The South Financial Group, Inc. Q4 2008 Earnings Call Transcript

| About: South Financial (TSFG)

The South Financial Group, Inc. (TSFG)

Q4 2008 Earnings Call Transcript

January 28, 2009 10:00 am ET

Executives

Mary Gentry – EVP, IR

Lynn Harton – Interim President and CEO

James Gordon – Senior EVP and CFO

Rob Edwards – EVP and Chief Credit Officer

Analysts

Ken Zerbe – Morgan Stanley

Adam Barkstrom – Sterne Agee

Kevin Fitzsimmons – Sandler O'Neill

K.C. Ambrecht – Millennium Partners

Bob Patten – Morgan Keegan

Jennifer Demba – SunTrust

Andy Stapp – B. Riley and Co.

Jefferson Harralson – KBW

Jeff Davis – Howes Barnes

Al Savastano – Fox-Pitt, Kelton

Christopher Marinac – FIG Partners, LLC

Operator

Good morning and welcome to The South Financial Group fourth quarter earnings conference call. (Operator instructions) This conference is being recorded. If you have any objections you may disconnect at this time. I would like to introduce Ms. Mary Gentry, Executive Vice President of Investor Relations. Ms. Gentry you may begin.

Mary Gentry

Good morning. Thank you for joining The South Financial Group’s fourth quarter 2008 conference call and web cast. Presenting today are Lynn Harton, Interim President and CEO, and James Gordon, Chief Financial Officer. In addition to our news release we have a quarterly supplemental financial package and presentation slides for today’s conference call, which are available in the Investor Relations portion of our website. Before we begin, I want to remind you that today’s discussion, including the Q&A session, contains forward-looking statements and is subject to risks and uncertainties, which may cause actual results to differ materially. We assume no obligation to update such statements. Please refer to our reports filed with the SEC for a discussion of factors that may cause such differences to occur.

In addition, I would point out that our presentation today includes references to non-GAAP financial information. We provided reconciliation of these measures to GAAP measures in the financial highlights of our news release and the supplemental financial package on our website. Now, I’d like to turn the presentation over to Lynn.

Lynn Harton

Thanks, Mary, and good morning. 2008 was the year of unprecedented challenges for the financial services industry and for TSFG. Going back just 12 months ago I don’t think anyone would have predicted the events that we are seeing come to pass. I also expect 2009 to have its off challenges. While the efforts of treasury to restore liquidity in the financial markets are beginning to work, there are rapid pull back and consumer spending experienced over the last 90 days will have economic cost even if the treasuries actions work well, as I believe they will. With that said these are the conditions that all financial institutions are dealing with the playing field is level.

For our part we are making every effort to be prepared for the challenging economic environment. It goes without saying that our fourth quarter and 2008 financial results are disappointing. In the fourth quarter we had an operating loss of $75 million driven largely by continuing elevated levels of credit cost as expected. Additionally during the quarter, our goodwill impairment tested required a non-cash write-off of the remainder of our Florida goodwill. Our discount rate for valuing our future cash flows is a set formula driven by the risk free rate plus a premium based on overall stock market volatility and the volatility of our own stock. This quarter that calculated discount rate increased from 12% to 16%. Our near-term credit losses for Florida have continued to increase over the past several quarters as well, but the discount rate change was the largest driver of valuation change.

We have not made any changes to the anticipated performance of our Florida Bank post recession arguably, post recession returns should be higher in Florida due to less competition and better pricing. Obviously the goodwill impairment charge had no impact on cash flows, tangible equity, regulatory capital ratios, and is similar to a charge we took in the first quarter as well as charges taken by other regional financial institutions. If there is a silver lining, it does clean up our balance sheet and make it easier to understand our numbers going forward particularly since many investors already look at performance on a tangible basis. Back to the theme of preparing for challenging conditions capital is the first line of defense. We do continue to have a strong tangible common ratio of 6.05% and upon the 2011 mandatory conversions of our convertible preferred stock that ratio would be 7.84%.

I know that some of you might argue with me about whether the mandatory converts should be considered tangible common? James will outline the transaction that we have just completed that converts nearly 20% of the issue into common today. It was a win-win transaction with liquidity benefits for the holder and dividend savings for our shareholders. To further add to our capital, we have completed a $347 million equity investment by the treasury that increased our tangible equity ratio to 10.29 up from 7.94 at 9.30. Reserves are also a line of defense. During the quarter, we continue to provide an excess of charge-offs and built the reserve to 2.45%. Liquidity also remains strong, our customer funding was stable based on period imbalances and our unused wholesale borrowing capacity remained strong at $4.4 billion. We’ve also made several management changes in the last month of the quarter including my appointment, and I will discuss those further in a few minutes.

First let us move to slide four and further review our fourth quarter results. Pre-tax, pre-provision operating income was $28 million down from $35.3 million in the prior quarter. Economic conditions drove some of that decline particularly in the margin and non-interest income areas. However our expenses were also up, which is not acceptable in this environment. Given our near-term revenue pressures and non-expense headwinds such as increasing FDIC insurance and loan collection expense, we must aggressively adjust our cost structure and operate more efficiently and I will discuss the actions we’ve take to do that in just a few minutes. In total our operating loss of $75 million for the quarter or $1.01 loss per share, in addition our non-operating items, which are outlined on slide five, including the goodwill impairment discussed earlier increased our loss for the quarter of the $319.4 million or a loss of $4.29 per diluted share, clearly numbers we are not proud off.

As that is the financial starting point for me and my current role, I would like to share a few observations about my view of the company on slide six. First, we operate in markets I am familiar with and markets I have worked in for my entire carrier and these are excellent markets great long-term markets to be in. Additionally I know the target operating model that we need to execute is a very similar model to my past experience and more importantly I believe will be the model that will win post recession. We are primarily a bank for entrepreneurial business customers that are also a natural fit for our private banking business. Our focus on opportunity involvement also provides us a strong niche for retail customers who both value local pride and service over price. We do have credit challenges, but we are addressing them by a combination of a very strong risk team that I personally recruited since my arrival and the strong capital base that I described earlier. Our product sets may not be class leading, but they are strongly competitive and our technology support is excellent.

I know talking doesn’t matter, execution does and this new team is focused on building credibility with our shareholders, which we in turn believe will drive our value. Since accepting the Interim role on November 14, I have made several organization changes and started with leadership changes to get the right people in the right spots and clarify responsibilities, as well as ownership for results. Slide eight shows the executing management team that put in place highlighting those executives who were in new roles. We’ve named Ernie Diaz, a 25 year Florida banker who knows our markets and customers extremely well as President for Mercantile Bank in Florida. Chris Gompper for a new role is head of Commercial Banking Strategy to derive support and strategy for our largest business line. Rob Edwards, formerly our Chief Risk Officer has become our Chief Credit Officer, while William Crawford, our General Counsel has assumed the Chief Risk Officer role. I have also changed reporting relationships so that all of our line bankers are now reporting to the state bank Presidents instead of operating in solid lines of businesses.

So, our strategies have been clarified, our incentive plans modified to support those changes and our internal measurement systems have been changed to clarify most important measures of success. We’ve also made some quick news to begin to reduce our call structure with 68 staff reductions or approximately 3% of FTE’s decided upon and executed on in December. We will not be paying bonuses for executing management for 2008 and we do not have any merit increases for the executive management team. We will have promotional increases where there has been a significant increase in responsibility. Additionally, I have initiated review of the corporate campus to determine our best short-term and long-term options relative to facilities and we have initiated work on Phase I of what we call project now. This project includes eight different work streams with an anticipated annual benefit including both revenue and expense opportunities upon implementation of $18 million to $20 million. We know that’s not enough, but I wanted to begin with this and begin build a culture of strong execution prior to taking on additional phases. So, now turning to credit quality, residential construction continues to be the primary stress as expected.

However we are seeing signs of the recession impacting C&I in consumer loan categories. Net charge-offs for the quarter totaled $76.1 million, which is 2.93% annualized essentially flat with last quarters charge-offs of $75.4 million. Our provision was $122.9 million and exceeded net charge-offs by $46.9 million. Year-to-date we have built the reserve from 1.26% to 2.45% or a dollar increase of $121.2 million. Non-performing assets increased to 4.1%, we had anticipated that the fourth quarter of 2008 and the first quarter of 2009 would be difficult ones for even our best developers and indicated increases in non-performing assets during that time should be expected. The components of non-performing assets include non-performing loans, which increased to $355.6 million during the quarter and an increase in ORE of 18.5 million reflecting the continued selection process and continuing the game control of the underlying assets. We began the loan sale process relatively early in 2008 and we did have several successful sales. Our theory was that the fourth quarter would become overloaded with product and hamper our ability to reduce non-reforming asset by loan sales. We did see more products come on the market as we expected. What we did not expect was the reduction in liquidity faced by many of the buyers.

Many long-term buyers were not able to find financings for the purchases that we had agreed to and many funds with liquidity were being pressured by their investors to return that liquidity to them. In short, the bulk loan sale market was severely limited in fourth quarter and our lack of sales contributed to the increase in non-performing assets. Moving on to the next slide, slide ten, which is an update of what you have seen before, you can see the residential construction and residentially related products continue to be the primary source of non-accrual loans with residential construction of 11.24% and mortgage of 10.17%. These categories continue to drive the majority of net charge-offs as well with residential construction and mortgage combined for 18% of our loan balances with 57% of our net charge-offs year-to-date. Slide 11 is new and is meant to give you a clear picture of the trends within each portfolio. As you can see, each of our commercial segments, which had demonstrated consistent performance in the second and third quarter showed some deterioration in the fourth.

The events of late September and October including the failure of several large financial institutions and the public debate over the treasury troubled asset relief plan had a significant negative effect on consumer confidence and consumer spending, which has managed best of itself in a level of manageable stress in our C&I and other commercial portfolios. On slide 12, the same trends are evident in our consumer portfolios. I would say that our indirect trends did actually a bit better than I expected given that this is a run-off portfolio and this point and you would expect to see decline in performance statistics as the portfolio declines. Slide 13 updates the information we’ve give you in the past by our residential construction by geography. The same relative performance continues. In other words, Florida has the highest stress followed by North Carolina with South Carolina showing the best relative performance that each bank is showing declines in absolute performance in this product type consistent with expectations.

I would point out that we have four relationships in Florida and South Carolina that we elected to leave in the past two statuses at quarter-end due to negotiations that were in process. Those accounts are the primary drivers for the increases in 30 day pass dues in both states in these products. This quarter-end it appears that two of those relationships will continue to perform and two of them have been or will be moved to non-accrual. As slide 14 demonstrates, we continue to carry our commercial non-accruals at 67% of loan balance when adjusted for our already recorded charge-offs and reserves individually allocated to those loans. Slide 15, there is some new information for you outlining additional statistics on our indirect portfolio. We are now only originating indirect through a very limited number of full relationship dealers in South Carolina. It is a well under-written and well diversified portfolio. The next slide updates our home-equity information that we have given you in the past. As the recession continues, we would expect these portfolios to weaken, but their branch oriented nature and our strong underwriting processes will keep these portfolios within peer averages or better for performance.

For the year, our home-equity line of credit net losses were 96 basis points and our home-equity term loan net loses were 42 basis points, both of which are good numbers for the environment. On slide 17, the best news about our mortgage portfolio is that it is small relative to the total. Non-accrual loans increased in the mortgage portfolio by 23 million for the quarter and passed two increases indicate that the first quarter will see increases as well. Some of the construction term loans have been completed, modified into a term loan and moved into the Alt-A category. These loans are part of the driver for the weakening performance in the Alt-A portfolio. There is a sub-segment of the lot loan portfolio, which totals 79 million that was originated by our mortgage lenders that it is causing a majority of our problems in the lot loan area. A portion of our reserve increase this quarter was part of this portfolio.

To summarize our credit business, we continue to work a full two fold strategy. First throughout this cycle we have and will continue to lend to our core customers in all of our markets. In the fourth quarter, we originated approximately 5,175 new loans and renewals totaling approximately $1 billion for our new and existing customers. We are supporting our communities by lending small businesses in individuals, while keeping our focus on period of lending consistent with the intent of the treasuries capital purchase program. Secondly, we are focused on recognizing problems early, dealing with them in the context of reality, and reporting them as we see them. We expect credit to continue to be difficult into 2009. We are entering the year ready for those expectations with strong capital base, higher loss reserves, stable customer deposits, ample liquidity, and a focus on core relationship customers. It is our job to strengthen our competitive position so that we can we can hit the ground running when we make it through the recession that we see ahead of us. So, now I would like to turn it over to James for additional discussion of fourth quarter results.

James Gordon

Thanks, Lynn, and again welcome everyone on the call. As Lynn discussed 2008 was the difficult and challenging year and 2009 brings many of the same challenges. However we have been proactive and diligent in strengthening our balance sheet with additional capital, higher reserves, and enhanced liquidity to manage through the cycle. Our GAAP net loss available to common shareholders totaled $319.4 million, primarily driven by $237.6 million due to our impairment charge for the fourth quarter. Overall, we have approximately $204 million of goodwill remaining related to our Carolina First Banking Segment, which includes both South Carolina and North Carolina and another $20 million related to non-banking subsidiaries. We do not consider these segments to be impaired at the current time, although we will continue to evaluate those amounts throughout 2009.

Now turning to capital, we ended the year with a 6.05% tangible common equity ratio compared to a 6.81% ratio at the beginning of 2008 while absorbing $345 million in credit provisions throughout the year. Our fourth quarter GAAP loss, excluding goodwill impairment accounted for approximately 54 basis points of the decline during the quarter offset by 43 basis point improvement in the swing and other comprehensive income to again balance at the end of the year. In addition, we had 15 basis points for tangible common equity related to the 19.3 million allocated to the warrants issued to the US Treasury. The other components of the income balance obviously moves the relation to changes and the underlying interest rates of the investment portfolio and derivative transactions.

Moving forward, this could cause fluctuations in the tangible common equity ratio from quarter-to-quarter as overall interest rates remain volatile. Additionally when we look at our tangible common equity, we think it is appropriate to include our mandatory convertible preferred stock, which will without further action of the company or anyone else converted to common in May of 2011 that is of course if it is not earlier converted. In fact, 14.5 million of those shares have converted now counting a transaction I am about to mention. We continue to be proactive in considerably working to manage our overall common equity level and mix and we will be opportunistic as market conditions allow. To that end we reached an agreement last night with one of our large preferred stock investors to convert over 45 million of their preferred stock holdings into common stock. In the transaction, we listed a total of 9.5 million shares of common stock. This represents the underlying conversion shares totaling approximately 7 million shares plus an additional 2.5 million shares to induce the conversion in lieu of future dividends which would total approximately 10.2 million.

While this transaction is slightly dilutive to book-value it increases our pro forma tangible common ratio to approximately 6.4% at December 31, while slightly the decrease in tangible common book value as I mentioned. The value of the additional 2.5 million shares issued in lieu of the future dividends will be treated similar to preferred stock dividends in our first quarter 2009 EPS calculations. We continue to believe our common equity is adequate although we do expect it to decline as we continue through the cycle and begin to grow their assets. Additionally as you are aware we completed our investment with the US Treasury in December totaling 347 million, we immediately injected 260 million or 75% of those proceeds into our subsidiary bank to go through its capital ratios and maintain the remaining 87 million as the only company to cover our future dividend allegations to the US Treasury for the next five years.

The proceeds were used to strengthen liquidity in the near-term until those proceeds can be further deployed through lending activities through in our marketplace. Now turning to the net interest margin, was decreased by 11 basis points from 3.08% to 2.97%. This decrease was primarily driven by 4 basis points decline from interest reversals of non-accrual loans and a 7 basis point decline due to the overall balance sheet mix and lower interest rates from the 175 basis point decline of the FED funds target rate during the quarter. Overall, we expect continued pressure in the net interest margin during the first half of 2009. We expect the margin to expand in the latter half of 2009 as we see better loan pricing and less deposit competition. Less deposit competition should lead to better price resolution on the liability side as we recently issued six month CD with aggregate CD maturing selling approximately 1.5 billion over the next six months.

Further more we expect the balance sheet to contract approximately $150 million per quarter for the first half of 2009 and remain flatter over the remaining portion of 2009. On page six of our quarterly financial data supplement, we provide additional details on the overall quality of our investments securities portfolios. We have been very conservative with this portfolio with over 99.2% rated A or higher and with over 85% US government related. Also due to the drop in interest rates and anticipated prepayments, the overall duration of our mortgage backed securities portfolio of 1.5 billion has shortened from approximately 4.4 years to approximately 3.3 years during the quarter, while the overall portfolio decline to an average duration of 2.9 years. This will also add to the margin pressure as we reinvested as proceeds in the near-term. We do not expect material impairment charges on the portfolio as we move forward given the overall quality of the underlying portfolio and securities.

However, we do have approximately 20 million in other investments, which are included in other assets and in 2009 we could have potential write-downs in the aggregate in the $3 million range on those underlying investments. Now look at liquidity, which remains as primary end focus as credit and capital in this environment. Our liquidity remains sound as our overall customer funding base is stabilized both in terms of mix and overall levels, due to various initiatives taken by the government to boost their confident in the banking system. Additionally, our secured borrowing capacity is at 4.4 billion comprised of federal home loan bank advance availability, federal discount window availability, and our unfledged securities. We have applied to our regulatory agencies permission to issue up to 241 million under the FDIC’s debt guarantee programs, which we would expect to issue if approval is granted in the near term. Our parent company cash totaled $210 million at December 31, 2008 it covers approximately four years of current fixed obligations as we have no principal maturities until 2033.

In looking at non-interest income on slide 33, the primary impact was related to the overall economic downturn, which decreased customer confidence and related customer spending. This had a negative impact on NSL, debit card, and merchant processing revenues. Additionally wealth management revenues declined due to lower asset valuations, which drive trust related fee income and lower brokerage transaction volumes on an overall basis. With the recent declines in mortgage rates we have seen an increased level of re-financing activities, which should help drive mortgage revenue higher going into 2009. Now looking at non-interest expenses on slide 24, we are expecting continued headwinds from FDIC insurance premium increases and loan collection expenses as we head into 2009. Loan collection expenses are expected to run above their current levels and are difficult to estimate given the nature of those expenses and are directly related to the increases of non-performing assets. As other real-estate owned increases, we would expect additional ORE write-down that the assets are held over longer period of time. Next, in looking at FDIC insurance proposal including the recent 7 basis point across the board increase for the first quarter, we expect FDIC insurance premiums to substantially increase in 2009 to approximately 5 million for the first quarter increasing to 6.5 million per quarter for the remainder of 2009. As Lynn noted earlier, we were working on number of fronts to control and reduce expenses as we move forward.

Finally, looking at our December 31, 2008 GAAP deferred tax asset of approximately 53 million, we are determined that the asset is fully realizable based on future taxable income with approximately 31 million of the balance supported by carry backs of future net-operating losses for 2007. Also the majority of our 2008 loss was carried back to 2006, which will result in approximately $43 million in cash refunds sometime during 2009. However, our regulatory deferred tax asset net of the 2007 carry back totaled approximately 60 million [ph] and has been deducted from tier 1 in total capital ratios from both the holding company and the bank as capital regulations only allow a 12 month rise for taxable income projections. This does allow for regulation purposes, reduced TSFG’s tier 1 and total capital purchase by approximately 45 basis points each at December 31, 2008. We will continue to monitor this issue during 2009. In looking at our effective tax rate and benefits for 2009, we expect the rate will benefit to be in the 35% to 40% range assuming no valuation allowance on the deferred tax asset for GAAP purposes. With that now I will turn it back over to Lynn for some summary and closing thoughts.

Lynn Harton

Thanks, James. To wrap-up I would like to give you a sense of what our expectation are for the balance of the year. First the economic environment and therefore credit cost will remain challenging. Absent the opportunities for any major portfolio sales, we believe the credit losses for the first half of the year will be similar to what we have seen for the last half of 2008. Provisioning levels will be somewhat dependent upon leading indicators such past dues, internal risk rating, and external economic conditions. Loan collection cost and FDIC insurance increases are going to be a headwind. There are potential one-time charges that will be generated dependent upon our corporate campus decision. There are essentially three options, first move into it as planned, second, modify the amount of space we take and lease the remainder or third market for campus for sale to an end user. Each of these options will have different financial impacts.

We are currently in the review stage and plan to make a decision by the end of the first quarter. We will also continue as James mentioned our ongoing evaluations for investment impairment and realizability of our net deferred tax asset. We do face near-term pressure on our net interest margin for the first half of the year. I believe we will see expansion in the second half as pricing initiatives on both the loan and deposit side begin to show results. We’ve already touched on estimated benefits from Project NOW and other expense initiatives. Given the right end market opportunity, we would consider an FDIC deposit transaction provided that it provides for more sufficiency and improves our customer funding measures. We will continue our focus on cross sale and customer satisfaction as we strive to be the best relationship bank in our markets. As I mentioned earlier we have entered 2009 ready for these challenges. To reiterate, we do have strong capital base higher loss reserves, stable customer deposits, ample liquidity, and focus on core relationship customers. All of us at The South Financial Group appreciate your support. We will now open it up for questions.

Mary Gentry

This is Mary. (Operator instructions) We are ready for the question-and-answer session again.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Our first question comes from Ken Zerbe of Morgan Stanley

Ken Zerbe – Morgan Stanley

Thanks. Could you just review the terms a little bit of the preferred stock conversion? I calculated the conversion price including the 2.5 million share kicker is at about $4.80. First of all, is that roughly correct? And also if you could address how much more of this that you would reasonably expected to do in the relatively short-term?

James Gordon

Good morning, Ken. This is James. Your calculation is roughly right. I mean the way we look at, the underlying conversion went out, you know based on those terms. The additional 2.5 million shares replace the dividends and represents roughly 1.65 years of remaining dividends versus a 2.25 remaining contractual period on the dividends. But your calculation is right. As far as the future transactions, we are not sure what the availability in interest would be into that. And again from an overall capital perspective, we would be opportunistic based on market conditions or legal conditions surrounding that.

Ken Zerbe – Morgan Stanley

Meaning that if you could, you would essentially?

James Gordon

Yes.

Ken Zerbe – Morgan Stanley

Okay. And then I guess one just a follow up. Do you feel are you getting any regulatory pressure or rating agency pressure that would lead you to do these conversions or with a 6.4% tangible common, you are not at the low end of range by any means, but I guess or is it just –?

Lynn Harton

Ken this is Lynn. Now, we really view this as I mentioned as a win-win. We would not – this was not any kind of pressure from anyone. We do obviously know that tangible common is what everyone is focused on. We do believe we already got strong tangible common ratio. But in this environment and some of the holders, this provides as I mentioned liquidity benefits for them and if we can get a better deal by paying out less then we would otherwise pay out dividends we think it’s good for both parties. So, that’s our approach to it.

Ken Zerbe – Morgan Stanley

Great. Okay. Thank you very much.

Lynn Harton

Thanks.

Operator

Adam Barkstrom of Sterne Agee, you may ask your question.

Adam Barkstrom – Sterne Agee

Yes. Good morning, by the way, everybody. Just wanted a follow-up on that and James the other piece of that 14.5 million. Could you explain that a little?

James Gordon

Remember the holder has the option to convert it any time that they want to and the 14.5 million of those holders or $14.5 million from various holders’ have converted and but I would call them course of business up through today.

Adam Barkstrom – Sterne Agee

That would be at $6 price, right?

James Gordon

Yes, the $6.5.

Adam Barkstrom – Sterne Agee

$6.5.

James Gordon

Yes.

Adam Barkstrom – Sterne Agee

$6.5. I’m sorry. Okay. And then a follow up on credit. You guys highlighted I guess the same areas that we’ve seen, problems remain problem areas. But may be one area that you guys are little more focused on is on the North Carolina market. And I was wondering if you could give us some more color perhaps by loan type and maybe particular markets in North Carolina, where you are seeing some of the pressure come?

James Gordon

Sure, Adam. I’ll let Rob Edwards, our Chief Credit Officer handle that.

Rob Edwards

Okay. Hi, Adam, it’s Rob. Really the markets that we are focused on in North Carolina is primarily the western portion of the state. Office is located in Hendersonville and Asheville are two hubs in North Carolina. In terms of the loan types, it’s really a more granular portfolio perhaps than we have in Florida, but also more residential construction ADC than we have in the South Carolina market. So, a lot of the same similar stresses moving into western North Carolina that we’ve seen in Florida over the last nine months.

James Gordon

Yes. The North Carolina portfolio is more small business, small builder oriented. So, the good news there is its smaller bites, it’s more diversified. The bad news is, there’s more of them. But it’s the same kind of product really. We expect houses to expand in lots that are really driving the problems there.

Adam Barkstrom – Sterne Agee

Okay. And one last and real quick. Lynn, where are you guys and where is the Board with the CEO search? The last update was –you talked about being done by year end and this seems to be just dragging on. And I’m just curious what you take is on that, what kind of time can we expect an announcement with that?

Lynn Harton

Sure, Adam. First, the Board’s job is to find the best leader for the Company and shareholders’ and they are following a process to do that. I know from our conversations with them that we both want that process to be completed as soon as possible and hopefully in the very near future. But that’s in their hands. My view is I’ve got – - I know only one way to do the job and that is to move the Company forward. We don’t have the luxury of standing back and waiting. So, I’m trading it with their permission as full and not interim and we’ll just go forward from there. So, you will have.

Adam Barkstrom – Sterne Agee

Okay. Thank you.

Operator

Kevin Fitzsimmons of Sandler O'Neill you may ask your question.

Kevin Fitzsimmons – Sandler O'Neill

Good morning everyone.

Lynn Harton

Good morning, Kevin

James Gordon

Good morning, Kevin

Kevin Fitzsimmons – Sandler O'Neill

Lynn I was wondering if you can just give us a sense for it, is there an option over the next few quarters to maybe try to shrink the balance sheet even more aggressively, is it simply a matter that the secondary markets just aren’t there for you to be able to do it. It seems like that might be away to improve the margin to get the tangible common equity ratio up, if you are able to do that. And secondly, some companies have mentioned that with the secondary markets being kind of overly punitive for certain loans like lots and possible parts of land that they have taken the hits on those and aggressively put them into all real – - and they are indicating they are going to hold on to them longer. Is that something that’s going on or you are looking at as well? Thanks.

Lynn Harton

Right. Two great questions. On the first one, yes we would look at opportunistic ability to sell certain pieces of those portfolios. For example, we talked about our focus on customer relationships and really building the bank around that. So, let’s take for example, our indirect auto portfolio, which is well underwritten. But with absent a few very strong dealer relationships that we have is really not part of the relationship strategy. If we saw pricing come to a level that we felt makes sense on that, we are preparing to pull the trigger on that to be ready forward if that situation arose. But an additional portfolio that we would look at is a part of our shared national credit portfolio, we separated that internally into those relationships, we believe are core and those relationships that we think will really – - realistically never had relationship with. And we think that’s a portfolio that you could see us bring down the balance sheet more aggressively if we had opportunities there. On the lot loans and other land, it is very difficult to move those. I mean what we are doing is as they move through the process, we get appraisal and write them down at the time we put them in our accrual. We update that appraisal at the time we put them in ORE. And with the market for purchasers being fairly limited right now, our view is there are a limited number of very nice properties that we might be willing to hold, but the properties when we look at it and we say it’s worth ”x”, it’s going to be worth same ‘x’ two years from now or three from now. There’s no sense in holding those. So, it would be a limited basis, but there will be probably two or three very prime properties that we might hold long.

Kevin Fitzsimmons – Sandler O'Neill

But I guess when you look at that kind of the segment of the portfolio, and I know you get the appraise, you write it down. But when you look at the loss potential of this stuff that may still be performing that hasn’t triggered that yet. Do you have any way to really get a sense on what that loss potential is and how fast it’s coming?

Lynn Harton

We do. We have a portion of our reserve that is dedicated to that land portfolio. We did increase that piece of the reserve this quarter, and we are just continuing to watch it through our normal processes, risk rating, our weekly workout bank meetings which a big portion of our land loans are in that. So, we are just continuing to watch it very closely. We have not been surprised, but we’ve not had any loans hitting on approval, hit charge off that we haven’t been watching for several months. So, that’s the good news. The bad news is there’s a lot off.

Kevin Fitzsimmons – Sandler O'Neill

Okay. Thanks.

Operator

K.C. Ambrecht of Millennium Partners, you may ask your question.

K.C. Ambrecht – Millennium Partners

Hi, guys, thanks very much for taking the questions. Just back to some of these marks, it looks like if you add up your construction and residential construction and residential condo books in for example coastal South Carolina, which a lot of that will be on the Myrtle Beach. So, that will be $127 million. The NPA is right now about $4.6 million. When we talked to Novis [ph] and BB&T, it seems like they are taking mark two to three times out of Myrtle Beach. Can you help true up where your NPAs are versus where their marks are?

James Gordon

I can only address some portfolio and how we manage them, so just I will describe it and I mean it is what it is.

K.C. Ambrecht – Millennium Partners

Okay. And then one follow-up, when CNB is taken over, it seems eminent now – - how do you think about the buyer? When the regular takes CNB over, whatever bank takes it over. They probably got to go in and mark down that bank’s balance sheet pretty aggressively, and if the FDIC is showing (inaudible) and such kicking out residential construction loans at $0.20, $0.15, $0.10 in $1. How should we think about your reserve adequacy when you have these things marked at $0.69 on $1?

James Gordon

First we just got to see how all that played out. We are selling and did sell, for example, residential land at $0.20 from the $1 this quarter. So, when you look at the portfolio, it’s not every loan, it varies loan by loan. We are looking at them, we believe realistically and accurately. And we continue to update appraisals and continue to take marks as they come. So, I think predicting where the market goes, that’s been a kind of a full therein for anybody over the last year. And so we weren’t proud of doing that. We are just to react to the market as it is.

K.C. Ambrecht – Millennium Partners

But do you think the market is going to soften more –

Mary Gentry

K.C., it’s Mary. We really are going to limit this to one question and a follow up.

K.C. Ambrecht – Millennium Partners

Thank you.

Mary Gentry

So, thank you very much.

Operator

Bob Patten of Morgan Keegan, you may ask your question.

Bob Patten – Morgan Keegan

Hi, good morning everybody.

Lynn Harton

Good morning, Bob.

Bob Patten – Morgan Keegan

I hate to do this to Mary, but I’m going to follow up on K.C’s question.

Mary Gentry

That’s it.

Bob Patten – Morgan Keegan

And here’s the way I think about it. We have 67% mark on that portfolio, and so that includes $44 million of specific reserve, correct?

James Gordon

That’s correct.

Bob Patten – Morgan Keegan

So, if you would allocate that $44 million RU reserve, you really have $1.99 million reserve for the rest of the portfolio, which is a mix of unallocated economic to a lot of different reasons, correct?

James Gordon

Correct.

Bob Patten – Morgan Keegan

Right. If we would take that 67% and mark it down another 20 BPs because (inaudible) just took 56% mark and we’ve regions in some other banks take similar marks. If you were just to play catch up, you got them even to get your reserve back to 240. You guys have to take a couple of quarters a whopping reserve –?

James Gordon

I think they are taking those as they sell them. I don’t know that are they taking that as in terms of what they’ve got on the books –

Bob Patten – Morgan Keegan

No. I think the reality is colonial action makes you guys look good. But the point is that lot of banks are playing catch up here and they mark in and the reserve bills. And while you guys have a much better capital base. I’m trying to get a feel for how much more the marks are getting worse, not better. And I think we all hope that in a normal cycle, these things get better, but looks like the first bid was probably the best bid six-months ago. So, I’m just trying to get a feel for how you right size your portfolio, if it continues to get worse you guys got to have to catch up on those marks?

Rob Edwards

I think we did some loan sales as Lynn mentioned earlier. This is Rob. Back in the second and third quarter when a lot of people where still on the sidelines. So, I think your point about people catching up is a very accurate point. We were able to sell one of our condo projects at 65% of book in the fourth quarter.

Bob Patten – Morgan Keegan

Okay. Just a point, I’m just trying to figure out how you guys are looking at it and looking at how fast things have accelerated to the down side?

Rob Edwards

Right.

Bob Patten – Morgan Keegan

Thank you.

Operator

Jennifer Demba of SunTrust, you may ask your question.

Jennifer Demba – SunTrust

Thank you. Good morning.

Lynn Harton

Good morning, Jennifer.

Jennifer Demba – SunTrust

You noted in your press release that you had a significant amount of duration in income producing properties and commercial development. I would wonder if you could give us a little more color there on what kinds of weakness, where the consistencies are?

James Gordon

Sure. On the completed income property, we had really three pretty good sized projects that drove a big piece of that. One is a project that is where you similar housing projects that we got a lot of interest in the project. We don’t believe we got a significant loss in it. But the developer had other problems unrelated to any of our issues that caused him to not be able to continue to support this. We’ve got some income properties that are frankly tied to real estate. You got a couple of realtors, their office facilities. They are strong realtors, build office facility that goes in income property. We’ve got one hotel property that was really more of a private banking situation that the – - again appraisals are very strong, but the partnerships are having some disagreements over how to manage the project. So, at this point, it is still I would say fairly related to residential. We have not seen at this point what I would expect may be begin to see in the third quarter and that would be more retail related vacancies for those types of things. These are still more tangentially related to residential construction.

Jennifer Demba – SunTrust

Thank you. That helps a lot.

James Gordon

Thanks.

Operator

Andy Stapp of B. Riley and Co. you may ask your question.

Andy Stapp – B. Riley and Co.

Good morning. Just wondering how much the inability of perspective buyers of ORE are to obtain financing. How much of that has been an issue?

James Gordon

It’s been an issue definitely on the loan sale piece. We had several LOIs, but they just weren’t able to complete. It is an issue also on the ORE side. We may finance some, our sales are consistent with accounting rules and consistent with getting cash down payments from those kinds of things but yes, it is a challenge.

Andy Stapp – B. Riley and Co.

Okay. And you talked a little bit about this, but could you just give some color on deposit pricing pressures, has there been any signs of moderation and just wondering what color you can provide there?

Lynn Harton

And on the positive pricing, we have actually seen the pressure abate just a small amount first part of the year, especially from some of the bigger institutions, we have seen the pricing become a little more rational. We still see some irrational specialty pockets where I think we have no institutions that are struggling with liquidity and we still see some pressure there particularly in the CD pockets, but we have seen as rates have dropped, we've seen that they have become a little more rational still very competitive.

James Gordon

You know, I think if you look at our CD rates today are probably half of where they were coming into the quarter and now if you looked across the market, higher (inaudible) on CDs are more the exception on the rule versus where there was more the rule than the exception, you know, coming out of the second or third quarters. So, it has significantly lessened. Has it returned to normal fully from a year ago, probably not.

Andy Stapp – B. Riley and Co.

And in your earnings release, you mentioned how there is mounting signs of stress in your Carolina markets, I guess North Carolina you touched on, and that was primarily less important state. Am I correct in assuming that South Carolina is primarily coastal area?

Lynn Harton

That is correct. From a residential construction point of view, that would be correct.

Andy Stapp – B. Riley and Co.

Okay, thank you.

James Gordon

All right, thank you.

Operator

Jefferson Harralson of KBW, you may ask your question.

Jefferson Harralson – KBW

Thanks. I was going to ask you guys a question on the corporate camp. As I understand it, the expenses that are capitalized until you move in, and then they will start hitting the expense line, so can I ask you guys that – I guess, when the building is done, and if you guys decide option one – more than as usual, how much expenses would it add to your annual expense base?

James Gordon

You know, Jefferson, we are not saying that right now. It is split, some increase in the occupancy expense not materially over the remaining part of this year. Obviously, one of the big drivers would then be carrying that level of a non-earning asset. It could be our capitalizing interest related to that right now and you would begin to not capitalize that interest and show up in the margin. That is as big or more of the impact than the underlying cost of it is.

Jefferson Harralson – KBW

So stuff really significant on the expense line, just more of a – how much non-earning assets do you want to carry?

James Gordon

Yes, I think the combined impact is significant if you look at that, I mean, if you just factor in say $90 million to $100 million of a non-earning asset setting there addressed on the fund obviously the carrier cost on that, depending on which rates you want to use, it is significant and while the individual occupancy expense is not that significant for the latter half of 2009, it does increase and so when you combine those two, it does, and then an additional portions of that would come online in 2010, it would continue to build. So, that is what we're looking at – that headwind from not fully utilizing it.

Jefferson Harralson – KBW

Are you saying that a portion of the building is ready in mid year ’09; the whole thing is ready in ’10?

James Gordon

Yes. That has been our revised plan since early 2008.

Jefferson Harralson – KBW

Okay, thanks a lot.

James Gordon

Thanks.

Operator

Jeff Davis from Howes Barnes, you may ask your question.

Jeff Davis – Howes Barnes

Good morning. Lynn, do you know the aggregator bank and its current format that is being kicked around Washington? Would it include to as a part of its charter to acquire things like construction loans and the like or is it strictly going to stick to securities, if you know either way?

Lynn Harton

I really don't – you know, we have tried to get any kind of inside line and everything we hear is just changing day by day and so we don't have much headlights into what that might turn out to be.

Jeff Davis – Howes Barnes

And do you know if the ABA lobbying or other banking organizations lobbying to get loans included in the aggregator bank?

Lynn Harton

I would think so.

James Gordon

Based on what I have seen, Jeff, they are trying to get more far reaching into where the problems are – both in terms of securities for some, from the former investment banks, if you will, and the like, and then from the more the big community and regional banks like ourselves, you know, we really need the loans put in there to really be helpful.

Jeff Davis – Howes Barnes

Have you all given any thought and I know it is still early in terms of selling to the aggregator bank and it is going to I guess raise the same issue that Casey and Bob are headed down, but getting into price and what is the haircut?

Lynn Harton

I just think it is too early to know. I mean, we clearly hope that it is a good, solid balanced program and if we look at the things that the Treasury has done to this point, well most certainly they have been debated, I think on balance they are doing the right things. So, hopefully this program will be positive and be something that we would support, but it is just too early to tell.

Jeff Davis – Howes Barnes

And last question. James, I know you don't have much credit in your securities portfolio, but the assets on the securities site of the aggregator bank might acquire in terms of CNBS or CDAs to the extent. What do you think if the aggregator starts to buy whether the price initially is viewed as being a little rich or low or about right, do a lot of these assets start to catch a bit in the re-liquification process should get underway?

James Gordon

You know, it is hard to say. And remember, most of ours are government issues.

Jeff Davis – Howes Barnes

I am talking bigger picture, I know you don't have government issues.

James Gordon

And you know, I think bigger picture, it is interesting what happened when the Federal Reserve started buying up some of not debt kind of paper, some were tied and what started happening to the spreads and other things. So, it really depends I think on what price the aggregator bank begins to buy relative to the overall liquidity of those positions, which has impacted price more so than the quality in most cases.

Jeff Davis – Howes Barnes

Thanks so much.

James Gordon

Thanks.

Operator

Al Savastano of Fox-Pitt, Kelton, you may ask your question.

Al Savastano – Fox-Pitt, Kelton

Good morning, guys. How are you? Just a question. When you guys raised your capital last spring, you had an idea of what the investment offset were in the portfolio. Can you just give us an idea of where you are running on that calculation, and what expectations have changed?

Lynn Harton

Al, this is Lynn. When we raised it, yes, we raised it for a stressed scenario. We are in that stressed scenario and a little above it. So, you know, clearly loss expectations have increased, as I think they would everywhere in the world. I don't think anybody would have predicted this thing, you know back at that point, which is again why we are glad with the Treasury Capital Purchase Programs in place, where we felt like it was prudent to participate in that given the level of uncertainty out there in the world.

Al Savastano – Fox-Pitt, Kelton

So the bottom line, you still feel comfortable with your capital position?

Lynn Harton

That is right.

James Gordon

Yes.

Al Savastano – Fox-Pitt, Kelton

Thank you.

Operator

Our last question comes from Christopher Marinac of FIG Partners, LLC.

Christopher Marinac – FIG Partners, LLC

Hi, I just wanted to go back to sort of an historical question. The leadership team that you originally had in North Carolina, are they still with you or if you had changes in the leadership there in the recent quarters?

Lynn Harton

We have had changes there, we have got a new state president actually has been rolled into the Carolina First Bank. Our market President there is new, one of our two Chief Credit Officers is also new. And we have probably got some more – - few people within the team as well, but we have made pretty significant changes there and we feel very good about the teams in place.

Christopher Marinac – FIG Partners, LLC

Okay, were there any additional review in North Carolina in this quarter or was that already done a while back?

Lynn Harton

I think we have talked previously about some deep drills that we did throughout the ADC portfolios in Florida and those were also done in the second half of 2008 in both states of the Carolinas.

Christopher Marinac – FIG Partners, LLC

Okay, great. Thank you.

Operator

This concludes the question-and-answer session. I would like to turn the call back to Lynn Harton.

Lynn Harton

Okay, again, we appreciate your interest and your questions and we will sign off and hope everyone has a great day. Thank you.

Operator

This concludes today's conference call. Thank you for your participation on this call. If you would like to access the replay, you may do so by dialing 1-800-678-0452. Again, the number for the replay is 800-678-0452. You may disconnect at this time.

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