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Executives

Mary M. Gentry - Executive Vice President, Investor Relations

H. Lynn Harton - President and Chief Executive Officer

James R. Gordon - Senior Executive Vice President, Chief Financial Officer

Robert A. Edwards

Analysts

Ken Zerbe - Morgan Stanley

Adam Barkstrom - Sterne Agee

Kevin Fitzsimmons - Sandler O'Neill

Jennifer Demba - SunTrust Robinson Humphrey

Jefferson Harralson - Keefe, Bruyette & Woods

Christopher Marinac - FIG Partners, LLC

Al Savastano - Fox-Pitt, Kelton

The South Financial Group, Inc. (TSFG) Q1 2009 Earnings Call April 22, 2009 10:00 AM ET

Operator

Good morning, and welcome to The South Financial Group First Quarter Earnings Conference Call. All participants will be placed in listen-only mode until the question-and-answer session of this conference. 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 M. Gentry

Good morning. Thank you for joining The South Financial Group's first quarter 2009 conference call and webcast. Presenting today are Lynn Harton, 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 call, which are available on 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 reference 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 would like to turn the presentation over to Lynn.

H. Lynn Harton

Thanks Mary, and good morning. I'd like to focus on three primary topics. First; as we expected this was a challenging quarter as the ongoing resolution of credit continues to be our primary focus and the key driver of our intermediate term performance.

We continue to be both, proactive and realistic in our approach to the credit environment knowing that we can't solve problems we don't recognize.

Secondly; we're making headway on controllable items, specifically expenses and pricing.

And third; I'll offer some additional thoughts on credit. While, it's too early to tell if I'm right or wrong that can make a case that we be might be a good way through the cycle for the parts of our portfolio that have been the most stressed.

So starting with the results for the quarter. As expected, we had a net loss for the quarter driven by continued credit stress primarily in residential construction. We have been and continue to be prepared for this environment with strong capital reserves and liquidity. Our tangible common equity ratio remained at 6.05% and our reserve were built to 2.84% after recognizing net charge-offs of 109.1 million.

Our liquidity remains solid with excess liquidity of 3.9 billion and 2.8% linked quarter growth in our lower calls for deposit accounts. We also made some headway on our controllables, the fourth quarter Fed run-rate cuts and reversal of LIBOR spread anomalies through margin contraction in December and January, followed by expansion in February and March to the 2.90 range.

The result for the quarter was a reduction by 14 basis points, but we believe that we will see some expansion from this level going forward. We experienced a favorable mix shift in our customer deposits, good growth in transaction accounts, and far from our successful score with core deposit campaign during the quarter, the drivers of our expectation of improvement in net interest margin are expected repricing of CDs, better loan pricing, and more loans originated before us.

James will cover our financial results in more detail later in the call. Before turning it over to him I'd like to comment on a few initiatives we have underway at that line on slide six of the presentation. On our call last quarter, we touched on the segregation of our loan portfolio in the core relationship loans and non-core loans based on our ability to expand -- build or expand banking relationships with those specific customers and product types. With that structure in place this quarter, we gained some traction and refocusing on core relationship loans as you can see linked-quarter our core loans grew 0.3%, while non-core loans declined 8.6%.

We're also gaining momentum in our efforts to improve loan pricing, which is one of our project now work streams we completed trainings with our commercial sales teams that included clarifying our target customers and methods of delivering value. We're seeing early results of these efforts to improve loan yields and the use of loan floors on 36% of our new production during the first quarter.

We reduced operating non-interest expense, down 2.5 million linked-quarter or 6 million if you exclude the credit related expenses and FDIC insurance premiums. Also, as expected, our FDIC are down 3% linked-quarter. We realized savings in many expense categories, good overall expense control by team members throughout the organization.

We also took actions to keep our expenses under control going forward including the announcement of no merit pay increases for all employees and a 50% reduction in 401K match for our employees. These are not popular items but certainly important since we know we face continual expense headwinds for loan collection calls and FDIC insurance premiums. Our evaluation of our corporate campus alternatives are nearing completion with a final recommendation to the Board regarding strategy expected in May.

Phase I of the project now is well underway with our eight initial work streams on track for utilization of 10 to 11 million of expected benefit from second half of '09. Our anticipated pre-tax operating benefits of 18 to 20 million include revenue improvements of 12 to 13 and expense items of five to seven.

As we discussed last quarter we have a new management team in place, we're focused, energy and team work around our mission in moving our company forward. In the last few weeks, Tom Holland has joined us as Director of Mortgage to take advantage of current mortgage opportunities. We frankly have underperformed in mortgage, and I believe that Tom will lead us to improved performance in this area.

Now I'd like to turn to credit quality beginning on slide seven. As expected, residential construction and housing related loans continue to be the primary stress, as they have throughout the cycle to-date. As detailed in the appendix residential construction net charge-offs for the quarter were 32.6 million, up 8.1 million from the previous quarter. Mortgage net charge-offs were 26.3 million, up approximately 15 million from the previous quarter.

And in a minute, I'll talk about the drivers of the mortgage losses, however I do want to point out that balances in both of these stress pieces of the portfolio are down significantly over the past year. It's summarized on slide seven.

While, we're seeing some signs of increased loss levels of slightly higher losses in our income property C&I and consumer portfolios, neither the pace nor the severity of these increases approach what we've seen over the past year at residential construction.

Our provision of a $142.6 million, exceeded net charge-offs by $33.6 million, as we continue to build reserve to reflect economic conditions. Non-performing assets increased to 5.8% during the quarter. Partially due to the fact that we continue to see loan, fewer loan sale buyers in the market.

A function we believe of a combination of waiting on the part of buyers either in the belief that prices will lower, or a desire to see how the government plans will effect them, and a lack of financing for buyers as well.

We have seen a noticeable increase in the number of interested parties in the last 30 days. But it remains to be seen where the transactions will materialize.

Slide eight and nine are new to our materials. In these unusual times, we know that you are all trying to understand how much of the cycle we have been through and how much remains.

We believe that origination vintage can provide some insight into that question, we started to share value information with you. The loss vintage chart on slide eight includes the entire commercial portfolio, including residential construction.

And as you can see that 2005 to 2007 vintages have noticeably weaker performance with earlier defaults out of cumulative losses, and while the chart doesn't show this, they also have had non-accruals.

There are several reasons for this performance, first and primary, our economic. And all vintage studies that I have seen for another institutions they have post '05 and '07 originations have market like weaker performance due to the inflation of collateral values that are current during that period.

Additionally, economic conditions in that period are very strong during that time encouraged increased risk taking throughout the lending industry, particularly in residential construction. That is now being realized as increased loss rates in these products and vintages.

Economic conditions we can't control, however I would note that we have changed underwriting practices with significant changes in both; people and processes since that time. And while it's too early to fully predict, it does appear that the 2008 vintage originations are much more normal in risk, perhaps similar to the pre '05 originations.

Slide nine gives further detail on the commercial portfolio vintages that the first column give a cycle beginning balance for our outstanding loan balance in each vintage and product as of December 31, 2007. Next, we have accumulated cycle for debt losses. In other words, total losses we have incurred since the December 31, 2007 in each category.

Finally, we show our current balances by each category and how much of our current balances have already been placed in non-accrual and therefore addressed either be a write-downs and/or specific reserves.

There are some observations I would make. First you can see the similarities that were for trade classically on the previous slide, and the 305 and post '07 vintages in terms of cycle to-date loss percentage the non-accrual percentages. And you can see how much better those vintages have performed in the 2005 to 2007.

Secondly, I will point that the C&I balances seem to be performing consistently across all vintages including the '05 to '07. That's not to say that P&L won't weaken as we continued in the recession, but it does imply that we should not see the '05 to '07 vintage perform materially worse in C&I.

Third, as we look at income property, all vintages are performing well with the exception of Florida income property during '05 to '07. We are see more tenant weakness in the Florida market. And I would expect those particular Florida income properties to perform below the standards of other markets and vintages driven much more of our tenant fee issue than underwriting issues.

Finally as expected, the Florida residential acquisition development construction, '05 to '07 vintages are worse performing with cycle to-date losses of 79.8 million and current non-accrual balances of 114.4 million. The good news on this portfolio is we are clearly past the halfway point of dealing with these loans.

Moving onto slide 10, I would point out at the bottom of the page that past due did declined slightly during the quarter, but still remain at relatively elevated levels. We've already touched on the commercial portfolios, but it should be noted that our indirect and home equity continued perform very well for the environment.

We do need to spend more time on mortgage, which had losses of 26.3 million for the quarter. Additional retail and mortgages provided on slide 11.

As you can see in the shaded portion of the slide, our charge offs continue to be concentrated in the lot loan portfolio. Nearly 90% of those losses are concentrated in four developments, and we originated through the mortgage channel as opposed to our normal branch origination process for lot loans.

At this point, we believe we are well over halfway through the losses on these sub-divisions with an expectation of 8 to 10 million in additional losses remaining.

With the plight we have placed additional credit information in the appendix for your review. However at this point, I would like to turn it back to James for additional discussion of first quarter results.

James R. Gordon

Thanks Lynn. And again, welcome to everyone on the call.

As we expected, we entered 2009 with same credit challenges that arose in 2008. We are confronting those challenges with sound capital reserves and liquidity, while transforming the company for opportunities beyond the cycle. Our GAAP net loss available to common shareholders totaled 90.8 million primarily driven by 142.6 million provision for credit losses. We summarize some of the more unusual items for the quarter on slide 5, now I'll talk about many of these in more detail throughout the comment.

Before discussing the results for the quarter, I want to first address capital as outlined on slide 14. We ended the quarter with a tangible common equity ratio of 6.05% unchanged from our year-end ratio. The conversion of 49 million of our mandatorily convertible preferred stock, a 14.5 million net increase and other comprehensive income due primarily to changes in interest rates, and a $16 million decrease in tangible assets offset our net loss and dividends for the quarter.

When evaluating our tangible common equity positions, we believe our most important lever is the conversion of our remaining 190 million and mandatorily convertible preferred stock, which will without further action of the company as a holder converted into 29.2 million common shares in May of 2011.

That is of course is not converted earlier is normally or through inducement similar to the transaction completed during the first quarter. After the May 1, 2009 dividend payment, we will have approximately 38 million or two year of remaining dividends, which can be normally settled at a discount in an induced... early conversion transaction.

For example, we issued 2.5 million share valued at approximately 6.5 million and remaining $10.5 million of dividend on the 45.3 million conversion completed in the first quarter. We'll continue to be opportunistic about converting the preferred stock going forward as conditions allow. Additionally, we continued to evaluate smaller transactions to improve our tangible common position.

For example, in early April, we repurchased 25 million of our outstanding REIT preferred stock, of which only 40% was included in tier 2 capital at an $8.5 million discount. In the second quarter 2009, we reported 8.1 million non-taxable non-operating gain related to the transaction, which will improve our tangible capital position.

Additionally the REIT preferred stock at a coupon of LIBOR plus 350 basis points, which was replaced with lower cost funding, so it should have a positive ongoing net interest margin benefit as well.

We continue to project and analyze our potential credit losses from the cycle and continue to believe we have enough tangible common equity given full consideration at the conversion and the mandatorily preferred stock through the cycle even in stress scenarios through the end of 2010. However, we will prudently evaluate all capital opportunities as they are rise, including liability management conversion of the preferred stock as well as the treasury's capital access program above private (ph) investment program et cetera.

And looking at the net interest margin, we expected a decline from our fourth quarter level of 2.97% on the significant federal reserve rate cuts and it changes the LIBOR spreads from the fourth quarter. We have approximately 3 billion of prime base variable loans and 2.5 billion of LIBOR base variable loans, which contributed to an overall decrease in the loan yields of 65 basis points during the quarter and have been fully reprised into the margin at this point.

A 61 basis point decrease in our rates on wholesale borrowings partially offset this decline. Deposit pricing however as process forward on the absolute level for most non-maturity products. Although, we did see a 50 basis point drop in money markets and a 10 basis point decline in overall CD rates.

Starting in mid-January, we began to see more rational and consistent pricing of CDs in our markets, and we expect the reprising of our CDs to provide positive momentum on the margin moving through the remainder of 2009. For additional information, we have summarized in the CD maturity amounts and rates about quarter on slide 15.

Yet the carrying costs associated with non-performing loans and related charge-offs as well as the maturing derivative as in transaction will continue to put pressure on the margin moving forward. The overall duration of our investment portfolio is shown page 5 of our financial supplement continues to decrease as interest rates fall and refinancings accelerate.

Our liquidity remain sound as our overall customer funding base stabilize both in terms of mix and level through various initiatives taken by the government to those confidence in the banking system as well as our continued focus on growing core deposits as Lynn mentioned. Additionally, our secured borrowing capacity totaled 3.9 billion at the end of quarter, which is summarized on slide 17.

At quarter-end, our parent company cash totaled 194 million, and we have no parent company in terms of maturities until 2033. Parent company cash totaled approximately five years of current fixed obligations. Although this cash could partially used to provide further capital support to Carolina First Bank, our principle banking subsidiary as we move through this environment.

Looking at non-interest income on slide 18, the primary impact was related to seasonal trends in the overall economic downturn, which decreased customer confidence and related customer spending, and negatively impacted in the sales debit card and merchant processing revenues. With the recent declines in mortgage rates, we have seen increased levels of refinancing activity, which should help drive mortgage revenue higher during 2009.

During the quarter, gains of certain derivatives transactions were 1.1 million, primarily due to recording changes in the value interest rates swaps no longer qualifying for hedge accounting and the ineffectiveness of other hedging relationship due to differences in movements of values of the underlying interest rate swaps and the asset to liability to restate your hedging.

As we discussed last quarter, we are focused on reducing our core non-interest expense. As shown on slide 19 and 20, we reduced operating expenses, excluding credit related and FDIC insurance premiums by 6 million while absorbing 1.3 million of Project NOW related expenses.

We continue to expect FDIC premiums to increase with the proposed changes effective during second quarter from 4.7 million this quarter to average approximately 6 to 6.5 million per quarter for the remainder of 2009.

This amount does not include the proposed FDIC special assessments, which at the current proposed 20 basis points level would be approximately $20 million although not finalized then we hope it will be significantly reduced before it is finalized.

Loan collection expenses are expected to run above the current level and are difficult to estimate given the nature of the expenses. However, we have hired additional resources as employs to assist and controlling in reducing these costs as we move forward.

During the quarter, we reflected 1.9 million in combined losses on other real estate loans and loans held for sale upon resolution of those related assets. And other real estate loan increases, we would expect additional write downs if the assets are held over longer periods of time.

During the first quarter, we repurchased 6.9 million of auction rate preferred stocks and mutual funds from various customers and recorded an impairment charge of 0.7 billion. We don't expect any further losses on those assets as the amounts are liquidated.

Also we evaluated our portfolio, whether investments, which I mentioned last quarter, which are included in other assets and totaled approximately 18 million and recorded a $2.9 million charge for impairment of those assets. 2.5 million was related to one real estate investment, with the remaining caring value of 2.2 million.

Finally, looking at our current GAAP deferred tax asset at approximately 65 million, we have determined that the asset is fully realizable based on future taxable income during the 20 year carry-forward period. Additionally, we have contract receivables for the carry back for 2008 and 2009 losses to prior year, still being approximately 70 million.

For regulatory and capital purchases, however, 95.5 million of deferred tax assets have been deducted from Tier I in total capital ratios for both the holding company and the bank. As capital regulations only allow 12 months for taxable income projection. This allows for regulatory purposes reduce TSFG's Tier I and total capital ratios by approximately 82 basis points each at March 31, 2009, compared to 51 basis points at December 31, 2008.

And looking at the remainder of 2009, we expect the tax benefit to be in the 35 to 40% range.

With that I will now turn it back over to Lynn for some closing comments.

H. Lynn Harton

Great, thanks, James. I will close with a few comments on our expectations for the rest of 2009. First, the environment results will remain challenging, although our overall credit outlook has not changed.

Our assets, major portfolio sales, we believe that credit losses will remain elevated in the second quarter and begin to decline slowly in the second half of the year. We remain focused on accelerating resolution of these issues and moving through the cycle. We also recognize the need to rebuild our pre-tax, pre-provision operating income, our net interest margin outlook is improving from the downward repricing CDs and returning to the roots of relationship banking. That is getting better pricing on loans, collecting loan stages and lower -- shifting the mix to lower cost transaction deposits and reducing non-core lower margin loans.

Obviously, we also honestly intend to remain focused on improving fee revenues and controlling non-interest expenses. We plan to continue to reduce our non-core loan portfolio, partially offset by growth and lending to core customers. And we would expect quarterly declines from non-core loans similar to first quarter at non-levels for each quarter the remainder of '09.

In addition to continuing our proactive and realistic approach to credit, 2009 is a rebuilding year. We focus on what we can control and work to deliver on some of the upside potential on our core banking operations.

I believe that this franchise can deliver great value post recession, and our entire team is committed to making that happen. The South Financial Group appreciate your support. And we'd now like to open it up for questions.

Mary M. Gentry

This is Mary. We ask that you limit your questions to one primary question, plus one follow-up. If you have additional questions, simply reenter the queue. We are ready for the question-and-answer session to begin.

Question-and-Answer Session

Operator

(Operators Instructions). Ken Zerbe of Morgan Stanley. You may ask your question.

Ken Zerbe - Morgan Stanley

Hi, good morning.

H. Lynn Harton

Good morning.

James Gordon

Good morning.

Ken Zerbe - Morgan Stanley

I guess my first and probably the only question. Just when you think about the shift towards your core markets and obviously, the decline in your non-core loan portfolio, how long should this process take for you to be substantially through and because I saw your comments just there about the decline should be similar to first quarter, but how should we think about that? Are you in terms of -- I guess overall balance sheet growth or decline?

Is there something where we should see a substantial reduction in your balance sheet hence possibly helping your capital ratios or is this you expect to keep your balance sheet relatively flat over the next several years?

H. Lynn Harton

Yeah, great question. It will decline the balance sheet will decline before it begins to build again. If you look at the rough percentages of amount of dollars in the non-core, it's about $2.5 billion. It's about a, we expect about a four to 4.5 year run-off of that portfolio. We would expect the core fees to grow at an increasing rate as the economy improves.

So obviously, your core business is defined lot but loan demand right now is week. So, while the core is growing slowly now is growing, but we'd expect that pace of growth to pickup over the next several quarters as the economy improves.

Ken Zerbe - Morgan Stanley

There is not as much as the decline in the non-core I guess?

H. Lynn Harton

Yes, that's right. It's certainly not for the next four to six quarters.

Ken Zerbe - Morgan Stanley

Okay, great. Thank you.

James Gordon

Thanks.

Operator

Adam Barkstrom of Sterne Agee. You may ask your question.

Adam Barkstrom - Sterne Agee

Hey, everybody good morning.

H. Lynn Harton

Good morning, Adam.

Mary Gentry

Good morning.

Adam Barkstrom - Sterne Agee

Hey, I want to follow-up on the last question. And I guess maybe if you could take a minute and talk about the core versus non-core, and how we're looking at that and what is core versus non-core, maybe some -- just some color around that. And then I have a follow-up.

H. Lynn Harton

Sure. We're really trying to focus on really relationship high transactions, so probably the easiest example is, the majority of our indirect auto is in non-core. We do or continue to do some indirect auto business or auto dealers who have deep relationships with us. So that the relationship tie is there. But many of our indirect auto businesses were done, the auto dealers that we didn't have a relationship with and we were not able to penetrate the relationship with our ultimate customers, consumers.

So that we moved in the non-core, a portion of our shared national credit business was placed in non-core where we still maintain relationships with several large corporate customers that are in our markets. And we have a strong relationship with the owners. But we were in some shared national credits, we're frankly, we had a small fees from a very large transaction and really couldn't penetrate that relationship. So we've put that in non-core loan and exit those type of relationships.

As opposed to core businesses, which are really small business, family business, locally owned businesses, where we can maintain primary relationship who are strong secondary. Our home equity businesses which had originated through the branch, and again all customer oriented. So the primary focus is really customer and our ability to prevail a relationship in multiple services with them versus just transactions.

Adam Barkstrom - Sterne Agee

Okay. I want to follow-up with a couple of things. There is a footnote in this I guess this time around about the impaired loans and how that's not included in non-performing this time around. I am curious what the -- just sort of what the change and thinking is there? And then also just wanted to make sure that you guys assuming the restructured loans or not included in non-performing? And then also wanted to ask you on the impaired loans, the impaired loans that you report those would or would not already be in the non-performing asset number?

James Gordon

Okay, Adam this is James. On the TBR, that we're not including, those were our performing loans that we restructured. Our general guideline is if you restructure a non-performing loan, you do not bring down, until they last six months of performance. So these were loans that were performing that we took some restructuring activities to keep them performing. And so therefore, we are not putting them in the non-accrual total.

Because that's going to continue to rise particularly in the mortgage bucket. There was 3 million or so in mortgages. In that 11 million, saw a number that we disclosed.

On your second part of your question related to impaired loans, impaired loans are basically commercial, non-accrual loans, FAS 114.

Adam Barkstrom - Sterne Agee

Got it.

James Gordon

Those would be roughly the same as that, except a small difference between the two numbers. But it is generically non-accrual commercial loans that are evaluated individually as over a $1 million or they approve under million dollars.

Adam Barkstrom - Sterne Agee

Right, that's I just wanted to make sure. Okay. Thank you, gentlemen.

Operator

Kevin Fitzsimmons of Sandler O'Neill. You may ask a question.

Kevin Fitzsimmons - Sandler O'Neill

Good morning, everyone.

H. Lynn Harton

Good morning, Kevin.

James Gordon

Good morning.

Mary Gentry

Good morning.

Kevin Fitzsimmons - Sandler O'Neill

Hey Lynn, you said right at the outset that you think you could make a pretty good taste why we're a good way through the cycle, particularly on the stress portfolio. I wanted to give you that chance. Just if you can expand on that thinking a little bit and then on a separate note, if you could talk a little bit about C&I and commercial real estate, I think you indicated that directionally things are deteriorating, but you are not seeing the signs of things deteriorating at a rapid pace, if you could just talk about what you are seeing there? Thanks.

H. Lynn Harton

Sure, great question, Kevin. On slide nine, in the vintage piece, the part is really given us the biggest amount of this has been that '05 to '07 residential ADC. So if you look at, we came into the cycle with 507 million outstanding. Plus an additional amount of committed but unfunded, so that's your starting point.

So this, as we stand today, we got 334 outstanding, but a 114 of that has already been placed on non-accrual and, therefore, as either we had write-downs on it or specific reserves. So worse case we had 200 million left of the 507. I would argue it's the strongest 200 million of the 507 which is why it has remained performing, but even if it was, which I think it is, we are clearly over half way through with that.

The next most difficult piece of that commercial ADC and the same kind of math works there as well. The other piece of stress is the course of mortgage portfolio. We talked about that in particular as mortgage loss, and we believe well more than half way through the mortgage loss side as well.

And a question, probably a follow-up question on slide 9, is going to be, what about CFB residential ADC from '05 to '07. We've got $420 million there. And I'll make a couple of points there. One is, there is a couple of significant differences in that bucket versus the Florida bucket. And the one the collateral value appreciation was not as rapid. And so you're going to have less of a boom, you don't have less of a bust.

Secondly, as I mentioned all along, a stronger relationships, better brand, better quality in that portfolio. So, while we will see some additional losses at about piece of it is not going to look like Florida, and we believe the Florida piece is more so that and we believe we are certainly more than... we're more than halfway through the past.

Kevin Fitzsimmons - Sandler O'Neill

Okay. And then Lynn, just what your thinking is on CRE and C&I?

H. Lynn Harton

Well. As I mentioned on the C&I side, all of the vintages are performing about the same. And we are at this point, which makes sense and the C&Is are longer lead time to sell. You didn't have the run up in collateral values that induced weaker underwriting. I mean it was just more consistent portfolio, so number one, I would say that C&I across all vintages are going to perform about the same.

Our C&I issues that we've seen to-date have continued to be crossover from residential real estate. So, it's C&I, but it's the cabinet manufacturer. It's C&I, but it's a real estate brokerage company. Now, I do expect C&I to weaken across the board. But it's going to be in my mind even weakening. And it's not going to be as dramatic as residential place.

On income properties, we're seeing the same issues. It's primarily a retail issue at this point. Some weakness in hotel. We've got... and we'll next quarter, we can get better detail on the individual pieces of those portfolios. I won't say in retail, we've got about 400 million across all vintages, hotels got around 2 to 300 million across all vintages. The only place, we are seeing is show up in performance numbers today is in the Florida piece. And again it's driven by tenant fee issues in Florida, where that economy is just having a rougher time.

Kevin Fitzsimmons - Sandler O'Neill

Okay, great. Thank you

Operator

Jennifer Demba of SunTrust Robinson Humphrey, you may ask your question.

Jennifer Demba - SunTrust Robinson Humphrey

Kevin actually took my question. But what would you see is the biggest risk to your feeling that credit costs could decline as the year progress?

H. Lynn Harton

The real question is going to be on the second half, how deep that recession goes. That's really what we're focused on trying to understand at this point. I think the biggest variable.

Jennifer Demba - SunTrust Robinson Humphrey

Thanks a lot.

Operator

Jefferson Harralson of KBW, you may ask your question.

Jefferson Harralson - Keefe, Bruyette & Woods

Thanks. I also follow up on the vintage chart. So, on the category you're seeing that, we believe that we are more than half way through. Is this specifically the Florida residential AD&C or just some other categories of that middle vintage as well?

H. Lynn Harton

Yeah, the Florida resi ADC and commercial ADC both of those, we believe were more than halfway through. And you know, so in the question only... and those also remember have much shorter weighted average line. So you recognize problems more quickly on both of those categories of products regardless of which vintage they're in, so it would they are addressed more rapidly and you get ahead of them more rapidly.

Jefferson Harralson - Keefe, Bruyette & Woods

And is it fair to say, I suppose that the expected cumulative losses of those portfolios based on their end of '07 balances would be less than 30% and then less than 7% respectively?

H. Lynn Harton

At this point I wouldn't... I don't have my stress numbers in front of me, but part of reason to play this out for you, so you can make better comparisons like that.

Jefferson Harralson - Keefe, Bruyette & Woods

Right. Because it seems like your 16% and 4% of the write through and you're saying you're than half.

H. Lynn Harton

Yeah, right; that's right.

Jefferson Harralson - Keefe, Bruyette & Woods

Okay. And if you were to sell these loans, obviously the buy price in the market would be a lot less than that. Do you think the difference between your estimate of cumulative loss and the price in the market is simply the rate of return on... for the buyers? Or do you think that the buyers would be putting a higher cumulative loss rates on the same assets?

H. Lynn Harton

I think two points: one is we do have, remember, additional specific reserves, a portion of which. So in addition to the losses have been recognized. There have been losses recognized in our income statement that would have these loans at slightly lower balance well. So one issue is, there is real value different that we've recognized through the income statement; that's a little lower.

Secondly, your point about returns on buyers, I mean, we're seeing buyers in the market desiring substantially a 25% compounded unlevered return, which that has a huge effect on what you value the asset at. So that would be the primary difference level.

Jefferson Harralson - Keefe, Bruyette & Woods

Okay, thank a lot Lynn.

Robert Edwards

And you've also got to consider that how much we've built the reserve during that period on top of that by 150 million of which, I will talk about would be in the 67 specific reserves if you add all that together, you get to that more mid point.

Jefferson Harralson - Keefe, Bruyette & Woods

And would that change... I see the loss percentage category, the 15.7% for residential AD&C and commercial AD&C, the 3.7. Would the reserve building, you're talking about the lower balance, would debt, I guess queue those two numbers, where if I am thinking about the cumulative loss you guys ultimately have on the residential AD&C when you're talking about being halfway through. Should I think about it being 30% and 7.5%, or should I... or is there other thing I have to take into account like reserve building and the lower balances?

Robert Edwards

I think you... I need to take into account, the specific reserves, which are on total residential construction is 28 million as shown on slide 28. And most of that would apply to Florida, not all. Then obviously one of the bigger reasons for the reserve, just the rest of the reserve building in general was the residential construction portfolio in Florida. It's hard to say. But if you added a 28 to the 79.8, and then calculate to that percentage, that would be closer to your loss assuming that you end up losing in writing off that specific reserve will get you to a higher percentage obviously. And then target the fully quantified how much is reserve build outside of that 28, it's specifically attributable to the even if you took let's say one-third of it, 50 million, it would obviously get you to a higher percentages.

Jefferson Harralson - Keefe, Bruyette & Woods

All right. Thanks a lot. That's great.

Robert Edwards

Okay.

Operator

Christopher Marinac of FIG Partners. You may ask your question.

Christopher Marinac - FIG Partners, LLC

Hi, James, just a kind of extend on that same point. What's the suggest of the frequency just the frequency of the problem is not a lot higher than you've seen them. I am thinking beyond the Florida residential and commercial AD&C. Just looking at the rest of portfolio. That really has more benign issues an d losses at this point.

H. Lynn Harton

This is Lynn. Make sure I understand the question again.

Christopher Marinac - FIG Partners, LLC

If we trying to understand the frequency of MTAs, and then the next step obviously is severity of losses. But just on a frequency of what's going wrong in the MTA balance. Why would... I mean it seems that some of these percentages are low when you move outside of the AD&C portfolio. I understand your point about being halfway through or thereabouts. But what's the suggest that you still have large losses coming from the other portions of these portfolio whether the '05 to mid '07 or the post '07 class.

H. Lynn Harton

Because we don't really have on here the default rates, because I mean you'd have to... some of the loans come in and go fault themselves and come out. So you can't get that directly from this chart. I would say... the way I would look at it is... you're the troughs times of severity to get to your cycle to loss. So you can kind of back into what you think is reasonable on a default rate. Kinds of what you think severity seems to make sense within these numbers.

I don't want to get into... go down to stress testing past. But again, we provided this information, so you would have better information. You could understand it better and you could consider those issues on your own. I think that this is good information, hopefully better than you see in other place. And we believe we've got a strong case for our capital position, strong case for how we understand the portfolio and where it's going to go.

Christopher Marinac - FIG Partners, LLC

Great, that's fine. And then just a separate follow up on deposits: is there any seasonality in the deposit growth you saw that that would be potentially reversed itself next quarter?

Robert Edwards

We do historically build in coming into the end of the fourth quarter and early in the first quarter and then starting towards the end of the first quarter and then through the second quarter, some run-off in public fund deposits. And I believe there was... we're down 52 million quarter-over-quarter.

So there would be some more of that, although we saw it a little bit earlier, I think there's just less liquidity for everyone, including some of our public fund depositors. So we don't think that will be dramatic and that we would be typically have and post this, from the end of the first quarter to second quarter. But there would be some in that Chris.

Christopher Marinac - FIG Partners, LLC

Okay. Great, James. Thank you very much.

James Gordon

All right. Thank you.

Operator

Our final question comes from Al Savastano of Fox-Pitt, Kelton.

Al Savastano - Fox-Pitt, Kelton

Good morning, guys.

James Gordon

Good morning, Al.

H. Lynn Harton

Good morning, Al.

Al Savastano - Fox-Pitt, Kelton

On the non-core and the core loan portfolio, with the non-core coming down, can you talk about the impact on the margin and the impact on the balance sheet side?

James Gordon

Well, I think on balance sheet side, I think what we were saying is the run-off in the first quarter over the next three quarters will look a lot like that. And we don't expect significant core loan growth in that period. Starting somewhere after that you should see the non-core begin to moderate, but then some pick up in the core, so the balance sheet should stay, decrease and then begin to stay flat and then begin to grow over the next 18 months or so, Al.

On the margin side, as Lynn talked about, these are non-relationship type base loans. And as a fair amount is obviously problem created from that. A fair amount of the residential construction is in the non-core book of which the fair amount of that is non-accrual. So as we work through that and get it out, it will have both the credit impact on the margin, plus those have tended to be the lower margin type loans on that. So it should benefit the margin, because obviously non-relationship, non-core loans are funded with higher cost wholesale borrowings in effect so if you make a perfect world you insure it that today, insurance your broker deposits just as an example.

It's not a perfect world. So it will take time to do that, but those loans don't make sense when you are funding them, primarily with brokered CDs for example. And that's how we're looking at that.

Al Savastano - Fox-Pitt, Kelton

Mary, don't punch I am going to ask three questions.

James Gordon

If this is your last we will allow that.

Al Savastano - Fox-Pitt, Kelton

Thanks. In terms of your loan loss reserves, the balance you're expecting improvement in the second half of '09 in terms of empty inflows. Does that mean the balance in the loan loss reserve is going to get red or decline?

H. Lynn Harton

It's too early to tell at this point. We've got to be sure we see a turn before we began to bring it back.

James Gordon

I wouldn't think if it turns in the second half that we wouldn't bring it down in the second half but 2010 will be a different decision. But I wouldn't think the allowance would come down, anybody into the year, even if we did see some of that turn begin to happen that we're talking about.

Al Savastano - Fox-Pitt, Kelton

Okay, great. And then lastly, then I was just wondering if you can review each of the three stage operating in terms of economic activity and outlook?

H. Lynn Harton

Sure, Florida was the first one in the cycle. Clearly, been the most stressed, starting to see signs in my mind that it's beginning to bottom, certainly at least on the residential and construction side. And we're seeing more people purchasing homes, we're seeing more investors interest. Clearly, still going to have the lag effect on the C&I side in Florida as you walk through those issues.

South Carolina, you know there's been a lot of talk about South Carolina unemployment and it is high. However, if you look at we are located in South Carolina, just 45 counties, we essentially, I mean we almost have with exception of OA county which is right in the middle on the midpoint of unemployment. All of our markets are in the better than average unemployment rates.

So we are in all the right places in South Carolina, is it going to get a little weaker, absolutely. But the C&I side continues to be strong in South Carolina. It's really real estate around the coast is going to be the question. And we'll work through that again it's got better relationships, better customers.

In the North Carolina mountains, is more of our business it's upon percentage side, is a on the construction and housing fees, that is slow, it didn't have the huge run-off that Florida had, it's not going to come down as fast. But that is a struggle. So I would say that it's kind of the same tale we've been saying for sometime, Florida is the weakest. We have seen signs of a bottom, North Carolina is next weakest. It hasn't yet bottomed in my mind yet, South Carolina continues to be relatively strong.

Al Savastano - Fox-Pitt, Kelton

Thank you.

H. Lynn Harton

All right, thanks.

All right, that concludes our call. We'll, thank everyone for your time and attention. And, we will talk to you again. Thanks.

James Gordon

Thanks.

Operator

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