Marshall & Ilsley Corp., Q1 2009 Earnings Call Transcript

Marshall & Ilsley Corp. (MI)

Q1 2009 Earnings Call

April 23, 2009 12:00 pm ET

Executives

Gregory A. Smith - Chief Financial Officer

Mark F. Furlong - Chief Executive Officer, President

Mark R. Hogan - Chief Credit Officer

Dave Urban - Director of Investor Relations for M&I

Analysts

Jason Goldberg – Barclays Capital

Terry Mcevoy – Oppenheimer

Kenneth Usdin – BAS-ML

Steven Alexopoulos - J.P. Morgan

Anthony Davis - Stifel Nicolaus & Co

Ken Zerbe - Morgan Stanley

Brian Foran - Goldman Sachs

Presentation

Operator

Good morning. Welcome to M&I’s first quarter 2009 results conference call. My name is Jackie and I will be your conference operator today. (Operator Instructions). It is now my pleasure to introduce, Dave Urban, Director of Investor Relations for M&I.

Dave Urban

Welcome to M&I’s first quarter 2009 earnings conference call. The presenter for today’s call will be Greg Smith, our Chief Financial Officer, who will review the first quarter financial results. At the end of our prepared remarks, Mark Furlong, our Chief Executive Officer; Mark Hogan our Chief Credit Officer; and Greg will be available for your questions.

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

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

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

And now, I will turn the call over to Greg.

Gregory A. Smith

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

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

As we have noted before, we continue to expect that the bulk of our Florida related credit quality issues are behind us as non-performing loan totals and inflows have stabilized. We have increased our reserve ratio to 2.75% of total loans for $1.35 billion reflecting continued deterioration in the national housing markets and general economic conditions. We have continued to take proactive steps to keep home owners in their homes as is shown by our $446 million in restructured loans, 80% of which are consumer related loans.

We continue to have a capital base well above any regulatory capital thresholds and have approximately $1.8 billion in excess tier 1 capital. At quarter end, our tangible common equity ratio remained 6.4%. For the quarter, we recognized the tax benefit resulting in a one-time gain of $51 million for an EPS benefit of $0.19 per share.

Now, turning to our results; as noted in our press release, we reported a loss of $0.44 per share for the first quarter.

Now for some additional insights into the quarter; first, the net interest margins. Our net interest margin decreased by 36 basis points on a linked-quarter basis to 2.82%. During the first quarter, our margin was negatively impacted by the front-end steepness of the yield curve and by deposit pricing force which have prevented us from realizing the full benefit of the Fed’s December rate cut. As you may recall, our fourth quarter margin increased on a linked-quarter basis by 12 basis points, and was positively impacted by the higher level of LIBOR relative to Fed funds. The loss of this benefit along with the first quarter factors are responsible for 33 basis points of our net interest margin contraction during the quarter.

In addition, the cost of funding non-performing assets also impacted our net interest margin by 4 basis points. We estimate the negative impact of non-performing assets to be 13 basis points over the first quarter last year and 24 basis points over the first quarter of 2007. As always in the first quarter, our net interest margin was positively impacted by day count by 2 basis points.

We continue to expect that the net interest margin will experience compression going forward. Like the industry in general, we expect to be challenged by competitive loan and deposit pricing, the impact of the positive pricing floors, the movement of new and existing deposits into lower spread higher yielding products, wholesale funding spreads, and of course the yield curve. There continued to be many variables that impact margin. It is difficult to project this one data point given the current interest rate volatility occurring in the market.

Now, moving on to our wealth management segment; equity market volatility persisted during the first quarter with the S&P finishing down over 11%. Volatility and continued downward pressure resulted in lower revenue and sales activity for the first 3 months of the year. Wealth management revenues declined 10% for the quarter versus the same quarter in 2008 and declined 4% on a linked quarter basis. These declines are attributable to overall market levels.

Within our trust businesses, assets under management were almost $30 billion, an increase of 15% compared to the same period in 2008 and down just 2% versus the fourth quarter. Assets under administration remained over $100 billion. Sales pipelines remained stable in both personal and institutional lines, although conversions of prospects are taking longer due to protracted investor decision making processes. Our outsourcing business revenues remain strong and we’re largely unaffected by the market changes. Our financial advisor revenue was weak early in the quarter but strengthened as investors began re-entering the market in late March. Private banking loans and deposits had strong growth with loans up 9% and deposits up 29% versus the same quarter in 2008.

Moving on to other fee income components; service charges on deposits for the first quarter were $35 million, in line with the prior quarter and the same period last year. Mortgage loan closings for the first quarter were $820 million which was slightly more than double the fourth quarter. With most of our production going into the secondary market, we have realized $8 million in mortgage sale gains this quarter.

From an expense standpoint, any comparison of our quarterly expenses to the prior quarter will be adjusted for the goodwill impairment charge realized as of year end 2008. Total non-interest expense amounted to $345 million in the first quarter; this is a $57 million decrease from the fourth quarter as we incurred fewer one-time expenses than we did in the prior quarter and realized the benefits of our expense initiatives. Nonetheless, expenses related to non-performing assets and loan sales continued to have an adverse impact on our expense base. This quarter, we incurred $42 million in expenses related to non-performing assets.

Although our reported efficiency ratio is 59%, when adjusted for these credit related expenses, we view our core efficiency ratio to be 52%. When adjusted for this, we have seen a 5% expense decrease on a linked quarter basis. Nonetheless, particularly in the current operating environment, M&I will continue to be very focused on maintaining our historical expense discipline.

A comment on capital management; with a period intangible common equity ratio of 6.4% and tangible equity ratio of 9.1%, M&I remains one of the most highly capitalized domestic banks. Our regulatory capital ratios remain well above any regulatory thresholds.

M&I remains dedicated to deploying our capital prudently through lending and investment in our customers and communities. This is highlighted by our home owner’s assistance program and continued lending through the economic cycle. Through the end of the first quarter, we have approved over $2.5 billion in either new or increased credit to our customers since we accepted the capital purchase program preferred stock from the US Treasury last November.

Now, moving on to our credit quality trends: M&I like other banks has experienced continued credit deterioration during the first quarter. Our commercial, non-construction commercial real estate and consumer portfolios continue to have non-performing characteristics materially better than the bank as a whole while our construction and development and residential portfolio continue to show the stresses of the national housing markets. As we have noted before, this stress is most apparent in the Arizona market where home prices have fallen nearly 50% from their peak in June 2006.

For the quarter we realized net charge offs of $328 million and we provided $478 million for loan losses. Our quarter end allowance was 2.75% of period-end total loans which is an increase of 34 basis points or $150 million from the prior quarter end and continues to rank us among the best reserved banks. In addition to building the allowance we have identified a specific loss content in non-accrual and renegotiated loans over a million dollars and marked them to net realizable value with either a specific reserve or charge-off.

As shown in slide #5, M&I has conducted a specific impairment analysis of $1.7 billion or 66% of total non-performing loans to quantify potential impairment. Through building the allowance and aggressively writing down problem loans, M&I posted a solid adjusted reserve coverage ratio of 128%. Our underlying market assumption in taking these charges and provisions is that the prevailing economic and national residential conditions will last through 2009 and likely into 2010 in some of our markets.

With regard to our loan loss provision, we continue to see deterioration in the estimated collateral values and repayment abilities of some customers, particularly commercial real estate developers and generally the consumer segment. These factors combined with general economic trends have led us to continue building our allowance. As we look forward we expect to continue taking aggressive steps to resolve our non-performing loans, the proceeds from which will be re-deployed in our business.

As in prior quarters, the largest proportion of the charge-offs, approximately 60% were associated with the Arizona, Florida, and correspondent portfolios. As shown on slide #15, the charge-offs by business were $121 million for Arizona, $25 million for Florida, and $51 million for correspondent business which includes a $34 million charge-off related to the Franklin relationship. These business line charge-offs highlight why we believe the bulk of our Florida challenges are behind us. In addition, we took aggressive steps to continue resolving non-performing construction and development situations in all our markets which led to elevated net charge-offs in our Kansas City market this quarter.

Discussing our non-performing loan trends. During the quarter our non-performing loans increased $725 million. Of this increase, $176 million or 24% is related to renegotiated loans which will be discussed shortly. For the quarter we sold $128 million in larger stressed construction and development loans. As in the past we have moved aggressively to identify potential non-performing loans and the associated loss content. This is supported by the following; 27% of our non-performing loans are past due less than 30 days, 37% of our non-performing loans are past due less than 90 days. We’ve already realized partial charge-offs of $665 million against our non-accrual loans representing a 24% haircut. Another way to look at our partial charge-offs of $665 million is that it represents a 48% write-down on specific non-accrual loans where a direct write-down was deemed necessary.

Within our loan portfolios we continue to focus on our construction and development categories particularly residential related. These loans are in both our commercial real estate and residential real estate portfolios depending on the underlying collateral. Please note slide #17 that we have provided detail regarding segmentation of our commercial construction portfolio between C&I related and housing related. This slide highlights the continued strong credit quality profile of a non-housing component of the commercial construction portfolio. Less than half of our commercial construction portfolio is related to housing. As of quarter end we have $1.2 billion in construction and development loans on non-performing status representing 48% of our total non-performing loans.

As shown on slide #18 of these non-performing construction and development loans 64% are in the Arizona, West Coast of Florida, and correspondent businesses. Clearly, our issues remain concentrated in these businesses.

To provide a little more granularity on our commercial real estate developer portfolio, the following may be helpful. We have 45 loans greater than $5 million on accrual status. Only 15 of these are in excess of $10 million and none of these are in excess of $20 million. We’re seeing further deterioration in the residential land portfolio during the first quarter. This portfolio is shown in slides #25 and #26. We have $2 billion in residential land loans to individuals and developers, $1.2 billion or 60% are located in Arizona zip codes. The bulk of the Arizona loans, nearly 70%, are in Maricopa County. The loans in the Arizona portfolio are relatively modest in size with an average balance of approximately $198,000.

We continue to refresh both FICO scores and LTVs for the Arizona portfolio. Individual FICO scores average 733 at the time of origination and remain around 700 today. This reflects the continued consumer stress in this market. Residential land accounts for $440 million of non-performing loans of which 74% are based in Arizona zip codes. As in prior quarters this level of non-performers and the underlying LTVs have factored into our allowance level. As we have noted before, our residential land portfolio is almost entirely zoned, entitled and improved, and largely to individuals.

With regard to conventional mortgages we have deterioration as individuals are feeling increased economic stress. As we have noted before we maintained our underwriting discipline through the cycle, have never originated sub-prime loans, and have avoided many of the more risky loan products. Nonetheless, during the quarter our non-performing residential loan totals have increased to $477 million or 8.35% of the residential mortgage portfolio. Of these approximately 39% are restructured mortgages.

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

To provide further detail on our Arizona residential portfolio, the average loan is around $325,000. The average refreshed FICO score on this portfolio is 705, down from 733 at origination. The average updated LTV is approximately 106%.

Just a couple of comments on our consumer loan trends. The overall consumer portfolio has maintained its non-performing loan levels below those of the overall bank. As on quarter end only 1.9% of consumer loans were on non-performing status. As we have noted in the past our credit quality experience with this portfolio has benefited from our historical practice of selling much of our production as we did in 2005 and 2006.

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

With regard to the commercial loan portfolio. During the course of the first quarter we realized $60 million of net charge-offs in our C&I portfolio of which the largest proportion was related to industries associated with the housing sector. This quarter, housing sector charge-offs amounted to approximately three quarters or $45 million including the Franklin relationship which was restructured at quarter end. As a restructure loan, the Franklin relationship is our largest non-performing loan. We continue to monitor our commercial portfolio closely.

Some more detail on the Franklin relationship. We worked closely with valuation expert throughout the Frankling restructuring which resulted in M&I holding four tranches of Franklin debt as of March 31^st. With this restructuring, we have realized a first quarter charge related to Franklin of $34 million which was included in the C&I charge-offs. As of quarter end, we have $69 million of remaining exposure, of which $17 million is on nonperforming status with the remaining $52 million on restructured status. As you would expect, we will continue to monitor Franklin’s performance and underlying portfolio closely.

A few comments on our renegotiated loans: Over the past quarter, we have seen $176 million increase in renegotiated loans to a total of $446 million. Franklin is $52 million of this increase, but the vast majority of these loans continue to be related to home, land, or construction loans to individuals. At quarter end, residential, residential land, residential construction to individuals, and home equity categories accounted for approximately $360 million or 80% of the total. We expect to see continued increases in this category over the next few quarters as we work with borrowers who’ll benefit from our home owners assistance program. Unfortunately, the types of modifications that are typically most successful with consumers involve reduced and often below-market interest rates which will preclude us from moving these loans back to performing status under GAAP.

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

As we have noted before, it is important to remember that most construction credits are complex, and that it will take time for us or any lender to work through them. As I noted in discussing slide 5, through building the allowance and aggressively writing down problem loans, M&I posted an adjusted reserve coverage of 128% of nonperforming loans. We will continue to evaluate the opportunity for further sales of nonperforming assets and weigh that opportunity versus the cost of keeping those assets for a period of time. Sometimes, the best resolution will be able to take the underlying property to maximize our interest which will cause increases to REO for a period of time.

As we anticipated, our REO increased this quarter to $344 million, which is up from $321 million in the prior quarter. The largest REO property is an $11.5 million Minneapolis-based multifamily property. We have three additional commercial properties over $5 million. We continue to expect that REO balances will increase going forward and view this as a natural progression as we gain control of projects and move toward ultimate resolutions. We will continue to aggressively manage our REO balances.

A few final comments on credit quality: Stresses in the national housing markets will continue to affect us, and we will continue to address them proactively. We have and will continue to take aggressive steps to resolve our nonperforming situations. Nonetheless, should the economy continue to deteriorate beyond our current expectations, our losses could continue. Our nonperforming loans continue to be concentrated in the housing construction-related components of the commercial and residential real estate portfolios, particularly our Arizona, Florida, and correspondent businesses. Again, we believe our largest challenges in the Florida market are behind us.

Although we are not immune from consumer deterioration, we believe our residential and consumer portfolios will continue to perform better than the industry as a whole. Recall that our credit card portfolio is relatively small with only $264 million of outstanding. We will continue to maintain a strong reserve coverage ratio and will continue to aggressively write down problem loans. We remain committed to returning M&I to a level of solid credit quality.

Changing focus to the organic balance sheet trends compared to the same quarter in 2008. First quarter 2009 average loans were $49.8 billion which is $1.2 billion or 2.5% higher than the first quarter of 2008 average. C&I loans increased on average by $356 million or 2.5%. For 2009, we expect C&I loan growth to be in the low single digits. On a linked quarter basis, C&I loans contracted slightly. Across all of our construction and development categories, we have seen approximately $1.9 billion or nearly 18% contraction since the first quarter of last year. This is consistent with our broader goal of reducing our total construction and development portfolio to 10% of total loans. At quarter end, construction and development loans accounted for 16.8% of total loans, down from a high of 22.6% in the third quarter of 2007.

Non-construction commercial real estate loans increased on average by $1.4 billion or 12% in comparison to the same quarter last year. Commercial real estate volumes were soft in all categories reflecting the economy. This has translated into significant declines in construction in all of our markets, with our Arizona and Florida markets most impacted. Less investor activity and new construction projects with multifamily and medical office being least impacted.

Retail continues to soften and is expected to do so throughout 2009 as many retailers have cut back expansion plans. Office continues to soften in most of our markets. Dramatic job losses could significantly impact this segment in 2009. Hospitality softened with the economy in the second half of 2008 and is expected to continue to soften as the economy contracts. Together, these factors lead to our expectation that commercial real estate growth for 2009 will be relatively modest.

On the deposit side, there are a couple of things to note. We continue to open net new DDA accounts in the community division each month, although growing DDA balances has been more challenging as retail customers have opted to move excess liquidity into higher rate products.

Commercial noninterest bearing deposits increased compared to the fourth quarter of 2008. This increase is attributable in part to the low interest rate environment and continued confidence in M&I. Reflecting recent deposit market dynamics including current low interest rates, we have seen a shift in deposits from our money market and Euro deposit accounts to CDs. We continue to maintain our pricing discipline.

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

As you are ware, every economic cycle brings its own set of challenges. This economic cycle has been marked by rapid deterioration in general economic conditions, a challenging and volatile interest rate environment, wider funding spreads driven by broader market liquidity challenges, competitive pricing pressures on many loan and deposit products, and a dramatic downturn in the national residential housing markets. As we move forward in this challenging economic cycle, we will continue to benefit from the strength of our capital position, the dedication of our employees, and the diversification of our franchise.

This concludes our prepared remarks. Mark Furlong; Mark Hogan, our Chief Credit Officer; and I are available to answer your questions. Operator, you may now open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Jason Goldberg with Barclays Capital.

Jason Goldberg – Barclays Capital

I think you mentioned you sold $120 million of NPA during the quarter. Can you just give us some color in terms of where they were sold relative to where you had them marked and if they contributed to charge offs at all in the quarter?

Gregory Smith

We sold a $128 million of stressed commercial and development loans in the course of the quarter. We have exercised our discipline of trying to move those types of credits out of the bank. We have also not changed our view about actually talking about the pricing of those loans that we sold. In terms of where the loan sales took place, roughly two thirds of the loan sales were out of the Arizona market place and then the next largest bucket was actually Kansas City as we really tried to move some of those issues out of that franchise and let them focus much more on the future.

Jason Goldberg – Barclays Capital

How much do they contribute the charge offs in the quarter?

Gregory Smith

Well, that would kind of answer the question. They did contribute to some to charge offs. I wouldn’t look at it as the biggest contributor to charge offs or anything like that.

Jason Goldberg – Barclays Capital

Secondly, in terms of the details in terms of the LCVs and the residential land book in Arizona, I guess 162% and that number continues to go up with 16% on nonaccrual. Maybe you can just give some more color in terms of how much reserves you have in that book, or in terms of how much have you now written down that book by to get us a sense in terms of how much of this excess are you going to have to write down.

Gregory Smith

Jason, certainly Arizona real estate is whether residential or whether the land portfolio is certainly a factor as to why we continue to build the reserve. We do go through a detailed FAS 5 analysis on these portfolio each and every quarter, and we have seen a build in that, but what we do when we look at these portfolios is we go through a detailed analysis multiple times a quarter in terms of the different stresses that we could see and how those would affect the loss rates. We go through a lot of scenario analysis, planning, looking at changing unemployment rates in that market and continued deterioration in that market. Certainly, we saw with the most recent Kay Schiller data that came out in the Phoenix market place, home prices are down 49 to almost 50% since their peak in June 2006. That certainly flows through in terms of how we look at the residential vacant land portfolio as well.

Mark Hogan

The other comment I would make just relative to the reserve in general is that typically over the past several quarters the C&I component of the reserve would have been just over 55-60% of our reserves, and right now we’re seeing that from a commercial standpoint versus the consumer side, they’re about 50:50, so as Greg said we’re building that portion of the reserve.

Jason Goldberg – Barclays Capital

A lot of your peer banks are also experiencing interest margin pressure this quarter, although a lot of them talked about stabilization and actually improvement in the latter part of the quarter and are seeing more improvement as the year goes on. Your expectations seem to differ. Anything in particular we should be paying attention to?

Gregory Smith

I don’t think that’s necessarily anything M&I specific. I think it’s more how we’re looking at the overall economic environment, and as long as rates stay as low as they are, deposit floors are going to be difficult for us to earn our way back against in the near term. We’re certainly looking at a number of different strategies both on the asset and the liability side that can help us improve the net interest margin. I do not expect that we would see this level of contraction again, although all it take is one odd shift in the yield curve, and that would change our expectation.

Operator

Your next question comes from Terry Mcevoy from Oppenheimer.

Terry Mcevoy – Oppenheimer

Thirty-seven percent of your loans are still in Wisconsin. Surprised to see the unemployment rate. The unemployment rate kind of jumped up in the first quarter. Could you just talk about some of the core credit trends that you’re seeing in that core market?

Mark Hogan

We’re seeing some stress in the builders’ portfolio, some of our development loans, but again it would track with the increase in unemployment rates that we’re seeing. The number of properties that are out there still are higher than that they should be, and with higher unemployment rates, we’re going to see some additional stress.

Terry Mcevoy – Oppenheimer

Given the large fourth quarter loss as well as the cut in the dividend which came out in January, did that have any impact your relationship with any of your larger customers in Wisconsin, and essentially did they lose any confidence in banking with M&I because of the news earlier in the year?

Gregory Smith

I think based on what we’ve seen and the business flows, again whether it’s what we see on the lending side, whether it’s what we see with utilization rates as well as what we’ve seen on the deposit side, I think our customer base is still pretty darn confident in M&I. Like any bank, we spend more time talking to customers today, but in terms of what we’ve seen, in terms of our business, and in terms of business flows, I’d say we’re seeing nothing other than normal competitive market dynamics.

Operator

Your next question comes from the line of Ken Usdin with BAS-ML.

Ken Usdin – BAS-ML

You just mentioned with regard to your thoughts on loan growth that you saw a bunch of these categories within the CRE bucket starting to slow from a business growth perspective, but I’m wondering there’s a lot of focus obviously on the C&D book, but can you expand you comments just into your outlook for the term CRE and the core C&I book and give us some color as far as how much deterioration and loan migration you’re seeing there? What if anything of that is already added into your over-provisioning, and how are you looking at the world as far as those areas are concerned?

Mark Hogan

From a CRE standpoint, what we’re seeing is that given the fact that there’s no secondary market for the development properties whether they’re retail or office, traditionally I think you’re aware that we’d be in two and three-year deals, maybe mini PERM at that point, then they would move out to the market. A lot of what we do is just on the development side, so what we’re seeing is with the contraction in the secondary markets, we’ll be extending those for a period of time in some form of mini-PERM. So we will see that portion of the real estate bucket continue to stay at that level.

Ken Usdin – BAS-ML

Mark, I was actually talking about the credit quality with it, not necessarily the growth. Greg was speaking about how the growth has slowed, but I just wanted to extend that over to the quality side of it as far as how much loan migration you’re seeing in that bucket and also in the C&I bucket, and how much you need to incrementally provision for broader economic deterioration going forward.

Gregory Smith

Certainly as we’ve through the build of our reserves and our analysis of the trends, we put a lot of focus into those two categories as you’d expect us to do in these economic times. In terms of the commercial real estate bucket, when we take out any of the construction and development credits in that, the migration so far has been relatively modest. We’re very watchful and continue to conduct a variety of stress tests on that portfolio. At the end of the day, we’ve benefited a decent amount that our CRE portfolio is largely skewed to the core Midwest markets. In terms of the C&I portfolio, we certainly saw an increase in nonperforming loans this quarter and continue to perform a number of different internal tests and analyses in terms of how this bucket or the CRE bucket could deteriorate depending on economic conditions. We did see an increase in C&I nonperforming loans this quarter, but a third of that increase is from Franklin, and throwing in one other housing related credit, that actually winds up being more than 50% of the increase. We’re finding the diversification of the Midwest-based manufacturers is so far continuing to benefit our credit quality portfolio on the C&I side. We’re right now in the midst of a lot of our annual renewals and getting a very real-time look at the balance sheets of the manufacturers, and what we’re finding is continued good liquidity, continued good capital, excellent inventory management which in an economic cycle is key, so actually we’ve been somewhat pleased with what we’ve seen coming through the renewal cycle. That said, there is more stress in that portfolio today than there was.

Ken Usdin – BAS-ML

Just from broader credit perspective, you’d mentioned that you do believe that you’ve captured the loss content in the portfolio that’s evident at least today. Are you at the point where you expect that you won’t need to over-provide going forward, or do you anticipate still having to build the reserve incrementally even on your prior comments here about continued stresses directionally?

Greg Smith

I wish I had the perfect crystal ball in terms of what the economy is going to do as we go forward to answer that, Ken. I think that’s a quarter-to-quarter analysis that we’re going to have to do and certainly as Mark alluded to earlier we’ve seen a shift in the reserve. So more of it is weighted to the consumer side, but I think it’s going to take us a little bit more time to give you a crystal clear answer on that. We would like to get to that point sooner rather than later though.

Operator

Your next question comes from Steven Alexopoulos - J.P. Morgan.

Steven Alexopoulos - J.P. Morgan

Greg, of the $8 billion in construction and development loans how much of that was for shopping centers?

Gregory A. Smith

The shopping center component of that is not that large and I just don’t have that one at my finger tips right now. Do you have a second question because I might find that in the interim here?

Steven Alexopoulos - J.P. Morgan

Yes, I was hoping you could actually give a little more color on the linked-quarter decline in deposits. Most banks were seeing record deposit out of this quarter and both period and an average were both down pretty sharp for you guys quarter to quarter?

Gregory A. Smith

A lot of the contraction; there’s two dynamics, within the core deposit base you’re seeing more a mix shift than anything else; as an example VDA is up and CD balances are up. On the wholesale side we’ve actually had some contraction. We got out of a number of broken CD relationships and we have opted not to compete so much as we had in the past in some of the wholesale euro dollar categories. Core deposit trends were actually reasonably good. Just to switch back to the shopping center construction question, it’s probably 1% to 1.25% of the overall loan portfolio; non-performing characteristics for us right now in that bucket running just about 2%. What we find in our overall shopping center construction is our underwriting criteria of sticking with centers that have large anchors that are already committed is making a big difference for us on that portfolio.

Steven Alexopoulos - J.P. Morgan

One final question; of the loans that moved into non-accural, how much if any of that was moved tied to shared national credits, and can you just remind us what your balance of shared national credits are?

Gregory A. Smith

Our balance of shared national credits is not all that material and in terms of the moves of anything in the non-accrual, there is nothing that I’m aware of, and Mark Hogan is agreeing with me as I say that.

Operator

Your next question comes from Anthony Davis - Stifel Nicolaus & Co.

Anthony Davis - Stifel Nicolaus & Co.

Can you give us some more color on what the tax credit was and should we expect more of those?

Gregory A. Smith

I’m always happy to, but in terms of; this has just been a year where there have been a number of tax changes in a variety of our jurisdictions and we were able to realize a benefit from that. So what you see this quarter you should really think of it as a one time.

Anthony Davis - Stifel Nicolaus & Co.

You’ve got a work outward to that. I’m wondering if you could expand on it a bit more; when if it is really up and running, any thoughts on volumes of dispositions that might be reasonable to expect this year, just your initial thoughts on PPIP?

Gregory A. Smith

Mark Hogan will answer the workout component of that, and I will handle the PPIP part of it.

Mark R. Hogan

We started that group about a year ago. As you know we didn’t have anything. All of the problem loans were handled in the region or the area that they had come out of and we started staffing at first quarter of last year. We got 40 to 50 people in that group right now that are actively engaged in basically the primary markets where we have issues; groups in Arizona, Florida, Wisconsin, Missouri, and Minnesota. It’s worked well. Part of the issues are always going to be identifying the appropriate asset, appropriate loan to move in there, and the timing of moving in there, but we aggressively are looking at the portfolio and determining what the appropriate strategy should be for either trying to rehabilitate the loan or for an exit strategy.

Anthony Davis - Stifel Nicolaus & Co.

Mark, how much is in that bucket now; the pool I guess.

Mark R. Hogan

Tony, I don’t have a number for you, but let’s just say that we’ve got our hands full and we continue to look for additional resources in that area.

Anthony Davis - Stifel Nicolaus & Co.

Greg, on PIPP?

Gregory A. Smith

On PPIP, right now there is not enough information for us to know whether we’re going to go the route of the PPIP or not. We’re going to pay attention as details come out and we will build an understanding as that plan is flushed up. That said, we’re going to continue on our normal pace of tackling asset dispositions and continuing to mark assets aggressively because you don’t know when that program is going to come out and you don’t know what the final structure of that program is going to be, whether it’s going to work for M&I or not. So, we’re going to continue to act as if we’re going through the private market and we’re going to continue to build our strategy around that until we have better information.

Anthony Davis - Stifel Nicolaus & Co.

One final question on the margin again, as rates stabilized a little bit more recently, did you see any improvement between let’s say January and where you were in March or later in the quarter?

Gregory A. Smith

Tony, I’m always a little reticent to go month by month on the margin. We did see a little bit better performance later in the quarter, but I am always real careful to read too much into a month to month margin; I just like to be careful there.

Operator

Your next question comes from Ken Zerbe - Morgan Stanley.

Ken Zerbe - Morgan Stanley

Just with the deposits; I heard your answer that there’s a mix shift causing some of the decline, but maybe just take a step back from our perspective and help us understand why you guys might have been seeing a sharp decline in deposits whereas most of the firms are actually seeing what I would probably call unusually high deposit growth?

Gregory A. Smith

Ken, I’m going to point on a lot of this to our maintaining our pricing discipline on deposits. You put out some good work on deposit pricing and what we’ve seen in a number of our markets has been pricing from competitors whether it is in CDs or some of the interest bearing transaction accounts, that we don’t think is justified and we’ve not been competing on that level. So, I think that may have cost us a little bit in terms of deposit growth, and again, some of the contraction is certainly on the wholesale side as we did not price up some of our euro dollar offerings as well as we terminated some broken CD relationships.

Ken Zerbe - Morgan Stanley

I guess we can’t get any names on who’s being most aggressive in your footprint then?

Gregory A. Smith

It would vary market by market, but I won’t go there. You can do your own research easily on that one.

Ken Zerbe - Morgan Stanley

Second question I had; maybe you could talk to us a little bit about default trends on some of the restructured loans after you do the restructuring because I think I read in different publications that the second recurrence of default is 50% or some very large number; what are you guys seeing on your restructured loans?

Mark R. Hogan

I think we’re probably about nine months into it and so that portion of the portfolio is just starting to build and we’re just starting to see some trends, but we do though when we put something into troubled debt restructuring is on the consumer side, we identify what the strategy would be to mitigate the loan, and we require that there would be a minimum of three payments made under that revised payment strategy. So, we’re just starting to see that. We think that our percentage delinquency on that portfolio should be less based on the fact that we’ve gone through that process of having the three additional payments made before we identify it as we negotiate it. In the meantime we continue to track that in the delinquency buckets as a delinquent loan.

Operator

Your next question comes from Brian Foran - Goldman Sachs.

Brian Foran - Goldman Sachs

When I look at your $2 billion land portfolio, it’s down about $145 million over the past six months. Given that I would imagine not a lot of new loans are being made and about 85% of the portfolios performing; can you help us understand why it’s not shrinking faster? Are the borrowers paying principal and interest or just principal? Are the terms of the loans being extended? And I guess ultimately just why aren’t we seeing that portfolio shrink much faster?

Mark R. Hogan

I think if you looked at the portfolio and if you look at slide #26 you’ll see that $1.2 billion of that portfolio is in Arizona and as those loans have come through those typically had been written down 3-year notes and as those loans have matured over the past several quarters, we’ve worked with the borrower to make sure that we have an appropriate payment strategy that fits their needs. So, in some cases we are getting principal reductions, in others we’re on an interest only basis, but it does reflect the borrower’s ability to pay. Given the significance of the portfolio in Arizona and the fact how those values have changed over the last three years, it’s unlikely that we would have wholesale reductions in that portfolio.

Gregory A. Smith

The other thing Brian; I am just looking at average balances in that category. Compared to the first quarter last year, we’re down between $400 million and $500 million in that category. So, we have had some shrinkage in that portfolio over the last year as we haven’t had recognitions into it.

Brian Foran - Goldman Sachs

You’ve given a lot of helpful information about where different loans are marked or different looks at where things are marked; during the quarter, the FDIC sale of the First National of Arizona portfolio obviously got a lot of press because it came at about $0.25 on the dollar; can you talk about specifically what the overall marked on the Arizona land portfolio would be and then what are the key differences in terms of geography or whatever as you look at your portfolio versus that portfolio that we should consider in terms of that valuation?

Gregory A. Smith

As I mentioned earlier we have been building a fast buy reserve that focuses on the homogenous portfolios and are existing loss experience in that Arizona land portfolio contributes to a build in that reserve. We have not said what that total dollar amount is. In terms of the FDIC sale, that is one data point in that market in terms of what the land values are. We’ll also take into account the nature of that sale as well as we think about loss rates in that marketplace. So, it did not go unnoticed; both the original story that came out that had the wrong pricing in it, then the final pricing as well.

Gregory A. Smith

Since it seems like we have no more questions, appreciate everybody’s calling in to our call today and have a good day. Thank you.

Operator

This concludes today’s conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: [e-mail]. Thank you!