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Frontier Financial Corporation (OTCPK:FTBK)

Q3 2008 Earnings Call

October 23, 2008 2:00 pm ET

Executives

John Dickson - President and Chief Executive Officer

Rob Robinson - Chief Credit Officer

Carol Wheeler - Chief Financial Officer

Lyle Ryan - President and Chief Banking Officer

Analysts

Dave Rochester - FBR Capital Markets

Matthew Clark - KBW

Jeff Rulis - D. A. Davidson

Brett Rabatin - FTN Midwest

Brian Rohman - Robeco Investment Management

Brent Krist - Sirius capital

Tim Coffey - FIG Partners

Operator

Good day ladies and gentlemen, my name is Carla and I will be your conference coordinator for today's call. I would like to welcome everyone to Frontier Financial Corporation Third Quarter 2008 Earnings Conference Call. Todays call is being recorded. Throughout the duration of this presentation today all audio participants will remain in a listen only format. However, at the conclusion of today’s presentation we will be conducting an interactive question-and-answer session via telephone line.

This conference may contain forward-looking statements as defined in Section 27A L1 of the Securities Act of 1933 as amended, including statements regarding among other things, the company's business strategy and growth strategy. Expressions which identify forward-looking statements speak only as of the date of the statement is made.

These forward-looking statements are based largely on this company's expectations and are subject to a number of risks and uncertainties, some of which cannot be predicted or quantified and are beyond their control. Future developments and actual results could differ materially from those set forth and contemplated by or underlying the forward-looking statements. In the light of these risks and uncertainties, there can be no assurance that the forward-looking information will prove to be accurate.

This conference call does not constitute an offer to purchase any securities nor a solicitation of a proxy, consent authorization or agent designation with respect to a meeting of company stockholders.

At this time, I would like to turn the call over to John Dickson, President and CEO of Frontier Financial Corporation. You may now proceed.

John Dickson - President and Chief Executive Officer

Thank you, Carla, and welcome everyone to our third quarter call. Joining me today once again, Carol Wheeler, our Chief Financial Officer, Rob Robinson, our Chief Credit Officer and Lyle Ryan, President and Chief Banking Officer.

I would like to start out with some general comments on the quarter and the marketplace and then I will review third quarter results and make comments about our strategy going forward. Regarding the quarter, we continue the quarter end to be well capitalized to regulatory capital purposes, and we are also very pleased with the improvement in our deposit growth and liquidity. We are disappointed with recording the net loss for the quarter, continued asset quality deterioration and margin compression. Despite that net loss we are pleased that our operating earnings excluding the onetime security transactions prior to taxes and loan loss provision mitigate $22.9 million. So on an operating basis we are continuing to report earnings that we can either put towards loan loss reserves or capital. And finally we did provide $32.1 million to beep up our loan loss reserve and net charge-offs were 14.3 million for the quarter. So we had an increase of approximately 28 million in our reserves, and the total reserves including most uncommitted un-dispersed loans to 2.86% of total loans.

Regarding our marketplace, unemployment continues to be fairly low Puget Sounds continues to be a very good market place to view business, unemployment was up slightly from the June numbers for the state 5.8% in September versus 5.5% in June, and likewise Snohomish County were headquartered unemployment likely 2% in September versus 4.5% in June. I get a good place to do business but the economies are showing a signs of strain but I believe just this week it was announced the Puget Sound was one of the top areas to invest as far as commercial real estate is concerned.

With our concentration on housing I will make some comments on the housing market and these comments are pretty much are limited to the Kings, Snohomish and Pierce County areas which is the majority of our lending area. The marketplace for housing actually sales remain fairly flat during the quarter typically in the Puget Sound house sales increased through the August September timeframe and then start decreasing through the rest of the calendar year. What we’ve seen is the number of sales per month have been fairly flat since the April, May timeframe. However, sales are occurring and houses in the lower price ranges the $200,000-300,000 price range is seem to be moving robust.

Inventories at homes and lands remain high, however, volunteers inventories that is inventory divided by sales and its being fairly stable since last reported in June in King County we have 8 to 9 months of relative inventory on the market compare to 9 to 10 months in June, and Snohomish County s 15 to 16 months compared to 14 to 15 months in June and Pierce County of 9 months of inventory, compared to 9 to 10 months of inventory in June.

In addition, sales activity is again I mentioned fairly flat to June and down from a year ago, however, it was September 2007 that we first started experiencing drops in our housing volumes, and in King County the year-over-year decrease.

According to the multiple listings, Northwest Multiple listing data, King County sales were down 16.6%, Snohomish County 30.3% and Pierce County 4.8%. And as far as prices are concerned, we did see price soften in the third quarter, year-over-year price declines in King County were 13% and Snohomish County 12.6% and in Pierce County 10.5%. Most of those -- the bulk of those percentage decreases occurred between June average prices and September average prices.

Regarding the quarter, addressing the balance sheet first, gross loan growth was 24.8 million for the quarter, most of that growth was at residential real estate area, many permanent loans we had experienced a number of properties turn into rentals during the quarter and those are reclassified to the residential loans. And offset to that construction loans were down 18 million, land development loans were up slightly 8.6 million and completed loss up 6.2 million, both of those numbers were increases based on prior commitments and jobs being completed.

I would note is our unused commitments which are down from 830 million in June down to 651 million in September. In the September down some 22%, so as our originations are down our unused commitments have been advanced out and that’s why you are not seeing a huge decrease in some of our loan categories. The 24.8 million of growth for the quarter was 0.7% or 2.8% annualized. And that’s also reflected in our loan originations in the third quarter of 2008, 175.6 million compared to 364.3 million in the third quarter of 2007 or down about 52%. So also raise fair value of strategy to control balance sheet growth and an effort to preserve capital.

And at this point I will turn the call over to Rob Robinson, our Chief Credit Officer, to review asset quality information.

Rob Robinson - Chief Credit Officer

Thanks, John. I will start with the non-performing loans, we ended the third quarter with 4.92% of assets in a non-performing status that compares to 2.97% at the end of the second quarter and 0.53% as of December 31, 2007.

Non-performing loans totaled 205.2 million at the end of the third quarter up from 119.9 million in the second quarter and 20.9 million at year end. The ORE portion of the non-performing assets totaled 3.7 million at the end of the third quarter which essentially made second quarter total, but I want to note that we did have good activity in moving product through ORE's this happens and the total remain relatively close.

As we have put in our press release non-accruals were concentrated in our real estate portfolio with a largest portion centered in construction loans which accounted for 65% of our total non-performing assets and land development loans which made up 20% of our total NPA's. On a geographical distribution, our NPA's show a concentration in our core market area Kind Snohomish and Pierce County.

Starting with the residential construction portion of approximately 135 million in NPA's that includes single-family residences and condos. King County represented 44.9 million or 33% of the residential construction NPA's. A majority of those dollars are centered in three relationships that involve two condo construction projects and a 40 lot single-family residential construction project in various stages of completion. These three relationships make up approximately 75% of the total residential construction NPA's in King County.

Snohomish County has 29.9 million or 22% of the residential construction NPA's. A majority of these dollars are centered in three relationships that involve a 26 lot, 33 lot, and a 47 lot Single family residential projects, and this represents 68% of the total NPA's in Snohomish County. And then Pierce county has 27.8 million or 20% of the residential construction NPA's and majority of these dollars have centered in full relationships that involved the condo project in 19 lot, 28 lot and 24 lot single family residential projects, and these represents 75% of the total NPA's in Pierce County.

Other County in this category have relatively small dollar amounts in the overall scheme with things with the exception of Clark County area we had 7% of our total there in one project that involves 65 lots single family residential project.

In the land development side we had 40 million NPA's, King County represented 9.7 million of that or 24%, majority of these dollar are centered in two relationships that involve a 27 lot project and a 26 lot project. These represent 86% of the total residential and development NPA's in King County. The Snohomish County had 7.5 million or 20% of the residential land development NPA's centered in three relationship involving a 21 lot project and 18 lot project and the 17 lot project and those re-project represented 87% of total residential land development NPA's in Snohomish County. And Pierce County has 14.8 million were 37% of residential NPA's government NPA's, majority of these dollars are in three relationship involving 33 lot projects and 18 lot project and then one buyer that had multiple projects throughout Pierce County. These three projects represent 84% of total residential land development NPA's in Pierce County.

On the residential lot loans 17.9 million dollars in NPA, King County has 9.7 million of this total or 54% of the residential lot NPA's, majority of those dollars centered in two relationships involved a plan 63 lot project in the land holding loan.

Pierce County has 6.3 million of over 35% of the residential lot NPA's and these dollars centered in two relationships that involved a lot holding loan and land holding loan. These represents 84% of the total NPA's in Pierce County or residential lot loan.

I do want to point out here as side note that we written-down these NPA's to current market or have properly funded our result to cover these loans. On the ORE side we entered the third quarter with asset side 3.7 million. We have 15 property centered primarily and finished new construction single family residential. We have had very good success selling homes out of ORE and today the partial write-down we’ve taken prior to loans moving into ORE have held up quite well, in other words would not had to take subsequent losses on the sales of those properties.

And our allowance loan losses as John mentioned we continue to step necessary to maintain a very strong robust loan loss reserve, in the third quarter we added 42.1 million to allowance boosting our reserves as a percentage of total loans from 2.07% at the end of the second quarter to 2.84% as of September, 30. If you include reclassification allocation for undispersed loan our allowance totals 106.6 million or 2.70% million of total loans outstanding at the end of the quarter.

We have also been taking aggressive line on risk rating our loan portfolio and our decision to increase loan loss reserve and the reflection of the continued market volatility nationally and regionally, with that said we believe our reserve is substantial and provide adequate support for losses that may arrive as our management team works through these challenging times.

Charge-off in third quarter we wrote-down loans by $14.3 million, most all of these were partial charge-off involving various real estate related projects. Where largest write-down was a $5.3 million write-down related to a condo project in the King County market.

On the delinquency side we ended the quarter with a 9.9% of our loan showing past due as of September, 30. Just to clarify I have done this in previous call our past due ratio includes all loans over 30 days past due and as well as all loans placed to non-accruals data. 96% of our path user centered real estate with 47% of that number in residential construction, 21% in residential land development and 6% in residential outlining.

On the classified asset side which includes non-performing loans totaling 485 million at the end of the third quarter, this grew from a 267.8 million. The majority of classified asset falls within the residential construction category at approximately 55% of classified loan and mere our MPH ratio as well.

John I think in your commentary you talked about special asset group.

John Dickson – President and Chief Executive Officer

Thanks Rob. Moving on the balance sheet a few other items of change during the quarter and all my comments from here forward will be based the quarter end express by otherwise. Fed Fund sold at a 130 million at the end of September was up substantially from the end of June again as a result of our deposit growth and limited loan growth and our desire to improve liquidity during the quarter. Securities gain 11 million to $98 million the reflection of our write-downs and sale of securities. During the quarter we had 30 million preferred shares totaling 4.95 million those were completely written down on an other than temporary re-impaired write-down and in addition we had Lyman bond and Lyman preferred stock which was written down and we have the sale of well new bond that was sold on a loss of $1 million. Total write-downs or sales are 8.5 million for the quarter and that’s reflective of the decrease in security balances. We did have a mandatory reduction of federal home loan stock and at par $6.1 million and our deferred tax asset increased by $8.2 million as a result of our loan loss provisioning being significantly higher than our net charge-offs.

On the liability and capital side of the balance sheet deposits were up $120 million, a 4.1% during the quarter or 16.4% annualized rate and again that growth is primarily in the timely positive category and we did see some shifting of dollar from Now and Money market and the savings and our non-interest bearing checking accounts were relatively flat.

Again with liquidity with our 130 million of Fed fund sold in addition to off balance sheet sources delineated in our press release we have over 1.2 billion of liquidity on hand at the end of the quarter. In addition, we have recently introduced the CD product which allows to maximize FDIC insurance on our CDs that was just introduced. During the month of October we expect to help in our deposit retention and deposit growth strategy. And as it relates to capital, we completed, finished the quarter at 434 million and down 18.5 million from June 30th and a result of our net loss for the quarter. Despite that, our leverage ratio 8.88% Tier I capital 9.48% on our total risk-based capital, 10.75%, again all three of those ratios put us in the well capitalized status for regulatory capital purposes.

And also I want to again emphasize that our pre-tax, pre-provision operating earnings about 22.9 million and allow us to observe large loan loss provisions without large decreases to capital.

And moving on to the income statement. Our interest margin reflected from decreases during the quarter averaging 4.05% from the quarter versus 4.63% in the second quarter of 2008. A part of that as a result of moving loans into a non-accrual status, but the majority of that decrease was impacted loans repricing and the flow is being reduced on the annual renewals. We still had fairly robust loan growth in the third quarter of 2007, most of those variable late loans received loans in the 8 in the quarter to 8.75% range as Fed have not started decreasing rates until the end of that third quarter. Since that time Fed has have multiple rate decreases, and our flows has been readjusted as those loans have been renewed. And at this point in the interest rate cycle, any further reduction by Fed in interest rate will likely result and the flow is not being adjusted as we feel that they are at minimum already. However, there are still some loans that are originated in the fourth quarter of 2007 which will come up for renewal in 2008 with those higher flows.

In addition of that we do found a change in our mix of earning assets with Fed Fund dollars is increasing during the quarter for liquidity and that had an effective decrease in our earning asset yield and likewise we went for the net borrowing position at the end of June to a net selling position at the end of September and illuminating the Fed Fund purchase at the end of June also we have the impact of increasing our cost of funds. During the quarter we did see a 37 basis point decrease in our overall cost of funds for time deposit and that’s primarily due to many time deposits from the third quarter 2007 mature and this year at premium and those rates came down during the quarter. Cost of funds and other categories remain fairly stable in the quarter and the competition for deposits and the need for liquidity in the Pacific Northwest remains very high, still very competitive.

In the non-interest income area we were impacted by the impacted by the other than temporarily impaired write-downs on our securities which I had indicated in loss on sale. We are pleased with our year-to-date growth service charges and other non-interest income both of which were up 21.4% and 20.4% respectively on a year-to-date basis compared to last year.

On an noninterest expense area with started with some of our expense reduction in the third quarter, as a result salary and benefit expenses were relatively flat and in the occupancy expense area we did have a new administration building come online late in the second quarter. So during the quarter we had a full quarter deprecation as well as items related to the building expense. In the other noninterest expense area we had an increase during the quarter which was primarily driven by accruals for FIDC insurance as deposits have increased and with penny increases in the FDIC insurance premiums, we built up that reserve and leave its appropriately the third quarter.

Looking forward we have several short term strategies that we are focused on during these challenging times. First and foremost is our asset quality focus. During the quarter we beefed up our special assets group, this is the group that focused on looking out names and collecting names, exclusively they have no podium, no production and the increased FTE is from 5 to 22 recently and they are also supported by very disciplined credit admin department and a credit review area and that looks both a new origination and our existing portfolio to ensure our loan loss reserve is appropriate and accurate.

The second focus is on capital preservation, and at this point we are looking at all options to maintain our capital ratios and hopefully increase those. We are looking at containing growth of our balance sheet and we are looking at potential asset sales. In addition, we have been reviewing the treasury program that has been recently announced on the surface and the program seems very attractive, but there is details coming out daily, which are yet to be determined whether we will participate in that program or not. The agreement is not yet out yet and certainly the treasury announcements make it sound quick and easy, but the demos and the details that I know the regulators are working through all the issues and we are waiting all those details to come out to determine whether we will participate in that program.

The third point on our short term strategy is that we are focused on expense reduction, both to improve our operating ratios and retain capital. Our expense reductions is announced in the press release started with the top of the leadership of our Board of Directors, they have elected to indefinitely postpone or defer their director fees beginning of third quarter. That would result in an annual savings of $400,000. In addition, the executive team has been informed that executive team and officer discretionary bonuses that have been eliminated for 2008 for the executive team about a 34% increase in total compensation. In addition to that, there will be salary reductions for the executive team that will average in the 5 to 10% range starting January 1, 2009. We are also targeting a number of other discretionary items and we expect annual expense reductions to be well over $8.5 million. We actually have over $10 million targeted right now, but our goal is to exceed 8.5 million and some of those may be a challenge to achieve of 10 million of those reductions.

In addition, I do want to mention that offsetting those reductions are higher cost that we expect both in FDIC insurance premiums and medical insurance costs and legal and foreclosure cost as it relates to working out foreign asset.

Finally, our fourth strategy is to continue the focus on deposit growth as we are looking at limited asset growth unless it’s to maintain driven liquidity and reducing the small reliance that we have on wholesale funds and that focus will continue with our branches and again with the introduction of the CEDAR’s program we expect we will continue to have good growth in deposits.

Finally, I want to comment once again on our experience management team. They have been on board for a number of years and have been through several cycles. I am confident that the special assets group and the rest of the management team will be able to work through this cycle.

Carla, at this point, I would like to open the line up for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions]. We will go to Dave Rochester with FBR Capital Markets.

Dave Rochester

Hey guys. How are you?

John Dickson

I am fine Dave.

Dave Rochester

Just a couple of quick ones. Could you give us some color on the magnitude of the write-downs that you are taking on those three budgets within the construction category for land what end vertical construction?

Rob Robinson

Yeah, Dave. Well, I think I understand the question. The third quarter, 12.1 million related to residential construction and then the balance 2.6 million was primarily residential land development.

Dave Rochester

And what’s the severity percentage on that, are you adding those down, defer vertical construction, let’s say, 30%, 20% on average?

Rob Robinson

Well, it depends on the market. If you talk about single payment residences, the further south we go the more severe the write-downs for example in our Oregon market, we are looking in some cases as high as 20%, but most of them are coming in around 8 to 12% on average across the board.

John Dickson

Of original appraisal.

Rob Robinson

Of original appraisal. On the commercial side, we haven’t had any – I am not talking about condos, not actually. As far as the finished product go, we haven’t had any issues with the finished products that’s been in progress. And so it’s hard to say that whether there is a relationship to the write-down in the market. We have had to write them down in order to put ourselves in a position to either finish the product or sell as is. So in most cases, we have seen as high as 30%.

Dave Rochester

Okay. And so you are saying for finished products, you really haven’t had to keep write-downs in that product yet?

Rob Robinson

We have, but we will write them down as it’s based on original appraisal. It’s somewhere between 9 and 12% on average and in some markets it’s been as much as 20% of that original appraisal.

Dave Rochester

Okay, got you. Thank you.

Rob Robinson

I will say that the sales have bee manageable at this point in time.

John Dickson

I guess I would add, Dave that we are encouraging our borrowers to move product as much as possible. So we are encouraging them if there is a short sale to bring it to us we can take a look at it and move the product.

Dave Rochester

Got you. Thank you for that. Could you give some of the stats you gave us in the last quarter for the watch list, the special mention, substandard, I guess it was your 4s, 5s, and your watch list is better than the 4s?

Rob Robinson

Well, the 5 and 6, it would be considering our classifying assets.

Dave Rochester

Okay.

Rob Robinson

And quarter-to-quarter, the – and there are grade 6, our loans that are non-accrual. And the grade 5 loans that are in some fashion moving either away from non-accruals and back into performing, a better performing status or possibly given in the non-accruals, we can’t come up with a solution for the customer. But a grade 5 loan increased from a 147 million at the end of the second quarter to 279 million at the end of third quarter. And our grade 6, our non-accrual bucket went from a 120 million to 205 million in the third quarter.

Dave Rochester

Great. And then just one last one. Thanks for that again. Do you know what you are seeing in terms of capacity bucket you are talking about 4.5%, which I guess if you back up NPAs equates to about 4.5% of the loan portfolio. We are going into a tougher part of the year generally for home sales and general housing market activity, are you at this point expecting that it’s likely the higher percentage of these are not going to cure at this point?

Rob Robison

I am anticipating that it’s going to a slow cure through the fourth quarter and I guess it remains to be seen how strongly we come out into the first quarter, but because a lot of it has to do with market conditions. But again, what we found is our finished product even right now the market should be relatively slow that it was four months ago, but actually finished products is moving as well now as it was a few months ago. I think our biggest concern remains with our residential land development product. That is – it really is not a seasonality issue right now, it’s a matter of moving that product even if you have someone that’s interested in buying as they are having a very difficult time finding a lender that will finance it.

John Dickson

I would also add that as loans come up for renewal unless there is additional collateral or some other case a lot of these builders and developers are being strange for cash flow, we are not reloading interest unless those very good credit underwriting reason why should sell, I think delinquencies you are seeing increase there because of the lack the exhausting of interest reserves and many of our amount were still paid out of pocket, and the other comment Dave you said, yeah, we are running into a tough time. Historically that is true that usually sales do drop off winter in the Northwest. Although, historically, sales increase in the summer, and we didn’t see that. So we are actually seeing sales volumes pretty steady and we are also hopeful that some of the actions that the treasury will bring confidence back into the system and maybe we will see that did drop in sales during the winter months here because there has been some pend up demand.

Dave Rochester

Okay. Great guys. Thanks for all the color there I appreciate it.

John Dickson

You bet Dave.

Operator

And now we will hear from Matthew Clark with KBW

Matthew Clark

Hi guys.

John Dickson

Hi Matthew.

Rob Robinson

Hi Matthew.

Matthew Clark

What you add in terms of the budgets some number for that special mentioned in terms of deal thus far?

Rob Robinson

If I can. It is a 371.9 million at this point in time.

Matthew Clark

Okay. And then I guess in terms of your -- what you call your watchlist, can you just quantify that this quarter?

Rob Robinson

364.5 million.

Matthew Clark

And the buckets include in (technical difficulty).

Rob Robinson

Watchlist is a separate category; our score will be considered as special mention.

Matthew Clark

Okay, I am sorry.

Rob Robinson

That’s clear your point. And of course, 5 and 6 is a classified.

Matthew Clark

Right, got it. Okay, thank you.

Operator

And we will take our next question Jeff Rulis with D. A Davidson

Jeff Rulis

Good morning guys.

John Dickson

Good morning Jeff.

Jeff Rulis

John you had capital ratio is at the bank level for the once you itemized.

John Dickson

I have the total risk based capital, although, we certainly had a discussion with the FDIC and they didn’t like our internal leveraging strategy and so, based on our original calculations we had in a 10.5, if you back that out its 10.05.

Jeff Rulis

That’s total risk based?

John Dickson

Yeah, the other ratios are well above the real capitalized level.

Jeff Rulis

Okay. And then did you guys complete your recent regulatory exam in the quarter?

John Dickson

Yes.

Jeff Rulis

Okay. And then you itemized this expense reduction measures pretty detailed, what was listed in the release is that the entirety of your measures there or are you targeting some other things in there?

John Dickson

Yeah, as I mentioned here on the call we actually have about $10.7 of expenses targeted. About 3.5 million of those expenses what we call the general expense period, and that we moved in the personal expense. In addition to the executive comp reductions we are – we have natural attrition in the organization, we are seeing to replace all of those positions, we are having some FTD reduction, we don’t have the specific number or a target plan, we are not planning a layoff, but we are looking at reducing FTEs through natural attrition and likewise our profit program, we typically allocated reserve 9% of net income in the profit sharing, obviously with a year to date income being eliminated those accruals will be drastically reduced. We are obligated to 401(k) match for our employees which we will take care of, but the bulk of the personnel expense saving are in salary reductions and profit sharing reductions.

Jeff Rulis

Got it. Okay, thank you.

John Dickson

Okay.

Operator

We will hear again from Matthew Clark with KBW.

Matthew Clark

Thanks. I got cut off.

John Dickson

Thank you so much Matthew.

Matthew Clark

Can you -- in terms of the -- before you made any cost saves, I assume you expect to realize then we can offset the plan?

John Dickson

That is the plan there. If you actually -- we started experiencing some of the savings in the third quarter, not much of it. We will experience a good portion of the personnel cost savings as it relates to profit sharing and discretionary bonuses during the fourth quarter and because we have it accruing through those during the year and then the bulk of the general expense and the FTE salary reductions will occur again in 2009.

Matthew Clark

Okay. And then can I just clarify a leverage issue at the bank level which had related to that branch strategy?

John Dickson

Yes.

Matthew Clark

So that is non-contractual obviously?

John Dickson

Well we were told yesterday by the FDIC that they were not going to accept that as regulatory capital. So we believe there are other strategies that we can employ regarding our fixed assets. So there can be downstream into the bank, but the internal leveraging strategy and apparently are even more as we thought. We have made inquires with the regulators and thought that we will able to do that, we were told yesterday that that is not the case. So as of the September 30, our ratio at the bank level is slightly been capitalized that is I expect by the end of the fourth quarter, we will relook at that strategy and be able to employ our fixed assets equity into the bank as capital. As well as we look at other measures.

Matthew Clark

Okay. And then can you just maybe further comment on the top program and any color on the eligibility issue that we are all struggling with in the industry?

John Dickson

Well I guess first of all again I would reiterate, I think the regulators are struggling with it too, and its also a new and there is new affirmation that comes out daily and we have been in discussion with the regulators and we are still awaiting more clarification on the whole process and all the elements and everything that’s goes along with it. So it’s still up in the air enough, I am not comfortable commenting any further on that until we get a better understanding of whole process and all the elements that are coming through the agreement.

Matthew Clark

Okay. And then lastly in terms of your construction balances, I guess not a lot verification in terms of shrinking you know, we have outpaced and start to shrink those construction down to mitigate?

John Dickson

That’s a tough one to escalate because, if you talk about it frequently in our meeting, we are having reductions in our construction or our land development portfolios, but again with some of the undispersed committed undispersed projects out there, there are still projects being completed and certainly and as it relates to construction, as a project is done vertical, its our objective to get it completed regardless of whether the borrower is going to sell the properties or whether we are going to sell the properties. And so we are still seeing advances to care of projects against that we are not approving a whole lot of new construction and development loans unless it will allow us to move our products from a gap to ultimate sale. But Matthew I apologize, I really don’t have numbers for you. We are pleased to see that the undispersed numbers seem to be coming down fairly rapidly though. So 22% in the quarter, I think in the first quarter we should start to seeing some better movement as far as reduction and construction balances.

Matthew Clark

Okay, thanks.

John Dickson

Okay.

Operator

Now we will go to Brett Rabatin with FTN Midwest.

Brett Rabatin

Good afternoon guys.

John Dickson

Good afternoon Brett

Rob Robinson

Hey Brett.

Brett Rabatin

I want to first ask, if I get back like a year and half or so in discussion about lots and the Puget Sound and there is discussion about the family the peaks a lot for allowing 180,000 and then I come down to 120 in the past six months, I am curious if you have a kind of a current level of where you see lots trading and that you just sound particularly like Snohomish County?

John Dickson

Rob addressed most of that question, but I will comment on of the challenges on lots is that it really hasn’t been a whole lot of sales. Until just recently we have seen a few power sales out there, but its difficult to really put a good number on that, because the builders really have not been buying additional lots. Rob what would you say to address that question?

Rob Robinson

Well just to point a little bit on what you said John, even if they want to buy the lots there is no lenders out there that are willing to finance them. So the only people that can buy those lots at this point in time are the groups that have cash. And there are some nationals out there that have cash, but are coming to the market and are starting to tie up some lots. And you know, there is a range, but as you get further and further out in the North Snohomish and then of course in Pierce County, I think you are probably looking at lot prices in the 70 or $95,000 range. If you know, you are selling today and if the individuals could come up with cash.

Carol Wheeler

Yeah, just to add to that I think some of the prior sales that we have seen recently are in 40 to $0.55 range from the original prices.

John Dickson

Yeah, and those five sales that we have seen with -- it appears to us it is also tax strategies, on the part of the sellers of those properties. In other words you know, prior to the fiscal year end moving certain product at a lower price and being able to realize the lot.

Brett Rabatin

Yeah, but you will see those……

Rob Robinson

(Multiple Speakers). Continue that we only saw that a couple of isolated into, but not stopped.

Brett Rabatin

Okay.

John Dickson

And that was also one part or so up in the area and the other parcel was down on the Olympia area. So there is further away from Seattle which seems to be the most straighter and then you know, as you go up further less stability.

Rob Robinson

Yeah, but I probably should add one more thing; I don’t want to confuse anyone on the lot prices. King County if you know, as you get closer into the metropolitan areas there hasn’t been any sales, and at the same time the prices are held fairly well, I mean they haven’t dropped as much as what you described on other lots. But again there is just no one that can finance them.

Brett Rabatin

Okay. And as I understood that you were on average having 9 to 12% write-downs and what’s you are taking losses on is that correct and that maybe 20% on a few, but maybe 5 or 6% on a few as well?

Rob Robinson

Well I mean we have got some, but we haven’t had any write-downs at all you know, that on the finishing within the residential, we would know, but we didn’t paid off. On the once that we have had actively get involved in those numbers that you described are about right.

Brett Rabatin

And what was the original value of the loan on the condo project, was it 0.53 million underwritten?

Brett Rabatin

What is the – can you speak through, okay, you have made alarm for condo development project and presume but they put in some cash and your presume with the LTV was, its not between 60 and 70%, how much cash you put in and how much was the loan for?

Rob Robinson

We typically underwrite condos in the 75%, 80% LTV.

Brett Rabatin

Okay.

Rob Robinson

And I would say that the right and correct result somewhere around 25% of what we had in this project.

Brett Rabatin

Okay.

Rob Robinson

That’s an extreme case I would say Brett but everyone is different.

Brett Rabatin

Okay and has – you obviously addressed some of the loans on migrating some new special mention and launch, has there been an analysis done of the remainder of the portfolio that’s not on large its better performing in large in terms of sales develop in the next two quarter when the interest reserve would expire so to speak?

John Dickson

Brett let me try to talk about. As part of interest reserve most of our loans since we pulled back the chain in any new approvals done. Most of our loans have come up through renewal or matured within the last few months. We had an opportunity to look at our portfolio, and as we have looked at and coming through, if we don’t see – that project is going to be move through to pay this off in entirety and we stopped interest accrual at that point in time.

Brett Rabatin

So the portfolio and entirety is matured and the loans that are still watch, that are above watch or loans that you have been able to reload with interest reserves with them pretty more collateral or cash into the project?

Rob Robinson

Anything I correct there when you said the entire portfolio is matured, the majority of the portfolio has gone through a renewal or an extension or paid up or we have looked at the individual credit.

John Dickson

And I would also add the interest relook situation is more than exception than the borrowers paying interest down the pocket right now Brett.

Brett Rabatin

So that’s primarily how they deal with the situation?

John Dickson

Yes.

Rob Robinson

And then we do, as John said, just to reiterate when we do an interest meet out at each backward we are looking for several collateral from our existing collateral, they may have a commercial office building that they are willing to pledge and there is plenty of equity in that and we are willing to loan against that and use those proceed to service interest on a construction project that we have got going.

Brett Rabatin

Okay. And then just lastly I wanted to get back to the tarp and it sound like your institutions evaluating that you are concerned about some of the details that are yet to come out or that might be buried in there, that would point of maybe the regulators would improve being more in your back pocket, but I guess I am surprised just given the charge-offs this quarter were basically the same as the pre-provision run rate and so, I guess it would seem to be you would be more enthusiastic about being into the tarp. Are there other ways that you’re going to be able to improve the capital ratio I don’t think you have plan any book sales or any other things that are missing that you’re going to do to preserve capital, I know that was cut or that board may – will be that again this quarter?

John Dickson

We review that individually every quarter and our next dividend would be look at in December and paid in January. And you are correct, that was other than expense reductions and things done internally looking at balance sheet strategies to improve the ratio, and in prior quarters we have talked about not needing to raise capital. I think at this point Brett, we are looking and saying, we do need capital. We will look at goodwill being turned down right now because of lack of capital there is opportunities out there and so we certainly would like to have some capital. On the surface, the treasury program looks great. Don’t get me wrong there I think there is a lot of mixed messages coming out through the regulators as to how the program is actually going to work, how the money is going to be allocated and I think that’s where the hesitation you probably hear from me and probably a number of my peers on their calls is, on the surface it looks like a great program. I think that again that is in the details and it would be irresponsible of me to say, yeah we are going for that money when we don’t know everything yet.

Brett Rabatin

Okay, that’s a good clarification. And I am assuming you’ve already been told you were able to be involved?

John Dickson

Those are some of the issues I am talking about that is I think they brought out for some banks who said, yes, you are in the program. For the rest of banks, it’s still a bit unclear.

Brett Rabatin

Okay, great. Thank you.

John Dickson

Okay.

Operator

And now we will hear from Brian Rohman with Robeco Investment Management.

Brian Rohman

Hi. Thanks for taking my questions. This question earlier, obviously you got a significant increase for non-performers, it was a little hazy on the distinction between category 4, category 5, and category 6s, but – the question I am asking is, as you look at 350 million in category 5 or 6, what’s your sense of the migration from that into non-performing?

Rob Robinson

Category 6 is non-performing.

Brian Rohman

Okay. Category 5 and 4?

Rob Robinson

Category 5 would be considered – category 5 and 6 are classified in credit.

Brian Rohman

Those are non-performing.

Rob Robinson

No. Category 6 is non-performing. Category 5 is elevated risk.

Brian Rohman

Just getting close?

Rob Robinson

Well, and on a loan loss reserve, we put back on percentage of 15%, against that category or that bucket of loans.

Brian Rohman

15% of them reserve?

Rob Robinson

15% of the principal balance?

John Dickson

Is reserved for.

Brian Rohman

Of the category 5. And how big is category 5?

Rob Robinson

279 million.

Brian Rohman

279 million. 279 times 0.15, you are saying you are reserving 42 million or is it against 42 million of that.

Rob Robinson

279 million times 15%.

Brian Rohman

Is the amount of reserve or the amount that you are reserving against?

Rob Robinson

No, it’s the amount of the reserve.

Brian Rohman

Okay.

Rob Robinson

Brian, I think we could spend a long time discussing the details of our…

Brian Rohman

I know. What I am trying to understand is there is a migration because I am looking at the non-performing number that’s gone from 12 million to over 200 million in 12 months, and I am trying to get a sense of where it’s going to go from here? And the best indication I guess is the 4 and 5 category loans. So you have got reserves, but it sounds like at some point that 279 could entirely tip into non-performing. Is that correct? I am not here to put words in your mouth. I am sorry.

Rob Robinson

That correct, but once it goes into the grade 6, we do a specific calculation reserve. In other words, you look at individual credit and you do an analysis of individual credit to come up with what your reserve is. And quite frankly, in some cases, the reserves end up being lower in a grade 6 non-performing than it does in a grade 5.

Brian Rohman

Okay. Couple of questions. It sounds like – I am looking for loan portfolio, the non-performers, the construction is stuff that is going vertical and you are saying you put up a house, you have probably taken a 15% markdown against that. Does that sound about right?

Rob Robinson

Not necessarily. We still have lots and lots of product that is selling at a price that pays us off entirely.

Brian Rohman

I am looking at – I am sorry. I am just looking at the non-performer, the 135 in non-performing construction.

Rob Robinson

Even in the non-performing status, we find that most those that are being finished we are getting our principle balance back on the sell of that product.

Brian Rohman

Okay.

John Dickson

The substantial portions of that were not and so, in that case that range of short sale we talked about.

Brian Rohman

Okay. And then on the land development and I guess I am going to lump land and completed lots together here for arguments sake. You sort saying a minute ago that there is no price discovery on this, there is no – so we cant really tell what the stuff is worth and you said there has been a couple of higher sales and is that what you are saying since there is no price discovery, we don’t know what its worth yet?

Rob Robinson

Well. Based on the bucket of sales Brian, I would say that its very difficult to determine values of lots and land development.

Brian Rohman

Okay. But there is a couple of one-off type sales and what cents on a dollar?

Rob Robinson

$0.40 to $0.50.

Brian Rohman

40 to $0.50. You definitely consist some of other market around the country once there is a developed market for this stuff. Months supply houses in the market do you remember for that and?

John Dickson

Yes I do.

Rob Robinson

John usually have that data.

John Dickson

Yeah I did give it earlier in the call in 10-K its eight to nine months.

Brian Rohman

Up been where?

John Dickson

Actually its down from 9 to 10 months from June. Snohomish County is 15 to 16 months which is up form 14, 15 months from June. And in Pierce County it's down slightly at nine months compared to 9 to 10 months in June.

Brian Rohman

Okay great that’s very helpful. Thank you very much.

John Dickson

Okay

Operator

And now we will Brent Krist with Sirius capital.

Brent Krist

Good afternoon.

Rob Robinson

Good afternoon.

Brent Krist

I just want to clarify on the severity measures the you guys highlighted a few minutes ago with kind of the 8 to 12% write-down original price value, is that stuff that you are actually selling or is that when you are closing on the property you’re taking those type of haircuts on it?

Rob Robinson

No that’s still the sales.

Brent Krist

Okay, those are sales.

Rob Robinson

Yeah those are short sales.

Brent Krist

Got you. And the same goes for kind of 30% on some of the in process condos that you would see that international sales do?

John Dickson

Yes.

Brent Krist

Okay. And then my other question is just with respect to the expense reduction initiative, could you give us a sense of how much the step up in FDIC insurance premiums is going to be an off set to that or order like to in terms of the step up?

John Dickson

Our estimations right t now based on recently announced premiums are 3 to $4 million increased expenses next year. In addition of that I would add that was calculated prior to this liquidy guarantee program, that’s included under the TARP and you may have ready for 40 days the FDIC provided unlimited FDIC insurance on non-interest bank checking accounts, at the end of that 30 days which I believe is middle of November. If you don’t opt out of that program then you will began to be assess 10 basis points on the amount of deposits that are being insured in excess of $250,000. So as result, we are also expecting because we do not intend to opt out of that program we are expecting an addition of 10 basis points on our non-interest bearing checking accounts in excess of $250,000.

Brent Krist

What would that bring the total up to?

John Dickson

We don’t have any number for that at this point.

Brent Krist

Got you. Alright, thanks a lot.

Rob Robinson

You bet.

John Dickson

Caller I think we have time for no more question.

Operator

We got Tim Coffey with FIG Partners.

Tim Coffey

Hi John.

John Dickson

Tim.

Tim Coffey

The question I had, most of my have been answered. But, I mean, you talked about asset sales. Now we think the asset sales are – our pricing is coming down, our pricing is being more rationale they have been before are you getting comfortable with current prices?

Rob Robinson

Well, I think the statistical analyst would say the excess inventory, our prices needed to come down. The numbers that I gave you earlier on the call kind of confirm that between June and September we did see reduction in price in home sales and I think that being reflective of pressure that lenders are putting on borrowers to move inventory and so, I guess, my comment on the house prices, they have adjusted down, but now how much further they need to build on down, but we have seen a decrease in prices whereas last quarter we reported our price is still were only off on a year-over-year basis single digit. So, Tim, I guess, I feel the price adjustment means the market is starting to work through this.

Tim Coffey

Okay. So we are talking about asset sales, we’re talking about home sales, not necessarily loan sales?

John Dickson

Those are purely home sales, we have not – as it regards to capital preservation strategies, yes I was talking about potential assets that we would look at.

Tim Coffey

Yeah. I have no more questions. Thanks.

John Dickson

Alright, thanks Tim.

Operator

Mr. Dickson I will turn it back to you for any closing and additional remarks.

John Dickson

Great, thank you Carla. Again I want to reiterate that we are still well capitalized for regulatory capital purposes and we’re in a very good liquidity position. We all are looking all the alternatives on capital are not only to handle the current cycle but also to be able to take advantage of opportunities that we are passing on right now. So with my experienced management team we are confident that we will make it through this tough cycle but certainly disappointed with our results in the third quarter and that's why we’re taking a short term initiatives to improve our performance going forward. And thank you for attending the call today.

Operator

And that does conclude our conference for today. Thank you for your participation. Have a pleasant day. You may now disconnect.

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Source: Frontier Financial Corporation F3Q08 (Qtr End 09/30/08) Earnings Call Transcript
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