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Executives

Robert Sarver - Chairman, President and Chief Executive Officer

Dale Gibbons - Chief Financial Officer

Hal Erskine - President

Analysts

Christopher Nolan - Oppenheimer

Brad Milsaps - Sandler O'Neill

Manuel Ramirez - KBW

Hugh Miller - Sidoti & Co

Brent Christ - Fox-Pitt Kelton

Alan Duncan - Wachovia Securities

Joe Morford - RBC Capital Markets

Brian Freckmann - Crown Capital

Western Alliance Bancorp (WAL) Q3 2007 Earnings Call October 19, 2007 12:30 PM ET

Operator

Good day, everyone. And welcome to the Earnings Call for Western Alliance Bancorporation for the third quarter 2007. Our speakers today are Robert Sarver, Chairman and President, Chief Executive Officer; and Dale Gibbons, Chief Financial Officer, and Hal Erskine, President of PartnersFirst.

Today's call is being recorded and will be available for replay after 5 PM Eastern Time today until 11 PM October 26 by dialing area code 888-203-1112, using the pass code 4231550.

The discussion during this call may contain forward-looking statements that relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts.

The forward-looking statements contained herein reflect our current views about future events and financial performances that are subject to risk and uncertainties, assumptions and changes in circumstances that may cause our actual results to differ significantly from historical results and those expressed in the forward-looking statements.

Some factors that could actual results to differ materially from historical or expected results include factors listed in the Initial Public Offering Registration Statement as filed with the Securities and Exchange Commission. Except as required by law, the Company does not undertake any obligations to update any forward-looking statements.

And now for opening remarks, I would like to turn the call over to your host, Mr. Robert Sarver. Please go ahead, sir.

Robert Sarver

Thank you. Thank you for joining us this morning. I would like to start off going over our strategic direction right now and some of our initiatives and really where the focus -- current focus of your management team is. After that, I want to talk a little about asset quality, which is something I know is at the top of the list with all bank investors, and also happens to be a topic that I spend a great deal of my time and my personal attention in.

Then, I'm going to turn over to Dale Gibbons, Chief Financial Officer of Western Alliance to give you some highlights of the financial results for our recently completed quarter. And then I thought it would be helpful to have Hal Erskine, who is the President of our new venture, PartnersFirst, to talk about where we are and kicking off our affinity credit card business.

Strategically in terms of our focus right now, and really kind of what is at the top of our list. Number one, I would say would be continue to grow our core deposit loan business. We want to continue to recruit good relationship bankers to the Company. However, we are slowing down the number of new offices we've opened. We opened three new offices in the third quarter, two in Las Vegas, one in San Diego.

As you know, we’ve grown over the last five or so years from five offices to 38 today. At this point, we feel we have very good coverage in markets like Las Vegas, San Diego, Phoenix, Tucson and Reno. So there is really not a business in one of those markets that can’t interact with us because we are too far away. Going forward, the number of new office openings we plan on for the next 12 months probably, looks more like one a quarter versus two or three a quarter that we’ve had previously.

We are also continuing to look internally in how we can improve our operating efficiencies within our organization. One thing about a tougher economy, it focuses you to look more internally. I think your weaknesses elevate, and you really get a better chance to see how you as a company can become a better organization. We’ve started that. We’ll have about a 5% FTE reduction excluding the PartnersFirst operation. Matter of fact, this last quarter, we reduced our FTEs by 13, including staffing up for the opening of these three new offices.

The money management business is something we’ve done really well at. We’ve been able to attract and retain a lot of key people from our acquisition from Miller/Russell. We bought China investments this quarter. Our assets under management have grown, pushing $2 billion, the business we think we’re good at that we can run profitably and do well. So we’re going to continue to put capital and emphasis on organically trying to expand that business, as well as looking for acquisition opportunities in that business.

PartnersFirst, a new venture I'm very excited about. I would say, since we started working on this in the last three or four months, results to date are kind of at the high end of what we anticipated. We do want to become the premier credit card program for small to mid-size affinity groups.

We added a great director, Ken Vecchione, former Chief Financial Officer for an MBNA and newly appointed CFO of Apollo Group. He's got a lot of experience. The quality of people we’ve been able to hire in that business is strong. And the receptiveness from the marketplace in terms of customers out there willing to talk to us about doing business has been really good. And Hal, will update you on some more information there a little later in the call.

Getting to something that’s kind of exciting to me is I think at this point, we’re beginning to look at what I’d call vulture opportunities in our market with the disruption. That could include the form of purchasing pools of assets at deep discounts. It may even include institutional purchases and potentially may include us partnering up with other investment funds and investment vehicles to help manage those acquisitions.

Myself personally, as well as the banks that I have run, have had a good track record of being able to acquire real estate assets at distressed prices and turn them around into very profitable investments. We also will continue to buyback stock in our Company at we deem to be opportune prices and surely trade it at 10% deposit premium today would be a price we would think would be opportunistic for us to acquire shares.

From a credit quality standpoint, let me just kind of give you a summary of our portfolio. 21% of our portfolio is what you would refer to as C&I, straight commercial and industrial loans, no real estate as collateral. 42% of our loans are secured with commercial real estate mortgages. They are term loans. About half of that portfolio is owner occupied and the other half is investor property. 10% of our portfolio is single-family mortgages.

And I make a comment on that. Our single-family portfolio, a lot of people are very interested in kind of what’s your exposure to sub prime in the mortgage business. We've got about $0.5 billion of mortgage-backed securities. They are all rated AAA. We bought no sub prime issues.

We do have one $10 million exposure on an Alt-A paper, but we bought the super senior tranche of that and in order for us to absorb any losses there, there would have to be over a 14% loss rate in that pool.

Our mortgage portfolio, which is a little over $400 million, we have said before very strong average loan to value 66% at origination, average FICO 704, no sub prime. In terms of where we are currently in terms of payment history, we have one REO house we took back for $150,000. We think we can sell for about 175. We don't anticipate any loss there.

We have one loan in the portfolio over 90 days delinquent for $450,000 that just appraised for 485. We will probably end up taking that back and having to sell it and then, we have zero loans 30 to 89 days delinquent. So the performance of our mortgage portfolio and our mortgage-backed securities portfolio is very strong. I feel pretty good there.

In terms of construction, 9% of our portfolio is in commercial real estate construction. About one-third of that is owner occupied; about two-thirds of that is to investors. 4% of our portfolio is in residential construction. That's a number that has come down. And 9% of our loans are secured with land, undeveloped lots. About two-thirds of that is residential and one-third is commercial. 1% of our loans are multifamily term loans and 4% are consumer loans.

I do believe that because we forecasted 18 months ago this downturn in the economy, especially in real estate, that we have been able to take certain actions to limit our exposure and our losses in our portfolio. I still believe firmly that we will continue to outperform our peer groups in terms of losses we take in our loan portfolio and in terms of delinquency and non-accrual numbers.

We have been fairly granular in terms of our approach to lending specifically in real estate. Even though we have a legal lending limit of about $75 million, the largest relationship we have in the bank is $26 million. We only have five credit relationships of $20 million and up. We have another 14 relationships between $15 million and $19 million.

Looking at our non-accrual loans, you can see some of the changes in the press release in there. We did make significant progress in resolving -- we resolved about $4 million of credits that were over 90 days past due through payoff or being brought current in restructuring with additional collateral.

Non-accrual loans, as we've said before, I mean, there just was no way that that number was going to stay nil. And that has bounced up to currently about $16 million. That really consists of only six credits. Most of them are house related, either some homes that are finished or some lots. They are all secured with a first deed of trust.

We currently in our loan loss reserve allocation have about $1.3 million reserve for those credits. They are in the process of collection. Some of them may take a little longer than others.

There's three big ones. One is a $2 million deal in Reno that is secured with some residential lots. The appraisal just came in. They are actually kind of higher end lots on a golf course. New appraisal just came in at $3 million.

We have another deal for $5 million in Tucson that was secured with some lots where we have some cost overruns and the builder and the contractor got into a little pissing match and it looks like they have come together now, are going to get this project finished. It is about 90% complete. We do have a takeout in place with a homebuilding company that has reupped their agreement to buy. And the other is about $6.5 million on a residential project that is under construction in Las Vegas. That is going to be a little bit of a more protractive workout.

But I guess my point is that we have had this step-up in some non-accrual loans. I don't think it is an alarming rate. The numbers are still well below our peers. And what is going to go back to whether how successful we are is the fact that did we underwrite deals in the right locations and do we have enough collateral.

Anything to do with residential right now, whether it is lots or houses, is going to take longer to develop, longer to absorb. The key is do you have enough equity and do you have the right sponsors in the right locations so when the market comes back, your properties are going to be sold and you are going to do that without taking losses to the bank.

We have significantly reduced our delinquency in loan delinquencies and are on top of that. I am looking at a chart, I guess, that shows every loan in the Company that is 30 days or more past due, 90 days or more, non-accrual, REO, the whole thing. The total is $12 million in Las Vegas, $2.2 million in Reno, none in Northern California, $0.5 million in Torrey Pines Bank in Southern California, and $6 million in Alliance.

So I am really -- while I would like to not have any NPAs, given where the market is, I feel pretty pleased that we only have $21 million of loans that are over 30 days past due. We are on top of that, and I think our underwriting is going to pay off in the long run.

Let's see -- I am sure we will get some more questions in the Q&A regarding real estate in specific. I know that is on the top of everybody's list. But right now, I'm going to turn it over to Dale. And Dale can give you some summary and highlights of our financial performance for the quarter. Dale?

Dale Gibbons

As you saw in the press release, net income for the fourth quarter was $11.9 million at $0.35 per share. It included $0.03 benefit from basically securities valuation. You may recall during the second quarter, we had an $0.08 charge related to the significant run-up in market rates during 2Q that reversed in the third quarter.

The benefit was less though, however, because as most people are aware, there was a pretty substantial expansion in spread relationships across the credit curve coming off some treasuries.

We also had a $0.01 gain on a security situation that was just an opportunistic deal that took place during the third quarter. Coming the other way, we had a $0.02 charge for PartnersFirst, a $0.02 charge for Alta. Alta does continue to make progress. It's still however pulling down consolidated earnings.

And then most significantly, we had a provision expense of $3.9 million, which was $3.3 million over our 600,000 in net charge-offs. That clipped EPS by $0.07, the excess over charge-offs. Half of that increase was a result of strong loan growth that we had during the quarter, and the other half was to cover credit deterioration as Robert alluded to.

In terms of the share count, we were down slightly to $31.7 million. We repurchased 560,000 shares. However, that was largely offset by the 310,000 shares that were issued for the Shine Investment Financial Services acquisition in the Denver area.

Revenue was up 20% over last year at $52.7 million, largely due to the First Independent acquisition, which closed at the end of the first quarter. It was up 6% on a link quarter annualized basis however. Our margin was down 14 basis points to 438 from a 452 in the second quarter. This decline was not caused by assets repricing faster than liabilities.

In terms of kind of a stand-alone basis on our interest rate risk profile, we see ourselves as modestly liability sensitive. However, we did have a deterioration in terms of our liability mix with continued declines in demand deposits, primarily driven by title companies, and that was offset by increases in money market accounts. Obviously, that is a more expensive funding structure.

In addition to that, in all of our, earning asset growth both on our loan book and securities was funded with wholesale sources, although that is at a positive spread and produces net interest income for us and a higher EPS, it is at a substantially lower margin than our average presently. And that’s what drove that down. In fact, net interest income was up 2% from the second quarter. In addition, we also had some interest reversals with some of the loans becoming non-performing. A year ago, the margin was 442, essentially flat.

Non-interest income was up 27% to $5.9 million from a year ago, and down slightly from the second quarter. We had $400,000 of revenue recognized for the two months that we had Shine during the third quarter.

However, we did not have any loan sales income, which explains the decrease that we have. We were getting traction there through the second quarter, and that kind of abruptly halted in the third quarter. And that was the drop in the other income category.

Non-interest expense, up 38% to $34.6 million over last year. It’s up $1.1 million from the second quarter '07 if you exclude the non-recurring merger related expenses we had in the second quarter. That $1.1 million is almost entirely explainable from PartnersFirst, about 80% of it. We also had about $250,000 of expenses from Shine. And as Robert mentioned, we had opened three new offices during the quarter.

The third quarter efficiency ratio was 65.1% compared to 64.2% in the second quarter. However, if you just exclude PartnersFirst, it declined slightly to 63.6%. Obviously, that’s not where we need to be. But we believe we are making progress and we're going to continue to do so with the reduction that we had in FTE a little bit during the third quarter, as well as slowing down the expansion of our retail distribution system.

Non-performing loans came in at 46 basis points at $16.4 million of total loans. Notably, however, we believe loans past due 30 days and still on accrual declined from $33 million to $5 million, with most of the reduction coming from a migration to NPL. The reserve level was at 1.13% at 9/30, up from 1.09% at 6/30.

To the degree that 30 to 89 day past due loans are really nascent non-performers, we think that the pipeline has been reduced from the increases that we had in 30 to 89 day past dues for the past five quarters. The tax rate; again, declined a little bit to 31.5%, nothing really nonrecurring in this category.

We have been managing this down through acquisitions of loans and securities that are tax advantaged; however, some of those are tied to LIBOR. And as LIBOR, we expect to come down in certainly the fourth quarter from the third, where it was quite volatile.

We do expect to see the benefit there decrease, and probably have about an increase in our tax rate about 1% from the 31.5%. Organic loan growth was 2% un-annualized on a link quarter basis. We have done some good deals in all loan categories.

The largest piece that we, largest loan that we did was in the construction category, it is in Utah. It is at 39% loan to value, and the guarantors are exceptionally strong. We feel good about this development opportunity.

In terms of the deposit side, really deposits were flat during the quarter; again, if you net out the title deposit decline we had of $35 million, we also had another increase, $9 million in our customer repurchase agreement. However, we think the title situation and deposits generally are going to be challenged for the foreseeable future.

In terms of where the affiliates are, organic loan growth was $57 million at Bank of Nevada, which is where the Utah loan was booked, $6 million in Reno, $38 million in Arizona and $46 million in San Diego, $11 million in Oakland. As I said, they continue to show increased performance.

Deposit growth or the lack thereof was distributed, it was flat at Bank of Nevada, small decrease at First Independent, minus $34 million at Alliance Bank. Alliance Bank took the brunt of the title company deposit decline that we had during the quarter.

At this point, I would like to turn it over to Hal to talk about PartnersFirst.

Hal Erskine

Thank you, Dale. And I want to say how proud I am of my Western Alliance teammates and the credit quality and steering this ship through a difficult market. And I'm very proud of our performance. And it has enabled us to do what we're doing, which is three things. Since July 2 when we started -- one, get ready to issue cards, which we will be doing on October 29; second, prospecting signing affinity groups and then, of course, bringing on good people.

I will start with the operation. We initiated our total systems agreement on July 2. And in four months, basically a little bit less than four months with two people to Hawkins (ph), Kevin Skirde, Tina Yorkers (ph) went down to Columbus, Georgia and it's like My Cousin Vinny all over again. But they did a phenomenal job.

And the fact that we will issue cards next week to select Western Alliance people for final testing and certification. It is a record time and with a great partner from Total Systems, normally takes six to nine months with a dozen or more people on the issuer side, we did with two people living down there in the last three months.

We had our compliance review by Western Alliance. They took four of their senior most auditors and compliance people through three days of very rigorous testing in Columbus again in Total Systems and passed with flying colors. So I'm very proud of that.

We have established vendor relationships and contract with Loyalty Rewards Plastic Agency Data Management and a variety of other vendors. We will issue two affinity programs, starting in November 1, National Association of Sports Medicine, which I will bring up in a minute. And we have, after the peak season through Thanksgiving holiday will be implementing our next six to nine programs, which we will talk about. FDR, Visa, MasterCard, freeze them during the holidays for level of card usage.

We will launch four to six new programs, as I mentioned, including a student loan pay down program for our college/university partners in December.

That is the operation. We are very proud of our credit and underwriting. The key for our affinity marketing will be of course our pre-approval, make sure we sign the right groups with the right demographics. And throughout the decision-making process of who we give our loan to, both in the automated TSYS structure as well as the judgmental. And every application will be reviewed by a PartnersFirst person.

Second category, affinity groups, we have developed -- Jim Duncan and our team have developed what I consider the finest prospect database in the affinity credit card market in the last two months. We have over 10,000 affinity prospects by credit quality and a database that we are talking with and sending out mailers to every month.

And from that, over 100 prospects or presently, it is actually 111 are what we would call a hot prospect phase. And in the next 6 to 12 months, we will be renewing their contract and have expressed significant interest in talking to that. From there, we have 20 in final stages of negotiations, where we are in serious discussions with them about finalizing the program. And we signed 10 new partners relationships since the launch.

We have shortened the sale cycle in addition to the operations cycle. We feel in the affinity market one of the issues is how long it takes to sign a group from contact to close. We usually in the four to six months range. We’ve now, as you can tell, shortened at least for the groups we signed to less than three months. And so, our goal is to be 120 days from contacting a group to have the marketing completed.

Finally, and I will end on this, we’ve attracted, as Robert mentioned some fine people to our organization. We started with seven, who you met in the launch in July. We are up to 12 now. We will have 30 by the end of the year. I added up this morning we have over 200 years of credit card experience from the 10 people we have presently onboard.

And a good example of that is how quickly with TSYS, the Hawk and Kevin have made things happen in getting our organization up to speed to issue cards 1 of November. We also have 20 outside brokers working to bring us business. And their skill set is well over 200 years of experience in selling and business development broker -- developing affinity marketing.

So that’s a quick update on PartnersFirst. We're very proud. A couple of highlights of the partnerships that we have signed since July, you heard about U.S. Squash, which of course has great demographics. And that’s something we will always focus on as our first criteria of who we sign.

The National Association of Sports Medicine, which is a program for team physicians and team physical therapists that there is 80,000 nationwide. Golf Magazine $1.6 million subscribers and if you know anyone who plays golf, they are using a very good demographic. And we’re excited about a new program for a VIP with The Palms, a casino in Las Vegas.

So with that, I will turn it back over to Robert.

Robert Sarver

Yes. Thanks, Hal. We really are excited about what you are doing at PartnersFirst. And we feel over the long term, this is a piece of business that can add significant value to the Company. And we are all working hard to get off to a good start here and I think so far so good.

With that, why don't we go to questions and just open it up right now?

Question-and-Answer-Session

Operator

(Operator Instructions) And we will take our first question with Christopher Nolan with Oppenheimer. Please go ahead.

Christopher Nolan - Oppenheimer

Good afternoon. Hello. Hal, does the turbulence in the credit market affect your planning for securitizations? Have you guys started considering alternative plans if you cannot access securitization markets?

Hal Erskine

Well, the first criteria will be credit worthiness, and that is something that is very important. We have six phases, the pre-approval of the group we sign who we market to in that group's list. We will do a lot of modeling to not necessarily market every single person on the list.

Third, who applies, we will have both an automated and judgmental review of all aspects of their credit quality. And then we will review everybody at least once and probably more times in terms of who we give a card to in the credit line. So that will be the first criteria that's important to securitization.

And then yes, of course, the securitization market, I would not want to be trying to securitize the sub-prime credit card business right now. But that first criteria is credit worthiness. And then second, the good part about having Western Alliance as our partner is -- and I will let Dale speak to this as well. There is no balance sheet issue relative to our growth for at least as far as in almost two years' worth of our growth. So from that point of view, I think we are not desperate to have a securitization. But we feel the first thing we will have to do is put on good credit and I don't think these credit prices will last forever either.

Dale Gibbons

Yes, we believe we can take about $1 billion of credit card receivables, which would get us to maybe a sweet spot in terms of the size to affect the securitization without having a kind of significant haircut for being a quasi odd lot.

And so, we will be able to do that, and then maybe run $500 million to $1 billion on our balance sheet, prospectively, as we build a securitization reputation.

Christopher Nolan - Oppenheimer

So that just basically uses your existing capital generation run rate, right?

Dale Gibbons

Correct.

Christopher Nolan - Oppenheimer

Okay. And should we expect, given these hot prospects then the comments that PartnersFirst is performing better than expectations in the startup phase and that the expenses related to it in 2008 will be greater than $0.02 a share -- $0.02 a quarter I mean?

Dale Gibbons

Yes. Actually, we expect that to kick up to $0.04 this quarter. And it could be a little bit bumpy as we go into 2008. But my -- kind of our best estimate would be that that $0.04 charge would continue quarterly throughout next year.

That said, I mean the purpose for this is because we are moving beyond the phase of just building infrastructure PartnersFirst. These expenses are to market to the members of our newly found partners.

Christopher Nolan - Oppenheimer

Great. And finally, Robert, could you give a little sub comment in terms of some of the raw land valuations and other observations in terms of the real estate market, both residential and commercial, in the Vegas market, please?

Robert Sarver

Yes, sure. The valuations for commercial have held up pretty good. I would say if there’s one area that’s starting to soften a little bit, it would be on the office side, the land for office development. Office is getting a little bit overbuilt.

The residential side is really kind of two components, and that’s why my comments a year ago, year and a half ago, you can't just underwrite real estate as a financial asset. You've got to know what real estate you are underwriting, the location, things like that.

The lots that are closer in that have infrastructure have a much better valuation. The stuff that’s far out and more speculative, boy, I wouldn’t even want to guess what some of those valuations are. Because really, in order to find out what residential land is worth now, you can't really look at comps.

What I've got our people doing is kind of going old school, which is what are the houses currently selling for in that market. Say a house is selling for $200,000. A builder can only pay $50,000 for a finished lot. So, if you've got finished lots, those lots could be worth $40,000, say, which gives a little discount and time value for absorption of lots to the builder.

But if you've got unfinished lots and you don't have sewer and you don't have utilities to the property, and it's just raw land sitting out there, if that lot were to cost, say, $50,000 to develop, then today your land is worth nothing.

And so, it really goes back to understanding your market and understanding which projects you have and which borrowers have the capacity to hold on.

Christopher Nolan - Oppenheimer

Great. Thanks for the color.

Operator

And we’ll take our next question from Brad Milsaps from Sandler O'Neill. Please go ahead.

Brad Milsaps - Sandler O'Neill

Hey, good afternoon.

Robert Sarver

Hey Brad.

Brad Milsaps - Sandler O'Neill

Hey Dale, just quickly on the net interest margin, I was a little surprised to see it come in as much as it did. I know you kind of walked through some of the interest reversals, et cetera.

But just curious when I was there in late September, you guys had talked about really aggressively lowering your deposit rates in anticipation of the fed cut. And just curious as to the direction of the margin going forward and just any additional color you can offer there.

Dale Gibbons

I appreciate that, Brad. And in terms of kind of the re-pricing that we have done on interest-bearing liabilities, deposits. It has been more aggressive than the contraction we saw in income as a result of the prime reduction.

But as we indicated, we did have about $250,000 of interest reversals. We also -- our wholesale borrowing has increased pretty significantly as our loan to deposit ratio continued to increase and deposits were flat.

I don't see any recovery on the deposit growth in the near-term at all. If anything, I think it’s probably continue to be under stress.

Title Company deposits, two years ago, two and half years ago were 20% of our total. Today, they are at just over 5%. But with what we see in the market, I think that could still drop further.

And so, to the degree that our funding mix is not going to improve, I don't believe, over the near-term, but we still continue to want to have some asset growth, although probably a little bit slower than what we experienced during the third quarter.

So with that, I would think that there’s going to be continued margin pressure as a result of mix issues, not to the substantial decline of 14 basis points that occurred in the third quarter, but at a more modest rate. But yet, I expect it to continue to contract in the single digit range in 4Q.

Brad Milsaps - Sandler O'Neill

Okay. One more question along the lines of loan growth. I'm just kind of curious, I guess last quarter, you guys talked about the competition and the profitability of doing commercial loans, et cetera, not being as attractive. And obviously this quarter, you had some very, very strong loan growth.

Just kind of curious as what changed in the last 90 days, kind of where a lot of the demand came from. And were you seeing better pricing, -- just better opportunities? Just curious as to direction there, what you saw over the last 90 days?

Robert Sarver

Well, I think there's a couple things there. Number one, we’ve hired a lot of new people over the last 12 months and opened up a lot of new offices. So, just because of the sheer numbers of new people we have calling, we are going to get growth.

Number two, a down market is also a good opportunity for us to pick out top quality borrowers that ordinarily, we really were not able to get from some of the bigger banks. So, we are still in business. A matter of fact, we are aggressively in business going after the A quality projects.

And finally, because the sales of houses and things has slowed down, you have less churn in your construction portfolio, so you have less payoffs. So, I think its kind of a factor of all those three.

Brad Milsaps - Sandler O'Neill

Sure, fair enough. Robert, would you say that your pipeline is right now at a level kind of where it was in the third quarter? Have you come off a little bit or how would you clarify?

Robert Sarver

Our pipeline is actually better, but it would be more commercial focused.

Brad Milsaps - Sandler O'Neill

Okay.

Robert Sarver

You know versus residential real estate and things like that.

Brad Milsaps - Sandler O'Neill

Okay. I’ll step back and listen.

Operator

And we’ll take our next question from Manuel Ramirez from KBW. Please go ahead.

Manuel Ramirez - KBW

Hi, good morning. Dale, could you talk about what kind of securities you are adding in the quarter? And is this a reflection of your anticipation that the Fed is going to ease further?

And then secondly, Robert, I hope you could elaborate on your comment about being a "vulture" investor potentially here with things kind of hitting an air pocket in the economy and the real estate market in particular.

If I look at your capital position, it is decent. But there are other companies out there that have more excess capital than you do. And you obviously have to support the credit card business. So, I'm curious how you would finance that.

Robert Sarver

Yeah. I mean smart people figure out how to make money in times like this. And part of it is being in a position, so that you can take advantage of those opportunities. I think as a company, we have a reputation of being able to make money in tough economies and to acquire distressed portfolios and turn them into profits.

We have that track record. We are beginning to look at opportunities out there that could present themselves. One way we could do that would be partnering up with another investor where we are using the bulk of their equity and their cash, and then maybe we’re getting a promote off the profits that are generated.

But, we will look clearly at how we can profit from what is going on in this market, because it will be oversold. And just as the markets overreacted on the plus side while back, they are going to overreact on the downside too.

Manuel Ramirez - KBW

And can you give me an example of the kind of stuff you are looking at now?

Robert Sarver

I mean not specifically with names, but there are institutions out there and banks out there that have portfolios of commercial real estate loans and residential real estate loans that are getting to price levels that are attracted and to be purchased.

And back in Arizona, when the market was bad, we went out and purchased loans from different S&Ls and different finance companies and then kind of worked our way out of those and was able to achieve returns that were over IRRs that’s over 20%.

Manuel Ramirez - KBW

And do you suspect that the regulators are at the point in the cycle where they would be concerned with that kind of strategy, or that they would be thankful that you would help them bail out other institutions that do have problem loans? Where do you think their heads are at?

Robert Sarver

I think if our, if our and it is the same thing I focus, same situation that happened in 1991 in Arizona. If our camel ratings and regulatory relationships and regulatory ratings are such that we are strong, which we are and if the regulators feel we have the expertise, then I think it is something we can do.

Manuel Ramirez - KBW

Okay. And then on the securities portfolio, Dale?

Dale Gibbons

Sure Many. We have been purchasing some collateralized debt obligations. These are primarily trust-preferred pools of other financial institutions. Those spreads have expanded. We are over the longer-term, we certainly remain sanguine on the banking industry.

And some of these pricing metrics or whatever, I am not sure reflect that. You can see the same thing in financial adjustment rate preferred stock. These are DRD beneficial, and those have really sold off pretty dramatically.

And, I mean we can buy A-rated paper of what I would consider a blue-chip name in Arps that would yield something on a taxable equivalent basis something pushing 9%.

Mortgage-backed securities, there has been expansion in those categories as well with the and we have been pretty tight here in terms of what we have been looking at with just basically super senior tranches. Although, I really can't understand how we could ever have losses in the double-digit range on prime paper.

And then also some municipal loans, we have gotten into Colorado as well, we have purchased -- we have acquired some municipal securities or municipal loaning relationships out of that market as well to mitigate our tax liability in that new state.

Manuel Ramirez - KBW

Okay. And if I look at the averages versus the peered and it looked like it haven’t pretty evenly over the quarter.

Dale Gibbons

I think that is fair.

Manuel Ramirez - KBW

Okay. Thank you.

Operator

And we’ll take our next question from Hugh Miller, Sidoti & Co. Please go ahead.

Hugh Miller - Sidoti & Co

Hi, good afternoon. I was wondering if I could follow up a little bit on the softness that you were talking about in the office space market in Las Vegas, and seeing if you were seeing anything else other than some of the residential real estate-related firms that were causing that softness, and wanted to get your thoughts on whether or not you feel that it will probably spill over into other areas outside of just office space?

Robert Sarver

I think office is the first one that we're seeing some deterioration in right now. And it is kind of similar to residential in that it is really more of a function of some overbuilding and over speculating, maybe a few too many office condos being built for sale and office buildings.

Retail is still doing pretty good. Although, some of the retail on the outskirts, that is depending upon a lot of the new residential developments to be built will be a little soft. Industrial is very strong. But I would say office is a little bit of a weakness right now.

Hugh Miller - Sidoti & Co

Okay. And can you maybe add some color then on just what you're seeing then for the construction market for the commercial side within Las Vegas?

Robert Sarver

Say that again?

Hugh Miller - Sidoti & Co

Just wondering if you could add some color on the commercial construction market that you're seeing in Vegas. Obviously, you said there is a little overbuilding with the office space, but what you're seeing in general on the commercial side in the Vegas market.

Robert Sarver

In terms of construction?

Hugh Miller - Sidoti & Co

Yes.

Robert Sarver

Yeah. I think that is starting to slow a little bit. Obviously, the one thing that’s not slowing are the casinos. We have about 100 cranes in Las Vegas building these projects. I counted last week, I counted 23 of them on one project, City Center.

Thing I would say about the markets we're in, we’re in some tough markets. And we knew they were getting tough and things are never as good as for as long as people think and they are never as bad.

But long-term and even mid-term, Phoenix has got 80,000 new jobs being created again this year. Las Vegas expecting 100,000 new jobs over the next four years just to meet the demand of the 40,000 new hotel rooms.

So, I see these markets coming back. I probably see Vegas coming back first and I see Arizona coming back next and Southern California last.

Hugh Miller - Sidoti & Co

Okay, and just last question is I guess, if you are seeing Vegas coming back first, over what time period would you anticipate that they will benefit from the job growth from all of the strip construction?

Robert Sarver

I would say within the next 12 months.

Hugh Miller - Sidoti & Co

Thanks so much.

Operator

We’ll take our next question from Brent Christ with Fox-Pitt Kelton. Please go ahead.

Brent Christ - Fox-Pitt Kelton

Good morning. Just a follow-up to the question on capital. You guys mentioned a number of initiatives that either you have in place or contemplating whether it is PartnersFirst, maybe expanding the asset management business a little bit, continuing to buy back stock or even getting into some of these vulture-type deals.

Could you just talk a little bit about how you’re prioritizing those, given your current capital levels and where you might see a floor in terms of absolute capital ratios?

Robert Sarver

Well, I can let Dale talk about our absolute capital ratios. But for me, PartnersFirst is definitely at the top of the list. This is a business, we think has tremendous upside for us down the road. And so we are going to make sure we capitalize it properly and devote the resources we can to make it successful.

I would say second would be kind of evaluating the returns that we think we can get by buying our own stock back versus whatever vulture opportunities we have. Of course, those opportunities can take place with our existing balance sheet and really don't require significant capital.

And then in terms of the actual numbers and where that shakes out, Dale, you can give him some color on.

Dale Gibbons

Sure. Certainly, what we look at primarily is going to be like tangible common equity. We’re only at 10.3% on total capital, but there are some things that we can do to, one, reduce our risk-weighted assets, and we will be looking at that this quarter.

And then there is also obviously an opportunity to issue some trust preferred to address that issue. Our tangible common equity took a bit of a clip during the third quarter related to other comprehensive income changes from the expansion of spreads in the securities markets.

Some of that has already tightened in a little bit. And in addition, I am not sure that should necessarily be included in that number. So if you adjust for that, we are above the 5.7 kind of reported level, but I would say I don't think we want to really escape below 5.5 in these market conditions.

Brent Christ - Fox-Pitt Kelton

And obviously, with the securities portfolio continuing to increase, are you guys considering doing that going forward? And would that eat into some of the capital that maybe you would allocate elsewhere?

Robert Sarver

The first priority is to be able to accommodate the business opportunity with PartnersFirst and so, the answer would be no. There are some things we can do. In addition, I think the securities growth will slow and there is also some things we can do in terms of 20% risk-weighted assets versus 100 and things like that.

So, to some degree, the securities portfolio is going to be an accordion to provide opportunity for the credit card initiative in particular, but as well as other loan situations and there are opportunities that arise in our markets.

Brent Christ - Fox-Pitt Kelton

Okay, and then just on a separate topic, at the beginning, you guys mentioned some pending reductions in the headcount. Could you just talk a little bit about the nature of those and over what time horizon?

Robert Sarver

Well, what we expect to do is we are continuing to kind of manage our FTE. We are looking at positions as they become available and as they open up and seeing if there's a better way to restructure that, so that we can operate more efficiently.

So it is not going to be a ratcheting downward, but it is an area that we are very, very conscientious of. With the slowdown that we have in our distribution system, and what we would expect would be continued growth after we get through these stagnant part on the liabilities side in particular.

We do have new offices out there. More than 40% of our offices are less than two years old. We think they are in good markets. We are going to be opening a branch this quarter in Mesa, Arizona.

So, what we are looking for is that our balance sheet growth would exceed the growth of our FTE, and we would drive efficiency in part by that method as well.

Brent Christ - Fox-Pitt Kelton

Okay guys, Thanks.

Operator

And we’ll take our next question from Alan Duncan (ph) with Wachovia Securities. Please go ahead.

Alan Duncan - Wachovia Securities

Thank you. What kind of exposure does the bank have to the Las Vegas residential high-rise market? How do you guys see that market developing over the next several years?

Robert Sarver

We have none.

Alan Duncan - Wachovia Securities

Good.

Robert Sarver

So that was kind of one of the things we made a conscientious effort to stay away from. In addition to not only that, but we had a policy in place that any just residential permanent condo mortgages that were done in high-rise condos or apartment conversion condos had to be approved by me personally in the bank, regardless of dollar amount. And I approved three over the last five years. So that was one we did not jump into.

Alan Duncan - Wachovia Securities

Thank you.

Operator

And we’ll take our next question from Joe Morford from RBC Capital Markets. Please go ahead.

Joe Morford - RBC Capital Markets

Thanks good morning. Really just about everything has been asked, so I guess a couple of quick follow-ups. One, Robert, you mentioned, still some interest in further expanding on the asset management side.

Just kind of talk about opportunities you are seeing now in pricing and the current market and things like that?

Robert Sarver

We have had good experience there. We bought Miller/Russell four years ago. We have doubled the size of the company. We bought it for about $6.5 million. We think today it's probably worth about $18 million to $20 million. We bought this other firm in Colorado. There is a network of these types of firms.

And many of them are kind of, from time-to-time, look to see, well, maybe I should exit our programs a little different than some of the others that are out there, like a Compass or Boston Private or Wells Fargo or whatever. I think it is pretty attractive. So we are going to continue to look for some of those firms in our region.

Actually, I was meeting with one yesterday to talk a little bit about it. So, local firms, managing $2, $300 million to $5, $600 million in assets that kind of want to team up with us.

Joe Morford - RBC Capital Markets

Okay. And then there has just been a lot of talk about Phoenix, Vegas, those places. Just what are your current thoughts about the San Diego market and where that is in this whole cycle?

Robert Sarver

San Diego is not doing too bad. Our stuff is clean as a whistle there. But we have stuck more to infill and coastal things. Farther you get away from the water, the more things have really got out of control. And if you look at numbers at San Bernardino, Riverside, Temecula, you get out there in the desert and it's really bad there. And part of it is because the price of housing has been really high.

And so people have to use a higher percentage of their income to make mortgage payments, and I think people stretch more in some of those areas to buy houses. And the people that stretch more tended to find themselves in more of the type of loan products that now they are getting into trouble with. But in terms of where we are in San Diego, I think things are still doing pretty good.

Joe Morford - RBC Capital Markets

Okay. Appreciate the update.

Operator

(Operator Instructions) And we’ll take our next question from Christopher Nolan with Oppenheimer. Please go ahead.

Christopher Nolan - Oppenheimer

Robert a follow-up on the vulture investing perspective. Is it fair to interpret that as your view that we are within sight of possibly the oversold -- the market being oversold in certain residential areas and so forth? Everything I hear or see and so forth just echoes we don't even see the bottom remotely yet.

Robert Sarver

Well, that is kind of the trick. Because, if you really want to make good money, you've got to see the bottom before everybody else. When it becomes evident that it is at the bottom and it is getting better, then it is too late to make really big returns because everyone else sees the same thing.

So my track record in my real estate company and with the banks has been to get in early and then get out early. So yes, I do think things are getting worse before they are getting better. But you will probably see us get in and make some of those investments before everyone thinks the bottom has hit.

Christopher Nolan - Oppenheimer

Good. Thank you very much.

Operator

We'll take our next from Brian Freckmann from Crown Capital. Please go ahead.

Brian Freckmann - Crown Capital

Hi, guy, how are you? Quick question for you. I think I must have just missed it in the dialogue. The mark-to-market gains, what were those again?

Dale Gibbons

During this -- effective at the beginning of this year, we elected to adopt FAS 159, and we have mark-to-market accounting now on fixed-rate mortgage-backed securities. That is the biggest piece of kind of what is in there. And so during the second quarter, rates rose rapidly, and we actually had a mark-to-market loss on those securities.

During the third quarter, rates dropped dramatically, even more than they actually rose in the second quarter. But we did not recover all of the loss as a result of expansion of spread relationships among mortgage-backed securities relative to treasury.

And hence that brought up one of the opportunities I talked about earlier in terms of being able to buy MBS at greater spreads and we think greater overall returns than what you have been able to previously.

Brian Freckmann - Crown Capital

Okay. And just I'll take this off-line. How big is that portfolio just going forward if we can try to model it out?

Dale Gibbons

MBS portfolio -- $252 million is what we moved in there, and it has been pretty close to that since. In terms of how we look at that going forward, I think our growth rate is going to slow, as I mentioned, going into the fourth quarter in terms of our investment. That said, those types of securities are 20% risk-weighted assets; they are AAA. And so it does provide an opportunity relative to the risk-based capital position at least.

Brian Freckmann - Crown Capital

Thanks guys.

Operator

And there are no further questions at this time. I would like to turn it back over to management for any additional or closing remarks.

Robert Sarver

Well, I appreciate you guys listening in. These are trying times. There're tough times. But there're also exciting times, and there's opportunities. I think this is when the quality of your management and the quality of your people really stands out.

And I think we are not only going to do well in terms of weathering the storm in the markets we are, but hopefully we will come back when things turn around as a much stronger organization.

And also, the diversity into the PartnersFirst operations and some of the other things we are doing will really pay-off for us. So we are excited about what is going on, and I think we have had a realistic outlook on things for the last year and half and not a lot of big surprises in terms of what is going on here.

We are moving forward, and just kind of charge on and see how we can take a tough situation and turn it into some opportunities and come out in good shape. Thank you.

Operator

Once again, ladies and gentlemen, this will conclude today's conference. We thank you for your participation. You may now disconnect.

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