First Merchants Corporation (FRMEP) Q1 2012 Earnings Report, Transcript and Summary

Good day, and welcome to the First Merchants Corporation First Quarter 2012 Earnings conference call and webcast. [Operator Instructions] I would now like to turn the conference over to Mr. Michael Rechin, President and Chief Executive Officer. Mr. Rechin, the floor is yours, sir.

Thank you, Mike. Welcome, everyone. Thank you for joining our earnings conference call webcast for the first quarter ending March 31 of 2012. As in prior calls, joining me today are Mark Hardwich, our Chief Financial Officer and John Martin, our Chief Credit Officer. They’re going to be adding detail as well as myself to our press release, which went out just after 10:00 this morning and our presentation speaks to material from that release, which is assessable on directions from the webcast contained at the backend of the release. My initial comments will start from Slide 4 titled, First quarter 2012 Highlights. Well, we’re pleased to be with you today. We had a strong core first quarter; $0.25 earnings per share, fully diluted, nearly a 50% core earnings performance over the first quarter of last year, our best core banking quarter since mid-2008, all of that within the $0.46 per share on absolute reported basis, 171% increase year over year. And a lot of that difference comes over an exciting happening for us. Second half of last year, in September, we actually firmed up the repayment of our CPP obligation, and I thought it put is in a position to be a little bit more outwardly focused and I think we’ve communicated on calls like this the last few times, our willingness to look at smart non-organic growth opportunities. So in the first quarter, we made a rapid assessment and, I think a smart bid, on a FDIC modified whole bank transaction and were successful in acquiring the loans and assuming the deposits of Shelby County Bank, which is referred to several times in this work as SCB. So while the immediate impact is strong, as evidenced by the $0.21 kind of immediate accretion, I think we’re more excited about the upside as we watch the acquired loan portfolio perform and watch our people interact with those of the bankers that joined us for SCB to put a first-class, First Merchants effort on the field in Shelby County, Indiana. Outside of that, I’m pleased to see revenue coming back at us, slow growth there, but as the slide indicates, $1.7 million year-over-year kind of equally split between net interest income and non-interest income. I think while there’s elements of the margins that are under pressure, our bankers are doing a great job in the value exchange in the field, preserving that at a pretty high level. And then we’ve had some success in restoring fee levels across several service categories, kind of in the post Reg E era. Mark here is going to talk to you about a couple of these bullet points. But we really feel like in the quarter, we eclipsed the few capital targets that we had set for ourselves going back a couple of years, specifically as it relates to the common equity level, getting through the 7% level and then the tier 1 common at 9.20. We’re pleased with that. As mark will talk about, the composition of our funding, it really is core funded from our customers in almost every respect. And then the lower rate profile speaks to what will be John’s remarks about his continued shepherding of the -- not only a traditional loan portfolio, but what our early findings are coming out of Shelby County. So at this point, I was going to turn the call over to Mark.

Thank you, Mike. My comments will begin on Slide 6. Just in looking at our balance sheet, our interest bearing assets increased year-over-year by about $144 million or nearly 4% due to increases in loans, investments and banked-owned life insurance, on lines 1, 2 and 5. And on the linked basis, our interest bearing assets increased by 97 million as our purchase of certain loans for the FDIC as of quarter end totaled 89 million, net of the $19.2 million fair value marks that we didn’t put on the SCB loan portfolio as of quarter end. Allowance on line 3 totals 2.5% of loans, or $70 million and specific reserves totaled just 5.9 million as of quarter end. That’s the lowest level of specific reserves since mid-2007. The remaining $64.5 million of the allowance, or 2.4% of loans are general allocations or ASC450 reserves. The composition of our loan portfolio, on Slide 7 is diversified, it’s granular and allows for pricing power. Our Community Bank balance sheet produces a 5.17% yield on loans for the quarter, down 39 basis points from the first quarter of 2011. As a commercial bank, our loans are predominately C&I, owner occupied, CRE, investment real estate and agriculture product loans. As for our SCB growth, we were pleased to see core commercial loans increase by $21 million year-over-year -- I’m sorry, $21 million over year end 2011. On Slide 8, our $960 million bond portfolio continues to perform well, producing higher than average yields with the moderately longer duration than peer. Our 378 yield compares favorably to peer averages of approximately 314 and our duration remains just a year longer at 4.1 years. The net gain on the available for sale portfolio that’s identified on the slide is at 29.3 million, but if you include our held to maturity portfolio, the total gain in the bond portfolio is $37.2 million. We have 99 million that will mature throughout 2012 with the yield of 350, and 113 million that will mature in 2013 with the yield of 314. So the tax equivalent of 378 should hold in pretty nicely as we go through the remainder of this year and into 2013. Now on Slide 9, I’m pleased by the progress that we made with the right side of our balance sheet. Non-maturity deposits, line 1, are up again and represent 70% of total deposits. Our broker deposits and Federal Home Loan Bank advances are only being used to inexpensively link the liabilities for ALCO purposes as we work hard to continue to be asset sensitive and prepared for rising interest rates down the road. During the quarter, we repaid $79 million of PLGP borrowings and replaced them with longer maturity obligations at much lower rates, saving around 180 basis points. It’s important to note that the SCB transaction actually self funds from a liquidity standpoint, and given the size of the gain, it also self capitalizes. Tangible common equity continues to grow nicely as changeable book value per share now totals $10.05 per share. The mix of our deposits, on Slide 10, continues to improve and our total deposit expenses now just 66 basis points, down from 105 basis points as of the end of the first quarter of 2011. Shelby County, or the SCB deposits, totaled 99 million at quarter end, down for 126 million on the purchase date. The run off was consistent with our M&A modeling as 21 million came from higher-priced Internet CDs. We really took advantage of the opportunity to reprice CDs through an FDIC transaction that you don’t typically have or do not have in a traditional merger. So we were pretty aggressive about modifying the interest rates on their CD portfolio to equate to market rate. All regulatory capital ratios on Slide 11 are well above the OCC and the Federal Reserve’s definition of well capitalized and the Basel III proposed minimum. We were especially pleased to cross a couple of key thresholds, as Mike mentioned, with the tier one common equity on line four growing, it now eclipsing 9% and a TC on line 5 now greater than 7%. The corporation’s net interest margin on Slide 12 totaled 3.96% for the quarter. A single basis point of improvement over the first quarter of 2011 and then interest income increased by 700,000 over the same period. Total non-interest income on Slide 13 always reflects some volatility due to line 6, securities gains and losses. Now, this quarter we’ve also added, or excluded line 8 from our totals, given the one-time gain on the FDIC transaction. Even after excluding $9.9 million of gains on line 10, line 10 still improved by $1 million over the prior year. Non-interest expense, on Slide 14, totaled 34 million for the quarter, up just 100,000 from the prior year as employee benefit expense increased by 1.2 million. While higher than the first quarter of 2011, the run rate of salary and benefits is really very consistent with quarters 2, 3 and 4 of last year. But they do compare unfavorably with the first quarter of 2011. Please turn to Slide 15. This is a busy slide and we’ve tried to minimize the number of extraordinary items. However, we still have several. The pre-tax pre-provision run rate remains strong and continues to improve, and I think it’s important to highlight the one-time gain from TARP, the exchange that we had back in 2010 and then the loss that we experienced on the repayment of TARP in 2011. We’ve discussed and presented the one-time gain from our SCB transaction in a similar fashion, however, it’s very different. The TARP gains and losses that we experienced in 2010 and ’11 were non-cash, driven really by accounting treatment, for the gain on the modified Whole Bank deal with the FDIC is the result of acquiring assets for a $29 million discount, or 25% discount. We’re hopeful that over time, as we move forward and work through the loan portfolio that we’ve acquired that at least a nice portion of the remaining 19 million will find its way back into our income statement. Now turn to Slide 16. Our employees and management teams are very pleased with our adjusted trend lines and we hope that you, as shareholders are as well. Now John will discuss our satisfying credit quality trends.

Thanks, Mark. Please turn to Slide 18, where I’ll begin by covering the asset quality summary. On line 1, non-accrual loans are down in the comparable quarter year over year from $87.7 million to $74.5 million. In the linked quarter, non-accrual loans were unchanged in the core portfolio. With respect to the acquired portfolio, we performed an initial due diligence followed by a full commercial portfolio review, which resulted in an increase in a $4.9 million of newly identified non-accrual loans. All these loans have been paying current, due to well-defined weaknesses, or identified weaknesses. In the high probability of potential loss, we moved those loans to non-accrual. On line 3, restructured loans decreased from $14.3 million to $6.7 million. As outlined in previous quarters, we primarily employ a strategy of restructuring loans to AB Restructurers. As mentioned on previous calls, the A note is underwritten and structured to market terms and conditions while the B note is charged off. We account for these by classifying the A note as a TDR and once demonstrated repayment has been established, we no longer report the loan as a TDR. If the loan is modified due to the borrower’s financial situation other than in an A-B note restructured as outlined, it is identified as a TDR for the entire life of that loan. In targeted situations, we have found the A note -- excuse me, A-B note restructure to be effective in assisting the borrowing in identifying the loss and returning the loan to performing status. On line 4, 90-day delinquent loans continue to remain low, with one half of the total resulting from the fair value portfolio. And on line 6, impaired loans were lower in the core portfolio both in the comparable quarter year over year and in the linked quarter, declining from 116.8 million and $79.8 million to $78.9 million respectively. The $15.4 million of impaired loans from the fair value portfolio includes all loans that were individually identified in the fair value analysis. Moving down to line 7, the allowance for loan and lease losses, while $500,000 lower, remains at 2.58% of the core loan portfolio and 2.5% of total loans. The change in the allowance remains directionally consistent improvement in the linked quarter in our core portfolio and classified assets in line 9. We continue to see migration upward and would expect to see improvement in overall criticized assets, in line with the improved performance in our customer financial results -- customer’s financial results. Before moving onto the NPA reconciliation, please turn to Slide 19. The lower bar graph shows the impact of the newly identified fair value portfolio non-accrual loans. The core portfolio non-accrual loans were relatively unchanged in the linked quarter, while we had 4.9 million in loans identified post closing that have been adjusted for fair value accounting. If the fair value accounting adjusted non-accrual loans are excluded, the overall coverage to non-accrual loans remains flat at 101%. Now, please turn to Slide 20, where I’ll walk you through the NPA reconciliation. Before I begin, I should point out that on this slide, the migration results include fair value portfolio loans. Now, beginning in the gold box in Q4 2010, I’ve once again highlighted the improvement in asset quality over the last year and a half. NPA and 90-day delinquent have decreased 25.8% and show significant improvement. Then moving to the far right column, Q1 2012, I will now step through the migration changes. On line 2, new non-accruals of $16.4 million were impacted by the fair value portfolio this quarter. Absent the addition of the $4.9 million in new non-accrual fair value loans, new non-accruals were in line with expected migration. To provide color, there were 8 customers greater than $250,000 comprising of the total new non-accruals. On line 3 and 4, we reduced $2.7 million in non-accruals and had $2.5 million in new other real estate owned. And moving down to line 5, gross charge offs were lower in the quarter at $6.3 million compared to $10.7 million in the linked quarter. As in the press release, the net charge offs for the quarter were $5.4 million compared to $8 million in the linked quarter All in all, our core non-accrual inflows were met with reductions and the driver in the increase was the addition of the newly identified fair value non-accrual loans. Moving down the migration to lines 8, 9 and 10. We saw a $700,000 net reduction in other real estate owned. $745,000 of the write down in line 9 resulted in the receipt of a current appraisal. The $15.6 million OREO portfolio has roughly $7.5 million of real estate under letters of intent pending zone or other issues impacting a potential sale. We continue towards resolving these issues, the progress is slow. So jumping down to Line 13 and 14, non-performing assets and 90-plus day delinquent loans declined $3.8 million, continuing the improvement in overall asset quality. Then turning to Slide 21. As mentioned, the migration analysis, net charge offs were lower for the quarter with the allowance remaining relatively unchanged. We provisioned $4.9 million of the $5.4 million in net charge offs. Our allowance methodologies continue to be actually consistent in future improve asset quality will of course, drive lower provisioning and overall allowance levels. Now please turn to Slide 22. In summary, asset quality trends continue to improve as measured by the lower level of classified assets and lower delinquent loans. We continue to work our way through the non-accrual and ORE and we continue to have success restructuring the loans while our charge offs and provision expense continues to remain at lower levels. With respect to new business, the internal measurement of pipeline saw improvement at the quarter and finally through the initial due diligence, the post-closing loan review and the ongoing discussions with the bankers in Shelbyville, we believe that we have a portfolio that is similar to our own composition and fairly marked based on our analysis. I’ll turn the call back over to Mike Rechin.

Thank you, John. I was going to make a couple of closing thoughts on Page 24 before opening the lines for questions. And I'm’ pleased when I look at this slide with the consistency of the initiatives that we have quarter-to-quarter. Our Chief Banking Officer keeps our retail, commercial, mortgage line of business folks constant in what we’re prioritizing. The one new item here, I would mention before I get to the middle part of the page would be the integration that’s in front of us. We look to grown in Shelby County, and a key component of that for customer satisfaction is to get them using our back offices as quickly as possible. And so our integration of SCB is scheduled just after the first week of July. So it will have taken place by the time we speak next in this call following the end of our second quarter. We go into that with a full expectation that it will perform off of our core systems and product offerings as have our last integrations. Going back to the middle of the page, market coverage tactics across all lines of business, including SCB, as John referenced, the portfolio feel around the kind of middle market calling we do around the company and SCB to us is more than a financial transaction and we view that as a core franchise community where we can excel in lieu of the regional banks, which occupy that same market. And so the market coverage tactics we use in all the lines of businesses are being deployed there today. And I’ll reference our pipeline here in a minute to give you a snapshot of how we think we’re doing. From an FTE standpoint, in terms of sales, folks, we’re pretty much full at this point. I know we highlighted over the last couple of quarters the willingness, and we sought the access to some high performance individuals, commercially oriented primarily both in investment real estate and C&I. We’re towards the end of adding those and the beginnings of their efforts are beginning to show up and we’re pleased with it. The one area where we’ll continue to add some people would be in business banking. It’s that unit that we have that linked to the retail bank, less than $10 million revenue dedicated, underwriting a little higher velocity for the effort. So what’s it producing? Our balance, I personally thought that we might make a little more headway in terms of balance sheet organic loan growth. On the commercial side we had a good quarter where we grew at about a 2% annualized rate, $11 million in commercial. Knowing that it’s offset by the mortgage business, whose volumes are huge, but where we continue to maintain our original and sell strategy that drives the size of gain on sale on interest income line. The consumer part, we’re still scratching our head, that we’re putting a huge amount of effort for making sure that our consumer customers know our willingness to use our balance sheet on their behalf. It doesn’t have the traction we would have hoped to. We’re just going to be consistent with it. Trying to quantify that a little bit more, I referenced our mortgage business, made a decision almost a year ago to do a lift out of a team that would diversify our volumes and maybe take some of the interest sensitivity out of what is the refine market, by owning a larger share of the purchase business, especially in the growth markets we’re in, in Indianapolis and Columbus. And that’s where it got pretty well and so as we sit here, early in the second quarter, our pipeline, for the mortgage business is at $71 million, is $15 million higher than last quarter. And on a seasonal year-over-year basis, $25 million, we’re almost 50% higher than it was a year ago. Those same kind of numbers exist in our commercial side of our business company. I referenced the investment we made in bank, but even apart from that, the marketplace is mildly stronger. There’s more business owners that are willing to hear our ideas and our market coverage is growing. So our pipeline there, and to be consistent definitionally on these calls, we’ve talked about a pipeline as opportunities where the credit has been approved in front of the customer and most cases in some early stage of documentation. That figure at, on the commercial side of the house, at roughly $165 million is 60% over the first quarter of last year and about 33% over year end. And so that growth I alluded to a moment ago, we would expect to continue at a single digit rate. I don’t think it’s going to go through the roof anytime soon, I think we’re applying our appetite and our calling efforts prudently. One more metric I’ve shared with you in the past, it’s our early stage pipeline. It’s less firm but it’s equally as strong as it was last quarter, at $365 million and it’s about 65% higher than it was a year ago. That’s probably a less seasonal figure, but I think as compared to last quarter it’s about flat, knowing that we harvested some of that onto the balance sheet. It’s just another source of optimism for me. I think we can do better there, I look for us to. We’d like to grow as I referenced last fall, on outstandings on all categories. And this year we will, because of Shelby County. I’d like to do it above and beyond that meaningful addition to us. Going back to my slide, the last point under growing revenue was this retail CRM, we’re still very, very excited about it. That product would go into our banking centers and support both traditional retail and business bank unit. We’re probably a quarter or two behind where we might have otherwise been, so that’s kind of a late 2012 initiative for the instillation, which we think has some upside. The bullet points directly beneath it, there’s one that I kind of think of differently from the way that I write it. When I say banking’s a rationalization, I know what Mike Stewart, our chief banking officer, is working on is really just a better understanding of banking center effectiveness or banking center profitability. We are, 18 months now, past full implementation of staffing model that’s produced some efficiency. But the real purpose of that was not only to be smart from an expense standpoint, but to try and glean a cleaner view of a given market’s potential and how we perform in that market on a sequential basis. So I would look for some decisions to be made around how we can best be aligned retail wise, certainly by the second or third quarter of this year as we make some decisions. The last bullet point there, just to be more specific, our credit folks evaluated last year the investment in some automated auto dialer technology. We made that investment in the fourth quarter, so we’re fully trained on it. And the 2 tangible results we have early for you, you might have seen them in John’s work, our consumer delinquency really dipped based on the really rapid ability to get to our consumers and bring to bear the knowledge they need to keep their obligations current. And then there’s some FTE savings associated with that technology as well, that have already made their way into our headcount and our expense phase. Last bullet point, beyond Shelby County, is what appears to be very, very attractive. We want to continue to participate thoughtfully in the accelerating industry consolidation. We are confident in our integration execution, confident in our product offerings, particularly I say that as we kind of transition a lot of our retail formatting in the post free checking world into products we think offer great value and serve that deposit mix that Mark spoke to. And then lastly, our service level. We’ve been in the retail line of business, knowledge is perhaps our greatest customer facing business and the consistency in the way in which we approach our customers, trying to add value is really in great shape. So we think we’re a good candidate for that if we can find the right opportunities, either in a traditional way or should other FDIC transactions be in geographies where we think we’d perform well. I think you picked up in the tone of my colleagues, we feel good about –- guardedly good about where our company is going as the economy kind of continues in our footprint to evidence a little more strength. So I’m going to turn over the call back to Mike to take some questions.

[Operator instructions] And the first question we have comes from Steven Geyen of Stifel, Nicolaus.

Mike, I appreciate the additional color at the end, maybe some additional thoughts. You know, I was looking at this loan portfolio and just the changes quarter-to-quarter, and trying to get a sense of the different categories that are broken down there, and that the growth rate quarter-to-quarter and how we should look at that with the acquisition and the production that you had?

Sure, if you’re looking at the 5 quarter trending of loans by type, it sounds like that’s what you have, Steve. I’d be happy to work with you on that, I thought that we could grow organically everywhere if you take the $90 million -- it’s actually $89 million, but if you back the $89 million out of the March numbers, you can see that we marginally shrank just about $10 million dollars. Our consumer portfolio was down about 13, our mortgage portfolio was down 9, and again that’s mortgages that we keep on the balance sheet -- and our commercial banking business was up 11, I think that’s consistent with what I shared. If you look into the March 31 numbers, with Shelby County included, as they are on this page, and if you broke down what’s in that $89 million, they had -- we have, I should better said, $22 million of home equities, $8 million in consumer, $10 million in first mortgages, and 50 in a combination of investment real estate and CNI lending. And you know, the other thing I would mention about it is, Mark talked about the transition on the deposit side of that bank, we haven’t had any movement given the fact that the most troublesome assets were left with the FDIC. We’re pleased that we’ve had great stickiness around a portfolio that so far feels good to us, like a lot of other FDIC failed bank candidates. A lot of the things they probably wish they did differently were outside their market, and so the temperature of the customer we find is the way they treat them there has gone well for us.

That’s helpful. And maybe a question for Mark, or John. Looking at the general allocation for the reserves, just curious how you look at that with the economy slowly improving a little bit, if you might make some changes to that. And then also, is there a look back period on that charge offs as well, is it like a 2 year, 3 year look back period on the charge offs that go into that general allocation?

We do have a look back period on the historical allocation component, and it’s 2 years. At one point it was a little longer, but we’ve shortened it over time and our expectation is that we are more likely to be able to provide similarly to what we did this quarter to our net charge offs and that as the portfolio continues to improve, as the historical numbers continue to improve, that we will be able to continue to reduce the amount of provisioning relative to charge offs.

The only other thing I would add is kind of at the end of my comment, which is as asset quality in the criticized assets come down, that obviously drives the model and will allow for us to provision less.

Great, and last question, the seller employed benefits, you talked a little bit about that, the expense management was really exceptional. And just curious if there is any one-time items in that, or is this kind of a good number to work off of.

Yes, there were some one-time items that we didn’t really highlight, they kind of offset. There was a one-time item in the bank of life insurance portfolio, that was essentially offset in the expense categories. We did have a death claim in the bank of life insurance category and on the expense side, we had some -- a handful of fixed asset write downs, the cost to continue to maintain the Shelby County systems and processes prior to integration and, net of taxes, all kind of equaled out to around $600,000 or so on the bottom line.

I think it’s fair to say to Mark’s expense side of that answer, Steve, that we’ve got some ongoing expenses with Shelby County that will run through the integration because their Jack Henry system we continue to support. That will go away, that is a small 6 figure number. Then we have about $200,000 of what we call temporary expense for some of the employees involved in that same effort, and then we have some one-time investment banking cost that were just over $100,000 with the transaction itself.

The next question we have comes from Scott Siefers of Sandler O’Neill.

Let’s see, I think first question I had is probably one of the most appropriate for Mark, just curious on your ability to sustain the margin, doesn’t sound like you’re necessarily too worried about the investment portfolio, but I would be curious to hear your thoughts on pricing pressure on the loan side, and any additional room you have on funding costs as well. And then, along those lines on the margin, if you could talk about whether or not Shelby had any impact on the margin in the first quarter, and then what you would anticipate it would do going forward.

Yes, we’re fairly optimistic about our ability to maintain our margins through the remainder of this year as we move our way into 2013, I think it will be under a little bit more pressure. The remainder of this year, if you look at loans over a 12 quarter period, they decline 39 basis points. The yield in the bond portfolio were somewhere around 20, but our interest expense on the deposit side came down from 105 to 66, some of the optimism that I have for the remainder of this year is just continuing to price down the CD portfolio as it runs off at about 50 million a month, and then some optimism around the ability to replace, or re-price wholesale funding as we work through the year. Just in the month of April, we had 16 million mature on the wholesale funding side of 480, we have another 26, almost 27 million in May at a 470. And over the next twelve months, those totals are 75 million that cost 440, and we can replace all of that funding, even protecting the balance sheet for rising rates, you know, out longer term and still pick up 200 to 250 basis points of cost savings. I mentioned that the TLGP that we just did on the last day of the month was a $79 million reduction of borrowings that were costing about 320, and we replaced those somewhere in the 140 or 150 range. And so, we’re keeping up on the wholesale funding side and on CDs, and I think that will continue through the remainder of the year. But as wholesale funds and deposits trying to cut more of a floor, it will be a little more challenging in ’13, and it’s more imperative that we achieve the loan growth, or the balance sheet growth, really either sides, either loans or deposits to continue to make up for whatever margin compression that we might see in ’13.

Okay, and then that outlook for -- pretty stable through the course of this year, that includes any impact from Shelby in there?

Yes, I should have -- sorry, I didn’t answer that question. It looks like, you know, Shelby is going to -- I mentioned today that it self-funds, that we have a little more in deposits that we have in loans, and so far through our 50 days of experience or so, the margin is over 4% at Shelby County. So, we’re pleased with the way it’s performing to date, and then some of the yield accretion that we certainly hopes happens over time, I’m sure will help enhance the spread of that transaction as well.

Okay, perfect. And then along the lines of the Shelby deal, have you guys gotten any of the cost saves out today? I don’t think any of the branches have officially been closed yet if I’m recalling correctly, and then obviously you have the integration. So, are the cost saves at this point all prospective, or is there anything that got in the run rate in the first quarter?

We did get a little bit in the run rate from an FTE standpoint there was -- but the 2 items that you referenced are both in front of us, you’re right. So we’re kind of are -- we have some money that will be saved, the banking centers close next week actually, the ones on which we decided not to keep open, and then as I referenced, integration, and those have roughly the same amount of FTE and direct cost impact to them, is, right after the end of the second quarter, around July the 7th.

The next question comes from the location of Daniel Cartinest of Raymond James.

Can you give us some color, or I guess some update on how the Indianapolis market is looking for you guys. Are you seeing more growth opportunities, and what’s competition like, you know, now that a couple of other community banks are trying to move into the market?

Yes, the - you know, we like our rock steady progress there, that it’s the -- when I reference business banking in my prepared comments, Dan, that the core market and the peripheral markets to Indianapolis is where the majority, not all, of those business bankers are being deployed, the deepest market for that sector. On the core and middle market business, we’ve had the largest amount of growth there in 2011 and have a projected largest amount in 2012, as well. To the extent that the commercial real estate is resuscitating itself, that’s where we have the best focus on the most capable developers, and so, that just is an added arrow in our quiver, if you will. As it relates to the other banks that target that same market, that’s not who we’re taking share from. So, I acknowledge their efforts there, they will probably do an adequate job. But to the extent that we’re taking share there, it’s really from the regional banks.

And how big is it in terms of total loans, how big is Indy right now?

Well, we combined it -- Shelby Country, for instance, would go into our Indianapolis mark, but it’s just under $1 billion.

Okay, great. And then as I look at your capital levels, kudos on breaking the 7% PCU ratio. What’s kind of the lower end of your comfort zone now with that ratio?

Well, as we mentioned, it’s been a long time, I think 2001, since we were above 7%. We, internally, feel like that 7% of TC and 9% tier one common is really kind of the lowest that we should operate, at least based on the current environment. And so, those are big hurdles for us, it gives us a little more flexibility as we evaluate the SBLF or our B of A relationship and those type of things. So, certainly if the right acquisition came along we would have to evaluate if the modest amount of dilution and what the payback period would be, and whether, you know, any type of enhancement would be required. But we feel really good about these levels, we think this is really an optimal spot for us to operate.

Okay, good, and then just one quick question on the MNA front. I mean, are you guys seeing more opportunities present themselves to you, or is the market still a little slow?

I think the market is slow. our efforts are outbound if you think of it like I am, Dan, meaning that the companies and the franchises, and the executives associate with the kind of targets that we think we could do a nice job, but are effectively are the same as they would have been 2 years ago, we just spend more time on it. But in terms of things coming to us, I haven’t noticed a difference, especially if you take the kind of FDIC type of transaction out of the mix. In terms of feeling that people need to combine with another company based on industry outlook, or the cost of running a bank, we haven’t seen that yet.

And the next question we have comes from John Barber of KBW.

You mentioned CD run off would be at 50 million per month, what’s your retention rate on that and where are you currently pricing on your CDs?

We’ve been keeping probably -- their retention rate is improving early on in the cycle when we were -- when rates dropped so dramatically, we were seeing higher run off as people were rate shopping kind of the single purpose accounts that we happen to have. But it’s worth somewhere in the 80 to 85% range over tension at this point. Our offer rates are, you know, right around 1%, the best rate we have is around 1%. So, most of our customers that are coming through those buckets, kind of on an annual 12 to 18 month basis, and their staying parked in fairly short offerings that are probably less than 1%. So, we’re trying to extend, we think that ultimately would be smart for us and the performance of our margin over time, but the customers are still wanting to stay awfully short.

Okay. And then on the SPLF, how should we think about the coupon going forward, and do include the acquired loans?

No, our understanding of the program from the day that we got in it was that acquired loans don’t count, and so, that wouldn’t accelerate our ability to enjoy or earn a lower rate, and we still, given that we’re in our -- wrapping up our third quarter, so, measuring our outstandings underneath that definition will get done here in the next couple of weeks. We would expect them to grow modestly, but I don’t think we’re on a rate where we would realistically expect a coupon or a rate decrease on that capital component in the near term.

All right, thanks, and last one that I had, mentioned the payback period is one of the considerations in MNA. I guess, what’s a reasonable period in your view?

We think 3 to 5 is probably, you know, probably the right place. I don’t get outside of 5 years, I think it’s pushing. Our company, it would have to be incredibly strategic to go that far out.

And the next question we have comes from Brian Martin of FIG Partners.

Just a couple, I think it’s more house keeping things at this point. Mark, maybe you would just -- maybe John, can you talk about the, kind of, you’re expectations for bringing down the OREO expense, now that credit is starting to feel a better, and still it’s at a pretty healthy level, and just trying to get an idea of what your thoughts are there.

Brian, yes, I mentioned in my remarks, we had one fair value adjustment, so out of the $2.1 million in credit and other OREO, and other credit related expenses, that was a significant portion of it. Then in the -- or excuse me, that was one of that $1.4 million in total write downs for the quarter. So, if you look at it and you take that one out, you start to see that we’re on a path really to begin to see a reduction in those numbers. Obviously, as we get appraisals back, we’re subject to, changes in market value. Our expectation has been and continues to be that with the firming and the real estate values that we’ve seen the write downs in that $2.1 million dollar number is really under control. So, I mean, I think speaking to that was the other remark that I made about in that $15 million number, we’ve got $7.5 million of it under contract to sell, and you know, we obviously, with that written it down to those guys, so…

Okay, so on the corporate portfolio, that the OREO expense is 700,000 this quarter, or somewhere in that range? Did I understand that right, or did I miss that?

More like 1.4.

Yes, 1.4 probably was the number, okay.

Is more like the number if you take that 2.1 back out to 700 as…

I got you, okay, and then just -- you talked about the influence, John, being, you know, also being impacted by the fair value -- is kind of the $10 million type of inflow number what you guys would see as more normal at this point?

I think we’ve said it in previous quarters, Brian, that it’s $10 million, $12 million is the inflow of, well, you know, on any given quarter what flows in and what flows out might fluctuate, but that’s what we’ve been seeing.

Okay, all right, and then just the last one maybe for Mark. On the income statement the FDIC expense this quarter, I guess that’s kind of bounced around, but now with Shelby in there, I guess, what does that number look like as you go forward?

We’re anticipating, I think we had in our budget what, $1 million a quarter.

Yes, it was a million and one.

The first quarter, and I think that maybe a tad higher based on the balance sheet that we bring from Shelby County, but I would think with first quarter looks pretty indicative, Brian, that’s Mike speaking.

Okay, and lastly, just how are you guys thinking about SBLF and, you know, eventually exiting that, not exiting it, or just, how are you thinking about that at this point?

I -- we are -- as we’ve been building capital to achieve the 7% level, we’ve essentially have been leaving the majority of the banks’ earnings, which are near $40 million a year in the bank, and this year we’re up streaming about 10 million. Our expectations are to consider, next year to start being a little more aggressive about how much we up stream in the bank to the holding company. It just gives us more flexibility to pay off some of the higher cost capital components that we’re carrying that may be in excess of what necessarily need, there’s a pretty big gap between our tangible capital and the total risk capital. And as we’ve said, we would like to over time see those start come a little closer together with a little higher TC, which we’ve achieved and to see the total risk based capital come down over time.

Okay, so the -- so, Mark, the cash -- what was the cash at the parent and what did you up stream this quarter?

We started the year right around 20, maybe 19, and we did a $2.5 million dollar up stream in the quarter from the bank. We’re likely to do the same thing each quarter as we go through the year, although we’ve thought about the, given the one-time gain that we have at the bank level, earnings are a little stronger than anticipated, that we may put a little cushion by up streaming that gain at one of these quarters as we go through the remainder of the year. So, it’s going to be somewhere between 10 and 20 million for the year.

10 or 20, okay.

Well, it appears that we have no further questions at this time, we will go ahead and conclude our question and answer session. I will now like to turn the conference back over to Mr. Michael Rechin for any closing remarks. Sir.

Thanks, Mike. I’m going to close, we appreciate the interest, we appreciate the quality of questions, we look forward to continuing to have a prosperous 2012, and look forward to chatting with you again mid-summer after the June 30 quarter. Thank you.

And thank you, sir, and to the rest of management for your time. The conference call is now concluded. We thank you all for attending at this time you may disconnect.