Midwest Banc Holdings, Inc. Q4 2008 Earnings Call Transcript

Jan.28.09 | About: Midwest Banc (MBHI)

Midwest Banc Holdings, Inc. (MBHI) Q4 2008 Earnings Call Transcript January 28, 2009 11:00 AM ET

Executives

James Giancola – President and CEO

Jay Fritz – EVP and President of Midwest Bank & Trust Company

Tom Caravello – EVP and Chief Credit Officer

JoAnn Lilek – EVP and CFO

Analysts

Carl Busca - Busca Family Partners

Ben Crabtree – Stifel Nicolaus

Dan Nigel [ph]

Joe Stephen [ph] -- Stephen Capital [ph]

David Leister [ph]

Daniel Cardenas – Howe Barnes

Jim Brown [ph]

Joe Holahan [ph] – RBC Capital

Kenneth Puglisi - Sandler O'Neill

Dan Quirk [ph] -- Seaquest [ph]

Operator

Hello and welcome to the Midwest Banc Holdings Incorporated fourth quarter earnings conference call. All participants will be in listen-only mode. There will be an opportunity for you to ask questions at the end of today’s presentation.

(Operator instructions)

This call contains forward-looking statements. Actual results may differ materially from the results suggested by these forward-looking statements for a number of reasons. These forward-looking statements are within the meaning of Section 27A of the Securities Act of 1933 as amended and Section 21E of the Securities Exchange Act of 1934 as amended and should be reviewed in conjunction with the company’s annual report on Form 10K and other publicly available information regarding the company, copies of which are available from the company upon request and on the company’s website at www.midwestbanc.com. Such publicly available information sets forth certain risks and uncertainties related to the company’s business which should be considered in evaluating forward-looking statements.

(Operator instructions) Please note this conference is being recorded.

Now, I would like to turn the conference over to James Giancola, CEO of Midwest Banc Holdings. Mr. Giancola?

James Giancola

Thank you, Amy, and thank you everyone for participating this morning. I’m going to start the call in much the same way that our peers have started the call and that is we are very happy to put 2008 into the rearview mirror. In my 35 years in the banking business, these are about the most challenging times that we and everyone in our industry has ever experienced. In these kinds of economic times, priorities change. Earnings will always be important, but in this environment, liquidity, capital management and credit quality are really in the forefront. I want a take a second and talk about each of those before I turn it over to other members of our management team.

On the liquidity front, the market really bottomed end of September, beginning of October as the financial markets’ essentially became paralyzed. Funds were not flowing between banks and it was just about as difficult a liquidity period as we have ever experienced.

During that period of time, I am happy to report that we were able to fund the bank. We were able to meet the customer needs on the loan side from our borrowers. As a result of that liquidity, we have spent and redoubled our efforts on the core deposit front to try and fund the bank more and more on the core deposit side and less from very volatile secondary markets. We actually went through year-end in a net fed fund sold position. We felt very good about that. We have new management in the investment area, Tom Bell. We talked about him briefly in the press release. Tom’s done a good job of managing our collateral position and making sure we are maximizing availability of funds at our different funding sources.

On the capital side, I think you all know, we received $85 million investment from the federal government in TARP funds in December late in the quarter. These funds allow us to achieve our 2009 budget without raising additional capital. Again, as you know, the capital markets are in disarray and raising capital in these markets is really not the appropriate strategy for our shareholders. So there's adequate capital at the holding company level to continue to downstream to the bank to fund our growth plans for 2009.

Credit quality, a number of initiatives going on there. First we have, as many institutions have, made a concerted effort to review loan policy and tighten lending standards. We're getting more equity in our transactions. We're getting more collateral in our transactions. We're getting better pricing on those transactions. Prior decisions, some a year or two ago, are starting to really protect this organization going forward. We have not put a residential mortgage on our books in over two years. We exited the credit card business about a year ago. Both of those are experiencing significant distress and we have avoided those problems.

Beginning about two years ago, we made a concerted effort to reduce our concentration in the real estate business. Construction lending has been, curtailed is too strong a word, but more narrowly focused, each deal more carefully considered. Our concentration in the construction area has been significantly reduced. Our concentration in the real estate area has been redeployed to owner owner-occupied buildings and away from straight commercial real estate transactions.

We booked a $14 million tax benefit in the fourth quarter. Now, the calculation of loan loss reserves is more art than it is science and we made the decision in this environment to use many of those dollars to build loan loss reserves and to very aggressively mark problem credits to what we believe to be realized value. At this point in the cycle, our loan loss reserves are up about 100% from the levels that we had in the middle of 2008. So, we are going into 2009 with reserves at 1.77, the highest level our organization has had in the past, the highest level we've had in a very long period of time, and I think appropriate for where we are in the economic cycle.

The march that we have taken that Tom Caravello we'll talk about in a moment, again I think prepare us to go into 2009 with no surprises. That said, no one can forecast to where this economy is going. We will continue to see challenges as the economy continues to deteriorate. We hope that doesn't happen. A lot of effort has gone into preparing our organization for what we think will be a challenging 2009. Again, the other members of the management team are going to talk about other specific plans that are going on in that area.

With that, I'm going to turn to Jay for some comments. Jay, as you know, runs majority of our revenue-producing areas. He and his team have done a really good job of positioning us for 2009. And with that, let me turn it over to Jay.

Jay Fritz

Thanks Jim. Our principal strategy at Midwest Banc is to build upon the relationships we have nurtured as an organization over the past 50 years, and of course, we want to exploit whatever new opportunities are offered to us. Those opportunities should include a reasonable return to our shareholders.

We want to attract low-cost core deposits before using things like customer CDs and wholesale sources at a higher cost. Second, we want to get fairly compensated for our credit risk. Third, we want to identify changes in the credit risk early and deal proactively with these changes. And finally, we want to exploit what we believe is a target-rich market, given relationship disruptions at our large competitors and weaker institutions.

As Jim pointed out, the fourth quarter was a difficult one. But it clearly displayed the loyalty and support from our portfolio of Chicago area customers. During the quarter, we noted a fair amount of fear throughout the financial sector. There was negative news about our country’s oldest and most prominent financial institutions. This negative press did not overlook Midwest Banc, but thanks to the strong relationships built over the years, we found with very rare exception that our customers remained loyal to our company and loyal to our people.

Loans during the quarter were essentially flat. Feeders rose from $33 million to a peak in November of $58.9 million, almost $60 million before settling to $41.6 million at year-end. At Midwest, all feeders’ deposits belong to our customers. We have not purchased any pools. Customer balances during the quarter were essentially flat and the halo effect of TARP's arrival in early December resulted in feeders' balances moving into core which of course will be margin friendly. Core balances moved up in December and (inaudible) core continues during January.

Under the heading fair compensation for credit risk, let me talk just a minute about rate floors. Currently, half of our floating rate loans have floors. In the fourth quarter, 62% of renewable variable rate loans had floors. The vast majority of all new transactions of variable rate loans have floors. Customers response has been promising because it's logical, given market conditions to use rate floors and competitors are moving in the same direction. Rate floors will be another key to growing a profitable loan portfolio and JoAnn will comment on this area later on this morning.

Finally, let me highlight several first quarter initiatives important to our company. We plan to launch an aggressive, high-level customer contact program involving Jim, myself, plus the executive team, with relationship managers calling on our customers. These calls will focus on building core balances, cross-selling, and credit monitoring. We know that we have good customers in our portfolio and these folks know other good potential clients and some of these business owners are experiencing service disruption at their large bank or even a credit freeze if they are at a weaker competitor.

Secondly, we're going to launch a new marketing campaign which will describe Chicago-style banking through the eyes of a 50-year-old company that understands its market and delivers. Finally, we will add an additional dimension, as Jim kind of referred to, an additional dimension to our loan review process, as executive management meet with our corporate account officers doing portfolio reviews. I've set in on several of these. We discuss credit issues, we discuss industry trends, we discussed cross-sell opportunities, and it's extremely helpful since we go through each and every credit.

With that, I'd like to turn the floor over to Tom who's going to expand further on our credit portfolio.

Tom Caravello

Thanks Jay. I'd like to make a few quick comments and observations concerning the bank’s loan quality in year-end December loan data related to past due loans, non-accrual loans, troubled debt restructured loans, and charge-offs. Some specific initiatives that the bank has taken that will not show up in our numbers is the increase in both competency skills and the addition of additional resources to the credit administration function to ensure credit quality, risk identification, and risk management.

The current economic and credit markets are the most challenging that we have encountered. The challenges are not only to our local community base of customers, but has also expanded nationally and internationally, and have directly or indirectly affected many of our customers. We continue to work with our customers to provide them with the products and services, and most importantly, the loan funding that takes into account the current economic environment.

Past due loans 30 to 89 days were a little over $25 million or a little over 1% of total loans. Of that $25 million, approximately $9 million or 35 basis points were in the 60 to 89 days past due category. Approximately $5 million of the 60 to 89 day past due loans were in residential one to four and residential construction loan-type categories. Of the $25 million of past due loans, loans past due 30 to 59 days totaled $17 million or 68 basis points with primary loan types past due consisting of residential one to four construction, commercial real estate, non-owner occupied, and some C&I credit.

Most, if not all, of the residential construction past due loans consisted of improved, finished properties for sale. While the Chicago and suburban real estate markets continue to see slowness and continuing declines in real estate values, we believe the original underwriting guidelines and continued monitoring of real estate values provide the bank with a reasonable reserve to work with our customers in many of their situations. Overall, loans past due 30 to 89 days stood at a little over 1% compared to the prior quarter ratio of a little under 1%.

Non-accrual loans were a little over $61 million as of December year end or approximately 2.43% of total loans. That compares to the prior quarter percent of 2.42% in the prior year end percent of a little under 2%. The bank has also identified an $11 million credit to one borrower that we have identified as a troubled debt restructured credit that we have entered into a loan agreement with that borrower that we believe we will receive back all of the principal and interest as the loan is currently structured.

Of the $61 million of non-accrual loans, a little over $27 million is in the construction and land development category. Within that $27 million of non-accrual loans, there are three credits that comprise approximately $19 million. But the bank has additional specific reserves of approximately $2 million after having aggressively charged off over $23 million of the original loan balances for these loans based upon current and updated evaluations of the remaining collateral.

Remaining past due loans for the construction and land development portfolio, which is a $366 million portfolio, are a little over $5 million or just shy of 1.5%. It should also be noted that based upon remaining availability of the loans within the construction and land development category that most of the bank's loans are in a near completion or completed stage as to the projects.

I am not suggesting that there may not be additional risk to that portfolio, but I am suggesting that we have identified and addressed risk exposure quickly and with resolve. You have been provided additional specific information as to the portfolio breakdown and related past dues, non-accrual loans, and specific reserves in the release information.

The bank charged off a little over $55 million of loans in 2008, with the largest charge offs occurring in the construction and land development category. The next largest category of charge offs were in the commercial real estate category at a little over $13 million. The bank has also, during this year, reviewed all impaired real estate secured loans with a minimum 25% or more discount to the current updated real estate valuations to determine potential exposure. As an example of some of our charge offs, the three largest non-accrual loans that we have as it relates to the charge offs in the original loan balances of those credits, we have charged those credits down 45% to 55% of the original amount of the loans.

The bank did have a regulatory review of its loan portfolio during the fourth quarter of 2008 that confirmed the bank's credit administration process as far as credit risk identification and administration of the bank's loan portfolio that resulted in no new marks and no new problem credits being identified.

In summarizing, we would continue to approach the current market cautiously and to approve upon our underwriting and credit administration processes that ensure a high level of credit quality while continuing to lend in this market and work with our existing customers who are also facing challenges.

With that, I'm going to turn it over to JoAnn.

JoAnn Lilek

Thanks, Tom. I'm going to touch on capital first. MBHI was well capitalized at the end of 2008 with a total capital ratio of 10.07%. When the market stabilize, as Jim said, we will likely look at the opportunity to raise more capital, but we don’t need or want to do this in the current market and we don’t believe that it's in our shareholders' best interest to do so right now.

What we think is important is that Midwest Banc is well capitalized. We have a total capital ratio at the bank of 10.54% as of year-end. This gives us adequate capital to take advantage of opportunities that we see in the Chicago market and to implement our budgeted growth plan for 2009. Finally, in the spirit of TARP, we do have the ability to downstream more capital to the bank if that becomes needed in order to continue to support growth.

I'm going to touch on our margin next. Our net interest margin decreased 26 basis points and our net interest income fell for the quarter. This is because the prime rate fell to 3.25% during the quarter and the GSEs that we wrote off in the third quarter impacted our fourth quarter results as their dividend was suspended. There were several positive developments in our margin toward the end of the quarter that will help to mitigate downward pressure and hopefully drive upward improvement in our margin.

First of all, as Jay discussed, we have floors on all types of loans that we book. They've been implemented for all new and renewing loans and the floors are holding. Because of these floors, our earning asset yields were flat each month during the fourth quarter despite the falling interest rate environment.

Second thing that is very positive for our margin going forward is we see the spread between LIBOR and fed funds narrowing, particularly for 30-day LIBOR. This saves us $150,000 a month on average compared to our fourth quarter numbers on our bank debt. And finally, the TARP money was received on December 5th so late in the quarter and we will see the full favorable impact of it during the first quarter. Our retail CDs continue to price downward and we would expect to see that for the next several months assuming rates remain low as our forecasters are all indicating. And then finally, our margin improved each month during the fourth quarter.

I’ll touch on non-interest income briefly. Our non-interest income was below the third quarter level in our trust and brokerage areas, and that was because of negative conditions in the capital markets. Our deposit charges were steady in the fourth quarter versus the third quarter and our other non-interest income which includes certain investments that we have related to CRA programs and other bank fund investments increased because the value of those investments increased.

In the non-interest expense area, the increase that we saw was in the salary and benefits and the professional services fees. These both increased compared to the third quarter. All of the increases in both of these categories represent a non-recurring type of expenses as described in our release. I want to stress that our headcount was down by 14 people for the quarter and our expense control remains very tight with every headcount that we add being specifically approved.

With that, I’ll turn it back over to Jim.

Jim Giancola

Thank you, JoAnn and Tom and Jay. With that, we will be happy to take questions from anyone on anything that's been said or anything that's in the press release.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from Carl Busca [ph] at Busca Family Partners [ph].

Carl Busca - Busca Family Partners

I'd like to revisit the subject of those abysmal Fannie Mae and Freddie Mac purchases. Can you tell us when those were actually purchased?

Jim Giancola

The last of them were purchased in 2004. Most of them purchased before then. At the time that they were purchased, they were very specifically aligned within our policy. They were AAA rated. The credits were downgraded in June to, I believe, a AA rating. We monitored those credits and reported those securities to our OPCO [ph] committee and Board on a regular basis. When they were further downgraded, we took a charge in June. We talked with every significant market maker of those securities to solicit input on whether this was a temporary deterioration of those credits or whether we thought that those credits would rebound. Substantially to a person, the feeling was that the market had overreacted and that these credits would come back, the securities would come back.

Carl Busca - Busca Family Partners

Obviously, those people were wrong as was the bank wrong in continuing to retain them at such a high level of capital.

Jim Giancola

That was a mistake. They were investments grade, on the Friday night before Mr. Paulson put the institution into receivership. And so that’s an unprecedented activity. It never happened before and we made a mistake. We were not the only ones. We don’t take any thaws from the fact that there were several hundred banks that took that loss, but again, it was an unprecedented activity and it happened.

Carl Busca - Busca Family Partners

People responsible for those purchases still employed by the bank?

Jim Giancola

Actually, no they’re not. We have a new Chief Investment Head, but that is not the reason. Those investments were reviewed by the Board of Directors, by the OPCO committee, by me, by other folks. And as I said, we’re talking about AAA investments that have tax advantage yields and we’re certainly not anything that were esoteric or viewed to be esoteric.

Carl Busca - Busca Family Partners

In light of the poor decisions made about loans in the past, the failure on the part of the Board and top management with regard to these preferreds certainly qualifies for something more than an apology. I would think multiple resignations would be more in order.

Jim Giancola

Well, I appreciate your opinion and we are all – nobody is happy about the current performance. I will say that we are right in the middle of a pack in terms of credit quality, that if you review the fourth quarter earnings releases of the banks in Chicago, our performance is going to be at the high end of that range. We are in a terrible recession that is real estate and financial industry related and no one is immune from what’s going on. I guess next question?

Operator

Our next question comes from Ben Crabtree of Stifel Nicolaus.

Ben Crabtree – Stifel Nicolaus

Yes, good morning.

Jim Giancola

Good morning, Ben.

Ben Crabtree – Stifel Nicolaus

I guess several questions. I probably could calculate it but I might be wrong. What’s the tangible common equity ratio or what’s tangible common equity?

JoAnn Lilek

Tangible common equity, the tangible assets is 2.57, Ben.

Ben Crabtree – Stifel Nicolaus

Great, thank you.

JoAnn Lilek

You’re welcome.

Ben Crabtree – Stifel Nicolaus

I guess in a normal time, just trying to guess the tax rate is difficult. When you’re reporting a loss, it's wildly difficult, but any sense of, if we ever get back to normal in this industry, what a normalized tax rate might be for you?

JoAnn Lilek

I would say you can look anywhere from 20% to 25% for 2009. And again, it always depends on pretax book earnings.

Ben Crabtree – Stifel Nicolaus

Right. Do you have a significant – I am assuming now you have a significant deferred tax asset on the books.

JoAnn Lilek

We do.

Ben Crabtree – Stifel Nicolaus

You know what amount that would be?

JoAnn Lilek

It’s $55 million to $53 million.

Ben Crabtree – Stifel Nicolaus

Okay. And was there – you didn’t have a real big increase in non-performing loans and I’m wondering if there was a significant impact of interest income reversals built in the margin.

JoAnn Lilek

It was less in the fourth quarter than there was in the third quarter. And so, the swing on that number was an increase positive to the margin of about $300,000.

Ben Crabtree – Stifel Nicolaus

Great. And I guess the final one will be for Jim and it’s a little broader, but given the size of the bank and somewhat of a limitation on capital and probably the ability to grow and then particularly the low level of margins, what do you have to do to get the bottom line, the pretax back into the black?

Jim Giancola

Well, we are profitable on an operating basis today. The things that drive our earnings are first and foremost net interest margin, which accounts for about 85% of our revenue. As JoAnn stated, margin has gone up every month in the fourth quarter, albeit from low level, but going in the right direction. The two things that will continue to drive profitability, Jay touched on the most important one and that is, we are back to getting reasonable pricing for the risk that we take on the loan side. A year ago, the candy store was borrowing below prime. Today, there is nobody borrowing below prime and the credits are being priced much more reasonably. As we work through the portfolio, that is going to be a very revenue and margin-positive. The second is the lag in the repricing of the CD portfolio. Again, JoAnn touched on this point, as we go through the year, the CDs that are maturing are maturing and being rebooked at lower rates. That’s going to be margin-friendly. The third piece of that is the aberration between fed funds and LIBOR. Totally outside of our control but we essentially borrow at LIBOR with lended prime, those numbers are more typically 25 to 35 basis points apart, they’re more than 100 basis points apart right now, that’s margin negative. But the gap on the spread has begun to contract and that’s helping. So, we are cautiously optimistic that we’ve got a better ’09 coming than ’08 which obviously is not saying very much but there’s some positive things out there, Ben, and those are the drivers.

Ben Crabtree – Stifel Nicolaus

Is there an opportunity to change your funding from LIBOR base to some other thing to get rid of that basis point – basis risk?

Jim Giancola

We are trying to do it actually with our customers and we are more open to LIBOR based loans on the customer side so that those things will move in sync. But the holding company borrowings, troughs and things like that have historically been tied to LIBOR and there really is no way to get that changed.

Ben Crabtree – Stifel Nicolaus

Okay, thank you.

Jim Giancola

Thanks, Ben.

Operator

Our next question comes from Dan Nigel [ph], a private investor.

Dan Nigel

Yes. My question is this. Since that Jim Giancola has come in, the stock price has dropped every year and now it’s down to 95% less than what it was when he came in. The dividends have been suspended, which have been paid for over 30 years consecutively, and the equity and the shareholders have been diluted substantially because of the additional preferred stocks that were sold. And with that said, my question is this, what do you say to your employees and retirees who have their funds tied up in Midwest Banc holding stock? What do you say to them?

Jim Giancola

Again just to correct the record, stock was up 2004, 2005, 2006. It has gone down in the last two years significantly and I’m a significant shareholder, everybody on the team is a significant shareholder. Part of that is what has happened in the marketplace. We review our performance versus everyone else's. You can go down a list of very significant banks that have gone to zero and are no longer in business. Our stock has been hit by essentially three (inaudible). The first is we had credit issue with a single large credit before everyone else. That hurt us. The second was the GSEs where we had a significant piece. That hurt us. The third piece was the whole industry malaise as credit quality has deteriorated across the board.

We monitor our performance and benchmark it against other peers as we look at the numbers that have come in the fourth quarter, our numbers unfortunately are in the middle of the pack to actually slightly better than our peers. The stock price is a volatile measure of what’s going on. Long term, the stock price will correlate to the performance of the company, the earnings of the company. Suggesting that we have done something that is somehow out of sync with what is going on in the marketplace like raising additional capital or that we’re the only one that’s experienced (inaudible). That would not be a fair characterization. We have been hit more than the average bank, but we have been hit. And what we need to do now is get our heads down and make some money for this company going forward and get the stock price back to where it needs to be.

Dan Nigel

Well, you haven’t answered the question. What do you say to those employees who've taken the hit? I mean, what do you tell them?

Jim Giancola

I'll say to them Dan exactly what I just said to you and that is the industry has contracted dramatically. Share prices of all bank stocks are down dramatically. Dividends for the overwhelming majority of the banks have been reduced to zero or a $0.01. What’s happening here is not a unique to Midwest situation. The other thing we’re saying to the shareholders is that we’re trying to do all the right things going forward to build value for our shareholders, to be prudent on the extension of credit, to do what we can to control expense. And again, as JoAnn said, headcount is down, bonuses are down, incentive comp is down; we’re doing the things that we think are appropriate. We’re not happy about the share price but I’m still buying stock. Other people on the team are buying stock and we’re committed to getting this turned around.

Dan Nigel

Then my last question is this. Is it your intention to remain as CEO if the Board intends to keep you on as CEO?

Jim Giancola

Dan, you can ask that question to the Board. I serve at their pleasure as does everyone else on the management team.

Dan Nigel

Thank you.

Operator

Our next question comes from Joe Stephen [ph] of Stephen Capital [ph].

Joe Stephen – Stephen Capital

Good morning, Jim.

Jim Giancola

Good morning, Joe.

Joe Stephen – Stephen Capital

Jim, you talked about that loan pricing is improving for you and I am sure it’s improving for the industry, but I guess one of the sticking points out there for the whole industry is deposit pricing. What are you starting to see on deposit pricing, across your spectrum of business?

Jim Giancola

Deposit pricing in Chicago is still very competitive. The thing that is helping us is the loan guys are able to command compensating balances and better – just better overall relationship pricing because they’re able to get compensating balances. We’re also doing a better job of making sure that if we’re going to extend credit in this environment, put our capital at risk, we’ll be doing that for relationships. I think the point Jay made is critical. If we own the relationship, we are a lender. If somebody comes in with a transaction, we are really not interested. And so, we are looking to have more self-funding, that's probably the most positive thing on the core deposit growth side.

Joe Stephen – Stephen Capital

Jim, with that being said, has that worked out to help you guys on both sides of the ledger? I mean should that not only helped margins a little bit on a loan side, but should that also probably keep growth under control to help the cap ratios a little bit?

Jim Giancola

That’s fair statement. I don’t believe this is the time to be experiencing explosive growth. We are in a recession. We’re picking and choosing very carefully and doing the best we can to make sure that when we deploy capital, we will deploy it at reasonable return.

Joe Stephen – Stephen Capital

Okay. Thank you, Jim.

Jim Giancola

Thanks, Joe.

Operator

Our next question comes from David Leister [ph], a private investor.

David Leister

Good morning, guys. For Jim, Jay or JoAnn, two questions please. One is you spoke a little bit this morning on your capitalization is okay now, and Jay, I kind of understand where you are at with the blocking and tackling of the normal business up and how you’re going to do it. So my question would more relate to, do you think you’re capitalized enough now, and if not, how much more capital do you think you’re going to need in the future? Jim, I suppose that question is for you to take.

Jim Giancola

Yes, we are – there is enough capital at the holding company that we can downstream the bank and keep it well capitalized. The number that we could downstream is in the $40 million plus range that would allow for $400 million of growth, and we’re not going to have $400 million worth of growth on the loan portfolio in 2009. So we have adequate capital to meet our growth targets in the budget in this environment. That said, more capital is always better, but we don’t feel it is appropriate to go out and dilute the shareholders by raising capital at these prices.

David Leister

Alright. Fair enough. And my second question then, I don't even know if you're allowed to speak to it, but what is the bank's position on the TARP money, and I may have seen in the spirit of -- you're planning on paying it back? If so, when? I think the common shareholders would like to know what are you going to do with $80 million that the government gives you. I'm assuming there is an interest picket on that and they want their money back someday.

Jim Giancola

Yes. This is a 5% coupon on them and pay that 5% coupon. We have five years to pay it back before the interest rate goes up. We anticipate that sometime over the next five years, the capital markets will return to some kind of normalcy and we'll be able to refinance that out in a more traditional manner.

David Leister

Rather than earn your way out of it?

Jim Giancola

There is no earn-your-way-out-of-it. We have to raise capital to pay it off. We are earning money to pay the dividend on it.

David Leister

It's too big to earn your way out of it, I believe.

Jim Giancola

Well, to retain $85 million of earnings in the next five years, it's possible that that would be pretty aggressive.

David Leister

Yes. Alright, thanks.

Jim Giancola

Thank you.

Operator

Our next question comes from the Daniel Cardenas at Howe Barnes.

Daniel Cardenas – Howe Barnes

Good morning guys.

Jim Giancola

Good morning Dan.

Daniel Cardenas – Howe Barnes

Can you give me some insight as to the cost for your new initiatives and new marketing campaign, the addition of additional loan review functions? What kind of additional cost are we talking about?

Jim Giancola

JoAnn, why don't you talk about the anticipated increase in non-interest expenses?

JoAnn Lilek

For the year 2009, Dan, our non-interest expenses -- we're again talking about much more of a normal environment, much more normalcy on credits and all of those kinds of things. Our expense range and we will try not to get the expenses out in front of the revenue, we've built in for it and adding people and small teams. I would say the expenses will range anywhere from 2% to 8% up depending on exactly what we're doing. We're not going to get the expenses out in front of the revenue. The revenue would have to be there first before we make investments to the 8% level.

Jim Giancola

Dan, I think the other part of that is what we have in this environment is reallocation of some resources from the lending team to the workout team. People who have had some experience in the past have been reallocated to special assets so that we're working problem preps [ph] very impressively.

Daniel Cardenas – Howe Barnes

And then as it relates to the margin, you said you had some deposit re-pricing opportunities. As we look at the first quarter, second quarter, what size of deposit base are we talking about here?

Jim Giancola

We'll look approximately $150 million of retails CDs. We'll re-price and we should pick up some positive spread.

Daniel Cardenas – Howe Barnes

And what's kind of the average cost in those CDs right now?

Jim Giancola

They're over 3 and our estimate is that will be coming in 2.75, we'll probably pick up 25 basis points on that. The real margin driver is what Jay and his team have going on in terms of pricing floors. The majority of the portfolio re-prices end of first quarter, beginning of the second quarter as we get their annual financial statements in. So when those normal renewals come in and rate floors go end of life [ph], that should be margin for everyone.

Daniel Cardenas – Howe Barnes

Alright. Thank you.

Jim Giancola

Thank you.

Operator

Our next question comes from Jim Brown [ph], a private investor.

Jim Brown

Good morning and thank you. President Obama has urged all companies receiving TARP funds to avoid acquiring other companies, avoid paying common dividends and avoid bonuses and incentive compensation to executive management. Now that Midwest has received TARP funds, will you comply with these three elements of the President's request?

Jim Giancola

We will be in full compliance with the TARP rules and you maybe assured of that.

Jim Brown

I'm sorry, and short of that?

Jim Giancola

Assured of that. The TARP rules are very specific. They've been discussed in detail and we will be fully compliant with the TARP requirements.

Jim Brown

Okay. Good. One other question. We've heard comments about the erosion in the stock price and the huge write-off on balance sheet assets, the dividend for common share holders is gone. My general question is this, as a fiduciary of shareholder interest, do you believe you owe the shareholders an apology for this kind of performance?

Jim Giancola

Interesting question and as a shareholder, I am happy to say we are disappointed with the performance. That performance is not unique to Midwest Banc and I think that's important to have the performance in the context of the other institutions that are operating in our marketplace. Everybody would like to say, well, the hindsight is always 20/20. I'm sorry the stock is trading at $1.40 for a lot of reasons. But again, I think that has to be viewed in the context of what's going on in our market.

Jim Brown

Alright. Well, thank you.

Jim Giancola

Thank you.

Operator

Our next question comes from Joe Holahan [ph] of RBC Capital.

Joe Holahan – RBC Capital

Good morning gents. Question for you, regarding the provision that you have made on the real estate loans, construction loans that are outstanding, I'm just trying to look back over the notes and I thought it was like 1% to 1.5%. Is that fairly aggressive compared with your peers, or how comfortable are you in that number?

Jim Giancola

There are two ways to look at that number, Joe, the first is the absolute level of the reserve of 177 will in all likelihood be above our Chicago peers. The other is what percentage of non-performing assets are covered by that. We are in the 70% plus range that will also compare favorably to our peers. But again this whole loan loss reserve and valuation of problem assets is art. Different people are taking different marks and time will tell whether their reserves, our reserves are adequate. Obviously, we have spent a lot of time, I have a lot of confidence in Tom Caravello and his team and how we've gone through that process and marks we’ve taken are very aggressive.

As Tom said on the largest credits we have written down about 50% of value. We think that’s aggressive. We think the reserve levels which have doubled since mid-year is a conservative way to deal with the economic environment we are in and time will tell if we're right. I believe we’ve done the job. Our regulators believe we’ve done the job. Our auditors believe we’ve done the job and what we need to get is this economy beginning to move in the right direction and then everybody will be in better shape. Banks are a mirror of the economy. We are not -- what happens to us is what's happening in the economy.

Joe Holohan – RBC Capital

Thank you.

Jim Giancola

Thank you.

Operator

Our next question comes from Kenneth Puglisi at Sandler O'Neill.

Kenneth Puglisi - Sandler O'Neill

Good morning.

Jim Giancola

Good morning.

Kenneth Puglisi - Sandler O'Neill

Just a quick question on the tax benefit. I wonder if you can just give us a little more color on that. Wondering if you can say again what the amount of the tax benefit was during the quarter? What triggered that in the fourth quarter and how was the amount determined?

Jim Giancola

JoAnn?

JoAnn Lilek

The benefit that we booked related to the loss that we took on the Fannies and the Freddies in the third quarter. We booked a benefit on that of $16.6 million in the fourth quarter and the way that it rose was on October 3, the taxing authorities decided that the losses on the Fannies and the Freddies would be ordinary as opposed to capital losses. That allowed us to book the remainder of our tax benefits. We had taken an $8.8 million benefit in the third quarter. We were able to take another $16 million which means we booked the full tax benefit on the losses that we sustained last year on those securities.

Kenneth Puglisi – Sandler O'Neill

Okay. So the other $53 million in deferred tax assets that you have, I can just bring that in going forward at a normal tax rate?

JoAnn Lilek

I'm not sure I understand the question, I’m sorry.

Kenneth Puglisi – Sandler O'Neill

You have a $53 million deferred tax asset?

JoAnn Lilek

Correct.

Kenneth Puglisi – Sandler O'Neill

I should use that going forward in making earnings projections just based on a normal tax rate?

JoAnn Lilek

I would say for our book earnings projections, you should be thinking in terms of an effective tax rate between 20% and 25%.

Kenneth Puglisi – Sandler O'Neill

Okay.

JoAnn Lilek

Okay?

Kenneth Puglisi – Sandler O'Neill

Thank you.

JoAnn Lilek

You’re welcome.

Operator

(Operator instructions) Our next question comes from Dan Quirk [ph] of Seaquest [ph].

Dan Quirk -- Seaquest

Good morning guys. There are some banks out there whose accountants have forced them to write down their deferred tax assets. Is this something that your accountants are working on, looking at? Can you give us any color there?

JoAnn Lilek

The accountants have been through our deferred tax assets and they and we believe that we have enough earnings going forward to be able to justify the tax assets and there has been no valuation allowance placed against our deferred tax assets.

Dan Quirk -- Seaquest

Okay, great. And Jim, just to clarify an earlier comment, you said you’re profitable on an operating basis and my back of the envelope just says that your revenue is around $23.5 million and your expenses were around $25 million. It sounds like that [ph] will increase, but that’s excluding or my numbers exclude any loan loss provisions, can you just clarify your comment?

Jim Giancola

Yes. I think there is a lot of one-time severance expense. There’s the capital raise expense. The variety of one-time expenses that we took again aggressively in the fourth quarter to get those behind us. And so what I’m looking at is a more normalized expense level and our projected earnings level and margin levels going forward. And so, JoAnn and her team have put together run rate sort of numbers and that is the source of that comment.

Dan Quirk -- Seaquest

Okay, so would it be fair to estimate or project that pre-provision earnings would be positive?

JoAnn Lilek

Oh, yes.

Jim Giancola

Post provision.

JoAnn Lilek

Pre and post, yes.

Jim Giancola

We'll be positive.

Dan Quirk -- Seaquest

Pre and post. Okay. Great, thank you very much.

Jim Giancola

You’re very welcome. Thank you everyone for your questions. Again, we are all around today to take additional questions that you may have and again, thank you for participating and I look forward to a better ’09. Thanks very much. Have a good day.

Operator

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.

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