Colonial BancGroup Q3 2007 Earnings Call Transcript

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Colonial BancGroup Inc. (CNB)

Q3 2007 Earnings Call

October 17, 2007 3.00 pm ET

Executives

Lisa Free - Director of Investor Relations

Robert E. Lowder - Chairman of the Board, Chief Executive Officer

Sarah H. Moore - Senior EVP, Chief Financial Officer

Patti G. Hill - Senior EVP, Chief Operating Officer

Kamal Hussein - Treasurer

Analysts

Robert Patten - Morgan, Keegan & Company, Inc.

Kevin Fitzsimmons - Sandler O'Neill and Partners, L.P.

Andrea Jao - Lehman Brothers

Todd Hagerman - Credit Suisse

Christopher Marinac - Fig Partners, LLC

David Bishop - Stifel Nicolaus & Company, Inc.

Jefferson Harralson - Keefe, Bruyette & Woods

Casey Imbreck - Millennium Partners

Operator

At this time all participants are in listen only mode. After the presentation we will conduct a question and answer session. (Operator Instructions) Now we’ll turn the meeting over to Lisa Free. Thank you ma’am you may begin.

Lisa Free

Thank you, we appreciate you joining us this afternoon for Colonial BancGroup third quarter earnings conference call. Our earnings report announcement was released this morning and many of you should already have received copies. If not you can access the report as well as the slide presentation for this call under the investor relations section of our website at colonialbank.com. With me today are Colonial BancGroup CEO Bobby Lowder, Chief Financial Officer Sarah Moore, Chief Operating Officer Patti Hill and Kamal Hussein our treasurer.

First, the advisory. I will remind you that any forward looking statements made during this presentation are subject to risk and uncertainty. Further we have no obligations to update any forward looking statements to reflect circumstances or events that occur after the date the forward looking statements are made. If you are interested in factors that do cause our results to differ materially from any forward looking statements they are detailed on our website in our SEC filing and summarized in our press release from this morning.

With that I will turn it over to Mr. Lowder.

Robert Lowder

Good afternoon. We appreciate you all joining us. I’m going to talk for just a second about the highlights from the highlight page. We had record EPS of $0.45. Our net interest income grew 3% over the second quarter of 07 and net interest margin was 3.65%. Our core noninterest income increased 16% over the same quarter of the prior year. Our core noninterest expenses decreased 3% from the second quarter of 07. We had improved efficiency ratio of 53.29% compared with 56.20% for the second quarter.

And with that I want to jump in and just talk about, let us talk about the things that I think you’re most interested in. You all have a copy of our charts that we sent out but I don’t think you’re all interested in seeing all that so what we’d like to do is just talk about many I think of the pertinent items about the quarter and looking forward into the last quarter and first of all I would like Kamal Hussein to talk about the credit markets and about our mortgage warehouse line. Kamal.

Kamal Hussein

Thank you Mr. Lowder. With regard to the mortgage warehouse business we are very pleased to report that business performed in the third quarter just sweet. Thanks to our high standards for that business after all there’s very high quality customers who continue to produce quality originations. Quality originations which are represented both on our balance sheet and in our securitization vehicle. Our securitization vehicle is not as you know an SIB or a CEO program and although our securitization funding costs did widen for a time during the third quarter along with the overall markets our current issue of spread always returns to the norms of prior years. We’re very excited about the future for this business it’s still the age of the main significant competitors in the space during the quarter and will be optimistic and selective in adding more quality customers in the fourth quarter into next year.

We continue to abide by and strengthen our proven credit and operational controls and we won’t become complacent. Despite our track record of no losses in the history of this business for Colonial including no losses in this most recent quarter challenges for the mortgage market.

Robert Lowder

Thank you Kamal.

Let’s talk about our credit measures for a minute. The question will be, what was the increase in our nonperforming assets? Well it’s the first quarter we decided to look at all of our credit portfolio and we identified some thirteen credits, many of those credits were not nonperforming , they were still performing and we put them out in a document for sale. I will tell you that was a very, very successful sale. Of the thirteen credits that we listed, eleven of those credits have now been removed and we’re working on a twelfth one to be removed. So that was a very successful sale of credits.

I think that gives you several things to back Colonial. Number one, we act quick, we don’t wait till the dirt’s piled in on the coffin before we move. We identify our problems that we think will be developing in the coming quarters and years, and so we moved several credits out that on the books were performing that we felt could show some weaknesses. So we have done that as you know, for years and we find that markets our there for the type of credits that we have to dispose of are still very viable and still looking for credits.

We don’t foresee that we will do anything of that magnitude again because we don’t need to. Because what we did was we identified the number of credits we needed to act on, we did that and we moved those credits out.

We did have an increase in our nonperforming assets. At the end of June total nonperforming assets were, at the end of September were at $70 million, that’s up $24 million from June 30th. That’s 0.46% remember as our nonperforming assets ratio, remember I told you that our goal is to stay below 0.50%. We’re happy that we did that. Most of that increase of $24 million, $22 million of the $24 million, was made up of four credits; three of them in Florida, one in Georgia. That represents some 88% of the increase for the quarter. All of those credits had to do with real estate construction. I’m happy to say that one of the four credits has already been resolved. Its sold and moved out and we’re working on the others.

We have a handful of credits there. As you’ve heard me say in the past, the secret to being successful in this is to always just have a handful. If you’ve got two or three handfuls and you’re in trouble and we’ve been able to act appropriately to keep a handful there. So our nonperforming asset ratio at 0.46% is very good. The question would be, is it going to go any higher? It could go higher. Now remember that’s just a snapshot of the last day of the quarter. That number could be less or more any time during the quarter or after the quarter. So when we think that we can keep within a respectful range of our goal of 0.50% and that’s our target to stay in there and we think that we can do that.

What caused our Charge-offs to increase? Well we had total Charge-offs for the quarter of $13.7 million. The good news is we had very strong recoverance. We had a recoverance of $900,000 on the loan that we had previously Charged-off and a recovery of $1.5 million on a loan we had previously Charged-off. That shows you that we stay after loans that we Charge-off even if it’s within several years and we continue to pursue it to see what we can get and we do have recovery. So we had net Charge-offs for the quarter of $10.4 million. 75% of that $10.4 million or $7.7 million were comprised of three loan relationships, two in Florida, one in Alabama. These were loans that were primarily in residential real estate. We charged these loans off and they’re off the books so we just took that stance and again we are aggressive in Charge-offs. There could be some possibility of recoveries on some of those. We’ll see. Net Charge-off ratio for the quarter 0.27%, slightly higher than what we would want at 0.25% but annualized year-to-date we’re 0.18%. I don’t think you’ll find a bank anywhere that’s got a lower ratio for the quarter or annualized that we have. So our net Charge-off ratio is very good. If you’ll notice that’s about half of what the nonperforming, that you go back historically, our net Charge-off ratio has been anywhere from a half to little less than a half of what the nonperformance was. Well I think that’s very good.

Now let’s talk about loan growth for a minute. Our period in loans outstanding, we’re down some $250 million or 2% from the prior quarter. Approximately $160 million of that or 65% of this decline was within the construction portfolio. So that’s good. That would be the high risk as far as our portfolio so that’s good that that has decreased. Where we see loan growth and where we see loan decline throughout our good friends, the western states, Texas and Nevada year-to-date are up more than $250 million in loans. So Texas and Nevada continue to be growth markets for us and we’re experiencing very little if no problems there. Georgia is about steady for the year and we projected that that will continue through the fourth quarter. We’ve had loan declines in Alabama and Florida but the markets have been the slowest and what is happening in those markets is that as these construction loans are paid off they’re not being replaced by new loans. Because of the inventory, they’re overbuilt down there and our developers and our builders are not adding new product which is good.

As you all know we took steps in years passed, up to two years ago and more to limit our exposure to high rise condos not only in Florida but everywhere. Whether it’s Atlanta or Dallas or Las Vegas we’ve got very little if any high rise condo exposure of any products. We limited our exposure to the panhandle of Florida and also up the coast there in Miami as far as any type of extensive condo exposure there. And the market said that the slowest for us continued to be the panhandle of Florida, the southwest coast of Florida from Sarasota down to Naples and in Miami proper. Those are the slowest markets for us. We do not project going forward for the fourth quarter any appreciation in loan growth. We think in fact there we’ll probably have some declines from the balances we have there,

So, what about our loan reserves? Because our net loans have decreased from $250 million with most of that being in high risk categories, we’ve filed a loan (inaudible) we felt like we were well reserved and we feel that we are well reserved so we’ve got a 0.25% allocated to our mortgage warehouse division. Let me remind you we’ve never had a loss and never had a Charge-off and never had a problem asset in mortgage warehouse lending. And so we feel like our reserves our very sound and very solid and we feel very good about where we are with that.

And with that I will ask Patti Hill our Chief Operating Officer to talk about retail portions of our franchise.

Patti Hill

Thank you Mr. Lowder. Colonial’s retail franchise continues to provide great opportunities to the [transaction] growth and market expansion. This year we have opened twelve new branches with eight more new branches opening before year end. In addition we acquired twelve branch locations through commercial banks. That transaction occurred in the second quarter and we will add another ten branches to the net worth when we close the citrus and chemical acquisition in early December. That’s a grand total of 42 new branches in 2007 and 33 of those locations are in Florida.

At the end of this year Colonial will have close to 200 branches in Florida where the population growth is expected to be over 12% for 2007 to 2012 and that’s twice the national average. People are still moving to Florida at a rate of approximately 1000 people per day. And as you know Colonial is the fifth largest commercial bank in that state. And so we’re positioned very well to provide financial services to those new residents through our Florida franchise which cannot be [dislocated] today.

With the new locations brings opportunity. For example, the commercial bank locations provide access to over 14,000 new households. And we have not only just changed the deposit balances associated with those households but we are seeing the balances grow since conversion. Also we issue check cards to every commercial bank deposit customer as this service has never been available to them.

Thanks to online we have seen a 7% lift in electronic banking revenue and a 9% increase year-over-year as a result of increasing our active check card base by 13%. And that does include those 5000 commercial bank customers who are now enjoying convenience of the service as well.

So by the end of the year we have opportunity to introduce citrus and chemical customers for the new products and services. We’ve received all of our regulatory approvals and we’re on schedule to close that transaction in December. The current local citrus and chemical senior management team will stay on with Colonial after conversion. And we have found that in the many, many conversions that we’ve had, the successful integration of that new customer base hinges on keeping that local management and that’s always our plan.

At the end of the year Colonial will have approximately 340 locations in five states. Three of which are the fastest growing areas in the nation. Our future plans are to continue to denote the branch in the high growth market to expand our reach in providing revenue generating products and services to both new and existing customers.

Bobby Lowder

Thank you Patti. Sarah, if you want to talk about margin in and expenses now.

Sarah Moore

Thank you. We’ll turn to page nine of the slide presentation. It’s a summary of items that impact the advantage for net interest income and margin in the quarter. The two items that I want to talk the most about are you’ll see the decrease in loan volumes which Mr. Lowder mentioned. Our average loans decreased in the quarter by $200 million or 1% in the quarter and what that enabled us to do and because of our stronger footed position resulted from the demerger activities that were completed earlier in the year, we were able to take advantage of the turbulent market conditions in the third quarter. We purchased approximately $900 million of security, and an average yield over 6%. We funded those purchases with federal home loan bank borrowing at 4%. Securities at the end of the quarter represented only 14.5% of annual assets, leaving room for additional leverage opportunities to replace loan balances in the fourth quarter.

Another item that will continue to have a negative impact on margin and earnings is the deposit migration and deposit cost. With any Colonial transaction account, customers shifted their balances to higher cost products from low or no cost products. The impact of the customer migration was partially offset by lower deposit rates in the third quarter. But looking out to the fourth quarter and beyond, Colonial deposit rates will not move as low as we have projected, given a 50 basis point cut in set fund rate.

Many of our competitors have increased deposit rates above where rates were before the Fed lowered the overnight borrowing rate. We don’t understand why. What we do understand, is that Colonial is not going to match those rates. We can get cheaper funding from [wholesale] sources. However, we will not be able to lower those rates, as much as we had previously anticipated, in light of the competitive rate environment.

I’d also like to touch on our expenses. We were very pleased with the results of our expense management. In the third quarter we saw 3% decline in our noninterest expenses from the second quarter. The ratio of expenses to average assets is also training now, and is lower, at 6.24% in the third quarter, than it has been in any of the previous five years. Even though we’ve done a decent job managing our expenses, with revenue growth challenges facing the company, we’re focused on further reducing our expenses.

We are addressing our largest expense, salaries and benefits, by reviewing staffing at all levels within organizations, to ensure that we are right sized given the current outlook of our revenue growth.

I’ll tell some capital and share repurchases. During the third quarter, Colonial repurchased 4.2 million shares of stocks, leaving approximately $91 million available under our existing buyback authorization.

As Patti mentioned, we anticipate closing on the citrus and chemical acquisition the first week of December. The acquisition will dilute potential capital ratios down to about 5% without any additional share repurchases in the quarter.

Robert Lowder

With that, what I’d like to say is that we recognized that we’re in a challenging environment. Everybody knows that. So I’m going to tell you, I wouldn’t swap our franchise with anybody else’s. We’re in a high growth market. You can go today to any of these markets, and what you’re going to find, you’re going to find a lot of people. They might not be buying houses or condos, but they’re spending money. They’re going to restaurants, they’re buying retail, and they’re busy. And we’re very excited about that, we’re excited about where we are.
We feel very positive about where we are, we think our credit is in good shape. And we think that our management team is more focused than ever in returning the bottom line profit to our shareholders. And when revenues are not there, you just have to attack expenses. And I’m very proud of our people, how we’ve gone about that. We’ve had all of our senior management in here in the last several weeks. And we’ve challenged everybody to reduce personnel. And to go about and attack every kind of expense out there. And that’s what we’re doing, and we will make it through this tough time, and tough times bring opportunity, and we’re set to take advantage of those opportunities.

With that, we’ll throw it open for any questions you may have.

Question-and-Answer Session

Unidentified Company Representative

In order that we may respond to as many individuals as possible, we ask that you limit your questions to a single question with one follow up. Operator, we are ready for the question and answer session to begin.

Operator

Thank you.

(Operator instructions)

And we’ll go first to Bob Patten, with Morgan Keegan.

Robert Patten - Morgan, Keegan & Company, Inc.

Yes, hey there everybody. Just a quick question, Bobby. On the loans that you guys sold, you mentioned that one of the, or not the ones that sold, the four credits, one was sold. Was that post third quarter?

Robert Lowder

Yes. After third quarter.

Robert Patten - Morgan, Keegan & Company, Inc.

And, the construction loans, in terms of the placing on these loans that you sold, I don’t know if that’s two questions, the loans you sold, what is the liquidity in the secondary market right now? Thank you.

Robert Lowder

The liquidity we found is still very good for ours. And I can’t speak for everybody, but I think that people recognize that what we have for sale is pretty good product, very good product, and they like the way it’s structured. There’s no crazy things about it, so we’re not having any trouble getting people interested in looking and bidding on things that we may have. Pricing is all over, Bob, it may be as much as $0.75 up to $0.90 on the top. It just depends on where it is, what it is, in a particular property.

Robert Patten - Morgan, Keegan & Company, Inc.

Ok, I’ll stop and let others ask their questions, thanks.

Operator

And we’ll take our next question from Kevin Fitzsimmons of Sandler O’Neill.

Kevin Fitzsimmons - Sandler O'Neill and Partners, L.P.

Good afternoon everyone. Can you give us a little sense on delinquencies? I don’t know that I saw a number on that.

Robert Lowder

Yeah, I meant to mention that. The delinquencies are 1.13%. That’s up from 0.99%. That’s sill a very low ratio, at 1.13%. But I think that, it’s again, that’s a snapshot of one day. And delinquencies move up and down throughout the quarter. You can keep it that rate, we’d like to keep it below 1%, but historically, 1.13%, going back many, many years, is still a very, very good ratio.

Kevin Fitzsimmons - Sandler O'Neill and Partners, L.P.

And Bobby, I’d assume that the inflow into that category is similar to the inflow of the amount performing real estate related type credit.

Robert Lowder

Well, it’s mainly that, yes.

Kevin Fitzsimmons - Sandler O'Neill and Partners, L.P.

And then just, you mention, Bobby, how over the long term historically, you’ve been able to keep the net charge up to nearly half the amount performing. And, that’s kind of a long-term picture. From your experience with credit cycles, and based on everything you know now. Obviously this is a fluid situation. Do you have any kind of timeline that you would guess on this point; on how long you think we are going to see accelerating non performing growth. Are we talking a few quarters? Are we talking, this could play out through the balance of 2008, based on what you’ve seen over time?

Robert Lowder

Well, I think that non-performance will rise slightly over the next two or three quarters. I think that our goal is to keep our net charge below the 2.5 on the annual aspect. I think we can do that.

Kevin Fitzsimmons - Sandler O'Neill and Partners, L.P.

Great, thank you very much.

Operator

And we’ll take our next question from Andrea Jao of Lehman Brothers.

Andrea Jao – Lehman Brothers

Good afternoon, everyone. I was hoping that Sarah could help me better understand the makeshift that’s going on both the asset and the liability side of your balance sheet. On the asset side, you grew the balance sheet this quarter, while putting on additional securities funded by borrowings.

Next quarter, you mention that additional leverage is possible. What exactly does this mean, will you continue to grow the balance sheet while putting on securities funded by borrowings, or will additional securities just replace loans that are coming off? Therefore have a flat balance sheet.

Sarah Moore

Well Andrea, we anticipate probably leveraging off our securities portfolio more than just the absolute dollar amount run off on the loan balances to replace the earnings. As you know, we were very fortunate that we delivered our balance sheet, what we did earlier in the year, so our securities as a percent of our average earning assets were very low, comparatively speaking. So we have plenty of room to grow. There’s additional security. They also help you in a (inaudible) doesn’t help you that much to the extent that we can grow in terms of deposits, and this variable rate funding that will help us in our interest rate risk position become a little bit more liability sensitive. So we are hopeful that we are able to continue to add high quality securities to our portfolio in the fourth quarter.

On the liability side, we are experiencing the makeshift and our average deposits declined 2% organically when you include the commercial bank acquisition in our numbers. We said that the incremental growth in deposits will be in the (inaudible) account. And those will be at rates above what we originally projected.

Andrea Jao – Lehman Brothers

So taken all together, does this mean we should expect to see margin pressure going forward?

Sarah Moore

Yes.

Andrea Jao – Lehman Brothers

Could you give us a bit more color on kind of the magnitude on how long that margin pressure will last?

Sarah Moore

Well, it’s very difficult to say on how long margin pressure will last. Because it’s really dependent on the economy turning around, and loan growth. Because loans are high [shielding] asset, and it’s very difficult to project when that will turn and when you’ll be able to grow your loans with a better yield than investment security. So, we’re just unable to say right now.

Andrea Jao – Lehman Brothers

Fair enough, thank you so much.

Operator

And we’ll take our next question from Todd Hagerman of Credit Suisse

Todd Hagerman - Credit Suisse

Good afternoon everybody. Couple questions just on credit, just a follow up. Bobby, you seem a little bit more optimistic when you talk about recent performance in terms of non-performing assets and the goal to hopefully keep them below 50 basis points. But, as you point out, non-performing assets have more than doubled the company in the last two quarters. And you mentioned that you don’t anticipate any additional bulk loan sales in the near term. Is there something there that gives you a little more optimism for the time being? Perhaps the inflow of non-performers will flow in the near term with that kind of outlook?

Robert Lowder

Well, we’ve been (inaudible) sitting here at my right hand side. Karen and I, along with our other (inaudible) lenders and our two gentlemen that are in charge of the various states. We spent a large amount of time over the last quarter, really the last quarter and a half, identifying every loan or every relationship that we thought had potential to have profits.

We’ve been through lists, and we’ve had discussions about it. Through that, we came up with credits we felt like needed to be moved out somewhere or another. You just see the credits which we sold, or we charged off, or we moved into non performers. You didn’t see the credits that maybe we were happy enough with somebody else to take off our hands, just by making it convenient for them to move to another bank. And so we went through our portfolio extensively, and we started with a very, very low base of non-performers. I don’t remember what it was. It was less than 0.10, I think.

And so we talk about doubling and tripling, you know, we still have levels that historically are very low. And so, I think, that by doing that, it caused a lot of things to bubble up to the top, so to speak. And, by doing that, we create, make things happen, and we force things to happen. And we think that forcing and that doing is not going to accelerate as much in the future, and that’s why I feel optimistic about that.

You know, really and truly though, again, it’s nice to have that non-performing asset ratio at 0.50 or below, and that’s our goal. And it’s only within the last couple of years that we achieved that. The important number is that net Charge-off. And it may be that we have a nice piece of property somewhere that’s got a bank (inaudible) for $7 million or $8 million and suppose, you know, no one wants to give you anything for it right now. Rather than give away an $8 million property away for a million dollars, I may take that and put it in something and stick it there for a while. I’m just not going to make a stupid decision just to keep the non-performing asset ratio. That’s why that ratio makes the [leap] up from time to time. More than the 0.50, but, I mean, we are enlisted to report 0.48 or 0.50, that’s still very, very low in today’s environment. Net Charge-off is what hurts, it comes out of your earnings, and that’s what we’re focused on, and non-performance is going to move around, but we feel optimistic in short because I think we’ve done an extensive look at our portfolio and I think we’re, they’re aware of where everything is and what needs to be watched after and we’re doing that on a daily basis.

Todd Hagerman - Credit Suisse

That’s very helpful, now if I could just ask a follow up to that, you know you talk about the loss severity and what may or may not do with particular property if you will, but I guess what concerns me and I’d like your perspective on this is if you think back two cycles if you go back to the late 80s early 90s and there was a, there was this propensity for the banks to hold on to some of these properties longer than they should have again thinking that the value was there and as some of us may recall that real-estate can be a pretty tricky game in the sense that you don’t recognize that loss until you actually recognize the sale of property. I’m just wondering if again given the current market conditions the loss severity could very well dramatically increase from current levels. Not necessarily for Colonial, but for the industry as a whole.

Robert Lowder

Well you’re certainly right that’s why we were aggressive in getting those 13 credits out there of 88 million again you know I’d get you to say that a lot of people wouldn’t have been acting on those 13 credits. We felt like they need to be acted on so we moved virtually all our amount quickly and that’s what we continue to do and you know we had that many to group up.
Now, we don’t have 13 more to do that with right now so you have to make a decision to either cut your losses and move on, or not. My tendency has always been to be realistic and cut your losses and move on out. The only thing I meant about my comment about not selling an $8 million piece of property for $1 million, I was just using that as an example of why your non-performing may group up a little bit.

But generally we have always acted quickly that’s why our recovery ratio has been pretty good I think because we still got endorsements and we got people we can go on after and those kinds of things. We dog them until the day they die and beyond.

Todd Hagerman - Credit Suisse

I appreciate your comments, thank you very much.

Operator

We’ll take our next question at this time from Christopher Marinac of Fig Partners, LLC.

Christopher Marinac - Fig Partners, LLC

Hi Bobby Good afternoon.

Robert Lowder

Hey.

Christopher Marinac - Fig Partners, LLC

I wanted to ask you about how acquisitions may look in the next year is that something that you would still be open to or do changes in asset quality that other companies experience kind of led you to back away from those?

Robert Lowder

Well, the position that we’ve been in for the last couple of years is that we’ve been inched in to what we consider to be real opportunities in trophy properties. I think the Good Store, the Patti Hood shared with you, the bank we bought down in Day County, I mean that has gone very smoothly. We think citrus and chemical is going to be the same way, going to be a great acquisition for us and we will continue to look for really good acquisitions for us going forward, acquisitions of opportunity where we think we can better our franchise and better our earnings power for the long haul.

Historically, we have not been a bank that has bought somebody with a lot of problems. We’re not looking to take on problems, but in today’s environment there may be some good banks out there that have got more problems than they want so we just have to take it case by case. Where we are is we don’t have to make any more acquisitions we’ve got a great franchise, we’ve got a great bank.

Even in the worst of times most banks in other parts of the country would trade places with us in being in locations that we’re in. So, acquisitions going forward are just going to be acquisitions of opportunity where we think we can better ourselves and bring people in that would fit with us and be able to add to our bottom line and to make it all work.

Christopher Marinac - Fig Partners, LLC

Great. My follow-up just has to do with Sarah’s comments about using broker CDs more in the future. At what point does that change the franchise value for the company as you know?

Sarah Moore

I didn’t say using broker CDs.

Christopher Marinac - Fig Partners, LLC

You mentioned the wholesale market…

Sarah Moore

We’re using federal home loan bank advances and we’re able to get very cheap funding around 4% to fund our investment security purchases. We are focused on organic deposit growth…the fact of the matter is we’re not going to pay up for short term money right now to match the competitive rates in the current environment.

Christopher Marinac - Fig Partners, LLC

Okay, so we would see the mixed shift of the wholesale borrowings, not the wholesale deposits per se.

Sarah Moore

Correct.

Christopher Marinac - Fig Partners, LLC

Okay, my mistake. Thank you Sarah I appreciate that.

Sarah Moore

No problem.

Operator

And we’ll take our next question from Dave Bishop of Stifel Nicolaus & Company, Inc.

David Bishop - Stifel Nicolaus & Company, Inc.

Hey Good Afternoon. Hey quick question regarding the client expenses this quarter. Is that attrition from the (inaudible) acquisition reduction, plan reduction and head count? Maybe just talk a little bit about that in terms of expense control efforts going forth.

Sarah Moore

Sure. The decline in the quarter came primarily from two sources. One we did have a small decrease in base salaries, but our model on acquisitions is that day one we realized call settings from the acquisitions so we never brought those people on to our payroll the ones we were going to let go. So, there was not attrition from the commercial bank acquisition, it was also not from announced takeout reductions. Just continue focusing on expense management, justifying every new hiree that we have. If somebody leaves us than we work with that position to see if we can absorb it within our organization. Promote somebody up rather than just replace in that position. You’ll also the detail of expenses in our slide presentation that advertising expenses declined a couple million dollars. That was the other very large set reduction item. In the second quarter, we had some campaigns for that and television promotions and advertising and a lot of print media that were very expensive and we focused in the third quarter more on the direct mail type campaigns and lesser avenues for advertising.

David Bishop - Stifel Nicolaus & Company, Inc.

How about in terms of what we should think about going forward here, keeping it any sort of any target goal for expense growth into 08.

Sarah Moore

Looking forward as I mentioned in my comments we are evaluating our staffing right now, we’re trying to make sure that we’re right sized in the current economic environment and so we’re on to looking at everything we’re doing, we’re looking at all of our variable expenses, but again our largest incentives is salaries and employee benefits evaluating all of our incentive plans to ensure that they’re on with our financial goals as well as evaluating our head count.

David Bishop - Stifel Nicolaus & Company, Inc.

Okay. I think we can start talking about transactions of Palms Growth, I’m jumping on interest bearing accounts there and some other accounts. Those advertising you mentioned there are you seeing any sort of quantifiable impact in terms of some of the in market competitors that your stealing some shares from?

Sarah Moore

I take the balances then I’ll hand over to Patti and talk of our advertising campaign. Now again as much as I talked about nonperformance at that period end we did benefit just from large deposits that did come into the bank that period end we are seeing the trend down on average deposit for a better matrix to look at when you’re talking about deposits. We did close on our interest spread analysis the average [non expenditure DDA] and the average town deposits and other transaction accounts. But, period end I would not break that into a runway and Patti will talk about our advertising.

David Bishop - Stifel Nicolaus & Company, Inc.

Okay.

Patti Hill

To go back to the second quarter I pick up on the comments that Sarah made. Our focus there is for the higher talk media that we utilized really was around some of the turmoil in our major markets where we see mergers and acquisitions. We thought we needed to be up front and center in some media we had not previously used, like television which is very expensive.
So, we did that in the second quarter to have better presence and then now we’re back more into what we’re more accustomed to, which is regular mid-cycle radio and then Sarah mentioned the direct mail. As far as what we’re advertising [premium] checking has been our product of the year, it continues to be a good seller for us. I think it has a direct impact on our fee income. You’ll notice that if you look at our retail banking fee increases. We’re capitalizing on the number of accounts we’re opening granted those balances are typically on the lower end, but over time they will grow as the numbers grow and that seems to have been our best seller from a rates perspective we’re not trying to get out there to top off the market rate, that’s just not where we are so we’re not throwing out the high CD rate or the high money market rate. We’re just going market to market and determining what works and just using the medium that we feel is most appropriate for that market and that customer base.

David Bishop - Stifel Nicolaus & Company, Inc.

Great, thanks.

Operator

And we’ll take our next question from Jefferson Harrelson of KBW.

Jefferson Harralson - Keefe, Bruyette & Woods

Thanks I wanted to ask a balance sheet question on the securities purchase under the agreements to resell, the mortgage warehouse business where you’re lending money to the warehouse, people, borrowers who have already sold the loans pre-sold the loans into the secondary market. That was a big increase if I’m right of about 900 million. Is that a strategic mix shift you guys have done or is it just more demand or a change in part of the plan?

Robert Lowder

It wasn’t - with the liquidity issues of the quarter we wanted to make sure that we were helping clients move along of their pipe lines and speed them up so that there needs were for financing weren’t strained any more than they otherwise had to be, which meant that they would reach the point in the lifecycle where they would be a security and hence that balance was higher. It’s a classification issue between low helper sale and (inaudible) helper sale, no larger strategic shift than that.

Jefferson Harralson - Keefe, Bruyette & Woods

Okay, do you think that $2.1 billion is a relatively stable balance? Or do you think that kind of sort of starts to trend down as the mortgage market starts to play itself out.

Robert Lowder

Well, you know, it’s hard to bridge this into the future, I would probably expect that it would trend down somewhat, but the overall balances for the warehouse businesses are going to be dependent on how the overall market is and how many prospects are going to pick up in the fourth quarter or the first quarter. We usually really look at it globally from the point of view of the warehouse assets under the management within the brief categories for which that comprises.

Jefferson Harralson - Keefe, Bruyette & Woods

Alright. And then the follow up is a simple accounting question is that I think, have you guys sell these loans using the line of credit? Would any discount you took on those loans show up as net Charge-offs or do they show up somewhere else?

Sarah Moore

Net Charge-offs.

Jefferson Harralson - Keefe, Bruyette & Woods

Okay, thank you.

Operator

And we’ll take our next question from Casey Imbreck from Millennium Partners.

Casey Imbreck - Millennium Partners

Hi Bobby, thank you very much for taking the question. Can you just kind of comment on what would happen if the market that buys some of these questionable loans you’re talking about dries up or pricing really falls off. I mean what’s plan B if you can’t move some of these questionable credits out of the bank.

Robert Lowder

Well plan B would be just to hunker down and work more with the borrower. But again going forward you’re not going to see the number of sales. I think we quantified what we needed to do and so you’re not going to see that. I mean I don’t think that we’ve got any program for this quarter or next quarter, so you know. But the folks that we’re dealing with in those types of situations we’ve been dealing with a long time. It dries up, we just work with the borrower.

Casey Imbreck - Millennium Partners

Did you guys cover the provision, the reserve against those loans? In the sales?

Unidentified Company Representative

Provision? We took the charge off…

Casey Imbreck - Millennium Partners

It might be the same when you have a set reserve loan against each loan and so if you have like, it’s a $100 million loan and you have a $2 million reserve and you sell for $98 million the push to you guys, because you need the reserve goes with the loan, but if you sell for $97 million you can charge.

Robert Lowder

As far as reserve allocated to that loan yes we did.

Casey Imbreck - Millennium Partners

Okay, also, can you also talk about interest reserves and where we are with some of your builders. I mean is there certain periods where there might be a hump where some of the interest reserves might be maxed out?

Robert Lowder

Not really I don’t think so.

Casey Imbreck - Millennium Partners

Isn’t that just something you should think about in the whole kind of Florida pan handle area?

Robert Lowder

No, not with us I don’t think so.

Casey Imbreck - Millennium Partners

Okay and what, when is the bank willing to take the reserve to empty out coverage too? Because you guys used to be the highest with close to 1000 basis points and now it’s been cut in half with this past quarter.

Robert Lowder

It’s 240…

Unidentified Company Representative

246% to loan.

Robert Lowder

280%.

Casey Imbreck - Millennium Partners

Yeah, but I mean this is down from 460 last quarter and over 1000%, 1000 basis points year-over-year.

Robert Lowder

Yeah, that’s cause we didn’t have anything in number.

Casey Imbreck - Millennium Partners

Yeah, no I understand that, but are there certain doubts that we’ve got to start building this back up, to a certain level or no, you don’t think about it like that?

Robert Lowder

Well, again we run categories on reserves on different for each loan and so that’s what we look at and that’s what we built our reserve on, so you know that’s one thing I think, if you go back I think we have got a chart in there somewhere historically which will show what page is that on? Page 5.

You go back to 2003, which was a pretty good year. The coverage was 184% of nonperforming assets, if you have that chart.

Casey Imbreck - Millennium Partners

Ok and lastly, last question for you. What aiming do you think we are, or aim in terms of the residential builders trying to move the products through?

Robert Lowder

You know I think that change is by market. We have got some markets in Atlanta, some submarkets in Alabama, some submarkets around Orlando, certainly Dallas, some markets in Las Vegas, Austin, it’s just been very little slow down in selling of the type of houses that our builders are building. But then you have got other submarkets that things are just dead as a doornail. I can’t just give you a one answer to that. You have to look at as we do market by market. That’s why we run numbers on every mart that we’re in and every submarket by type and by cost so it would be hard to give you just one answer for that. Although I will tell I saw more encouraging signs in the last sixty days in markets that I had seen.

Casey Imbreck - Millennium Partners

Ok. Thank you very much.

Operator

We will take our final question today from Joe Styben from Styben Capital.

Joe Styben – Styben Capital

Good afternoon everybody.

Robert Lowder

Hey Joe.

Joe Styben – Styben Capital

Actually all my questions have been thoroughly asked by now, but thanks, and good quarter.

Robert Lowder

Thank you. Is that all the questions operator?

Operator

Yes sir. There are no further questions. I will turn the call back over to you for any additional or closing remarks.

Robert Lowder

Well, we appreciate your participation; we are excited about where we are. We know we have got challenges but we are ready for the challenge. We are ready to go and if people invest with us they won’t be sorry.

Operator

And that does conclude today’s conference call, thank you for your participation. You may disconnect at this time.

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