AMCORE Financial Q3 2007 Earnings Call Transcript

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AMCORE Financial, Inc. (AMFI) Q3 2007 Earnings Call October 18, 2007 12:00 PM ET

Executives

Ken Edge - Chief Executive Officer

Don Wilson - Chief Operating Officer and Chief FinancialOfficer

Analysts

Ben Crabtree - Stifel Nicolaus

Ken Puglisi - Sandler O'Neill

David Konrad - KBW Company

Kenneth James - Robert W. Baird

Peyton Green - FTN Midwest Securities

Brian Martin - Howe Barnes & Arnett

Operator

Good morning, ladies and gentlemen, and welcome to theAMCORE Financial Third Quarter 2007 Earnings Conference Call. At this time, allparticipants are in a listen-only mode. Later we will conduct aquestion-and-answer session.

This conference call is also being webcast and can beaccessed at www.amcore.com and will beachieved for an additional four weeks. Please note that this conference isbeing recorded.

Statements made in the course of this conference callstating the Company's or management's intentions, hopes, beliefs, expectations,or predictions of the future are considered forward-looking statements.

It is important to note, that the Company's actual resultscould differ materially from those projected in such forward-lookingstatements. Additional information concerning factors that could cause actualresults to differ materially from those in the forward-looking statements iscontained from time to time in the Company's SEC filings and within the pressrelease itself.

Conducting the call today will be Mr. Ken Edge, ChiefExecutive Officer and Mr. Don Wilson, Chief Operating Officer and ChiefFinancial Officer. I will now turn the call over to Mr. Wilson.

Don Wilson

Thank you. We appreciate you taking the time to listen tothis conference call. We will welcome your questions at the end of our reviewof the results. We assume that you have a copy of our press release fromearlier this morning.

So while we will not review every item in detail, we willdiscuss operating results for the quarter, differentiate those from the natureof some specific actions we took during the quarter, and provide someperspective on our expectations for the future.

Our second quarter earnings per share from continuingoperations were $0.08. This represents a decline of $0.38 per share or 83%compared to the previous quarter, a decline of 84% from the same quarter a yearago.

Before we walk through the customary earnings components,there were two specific actions taken during the quarter that substantiallyreduced this quarter's results. These actions were taken in light of currentmarket conditions, which we will discuss in more detail later in the call.

First, we added approximately $11 million of provisioncompared to the previous quarter. This increase in provision boosts our reservesfor loan losses to $51.5 million at quarter end, or 1.31% of total loans, upfrom 1.01% last quarter.

This action was taken in light of sustained increases in thenon-performing categories of our loan book, and general slowing of the realestate conditions in our markets. However, it is important to note that ourcharge-off level actually declined slightly from last quarter. In fact, $1.7million of this quarter's charge-off total was generated by the remainingnon-real estate portions of the $10 million loan we placed in non-accrual inthe second quarter of '06.

We have and accurately reserved for the losses eventuallyrecognized upon resolution of this transaction, which is now materiallycomplete. Absent the resolution of this single credit, which spanned twoquarters, our charge-off levels have remained approximately consistent withprior quarter's levels of 27 to 30 basis points.

Nonetheless, persistent weakening of the credit conditionsof some of our borrowers make this increase in the reserve level a prudentaction and one that fully reflects the status of our markets and our borrowersas of the end of the quarter.

Second, we decided to liquidate a portion of our investmentportfolio in order to reflect current market conditions and to continue tomatch the re-pricing characteristic of our assets and liabilities, especiallyin years three through five of our measurement horizon.

The bonds being sold are longer dated pass through mortgagebacked securities, purchased during 2003 and 2004 with average life materiallyextended. We expect to reinvest the proceeds in shorter and more tightlystructured securities. This actions is expected to generate a $5.6 millionsecurities impairment loss, which we expect to recover over approximately thenext three years.

These two actions together accounted for a reduction ofcurrent period income of $16.6 million on a pretax basis, bringing our pretaxnet income level to near breakeven. The tax benefit of $1.8 million shown onthe summary financial statement is primarily a function of having negativetaxable income, with the difference representing the amount of tax exemptsincome.

Moving on to the measures of business performance, now let'slook at the margin or the net interest income line item. Margin incomedecreased from the previous quarter by $347,000, and was down $779,000 from theyear ago quarter.

The reduction in size of the investment portfolio, thesubstitution of debt for equity in the share buyback program both of whichimproved the efficiency of the capital structure also served to reduce marginincome, all else held equal.

In addition, the conditions in the broader credit marketsduring the quarter created an anomaly where by LIBOR rates did not track tomove in the Fed funds and therefore prime rates. This rate differentialsqueezed margins since the Balance Sheet has more assets based off of prime,which fell 50 basis points than liabilities that are based off of LIBOR, whichinitially rose then fell less than 50 basis points from its peak.

The margin statistic for the quarter was 3.35%, down 4 basispoints from the previous quarter and up 2 basis points from the year agoquarter. In addition, to the LIBOR rate effect, unfavorable mix changes in thedeposit category between non-interest bearing and interest bearing accountsalso pressured margin during the quarter. As we have indicated for the lastseveral quarters, we expect the margins statistics to have stabilized atapproximately this level, especially once the debt market condition stabilize.

Now let's turn our attention to credit conditions. Oureconomic statistics such as unemployment levels and wage growth continue toshow the core economy to be stable, clearly there have been deterioration inthe factors that have powered growth over the last several years. Thelengthening in the sales cycle for various forms of real estate has pressuredborrowers' cash flows from a variety of property ventures. And even on ouroccupied properties they’re seeing the effect of softening collateral values.

This pressure is evidenced in the increasing levels of loanspast due 90 days or more from $7 million last quarter to $13.6 million thisquarter. While we do not materially participate in the so-called nonprimesegment of the market, valuation and cash flow deterioration has lessened theamount of cushion protecting our credit and slowed net new credit extension.

We charged-off $4.5 million on an annualized rate of 45basis points during the quarter, which was $326,000 lower than the previousquarter's level and $1.7 million higher than was charged-off in the year agoquarter. As mentioned above, absent the recognition of the loss on theremainder of one longstanding form of credit, net charge-offs wereapproximately flat in the last several quarters.

Non-performing loans rose $3.5 million from the previousquarter and $11.1 million from the year ago quarter. However, all of thischange is due to loans past due more than 90 days where the loans areconsidered adequately reserved and/or in the process of collection.

While loans that did not meet this criteria and aretherefore considered non-accrual actually fell $3.1 million during the quarterand fell $1.3 million from the year ago period, the material increase in pastdue loans is part of the justification for the increased provision level thisquarter.

The foreclosed real estate increased $1.7 million from theprevious quarter. We are actively marketing these properties and the book valuefully reflects our expected proceeds from the sale. The allowance for loanlosses then ended the period at 1.31%, up from 1.01% last quarter, andrepresents three to four years’ coverage of charge-offs assuming a 30 to 45basis point annual charge-off level.

The next category to discuss is non-interest income. Absentthe effect of the security sales mentioned earlier, non-interest income wasflat to the previous quarter and down $1.6 million from the year ago period.However, the year ago period also included approximately $3.5 million ofprivate equity fund gains and bully claims.

Investment management and trust income improved $0.8 millionfrom the previous quarter and $0.3 million from the year ago period. Recall thelast quarter this category included a non-recurring expense. The improvedincome in this category includes both an improvement in the account valuationsduring the quarter and a rationalize fee structure as well as a small recoveryof the previous quarter's non-recurring expense.

Service charges on deposits were up $0.4 million on a linkedquarter basis, primarily due to increased focus on this area across ourbusiness lines. We believe this level to be sustainable over the next severalquarters, with a small amount of incremental improvement due to the recentreduction in short-term rates increasing the revenue from commercial demanddeposit accounts.

Net mortgage revenues are down $279,000 from linked quarter,primarily due to the transition to the new mortgage platform during theprevious quarter. The reduction in revenues from the amortization of theservicing rates sold earlier in the year and slower sales volume due to thehousing market slowdown accounts for most of this change.

This reduction however is partially offset by lowerpersonnel costs from the reduction of the processing and servicing staff thatbegan during the previous quarter as we transitioned to the new platform. Thesesavings are reflected in the personnel cost lines item.

Moving to our non-interest or operating expenses, these fell$1.5 million on a linked quarter basis. This reduction was a result of lowerpersonnel costs, partially offset by an increase in compliance relatedprofessional fees. Ken will discuss in a couple of minutes the outlook foroperating costs over the next two years.

From a balance sheet perspective, average loans were down$11.6 million from the previous quarter and up $91 million from the samequarter year ago. Ending loan balances were lower than the average for thequarter by $51 million as the maturation of the commercial real estate bothgenerates pay down faster than new loans are available in this marketenvironment.

Average bank issued deposits fell $11 million during thequarter, as the runoff of lower spread CDs continue to exceed the increases inhigher spread DDA and money market accounts. The average balance in the westernportfolio decreased approximately $8 million during the quarter, as we're nowreinvesting most but not all of the cash flows from the portfolio.

We do not expect the size of the portfolio to materiallychange in the current market environment. During the third quarter, 465,000shares were repurchased at an average price of $25.35. We expect to continue tobe aggressive with the repurchase activity and liquidity at the parent companyof loss.

Let me now turn the call over the Ken to discuss thestrategic perspective.

Ken Edge

Thanks, Don and good morning everyone. As mentioned at thebeginning of our remarks today, we have taken steps to recognize the effectscurrent market conditions are likely to have our loans and investments. Our newmanagement team has been working over the last couple of quarters to build aperformance-oriented culture that recognizes and respond to conditionsaggressively and realistically.

We do not take the actions we have pursued this quarterlightly. We rather, feel they are the pragmatic response to prudent andrational assessment of the marketplace, as it exists today. While, we do notprovide near-term guidance on earnings, we feel it is important to provide alonger term perspective on our expectation for key categories.

Over the course of the next two years, assuming thepersistence of current market conditions, we would expect low to mid singledigit annual percentage increase in loan balances and commensurate increases innet interest income. We would further expect similar annual percentageincreases in non-interest income.

In order to leverage this moderate expectation of revenueand asset growth, we are actively pursuing expense related initiatives acrossthis company. These initiatives including changes in the way we originate,process and monitor small business lending implementation of a streamline andfortified credit approval and documentation process and increased focus onperformance management across the company and targeted efficiency measuresacross the organization, which will allow us to reduce non-interest expenses by3% per year on average for the next two years. Compared to the 2007 run rate,absent any material changes in tax environment, or the FDIC insurance premiumlevels.

Finally, given what we see in the current marketenvironment, we would expect charge offs in the next year or so to be in therange of 35 to 40 basis points on average. Of course, we will continue toclosely monitor both market conditions and our portfolio and are committed toresponding to changes as they become visible.

We remain focused on attracting and retaining talented anddriven individuals across our business and providing them a challenging andrewarding opportunity to build a strong and dynamic organization. Our newmanagement team is working together well and I am encouraged by the constancyof focus and strategic discipline we are building throughout the company.

Operator, you may now open up the line for questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answersession. (Operator Instructions) One moment, please. The first question comesfrom Ben Crabtree from Stifel Nicolaus. Please go ahead.

Ben Crabtree - Stifel Nicolaus

Good morning. I guess the first one would be a little bit ofa philosophical or strategic question. The reserve build here, I'm curious asto if you -- in light of what the SEC's and accountant's attitude have beenabout reserve building in advance of deterioration, it strikes me that maybewhat's going on is a fairly significant negative migration in your loanratings. Is that true?

Ken Edge

I think the right way to say this clearly, we have seenweaknesses in many of our borrowers, much of which is reflected in the ratings.You are right and this is based upon what we see, where we sat at the end ofthe quarter and for SEC and accounting purposes, we cannot just say well, maybethis is extra. Here. We have to be able to be clear about the nature of ourborrowers and this is why we are at the level we're at.

Ben Crabtree - Stifel Nicolaus

Okay. And the -- not that it's a huge number but theincrease in OREO, what kind of properties are we talking about here?

Ken Edge

There's a fairly wide range of them. I think the larger onesare commercial and owner occupied type of properties.

Ben Crabtree - Stifel Nicolaus

Okay. And you feel that you've pretty much reflected currentsaleable values as you carrying value.

Don Wilson

Absolutely. That's part of what you have to do before youcan put it in that category. There's a couple of apartment buildings in therefor example, there's a couple of gas stations in there. There's a variety ofdifferent types of properties. But clearly what you have to do is you mark themdown through the expected realizable value before you put it for those realestate.

Ben Crabtree - Stifel Nicolaus

Okay. And then hopefully not much in the way of raw land orearly stage development projects.

Don Wilson

Almost none.

Ben Crabtree - Stifel Nicolaus

Okay. Final question. The bonds that you're selling, is itpretty much just because of the extension and then the asset liabilityimplications of that or are there some low quality kind of things in there thatyou want to get rid of for that reason as well?

Don Wilson

No, this is not a credit driven decision. This was again forthe outer years of our interest rate risk perspective. We look at a five yearhorizon for mismatch and for cash flows and these bonds are out in the five,six year average life range and so we -- tough to get some liabilities outthere so we liquidate them for that reason, for long-term liquidity purposesand not for any credit risk.

Ben Crabtree - Stifel Nicolaus

And the sales are what is going to occur during thisquarter, or are they already occurred?

Don Wilson

They're already in the process of occurring as we speak.

Ben Crabtree - Stifel Nicolaus

Okay. Great. Thank you.

Don Wilson

Thanks Ben.

Operator

The next question comes from Ken Puglisi from SandlerO'Neill Asset Management. Please go ahead.

Ken Puglisi - Sandler O'Neill

Actually, yeah, Ben just asked most of my questions. Butgood. On the asset quality issue again, I mean, the way I heard it, theincrease resolved in 90 day past due and those are loans that are well securedand in the process of collection so I guess I could jump to the conclusion thatyou don't anticipate loss on that. At the same time non-accrual loans camedown. So I guess the way to read that is you're expecting the 90 day past dueloans to continue to increase?

Don Wilson

I think the way I would read that is statistically, theportfolio is weaker than it was the previous quarter. And so let's take thenon-accruals for example. While the total came down, remember what we talkedabout is that we took out a fairly large single transaction out of there andall else held equally, would you have expected and $8 to $9 million decline inthat number.

It went down by 3 implying that other credits came into thenon-accrual category to offset two-thirds of the other form of decline.

Ken Puglisi - Sandler O'Neill

Okay and Don, on the net charges, did you indicate that noneof the net charges was due to that one credit or did I miss hear that?

Don Wilson

No what we said was that one credit for the differencebetween the dollars that we are the basis points that we had this quarter andthe more normal 27 to 30 range that you saw like two, three, four quarters ago.

Ken Puglisi - Sandler O'Neill

Okay.

Don Wilson

We're saying absent that one credit, the rest of theportfolio level of charge offs this quarter would have put you in that 27 to 30range.

Ken Puglisi - Sandler O'Neill

Okay.

Don Wilson

Having said that, we then said at the end that we thing itis reasonable with what we see happening in the market right now that as youguys try to built your models and what not we would suggest you should assume a35 to 40 basis point charge off level going forward.

Ken Puglisi - Sandler O'Neill

Okay. And just one other thing. On the commercial realestate, can you tell me how much of that is construction? The period endnumber?

Don Wilson

The real estate construction as of the end of the quarter is$483 million.

Ken Puglisi - Sandler O'Neill

Thank you very much.

Don Wilson

Thank you.

Operator

(Operator Instructions) The next question comes from DavidKonrad from KBW Company. Please go ahead.

David Konrad - KBW Company

Good afternoon.

Don Wilson

Hi, David.

David Konrad - KBW Company

Couple of questions, kind of looking out on the spreadincome. Don, if I heard your comments correctly, it sounds to me like the Fedfund LIBOR issue, I would think would kind of persist through this quarter,given it happened late last quarter, which would probably cause pressure.

But probably the refinancing or the selling the bonds andbuying the new shorter securities will give you some lift. So is that kind ofan offsetting dynamic to stabilize the margin.

Don Wilson

I question the initial premise. I mean there's a judgmentcall on when you see LIBOR kind of fully -- if you go back to let's say end ofJuly, levels of short term LIBOR and compare that to when do you expect thatnumber to get down current levels to be 50 basis points below that level.

David Konrad - KBW Company

All right.

Don Wilson

That's a question that we all have to assess on our ownabout when we expect those condition's to stabilize. They clearly have comealong way from where they were at the end of the quarter. There's still moreprogress that has to happen.

So some of that has already dissipated. But you're correct,not all of it. And I don't know how to predict how long it will persist. Thesecond part of your question is exactly right, that, the sale and reinvestmentin a different term of security will materially support our margin goingforward.

David Konrad - KBW Company

Okay. And then the second question on the loan growth side,can you talk about maybe mid single digit growth over the next two years. But Iguess given where we ended up this quarter, is it fair to assume that we'll bea might be little bit light of that kind of two year growth rate over the nextquarter or so?

Ken Edge

I would think that would be a reasonable assumption. Youknow, it's just very slow right now. There is too many players chasing too fewgood deals. We're obviously focused on maintaining our credit quality and thediscipline lending practices that we want to instill. So it's going to be slowon the volume.

Don Wilson

Let's be clear. I mean, we're not walking away from thecommercial real estate business by any means. We're trying to make sure that weare handling that business in appropriate and well-secured fashion.

Having said that, clearly the emphasis, and I'm sure you'rehearing from this 1,000 other banks, continues to be on growing the CNI sideand it's part of why we've changed the management at the top of the commercialgroup in terms of the focus on the CNI side, we've got to make sure we havepeople who know that business well and we feel that we do at this stage.

David Konrad - KBW Company

Okay. Thank you.

Don Wilson

Thanks, Dave.

Operator

The next question comes from Kenneth James from Robert W.Baird. Please go ahead.

Don Wilson

Good morning, Ken.

Kenneth James - Robert W. Baird

Hi, good morning. Can you give any update on the actual 30to 89 day past due number, kind of advance of the call report here? I know it'sbeen running about 60 million year-to-date. Can you provide that number?

Don Wilson

Let's see here. Do we have a -- I'm not sure I have thatnumber at my disposal side. If I can get it them before the call is over I'llinterrupt and do it at the end.

Kenneth James - Robert W. Baird

Okay. And then can you provide any color or maybe, is thereany geographic differentiation between where you're seeing a lot of problemshere? Is it concentrated around rockland or projects in suburban Chicago ormore in southern Wisconsin or is it spread out across your footprint?

Don Wilson

I would tell you that in terms of charge-offs, that has beenrelatively spread out across the footprint. And again we had that one largecredit that we've been referring to here, that was Rockford based.

So, that obviously uses some of the numbers. But I thinkproportionally in terms of looking at criticized assets, you would see apredominant amount of that be in the commercial real estate sector. Notsurprisingly, given the proportionality of the loan book itself.

So it's not disproportionate to the loan balance as a whole.In terms of geography, I would tell you that the dollars would be more heavilyweighted towards the Chicago market than the Western Illinois and WesternWisconsin markets.

Kenneth James - Robert W. Baird

Okay. And then on the loan growth, over the past year theloan portfolio is flat. But I mean all of your growth, the only category that'sbeen growing and it continued to grow this quarter, somewhat surprisingly isconstruction loans.

Now, you could look at that and say that should you begrowing construction loans at all at this point in the cycle, given that'swhere most of the problems seem to be cropping up and I just kind of wonder ifyou could provide some color on that, especially given commercial real estateis probably not going to be growing, the short growth you've seen out ofconstruction doesn't seem like it would be sustainable and really where youneed momentum on the CNI side, hasn't really shown any.

So, I wonder if you could just kind of comment on that, whatyou would do on the CNI side and then comment on the construction growth.

Don Wilson

Yeah, I think there’s two aspects of that and somehow Iwould agree with the back end of that in terms of the need to focus on the CNIside. I'll come back to that in a minute. How it looks, let's explain andunderstand the construction growth for the moment.

A lot of that is simply drawdowns of lines that have beenput in place as the projects continued to mature towards completion. So,understand that that's not necessarily a net new relationship or materialamounts of net new relationships, but rather drawdowns on lines that have beenput in place in the past as those projects are trying to get completedturnaround and sold to generate some cash flow.

Therefore, I think that is further evidence that you arecorrect, that that is one of the headwinds that we face as we go forward interms of growing the total loan book, which is part of why we gave you what weconsider to be a relatively conservative estimate of expectations over the nextcouple of years.

But I think over the next couple of quarters, you’re right,there's something that we're go to have to face there. Many of our projectshave been completed and in fact paid out. That will probably continue as we goforward here to put additional pressure on that side of the fence.

In terms of how are we trying to pursue the loan growthside, there's really kind of two components that answer. The first one Imentioned earlier, which is the continued management, if you will, managementchanges of the organization. We brought in an individual to run the commercialgroup that has come from a strong middle market CNI lending background.

He is working through the process of getting our teamstrained and ready to roll on the CNI side. We made substantial progress in thatas we did go forward. I think the other component to that is one of recognitionof just the nature of the market today and the economy, which is why Ken'sremarks at the end talked about trying to make sure we address the expense sideof the equation.

So, when you expect relatively moderate loan growth,particularly if the face of the headwinds of paydowns and project completionson the real estate side, you have to address net income of the expense side,which is why we tried to clarify that at the end of our remarks.

Kenneth James - Robert W. Baird

Okay. Thanks. And then just one follow-up and I apologize ifyou gave this and I didn't catch it. Can you give the yield differentialbetween the securities you're selling and the ones you're buying?

Don Wilson

Easiest way to do that, rather than give you a hard numberis that it's about a little over $200 million your worth of bonds. They bookedyield range from 3.5 to 4.25 range. And we're reinvesting in let's call itthree year average life or thereabouts, two to three year average lifesecurities at current market yields. You can figure out where those are.

Kenneth James - Robert W. Baird

Okay. Thank you.

Don Wilson

Thanks.

Operator

The next question comes from Peyton Green from FTN Midwestsecurities. These go ahead.

Peyton Green - FTN Midwest Securities

Okay. I think you just answered the question. The decisionis to reinvest what you're selling, not just operate with a smaller BalanceSheet and reduce wholesale borrowing.

Don Wilson

We've already been reducing the Balance Sheet, as you know,and the investment portfolio substantially. We are pretty much at the levelthat we would expect to be sustainable. So, therefore this is a shortening ofthe term, of the duration of the bonds that we're buying but it's going to getreinvested.

Peyton Green - FTN Midwest Securities

Okay. And then I mean with an outlook that loan growthshould continue to kind of decline or decelerate, shouldn't you be lengtheningthe securities book?

Don Wilson

No, sir, that's a function not of where the loan book sits,but rather the liabilities that you use to fund them. So what we're trying todo is make sure that we match fund, all assets and all liabilities across thefive year horizon. It's indifferent to those sides or the maturity little ofthe loan book.

Peyton Green - FTN Midwest Securities

Okay. And then, do you see any I guess restructuring on theborrowing side that might come between now and year-end as you continue torefine where you are on both sides?

Don Wilson

The process of managing interest rate risk is an ongoingprocess of kind of constantly ebbing and flowing and tacking into the rightposition. We do not expect anything that would generate at this point in timewe have no expectation of anything that would generate a gain or a loss in thefourth quarter related to that.

Peyton Green - FTN Midwest Securities

Okay. And then I mean, do you feel pretty good about thebalance of the securities book in terms of I guess kind of shooting the thingsthat needed to be shot?

Don Wilson

I'm not sure I would use that term, but yes, we would agree.

Peyton Green - FTN Midwest Securities

Okay. Okay. So, we shouldn't expect anything material.

Don Wilson

No, sir.

Peyton Green - FTN Midwest Securities

Okay. All right. And then in terms of where you are inhiring and trying to hire to kind of reposition the franchise, how do you feellike the outlook is over the next 12 to 18 months? Is it still very difficultto hire? Or are you making more strides on that and I guess, you know how doesyour emphasis shift, I guess?

Don Wilson

It's never easy to hire extremely talented people. So, Thefirst thing you have to do is find them. That's an ongoing process. You have tomake sure that they are understanding of the challenges of our situation andwhat we're trying to accomplish here and that they are enthusiastic about thechanges that we're making in the company. And when we find those people andwe're able to explain what we're doing and why we're doing it, we actually areable to attract the right players. But that's not where you go out and hire 50to 75 people in one full swoop. It's an ongoing, constant process.

Peyton Green - FTN Midwest Securities

Okay. And then a follow-up on the construction book. Youmentioned that it was about 480 million in size. Is that right?

Don Wilson

Yes, sir. Correct.

Peyton Green - FTN Midwest Securities

Okay. How does -- that necessarily the funded balance, buthow does that compare to the commitment level? And then is there any particularperiod over the next 12 months where you expect maturities to be very lumpy andsignificant?

Don Wilson

No, we wouldn't suggest a lot of lumpiness. I think whereyou are likely to get -- you won't get lumpiness from a pool of loans that allhave a similar maturity date to them. Those are all reasonably spread out fromwhat we look at in a variety of other context. What I think may be happening --I think happened a little bit this quarter as well, as the liquidity positionof some of our borrowers deteriorates, as we continue to put pressure on themfor payments, they often find the easiest way to deal with that is to go toanother bank to refinance the transaction.

That doesn't necessarily pose another problem for us. Ifthose are indeed those types of borrowers, essentially let some other bank dealwith the problem down the road. So, we certainly want to support our borrowerswhere they are supportable. And by know means do we want to suggest that we aretrying to change that form of behavior. But having said that, where they startto have liquidity problems, et cetera. If they choose to pay out by going toanother party, we can live with that.

Peyton Green - FTN Midwest Securities

Okay. And I guess, I mean, is your sense that there areenough competitors out there willing to take the paper or is that starting tochange also?

Don Wilson

I'm sure it's starting to change, but the pool is stillfairly deep from what we can tell.

Peyton Green - FTN Midwest Securities

Okay, great. Thank you.

Ken Edge

Thanks, Peyton.

Operator

The next question comes from Brian Martin from Howe Barnes.

Brian Martin - Howe Barnes & Arnett

Hi, guys.

Ken Edge

Hi Brian.

Brian Martin - Howe Barnes & Arnett

Most things have been answered. But Ken, you talked aboutjust the -- your assumptions over the next few years, kind of the -- on the feeincome and the expense side. I guess wondering, given some of the non-recurringnature of some of the things that have gone through both of those lines. When welook at the numbers you kind of talked about, I guess I'm assuming that you'relooking of on a core basis to project based on those numbers you gave, is thatthe way you guys are looking at it? Do we look at the actual reported number?Can you just I guess clarify a little bit there?

Ken Edge

Well, we're looking at the 2007 run rate. So what you needto do, Brian is just look at what the run rate is for this year. And we'relooking for a 3% on average over the next couple of years’ reduction in thatrun rate.

Don Wilson

You're talking non-interest expense?

Brian Martin - Howe Barnes & Arnett

Yeah, the non-interest expense side.

Don Wilson

Right. I'm not sure I know what you're driving at.

Brian Martin - Howe Barnes & Arnett

Well, I guess. I just wanted the sense -- I guess there'sbeen a lot of things that have gone through that line item this year, so therun rate I guess we just look at quarter is this a good run rate on the expenseside?

Don Wilson

What we're trying do is -- understand that there were somepositive and negatives that run through that line. So, yes there are someunusuals and clearly, we have already begun the process of the focus ofexpenses in a variety of different categories. So, we are trying to tell youwithout being incredibly precise on what quarter things happen, et cetera.We're trying to tell you that over the course of '08, we would expect thenon-interest expense number to be at or more than 3% below the '07 total. Andagain that, you are right includes some things, positives and negatives, butit's continued to move down over the course of the year.

Brian Martin - Howe Barnes & Arnett

All right. That's all I had.

Don Wilson

If I can go back, before we take the next question, therewas a question on the 30 to 89 days. And what I can tell you, I'm not sure it'srelevant to giving you the specific number at this point, but I can tell youthat the September 30 -- level of 30 to 89 days past due was consistent, prettymuch right on top of the level that it was at the end of June. And so thatnumber has not gone up quarter-over-quarter at this stage. But obviously, thatis something we continue to focus aggressively on with all of our lenders.

Operator

The last question is a follow-up from Ken Puglisi fromSander O'Neill. Please go ahead.

Ken Puglisi - Sander O'Neill

Thank you. Don, I think I heard you say that even your owneroccupied commercial real estate credit are feeling some stress. I wondered ifyou could give us some color on that. I tend to think of owner-occupied loansas loans where the cash flow to service the loan is coming from someplace otherthan the property. So, is this just a -- is this just because the collateralvalues have declined or how should I read that?

Don Wilson

Yeah, I think that's exactly what we said, is that it's the-- as you evaluate the credit condition, while the borrower may be current andmay have the cash flow at the moment, you also have to look at the underlyingcollateral value. And as those collateral values weaken, you need to recognizethat in the process. In addition, some of them also have liquidity issues fromother components of their business. So, we need to recognize that as well.

Ken Puglisi - Sander O'Neill

And I'm not quite sure how you're going to answer thisquestion, but I know that you’ve kind of expanded your credit evaluationprocess over the last couple of years, expanded the number of categories, etcetera. I'm wondering to what extent is this increase in the reserve a functionof those changes or would it have occurred under the old system as well?

Don Wilson

It would have occurred under the old system as well. I thinkthat’s the clarity of it -- the vision that you have into it is improved by theextra grading – gradations. But the reality is that we do not believe that thisis a direct function of the credit rating it grades. It's rather a function ofthe underlying credits.

Ken Puglisi - Sander O'Neill

Thank you.

Don Wilson

Thanks, Ken.

Operator

Gentleman, at this time we have no additional questions.Please go ahead with any concluding comments.

Don Wilson

We have no more comments, but we thank you for listening inon the call.

Ken Edge

Thank you, everyone.

Don Wilson

Good-bye.

Operator

Thank you for participating in AMCORE financial thirdquarter 2007 earnings conference call. This concludes your conference fortoday. You may all disconnect at this time.

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