Marshall & Ilsley Corporation 4Q08 (Qtr End 12/31/08) Earnings Call Transcript

Marshall & Ilsley Corporation (MI)

Q4 2008 Earnings Call

January 15, 2009 12:00 pm ET

Executives

Dave Urban – Vice President and Director, Investor Relations

Greg Smith – Senior Vice President and Chief Financial Officer

Mark Furlong – President and Chief Executive Officer

Analysts

Steve Alexopoulos - J.P. Morgan

Terry McEvoy - Oppenheimer & Co.

Kevin St. Pierre - Sanford C. Bernstein

Ken Usdin - Banc of America Securities

Anthony Davis - Stifel Nicolaus & Company, Inc.

Presentation

Operator

Good morning. Welcome to M&I's fourth quarter 2008 results conference call. My name is [Christy] and will be your conference operator today. (Operator Instructions)

It is now my pleasure to introduce Dave Urban, Director of Investor Relations for M&I. Sir, you may begin your conference.

Dave Urban

Welcome to M&I's fourth quarter 2008 earnings conference call. The presenter for today's call will be Greg Smith, our Chief Financial Officer, who will review the fourth quarter and year end financial results. At the end of our prepared remarks, Mark Furlong, our Chief Executive Officer, and Greg will be available for your questions.

Before we begin, let me make a few preliminary comments. If you have not read our earnings release, you may access it, along with supplemental financial information, from the Investor Relations section of our website at www.MICorp.com.

Also before we start, I would like to mention that comments made during this call contain forward-looking statements concerning M&I's future operations and financial results. Such statements are subject to important factors which could cause M&I's actual results to differ materially from those anticipated by the forward-looking statements. These factors are described in M&I's most recent Form 10-K and M&I's other SEC filings. Such factors are incorporated herein by reference.

For a reconciliation of any non-GAAP financial measures mentioned in this presentation to the most comparable financial measures calculated in accordance with GAAP, please refer to M&I's website at www.MICorp.com.

And now I will turn the call over to Greg.

Greg Smith

Thank you, Dave, and thank you everybody for taking the time to join us today.

By now you've had an opportunity to see our press release and supplemental financial information. In addition, we have included detailed credit quality slides on our website, as we have in the past. You may want to have those printed out and available for our credit quality discussion.

Our fourth quarter results reflect the challenging operating environment that confronts banks. The important items to focus on to better understand our fourth quarter performance include the following: We have continued our aggressive steps to address exposure to the Arizona, West Coast of Florida, and corresponding construction and land development businesses even though these steps are the primarily reason for our loss in the quarter and the year.

With the continued deterioration in the national housing markets and the notable economic weakening in general, we have increased our allowance for loan and lease losses to 2.41% of total loans or $1.2 billion.

As we work with homeowners, we have declared a foreclosure moratorium through the first quarter of 2009 and have restructured residential real estate loans as shown by our increase in renegotiated loans.

While we cannot predict whether or not the housing crisis has reached the bottom, we do believe the actions we have taken over the last year address the current exposure embedded in our housing-related construction and development portfolio. Like others, rapidly deteriorating economic conditions have continued to drive losses above previously anticipated levels.

As I will discuss in more detail shortly, we incurred $63 million in one-time after-tax charges this quarter, including certain credit-related costs. This equates to $0.24 per share.

We continue to have a capital base well above any regulatory capital thresholds and have approximately $2 billion in excess capital. Our selection to participate in the U.S. Treasury's capital purchase [inaudible] continues to highlight the strength of M&I.

Now, turning to our results, as noted in our press release, we reported a loss of $1.55 per share for the fourth quarter. In the same quarter last year we reported earnings of $1.83 per share, which included a loss of $0.09 per share from continuing operations.

As I discuss aspects of growth in our banking business from this point on, I will highlight organic growth for the combined franchise in an effort to give as clear a picture as possible of the underlying bank trends. Any balance sheet discussion comparing fourth quarter of 2008 with fourth quarter of 2007 will be adjusted for our acquisition of First Indiana.

Now, for some additional insights into the quarter, first, the net interest margin. Our net interest margin increased by 12 basis points on a linked-quarter basis to 3.18%. During the fourth quarter, our margin was positively impacted by the higher level of LIBOR relative to fed funds earlier in the quarter, which was at least partially offset by the cost of funding nonperforming assets by 6 basis points. We estimate the negative impact of nonperforming assets to be 12 basis points over the fourth quarter of last year. We continue to expect that the net interest margin will experience compression going forward.

Like the industry in general, we expect to be challenged by competitive loan and deposit pricing, the movement of new and existing deposits into lower spread, higher yielding products, wholesale funding spreads, and, of course, the yield curve. Recent rapid decreases in the targeted fed funds rate to all-time lows will increase pressure on the net interest margin because of the downward repricing of many earning assets which cannot be offset with the downward repricing of many deposit categories, which are already priced at or near their floors.

There continue to be many variables that impact margin. It is difficult to project this one data point given the current interest rate volatility occurring in the market.

Now moving on to our Wealth Management segment, in spite of financial market volatility and disruption, the Wealth Management's segment full year 2008 revenues finished 10% ahead of 2007. Fourth quarter revenues were 2% lower than fourth quarter of 2007 and on a linked basis were don 6%. The primary drivers of this decline were overall equity market declines and the shifting of higher fee assets into cash equivalents.

Looking at the components, our trust businesses reflected general market conditions. Sales activities slowed, however pipelines remained at levels comparable to the prior quarter. Outsourcing revenues continued to grow with the addition of new clients and pipeline opportunities remain strong for 2009.

Assets under management were $30.4 billion at quarter end compared to $24.3 billion at the end of the third quarter. The growth was primarily attributable to the acquisition of Taplan, Canada, and Hayback as they finished the year with $7.3 billion of assets under management.

Assets under administration increased to $104 billion at the end of the fourth quarter compared to $101 billion at the end of the third quarter. Growth in the outsourcing client base and the addition of Taplan were key factors.

Moving on to other fee income components, service charges on deposits for the fourth quarter were $36 million, an increase of $4 million over the same period last year.

Within our non-interest income we have realized two securities losses. We incurred a $12 million marked-to-market adjustment in one of our BOLI policies. We expect to recover on this marked-to-market loss and do not expect an actual credit loss in the underlying fixed-income portfolio. We wrote off our entire $10 million equity investment in a small business lending venture.

We have also benefited from $15 million in gains from buying back our own debt securities.

A comment on capital management. With a period end tangible equity ratio of 8.9%, M&I remains one of the most highly capitalize domestic banks. Our regulatory capital ratios remain well above any regulatory thresholds. M&I remains dedicated to deploying our capital prudently through lending and investment in our customers and communities. This is highlighted by our Homeowners Assistance Program and continued lending through the economic cycle. Nonetheless, it will take time for us to deploy the new TARP preferred capital effectively and to earn an acceptable return.

With regard to our revised dividend policy, given the continued economic uncertainty and specifically stress in our housing-related portfolios, we announced the reduction of our quarterly cash dividend to $0.01 per share starting with the next dividend payment in March. This was a very difficult decision, but a prudent one given the lack of economic clarity and the overriding priority to preserve capital.

The choice of this dividend level was based on our desire to maximize our capital during the recession, not by setting a targeted payout ratio. It is our intent to rebuild our dividend to higher levels as soon as financial results and economic conditions make an increase prudent.

From an expense standpoint, as is outlined in today's press release, we have conducted a rigorous review of our expense base and operations. The goal of these initiatives is to allow us to maintain our strong capital base during these difficult economic times. With this review, we have identified over $100 million in annualized expense savings.

The largest component comes from people-related costs as we have eliminated over 830 positions or approximately 8% of total positions. These reductions include a combination of positions eliminated in 2008, the elimination of open positions and staff reductions. As of today, approximately 80% of these reductions have been completed, while the remaining 20% are expected to be realized through operational efficiencies later this year.

Total non-interest expense amounted to $403 million in the fourth quarter. This is a $43 million increase from the third quarter, as we incurred more one-time expenses than we did in the prior quarter. These one-time expenses totaled $71 million for the quarter.

Among the one-time pre-tax expenses incurred this quarter are the following: Our Wealth Management business incurred approximately $31 million in pre-tax expenses related to financial market disruption and its impact on operations. We have accrued $9 million in severance-related costs. Finally, reflecting current housing market dynamics, we incurred $26 million in real estate owned valuation adjustments, which is an increase of $21 million compared to the third quarter.

As a partially offset to these charges, bonus accruals were adjusted to reflect our financial performance for the current quarter and year. Although our reported deficiency ratio is 62%, when adjusted for these items and other credit-related expenses as well as other charges, we view our core efficiency ratio to be 49.7%. On this basis, our prior quarter was 51.7%. When adjusted for these items, we have seen a slight expense decrease on a linked-quarter basis. Nonetheless, particularly in the current operating environment, M&I will continue to be very focused on maintaining our historical expense discipline.

Now moving on to our credit quality trends, M&I, like other banks, has experienced continued deterioration in the national residential real estate markets during the fourth quarter. In addition, we continue to note some stress among our consumers, with conventional non-accruals continuing to pick up, but with home equity remaining stronger than the overall bank.

For the quarter we realized net charge offs of $680 million and we provided $850 million for loan losses. Our quarter end allowance was 2.41% of period end total loans, which is an increase of 36 basis points or $170 million from the prior quarter end and we expect will continue to rank us among the best-reserved banks.

Our underlying market assumption in taking these charges and provisions is that the prevailing economic and national residential conditions will last well into 2009 and likely into 2010 in some of our markets.

With regard to our loan loss provision, we continue to see stress in the estimated collateral values and repayment abilities of some customers, particularly among our small and midsize local developers and generally the consumer segment. These factors, combined with general economic trends, have led us to build our allowance.

As we look forward, we expect to continue taking aggressive steps to resolve our nonperforming loans, the proceeds from which will be redeployed in our business.

As in prior quarters, the largest proportion of the chargeoffs, approximately two-thirds, were associated with the Arizona, West Coast of Florida, and correspondent portfolios. As shown on Slide 11, the chargeoffs by business were $249 million for Arizona, $73 million for the West Coast of Florida, and $124 million for our correspondent business.

In addition, we took aggressive steps to continue resolving nonperforming construction and development situations in all of our markets. This led to elevated net chargeoffs in our Minneapolis and Kansas City markets this quarter.

Discussing our nonperforming loan trends, during the quarter our nonperforming loans increased $450 million. Of this increase, $181 million or 40% is related to renegotiated loans which will be discussed shortly. The remaining increase is in non-accrual loans.

For the quarter, we sold $164 million in larger, nonperforming construction and development loans. As in the past, we have moved aggressively to identify potential nonperforming loans and the associated loss content. This is supported by the following: 27% of our nonperforming loans are past due less than 30 days; 35% of our nonperforming loans are past due less than 90 days. We have already realized partial chargeoffs of $647 million against our non-accrual loans, representing a 30% haircut.

Within our loan portfolios we continue to focus on our construction and development categories, particularly residential related. These loans are in both our commercial real estate and residential real estate portfolios, depending on the underlying -

[break in audio]

Operator

I apologize for that. One moment, please.

Greg Smith

Okay. Thank you. I'll go back a couple of points here just to make sure everybody caught everything.

We have already realized partial chargeoffs of $647 million against our non-accrual loans, representing a 30% haircut.

Within our loan portfolios we continue to focus on our construction and development categories, particularly residential related. These loans are in both our commercial real estate and residential real estate portfolios, depending on the underlying collateral.

Please note on Slide 13 that we have provided detail regarding segmentation of our commercial construction portfolio between nonhousing and housing related. This slide highlights the continued strong credit quality profile of the nonhousing component of the commercial construction portfolio. Less than half of our commercial construction portfolio is related to housing.

As of quarter end, we have $1 billion in construction and development loans on nonperforming status, representing 56% of our total nonperforming loans. As shown in Slide 14, of these nonperforming construction and development loans, two-thirds are in the Arizona, West Coast of Florida, and correspondent businesses. Clearly, our issues remain concentrated in these businesses.

To provide a little more granularity on our midsize local developer portfolio, the following may be helpful. We have 32 loans greater than $5 million on nonperforming status. Only 8 of these are in excess of $10 million.

We have seen further deterioration in the residential land portfolio during the fourth quarter. This portfolio is shown in Slides 21 and 22. M&I has $2.1 billion in residential land loans to individuals and developers. $1.3 billion or 62% are located in Arizona zip codes. The bulk of the Arizona loans - nearly 70% - are in Maricopa County. The loans in the Arizona portfolio are relatively modest in size, with an average balance of approximately $215,000.

We continue to refresh both FICO scores and LTVs for the Arizona portfolio. Individual FICO scores have declined slightly, but remain above 700. LTVs have moved higher and are approximately 139%.

Residential land accounts for $379 million of nonperforming loans, of which 75% are based in Arizona zip codes. As in prior quarters, this level of nonperformers and the underlying LTVs have factored into our allowance level.

As we have noted before, our residential land portfolio is almost entirely zoned, entitled and improved and largely to individuals.

With regard to conventional mortgages, we have noted deterioration as individuals are feeling increased economic stress. As we have noted before, we maintained our underwriting discipline through the cycle, have never originated subprime loans, and have avoided many of the more risky loan products. Nonetheless, during the quarter our nonperforming residential loan totals have increased to $324 million or 5.7% of the residential mortgage portfolio. Of these, approximately 32% are restructured mortgages.

Within the residential portfolio, we have seen some deterioration in many of our markets, with the Arizona market being the most notable. We continue to aggressively monitor and manage this portfolio.

To provide further detail on our Arizona residential portfolio, the average loan is around $320,000. The average refreshed FICO score on this portfolio is 712. The average updated LTV is approximately 93%.

A few comments on our renegotiated loans. Over the past quarter we have seen a $181 million increase in renegotiated loans, to a total of $270 million. The vast majority of these loans relate to home or construction loans to individuals. At year end, residential and home equity categories accounted for $231 million or 86% of the total. We expect to see continued increases in this category over the next few quarters as we work with our borrowers, who will benefit from our Homeowners Assistance Program. Unfortunately, the types of modifications that are typically most successful with consumers involve reduced and often below-market interest rates, which will preclude us from moving these loans back to performing status under GAAP.

Just a couple of comments on our consumer loan trends as the overall consumer portfolio has maintained its nonperforming loan levels below those of the overall bank. As of quarter end, only 1.4% of consumer loans were on nonperforming status. As we have noted in the past, our credit quality experience with this portfolio has benefited from our historical practice of selling much of our production, as we did in 2005 and 2006.

Looking forward, consumer non-accruals, including both residential and home equity, are likely to trend up, reflecting continued consumer stress, although we expect that our ultimate losses will remain better than industry averages.

With regard to the commercial loan portfolio, during the course of the fourth quarter we realized $93 million of net chargeoffs in our C&I portfolio, of which the largest proportion was related to industries associated with the housing sector. The housing sector-related chargeoffs amounted to approximately two-thirds or $60 million, which includes the Franklin relationship. We continue to monitor this portfolio closely.

With regard to the Franklin relationship, our quarterly impairment analysis determined that Franklin's financial performance deteriorated with declining cash collections, rising delinquencies, and higher-than-expected servicing expenses. These developments have led us to chargeoff an incremental $29.3 million of our Franklin exposure. Despite this, we have received $76 million in principal payments this year, resulting in a $107 million performing balance at quarter end. As you would expect, we will continue to monitor its performance and underlying portfolio closely.

In terms of the future, we continue to expect nonperforming loan and real estate owned balances to remain elevated. We expect nonperforming loans to continue increasing over the next few quarters, reflecting broader economic stresses. We also anticipate that the inflows of larger construction credits will abate, while consumer-related inflows will continue to build.

As we have noted before, it is important to remember that most construction credits are complex and that it will take time for us or any lender to work through them. We will continue to evaluate the opportunity for further sales of nonperforming assets and weigh that opportunity versus the cost of keeping those assets for a period of time. Sometimes the best resolution will be to take the underlying property to maximize our interest, which will cause increases to REO for a period of time.

As we anticipated, our REO increased this quarter to $321 million, which is up from $267 million in the prior quarter. The largest REO property is an $11.5 million Midwest-based multifamily property. We have three additional commercial properties over $5 million. We continue to expect that REO balances will increase going forward and view this as a natural progression as we gain control of projects and move toward ultimate resolutions. We will continue to aggressively manage our REO balances.

A few final comments on credit quality. Stresses in the national housing markets will continue to affect us and we will continue to address them proactively. We have and will continue to take aggressive steps to resolve our nonperforming situations. Nonetheless, should the economy continue to deteriorate beyond our current expectations, our losses could continue.

Our nonperforming loans continue to be concentrated in the housing construction-related components of the commercial and residential real estate portfolios, particularly in our Arizona, West Coast of Florida, and correspondent businesses. Although we are not immune from consumer deterioration, we believe our residential and consumer portfolios will continue to perform better than the industry as a whole.

Recall that our credit card portfolio is relatively small, with only $280 million of outstandings.

We remain committed to returning M&I to a level of solid credit quality.

Changing focus to the organic balance sheet growth trends compared to the same quarter in 2007, fourth quarter 2008 average loans were $50.2 billion, which is $3.2 billion or 7% higher than a fourth quarter of 2007 average. C&I loans increased on average by $1.3 billion or 9%. For 2009, we expect the C&I loan growth rate to be in the low single digits. On a linked-quarter basis, C&I loans contracted slightly.

Across all of our construction and land development categories, we have seen over $700 million or nearly 7% contraction since the fourth quarter of last year. Commercial real estate increased on average by $1.3 billion or 8% in comparison to the same quarter last year.

To repeat comments we have made before, we continue to see softness in construction and development activity. This has translated into significant declines in new construction in all of our markets, with our Arizona and Florida markets most impacted and less investor activity in new construction projects, with multifamily and medical office being least impacted. Retail has softened as many retailers have cut back expansion plans. Office is relative balance in most of our markets, although dramatic job losses could impact this segment in 2009. Hospitality softened with the economy in the second half of 2008 and is expected to continue to soften as the economy contracts.

Together, these factors lead to our expectation that commercial real estate growth for 2009 will be relatively modest, which is consistent with the 1.9% linked-quarter growth posted in the fourth quarter.

On the deposit side, there's really only a couple of things to note as many trends remained consistent with prior quarters. We continue to open net new DDA accounts in our community division each month, although growing DDA balances has been more challenging as customers have opted to move excess liquidity into higher-rate products. Non-interest bearing deposits increased compared with the third quarter of 2008. As we have seen in prior years, our DDA balances grew in the fourth quarter, reflecting our usual seasonality, and we expect our DDA balances to fall in the first quarter of 2009 as they have historically.

Reflecting recent deposit market dynamics, the increased level of high-priced competition has caused our bank-issued deposits to be down in comparison to the fourth quarter of 2007 as we have maintained our pricing discipline.

A few final comments. As we move into the first quarter of 2009 - and to reiterate comments made earlier - we expect our financial results to reflect the benefits of the aggressive credit steps we have taken this year, but also the challenges of the broader financial markets. Similarly, our strong capital position and high level of loan loss reserves have fortified our balance sheet in the current economic climate. Although we do not believe we are at the bottom of the housing cycle, we remain confident that we have realized all the loss content that is currently identifiable in our portfolio.

As you are aware, every economic cycle brings its own set of challenges. This economic cycle has been marked by rapid deterioration in general economic conditions, a challenging and volatile interest rate environment, wider funding spreads, driven by broader market liquidity challenges, competitive pricing pressures on most loan and deposit products, and a dramatic downturn in the national residential housing markets.

As we move forward in this challenging economic cycle we will continue to benefit from the strength of our capital position, the dedication of our employees, and the diversification of our franchise.

This concludes our prepared remarks. Mark and I are available to answer your questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Steve Alexopoulos - J.P. Morgan.

Steve Alexopoulos - J.P. Morgan

Greg, could you first break out the specific reserves on the construction and development portfolio? And then I know there's overlap, but what's the reserves on the nonperformers as well?

Greg Smith

Well, Steve, we don't break out the specifics of our reserve in terms of the specific reserve, how much is on nonperformers and how much goes into the general. You'll get some of that detail when the 10-K gets published, but we're not going to go into those specifics today.

I will, of course, reiterate that we have $647 million of partial chargeoffs against our non-accrual loans. And, of course, of our nonperforming loans, $270 million are renegotiated loans. The other item that I thought was particularly in terms of our non-accrual loans as we were going back through them is that basically $470 million of our nonperforming loans are not even past due.

Steve Alexopoulos - J.P. Morgan

Maybe we could change direction for a second. I know you said you were comfortable with total equity. What do you think about a trigger point where you start to think more seriously about going to the markets with common? Is it a specific level of total equity, tangible common, nonperformers? How are you thinking about that in this environment?

Greg Smith

Well, we are, as is very clear with the variety of steps we've taken today and the uncertainty in the economic environment, we are preserving capital, again, whether it's the dividend or some of the expense initiatives that we announced. Those are all capital driven.

There is not a magic number, a magic threshold to answer your question, because you've got to look at a number of factors at any point in time. It's got to be your own existing capital levels, where we are in the economic cycle, so I can't give you a hard-and-fast number. It would depend on the conditions at that point in time.

The other thing I would point to is our regulatory capital ratios are still very strong, with a Tier 1 of about 9.5% and a total in excess of 13%.

Steve Alexopoulos - J.P. Morgan

With tangible common I guess hovering around 6%, is it something you're at least contemplating or is it just not something you're even evaluating today?

Greg Smith

Well, our tangible common is 6.3%, which is still a very strong tangible common ratio. So at that type of level, to think about incurring that type of dilution to our shareholders, we don't think that would be warranted at this point in time.

Operator

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

Terry McEvoy - Oppenheimer & Co.

I was wondering if the company took any actions with regard to the liquidity position of M&I ahead of today's earnings release, the downgrade from one of the rating agencies, the cutting of the dividend, etc., with the assumption that maybe you'll see some pressure on deposit flows following today's news.

Greg Smith

Well, first of all, Terry, given where our capital levels are, given where our reserve levels are, we do not anticipate pressure on deposit flows. We have as an organization been very conservative in how we've managed our liquidity since before this cycle even kicked in, and we maintain backup liquidity at all of our different entities in excess of 12 months of any cash needs. So from that perspective I'd say we all are very confident with our liquidity position.

To have taken the types of steps we have done - to extend maturities over the last couple of years  there's been an incremental cost to doing that, but in this type of environment, managing liquidity as conservatively as we have has had great benefits, enabled us to continue lending through the cycle as well. So in that situation we've got a lot of capacity out there.

Terry McEvoy - Oppenheimer & Co.

Could you talk about specific areas of the bank where you plan these expense reductions and the reductions in headcount, etc.

Mark Furlong

Sure. There're all throughout the organization but, you know, predominantly they're more heavily weighted in Wisconsin and weighted on the administrative side. But there's headcount reductions in each one of the markets, so it's really broadly across the network. When you have volume decreases to the extent that we've all seen in the market, then it just makes sense that you look at each one of the business units in each market separately. But more, from a concentration standpoint, more weighted toward the Wisconsin market and specifically in Milwaukee.

Terry McEvoy - Oppenheimer & Co.

And just one last thing, Slides 26, 27 and 28 from the credit quality slides, where can I track down historical data because those slides are new and the categories that you disclose and how you present the information doesn't match up with Call Report data.

Greg Smith

Obviously there's lots of different ways to slice this, Terry. Some of this has been available in prior quarters, but only going back one quarter, I believe. This was new data that we started providing back with the October call. That's the one data point that is out there.

Operator

Your next question comes from Kevin St. Pierre - Sanford C. Bernstein.

Kevin St. Pierre - Sanford C. Bernstein

I was wondering if you could help us dissect the $680 million in chargeoffs a bit. I'm trying to determine how much of that was writedowns of new nonperformers, how much of it was writedowns of existing nonperformers, and how much of it was actually related to loans which left the balance sheet.

Greg Smith

Well, we have not discussed the level of chargeoffs with our nonperforming loan sales and that's consistent with what we have done in the past. It's just one of those things. We don't really want to have people coming back at us saying hey, I know you're already realizing type of pricing in a given market. Because what we do find is the pricing on the nonperforming loan sales really winds up being all over the board depending on the market, depending on the type of project, and depending on the type of buyer.

In terms of chargeoffs, we have highlighted and I think provided pretty good detail in the slides about how the chargeoffs have applied across markets and across collateral types, and the real important thing that comes out is clearly the focus in the construction and development categories in Arizona, the West Coast of Florida, and the correspondent business. I do not have at my fingertips how much is against new nonperformers versus what had been existing nonperformers. There certainly would be chargeoffs that fall into both buckets.

Kevin St. Pierre - Sanford C. Bernstein

And the data you gave us, the $647 in partial chargeoffs, can you remind us what that number was last quarter?

Greg Smith

Last quarter that number was roughly $340.

Operator

Your next question comes from Ken Usdin - Banc of America Securities.

Ken Usdin - Banc of America Securities

So I guess my first question is, obviously companies continue to be very aggressive in terms of trying to get ahead of the chargeoffs and this is the second really sizeable provision expense we've seen this year. I'm just wondering if you can help us at all try to understand how you're just thinking about provisioning going forward as far as incremental expected reserve builds and even profitability of the company and thirdly just could we continue to see further just drag of tangible capital levels? I'm just trying to understand, again, like how much was actually pulled forward versus how much we could expect to just still continue to see as far as an absolute provision expense as we look ahead.

Mark Furlong

Well, Ken, you know, that's the magical question right now, how much has been pulled forward, and we always ask ourselves that, too.

Maybe just to give you some sense of it, if you look at a couple of the markets where we've seen higher levels of chargeoffs, in Arizona we have five nonperforming loans kind of in the $10 to $20 million range, even though we have three others in that $10 to $20 million range that, while they're performing today, we have some concern about.

So we're not really carrying a big number of large loans in Arizona, but what we've run into is just instances where developers, everything is going fine, they make a payment in one month, they come in the next month and they say, you know, I'm done. I don't think I can go any farther and my equity partners can't go any farther. From a large loan standpoint, we feel like we've took some pretty aggressive steps this quarter in Arizona.

Florida would be a similar point. We thought we were likely done in Florida from anything from a significant size of chargeoffs. We had two relationships of size that were fine and kind of went all the way through the exercise into chargeoff and what actually sold in a month where it wasn't even - or a quarter when it wasn't a no performer to start the quarter and it deteriorated that fast. And so in Florida, for example, we have two loans that are right around $10 million. We have five loans that are in the $5 to $10 million range that we're concerned about, but are performing today. So you can see the numbers are getting relatively small in both those areas.

I don't know what that holds for us in the future. I think it tells you from the large loan standpoint that the pace of sizeable loan loss provisions and chargeoffs should be a lot less and that's certainly what we believed when we finished the quarter. We didn't save anything for 2009, if you're wondering. I'm not sure that that means we've pulled anything back into 2008 per se, although you can see we've been aggressive in dealing with loans that we thought were slightly past due and moving them into nonperforming status.

The story is we stay as close as we can to all the larger loan relationships because they're the ones that drive the most significant loss activity.

On the consumer side, then, what we see now is the fairly significant pace of deterioration on  and Greg took you through the average loan sizes - on relatively small loans in the real estate market that are housing related or a single lot loan. And so we'll watch that as we watch unemployment levels move in 2009.

So I think that's a long way of saying no expectation that we would have more quarters like the fourth quarter in 2009, but I can't perfectly predict the recession and I can't perfectly predict the end. But that's how we feel today. If we thought we were going to have quarters like that, we would have - and we could identify the assets - we would have taken the charges today.

Ken Usdin - Banc of America Securities

And Mark, can you just address, do you expect the company to be profitable this year?

Mark Furlong

Yes, we think we have a pretty good chance of being profitable, although I would tell you when we started 2008 we thought the same thing. And somehow I have to find some balance and the point to say what's a guarantee of profitability compared to what we thought a year ago today? But I think we have a good chance to produce profitable earnings in 2009.

Ken Usdin - Banc of America Securities

My last question is then, as we talk about just this broader economic cycle and deterioration, can you just talk about how much you have thought through that in your reserving? A lot of the conversation already and Greg's comments is really about the C&D and the consumer side, but what about just regular commercial and term CRE, how much is that stuff starting to change, how much change in the fourth quarter, and what's your broader outlook on kind of that remaining bulk of the loan book?

Mark Furlong

Sure. I'll give you a few comments, then if Greg has a chance he may add to it.

We have done a fair amount of analysis on the broader performance at M&I and certainly the commercial book was part of it. And then looking at commercial real estate properties by category and certainly for us bigger ones might be industrial, retail trade and office, delinquency levels have continued to stay very low, anywhere from 0.6% - or nonperforming levels, I should say  0.6% to 1.2% - 1.3%.

I think we're the beneficiary of we really have stayed out of large office buildings, large multifamily developments, large shopping center developments, and so as a result, we haven't been faced with maybe the same pressure yet that others have seen.

It's virtually in footprint where we do business; not very much of that in Arizona. More of what our focus in Arizona had been was housing, much to our demise in some of that.

So so far it's performed pretty well. I don't have the concentration right in front of me, but we have a fair amount of concentration in the Midwest and particularly in Wisconsin. That portfolio has performed real well. Those would be multi-decade relationships and relatively seasoned buildings. I don't have all the vacancy level averages by type or any of that, but the vacancy levels have stayed relatively low.

And we went through a pretty broad analysis in the fourth quarter, led by our Chief Credit Officer and a couple of very senior bankers at M&I. And we went at a loan level review, so that did not reveal a bunch of unknown things to M&I, and we continue to see the weaknesses stayed in the housing sector, predominantly in the construction and development portfolio.

As Greg mentioned, by the way, too, what might be classified as a C&I chargeoff for M&I in the fourth quarter, the bulk of that was not what we would call true C&I either. Those were things related to housing and things related to an old Franklin relationship that we have in there as well, too. By and large, that was not the traditional manufacturing, service oriented, retail businesses and so forth.

So at this point in time, while we obviously have concerns going into at least a couple of quarters of recession of what those credits look like when we come out on the other side, but so far we have some comfort in that and feel like they're going to hold up okay.

Greg Smith

Ken, let me just chime in for one second. As we've gone through the build of the allowance, we are, particularly in the C&I side, we are interestingly enough focused on a lot of the same issues that we were focused on six or nine months ago and seem to have gotten in front of these things pretty early. We've even had a handful of relationships on the C&I side that we've actually been able to manage out of the bank, just kind of looking ahead to where the cycles are going to be.

When you take a look at the performance we've seen by market, Mark mentioned how strong the Wisconsin market has been in many of these categories. That is also true in the St. Louis markets and really through most of the Midwest, which has certainly been factoring into how we've looked at things. We haven't had the same run up in these markets that you have in others, and the businesses in these markets have continued to manage their capital, liquidity, and inventories very cautiously.

Operator

Your next question comes from Anthony Davis - Stifel Nicolaus & Company, Inc.

Anthony Davis - Stifel Nicolaus & Company, Inc.

I wondered if you could talk a bit about in Arizona and Florida, the losses you see in resi construction, how much of this is incrementally a function of the increased loss frequency as opposed to increased loss severity? Any thoughts about that?

Mark Furlong

You know, if looked at loss severity, if you went back to like end of 2007, first quarter of 2008, and then compared it to today, yes, you would see some increase in severity, clearly. Probably the severity, if you looked at the first quarter of last year, it might be in the, oh, gee, 20% to 40% depending upon the type of credit. If you looked at the fourth quarter today it might look more like maybe 40% to 60% maybe on average. It ranges all over, although they're not all at 40%, they're not all at 60%. Some are less.

So I'd say absolutely, that time has been the enemy. But we started selling loans, a few in the fourth quarter of '07 and then very active in the first quarter of '08 just because of what we saw coming. Feel very fortunate to have been able to move those properties to people who could be better developers and finish the property.

And there's certainly some unknowns going into 2009 about what the buyer universe and the interest levels will be. And I say all that, but we also have a fair number of properties we're going to finish and develop out unless circumstances change and just continue to lease out the units. And that will sit in REO for a period of time, but that may be the right answer as well, too.

Anthony Davis - Stifel Nicolaus & Company, Inc.

Mark, in that regard, the workout group, I just wondered if you could give us some feel for that. How many folks are working on that, your thoughts about loan sale activity, and interest levels as you see them today? Also maybe the potential for a carveout or segregation?

Mark Furlong

Clarify the last question?

Anthony Davis - Stifel Nicolaus & Company, Inc.

Well, just simply a segregation, a carveout, of a particular pool of loans that might be managed better in one place?

Mark Furlong

We have a group of about, oh, I suppose there's 65 to 70 now. We'll probably add a few more on the smaller loan side that's kind of going on right now. That group is predominantly focused in Arizona, although there's some activity in each one of the markets, so we continue to move the properties. I don't think that group's going to change much in size.

In fact, very likely what will happen is the group that worked on some of the larger commercial projects - as you heard my numbers a few minutes ago, both nonperforming loans today and those that we're watching closely of size, so that $10 to $20 million range in Arizona, are really dwindling down very, very fast - so that group, the expertise they have, they'll move and look at some of the much smaller loans and there's much more granularity.

And then what's been interesting is that, if you'll look at larger projects - and I'd say it probably pertains as much to Arizona as Florida as well, although there's really not much left in Florida for us anyway - the larger projects, when they weaken they tend to tip over and weaken quickly, and then we have to deal with them, you know, from a nonperforming standpoint. The smaller projects, the borrowers seem to find partners, family members, other investors, and the loss levels tend to be lower and they tend to be able to deal with the pain. And I suspect a lot of it has to do with just the sheer size of the project and the magnitude is much different and they can move with a lot less loss severity.

So I don't know if that gives a little bit of the thinking in terms of size of staff and size of future losses. I don't know if you had a second question in there?

Anthony Davis - Stifel Nicolaus & Company, Inc.

Let me move on to a final one. I wondered, in primary mortgage and home equity, the chargeoffs last quarter that were due to bankruptcies and generally your thoughts about these cramdown proposals, what are the potential consequences you might see in your portfolio?

Mark Furlong

Well, you know, I don't have the bankruptcy numbers at my fingertips right now, although we do track that. We don't have all that here.

Well, on the cramdown proposal, that would be a tough one. Now remember, the borrower has to declare bankruptcy, so that's an event that's other than just having a tainted credit record. We're making loan modifications right now that we think are in the best interest of M&I and the borrower as well, so maybe to some extent that won't be all bad if it stabilizes real estate values and it moves us through the cycle. That may not be all bad.

Certainly, no bank stands on the side of saying gee, let a bankruptcy judge dictate through some formula how you get to a value that is other than the value that we loaned at.

So I would say I would leave that more as an uncertainty. And I'd say, is our preference that they have cramdown? Probably not. When you look at the statistics on when a debt is reduced to a level like that, the pace of future delinquency is relatively high.

Everyone's groping for a solution. I'm glad that they're still working on trying to find a solution, but it's hard to say that that's going to be the right one and not necessarily the right one for us.

I don't know that that would have a big material change in chargeoffs for us on the consumer side, though. It'd be hard to predict a dramatic change that would be caused by that law.

Operator

(Operator Instructions) We have no further questions in the queue.

Dave Urban

Okay. Thank you very much for joining us today. We appreciate everybody's dialing in. Have a good afternoon.

Operator

Thank you so much. This concludes our conference call for today. You may now disconnect your lines.

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