Welcome to today’s teleconference. (Operator Instructions0 I would now turn the program over to Kristine Brenner, Director of Investor Relations.
Good morning and welcome to the Citizens Republic Bancorp second quarter conference call. This call is being recorded and a telephone replay will be available through July 25. This call is also being simulcast live on our website, www.citizensbanking.com where it will be archived for 90 days. With me today is Bill Hartman, Chairman, President and Chief Executive Officer; Charlie Christy, Chief Financial Officer; John Schwab, Chief Credit Officer and Marty Grunst, Treasurer. After management concludes their prepared remarks, we will open the line up for questions from research analyst.
Before we begin I would like to point out that during today’s conference call statements will be made that are not historical facts. These forward-looking statements involve risks and uncertainties, which include but are not limited to those discussed in the company’s filings with the SEC.
Forward-looking statements are not guarantees of future performance and actual results could differ materially from those contained in the forward-looking information. These forward-looking statements reflect management’s judgment as of today and we expressly disclaim any obligation to update and/or revise information contained in these statements in the future.
Now I’ll turn the call over to our CEO, Bill Hartman.
William R. Hartman
Thank you Cristine. Good morning everyone, and thanks for joining our call.With me as usual are Chief Financial Officer, Charlie Christy; Chief Credit Officer, John Schwab and Treasurer, Marty Grunst.
We have reported earnings yesterday evening very much inline with our expectations that we announced in June. And although the Midwestern banking challenges do continue, we believe that the $200 million capital raised strongly positions us to successfully and prudently manage through this economic cycle. And based on the actions we’ve taken and continue to take, we expect to operate profitably in the third and fourth quarters.
Today I would like to discuss how we’re positioned to improve our performance and shareholder value, but first, Charlie will do the financials and John who will bring you up-to-date on credit quality. Today we’re going to give you a little bit more detail since our capital and liquidity positions have been significantly enhanced and since a full understanding of the goodwill impairment and credit write down are also very important to having a full understanding of why our balance sheet is so much stronger than it was in the last quarter.
Charlie, will let you start off with the discussion of the balance sheet, income statement and the transactions completed during the quarter.
There are a number of transactions and activities during this quarter that may make it difficult for an investor to evaluate our performance and make meaningful historical comparisons. Therefore, today I hope my discussion will help with the following; our goodwill impairment charge, its impact on our financials, why it was required and when it will be complete.
John will touch on our credit quality and it’s outlooks, so I’d planned to just clarify the credit write down we conducted during the quarter and why that made sense and why we use the “held for sale” designation, our capital raise and why $200 million was enough as well as touch on the stress test we conducted to make sure that $200 million was enough and note where the capital ratios landed and as I normally do, touch on a few key financial highlights that will help everyone better understand our run rate, going forward.
The $178.1 million goodwill impairment charge; the majority of our goodwill was first created when we purchased Republic Bancorp. The goodwill from that acquisition was approximately $720 million. At the time of the acquisition we allocated a portion to our specialty commercial group, which includes the investment commercial real estate team, a much larger portion to our Regional Banking group, which includes our retail delivery franchise, consumer lending and mortgage.
During the quarter we determined that we should conduct an interim analysis of our goodwill because of the ongoing volatility in the industry, the fact that our market cap had fallen below our tangible book value, and the continued deterioration of our commercial real estate portfolio.
We updated our annual goodwill analysis, conducted discounting cash flows and pricing analysis, to see if the fair values of the assets and liabilities in the different groups exceeded their carrying values and determine that the Regional Banking portion of our goodwill was not impaired, which makes sense because that is where the franchise value has increased for Republic Branch network as they now utilize our larger menu of deposit products and services and more access to small business, cash management and wealth products and have transitioned to a more commercial bank format.
However we did determine that the specialty commercial group portion of the goodwill was impaired and that we needed to take the charge. That group houses our commercial real estate division, which is were the credit stress on our balance sheet has occurred for the past six quarters.
The charge is equal to the full amount of goodwill allocated to our specialty commercial group, but it is a non-cash charge that is not tax detectable, it has no effect on our tangible equity or regulatory capital ratios and it does not affect our liquidity and cash position. We anticipate that the step two portion of the impairment test should be completed in the coming weeks and we do not expect any material difference from what has already been recorded.
Let’s talk about the $42.4 million credit write down. Since we were seeing continued deterioration of collateral values in the marketplace and we expect to experience a more protracted period of workout in this economic environment, we thought it was important for us to isolate our higher risk allowance and move their values to more liquidation type values as if we were to sell the underlying collateral very quickly.
Utilizing the Held to Sale designation allows us to write down the higher risk, non-performing loans to these liquidation type fair values before we actually foreclose on the properties. That way our balance sheet reflects more conservative loan values based on current fair market values of the collateral involved.
Initially back in June when we announced the credit write down we had estimated it would be around $47.1 million or $4.7 million more than the final amount taken during the quarter. We had a few loans that were designated to be written down, that subsequent to our analysis, ended up being settled for amounts better than estimated which then lowered our credit write down.
The $42.4 million credit write down was comprised of the following; $35.1 million of gross charge-offs from transferring the $128.5 million of non-performing loans to held for sale status at an aggregate estimate of fair market value of $93.4 million. The total gross transfers were comprised at $86.2 million of higher risk, non-performing, commercial real estate and all the non-performing residential real estate at the time of the write down, which equated to $42.3 million.
Also recording the loss of fair market value write down to $2.3 million on $29.8 million of commercial real estate loans that were already designated as held for sale. Since these loans are classified as held for sale, any gains or loss are recognized as non-interest income and recording a loss of fair market write down of $5.0 million on $34.2 million of commercial and residential repossessed assets. This loss is recognized in our non-interest expenses.
Now the $200 million capital raise. During the quarter we issued $79.6 million of common stock and $120.4 million of contingent convertible perpetual non-cumulative preferred stock. We issued the preferred stock because we did not have enough authorized shares of common for the full amount of capital needed. We anticipate that we will receive approval for the new shares in September 2008. The preferred stock will then automatically convert to a total of 30.1 million shares of Citizens’ common stock.
A few key reasons we needed to raise the capital were; it had become evidence that the Midwest economy, and specifically Michigan, has that risk of having a protracted period recession in the economic downturn. At the end of the first quarter, we increased our expectations for 2008 credit losses. We continue to see collateral values decline and national recession fears may impact other components of our industry. All these contribute to a high level of uncertainty in how long and how deep will the real estate decline be, as well as uncertainty behind national recession and its impact.
Our parent company had $57 million of cash at the end of March and $50 million in term debt maturing in two years, with credit quality covenantsAnd excess the capital market was worsening rapidly for smaller regional banks. Knowing all of these factors, we determined that we needed to raise some capital. So we recognized that our decision of that magnitude has dramatic ramifications on our existing shareholders and we do not take that lightly at all.
The decision to raise the capital was to help better position Citizens to have the ability to work through this cycle. They have a balance sheet that is positioned to take advantage of better times in the future when the economy rebounds and to eventually bring back value to our shareholders.
We also wanted to make sure that we would never have to do it again. With that in mind, we researched a number of sources, including lessons learned from the 1980’s and 90’s from the FDIC and other research firms, and used that information along with our normal forecasting process to determine the level of losses we can see in the variety of scenarios.
We started with our expected loss forecast, which was included in our 8-K back in June. We also conducted a number of hypothetical accelerated loss level analyses. We utilized historical life of the loan, peak industry loss levels and even stressed some of our portfolios above those levels.
We wanted to make sure we had enough capital that would carry us through an extended three year credit cycle if such losses did occur. We do not expect our losses to reach peak industry levels, but in case that were to happen, then capital needed to be of a size, that enabled us to have healthy regulatory capital levels at the end of the hypothetical cycle.
It should be noted that unlike many other banks who have had to raise capital, we began this process with the tier I level capital at 9.04%, which was all above regulatory levels and above many of our peers. Results of the stress test showed that along with our current and stressed annual pre-tax pre-provision earnings level, the $200 million additional capital and starting that with a capital level already well above regulatory levels, we were able to maintain the capital levels we need in that type of scenario. Some of this information was also included in our 8-K filing back in June.
Our new capital ratios are now at levels above most of our peers. As of June 30, 2008 our estimated levels; and were estimated until we completed our call reports were our tier I ratio was 10.75% up from 9.04%, our total capital ratio was 12.98% up from 11.26%, tangible common equity was 7.35% up from 6.07% and our leverage ratio was 8.71% up from 7.4%.
Also as a result of raising $200 million of new capital, our parent company now has cash resources over $277 million. All the parent company’s annual interest and preferred stock dividend payments are approximately $22 million. Due to the strong liquidity levels at our parent we do have any plans to suspend the regularly scheduled quarterly dividend of our enhanced trust preferred securities, which trades on the New York stock exchange as CTV PRA.
Moving on to the key financial highlights for the quarter; $178.1 million goodwill impairment charge and $42.4 credit write down, which together equal $220.5 million pre-tax or $205.6 million after-tax, drove our results to a net loss of $201.6 million. These results were inline with our revised guidance, which we provided back in June 2008. From a balance sheet perspective and on an End of Period basis, student loans were down by $124 million from the first quarter, but were up $233 million from the second quarter a year ago.
The majority of the decrease was caused by the $120.8 million transfer of non-performing loans to held for sales. Excluding the transfers, our commercial industrial loans were up $15 million, our commercial real estate loans were up $13 million, residential mortgage loans were down $43 million, home equity loans were down $22 million, all other direct loans were down $8 million and our indirect loans were up $14 million.
We’re still seen good customer demand for C&I loans and very select commercial real estate loans across all of our markets, even as we are increasing spreads on new production; however, consumer loan demand remains weak.
Total deposits were up $174 million from the first quarter driven by an increase of $68 million in core deposits and an increase in time deposits of $106 million. Total deposits were up $580 million from the second quarter of 2007 or 7.2%. Core deposits were up $408 million or 9.9%, while our time deposits were up $171 million or 4.3%.
Net interest income was relatively flat from the first quarter and our net interest margin percentage was nearly flat, down 1 basis point to 3.11%. We continue to see some minimum deposit migration from low cost deposits to high cost deposits, however much less than prior quarters. The positive price competition within our markets continues to be fierce, especially in the CD arena. And we saw much less movement of loans to a non-performing status in the prior quarter.
Looking forward in the third quarter, we anticipate net interest income would be consistent with the second quarter. Total charge-offs were equal to $69.3 million, but included $35.1 million from the credit write down. Excluding the credit write down, the charge-offs were inline with our qualitative guidance in the first quarter of 34.2, which was almost in level with our first quarter charge-offs. Provision expense was $74.5 million as we replenished reserve for the total charge-offs and slightly increased reserve due to growth and historical loss migration metrics.
We anticipate that commercial net charge-offs for the third quarter of 2008 will be higher than the first quarter of 2008, but less than half of the commercial net charge-offs for the second quarter. We also anticipate that our consumer net charge-offs will be consistent with the first quarter. Provision expense is expected to be higher than total net charge-offs as our historical loss migration metrics used to calculate our reserve continue to grow.
Non-interest income for the quarter was $27.1 million, a decrease of $3.9 million from the first quarter of ‘08. The decrease was primarily the result of the $2.3 million held for sale credit write down and the $2.1 million gain in the first quarter on the partial redemption of the VISA shares. These decreases were partially offset by a $600,000increase in deposit service charges and minor increases in other fees related to brokerage, ATM and bankcard.
We anticipate total non-interest income from the third quarter of ’08 to be higher than the second quarter of ’08, due to the $2.3 million net loss and held for sale loans taken this quarter, partially offset by a lower mortgage origination volume.
Non-interest expense for the quarter was $261.2 million; however that includes the $178.1 million goodwill impairment charge and a $5 million net loss taken as part of a credit write down on ORE properties. Excluding those items, NIE was $78.1 million or $1.5 million higher than the first quarter of ’08. First quarter included $900,000 release of a liability related to the VISA litigation and we incurred $700,000 of cost associated with existing two third-party contracts during this quarter. Taking those into account, we were able to keep our run rate expenses relatively flat.
From the run rate level discussed above, we anticipate our total non-interest expense for the third quarter to be slightly higher due to expected increases in costs associated with repossessed assets.
Taxes; our pre-tax income included several items that are excluded from the tax calculation, such as the goodwill impairment charge and factors of net interest income. Our second quarter effective tax rate was 8.8%, which is inline with our full-year 2008 expectations of approximately 5% to 9%. John is now going to go through his credit review in much more detail. John?
Our release appropriately discloses the series of credit related steps we took in the second quarter to identify and isolate the collateral valuation declines supporting our commercial and residential real estate portfolios. Nearly $70 million increased in non-performing loans held for sale to $92.7 million, effectively segregates real estate supported loans, marked to more conservative carrying values on the balance sheet enabling us to work through these assets without leveraging the loan loss reserve to do so.
Net of the marked activity in the quarter, net charge-offs of $34.2 million were inline with our first quarter end guidance. Again net of the mark and held for sales write downs, charge-offs in small business consumer direct, including home equity, consumer indirect and residential mortgage were inline with the prior three quarters. Commercial charge-offs of $25.2 million were essentially all commercial real estate with the majority representing land development and construction.
Notably, less than 30% of our commercial real estate construction portfolio is residential with preponderance over 70% commercial construction, which upon completion and lease-up will convert to income producing. Less than 15% of commercial real estate construction charge-offs for the quarter were income producing properties.
In dealing with the commercial credits now and the held for sale, our near term strategy will be to resolve these credits on a one-off basis rather than pursue a bulk sale. Our experience has been that we can reach better resolution by working with individual properties and developers. For residential held for sale, we may consider a package sale. However, we do not expect a precipitous drop in the held for sale number in the near future.
Overall, delinquencies in the 30 to 89 day group have remained essentially leveled from the first quarter, with nearly all of the $19.2 million increase in the income producing. Commercial real estate is attributable to three credits, with one a $7 million exposure in default and against which we have initiated legal action. Over $16 million of the 19.2 million increase has already been moved to our workout group.
Discussion about movements in our commercial watch list always attracts interest so we will attempt to add some color on this quarter. Overall, commercial exposure considered watch, increased $57 million or 6% quarter-over-quarter, though reductions were noted in both land hold in land development.
The $19.6 million increase in construction watch is largely attributable to one participation loan to a Minneapolis financing company, which supports receivables from various building contractors in that market. We expect resolution without loss. We also added a $5 office building in Cleveland likely tracking to non-performing before year end.
The $18 million increase in income producing is largely related to two credits, neither of which needs to be moved to our workout group at this time. Of the $25.4 million increase in our commercial and industrial watch exposure $20.6 million is a single credit in our asset-based unit. The credit is appropriately collateralized, has positive cash flow, what was down grated to a seven because the borrower is a distributor of whole sale building materials nationally, hence a watch industry. The asset-based unit increased its watch exposure over $40 million this quarter. Virtually half of the assets-based unit’s portfolio is by definition watched at origination, which is why that business is so closely monitored.
It is important to note that during the second quarter we moved commercial real estate monitoring under the administration of credit, responsible now for servicing commercial real estate exposure following origination. One of my former senior credit officer now leads this group of 19 professionals.
With the mark and credit related charges this quarter, non-performing loans and assets are down this quarter with commercial real estate and residential driven largely by mark activity. C&I non-performing loan exposure increased $11.3 million or 55% over the first quarter with $10.3 million, or over 90% of which is attributable to three credits, the largest of which is being renewed with principle guarantees, a second well collateralized with no loss anticipated, and the third currently in liquidation with both dealerships sold and no loss anticipated.
Of the ten largest non-performing loans at June 30, excluding the three just mentioned, four carry specific reserves and charge off have already have been taken on the other three. As mentioned earlier the mark activity was focused on the commercial real estate and residential mortgage portfolios with a primary objective of segregating these assets, carrying them at values allowing us to work them out of the portfolio without further burden on the loan loss reserve.
Behind the table summarizing our residential mortgage portfolio we note that having moved our servicing to PHH, enables us to benefit from their established default management and loss mitigation strategies. Further we have materially tightened our portfolio lending practices and approval process, perhaps at least partially explaining the $100 million reduction in portfolio loans year-to-date through June 30.
We have been closely analyzing industry trends on arm adjustable rate loan performance and are particularly monitoring our three one arms originated between 2004 and 2007 as industry data suggests, higher levels are at risks levels here. Three one arms are less than 15% of our mortgage portfolio.
Sub-prime mortgage loans based on original FICO score are negligible in our company, but we note that a recent refreshing of scores approximately 20% of loans now have scores below 620. This is not a surprising development in the Michigan economic environment. Our average refreshed FICO score of the portfolio is 692 and we continue to believe that FICO and customer cash flow is a primary indicator of customer and mortgage loan health. Eroded LTVs become a factor in liquidation.
The majority of our consumer loan portfolio is home equity, of which notably 38% is first lien position. Our home equity net losses have stabilized in the 70 to 80 basis point range, a level which compares very favorably with the top 25 in peer banks. While we expect normal seasonal delinquency increases in the third and fourth quarters, we are not seeing material deterioration in the home equity portfolio. Our practice in home equity foreclosure proceedings is to recognize value deficiency write downs and related charge-off prior to commencing foreclosure.
Average FICO score from the home equity portfolio is 724 and 746 for loans originated in 2008. We refreshed FICO scores on a regular basis. You will recall that most of our indirect consumer portfolio is comprised of marine and RV paper. Indirect auto paper is less than 2% of total indirect loans. Our interest is that indirect delinquencies have increased only 11 basis points quarter-over-quarter and charge-offs have remained relatively stable.
Overall, our consumer portfolio remains a stable portion of our overall total portfolio reflecting our conservative underwriting guidelines which we regularly adjust as economic circumstances suggest.
In closing I emphasize to you that Citizens will continue to deal with our primarily real estate impacted loan portfolio in a proactive upfront manner as confirmed by our second quarter initiatives. Going forward, we expect some pressure on non-performing levels over the next several quarters. Back to you Bill.
I’d like to take a few summary comments around the key points we’d like investors to come away with and I’d also like to highlight some of the keys to our improved performance and increased value.
First of all, in terms of our present financial condition we are extremely pleased with the strength of the balance sheet now; the leverage ratio at 8.7, the tier I capital ratio of 10.75 and the total capital of 12.98%. Our capital ratios, as Charlie indicated, are near the top of our peer group and when you add to that our strong loan loss reserve of 1.92%, we believe that we are more than adequately prepared for whatever this credit cycle may bring.
Additionally, our liquidity and cash positions are also very strong, resulting in us being well prepared for potential market volatility. We strengthened our balance sheet and we’ve reduced its risk. We intend to manage the company very conservatively to protect and strengthen the capital position that we now have. We’re going to continue to be very disciplined in loan pricing, looking to achieve adequate loan spreads and returns on equity, in addition to good credit quality as criteria for approval.
We have been discriminating and we believe that’s helped us maintain our net interest margins compared to last quarter and overtime we believe our loan pricing strategy will enable us to improve our net interest margin. Improving the profitability of our loan portfolio will be more important than the growth of the portfolio.
Our credit quality discipline, as John reviewed, remains strongly intact. The underwriting standards are high and with the exception of our loans to residential developers, we believe our loan portfolios are performing very respectably in light of the current economy.
The work out group has been increased by 90% and this special commercial real estate portfolio management group that John discussed, will ensure that we are managing our problem credits and potential problems credits aggressively and proactively. There was no real increase in non-performing loans at quarter end and delinquency levels were also stable from last quarter.
We are going to increase the focus of our deposit strategy in an effort to continue to improve our core deposit performance. Our non-time deposits grew by 4.86% over the last year and total deposits grew by 1.15%, as we were not as aggressive on CD pricing.
Sales of consumer checking and savings accounts are up by 9% year-to-date and sales of business checking and savings accounts are up by 34%. Cross sales of new accounts are up from 32% a year ago, to 50% for the second quarter of 2008. We’ve moved our services per household from 1.62 in 2006, to 2.0 in 2008. We believe we can continue to improve these improving trends.
Brokerage and investment fees are up 15.4% over the first quarter and both our treasury management sales and our trust sales are ahead of last year’s levels. The C&I loans are up by $50 million with good credit quality and improved spreads and our core deposits grow. And the point I want to make here is that despite our very strong focus on credit quality, capital and liquidity management and expense control, we continue to improve the sales results within our lines of business.
We have been and we will continue to be very expense conscious. I was reviewing some numbers last week and I went back to 2002 when Citizens had $8.3 billion in assets, 197 branches and in 2735 FTEs. Since then we’ve increased our assets to $13.5 billion, we’ve increased our branches to 245 and we’ve increased our revenue by 20%, all while decreasing our FTEs by 11%.
We took out $34 million in expenses since the merger and have identified another $15 million of additional expense opportunity on top of that for a total of $49 million. The $15 million we’ve identified will be realized between now and mid 2009 and will be somewhat offset by uncontrollable items such as FDIC insurance increases, which are applying to all banks and increased OREO and work out expenses.
While we have at this point not done our 2009 budget yet, we do expect that our expenses in 2009 will be less than 2008’s levels. As opposed to having one-time big bang approaches, our strategy and culture has been to continuously and continually look for ways to ring costs out of the company and to drive costs down. And we’re going to continue to look for ways to operate our company much more efficiently.
In summary, we’re going to use loan pricing, fee income, core deposit growth, credit quality improvement, and expense management as the primary drivers of shareholder value improvement. Those are the comments we wanted to leave you with and at this point we’ll be happy to open this for questions-and-answers from the analyst on the phone.
(Operator Instructions) Your first question comes from John Pancari - J.P. Morgan.
John Pancari - J.P. Morgan
Can you give us some more detail on the other credits that you have identified that had drove some of the increase in these delinquencies in your income producing area. I know John you mentioned one credit there. I just want to get some detail on the other credits and then also what industries you may be concentrated in, in terms of for income pricing, whether it would be retail, properties, or office or just any detail there?
Increase and you’re talking about non-performing?
John Pancari - J.P. Morgan
That the largest is a commercial real estate building in Cleveland that was downgraded and the second largest is a commercial real estate property that’s a hotel conversion to condo in the Traver’s city market. Then we have one that is I think temporarily in the non-performing category because we have strong guarantor behind this, but it’s an auto dealer. Generally speaking the increases have been, John, limited to commercial real estate.
John Pancari - J.P. Morgan
In terms of your retail exposure in that bucket, there are strip malls and everything. I mean are you seeing weakness there and I am just trying to get an idea here of the level of contingent you maybe seeing throughout the real estate sector?
Not in the non-performing in any material way yet. But yes there is some lease slippage in a number of the strip properties. The tanning salon and the nail salon are not renewing their leases, volume is down, but for the most part these have been underwritten with strong principal guarantees and liquidity. So building and movements in the non-performing, I do not expected it will be a material factor in the near-term.
John Pancari - J.P. Morgan
The weakness you’re seeing in C&I, I know you had indicated that you won’t credit in your ABS Group; I guess can you give us a little more detail on some of the other ABS exposure your having and any signs of pressure there and then any concentrations of industry weakness within the C&I portfolio or is it largely somewhat still concentrated in the home building related silo or real estate related silo?
I think I’ve tried to say it as often as I’m allowed that the majority of our problems are in the commercial real estate business. Increases in the, we’ve had a number of credits in the asset based unit that were downgraded in the quarter. Three of the four that were downgraded are automotive industry related, this is not surprising and one of them was the building supplier credit that I had mentioned in my comments.
The asset-based business and I again, John, have said this over and over; I really like this business. We are fortunate to have a very experienced team managing this business. I think we got some enquiries as to why we were lending money out of that unit into a company that had been in bankruptcy and I had to go some length to explain to somebody what a better possession is and a post petition lender is in a far better position than anybody who happened to be there before the company filed.
So I am very pleased with this unit, there is some automotive supplier exposure. And I mentioned last quarter that there was one that had slipped into non-performing. We continue to be optimistic that we will work out of that successfully. The business is monitored extremely closely and within the advance formulas essentially primarily short-term collateral that it’s underwritten in that matter.
John Pancari - J.P. Morgan
I know you indicated in the press release that you expect loan loss provisions to be stabilizing in the third and fourth quarters and I know coming off a high quarter here, but can you talk a little bit about that expectation particularly given the risk to continue to add the reserves here as you see this slippage in credit trends evolve through other portfolios in particularly as it hits consumer?
When you look at loan loss reserve obviously that’s a calculation that has specific reserves identified into it, formula reserves and then you have your general type reserves.
When we transfer a number of the loans down to the held for sales status in the markets we want right after the highest risk for the higher risk type loans and many of the loans that we see on the commercial side progressing to charge-offs in the third quarter, we probably already have 90% of those specifically reserved. But we like to go ahead and replenish. Even though we could take it down, we’d like to go ahead and replenish in order to keep the reserve at levels for the unknowns that are out there.
When you really take a step back and look at our portfolio, you look at the consumer side of the portfolio, it’s very consistent in how it transitions to charge-off after it works its way through the process and you look at the C&I, it too is still performing very well from a charge-off perspective and so are the income producing from market plan. The biggest stress is still coming from the land holding, development, the construction and that’s why we really were aggressive in attacking that during the credit write down.
So, when you look at the provisioning going forward part of that is because you have some migration and that’s (inaudible) and that’s also because we like to take care of a conservative posture, we replenish right back just because I think we need to be that prudent in these certain times.
Your next question comes from Scott Siefers - Sandler O’Neill.
Scott Siefers – Sandler O’Neill & Partners
Just on the loans that have been moved held for sale; I guess I am just curious if you guys will be comfortable giving sort of where in aggregate you’ve marked those all down to. And we can kind of back into the various pieces, but I’m sure if they’ve been marked on before. At least a little before they were moved into available for sale, is that a number you guys are comfortable with this quarter?
When we came back out in June and talked to a number of people in lot of conference call and things like that. Basically, on the commercial side actually. As we moved loans down hill for sale, we were seeing some various levels on 40% to 60% in the collateral and so therefore we were writing our loans down to those levels to make sure we were getting properly classified and when we marked the existing held for sale, we took the charge on that
We also took the charge and repossessed that, because it’s all still from the same perspective, but what if the loan goes default, you can kind of see it at a 40% to 60% range. It depends by the market, depends by the loan type. Certain things might perform better in Wisconsin than it would in Cleveland or something like that. So, it just depends on what we see and the appraisals that come back, but that’s the part about the good range.
Scott Siefers – Sandler O’Neill & Partners
John you had made a comment about the held for sale portfolio. Just in that it sounds like you were much preferred to work through those credits. I guess almost done in more individual base or more granular basis than look at bulk sales, but I guess I’d just be curious if they’re already written down and it’s sounds like they’ve been written down pretty substantially. I guess the risk to keeping them in held for sale is that if things continue to deteriorate, I guess you’d have potentially on going marks, their presence would take up or continue to take up management resources etc. So, I guess I’d just be interested in a little more color on why not just go ahead and jettison them if possible.
Let’s talk from a financial perspective. When you put auctions together, you end up having a sales person takes it out, then you have the buyer who buys that auction package, who then turns around and starts selling that individually and so what we’ve tried to do is just move it individually our self as best as possible to eliminate the two middle people that take profits out of that and take deep discounts on top of what the liquidation value would be.
What we work these down to is really, as we move these out one-by-one and work with our individual borrowers or other developers that we see that can help us out, we have found that that’s been the better case and point. We basically came out in June with the $47.1 million and it ended up being $42.4 million, that was because we were able to workout two or three of the loans with the individual borrower and workout where we didn’t have to take the charge. And so it’s proven more that way, versus trying to take these – just get them off the books and we have beefed up our team to handle the workout levels that are more appropriate.
It’s also highly relevant that we have individuals who have in many cases, they fully guarantee these loans and so some of these guys have a pretty strong interest in trying to workout a deal with the bank, getting other potential investors to come into the project with them and essentially settle for some discount that, in many cases would be above where we have set the discounts.
I think it’s important just to add the individual borrower ingredient to dealing with held for sales that sometimes it’s also easy to get massed into a very clinical and a bulk sale. And our experience has been by working in a one off basis, we can keep the people who started these projects originally, we can keep their interest and attention and sometimes faced with personal bankruptcy, that raises their level of interest to even higher.
Scott Siefers – Sandler O’Neill & Partners
Have you guys set the date for the shareholder meeting to increase the share authorization?
It’s in early September sometime.
Scott Siefers – Sandler O’Neill & Partners
I know we had the sort of anti-dilutives issue this quarter, what’s going to be the total share comp assuming post conversion of the preferred?
Just a hair over a 133 million share account.
If a green, she was not exercised.
Your next question comes from Terry Mcevoy - Oppenheimer & Co.
Terry Mcevoy - Oppenheimer & Co.
Just looking back over the last couple of years beyond just the acquisition of Republic Bank, was there anything specific you could have done to limit the losses on what has happened over the past two quarters or was it simply a function of the economy in Michigan, the real estate market in Michigan just deteriorating above and beyond the expectations you had at that point in time?
Well I think certainly the economic environment, Terry, has had an exacerbating impact on the collateral values and the ongoing viability of some of the real estate projects that have been under written.
I think in terms of lessons learned, I would put Citizens legacy under writing practices for commercial real estate development. We have not wavered from those since the merger and what we’ve learnt is that those who have underwritten loans without strong liquid guarantors, who have advanced with minimal equity in a project that the last one may have been successful when the economy was robust. But when the economy is not robust, that’s when the other factors, more equity, strong liquid guarantors and phasing of projects rather than try to undertake the whole residential development at one time.
These are fundamental to Citizens real estate underwriting practices and I’m just suggesting that in instances where those were not adhered to years ago, now we are faced dealing with when the guarantor doesn’t have much in the way of deep pockets. There isn’t enough equity in the project to carry the decline in value of the real estate. So, yes there is some very definite lessons learned, but it wasn’t anything that we didn’t know going in.
Your next question comes from Jason O’Donnell - Benny & Scattergood.
Jason O’Donnell - Benny & Scattergood
On the lending side semi growth has been favorable and it’s become a larger component of the loan portfolio over the last several quarters, just talk a little bit about the drivers behind this strengthening and whether there’s been any tightening of underwriting standards?
I think that there are a lot of drivers behind it. First of all, we’ve got a lot of good people in our commercial banking units that do prospect in addition to trying to expand the relationships with the existing clients. So as a result of that, there is a lot of efforts going on to find strong profitable new relationships as well. And frankly we have been able to do that without compromising or underwriting standards one bit. I mean what I am saying is that, John, the senior credit officers are very much focused on making sure that our underwriting standards are very much in alignment with the current economic environment.
The other thing that we are ratcheting up is frankly our profitability standards on commercial and industrial loans. We want to, as I mentioned in my comments, we’ve got this capital in place, and we want to manage it very intelligently. And when we put these assets on the books, in addition to having credit quality, we want to make sure that they’re adequately profitable, so we have been trying to push up the spreads and the returns on equity wherever we can.
The sure answer to your question is we’ve been able to do this without compromising credit quality standards and frankly we would trade off growth for credit quality any day of the week and we are going to be doing that. In fact you saw that our commercial real estate numbers were down a little bit for the quarter and frankly we are still prospecting commercial real estate loans and we are still making loans. They are limited to income producing property loans with very good credit quality and again with very disciplined pricing standards, but we will not compromise the credit quality standard or our profitability standards to grow.
Jason O’Donnell - Benny & Scattergood
In light of the changes in the loan mix and the fact that you paid down borrowings this quarter there has been a shift in the interest rate sensitivity and what’s your outlook for the margin in the second half of this year?
Yes, first of all on the rate risk, we are very neutral. We’ve got a very, very small exposures to rates up or down, so that’s extremely well balanced and for margin, we expect that margin will be kind of flattish to maybe up a smidgen as we go into the third quarter.
Your next question comes from Eileen Rooney - KBW.
Eileen Rooney - KBW
About the write-downs that you took on the held for sale or moving to held for sale. I know you talked about the commercial side, but if you could talk a little bit about the residential mortgage stuff that you moved, what type of write down you took there?
What we did on that was, we went back and looked at the last 15 months of really what the loans were before they went into the non-performing and then once we find, collected proceeds on those once we foreclosed on them. And over a 15-month period it was probably say about 30% discount and then I looked at the previous seven months.
I did this back in May and it was probably averaging about 38% to 39% discount. So we went ahead and took a 45% discount on those anticipating that you have work out period time over say the next six to nine months and thought that that was probably a more appropriate one because we don’t expect the housing value to settle and that’s what it was, 45% discount.
Eileen Rooney - KBW
What would have been the typical loan to values when you made those loans?
Well, many of those loans; I mean obviously, a lot of that came from the Republic portfolio and we were probably averaging below 80% or so. They were pretty good about underwriting like that and then if they did get over, what is that?
Yes it was over eighty SPMI.
Yes it was over eighty of SPMI, but I think we averaged less than 80. So it clearly is an effect of the economy and the housing downturn. You can see that the collateral value in the housing environment just is down in our markets?
Eileen Rooney - KBW
On an average how much would you say home prices are down in your markets?
I would say in Michigan, if you would look from the peak, home prices are down, last time I looked, about 15.3% to 15.4%. So, I don’t think that’s the bottom at this particular point, they are expected to go down a little bit further. Frankly, not just in Michigan but also nationally and it’s just the function of the high-level of inventory that’s out there.
Certain markets, Eileen, it would be more than that 15%. I think those are giving you on average and particularly the higher-end stuff, that’s where the haircuts are taking place.
So, then when you’re moving a foreclosed property, there it’s a whole different ball game. When people know that that’s the bank trying to sell it, the only interest you get are deep discounts or free for all, so that’s why it’s at a 45% discount.
Eileen Rooney – KBW
Okay, that makes sense, thank you.
Your next question comes from Jon Arfstrom - RBC Capital Markets.
Jon Arfstrom – RBC Capital Markets
In your capital raise presentations, I guess were about perhaps six or seven weeks away from that, you’d laid out your forecast and then the stress scenario for net charge-off. But I guess I know it’s a little bit early; the question is where do you think we are in that scale? Are we online with your forecast, are we moving more towards the stress scenario or perhaps better than your forecast?
I would say that we were inline with our forecast and maybe a little more worse than that, but we’re not moving anywhere near the stress whatsoever. I think the forecast had $79 million for the first three quarters or the next three quarters and we just took 34 of that, last call. There is 45 left that we would see over the next couple of quarters. Based on the qualitative you can kind of do some of the math there. We are still working to try to make that forecast; we see ourselves coming in around it in a give or take, but nothing towards the $163 million that was on the stress test.
Jon Arfstrom – RBC Capital Markets
In terms of your capital, how much excess capital and I know you can look at the number in different ways, but how much excess capital do you feel like you’re sitting on at this point?
I would say it’s too early to tell what the excess until you see what the economic environment is going to be. There is just too much uncertainty out there and what we are looking at is this; we never even got this capital. We are managing our business as if we never got it so that we make sure that we’re prepared for 2009 and maybe even 2010 issues if they creep up.
Yes, John this is Bill. I’ll just add to that. I think that’s exactly right Charlie. I think that when we size the capital request, we took all those factors into consideration with the idea that we will have enough capital to get us through this. And we also did it to make sure that we didn’t have to go back for capital again. In other words if we wanted err a little bit, we felt erring on the side of getting a little bit too much was more intelligent than erring on the side of getting a little bit too little. So, we wanted to make sure that we were well positioned, but as a practical matter, I don’t think any other banks that went out to get capital. I don’t think we are going to really know the answer to your question for a couple of years.
Jon Arfstrom – RBC Capital Markets
Do you think that the risk premiums in the new loans that you’re seeing have adjusted enough in Michigan and maybe Northwest Ohio in terms of the pricing and structure in term?
We haven’t seen, Marty can answer this, we’ve seen across the board increase in what customers are willing to pay for access to capital today.
Martin E. Grunst
But we think that there is more credits spread leverage yet to go as we go through the next couple of quarters.
And part of that it is a cultural change among all of our bankers. We have set a number of ways in which we capture and track and make sure that we are improving margins and pricing as loans are in the process of approval.
Yes, I think we’ve seen Jon, I think we’ve seen a little bit more leverage in the commercial real estate business than we have in the C&I business. I think the leverage appeared in the market earlier in CRE that it did in C&I but we are starting to see it in the C&I business and we think that’s very prudent and frankly. We think that absolutely has to happen.
Jon Arfstrom – RBC Capital Markets
So possibly more to come in terms of prices moving up.
We would hope so.
There are no further questions at this time.
Well, thank you all very much for joining us. I hope you have a good weekend.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: firstname.lastname@example.org. Thank you!