Q3 2019 Earnings Call
After today's presentation there'll be an opportunity to ask questions to ask a question you May Press Star then one on your telephone keypad to withdraw your question. Please. Please press Star then too. Please note. This if that is being recorded.
I would now like to turn the conference over to temper Schneider President of County Bank. Please go ahead.
Good morning, everyone welcome to our earnings call for the third quarter of 2019.
As a reminder, we ever disclaimer on the use of forward looking statements and our slide deck, which we currently have shown on the webcast.
I'll start with some comments on asset quality, which is on slide three.
We are encouraged that the current level of milk prices a your go forward C. M. E class three milk prices were in the 15 to $16 range. We're now seeing Ford milk prices in the 16 to $18 range.
The improved milk prices, where a contributor in the upgrading of Wanda dairy egg relationship, which improved our adverse acid coverage ratio of 45.67% this quarter.
As you can see from our slide there does appear to be a good correlation between milk price in or adverse asset coverage ratio.
We are having positive conversations related to one sub standard performing loan in a few of our Oreo properties, which we hope will allow us to lower this ratio again in quarter four.
We also upgraded another dairy relationship from special mentioned to watch.
The decrease in loans rated sub standard performing and special mention allowed us to book 1.2 million dollar credit to provision for loan losses this quarter.
We allocate higher general reserves for loans rated watch special mention and sub standard performing in our allowance for loan loss calculation.
We expect that the current gold price levels will continue to lower the dollar amount of loans rated watch and worse into 2020, which could continue to lower our reserve levels.
We're currently 92% of the way through our annual reviews are watching worst credits.
Since we prioritize Howard higher dollar relationships and are in a reviews. It should not have any material impacts in the credit quality ratios are allowance levels.
We continue to see overall stability in Wisconsin farmland values, which continues to contribute positively to the strength of our credit portfolio.
We are in the process of updating our capital plan during fourth quarter, and we'll begin to evaluate its stock buyback plan for 2020 with continued positive trends in milk prices and her adverse asset coverage ratio.
I'll now turn it over to Glenn.
Thanks, Dan Good morning, everybody.
As we announced during our fourth quarter 2018 conference call. We continue to deleverage our balance sheet by continuing to use loan partition participation sales well servicing income attached.
Now this has allowed us to continue to maintain profitability, while continuing to improve the funding mix and the right side of our balance sheet.
We increased long sold in service by 41 million this quarter.
On servicing income this quarter grew to 1.7 million in loan servicing right origination income grew to 1.7 million.
Now 1.7 million Oh blown servicing rights origination income included 250000 of servicing right valuation allowance, which will continue one more quarter in Q4.
On this combined with 19 million inclined deposit growth.
A lot of the continue reduce wholesale funding by 97 million. This quarter, we're really pleased with the change in our funding mix wholesale funding is now down 224 million and client deposits are up 100 million year over year. Our wholesale funding now represents 28% of total funding compared to 41% year over year.
We will look to to grow our loan balances over the next year, but this will be governed by our growth and client deposits.
We would target of 44% to 5% a 4% to 5% growth rate, we're still very focused sudden relationship lending a profitable pricing.
[noise], our net interest margin increased during the quarter due to increasing loan yields and flattening funding costs.
Because of our asset sensitivity and 33% of our loan portfolio being adjustable we do expect to see some slight margin compression in Q4.
We've been able to offset the impact to rate cuts and the loan portfolio with aggressive cuts to interest rates paid on our client deposits.
For example, read on for money market accounts with the $100000 more has dropped from 1.95% at the end of June So 1.2 0.1, 0.26% currently.
Well one year C.D. has dropped from 2.05% to 1.65% during that same time period.
We haven't seen much in the way of client deposit outflows from our recruiting date, but well have to be watchful of that as as competition either increases or decreases.
And I'd like to open up for questions.
We will now begin the question answer session to ask a question you May Press Star then one on your Touchtone phone.
If you're using the speakerphone. Please pick up your handset before pressing the keys to withdraw your question. Please press Star then to at this time, we'll pause momentarily to assemble our roster.
Our first question comes from Brendan nozzle with Sandler O'neill in partners. Please go ahead.
Hey, good morning, guys how are you.
Right Britain running [laughter]. Good I, just want to start off on the expense base here I mean, I thinking that the last quarter. You know if I recall correctly. You know we were thinking a run rate of around 7.2 million was kind of the expectation for the back half year, and then obviously things where we're a bit higher this quarter after backing out the FDIC benefit.
Can you just help us understand what you know what you expect for expenses <unk> the final quarter. It a year and then heading into 2020.
Yeah, Brett and this is one so you know.
One of the things that popped out is on employee compensation and benefits.
We started to ratchet up our incentive comp because we're hearing a lot of our targets. This year. So we ramped that up in the quarter I'd say employee compensation and benefits could go up about 500000 from where you see that level on the other level should be you know I think turning kind of similarly to what that was this quarter. So one of the contributors the employee comp.
Station and benefits as we've started to fill some key positions we've been looking for a one on the treasury side and one on our concierge banking side.
Again, a lot of its just tied to us continuing to make sure we can be thoughtful about how we grow point deposit so.
Okay. So just to make sure I understand correctly. So I guess, if you kind of add back your I rather removed. The FDIC benefit then add another 500 Kaye of incentive comp that kind of gets you around like a 8.2 to 8.3 million dollar expense level for the fourth quarter, Yes, that's that's sounds about right. So.
Okay, Alright, and I think that and I think as of right. Now we're just starting our budgeting process now so going into 2020, I think that should probably be a good level too.
Well, obviously update folks as we start to get through our budget process Hill.
Got a great and then moving on to the the net interest margin you know there's a comment in the slide deck that you might feel a little bit of compression in the fourth quarter of 19 could you just help size up what that might look like and then you know will there be further pressure if the fed continues to cut rates.
Yes, you know.
No I think it's maybe a 101% to 2% Ed Ed worst I think compression I mean, we are seeing the loan yields started as we look month by month in the third quarter. We did see some pressure on loan yields, but we are again, we were pretty aggressive on cutting rates. They try to get ahead of this part of it just because we have lot of it we had a lot excess cash and.
We're trying to be cognizant of have not.
Paying up too much on read on the deposit sites, we've been very successful with that and again, we haven't seen any outflows. So if I'm looking at it like I said, I think one and 2% at worst would be what I'd be looking at.
Okay, Great finally, when I see on one or 2% I'm talking about the the rate so the net interest margin rate. So.
You mean basis points or yes end of GAAP total okay. All right. Good and then finally went from four I step back just to get it top level I mean, no prices. It obviously improved a great deal in the the forward outlook is it better I mean, if milk prices hold near here for the next 12 months.
And I know, that's a big yet, but I mean, how much reduction hypothetically could you see an overall problem asset levels.
Well I think you know if we continue to see this a this kinda current more gold price level. We're hopeful that we can get under the 40% maybe into the mid Thirtys. That's just to guess at this point, but you know at this level. Most if not all of our dairy farmers are going up a profitable level and the futures market is pointing to at least.
Continued solid milk prices through the end of next year.
Yeah, Hey, I understood and you know I what it was interesting we did we added something to slide deck no price versus the adverse.
Asset coverage ratio you can see it is the kind of correlation there. So again, if we continue to see were known prices at this level. We think we can get that again under the 40 or download 30 level, so 30% I mean so.
All right that's helpful. Thanks.
Our next question comes from Kevin Reevey with da Davidson. Please go ahead.
[noise] good morning.
Hi, Kevin.
So first question is I believe the bank recently underwent a regulatory exam without giving away too much can you give us a sense as to how about went.
Do I want to go ahead, you know I think it went pretty well you know, obviously or adverse asset coverage ratios moving into right direction, which they were pleased to see they continue to complement us and the way. The we're managing through this cycle managing Greg credits and how we're on top of them.
As well I mean, they were pleased with our continued kind of wholesale.
Reduction on the right side of the balance sheet and more core deposits and obviously milk prices at this point of helped our overall AG portfolio to to heal little bit. So that's that's that's positive news for all of us.
Yeah, that's great and then as far as a you know we've been reading about negative weather issues impacting farmers. Oh, you guys are your farmer seeing any of that in Wisconsin it'll.
Yeah, it's been a little more challenging at this point for harvests because of the continued rainfall and its creating a little bit more work for them, probably a little more expense relative trying to get the of the corn to how to the field in particular.
But I think most of them have made headway as and little windows that they've had here in between the rain showers. So we'll hope that it will hold off a little bit to Nobel to get the balance of the the crop harvest it but a little bit behind harvest at this point, but you know we've got some time left here yet.
And then lastly, you'd you'd mentioned in your prepared remarks, it a way in values continue to improve within regions within Wisconsin that you see you did a doing a much better than others and then what are those regions.
Yeah, you know I'd say hit a the depends upon where you are but the east central part of the state were where the bank is located at our headquarters and Manitowoc is a very strong dairy area and there still seems to be decent competition for land.
You get into the you know kind of the the northern parts of the state. It's maybe a less competitive I'd say that the southern two thirds of the state overall are still pretty solid from up a land value standpoint, you're not seeing a ton of softening anywhere. It's just there isn't just maybe as much competition for the land in the northern third of the states.
Excellent. Thank you very much.
Thanks, Kevin.
Our next question comes from Terry Mcevoy with Stephens. Please go ahead.
Morning, guys more entertaining.
Glenn maybe just start with you I'm just trying to understand the size of the balance sheet into earning assets in fourth quarter and beyond I know you talk about client deposit growth target, 4% to 5% was that's what type of timeframe was there and how should we just think about kind of run off of wholesale deposits incur.
Recent core deposits and then what you do on the asset side as that mix I'm changes.
Yes, I think I think the four to five for its probably more loan growth target Terry we're targeting a little bit higher on the client deposits I. Just stay ahead of that and just maintain liquidity. So quite deposits I would say is probably in that 6% range.
You know, we're going to continue to to hammer on the wholesale funding it probably won't be as aggressive as we've had been in the last year, but we're still going to continue to drive that down.
I think long term, we want to give that.
Kind of in that 5% to 10% levels compared to where we're at today that that's still going to take some time so.
So as you think about 2020 do you expect the balance sheet to stabilize grow from here.
I would say you know.
You know I would say the client deposits and loans are going to enroll I'd say, we're going to continue to hash away at wholesale again, but not not the level today. So total assets maybe.
Up a little but again, we're going to focus on growing the you know kind of core relationships on the loan deposit side.
And then a question on the loan servicing right origination the $1.74 million in the quarter you mentioned in the fourth quarter there'll be another 250000 dollar gain on the loan servicing rights.
Which which makes sense what happens in 2020 and I guess what are your thoughts in that line ex the rights mortgage servicing rights in the fourth quarter.
Yes, so fourth quarter you know it is you know we just had so much in sales. This this quarter that usually what happens is we have more modest sales. So the amortization of that really kind of offsets the your origination volume, but because of origination volume was so high. This this last.
Quarter.
I would think that they're kind of levels off you know we may have a little bit of of income, but I don't think it'll be as aggressive as it was this quarter for sure. So.
Okay and then the last question I mean, I understand upgrade and substandard performing special mention is down and just feeling better about dairy overall, though just from reading the headlines around some of your customers NAFTA deal I guess hasn't been kinda signed in isn't a done deal yet, but yeah, we had to releasing or the reserve.
And is that I guess my question is is that just the internal formulas that you have spits out the reserve releasing a despite maybe the uncertainty that still out there in the marketplace, particularly to your dare dairy related borrowers yeah, Tim Tim can jump in after I'd commentary, but you know the way we look at it is.
Well, you don't know price kind of drives long grading, but land values Gen that that governs impairments.
So you know.
No I think.
Theres a lot of things going on there I think there is some optimism in the marketplace on milk supplies are are right. Our regulating now they're they're down from where they used to be at all time highs.
You know you a year or two ago. So there's a lot of positive momentum I think the all the trade agreements can will definitely help sustain this kind of uptick in milk price, but you know everything that we're seeing and reading is that folks are.
Not overly optimistic about milk price, but we think it's going to we think it's in a good spot and could hold for the immediate future Sol and Tim can kind of jump in on his thoughts there too, but yeah, and we're definitely consistent with our application of how we you know apply our allowance for loan loss, we don't want to be jumping around and we've taken some hits in the past.
And increases in low loss because of milk prices and some of our challenges with Reg portfolio, but.
Excuse me overall.
As we mentioned many times before I mean again or heavy use of the FSC guarantees really kind of minimizes our loan loss exposure and obviously some of the improvements with the milk prices now and I think no prices stay here, we should continue to see some more improvement in our class classified assets, which will you know probably drive down our need for.
<unk> for loan loss longer term.
Okay.
That's good to hear thanks, guys.
Yep.
Again, if you have a question. Please press Star then one our next question comes from by Brian market with Janney Montgomery. Please go ahead.
Hey, guys.
One of the right.
Hey, just one question going back to the margins just if you I know I appreciate the color on these fourth quarter and just one more a rate cut but I guess, if you wouldn't see multiple cuts from here you know lets say you get two or three markets I.
I guess do I guess can you just give any thought on I think the margin behaves kind of in that scenario. If you get one in October another December and early next year as it is it kind of that does it <unk> as a pressure begin to alleviate the more cuts you get it just just any color on just multiple cuts.
Yes, So you know well, we do have a very short loan portfolio.
You know the duration on its about a year and that's driven largely by the by the AG side.
So.
No we keep getting rate cards, it's I mean, it it is going to be hard for us to maintain margin.
Especially if they're you know what's there is if there is like one a quarter. That's that's when it gets a little challenging I think for us.
But again, we you know.
I'd say, we're being very aggressive again on the on the deposit side as or as aggressive as we can be so you know it's going to be hard for us to maintain margin levels, if we get more than one so.
Okay. All right. That's that's helpful and I guess, maybe just one other question you guys mentioned you know the buyback I guess are there certain hurdles you would have to kind of hit to make it more likely you would you go down that road or I guess, just what's what are kind of the key elements, you're looking at to make that decision.
On the buyback and how to utilize that Richie useless, if you utilize it.
Yes, I mean, I think we've been I think we've been consistent when we're on their own talking to folks you know, it's really driven by two things you know milk price.
Holden kind of where these levels are and secondarily getting our classified ratio under 50%, So and we've kind of use the hurdle of and again, it's there's no magic behind us, but if we get the classified ratio wonder if presented for two quarters straight and we feel good about milk prices I think we feel a lot better about.
Kind of you know using utilizing some of our excess cash to start buying some stock back. So it's something we're to its definitely on our radar and on our played to discuss with our board here this quarter and hopefully have some more guidance on that as we get into the.
First quarter next year so.
Okay, Alright, perfect and then just the last one or two for me just the watch list Glenn It looked like it was up I mean, I guess the trend sounds great with the milk pricing, but just the watch list. It looked like it was up a little bit linked quarter is there something in that number as it is desktop nominally the weight those trends were this quarter did I look at that run in slide deck well.
It's really it's really a product of all the upgrades that we've had a there's got to moving out of classified bucket and a one big deal that moved from special mentioned into to watch and trending in the right direction. So that's why that numbers up substantially.
Okay. All right. That's thanks, Jim and just the a comment you made about it prices, maybe I'm just confused and trying to understand it when you see it at prices that milk get better if they're getting better how that affects see you know the adversely classified ratio of course, it just hold the price holding its own those loans will you continue to look at dish.
Our as a you know their rating and that's that's what's driving the power how to think about that adversely classified ratio at the milk prices kind of stabilizes here versus gets better.
Well I think of milk prices stay where they're at right now when we get through the review cycle of of the vast majority of our credits and that and that buckets of into early first quarter and second quarter of 2020.
We should see some upgrades because they're gonna have a stronger 2019 because of better milk prices. The last two thirds of the year and then if projected milk prices moving forward continue to stay at least at this level or or maybe if we get some trade deals done move up.
We should see some more positive movement in that classified ratio.
Right and it another way to look at it is that you know when we get the N., we start the annual reprocess, probably starting in late first quarter, but I think you'll see probably some you know probably more material movements probably in second quarter of next year, we may see some upgrades in the for in the fourth in fourth quarter. This year and first of next year, but.
I think the a lot of it could come in the second quarter.
Gotcha, Okay, and and when you just remind me Glenn when you guys look at the process to upgrade of credit. It looks like you know kind of reading some of that common share that you some of that Doug intra quarter, but I mean is it or is it more traditionally done when you get an annual new secure point, maybe the second quarters. When you started to see a more or I felt like your upgrade.
To answer quarter as opposed to or intra entry year as opposed to just annualize that is that fair just how to think about that.
We may do that selectively and we have done it selectively uncertain deals, but I'd say the vast majority of the movements can occur once we get through the you know the review cycle.
Late first quarter and into second quarter next year, but there are certain deals that we feel it made significant improvement.
That are maybe still in that substandard bucket, which is what you saw in this last quarter and as we watch them closely and see certain things change, we aren't afraid to to make some of those most intra quarter.
Brian as you're looking at the you know we've got about 9 million in special mention you know Theres, probably maybe two to 3 million of that that could move here in the fourth quarter.
The rest of it could you know could move maybe first quarter.
Those are that's kind of and that's kind of an upper out category, it's not meant to be a permanent category.
We're watching those pretty just like all of the watch in worse, we're watching closely but like I said, we may see a little bit of movement fourth quarter, but hopefully first quarter, we'll see the rest of it.
We're we're optimistic but again, we're watching pretty closely.
Okay.
All right and I think just the last one from me blend that that wholesale target I thought you guys. What was a 20% you wrap this quarter.
Yep.
Did you say, you're I guess the longer term target was what five to 10.
Well, yeah, I'm mixing it up Brian So I'm. The five to 10 is probably more as a percentage of assets that 20% is the 20% is just mix pure you know, it's just the funding mix based on the the funding not assets. So I started to confuse the but on top.
Understood. Okay I appreciate it thanks guys.
Thanks, Brian .
Thanks, Brian .
Next question as a follow up from Kevin Rosy.
<unk> with D.A. Davidson. Please go ahead.
Oh, yes, Tim and gone could you remind us what be break even a price level for no Clark from old gifts for for farmers. It's it around 16, if I recall.
Yeah, I still think it's in that 16, 16, and a half France something like that so at least that's if you. If you average sell through our entire portfolio. That's that's about where the breakeven point as for our book.
Yes, that's what I thought and then I'm just going back to the regulatory gems that FDIC yield was that Oh seifi.
FDIC and stuff Yeah CN state.
Great. Thank you.
Our next question is also a follow up some Brennan nozzle with Sandler O'neill and partners. Please go ahead.
Hey, so it looks like you've you're working on an update to the stress testing model that you guys ran last year I'm, just kind of curious as to the thought process behind that I mean, the last test show that you had plenty of capital Ben since I know prices have improved and you haven't taken a dairy losses since that so is it just to convey you know.
Added comfort with the state of the portfolio.
Yes, I mean.
You know, there's there's a definite expectation by risk by regulators for anybody that's got a concentration like ours that we do more modeling around stress testing, whether its risk rating migration and or.
You can't just overall capital stress testing. So we just we think it's an important tool for us to make sure that we can kind of watch were add on the risk migration cycle.
But it's also just a good capital planning tool for us to establish what we think we have and establish our capital policy limits to Brendan so.
It's something we think is really important we're you know we're working hard to get better data as part of this we do provide loan level data for this but the collateral data has been not as good as we'd like so we're working hard to get that better and tweak to get do you can get better color around there. So.
Understood all right well thanks for the question and congrats on the good quarter.
Thank you thanks Brent.
This concludes our question and answer session.
I would like to turn the conference back over to Timm Schneider for any closing remarks.
Thank you all for joining us this morning and [noise].
We're excited about the strong quarter that we've had and up.
Continued outlook for the dairy space, which is important to us and and feel like we're headed in a in a positive direction here.
So again, thank you all for joining us and will love if there any follow up questions. Please feel free to call going or I and we'd be happy to answer them answer your questions.
Thank you.
Thanks all.
This conference has now concluded. Thank you for attending today's presentation you may now disconnect.
[noise].