next year to year and half I would guess.

Any comments on the argument that there are too many branches being built at this point in time, industrywide -- you know hot chasing fewer and fewer deposit dollars.

Yes. that's an issue, I guess it is a local phenomenon and again in our strategic objective to built a strong, particularly strong retail franchise here on the east side of Lake Washington, and I think we do offer a very viable alternative when it is proving itself as you look at the increases in balances and consumer checking and business checking accounts. Physical presence is important and I won't say it is a zero-term game but it's -- yes, overall it's probably close to a zero-term game and it's a -- for us a take-share game.

Okay. Then one last question if I may, can you talk about, in non-interest income an overall decline in loan fees despite production increases was this related to the decline in mortgage originations for the quarter on a year-over-year basis or is there something else going on there?

Well the gain on sale of loans went up quarter-over-quarter. It does not answer your question although. It went up in second quarter of last year with 184,000 and it is 322,000 in the second quarter of this year. Year-to-date at roughly 280,000 compared to 670,000 so most of that has come from the sales finance area, which constitutes the bulk of it. There has been a drop in the residential sector gain on loan sales. So, maybe that what you are thinking of --

Well, I'm just -- bottom of page 9 on year-over-year basis -- the decline in the loan fees from 106,000 to 84,000. I am wondering -- again, I am wondering is that the function of the lower over all mortgage operations?

I'll try and catch up with you.

I feel .

That sort of arguments there. That's actually two things that go under that. One of prepayment fees so for loans that, which run in to refinance business. The other piece of that is that last year the retail residential loan officers and we sort of break them into wholesale on retail folks. Many of those folks I had a preference for using you know financial products with other banks and we offered a wide variety to include our own obviously, the folks that we have onboard today preferred to try and launch use our own. So the broker fees that were involved in last year's numbers has gone down where we just pokered out, principally residential loans and then secondly because of the drop in the retail business, the prepayment fees fell, declined and sort of combination of those two things is what led that particular segments there, other incomes to drop from 106,000 down 84,000.

Allright. Great. Thank you.

Thank you. Your next question is a follow up question from Bill Deslin, please go ahead.

Thank you. I also wanted to follow up on the efficiency ratio and I am curious how would that number have looked if we were to remove the drain from the business-banking segment? Is there a way to easily and quickly calculate that for us relative to the 61.7 reported in the second quarter?

Well Bill, Scott would say that we have dropped about 30%. Actually, we haven't I don't think we have broken that out Bill. I mean clearly it would drop somewhat Roger do you have a --

No I don't think we were analyzed from that perspective.

Allright, thank you.

Thank you. At this time, we have no further questions. I would like to turn the conference back over for any concluding comments.

Allright. Thank you all for taking the time to talk to us this morning. Again, we are very pleased with the quarter, good long growth as I said, excellent credit quality. We look forward to talking to you all again if not in the intervening three months at the conclusion of our third quarter. Good bye.

Ladies and gentlemen, this concludes the First Mutual Bancshares, Second Quarter 2004 Conference Call. If you would like to listen to the replay of today's conference, please dial 303-590-3000 or 1800-405-2236; you will need to enter the access code of 110-016-53 followed by the pound sign. Once again, thank you for participating in today's conference. Have a great day.