Wintrust Financial Corp (WTFC) 2009 Q2 法說會逐字稿

Welcome to Wintrust Financial Corporation's 2009 second 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 second quarter's earnings press release and in the Company's form 10-K on file with the SEC. I will now turn the conference call over to Mr. Edward Wehmer. Please go ahead.

Thank you. Good afternoon, everybody, and welcome to our earnings conference call. With me, as always, are also Dave Stoehr, our Chief Financial Officer, and David Dykstra, our -- what are you our Senior Executive Vice President and Chief Operating Officer. Hope you can all hear me well. I know Chris Storey, you hurt your ear this weekend, so hope you have the right ear to the phone and are feeling better. We have a lot to talk about today, so let's have at it right away. I'm sure there's going to be a number of questions. We'll attempt to keep our comments brief so we have enough time to accommodate the questions that you may have. What we're going to do today, first we are going to talk about the second quarter results. Secondly, Dave Dykstra will spend some time talking about the life insurance premium finance portfolio transaction that we announced yesterday. Thirdly, we're going to talk about our thinking on the sale of P&C Property and Casualty premium finance loans.

Fourth, we will give you a little summary of our objectives for the remainder of the year and then we'll move into questions. Second quarter results. The balance sheet very strong. Strong core growth on the deposit side. $565 million of core deposit growth versus quarter one, 7% quarter over quarter and 28% year-to-date. That is good core franchise growth. Since the end of the year, deposits have grown $814 million or 10% or 20% annualized, again good core franchise growth. If you recall when we went into our stall strategy, we -- pardon me, we slowed down growth at a number of our younger banks. We're -- we've been able to pick that growth up and allow them to continue to grow under their overhead and get back on track. Loan. Loan growth again was also relatively strong, core loan growth, including the premium finance, the P&C premium finance portfolio that was transferred into held for sale.

Core loan growth grew $274 million or 12% on an annualized basis. Grew almost $500 million from the beginning of the year or 12%, again, annualized basis. Just a second on the -- the reclass of the $520 million of property and casualty and we're going to have to refer to them now as life insure premium finance and property and casualty premium finance, but the reclass of the $520 million to available for sale from loans held. As you all know P&C premium finance loans are TALF eligible. We are looking at all sorts of alternatives as it relates to the sale of approximately $700 million of premium finance, P&C premium finance loans in the -- in the near future. You think about what that means, we just acquired close to $700 million of life insurance premium finance loans. We were able to sell $700 million of P&C loans. Makes a hole in the balance sheet.

You do -- we will be looking for capital relief in the form that we take when we do sell those premium, the P&C loans, so all and all it will be -- it should be a good transaction for us where we can basically double-dip. We get the gain on sale from the premium finance loan sale, plus we'll be able to appreciate the -- the earnings from the life insurance portfolio in a very capital-efficient way. So I know a number of you have written the P& -- the life insurance portfolio purchase could hurt our regulatory capital, completing the other leg of this transaction, if market conditions are right and we're able to -- to do this, should really make that a capital neutral event for our -- a regulatory capital neutral event for our balance sheet. We have a very efficient balance sheet. Continuing on with the balance sheet, equity capital ratios remains strong. The $300 million of extra capital in the form of TARP money and the CIBC convertible preferred, it's $300 million of extra capital and we have been judicially leveraging that into growth to support our core earnings growth.

On to the income statement. We did experience margin expansion of around 20 basis points, the majority of it all coming from the decrease in our cost of funds as we have repriced our deposits as they have come due. You recall rates went to basically nothing at the end of the year last year and does take some time for us to reprice the -- our core portfolio, especially the CDs, and we have been able to do that and that is indicated in the -- in the numbers that you have seen so far. I will point out to you that over the next -- between now and the end of the year, there's an additional $1.9 billion of certificates of deposits repricing, those are currently on the books at around 307 to 310, so we believe that if we can get that down to our cost right now, it's a 110 basis point pick up on that, or close to $22 million to $23 million that if we're able to execute that we should be able to pick up on an annualized basis into that pretax, preprovision number.

Over the next 12 months, there's $3.23 billion, so that includes the $1.9 in the next six months and so we have $3.23 billion that are roughly at 3%. Again there's a 1% to 1.1% of rates stay relatively the same, that's almost $35 million. We should be able to pick up on the liability side of the equation if we execute properly. Asset yields remained relatively steady despite the effect of non-accrual of loan interest reversals and our premium finance, our P&C premium finance portfolio, as you recall those are nine-month full payout loans, so it takes some time for a reduction in rates as we had in the fourth quarter to work its way through the portfolio. So in spite of that, we believe that that's pretty much -- that portfolio is pretty much where it will be right now, notwithstanding changes in the rate environment, so that should be behind us. The asset yield side was also affected by the building up of liquidity in the balance sheet.

We have built up close to $700 million of Fed funds where you make basically nothing during the course of -- course of the quarter in order to accommodate the AI credit asset purchase. So that hurt our asset side of the equation and that should be turning around now that we have those loans -- those loans on our books. We still believe that there are opportunities on the asset side of the equation through both loan repricing and, again, that liquidity. Subsequent to if we -- if we are able to -- if we are successful in a loan sale, we will again be bringing $700 million worth of liquidity on the books, which we will then be able to go out and invest and -- and pick up additional revenue on that. So we think that the margin, notwithstanding the AI credit portfolio, will continue to expand over the course of the next six months and then beyond. On the other income side, you noticed we had no number -- no covered call income with rates being as low as they are. The covered call premium program that we do is most effective at a higher rate environment and protects us, if you recall, against the falling rate environment.

Well, rates aren't going to fall so much and we're not going to go out and do a lot of long stuff right now. I think we're trying to position our balance sheet for a raising rate environment as best we can, so there were really no covered calls. If rates were to rise over the next few years, months or years, or whatever, we're positioned well for that movement and that also would probably allow us to start bringing that program back into play as we have in the past. The mortgage business has been off to a very strong start in the first half of the year. $1.2 billion of production in the first quarter. $1.5 billion in the second quarter. From all accounts, the mortgage -- that business looks like it's still remaining very strong, in terms of applications and pull-through. One thing to remember on this business is that we acquired PMP, partnered with them the end of last year and that was an exercise that basically doubled the size of our annualized production on a historical basis.

We also been adding to that platform as the mortgage industry has consolidated, so a lot of this growth, although somewhat is seasonal and related to the rates, we are building a world class mortgage operation, the PMP acquisition brought in a -- a lot of Chicago retail to us and really balanced our production in -- to more retail. Our goal in that business is to be -- we want to be the top mortgage provider in the city of Chicago, and although Wells Fargo can claim that, chase can claim that, but we're out to claim that, and we're going to build this business. We have a great group of people there. They are a motivated group of people. We think we have a great brand name and we can give great service there. So we would expect to continue to grow that business even when the seasonality of -- of some of this excess business is coming in right now. Changes. We are seeing a pickup probably at least in applications on the mortgage side, where 20% in the first half of the year related to purchases. It's now up to 30% or 35%.

So all of those who want to use that as a leading economic indicator, we do see more purchase activity and we are embarking on numerous marketing campaigns to try to garner more of that business as that -- that -- that area of the industry gets back to more normalized rates. Wealth management profits were also up with the rebound of the market. Obviously, we are tied to that on the wealth management side, but also through organic growth. Again a business that we are growing, that we intend -- we're spending a lot of time and effort. Our recruiting efforts in that business have been very strong. As you can imagine, the turmoil in the markets, in our competitor's markets as they've been bought up, sold, going through rifts and the like, has brought a lot of opportunities for us to pick up quality professional people with -- who do have followings and we're trying to take advantage of all of that. We did our training -- trading gain in the quarter. Dave will talk about that.

But basically that trading gain offset the special FDIC insurance assessment that all -- all banks need -- had to endure during the quarter. Ours was $5.6 million, which was really the only big item in our other expenses. Other expenses stayed relatively flat other than the FDIC special assessment and that includes probably inflated expenses for loan collections and OREO expenses and the like were in there, also, but quarter to quarter they stayed pretty strong. From a 30,000 feet, I look -- kind of look at it this way and look at the quarter and look at our progress. You do recall, at the beginning of the year we talked about our objective was to really -- to work on core earnings, to get our core earnings up. To continue to push our core earnings, to execute a plan to get our liability side repriced in accordance with market, to reprice our asset side of the balance sheet, to grow at profitable good growth spreads, and really work on that. At the same time work on the -- on the asset quality issues.

But from an income statement standpoint, from 30,000 feet, our pretax preprovision run rate, if you take the FDIC and some of the -- the items back and forth, they basically wash as they did in the first quarter, the negatives and the positives that some of you call non-core. Pretax preprovision was about $183 million. That's up from $100 million in the first quarter and $70 million at the end of the fourth quarter. If you consider the opportunities and the numbers I threw out on the asset repricing and on the liability repricing, that's substantial earnings capabilities if they're able to execute. Add to that the, however you want to compute, the earnings accretion that is going to or should consider through the AI credit portfolio and you're looking at hopefully a run rate at the end of the year north of $200 million in pretax preprovision numbers. That's very strong for us. That's gives us the ability to absorb these -- the credit issues and to hit the ground running at the beginning of the year.

I'll talk about that a little bit later when we talk about what our goals are for the remainder of the year. On the credit quality side, non-performers did increase. I kind of feel like the -- we're kind of at the tipping point right now in that we're starting to see some traction or better traction in terms of getting these things out of here. As you know, we try to recognize these non-performers early. We try to deal with the charge-offs and the reserves related with them right out of the box and mark them to market when they occur. We believe we're carrying these things as close to market as close as we can. We try not to kid ourselves on that, take the charge-offs, and build the reserves as that comes up. But charge-offs and the expenses related to this were in the provisioning. We're off in the quarter, as you can imagine as we deal with these issues.

However, our loan/loss coverage became 1.14% as we moved -- as we increased the provision and we feel comfortable with those numbers as they stand right now and as we go through the portfolio. Again our methodology, we go loan by loan, rating by rating, and then we -- the entire portfolio and any nonperformer we go in and specifically provide allocations, if we haven't already charged them off. If there's any issue as to what value really is, we will provide an allocation in the reserve to-- to a number where we think is realizable and that's how we build the reserve up. We think we're doing it correctly, we think we are ahead of the game on this thing, but, again, it feels like we're kind of at the tipping point on this, but really our goal for the rest of the year, and it was our goal at the beginning of the year, is gets the pretax, preprovision earnings up, get the core earnings of the Company up, and our goal for the rest of the year is clean this junk off the balance sheet as best we can.

I would love to hit the end of the year with a pretax preprovision run rate north of $200 million and relatively clean balance sheet. I think at that point in time we can look at some of the other larger expansion opportunities that are out there. Until that time, I'm really not interested in doing that. On a franchise basis, I'm interested in -- I've got everybody looking to accomplish the goals I just laid out, core earnings and clean up the balance sheet. That's what our goals are. Dave, maybe we can turn it over to you for a detail analysis of the income statement, talk about the AI credit deal and the potential loan stuff.

Okay, thanks, Ed. Ed touched on a few of these, so going through the other income and other expense categories. Wealth management revenue increased $6.8 -- to $6.8 million in the second quarter of 2009 from $5.9 million in the first quarter. Although the depressed equity markets have hindered this source over the past year, the second quarter saw improvement in the equity market and accordingly the asset valuations. This coupled with new client activity resulted in the increased revenue. Mortgage banking Ed spoke about. It increased to $22.6 million in the second quarter of 2009 and again this being a record quarter for Wintrust from a mortgage banking revenue perspective from the $16.2 million in the prior quarter. Obviously the favorable rate environment has driven the refinancing volumes and the addition of the PMP staff, that Ed talked about, and additions of other production staff throughout our system have resulted in this positive result.

As Ed mentioned, we continue to see stronger than normal application volumes so far in the third quarter and expect to have another strong mortgage banking revenue quarter in the third quarter. As the debt markets improved in the second quarter, our securities gains and losses, we -- we had $1.5 million of gains this quarter versus $2.0 million worth of losses in the first quarter. The first quarter included some other than temporary impairment charges, which we had none of in the second quarter of 2009. Other than those two categories, the first quarter to second quarter variances were fairly minor, other than the fees from covered calls that Ed talked a about. We had $2 million of -- of fees from covered call on the first quarter. We had none of those in the second quarter, as Ed mentioned, but due to the low yields on the securities and the propensity for rates rising, we backed off of that category in this quarter and, as rates rise and there's a higher possibility that rates could come down and we could get into some of these agencies or treasuries at reasonable prices, we probably would dip our toes into that market again.

This is really the first quarter we haven't had any in a long time, but as Ed mentioned, we do this to protect ourselves on an overall global interest rate risk perspective from falling interest rates and I think we're at the bottom of that cycle right now, from our perspective, and so we made the decision not to engage in activity this quarter. The trading income that Ed mentioned was roughly the same as the first quarter. We had $8.7 million of trading gains in the the first quarter, we had $8.3 million in the second quarter. Those gains relate to some collateralized mortgage obligations that we bought earlier this year where spreads have tightened, refinancings have helped out tremendously, and default rates are lower than what were anticipated when we bought those CMOs. So the values of those have increased dramatically over the last two quarter, but again, quarter to quarter roughly the same numbers there. It's sort of interesting to note that if you looked at the trading gains in the first half of 2009, it's about $16.9 million, but we are about $16.9 million less in covered call income, too.

So we do do manage our balance sheet with a lot of diversified product lines and those two just happened to offset each other identically so far on a year-to-date basis. If you look at the salaries and employee benefit expense, it rose to $46 million in the quarter ended June 30th, from $44.8 million in the prior quarter. This increase is primarily related to higher commissions paid as a result of the increased mortgage banking and wealth management areas. There were really no other significant reasons for the increase. It is simply the commissions paid on the increased volumes in those business lines. Going through the other line items that we have and the other expenses, the equipment expense, occupancy expense, data processing, marketing, and amortization of intangibles, they were all really relatively in line with the quarter -- prior quarters and really had no significant fluctuations to talk about.

As we noted in the press release and as Ed mentioned, FDIC insurance expense increased to $9.1 million in the second quarter from $3.0 million in the first quarter, so an increase of $6.1 million. That increase in primarily the result of the FDIC's industrywide special assessment and to a lesser extent a result of a larger assessable deposit base as we've grown the business. Really there were no other notable items in the other income and other expense categories. Moving on to discussion about the acquisition that we announced yesterday, the acquisition of life insurance premium finance portfolio. Wintrust premium finance subsidiary, First Insurance Funding Corp, purchased the majority of the U.S. life insurance premium finance portfolio from a wholly owned subsidiary of AIG, which I'll refer to on this call as AI credit. The aggregate unpaid balance of the portfolio that we purchased was approximately $941.3 million and we paid a purchase price of $679.5 million for that acquired portfolio.

We could also purchase up to an aggregate of $84.4 million of additional life insurance premium finance loans for a corresponding aggregate purchase price of up to $61.2 million, subject to satisfaction of certain conditions between the parties. AI credit is known as a pioneer in the development and the provision of life insurance premium finance products and -- and in my opinion could be really deemed to be the gold standard in the industry. We were fortunate to have the opportunity to get involved in this transaction and as we -- as we started our business, we really looked to a great extent on how AIG did their business, because they were gold standard. So we're fortunate to have had an opportunity to bid on that and to be the successful bidder. In conjunction with that transaction, we believe space in Jersey City, New Jersey, happens to be in the same building that housed the current AI Credit employees, and will continue to run that business out of Jersey City with the majority of AI Credit's life insurance premium finance employees.

Accordingly, we really expect to have a very smooth transition of ownership and the operational aspects of that business. As we talked about, it's important -- as we talk about this transaction, it's important to note that we're already in the life insurance premium finance business with nearly $200 million of loans outstanding at June 30th. So we had built up a portfolio over the last couple of years to about $200 million. The acquired portfolio we had, as I mentioned earlier, has a unpaid balance of $941 million. So it really does jump start us into a business we were attempting to get more involved in and it does so with a high quality portfolio. I should also mention that in addition to having the space that we have leased in Jersey City, as part of the purchase we also acquired AI Credit's loan system, where they accounted for and serviced their loan portfolio. They had many more years to fine tune a system designed specifically for the life insurance premium finance business, and although we believe we have a good system, we believe theirs is better.

So as part of the transaction, we've also acquired their system and that, again, should make the servicing and the transition of that portfolio relatively seamless. I was reading some of the research reports that have already been issued on this transaction by some of the analysts and one of the questions that seems to be consistent is I wonder how they funded the deal? So as we noted in the press release today, we funded this transaction with liquidity that we had already accumulated on the balance sheet and we did not need to borrow any funds to finance the transaction. We essentially used our overnight liquid assets, the Fed Funds sold are funds that were on deposit in the Federal Reserve accounts of our banks to fund the transaction. Short-term overnight money to fund the transaction. So we didn't balloon the balance sheet to do this transaction, we simply converted short-term liquid assets into this loan portfolio premium finance loans. As to the business itself, the life insurance premium financing that we do and that AI Credit did, relates primarily to financing life insurance premiums for estate planning purposes of high net worth individuals.

This business has many different types of forms of lending or can go all the way from life settlement deals to a high-end estate planning deals. We do not, and I want to repeat, we do not deal on the life settlement end of the business. What we do and what AI Credit did is primarily high-end, high net worth individuals financing policies for estate planning purposes. The characteristics of the portfolio we disclosed in our 8K, but I'll repeat them here and go through them in some detail, are that the loans that we make are collateralized by a number of different instruments. The predominant one is the cash surrender value of the life insurance policies that we financed. We also get letters of credit if there are shortfalls from reputable banks, annuities, policies can count as collateral, and we also take cash and marketable equity securities that we control the accounts over as collateral. So it's very liquid high quality collateral securing these assets. The number of loans that we purchased were approximately 530, so the average size, if you take the unpaid balance divide by 530, is about $1.8 million per loan.

As such, this is a relatively small number of loans given the business that we run on the premium finance side of the world and it really should be relatively easy to assimilate into our Company. We expect the average life of these loans to be in the range of five to seven years and juxtapose that against our P&C business where the loans are nine month full payout loans that probably have an average life of four and a half to five months. These loans we expect to have a life of about five to seven years. Again for they are estate planning longer term purposes. The portfolio prices at an average spread of approximately 190 basis points over the one year LIBOR and they generally reprice on an annual base. That spread that I talked about does not include any accretion of the purchase discount. As to credit quality, the acquired portfolio, as well as our existing portfolio, have had loss ratios of less than 10 basis points. It's a -- it's a very nice asset class and given the collateral types that we take, the losses have tended to be very low.

As to the purchase discount of $261.8 million, which is simply calculated by taking the $941.3 million of the outstanding balances less our purchase price of $679.5 million. That discount will be allocated partially to a credit discount and partially to a yield discount. We'll disclose that allocation of that recorded discount to each of those types in our third quarter filings, but we believe that based upon the disclosed characteristics of the portfolio, giving you what the historical loss experience has been, and where the deals are on that portfolio, that investors can make reasonable assumptions about the general magnitude of the discount that could be assigned to each component. As far as recognition of that discount, we'll accrete the yield discount into interest income over the estimated life of the loan or earlier if the loan pays off earlier. These discounts are assigned on a loan by loan basis. So if a loan pays off, the discount, the credit and the yield discount would come into income.

If the loans live out to be the average of five to seven year lifes, like we expect, with no early paydowns, then the dis -- yield discount would be amortized into interest income over the life of those loans. One other point to note is that we believe the transaction helps further diversify our portfolio. We believe that the life insurance premium finance business and the related life carriers are distinctly different from the P&C premium finance business and those carriers. Our goal over time has always been, and we've said this since we started the Company, is that we want to maintain a diversified portfolio and we want to keep roughly a third of our balance sheet in an earning asset niches, specialized earning asset niches, so we can keep the portfolio diversified and to keep the pressure off of our commercial lenders from trying to reach for that net -- next asset, trying to get yield when maybe they shouldn't be doing a deal. So we've always had that philosophy.

We've talked about it from day one and this acquisition further diversifies the portfolio in a manner that we think is very economically beneficial to the Company and helps us achieve that objective. So with that, Ed, I will turn it back to you for summary.

Anything you want to say on the potential asset side?

Well, Ed mentioned it. We have reclassified $520 million of our P&C premium finance portfolio to held for sale. As we mentioned in our Form 10-Q that we filed for the first quarter, subsequent to our last conference call, the Federal Reserve Bank indicated that the P&C premium finance portfolios are TALF eligible assets. And we have also talked to other people about the potential sale of those assets. So we are looking seriously at selling some of those loans, again, like we have in prior quarters. For many years, we've sold these loans to balance out our liquidity. So we're seriously looking at taking the $700 million worth of those loans and trying to sell them in this third quarter, subject to market conditions and other conditions, that would be our goal is to sell some of that portfolio in the third quarter. Now, I'm not saying whether it's going to be through a securitization or a sale to a bank, like we've done in the past. We're evaluating all of the alternatives right now, and given market conditions, we think that we can accomplish that.

If we -- if -- and because we are planning that, the account rules say if you have intentions to sell the asset, you need to classify them as held for sale, so we made that reclassification on our balance sheet. We only did $520 million because we believe that some of the volume will actually be generated in the third quarter. So we didn't have to reclass all $700 million into held for sale. Some of the volume that we anticipate selling will be actually volume that we generate subsequent to the end of the second quarter. And as Ed said, the goal of that would be to provide capital relief, provide additional earnings with a gain on the sale of those assets, and, also, provides additional liquidity. In essence we paid $700 million for this life portfolio. If we sell $700 million of the premium finance P&C portfolio and maybe it's -- maybe it's a number up to that, it could be somewhat less than that, we'll see what the market conditions are, but it would basically put the balance sheet back to where it was for on balance sheet assets.

We would have a sizable amount of liquidity that would let us be opportunistic in the marketplace going forward. We would get capital relief on the sale of those loans and we would get a little bit of a bump into earnings on the gain that we would recognize on the sale of those loans. So we're investigating that. It's subject to market conditions. It's subject to reaching an agreement with someone to sell them to, but it's our plan and we are diligently going down that path to investigate it and to actually execute on it.

Thanks, Dave. In summary, I think we have to put the year in perspective. You have to put it in perspective by -- by looking at our strategy that we embarked on three or four years ago that we called the old rope-a-dope strategy. The integral part of that strategy was how you come out of this credit cycle. We believe we have positioned ourselves properly to do that, to take advantage of the dislocations that are in the marketplace when one of these credit cycles hits, take advantage of -- it's not just asset dislocations, but competitive dislocations where you can pick up people and to really grow your business. We -- our goal is to be first out of this thing, to take advantage of these dislocations and market disarray as it was taking place. You can see the steps that we've take so far, concentrating on building core earnings. That was number one. Build core earnings.

Item number two is get the credit quality, get the balance sheet, get the stuff off the balance sheet. We are working extremely hard to do that. In this market, it's kind of hard to do that. Borrowers can hold you up in court for two or three years before you can get control of the collateral and get rid of it. We're working with the borrowers to the extent we can, but our objective is to get this stuff out of here. It's primary focus between now and the end of the year is to clean that stuff up. We're have the core earnings now and we'll continue to support it. At the same time we are going to be looking at other market dislocations, the -- and continuing to grow our core business in a manner that we have in the past. So we feel good about where we are right now. We have a lot more to do to achieve that goal and I will tell you that, notwithstanding the increase in the credit side of the equation, we're making good progress there and it's kind of fun again.

This is what we know how to do is how to build businesses. It was hard for a period of time when we had to play defense. And I've used this before, but most people think that we're not very good at defense, we're much more offensive. I've been called offensive by a lot of people, but we play offense much better than defense and we're back and it's fun again. We're back in the ball game. It's fun. We have a lot of work to do, but we're going to get back on the growth track that you all experienced before and we think that because of the markets and where it is and the market disarray that we'll be able to slingshot back. We have got a lot to do to get there. There's still miles to go before we sleep. I will also mention, as I did earlier, that maybe -- right now we are not interested in whole bank or bruised bank acquisitions.

We do get multiple calls on them, but we are not interested on them unless somebody makes us a real offer we can't refuse. And I don't know what that offer would be, but in terms of an opportunity out there and I want to keep everybody's eye on the ball to accomplish the goals that I have laid to you. So thank you for listen us -- listening to us drone on and we've got some time for questions.

(Operator Instructions). Your first question come comes from the line of Jeff Armstrong. Your line is open.

Jon Arfstrom. Good afternoon, guys.

Hi, Jon.

Jeff.

You liked that. Okay. So a question on the provision and the balance sheet cleanup that you talked about. The provision was up quite a bit sequentially and I'm just wondering is that part of the balance sheet cleanup that you're talking about? Do you need more provision and what can we expect, I guess, from the term balance sheet cleanup?

Well, we believe, Jon, that we mark these things when we get them in to the best extent we can. We mark them to market when they come in. We take the charge-offs that we believe -- pardon me -- are necessary right when they hit the nonperforming status where we reserve for them at that point in time. While we get fresh appraisals, we value that collateral. If there are guarantees in place and there's any sort of question about our ability to collect some sort of things, we will reserve for those things. When we added -- we did charge-offs where we're $12 million and the provision was almost double that. That all related to -- a lot of that related to the new non-performers that did come on the books. Some of it related to changing the factors, because the factors and the general allocation are based upon your charge-offs, if they've gone up from 20 basis points to 50 basis points, that does affect the general allocation.

So ours is kind of an ongoing basis, is when we -- when we -- when we get the loan in and we try to keep it as close to market as we can. We try not to kid ourselves. The -- if you look at a valuation of assets, it's kind of like a bell curve, Jon. If you drew a bell curve and you'd say on the far right-hand side is a real aggressive evaluation of assets, to take a two or three-year-old appraisal, and we don't do that. The top of the bell curve relates to getting new appraisals, what you think you can sell that asset in -- at a value in a normalized sale based on today's current market price. We tried to price it kind of the down slope of that part of the bell curve. On the left-hand side of the bell curve you have the bottom feeders. Okay? The bottom feeders who are -- who are out there and who will buy a loan that might still be in foreclosure where you have to dump things out.

So if you consider, we value things on the bottom, on the slope, on the conservative slope. There is, if we decided to go the route of dumping everything, there might be additional provisions, but we think that we're more on the normal course of business to get rid of these things. What we're seeing is -- is a lot of work that's been done on this, the legacy bad portfolio over the past three or four months to get those into a position where we can move them on. So, if you think provisioning, I think that the provisioning will follow that course. Our goal is to try to get these things down and it will be what it will be. I can't tell you right now, because I think we've marked them where we think we can get rid of them. But to the extend that somebody came and made you a bulk offer for $100 million worth of bad loans and it cost me, so I'd probably take that just to get them all out of here.

So we are going down a thousand avenues, we have got a managed asset division that's working day and night. They're very talented people. They're smart folks and they're working day and night and that is our objective. And that's -- really its hard to tell you now, but that's our objective. I think, as I said before, I think we're kind of at the tipping point here. I think -- will there be more coming? Probably. But I think our cleanup's going to be a lot faster and we're motivated to clean this stuff up. So, I'm sorry I can't give you a direct answer, but that's -- that's our plan and that's where we stand on it right now.

Yes. You made a couple of comments, you talked about how the tipping point and then you talked about wanting to be first out of the credit cycle and I get back on the same topic, it doesn't feel like -- does it feel like things are getting worse? Does it feel like more is washing up on the shores, I guess the term you use, or does it feel like it's pretty steady?

Well, I think more will wash up, but I think our ability to clear is going to -- is going to outweigh what's washing up. So that's what I meant by tipping point.

Yes, okay. Okay. Because obviously we're -- I was calculating that pretax preprovision number and I came up with a similar type number and all of it depends on that provision line and I guess what I'm trying to get at is if it's not materially worse, that helps in terms of our ability to try to model the Company and I just -- that's what I'm trying to get at.

Yes, -- you figure if you hit -- you hit the end of the year with the pretax preprovision numbers we talked about, we can pretty much take whatever is thrown at us. With those types of numbers you could write off 100% of all the non-performers and breakeven for the year. And that's why we concentrated on building the, which we're not going to have to do, obviously, but we're building the ability to absorb this stuff as it comes through and the objective would be to hit 1-1-10 running. And then be in, like we said in our presentation, be the first out where we'd be like Forrest Gump after the hurricane, have the only shrimp boat in town and that would really offer up a lot of additional growth opportunities for us, profitable growth opportunities for us. So that's -- that's why we're working on that net, but our ability is to, when we execute this and have our -- have that pretax preprovision number up in the two some place, we're pretty good shape to weather, even if -- if I'm wrong on the tipping point, to weather what comes along pretty nicely.

Yes. Okay. And then quick question for you, Dave. I know it's a little bit -- you hedged a little bit in talking about the possible premium finance sales, but is this -- is this something where you envision it to be back like it was a few years ago, where you have some kind of a vehicle to sell production and we would see quarterly gains going forward, like a serial type event, or would you view this more as a onetime option to make room for these loans?

I think we're going to look at both, Jon, but I think what we prefer is if we get an option, it would be one that we could continually access. So it would kind of go back to the old days, I think, where you could continue to sell it, so you would have this, hopefully, semipermanent production that you could sell-off. There are lots of different vehicles. If you did a term securitization vehicle, you would obviously have to keep that full. If we sell like we did in the past, it's sort of best efforts to a bank that we did the business with and there are a couple of other options. But one of the things I think is going to happen on it, certainly I don't think this is carved in stone that it will happen, but one of the things we're seeing out there is that insurance premiums are starting to harden, or get higher.

Our average ticket size is still in the low 20s, to $20,000 range, but what we're seeing is that we're financing premiums at about the same level that we have the last couple of quarters, but that the customers are just getting less insurance or they're taking higher deductibles or they've laid off people and their payrolls are down, so they don't have to fin -- their Workers' Comp premium isn't as high, so they don't have to finance as much. But what we're seeing is that premiums are higher. And in this business when premiums are higher, then our loans are higher and our average ticket size right now is sort of in the $23,000 range. At the peak of the last hard market, we were up around $40,000. Even if -- even if premiums go up to $30,000, not even half way between our -- not even half way between where we are now and the peak of the last hard market, that would be almost a 30% increase in our volume and with $1.4 billion of those assets out there, that would be about $0.5 billion of additional production for nothing.

So our preference would to be find a vehicle where we could continually sell into it to help accommodate funding for increased loan volumes from a hard market. But it's all subject to market conditions and what people are willing to do. The markets still aren't as fluid as they were probably three years ago, so we're going to work out, see what we can work out the best deal for that. But our preference would be to have a vehicle where we could do that and that would help accommodate the extra volume that we could get from a hard market.

Okay. And then just last question. Do you have any prepayment history on the loans that you just acquired?

Well, I can't really -- we've agreed on what we can and can't talk about. The terms of the deal. But these tend to be, like we said, loans for estate planning purposes, which tend to be longer term, but in essence by giving you this five to seven year term, that would incorporate prepayments.

Okay. All right. Thanks guys.

Your next question comes from the line of Brad Milsaps. Your line is open.

Hello, Brad.

Hi, good afternoon.

Hi.

Dave, was going to see if you could kind of give us a sense of maybe what the overhead associated with the acquired loans might be. Is it going to run similar to the profit margins on your existing premium finance business?

Well, we own the system, so it's not like we're paying big dollars for the system. So, I mean, the -- the big pieces of the overhead associated that with almost any business would be people and would be space. And like we said, we occupied some office space in Jersey City. We aren't disclosing how many people we hired, although we are saying that we hired the majority of AI Credit's life insurance premium finance staff. But I think how I can maybe frame this for you is we've got about a $200 million portfolio and we've got five people dedicated to it and then we get some ancillary support from -- some crossover from the P&C side from -- on the operational side. Not full people, but maybe you've got a -- another two FTEs lined up between some other minor operational support.

So maybe our $200 million is serviced by seven FTEs. They've got a portfolio that's about five times our size, but you would get some economies of scale with a bigger portfolio. So you can kind of do the math, the extrapolations there, but I think you can get it in a range. Even if you -- even if you took our five people and multiplied it by five, you would be at 25, or you are going to take the seven and multiply it by five you would be at 35, but you would certainly get some economies of scale. So somewhere in the 20 to 30 people range is probably a reasonable number to guess from that perspective as to how many we would need to service our combined portfolios.

So I think you can gather from that that there's -- there's only in that portfolio purchased 600 plus or minus loans.

Yes, it was 5 -- actually 530 and we had the option to purchase a -- a few other loans, but it's not -- so you don't have a ton of stationary supplies and other costs.

It's not -- it's not like the P&C funding business where you've got 12,000 loans out there that are nine month full payout, monthly statement, lots of activity to keep those going. This is a 600 and some plus or minus loans for $1 billion. If you add their portfolio and ours together, a little over $1 billion book. It's just really the people in the space, that's the big ticket items.

Okay. And would the yield on the premium finance loans you're hoping to sell be -- be a little higher than -- than the loans that you're bringing in, excluding obviously the discount accretion?

Well, the loans we're going to sell are the -- you have to divide our premium finance business down into the life portfolio and the P&C portfolio. Totally different portfolios.

Right.

The loans that we would envision selling are the P&C loans. Our old portfolio. So the yields on that are -- are what our historical yields have been on the $1.4 billion portfolio that we've been carrying along.

And excluding the discount, they are a little higher than -- than what we purchased. Excluding the discount accretion, they would be a little bit higher than what we purchased.

Right.

Right, typically those are prime-plus, correct?

Yes.

Correct.

Right. Ed, obviously this is a very attractive deal for you guys. Are others that -- like this out there that could potentially come down the pike? I know you talked about not wanting to buy a bruised bank or anything like that, but just kind of curious what your appetite is at this point.

We are very interested -- as we said early on, in these types of cycles we can go back to the 80s, there were lots of dislocated assets out there from back in the old days when the FDIC was selling assets. When you come out of one of these cycles there's a lot of that going around. We have been able to -- we've looked at a number of portfolios and a number of different, things in that regard and we've passed on a lot of them. We will continue to look in that regard. We want to keep the one-third, two-third relationship of niche lending versus core lending, but we will continue to look on the asset side of the equation as we always too. And I'm sure that they are out there. We -- we have looked at a number of portfolios that are in businesses that we are in and we could not achieve the returns that we felt were appropriate. So we would take a pass on those. But we will continue to do that. We think that we will be opportunistic as those opportunities come along.

Okay. Great. Thank you.

Your next question comes from the line out Mac Hodgson. Your line is open.

Mac. Hi, good afternoon. Just a follow-up on the previous question. On the P&C premium finance loans that you are going to sell or intend to sell, is it prime plus 2? What's the -- what's the most (inaudible) could you give us to kind of the yield on those?

Historically they've been in sort of the prime plus two to prime plus three range. Part of the issue there, Mac, is going to be depending on who you talk to and what they want, where you cut the loans off. So it may be that you don't sell some of the lower yielding ones and you sell some of the higher yielding ones or vice versa, depending how they want -- how -- which ones they would like to buy, if they want the bigger loans or the -- if they want to exclude the bigger loans. Sometimes in the past when we've sold them, the purchasers didn't want to buy loans over X dollars and those tend to have lower yields, so what you are left with is a little bit higher yielding, but historically that portfolio has sort of been in the prime plus two to prime plus tree net and it's somewhere in that range, most likely.

Okay. Great. And as far as the gain that you might recognize, I mean, will it be on a relatively basis similar to the type of gain that you had when you sold these loans several years ago? Is there any way of kind of having an idea what that might look like?

Not until we finish negotiations. I mean the market conditions are fluid, but I think you could probably go back and look over the -- the last five or six years and -- . When we sold them in the past, we-- we sold them to a bank on a best efforts basis and they -- they sold them down stream to some of their correspondent banks that they did business with and sometimes those banks were real hungry and -- for credit and we got good rates and sometimes if they weren't as hungry, we paid a -- I got higher funding costs out of it. But obviously, this market is not as good as it was a few years ago, from that perspective. If you were able to do a -- a TALF deal, the funding on that -- our understanding is that there has been a premium finance deal that's gone off in the marketplace where the funding costs were somewhere in the neighborhood of one month LIBOR plus 180 to 200 basis points range. So I'm not sure if that's what we'll do. I'm not sure if that's the deal we'll get, but there's -- I guess if I were to do I would use that data point on the TALF and I'd probably use our prior data points and you can probably box it in a little bit.

Okay. Is there -- is there a plan B if for some reason you guys aren't able to get a transaction done this quarter or it looks like its going to be more harder to do is there a backup plan. Would you look to maybe raise capital a little bit more to (inaudible) regulatory ratios.

We don't have to do this deal. Our capital ratios even after this asset purchase -- our total risk based capital was over 12 before the -- in the first quarter and in the -- in the second quarter, which we disclosed in our earnings release, our total risk base capital was over 12%. So we didn't balloon our balance sheet for this. We converted some assets from zero% and 20% risk weighted assets to 100% risk weighted assets. So you might have -- you might have compressed your regulatory capital by 50 bps. You didn't compress your -- your tangible equity capital ratio, tangible capital of the assets ratios, because we didn't grow the balance sheet because of it. We just switched asset categories. We still have plenty of regulatory capital. We still have liquidity. We didn't use up all of our liquidity for this. What this -- what that transaction would do is provide capital release, provide another source of earnings, and -- and provide some liquidity. So it would be beneficial. You probably keep working on it to see if you could get it -- get it done.

But, again, it's not like you have to -- we have to do it. It's not like if we don't do it, we say, oh, my gosh. It would be a nice thing to do to help the earnings, to help the capital, and to help, really, beef up liquidity so you can take advantage of more opportunities like the one we just did with this asset purchase of the life insurance premium finance portfolio.

You have to remember that based on here six months ago or seven months ago, we have $300 million more capital than we had before. That's kept our capital ratios up relatively high. There's been lots of discussion related to your TC ratio, TC ratio. Well, your TC ratio has been a topic of discussion because you need that to absorb losses and your earnings rate isn't high enough to do that and we're all worried about it. Our earnings rate is up pretty high and we can't absorb those things. So I think the pressure is -- is at least -- if it was never after my perspective, but from your perspective out there, the earnings side -- there's couple ways to raise capital. There is -- you can go out and take advantage of the markets or do private placements or whatever or you can earn it. And we've taken the approach not to dilute our shareholders at crummy prices, but to earn our way through this and create capital and ability to absorb whatever comes our way that way. We think that's the prudent thing to do.

And we think we're in -- with the -- with the progress that's been made on the pretax preprovision earnings, the progress that will be made by -- enforced by continued deposit liability repricing, good growth at good spreads, and the earnings brought about by the -- and hopefully brought about by this transaction we just accomplished, should give us plenty to do all of the above. So we have never -- we try to do the best thing for our shareholders, so we would never box ourselves into a corner with a transaction that would -- that would force us to do something that would in the long run dilute our shareholders. We will do things to accrete wealth to our shareholders. That's our main plan. So hope that answers your questions.

That does. That's helpful. Maybe just one last quick one, Dave, on the AI Credit loans, you mentioned there's credit discount and a yield discount, given that losses on those portfolios just about 10 basis points, wouldn't the credit discount just be pretty nominal, $4 million or $5 million, or something like that?

We're not going to disclose the number, Brad, but it -- it relative to the full discount, given those metrics, I think you can make the assumption that the majority of the discount is going to relate to yield and a substantially smaller amount is going to relate to credit, yes. That's -- that's why we gave it the criteria there. Now, we might be a little bit more conservative than 10 basis points, obviously, but it's going to be predominately yield. We just aren't going to give the breakout 'til the third quarter Q.

Okay. Great. Thanks.

Your next question comes from line of Dennis Klaeser. Your line is open.

Good afternoon. Just drilling down on that discount and the $260 million, kind of wanting the diligence or the realizability of that discounted into earnings and given that the credit risk at least historically has been very low, it seems like there's a very high probability that that $260 million will be realized into earnings. But what are some of the key risks there that could -- that could confound that conclusion? For example, your exposure to different insurance companies or the -- are there any particular concentrations with insurance companies for the underlying insurance policies?

Well, I mean, I -- we -- that business, as well as ours, is diversified amongst insurance companies and predominantly they're AAA, double A, single A rated insurance companies. On the life side most of them are rated by Moody's and S&P and Fitch and A.M. Best. And we did our diligence on those. It's fairly diversified. That is a risk. I guess if a life carrier goes down and somehow the policy no longer has cash surrender value, that's collateral to your loan. The interesting thing about that business, and that -- it's the business, not specific to AI Credit's business, because it's the same with our business and whoever else does life insurance premium financing, is that if you start to see a carrier's credit quality deteriorate, so if someone is going from double A to single A and all of a sudden they're triple B, the borrowers interest is really aligned with ours.

The borrower doesn't really want to have a policy that he's got a cash surrender value that he's paid for tied up in a carrier that may have real financial difficulties, nor do we want our collateral to be with that carrier. So generally what happens, if that's the case, is that the borrowers attempt to exchange their policy, what's known as a 1035 exchange, with another carrier and so they would -- they would take their policy and exchange it for a policy of a higher rated carrier to feel safe and sleep at night that their life insurance is safe and sound. So they -- they're sort of aligned with us. So generally in our business, if you start to see a carrier deteriorate in quality, you and the borrower work diligently together to get them to another carrier. And -- and on the other side of the equation is if a life carrier goes down, it's generally probably the holding Company of the life carrier that's having problems, or the -- the asset side out there that's the problem. The policies themselves generally have value, just like deposits in a bank have value.

The policies could very well be purchased by a healthier Company, if the other Company has a problem, and then your collateral would be upgraded. But generally-speaking if we start to get less than a single A, we're not doing business with those companies. And if they go less than a single A, you would want to start diligently trying to exchange that policy for another one, or attempt to get additional collateral from the borrower.

And in recent periods has the credit performance been changing for the pool?

No, I -- I think generally -- I mean, between us and that portfolio, there's maybe less than a handful that would be less than single A carrier. Very little outstanding, because you worked to get them out of those carriers. There are some down grades, obviously, with life carriers recently, as far as negative outlooks, but they're rated by three different rating agencies and -- and we look at the financials ourselves. We underwrite the carriers ourselves. And obviously in this environment there's some stress out there, but nothing that's dramatic from our perspective.

If you look at it from our perspective, Dennis, what I can do about our portfolio, we've had, I think, two loans in our portfolio that -- where we had to go to liquidation for one reason or another. The interesting thing about -- thing about that is the liquidation takes place in about a week. You get -- you get your cash surrender value back, usually holding any cash collateral that's marketable securities. You have control over the accounts and you're usually paid off within a week if there's any sort of noise in there. So the collateral control it's liquid collateral and it's not like sitting around for three years in a court in Joliet trying to get a judge to release your collateral. It's all happens relatively quickly. So you can move very fast on these and that's part of the -- why you have to have a real top notch servicing org, they know where everything is, monitor your collateral. That's a big part of what we too.

Sure. Okay. And when we think about the growth prospects of this business, is this a -- is this a line of business that we should expect some reasonably strong growth?

It's a -- yes, I -- I -- reasonably strong is, I guess, is subject to interpretation. It is a business that we're in. I think we are probably the leader in this industry right new through this acquisition. We intend to maintain that leadership role. We want to keep the niche portfolios diversified, P&C premium finance, all of our niches. We -- we like to keep that about a third of our earning asset portfolio or our loan portfolio. So -- so we will be growing. As it grows, as we grow, there will be plenty of opportunity for this business to grow and we can maintain that metric. So we're in the business and we intend to stay in the business and grow the business.

Okay, good. And quickly, on your mortgage banking line of business, on the last call you mentioned your goal of achieving -- achieving some better operating leverage there. And it looks to me that you may have been able to achieve some of that in the second quarter, because you're -- the growth of employee expense looked to be relatively modest relative to the growth of mortgage banking. I think you had commented that the profit margin on mortgage banking was 25% or so. Are you seeing efficiencies of scale there or operating efficiency there

Because of the -- remember, we did -- we merged two equal sized companies together at the same time we did a technology conversion, so it was -- and we had huge volumes coming through. So I can honestly tell you, we have not achieved the operational efficiencies that we intend to achieve going forward. So we've achieved some of them through the systems conversions and the like, but we still believe that there is -- there's some -- there are some efficiencies that we can pick up, but I would rather -- I would rather be building the revenue side right now on the customer base when the opportunity is hot. So, no, we have not achieved what we expect to achieve out of that to date, but we have done a little bit.

Okay. Thanks. Good.

Your next question assumes from the line of Adam Klauber. Your line is open.

Thanks. Good afternoon. On the OREO write-down on the residential construction, what percent discount compared to the original? And also with that, based on appraisal or sales?

Dave is going to look up the exact number, but I don't recall it being -- we're pretty close on that, Adam. Sometimes we actually, I think, during the quarter we had half of them had gains and half of them maybe had losses, what we're able to get out of. So on the OREO itself, I think we're pretty darn close to our evaluations when we take them into OREO. So what number were you looking at? I'm a little -- .

I think it was $3 million.

Yes, $3 million for the six months ended where -- were -- would the OREO expenses including -- including any write-downs we had. There was $1 million for -- for this -- this quarter. So that would include operating expenses, taxes, and any write-downs.

Okay.

But I think if in the back -- in the back, we sort of do a reconciliation of our earnings release about the activity in OREO and we had $41 million at the beginning of the quarter and $41 million at the end, but we 4.7 go on and 4.8 come off, so 7 sort of relationships came off, but I actually had them-- I don't have the exact number, it is less than $1 million of that would be losses on that.

Okay.

Because a lot of that is also operating expenses.

How about on the transaction? Did AIG have similar distribution relationships. Did they deal with the same agents, wholesalers, or do they have a different set than you?

Well, they obviously had a much broader distribution channel than we did, given their size. We had a little bit of crossover between the companies, but we actually gained better distribution channels through their systems than what we had.

Okay. Great. And also on deposit growth, obviously very strong. Are you running any special programs or is that just normal course of business?

Really, normal course of business. Our -- we have opened one permanent facility in the course of the year this year. We moved from a temporary facility to a permanent facility in St. Charles. We would run a special there, but that -- that bank might have grown maybe $20 million. Most of this is -- is just core growth, as -- you have to remember that our competition is not just the bigger banks around, but a lot of the smaller community banks around Chicago are really who we have positioned ourselves to compete. We position ourselves as a local alternative to the big guys. We'll compete with the big guys, but we have another of local -- a number of other local alternatives out there and the stress on the community banks has not gone unnoticed by the -- by the clientele. So we have been picking up market share with this. I said it was good core fundamental market growth.

We'll also say that our max safe deposit, the one where we offer the 15 times the FDIC coverage, has worked out very well for us in terms of getting new clients in and we immediately go and cross-sell those clients when they come in. They are the higher net worth folks and even -- and many of them live in our areas and we have been able to pick up good client relationships from that. So more a product mix issue and competitive issue. We, as the -- as the income statement showed and as I laid out earlier, we still have significant repricing. We've experienced good repricing and have significant repricing that will take place throughout the rest of the year in the liability portfolio and we're not over-paying to get those funds.

Great. Thank you very much.

You're welcome. Have a good day.

Your next question comes from the line of Jeff Bernstein. Your line is open.

Yes, hi. Do you have an LTV number for the non-performing assets on current appraisals?

An LTV number for non-performing assets based on current appraisals?

Correct. On then commercial piece.

Well, when -- when the asset goes into non-performing, we will go out and get a new appraisal and we'll look at it and we've generally priced it at a discount to whatever that new appraisal is.

Great. Is there a composite kind of number you can share with us on where those commercial assets are?

It's hard to do that, because it -- there are other forms of collateral that are built in there, including guarantees, including seconds on things and the like. So it's really hard to look at the collateral from that pers -- . We have to look at all aspects of the collateral when we do this and so we -- I don't know how meaningful that number would be.

Do you have any other way of giving us an indication of kind of what's the severity out there in commercial?

Severity? Well, again, you have to -- our methodology, Jeff, is that when it comes in we try to market to a realizable value, what we think the realizable value is going to be either through specific reserves or actual charge-offs. So we think we're carrying it as a realizable value. If we thought that it was a non-realizable value, we would write it down to whatever we thought that value was. I hope that makes sense to you. But it's not like we're carrying at a level that we don't think we can realize. As soon as it hits that non-performing status, there is a full evaluation of the collateral that takes place. We either charge it off and/or reserve for what's out there, put a specific reserve against it. So we believe we're carrying it at what we think we can realize.

If you only choice at the end of the day was to go to a bunch of bottom feeders that are out there, there's a bigger discount there, but we try to price on that curve between realizable value and down the curve a little bit towards those bottom feeders, give ourselves a discount, what we think the value of the collateral is, sometimes that's maybe around 10% would be that number. What that discounts we might apply to the collateral values we bring in, we might apply a 10% discount, but it's a function of the collateral itself, so we're carrying it at what we think we can realize.

Great. Yes, I understand that. I guess because the growth in non-performers appears to be a bit faster than the growth in charge-offs, there's the implication there that these things were very well underwritten and the ultimate loss to you is not going to be that great. Can you give us any kind of feel for -- are you out -- out there actively marketing properties for sale from OREO or are you kind of trying to have a longer marketing period so that you're not essentially selling to bottom feeders?

We have to actually look at the OREO itself. If we bring in a smaller -- like if it is a smaller project or a built, a three flat, a six flat, an existing house, two or three houses, a townhome, whatever you bring in, on the smaller side of things that are completed, we try to get it out. We -- we not only get an appraisal, we go to local realtors and say what's the 90 to 120-day clearing price on this stuff and we'll take the lesser of those two. So if we can -- if there's not a lot work involved in it, we try to blow them out 90 to 120 days. That's the standard operating procedure here if we bring this stuff in. The larger deals it's a little bit different. You do have to -- if you got a development loan that's got a couple of specs on it or it's improved, it's got a couple of specs, that's a little bit different in terms of how you're going to liquidate that. We -- we do have our mad division, our managed assets division.

We were going to call it special assets, but the guy who runs it is more mad than anything else, so we call it MAD Ad, managed assets division. Those people are out marketing. As you know, there are firms that run the whole spectrum on the bottom feeder side, from the bottom up to reasonable. We have contacts with all of those folks. We have put properties together in various forms and various geographies. We've put packages together to try to push those out, but, no, we are actively -- that is -- that is number one objective is to get this stuff out of here.

And last question, any feel for just absolute land loan exposure, pure land?

Well, we haven't disclosed that number specifically, but we do disclose the difference between, in the press release, the difference between residential real estate development and land loans and construction real estate and land development. I think in the third quarter report, we're going to get in a lot more specificity about that type of breakdown, but the best we can do for you on this call, given what we've disclosed, is the disclosure that we have in the earnings release.

That's great. Thanks very much.

Thank you.

Your next question comes from the line of John Rowan. Your line is open.

Good afternoon.

John.

Hi, John.

Just to go over a couple of quick points. So on the acquisition. So the loans that you're buying are paying LIBOR plus 190, but if I'm not mistaken you guys said that the loans that you're going to sell is prime plus 200 to 300. So if I'm not mistaken, there is a trade-down in rate, therefore that's an offset to the margin improvement that you're going to get from the discount accretion. Is that right?

No.

No.

No. I mean if you go through and use the metrics we had out there and take the LIBOR plus 190 and you have to remember over the last 12 months, LIBOR has ranged from 420 to 150, basically, and so these things reprice annually, so they're not all at today's one-year LIBOR rate. But if you take the one-year LIBOR plus the spread that we have out there and then you amortize that discount in over a period, and you can pick your period that you want, the yield on the portfolio we bought is much higher than what we would be selling.

And let me just throw a little caveat in there. The LIBOR plus 190 yield is on $900 million worth of assets that are on our books at $700 million. So the yield on that portfolio until it's accreted up it is actually higher than LIBOR was. You see what I'm saying? So the LIBOR plus 190 is actually at the beginning, if you have a third of -- is probably LIBOR plus 250 on that basis. So on the underlying basics of the transaction. And -- and then you put the discount on top of that and, no, there will be -- absolutely not. The margin pickup from this under normal amortization pick up is -- is much bigger than the give up. And if you also, just as Dave gave numbers before and again we're looking at any number of different alternatives on the loan sale, but if you take 30-day LIBOR plus the spread he talked about and apply it, that's a pretty good spread on that business, too, that you would be computing the gain on. If you were able to do a TALF-based product, that's a pretty -- that's pretty inexpensive funding to compute your gain off of. So -- .

John, like Ed is saying and I'm not saying we're going to do this, but I mean as we talked about data points, you can go back and look at how we did some of the other. When we did some of the other deals with other banks, they wanted sort of, since these were four and a half month loans, they wanted sort of four and a half month LIBOR. On the TALF deal that we saw out there for premium finance so far was sort of in the one month LIBOR plus 180 to 200 range, so that would equate out to in a low 2% funding costs. So I'm not giving up all of the yield on that loan, I'm funding it at 2% and I -- I do a dis -- you take the gain on it like you would do on our past 40 and take that income in -- take that income in on your books. So the differential would -- may be what -- what the difference in your funding cost is and not necessarily the asset yield.

Okay. And just one quick question. The decision to sell the loans versus funding this from what you're obviously funding it for is a temporary basis from the liquidity from your short-term assets. Is that a decision just to keep the loan to deposit ratio below 100% and keep risk to a minimal level on the balance sheet?

Well, to add capital relief. You should be able to -- we're going to find the most efficient form of doing this and you could -- you -- under a TALF proposal you could take 100% assets and lower them down to 20% assets or something close to that, gets a little complicated, but there is regulatory capital relief with it, which actually makes your returns go relatively high on that particular class of business.

And if we saw them in another fashion, you get regulatory capital relief too, if you can make it into a true sale and make it a bankruptcy remote sort of facility. So we have done that in the past by selling it to other people. So you get the capital relief, you get the earnings off the assets you told sold through a gain on the sale, and you get liquidity, and you get divers -- you get diversification. We've always said that liquidity is important and we have liquidity now. We have a fair amount of liquidity, even with the sale, but you have the liquidity and it's available to take advantage of other opportunities, you get some capital relief, you get some earnings, additional earnings generated out of that transaction. There are a number of positive things that coming along with that. Again, if it doesn't happen, it's not the end of the word, it's just something we think would be positive from an earnings and opportunity perspective, a capital perspective, and a liquidity perspective.

Your return on equity on that type of transaction is pretty big, if you can pull it off. Those markets have been closed up for a long time or we might have done it even earlier.

Yes, we had looked at doing this last year about this time and in the March, April, May time frame. Conduit markets were fairly favorable, securitization markets were fairly favorable, then they started to go away and then in the fall they just completely seized up. We've always thought this is a good idea. The markets have just started to open up again and so it's somewhat coincidental it's happening at the same time as the life deal, but it just -- it makes a lot of sense.

Back, if you think of the last three or four years, the credits that you could bring, if you look at loan demand, the credits you could bring on your books were at crummy rates. We would rather keep the premium finance loans on the books and do and not stretch for credit. There was no need for us to do this. Right now we see dislocated assets, we see good portfolio loan growth, so there's an opportunity now to take this off our balance sheet, get real good -- it's real good use of our capital, because we can basically double up on the earnings on the capital side of thing. It's basically driven by capital and loan demand and it seems to make a lot of sense.

And as I said before, we truly do think that the P&C portfolio is going to grow at a pretty good rate because of what's going on in the insurance industry as far as P&C premiums go. So you would rather have a vehicle like this in place one way or the other, given the market conditions and all of that, if it works, where you have it in place where you can just handle that volume in the normal flow versus trying to get funding at different times and different places. Let's get it set up, let's be prepared for it, and let's go on, in the mean time, we get capital relief.

All right. Thank you very much.

Thank you.

Your next question comes from the line of Joe Stieven. Your line is open.

Hi, guys.

Hello, Joe

Guys, actually all my questions that you actually just finished answering one of the final questions. But good quarter and and that's it. Thank you.

Joe, last time I looked Cardinals weren't in first place, but nice talking to you.

Go Coveys.

Your next question comes from the line of Daniel Cardenas, your line is open.

Hi, guys.

Hi, Daniel.

Can you give us a little bit of color on past dues, 30, 89-day past dues, how that's looking compared to the first quarter and the year ago quarter. Same thing for your watch list trends?

The 30, 89 category we think is relatively flat, maybe down just a little bit from the first quarter.

Watch list trends we don't disclose.

All right. Most of my questions has been answered. Thanks.

Thanks, Dan.

Your next question comes from the line of Bryce Rowe. Your line is open.

Thanks. Guys, got a couple of questions here. Dave, can you -- can you talk about the CMOs you have on the books that generated the trading gains. What's the par value there? What's the potential for more gains?

You tell me where the market is going to go, I'll tell you what the potential is. We purchased some CMO products in the first quarter when the market was really dislocated and seemed like people were dumping those securities and without getting into the specifics -- I mean, we have less than $200 million of those on the books. They're prepaying at a fairly rapid rate, so the prepayments on those, given that we bought -- we bought them, from a par value perspective, we -- probably about 50 -- $0.50 on the $1.00 it was. I ought to give you exact number, but it is somewhere in that range, $0.50 to $0.60 on the $1.00 and we built in fairly significant default rates, very low prepayment rates, and at that time spreads were high. The market has dramatically tightened up since then, so spreads have come in, prepayment rates are much higher than what was projected, and defaults are much lower. So if you -- and we expected that to happen and so we put some of these into the trading account portfolio thinking that there may be a point where we want to blow them out or just be able to take advantage of the increase in the values. So that's -- that's the story on it.

Okay. Thanks. And again, one more question, on the liability side of the balance sheet, any opportunity to pay down some of the FHLB advances or do you expect the, I guess, non-deposit liabilities to kind of remain where they are right now?

The prepayment penalties on doing that are awfully high. We use historically, and it's still our plan, we use brokered CDs and Federal Home Loan Bank advances for asset liability purposes to match things up and those are mostly longer term things that we used and the prepayment penalties are awfully high to get out of those right now.

And they're probably still performing the matching on the assets we tried to match them up with when we put them on the books, so they're probably still effective and we don't have much in the brokered CD arena, but -- and you can tell what we have for that, but it's really done for asset liability management purposes, so.

Okay. I appreciate it. Thank you, guys.

We will take one last question from the queue. Your final question comes from the line of Stephen Geyen. Your line is open.

My questions have been answered. Thank you.

Thanks, Steve. Okay. I think we've cleared the queue. It's been a very -- I think we have set a record at an hour and a half on this call. We appreciate you listening in. We appreciate your interest in our firm. You can be assured that we intend to execute the plans we laid out today and we thank you and look forward to talking to you, if not in the interim, at the end of the third quarter. So everybody have a good summer. Thank you.

This concludes today's conference. You may now disconnect.