Q2 2019 Earnings Call
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Yeah.
2019 earnings release conference call.
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Please note. This event is being recorded I would now like to turn the conference over to Timm Schneider President. Please go ahead.
Thank you and thanks, all for joining us today.
Before we start I'd like to direct you to slide two of our deck, which is our forward looking statement disclosure.
And now I'd like to start with.
In AG credit updates.
We saw an increase in classified assets this past quarter as well as increases in loans rated special mention.
Increase in special mention loans from the prior quarter quarter is driven primarily by three AG relationships.
We placed loans and special mention as a temporary grade.
We monitor these credits monthly to see if their proposed changes in their business plans are successful and we anticipate updating their loan grading by the end of Q4.
The increase in substandard performing loans is driven by.
Six AG relationships and one commercial relationship.
The AG relationships downgraded are related to getting through our annual financial reviews of these relationships.
The commercial relationship was the startup manufacturing business, which is having challenges on their sales cycle, extending which has.
Which has created stress in their cash flows. We previously had this rated as a special mention in Q2. We also moved one commercial credit from substandard performing to Oreo and charged off a portion of our specific reserve.
We had allocated in Q1.
While you have seen some credit stress from a handful of commercial deals overall, our commercial portfolio continues to perform well.
From an agricultural perspective, we're about 80% of the way through our total dollars on the credit review process of our watch and lower classified credits.
We continue to manage as aggressively as possible reduction of classified ads.
With a few liquidations of farm operations occurring this spring in a few more ongoing through fall.
And some solid activity on more of our or he currently.
Of the 80% of watch or worst credits reviewed we were selective in reviewing the credits. We felt are more sensitive to the recent loma build price cycle and the size of the relationship.
We have seen continued improvement and milk prices on the Chicago Mercantile exchange class three futures market.
The 12 month forward looking averages 17, all four per hundred weight this quarter up from $16 per 100 weight last quarter.
Since we use a three year average of cash flows when determining a loans credit rating the uptick in milk prices in 2019, and the drop off of the lower cash flows from 2016 should have some positive impact on the overall credit quality in 2020, when we go through the reviews.
Discover mercantile exchange class through 2019 milk prices actual through June .
And futures for the balance of the year are at $16.31 per hundred weight and this is the best year over year price that weve seen since 2014, which as you recall was a record high milk price here.
We also had a couple of commercial deals bubble up and have been downgraded, including one involving a deed in lieu related to the regional retailer that filed bankruptcy, which I alluded to earlier and that did have a specific reserve in quarter, one that was charged off that quarter.
Now from a client deposit growth standpoint, we continue to be focused on client deposit growth and I've been really pleased by our growth in such a competitive landscape.
Client deposits are up $39.6 million or 5.2% since last quarter and up $96.3 million or 13.7% year over year.
And now I will turn it over to Glenn stately.
Thanks, Tim.
Couple of things first off on deposit pricing, we are closely watching the inversion of the yield curve.
Thats occurring and we're reflecting that in our deposit pricing strategies.
We have begun to cut back on our rates across the board to more closely mirror wholesale funding rates.
Our aggressive reduction in FHLB advances during 2019 will also allow us flexibility.
In case, we have to plug in the loop liquidity holds by the end of the year.
On the wholesale funding front as we've talked about we will continue to focus on reducing our wholesale funding, especially on the broker deposit side.
As we talked about earlier, we are targeting a 120 million dollar reduction in wholesale funding. This year unfolds focused mostly on brokered Cds.
We told a reduction of 51.7 million this quarter and $92.9 million year to date.
In this challenging rate environment, we will continue to be aggressive in paying off wholesale as it comes due.
In regards to the Russell reconstitution at the end of June we were taken out of the Russell 2000 index.
So far in July we have not seen an overall negative impact of trading volumes in comparison to the trading volumes. During the first two weeks in July a year ago.
Let me take that concludes our prepared remarks, and we'd be happy to open it up for questions.
Thank you we will now begin the question and answer session.
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John a question. Please press Star then Q.
At this time, we will pause momentarily to assemble our roster.
Our first question today comes from Brendan nozzle with Sandler O'neill and partners. Please go ahead.
Hey, good afternoon, guys how are you.
Good Brendan how are you. Good. Thanks, just wanted to start off on the commercial book.
I know that.
The one credit that drove the loss content. This quarter had been discussed previously and been reserved for but it sounds like there are a couple of other commercial credits that you mentioned that you're kind of keeping a closer eye on is there something broader that's going on in the commercial book or are these more or less a handful of isolated credits it probably wouldn't be very noteworthy if dairy were and so pressured currently.
They're really handful of isolated credits and definitely obviously with our higher level of classified assets in the AG side as you know.
Obviously, raising the question, but there is nothing systemic that's that's occurring in the portfolio on the commercial side right now generally it's very very healthy.
Okay. Good thanks.
And then moving over to the review of the dairy book, So it sounds like you're about 80% of the way through the dollars here I mean I know, it's it's caused some migration, but have you found any any big surprises where certain borrowers were much worse off than you would have assumed going in there and things pretty much played out as you would have expected.
I think they've played out.
As we expected, maybe even a little bit better than we expected earlier in the year.
As as we've talked before our AG lenders our AG bankers are out in the firearms quite often we are obtaining interim financial statements. So we're keeping a close eye on things and I don't think we had any any real surprises.
At this point.
Okay. Good and then one more for you for a step back just on the margin I mean, it obviously a lot of moving parts here.
Loan balances have kept declining which of course, you give up some earning asset yield on.
You do keep hitting the wholesale funding and you are bit liability sensitive. So how do you see the NIM trajecting throughout the course of the year, especially if we get one or two rate cuts in the second half of the year here.
Hey, Brian This is Glenn.
No.
Just let me speak first to the kind of current rate environment I can talk about the rate drops so.
Kind of inter quarter Kim May June we saw some creep up in loan yields. So we hope that's a positive sign that things are still repricing to that kind of higher rate environment from a.
Kind of from the last year or two as things refinance.
On the deposit side, we've seen things kind of flatten out right now so we're hoping that's positive on the.
On the margin side going going forward based on the current rate environment.
Because I hope it is.
Its competition I talked about deposit pricing I think it feels like folks are being more disciplined and kind of working on on ratcheting back reads on thinking that's going to really help the deposit side.
No, we're not really liability sensitive we're asset sensitive, but it's but it's very you know we're not aggressively asset sensitive. So we aren't subject to near term rate increases first and foremost on the on the liability side, but long term we are asset sensitive so and we see if we see some rate cuts.
Im hoping thats going up.
Have some.
Hopefully hopefully have some more positive impact to us on the margin side in the short term so.
Got it okay. Thanks for taking my questions.
Yes, Thanks Brendan.
Our next question comes from Kevin Reevey with D.A. Davidson. Please go ahead.
Good afternoon, gentlemen, how are you.
Hi, Kevin Great Kevin how are you.
Good thanks.
So first question is on the reserving and net charge off assumptions, how should we think about those two items as we're modeling out the next two quarters.
This is Glenn Kevin so.
So the charge offs, especially if weve got reserves or specifics built in.
It hasn't seemed to have as much impact yet because they haven't they've been fairly manageable.
I think what's what's had more impact on the movement of our allowances the loan gradings we tend to.
We tend to put in some flat percentages for loans that are.
Not impaired butter in the special mention and substandard performing buckets.
So that and the movement of loan grading seems to have had as much impact as charge offs right now again knock on wood hopefully they are manageable and the charge off site. So.
If we keep them in the second 1 million to 2 million range. If we have any it seems to not have as much impact so.
And then.
And given the outsized charge off that you had this quarter how should we think about the charge off side of that equation as we as we model out.
That's a good question you know.
I don't know if I don't know if it I don't know if anything we've got specific reserves on is headed the charge off in the immediate in the immediate future. So I don't.
I don't anticipate anything right now.
For the next couple of quarters. So I mean, obviously something can bubble up but we haven't seen that yet that we think is going to be in the charge off and weve articulated what occurred with that situation in the past. So I think we knew that was coming down the pike and that seems to be sort of a one off at this point, but as Glenn said, we don't have anything that were.
Watching closely from that standpoint from a charge off for the next couple of quarters, Yes, as we talked about the charge off was from a regional retail bank kind of a larger shopping center bankruptcy.
That we took we just decided to move into Oreo this quarter. So.
Okay, and then lastly, you are participating out loans.
Can you give us some color is there kind of what youre always scares us following them being put back if there is a quite issue and is there also any risk of devaluation negative valuation adjustment on those loans.
No.
On both fronts those are sales that.
The buyer ultimately.
Has to take the risk they can't put it back to us.
The only risk we have is that maturity that they could.
You know not agree to renew into mind.
For us do some other things but.
And then from a.
The allowance standpoint, or valuation standpoint, there really isn't anything there that would impact our valuation on the servicing side either.
Great I'll step back and I'll go back in the queue. Thanks.
Okay. Thanks, Kevin.
Our next question comes from Terry Nick on ROI with Stephens. Please go ahead.
Good afternoon guys.
Hi, sorry, Derek.
Maybe just start with expenses, if I look at the quarterly expenses and remove the write down of Oreo, it's kind of a $7.2 million run rate as you think about the second half of this year what are your thoughts on it on expenses again kind of isolating Oreo.
Yes sure this glide.
I think the run rates pretty pretty level, I mean, I don't I don't I don't anticipate any big.
Changes in those kind of the last.
The last two quarters of the year. So it it might be just slightly higher as we filled at an all handful of physician yeah at open for a while here.
Just recently and I think there most of those people are starting in the next couple of weeks. So yes on a percentage basis I don't see any big changes, but we may have a little bit of an uptick on the dollars, but not not significant.
Okay, and then just just as a follow I went to the your web site 30 minutes ago that Lucky 13 to CD product. The 235 has that come down at all and I guess I was looking at your average time deposit rate of.
2.26 versus the CD product it seems like if thats the peak product out there we are getting close to at least CD prices or CD rates at your bank kind of peaking out is my math correct and do you see that that to 35.
Potentially make that the top there.
Yeah, you know were.
Were we just introduced that it was a couple of weeks ago. So we we're going to constantly be looking at.
If we need to start pulling back on on everything as far as rates go so.
Right now, we're pretty comfortable with that we still want to track.
Good client relationships.
I don't think Thats overboard kind of where the market is right now like I said, we really tried to ratchet back kind of the more.
Kind of our rack rates that you'll you'll see hopefully for track and then you'll see we've cut back those quite a bit again.
Samir the FHLB advance rates.
More so.
Maybe one last question if I could loan yields went up four I'm, sorry, 514 to 526 quarter over quarter.
Just talk about any impact loan yield had loan the loan fees had or TDR is there any call it noise that impacted the rates.
I don't know I don't think we I don't think we had anything material in the first quarter that would have taken that one down or or anything that's juice and at this quarter Terry so.
We're obviously that still deal with the non accrual situation.
As far as the overall level of loan yield, but I don't think there's anything unusual go back out.
Great. Thanks, guys.
Thanks Terry.
Our next question comes from.
Great Stricklin with Janney. Please go ahead.
Hey, Tim and Glenn how are you guys doing.
Okay fair value.
Good good thank must find been answered, but just one quick question.
How far you guys through the balance sheet for adoption and how much more do you think you're going to have in the loan side there too.
Yeah, you know we had some we had some commercial pay offs that we didn't expect.
You know, we kind of targeted going down for you this year.
So were obviously a little bit past that.
I don't know.
I don't know that we're going to go much further than that right now because I think we feel really good about our overall liquidity so.
We're kind of we're kind of.
In the mode now with kind of we'll probably we'll try to maybe feel a little bit of that.
Well, we went over 40 million, but I don't know that we're going to aggressively grow from from here on out for the next you know.
18 months here, but.
Thanks could change as we see better metrics on the on the milk prices and also the classified as too. So I mean, it's also to really just governed by our ability to continue to generate client deposits too. So we're really trying to watch and manage our growth our ability to bringing good deposit so.
Got you. Thanks, a relatively flat I guess, that's kind of how we should be looking at the total assets, yes, maybe maybe maybe little uptick in between now and the end of 20, but it wouldn't be I don't anticipate being material right now, especially again based on.
Our ability to bring in the client deposits. So.
Got you. Thanks, so much.
Yep.
Again, if you have a question. Please press Star then one our next question comes from Ross Haberman with Arlington investments. Please go ahead.
Hi, how are you John made a quick just.
One or two quick quick questions.
What is your total exposure.
From the loan book on retail.
Today, many great retail strip centers, you're talking about retail shopping centers Thats good thing, yes exactly.
It's pretty minimal I don't know the exact percentage, but it's it's insignificant relative to a concentration or anything we've got a few but not many.
Okay, and and then on on the AG loans.
Our our most collateralized by land or would it be land and door.
Distilleries warehouses and.
So on and so forth.
Everything when we take out an AG client engagements and that's almost without exception, we have their entire asset base as collateral.
Over the last dollar facilities dollar cattle their equipment their crops their feed.
Yes.
Waterlife.
Have there.
Has there been any significant weakness in the land sales side, and then and if so what have you seen there in the last year.
No Dave land values have continued to remain strong up obviously theres pockets that there may not be as much competition for land, but in the situations, where the farmers have been liquidating their assets in the land in particular the values have been maintained.
Okay, and then and just one last question.
Regarding.
AG loans going forward, what's sort of your.
What sort of your emphasis or your adjusted parameters in terms of making additional new loans today, particularly in.
In dairy.
Well there are still producers out there that are have made money through this entire lower milk price cycle and.
We were being up obviously very selective.
There isn't much expansion occurring but.
Your been a few deals that we booked that are brand new relationships, but to manage the overall exposure on our books were generally.
Selling are participating the vast majority of those deals in those relationships, where we can make a nice servicing spread but.
There hasn't been a lot of organic growth occurring over the last 12 months or so we're definitely managing that very tightly.
And a final question do you do you think we peaked in terms of your.
Nothing nonperformers mature.
By certified assets.
Are you classified yes correct.
Hard to say I mean with the the futures price on milk right now and I alluded to in my comments earlier.
Even though that $16 or so averaged 16 31 for this year.
Maybe seems closer to that breakeven point. The reality is the early part of 2019 year had some quite low milk prices in January and February and that 13 $14 range or we're seeing out. The next six months, it's pretty much all over $17 in even approaching $18 per 100 weight for their base price. So we're feeling better about the operations out there and where their breakeven points are and the fact that at this stage if those milk prices hold that the majority of our operators will we'll be able to make money.
Okay guys best of luck. Thank guys. Thank you.
Our next question is a follow up from Kevin Reevey with D.A. Davidson. Please go ahead.
Just curious if you have an updated stress analysis from the fact that this that you shared with US when you had your earnings call last quarter, if there been any changes.
To that stress analysis.
No. Kevin this is Glenn so, we'll we'll probably do that once a year and it just it doesn't pay off to do it more than that.
No.
You know that the leveraging of our balance sheet and continued earnings is only going to help that what we call that cushion.
So.
You think it's we hope it's going to be and continue to improve so.
And then good then lastly.
During this can you correctly what's your.
Or whats the breakeven for milk pricing for your farmers on average is it just is it around 16 or is it higher than that.
No I think thats kind of the range that if you average it all out that we've said that's probably in the ballpark for breakeven, obviously every operation depending upon efficiency and management.
They vary, but that's probably a reasonable.
And that's the that's the that's the base price that I was referencing earlier with the CMV. The dairy farmers are receiving anywhere from one dollar to $202 100 weight of additional basis on top of that four components.
So if you add that onto the $17 milk price, we're looking at the balance of the year Latam, we'll be making 18 $19 per 100 weight.
And we call it mailbox price that's the that's the the final price they receive.
From the dairy plant.
Great. Thank you that's helpful.
Appreciate it.
Yeah.
The next question is a follow up from Brendan Nosal with Sandler O'neill and partners. Please go ahead.
Hey, guys just a couple more from me year.
First can you just elaborate on the build in TDR is this quarter.
Are these credits you identified throughout the dairy, we review and opted to restructure or.
And any color there would be great.
Well, primarily they were a couple of relationships that slid into their that slid into.
Substandard and we did some restructuring with them they're in substandard performing though.
And I noticed in your note. This morning that you're kind of NPL number was quite a bit more elevated we've done. These interest only periods for these operators. If we believe they have viability and can make it through the cycle, especially with some of the changes they're making in their business models. So unfortunately with the TDR definition, we've been trying to stay conservative on that and.
Unfortunately, some of those numbers of elevated but again.
The performing Tdrs, we feel good about and Thats, maybe where you're you're referencing that number yes, no and Brendan This is Glenn I mean its.
Because they are to be ours, we have to go through the impairment process and those don't handle the two that you are the two that Tim mentioned are we haven't seen material impairments and also.
Got it Okay, and then last one for me I mean, if milk prices kind of holding that 16 to $17 range, let's say on average over the course of the year.
How long will it take you to see a meaningful decline in either classified assets or non accruals.
Well I think if we get another if this milk prices sustained for the next 12 months and we're at this point next year and our through.
80% of our watch and worse review cycle again, I think we'll see some meaningful movement in both those numbers.
By then but it kind of a year over year 632020.
Okay.
But it sounds like you would take another review process, which happens once a year or two to really work through that noise and again, assuming we have stable no prices.
Yes, we generally havent moved classifications in between years and I think we've talked a little earlier about our score looks at a three year milk price average and.
The benefit that's going to help us is that 16, which was kind of a low point for some of the milk prices here in the last.
Four years will fall off and 19 as it appears should finished pretty strong and will add on so that should help our score on the classification side.
Perfect. Thanks for taking the follow up.
Yep.
Our next question comes from David Hannah Patriot. Please go ahead.
Good afternoon guys.
Good afternoon, David.
So just a follow up on the balance sheet and nice work.
Sort of deleveraging during the quarter how much more do you think you can do as it relates to reducing wholesale funding and and.
Selling off participations on the other side from here.
Yes, so David this is Glenn so.
You know right now were essentially just using cash to.
I will pay off anything that comes due we've got we've got decent chunks of maturities coming up here this quarter.
But we should be able to we should be able to take care of those with.
Securities cash flow and the deposit.
Growth in annual principal payments on loan side.
I think we should be okay. There. So we shouldn't have to do anything drastic as far as participations other than normal participations that we would do anyway. So.
Thank you.
Concludes our question and answer session I would now like to turn the conference back over to Timm Schneider for any closing remarks.
We appreciate all of you jumping on the call today, we feel pretty good about the quarter overall I think core earnings were pretty solid.
Unfortunately, the classified assets elevated a little bit, but we anticipated some of that as we get through that got through the review cycle. We're also encouraged by the the futures price on the CMU right now that I think is helping and will help our dairy farmers moving forward if this.
Prices sustained so.
Overall, we feel like we've got our arms wrapped around things and hopefully will be on this call 90 days from now on.
We reported good news again.
Thank you all for joining us.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.