NewStar Financial, Inc. Q4 2008 Earnings Call Transcript

| About: NewStar Financial, (NEWS)

NewStar Financial, Inc. (NASDAQ:NEWS)

Q4 2008 Earnings Call

February 18, 2009 10:00 am ET


Colleen M. Banse – Investor Relations

Timothy J. Conway – Chairman, Chief Executive Officer

John Kirby Bray – Chief Financial Officer


Sameer Gokhale - KBW Brokerage

David Long - William Blair & Company

Brian Hagler - Kennedy Capital


Good morning ladies and gentlemen and welcome to NewStar Financial’s fourth quarter 2008 earnings conference call. My name is [Corinne] and I will be your coordinator for today’s call. (Operator Instructions) I would now like to turn the call over to your host, Colleen Banse. Please go ahead ma’am.

Colleen M. Banse

Thanks Corinne and thanks to everyone to joining us for our earnings conference call where we will be discussing our fourth quarter 2008 results. With me today are Tim Conway, Chairman and Chief Executive Officer of NewStar Financial; and John Bray, our Chief Financial Officer.

Before I turn the call over to Tim, I want to remind you that we have posted a presentation on the Investor Relations section of our website, Also available on our website is our financial results press release which was filed on Form 8-K with the SEC this morning.

This presentation and our financial results press release contain additional materials related to this conference call that we may refer to during our remarks today, including information with respect to certain non-GAAP financial measures. This call is also being webcast simultaneously on our website and a recording of the call will be available beginning at approximately 1:00 PM Eastern Time today. Our press release and website provide details on accessing the archived call.

Also before we begin I need to inform you that statements in this call, which are not historical facts, may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All forward-looking statements including statements regarding our proposed acquisition of Southern Commerce Bank as well as future financial operating results involve risks, uncertainties, and contingencies, many of which are beyond NewStar’s control and which may cause actual results to differ materially from anticipated results. More detailed information about these risk factors can be found in our press release issued this morning and in the Risk Factors Section as updated on our quarterly reports on Form 10-Q.

NewStar is under no obligation to and we especially disclaim any such obligation to update or alter our forward-looking statements whether as a result of information, future events or otherwise, except where required by law. NewStar plans to file its Form 10-K with the SEC on or before March 16 and urges its shareholders to refer to that document for more complete information concerning the company’s financial results.

Now I’d like to turn the call over to NewStar’s Chairman and Chief Executive Officer, Tim Conway.

Timothy J. Conway

Thanks Colleen and thanks for joining the call today to discuss our fourth quarter results. I will begin by providing my perspective on current market conditions and by highlighting key aspects of our performance in the fourth quarter. Given the importance of announcements we made during the quarter and some of the changes in our balance sheet, I will also provide some strategic context. I will comment on our outlook for 2009 and the status of our previously announced proposed acquisition of Southern Commerce Bank, which factors prominently in our plans for the year as we transform our business model to adapt to changing market conditions.

After I hand it over to our CFO, John Bray, to provide additional detail on our Q4 results, I will recap what we have discussed and take some questions. So let me begin with my perspective on market conditions and on our fourth quarter results.

The fourth quarter was challenging for our industry as the sharp decline in the economy intensified the stress on the country’s financial system. NewStar has been impacted by the economic slowdown, but we continue to benefit from the fact that we have a simple business strategy; a conservative capital structure; and from the actions that we have taken to position the company to operate in a range of business conditions, including severe economic stress.

In contrast with most of the industry, our results in 2008 reflect four quarters of profitability and increase in book value per share year-over-year. For the quarter, the company generated adjusted earnings of $5.1 million or $0.11 per share. Cap earnings were $2.8 million or $0.06 per share. Full year 2008 earnings were $27.7 million and book value increased to $12 a share.

We continued to manage expenses aggressively in 2008, and as a result they were down $12.7 million for the year or 22%. This reduction was due in part to lower cash bonuses approved under our 2008 incentive program. Although our operating results would have provided for a higher level of funding, in light of the current market conditions we reduced total 2008 incentives, including payments made to our named executives, to approximately 50% of 2007 levels and required that 20% of all bonuses in excess of $50 thousand be settled in restricted stock, subject to multi-year vesting provisions.

We continued to manage staffing levels to insure that we have an optimal level of resources in place to respond to current market conditions. The slower pace of new lending has reduced our need for certain origination and support staff positions, and earlier this month we eliminated 11 positions. As you know, we made other similar reductions during 2008.

I am pleased that we were able to complete an important step in our depository strategy by entering into a definitive agreement to acquire Southern Commerce Bank, and by filing the necessary applications with the Federal Reserve Bank to become a bank holding company. Southern Commerce is a $235 million Tampa, Florida based, full service commercial bank operating under a National Bank Charter. It provides an attractive platform in a large market for NewStar to develop a retail banking franchise.

Paired with NewStar’s commercial lending business, this platform strengthens our business model and positions us to position in the revival of traditional commercial banking. Clearly the lending landscape has changed for the longer term and we believe that this environment will prevail for an extended period of time.

We expect 2009 to be challenging, and as a result we are focused on a few very important things.

First is funding. Two-thousand-and-nine will be a transitional year as we transform our business model into a banking company; we plan to use the Southern Commerce platform to expand our depository funding capabilities and consider other opportunistic acquisitions arising from regulatory actions.

Following the completion of our proposed acquisition of Southern Commerce, NewStar would combine three important assets that together create a unique platform; a leading loan origination business, a funding platform with long term capacity to match fund loans, and a retail deposit franchise with significant growth potential. This combination would allow us to reduce risks inherent in our current funding model, which relies substantially on the capital markets and banks for access to capital.

It would also position us to capitalize on an unprecedented lending environment in which we believe traditional banks will dominate as the primary source of capital to mid-sized companies. Southern Commerce has approximately $200 million of deposits across their retail branch network, including four traditional brick-and-mortar branches and seven branches located in Wal-Mart Supercenters across the state of Florida. The bank offers a complete set of depository products and services, and manages a commercial loan portfolio comprising of about 32% commercial and industrial loans; 64% commercial mortgages; and 4% consumer loans.

We have conducted extensive due diligence on the bank’s loan portfolio, and we believe that the credit risks in the portfolio are well understood and manageable. We have proposed in our regulatory applications to complete a one-time balance sheet restructuring connection with our acquisition of Southern Commerce Bank. The proposed transaction would result in a recapitalization of the Bank with the transfer of up to $300 million of existing commercial loan commitments from NewStar and the redeployment of capital from warehouse vehicles to the Bank.

We anticipate that a significant part of our lending activity would transition to the Bank, and that we would generate increasingly attractive returns as markets stabilize and the Bank increases in scale. While the acquisition of Southern Commerce is subject to regulatory approval, we believe that it is on track. The transaction would improve leverage at NewStar and reduce our reliance on short-term bank funding. Nevertheless, we continue to have an active dialog with our bank warehouse lenders.

Although deposit funding is an important part of our corporate strategy, please remember that approximately 70% of our existing portfolio continues to be match funded by securitized long-term debt at attractive spreads. We expect to further reduce our need for bank lines over time as we continue to match fund loans through our securitization platform. We also have the ability to reinvest runoff in two of our three securitizations.

The second important thing is lending. We have remained active in the market and continue to be an important lender to mid-sized companies. While new issue volume was down significantly, we made $587 million of new loans in 2008, of which we returned just over $500 million on the balance sheet. We continue to maintain a cautious and highly selective approach to new loan origination. Origination volume in Q4 was just shy of $50 million with average credit spreads greater than 660 basis points.

Our current focus is on making very conservative loans at historically wide spreads. That translates into making first liens senior, secured bank loans to solid companies and non-cyclical industries with low leverage and substantial cash equity. Pricing today is in the LIBOR plus 750 range with three points up front and in the money LIBOR floors. Senior debt to value is typically 30 to 40%. Following the completion of the proposed acquisition, we expect to continue lending at both the NewStar holding company level and the bank level, but with increasing amounts done at the bank as we capitalize on the cost advantage of deposits.

The third area of focus for us is credit. Q4 was challenging as credit conditions worsened dramatically across the industry. NewStar’s credit performance also declined, but somewhat less dramatically and on a smaller scale. Non-performing assets increased from three loans in Q3 totaling $26.4 million to six loans in Q4 with outstanding balances of $60.6 million. Net charge-offs for the quarter were $8.9 million or 147 basis points on an annualized basis, up from $5.3 million or 87 basis points in Q3. Total charge-offs for 2008 were $19.7 million or 82 basis points on total loans.

New specific reserves totaling $13.2 million were established in the fourth quarter compared to $11.5 million in Q3. Total reserves increased to 225 basis points at year-end from 187 basis points at the end of Q3 due to a combination of higher specific reserves; migration; and changes to cycle adjustment factors that we use in our loan loss model.

The credit environment has clearly become more challenging and the current credit cycle is shaping up to be the most severe in decades. We cannot predict when the government’s efforts to stimulate the economy will begin to take effect. I believe that they will be effective but the credit conditions will worsen before they improve. We continue to experience weakness in sectors I have highlighted in prior calls including building products, transportation, restaurants and media.

We have also begun to see softness in consumer products and slowing absorption rates in our commercial real estate portfolio. In an environment like this we are happy to have made the decision to land in the senior position in the capital structures and to diversify across industries that we believe will allow us to outperform our peers. We are actively working with our borrowers, credit by credit, to weather the downturn. We take comfort in the fact that the vast majority of our middle-market transactions have meaningful financial covenants and get us to the table earlier.

In this environment we expect MPA’s and reserves to continue to increase during 2009, but we believe that we have taken a realistic view of the portfolio in the current market environment.

With that, I’ll turn the call over to John to provide more detail on the quarter and then I will provide a recap. John.

John Kirby Bray

Thank you Tim. My presentation will follow the presentation we’ve put out on the website and I’ll begin with Slide 13. Here you will see a summary of our financial results for the fourth quarter and year-end of 2008. Adjusted net income was $5.1 million for the quarter and $27.7 million for the year. Adjusted net income is defined as GAAP net income, excluding after tax, non-cash compensation expense of $2.1 million for the fourth quarter of 2008 related to restricted equity grants made in connection with our initial public offering, and a $300 thousand tax true up related to the 2007 residual interest.

The $2.1 million adjustment for non-cash compensation expense reflects the tax rate impact of a discrete tax item during the fourth quarter, and which had to do with the December vesting of our restricted stock which was granted at the IPO. If you look at our GAAP tax rate, you’ll see it’s almost 62%. It is up significantly because of that one factor from a normalized rate of 40% and that reason is that when those options are granted, they were granted at $17 a share. The expense is calculated at $17 a share.

When the options actually vest, you have to recalculate how much the expense should have been deferred so given that our stock price less expense was deferred, it is just a trade off between the equity accounts which actually goes up because we would have more earnings over time. So it is really a timing issue and had to do with restricted stock vesting.

This resulted in an adjusted basic and diluted income per share of $0.11 for the quarter and $0.57 for the year. On a GAAP basis, net income was $2.8 million or $0.06 per diluted for the fourth quarter and $22.4 million and $0.46 for the year. On a share count, our weighted average basis was 48.5 million shares for the quarter. We have added to book value for the fourth consecutive quarter during difficult economic times. At the end of the fourth quarter, our book value was $12 per share.

If you now turn to Slide 14, you can see that during the fourth quarter and in January of this year we reduced our reliance on credit facilities. We entered into a definitive agreement to purchase Southern Commerce Bank and we entered into amendments to our credit facilities with Citibank, Wachovia and Deutsche Bank which reduced our advance rates, the size of the facilities, and increased pricing.

Given our capital conservation strategy, we were not utilizing the full amount of these facilities, nor did we anticipate that the current or expected level of origination would be enough to maximize the facilities. We gave up capacity. We gained flexibility in other areas such as extending maturity dates and increasing industry concentration limits.

A reduction in our warehouse lines is consistent with our strategic plan to become a bank holding company. Assuming successful completion of the bank acquisition and the resulting anticipated growth, we expect the credit facilities to represent a smaller portion of our funding strategy. As our credit facilities mature, we believe they will continue to re-price at current market rates. As such, the information presented in these slides is presented as if the Deutsche Bank amendment which occurred in January had occurred at year-end.

As you can see, on the bottom right hand chart our diversified funding source totaled $2.9 billion at year-end, pro forma for the Deutsche Bank amendment. As you know, our warehouses are not subject to mark-to-market collateralization valuations.

In addition, we have $18 million of reinvestment capacity in existing CLOs at attractive, locked in spreads as of December 31. In the fourth quarter we were able to reinvest approximately $55 million in our CLOs. Our CLOs have reinvestment periods that are significant. Our $600 million CLO from 2007 has a six year reinvestment period and our $500 million CLO from 2006 has a five year reinvestment period. As I mentioned during last quarter’s call, the reinvestment period for our $375 million CLO from 2005 expired in October and we were able to max out the loans contributed to it. We also had $31 million of investment capacity in our $250 million private CLO with Deutsche Bank.

We had $84 million in restricted cash in our balance sheet at year-end, including $29 million of restricted cash available for reinvestment and another $29 million of restricted cash available for debt service. Taken together with our unrestricted cash of $50 million, this cash can be used to fund loan originations and pay debt service. As demonstrated by the Citi, Wachovia and Deutsche Bank amendments we continue to have access to capital during this market dislocation.

If you’d turn to Slide 15 it gives you a detailed look at our borrowing and funding capacity, our pricing and leverage by term debt and warehouse. At the end of the fourth quarter more than 70% of our loans were funded with term debt at very attractive, locked in prices with long term maturities. Our total funding capacity was $223 million at year-end if we optimized advance rates in each facility.

We anticipate originating loans at both the holding company level and if the bank acquisition is approved and completed at the bank. In addition, as Tim stated earlier with the potential bank acquisition we requested to do a one-time balance sheet restructuring, moving loans out of our credit facilities into the bank. We plan to increase originations at the bank level as part of our strategic initiative to become a bank holding company. Loans originated at the holding company will be directly linked to the reinvestment capacity in our securitization platform at attractive, locked in rates.

If you’d now turn to Slide 16 entitled Core Business Performance, you will see our managed loan portfolio that was roughly $3 billion equaled levels in the past four quarters. Our origination volume was essentially offset by prepayment amortization loan sales. Our adjusted revenue reflects the slower pace of managed asset growth. However, for the fourth quarter it was $33 million, up from $30.6 million for the third quarter. Net interest income declined slightly to $24.4 million from $25 million in third quarter. I will explain the factors affecting the net interest income and net interest margin in greater detail later.

Non-interest income was $8.6 million in the fourth quarter compared to $5.5 million in the third quarter. The growth was primarily due to a gain on the repurchase of our CLO debt. Adjusted revenue and net interest income were relatively flat, year-over-year as our managed portfolio was roughly equal to what it was at the end of 2007.

Turning to Slide 17, which describes the amount and composition of fourth quarter origination volumes and related volume that origination volumes drive, our total originations to the fourth quarter were $44 million and for the full year $553 million. Of that $553 million, $475 million was retained on NewStar’s balance sheet. The rest was either sold to the NewStar Credit Opportunities Fund or syndicated off to third parties. During the fourth quarter, $42 million of the $44 million was retained on the balance sheet with $2 million being booked for the NewStar Credit Opportunities Fund.

Credit spreads and amortizing fees on new loans originated in the fourth quarter were more than 660 basis points over LIBOR, up 235 basis points from the fourth quarter of 2007. We continue to get LIBOR in the money LIBOR floors on all of our new transactions and approximately 22% of our portfolio now includes LIBOR floors.

Slide 18 gives you a detailed look at our net interest margin. Net interest margin was 3.79% for Q4, down from last quarter’s number of 3.90%. During the quarter we lost approximately 15 basis points from an increased level of non-performing assets. This was slightly offset by an increase in loan spreads of four basis points due to re-pricing of loans and new originations in the portfolio. In the quarter we re-priced approximately $370 million of loans at an average increase of 62 basis points due to pricing grids and amendments.

Slide 19 shows how diverse the portfolio continues to be and how it’s been structured to show that diversity across many different industry sectors. If you turn to Slide 20, we can talk about our credit statistics for a second. Our allowance for credit loss was $54 million or 225 basis points on period end loans. At September 30, our allowance for credit loss was $44.9 million or 187 basis points.

Non-accrual loans as Tim said increased to $60.6 million from $26.4 million in September. Last quarter we had three non-accruals. This quarter we have six. In addition, we are very proactive in working with borrowers to get out in front of potential issues which results in restructuring loans to insure principal and interest payments.

We have established $13.2 million of specific reserves to reflect expected losses in the fourth quarter of 2008 compared to $11.5 million in the third quarter. We incurred charge-offs of $8.9 million or 1.47% of loans on an annual basis this quarter and $19.7 million or 0.86% for the year compared to $5.3 million or 0.87% of loans on an annual basis for the third quarter.

Credit remains uncertain given the slowing economic conditions and charge-offs may be lumpy quarter-to-quarter as the table shows. We expect credit performance to continue to deteriorate in 2009 in line with economic conditions. We anticipate that our first lien status loan portfolio diversification direct origination platform, close credit monitoring will benefit us during these difficult economic times. However, the timing of any improvement will be linked to the overall improvement of the economy.

Slide 21 shows the income statement for the quarter. As I mentioned earlier, adjusted net income was $5.1 million for the quarter and $27.7 million for the year. GAAP net income was $2.8 million for the quarter and $22.4 million for the year.

Now I will drill down to the different components of the income statement. Net interest income was $24.4 million for the fourth quarter compared to $25 million for the third quarter. Net interest margin declined to 3.79 in the fourth quarter from 3.90 for the third quarter as I explained earlier. Provision increased $6 million for the quarter from $12 million in the third quarter, primarily due to growth in both general and specific reserves.

Non-interest income increased to $8.6 million this quarter from $5.5 million last quarter, primarily due to gains on rate protection products sold to clients and the repurchase of debt. Our asset management fees were slightly down quarter over quarter.

Expenses decreased to $7.9 million in the fourth quarter from $8.5 million in the third quarter, reflecting lower compensation expense partially offset by higher professional fees incurred with the bank strategy. The decline in compensation expense is attributable shifting the payment mix of 2000 incentives in cash to a combination of cash and restricted stock for many of our employees, including our executive officers.

With that I’ll turn it back to Tim.

Timothy J. Conway

Thanks John. So to summarize we’re clearly in the midst of a severe economic cycle. We believe there are several factors which will help distinguish us through this period. Among them is our relatively small size and simplicity which is important, especially as we make changes to our business model and add new stakeholders. We are a traditional spread lender making senior secured bank loans.

We do not have multiple lines of business engaged in activities that would be impermissible for a bank. We have a conservative balance sheet with strong capital ratios and low leverage. We firmly believe that our origination model will help differentiate our performance through the credit cycle. And we have taken important steps to reposition the company, including the transition to a banking company and reduced reliance on bank and capital market funding.

As I said earlier, we’re combining three important assets together to create what we think is a unique platform; a leading loan origination platform, a funding platform to match fund loans at attractive locked in rates, a substantial retail deposit franchise with significant growth potential. That concludes my prepared remarks and we’ll open it up for questions.

Question-and-Answer Session


Thank you sir. (Operator Instructions) Your first question comes from Sameer Gokhale - KBW Brokerage.

Sameer Gokhale - KBW Brokerage

My first question was basically unless I have my math wrong here, it looks like the repayments on the loan portfolio were something like $37 million in the quarter, down from about $213 million last quarter. And I would imagine perhaps you know the higher funding costs to borrowers may be making a fewer alternatives, maybe forcing them to put off repaying loans or refinancing the loans. But still that sequential drop seemed pretty high again, unless I have my numbers wrong. So could you shed some light on that big drop in repayments of loans compared to last quarter?

John Kirby Bray

Yes. This quarter we had roughly about $44 million of repayments which I would say this quarter would be – if you looked at it, it was much more just normal amortization of the portfolio and you didn’t see refinancing of existing loans. So refinancing in the quarter ran about 12% of the portfolio which is what I would say kind of normal amortization. But we didn’t have any significant payoffs of loans.

Timothy J. Conway

So Sameer it is lumpy how that works. We continue to get amortization. We’ve been running around 15%, some of which is amortization, some of which is prepayments. And clearly in this environment, two things have happened. One is you know for the first time we really haven’t seen any re-financings at all. And two I’d say and more importantly is the M & A activity and the sale of many of these companies has either been curtailed or certainly been pushed off, given the difficult financing environment and just the economic conditions.

So no question, the prepayments have slowed down for the time being based on I think primarily lower M & A activity.

Sameer Gokhale - KBW Brokerage

You know, in terms of the unfunded commitments I think they totaled about $370 million or so roughly at the end of the quarter. That includes the unused lines of credit and stand-by lines of credit. Of that $370 million, how much is actually available for your borrowers to draw on?

Timothy J. Conway

It would be roughly $150 to $175 million of it.

Sameer Gokhale - KBW Brokerage

This goes down a little bit into the charge-offs. Perhaps you mentioned it in your prepared comments. I may have missed it. But the charge-offs that you had during this quarter, can you give us some detail as to what the loan types were? Were those [med] loans? You know just some sort of break-out there. And then also perhaps by industry type where those charge-offs came from. And then also in the increase in the loans on non-accrual, you know, were there any loans that came out of that bucket during the quarter and which ones were the new ones that went into that bucket of loans of non-accrual? That would be helpful.

Timothy J. Conway

In terms of charge-offs I would say, you know, and these lag a little bit behind the specific reserves that we take, a handful of – four or five names where actually took a charge in the quarter. And I would say we had one relatively small charge in a residential real estate property. And then it was a range of companies that we’ve been working on for a period of time that are – and this is for the full year of 2008. A couple of consumer product companies, retail property where we had taken specific reserves and then charged them down.

NPA’s going from 3 to 6 – the NPA’s will get reduced to a degree as we take a charge-off against the reserve. So they did come down to a degree on that. But basically it was three names, increasing to six. And I would say similar to the pattern we saw in terms of charge-offs we had for the year.

We had a couple of on the NPA’s a couple of transactions that were in real estate and then ranged across restaurants, consumer products, and an industrial company. So can’t really generalize that much, although I’d say there’s a concentration in the areas that I highlighted earlier, consumer products and certainly retail oriented business and a couple of real estate transactions.

Sameer Gokhale - KBW Brokerage

So just to clarify then, during this quarter there wasn’t any charge-off for mezzanine loan. Is that right?

Timothy J. Conway

No, it was all – correct. These are write-downs of senior debt. And we have very little – you know, a very, very small percentage of our debt is mezzanine debt anyway.


Your next question comes from David Long - William Blair & Company.

David Long - William Blair & Company

Looking at the compensation and benefit expense line, obviously you had some reversal – some accrued compensation there. What’s a good run rate to look at with that number going forward?

Timothy J. Conway

John’s looking at the numbers, but I’d say from a planning perspective, you know we’ve done a number of cuts. We’ve been very careful to reduce staff where we’re doing it based on either low origination volumes or lower support levels needed to support the business. And I think we’ve done it very carefully and selectively. It’s always difficult to do, but we’ve been pretty aggressive and proactive about doing it during the year. So number one, we’ve cut back pretty significantly. As I said we’ve cut back on bonuses beyond what would have been paid out on our performance.

And then as you look into next year, I’d say we start out with a smaller staff. A lot of our compensation is variable compensation in the form of bonuses. And so we start out with lower fixed costs and I think frankly 2009 is a very challenging year to determine and give you a run rate for bonuses because I think performance is going to be and earnings will be hard to predict in 2009. And so the good news is it’s mostly variable and we’ll make some assumptions as we plan forward. It will be at levels that are I’d say lower than where we have been, but I can’t give you a number.

John is crunching some numbers and may be able to give you the run rate number but it’ll be largely variable expense and that’ll be a function of how we do for the year.

John Kirby Bray

Yes, I mean David, if things kind of play out the way we are modeling it probably will be in the 74 to 77 range, somewhere in that would be kind of a run rate for a quarter. There’s pluses and minuses but it’d be somewhere in there depending on –

Timothy J. Conway

And that assumes assumptions on how much we would accrue for bonuses, and again that’s –you know a component of that is all variable and may or may not get paid based on how we do.

David Long - William Blair & Company

Okay. That’s helpful.

Timothy J. Conway

That does not include the Southern Commerce.

David Long - William Blair & Company

And then looking at Southern Commerce, you know given the large concentration in CD’s how would you characterize the stickiness of those deposits?

Timothy J. Conway

Well, we think it’s a very interesting deposit base for a couple of reasons. One is we – I was just down last week and we spent a lot of time at the branches. And with the team down there, they’ve been in business for many years and they’ve got some very well established branches that we think have interesting core deposit position and also potential. We believe that the Wal-Mart in-store branches which are relatively newly established have significant potential for us to grow the deposit base, and those that we’ve seen already some positive momentum in that regard.

I’d say that an important part of this deposit base is that a relatively small portion of them are brokered deposits. It’s 7% or so of their deposits are brokered so it’s a relatively small number. And on the CD side a lot of them are longer term; you know, a very significant portion are 12 months or more. So we have a strategy. We’ve hired some consultants. We have been working hard with the people at Southern Commerce and our consultants to fine tune a deposit growth strategy and also a strategy to maintain the current deposits.

And we think there’s significant opportunity to keep those deposits, to grow them, and we’ve got some flexibility in terms of how we would price some of the deposits as well to maintain those and to generate some growth in that marketplace. So I’m comfortable that we’ll be able to build on it. We’ve seen – as I said since we got engaged with Southern Commerce, we’ve seen already some positive momentum in the deposit base.


Your next question comes from Brian Hagler - Kennedy Capital.

Brian Hagler - Kennedy Capital

Just a few questions. One you talked about changes in pricing on a couple of the credit lines that were renewed. Can you just get a little bit more specific and obviously you’re getting better spreads on your loans, I’m just wondering how much of that’s given back on the increase in the credit line spreads?

John Kirby Bray

The ones that we’ve re-priced are up to right now LIBOR 250ish range.

Brian Hagler - Kennedy Capital

And what were they before roughly?

John Kirby Bray

They varied from LIBOR 75 to LIBOR 125.

Timothy J. Conway

And the fact is that the advance – not only has the pricing gone up, the advance rates have come down and so you know they’re not that attractive in terms of the new spreads you’re getting in the market – with the new spread levels we can make decent returns in those warehouses but over time our view is that we have a clear strategy, I think, to move away from those facilities and reduce the reliance on them significantly. Because the returns you can generate with other forms of funding are so much better.

Brian Hagler - Kennedy Capital

Yes, and that kind of leads to my second question. If you look at Slide 14, you guys kind of lay out in the chart that you have roughly 25% of your current funding in these facilities. Obviously you’d like it to be less over time. Can you just kind of talk about or get a little bit more specific on longer term, kind of where you envision that? And maybe how much progress you hope to make if you close on the bank in the second quarter? And how much progress you could make by the end of the year?

Timothy J. Conway

Well, you know, this is subject to discussions we’re having with the regulators and so we have to be careful. But as we said, we have proposed on and we’ll be working with the regulators on this, our business plan and proposal suggest that we would transfer around $300 million of commitments and that would come largely from the warehouse facilities. And so we would reduce during 2009 by those amounts. And then as our other vehicles – long term securitization vehicles provide us with great flexibility because of the reinvestment periods that are in place.

So we also – we’ll originate new loans into the interest securitization vehicles and much less so into the warehouse facilities. And with runoff and so forth you can get a good feel for how significantly – they’ve already come down a lot. Our understanding is the warehouses have come down and for 2009 I want to say they’re going to come down significantly. And over time our view is that our reliance on traditional bank – short term bank warehouses to fund our assets is going to be a much smaller percentage than it is today.

Brian Hagler - Kennedy Capital

I guess the total of $900 million in lines between Citi, Wachovia and Deutsche Bank, how much do you currently have outstanding on those? I know on the Wachovia line it’s $210 out of $350 available at the end of the year, but I couldn’t find the data on the other two.

Timothy J. Conway

Deutsche is a little different. It’s got a better advance rate and it was set up to be a longer term financing vehicle. In fact it is working that way. So Deutsche we look at as a longer term funding vehicle and that will run off now as we ramped it up as we planned to do and it will run down consistent with the way we structured it. And so the question to me is really what, you know, the Citi and warehouse lines and the small TIPS –

John Kirby Bray

Brian, if you look at Page 14 and you look at the chart on the left-hand – the bottom left-hand corner, you’ll see Wachovia we have $213 million in funded, Citi we have $188 funded and the TIPS a very small amount and the Deutsche Bank we have $219 against that $250.


Your next question comes from Sameer Gokhale - KBW Brokerage.

Sameer Gokhale - KBW Brokerage

Just a couple of quick ones. On the debt that was repurchased I think you’d mentioned it was CLO debt, can you just remind me again what was the – where did you buy it as a percentage of face? Was it like 50% of par or something?

John Kirby Bray

No, we bought on face about $5.2 million on an – there were a few purchases, but we bought on an average about $0.14 on a dollar.

Sameer Gokhale - KBW Brokerage

And then Tim on your commentary you talked a little bit about some absorption rates coming down, I think on the commercial real estate portfolio. Would you mind just explaining exactly what those are? What that means? I’m not familiar with that terminology.

Timothy J. Conway

Well, we – absorption rates refer to most of our buildings that we finance are office buildings and so the lease occupancy levels are a key driver of cash flows and we lend senior debt to existing buildings with conservative loan to value going in up front. What we’ve seen in many markets is absorption rates or occupancy levels that are lower than what we originally forecasted in various areas across the country, based on the current economic condition.

We still have – you know, when we did these loans we assumed that some of that might be the case and we structured around those, especially with our loan to value up front. But in some cases we have issues where the buildings don’t have as many tenants as we had hoped and so they’re much tighter on cash flows than we had planned when we underwrote the deals.


And we have no further questions at this time.

Colleen M. Banse

Thank you Corinne and thanks everyone for joining us today. That concludes our fourth quarter 2008 earnings call. We hope you have a wonderful day.

Timothy J. Conway

Thank you.


Again ladies and gentlemen that does conclude today’s conference. Thank you for your participation and have a wonderful day.

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