Citizens Republic Bancorp Q3 2007 Earnings Call Transcript

Citizens Republic Bancorp, Inc. (CRBC)

Q3 2007 Earnings Call

October 19, 2007 10:00 am ET

Executives

Bill Hartman - President and CEO

Charlie Christy - CFO

John Schwab - CCO

Marty Grunst - Treasurer

Analysts

Jon Arfstrom - RBC Capital

John Pancari - J.P. Morgan

Scott Siefers - Sandler O'Neill

Terry Mcevoy - Oppenheimer

Presentation

Operator

Welcome to today's teleconference entitled, Citizen Republic Bancorp’s Third Quarter Conference Call. At this time all participants are in a listen-only mode. Later you will have the opportunity to ask questions in our Q&A session. Please note, this call maybe recorded.

I will now turn the call over to Ms. Kristine Brenner. Ms. Brenner you may begin.

Kristine Brenner

Thank you. Good morning everyone, and welcome to the Citizen Republic Bancorp’s third quarter conference call. This call is being recorded and a telephone replay will be available through October 26. This call is also being simulcast live on our website, citizensbanking.com, where it will be archived for 90 days.

With me today is Bill Hartman, President and Chief Executive Officer, Charlie Christy, Chief Financial Officer, John Schwab, Chief Credit Officer; and Marty Grunst, Treasurer.

Before we begin, I would like to point out that during today's conference call, statements will be made that are not historical facts. These forward-looking statements involve risks and uncertainties which include, but are not limited to those discussed in the Company's filings with the SEC. Forward-looking statements are not guarantees of future performance and actual results could differ materially from those contained in the forward-looking information. These forward-looking statements reflect management's judgment as of today and we expressly disclaim any obligation to update and/or revise information contained in these statements in the future.

Now, I'd like to turn the call over to our CEO, Bill Hartman. Bill?

Bill Hartman

Thanks Kristine. Good morning everyone, and thank you every much for joining our analyst conference call. Given the economics and the conditions of the market place, we were satisfied to report results that were consistent, both with our own expectations, and with what we had communicated to investors last quarter.

We continue to be well on track to achieve our cost savings that we committed as part of the merger, and while we are investing in proven markets where we are growing, such as Southeast Michigan, Northeast Ohio and East Central Wisconsin. We do have a number of important expense initiatives underway to help us fund those strategic investments, while still keeping our overall cost structure intact.

Our efforts in cost management are showing up in the form of both, a much improved efficiency ratio for the quarter and in terms of much lower dollar expense level for the third quarter as well. Revenue of course continues to be a challenge, a chorus at this point, and our peers as well. And we are continuing to experience margin compression and the Midwest economic challenges.

The good news is that we continued to enjoy good momentum in our commercial and industrial lending business which was up almost 16% on an annualized basis for the quarter. And our treasury management sales which compliments that business continues to grow and it was up by actually over 25% year-to-date.

Our sales production of new checking and savings accounts and the cross-selling of additional accounts of those new accounts does continue to increase, and while it hasn't yet offset the migration of low cost to high cost deposits, a continuation of our trends will unable that to happen, prior to the end of next year.

Our brokerage and investment fees exceeded $2 million, this was the second straight quarter where we had exceeded that level and it’s an example of the investments that we have made in that business, continuing to pay off. We have a number of revenue initiatives in place. They include addressing sales execution, sales talent management, business-owner banking, fee income, and an improved level of back-office support to the front line.

We are convinced that these revenue initiatives will help us generate profitable revenue in 2008, and we’re going to comment little bit more on that when we give a 2008 outlook, during the January 2008 Analyst Conference Call.

After the last quarter we did announced a new regional management structure. And based upon what we have seen so far, we continue to have positive feelings that the increased teamwork between the regions, the lines of business and the back-office, that the new structure enables, will greatly enhance our ability to perform, as this new structure continues to mature.

Also subsequent to quarter-end, we announced that Peter Ronan has joined us, as the President and CEO of Citizens Bank Wealth Management after an extensive national search that developed a number of outstanding candidates.

Pete has extensive trust in sales experience and most recently ran a large trust organization for a $50 billion plus regional bank. He has extensive experience in Southeast Michigan, and we think that he can help us increase the revenue and profitability momentum we have begun over the last several years in our wealth management businesses.

Our credit quality performance, as John will comment on later, was also inline with our expectations as charge-offs did reduce and non-performers did increase. The actions that we took in the second quarter to [ballpark] the reserves helped us this quarter and position us well for future quarters. And while these credit challenges are going to continue, as the commercial real estate markets remain challenged, we have proven processes and people to help us manage through this, and we're very committed to staying the course.

We're not compromising any credit standards on the new business we're writing. This is a time when there are strong headwinds in our industry, these headwinds are heavy, and the tailwinds are light, as they are existent at all. Despite that, our Board and Management team are very committed to strong and consistent execution and making the right decisions for shareholders, as we impress the current operating environment.

So we'll next move on to John Schwab, our Chief Credit Officer, who will give you an update on credit quality trends. Charles Christy, our Chief Financial Officer will cover the financials. And then, I will make a few summarizing comments before we open it up for a general questions. John?

John Schwab

Thank you, Bill. Nonperforming assets increased $44.6 million or 30% over the second quarter end, with increases in nonperforming loans of $38.4 million, comprising the majority of that increase.

Virtually, all of the increase in nonperforming loans was a non-owner-occupied commercial real estate, principally land development and income producing, which together accounted for $34.4 million of the increase. The large majority of the land development increase is attributed to two loans, on both of which we have already established specific reserves against quantified future charges.

The nonperforming levels of all the other portfolios have remained relatively constant. With the preponderance of our troubled credit concentrated in commercial real estate, we are working through individual strategies to resolve each loan proactively, mindful of using the company's capital prudently.

The bulk sale of nonperforming held for sale loans which we executed in the first quarter of 2007, is no longer an economically attractive option for us to deal with current nonperforming loans, as bulk sale markets have declined materially. Therefore, affirming our strategy of working through each commercial real estate situation, one at a time.

In last quarter's conference call, we stated that the second quarter provision coupled with our historically strong reserve levels will enable us to work through continuing deterioration in Michigan and the Midwest commercial real estate collateral values. We believe that statement is still valid.

The third quarter increase in nonperforming loans and nonperforming assets, likely to increase again in the fourth quarter, has lowered our loan loss reserve to nonperforming loan ratio to 114%, but not for several reasons to a level of concern.

Citizen’s historically high loan loss reserve to nonperforming loan ratio through 2006, supported a largely C&I portfolio, whose loss given to fault dynamics differ materially from the mainly commercial real estate issues with which we are now dealing.

Analysis of the constituent loan loss reserve allocations to our respective nonperforming loan types, confirms we are well positioned to deal with identified credit issues in each loan group. For example, 84% of our nonperforming loans are collateralized with real estate, which has ongoing value. Charge-offs in our real estate portfolio has historically a small percentage of the nonperforming loan amount.

Further, according to the tables in our press release, residential mortgage, nonperforming loans of $32.8 million resulted in charge-offs at $1.6 million for the quarter. Annually, this loss experience translates to less than 20% loss on residential nonperforming loans.

Net charge-offs of $7.9 million for the third quarter represented 0.34% of average portfolio loans. The decrease from the second quarter was primarily the result of lower commercial real estate charge-offs, principally due to timing variances from obtaining fresh commercial real estate valuations, negotiating with principles involved in these projects and assessing ongoing project viability.

While increases in commercial real estate nonperforming loans, will likely lead to some level of charge-offs in subsequent quarters, both the timing and level of predictability is different from C&I. In short, commercial real estate charge-offs will, going forward, tend to spike and valley. Importantly, of the forecasted commercial charge-offs in the fourth quarter, our evils that have been identified, known shortfalls from updated collateral valuations and work out agreements. Over 90% has already been fully reserved, minimizing the need to add provision expense for these loans.

You will have noted, that our commercial watchlist exposure appears to have flattened in the third quarter, following the explained increases earlier in the year as we impose Citizens credit risk perspective on the then recently acquired portfolio. While the leveling in the C&I watch portfolio appears sustainable, some of the decrease in the commercial real estate watchlist is attributed to both movements into nonperforming status, while others returned to past status.

During our third quarter watch process, we downgraded 35% fewer dollar than the second quarter, upgraded 18% more and transferred 37% less dollars to special loans. While one quarter does not constitute a trend, there is some early evidence that the riskier commercial credit has been identified and stabilized. It is noted that the disclosed watchlist table includes all occurring commercial watch loans, including those managed in our special loans workout unit.

Dollars in this workout group have more than doubled this year. However, we believe that early identification of deteriorating credits is a basis for proactive credit risk resolution. That process is working. On a previous call, we had indicated our intension to conduct a review of the non-watch pass investment commercial real estate credits.

To ensure that risk ratings were accurate, and that credit risk management practices appropriate for each exposure were being implemented. At September 30, '07, $495 million in commercial real estate pass credits hit the size and risk parameters for this review.

To date, we have reviewed $204 million or 41% of this identified exposure with the remaining 59% being reviewed later this month. From this first assessment of these past credits, we downgraded 14% resulting in a relatively minor increase in loan loss reserve.

The extent to which our next scheduled review, mirror these results, we can suggests that there are no material unidentified commercial real estate exposures lurking in the portfolio. You will recall that we have been diving into and slicing this entire portfolio from nearly a year now. And I believe the large majority of the goblins have been disclosed and are being worked.

30 to 89 delinquencies have remained constant at $178.1 million or 1.93% of the portfolio. While the commercial real estate loan delinquencies have increased slightly, residential mortgage delinquencies at 2.58% of the mortgage portfolio did not change from the second quarter.

While we have experienced some increase in our 60-day delinquent residential mortgage portfolio, there is no evidence yet that these will translate into the larger nonperforming levels. We are monitoring the residential mortgage portfolio for potential reaction to Arm re-pricing. ARMs represent 60% of our retained portfolio, and nearly 35% of the ARM portfolio will re-price over the next five quarters.

At the risk of repeating myself, Citizens is not in the subprime business. 30 to 89 delinquencies in the consumer portfolio are well within our historical seasonal ranges, including both home equity and indirect, which you recall is mainly Marine and RV.

Before differing to Charlie, I conclude by observing to no one's surprise that the Midwest's, specifically Michigan, economic environment is impacting the historical performance of our loan portfolios, particularly commercial real estate.

We have implemented numerous proactive credit risk management practices in order to identify deteriorating loan assets early. Work them aggressively, yet prudently, in balance with our capital management strategies and utilize our reserves thoughtfully. We will, with confidence successfully work through the issues confronting both Citizens and the other banks with significant Michigan exposure. Charlie?

Charlie Christy

Thanks, John. Before, I review the financial highlights, it should be noted that the third quarter of 2006 still represents the legacy Citizens only, while the first, second and third quarters of 2007 on acquired basis. And for most of the differences, you see in the report between the third quarter of '07 and the third quarter of '06, are due to incorporating in Republic.

Net income for the quarter was $31.8 million, which equates an EPS of $0.42 per diluted share, and ROA of $0.96 and an ROE of 8.2%, all of which were in line with our expectations and slightly stronger than in consensus.

Following normal practices of presenting non-GAAP information, which excludes restructuring and merger related expenses, and the amortization of core deposit intangibles, our core operating earnings were $34.2 million. Merger related expenses for the quarter in that were $1.0 million, which equates to $0.01 impact to GAAP EPS, and core deposit intangibles amortization was $2.8 million, which equates to a $0.02 impact to GAAP EPS. Therefore both adjustments generate a core EPS of $0.45 per diluted share. As in the balance sheet adjustments in goodwill and core deposit intangible assets, a return on the average tangible assets was $110 and our return average tangible equity was 18.6%.

Key highlights for the quarter, we are still on track to achieve our target in annual cost savings of $31 million, where 70% was expected to be realized in 2007 or 100% in 2008. Since the merger was announced in June of 2006, we immediately began to reduce our cost structure in order to meet these goals. Therefore, when you adjust our third quarter 2007 total NIE by the $1 million merger-related expenses, we are at the expected NIE levels that basically exceed the target of $31 million annual cost base.

As we have noted before, we have used the additional saving to help fund revenue generating initiatives in our high growth market place, Northeast Ohio, East Central Wisconsin, and Southeast Michigan. So let's be clear. We are not done with our cost saving initiatives. We realized it's important for our bank to continue to build efficiencies in our products, services, people, processes and culture.

We continue to see good customer demand for our commercial and industrial loans across all of our markets, as evidenced by an increase of $83 million or 3.9% over the second quarter. We launched several revenue initiatives during the third quarter, and began see results in higher service charges on deposits, profit accounts, good volume in SBA lending, and continued strong performance in treasury management sales, and brokerage and investment fees.

Key drivers for the quarter, net interest income was down by $1.9 million for the second quarter of 2007, due to low average earning assets caused by the branch divestitures which were completed in the April, decreases in the investment portfolio and lower demand in our consumer loan portfolios, as well as the lowered net interest margin.

Our net interest margin percentage was down 5 basis points to 3.39%, when compared to the second quarter, primarily due to a shift in our funding mix, which is common in the industry, and a decrease in our commercial loan yields caused by increased nonperforming loans. The increase is the non-accrual loans equated to the 3 basis points of the margin declined, while low cost deposit declines drove the remaining 2 basis points.

In the fourth quarter, we anticipate net interest income will be slightly lower than the third of quarter 2007. We expect to see a continued migration of low cost deposit to high cost deposits, even though we have recently experienced the slowing of the migration.

Additionally, our expectations include the effects of loan pricing pressures, the full quarter impact of the movement of commercial real estate loans to nonperforming status during the third quarter of ’07, a slight interest rate curve in stable to declining average earning assets due to the economic environment.

Provision expense was $3.8 million, which was right on expectations. Net charge-offs totaled $7.9 million, which was expected as to our second quarter prior to quality results and initiatives. We anticipate the net charge-offs for the fourth quarter of ’07 will be similar to net charges in the second quarter of ’07, due to the migration of a number of credits, expected appraisal results and some increase in nonperforming loans.

However, most of the projected commercial real estate charge-offs already have specific reserves assigned to them, which will not require replenishment of the reserve. Therefore, we anticipate the provision expense for the fourth quarter of 2007 to be consistent with the higher than the third quarter of 2007.

Non-interest income was $30.6 million, a decrease of $0.7 million from the second quarter. The decrease was primarily the result of a $1.2 million decrease in mortgage. The income partially offset by increased deposit surcharges and bankcard fees.

We anticipate total non-interest income for the fourth quarter of ’07 will be consistent, a little bit slightly lower than the third quarter due to an anticipated decrease in the mortgage loan or risk financials.

Non-interest expenses decreased by $10.1 million from the previous quarter while $7 million was due to low restructuring and merger-related expense. And other expenses related to merger integration activities, $3 million was a true run rate reduction as we will get recognized for the full quarter impact of a computer systems convergence, the branch consolidations in the branch divestitures which were all completed in the second quarter.

We expect the fourth quarter merger-related cost to be approximately half the amount of this quarter, which should add all merger-related costs and activity. Excluding restructuring and merger-related expenses and additional expenses related to merger activities, we anticipate total non-interest expense for the fourth quarter of '07 to be slightly lower than the third quarter of '07 due to lower salaries and employee benefits of professional services.

Our income tax provision returns on more normalized level this quarter, primarily due to higher pre-tax income. We anticipate the effective tax rate for the full year of '07 to be approximately 22% to 25%.

And lastly, our capital ratios continue to remain strong. Our Q1 ratio was 9.2%, and the total capital ratio was 11.7%, intangible common equity was 6.04% and our leverage ratio was 7.51%. Back to you, Bill.

Bill Hartman

Thank you, Charlie. In summarization, we're getting more comfortable with our understanding of the risk in our credit portfolio. We're managing expenses, as prudently as we can while we implement our enhanced revenue initiative in an attempt to build some momentum in the current operating environment.

I'd like to briefly comment on our capital management strategy, which continues to remain prioritizing, number one, in terms of maintaining the dividend. Priority number two, maintaining the capital to support earnings growth, and priority number three, stock buyback. So, it is highly unlikely that you would see an increase in stock buyback at this time.

Lastly, based on our lower net interest income, projected flat to lower non-interest income, lower expenses and flat, but slightly higher provision expense, we expect earnings for the fourth quarter to be lower than our third quarter earnings.

That concludes our prepared comments and at this point, we would be happy to open it up for questions from any of the analysts on the line.

Question-and-Answer-Session

Operator

Thank you. (Operator Instructions) We will take our first question from the side of Jon Arfstrom with RBC Capital. Your line is open, go ahead.

Jon Arfstrom - RBC Capital

Thank you, good morning.

Charlie Christy

Good morning, Jon.

Jon Arfstrom - RBC Capital

A question for you Charlie, probably on the charge-off guidance for the fourth quarter?

Charlie Christy

Yes.

Jon Arfstrom - RBC Capital

I just want to make sure I understand, are you saying that we'll expect to see the loss reserve come down because of the specific reserves against some of the credits, and its possible that nonperformance come down as well. Can you help me think through that?

Charlie Christy

I would say that -- and John can add to this, but I would say that the reserve would come down because basically the majority if not, almost all of those loans we anticipate to be charged-off. We already have the specific reserves. So we would replenish, but act it.

Jon Arfstrom - RBC Capital

Okay.

Charlie Christy

And on the commercial real estate, the large majority of the charge-offs as you saw in the second quarter will be late in the commercial real estate too. So, these are things that we identify in the second quarter, clearly this manifesting to as they migrate through.

The nonperforming loans we would anticipate some more increases in those, probably not as high a level as we saw in this quarter, but John, why don’t you add some talks on that.

John Schwab

Yeah. So Jon, yes, non-performers may creep up a little bit in the fourth quarter. But I think the way in which are attacking some of these that have been in the nonperforming bucket, we may see some material reductions on those numbers as well. So, net effect that we will not see what we experienced here from second to third quarter.

Jon Arfstrom - RBC Capital

Okay. And then John, just a follow on that. It seems like your -- I wouldn’t call you optimistic, but maybe you’re a bit more optimistic than you were a quarter or a two ago. And I'm just curious if you could give us an assessment of how you feel about overall credit in your market, and do you still feel like you were able to go deep enough in the first quarter and the second quarter to get your arms around everything?

John Schwab

That’s a very good question, Jon. I think the optimism that I may feel is that, because we have been diving and slicing in this portfolio for nearly a year now, I don’t think that there are any areas of the pond that we haven’t swum through. And therefore, I think we have identified through these various credit risk management practices all of the stuff that really needs to be identified and now worked.

How do I feel about the economy within our footprint, not very good. So, the extent to which the Michigan economy will continue to weigh on us and everyone else, there maybe future causes for everybody to rethink that optimism. But as far as this portfolio that we have now, yes, I think you appropriately read some optimism at my remarks, because I think we've looked at everything, including now, the portion of the pass credit investment real estate, and there is nothing really ugly that we've discovered.

Jon Arfstrom - RBC Capital

That's great. Thank you.

Operator

Thank you. And our next question comes from the side of John Pancari with J.P. Morgan. Your line is open, go ahead.

John Pancari - J.P. Morgan

Good morning.

Charlie Christy

Good morning John.

John Pancari - J.P. Morgan

I can't go on off of Jon's question there, just a little bit more there. I mean sensed a similar type of optimism there, and I appreciate you for giving us some color there. Can you give us a little bit more of your insight on any other parts of your portfolio including home equity, to the extent that you see any deterioration there. Just to give us an idea of what you are seeing in other areas?

John Schwab

Sure, John. The home equity delinquencies have been creeping up, but that is not at this point an alarming level. Historically, neither of the legacy organizations would assume the over 100% loan-to-value business. And frankly, loan-to-values in this market, and probably, if we would have rephrase everything, everybody would be underwater. More importantly, we have the relied on the credit score and people's ability to keep the cash flow coming. So, I really don't anticipate any material issues in the home equity portfolio. Some of the delinquency patterns that we have experienced in our indirect Marine and RV are seasonal, are slightly up, but seasonal. It is nothing that is going to have us hit the wall.

John Pancari - J.P. Morgan

Okay. But as you said, what is the current -- do you have a current LTV or do you have -- what's historical LTV you have for that home equity portfolio?

Charlie Christy

Less than 85%.

John Schwab

And the delinquency rates, if you refer to the table, John, in our press release, the delinquency rates from last December are really quite in line with our delinquency rates as of the end of September in both the direct and indirect portfolios.

John Pancari - J.P. Morgan

Okay. Alright, and also that 85% is a historical LTV.

Charlie Christy

That's pretty much what the LTV was, yes.

John Pancari - J.P. Morgan

Okay, alright. And then again, what is you average FICO for that portfolio?

Charlie Christy

On the home equity, it's 739 or close around there; the indirect is about 720.

John Pancari - J.P. Morgan

Alright, okay. And then, and give us additional color, I guess, on the commercial loan growth if you could, I know you indicated it's relatively solid. Can you just give us an idea of what markets are you seeing that demand?

Bill Hartman

Yes, it's Bill Hartman, John, yeah. We are seeing its all over, at this point predominantly driven by Southeast Michigan, but also seeing some good growth in our Green Bay and Appleton markets as well. And we anticipate future good commercial growth in our Northeast Ohio market with the new team that we've put together there, and as they continue to develop some fairly nice backlogs.

John Pancari - J.P. Morgan

Okay, that's helpful. And then, last question is on the service charge number. I know you had indicated that some efforts there have been helping in terms of your fees that you're collecting. I just want to get an idea of the sustainability of the level that we see this quarter, if you have any outlook on NSF charges or any of the fees rolling up to that line?

Charlie Christy

Well, this is Charlie. We are looking at a number of different fees because it has been about two plus years since we, or may be three years since we have had any increases in certain component fees. And there is a lot of different types of fees. So, we start implementing some of those, we clearly don't want to overcharge. We still were not the highest in the market, whatsoever in those types of fees.

Now the sustainability, obviously, it has its seasonal aspects too, but we feel that the third quarter was a good indicator of our future run rate.

John Pancari - J.P. Morgan

Okay, alright. Thank you.

Operator

Thank you. And our next question comes from the side of Scott Siefers with Sandler O'Neill. Your line is open, please go ahead.

Scott Siefers - Sandler O'Neill

Good morning guys.

Bill Hartman

Good morning, Scott

Scott Siefers - Sandler O'Neill

Just wanted to drill down onto the credit a bit more, I guess, if I'm understanding it correctly, its sound like, non-performers on an absolute basis will probably still go up in the fourth quarter inspite of, I guess some pretty significant charge-offs also in fourth quarter. And I guess, my question is, I guess, we boosted the reserve on a net basis by about $12 million or so in the second quarter, it went from 169 to 181. So, looks like you will have eaten up, I think, all that incremental reserve, Bill, but with non-performers still increasing, the cover of non-performers will start to look down, pretty clear. And I guess, I'm just curious, at what point what added that coverage or continued deterioration in credit, necessitate another reserve, Bill?

Charlie Christy

This is Charles. I'll just answer reserves calculation, and John can maybe answer the other part of the nonperforming thing.

Basically, as we worked for our reserve, we obviously, that's an art version to science, and you have the specific portion, the formula portion, and obviously then, your qualitative portions and the general reserves, and so on. It’s important to realize that what we did in the second quarter on top of booking extra reserves, we did allocate different parts of the reserve to specific, and grew in certain areas we though would -- the risk needed to be covered. So, that’s why it's following, kind of how we predicted here.

The reserve growth would only occur if you see that phase will start coming in, when we actually need to bolster back up to the nose. So, it all depends on how, with the next coming quarters that the phase or some things like that start coming in, whether or not they will be worst than all the reserve began, so partially charged down. And that will drive whether or not that you have to book higher provisional or you are allowed some of the reserve to continue to migrate down.

John Schwab

Scott, I might add to that. First of all, I would emphasize, our historic practice of moving deteriorating credits as quickly as possible into our special loans workout group, get some into a discipline that is very, very hands on. As these loans become nonperforming, when they move into special loans group, appraisals, valuations, liquidations analysis are done, and that drives our reserve process. So, I can repeat the comment that we made earlier that those that we have forecasted as charge-offs for the fourth quarter have essentially been fully reserved.

So what do we see going forward? Well, we see still have some loans that have moved in to that group, that were in the process of assessing what the underlying real estate values are, are the projects completed? Is it going to take some more to complete them, and what is our best strategy in working with individual customers and their ability to work with us and working through the situations? So, I don’t see huge increases in nonperformings. And I see some significant reductions as we rid ourselves of some of these exposures that have already been reserved.

Scott Siefers - Sandler O'Neill

Okay. And then, as prior to this quarter, I think the vast majority of stuff that was coming onto nonperforming and the watchlist was on the legacy republic franchise. As stuff continues to migrate in, either due to watchlist or into nonperforming. What is your sense of how much of that is coming from legacy republic versus kind of combined -- I guess the legacy to this in franchise as well?

Bill Hartman

Those we shared with the Board yesterday, we’re all on the same team now. But I'll just say this. It is the large majority, is commercial real estate.

Scott Siefers - Sandler O'Neill

Thank you very much.

Operator

Thank you. (Operator Instructions). Our next question comes from the side of Terry Mcevoy with Oppenheimer. Your line is open please go ahead.

Terry Mcevoy - Oppenheimer

Good morning.

Bill Hartman

Good morning Terry.

Terry Mcevoy - Oppenheimer

I guess a similar question to what Scott just asked, the increase in MPA is particularly on the land development side. Geographically, has that changed at all over the last two quarters, and I guess, earlier on, as you were analyzing credit, did you focus initially close to home in Southeast Michigan as you have expanded across the franchise. Is that the increase or has it been pretty even quarter-to-quarter in terms of the geographic breakdown, and right into Wisconsin as well.

Bill Hartman

Actually, Terry, the land development loans that have tipped into nonperforming over the last quarter are largely Southeast Michigan. I am taking a look at the list that flopped into nonperforming during the quarter, and for loans constitute $17 million of the increase, and that are all in Southeast Michigan?

Charlie Christy

Hi Terry, this is Charlie. You had Southwest Wisconsin. So, I think, what we are seeing in Wisconsin is a very clean portfolio performing very well at hand. It does not have the F&M kind of historical loss factors or credits issues. And then also, there is a market that we are seeing good growth, both in loans and deposits. So, we are very, very pleased with where Wisconsin is performing from a growth perspective and a credit quality perspective.

John Schwab

I would add to that Terry that the Wisconsin market, we are seeing some good opportunities in the commercial real estate projects, and a couple of very interesting healthcare industries. So, we are getting some growth over there, and I think the heavy lifting was done in Wisconsin at several years ago, and we looked to that market to sustain some very good growth.

Terry Mcevoy - Oppenheimer

And on the revenue generation initiatives, is the ball rolling on every potential initiative as the few more mentioned this quarter? Are there still some others that will be put forth in the fourth quarter into 2008?

Bill Hartman

Yeah, Terry, Bill Hartman. The initiatives we have in place are all the primary initiatives that we are going to use to drive the increases in 2008. To use your term, yes, the ball is rolling on all of those. We expect to see significant reintegration of the sales and sales management processes in all of our lines of business, that's obviously one of them. Charlie mentioned a little bit earlier in the call, some of the fee income things we are looking at, both in terms of pricing and in terms of waiver levels. We think the business-owner banking initiative, the very small businesses, its a great opportunity for us given our product line.

We think there is going to be a lot of improvements in that area. So virtually, all of these things are working well. I want to also comment on the back-office. We think that there are some significant improvements we can make in reducing cycle time, turnaround time and responsiveness to the frontline from the back-office. We think that's going to make revenue enhancement a little bit easier.

And then lastly, I want to comment on the continued success of our asset-based lending group, as you will recall, that much like the Northeast Ohio initiative was in essence, a list-out type of initiative, and its been very, very successful. And we look for continued growth in that revenue initiative as well.

Terry Mcevoy - Oppenheimer

One small question for Charlie, merger-related charges, is the fourth quarter, is that, will we see any of those in 2008? And then, as you look to report 2008 earnings, where you continue to have to kind of breakout core operating earnings, and then mention the amortization of core deposit intangibles or will we just see one clean number next year?

Charlie Christy

Good questions. The merger-related items, and it's due to accounting of how you have to handle things. That ends at the end of '07. So, there should be no -- anything trickle into '08 related to merger-related activity.

The reporting of core operating earnings is a very standard kind of calculations for that one page that we have or does that reconciliation, we usually do that, is because, in purchased accounting you have the goodwill number. So, when you start comparing return on equity to other things, they have lot of organizations that you are comparing to. Some of that purchases stuff have it, and therefore, it's better to have the intangible common equity comparison between other peers. And so that's why, we'll continue to show that, but you really just have the one adjustment, and we just try to stick to what the SEC allows in that kind of calculation.

Terry Mcevoy - Oppenheimer

Thank you.

Operator

Thank you. And it appears that we have no further questions in the queue at this time.

Bill Hartman

Well, in that case, thank you all very much for joining us. And we will be happy to answer any questions or help in any way we can at any time. Thank you.

Operator

Thank you. This does conclude today's teleconference. Thank you for your participation. You may disconnect at anytime, and have a wonderful day.

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