First Midwest Bancorp, Inc.
Q2 2008 Earnings Call Transcript

Published: 16 Jul 2008

[Operator:]

Welcome to the First Midwest Bancorp 2008 second quarter earnings conference call. (Operator Instructions) It is now my pleasure to turn the floor over to your host, Paul Clemens.

[Paul F. Clemens:]

We think we’ve got a really good story to tell. Earlier today First Midwest announced its results for the second quarter of 2008. If you haven’t already received a copy of the press release, you may obtain it at our web site or by calling our offices at 630-875-7463. And now let me add the customary reminder that our comments today may contain forward-looking statements which are based on management’s existing expectations and the current economic environment. These statements are not a guarantee of future performance and actual results may differ materially from those described or implied in the forward-looking statements. Forward-looking statements are inherently subject to risks and uncertainties including but not limited to future operating results, market penetration, and the financial condition of the company. Please refer to our SEC filings for a full discussion of the company’s risk factors. We will not be updating any forward-looking statements to reflect facts or circumstances beyond this call. Here this morning to discuss First Midwest’s second quarter results and outlook are John O’Meara, Chairman and Chief Executive Officer, Mike Scudder, President and Chief Operating Officer of First Midwest Bancorp, Tom Schwartz, President and Chief Operating Officer of First Midwest Bank, Mike Kozak, Vice President and Chief Credit Officer, and myself Paul Clemens, Executive Vice President and Chief Financial Officer. I’ll now turn the call over to John O’Meara.

[John M. O’Meara:]

I’m very pleased to make this announcement here this morning. We had strong operating performance driven by record sales. That’s a wonderful combination to put in the same sentence. In addition to that we’ve been able to rigorously pursue the remediation priorities in tandem with executing our long-term capital management plan. Let me spell that out in four concrete bullets and then I’ll summarize that in a little bit more detail and then take questions for the table. Second Quarter Highlights; ully-diluted earnings per share were $0.56 versus $0.52 on a linked quarter basis. That’s 7.7% increase. Return on assets was 1.33% versus 1.25% and return on equity 14.57% versus 13.75%. Loan growth which I’m using as a surrogate for our overall business dynamic in targeted commercial and industrial and agricultural categories was up 14% annualized for the second quarter. Non-performing assets plus 90 days past dues as anticipated increased from the first quarter 2008 levels by about $10.7 million and they presently stand at 1.35% of loans outstanding. In anticipation of this $4.3 million was added over the two quarters to reserve for loan losses above and beyond charge-offs in anticipation of future developments. Beyond the monetary portion of the remediation issues there were several administrative enhancements that were made as well

[Operator:]

(Operator Instructions) Our first question comes from John Pancari - J.P. Morgan Securities, Inc.

[John Pancari:]

Can you talk a little bit more about the continued rise you’re seeing still on delinquencies and I know they’re coming off of somewhat elevated levels already so if you could just talk about what you’re seeing there in certain portfolios that are really seeing pressure? And then how that relates to your comfort in the loan loss reserve? I know John that you indicated you still view the reserve as adequate in light of the projected loss content and I’m just curious, with the delinquencies continuing to rise here you haven’t changed the relative size of your loan loss reserve in terms of relative to loans from last quarter. I’m just trying to get a better understanding of how you view the adequacy of the reserve in relation to what you’re seeing by way of the delinquencies?

[John M. O’Meara:]

I’m going to ask Mike Kozak, the Chief Credit Officer, to take the first swing at that and anybody else who wants to chime in.

[Michael J. Kozak:]

John we certainly have seen a slight pickup in our past due loans and we’re certainly monitoring that very carefully. A number of that increase is coming as John alluded to from the residential area and we’re really intensely looking at it as John mentioned on a customer-by-customer basis. We have increased our staff as John alluded to and we have increased our monitoring. For example in our residential land and development portfolio we have a series of meetings. We meet weekly. The entire portfolio is looked at on a monthly basis, one part of the portfolio every week. It’s very hard to categorize any particular set of problems. Every situation has tended to be unique. We have some individual cases, let me back track and say we are working with all of our customers and each case is unique. In some cases we’re able to see new equity come into projects; in other cases we’re seeing projects carried by other sources of cash flow; and in some cases we’re working with the borrowers to consider giving us deeds in lieu where appropriate. So we’re really on top of it. We’re not sure how long this is going to continue but we think that we have the resources in place to deal with it. We have the ability to add more resources as is necessary, and as John mentioned we try to cover it in a loan loss reserve by adding the additional $4.3 million. So we think at this point in time we’ve got our bases covered.

[John Pancari:]

In terms of the delinquencies are you able to quantify how much of the delinquencies are limited or possibly in the maturing phase here but still performing? Is there any type of timing disparity that we need to take note of that could be partly influencing the level?

[John M. O’Meara:]

In terms of our under 90 day delinquencies generally we see roughly 30% to 45% are what we call soft delinquencies or administrative past dues is the phrase we use here in the bank and that could be a timing issue with financial statements, it could be working through a covenant situation, but generally I wouldn’t suggest that the full amount of the delinquencies are indicative of a past due problem. We do have that very strong component. It’s been this way historically quarter after quarter where the past dues are more of an administrative nature.

[Michael J. Kozak:]

And that continues to be the case.

[John Pancari:]

Last question just really around capital. If you can just give us a little more clarity on your comfort with the capital level. I mean I know you just indicated you’re focusing more intently on the reserve and your requirements there and you indicated that you’re certainly suspending your buy-backs although I know you haven’t been all that aggressive there but you are suspending them, and now with the tangible common equity ratio including OCI down at 5.45%, I just wanted to see, talk a little bit more about your comfort in capital and if you think you need to be longer term that you could need to be higher than where you are now?

[Michael L. Scudder:]

We’re very comfortable with it. I mean if you take out the OCI which is subject to what’s going on within interest rates within the market, you’re sitting there with an OCI excluded tangible equity to tangible asset ratio that’s at 5.90% and we continue to add. The comfort level that we drive is we run at about a 25% to 30% premium profitability-wise to a lot of our peers, so we can pay the dividend, we can support some level of growth, and then we can add and build the capital over time. So if you look just on a quarter-to-quarter basis and exclude out movement and interest rates, then we actually increased our overall tangible equity by about 17 basis points. And the same with our regulatory ratios; those went up somewhere between right around 10 to 20 basis points as well. So as we project out and even at the levels that you’ve got, we’re still able to continue to add just from the level of performance that we’ve gotten. So that’s where our comfort level comes there.

[John M. O’Meara:]

All of the erosion of that ratio that you’re making reference to is strictly the M&A activity that we’ve had over the last several years.

[Michael L. Scudder:]

To pile more back on there for you, John, if you go back and you can look, our capital levels exclusive of OCI are just about where they were in 2006 and we absorbed a fairly sizable hit in the fourth quarter simply from a function of the problems in the market. So we’re able to restore capital fairly quickly. I think the other thing to keep in mind generally is our strength relative to well capital. We’re still $130 million above the minimum level to be considered well capitalized. We’ve got strong capital and as we go forward any need that we would have for additional capital would simply be a need for continued growth on our part.

[Operator:]

Our next question comes from Andrea Jao - Lehman Brothers.

[Andrea Jao:]

First a quick question on capital. So at 6% tangible by year end, is that ex-OCI, so it’s comparable to the 5.90%?

[John M. O’Meara:]

Yes. That’s what we’re talking about.

[Andrea Jao:]

Then on the credit side, you look at the rest of the portfolio one-fourth of it every week, that means you look at every credit? For one month you’d look at every credit, not just the bigger ones?

[Michael L. Scudder:]

The inference was to our residential portfolio. We’re looking at it one-fourth of the portfolio every week. Our residential portfolio which is around $415 million.

[Andrea Jao:]

Have you obtained updated appraisals?

[Michael L. Scudder:]

Generally when a loan is in for renewal or if the loan is recognized as being in trouble, if there’s a past due, if there’s a covenant issue, we will generally get an updated appraisal.

[Andrea Jao:]

So on average for the $418 million portfolio, what would you say the average LTVs were and how much deterioration in collateral values have you seen?

[Michael L. Scudder:]

In general it’s been a range and the range has been between 25% and 35%.

[Andrea Jao:]

Deterioration in collateral values?

[Michael L. Scudder:]

Yes.

[Andrea Jao:]

And the average LTV?

[Michael L. Scudder:]

Well again it’s going to vary on a property-by-property basis. Obviously where the diminution in value’s been closer to 35%, in those cases we are near 100% loan to value.

[John M. O’Meara:]

Andrea, that would help define our stomach for holding the property whether we were going to be looking for a quick sale or whether we had the equity to hold the property for a longer period of time waiting for a cyclical turn.

[Operator:]

Our next question comes from Terry McEvoy - Oppenheimer & Co.

[Terry McEvoy:]

I just want to talk a little bit about loan growth which was very strong. Was that a function of an internal sales marketing focus or was it to some degree maybe generated from what some of your bigger larger competitors are going through in terms of just taking their eye off the ball and focusing on other issues or is it just a function of the whole market really benefitting from stronger demand this past quarter?

[John M. O’Meara:]

We’ll give you the sales manager to talk about that.

[Thomas J. Schwartz:]

I think it’s a combination of all of those items. We have talked for many years about our relationship banking model and our approach to our clients. And in times like this I think that bodes well and plays out effectively to those clients. We have grown our portfolio probably a 50/50 split between new customers and borrowings from our existing customers, additional borrowings from our existing customer base. We have seen in our commercial real estate portfolio an opportunity. We’ve been seeking out maturing commercial mortgages on seasoned strong stabilized properties in all of the different areas including office, retail, industrial and apartments, and these properties were originally financed with conduits, insurance companies and other banks on terms less favorable and we would not have done them in the past. But now with movement in interest rates and the lack of conduit financing, we’re able to book these deals on our terms.

[Terry McEvoy:]

And could you talk at all about the additional expenses relating to hiring I think it was 50 people to work on the credit remediation staff? Was it meaningful in Q2?

[John M. O’Meara:]

I said that and if you hard that, I misspoke. We increased staff by 50% taking it from six full-time professionals to nine. I’m glad you asked that question. No, we didn’t add 50 people. We wouldn’t have a place to put 50 people.

[Terry McEvoy:]

And then just one last small question, the assets under management grew by 9.1%, assets in the trust department. It looks like the revenue has been flat the past couple quarters or I guess your quarter and sequential quarter. Should we expect a pickup in revenue as those new assets are accounted for in Q3?

[Paul F. Clemens:]

Well to be honest with you it actually depends on what the market’s going to do for us. We had seen some growth over the last half of last year and then with the market decline it’s tapered off but at the same time we’ve had a substantial increase in assets under management of several hundred million dollars, so with that combined we expect to see that turn over as the markets rebound.

[John M. O’Meara:]

We will do a lot better with a $13,000 than we do with an $11,000.

[Michael L. Scudder:]

Our sales process there Terry again has been very successful and we’ve added a number of new clients so hopefully the markets will come back and reward us.

[Operator:]

Our next question comes from Brad Milsaps - Sandler O’Neill & Partners, L.P.

[Brad Milsaps:]

I appreciate the additional disclosure you guys gave this quarter. Just a couple kind of housekeeping questions. Paul, the tax rate obviously disclosed the reversal but still maybe a little bit lower than it has been. Can you kind of give us a sense of where you think that might fall out going forward?

[Paul F. Clemens:]

Well, our effective tax rate’s been around in the low 20s and I expect it’ll return there. We just had some events that happened this past quarter that allowed us; that basically under accounting guidelines forced us to evaluate our tax reserves and reverse certain things. There was a tax ruling by the U.S. Tax Court that clarified some deductibility of some things that we had reserved for. And then also some audits that are ongoing from past years and as we met with the examiners from the state and they clarified their position, we were able to re-evaluate our exposure there. So apart from those two things, we’ll be back up in the low 20s over the next couple of quarters I would expect.

[Brad Milsaps:]

And Paul, most of the increase in the OCI loss related to the bank trust preferreds, can you give us a sense where you mark those at June 30?

[Paul F. Clemens:]

Sure. Those actually range. There’s actually seven specific CDOs, trust preferred CDOs that we have there, and they range actually from around in the high 50s to the high 80s in terms of market value. These are actually dealer quotes that we’ve obtained and we’ve looked at their cash flows as we’re required to underlying these CDOs and I don’t think there’s any impairment at this point. All of these have collateral, the underlying banks in excess of the amount that represents the CDO itself, so at this time there’s a range here of what’s going on. You’ve seen what’s going on with the bank stocks in general so they dropped somewhat but we don’t think it has affected cash flows and we’ve not seen any impact on cash flows in our reserves.

[Brad Milsaps:]

And maybe a couple questions. John, the last time we talked, you mentioned maybe receiving $8 million in deeds in lieu of foreclosures in the second quarter. I’m just curious if those came through? And I think at that late in the quarter you mentioned that you’d received maybe new appraisals on $50 million to $60 million of the resi-land portfolio. I’m just curious, is that number higher at this point and how much more you have to do there?

[John M. O’Meara:]

We have three discreet parcels of land that we’re negotiating for deeds in lieu and we didn’t get them accomplished in the second quarter. We likely will get them accomplished in the third quarter. It was not for lack of understanding or agreement between ourselves and the borrowers. We found some [diminimus] interspersed liens of material between ourselves and - For instance one was a $4 million or $5 million transaction that had a $200,000 concrete material man’s bill that we had to get cleared off. So just housekeeping type of stuff that delayed that. The $50 million to $60 million, well clearly these would be part of that. I would say that I probably was overly optimistic in that. Probably at this point it’s maybe $30 million, $40 million, $50 million. I would say $40 million, $45 million in appraisals. That’s the monetary value of what Mike Kozak was talking about a little bit ago.

[Michael J. Kozak:]

It’s an ongoing process that we’re going through. We’re adding new appraisals every day. It’s a moving target.

[Brad Milsaps:]

And just so I understand and John you talked about this a bit, sort of the detail on the charge-offs, only about $138,000 of charge-offs in that residential and land portfolio this quarter. You’re anticipating that that number is going to go up from there as we move into the second half of the year but you think that it can be offset with lower C&I charge-offs?

[John M. O’Meara:]

I believe that we did some anticipatory or accelerated charge-offs in the commercial portfolio so that that wasn’t a distraction for us. I think we’ll be in a position to do some charging in the [one to four portfolio] but I don’t know. We can’t charge what we don’t own. We can’t charge until we get the loans wrapped up in a place where we can ascertain values and shortfalls and things of that nature.

[Brad Milsaps:]

And then finally, any new hires to speak of in the second quarter? Tom talked about a little bit how the loan growth is driven but just curious, any new hires?

[Thomas J. Schwartz:]

No Brad, we really haven’t hired any new folks into our staff other than with normal openings that you might have.

[John M. O’Meara:]

The one interesting new hire on the credit side, the administration side, is this person I described as the administrator in the builder/developer portfolio. We actually went out and solicited on a contract basis one of our customers who is in this business, that is a builder/developer, who took his money out of the market when he saw the turn coming and was basically just hanging around. And we said, “Would you like to work for us and do some work-ups and the like?” And it was like a hand-in-glove and worked very very well. And we’re paying him a monthly stipend to act as owner’s agent if you will on these transactions in the same market where he was competing with these same people.

[Operator:]

Our next question comes from Ben Crabtree - Stifel, Nicolaus & Company, Inc.

[Ben Crabtree:]

Actually just a bunch of small kind of questions. Do you have anything in the way of [GSE] preferreds in your investment portfolio - Fanny and Freddie?

[John M. O’Meara:]

No. Zero.

[Ben Crabtree:]

The trends in deposits. You mentioned in the release the public funds. Other than that would you say that non-interest bearing deposits and deposits in general were relatively flat?

[John M. O’Meara:]

Yes.

[Ben Crabtree:]

The REO number dropped and I’m just curious, I know you don’t want to make too much out of a limited sample size here, but what kind of a hit was required to move that number down versus not so much what you were carrying it at but what you originally lent? In other words, I’m trying to get a sense of what’s going on in the market place in terms of haircuts.

[John M. O’Meara:]

I wish I could tell you we had a leading edge transaction there. It was an old REO that had been limping along literally for three or four years. So I don’t think it’s a real good period transaction.

[Ben Crabtree:]

This was kind of inferred but maybe you could flush it out a little bit. Based on the incoming calls there are a lot of people out there that expect Chicago to be heading into a severe recession here. I certainly don’t get that sense from your numbers or your conversation, but any read on - and maybe this is Tom - when you get it out and talk to your commercial customers, how are they doing? How are there cash flows? And how are they feeling about things?

[Thomas J. Schwartz:]

That’s a good question Ben. It’s a mixed bag frankly. We’re finding some of our clients are doing very well in this market place. Some are changing their direction a little bit. If they were contractors in any way, they’re going to remodeling and more to the commercial side of the equation than the residential as you can well imagine. And so it’s really a mixed bag at this point in terms of their reaction to the economy. I think everybody is nervous in the world right at the moment. If the press could only maybe stop publicizing every negative aspect of our world. We just had some good news in Chicago with the new corporate headquarters of Miller and Coors being named here for Chicago.

[John M. O’Meara:]

400 jobs.

[Thomas J. Schwartz:]

That’s 400 jobs that will be created in the Chicago market place. That truly helps the single-family residential people as well as the rest of the economy here.

[John M. O’Meara:]

I spoke with one of Tom’s Lieutenant’s yesterday in getting myself prepped for today and the man who runs our commercial real estate group and said, “Go on out if you would please and find out what traffic is like.” And the report back to me is that traffic is picking up. He was going through one of these professional agencies that monitors traffic. But it’s not cashing into contracts yet but if the [inaudible] was a four, they’re running at about eight but contracts if they were at four they’re still at four.

[Thomas J. Schwartz:]

The good news there in talking to that same individual later in the day is that he gave me some statistics or numbers. I can’t repeat those numbers specifically for you in terms of the number of new starts in housing and the number of sales, etc. but the inventory numbers that are on the market are reducing, which is only a good sign. We need that to happen so that the developments that are out there can then start to have traffic and new contracts and new deals.

[Ben Crabtree:]

You’d be talking about completed inventory rather than raw land inventories?

[Thomas J. Schwartz:]

Yes sir.

[John M. O’Meara:]

It’ll be a while before anybody breaks ground on a raw land deal.

[Operator:]

Our next question comes from David Konrad - Keefe, Bruyette & Woods, Inc.

[David Konrad:]

I had a follow up question on the securities portfolio because most of my questions have been already asked and answered, but it looks like tangible or book value declined link quarter despite the earnings. I’m assuming that’s a swing in the OCI. Was that primarily due to the trust preferred [CMOs] that you’re talking about with the marks that are there or is that the fact or is there other securities that are kind of getting hit through OCI that we should think about? And then in terms of the trust preferred CMOs is that a senior tranche in those securities? I just want to confirm that.

[Michael J. Kozak:]

I’ll take a quick swing at it and maybe Paul if he’s got any backfill he wants to do that’s fine. The actual change in the OCI is not predominantly due to changes in the value of the drops. I think the swing quarter-to-quarter in those was somewhere around $6 million. That’s just movement in the market. Fundamentally what you see is some shift in terms of credit spreads and widening credit spreads given some of the jitters in the market place and some of the shift in interest rates.

[John M. O’Meara:]

We have a lot of mortgage back that are GSE guaranteed. You know what that’s gone through in the last [inaudible].

[Paul F. Clemens:]

Frankly since Mr. Paulson’s announcements those values have come back, the spread has come back. I wouldn’t suggest anything other than the normal movement in a jittery market is what you’re seeing today.

[David Konrad:]

And just the follow up on the truffs. Just to confirm, is that senior tranches in the securities?

[Paul F. Clemens:]

Well, there’s about three or four different tranches. We are in the middle of those tranches to be honest with you. We’re not senior traunch on these but we’re well positioned I think in terms of collateral.

[David Konrad:]

Not the equity traunch either?

[Paul F. Clemens:]

No.

[Operator:]

Our next question comes from Kenneth James - Robert W. Baird.

[Kenneth James:]

First of all I wanted to ask in terms of the 90 days past due number, how much of that is residential land and development? Because when I look at the MPAs kind of on that portfolio sitting at under 3%, it’s just so far below a lot of other banks even in the area and what we’ll see from most others this quarter so I wondered if you could give me that number to kind of get an overall feel? And then secondly, I wonder if you could just comment on given that the kind of non-accrual numbers is kind of so low relative to what’s going on, do you think that has anything to do with maybe geographically within the Chicago footprint where your properties are positioned that they’re in neighborhoods or developments are doing better, not outlying areas, maybe more close in price points, etc.?

[Michael J. Kozak:]

Ken the break-out is on page 10 of the earnings release but you’ll see on our over 90 the residential portion is around $17 million; it’s about level from the prior quarter but it actually represents an increase of about $7.5 million to $8 million because one of the items from the prior quarter which was over 90 moved to the non-accrual category. So we had basically four projects, the largest of which was about $3.5 million that moved into the over 90-day category. We’re pretty much on top of what we see coming into the portfolio. I really can’t speak to what the other banks have in their portfolio but we think we’re managing what we have at this point reasonably well. I can’t speak to your comment on the other banks.

[Kenneth James:]

No, I was just saying relative to industry average I guess the number was low so I was wondering if you thought you had an advantage, just looking at your own portfolio, relative to where it’s positioned in the market because it can be a neighborhood-by-neighborhood basis if you thought you had some more kind of solid geographical positioning than what you think is going on not relative to other banks but just relative to the Chicago market?

[Michael J. Kozak:]

We have concentrations pretty much throughout the metro Chicago area, probably more of a concentration in the South markets but there are certain pockets of it that perform quite well. For example Northwest Indiana which came to us through our [Hammond] acquisition, that continues to be a fairly strong market. We’ve actually done one or two small transactions that met very very strict parameters but that market continues to be quite strong and it’s the low end of the market. So there are pockets like that in our market place but in general nothing really comes to my mind to answer your question.

[John M. O’Meara:]

We’re big in Will County and Will County has been the fastest growing.

[Michael J. Kozak:]

And we’re not in the condo business.

[Kenneth James:]

And on the other, you referenced an REO property moved. Does that have any effect on the other expense line that looked a little higher this quarter?

[John M. O’Meara:]

Yes, we did charge $400,000 or $500,000 through our for a particular REO transfer so it’s what drove that up.

[Kenneth James:]

And then in terms of your loan growth just from the period end and average balances it looked like it was, the funding at least was kind of waited towards the end of the quarter kind of anecdotally and with some other data, it looked like things slowed down maybe in the aggregate towards the end of the quarter. Do you think you have a pretty good pipeline going into the third and feel pretty good about the sustainability of what you’re seeing?

[John M. O’Meara:]

Yes, thanks for asking. We have a very strong pipeline still. Deals are taking a little longer to get accomplished just because of the hesitancy in the market place because of the economy. People are a little slower on the trigger. But absolutely the pipelines are very strong and we expect continued growth.

[Operator:]

Our next question comes from Andrea Jao - Lehman Brothers.

[Andrea Jao:]

If you’re looking at a relatively stable net interest margin for coming quarters and credit spreads, and loan spreads are better, what are the other drivers? What are the offsets?

[Paul F. Clemens:]

I actually think that we don’t see the Fed doing much over the next couple quarters and we’re seeing really a balancing. What’s happened is LIBOR gave us a lift as Fed funds for us dropped about 111 basis points on average from first to second quarter. We saw the benefit of that. Now we see it’s all kind of catching up with our funding. We are fairly short-term funding and so the liabilities will come up a little bit we think or catch up with some of what was going on. We had some significant growth, our highest growth ever at least in the last seven years if you will, so we’re going to see some benefit from that with the LIBOR spread. But actually it’s not going to be the benefit going forward that we saw from the first to second quarter simply because now things are starting to catch up a little bit with regards to the funding and the asset side.

[John M. O’Meara:]

By way of offsetting some of the advantage that we have here, we very recently made decisions to enter the retail CD business which is frankly a very expensive part of the funding mechanism but we can’t just concede that market to our competitors. Even though we can fund ourselves less expensively away from that, we have to probably go in there and participate at levels that are higher than I’d like to pay but competitively necessary.

[Andrea Jao:]

What is the interest rate sensitivity of your balance sheet and do you expect changes to that from now till year end?

[John M. O’Meara:]

I think it’s going to be pretty stable right now. When there is a big movement in rates, we have a little bit of a jump shift where our margin scoots out for a while, while liabilities reprice over a little bit longer period of time. So we in a very short timeframe we’re asset sensitive but we catch up within 60 to 75 days.

[Andrea Jao:]

If you could share with us your anticipated losses for the remainder of the year? What should your net charge-offs look like for the remainder of the year?

[John M. O’Meara:]

Andrea, I gave you everything including my shirt size. I’m being facetious of course. We think provisions in the general range that they have been over the last two quarters. And I was only teasing about the shirt size.

[Operator:]

Our next question comes from L. Erika Penala - Merrill Lynch.

[L. Erika Penala:]

Of the $15 million to $20 million in resi-development loans that you’re watching, how does that break down percentage-wise from raw land to lot development to vertically constructed projects?

[John M. O’Meara:]

It’s probably more raw land.

[L. Erika Penala:]

And I just wanted to clarify, there were a couple of numbers flying out there in terms of how much you’ve actually reappraised of your portfolio. Now, you’ve already reappraised $40 million in construction loans?

[John M. O’Meara:]

The answer is we don’t keep a running tally of that number because we’re dealing with this on a file-by-file basis. My general understanding is that it’s probably around $40 million and Mike Kozak’s understanding was it changes every day because we make new decisions every day about what we’re going to reappraise.

[L. Erika Penala:]

But included in this is the $15 million to $20 million in problem loans already, right?

[John M. O’Meara:]

Absolutely.

[L. Erika Penala:]

And based off of these appraisals, that’s where you get the 25% to 35% value haircut?

[John M. O’Meara:]

Yes.

[L. Erika Penala:]

Since this position of these projects seems to be the solution that you’re embracing, what is the current demand for these projects and what is for lack of a better term the bid/ask spread? Like what kind of discounts are the bidders asking for and what do you think is reasonable?

[John M. O’Meara:]

Unfortunately Erika what that would surmise is that it’s a homogeneous market and it isn’t. It depends upon how entitled the property is, where it is, does it have an underlying lease to pay the real estate taxes, has it been approved by the annexing villages, where are the sewer lines, what school districts they’re in, it goes on and on and on.

[Michael J. Kozak:]

And Erika, as John alluded to earlier we do not own these properties yet. They’re in the process of being acquired through the normal process of the deed in lieu so we’re not in a position to actively solicit bids at this point.

[L. Erika Penala:]

But in terms of your observation in the market whether the transactions have been your own or other banks, have the discounts been steep for secondary market transactions of construction projects?

[John M. O’Meara:]

We are told by our people that we are ahead of our peers in terms of being out marketing and preparing these properties for marketing.

[L. Erika Penala:]

And thank you so much for the new disclosure on the commercial real estate book. I was wondering what the $274 million in construction land loans were? Is that raw land for commercial purposes? It’s under the commercial real estate category.

[Michael J. Kozak:]

$274 million you’re referencing, Erika, I’m not tracking that number.

[John M. O’Meara:]

Yes, where are you?

[L. Erika Penala:]

I’m under the commercial real estate category when you break down by underlying product type.

[Michael J. Kozak:]

Are you talking about the commercial land?

[L. Erika Penala:]

Commercial land, it’s $381 million actually.

[John M. O’Meara:]

That growth is made up of approximately three large deals. One is a piece of commercial land to a very strong commercial developer. There was a new highway built in Will County and this represents a cornerstone piece that is being land-banked at this point at one of the exits on that new highway. It’s a great location. The other two pieces represent properties that will be developed very shortly. One is actually in Champaign, Illinois that will be in a retail project on the main drag of the campus there. And the last is again a commercial, excuse me a retail project that will be built at one of the exits on one of the highways by one of the strongest developers in Chicago also.

[L. Erika Penala:]

I think Mike you mentioned that some of the inflows and outflows in the delinquency bucket is of an administrative nature. I was wondering if you could explain that in terms of is there a trigger that automatically classifies the loan as delinquent.

[Michael J. Kozak:]

Well it’s a chronology that determines the delinquency but I’ll give you a common example. We might have a customer that does his financial statements on a calendar year-end and we might have a maturity date that might be March 31 and for a whole variety of reasons his annual statements might not be prepared by March 31. They might be prepared by April 15 or even into May based on a whole variety of possible delays. We would then have a loan; we don’t like to renew the loan until we’ve seen how the company’s performed for the prior calendar year so it could be a delay in getting those statements that causes the loan to run past due. That’s a fairly common example.

[L. Erika Penala:]

And also I wanted to ask on the loan pricing side, you alluded in the text of the press release that loan pricing is becoming more favorable for the banks. I was just wondering because the yield on earning assets came down 48 bips. What was the loan yield like in the second quarter versus the first quarter and also what do pipeline yields look like going forward?

[John M. O’Meara:]

We’re really not prepared to talk about the margin contribution at that level of contribution. I can tell you when our asset liability modelers were in here they suggested to us anywhere from 5 to 8 basis points changes upward in the spreads of the drivers that they were using was what they were modeling for the second half of the year.

[L. Erika Penala:]

I understand that at this point you’re above well-capitalized metrics both on a regulatory and practical side, but if this credit cycle for all banks is much deeper and lasts longer than we all expect, is there an internal tangible capital or Tier 1 floor at which you would reconsider the payment of the dividend at current levels?

[John M. O’Meara:]

I don’t think it’s even appropriate to answer that question. We have a 45% margin on the dividend right now.

[Operator:]

There are no further questions.

[Paul F. Clemens:]

We really do appreciate all the calls, all the questions and your participation today and if you have anything else, don’t hesitate. Thank you for joining us and have a great day.