PFF Bancorp F3Q08 (Qtr End 12/31/07) Earnings Call Transcript

PFF Bancorp Inc. (PFB)

F3Q08 (Qtr End 12/31/07) Earnings Call

January 29 2008, 5:00 pm ET

Executives

Kevin McCarthy - President and CEO

Greg Talbott - COO and CFO

Greg Standlea - CLO

Jim Milhiser - MLM

Analysts

Dave Rochester - Friedman, Billings, Ramsey & Co.

Bobby Bohlen - KBW

Chuck Griege - Blue Lion Capital

Ariel Warszawski - Firefly Value Partners

Don Worthington - Howe Barnes Hoefer & Arnett

Wilson Jaeggli - Southwell Partners

Rajeev Patel - SuNOVA Capital

Presentation

Operator

Good afternoon, ladies and gentlemen. My name is Matthew Moses and I will be your conference facilitator today.

At this time, I would like to welcome everyone to the PFF Bancorp Incorporated third quarter Earnings Call. (Operator Instructions).

It is now my pleasure to turn the floor over to your host, Mr. Kevin McCarthy, President and Chief Executive Officer. Sir, you may begin your conference.

Kevin Mccarthy

Thank you, Matt. Good afternoon, everyone, and thanks for joining us today. As Matt said, my name is Kevin McCarthy and I am the President and CEO of PFF. And here with me today is Greg Talbott, COO and CFO and Greg Standlea, Chief Loan Officer. And we have with us as well today Jim Milhiser, our Major Loan Manager.

As you know by now today, we reported numbers that continue to reflect the difficult market conditions that have impacted not only the housing market in California, but in many of the markets around the country.

As a result today, PFF reported a net loss of $14.7 million for the quarter ended December 31st due to significant provisioning and charge-offs related primarily to our construction loan portfolio.

The $35 million we provisioned this quarter is consistent with what we did last quarter and reflects the continued downward pressure on valuations of residential real estate and that's both new and existing I might note.

Greg Talbott and Greg Standlea will go through the specifics of the financials and the loan portfolio today.

You are going to hear that while the market has not demonstrated any marked improvement particularly, we continue to proactively work with our builders to minimize the impact of the problem loans.

We successfully restructured a significant number of the loans that either have been restored to accrual status or will be restored to accrual status in the near future. We continue to allocate the necessary resources to maximize the recoveries.

You will also hear that 40% of the provision was attributable to changes in valuation of loans previously identified. This reflects the continued downward pressure on the market as well as our aggressive identification of the issues.

In addition, as we noted previously, we continue to aggressively identify Class V loans with material weaknesses such as collateral value or borrower strength, but are still current.

As you know, the best opportunity to maximize recovery is early in the process. We believe that the actions we have been taking in recent months were negative to earnings, but certainly positive to shareholders in the short run put the company in a position to deliver better results on a go-forward basis.

The fundamentals and safety and soundness of the bank are strong and we continue to deal with a weak housing market.

While we expect the strong economic fundamentals of the Inland Empire to try the recovery in this market, as evidenced by the success of our recent de novo branches, it will continue to be challenging for the next quarter or two on the housing side. But we intend to position this company to benefit from the recovery opportunities by continuing to proactively work with our borrowers for a solution early and to continue developing our retail banking franchise.

As noted in the release due to the uncertainness surrounding the timing of the recovery, the Board has suspended the quarterly cash dividend to help bolster capital and liquidity risk during this period. And the Board will review this policy each quarter and resume dividend payments when our operating results return to a level of sustained profitability.

At this point, I am going to turn it over to Greg Talbott to go through the specifics of the financials, and following him, we will have Greg Standlea speak to the current loan environment and the portfolio, and then we will take any questions. So Greg?

Greg Talbott

Thank you, Kevin. You can clearly see from our results, we aren't out of the woods on the credit front. As Kevin mentioned, $35 million provision for the quarter was comparable to that of the prior quarter and our level of non-accrual loans stood at $233 million or 5.8% of loans and leases at December 31st compared to $228 million at September 30.

Net of specific valuation allowances we were carrying at September 30, almost all of which were charge-off last quarter. Non-accrual loans raised approximately $43 million. It's clear that we are still facing difficult market conditions.

At the same time, there are some positive developments on the asset quality front. Over the past several months, we have begun seeing evidence of borrowers' willingness to put funds into their projects in exchange for rate or balance concessions on our part.

While we absolutely prefer to not have to make these concessions, working out our problem credits is our number one priority and we are not sitting back hoping problems cure themselves.

We restructured eight loans aggregating $38 million last quarter, only one of those eight loans in the amount of $10 million qualified for immediate return to accrual status.

Under the accounting rules, the other seven loans must demonstrate performance under their new terms for a period of time, generally about six months, before they can be restored to accrual status.

Additionally, subsequent to December 31st, we have successfully restructured an additional 12 loans aggregating $59 million. I began my remarks with a statement that we are not out of the woods and while that remains true, we are not sitting around waiting for someone to show us the way.

One of the steps we have taken to ensure that the Bancorp has staying power for the journey is the suspension of our quarterly cash dividend.

Our analysis cash flow is coming into the holding company from paydowns on the DBS loan portfolio. That indicates we have adequate cash flows to continue the dividend for the next several quarters. However, just as we suspended our share repurchase program early last summer in anticipation of difficult times ahead, we are suspending our cash dividend to ensure that our liquidity cushion remains intact.

We believe the willingness of existing borrowers or third parties to put fresh cash into problem projects, as evidenced by the restructure activity, I just noted, is indicative of a nearing of the bottom of the cycle in the residential construction market, which is where our problems lie.

Nevertheless, until we see further sustained evidence of that bottoming and clear signs of a sustained recovery, we are managing our resources very conservatively. Absent the quarterly cash dividend, the Bancorp's cash needs of approximately $3 million per quarter including approximately $1 million for debt service on the Bancorp's line of credit and approximately $1.5 million for debt service on trust preferred securities.

Paydowns from the DBS loan portfolio were $7 million last quarter and are projected to run between $5 million and $15 million per quarter over the next year.

Our primary focus is on reducing the risk profile of the holding company's balance sheet by applying all available cash flows to retirement of the line of credit of the holding company, which presently has now, an outstanding balance of approximately $49 million.

As you read through the release, you will note that we are in the process of attaining the waiver on two of the debt covenants as of December 31. I have been in discussions with the lead bank on that credit facility as recently as approximately 45 minutes ago, and I am comfortable on representing that we are in agreement in principal with the restructure of that debt and that should not place an undue hardship the Bancorp.

But I am sure most of you are aware a unitary savings and loan holding company such as ours does not have a capital requirement at the holding company level. That being said, our consolidated tangible capital level is nearly 7.5%.

At the bank where we do have regulatory capital requirements, our tangible and risk-based levels stand at approximately 8.5% and 11.3% respectively. Those levels are not only very comfortably above the levels required to be considered well capitalized, but perhaps more importantly they are also virtually unchanged from the levels of one-year ago, indicating that the bank's capital position remains intact and strong.

That being said, we don't believe it would be prudent to send any funds out of the bank up to the holding bank until the bank reestablishes a consistent pattern of profitability. That factor played a significant role in our dividend decision noted earlier.

While our total asset base is contracting, we aren't running off our asset base out of concern for capital, rather the $70 million sequential quarter and $160 million fiscal year-to-date decreases in the loan portfolio are a function of the dramatically slower demand for loans as the same market forces that have negatively impacted earnings, have also caused our asset base to contract. The net result is that capital ratios have been in the state of equilibrium despite significant provisioning and a significant build to our allowances.

With the low level of loan demand, we have not had a robust appetite to compete aggressively for deposits. We are very committed to maintaining our deposit franchise and are not running money off. At the same time, we haven't had an appetite to pay up. We've never had an appetite to pay up for non-relationship funds.

Despite the housing war, the demographics of the Inland Empire continue to provide fertile ground for development of our retail banking franchise, as evidenced by the $95 million of deposits that we have garnered with the six new branches we have opened since last April.

Before I turn the call over to Greg Standlea for more in depth comments on loan portfolio and overall state of the real estate market, I want to emphasize that our core banking franchise remains unimpaired and continues to prosper. The current credit problems, albeit severe, will be transitory with our current capital and liquidity positions and with the proactive steps we have taken, we have the staying power to ride out the current credit situation.

With that, I will turn it over to Greg.

Greg Standlea

Thank you, Greg. First I will provide general commentary about the market and direction of our loan portfolio, and then we will address any specific questions you may have.

Housing market correction that began in mid-2006 continued to decline during the last quarter. We saw further contraction in single family home sales and prices for both existing and new homes, as compared to the previous quarter.

In our primary market, the Inland Empire, as reported by Real Estate Economics, new home sale volume declined to an estimated 18,990 units for the year 2007 versus 23,369 in 2006, with resulting downward pressure on a median home price to $403,835 from $426,654 in 2006.

New single family construction also is trending downward, with single family starts estimated to total 18,737 units for 2007, representing a 43% decline from the prior year. New home absorption rates are currently ranging from one-to-four sales per month for our specific portfolio, with an average of two sales per month.

That being said, we have seen recent improvement in weekly absorption numbers due to lower long-term rates, aggressive pricing and incentives in the market. We expect new home inventories to continue to decline through 2008, due to improving absorption and declining level of new construction.

The overall volume of sales in the existing housing market for the Inland Empire has declined between 25% and 60% depending upon submarket, with the largest decline in the Moreno Valley/Perris submarket.

The Inland Empire average price of $379,371, represents a 19% decline on a price per square foot comparison to the previously year.

The distribution of sales and preferred price point in the existing housing market has migrated to the lower range of the market between $200,000 and $400,000. While this category experienced an increase in volume for the fourth quarter 2007, over the fourth quarter 2006, all higher price categories experienced a drop in sale.

Foreclosures in the Inland Empire are estimated to reach 7500 for the fourth quarter calendar year end. Foreclosures levels now exceed the all-time high last seen in late 1996 and are projected to level off in the next quarter and decline through 2008.

The recent declines in interest rates and potential for increases to the conforming loan limits for Fannie Mae, Freddie Mac, and FHA are expected to have a positive stabilizing affect on sales and prices for both the new and existing homes in the $500,000 to $800,000 move-up market.

Other fundamentals such as population, education, job growth remain favorable and suggest that the new and existing housing markets, longer-term prospects for our region, are positive.

The performance of our construction loans in relation to the market mirrors the ongoing market stress throughout the region and state.

During the quarter deterioration and borrower financial capacity, low absorption, depletion of interest reserves, and lack of a market for land sales increased our level of special mention and substandard construction loans.

We have a very experienced construction lending and special asset group that continues to work daily with our identified problem loans to successfully work through the housing correction and we believe we are adequately reserved for the identified problem loans.

In addition to the workouts completed and in-progress, we received paydowns on the construction portfolio of $106 million during the quarter. We expect that trend to continue. Single family consumer and commercial real estate portfolios remained strong.

At this point Jim Milhiser, our Major Loan Manager and I will be happy to answer any questions you may have in regards to the loan portfolio. Thanks.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Dave Rochester.

Greg Standlea

Hi Dave.

Dave Rochester - Friedman, Billings, Ramsey & Co.

Hi guys. Thank for taking my questions. Just real quick on a liquidity position: With the $60 million line, you said you have $49 million that leaves you $11 million. Did I get those numbers right?

Greg Talbott

That's correct. The line is presently at $60 million.

Dave Rochester - Friedman, Billings, Ramsey & Co.

Okay. And in terms of the DBS portfolio, have you guys ultimately decided at this point to just allow that to run off completely?

Greg Talbott

Our current strategy is to allow that to generally to run off. In isolated instances, there may be a need to put some additional dollars into the portfolio to protect positions, but those situations will be very few and far between. So, yes, we are in a risk reduction mode with respect to DBS portfolio and allowing that to pay down upon proceeds to retire debt.

Dave Rochester - Friedman, Billings, Ramsey & Co.

Okay. And in terms of absorption rates, you said the average is about two homes per month in your markets, and I would imagine that is comparable to the one and a half homes, if I am getting that number right from the last quarter. So it sounds like you are seeing a modest improvement, but we saw marks on the portfolio go down pretty significantly in the NPAs, and then we had some new loans coming into special mention substandard. So, at what level do we need to get to an absorption to see that flow into those lower grade stop and ultimately reverse?

Greg Standlea

Dave, I think we need to see absorptions in the 3.5 to 4 per month.

Dave Rochester - Friedman, Billings, Ramsey & Co.

Okay. And at this point, you said you had seen some recent upticks as early as or as recent for the last few weeks. At this point, I know that it is too early to call anything a trend. But what are you seeing at this point, are you seeing near that range, three, maybe four, homes? Or are we still around that two mark?

Greg Standlea

I am pretty encouraged the last few weeks. And it's too early to actually put numbers to it. But we've have a number of builders report to us because we get reports weekly on having sales. Now sales is not a closing, of course -- but a number of the projects that been a lot of sales are reporting three and four sales per week. And that really goes to how aggressive they price the product.

If you get the right product price and the right demand in the market, you can sell it. Where the slower sales are, the problems, I might say would be some of the problem projects in the substandard category that run out of marketing dollars. So their staff is down, and their sales staff is not there, and that is impacting the sales on those projects.

Dave Rochester - Friedman, Billings, Ramsey & Co.

Okay, great. That's good detail. Thank you. And in terms of appraisals, I think you had mentioned earlier in prior conversations that the appraisal process looks back data from the past six months. And as a rolling forward into our new quarter, I am sure you are still waiting to hear back on some appraisal in that process will be ongoing. But just given your take or your view of what the data is looking like now, and the quarter or the months that we're leaving behind as we roll through into the next quarter, would you anticipate the data that is being used in these appraisals being more favorable or less favorable this upcoming quarter versus last quarter?

Greg Standlea

No, I think the data and the appraisals are showing, of course, the last six months, which is the worst part of the market. Most of our portfolios have already been appraised and reappraised where necessary. Anything that is substandard, we ordered an appraisal on. So there is a lack of sales in terms of land sales and lot sales to substantiate that portion. So it's a really a quote opinion value when it comes in.

Kevin McCarthy

But Dave, the part you may see improvement in based on what Greg saying here is the absorption rates will impact the cash flow analysis.

Dave Rochester - Friedman, Billings, Ramsey & Co.

Right.

Kevin McCarthy

Which will help to support…

Dave Rochester - Friedman, Billings, Ramsey & Co.

Okay.

Kevin McCarthy

…improvement in those values.

Dave Rochester - Friedman, Billings, Ramsey & Co.

Sounds good. Thank you. And one last and real quick question here: Could you update us on the new hires in your workout group and on what you have been working on pretty diligently in the last quarter? And any new needs that you see coming out of last quarter as far as how many more spots you are looking to fill?

Greg Standlea

We have six people in the special asset group handle the more difficult transactions, and they are backed up by the entire major loan staff as well as other parts of the bank. We had two additional people come back from retirement, as a matter of fact, and we added to the staff. They are the former Chief Loan Officers of the residential area and of the consumer loan division. So, we beefed up that area. We would probably add, I would guess, maybe one or two more spots -- full-time spots in that particular area.

Dave Rochester - Friedman, Billings, Ramsey & Co.

Okay, great. Thank you very much guys.

Greg Standlea

Thanks, Dave.

Operator

Our next question comes from Bobby Bohlen with KBW.

Bobby Bohlen - KBW

Hi, and thanks for taking my question. Actually you have answered a few of my questions, already. Quickly though on the DBS portfolio: I realize it is a run off, but it looks you continue to take provision on that portfolio. How should I think about that portfolio in kind of risk terms going forward? Is there still going to be provision and loss coming from that? Or do you think it is pretty well, that way it is going running off?

Greg Talbott

As of December 31, if it's with the bank portfolio, we have evaluated the credit risk inherent in that portfolio and believe that we adequately provisioned and provided for the risk inherent. It is a higher-risk portfolio. The allowance coverage is commensurately higher against what is approximately $88 million, $89 million in gross outstandings. We are carrying approximately $6 million allowance against that portfolio. So that is reserved to about 8% of outstandings -- 800 basis points is the allowance coverage against that portfolio, that's reflective of the risk profile.

Bobby Bohlen - KBW

And then the only other question I had, in some of the recent 8-Ks that have been filed concerning ownership status: One of the 8-Ks that you filed suggested that you are looking into other business lines. Could you expand on any of that in this call?

Greg Talbott

Yes. We are in the process of evaluating the real-estate brokerage activities, a subsidiary that would be PFF Real Estate Services Incorporated that would engage in real estate brokerage on our behalf acting as a selling broker as well as potential third-party activities and the possibility of escrow and perhaps 1031 facilitator activities through that subsidiary. So that is still in the informative stages. We have not yet engaged in any activities in that subsidiary, but we are in the processes of evaluating that developing business plans for that subsidiary.

Bobby Bohlen - KBW

Okay, thanks. Those are all my questions.

Greg Talbott

Thanks.

Operator

Next question comes from Chuck Griege from Blue Lion Capital.

Chuck Griege - Blue Lion Capital

Good afternoon. Just a couple of questions. Could you give us a little more color on the distribution, the charge-offs across your loan portfolio?

Greg Talbott

The charge-offs are principally in the construction-land portfolio. There was also a significant charge-off in the commercial loan and lease portfolio, but it is principally the construction land segment in our portfolio where the problem assets and the charge-offs resulting there from.

Chuck Griege - Blue Lion Capital

So the $56 million a charges-offs 75% of that was construction portfolio? I am just trying to clarify that.

Greg Talbott

I think that it would be an appropriate ballpark.

Chuck Griege - Blue Lion Capital

Okay. And then could you talk a little bit about your residential portfolio, the one-to-four family? Can you give us a little color as to what you are seeing in that portfolio from a performance standpoint?

Greg Standlea

Sure, Chuck, this is Greg Stanley. Debt portfolio is a $1.4 billion portfolio on first-trust deeds. Consumer loans mostly make up second trust deeds and HELOCs, and that's an outstanding balance of about $350 million.

Chuck Griege - Blue Lion Capital

Right. HELOCs, do you own first lien on those?

Greg Standlea

We have a first lien on the first trust deed one-to-four. The consumer loans are mostly 90% second trust deeds.

Chuck Griege - Blue Lion Capital

And do you own the first?

Greg Standlea

And we own the first, and probably 20% of the cases.

Chuck Griege - Blue Lion Capital

Okay.

Greg Standlea

That portfolio is performing very well in light of the current market situation as evidenced by the number of REO, which I believe is at three properties and the 90-day delinquencies being at about 64 basis points of that portfolio. We are seeing some strains that we haven't seen in the past years with largely due to life changes.

When I mean life changes, I mean divorce, health problems, change of jobs, job disruption, those types of things that necessitates the sale of homes that they are in markets where they can't sell the home because of the downward pressures on the prices, and that is the source of the most of the delinquency. Although all the loans were underwritten and are what we would term “A-graded loans” -- with the small exception of about 5% of the portfolio that we term A-, for which would add a 0.5% on a commonsense basis. So we weren't doing any kind of sub-prime type of activity in that portfolio.

The non-traditional part of that portfolio, which would be the part that has negative amortization, has had limited amount of negative amortization to it, and that portfolio has a potential for negative am is about $280 million.

Chuck Griege - Blue Lion Capital

Of the $1.4 million?

Greg Standlea

And half of it. Of the $1.4 billion and half of it has experienced negative amortization.

Chuck Griege - Blue Lion Capital

Okay.

Greg Standlea

We have been making those for over 25 years now, and the limits that we put on that type of product have always been very conservative, a maximum of 110% of the loan amount as the maximum amount it could go negative, and we have the margins in there that are very reasonable margins. So the people can have an interest rate that is comparable if not less than a fixed-rate interest rate.

Chuck Griege - Blue Lion Capital

Okay. And then my last question: Given the reduction in LIBOR and what the Fed is doing, are you seeing a positive impact on your cost of funds?

Greg Standlea

We are seeing a very positive impact on our cost of funds.

Greg Talbott

Yes, the cost of funds continues to come down. We have lowered our rates last week with the Fed's easing and expect regard to what the Fed may or may not do tomorrow we anticipate further reductions in our deposit costs.

Chuck Griege - Blue Lion Capital

And so CD costs are coming down?

Greg Talbott

Yes, they are: CD as well as money-market rates. And, Chuck, just to add a little bit of color to Greg's comments with respect to performance of the one-to-four portfolio, our total delinquencies in that portfolio 30 days and up total approximately $44 million roughly 30 basis points on the portfolio.

The majority of those delinquencies reside with the single borrower relationship that we've discussed in previous calls. Excluding that particular relationship, we have a total delinquency of ratio in the one-to-four portfolio of somewhere south of 10 basis points probably close to 7 to 8 basis points.

Chuck Griege - Blue Lion Capital

Right.

Greg Talbott

So that portfolio continues to perform exceptionally well.

Chuck Griege - Blue Lion Capital

Okay. And then, I guess, my last question: Your charge-offs were larger than your reserve. Can you just walk through how you came to that decision rather than having charge-offs and reserve provision ratio equal to 1, given some further deterioration in the loan portfolio?

Greg Talbott

Sure, we have been carrying some substantial allowances into the current quarter. The allowances that we brought in this last, I think, totaled approximately $36 million, $37 million, specific valuation allowances that does not include the general valuation. Those are allowances established against effectively-troubled, collateral-dependent loans -- our only source of which will be the property, and given the term market conditions this quarter, we came to the conclusion that it was no longer appropriate to consider to continue to carry balances on a gross basis.

In other words, we went ahead and took the charge-off, effectively collapsed the specific valuation allowance into the loan balance, and wrote down the loan balance to the current appraised value of the net realizable value of the property. So, there was a bit of a catch up in terms of the current quarter based upon developments, and we believe that it was no longer appropriate to carry those value allowances to get the loan balances.

Chuck Griege - Blue Lion Capital

Okay. I am not quite sure I understand that.

Greg Talbott

Well, rather than having a $10 million loan with $1 million specific valuation allowance against it because on that $10 million loan, it's our expectations that we will only realize $9 million in repayment of that loan rather than carrying that as a $10 million loan with 10% allowance coverage.

Chuck Griege - Blue Lion Capital

You just write it down to $9 million.

Greg Talbott

We wrote it down to $9 million and collapsed the specific reserves.

Chuck Griege - Blue Lion Capital

Okay. Thanks for that illustration. I appreciate it.

Operator

Next question comes from Ariel Warszawski from Firefly Value Partners.

Ariel Warszawski - Firefly Value Partners

Yes. Hi, guys, can you hear me okay?

Greg Standlea

Yes, go ahead.

Ariel Warszawski - Firefly Value Partners

Thanks, first of all, for being probably the most transparent bank around these issues that I have heard speaking about the stuff yet. It's very helpful. Question about your absorption rates: You mentioned you need to get up to 3.5 to 4, and you are somewhere around 2 now. What price level does that assume sort of for it to be okay?

Greg Standlea

That assumes price levels are all over the place but that generally assumes a price level in the neighborhood of $400,000.

Ariel Warszawski - Firefly Value Partners

So 400K?

Greg Standlea

For a 1950 square-foot house, is that what you say, Jim?

Jim Milhiser

Yes.

Ariel Warszawski - Firefly Value Partners

And is that sort of where the market is now, or that's where the market was then?

Greg Standlea

The market has really moved down to that price point.

Ariel Warszawski - Firefly Value Partners

Okay. So we need absorption to pick up at current price?

Greg Standlea

We need absorption to pick up at current price, and I think that what we are seeing is that you would probably see prices go down a little bit further if it wasn't for the interest rates. Now you can get a thirty-year fix at 5 in a quarter.

Ariel Warszawski - Firefly Value Partners

No, that definitely helps on the margin.

Greg Standlea

That is really a big boost.

Ariel Warszawski - Firefly Value Partners

One of the things that you mentioned, I think, is that you were encouraged in the last few weeks because you are seeing three-to-four per week at aggressive pricing of product?

Greg Standlea

Right.

Ariel Warszawski - Firefly Value Partners

What does that pricing look like, that "aggressive pricing"?

Greg Standlea

Well, that means that when I say “aggressive pricing,” three months ago that $400,000 house would have been at $450,000.

Ariel Warszawski - Firefly Value Partners

But, guys, in the last two weeks that are really trying to move the product are doing it at that 400?

Greg Standlea

Yes.

Ariel Warszawski - Firefly Value Partners

I see. Okay. So really that's a solid three-to-four per week.

Greg Standlea

On some projects that's has been solid three-to-four per week, yes.

Ariel Warszawski - Firefly Value Partners

But at prices where you can actually be made home loans today where they are marked?

Greg Standlea

Right.

Ariel Warszawski - Firefly Value Partners

Okay. I got you. And so if we take another leg down in price, then we have another leg down in problem, but if we don't, we probably are good if absorption doubles from here.

Greg Standlea

Exactly.

Ariel Warszawski - Firefly Value Partners

I got you. Okay. This is just my little psychosis here, but I am tracking absorption rates in the Inland Empire. I don't know if that's the right thing to do. And I am only seeing them at around 0.34, 0.3, 0.26 per week in the last three weeks. And I think you guys are seeing an average of 0.5. Am I looking in the wrong place?

Greg Standlea

I think you are looking at the whole market. I am not sure what exactly you are looking at.

Ariel Warszawski - Firefly Value Partners

I am looking at [Reines]; I think that's one of the [Reine] report.

Greg Standlea

Yeah, the [Reines] report, and not everyone reports to the [Reines] reports.

Ariel Warszawski - Firefly Value Partners

I got you.

Greg Standlea

I don't think hardly any of those mid-sized builders that will deal with are on that report.

Ariel Warszawski - Firefly Value Partners

That's more the big guys, right?

Greg Standlea

Right.

Ariel Warszawski - Firefly Value Partners

And so you are saying the little guys are doing a little better than that?

Greg Standlea

I am saying the little guys have got their prices down to where the big guys were. They had a big move-in, and I think if you go back to that [Reine] report and look back in the latter part, in December and then late November, they were cutting prices and really offering some deals and moving product out, that is not really there right now.

Ariel Warszawski - Firefly Value Partners

Okay. So there is a little bit of sort of time lag between big and little between [Reines] and your actual projects. But generally speaking if I see [Reines], that's a move up, that's good for you guys -- and if I see it go down, again that's probably bad, right?

Greg Standlea

That's right.

Ariel Warszawski - Firefly Value Partners

Okay. I mean, it's just a proxy. I see desert and San Bernardino is looking at 0.5. I know in Ventura and LA, it seems like somebody cut the hell lot of prices in the week and moved a lot of product, but generally it doesn't yet look like it's picking up but that shouldn't. We haven't seen impact of the cut yet, I don't think.

Greg Standlea

No.

Ariel Warszawski - Firefly Value Partners

Well, listen that's actually very helpful. I can do some more off-line with you guys.

Greg Standlea

Okay.

Ariel Warszawski - Firefly Value Partners

On the whole Cottonwood debacle, if I may use that term, where do you think stand now?

Greg Standlea

He has filed his response. Go ahead Greg, you can answer this.

Greg Talbott

I think, Ariel, we are in a position to speak to at this time is what is in the public record in terms of his application or objection to his application is response to our objection.

Ariel Warszawski - Firefly Value Partners

I didn't even see his response.

Greg Talbott

Yes.

Ariel Warszawski - Firefly Value Partners

That is, I can find that under your SEC filings.

Greg Talbott

It was under SEC filings because it was not ours. But I believe you can locate that on the Federal Reserve website.

Ariel Warszawski - Firefly Value Partners

All right. When did that get filed?

Greg Talbott

It was several weeks ago. I think approximately two weeks ago.

Ariel Warszawski - Firefly Value Partners

Two weeks ago, okay. I am sorry, I missed that. And I guess one quick follow-up, maybe this is dealt with there. You basically said it is illegal for him to have more than 5% of company, and he has got somewhere close to 10. Has he sold that stake yet?

Greg Talbott

I do not know what his current ownership position would be, and I believe it was our position and our letter that in the event that we were to engage in certain prohibitive activities, he would be prohibited from only more than 5%.

Ariel Warszawski - Firefly Value Partners

It's not that you already have it. It's the real estate thing you talked earlier about.

Greg Talbott

That is correct.

Ariel Warszawski - Firefly Value Partners

Okay. Did you mention when you are going to open that up?

Greg Talbott

The subsidiary has been incorporated. We are in the process of formulating or finishing the business plan and commencing operations. I do not have a firm date for that taking place.

Ariel Warszawski - Firefly Value Partners

So, technically as soon as that is announced, you have to tell him and he has to sell his share. Are you in a position to buy them from him so that it doesn't have such a big impact on your stock?

Greg Talbott

We are not in a position to repurchase shares in the open market or from…?

Ariel Warszawski - Firefly Value Partners

It's a strange situation. I mean just from an outsider’s perspective. I will go ahead and look at his stuff, and I won't ask you guys to comment further then if I missed the response. So, I apologize for that. Well, thank you very much.

Greg Talbott

Thank you.

Operator

Next question comes from Don Worthington with the Howe Barnes Hoefer.

Don Worthington - Howe Barnes Hoefer

Good afternoon. Just want to make sure I am calling the numbers right. You excluded the interest reversals in the quarter. It looks like you would have actually had pretty good margin expansion, is that correct?

Gregg Talbott

Yes, margin is holding in reasonably, reasonably well.

Don Worthington - Howe Barnes Hoefer

And then just a little bit more on the letters of credit. You have mentioned recording a probation against 41 letters of credit. What do those support?

Gregg Talbott

They are all across the board, Don. They are everything from trade, letter of credit to completion bonds for development of public-facilities improvements. Really range is a broad range.

Don Worthington - Howe Barnes Hoefer

Okay. And then, what you have mentioned here the $24 million is actually total exposure there to LCs?

Gregg Talbott

That is correct.

Don Worthington - Howe Barnes Hoefer

Okay.

Gregg Talbott

The total undrawn commitment that we have.

Don Worthington - Howe Barnes Hoefer

Okay. And then lastly in terms of the deposit portfolio, what is the duration or the average maturity of your CDs?

Gregg Talbott

Relatively short-term. It is approximately about 6 months, 5 to 6 months.

Don Worthington - Howe Barnes Hoefer

Okay.

Gregg Talbott

We have intentionally stayed pretty short with the portfolio, both based upon expectations for what has been happening with rates, but perhaps even more importantly we have substantial portion of our loan portfolio that is tied to prime or resets in fairly short order and so we remain fairly short on the funding side to match the pricing calculations of our assets.

Don Worthington - Howe Barnes Hoefer

Okay, great. Thank you.

Operator

Your next question comes from Wilson Jaeggli with Southwell Partners.

Wilson Jaeggli - Southwell Partners

Thank you. In the charge-offs this quarter, there was a possibly $12 million that was tied into commercial loans, where we never seen charge-off historically like this, I guess. Could you help us what is that? Are those commercial loans tight to the real estate market or are they strictly commercial operations or what?

Gregg Talbott

There was a charge-off attributable to the single-borrower relationship. I briefly allude to the fact that we have a concentration with single-family properties at approximately $36 million in single family residential, that same borrowing relationship that was a family relationship had a commercial credit facility basically secured by pieces receivable, and there is also a very small commercial real estate piece. That is a bankruptcy situation, and in connection with the workout under the bankruptcy, we charged off our commercial business loan exposure.

Wilson Jaeggli - Southwell Partners

And then in that commercial, if I understand you, that commercial was secured by these leases?

Gregg Talbott

That's correct.

Wilson Jaeggli - Southwell Partners

Okay. And then of the $36 million you mentioned, are you a party to that loan, or what is that loan?

Gregg Talbott

Those are our loans. There are 80 or 82 individual completed occupied single family residences in Southern California that make up that balance. We are in the process of obtaining relief from the bankruptcy, taking possession of those properties in order to dispose off that.

Wilson Jaeggli - Southwell Partners

I see, are you the first-lien on those properties?

Gregg Talbott

Correct.

Wilson Jaeggli - Southwell Partners

Okay. So, this is a commercial operation? 80-plus units were being rented, then you did have commercial loan on the side and you have first lien on the collateral here?

Gregg Talbott

That is correct.

Wilson Jaeggli - Southwell Partners

Okay, was $36 million the original loan, or is that current balance that you have written down to it?

Gregg Talbott

We have written it down. That reflects our evaluation based on current appraisals.

Wilson Jaeggli - Southwell Partners

I see, current appraisals, okay. So that's what that is. Outside that one commercial loan, are you seeing any weakness in your commercial portfolio?

Gregg Talbott

No, we really are not. The weakness are due -- almost entirely, certainly very substantially -- to the construction and land portfolio, the other segments of the other portfolio are performing well.

Wilson Jaeggli - Southwell Partners

Okay, good. Could you help us with [OREO] in this quarter? What is the number and kind of what are the components of it?

Gregg Talbott

The total [OREO] balance on the books as of December 31, 2007 is $973, 000.

Wilson Jaeggli - Southwell Partners

Great.

Gregg Talbott

And that is comprised of two or three single-family, residential properties.

Wilson Jaeggli - Southwell Partners

Okay, so, that remains quite low then.

Gregg Talbott

Very low.

Wilson Jaeggli - Southwell Partners

That's good. Okay. Thank you very much.

Operator

And next question comes from Rajeev Patel at SuNOVA Capital.

Rajeev Patel - SuNOVA Capital

Hey, guys thanks for taking my question. Can you hear me?

Kevin McCarthy

Yes.

Rajeev Patel - SuNOVA Capital

Just two questions for you: First, are you able to disclose what bank your line of credit is with or what banks?

Gregg Talbott

No, we do not know. I don't believe that would be appropriate.

Rajeev Patel - SuNOVA Capital

Okay, and then secondly: A lot of banks have started to talk about the regulator starting to get a little more aggressive in their analysis of credit at some of the banks in the more troubled areas. Given the large NPA increase over the last couple of quarters and the charge-offs, can you just comment on the regulatory environment that you guys are seeing? What contact you have with the regulators? Whether it will be prior to this earnings release, or if they had any say in terms of how to conduct operations?

Kevin McCarthy

No, they just recently completed their safety and soundness exam, and it was satisfactory all the way through in terms of an agreement on any loans and provisioning, and there are no major disagreements in any of those areas.

Rajeev Patel - SuNOVA Capital

So, they have issued their exam report?

Kevin McCarthy

Sorry?

Rajeev Patel - SuNOVA Capital

So have they fully issued their exit report yet, or no?

Kevin McCarthy

Well we have -- in a verbal, informal manner.

Gregg Talbott

Rajeev, on the credit evaluation front, we delayed the release of earnings by a week in order to allow both external auditors as well as the OTS to complete their credit evaluation and provide us with their findings. The numbers that are in this release are reflective of their findings.

Rajeev Patel - SuNOVA Capital

Okay.

Gregg Talbott

And I might quickly add that we did not materially change any of our allowances nor accrual, non-accrual classifications as a result of KPMG or OTS report, but we wanted to make sure that we were in agreement prior to releasing earnings.

Rajeev Patel - SuNOVA Capital

Okay, that's great to hear. And then just lastly, going back to your market commentary just about the Inland Empire, if the GSP portfolio caps -- I mean the loan limit -- are lifted, then combining that with the lower rates, give us your projected outlook. What king of impact that could have in the Inland Empire market because the loan limit caps being lifted, will that be more of a LA and coastal areas issue rather than the Inland area, just given the pricing?

Kevin McCarthy

Or the FHA limits?

Rajeev Patel - SuNOVA Capital

I am talking about the GSElimits.

Kevin McCarthy

If I break in this limits, what kind of impact do you think they will have on our [ORIS]? I think they will have a big impact because median prices are close to $400,000, so half of a property in the Inland Empire alone is over the GSE limit. So that's going to help a lot, especially in terms of new housing market. It depends a lot on the movement of equity. So we have a lot out here of people moving from LA and Orange County, and that necessitates that they may able to sell their property. or where I could a to sell a property high, and then come out and get Inland Empire house at a lower level and specially the baby boomers that are contemplating or who are retiring move out this way.

Rajeev Patel - SuNOVA Capital

Okay, and then just lastly: The example of three months ago you are used earlier , if there was a property for $450,000 that today can clear for 400 given the current rates, that same property what was is it at the peak, was it 450 or was it 525?

Greg Standlea

That property at the peak?

Rajeev Patel - SuNOVA Capital

Yeah.

Greg Standlea

Probably at $500,000.

Rajeev Patel - SuNOVA Capital

Okay. So that is somewhere down about 20% from the peak at least in some of your markets with some of your senior borrowers.

Greg Standlea

That’s true.

Rajeev Patel - SuNOVA Capital

Okay. Thanks Greg, thanks very much.

Greg Standlea

Thanks.

Operator

There are no more questions at this time, so I would now like to turn the floor back over to management for any closing remarks.

Kevin McCarthy

Well, thanks for joining us today. You have heard today that our issue is no surprise, it’s the housing market. The area we’re operating in and co-earnings in the bank are still strong. The market we are operating in still has very strong job growth, and it still has very strong population growth.

The industrial vacancy rates in our areas with the relocations taking place on the commercial side are very low in most of our market. In commercial, we have seen no significant downturns.

So we are going to continue to work hard on getting through these, working through our loans with our builders and get ourselves in a position to take advantage of the opportunities that they are going to create themselves as we recover from this housing crisis. So, once again, we appreciate you joining us today, and we will talk to you next quarter.

Operator

Ladies and gentlemen, this concludes today's conference call. You may now disconnect your lines and have a wonderful day.

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