First Midwest Bancorp Incorporated, Q3 2008 Earnings Conference Call

| About: First Midwest (FMBI)

First Midwest Bancorp Incorporated (NASDAQ:FMBI)

Q3 2008 Earnings Call

October 22, 2008 10:00 am

Executives

Michael L. Scudder - President and Chief Executive Officer

Thomas J. Schwartz - President and Chief Executive Officer of First Midwest Bank

Michael Kozak - Executive Vice President and Chief Credit Officer of First Midwest Bank

Paul F. Clemens - Executive Vice President and Chief Financial Officer

Analysts

Andrea Jao - Barclays Capital

Polly Zhang - J.P. Morgan

Erika Penala - Merrill Lynch

Terry McEvoy - Oppenheimer & Co.

Ben Crabtree - Stifel, Nicolaus & Company, Inc.

Mac Hodgson - SunTrust Robinson Humphrey

Terry Maltese - Sandler O’Neil

Operator

Good day ladies and gentlemen and welcome to the First Midwest Bancorp Inc. 2008 third quarter earnings conference call. (Operator instructions)

It is now my pleasure to turn this now over to Paul Clemens. Sir, you may begin.

Paul F. Clemens

Thank you and good morning, everyone and thank you for joining us this morning. Earlier today, First Midwest announced its results for the third quarter of 2008. If you haven’t already received a copy of the press release, you may obtain it on our website, by calling our office at 630-875-7463.

At this time, I would like to 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 such as it is. 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 included 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 backs or circumstances after this call.

Here this morning to discuss First Midwest third quarter results and outlook are Mike Scudder, President and Chief Executive Officer of First Midwest Bancorp; Tom Schwartz, President and Chief Executive Officer of First Midwest Bank; Mike Kozak, Executive Vice President and Chief Credit Officer of First Midwest Bank and myself, Paul Clemens, Executive Vice President and Chief Financial Officer.

I’ll now turn the call over to Mike Scudder.

Michael Scudder

Thank you, Paul. Good morning to everyone. As is typically our practice, let me first start by thanking you for ongoing interest in our company.

The volatility within the markets, the strain that we’ve seen in the economy, the level of government intervention since our last release has been, to say the least, remarkable. As I know that we have a number of our employees listening to the call, I would be remiss if I did not first stop and recognize and thank them for their commitment and focus in helping our clients navigate what has been an unsettling time. They have been equally as remarkable as the environment has been volatile.

As we discuss the quarter, the themes are consistent with what we’ve talked about in prior quarters. Our focus as a company and our story for the third quarter essentially remains the same which is a discussion of three primary bullets; solid operating performance, continued aggressive credit remediation, increase capital and loan loss reserves.

Let me offer you more detail on these same points and then I’ll offer up some final comments and then we can open it up for questions to the group.

Operationally our earnings were down but solid. Earnings per share was $0.50 as compared to $0.57 a year ago and $0.56 last quarter. The quarter reflected some noise related to a $1.7 million pretax securities loss and $2.5 million in tax benefits. If you extract those items, our EPS was $0.47, off about $0.04 from our last quarter primarily due to higher levels of loan loss provision which cost us about $0.09 in the quarter.

Our overall earnings excluding these credit provisions improved some 6 to 7% on a linked quarter basis, as our net interest margin improved to 3.63%. That’s up about five basis points from 3.58. Our return on average assets was 116 and our return on equity was 13.09%. Both solid levels when you compare us to peers.

Our sales activity remains encouraging. Following second quarter performance that’s our highest level of corporate loan growth in a number of years, our annualized total loan growth of 3% from June 30 seems low but was really muted by relatively stable levels of consumer lending in our residential construction and development portfolios and some seasonal decline in our ad portfolio.

We posted 10% annualized growth in targeted C&I and commercial real estate categories. We are still out there actively looking to build relationships and make loans.

Our trust sales activity remains strong helping to hold our assets under management levels and revenue in the face of falling markets. Our credit quality trends reflect continued stress in the housing sector particularly as it relates to our residential land and development construction portfolio.

Overall, levels of nonperforming assets plus loans past due 90 days and still accruing interest totaled $116 million. That’s up from 70 million with some 75% of these levels and the majority of the linked quarter increase related to this construction portfolio.

Of the 66 million of our land and development loans currently classified as nonperforming are within this past due 90-day category. I would ask you to recognize that four loans comprise some 60% of the total. So the majority of the increase in the outstandings here, really are comprised of four distinct loans.

As we suggested last quarter, we have been aggressively engaged with our builder developer clients to maximize realized value. We are reviewing the credits actively and frequently and following our credit policies. It’s important to recognize that these remediation plans vary as due the size of the credits.

As a result the migration of loans between categories from performing to nonperforming to other real estate and finally to disposition will also vary. As an example of the 17.6 million in residential development loans classified as 90-days plus and past due, as we stand here today we expect 10 million to be recapitalized next quarter and effectively brought current. So there’ll be a lot of movement between the categories over the succeeding quarters.

Our residential disposition strategies are reflective of lender judgment as to pursue immediate liquidation or simply a way to term. We have a number of experienced officers who have navigated this process previously. And we have increased our resource allocation to the area generally and have a property professional, we’ve engaged to deal specifically with the disposition process. We would expect our nonperforming asset levels from this category to remain elevated over the next few quarters as we work inflows and outflows through our process.

As we have pointed out previously, our exposure to this category is really cushioned by our original loan to value levels of 60 to 75%. But also recognize that the current appraisals, in today’s world, suggest values that eroded this cushion. At present, 60% of our residential land and development portfolio has an appraisal that is within the last 12 months.

Net charge-offs for the third quarter of 2008 totaled $9.3 million, about $6 million of which related to residential properties with the remainder distributed between our other general categories. Analysis of our portfolio exposure has seen us take our loan loss reserve level to 1.34% of loans. That’s up about six basis points and covers our nonperforming loans by 126%.

Our provisioning for the quarter totaled $13 million. That exceeded net charge-offs by some 40%. Respectively, we would expect to see comparable charge-offs levels over the short forward period.

First Midwest’s advantage over a number of peers is the strength of our operating performance. As a result, we’ve been able to increase our reserves as I just alluded to and at the same time, over the course of 2008, we’ve been simultaneously increasing our capital levels.

Our tier one capital level has increased to 9.42%. That’s up 27 basis points from December. That’s a $221 million above the level designated as well capitalized. On a total risk basis measure, our levels have increased 31 basis points since the start of the year to 12.04% and that’s $132 million or 1.2 times the well capitalized requirement.

And finally as we’ve discussed in the past and talked about, we’re looking to grow our tangible equity levels as well. In excluding OCI, these levels increased to 6.09% and that’s up 19 basis points.

During November, we will undertake a comprehensive review of our existent capital plans to embrace both dividends, share repurchases, required reserves and appropriate capital levels. We will do so in the context of the current and projected environment. As a part of that review, we’ll assess the opportunities recently presented by the announced governmental equity investment and related program.

That would conclude my comments. In closing I would simply highlight that our core operating business remains solid which puts us in a position to both administer great (inaudible 00:10:11) emerging credit issues and enhance our capital.

That affords us great flexibility. Let me say that again. It affords us great flexibility in weathering the economic storm and we have the advantage of a strong sales force that’s focused on building relationships. The combination of those two put us in a great position to take advantage of opportunities that lie in front of us. That would conclude my remarks.

I will turn it back to the operator and we can then open it up for questions.

Question-and-Answer Session

Operator

Ladies and gentlemen. (Operator Instructions).

Your first question comes from the line of Andrea Jao from Barclays. Please proceed.

Andrea Jao - Barclays

Good morning, everyone.

Michael Scudder

Good morning, Andrea.

Andrea Jao - Barclays

I apologize if I missed something but could you give us an update on the pool trust preferreds? And if I’m not mistaken you haven’t been as aggressive as your peers in recognizing old CTI in this portfolio. Perhaps you could share your thoughts on that.

Michael Scudder

Sure, go ahead Paul.

Paul F. Clemens

Okay. Thank you, Andrea and good morning and welcome to Barclays I guess.

Andrea Jao - Barclays

Thank you.

Paul F. Clemens

That’s a good question because we’ve probably spent much time on our CDO portfolio trust prefers apart from credit and sales as any one topic and as our auditors. I would say we may not have been as aggressive of writing it down but we certainly have been aggressive at looking at these things.

At September 30th, we recorded an unrealized loss of approximately $15 million related to our trust preferred CDO portfolio which has a par value of about $85 million. That’s about a 84% fair value, percent of par.

During the past two quarters, the SEC and the FASB have both come out. I’m sure you’ve read that they’ve indicated and acknowledged that dealer quotes really aren't, in this extremely a liquid market really aren’t a very good indicator of fair value and we struggle with that as well as everybody else. With the past two quarters, we contracted with a structured credit valuation firm to help us create a model and derive fair values for our CDOs.

The model we’ve created takes into consideration our specific underlying collateral, the credit history, the default probabilities, a whole series of information that’s available from the market, market volatility. It enables to actually do a pretty detailed analysis of what’s going on with our particular CDOs.

And as they’ve done those, we’ve basically at this time we determined that we have sufficient excess collateral in our cash flows that we project are sufficient that what we have in unrealized loss. We still think that we’re going to get our money back and don’t have any impaired loss at this time.

Andrea Jao - Barclays

Great and my follow up question is I was hoping could you share your outlook for the economy in your footprint. And then what that implies for the rest of your loan portfolio given that so far deterioration is kind of concentrated in a limited slice of the portfolio.

Michael Scudder

Hey, Andrea, this is Mike, I’ll tell you. I’ll cover the kind of economic outlook and then turn it over to Mike and Tom. They can give you their perspective on the loan portfolio and some other pressure points that may come down the road.

I think generally you’re going to see housing under pressure through 2009, certainly residential housing and you’ll see that probably into the first portions of 2010. This is an exceedingly difficult environment to try to predict simply because things seem to swing wildly from week to week in terms of the level of government intervention and the timing and pace at which that may take hold.

I think in the short forward period though, I think we’ll still see struggles within the economy, struggles from a consumer perspective at a minimum through the first half of the year. We’ll have to just see how it pans out from there.

Tom or Mike did you want to cover?

Tom Schwartz

Yeah, and this is Tom speaking. As Mike suggested the housing industry has a lot of to do with the circumstances in the economy and of course in our portfolio. I don’t foresee any kind of recovery there for probably at least 18 more months.

So depending upon, of course, what the government programs brings to us. Housing won’t improve, by the way, until jobs are created here in Chicago and that truly isn’t on the horizon as I see. If anything, I think we’re going to have some pressure on creation of jobs here in the Chicago marketplace.

The rest of our portfolio, so far, is not showing stress. That is in our C&I portfolio with our commercial clients. We are not seeing tremendous stress there.

I do think that we will see some problems in the retail industry which could cause some problems within the commercial real estate portfolio in the strip shopping centers. And we are beginning a process of looking through each and every one of those credits as we speak. That’s about a $300 million portfolio, Mike?

Michael Kozak

That’s correct.

Tom Schwartz

So, our commercial portfolio continues to perform well and we have not seen significant stress in any of our clients there other than the normal stress of our business. I think our commercial real estate portfolio is also in good shape depending upon, of course, the strip shopping centers and the retail portion.

Michael Kozak

Andrea, if I might just add to a couple of Tom's comments. This is Mike Kozak. The reality is we have seen very little in the way of spillover from the housing debacle. The commercial sector continues to be fairly robust as Tom has indicated.

If you look in particular at our 30 to 90 day category, you'll note that's come way down from the last quarter as we suggested it would with our renewed attention to that category.

We are mindful of the fact, though, that vacancy rates in the office and in the retail commercial sector and our metropolitan area are beginning to pick up a little bit. So we're watching it very carefully; we've increased our due diligence and our frequency of review on the noncommercial retail as well as the other commercial credits. But right now we're just not see a lot of spillover.

Andrea Jao – Barclays

Great. Thank you so much.

Operator

Your next question comes from the line of John Pancari from JP Morgan. Please proceed

Polly Zhang – JP Morgan

Hi this is actually Polly Zhang on behalf of John. How are you? I was wondering if you could just give a little bit more credit, a little more color around the three credits that moved onto non-accrual in the third quarter. What geography was specifically and were they raw land versus built sector?

Michael Kozak

This is Mike Kozak, Polly. Yes, the three credits, actually two went to non-accrual and one of those went to OREO and they were primarily vacant land, primarily two of those would be more on the southwest suburban area of the Chicago marketplace and one would be further out west.

The one that went further out west is the one—actually there's four credits that Mike alluded to. The one that's further out west is the one that we're expecting to be recapitalized in the current quarter that we're in right now and become and accruing loan. But primarily vacant land, primarily southwest suburbs.

Polly Zhang - JP Morgan

And within the metropolitan Chicago area I'm assuming things continue to hold up relatively well?

Thomas Schwartz

When you say the metropolitan area, we do not lend money in the condo development world of downtown Chicago. So we're not familiar with what's happening down there.

Polly Zhang - JP Morgan

Okay.

Thomas Schwartz

If that answers you. I guess I would characterize it more as we're not seeing any real significant signs of improvement but on the same token we're not seeing any continuing significant deterioration.

We seem to be leveling, hopefully near bottom. But certainly there are not significant signals that we're interpreting as deterioration in the residential market. We 've seen drops in value of 25 to 30% and we're still holding at roughly that level.

Polly Zhang - JP Morgan

Okay, no that's very helpful. Lastly, I was just wondering if you guys are evaluating any bulk loans at this time, and if so what type of marks are you seeing out there?

Michael Kozak

No, that's not something that we've looked at in terms of bulk loans sales.

Thomas Schwartz

Our sales are homegrown, underwritten by ourselves and they're in our markets. So we think we're best capable of determining what's the best way to maximize the values there.

Polly Zhang - JP Morgan

Okay. Thank you very much.

Operator

Your next question comes from the line of Mac Hodgson from SunTrust Robinson Humphrey. Sir, you may proceed.

Mac Hodgson - SunTrust Robinson Humphrey

Good morning.

Thomas Schwartz

Hi, Matt.

Mac Hodgson - SunTrust Robinson Humphrey

I had a question, of course maybe a technical question. When I look at the real estate residential land in development, I believe it shows balances of 510 million end of this most recent quarter and I think you mentioned 10% of the total loan portfolio is in that category.

I think in the last quarter it was more like 8% and 400 million. I'm assuming there's a reclassification there. Could you provide any color on that?

Michael Kozak

Mac, this is Mike Kozak speaking again.

Yes, there was an increase of about $90 million but that was strictly reclassification. In going through some of the details of our portfolio we noticed that about approximately 90 million was classified as commercial that should have been classified as residential.

So it was strictly a reclassification. We are not doing, basically, any new residential land and construction loans, strictly a reclassification.

Mac Hodgson - SunTrust Robinson Humphrey

Okay, got you. And I guess could you provide any more color, Mike, on the improvement in the 30 to 89 day category. That was obviously good to see. It was a very considerable improvement.

Would your say that that improvement was driven by kind of getting rid of some of the softer administrative past dues or any other you could put on there would be helpful.

Michael Scudder

Mac, I think there were two components to that improvement that we have been making reference to at the last couple of earnings calls.

As you alluded to, first and foremost there had been a very heavy administrative component for those past dues, and we've really knuckled down to try to eliminate that. Where it has been truly administrative in nature we've gone more too short-term extensions while we're waiting for an appraisal, while we're waiting for a current financial statement.

And so that helps certainly. But the other factor also is a cultural factor. Senior management has taken ownership of that category and it has gotten a lot of scrutiny and I think that that has had an impact as well.

Our goal is to get closer to peer averages, which are trending closer to 1%. And we've gone from about 3.5% down to 2%, so we're well on our way to accomplishing that goal.

Mac Hodgson - SunTrust Robinson Humphrey

Okay, great. Thanks.

Another question, I guess, on subtle NPAs. I think you mentioned in the comments that about those three loans stood only 20 million and there's a commercial loan, 5 million, so those sum up to about $25 million.

When I look at total NPAs going from 32 or so to 80, second quarter to third quarter, there is still a decent jump that's maybe unaccounted for specifically. Was that just across the board or was it primarily focused on the residential land and development side?

Michael Scudder

Primarily on the residential land and development side. I mean, that's where the substantial amount of our increase has come from. I mean, we've had roughly, I'm just looking at a total list here, of the land, the residential land and construction we had basically four loans. Four relationships of about $42 million that were new.

And on the C&I side where we had two that totaled about 7 million. So roughly those two categories together take you to about 50 million of the increase.

Mac Hodgson - SunTrust Robinson Humphrey

Okay, great. And then maybe just a final question for Paul. Paul, could you give any color on the outlook on the margin. You saw some expansion this quarter. You feel like you can hold this level in the near-term given the rate cut?

Paul F. Clemens

I guess the short answer is no. We expect some pressure in the fourth quarter, no question about it given the rate cut. There is still pretty good pressure on in the market for deposits, particularly as it relates to time deposits, so we will continue to hold those constant.

And certainly some of our growth in non-performing assets has an impact on that as well. That's basically the answer.

Mac Hodgson - SunTrust Robinson Humphrey

Okay. Thanks guys.

Operator

Your next question comes from the line of Terry McEvoy from Oppenheimer & Co. Please proceed.

Terry McEvoy - Oppenheimer & Co.

Good morning.

Paul F. Clemens

Hi, Terry.

Terry McEvoy - Oppenheimer & Co.

You commented briefly on just charge-offs remaining over the short term at levels consistent with the third quarter.

Could you talk about further reserve building? Some of the criticism this morning I've heard is just reserves versus MPAs have gone down below 100% for two straight quarters. And did you expect further rebuilding, further building of the reserves?

Michael Scudder

I think the thing to characterize off of there, Terry, is when I look at reserves relative to loans, I don't include other real estate as a part of that category. As you look at that, particularly as one's talking about an influence of residential land and development, those are coming into our real estate, our other real estate categories that had appraised values. Any future issues attending to those particular assets really flow through operating expense as opposed to loan loss reserves.

But when I look at it I look at it relative to non-performing loans and the coverage there is at 126%. Now if you even take a step further off of that and look at what's in the 90-day past due categories and incrementally add that there, I think you can get a general sense of the sufficiency of the reserve levels. Particularly in light of the fact that we indicated we had a credit in that particular category that we thought was going to be recapitalized.

I don't tend to denominate reserve levels in terms of other real estate. That's already reflected in our existing reserve numbers.

Terry McEvoy - Oppenheimer & Co.

And then could you just provide some color into the other commercial real estate? There is about a billion dollars there. Any large concentration outside of I guess office retailer industrial which are included in another category?

Thomas Schwartz

No, no large concentrations to report.

Michael Scudder

Terry, you may recall we tried to expand our disclosures there in the back of the release, so we offer a little greater clarity in terms of what goes through the other commercial categories. If you refer to the back of it, you can see a little greater detail.

Terry McEvoy - Oppenheimer & Co.

And then just one last question on the taxes. There was another tax benefit, $202.5 million. As you are looking out into the fourth quarter and into 2009, what do you see the tax rate looking like?

Paul F. Clemens

Well, this is Paul. We keep thinking we've exhausted our tax benefits but I'd say in 2009 we started around 25, 26% as an effective tax rate, somewhere in there.

Terry McEvoy - Oppenheimer & Co.

Excuse me, that was 2009?

Paul F. Clemens

Yes.

Terry McEvoy - Oppenheimer & Co.

What about the fourth quarter, same thing?

Paul F. Clemens

For the fourth quarter, I would say somewhere in the low 20s.

Terry McEvoy - Oppenheimer & Co.

Okay, perfect. Thank you.

Operator

Your next question comes from the line of Terry Maltese from Sandler O'Neill. Please proceed.

Terry Maltese - Sandler O'Neill

Hi, good morning guys.

Michael Scudder

Good morning

Terry Maltese - Sandler O'Neill

I have two questions related to credit. The first one, could you – you've talked in the past about what you called the soft past dues and you alluded to them earlier being about 45% of all past dues. And I know you mentioned you addressed some of those.

Could you just give a little bit more detail? How many of the past dues would you say now would fall under that sort of soft past dues and can you also give us a sense of where those soft past dues went?

In other words, how many wound up in non-performing loans? How many wound up getting, what percentage wound up getting rectified and going back to performing?

Michael Kozak

Terry, this is Mike Kozak again. I would suggest that based on our efforts this past quarter, the amount of soft past dues is probably well under 15 to 20% of the total amount of past dues. Virtually none went to non-performing. Most, as I said, of the administrative portion we were waiting for an appraisal.

Appraisal lead times continue to be very long, where we’re waiting for a year-end financial statement, where we’re negotiating a covenant violation. So I would suggest we’ve made substantial inroads in reducing that number from 40 to 45 % to probably 15 to 20 %. There’s still room to go, but a good effort I think for the last quarter. But no, none of those would have gone to nonperforming.

Terry Maltese – Sandler O’Neil

Okay. All right. And then the last question is, as recently as last month, you guys were suggesting that the second half provision should look similar to the first half provision. The third quarter provision was about 85 or so percent of the first half.

So could you give us sort of number one, a little color on what happened there, did you have some deterioration late in the quarter? And number two, can you give us sort of an update on where you think the provision is going?

Michael Scudder

Yeah, I think as best we can in this environment. I think as we talked about, Terry, as we did that is that was the expectation that we had at the time. Fundamentally what happens over the course of the quarter is you’ve got a number of credits that move in and out and as we get better information we’re in a position to make a better call.

I think the reality of it is the size and the nature of the credits have some lumpiness to them. So it becomes more difficult to call.

I think fundamentally as I alluded to when I was making my remarks, I think you’ll see our charge-off levels somewhere comparable to where they were in the third quarter in the next couple of quarters

Terry Maltese - Sandler O’Neil

Okay. All right. Thank you.

Operator

The next question comes from the line of Ben Crabtree from Stifel Nicolaus. Please proceed.

Ben Crabtree - Stifel Nicolaus

Yes, good morning.

Michael Scudder

Good morning.

Ben Crabtree - Stifel Nicolaus

Just a couple of quick little questions, actually. I want to make sure I didn’t miss anything, but I think that Tom mentioned the category of loans that you were kind of watching, especially with some of the retail, the commercial real estate loans to retail developers. Are any of that category of any size in the either the nonperforming loan category or significant in the delinquent category yet?

Tom Schwartz

As I look at it, we have a couple smaller ones that—

Michael Scudder

Very small, though.

Tom Schwartz

We’ve got one or two small office and retail ones that are probably under $3 million that are in the 30 to 90-day category at this point in time.

Ben Crabtree - Stifel Nicolaus

None in NPL, though?

Tom Schwartz

One of those. We have an additional one under $3 million that is in the over 90.

Ben Crabtree - Stifel Nicolaus

Okay.

Tom Schwartz

Haven’t seen a lot of spillover at this point in time.

Ben Crabtree - Stifel Nicolaus

Okay. And then the other question is, I guess it kind of feeds back to the margin question. Given the significant increase in non-accrual loans, I guess I would have thought that there might have been some significant interest reversal, and yet the margin surprised me by going up. They’re wondering if there was any of that in the quarter and if it amounted to anything so that if you will the core margin was a little better than the quarter?

Michael Scudder

Yeah, we probably at that number we probably lost two to three basis points just off of the reversal of interest—

Ben Crabtree - Stifel Nicolaus

Okay.

Michael Scudder

—in the quarter. So the margin itself would have been elevated.

Ben Crabtree - Stifel Nicolaus

Mm-hmm. Okay.

Michael Scudder

I think we are anticipating and what Paul alluded to is you are going to see continued pressure on margins as it relates to that elevation. And I think again, as Paul alluded to, being asset sensitive.

And given the competitive environment that we’re seeing here for time deposits, particularly for retail deposits generally, they’re not reacting quite as aggressively as the Fed is lowering interest rates. But we end up with a little bit of time that we need for that market to come back to norms if you will. That's more pressure on the margin.

Ben Crabtree - Stifel Nicolaus

I guess just from somewhat of an outsider view it would appear that some of the probable worst offenders on the pricing of deposits might no longer be a factor. Countrywide, WaMu, and who knows, Nat City or somebody like that. So I’m just wondering if, if you look at who’s actually putting competitive pressure on, is it still as intense? And if so, where’s it coming from?

Michael Scudder

You know, interestingly enough, what we’ve seen is— and again, recall in the Chicago marketplace we have both the large and a high volume of smaller competitors.

Ben Crabtree – Stifel Nicolaus

Right.

Michael Scudder

We still continue to see high deposit levels here that are elevated from what I would suggest the normal markets would be paying. We see that both on some of the larger players, still. And we see it on some of the smaller guys who have been emboldened by the FDIC insurance coverage increases. So they’ve been put in a position where they can attract those deposits and pay up for those deposits with the safety net of the FDIC behind them.

Ben Crabtree - Stifel Nicolaus

And then just closing up with wrapping up on that point, in terms of total deposits, did you see much evidence at all? I mean obviously your bank has a reputation of good quality, but did you see much evidence at all in the third quarter that large denominated DDAs of payments as the money was in fact being spread around was hurting you at all?

Michael Scudder

Yes, we saw some noise at various points in the quarter. You know, as I alluded to when I opened, it was unsettling times, certainly for a number of the depositors that were out there. So we were very proactive in terms of our overall communications. And you’re right, we do have the benefit of having a very solid reputation.

We saw questions coming both from the standpoint of safety within the markets going up and people being concerned relative to spreading some of the risk. We also saw, interestingly enough, a number of people coming to us from other institutions, looking for that haven as well. But we did see some noise off of it.

Tom Schwartz

Ben, this is Tom. We had a very fast-moving communication plan put in place that reached out to our depositors, and I think that helped an awful lot in settling down our clients.

Ben Crabtree - Stifel Nicolaus

Okay. And I guess I do have one final question. The debt guarantee program. Do you have a significant amount of bank or holding company debt coming due by next June, and how attractive does the guaranteed debt issuance look to you at this point?

Michael Kozak

Ben, this is Mike. We do not have short term debt. Our debt, both on the subordinated debt level as well as our own trust preferred issuances were all long term, low cost, debt levels. So we don’t have anything coming due. How much interest do we have in that? It simply depends upon getting some clarity as far as how the overall program itself is going to work.

Ben Crabtree - Stifel Nicolaus

Good luck.

Michael Kozak

Yeah, really. James Hotchkiss, who’s our treasurer, was on a call that as I understand it was of a series of calls that the FDIC has hosted that were suggestive of the majority of questions asked that the majority of the responses were, well, we’ll have to get back to you with more clarity.

Ben Crabtree - Stifel Nicolaus

Right. Thank you.

Michael Kozak

Yup.

Operator

Once again ladies and gentlemen as a reminder. (Operator Instructions)

The next question comes from the line of Erika Penala from Merrill Lynch. Please proceed.

Erika Penala – Merrill Lynch

Good morning.

Michael Scudder

Good morning Erika.

Erika Penala – Merrill Lynch

You noted that your looking at retail income CREs as a possible source of concern. But I noticed that the loan balances increased fairly significantly sequentially. Could you tell us a little bit more about the opportunity that you see in the marketplace that gives you comfort in increasing your exposure to this product at this time?

Michael Scudder

Those properties were all fully leased, long-tenured leases in place, good cash flows and they were refinance opportunities, Erika.

Erika Penala – Merrill Lynch

Okay.

Michael Kozak

Erika, the advantage that we have and the ability that we have out here is being a long-term player in the market place itself and given the folks here, we have a real opportunities for us on a targeted basis are to pick up some strong clients. So those are things that we’re not shying away from, per se, for the right deal.

Erika Penala – Merrill Lynch

And on the homebuilder side, I’m guessing that you’ve marked the NPAs to current appraisals. Could you give us a sense of what the average haircut is between current and original appraisal value?

Tom Schwartz

What we’re seeing Erika is 25 to 30 % seems to be the number that’s still holding up. And yes we are, when we get current appraisals, it’s verifying that number and we’re taking appropriate action based on those appraisals.

Erika Penala – Merrill Lynch

And how far are you in the disposition process of these nonperforming projects? I mean, do you have a sense of what the bid-ask spread is right now?

Michael Scudder

Yeah, we continue to work up, to market those. Interestingly, the bid-ask spread, with a lot of the volatility that was in the market over the last portions of the quarter, basically stopped while people waited to see what was going on. We would anticipate that would start back up and come through. And bid-ask spreads are really going to depend on the nature of the properties.

Erika Penala - Merrill Lynch

Thanks

Michael Scudder

There are a number of people out there that are looking for the home run and getting something extremely cheap. What we do is continue to look at it in terms of what is the fair value of the asset today and what do we think we’re willing to move it for. And in some cases that may require us to hold it for a little bit, but we’re not going to give it away.

Erica Penala - Merrill Lynch

And of your nonperforming resi construction projects, what’s the split between raw land and partially completed versus completed projects?

Tom Schwartz

We’ve got basically—we’ve gone to about 55 % raw land, to about 45 % projects that are vertical.

Erika Penala - Merrill Lynch

Okay. and of the vertical, how much of that is fully completed?

Tom Schwartz

I don’t have a number for you, Erika. There are a number that are in process. There are some that are completed. We’re covering both categories. But I don’t have that number. I can perhaps get that for you after the call.

Erika Penala - Merrill Lynch

Okay. And you mentioned the LTVs on this portfolio. When you calculate the LTV on some of these raw land projects or development projects, do you base the V off of the value of the completed project or off of the value of the raw land?

Tom Schwartz

Well, if it’s vacant land that we’re lending against, it would be the value of the vacant land. If it’s a project that’s underway, it would be a discounted value based on the completion of the project.

Erika Penala - Merrill Lynch

And one more question, if I may. Did you see seasonal strength on the deposit side from the inflow of public funds? And if so, how much flowed in on a dollar basis on the quarter?

Michael L. Scudder

I do not have the statistics right here. We generally see some inflow coming into the deposits from that. Keep in mind though, a percentage of that inflow also shows up in the other borrowing lines, as that ends up being repurchase agreements.

Erika Penala - Merrill Lynch

Okay.

Michael L. Scudder

But generally, we see it anywhere from 100 million maybe to 150 million on average for the quarter.

Erika Penala - Merrill Lynch

And, I guess one more question on TARP. I mean do you see yourself participating into TARP whether it’s selling assets or being a beneficiary of the capital purchase program?

Michael L. Scudder

You know that’s a difficult question to answer Erika, because we don’t have all of the information. You know, I think as I would respond as most CEOs would probably across, it’s something as we read and from what we hear that institutions are going to be required to take a look at.

But until I know all the strings attached and all the heretofores and therewiths attached to that, it becomes difficult to say what exactly you’re going to do. But we’ll take a look at it.

Erika Penala - Merrill Lynch

And would you look to raise capital outside of what the government would infuse to the bank?

Michael L. Scudder

I think what we’ll do, as I eluded to in the comments, over the course of November, we’re going to take a hard look at capital generally in all the plans. And while I would not say that’s a specific strategy that we’re talking but we’re really not ruling anything out.

The advantage we have in this environment, is we are a very strong financial performer. We have a number of capital options available to us and flexibility there.

Erika Penala - Merrill Lynch

Okay, thank you so much for your time.

Operator

(Operator instructions)

At this time, I’m showing you have no further questions. I would like to now turn the call back over to Mr. Clemens for closing remarks.

Paul F. Clemens

Okay, we certainly want to thank you for joining us today. It’s been a busy time for us and for you. We thank you for your interest of the First Midwest Bank and we hope you have a good day.

Operator

Ladies and gentleman, thank you for your participation in today’s conference call, have a wonderful day.

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