Midwest Banc Holdings Q3 2007 Earnings Call Transcript

Oct.24.07 | About: Midwest Banc (MBHI)

Midwest Banc Holdings, Inc. (MBHI) Q3 2007 Earnings Call October 24, 0000 11:00 AM ET

Executives

James Giancola - Chief Executive Officer

Dan Kadolph - Chief Financial Officer and Executive VicePresident

Jay Fritz - President of Midwest Bank & Trust

John Eilering - Chairman and CEO of Northwest Suburban

Analysts

Dave Rochester - Friedman, Billings,Ramsey

Brad Milsaps - Sandler O'Neill

Barry White - River Capital

Operator

Greetings and welcome to the Midwest Banc Holdings,Incorporated Third Quarter Conference Call. At this time, all participants arein a listen-only mode. A brief question and answer session will follow theformal presentation (Operator Instructions). As a reminder, this conference isbeing recorded.

This presentation contains forward-looking statements.Actual results may differ materially from theresults suggested by these forward-looking statements for anumber of reasons. These forward-looking statements arewithin the meaning ofSection 27(a) of theSecurities Act of 1933, as amended, and Section 21(e) of theSecurities ExchangeAct of 1934, as amended and should beviewed in conjunctionwith the company'sannual report on Form10-K and other publicly available information regarding thecompany.

Copies of which areavailable from thecompany upon request and on thecompany's website atwww.MidwestBanc.com. Such publicly available information sets for thecertain risks and uncertainties related to thecompany's business that should beconsidered inevaluating forward-looking statements.

It is now my pleasure to introduce your host, Mr. JamesGiancola, CEO for Midwest Banc Holdings Incorporated. Thank you Mr. Giancola,you may now begin.

James Giancola

Thank you and welcome, everyone. Thank you for participatingin the call. We are not going to go through the press release in detail. I hopeyou've noticed that we continue to modify that document to make it astransparent and as comprehensive about operations here as we can. I will make acouple of opening comments but I'm going to ask several other people to speakto specific issues.

The core business is up modestly from the prior quarter. Ourearnings power continues to be going in the right direction. We are stillprimarily a spread bank. Margin, as you note, in the first quarter was 3.01%,up to 3.05%, up to 3.10% here in the third quarter.

The rate reduction that we got from the Federal Reserve didnot help as much as it could have because of the turmoil that still exists inthe credit markets. While Fed funds went down 50 basis points, much of ourborrowing is tied to LIBOR, and LIBOR went down about half that amount

And so, absent action on our part, just the change in themarketplace would have been margin negative to us, but we have made somechanges and as I said, margins are up in the third quarter, and lookingforward, the battle continues. Again, we're trying to drive that number up butanything but modest improvement going forward is going to be difficult in thisenvironment.

Credit quality is probably the hot button out there now. Iwant to make a couple of comments. Our delinquency rate is down aboutone-third. Our internally classified credits are down about 10%, non-performingassets is up about 2%. We have no 90 day past due loans reported as accruing.

We think that is a conservative way to look at credits. Ifthey are 90 days past due, they clearly are not performing in our mind, and sowe try to keep that number to an absolute minimum. We have no foreclosedproperty in 2007 and that number continues to trail down modestly.

I have no particular information to report on Large ProblemCredit other than that we are actively involved with all concerned parties.Progress has been made. We will issue a separate press release when we havesomething specific to announce. We did choose to provide $1.8 million in thisquarter, up from $1 million last quarter.

Even though that covers charge-offs by more than threetimes. We think, in the difficult real estate environment that we operate in,that is prudent. And so, reserves continue to trend upward. Most importantly,we are very actively monitoring watch list credits, identifying credits we wantmoved out of the bank with very specific exit strategies.

And we have been successful thus far this year, successfulin moving $70 million in credits that we have identified with exit strategiesthat were still technically performing but we thought very vulnerable to acontinued downturn in the economy.

That affects loan growth. We think credit quality is moreimportant than loan growth, and that is driving our strategy at this point.Loan growth is in the mid-single digits. That's a very active sell-down programamong our larger credits. We would have been in the high single digits. Again,all of that is reported in the press release.

On the deposit side, the market continues to be competitive.Our core deposits, that defined as other than CDs, are up fractionally in thequarter and up about 1% fractionally, point-to-point, up about 1% on averagefrom the prior quarter.

We had a very significant reduction in brokered CDs, whichaffects the total deposit number, but obviously we just look at our wholesalefunding opportunities and migrate to that which is the cheapest cost of fundsto the bank.

So, core deposits are up fractionally. And in think, that'svery important in this marketplace where there's a ton of branching and lots ofcompetition. Jay is going to give you some more color on that.

The Northwest Suburban transaction closed, as announcedearlier on October 1. The conversion is scheduled for this weekend. For thoseof you with nothing to do this weekend, you are more than cordially invited tocome join help the conversion team this weekend.

With that, I am going to turn it over to Dan Kadolph to makea couple of comments about the numbers, and then both Jay Fritz and JohnEilering will make some additional comments.

So, Dan, would you share with them some wisdom?

Dan Kadolph

Thanks, Jim. I want to discuss our top line revenue. For thethird consecutive quarter, we've had increases the top line revenue. Top linerevenue is net interest income plus non-interest income.

It still remains an area of opportunity for Midwestto increase that for our own good as well as in comparison to our peers. Welook at our Illinois-based bank holding company, a peer group of $1 billion to$10 billion organizations, primarily in the Chicagomarket.

Previously announced, we previously announced that we exitedthe mortgage business. And with that exit, we had declined in our revenue thatimpacted top line revenue and non-interest income. However, the correspondingexpense for having that type of operation is also down. So on a net basis, wefeel that has been friendly to our earnings stream this quarter and will be sogoing forward.

Non-interest income was flat, as I already said. We feelthat we would have been flat, if we did not exit the mortgage business, basedon the averages that the sales of loans we had in prior quarters.

We had a slight decline in service charges, during thequarter. We attribute that to typical decline. We had a very nice increase ininsurance brokerage commission and our trust revenues were slightly down.

Jay will be covering discussion on those lines of businessesin his discussion in a couple of minutes.

The non-interest income expense is for Midwest Bank. Itdeclined for the second straight quarter, a trend that we like and a trendwe're working hard to continue. We had 29 less full-time equivalent employeesat 9/30 compared to June 30, primarily the decline for the mortgage and themaintenance areas that we announced in the prior quarter.

On a link-quarter basis, our efficiency ratio declined from66% to 64%. Expense controls are very much being looked at all times by seniorand executive management of this organization.

Our effective tax rate, during the quarter was 19.4% thatwas up from the prior quarter of 17.4%. That's attributed to an adjustment fora true up after we filed our federal state income taxes for 2006. We took anexpense of $159,000. After that expense, we would have been at a 17.4%effective rate, flat quarter-to-quarter from second and third.

During the second quarter or late second quarter, the Stateof Illinois did pass a new billinto law that will make some changes that will impact our effective tax rate inthe years 2008, 2009 and beyond.

To cut to the chase, for 2007, if the first stuff of thattax strategy we implied which is an 80/20 company did not exist. Our effectiverate would have been 21.7%, compared to 17.4%.

During the quarter, we also called for November 7 at par $15million of trust-preferred securities that are currently priced at LIBOR, plus345 basis points. We have yet to make a final determination on replacing thatinstrument or not.

During the quarter, we repurchased 142,000 shares of stock,at an average price of $14.05. Year-to-date, we've purchased 321,500 shares at$15.48. We have remaining capacity of 714,000 shares and we will make thatdecision on any future buy-back as market conditions warrant, whether a privateor public transaction.

With that, I'd like to turn over the call to Jay Fritz forhis discussion.

Jay Fritz

Thanks, Dan. Let me begin by talking about the commercialloans side of our business and let me start with real estate. Commercial realestate loans are up 2% for the year and 1% for the quarter.

We have a $400 million construction portfolio, but only halfof it is involved with single-family construction, the other half is incomeproducing properties and other good commercial properties.

Two years ago, construction loans were 30% of our realestate portfolio. And now, we see they are only 20% of that portfolio. Payoffsin our construction portfolio are running 100% over last year, which we believeis a good thing, as we proactively weed out troubled credit.

The C&I side remains very strong with 16% growth for theyear, while we also remain attentive to moving out potential problem credits.

We have weekly loan officer meetings, which help us identifyproblem credits early. We believe the loan officer staff is key in terms ofpercolating up troubled situations so we could deal with them or perhaps movethem out of our company.

Let me just talk a little bit about the acquisition ofLaSalle by Bank of America, because this will continue to create opportunitiesfor our company. Our calling staff has been consistent in the marketplaceidentifying key targets, many of which are LaSalle customers. And now, we areseeing strong, good new business coming from this competitor.

We have all read about market competitors bringing overlarge groups of LaSalle lenders. While we, too, have selectively brought ingood talent from LaSalle, at this time, we feel very good about our existingcadre of loan officers; we feel good about their competency; we feel good abouttheir market presence; and we feel good about their opportunities forcontinuing success.

As Jim mentioned, on the retail side, the marketplaceremains extremely competitive with over 500 new banking offices opening in thelast couple of years. One indication of how competitive the market has become Iwas reading the newspaper a week ago, saw an ad from Fifth Third Bank for ahome equity loan priced at 5.75%. On the same page, I saw a Countrywide adpaying 5.65% on CDs.

At Midwest, we will continue toupgrade our branch manager talent, our branch talent. And we feel good aboutour ability to compete for good but profitable business.

On the wealth management side, our Trust department for thepast two quarters has not experienced growth, and yet from the beginning of theyear, assets under management are up 16%. We do have two new Trust salespeoplethat are slowly gaining traction, and we feel the fourth quarter is going to bevery good.

On the brokerage side, on the other hand, we had anexceptional quarter with revenues up 27%. I have to comment that revenues inthis area will continue to be subject to large one-time transactions, but wefeel good that brokerage has transitioned from a business that had just focusedon personal transactions to one that is now squarely focused on small businessdeferred comp plans, retirement planning, and insurance reviews, which webelieve will continue to bode well for the future.

Now, I'd like to turn things over to John Eilering, who isgoing to comment about his company's -- recently joining the Midwestfamily.

John Eilering

Thank you, Jay. I'm going to start out with balance sheet.Northwest brings $442 million in loans into the Midwestfamily. Of that, commercial and industrial represents $96 million or 22%;commercial real estate is $191 million or 43.3%. Of that commercial realestate, owner occupied is $101 million, or 53% of total commercial real estate.

On the construction side, there is $55 million 4.4% and theconsumer side, $47 million or 10.5%. The fourth-quarter pipeline isapproximately $30 million. And credit quality ratios are very strong atNorthwest, bolstering the overall credit quality at Midwest.

The merger also gave us an opportunity to pursue largercredits, and consequently, on Friday, we landed a $15.4 million creditfacility, something we could have not done under the Northwest flag. I'mpleased to say that all of our lenders have signed on and our team is intact.

Moving over to the deposit side of the balance sheet, Midwest'ssophisticated cash suite products will allow Northwest to move an additional$15 million to $20 million back onto the balance sheet from what Northwestviews a brokerage facility. We've combined the Midwestand Northwest cash management staffs and will be migrating to Northwestimage-based lockbox system. And plans are also underway for a bank wayimage-based system.

Jim mentioned earlier the conversion this weekend. Ourcombined operations staff has worked tirelessly to prepare for this weekend'scomputer conversion. Preliminary tests have been very successful, and we expectsmooth sailing this weekend.

Cost saves while Midwest Bank is primarily revenue-driven,we did originally project 22% cost saves. Our game plan is to exceed thattarget. The integration process is nearly complete, and the signs were up. Weare Midwest.

And now what, we will all be happy to answer any of yourquestions.

Question-and-AnswerSession

Operator

(Operator Instructions) Our first question is from Mr. Dave Rochesterfrom Friedman, Billings Ramsey. Please state your question.

Dave Rochester -Friedman, Billings, Ramsey

Hi, good morning, guys.

James Giancola

Hi, good morning.

Dave Rochester -Friedman, Billings, Ramsey

It looks like NPAs were stable and your 30 to 90 day theloan delinquencies and charge-offs had improved, so in light of that, can youjust give us some additional color on the loan downgrades in the portfolio thatprompted you to take the larger provision? And could you perhaps, quantify howlarge the watch-list is at this point? I know it’s down 10%, but could you puta dollar figure to that?

James Giancola

Let me startat the beginning. Wehave a formula thattakes into account loan growth, sothere's a provisionfor that. We regularly update watch list credits forthe quality appraisal-wise for how solid ourcollateral is. We've provided additionally for that.

Then there's a big economic component that we use incalculating our reserves and our valuation or our assessment of the economy isthat it is weaker now than it was last quarter. And we thought it prudent toput additional dollars into the reserve because the economy is weaker.

Dan Kadolph

Internally classified is approximately a 101,000.

James Giancola

We have $100 million, this quarter we have $101 million in abroad definition of classified credit, that's down from about $110 million oflast quarter.

Dave Rochester -Friedman, Billings, Ramsey

Okay, great. So most of that provision, aside from loangrowth, went to, I guess, the general or unallocated, nothing specifically inthe portfolio?

James Giancola

Nothing significant, specifically…

Dave Rochester -Friedman, Billings, Ramsey

Okay. Could you also give us a little detail on what is inthat 30 day and 90 day bucket right now?

James Giancola

It's a cross-section of things and I am somewhat embarrassedto report part of it is, just loan officers getting documents in.

Dave Rochester -Friedman, Billings, Ramsey

Okay.

James Giancola

And so, the early delinquencies are not a tremendously largeconcern to anyone, but our Chief Credit Officer who stays awake at nightworrying about it. When it gets to 60 to 90, we worry about it. We are veryactive on that and that's where I think the majority of the reduction camefrom.

Dave Rochester -Friedman, Billings, Ramsey

Okay. Just real quick on the home equity portfolio, I know it'sa smaller portion of the portfolio, but just given the deterioration we've seenrecently in housing markets pretty much everywhere, could you update us on theaverage CLTV of that portfolio? And could you give us perhaps a percentage ofthe portfolio in the 80 to 90, 90 to 100, and then over 100 buckets at thispoint?

James Giancola

Our home equity program is pretty traditional. The over longmajority of the credits are 80% loan-to-value. When we go higher than 80% ofloan-to-value, it is typically in very low debt-to-income situations. Thecredit department has just done a comprehensive review of that portfolio and wedon't feel like there’s any surprise in there.

We also do not buy any brokered deals, so I think the creditquality there is okay. We're not anticipating any surprises. As I said, we justfinished the pretty thorough review of it and no surprises there right now.

Dave Rochester -Friedman, Billings, Ramsey

Okay. Do you have an average FICO for that portfolio, or arange, or both?

James Giancola

I don't off the top of my head, Dave, but we will look it upand call you back.

Dave Rochester -Friedman, Billings, Ramsey

Okay, no problem. And on the construction portfolio realquick, have you experienced or have you seen, amongst your borrowers, a greaternumber of extensions in that portfolio beyond the original maturity dates inthe third quarter versus the second quarter and could you possibly quantifywhat percentage of the portfolio right now is extended beyond maturity dates?

James Giancola

Almost none is extended beyond maturity dates. We continueto work with borrowers who are strong to assure that these things get workedout by -- we will extend the term for a qualified borrower, but as we identifythese things early on, we're getting most of this stuff moved out of the Bank.

We are not really interested in doing major restructurings.If it's a restructuring that is credit driven it gets reported as an impairedcredit. We have none of those to report this quarter.

Dave Rochester -Friedman, Billings, Ramsey

Okay, great. And just real quick on capital, you gave somepro forma figures in the press release and balance sheet items. I was wonderingif you might have also a pro forma risk-based capital ratio for us.

Dan Kadolph

Dave, we have the risk-based capital numbers in the releaseas it relates to Midwest Bank as of 9/30. Total risk-based capital is 12.51%.On a pro forma basis -- after the acquisition, you'll see that number decline, Iwould say, about 100 basis points.

Dave Rochester -Friedman, Billings, Ramsey

Okay. So, about 11.5 right now?

Dan Kadolph

11.5.

Dave Rochester -Friedman, Billings, Ramsey

Okay. And I -- You obviously had some buyback activity thisquarter. Just given what you are seeing in terms of deteriorating economicconditions in general. Are you thinking about being potentially moreconservative there on this front going forward, less active, or are you stillconsidering to maintain the activity for the next couple of quarters?

James Giancola

I think that depends entirely on market conditions, and weare just -- we monitor it pretty regularly and we see a pullback in the stock,we will probably be more active and than we have been, and if the stockrallies, we will probably be less active. But we monitor that pretty regularly.

We have authorized shares that we can buy. We are cognizantof our overall capital levels and are involved right now in an update of ourcapital planning position.

Dave Rochester -Friedman Billings Ramsey

Okay. Great. Thanks a lot, guys.

James Giancola

Thank you, Dave.

Dan Kadolph

Thank you.

(Operator Instructions) Our next question from Brad Milsapswith Sandler O'Neill. Please state your question.

Brad Milsaps -Sandler O'Neill

Hi, good morning.

Dan Kadolph

Good morning, Brad.

James Giancola

Good morning, Brad.

Brad Milsaps -Sandler O'Neill

Hey, Jim, I may have missed it, somewhere along the way, butcan you guys disclosed how you're going to finance the cash portion of theNorthwest Suburban acquisition, and how that's going to kind of affect numbersover the near-term?

Dan Kadolph

Hi, Brad,it's Dan Kadolph. We filed an 8-K with the Promissory Note. We hadborrowed some money on a three-year basis from a correspondent. We borrowed $75million at LIBOR plus 140 with no pre-payment penalty. That's what we used tofinance the cash component of the transaction.

Brad Milsaps -Sandler O'Neill

Okay, I wasn't sure if that was going to be -- what that wasgoing to be the long-term fix there or if that was sort of a short-term kind ofborrowing.

Dan Kadolph

We were committed to doing a long-term commitment and that'swhat we did with our correspondent.

James Giancola

But we are reviewing -- and now it is a long-termcommitment, which satisfies our regulators, but we're looking at our strategicalternatives right now. Again, the market is in such a state of flux that it'schanging week-to-week, and so we are monitoring what our options are and we’llbe issuing a press release when we make a final decision.

Brad Milsaps -Sandler O'Neill

Sure. And I know you guys mentioned you thought you couldexceed your initial costsavings with theacquisition. What else have you found on therevenue side that might changethe original accretionnumbers you talked about when you announced this deal back atthe beginning of theyear?

James Giancola

We’ll never put revenue into our analysis, but we alwaysbelieve them -- there as John articulated, is already closed a $15 million dealthat would not happened without our capacity. They have about $30 million intrust and that’s not at our bank that was outsourced.

That is possibility to come back on our books and so, thereare those sorts of opportunities appearing pretty regularly, not unlike theRoyal situation where both Northwest Suburban and Royal had what we callgraduates, companies that they got started and did very well and simply outgrewthe bank.

We just are not going to have any of that. We're going backto customers that have left because they could not be accommodated by thesmaller bank, that we can now accommodate.

The critical thing, part of the critical component of thistransaction is John has retained all his lending talent. He's got a good team,and we are aggressively out, taking care of existing customers and calling oncustomers that are vulnerable in the marketplace.

So, that's where the revenue comes from. Somewhat biggerdeals, more cash management, more trust capability.

Dan Kandolph

And the other thing that I will say about John's team isthat his lenders worked together with some of our lenders. We know them verywell, so therefore, credit approval, et cetera is going to be very smooth. Wethink they are going to hit the streets running and, armed with additionallending power, are going to continue to have successes such as what John justdetailed.

James Giancola

The $15 million deal that John referenced was apiece of business thathis lenders secured from LaSalle, sothat again, we feelpretty good about our ability to compete in that space.

Brad Milsaps -Sandler O'Neill

Okay, fair enough, and final couple of questions. Jim, anyexposure to this publicized Neumann Homes out in the suburbs at all?

James Giancola

No.

Brad Milsaps -Sandler O'Neill

Okay.

James Giancola

Short answer; I mean, we have acustomer, we filed some liens; wewere named plaintiff. We have some collateral that we're trying to collect for acustomer that owes ussome money. The aggregate amount ofthat is $260,000. It is not in our collateral pool as we calculate ourcoverage. So we have essentially zeroexposure.

Brad Milsaps -Sandler O'Neill

Okay. And I know you said you had no update really on the$29 million loan, but I guess if you had acrystal ball, I mean is itpushed out further than thelast time we talked obviously? Ifyou had to guess, arewe still talking kind of first or second quarter of '08 to seesome resolution, or is iteven further than that?

James Giancola

I think I've said to this point what we can say about it. Weare very heavily involved daily with negotiations on a limited settlement.Whether that comes to fruition in the near term or not, I just don't feelcomfortable making that statement.

Obviously, it is the top priority item here and hopefully wewill get some movement on it. But again, I can’t, I don't want to make anycommitments that we can't keep. These things always take longer and always costmore and I think our people are all over it and we will keep you posted asthere is something to release.

Brad Milsaps -Sandler O'Neill

Okay. And ultimately, does that keep you out of the M&Agame for now? I mean, obviously you've got to digest Northwest Suburban itsounds like that's going as planned. But when do you think you might get backin looking at smaller banks to join up with you guys?

James Giancola

There is no shortage of targets in the marketplace, booksare still flying around. We cannot, at this stock price, do an accretivetransaction at the price expectations that people have, so that effectivelymoved us to the sideline until there is a recovery in the stock price. And youknow that’s sort of where we stand. So I would not expect any transactionsimminently.

Brad Milsaps -Sandler O'Neill

Fair enough. Thanks, guys.

James Giancola

You’re welcome.

Operator

Our next question is from Barry White with River Capital.Please proceed with your question.

Barry White - RiverCapital

Can you give methe proforma tangible book value pershare for this acquisition that just closed here?

Dan Kadolph

Barry, it's Dan Kadolph. I don’'thave that information available atthis point, and I amnot sure we would like to --

James Giancola

Barry, we will call you back with the number. We have itcalculated. I just don't have it here at my fingertips.

Barry White - RiverCapital

Okay.

James Giancola

And we will call you back with that number.

Barry White - RiverCapital

All right. Thanks a lot.

Operator

There are no further questions in queue at this time. Iwould like to turn the floor back over to management for closing comments.

James Giancola

Again, thank you for your questions and your participationthis morning. We are allaround to take additional questions that you may have on thereport. Again, thank you for your interest and your participation this morning.Talk to you all soon.Thanks.

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