Citizens Republic Bancorp Q3 2007 Earnings Call Transcript

| About: Citizens Republic (CRBC)
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Citizens Republic Bancorp, Inc. (NASDAQ:CRBC) Q3 2007 Earnings Call October 19, 2007 10:00 AM ET

Executives

Bill Hartman - President and CEO

Charlie Christy - CFO

John Schwab - CCO

Marty Grunst - Treasurer

Analysts

Jon Arfstrom - RBC Capital

John Pancari - J.P. Morgan

Scott Siefers - Sandler O'Neill

Terry Mcevoy - Oppenheimer

Operator

Welcome to today's teleconferenceentitled, Citizen Republic Bancorp’s Third Quarter Conference Call. At thistime all participants are in a listen-only mode. Later you will have theopportunity to ask questions in our Q&A session. Please note, this callmaybe recorded.

I will now turn the call over toMs. Kristine Brenner. Ms. Brenner you may begin.

Kristine Brenner

Thank you. Good morning everyone,and welcome to the Citizen Republic Bancorp’s third quarter conference call.This call is being recorded and a telephone replay will be available throughOctober 26. This call is also being simulcast live on our website,citizensbanking.com, where it will be archived for 90 days.

With me today is Bill Hartman,President and Chief Executive Officer, Charlie Christy, Chief FinancialOfficer, John Schwab, Chief Credit Officer; and Marty Grunst, Treasurer.

Before we begin, I would like topoint out that during today's conference call, statements will be made that arenot historical facts. These forward-looking statements involve risks anduncertainties which include, but are not limited to those discussed in theCompany's filings with the SEC. Forward-looking statements are not guaranteesof future performance and actual results could differ materially from thosecontained in the forward-looking information. These forward-looking statementsreflect management's judgment as of today and we expressly disclaim anyobligation to update and/or revise information contained in these statements inthe future.

Now, I'd like to turn the callover to our CEO, Bill Hartman. Bill?

Bill Hartman

Thanks Kristine. Good morningeveryone, and thank you every much for joining our analyst conference call.Given the economics and the conditions of the market place, we were satisfiedto report results that were consistent, both with our own expectations, andwith what we had communicated to investors last quarter.

We continue to be well on trackto achieve our cost savings that we committed as part of the merger, and whilewe are investing in proven markets where we are growing, such as SoutheastMichigan, Northeast Ohio and East CentralWisconsin. We do have a number of important expense initiatives underway tohelp us fund those strategic investments, while still keeping our overall coststructure intact.

Our efforts in cost managementare showing up in the form of both, a much improved efficiency ratio for thequarter and in terms of much lower dollar expense level for the third quarteras well. Revenue of course continues to be a challenge, a chorus at this point,and our peers as well. And we are continuing to experience margin compressionand the Midwest economic challenges.

The good news is that wecontinued to enjoy good momentum in our commercial and industrial lendingbusiness which was up almost 16% on an annualized basis for the quarter. Andour treasury management sales which compliments that business continues to growand it was up by actually over 25% year-to-date.

Our sales production of newchecking and savings accounts and the cross-selling of additional accounts ofthose new accounts does continue to increase, and while it hasn't yet offsetthe migration of low cost to high cost deposits, a continuation of our trendswill unable that to happen, prior to the end of next year.

Our brokerage and investment feesexceeded $2 million, this was the second straight quarter where we had exceededthat level and it’s an example of the investments that we have made in thatbusiness, continuing to pay off. We have a number of revenue initiatives inplace. They include addressing sales execution, sales talent management,business-owner banking, fee income, and an improved level of back-officesupport to the front line.

We are convinced that theserevenue initiatives will help us generate profitable revenue in 2008, and we’regoing to comment little bit more on that when we give a 2008 outlook, duringthe January 2008 Analyst Conference Call.

After the last quarter we didannounced a new regional management structure. And based upon what we have seenso far, we continue to have positive feelings that the increased teamworkbetween the regions, the lines of business and the back-office, that the newstructure enables, will greatly enhance our ability to perform, as this newstructure continues to mature.

Also subsequent to quarter-end,we announced that Peter Ronan has joined us, as the President and CEO ofCitizens Bank Wealth Management after an extensive national search thatdeveloped a number of outstanding candidates.

Pete has extensive trust in salesexperience and most recently ran a large trust organization for a $50 billionplus regional bank. He has extensive experience in Southeast Michigan, and we think that he can help us increase the revenueand profitability momentum we have begun over the last several years in ourwealth management businesses.

Our credit quality performance,as John will comment on later, was also inline with our expectations ascharge-offs did reduce and non-performers did increase. The actions that wetook in the second quarter to [ballpark] the reserves helped us this quarterand position us well for future quarters. And while these credit challenges aregoing to continue, as the commercial real estate markets remain challenged, wehave proven processes and people to help us manage through this, and we're verycommitted to staying the course.

We're not compromising any creditstandards on the new business we're writing. This is a time when there arestrong headwinds in our industry, these headwinds are heavy, and the tailwindsare light, as they are existent at all. Despite that, our Board and Managementteam are very committed to strong and consistent execution and making the rightdecisions for shareholders, as we impress the current operating environment.

So we'll next move on to JohnSchwab, our Chief Credit Officer, who will give you an update on credit qualitytrends. Charles Christy, our Chief Financial Officer will cover the financials.And then, I will make a few summarizing comments before we open it up for ageneral questions. John?

John Schwab

Thank you, Bill. Nonperformingassets increased $44.6 million or 30% over the second quarter end, with increasesin nonperforming loans of $38.4 million, comprising the majority of thatincrease.

Virtually, all of the increase innonperforming loans was a non-owner-occupied commercial real estate,principally land development and income producing, which together accounted for$34.4 million of the increase. The large majority of the land developmentincrease is attributed to two loans, on both of which we have alreadyestablished specific reserves against quantified future charges.

The nonperforming levels of allthe other portfolios have remained relatively constant. With the preponderanceof our troubled credit concentrated in commercial real estate, we are workingthrough individual strategies to resolve each loan proactively, mindful ofusing the company's capital prudently.

The bulk sale of nonperformingheld for sale loans which we executed in the first quarter of 2007, is nolonger an economically attractive option for us to deal with currentnonperforming loans, as bulk sale markets have declined materially. Therefore,affirming our strategy of working through each commercial real estatesituation, one at a time.

In last quarter's conferencecall, we stated that the second quarter provision coupled with our historicallystrong reserve levels will enable us to work through continuing deteriorationin Michigan and the Midwestcommercial real estate collateral values. We believe that statement is stillvalid.

The third quarter increase innonperforming loans and nonperforming assets, likely to increase again in thefourth quarter, has lowered our loan loss reserve to nonperforming loan ratioto 114%, but not for several reasons to a level of concern.

Citizen’s historically high loanloss reserve to nonperforming loan ratio through 2006, supported a largelyC&I portfolio, whose loss given to fault dynamics differ materially fromthe mainly commercial real estate issues with which we are now dealing.

Analysis of the constituent loanloss reserve allocations to our respective nonperforming loan types, confirmswe are well positioned to deal with identified credit issues in each loangroup. For example, 84% of our nonperforming loans are collateralized with realestate, which has ongoing value. Charge-offs in our real estate portfolio hashistorically a small percentage of the nonperforming loan amount.

Further, according to the tablesin our press release, residential mortgage, nonperforming loans of $32.8million resulted in charge-offs at $1.6 million for the quarter. Annually, thisloss experience translates to less than 20% loss on residential nonperformingloans.

Net charge-offs of $7.9 millionfor the third quarter represented 0.34% of average portfolio loans. Thedecrease from the second quarter was primarily the result of lower commercialreal estate charge-offs, principally due to timing variances from obtainingfresh commercial real estate valuations, negotiating with principles involvedin these projects and assessing ongoing project viability.

While increases in commercialreal estate nonperforming loans, will likely lead to some level of charge-offsin subsequent quarters, both the timing and level of predictability isdifferent from C&I. In short, commercial real estate charge-offs will,going forward, tend to spike and valley. Importantly, of the forecastedcommercial charge-offs in the fourth quarter, our evils that have beenidentified, known shortfalls from updated collateral valuations and work outagreements. Over 90% has already been fully reserved, minimizing the need toadd provision expense for these loans.

You will have noted, that ourcommercial watchlist exposure appears to have flattened in the third quarter,following the explained increases earlier in the year as we impose Citizenscredit risk perspective on the then recently acquired portfolio. While theleveling in the C&I watch portfolio appears sustainable, some of thedecrease in the commercial real estate watchlist is attributed to bothmovements into nonperforming status, while others returned to past status.

During our third quarter watchprocess, we downgraded 35% fewer dollar than the second quarter, upgraded 18%more and transferred 37% less dollars to special loans. While one quarter doesnot constitute a trend, there is some early evidence that the riskiercommercial credit has been identified and stabilized. It is noted that thedisclosed watchlist table includes all occurring commercial watch loans,including those managed in our special loans workout unit.

Dollars in this workout grouphave more than doubled this year. However, we believe that early identificationof deteriorating credits is a basis for proactive credit risk resolution. Thatprocess is working. On a previous call, we had indicated our intension toconduct a review of the non-watch pass investment commercial real estatecredits.

To ensure that risk ratings wereaccurate, and that credit risk management practices appropriate for eachexposure were being implemented. At September 30, '07, $495 million incommercial real estate pass credits hit the size and risk parameters for thisreview.

To date, we have reviewed $204million or 41% of this identified exposure with the remaining 59% beingreviewed later this month. From this first assessment of these past credits, wedowngraded 14% resulting in a relatively minor increase in loan loss reserve.

The extent to which our nextscheduled review, mirror these results, we can suggests that there are nomaterial unidentified commercial real estate exposures lurking in theportfolio. You will recall that we have been diving into and slicing thisentire portfolio from nearly a year now. And I believe the large majority ofthe goblins have been disclosed and are being worked.

30 to 89 delinquencies haveremained constant at $178.1 million or 1.93% of the portfolio. While thecommercial real estate loan delinquencies have increased slightly, residentialmortgage delinquencies at 2.58% of the mortgage portfolio did not change fromthe second quarter.

While we have experienced someincrease in our 60-day delinquent residential mortgage portfolio, there is noevidence yet that these will translate into the larger nonperforming levels. Weare monitoring the residential mortgage portfolio for potential reaction to Armre-pricing. ARMs represent 60% of our retained portfolio, and nearly 35% of theARM portfolio will re-price over the next five quarters.

At the risk of repeating myself,Citizens is not in the subprime business. 30 to 89 delinquencies in theconsumer portfolio are well within our historical seasonal ranges, includingboth home equity and indirect, which you recall is mainly Marine and RV.

Before differing to Charlie, Iconclude by observing to no one's surprise that the Midwest's, specifically Michigan, economicenvironment is impacting the historical performance of our loan portfolios,particularly commercial real estate.

We have implemented numerousproactive credit risk management practices in order to identify deterioratingloan assets early. Work them aggressively, yet prudently, in balance with ourcapital management strategies and utilize our reserves thoughtfully. We will,with confidence successfully work through the issues confronting both Citizensand the other banks with significant Michiganexposure. Charlie?

Charlie Christy

Thanks, John. Before, I reviewthe financial highlights, it should be noted that the third quarter of 2006still represents the legacy Citizens only, while the first, second and thirdquarters of 2007 on acquired basis. And for most of the differences, you see inthe report between the third quarter of '07 and the third quarter of '06, aredue to incorporating in Republic.

Net income for the quarter was$31.8 million, which equates an EPS of $0.42 per diluted share, and ROA of$0.96 and an ROE of 8.2%, all of which were in line with our expectations andslightly stronger than in consensus.

Following normal practices ofpresenting non-GAAP information, which excludes restructuring and mergerrelated expenses, and the amortization of core deposit intangibles, our coreoperating earnings were $34.2 million. Merger related expenses for the quarterin that were $1.0 million, which equates to $0.01 impact to GAAP EPS, and coredeposit intangibles amortization was $2.8 million, which equates to a $0.02impact to GAAP EPS. Therefore both adjustments generate a core EPS of $0.45 perdiluted share. As in the balance sheet adjustments in goodwill and core depositintangible assets, a return on the average tangible assets was $110 and ourreturn average tangible equity was 18.6%.

Key highlights for the quarter,we are still on track to achieve our target in annual cost savings of $31million, where 70% was expected to be realized in 2007 or 100% in 2008. Sincethe merger was announced in June of 2006, we immediately began to reduce our coststructure in order to meet these goals. Therefore, when you adjust our thirdquarter 2007 total NIE by the $1 million merger-related expenses, we are at theexpected NIE levels that basically exceed the target of $31 million annual costbase.

As we have noted before, we haveused the additional saving to help fund revenue generating initiatives in ourhigh growth market place, Northeast Ohio, East Central Wisconsin, and Southeast Michigan. So let's be clear. We are not donewith our cost saving initiatives. We realized it's important for our bank tocontinue to build efficiencies in our products, services, people, processes andculture.

We continue to see good customerdemand for our commercial and industrial loans across all of our markets, asevidenced by an increase of $83 million or 3.9% over the second quarter. Welaunched several revenue initiatives during the third quarter, and began seeresults in higher service charges on deposits, profit accounts, good volume inSBA lending, and continued strong performance in treasury management sales, andbrokerage and investment fees.

Key drivers for the quarter, netinterest income was down by $1.9 million for the second quarter of 2007, due tolow average earning assets caused by the branch divestitures which werecompleted in the April, decreases in the investment portfolio and lower demandin our consumer loan portfolios, as well as the lowered net interest margin.

Our net interest marginpercentage was down 5 basis points to 3.39%, when compared to the secondquarter, primarily due to a shift in our funding mix, which is common in theindustry, and a decrease in our commercial loan yields caused by increasednonperforming loans. The increase is the non-accrual loans equated to the 3basis points of the margin declined, while low cost deposit declines drove theremaining 2 basis points.

In the fourth quarter, weanticipate net interest income will be slightly lower than the third of quarter2007. We expect to see a continued migration of low cost deposit to high costdeposits, even though we have recently experienced the slowing of themigration.

Additionally, our expectationsinclude the effects of loan pricing pressures, the full quarter impact of themovement of commercial real estate loans to nonperforming status during thethird quarter of ’07, a slight interest rate curve in stable to decliningaverage earning assets due to the economic environment.

Provision expense was $3.8million, which was right on expectations. Net charge-offs totaled $7.9 million,which was expected as to our second quarter prior to quality results andinitiatives. We anticipate the net charge-offs for the fourth quarter of ’07will be similar to net charges in the second quarter of ’07, due to themigration of a number of credits, expected appraisal results and some increasein nonperforming loans.

However, most of the projectedcommercial real estate charge-offs already have specific reserves assigned tothem, which will not require replenishment of the reserve. Therefore, weanticipate the provision expense for the fourth quarter of 2007 to beconsistent with the higher than the third quarter of 2007.

Non-interest income was $30.6million, a decrease of $0.7 million from the second quarter. The decrease wasprimarily the result of a $1.2 million decrease in mortgage. The incomepartially offset by increased deposit surcharges and bankcard fees.

We anticipate total non-interestincome for the fourth quarter of ’07 will be consistent, a little bit slightlylower than the third quarter due to an anticipated decrease in the mortgageloan or risk financials.

Non-interest expenses decreasedby $10.1 million from the previous quarter while $7 million was due to lowrestructuring and merger-related expense. And other expenses related to mergerintegration activities, $3 million was a true run rate reduction as we will getrecognized for the full quarter impact of a computer systems convergence, thebranch consolidations in the branch divestitures which were all completed inthe second quarter.

We expect the fourth quartermerger-related cost to be approximately half the amount of this quarter, whichshould add all merger-related costs and activity. Excluding restructuring andmerger-related expenses and additional expenses related to merger activities,we anticipate total non-interest expense for the fourth quarter of '07 to beslightly lower than the third quarter of '07 due to lower salaries and employeebenefits of professional services.

Our income tax provision returnson more normalized level this quarter, primarily due to higher pre-tax income.We anticipate the effective tax rate for the full year of '07 to beapproximately 22% to 25%.

And lastly, our capital ratioscontinue to remain strong. Our Q1 ratio was 9.2%, and the total capital ratiowas 11.7%, intangible common equity was 6.04% and our leverage ratio was 7.51%.Back to you, Bill.

Bill Hartman

Thank you, Charlie. Insummarization, we're getting more comfortable with our understanding of therisk in our credit portfolio. We're managing expenses, as prudently as we canwhile we implement our enhanced revenue initiative in an attempt to build somemomentum in the current operating environment.

I'd like to briefly comment onour capital management strategy, which continues to remain prioritizing, numberone, in terms of maintaining the dividend. Priority number two, maintaining thecapital to support earnings growth, and priority number three, stock buyback.So, it is highly unlikely that you would see an increase in stock buyback atthis time.

Lastly, based on our lower netinterest income, projected flat to lower non-interest income, lower expensesand flat, but slightly higher provision expense, we expect earnings for thefourth quarter to be lower than our third quarter earnings.

That concludes our preparedcomments and at this point, we would be happy to open it up for questions fromany of the analysts on the line.

Question-and-Answer-Session

Operator

Thank you. (OperatorInstructions) We will take our first question from the side of Jon Arfstromwith RBC Capital. Your line is open, go ahead.

Jon Arfstrom - RBC Capital

Thank you, good morning.

Charlie Christy

Good morning, Jon.

Jon Arfstrom - RBC Capital

A question for you Charlie,probably on the charge-off guidance for the fourth quarter?

Charlie Christy

Yes.

Jon Arfstrom - RBC Capital

I just want to make sure Iunderstand, are you saying that we'll expect to see the loss reserve come downbecause of the specific reserves against some of the credits, and its possiblethat nonperformance come down as well. Can you help me think through that?

Charlie Christy

I would say that -- and John canadd to this, but I would say that the reserve would come down because basicallythe majority if not, almost all of those loans we anticipate to be charged-off.We already have the specific reserves. So we would replenish, but act it.

Jon Arfstrom - RBC Capital

Okay.

Charlie Christy

And on the commercial realestate, the large majority of the charge-offs as you saw in the second quarterwill be late in the commercial real estate too. So, these are things that weidentify in the second quarter, clearly this manifesting to as they migratethrough.

The nonperforming loans we wouldanticipate some more increases in those, probably not as high a level as we sawin this quarter, but John, why don’t you add some talks on that.

John Schwab

Yeah. So Jon, yes, non-performersmay creep up a little bit in the fourth quarter. But I think the way in whichare attacking some of these that have been in the nonperforming bucket, we maysee some material reductions on those numbers as well. So, net effect that wewill not see what we experienced here from second to third quarter.

Jon Arfstrom - RBC Capital

Okay. And then John, just afollow on that. It seems like your -- I wouldn’t call you optimistic, but maybeyou’re a bit more optimistic than you were a quarter or a two ago. And I'm justcurious if you could give us an assessment of how you feel about overall creditin your market, and do you still feel like you were able to go deep enough inthe first quarter and the second quarter to get your arms around everything?

John Schwab

That’s a very good question, Jon.I think the optimism that I may feel is that, because we have been diving andslicing in this portfolio for nearly a year now, I don’t think that there areany areas of the pond that we haven’t swum through. And therefore, I think wehave identified through these various credit risk management practices all ofthe stuff that really needs to be identified and now worked.

How do I feel about the economywithin our footprint, not very good. So, the extent to which the Michigan economy willcontinue to weigh on us and everyone else, there maybe future causes foreverybody to rethink that optimism. But as far as this portfolio that we havenow, yes, I think you appropriately read some optimism at my remarks, because Ithink we've looked at everything, including now, the portion of the pass creditinvestment real estate, and there is nothing really ugly that we've discovered.

Jon Arfstrom - RBC Capital

That's great. Thank you.

Operator

Thank you. And our next questioncomes from the side of John Pancari with J.P. Morgan. Your line is open, goahead.

John Pancari - J.P. Morgan

Good morning.

Charlie Christy

Good morning John.

John Pancari - J.P. Morgan

I can't go on off of Jon'squestion there, just a little bit more there. I mean sensed a similar type ofoptimism there, and I appreciate you for giving us some color there. Can yougive us a little bit more of your insight on any other parts of your portfolioincluding home equity, to the extent that you see any deterioration there. Justto give us an idea of what you are seeing in other areas?

John Schwab

Sure, John. The home equitydelinquencies have been creeping up, but that is not at this point an alarminglevel. Historically, neither of the legacy organizations would assume the over100% loan-to-value business. And frankly, loan-to-values in this market, andprobably, if we would have rephrase everything, everybody would be underwater.More importantly, we have the relied on the credit score and people's abilityto keep the cash flow coming. So, I really don't anticipate any material issuesin the home equity portfolio. Some of the delinquency patterns that we haveexperienced in our indirect Marine and RV are seasonal, are slightly up, butseasonal. It is nothing that is going to have us hit the wall.

John Pancari - J.P. Morgan

Okay. But as you said, what isthe current -- do you have a current LTV or do you have -- what's historicalLTV you have for that home equity portfolio?

Charlie Christy

Less than 85%.

John Schwab

And the delinquency rates, if yourefer to the table, John, in our press release, the delinquency rates from lastDecember are really quite in line with our delinquency rates as of the end ofSeptember in both the direct and indirect portfolios.

John Pancari - J.P. Morgan

Okay. Alright, and also that 85%is a historical LTV.

Charlie Christy

That's pretty much what the LTVwas, yes.

John Pancari - J.P. Morgan

Okay, alright. And then again,what is you average FICO for that portfolio?

Charlie Christy

On the home equity, it's 739 orclose around there; the indirect is about 720.

John Pancari - J.P. Morgan

Alright, okay. And then, and giveus additional color, I guess, on the commercial loan growth if you could, Iknow you indicated it's relatively solid. Can you just give us an idea of whatmarkets are you seeing that demand?

Bill Hartman

Yes, it's Bill Hartman, John,yeah. We are seeing its all over, at this point predominantly driven bySoutheast Michigan, but also seeing some good growth in our Green Bay and Appletonmarkets as well. And we anticipate future good commercial growth in our Northeast Ohio market with the new team that we've puttogether there, and as they continue to develop some fairly nice backlogs.

John Pancari - J.P. Morgan

Okay, that's helpful. And then,last question is on the service charge number. I know you had indicated thatsome efforts there have been helping in terms of your fees that you'recollecting. I just want to get an idea of the sustainability of the level thatwe see this quarter, if you have any outlook on NSF charges or any of the feesrolling up to that line?

Charlie Christy

Well, this is Charlie. We arelooking at a number of different fees because it has been about two plus yearssince we, or may be three years since we have had any increases in certaincomponent fees. And there is a lot of different types of fees. So, we startimplementing some of those, we clearly don't want to overcharge. We still werenot the highest in the market, whatsoever in those types of fees.

Now the sustainability,obviously, it has its seasonal aspects too, but we feel that the third quarterwas a good indicator of our future run rate.

John Pancari - J.P. Morgan

Okay, alright. Thank you.

Operator

Thank you. And our next questioncomes from the side of Scott Siefers with Sandler O'Neill. Your line is open,please go ahead.

Scott Siefers - Sandler O'Neill

Good morning guys.

Bill Hartman

Good morning, Scott

Scott Siefers - Sandler O'Neill

Just wanted to drill down ontothe credit a bit more, I guess, if I'm understanding it correctly, its soundlike, non-performers on an absolute basis will probably still go up in thefourth quarter inspite of, I guess some pretty significant charge-offs also infourth quarter. And I guess, my question is, I guess, we boosted the reserve ona net basis by about $12 million or so in the second quarter, it went from 169to 181. So, looks like you will have eaten up, I think, all that incrementalreserve, Bill, but with non-performers still increasing, the cover ofnon-performers will start to look down, pretty clear. And I guess, I'm justcurious, at what point what added that coverage or continued deterioration incredit, necessitate another reserve, Bill?

Charlie Christy

This is Charles. I'll just answerreserves calculation, and John can maybe answer the other part of the nonperformingthing.

Basically, as we worked for ourreserve, we obviously, that's an art version to science, and you have thespecific portion, the formula portion, and obviously then, your qualitativeportions and the general reserves, and so on. It’s important to realize thatwhat we did in the second quarter on top of booking extra reserves, we didallocate different parts of the reserve to specific, and grew in certain areaswe though would -- the risk needed to be covered. So, that’s why it'sfollowing, kind of how we predicted here.

The reserve growth would onlyoccur if you see that phase will start coming in, when we actually need tobolster back up to the nose. So, it all depends on how, with the next comingquarters that the phase or some things like that start coming in, whether ornot they will be worst than all the reserve began, so partially charged down.And that will drive whether or not that you have to book higher provisional oryou are allowed some of the reserve to continue to migrate down.

John Schwab

Scott, I might add to that. Firstof all, I would emphasize, our historic practice of moving deterioratingcredits as quickly as possible into our special loans workout group, get someinto a discipline that is very, very hands on. As these loans becomenonperforming, when they move into special loans group, appraisals, valuations,liquidations analysis are done, and that drives our reserve process. So, I canrepeat the comment that we made earlier that those that we have forecasted ascharge-offs for the fourth quarter have essentially been fully reserved.

So what do we see going forward?Well, we see still have some loans that have moved in to that group, that werein the process of assessing what the underlying real estate values are, are theprojects completed? Is it going to take some more to complete them, and what isour best strategy in working with individual customers and their ability towork with us and working through the situations? So, I don’t see huge increasesin nonperformings. And I see some significant reductions as we rid ourselves ofsome of these exposures that have already been reserved.

Scott Siefers - Sandler O'Neill

Okay. And then, as prior to thisquarter, I think the vast majority of stuff that was coming onto nonperformingand the watchlist was on the legacy republic franchise. As stuff continues tomigrate in, either due to watchlist or into nonperforming. What is your senseof how much of that is coming from legacy republic versus kind of combined -- Iguess the legacy to this in franchise as well?

Bill Hartman

Those we shared with the Boardyesterday, we’re all on the same team now. But I'll just say this. It is thelarge majority, is commercial real estate.

Scott Siefers - Sandler O'Neill

Thank you very much.

Operator

Thank you. (OperatorInstructions). Our next question comes from the side of Terry Mcevoy withOppenheimer. Your line is open please go ahead.

Terry Mcevoy - Oppenheimer

Good morning.

Bill Hartman

Good morning Terry.

Terry Mcevoy - Oppenheimer

I guess a similar question towhat Scott just asked, the increase in MPA is particularly on the landdevelopment side. Geographically, has that changed at all over the last twoquarters, and I guess, earlier on, as you were analyzing credit, did you focusinitially close to home in Southeast Michigan as you have expanded across thefranchise. Is that the increase or has it been pretty even quarter-to-quarterin terms of the geographic breakdown, and right into Wisconsin as well.

Bill Hartman

Actually, Terry, the landdevelopment loans that have tipped into nonperforming over the last quarter arelargely Southeast Michigan. I am taking a lookat the list that flopped into nonperforming during the quarter, and for loansconstitute $17 million of the increase, and that are all in Southeast Michigan?

Charlie Christy

Hi Terry, this is Charlie. Youhad Southwest Wisconsin. So, I think, what weare seeing in Wisconsinis a very clean portfolio performing very well at hand. It does not have theF&M kind of historical loss factors or credits issues. And then also, thereis a market that we are seeing good growth, both in loans and deposits. So, weare very, very pleased with where Wisconsinis performing from a growth perspective and a credit quality perspective.

John Schwab

I would add to that Terry thatthe Wisconsin market, we are seeing some goodopportunities in the commercial real estate projects, and a couple of veryinteresting healthcare industries. So, we are getting some growth over there,and I think the heavy lifting was done in Wisconsin at several years ago, and welooked to that market to sustain some very good growth.

Terry Mcevoy - Oppenheimer

And on the revenue generationinitiatives, is the ball rolling on every potential initiative as the few morementioned this quarter? Are there still some others that will be put forth inthe fourth quarter into 2008?

Bill Hartman

Yeah, Terry, Bill Hartman. Theinitiatives we have in place are all the primary initiatives that we are goingto use to drive the increases in 2008. To use your term, yes, the ball isrolling on all of those. We expect to see significant reintegration of thesales and sales management processes in all of our lines of business, that'sobviously one of them. Charlie mentioned a little bit earlier in the call, someof the fee income things we are looking at, both in terms of pricing and interms of waiver levels. We think the business-owner banking initiative, thevery small businesses, its a great opportunity for us given our product line.

We think there is going to be alot of improvements in that area. So virtually, all of these things are workingwell. I want to also comment on the back-office. We think that there are somesignificant improvements we can make in reducing cycle time, turnaround timeand responsiveness to the frontline from the back-office. We think that's goingto make revenue enhancement a little bit easier.

And then lastly, I want tocomment on the continued success of our asset-based lending group, as you willrecall, that much like the Northeast Ohioinitiative was in essence, a list-out type of initiative, and its been very,very successful. And we look for continued growth in that revenue initiative aswell.

Terry Mcevoy - Oppenheimer

One small question for Charlie,merger-related charges, is the fourth quarter, is that, will we see any ofthose in 2008? And then, as you look to report 2008 earnings, where youcontinue to have to kind of breakout core operating earnings, and then mentionthe amortization of core deposit intangibles or will we just see one cleannumber next year?

Charlie Christy

Good questions. Themerger-related items, and it's due to accounting of how you have to handlethings. That ends at the end of '07. So, there should be no -- anything trickleinto '08 related to merger-related activity.

The reporting of core operatingearnings is a very standard kind of calculations for that one page that we haveor does that reconciliation, we usually do that, is because, in purchasedaccounting you have the goodwill number. So, when you start comparing return onequity to other things, they have lot of organizations that you are comparingto. Some of that purchases stuff have it, and therefore, it's better to havethe intangible common equity comparison between other peers. And so that's why,we'll continue to show that, but you really just have the one adjustment, andwe just try to stick to what the SEC allows in that kind of calculation.

Terry Mcevoy - Oppenheimer

Thank you.

Operator

Thank you. And it appears that wehave no further questions in the queue at this time.

Bill Hartman

Well, in that case, thank you allvery much for joining us. And we will be happy to answer any questions or helpin any way we can at any time. Thank you.

Operator

Thank you. This does concludetoday's teleconference. Thank you for your participation. You may disconnect atanytime, and have a wonderful day.

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