Q3 2019 Earnings Call

Total deposits, excluding our BNP were down on a linked quarter basis, driven mainly by a decline in higher cost of public funds and brokered Cds.

As we chose not to renew certain deposits when they mature.

Core deposit gathering across our entire footprint remains a significant focus and year to date. These deposits have grown by 11.5%.

On an annualized basis, when excluding RB NPS deposits held for sale.

Despite robust comp.

Okay.

Okay.

Vision.

Net interest.

In order to mute.

They are to lessen our reliance on higher cost wholesale funding and maintaining our pricing discipline, a new loan production. These actions resulted in a significant increase in net interest margin this quarter.

Our aggressive reductions in the rates paid on our deposits resulted in a reduction in our overall cost of funding of five basis points also positively impacting NIM. This quarter was a larger than normal amount of interest recoveries on previously charged off loans that were repaid during the quarter.

These interest recoveries provided five basis points of the NIM improvement during the quarter.

After accounting for the positive impact of these recoveries, we were still able to maintain static loan yields even as market rates continued to fall.

To summarize all of the moving parts impacting net interest margin this quarter, our reported NIM improved by.

12 basis points on a linked quarter basis stripping out the impact of acquisition related net accretion our NIM ex accretion improved by 10 basis points.

Finally, removing the impact of the outsized interest recoveries that I just mentioned our true core margin improved by five basis points this quarter.

We are well positioned to continue to benefit from a flat to moderately down short term interest rate environment as our balance sheet is modestly liability sensitive and we expect to see further margin improvement in Q4.

While we do expect to see this additional improvement in core margin. We do not expect the same level of onetime interest recoveries that created five basis points of margin accretion in Q3, two re occur again in Q4.

Therefore on a net basis, we're guiding to a static net interest margin in the fourth quarter.

Now turning to our noninterest income results as Larry mentioned, we're extremely pleased with the growth in our noninterest income during the quarter, which was once again driven by record swap fees.

Our swap fee income.

And gains on the sale and loans for them.

<unk> was over 21 million already putting us well in excess of our initial full year target of eight to 12 million.

Our pipeline of loans that are specialty finance group remains robust. So we anticipate another solid quarter of swap fees as we close out the year.

Our current expectation is that this fee income source will be in the range of five to 7 million for the fourth quarter.

We're not yet providing guidance for full year 2020, but instead expect to do that on our 2019 year end earnings call.

On the expense side, we remain focused on controlling expenses and improving our efficiency ratio.

While our reported expense number came in at 39.9 million for the quarter. There were a number of significant items that impacted expenses.

First we incurred post acquisition costs of 884000.

Second we recorded a $2 million write down on an Oreo property.

Third we had an additional 3.9 million of bonus and commission expense driven by the higher than anticipated fee income and very strong year to date net income.

And fourth we recorded debt extinguishment costs of 148000.

Excluding these line items, our noninterest expense came in just under 33 million within the guidance range of 32 to 33 million, we provided on last quarters earnings call.

Looking ahead to the fourth quarter, we anticipate that our level of spending will be moderately higher based on increased staffing and some year end investments in technology and efficiency improvements.

Therefore, including the compensation impact of anticipated level of swap fee income our expectation for non interest expense in the fourth quarter is between 35 and 36 million.

Our asset quality continues to be excellent with no material additions to npis in the third quarter.

Our nonperforming assets declined by 2.5 million from the second quarter, if you exclude our BMT.

This was primarily due to the 2 million additional write down of an Oreo property, our loan loss provision, excluding our BMT decreased on a linked quarter basis, primarily due to improved credit quality.

As I just mentioned we have further written down the large other real estate property that we are marketing for sale in order to reflect current market conditions. In recent offers we are considering.

We remain very focused on moving that property as soon as possible.

Our effective tax rate for the quarter came in at 19.1% there were not any onetime items impacting this rate. However, it was slightly elevated again this quarter due to the high fee income it changed our mix of taxable versus non taxable income.

We expect that our tax rate for the fourth quarter will be in the range of 19% to 20% not including the beneficial impact of stock option and RSU exercises.

I'd like to wrap up my comments with some observations regarding the pending sale of Rockford Bank and trust.

As Larry mentioned, we expect the transaction to close late in the fourth quarter and therefore, we will see the full benefit as the transaction in the first quarter of 2020.

As a result of the sale of our BMT, we anticipate significant improvement in our profitability metrics, including a seven to nine basis point lift in net interest margin.

And eight basis point increase in our okay.

150 basis point improvement in our efficiency ratio.

And 60 cents increase and our tangible book value per share.

From a capital perspective, the transaction will significantly strengthen our capital as we anticipate an immediate increase on or tangible common equity to tangible assets ratio of approximately 110 basis points.

Again this decision makes great sense for our company has it frees up capital for us to redeploy in our existing and more profitable markets and significantly improves our go forward financial performance.

With that let's open up the call for your questions operator, we're ready for first question.

We will now begin the question and answer session to ask a question you can press Star then one on your Touchtone phone, if you're using a speakerphone. Please pick up your handset before passing the keys to try your question. Please press Star then tell at this time, we'll pause momentarily to assemble our roster.

The first question will come from Jeff Rulis of D.A. Davidson.

Thanks, Good morning.

Good morning, Jeff.

That Todd you I.

I guess given that the timing of this sale I just wanted to there's some of the assumptions you you outlined for for Q on expenses and in some of the fee income inputs curious as to is that inclusive of.

Of rock for run rate I guess as we get into 2021. This is is completely sold do you see an adjustment to those fee income and expense levels or is it largely immaterial.

Great question, Jeff. So the guidance. We just gave for Q4 really has Rockford Bank and trust in it for the entire quarter, we do expect that to close late in the quarter.

Could be as late as year end.

BT end of November .

I think we're on schedule for that so rather than parse the quarter. We've given you guidance for the entire quarter going forward into 2020, we expect to be pretty transparent about to go forward a run rate on expenses S. Rockford I'm really not as significant impact on the fees.

As many of our wealth management and certainly the swap fees are generated in our other charters, but the guidance that we provide it really has rockford in it for the entire quarter.

Okay.

If you come impact is is immaterial I guess the expenses, we could assume or are safe to.

I think that there may be some moderate savings into the run rate is that true.

Okay, you that certainly sounds like some there'll be some expense reductions.

Our BMT and what we thought would be best wouldn't be the yearend earnings call to really carve out.

All the income impact and revenue impact in the expense run rate impact at that point.

Okay.

If we were to take a just as a percent of assets or something.

Similar percentage on expenses is that it's gotta guesses any or and would there be some puts and takes to that.

Yeah, there's going to be some puts and takes there as I think everyone's aware of the underlying financial performance at our BMT is less than our other subsidiary banks. So the overall impact on EPS going forward, which is really what I think you're trying to get after Jeff.

Will be fairly modest when you consider the financial for performance of Rockford coming out we do have some.

Loans that are not part of the purchase that will be taken back to our other sister banks that will help offset the EPS dilution as a result of learning or losing the Rockford earnings.

It really should only be a penny or two of the P.S. going forward into 2020.

Each quarter, I'm, sorry, penny or two each floor right.

Okay and got your appreciated the impact to margin post a sale.

The margin discussion in general it just trying to get a baseline rate assumption are you assuming cuts to come.

By year end and in that are in that figure.

Yes, we're expecting a code as early as a next week and I think the occur expectation is for at least one more after that our balance sheet is positioned to.

Really benefit from that.

That's our current expectation.

We typically don't like to get as granular with the NIM discussion as we did.

We thought it was important to be pretty transparent about the fact that.

We should think less about we picked up 10 basis points of core margin this quarter, but more five the onetime lift from those interest recoveries added that other five basis points.

And we didn't really want to.

Everyone expecting another 10 basis point improvement in Q4 when in reality, what really happened is we improved core margin by five Bips here in Q3, and we expect to do that again Thats. Our guidance for Q4 was another five basis points. The swing in those onetime interest recoveries really made it looked more like tenants.

Zero, if that makes sense.

No I appreciate the detail on the on the margin very helpful. I'll step back. Thanks.

Thank you Jeff.

Your next question will come from Matt Damon Delmonte of KBW.

Hey, good morning, guys has gone today.

Great. Good. Good first question on loan growth did you quantify the size of the specialty Finance group loan book without all the activity that they've had going on.

Basically.

They continue to grow at a pace.

Consistent with the core bank growth, so about half of our growth and loans during the quarter came from especially finance group and half from the core business.

Okay.

And what's the overall sizes that Buck.

Its broke into a couple different factors.

And the tax credit side, it's probably approaching $200 million of Outstandings.

And ER, we also had some municipal lending in that space, that's probably another 100 million.

Gotcha Okay.

That's helpful. Thanks, and you know as you I just kind of look out through the end of this year and and we head into 2020.

Do you still feel good about that you know 8% to 10% range beyond 2019 are you guys not at a point, where you want to disclose that.

No I mean I think.

We've done 8% to 10% for.

25 years, so I mean, certainly there's a little ebbs and flows in that 8% to 10%, but I think we feel good at this point about being able to maintain that real estate.

Yeah Okay.

Okay, and then you know credit trends seem to be holding up pretty well Todd can you help us think 11 about the provision expense going forward and you know what a reasonable range to out to expected.

Sure over the last several quarters, we said right on top of 2 million.

There was a good size chunk of the provision in Q3 was related to a NPK issue at Rockford Bank and Trust Oh, you got arms fully around that based on further improvements and asset quality and no real degradation in any of the portfolio's I would expect that 2 million.

And would be more like an upper limit in terms of Q4 provisioning probably be a little lighter than that maybe a closer to 1.5 in terms of Q4.

And we obviously have our arms fully around Cecil we're not yet disclosing any specific numbers there, but I would tell you. We worked really hard to be prepared for the first quarter next year at this point, we do not expect any material impact on capital ratios.

On adopting seasonal.

Got it okay.

That's all that I had thank you very much.

Thank you Dave.

The next question will come from Nathan race of Piper Jaffray.

Hi, guys good morning.

Good morning, Good morning May be Todd, maybe just to touch on deposit growth you know deposits shrink a little bit and I imagine some of that shrinkage wasn't potential just given the improvement that we saw on your funding costs sequentially. So just curious how we should think about deposit growth going forward and if there's some additional kind of pruning of the deposit base going for the old comes up.

For the NIM outlook.

Yeah. Good question Nate.

We actually.

Really intentionally pull back on liquidity in the quarter to help us with margin I think you remember both Q1 in Q2, we had a fair amount of excess liquidity, we're having a fair amount of success growing deposits. Even ahead of our 8% to 10% loan growth we did shrink deposits.

But in a in the right buckets, we got out of some public funds and some other more expensive or deposit relationships really pruned those got a lot more efficient in terms of the balance sheet I would expect our core deposit growth and that's really where we did grow deposits during the quarter.

So good noninterest bearing demand for example, or average.

Noninterest bearing demand was up for the quarter.

I would expect going forward that we would match our loan growth and so if you look at our 95% loan to deposit ratio. We would expect it really stay on top of that and be able to grow deposits at the same pace. We're growing loans, that's our expectation really keeping our wholesale utilization around that 10% number.

It was a little higher than that at the end of the quarter, we always have a little better run off of correspondent deposits right at quarter end, but it really was 10% on average during the quarter and I would expect us to keep pace with that on deposit growth. We are very focused on growing core deposits.

We want to continue to fund our loan growth with that and I know, Larry and I expect that to continue to happen.

That's very helpful and if I could just asked kind of along those lines and thinking about kind of the trajectory of core loan yields appreciate the goes for the margin for the fourth quarter, but it may be assuming we get additional fed rate Touretzky kinda just help us think about you know the variability of the loan book relative to maybe the all says you have in terms of someday.

Deposits up maybe index of the sort of the curve as well.

Sure Hey.

We have about 1.2.

<unk> billion in rate sensitive assets and we've got about 1.1 billion in rate sensitive liabilities.

We are getting much better better beta results on the liabilities of that 1.1.

Roughly 700 million of that is really performing at a 100 beta on in a way down and we're working really hard to continue that we actually have some repricing on public Cds that we did he answered brokered Cds that we are going to retain that are actually performing better than hunter.

Your data probably about 120 based on the way down so the lift in margin that we saw in Q3 and that we're expecting a Q4 is really coming on the funding side as you would guess.

Yeah, 1.2 billion or rate sensitive assets.

Probably only about 25% of those are prime floaters and on those prime floaters for the most part we do have floors.

Probably with this next caught will start bumping into some of those floors I think Larry and I would expect that once we get to perhaps a second cut we'd be at the floors on most of those.

The other 75% of those are really LIBOR floaters and as you know there some.

Just joined a reaction between LIBOR disintermediation between LIBOR and said funds and the LIBOR loans are performing pretty well, we expect those to be a relatively modest beta going forward and that's really why we're going to see a lift in margin.

Understood very helpful and if I could just asked one more on fee income I guess with the rock for divestiture you guys acquired base there within the last couple of years. So is it fair to assume that you guys will maintain a wealth management presence and Rockford going forward.

Yeah. So a great question May currently the based financial companies given the timing of that.

Transaction and its proximity to our decision to sell our BMT.

Weve left the based companies at the holding company. It was not part of our transaction with Heartland, we continue to own base and right now.

That's generating about a three to 3.2 million a year in wealth management fees.

Okay got it thank you for all the color.

Thanks Me.

The next question will come from it Terry Mcevoy of Stephens.

Good morning, everyone.

Morning care.

First question on capital can you just talk about the excess capital coming from the RB and T cell and just prioritize I know you mentioned redeploying and more profitable markets acquisitive growth and there's also I guess I'll throw a buyback. So how are you thinking about offsetting the dilution from the transaction a is.

It emphasis on finding an acquisition to utilize utilizing the capital if that doesn't materialize what are your thoughts on buyback.

Okay. Our first priority certainly wouldn't be to fund our strong organic growth in or other markets and we're fortunate to have that in really all the other markets that we operate.

Our second focus would be.

On potential acquisitive growth within those markets I would be our right because if we think the ability to execute on the lower risk executing on something inside one of our existing markets.

After that would be you know one additional market at sometime.

From a stock buy backs standpoint, we do plan to talk about that conceptually and our next holding company Board meeting in a few weeks.

We're not in a rush to do a buyback.

Because of what we think our opportunities are to redeploy that.

Either in strong organic growth or an acquisitive growth within our markets in the not that there's some future.

However, we will consider it a stock buyback really to position ourselves in case, there is a meaningful.

Disruption in the bank stock markets.

Values would.

I guess I'd be curious substantially.

Thank you and then as a follow up if I go back to the presentation. When you announced the sale. There was an appendix slide that had the pro forma impact that listed noninterest income noninterest expenses is that's <unk> getting back on he was jeffs question is that a.

Good guide to use as we do our best a model out the first quarter in second quarter on a pro forma basis ahead of January when you are prepared to provide more formal guidance or discussion.

Yeah, I think that would be [noise] tier that'd be good proxy for more detail in January with her.

Q4 that was even 10 of putting that deck together to give give you and everyone else them.

The modeling information for that so I think that'd be a good proxy for from now I do want to fill in a little bit of the capital discussion. We talk about 110 basis point lift in T.C.E. and closing I just thought I'd.

You can give everyone. The expected target there as we ended the year. So we agreed at 15 basis points of TC He organically here in the third quarter.

We certainly would expect something like that in Q4 that would put us at about 8.35, Tc He and the 110 basis point of left.

After closing the transaction puts us in the midnight. So just to put some context around larry's comments on capital and deployment and usage of capital.

We think we should feel very good about being in the 950 range. That's really a good number for us we feel good about landing there and.

We'll be very.

Very mindful of how we deploy it spend that capital.

Okay. Thanks Todd.

Thank you.

The next question will come from Daniel Cardenas of Raymond James.

Good morning, guys.

Morning morning, Dan.

Maybe I appreciate all the information and color so far but maybe some color on competitive factors I mean have been a mixed bag in terms of what I'm hearing from other companies in terms of frothiness building up in various markets on both well I'm primarily on the lending side are you seeing any of that in your footprint.

And then maybe up.

Quick update on how <unk>.

<unk>, Missouri is working for you guys.

And Dan, but your sand property nest and.

Loan activity or I'm, not sure I want to me, yes rock frothiness in loan activity.

You know kind of irrational pricing in terms.

Yeah. We're we're certainly trying to remain discipline in the markets. It ran I think we're fortunate that were in kind of mid sized markets in the Midwest.

Don't necessarily experience that extreme highs and lows of some of the larger metropolitan areas.

So certainly there's competitive pricing pressure starting to come into the discussions.

We did a really outstanding job this last quarter Colin on pricing.

Certainly.

You know, we're going to feel some of that pressure ultimately.

Over the next few quarters likely so it's hard to measure what that impact is gonna be because it's kind of little more forward looking than we probably can anticipate at this point.

But our loan growth has been pretty broad they until it's not like us.

Factors that are I think.

One particular sector frothy more than another or any of those kind of thing so that helps us hopefully to withstand that pressure down the road.

With regard to Springfield, we're really excited about that marketplace. The major theme there has done a great job so far a growing the business and growing earnings in a meaningful way in a fairly short period of time, So we really love that market and hope to continue to grow there.

Excellent and credit metrics are good, but maybe a little bit of color on.

Classified levels, how how did they trend this quarter.

Yeah modestly lower on the classified trends really no no meaningful movement of significant so you know we hear the noise, particularly.

Manufacturing international level, but it really has not shown a client making much yet.

Okay great.

All my other questions have been answered thanks, guys I'll step back if you did.

Once again, if you have a question. Please press Star then one the next question will come from Evan while of Janney Montgomery Scott.

Hi, Good morning, this isn't law and I'm on for Brian Martin.

Good morning, good morning, Yemen.

Just a couple of quick questions I'm clarifying your comments on floors in your loan book, how many loans have floors and what percentage of those what percentage those loans or or after floors.

Yeah, So again of our.

Roughly a 1.2 billion floating rate loans about 25% of those would be prime based floaters and right now.

You have those would be at their floors of code of course, the floors to be scattered.

A fair amount in terms of where they get triggered but a few of those would have been triggered now another good size chunk, probably get half way there, but the next rate cut but if there is a second 25 basis point cuts or another 50 down we'd expect virtually all of those two of it there.

For.

Okay Awesome appreciate that and then I'm just a few housekeeping items can you talk about your accretion income and then also the tax rate moving forward.

Sure. So first on tax rate, that's an easy one that's elevated of debt as we.

Have a little bit more.

Taxable strings of income coming from the.

SFG swap fees.

So we're guiding to stay in that 19% to 20% tax rate range or in terms of accretion.

We expect to another about 1.1 to 1.2 of that in Q4.

We got a estimated remaining discount at the end of the year of 6.6 going into 2020 or so.

Right now it.

The end of Q3 7.7.

Budgeted accretion for expected accretion for Q4 s or about one one gets us to six six remaining at the end of the year.

All right Awesome and then lastly, another meant a lot of questions on your margin and you give guidance for Q4, Q, but can you talk about the possibility of three rate cuts and the next three meetings and what that means.

Yeah really based on our.

Our balance sheet position based on some of the comments that we just shared with you on floors, helping us a bit on the floating rate loans and based on the success, we're having with being very aggressive on rate reductions and having a pretty big chunk of our rate sensitive liabilities.

Really moving at 100 beta.

Additional costs over and above the one or two that everyone's counting on now actually we would expect to help us so based on our balance sheet position based on how we're having a great deal of success managing deposit rates down we could see three cuts and still have.

Have positive impact on margin go for it.

Alright, perfect wall Ah. Thank you for your color and nice quarter.

Thanks I. Thank you.

And this concludes our question and answer session I would now like to turn the conference back over to Larry Hamling for any closing remarks.

Thank you all for joining us today and for the great questions.

We look forward to speaking to you all against a have a great day.

Thank you Sarah the conference has now concluded. Thank you all for attending today's presentation. You may now disconnect your lines have a great day.

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