Wintrust Financial Corp (WTFC) 2008 Q3 法說會逐字稿

Welcome to Wintrust Financial Corporation's third quarter earnings conference call. All lines have been placed on mute to prevent any background noise. Following a review of the results by Edward Wehmer, Chief Executive Officer and President and Dave Dykstra, Senior Executive Vice President and Chief Operating Officer there will be a formal question and answer session. (OPERATOR INSTRUCTIONS). The Company's forward-looking assumptions are detailed in the third quarter's earnings press release and in the Company's Form 10-K on file with the SEC. I will now turn call over to Mr. Edward Wehmer.

Thank you very much. Welcome everybody. I think we'll go through some preliminary comments by me and then Dave will talk about specific numbers and then I'm sure the question and answer period will be lively.

As indicated in the press release, Wintrust recorded a small loss for the quarter. This $2.4 million loss was mainly the result of the Company Recording a provision for loan losses for approximately $25 million as compared with $4 million for the same quarter last year. This higher provision was necessitated by both higher charge-offs and an increase in the amount of non-performing loans in the quarter. We also raised the reserve as a percent of loans to 91 basis points from 72 basis points one year ago. To a lesser degree, earnings were held back by net interest margin that (inaudible) due to the recent drop in rates. It's making a comeback and we will talk about that.

The first -- a little bit of perspective. Back in March of 2005 in light of what we considered a rational markets. The inverted yield curve, market pricing void of any credit spreads on the overall in the markets, profitable growth at acceptable risk levels was not available to us. That's when we adopted our rope-a-dope strategy you've heard us talk about. As it was apparent to us that the cycle was soon to be upon us our strategy involved tightening already our already conservative loan underwriting standards. This slowed the flow of earning assets and accordingly slowed our overall growth in deposits. We used this period to solidify our funding sources in attempt to weed out potential future problem assets. It should be noted that our banks have never invested in the subprime mortgage markets or any related (inaudible) assets. We also have had and continue to have no exposure to the problematic investments of Fannie Mae and Freddie Mac equity securities Sure enough in March of 2007 we saw the first signs of the credit cycle. If you recall, this is when the subprime mortgages and related investment securities start taking their toll on the Lehman, Bear Stearns, Merrill Lynch and of the other large banks. We felt history would hold true, the cycle would be around fort three years in actual duration but be subject to a much longer hangover. We have talked about this, 85, now 95% of the time we've been in an inverted yield environment, it's followed by a credit cycle of the same length and depth of that inversion. If this actually was the case, which by the way we belive it is, the third and fourth quarters of this year are really the absolute middle of the middle. This is depths of the depths as far as we're concerned as it relates to where we are in the cycle.

Just because we saw a storm on the horizon and batten down all the hatches and through overboard as the excess baggage we're still in a storm and it's a heck of a storm. The effects of the storm are further exasperated by the mandatory adoption of-- on 1108 of FASB 157, the infamous Fair Value Accounting Rules. These rules basically require a mark-to-market methodology as opposed to a a mark-to-value methodology and in distressed markets like we have right now, charges on impaired loans, which we are taking are in many cases ultra conservative. According to our auditors and our regulators and what we have learned from talking to bankers, not just in Chicago but all around the country, we believe we're wat ahead of the game in our application of these rules from 157 as they relate to problem loans. There's no doubt as you all know, I don't have to tell you that the entire banking industry is under stress and there are no assurances as to when and how the stress will be alleviated. Our stated goal when we adopted our rope-a-dope strategy was to be the first guys out of the cycle in order that we could take advantage of opportunities that always present themselves as these things work out. That remains our goal, we intend to deal with our issues at a timely in a conservation basis. Further we believe the planning we have done and the actions we have taken will allow us to get through these troubled times and ultimately we are going to thrive.

In order to kind of take a look at our relative position as the banking industry ask to just consider the following. Although our non-performing assets in charge-offs have increased, they still compare reasonably well with our peer group with banking in general. We generally on the past operated with these two categories being at 40 to 50% of our peer group. We firmly belive that when the dust settles and accounting valuations are consistently applied throughout the industry, we anticipate that this again will be the case. We'll be at that 40 to 50% levels at the end of the day.

To give you a little further evidence of our credit quality and where the portfolio stands, I'd ask you think about the following. We have no regulatory issues. We have regulators going through our banks all the time. And our recent successful capital offering our investors performed over one month of independent due diligence and they committed and-- when we closed the deal. We recently had our $100 million line of credit renewed at the holding company the time when many other banks were having their lines curtailed. I will tell you that none of internal/external examining bodies have come up with any significant problem assets or deficiencies that we have not already identified or we are working at.

On the liquidity front, Wintrust hs never realigned on Institutional Funding on its balance sheet. Our subsidiary banks are 90% funded by good old fashion retail commercial deposits and retail deposits spread out over our 79 banking locations. In contrast, many of our competitors rely on Institutional Funding degrees of 40, 50 or 60%.. We've been able to maintain and grow our funding basis in a market that would suggest in contrary by providing innovative products like our Match Save product, which provides 15 times the level of FDIC Insurance and these products have been well accepted and we've been able to keep our funding base solid and actually growing. We've historically used this product defensively to maintain existing deposit relationships, but now we're starting to use the product more offensively to garner new relationships throughout our market areas. We're in the local papers. We're doing direct mail, and we're actually on the radio right now advertising this. We're also looking into the wholesale product related to this 15 times coverage.

As you know, we have deposits from the liquidity in our bulk management accounts that fund bank right now by using this product. We are taking this our on a wholesale level to other broker dealers and other asset managers and we've seen relatively good reception. We have a commitment. We'll see if it happens. We have a soft commitment for $250 million of these funds which will yield on the 1.25--- will pay in the 1.25, 1.5% range for the fourth quarter. Liquidity, we think is always an important attribute for a bank but even more so in this environment. WE have not been out, even though it's been prevalent now, if you read the local papers. We're not advertising 4 and 5% CD rates. We believe that we are able to fund ourself and to grow by being innovative and competitive and we've kept a very strong deposit base during this time.

Mentioned it earlier, but we also raised $50 million in new capital to help us weather the storm and take advantage of the opportunities that will present themselves we think going forward. It's important to note that even before we raised that capital and even taking into consideration our results this quarter, we would have been well capitalized in all of our banks and at the holding company. So the $50 million actually improved our well capitalized base and we expect that to be the case going forward.

Just in summary on this relative analysis, I think I'd like you to consider that all though the third quarter showed a loss, we expect will be profitable for full year. The banks and the holding company are well capitalized and will continue to be so. We never participated in any of the asset classes that caused the subprime debacle. Our portfolio though more stressed than usual is in relatively good shape and our non-performers are being worked on and they are very manageable. And our overall liquidity is strong with the vast majority of our funding coming from diversified local and retail sources.

A little comment on the balance sheet if you will. We had measured growth, again, in deposits and in loans. During the quarter, loan demand is extremely strong right now but we're handing it out with an eye dropper. We want to make sure that we maintain enough cash on the holding company to service our obligations while we work through the problem assets and our goal is to hit the ground running on 1/1/09 and have most of this behind us. But, loan demand is strong and at very good spreads. We're making great progress in reevaluating our existing portfolio as it--- the loans come up for renewal or maturity. We're getting 1 to 2% additional pricing on those loans and will continue to do that.

I know you're all interested on the TARP issue. We are actively evaluating our participation in the program. There's a lot of pluses and minuses to it, we're eligible for $80 million to $240 million of TARP money if we should so choose to do so. If we were to choose to do it, we think that the opportunities would be enormous for us. It would certainly alleviate the pressure on the growth side of things which we think we can take advantage of, again, we continue to look at over $100 million of new credit opportunities every week. We're tossing out a lot of them even though they are past credit munster for pricing because, again, we're adopting this measured growth approach and making sure we're able to maintain our capital and our cash. With 200 million, hyperthetically of additional capital, leveraged 10 times that's $2 billion worth of growth that you could pick up at a 4 point spread.

Importantly, we see the loan demand and we see its good credit quality. We also see that we believe-- we believe we'll be able to fund this, fund this without having to go out and pay the big rates that other banks are trying to pay to keep themselves adequately funded. So we think that good spreads would be there and this could be a real jump start for us to make that first out of this environment that we talked about, jump start the earnings and really get the ball rolling at a time when other people are not going to be able to do that.

Question is often asked are we -- would we use the fund if we were to take advantage of this. Would we use those funds to do acquisitions? I would say that on a selective basis we would be interested in smaller, assisted or unassisted deals that would be in our market footprint where you would get a good strong deposit base. Certainly, don't want to pick up a cancer transplant from anybody. I don't believe we're interested in doing a larger transaction and that would usually, a larger transaction would involve additional asset workouts that would take -- that might set us back in terms of our goal of being first out of this particular environment.

So gain, our goal is to get out of this and get all this stuff behind us in 2008 and hit the ground running in 2009. Again, we intend to be profitable in 2008. And this is something that's manageable and we'll work through. I don't think we're out of the ordinary or extraordinary in reporting the results that we're reporting. I'm confident in saying that we're being aggressive in dealing with these issues in our financials. And we're aggressively working these problem loans through the system. Some may be around here, because we've marked them down to acceptable levels. They may be around here for a lot longer than we anticipate, but if I have got to build in 35% IRR on these when I mark them down I'd rather make that money than someone else. But, for the most part, we will be pushing a lot of these assets through because there will be more coming. And I think we can get this cow through the boa constrictor over the next few quarters with the increase in the margin and with the opportunities if, in fact, our board when it meets this week decides to take advantage of the TARP funding that we'll be able to really leapfrog and jump start this growth and earnings and achieve our goal for 2009.

Again, I'm going to turn this over to Dave who's going to talk a little bit more in detail about the charge-offs, the non-performing assets, our margin, and the other expense, and then we'll open it up to questions.

Thanks, Ed. We will quickly go through those areas. Net interest margin, our net interest margin declined three basis points in the third quarter from the 2.77% that we recorded in the second quarter of '08. The impact of non-accrual loans negatively impacted the margin by approximately 4 basis points since last quarter. Additionally, the compression in the asset yields had the impact of declining the margin by 2 basis points as a result of the prefunds contribution. We also continue to have a negative impact on our loan yields from our Premium Finance portfolio. And not because it's not a good business but because the yields we were putting this on at a year ago were substantially higher so the loans that are maturing off our books were higher. As you recall, rates dropped significantly in the January, March, and April time frames of 2008. So the assets that have been going on during 2008, have been going on at rates lower than the loans that have been maturing. The good news is that over the past few months, our yields have been increasing in the marketplace for those assets is getting favorable to us. The turbulence in that marketplace with some of our competitors and their cost of funds as a result of their conduit fundings coming due and repricing has resulted in increased prices on those loans and we're starting to see the benefit of that. So we expect that to start improving over the course of the next quarter and we should see margins improving. For some of the reasons that Ed talked about, we are seeing spreads increase on renewals of our commercial deals and due to the temperate approach we're taking to the growth and looking for good yield in assets, we are seeing spreads come back in the marketplace.

The one wildcard continues to be the cost of funding. Ed explained our strategy on that. We have many of our competitors that are apparently very thirsty for deposits right now. That are offering 4 to 5% yields or rates out in the marketplace. We're trying not to go down that path. Our advantage of having the 15 different charters and being predominantly retail funded has proven beneficial to us. That combined with our Match Save program where we can offer 15 times the FDIC limit to our depositors that are looking for safety and not just yield on their CDs has proven beneficial to us. Overall, our cost of funds on interest bearing deposits declined 16 basis points quarter-over-quarter. We're hoping that some of this competitive pressure goes away in the marketplace and we can grow those deposits at the lower more favorable rates to us, combine that with the increasing spreads in the marketplace and we're hopeful that we've hit bottom with the margin. We should start to see that increasing from here on out. On the non-interest income site the Wealth Management revenue decreased by 9% from the second quarter.

The recent equity market declines have hindered the revenue growth as fee based accounts where the market values have declined have impacted the fees that we receive on those accounts and the uncertainty surrounding the equity markets have slowed the growth on the brokerage side of the business a bit. Mortgage banking revenue declined to $4.5 million in the quarter down from the 6 to $7 million range that we've been experiencing in the past quarters. Clearly, the lack of market activity for residential real estate loans has negatively impacted the revenue in this business product. But we are committed to lending to qualified individuals, and we have been using the recent months to solidify our infrastructure to higher new solid originators and we're ready to take advantage of the opportunities in the market. But clearly we need to see the real estate market stabilize a bit here and people to be able to sell their homes so they can buy new homes. We think we're well positioned. We think we have a good infrastructure and we're continuing to add new originators from different areas and we're hopeful that as the market stabilizes at some point and begins to rebound, we will absolutely be standing at the table ready to take advantage of that.

The other areas of non-interest income that had any significant changes would have been the fees from our covered call income, the amount of fees that we received in the third quarter stood at $2.7 million. That was down from the amounts recorded in the first and second quarters of 2008 but higher than amount recorded in the third quarter of '07. As you know the amount of revenue received is dependent upon the level of interest rates and the volatility present in the marketplace at the time that we enter into those contracts. The environment for the call option income was somewhat better in the fourth quarter of this year so far. And to date we have recorded $6.2 million in the fourth quarter of '08. So the market was a little bit better this quarter. So we obviously will see an increase in that line item in the fourth quarter of 2008. Again, we view this program as a way to mitigate the impact of the margin compression and falling interest rate environment and consider the revenue as an enhancement to the yields that we receive on US Treasury and Agency Securities. Other than those three major areas, we have no other income areas that were significantly different from the second quarter of 2008.

On the non-interest expense side. Total non-interest expenses actually declined $1.6 million from the second quarter of 2008. And the majority of the decrease came in the salaries and employee benefit areas. That was due primarily to the lower commissions related to the declines in the revenues that we saw in the mortgage banking and brokerage areas. So we actually were able to decrease our overall cost even though we did have additional costs with working out of some of these problem credits and the other real estate costs and professional fee costs still being somewhat elevated over our normal levels. Other than the decline in the salaries area, there was really no other significant changes in non-interest expenses in the third quarter.

Turning to non-performance assets area, if we go to our commercial consumer and other areas, the increase in that area from June of '08 to September of '08, we went from $64 million to $88 million so an increase of $24 million. Primarily that increase related to seven credits that range in size from 2 million to $7 million in total. So it's not a wholesale across the board increase of non-performing credits. It's a rather manageable number of individual credits. On page 25 of our press release, we break that down and we have $39.1 million of residential real estate construction and land development related loans. We have $17.5 million of commercial real estate construction and land development loans. And $19.2 million of straight commercial real estate loans and $5.9 million of commercial real estate loans. So it's broken out but primarily again, the impact as we've talked about in prior quarters are the residential real estate development types of credits that we have and again, we've just had a small number of those, less than 10, that were over $2 million, that got added to the list.

On the residential real estate side, single family residential and home equity classification, we went from 3.4 million to 6.2 million. And that was primarily related to one credit that we have in Lake Forest, a single family residence with a balance of $3.3 million. Other than that, there's small items here and there. But really not a significant change in that line item other than the one credit that we have that was added during the quarter.

This is Ed Wehmer, again, It's interesting. There's about $20 million of increases. It's called commercial development loans that related to six properties. We have a nice property on Lake Michigan if anybody would want to buy it. We have properties in the Lake Forest, (inaudible) area that are in the 4 to $5 million range that have been taken back or are in the process of being taken back. That made up almost $20 million of the increase.

We only had one or two of the multifamily type development loans that came on the books as non-performers. Again, in the markets that we're in, the higher real estate markets, the higher value real estate markets, those types of deals can have a material effect on our overall numbers, but they're still very attractive pieces of property. Ones that we have marked down to what we consider to be reasonable, 90-day liquidation rates. And will be working once we can push them through the system and the system has slowed down a little bit. If we can get a cooperative borrower it's a lot easier. We can get a hold of the property and once we get things into (inaudible) single-family type things we're able to push them out relatively quickly. We do mark them down to 90-day liquidation so there will be bargains here. Anybody looking for a house around Chicago we might be able to help you with that. You have to keep that in mind when you look and remember the markets that we're in. $20 million increase can relate to six individual credits in single family residences.

Besides that the only significant category we have is the premium finance area and that showed the lowest levels of non-performance that we've had over the course of the last 5 quarters. That portfolio is performing very well and we're on top of it and --

And, again, we don't expect losses on that portfolio that just while we're waiting for insurance company to return the money to us. Any loss in that portfolio has been taken when we confirmed the actual amount of the returned premium. That's just a timing difference for us and we really don't consider them non-performing but we have to put them in that category for accounting purpose. With that we can open it up to questions.

(OPERATOR INSTRUCTIONS). Our first question comes from Jon Arfstrom. Your line is open.

Thanks, good afternoon, guys.

Hello, Johnny.

A couple of questions. Would you say that you were more aggressive in this third quarter than you have been in previous quarters in terms of going through your portfolio? Because obviously, several of us were surprised by the size of the provision and the size of the non-performing increase.

I don't think we were more aggressive. It was not on -- it was not something we hadn't identified and were working on. What it relates to, Jon, is the FAS 157 issue where you have to apply market values as opposed to real values to these assets. And what we have done in the past, we had -- if we had a particular asset land development loans, we had computed the value based upon 15% IRR and actual real intrinsic numbers, what our cost to carry is and that sort of thing. And FAS 157 says you can't do that. You have to look at the outside world and value it like the outside world would do, which is 35% equity, 65% leverage. The leverage you have to assume a 10% cost to carryon that. And you have to assume a 35% IRR. So we -- no one argued about absorption periods as you ran through these calculations. What we had done was reserved up to our what we consider the value to be and in consultations with our auditors. You have to do it this way. What we did was we charged those assets down to what our values were and we reserved up to the more conservative values. We added reserves to cover that differential. We kind of -- we think we've been very aggressive in applying 157 the way it's supposed to be applied.

There's nothing that's coming up that wasn't on a watch list. It was more of a valuation issue and then turning around and applying these draconian variables to value. I think we've given the example before. There's one lone that was appraised two years ago, $22 million. It was appraised eight or nine months ago at about $18 million. And if you run these numbers on that land, it doesn't matter what the appraisal is, it comes down to $5 million. It's $15,000 per acre on this property. But that's what they say you have to market to. We think it's a distressed market as opposed to a mark to value.

However, those are the rules and we're going to be ahead of these things. It is what it is. There was really nothing that popped up that made our number work. It was the application of this particular accounting principle as we understand it to values and just being ultra conservative about it and we're going to work through the rest of the assets and push them out. Nobody should think that we -- all of a sudden we took a look and said "oh no", no we have been on these all along and it is strickley a valuation issue. How much of the 24 million in provision would you say is 157 related? Funny you should ask that. I have to get my papers out here. I would probably say close to $9 million.

So the other $15 million --

Well, the other $15 million was charge-offs and to bring them town to the additional levels. Plus other assets coming on that we reserved in the normal course of business in our calculations.

And the growth of the portfolio.

Okay. This is more of an open ended question but needs to be asked I guess. How should we interpret the statement that you'll be profitable for the full year? You have 18 million in year to date earnings, and the loss is a surprise. It's not end of the world and we all understand it. But how do we interpret that?

Just like we said it.

We don't give guidance, Jon. The closest we're going to get is we'll be profitable for full year. The fourth quarter we're starting to see the margin increasing. We have additional. There are -- we continue to see opportunities out there. But we're working through these problem assets and our goal as I said is we're going to hit the ground running the first part of next year. I'd like to get all this behind us. We believe that even in doing so, we will be profitable for the year. I'm not telling you will the fourth quarter look like this or show a profit? You guys get paid big bucks to figure that out.

This is Dave Dykstra. We've tried to value these down to these distressed values as required by 157 on the impaired loans that we're aware of. So you shouldn't have any more significant write-downs unless the market completely falls out on those assets.

I guess that's what I'm trying to get at. Is there anything behind this that says there's more problems cascading in? Or is this a fairly aggressive take where you're saying we think we've written these down and at some point we're going to get a recovery. Is there a lot more behind this from where you sit right now?

I think the charge-offs will be higher than they've normally been for the next couple of quarters. Do I think we'll be at another $25 million provision? I quite frankly don't know. It doesn't appear that way. But we're going to get the stuff behind us one way or the other. We'll leave it at that.

And John, as Ed said, we do think that if you decide to hold some of these assets where you've had to value them, assuming that an outside participant had to put in 35% equity and get returns of 30 to 40%. You count it back over a absorption period on a residential development loan and you come up with a very low number. And you can look at the example Ed gave. If we can hold on to these at our cost of capital and our cost of funds and move these things out, we clearly think that there's value significantly above what we've written them down to. I don't think you could look at that and say the market is going to turn around next quarter. So it's going to be a while before we realize that value back.

Clearly, we think there's value there if you were to hold these assets and work through this current distressed market condition. Or if the SEC or FASB decide they're going to make the FAS 157 Fair Value Accounting Standard a little bit more reasonable where people could use their own cost to capital carry if they're able to hold it to maturity or some other methodology. But the market values out there now if you read 157 and understand it and we believe talking to a lot of people that the market hasn't fully got their arms around this yet, that we valued these down to very conservative and we sometimes refer to them as scavenger values. Do you want to hold onto it and work it through at your own carrying cost? And if that's the case you're going to get the value back, but probably not next quarter. Over a period of time as the market recovers.

At the same time you have the option if you want to blow them off to a scavenger, you can do that too. We will be dealing with theses things on a one-by-one basis, really anything that's got -- that has anything that is aboveground, where there are sticks aboveground. We probably will get rid of our joint venture to complete the project. Other situations fire hydrant aboveground. We only have $40 million of that type of credit. There may be longer workouts on that. The recoveries might come a little bit later.

When you talk about do we have another one coming? We try to identify things quickly and deal with them quickly and we'll deal with them on this conservation method until somebody tells us otherwise. These are uncertain times, who knows what's going to show up in the next three weeks. And there's things that pop up. We'll deal with that right out of the box. When you say will you have those issues? I think we've got our arms around it but these are extremely uncertain times and it's hard to predict. Our goal is to be as conservative as we can and push this out as we can. And push these things out. That's the secret behind all of it. And that's where we are on it.

Okay. Thank you.

Thank you. Our next question comes from Brad Milsaps Sandler O'Neill & Partners Your line is open.

Good afternoon.

Hi, Brad.

Just wondering if you could add a little bit more color to the margin. Just curious with the cut in Fed funds, why you think it's going to start to expand over the near-term and just thought if possible you could talk about where you think it could get to over the next couple of quarters.

The issue that we talked about is it's not going to pop right out of the box. We do think that with the drop in the recent Fed funds rate and on the prime rate and the like, that that does cause further compression to the margin because you just can't cut your now accounts and some of your savings products the full amount. If you had something at 25 basis points, you can't cut it to zero. And you free funds provide less. So it's that historical thing that we talk about, that lower rates cause compression on our margin. But we're seeing across the board on lone renewals But we're seeing across the board on lone renewals wals and significantly higher yields on those assets. We're trying to be very disciplined.

We've been successful in bringing in some of these deposits because people are looking for safety and we've got the ability to provide them with a significant amount of safety with our 15 different charters, multiplying that out by the FDIC rate and they're not necessarily looking necessarily for the 4%, 5% rate. They want something where they're comfortable with their bank. They want a decent return. And they want ease of execution. And we're able to provide that for them. We don't have a whole lot of hot funding out there. We've got just very little brokerage CDs. Our banks generally are almost all retail funded. And we've got a good customer base and we're going to try to keep that cost of funds low. And the repricing of the assets will offset that in the near-term.

The lending environment is inelastic relates to recent drop in rates. We didn't lower the rates that we're charging people we actually just increase spreads over it and it's being accepted right now. Your asset side of things, we're taking a huge portfolio and repricing a bit of it every month up one or 200 basis points. It's going to take time for that all to take hold. And we can drop our funding costs just a little. If we can keep our marginal cost of funds as Dave said relatively low, it should be mitigated and we believe that the margins should start growing. Dave talked about first insurance.

Although that portfolio over nine or ten month period that the new loans are coming on, we're not rushing to drop our rates. Many of our competitors are funded through securitizations. Those are bearing larger cost so some of the people who caused us to drop those rates before can't afford to do that. We're experiencing the highest spreads on new business than we have seen in probably three years. So the asset side should more than make up for the compression aspects of it. We stay disciplined and get the pricing we need to get and we'll continue to work the liability side. Although you do get compressed. We can bring that down a couple of basis points here and there. So there are some CDs repricing and the like. We think there's room on the liability side in spite of what the competitive market for funding. Again, the asset side is relatively inelastic to that drop in rates. People are happy to get loans in this environment and we're able to get reasonable pricing again.

So Ed, your comments that the margin should work up. It's more over time as you add these better assets at better spreads over the next couple of quarters. You weren't saying you thoughted the bottomed.

I think it has bottomed this quarter. If you add back the non-accrual interest we probably were up a little bit. Hopefully, we won't have a lot of where we have to reverse interest that has been accrued on loans we taken to non-accrual. But you never know. But we believe that -- I think it has bottomed. And I think that you're going to start seeing the benefits of that asset repricing coming through each quarter going forward. And I still stand by the fact that over the next six or seven months we should be back into the pre-drop range. We still believe that will be the case. The repricing should not be underestimated. You're talking about coming out of an environment where prime meant nothing and prime plus one was a deal. Real Estate deals started at prime.

Right now prime means prime again. And prime real estate deals starts with prime plus 1, 1.5. That's the base rate. And we work off of that. It's been very well accepted by our customers. Probably because they have nowhere else to go and they're happy to have the money. We haven't had a lot of push back from customers and the new transactions they're all bearing terrific rates. Back to LIBOR plus 300/400. Back prime plus 1, 1.5 type pricing on deals with very good credit quality. It's going to take time to work through. But as it does, we expect the margin to increase.

Okay final question. Just curious with the pre-provision earnings now. Are there any levers you can pull in terms of expenses. You've done a pretty good job. You mentioned hit the ground running on January 1, 2009. It seems that core earnings powers at a level that would prohibit you from being as aggressive as you'd hoped. Anything on the fee income side or coming out of operating expenses that you could pinpoint to kind of offset some of the time it take for margin to improve as well as additional provisioning of the near-term.

We're always looking for ways to improve other income and we'll continue to do that. And we raise prices where we can and develop additional fee income. That's ongoing no matter what cycle we're in. On the expense side of things we think we're running pretty lean and mean as it stands right now. Consider what I talked about in terms of potential participation in the TARP Equity program. If we -- if the board decides and we decide that it makes sense -- and we still are evaluating it. You're talking about the ability to bring in $200 million of fresh capital and say if you deployed half of it that's a $1billion worth of growth. I have a billion dollars worth of growth and I believe that the asset generation could support that right now just based on what we're seeing come through the market.

I also believe because of some of the things I talk about is related to our initiatives on the funding side of things that we can fund that growth very, very inexpensively. So if you -- and I also said that this TARP program if we adopt it and wanted to go with it could be the jump start that -- to the growth and the earnings again that we've been waiting for that would have to be tempered because of the things. Getting the earnings back online and being able to start growing again. If you had this extra capital you could pull the switch right now. From the expense standpoint. I'll probably need all hands on deck. And if we go with that program. So we're always looking to become extremely efficient. But if you're talking about us doing reduction in force or that sort of thing, that's not in the cards right now.

Okay, thank you.

Thank you. Our next question comes from John Pancari. Your line is open.

Good afternoon. Could you talk a little bit more about the -- your outlook for the reserve. I know you've been talking quite a bit about the jump in the non-performers and the charge-offs, etc. Given that your coverage is still relatively low at 59% of non-performing loans, it seems -- and the ratio, the reserve ratio is 90 basis points. Reserve needs to go higher, just generally looking at where we are going potentially looking at a pretty deep recession here. Where do you think is a reserve level that you think one adequate in light of the trends that you have seeing more recently.

The reserve we have right now we believe to be adequate or we wouldn't have it. We go through a very elaborate process of doing this. And when you look at the non-performers, we talked about about how we reserve them. We do it very, very conservatively. We look at our overall portfolio and apply pretty string gent factors to it. If the portfolio continue to grow, you'll see the reserve continue to grow. But we believe or we wouldn't have it there. We believe it's adequate where it stands. So going forward, will non-performers increase? They probably will increase over the next quarter. This is the depths of the depths and the problem is trying to push these out the back end when the courts are so jammed up right now. We have exit strategies on these things. But you have courts and in some cases -- if a borrower works with you, you can get the assets pushed through. The borrower is getting bad advice from attorneys, we're going after him and we'll follow them to their grave if we have to. But the problem is the back end isn't flushing out as quickly as you'd like just because of systemic issues that are mainly out of our control.

You will see because of the environment non-performers kick up, new ones coming on, to the extent we can't push old ones off. That would requires us to increase the reserve just based upon the formulas that we apply and applying the impairment values as required by 157. So will the reserve probably be going up in the future to the extent we can't push the old stuff off and get them cleared? Yes, probable will, but we look at that in a very systemic way, a very detailed way. Down to each individual loan. Each loan category. And it's adequate right now. If non-performers increase before it deteriorates, we'll be adding to it. The portfolio stays stable. We're in a pretty stable position right now.

Okay. Fair enough.

You have to understand, we've taken the valuation charges against the loans that are in there. It's just a matter of moving them out.

Okay. I understand that. I know that FAS157 is certainly something the banks have been dealing with over the past couple quarters. And I know you had indicated your comfortable with your reserve level last quarter. And now we're seeing these moves in a pretty big way that caught a few of us by surprise.

Wait a minute. I would tell you that's not what you said I don't believe is absolutely true. As I said in my comments earlier at discussions at conferences all over and probably with you, we have participation with other banks in the market that are not valuing the assets the way we're valuing them. If people have been dealing with 157 as it might relate to the securities portfolio, I would tend to say that I don't believe they've adopted it in the way we've adopted it as it related to lending portfolio and there's specific evidence we have with other banks and in discussions that they haven't. So I want to make that point perfectly clear. This was not a all of a sudden we figured it out, something that everybody else has already figured out. I think it's quite the contrary.

It's a drastic move in the numbers. That's why I asked about the reserve. In light of that, if we could talk real quickly about capital. I know you have access here in terms of TARP to cheap Tier 1 capital as well as many of your peer banks do. On the tangible common equity ratio, I know that's a ratio that matters more to rating agencies. And given where your tangible common equity ratio is right now and where the rating agencies look at, can your just talk about that. Where's the level that you think the rating agencies may get a little bit more concerned? And how could that impact your ability to raise funding on the balance sheet?

We aren't rated by anybody. The rating agencies are not our primary concern. The shareholders are our primary concern. We went out and raised $50 million of capital in August. At that time it seemed to be a pretty decent deal, given where the marketplace was. And we increase our capital levels $50 million. And we thought that was a good level of capital to support some additional growth as well as help us weather the storm a little bit and have some cash at the holding company. So we increased by $50 million, the TARP plans out there. We'll evaluate it and look at it. The pros are that you could take advantage of some things in the marketplace to grow. We think that $50 million capital raise was appropriate. And at the time, the government's offering below market rate capital out there right now to entities. But we'll look at that. But we don't concern ourselves with the rating agencies since we weren't rated. We look at what's the best thing for the shareholders.

I was just going from the standpoint if there was a need for additional capital, what your options are available to you. It's fair to say that you would not see a need to raise additional common equity versus the preferred equity stakes that could be available under TARP.

We're not -- yes, I don't think we're actively looking at raising common equity at these prices. That's why we went and did the preferred in August.

That's why it makes the TARP so attractive. Notwithstanding if we have to go through it. If-- the TARP is interesting. If you're stock were to go up 30% a year for the 5 years, the overall cost of the TARP is 9%. If you went up 20% that's 7%. That's cheap capital. If you look at when you push this stuff through and spreads are now back and the earnings come online, especially if you are able to leverage, if you brought some of that capital in.

Your return on equity is pretty darn good and it makes it pretty expensive capital and the right way to go. In the preferred that we raised earlier, the 50 million is totally convertible. Convert it and add it into the common tangible equity. The TARP is only 15% of what you would take indirectly have an increase in tangible common equity and if you happen to replace it, you have to have some factor of these preferred shares that would have a converted effect on what your tangible capital equity numbers are, call a diluted basis.

The preferred we issued in August is convertible. I think you've got to assume that will convert and that will be common equity.

Okay. All right. Thanks for taking my question.

Thank you. Once again if you have a question at this time press star one on your telephone key pad. Our next question comes from John Rowan, your line is open.

I just want to go back to the margin and the TARP a little bit. If I remember correctly, obviously, you can leverage the money from the TARP, 10 to 1but you get a 4 point spread. You talked about loan surprising and prime plus a point and a half. Are you going to be able to lever a $1 billion worth of growth with 2% funding? Am I thinking about this right?

I think that part of the strategy is that you could do that. If you look at the wholesale funding opportunities that we have, taking our IBD product and as I said earlier, we have a soft commitment for 250 million-dollar of this money to be about 1.25%. There are other opportunities for this same product that could be around 2%. You could average out and be at those levels. So that's part of the strategy and part of the discuss the if you take this, (inaudible) can your lever it out? Otherwise, it's just dead capital. We think that we have because of our unique structure and this product and all the plumbing in place to do it, we do have an opportunity on the funding side to bring in those inexpensive funds. That's the key, bringing the inexpensive funds in. Couple that with putting floors on loans. You could be close to that number.

I was just asking because it's quite a bit higher than your margin and your core margin. It seemed like a pretty big jump in terms of margin on new business.

Right. The secret is the spreads are back. And if you can get assess to the cheap funding, it's a home run and you hit the nail right on the head. That's the same phenomena that happening in our existing portfolio as we reprice these assets when they come up for renewal. That same sort of spread phenomena is going to be happening on $7 billion worth of assets over the next three or four years. With a lot of it accruing in a one year time period. This is what we've been waiting for to get reasonable spreads back and that's the thing that's going to move our margin. And that's what we're doing and we're seeing it happen. We talk about our margin increasing with some degree of confidence because for the past four months, we've been putting these new loans and this repricing in place on existing loans. And pretty soon, the number is going to catch up and it's going to have a material affect on the margin.

The key will be exercising our funding side of the strategy. And so far that's going okay. There's a lot of competitors out there that are pricing irrationally. Some offering funding costs for a year or less at prime rate or more. And how are they making any money, any decent money off of that. There's that pressure. But we think we've got some strategy in place where we can bring in the funding cheaply because of our structure. We'll attempt to execute on that and the loan prices are there. And they continue to be there.

Okay. And last question on the TARP issue. Theoretically, you get a builds, 200 million from TARP. You can lever up a $1 billion on your balance sheet; right. How long does it take you to lever that? If you come out three weeks from now and say we're taking this. How long should we look at that leverage process?

It's going to depend on the economy and how strong it is. Loan demand is pretty strong but you could actually lever up to $2 billion over time. Because if you take $200 million at 10% capital, you can get the $2 billion. You've got to be able to execute on half of it over some period of time. Generally, in the days before we pulled back because of the credit issues, each of our banks were going 50 to $75 million a year, I got 15 different charters, you could easily grow just with normal growth at that range, 6, $700 million. And we've been pulling back on that because of the market and the capital and the need to be careful were the liquidity and the like. You could get back into that and you could look at historically where we had growth and some of the players are backing off or being taken out of the market and there's lots of opportunities there.

We don't want to stretch, how long would it take? Could we grow a $1 billion in a year? Yes, probably in a year. But I don't want to commit to something like that. We're certainly not going to stretch for credit to make the high bar. We are seeing a lot of good credit every week and turning our back on a lot of it just because we're handing it out with an eye dropper. We mange our holding company cash and our capital right now . With that additional capital, that's 50 or $60 million a week that we could go after. The secret is going to be in the funding side of things.

This isn't quite as attractive to is going to be if we have to go out and play with our rationale competitors that are offering 4.5% 8 month CDs. If we have to do that, you're spreads are down at the 3% range. And although it's marginally profitable because we don't have a lot of overhead associated with it it makes it less attractive and I really don't want to do that. The question is on the funding side would we be able to execute that? Would we be able to bring home and close a lot of these deals we're working on on the institutional side. Up until two weeks ago we weren't that excited about trying to raise $0.05 billion of this wholesale cheap money product to other broker dealers and the like. We didn't think we could grow that fast right out of the box. We've had to turn it up. We want to see what the potential is. Is the money out there. Is there more where that 250 commitment came from? If there is, that will weigh heavily on our board's decision to whether or not to go ahead and how much of the TARP money we could actually take.

Our last question comes from Ben Crabtree. Your line is open.

Thank you. A few small questions. First of all, Dave, I wanted to make sure I heard you correctly. You talked about the impact -- or maybe it was Ed talked about the impact of non-performers being four basis points in the quarter. Was that a reversal charge.

That was the impact of the reversal of interest during the quarter.

Okay. Great. The premium finance, the discussion of how the margin is getting better there. I'm wondering if that is altering your decision about keeping more on the balance sheet. I guess if you could discuss a little bit how you're thinking about upcoming sales of premium finance versus the decision to maybe hold more on the balance sheet.

Basically, the market for the premium finance loans is dried up. With the securitization market where we were hoping to lay off $0.05 billion, it's dried up. There is nobody out there that will do a new conduit or securitization. It's further exacerbated by the fact that FAS 140 is going to make you put a securitization on your books anyhow, effective 1/1/10. We used to sell through LaSalle. LaSalle was taken over by Bank of America. Although they did put their best efforts forward. Most of the people who used to buy that are conserving their own cash and capital right now. So the market basically has dried up and most of the stuff is going to stay on the books until we find some other opportunity or source to lay it off. Those will be on our books, there's no place to put them right now.

Doesn't that kind of mean that the people that are non-deposit funded are going to be in a long-term competitive disadvantage.

Oh, , when if they hold true to that date of 1/1/10, for FAS 140, that close to $5 trillion worth of assets that are going to have to show up on balance sheets some place. In a capital starved industry already, this stuff is going to have to show up. Those $5 trillion worth of assets were not just -- they covered car lending, credit cards, they covered probably 30 to 40% of all consumer lending was put out into these off balance sheets they are going to come on someplace. Then take all the conduits that were out there that did commercial real estate. And all that money is going to have to be intermedial because there are no conduits for them out there anymore and those 3 and 5 year deals that were being done are starting to come due.

We're starting to see on the loan generation side, not just commercial loans but you're starting to see nice commercial real estate deals that are coming out of conduits and have no place to go. And if you have your powder dry, you'll be able to pick up some of those assets. If funding is I think somebody said it, it wasn't me but I thought it was a great line, he said "I never thought I'd see the day when my assets were my liabilities and my liabilities were my assets." Funding is very important right now and a strong point to our franchises is that our approach over the years to build a solid balance sheet on both sides and the funding side and the asset side is going to payoff. Especially on the funding side where we have all the retail and commercial deposits and the very spread out way.

We don't have any inside information to any of our competitors on the premium finance side as far as their funding costs. As you talk to the market participants that are offering that sort of funding, what they're telling us is in a the cost of those conduits when they are coming due are probably going up 175 to 200 basis points at least. So to the extent that they are 1 year conduits some of these people are coming due or will be so we think will have continued upward pressure there. Some of our competitors were out there doing deals that it appeared to us were 100 basis points over whatever their conduit funding cost was. And if that's the case, it's got to go up dramatically. We're looking forward to that, seeing some of it come through. And we're in an enviable position if we can fund it with our retail deposits.

Right, right. I'm wondering if you could comment at all -- obviously we talked about the 90 days and the non-accruals. If we look further, I'm trying to get some sense of what was happening with loan ratings in the quarter. Is it deteriorating across a fairly broad ranges of loan types? Or is it -- first of all, how much of it is happening? Is it related to real estate?

We never really disclose loan ratings in a public document, Ben. As you can see the residential and home equity, there's a little bit more numbers there. But the dollar amounts are not that significant. The majority of the increase was one lone on the single family residence side. And the majority of the dollars still are in the residential development sort of area. We're not seeing widespread deterioration on the consumer side or the commercial side. It still is primarily driven by the real estate absorption rates on those sort of development deals.

So the cash flows of our commercial customers are still behaving fairly well?

We're knocking on wood but, yes.

Of that non-accrual number, there's probably $6.5 million of larger commercial deals in total. So most of it is -- there's a lot of smaller deals out there. But the big ones of what you would consider your bread and butter, a couple million dollars, commercial deals. There's that number out there. Nothing out of the ordinary.

Who knows what's going to happen? It's interesting times.

And the last question since you've talked a bit about the TARP program. I don't know if you've looked into the possibility of issuing guaranteed debt. I'm not sure how that is going to work and how much cheaper the money is going to be to you.

Do you have a significant amount of debt at the holding company or the bank level rolling over between now and June 30? No, really what we have at the holding company was our secured senior line. That comes due a year from now in August. And then we had our subordinated debt which is long-term. And we have $250 million of trust preferred securities, which are long-term This is how we fund ourselves at the holding company.

All right. Thanks.

Thank you everybody. We appreciate your questions, your calls. You can always feel free to call Mr. Dykstra or myself if you have any follow-up questions. So with that, we'll end it.

Thank you for calling. This concludes today's conference call. You may now disconnect.