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MB Financial, Inc. (NASDAQ:MBFI)

Q1 2008 Earnings Call

April 25, 2008 10:00 am ET

Executives

Mitchell Feiger – President and Chief Executive Officer

Jill York – Vice President and Chief Financial Officer

Thomas Panos – President and Chief Commercial Banking Officer of MB Financial Bank

Analysts

John Pancari – JP Morgan

Brad Milsaps – Sandler O’Neill & Partners

Ben Crabtree – Stifel Nicolaus & Co.

Kenneth James – Robert W. Baird & Co.

Mary Schaeffer - Morgan Stanley

Mac Hodgson – SunTrust Robinson Humphrey

John [Hupale] - Financial Insurance

Operator

Welcome to the first quarter 2008 MB Financial earnings conference call. (Operator Instructions)

Before we begin I need to remind you that during the course of this call the company may make forward-looking statements about future events and future financial performance. You should not place undue reliance on any forward-looking statements which speak only as of the date made.

These statements are subject to numerous factors that could cause actual results to differ materially from those anticipated or projected. For a list of some of these factors please see MB Financial’s forward-looking statements and disclosure in their 2008 first quarter earnings release.

I would now like to turn the presentation over to your host for today’s call, Mr. Mitchell Feiger, President and Chief Executive Officer; Jill York, Chief Financial Officer of MB Financial, Inc.; and Tom Panos, President of MB Financial Bank and Co-Head of Commercial Banking.

Mitchell Feiger

This morning we issued our regular quarterly earnings press release. I urge you to review the information in that release. It more fully describes our performance in the first quarter than we will be able to do in the limited time we have on this call.

Jill, Tom and I have the unusual task this morning, at least unusual for us, of explaining how an otherwise good quarter was severely impacted by what we believe is a one-time event.

First I’m going to undertake the more difficult and unpleasant task of explaining how our Commercial Loan Division that didn’t follow proper procedures allowed a charge off and caused us to make a significant provision for loan losses. Then Jill will have the more pleasant task of discussing the rest of our performance which was very good on almost all measures.

Along with Jill and me, Tom is available to answer your questions after our prepared remarks.

All right. What happened? During the first quarter we discovered two borrowing customer frauds. One of the two, the larger one was discovered in mid-March when we learned that a secured and monitored borrowing customer was falsifying various monitoring reports submitted to our bank. Unfortunately, falsified reports are not as unusual as they should be so we have procedures designed to protect and prevent such occurrences.

Further investigation into this fraud revealed that personnel in our loan division responsible for the credit knew, or should have known, the reports submitted by the borrower were incorrect. If the loan division had followed proscribed MB procedures this customer deception would have been discovered early, or at least earlier, and the loss subsequently incurred would have likely been less or perhaps even non-existent.

We then, upon discovering this, of course performed a thorough and extensive review of the credits managed and originated by this particular division. The review indicated that monitoring and reporting procedures had not been followed on only three additional credits allowing those loans to deteriorate to potential problem loan status. You’ll see that if you read our press release. The outstanding balance of these three loans totals around $42.5 million.

The good news is that all these loans are current with respect to interest and principle payments and we have a very positive relationship with all three borrowers and are working together to solve the problem. These are significant companies with significant businesses and there is good reason to believe all three will work out fine.

However, we felt that because of the sequence of events and the current financial status of the borrowers caution and conservatism was in order. As a result then of the increase in potential problem loans caused by adding these three loans to the list and as a result of the charge off in increase in non-performing loans caused by the fraud that started the investigation we increased our provision from loan losses from an otherwise quite normal $5.5 million to a very abnormal $22.5 million in the quarter.

I just have some general comments to make on commercial lending here. I think good commercial lending at MB and I’m quite sure at every other bank requires an effective coordination of underwriting and credit monitoring. By that I mean the underwriting process assume a certain level of post-origination loan monitoring. For example if you knew you had say almost no effective loan monitoring systems in place prudence dictates you only make extremely high quality loans with no virtually no risk of default or loss.

On the other hand if you knew you had a really good, really effective daily monitoring system where you could intervene very early when a credit began to deteriorate, and early intervention would materially reduce the risk of loss you would be willing to make riskier loans to get better returns. The latter monitoring system describes what we do in our very good asset based lending department. Though that is not the division that had the monitoring problems I am talking about. In fact that division is helping us repair them.

We had difficulty because our underwriting process presumed this particular division was performing the appropriate monitoring activities when in fact they were not, either intentionally or unintentionally.

So the bottom line is this. We think we have found the problem and we have addressed it through the quarter.

With that said let’s turn our attention to more recurring matters and in the long run more important matters. Other than what I’ve just discussed our performance including credit outside of that was quite good.

Jill Young

Thanks Mitch for covering the hard part. It is my pleasure to cover the rest of the quarter, almost all of which was positive. First, we continue to enjoy strong balance sheet growth both on the loan and deposit side. Commercial related credit grew by a 16% annualized rate since year end while deposits grew 12% annualized clip during the quarter.

The loan growth was driven by strong CNI and lease loan growth. I am pleased to report we added 20 bankers during the quarter primarily on the commercial side of our business. We are confident that these additions will help us continue to gain market share from our competitors in the coming quarters.

Our securities portfolio continues to perform well with unrealized gains increasing to $24 million. As a result of the strong balance sheet growth even though our margin compressed by 6 basis points during the quarter, our net interest income was stable compared to the fourth quarter and increased by 3% compared to the first quarter last year.

Our net interest margin compression was due to the rapid decline in overall market rates during the first quarter. Our loans tend to re-price slightly faster than our deposits so it was not surprising to see some modest compression.

On a positive note we are seeing significantly better credit scores on renewed credits and also on new investment security purchase. However, competition for deposits continues to be fierce, which is impacting both customer and wholesale deposit prices.

Excluding the problem division that Mitch discussed our provision for loan losses was $5.5 million and net charge offs were $3 million. Our loan portfolio is performing generally as expected. Non-performing loans again, excluding the problem division increased by $20.5 million.

This was not a surprise to us and we have been communicating to investors that non-performing loans at $23-25 million were non-sustainably low. Our construction portfolio has remained stable and our allocated allowance to this sector of the portfolio was essentially the same as at the end of 2007.

As mentioned in our previous call, non-performing construction loans take more time to work through and as a result they tend to remain in non-performing status for a longer period of time than [CNM] loans.

Now, let’s talk about fee income and operating expenses. We have received a lot of positive comments on the core and non-core fee income and expense schedules that we added to our last few earning’s releases. We have included them again this quarter.

Core fee income has been quite strong and grew by 11% on a one quarter basis driven by strong loan and deposit fees. Much of this benefit is coming from the lower rate buyer [meant.] So while the rapid change in market rates has caused some margin compression this change has had a positive impact on treasure management fees and loan prepayment fees.

Core expenses have been manageable and declined slightly even though we spent $500,000 in the first quarter on bankers hired in the fourth and first quarters. We estimate that the full impact will be an additional $800,000 this quarter for a total of $1.3 million per quarter for the 27 bankers hired to date. We are doing the best we can to limit our expense growth to revenue producing personnel.

Finally, to summarize overall net income for the quarter was $5.8 million or $0.17 per share. The negative impact of the provision for loan losses related to the problem division as well as the impact for non-core fee income and other expense net of tax was $10.3 million or $0.29 per share. Thus while we understand that you can’t disregard the large provision we do believe that the problem has been captured and is an isolated event. As a result, for those that are forecasting future earnings we estimate our core net income for the quarter at $16.1 million or $0.46 per share.

Now I’d like to turn the call back over to Mitch for final remarks.

Mitchell Feiger

Just a couple more thoughts and then we will open up for questions so get your questions ready. While we are not seeing a meaningful deterioration in our CNI or commercial real estate portfolio we are being very careful. I think this reflects my feeling the economy is quite weak and perhaps may weaken much more so we are being careful.

Residential real estate sales have been sluggish; continue to be sluggish especially in the suburban Chicago market and residential construction loans I think are suffering as a result. On a relative basis Chicago city projects seem to be doing better. Fortunately for us a significant portion of our construction loan portfolio is for projects in the city of Chicago. The Chicago winter was particularly bad this year making it harder for the few home buyers out there to get out there so we are all anxious to see if the spring selling season picks up some of the weaker slack.

Finally, and I admit this is an odd thing to leave to the end of our remarks, we are thrilled to announce that in April we acquired 80% of Cedar Hill Associates, an investment manager with offices in Chicago and Highland Park, Illinois. Cedar Hill manages slightly under $1 billion for high net worth individuals. It realized solid growth in recent years because of strong investment performance and superior customer service.

Cedar Hill will continue to operate under the Cedar Hill name and its management team, Joel Jastromb and Alan Cole will continue to manage the company. The company will operate as an independent subsidiary of MB Financial Bank and we are absolutely thrilled to have them. I think this is a great transaction for our asset management business and the bank as a whole.

We’ll take questions now.

Question-And-Answer Session

Operator

(Operator Instructions) Your first question comes from John Pancari - JP Morgan.

John Pancari – JP Morgan

Could you give me a little bit more detail here on the other increase in your MPA’s? I know you mentioned the $12 million that came off of potential problem loans and non-accrual and the fraud had $6 million there. What was the remaining increase and what type of credit? Can you talk about granularity for that and what you are seeing?

Mitchell Feiger

I think the bulk is 90-day past due in still accruing loans. Is that the one you are talking about?

Jill Young

That’s correct.

Mitchell Feiger

I think that is the book of the difference. With regard to granularity in the press release I’m sure you haven’t had time to review it since it came out not too long before this call but we’ve put a table in there that shows the amount and quantity of loans stratified by outstanding balance and I think the interesting thing on those charts it shows we still have about five construction loans that are over $5 million that we are concerned about and that is about the same number as last quarter. Last quarter we talked about $5-7 million. I’d still put the numbers at 5-7.

So we don’t see meaningful movement. Some of the numbers bounce around a little bit as credit goes out and credit comes in.

John Pancari – JP Morgan

That 90-day past due at the 4.2…what is that comprised of?

Mitchell Feiger

It is one loan…

Thomas Panos

Actually there are two loans there. They are both commercial real estate loans that are well secured.

John Pancari – JP Morgan

On that point, on the collateral and commercial real estate have you done appraisals or re-appraisals of some of these credits as they have hit potential problem loans or non-accrual? What do you see in the way of depreciation in collateral values there?

Mitchell Feiger

We are constantly doing appraisals on any real estate loans that hit the potential problem loan list and real estate loans that go on non-accrual. On the for sale housing side we see deterioration in values for sure. Especially in the suburbs where sales loss there is particularly weak.

John Pancari – JP Morgan

And are you going to quantify the depreciation in values you are seeing on average in your market?

Thomas Panos (?)

I think what John is referring to is some of the calls people have been able to put a percentage of depreciation they are seeing on old appraisal versus new appraisal. I don’t have a sense for that. It is kind of all over the board.

Mitchell Feiger

I think it is all over the board, yes.

John Pancari – JP Morgan

Then just more specific, Mitch, on this division that had some problems have you done any other assessment of other parts of the company in terms of credit underwriting and monitoring? I’m just trying to figure out if this one got by you how do we know there is not other divisions that are squeaking by with issues like this? Just give us an idea of how this came about and how you feel about other areas of the company where you are doing underwriting and…?

Mitchell Feiger

We regularly look at all of our loan divisions and I am highly confident we don’t have this situation in any of our other divisions. Is it possible? I suppose anything is possible. We don’t believe and I’m quite certain this kind of thing is not happening elsewhere. I can’t answer it any other way. Let me say it this way. We’ve looked where we needed to look and we’ve done the investigation that needed to be done to completely thoroughly isolate this thing and get it marked.

John Pancari – JP Morgan

The banker hires…we saw the number you have brought in to date. Can you just give us an idea of additional hires you are looking at here you expect to come on within the next couple of quarters?

Mitchell Feiger

I think we’ll have a few more bankers start here in the next couple of weeks or few weeks and then I think we’ll pause for a little while and we’ll get into the summer and see how things are going. We want to be able to digest the bankers in an orderly way and make sure their entry to MB is successful and that we have the right support mechanisms for them. So I think we’ll pause. We’ll see how we are doing and if things are going well then I think we’ll resume hiring later in the year – perhaps mid summer or late summer. If we do resume I would imagine we will resume with a similar pace.

Operator

Your next question comes from Brad Milsaps - Sandler O’Neill & Partners.

Brad Milsaps – Sandler O’Neill & Partners

Can you give us a little more color at how you arrived at the provision number this quarter specifically related to the potential problem loans? You had a pretty reasonable, or I guess double in last quarter, a handful of credits on the residential side that you talked about but the jump in the provision wasn’t as dramatic. I’m just kind of curious what you saw differently with these loans. Your commentary here is that they continued to perform as agreed but it trigger maybe a larger provision than maybe I would have thought. So I’m just hoping for maybe some more color there.

Mitchell Feiger

Well, these are CNI loans and we have applied essentially our standard substandard reserve on these loans. I think…there isn’t anything unusual. There is $42 million of them and it is just a standard provision on a substandard loan.

Brad Milsaps – Sandler O’Neill & Partners

Aside from the charge offs related to these loans you had this quarter are you still comfortable with that kind of 30-40 basis point range for net charge offs for the year that you alluded to when we last talked?

Mitchell Feiger

I may have, but I don’t remember giving specific charge off guidance in the last call. But I don’t see…just looking at our non-performing list outside of these unusual credits and looking at the performance of our construction portfolio I don’t see why it should move that much. Now I would offer a word of caution. The market, as you know, the residential real estate market in particular is quite soft and things can be lumpy. We have five loans over $5 million. The biggest one I think is $14 million. Is it possible two of those could require some type of charge off activity in one quarter? Yes. I think it is in which case I think the charge offs would be a little bit higher. Is it possible that none of them could require charge offs in a quarter? Yeah that is possible too. So I think we all have to be cognizant of the lumpiness not just for our company but all banks in our space…the lumpiness that comes with the charge offs. Especially when you are operating…when we were operating at $23-25 million in non-performing loans and charge offs were in the 24/25 basis points, sometimes 13 basis points, we were saying at that time that those levels were unsustainable. I think they were. I think they are on the high side now. The truth is in the long run it is probably some place in between.

Brad Milsaps – Sandler O’Neill & Partners

Just kind of curious, the potential problem loans and the NPA you have, what percentage of those would you say would have been acquired in the first Oakbrook deal versus what would have been homegrown at MB Financial.

Mitchell Feiger

Something a little less than 50% of the non-performing loans are Oakbrook loans. Let me give you a little color to that because I think it will give you some insight into how we think about credit. Some years ago…a couple three years ago we did not like what was happening in the suburban residential development market and we moved away, MB moved away from that space. We focused our development or construction loan efforts on the city of Chicago where we felt the length of the project and the term of the projects were shorter and so if the economy weakened we would have a better chance to react. In effect that has proven to be true.

Now, let’s step back. Oakbrook bank, on the other hand, I think felt more like others in the market – more like other lenders in the market that the suburban markets were pretty good and there was good opportunity there and they lived in the suburban market. They really didn’t have any city offices to speak of. So they focused their residential construction lending on suburban markets which was not unusual.

We were the MB side was unusual one when we moved away from the suburban markets. When we did our due diligence at Oakbrook bank we saw these loans were out there. We thought they were very ordinary. Obviously at that time they were all performing very well. The market was strong and they weren’t out of the ordinary for where the market was. I think a little bit in the back of our mind maybe was our backing away at that time from the suburban market maybe wasn’t the best thing to do.

But anyway we acquired Oakbrook knowing those loans were there. Low and behold our judgment was right and suburban loans turned out to be quite a bit worse than the city markets. So non-performing loans Oakbrook loans are about 42-45%. Something like that.

Brad Milsaps – Sandler O’Neill & Partners

Mitch, if I remember correctly and we may have to dig deep here, but Oakbrook had a couple number million dollar construction portfolio roughly when you took it over?

Mitchell Feiger

That might be right, Brad, I don’t have that figure in front of me.

Brad Milsaps – Sandler O’Neill & Partners

If you had to just guess, and you talked a little bit about it on the call…if you had to divide roughly $500 million residential portfolio in urban versus suburban…how would you divvy that up?

Mitchell Feiger

I don’t know. We did it about maybe six months or maybe as long as a year ago. It was something near 50/50 but I haven’t run that math recently.

Brad Milsaps – Sandler O’Neill & Partners

On the expenses you talked about the new hires. Would the core expense run rate seems lower on a lean quarter basis, x number of new hires. Is that just you guys continuing to make strides on that on the income statement? Then secondly kind of can you give us some thoughts on the tax rate going forward? Thanks.

Jill Young

I think the first quarter is a pretty good run rate. I think sometimes during the fourth quarter you can have some accrual adjustments that may impact the total expense level but I think the core other expense adjusted for things we talked about with respect to the new bankers…I think it is a pretty good run rate.

With respect to our overall tax rate that is something that can vary some just depending on the ratio of tax exempt income source as the total income. So I actually think the current rate may be a little low but it depends on what our total pre-tax income is next quarter.

Operator

Your next question comes from Ben Crabtree - Stifel Nicolaus & Co.

Ben Crabtree – Stifel Nicolaus & Co.

Just to make sure that I understand this whole discussion of the non-performing assets. First of all it sounds as though Mitch as you haven’t made any procedural changes…any changes in your overall procedures in monitoring credits and it is just a case of where these weren’t followed?

Mitchell Feiger

No. That is not correct. We have modified procedures so that this kind of event should not happen. But you know look at some level, at some place along the way we are dependent on what our bankers tell us. They are our primary interface to our customers or clients and they have to be straight with us. We can’t put them in a straight jacket so tight that every time they have a conversation with a client a credit officer has to be standing next to them. But we have tightened procedures in this instance and I think this kind of thing shouldn’t happen again. Or if it does we’re going to catch it an awful lot earlier. By the way, early intervention is the key here. We’re not perfect making loans. I don’t think anyone is. So our processes are designed around early intervention and there is an awful lot of early intervention that goes on. It is when we don’t get a crack at early intervention that we have these kinds of problems. So that is where we beefed up our procedures to try and make sure that when early intervention is needed it is there.

Ben Crabtree – Stifel Nicolaus & Co.

Kind of a similar vein, or at least in that whole subject of bankers, the new bankers you hired I’m trying to get a sense with how they fit with your overall business strategy? Do they aim for the same size customers you have gone after? Would they be more or less commercial real estate oriented than what you do now? In other words is there a kind of subtle shift of strategy or focus that might occur as you bring those bankers on?

Mitchell Feiger

No. There isn’t. They are exactly in line with what we are doing and none of them are in the commercial real estate space. They are all CNI and…some of them are in the private banking space – a handful, but most are straight CNI commercial bankers. We have been very careful about the people we have hired because we want them to fit in with exactly what we are doing. We do not have an interest in expanding beyond what we are doing, if you will scope [creek].

Ben Crabtree – Stifel Nicolaus & Co.

And then I’m not sure that I understand all the ins and outs of the whole NPL area and the bad loan situation. The loan fraud which resulted in the charge off and the 5.9 in non-performance, those loans were not in the non-performing category before this quarter?

Mitchell Feiger

That is correct and they are still not in the non-performing loan category. They are just in the potential problem loans…

Jill Young

They are now.

Mitchell Feiger

I’m sorry, they are now.

Jill Young

We charged them down 50% down to what we thought was collectable and then the balance.

Mitchell Feiger

I’m thinking of the other ones.

Ben Crabtree – Stifel Nicolaus & Co.

Did I hear this…that of the 42.5 of the additional loans that are still essentially behaving…paying on time and all that sort of thing, twelve of those did migrate into non-performing?

Jill Young

No. What we said was the $42.5 million related to the review of the division and that went into the potential problem. Then just in our core business we had $12 million construction loan that migrated from a potential problem to non-performing. So just kind of normal migration that one would expect as you are working out.

Operator

Your next question comes from Kenneth James - Robert W. Baird & Co.

Kenneth James – Robert W. Baird & Co.

Question on the margin. You have referenced many times in the past what a large benefit it would be once you start seeing widening credit spreads. As I look through your portfolio you have highlighted that again this quarter. I’m just curious given some of the other negative factors that continue to work against you at what point do you think we’ll start to see that positively impacting margin to the point of getting some expansion?

Mitchell Feiger

Boy that is a hard question. I think part of it depends on what happens in deposits. We’re definitely seeing better loan spreads. But deposit rates are high.

Kenneth James – Robert W. Baird & Co.

Right. But can you talk about…obviously it kind of seems like you are having to do a lot of funding on a wholesale or a broker CD basis. Can you talk about the average spread of a commercial loan now over wholesale funding costs versus say last quarter or a year ago?

Mitchell Feiger

The spread difference…how much they have increased? I’d say the spread is probably 25 maybe 50 basis points. Quarter to ½ point better spread.

Thomas Panos (?)

Our lease loans it is probably up 150 basis points. Maybe more.

Kenneth James – Robert W. Baird & Co.

Then just in the near term what is the effect on the margin given a late first quarter rate cut and probably another one coming here soon…do you think the margin will give up a few more basis points in the second quarter?

Jill Young

You know it is interesting, I didn’t talk about this in my prepared remarks. But we have loan floors on an awful lot of our loans which has actually helped mitigate some of the compressions as well. Right now we estimate about…a little bit under $400 million would be currently in force, in that the floor is higher than what the rate would have adjusted to. That’s going to help us, I think, mitigate downward pressure on the margin. So I’m actually fairly optimistic that we can weather out another rate decline pretty well.

Kenneth James – Robert W. Baird & Co.

Just in regards to the acquisition and the interest in the asset manager can you discuss any impact on the financials that is going to have going forward?

Jill Young

My view on it is we will see nice revenue growth and certainly the overall transaction is accretive albeit small because it is a small acquisition relative to overall company size. But I think it is a fantastic transaction and will really help us drive wealth management growth going forward.

Kenneth James – Robert W. Baird & Co.

Is that part of a…or any other kind of additions to that strategy, if you will? Or is that kind of just a one-off event or a one-time opportunity that you saw that you had to snap up?

Mitchell Feiger

Well it was a great opportunity and we have wanted to expand our asset management revenues. We want to expand all of our fee revenue sources and we’d like to expand them faster than our net interest related revenues. But it has been difficult. This opportunity came along which we felt was an excellent one and has an excellent fit with our company. So I think we’ll do this and we’ll look and see how it goes and if a year or two from now it looks like it is going well maybe then we would consider entertaining another one or something like it. But at this point no, it is not the launch of a grand strategy to begin doing asset management or anything like that.

Operator

Your next question comes from Mary Schaeffer - Morgan Stanley.

Mary Schaeffer - Morgan Stanley

I’m concerned about your internal controls following this fraud loss. Can you describe more thoroughly how you are addressing your controls and procedures especially in light of the road we’ve had in the balance sheet and with your new bankers?

Mitchell Feiger

That’s a really wide question.

Mary Schaeffer - Morgan Stanley

I think that just having some more detail or some examples of what you have done would be helpful to us.

Mitchell Feiger

By way of example in this instance I think that what we have done is we have put mechanisms in place that ensure there is communication on certain items, certain important items, that automatically go beyond the division. Directly in credit. Now we’ve had some of those in place already but what we’ve done is we have beefed them up.

I think that generally you’ll find the controls strong around here and in the past we haven’t had anything like this. Part of the reason is we like to hire very experienced bankers who know their business well and then supplement that with a pretty strong control environment. We have the full control processes that you would expect in a commercial bank including loan review and post-funding loan review, all the other things that credit people do in a commercial bank. So, I don’t think…my feeling is the control environment around here is strong. I think in this instance we had people in a loan division that didn’t do what they should have done. Let me just say it that way. And that combined with the borrower, particularly in the fraud that was dishonest, I think prompted that portion of the charge off this quarter.

But, I think I am highly confident we have the right processes and controls in place and I think the adjustments we have made are the ones that need to be made.

Mary Schaeffer - Morgan Stanley

Can you see from our perspective though I don’t work for a commercial bank and so I don’t know what normally happens there and so I don’t understand why you have people who are very experienced and who know their customers why they aren’t already reporting in to you if you have strong standards in place?

Mitchell Feiger

I very much appreciate your question and your thought on this. I need to be a little bit careful here in that we have Human Resources issues involved and I cannot describe to you…I wish I could, I really do…I cannot describe to you the exact specifics of what happened in this instance. But I can tell you that we have taken appropriate steps so this kind of thing should not happen again. I think we have been in the commercial banking business a long time and our people are very experienced, both management team as well as our bankers, and we know how to do these things and we haven’t had these instances in the past. In fact I can’t remember…there hasn’t been another one like this in our history. This is our first one. I wish I could describe to you more fully what happened within the division. I think you’d be quite comfortable with the changes we have made but I can’t.

Mary Schaeffer - Morgan Stanley

Is that maybe something we could discuss further in the future?

Mitchell Feiger

I suppose perhaps.

Operator

Your next question comes from Mac Hodgson - SunTrust Robinson Humphrey.

Mac Hodgson – SunTrust Robinson Humphrey

I’m curious you haven’t mentioned the name of this division and maybe you can’t say it for HR reasons as you mentioned, but can you give us any more details on the size of that division’s loan portfolio and maybe if it was focused on a particular sector, etc.

Mitchell Feiger

It is a general commercial and industrial division and it has about $200 million of total loans outstanding. We’ve been through every loan in that portfolio inside out. So we know what is there. The rest is fine. The rest is actually very high quality.

Mac Hodgson – SunTrust Robinson Humphrey

Did an external firm assist in those internal reviews?

Mitchell Feiger

No. You’re talking about a small number of loans. The senior manager of the bank looked at every one of them.

Mac Hodgson – SunTrust Robinson Humphrey

I think this question was asked earlier but when you take out the $6 million in charge off related to commercial customer loan frauds and I guess the rest of the increase was due to those three commercial loans that were $42.5 million, just trying to get a sense of what went into that provision. I think you described it as a standard provision on substandard loans. Just the process again if you can describe it. You guys just apply a percentage haircut on the loan balance to come up with it? Maybe just any more detail you can provide would be helpful there.

Mitchell Feiger

This gets a little complicated but we study very carefully what our losses are on loans and we study the default probability as well, as you can imagine. We are rather sophisticated about it. The first crack at it is a computer model, it sounds weird, but a computer model predicts what those might be. Then on potential problem loans and non-performing loans the senior management of the bank looks at every one of them and makes a determination. Is that the right amount or not? If it isn’t the right amount then they adjust that up or down. That is exactly the process we followed in this case.

We think they are properly reserved.

Mac Hodgson – SunTrust Robinson Humphrey

You mentioned they are current, you have a good relationship with the borrowers. I guess their financial condition has deteriorated?

Mitchell Feiger

Yes.

Mac Hodgson – SunTrust Robinson Humphrey

All the documentation is in place that you need though?

Mitchell Feiger

All the documentation is in place. It is an instance, I guess to maybe shed a little light on this it is an instance where earlier intervention we think would have had a positive impact on the situation here. Because of what happened in the division we were unable to take advantage of that.

Mac Hodgson – SunTrust Robinson Humphrey

Then maybe outside of this and I apologize if you touched on this earlier. Loan growth was strong and I just didn’t know if you could provide any color on where it is coming from? If it is some of the new bankers you hired in the fourth quarter or if it is just across different sectors of the market? That sort of thing.

Thomas Panos (?)

We have had a really good commercial banking staff on board for years and they are continuing to go out and find new business and that business is from all sectors. The additional bankers are just now creating the additional volume. It takes a little bit of time for bankers to get up to speed on our bank and get out and see their prospects. So it is more weighted now towards our former bankers.

Mac Hodgson – SunTrust Robinson Humphrey

And the pipeline is still strong?

Thomas Panos

The pipeline looks very good.

Operator

Your next question comes from John [Hupale] - Financial Insurance.

John [Hupale] - Financial Insurance

With regard to the potential for fraud involved in the situation that you have been describing, has the financial institution-bonding carrier been placed on notice?

Jill Young

Yes.

Operator

Your next question is a follow-up from John Pancari - JP Morgan.

John Pancari – JP Morgan

I just want to touch back on Mary’s question there. In terms of your credit organization do you have any plans given the number of the bankers you are bringing in, most coming from LaSalle obviously, and then this issue, are there any plans of changing or appointing a formal chief credit officer or someone? I know you already have that responsibility baked into the organization, Mitch, but do you plan to elevate this and make it more of a firmly part of your organization? Just given the growth you are seeing…particularly just coming from your new bankers and now this fraud issue?

Mitchell Feiger

If I understand your question right first we do have an important and significant credit department and a chief credit officer. So that is not…

John Pancari – JP Morgan

I wasn’t implying you don’t. I meant in terms of elevating that person or new hire or something that is an actual change at the executive level?

Mitchell Feiger

Well no. We aren’t going to do that. The answer is we are adding to the credit department and plan to add more resources and capabilities to the credit department as we grow our bank. We always have. If you go back years ago we only had one person in the credit department and then it was 2, 3 and so on. So we’ve tried to keep the credit department the right size relative to the size of the commercial bank. Frankly I think we’ve done a pretty good job. This instance, I don’t think, is reflective on…I suppose from the outside it may appear that way, but I don’t think this instance is reflective upon their capabilities.

Jill Young

I think we have also continued to build up our loan review staff and a significant amount of our loans each year are reviewed by loan review in loan divisions.

Mitchell Feiger

It is all in the control process. You know, I think it is quite sound.

John Pancari – JP Morgan

And then you just mentioned you have been emphasizing that early intervention could have prevented this. In terms of the people you are bringing in from LaSalle and they are obviously going to bring in quite a few of their own people with their own relationships, are you approaching that differently now that this has happened in terms of evaluating the relationships they are bringing in before you put some real growth on your balance sheet?

Thomas Panos

Those credits go through the same exact credit process we have had in place here for years. It is not different.

Mitchell Feiger

This is a healthily skeptical lending group and there is a rigorous process that begins. See on these credits we are talking about the issues were not in the underwriting process. They were much more on the control and monitoring process. That is what we fixed. So with regard to the new bankers we have hired and the new credits we are originating I think they are going through what is a very rigorous and sound process. I don’t think that needs to change.

Operator

There are no additional questions at this time. I would now like to turn the presentation over to Mr. Mitchell Feiger for closing remarks.

Mitchell Feiger

Thank you everybody for your questions this morning. They were all good ones. If you have any more, as you know we are happy to answer them. Just give them to Jill or give me a call and anything we can answer we will do for you. So, that’s it. Thanks again for listening this morning.

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Source: MB Financial, Inc. Q1 2008 Earnings Call Transcript

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