Frontier Financial Corporation Q1 2008 Earnings Call Transcript

Frontier Financial Corporation (FTBK)

Q1 2008 Earnings Call

April 22, 2008 4:00 pm ET

Executives

John Dickson - President and CEO

Lyle Ryan - President and Chief Banking Officer

Carol Wheeler - CFO

Rob Robinson - EVP & Chief Credit Officer

Analysts

Dave Rochester - FBR Capital Markets

Jeff Rulis - D. A. Davidson

Brett Rabatin - FTN Midwest Security Corp

Matthew Clark - KBW

Presentation

Operator

I'd like to welcome everyone to Frontier Financial Corporation’s first quarter and 2008 Earnings Call. Throughout the duration of this presentation today all audio participants will remain in a listen-only format. However at the conclusion of today’s presentation, we will be conducting an interactive question-and-answer-session via the telephone lines.

This conference call may contain forward-looking-statements defined in section 27A of the Securities Act of 1933 as amended, including statements regarding among other things, the company’s business strategy and growth strategy - expressions which identify forward-looking-statements being valid only as of the date the statement is made.

These forward-looking-statements are based largely on this company's expectations and are subject to some risks and uncertainties, some of which can not be predicted or quantified and are beyond the company’s control.

Future developments and actual results could differ materially for those set forth in, contemplated by or underlying forward-looking statements. In light of these risks and uncertainties there can be no assurance that the forward-looking information will prove to be accurate.

This conference call does not constitute any offer to purchase any securities nor solicitation of a proxy, consent, authorization or agent designation with respect to a meeting of company’s stockholders.

At this time I’d like to turn the call over to John Dickson, President and CEO of Frontier Financial Corporations. You may now proceed.

John Dickson

Thank you Mary. And thank you all for joining us on this call. And this afternoon assisting me I have Lyle Ryan, our Chief Banking Officer and President, Carol Wheeler, our Chief Financial Officer and Rob Robinson our Chief Credit Officer.

I will make a couple of overall comments on the quarter and comments on the marketplace, and then get in to some of the detail of the financials.

Overall with the quarter we are pleased with the loan growth and the diversity of our loan growth, despite a challenging housing market. We are pleased with our overall credit quality. There is a lot of strain on our borrowers with construction and land development lending.

We are also pleased with our earnings after setting aside $9 million in to our loan loss reserve and building our overall reserve for credit losses up to 1.71%.

Our margin compression was more significant than expected and I'll go into some more detail about that later. There is a combination of both loans maturing coming off [therefore in] re-pricing, as well as, lack of growth in our noninterest bearing deposit area.

Again on the economy in the housing market in the Northwest here, the economy continues to be very strong, one of the strongest economies in the nation. Most recently, unemployment numbers announced continue to go down. In Snohomish County, the unemployment rate was 4.3%.

Foreclosures were announced this last week, and foreclosures in Snohomish County actually are down from a year ago, that being one of the few spots in the country. And home sales for March were more than in February by anywhere from 11% to 27% in our primary markets.

And speaking of the housing markets, just to give some color from our [RealEStats] subscription, again, I'll focus my comments on Snohomish, King and Pierce Counties, our primary lending areas. 77% of our construction loans are in those three counties. And about 60% of our land development and land loans are in those three counties.

Inventory levels at the end of March hit the high levels that they were at last September, but we did see a dip at year end in inventory levels throughout our market, and those inventory levels continued decreasing through weak sales in January and February.

In Snohomish County, there are 8119 units on the market, in King County, 16,400, and in Pierce County, 9062. Relative to last year, Snohomish County is up 47% in gross inventory, King County is up 56%, and Pierce County, is up 25%.

Regarding the sales for the month; in March, in Snohomish County, we had sales of 712 units giving us a relative inventory - a gross inventory divided by sales of 11.4 months, which was down from February.

King County had 2,059 units sold, which gave us a relative inventory of 8 months, also down from February, and Pierce County 728 units sold, giving us a 12.4 month inventory. And all these sales numbers are down from a year ago between 44% and 54%. So our sales numbers although up in March are down from a year ago and we need to see those sales numbers continue to increase.

Related to average home prices in Snohomish County, the price of existing homes at 379,000 is down 4% from a year ago, and down 2.5% from a year-end. The price of new homes in Snohomish County being $453,000, is down is 9.6% from a year ago and 5.5% from December year-end.

In King County existing homes average $549,000, down 6.7% from a year ago but up 2.2% from end of year and new homes in King County averaged $631,000, which is down 10% from a year ago, down 5.5% from December.

In Pierce County existing homes, $314,000 represents an increase of 2% from a year ago and an increase of 6% from year-end and finally new homes in Pierce County at $358,000 down 11.8% from a year ago and down 1.6% from December.

So, here is a general overall comment. Average house prices are holding up better for existing than new homes. New homes from a year ago are down between 10% and 12%. Existing homes are mixed between being down 4% and being up 2%.

So on an overall basis, average home prices are holding up fairly well relative to the significant inventory levels that are out there.

Let’s talk a little bit about our financial results on the balance sheet. I mentioned our loan growth is at $104.8 million and that's up 2.9% from the end of the year. We are pleased to see that our growth was spread fairly evenly between our product lines. Our land development is up $28 million, real estate mortgage, which is a lien on a completed one to four family home, is up $24 million. Construction residence and real estate construction are up $22 million. Commercial real estate is up $21 million and C&I lending is up $13.6 million.

Related to the originations of new loans, we had $287 million in new loans originated in the first quarter. That's down from $489 million a year ago, or down 41.4% and likewise in our real estate division, which primarily originates construction and land development loans. New loan originations were down 54% from a year ago. Relative to the fourth quarter, originations were $255 million. So that was up $32 million or 12.7% from the fourth quarter.

At this point, before turning it over to Rob Robison I would like to mention that we are not involved in originating subprime loans, nor do we hold any subprime loans or mortgage-backed securities as collateralized debt obligations on our balance sheet at this time.

Rob, would you please talk about the asset quality.

Rob Robinson

Sure. Thanks, John. I wanted to start off with saying that John did a good job of explaining our footprint in the goods movement in March. Besides those markets that we do serve, it might be just as important to know what the areas that we do not have material exposure in within our footprint include. We have nothing in Northern California or California, we have no exposure in Boise, we have limited in Center Oregon and in the Bend market. In fact our exposure there is less than $6 million right now.

On the nonperforming assets side; at quarter end, our nonperforming assets totaled $38.8 million, that’s 0.97% of total assets, up from $20.9 million or 0.53% of total assets at year end. The breakdown of our non-accrual loan by categories shows that 64% of those are in residential constructions, 27% are in residential land development, 7% are in residential lot loans and 2% is in other category.

The breakdown of non-accrual loans by location shows that of the $24.7 million in residential loans, the majority of those being 26%, are in Snohomish County - $6.6 million that's represented in two credits, and $3.9 million balance on a [spec] project. We wrote that project down by $2.2 million. I will be talking about that a little bit in our charge off, and then, about the $1.9 million fed project, in Snohomish County as well. 17% are in Jefferson County, which is a Kitsap and [Skagit] and that is one credit involving residential and commercial condos. Then, 11% are in Kitsap County, that's $2.6 million, two high end, in fact to one builder, of one completed and the other one nearly completed but on the market.

And then, our exposure in that thin market, we have 10% in the non-accrual in the [Skagit] county area - that's $2.3 million in various completed projects or homes on the market just for sale.

Of the $10.5 million in residential land development, it's broken down pretty much 50-50. One project in King County is 27 finished lots that are in for foreclosure at this point in time, and the other one is $5.1 million and 43 lots in Kitsap County, also foreclosure at this point in time. Both of them have good equity positions. Others are of the lien kind that is forcing our hand at foreclosure at this point. And then we have two - at this point of time - two properties in ORE, combined to total of $633,000.

Moving on to our loan-loss reserve, during the first quarter, John mentioned that we had a $9 million for loan loss reserves. That brought our reserve to 1.62% or 1.71% of total loans including the reserve for undisbursed loans. The increase in loan loss reserves here most definitely reflect continuing uncertainty in the markets that we serve. We are taking a very cautious approach to risk rating our loans. As [we hoped], our loans have migrated to higher risk categories and so [ready] for increased reserve. Not surprisingly, residential spec construction is where we're seen the biggest migration of loans moving to higher risk ratings, with residential and development following close behind.

On the charge-off side, during the quarter we wrote down $3.090,259 million. Of this amount, the largest breakdown was a $2.2 million write-down on a [spec] construction project that was the one I talked about earlier, the balance remaining in non-accruals at this point of time. This loan was approved in June '07. I believe we talked about this loan in our previous conference call at the end of the year. It was booked to build 33 homes.

Our initial draw took down finished lots, and in the process of working through our foreclosure we've written down the long balance to more closely reflect distress sales in the market.

And the balance of our chargeoffs in the quarter totaled just over $800,000 and those were spread between 18 separate relationships ranging in size from a low of $1,000 to a high of $500,000, and that was a King County [spec] project. This has been experiencing delays and cost overruns and we've written it down to distress sale level.

On the delinquency ratio side, our loans past due over 30 days was 1.67% of total loans at quarter end compared to 0.91% at year-end, and again as you'd expect that was centered in residential [spec] and land development projects that we're working through. John.

John Dickson

Thanks Rob. On the right hand side of our balance sheet, funding remains a challenge for us. We did see deposits increase $220 million for the period. Within that growth the majority of the growth continues to be in the CD category and noninterest bearing deposits from a year ago are down $17.3 million or 4.4%.

We continue to see a lot of competition in the marketplace for deposits. In addition to that, the [escrow] company's builders and developers that we do bank have seen their cash balances diminishing as inventory carriers have an impact on them. Savings are up $51.3 million or 20%, time deposits $198 million or 12.8%.

Between the fourth quarter and the end of the first quarter, we saw a shift of dollars out of Fed funds purchased into CDs at year-end. We were borrowing overnight and we suspected rates may come down and waited a bit to take some of those out into time deposits. Fed funds being purchased were down $190 million from year-end to quarter-end. Federal Home Loan Bank advances were up $19.5 million for the quarter and $32 million since a year ago.

On the capital of our balance sheet; capital was up $8.3 million or 1.8% in the quarter despite the large provision added to our loan loss reserves and the increase in dividend. We did not have any buybacks in the quarter, nor do we plan any in the second quarter. [We are a] capital preservation mode and we'll continue to monitor capital as we work through this difficult credit environment.

On the income statement; again we were a little bit taken back by the drop in our net interest margin. We finished the quarter with the 5.01% net interest margin, down from a 5.63% in the fourth quarter of '07, and 5.59% from a year ago quarter. That was driven primarily by the drop in earning asset yields, from first quarter to first quarter down 85 basis points, and that was being driven primarily by the real estate construction and land development. Loans construction was down a 175 basis points in yield, land development was down a 165 basis points in yield.

During the quarter, we had $776 million of variable rate loans, which matured during the first quarter of 2008. And going into the quarter, Fed had moved the prime rate down a 100 basis points. So going into the quarter, we assume that as those loans that hit their floors came up for renewal or maturity of that, re-pricing would come down 50 to 100 basis points.

But during the quarter as everyone is aware, Fed continues to lower rates another 200 basis points for a total of 300 basis points since first quarter of last year. So as a result, we saw a lot of our loans that had hit floors -- variable rate loans that had hit floors dropping down on a new floor anywhere from 100 to 250 basis points, and that had an impact on our earning asset yields.

In addition on a linked quarter basis, in the fourth quarter we had net recovery of interest income as a result of a land development loan which was paid off, and the net recovery was $1 million in the fourth quarter. In the first quarter, by putting loans into non-accrual, we had a net reduction of $480,000 of interest. That swing of a $1.5 million represents a 16 basis point drop on our non-interest margin. And in the fourth quarter of '07, we had 92 days versus 91 days in the first quarter of '08, and that dropped our margin another 5 basis points.

And then, finally, we did have variable rate loans that did not have floors, and based on the average, prime rate is being down 131 basis points from the fourth quarter to the first quarter. We estimate the impact of that about 16 basis points. So all of those elements in our earning asset side combined to have the impact on our margin.

On the funding side, again we've been primarily funded by time deposits. On a year-to-year basis, our time deposits are down 17 basis points in cost, from the fourth quarter time deposits are down 28 basis points. In the second quarter, we have $514 million of time deposits maturing carrying an average cost of $450 million and in the third quarter of 2008, we have $584 million of CDs carrying an average cost of $487 million. So we do expect to see some relief on the cost of funds as the year goes on. But that being said, we also have variable rate loans that are at their floor, that will be maturing in the second and third quarters.

On non-interest income; during the quarter we had two gains on sale that accumulated to a $2.3 million gain on sale. The first one is that we liquidated our position in Skagit State Bank and we held about 11% interest in Skagit State Bank. This is a non-publicly traded community bank about 30 miles north of our headquarters in Skagit County, and we elected to approach them to sell that stock back, and again in a capital preservation mode we sold that stock for a $2 million gain and then related to the VISA IPO. We did have the required liquidation of $270,000 of VISA stock liquidated in the quarter.

Service charges on a year-over-year basis are up about $0.25 million, and that's being driven by business service charges being up about $83,000, and [NSFODC] is up about $180,000. Other increases in non-interest income were spread out among several things including the debit card activity.

Non interest expenses were up being driven primarily by the addition of six offices and one LPO since first quarter of last year. Salary and benefits were the primary driver of that increase with salaries, and the medical expenses are being up. In addition, for the first quarter of our second year, layer of our equity compensation that as required by FAS123R is being expensed. That added $322,000 of expenses in the quarter.

In other expense category, we were up $718,000. We did have consulting fees of about $280,000m which were related to several infrastructure projects that we have ongoing, and including an update of our website and about $75,000 of that was related to our pending merger, and the other expenses were increased primarily based on the addition of those six offices I mentioned.

The effective tax rate for the quarter is down slightly due to the tax rate on that $2.3 million in capital gains that I mentioned.

I'm looking forward to second quarter of '08, our merger with Washington Banking Company continuing to be pending FDIC approval. We are hopeful that we will receive definitive answer from them - from the FDIC - in the near future. Their shareholders did have their shareholder meeting and approved that merger at a 95.5% approval rating.

We are going to continue to focus on credit quality. And we have the experienced management team that's been through several cycles. And we were encouraged to see March sales up. We need to see April and May sales continue to increase to alleviate the inventory levels that we are faced with.

We are going to continue to focus on increase in our core deposits. Again, it’s a very competitive market. We expect continued margin pressure, and we continue to focus on our capital reserves, and they continue to be strong, to put us as a well capitalized organization.

And at this point I would like to turn the call back over to Mary to entertain questions.

Question-and-Answer Session

Operator

Thank you. We will now take question from the telephone lines. (Operator Instructions). The first question is from Dave Rochester of FBR Capital Markets. Please go ahead.

Dave Rochester - FBR Capital Markets

Hey, good afternoon guys.

Rob Robinson

Good afternoon Dave.

Dave Rochester – FBR Capital Markets

Thanks for all the details. Some great detail there. Just real quick on the nonperforming assets, could you comment on the growth of the NPAs during the quarter. Was it weighted to the beginning or the end or was it kind of a gradual growth through the quarter?

Rob Robinson

Through the quarter, it was generally towards the end of February and March is when the growth occurred.

Dave Rochester – FBR Capital Markets

Okay. You had -- its kind of related to that my next question, you had indicated I guess previously at your annual exam might be some time at this time consistently with the timing last year in the June, July timeframe. Are you stepping up appraisal activity at all an anticipation of this, is that what caused the back-ended growth there?

Rob Robinson

We are stepping up appraisal activity but not in anticipation of the regulators. It is our opinion that these projects come up for renewal and we are assessing them and we need to know the values are on those projects moving forward. So I guess back to answer your of appraisal, we are stepping up activity on the appraisal side.

Dave Rochester - FBR Capital Markets

Okay. Do you have sense for what portion of the portfolio has been reappraised at this point there, the resi-construction portfolio end?

Rob Robinson

No, I don’t have that figure.

Dave Rochester - FBR Capital Markets

Okay. John, given your comments on the increase in sales, is it safe to assume… I'm just trying to get a sense for where the provision is going… if we do not see more meaningful acceleration in new home sales in the second and third quarters, would you expect given what you see in the portfolio right now that the provision and charge offs would likely trend higher from the first quarter levels?

John Dickson

Tough question. I would anticipate if inventories remain high, I would add to Rob's comments on the trend of non-accruals. Our builders and developers that made it through the winter, a lot of them have their liquidity and their cash reserves are down and what's going to help them is to see increased sales. If we don't see increased sales, then likely we'll see further credit deterioration and our provisioning will be made based on our analysis of the reserve and where that credit deterioration is. There is a lot of builders and developers that are [hurting] for cash flow right now. So I guess that's a long way to say, yeah, we need to see sales increase over the next several months.

Dave Rochester - FBR Capital Markets

Okay. That's very helpful. And just one last, I know taken so much here, the margins for March if you have that or at the end of the month if possible?

John Dickson

Sure. During the month of March, our margin was 495 based on, we measure ours on a month over year basis or 33-60 basis and during the month, we also had reversals of interest of about $292,000 related to non accrual activity so that had some impact on that margin there.

Dave Rochester - FBR Capital Markets

Okay. And one last one, how many loans, what was the volume of loans at their floors in December, at the end of December that are up for the maturity or renewal in the second quarter?

John Dickson

Let me answer it this way. We measure our sensitivity versus maturity in our ALCO meetings. At the end of December for the second quarter we had $645 million of variable rate loans that we saw maturities or will see maturities in the second quarter. As of March 31st that number is now $995 million. So during the quarter there were variable rate loans that were renewed or extended for 90 days that added to that difference there.

Dave Rochester - FBR Capital Markets

Okay, great. Thank you very much guys.

John Dickson

Okay, Dave.

Operator

Thank you. The following question is from Jeff Rulis from D. A. Davidson. Please go ahead.

Jeff Rulis - D. A. Davidson

Good afternoon.

John Dickson

Good afternoon, Jeff.

Jeff Rulis - D. A. Davidson

John, I don't know if the real estates publishes this or not, but I don't know if they speculate on sort of a bottom of the real estate cycle or if they suggest when the data may begin to improve, do they publish anything of that sorts?

John Dickson

No, I'm sorry Jeff to interrupt. No, this is purely a group that takes multiple listing information and compiles it with other information and it's basically a statistical or a data report. He doesn't really make projections, future projections.

Jeff Rulis - D. A. Davidson

Any sort of consensus among sort of local economists or anything you are hearing '08 have been kind of sort of broad question but any color on that?

John Dickson

I don't know Rob, if you have anything to add I guess, we're encouraged by March sales. March sales don't get us or any other lender in the construction development area out of the woods. We need to see sales continue to increase in the second quarter. With that said, we do have a good market here and we don't see large volumes of foreclosures. House prices have held up fairly well. Where is the bottom? I'm not exactly sure. I'm hopeful we will see it here in the second quarter.

Rob Robinson

And I think as we said the last time we are looking outside of our market to see what's happening in other areas. That's really what's impacting us. As John mentioned all the rest ingredients are here, we've got strong job growth, good economies throughout our footprint. It's just that all our neighbors around that have deterioration that's impacting us.

Jeff Rulis - D. A. Davidson

Got it. Okay. And then gentlemen about $200 million put on in CDs, do you have an average rate and average maturity of those CDs?

John Dickson

I don't have that for the CDs. As of quarter-end, I can tell you that our $1.75 billion portfolio, a $1.564 billion mature within a year at an average cost of 453 and I have already given the details on the second and third quarter as far as how many dollars are rolling off by in the next six months.

Jeff Rulis - D. A. Davidson

All right, okay. And then I guess lastly just what's the decision behind, I mean you grew deposits 2x the level your level of your net loan production. I guess if you can kind of discuss the -- what you are attempting to do there why grow deposits at that level?

John Dickson

We can discuss what were we thinking.

Jeff Rulis - D. A. Davidson

Right.

John Dickson

Well, at year end Jeff we had nearly $200 million -- actually $250 million of FED funds purchased, which is a higher level then we are normally comfortable with. Again at year end with the tightness of the credit markets we saw wholesale funding rates higher than we felt they should have been at year end and so we chose to a allow that FED funds purchased level to build up to a high level at the end of December.

If you look at our average FED funds purchased quarter-to-quarter and I think we are up about $10 million in the first quarter compared with the fourth quarter and likewise on CDs, our average CDs balance between the fourth quarter and the first quarter, let me see here, on time deposits we are up an overall growth of $254 million.

But I guess we wanted to reduce the amount of overnight borrowings we had to keep our liquidity available and so it was a cautious decision to move money out of that overnight borrowing in to some CDs.

Jeff Rulis - D. A. Davidson

Okay. All right, thanks.

Operator

Thank you. The following question is from a Brett Rabatin from FTN Midwest. Please go ahead.

Brett Rabatin - FTN Midwest Security Corp

Good afternoon, John, how are you?

John Dickson

Good, Brett. How are you?

Brett Rabatin - FTN Midwest Security Corp

I'm doing great. Thanks. I wanted to know; of the past few questions asked to you about lot inventory and just land and this was not really good numbers to put around that. I'm curious to hear with updated appraisals, what you're seeing on the lots. Just where they are relative to where they might have been a year ago. It seems like, in your area, and the Pacific Northwest, I'm hearing the housing prices are not that bad relative to what we're seeing in other places in the country but land seems to be under some pressure. And so, I'm just curious what you're seeing and curious around in terms of lot appraisals or just land in general.

John Dickson

Sure. I'll take a stab at it and then I'll let Rob add to it. But generally, what we're seeing is, during the winter, nobody really wanted to buy a lot, and so the market really tightened up. So, some of the appraisals we're seeing, and actually, some of the prices that we're seeing being asked for are down, I don't know, Rob, 20% to 30%, 35% in some cases. What are the appraisals looking like, Rob?

Rob Robinson

Brett, it depends on the market. The Oregon market right now, we're seeing about 30% off the original appraisal. [Those sale] appraisals were done a year ago. The new appraisals are coming in at about 30% of that figure. It's a little different up here, in Snohomish and King County, we're seeing anywhere between 15% and 20%. The big issue though is John alluding to -- there hasn't been any large bulk sale to use as comps. So our appraisers are out there doing what we believe is pretty deep discounting.

John Dickson

Right. The other thing I guess I would add is that we had a builder come in recently and make the comment, “Gee, if I try to sell my lot maybe I will take a $40,000 to $50,000 hit on a lot and based on the appraised value of building out my home even in today's market the lots would be substantially less to the builder anyhow.” So that's how bad the lot market is relative to the house market.

Brett Rabatin - FTN Midwest Security Corp

All right. I guess I'm surprised to hear it's only down 15% or 20% in Snohomish County, okay. Where on these updated appraisals, where are the LTVs falling out particularly on the land side? Do you have an LTV at 65% a year ago, and obviously in Oregon where you'd be around 90% for some of these properties, is that a fair assessment?

John Dickson

Well, that's true, Brett.

Brett Rabatin - FTN Midwest Security Corp

And as you get to that threshold and you're updating those loans, what causes those loans to move to non-accrual, or how do you evaluate those loans as the LTVs are approaching 100%?

John Dickson

Well, you're evaluating it based on net, not just collateral but also the strength of the bar behind it and as a result, you've seen it in this quarter. Those loans are migrating to higher risk ratings. Generally we're moving; it's rare for one of our loans to go from a past grade right into non-accrual. We've usually identified it, moved it into higher risk rating, contracted through and at the end result, we are reserving for the situation appropriately.

Brett Rabatin - FTN Midwest Security Corp

Okay. And then on the stake of article for residential construction side of the business, I'm just curious as these loans are coming up and you're figuring out after renewal or get them off the balance sheet. Lot of these builders are fairly leveraged and so they are just like you said, from a liquidity perspective tapped out, are you able to get additional collateral or how are you keeping those loans from migrating?

John Dickson

In some cases we are able to get additional collateral and in some cases, rare cases there is the builders out there that still have some cash. But there is, if they have no cash and there is no equity, they are migrating down to either higher risk ratings or into non-accruals. And Brett I just want to clarify when you talked about the 15% to 20% then keep in mind when we are giving you that figure that's 15% or 20% off and already discounted value.

Brett Rabatin - FTN Midwest Security Corp

Okay. So the 15%, 20% would be off maybe some six months ago or something like--?

John Dickson

Yes.

Brett Rabatin - FTN Midwest Security Corp

Okay. And then John you mentioned earlier, you need to see sales continue to increase for the home builders to clear out their inventory and if what assume that March is sort of trend line, I mean what if March is the trend line going forward, I think there was a similar question asked earlier. If that's the case, I mean what do you do with your construction loans? Do you continue to try and extend them or do you try to solve working them off via sales or what’s your strategy?

John Dickson

I guess the answer would be both on that Brett. We have a long tradition of working with our borrowers and certainly the value of the collateral was worked more in their hands then it is ours, and so we have a tendency to want work with our borrowers. If we have during the quarter accepted some short sales on some homes in order to move them, again, we work with our borrower and do what makes the most sense and if we have an uncooperative borrower then will have tendency to act more swiftly and move towards foreclosure but, Rob do you have any think to add to that

Rob Robinson

Yeah, our portfolio of borrowers has really never been a transactional portfolio. Our relationships, they go back for the most part several years and in some cases generations. So we are working with these builders as much as we can and they are working with us.

Brett Rabatin - FTN Midwest

Okay. Lastly, do you feel comfortable giving any color for classified ones or kind of what you're saying from most migration perspective during the first quarter, I am sorry?

John Dickson

Well, Rob is looking at a report.

Brett Rabatin - FTN Midwest

Okay. While he is looking for that, you tied into the decline in the DDA some reduced borrower liquidity I'm assuming that was directly a function of residential borrowers, and so, I'm just curious that if, you have a number for how much your borrowers still -- I'm trying to gauge liquidity for some of these borrowers and just, I know it's getting tighter, but I'm trying to figure out. Do they have five months or do they have six months? I'm trying to figure out what the life of these things are before you have to start this, moving that to non-accrual and trying to work them off the balance sheets?

John Dickson

I don't have a good answer for that, Brett. Each borrower is a different individual case. Some of them did a good job of staying liquid, and they're doing fine. Others seem to have gotten over-leveraged and my guess, we saw stress with our smaller builders first, those that maybe do 5 homes to 50 homes a year. I think the larger builders seem to anticipate and have more liquidity but I don't have a good answer to say, our typical borrower has four more months left. I don't know that.

Brett Rabatin - FTN Midwest

Okay. And during the (inaudible), but that to me seems to be the real risk if for things going forward anyway.

John Dickson

Yes. I agree.

Rob Robinson

And Brett, I don't know whether I can put specific parameters to your question. However on our Watch rating, that where the biggest increase occurred, and that went from the end of December, 8.21% of loans to 9.56% of loans. Our Watch category are loans that are showing some stress but still in a fast category.

Brett Rabatin - FTN Midwest

So wash, would that include five and lower?

Rob Robinson

No, that would be -- we call it as a zero.

Brett Rabatin - FTN Midwest

Zero. Okay.

Then our risk rating 4 which is a traditional special mentioned credits, so these are credits that are showing greater stress, a potential for moving to a classified situation where you could occur some loss. Those moved from 3.89% and actually reduced to 3.63%. Well, that's not necessarily a positive because many of those 4s then migrated to 5 which is a substandard credit which does show exposure to lost words and those moved from 1.87% in December to 2.66% in the end of the quarter.

Brett Rabatin - FTN Midwest

Okay, lots of other, okay. Let me back up there Rob, the zero, the first category that increased to 9.56%?

Rob Robinson

Yes.

Brett Rabatin - FTN Midwest

Zero, what you call your Watch at 02, is it one or just to three? They are all past ratings still but.

Rob Robinson

I see what you mean, yeah, our past ratings are 1 to 4.

Brett Rabatin - FTN Midwest

Right

Rob Robinson

So the Watch credit would be: 1 cash secured, 2 incredibly strong, 3 for normal credit, which is where many of our loans sat 2 years ago. Watch requires additional activity on the part of the bank, more cooperation between and communication between us and our borrower.

Brett Rabatin - FTN Midwest

Let me interrupt you there. I'm sorry, so the 9.56%, what, I am sure if I am clear, what number does that represent?

Rob Robinson

The percentage of total loans.

Brett Rabatin - FTN Midwest

So that is Watch, so that's 4 and lower?

Rob Robinson

No, it'd be above 4.

Brett Rabatin - FTN Midwest

Above 4, okay. Misunderstanding here.

Rob Robinson

It's between a normal loan and a substandard loan.

Brett Rabatin - FTN Midwest

Okay, fair enough. And then special mention, 3.63% that's basically 5.

Rob Robinson

No, that's four.

Brett Rabatin - FTN Midwest

That's four. Okay. And then the 2.66 is --?

Rob Robinson

Five. That's correct.

Brett Rabatin - FTN Midwest

Okay, great. Sorry for the confusion. Thanks for the color.

Rob Robinson

No problem, Brett.

Operator

Thank you. The next question is from Matthew Clark from KBW. Please go ahead.

Matthew Clark - KBW

Hi, guys.

John Dickson

Hi, Matthew.

Matthew Clark - KBW

I guess just a quick follow-on to the Watch list. Is there any markets data show heavier concentration, or was it so much similar to this, I guess the [Oregon ] footprint dominates your construction book?

John Dickson

It's fairly similar to the spread across our counties. But we have seen obviously the most increase had been in our real estate division, which is spread across all of our markets. We've had increases, some significant increases in the Oregon footprint. But fortunately down there most of that is a smaller credit relationship.

Matthew Clark - KBW

Okay. And then there's a follow-on to the extensions on to with some of your borrowers, can you give us the magnitude. I don't know if this is you imply that it was $250 million or so because we are talking about the variable rate loans and that increase from I guess 645 to 985 and that's because of some extensions. Can you give us just a sense as to how much or how much of that you are seeing in terms of borrowers coming up from maturing and kind of working with them to extend terms?

John Dickson

I guess renewals and extensions are a much higher volume than they were previously as a result of sales slowing down. And again borrowers are communicating with us. If they're showing some sales they just slowdown dramatically then we will renew the loan. Rob do you have any addition.

Rob Robinson

No, that’s accurate.

Mathew Clark - KBW

Okay. And the question I had was, are you seeing any other borrowers comparable in size maybe in scope as Barclays North. I mean obviously that’s one that's been -- obviously you guys dodge a bullet, which is great to hear and I think surprised a lot of people, but just curious and maybe I guess how you are able to dodge that bullet number one, if there was anything you saw early on and then also if you see any other borrowers of comparable size in the market like that, like they seem to be struggling?

John Dickson

Well. Let me step back. We did do a press release and 8-K after our Annual Shareholder Meeting on Barclays North. Normally, I wouldn’t talk about a specific borrower but I did have their principles, permission to discuss it, and Mathew this is a prefect example of how we work with the borrower. Again, as long as they're working with us and communicating to us, the principle of Barclays has been to communicating to us very well. He is being attempting an orderly liquidation of assets to payback creditors and in our particular situation we found some other borrowers that have liquidity, had more financial strength to take over his credits and we agreed to the new borrowers.

So Barclays was one of our significant credit relationships. I guess dodging a bullet is okay. I know there's a lot of rumors running around out there that weren't necessarily true. The other rumor was that Barclays was going to file bankruptcy, and they have not filed bankruptcy. The principal has worked very hard to try to liquidate his position there.

So, yes, we have a number of borrowing relationships that range in the $30 million - $40 million - $50 million range as I discussed in prior calls. In many of those situations, it's multiple projects, and the projects individually can vary as to the strength, and how good the sales are. Did I answer your question, Mathew?

Mathew Clark - KBW

You did, you did. Thank you. And just a quick follow on. In terms of getting the exposure off your balance sheet, did you retain any risk? What was the cost of having that exposure removed?

John Dickson

On Barclays North?

Mathew Clark - KBW

Oh, I'm sorry. I thought that you had suggested that you guys had some and it was taken from -- you want to get unloaded. Did I misunderstand you?

John Dickson

No. Other than the balance directly to Barclays North is less than $300,000. The other loans that they did have or were assumed by other borrowers with more of strength and staying power, there were no adjustments to, no write-offs, no adjustments, anything of that nature.

Mathew Clark - KBW

Okay. I'm sorry. I think I misinterpreted what you said. Thanks.

John Dickson

Okay.

Operator

Thank you. Your next question is from Dave Rochester from FBR Capital markets. Please go ahead.

Dave Rochester - FBR Capital Markets

Hey thanks guys,

John Dickson

Hi, Dave.

Dave Rochester - FBR Capital Markets

Just a real quick on just for a normal residential construction loan, I really appreciate the detail on the different loan grades. Could you perhaps go through what your average reserve would be for each grade for past, would it be 50 basis points, special mention, 150 basis points of standard, a lot more than that, can you give us sense for what that is?

John Dickson

Sure. On Watch credits 2.5, on a grade 4, 5.

Dave Rochester - FBR Capital Markets

5%.

John Dickson

5%.

Dave Rochester - FBR Capital Markets

Okay.

John Dickson

Grade 5, 15% and then Grade 6, we've charged the loan off. We also as they move into non accrual we'll do a specific reserve which addresses exactly what we believe the exposure to lot is so that's all calculated back into our March reserve.

Dave Rochester - FBR Capital Markets

Perfect. And you are saying the Watchlist is that past 1 through 4 is that right? And the past 0 is a normal loan?

John Dickson

Yes, it would be considered a normal loan.

Dave Rochester - FBR Capital Markets

Okay.

John Dickson

Just requiring extra scripting.

Dave Rochester - FBR Capital Markets

Got you, okay. And on your comments on the small home builder I know you said you saw stress last quarter, are you seeing, I'm sure you're seeing increased stress amongst that group, are you seeing that stress extended to the larger builders at this point in a more meaningful way?

John Dickson

I don't think more meaningful than it was at the end of the quarter. There's no question that everybody regardless of the small or large is feeling stress in their projects and their portfolios but the smaller builders are definitely feeling it much slower than the larger.

Dave Rochester - FBR Capital Markets

Okay. And lastly the growth and the verticals instruction and the land portions, do you have a sense for what portion of that came from additional draw downs, commitments or interest reserves versus the addition of new project?

John Dickson

I don't have a feel for that Dave. I guess I would say that I believe most of the growth in land development was drawing on existing commitments whereas on the construction side, there is two ways out of the land development project. You can either sell all the lots or you can build on then and in some cases, our builders are coming in with plans to build out the lots and sell the homes. We are limiting those build-outs substantially relative to in prior periods because of the inventory levels. But again for well-established borrower with good liquidity sources, we have originated some new construction loans during the period.

Dave Rochester - FBR Capital Markets

Okay. Thanks guys.

John Dickson

Yes.

Operator

Thank you. There are no further questions registered at this time. I would now like to turn the meeting back over to Mr. Dickson.

John Dickson

Thank you, Mary. Again I would like to thank everybody for joining us on the call today. Obviously, the stars had wind up with margin compression, credit costs going up and we continue to work diligently to manage our risks and again we've got good collateral, good capital and good reserves to sustain this marketplace and a great management team to handle this and so look forward to chatting with you here next quarter. Thank you.

Operator

Thank you. The conference is now ended. Please disconnect your lines at this time. Thank you for your participation.

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