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Executives

Michael McMullan - President and CEO

Tracy Keegan - EVP and CFO

John James – CAO

John Chaperon – CRO

Roy Hellwege - Director of Banking

Analysts

Dave Bishop - Stifel Nicolaus

Michael Rose - Raymond James

Steve Covington - Stieven Capital

Bank of Florida Corporation (BOFL) Q3 2008 Earnings Call Transcript October 28, 2008 9:00 AM ET

Operator

Good morning, and welcome to the Bank of Florida Corporation Third Quarter Results Conference Call. Today’s call is being recorded. With us today from the company is the President and CEO, Michael McMullan; Chief Financial Officer, Tracy Keegan; Chief Administrative Officer, John James; Chief Risk Officer, John Chaperon; and Director of Banking, Mr. Roy Hellwege. Following the company’s remarks, there will be a short question-and-answer period.

I’ll remind you that any forward-looking statements made during this presentation are subject to risks and uncertainties. Further, the company has no obligation to update any following -- any forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements were made. If you are interested in factors that may cause our results to differ materially from any forward-looking statements, they are detailed on our website in our SEC filings and summarized in our earnings release issued yesterday. A replay of this call will be available for 90 days on the company’s website at www.bankofflorida.com.

And at this time, I’d like to turn the call over to Mr. Mike McMullan, President and CEO. Please go ahead, sir.

Michael McMullan

Good morning. Welcome and thank you so much for joining us today. We appreciate your participation and continued interest in Bank of Florida. As we discussed in our third quarter 2008 preliminary release on October 10th, residential real estate continues to be extremely difficult to value, particularly in the Lee County market. For example, September’s median sales price in the Fort Myers area was $126,250, 42% lower than the $218,000 level a year ago, according to the REALTOR Association of Greater Fort Myers.

Lee County also has the highest real estate inventory in the state according to data provided by local real estate economists which is obviously another factor impacting these real estate values.

As a result of the significantly lower real estate valuations we took a $6.2 million provision for loan losses during the third quarter of 2008, which was obviously the greatest contributing factor to our net loss.

The $6.2 million was driven by $5.2 million of net charge-off, which was primarily related to two residential construction credits totaling approximately $3.2 million, both of which we discussed on our October 10th preliminary earnings call.

Our loan-loss allowance as a percentage of total loans increased to 1.14% during the third quarter of 2008, up slightly from 1.11% during the second quarter. Nonperforming loans increased $4.8 million to $29.1 million or 2.33% of total loans during the third quarter of 2008, up from $24.3 million or 2.03% in the second quarter of 2008.

The primary reason for the increase, which was net of the $5.2 million in charge-offs taken during the quarter, was the addition of four large commercial relationships totaling $8.5 million.

Also as you may have noticed on the chart in the press release breaking out nonperforming loans, the one-to-four family category totaled $5 million. This amount is primarily made up of one $3 million loan that we don’t anticipate any loss on.

While nonperformers continue to increase, they increased at a slower rate than in previous quarters. I will address our process around ongoing identification a little bit later in my comments.

In regards to other real estate owned, we increased from the second quarter level of $439,000 to $4.1 million, which was primarily due to the addition of 30 acres of vacant land in Punta Gorda which is in Lee County valued at approximately $2.6 million.

Loans 30 to 89 days past due increased $23.4 million to $37.3 million as of September 30th, 2008; however, within the first several days of October these past dues decreased $9.1 million to $28.1 million. So while economic conditions remain very challenging, we are continuing to aggressively manage nonperformers and delinquencies.

Switching gears a little bit, I’d like to address our expectations for the fourth quarter of 2008. The fact remains that maintaining current valuations across our markets continues to be challenging. As difficult as it may be identifying problem loans, determining valuations, and assessing the ultimate resolution is all part of an effective process.

We have always had a very detailed loan review and credit administration process, which we have stress tested at least twice over the past nine months. The first test was in the fourth quarter of 2007 where we had little to no changes in our then valuations on classified assets as a result of our regulatory exam by the FDIC.

Our second major stress test came during the third quarter of 2008 when we hired a third-party loan review consulting firm to analyze our loan portfolio. This firm reviewed over 40% of our total loans, including 99% of our classified assets, and reported a final reserve member in line with management projections.

However, we continue to monitor the valuations on the loans specifically identified and reviewed by ourselves and the firm as well as loans that they did not review but may be showing signs of stress.

As a result of these ongoing efforts, we anticipate increasing the reserves during the fourth quarter as these valuations and any subsequent impairments are identified. Although there will be additional provision expense as part of increasing the reserves during the fourth quarter, we certainly expect to remain well-capitalized, which will allow us to continue to grow as we move into 2009.

Also during the fourth quarter we anticipate further net interest margin compression, primarily due to the extremely competitive deposit pricing conditions that persist across our markets.

We also believe that the recent 50 basis point decrease in the prime rate will have a modest impact on our net interest margin as we saw little to no changes in deposit rates by the competitors that continue to pay significant premiums on deposits in our markets.

In terms of improving our profitability, we will continue to focus on reducing our non-interest expenses and improving operating efficiencies. We’re in the early stages of our annual review of non-interest expenses and will be taking a very close look at opportunities where we can improve efficiencies. Actions already taken include the closing of the Cape Coral office last May, which is expected to save $500,000 annually beginning in 2009.

Finally, we are currently planning to participate in the recently announced Treasury Capital Purchase Program, a program intended to strengthen the capital position of already healthy financial institutions. We intend to apply for the program’s maximum investment of 3% of risk-weighted assets which translates to approximately $35 million to $40 million.

While we remain well-capitalized and intend to do so, we believe this opportunity is an attractively priced option which would allow us to capitalize on the current opportunities, including both organic growth as well as the various low to no premium acquisitions that continue to present themselves as a result of the significant market disruption.

I’ll now turn the meeting over to Tracy Keegan.

Tracy Keegan

Thanks, Mike, and good morning, everyone. My comments this morning will be brief as most of the information has already been covered by Mike or in the press release; however, there are a couple areas I’d like to comment on.

I’ll start off with net interest margin which, as you’ve already heard, decreased 25 basis points to 3.33% compared to the second quarter. The primary reason for this decrease is related to interest reversals on non-accrual loans, which accounted for approximately 15 basis points of the net interest margin compression.

We also ran promotions on money market and CD deposits mid-September with premium rates in the range of 4% to 4.25%. These promotions, which increased our on balance sheet liquidity and dropped our loans to deposit ratio to just over 100%, also contributed to the net interest margin compression and will continue to do so during the fourth quarter.

Also, as Mike mentioned, we’re seeing little to no change in the advertised rates of our competitors since the last Fed Reserve rate cut, which has limited our ability to drop deposit rates another factor impacting margin as we head into the fourth quarter.

It is still hard to say what the total margin compression will be during the fourth quarter given almost the daily economic changes impacting the factors driving margin. However, at this point, I am anticipating a decline similar to what we saw during the third quarter.

Going back to the deposit campaign that I mentioned earlier, total deposits increased 19% or 74% annualized compared to the second quarter, primarily due to the addition of $80 million reciprocal CDAR deposits, as we mentioned in the call on October 10th.

Core deposits represented approximately 58% of total deposits at September 30th, 2008, relatively unchanged from the prior quarter. The majority of this deposit growth came from new relationships, which we have developed a strategy to expand upon over the next couple of months.

Also as previously mentioned, our loans-to-deposit ratio decreased to just over 100% during the third quarter, down significantly from 118% at the end of the second quarter. We believe this on-balance sheet liquidity, outside of impact on margin, is a positive factor and will be viewed as such by regulatory agencies as we understand this is an even higher focus of their recent exams.

From an off-balance sheet perspective, we currently have just over $350 million of available lines including FHLB borrowings and brokered CD availability, which we continue to test on a regular basis.

We also had a strong quarter from a loan growth perspective, increasing the portfolio $56 million or 19% annualized between the second and third quarters. We are continuing to see significant opportunities to grow the balance sheet as a result of the significant market disruption that continues to unfold across our markets, and our loan pipeline remains strong relative to the current environment.

While many of our competitors have stopped lending to small and mid-sized businesses, we remain well-capitalized and are continuing to lend. We have also just recently started to see small improvements in loan yields as a result of the changes in the competitive landscape around lending, which will hopefully continue and will offset the pricing issues we’re seeing on the deposit side.

Moving on to non-interest income, we mentioned in the press release that we experienced an 11% increase over the second quarter. This was primarily associated with the 146,000 gain on security we sold during the quarter. The second quarter, however, was low due to a one-time loss of $136,000 related to the disposal of certain fixed assets. So backing out these two one timers the third-quarter non-interest income would have been lower than the second quarter by approximately $170,000. This is primarily due to lower service charge income and loan fee income.

Trust fee income, however, was relatively flat quarter-over-quarter as we continue to offset the impact of lower market valuations with the addition of new trust accounts. Non-interest expenses increased 6% to $11.4 million compared to the second quarter of 2008, most of which was related to higher costs associated with managing and working on problem assets including the higher cost associated with repossessions and the movement of loans into OREO.

Lastly I'll comment on our capital position. We continue to remain well-capitalized with approximately $20 million in excess of the minimum regulatory requirements to be considered well-capitalized. Our leverage and tangible equity ratios were 9.19% and 8.9%, respectively and the total capital ratio was 11.57% at September 30, 2008.

As Mike previously mentioned, we intend to participate in treasury capital purchase program by applying for the maximum of 3% of total risk weighted assets. We believe the infusion of this capital would help to strengthen our already solid balance sheet and allow us to fully capitalize on the opportunities before us including organic growth as well as acquisition opportunities.

Now I'll turn it back over to Mike.

Michael McMullan

Thank you, Tracy. This concludes our prepared remarks and we'll now take your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Dave Bishop with Stifel Nicolaus.

Dave Bishop - Stifel Nicolaus

Hey. Good morning.

Tracy Keegan

Good morning.

Michael McMullan

Good morning.

Dave Bishop - Stifel Nicolaus

Mike, just sort of looking at some of the different details here in terms of the loan growth here, looks like you had a pretty nice jump here in the retail segment of the commercial real estate portfolio. Maybe you can give us some detail here of how you're getting comfortable in terms of the growth here at this state of the economy and maybe what you're seeing in terms of loan pricing, loan terms now versus before that leads you to believe you're not the victim here of potential adverse selection?

Michael McMullan

Certainly. Being very selective is job one in this environment. The comment that we made in our earlier announcement this month was that we had turned down well over $100 million worth of loans in the Southeast market and that those loans were turned down because of credit underwriting standards, pricing or the lack of a relationship opportunity.

So the underwriting standards that we're using were as stringent as we could apply. The nature of the opportunities is really a result of banks in our markets that are literally out of the lending business right now. So many of their disenfranchised good borrowing customers are trying to find institutions that are still lending. In fact, I've had a couple of calls from CEOs in the last couple of months that are asking if we would take care of some of those better borrowers with a loan request.

So the concern that the regulators and the treasury have that loan dollars are not getting out to the main street right now is somewhat valid, that banks that are going through this examination cycle are being told that they need to raise capital before they can make any more loans. That is becoming evident in the markets that we compete in. So the nature of Florida, as we said, there's still, according to zip code, a lot of good borrowers out there and the borrowers are seeing some disruption in their traditional relationships with their banks.

Dave Bishop - Stifel Nicolaus

You talked, or I think Tracy alluded to, pricing improving somewhat there. Maybe can you give some examples in terms of the degree that's happening in terms of spread or maybe just a basis point number there?

Roy Hellwege

This is Roy Hellwege. I would comment that I think the opportunity for improved pricing I think has really materialized in the last several weeks, to be frank with you. We looked at a conceptually at least at a rather large loan request by a very wealthy family, well-established family in the Fort Lauderdale market. And during that discussion our discussion really based on a prime plus one type of scenario. That just wasn't available two, three, six months ago for a family of that stature.

We're seeing the opportunity to price short-term fixed rate credits three to five years max closer to 7%. And again, that wasn't available in the recent past. Given the collapse really and availability in the credit markets it's certainly providing some significant capacity I think right now to enhance our pricing on the asset side. The challenge of course is that the cost of funds remains just unusually very, very high as well, too.

Dave Bishop - Stifel Nicolaus

Do you think -- maybe this is more of a -- I don't know if it's a personal or philosophical question. As the TARP program rolls along there do you see any sort of improvement -- ancillary improvement benefiting from that in terms of deposit pricing as that sort of rolls through the industry?

Roy Hellwege

I personally do. I think it may take a little bit longer than just the initial equity coming into the market I think, but once the consolidation phase, which I think we all agree will be significant here in the Florida market, begins to occur I think the cost of funds should decline and hopefully rather dramatically. So I would look to, and this is just speaking as the Director of Banking, not our finance chief obviously, but I would look to some rather significantly improved margins six, nine months down the road.

Michael McMullan

The individuals in Florida that have made such an incredible sport of chasing high-priced deposits, rates on CDs and money markets, I think that's becoming a smaller field in that the concern for safety and soundness has really become a front and center issue in the last 90 days and we did run somewhat of a low premium campaign of 4% and 4.25% in the last quarter and we were able to pull that after about four days. Because the money market mutual fund scare of that Friday about a month ago resulted in significant new account activity coming in the door that next week. And that to us began the process of recognition that field of people that are willing to chase that rate differential is getting smaller and that the new account activity that we've had wasn't -- in the last 90 days, a lot of it was indicative of folks that were really looking for safety and soundness.

Dave Bishop - Stifel Nicolaus

Got you. One final question and I'll jump off. In terms of the uptick in the 30 to 89 days past due, maybe give us some color there in terms of some of the granularity there and I guess it sounded like there was some outflow too after the quarter?

John James

Dave, this is John James. We're going to see delinquencies kind of jump around in this environment. They're up one day, down the next day. But there was an uptick in the third quarter as we continue to go through the portfolio and then as borrowers just show more stress and show up on the delinquency list. We've taken a hard look at those to see if it's a permanent picture there just running past due because of maybe a particular situation. But I think we'll see our delinquencies jump around in this environment because people are cash strapped and working to -- working through their issues and we continue to pay a lot of attention to the portfolio.

Michael McMullan

But one thing that we take note of which is the beginning of the process of working with a credit that's showing stress is how cooperative are the borrowers. And that you have loans that go past due that you're in the process of negotiating terms and conditions for that renewal, and we've been holding the line in pretty much a disciplined fashion as to if a loan is going to carry because we're still in negotiations to improve the status of that credit, that's what's going to happen.

And when you have borrowers that have had a difficult time in dealing with the current structure of the credit, when they come in there's a lot of discussion that goes on in terms of strengthening that credit with additional collateral, additional guarantors and those discussions sometimes can take a while and at times they have very positive results and at other times we can't realize the objectives that we set in trying to renew that loan.

And those discussions are hard to predict, but I'll say clearly that the C in credit of character is very important in dealing with these relationships that are showing stress and the discussions are very much detailed and disciplined and several of the credits that pay down in the first part of October were loans that we were in discussions as to how we were going to renew those loans.

Dave Bishop - Stifel Nicolaus

Thank you.

Operator

And we will take our next question from Michael Rose with Raymond James.

Michael Rose - Raymond James

Hey. Good morning.

Michael McMullan

Good morning.

Michael Rose - Raymond James

Tracy, on the margin, given that the Fed is probably going to cut tomorrow 50 or maybe even 75 basis points, you mentioned that in the fourth quarter you expected margin compression of roughly 25 basis points, does that include this rate cut?

Tracy Keegan

That's one of the factors, absolutely.

Michael Rose - Raymond James

It does, okay. I guess secondarily, I noticed in your loan portfolio this quarter that land loans, raw land loans actually increased about $12 million. What's kind of driving that? Because most companies are experiencing a pretty dramatic reduction in that loan category?

John Chaperon

Michael, this is John Chaperon. I think what is driving it is our relationships that we maintain with our good borrowers. We're not necessarily looking to do transactional loans. So where we have a good sponsorship in the loan itself we'll take a hard look at it. We're focusing primarily on loans that are going to develop into office, professional, owner occupied types, so we have some land that we have loaned against for future development for those types of projects. But again, it's sponsorship and relationships that we're dealing with.

Michael Rose - Raymond James

Okay. And I guess finally, can you give an update on the trust company and kind of the opportunities that you're seeing out of this current environment?

Michael McMullan

Well, the brand and the advertising emphasis that we highlighted last quarter is falling into a scenario that we think is going to be very advantageous for us. We have interviewed six marketing and advertising firms, and are in the selection process right now. The word that we are hearing back from our clients in the trust company is thank you for calling, thank you for being so proactive, thank you for reaching out to us and staying connected.

And that the last time we had a market like this we received a lot of business in the trust company, although we were very young at the time, because of the disconnect of the relationship management of our large competitors with their client base. And we are seeing that same disconnect taking place, the disruption with Merrill Lynch and the relationships that are affected in that change of ownership we think are going to be significant.

So advertising and positioning, what we do in terms of our investment management strategy holds up very well in the current conditions. And we think that we are going to be able to report to our existing clients and to convey to the market that our strategy of investment management, asset allocation and wealth preservation is going to perform very well to the specific market indexes.

So to position ourselves now, we feel, is a very opportunistic time and that we should be rolling out sometime in the fourth quarter. Some very targeted branding and marketing to make that statement to the community of investment management customers that are feeling somewhat disconnected and looking for a more conservative and consistent maybe local relationship with their investment management entity.

Michael Rose - Raymond James

Great. Thank you.

Operator

(Operator Instructions). And we go next to Steve Covington with Stieven Capital.

Steve Covington - Stieven Capital

Good morning, everyone.

Michael McMullan

Good morning.

Steve Covington - Stieven Capital

Mike, in the past you have talked about some overall longer-term goals on profitability and kind of a timetable, whether that be in ROA or in ROE, and understanding that this is a very unusual and difficult operating environment -- I guess, when is it reasonable to expect the bank to return or to get to a -- even if you want to talk about a pretax pre-provision acceptable range of profitability?

Michael McMullan

Steve, I appreciate the question very much in that we look at '09 as a year of some very large expenses related to credit costs, managing our problem assets, supporting our special assets group, the impact on the margin from the non-performing loans and the impact on margin based on the current rate environment.

So, looking through '09 we feel like we are going to make a lot of progress in continuing to build a very healthy balance sheet to have close to 60% core deposit right now, I think is indicative of our deposit strategy going back several years. And if you look at some of our peers that were building their balance sheet in a different way, the core deposit ratios are going to be I think very low.

So, to continue just to invest in building a healthy balanced loan portfolio with a deposit strategy that we feel is going to pay off for us in '09 because of the disruption of relationships in our competitors’ deposit relationships, as well as their loan relationships. The model that we referred to in the past of reaching about a 1% ROA run rate and a 65% and better efficiency ratio was based on about a $2 billion asset size.

And looking at returning to a normal operating environment and a normal margin environment, getting closer to 3.9 range hopefully in '10 and looking at hopefully seeing some of these deposit competitors that continue to skew the market not being that much of a significant affect on deposit pricing in the future, and that we get back to normal deposit pricing, all those things, I hope, and we anticipate are going to become evident as a trend in late '09. And getting into 2010, and say we lost six or eight quarters through this cycle, we still look at those projections as being consistent with our assumptions of hitting those targets in a normalized operating environment.

Tracy Keegan

Steve, going back to your comment on the pretax, pre-provision, if you look at our investor presentation, itt's out on our website as of June and we will update that now with September numbers, we do have a slide in there that compares pretax pre-provision over the last 12 months, and you will see an improvement excluding obviously, as Mike said, that the current credit situation and excluding the costs associated which has been now over $700,000 this year on working on those credit issues. So, there have been improvements on those and once we come out of this that will be a benefit to the ongoing profitability of the Company.

Michael McMullan

And on our run rate, say going into '10, but even very evident on expenses in '09 and trends in '08, that we are going to come out of this with a much more efficient operating company on the expense side.

Steve Covington - Stieven Capital

Okay, thank you.

Michael McMullan

Thank you.

Operator

That does conclude the question-and-answer session today, Mr. McMullan, I will turn the call back over to you for any closing remarks.

Michael McMullan

Well again, we want to thank you very much for joining us. These certainly are very challenging times in the financial sector. We feel very connected with our communities, that is our model, that with our directors and our local leadership that we are connected with the business’ community and with the civic mindset of the issues that are challenging these communities that we serve. And our model and the impact that it has of being very evident in our commitment to our communities and in our advertising, the Bank of Florida franchise and the fact that we are a unique community bank that has multiple skill sets in taking care of customers in our markets will continue to serve us well.

I will briefly comment that when we ran an ad in the Southwest Florida market with a picture of our Board of Directors and the leadership positions that those Board members have in our community, both in civic and business sectors, many new accounts we opened because of that connection and that recognition that Bank of Florida had that type of reputation, commitment in our communities of that type of Board of Director group.

So we will continue to work on maintaining momentum and focus of growing our bank in '09. We look forward to -- and I know that that may sound like a unique statement, but we do have an examination in the first quarter with the State and we are doing everything possible and staying current with our discussions with our regulators and anticipating what they will be looking for in that examination. And we do look forward to that examination in the first quarter.

So with all of the issues at hand, we will continue to grow our bank in '09 and be an alternative to customers that are being disrupted in their existing relationships and we'll stick to business. So, thank you very much for joining us and please call us or come see us if you are in the neighborhood.

Operator

This does conclude today's conference call. We appreciate your participation. You may disconnect at this time.

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Source: Bank of Florida Corporation, Q3 2008 Earnings Call Transcript
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