Great Western Bancorp, Inc.
Q1 2018 Earnings Call Transcript

Published: 25 Jan 2018

[Operator:]

Good morning. And welcome to the Great Western Bancorp First Quarter Fiscal Year 2018 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. At this time, I would like to turn the conference over to Ann Nachtigal, Director of Corporate Communications. Please go ahead.

[Ann Nachtigal:]

Thank you, Denise and good morning everyone. Joining us this morning on Great Western Bancorp’s first quarter fiscal year 2018 conference call are, Ken Karels, Chairman, President and Chief Executive Officer; Peter Chapman, Chief Financial Officer; Steve Ulenberg, Chief Risk Officer; Michael Gough, Chief Credit Officer; Doug Bass, Regional President; and David Hinderaker, Head of Investor Relations. Before we get started, I would like to remind you that today’s presentation may contain forward-looking statements that are subject to certain risks and uncertainties that could cause the Company’s actual future results to materially differ from those discussed. Please refer to the forward-looking statement disclosures contained in the presentation that we have made available on our website, as well as our periodic SEC filings for a full discussion of the Company’s risk factors. Additionally, today, we will be discussing certain non-GAAP financial measures on this conference call. References to non-GAAP measures are only provided to assist you in understanding Great Western’s results and performance trends and should not be relied upon as a financial measure of actual results. Reconciliations for such non-GAAP measures are appropriately referenced and included within the presentation. And with that said, let me turn it over now to Great Western Bancorp’s Chairman, President and Chief Executive Officer, Ken Karels. Ken?

[Ken Karels:]

Thank you, Ann, and good morning, everyone. Thank you for taking the time to join us. There were a number of unique items in the quarter that Pete will run through shortly. But before that, I want to call out a few of the highlights for the quarter. Net income was $29.2 million or $0.49 per share, while adjusted net income excluding the revaluation of deferred tax asset was $42.8 million, or $0.72 per share. Loan growth was robust with loans increasing $197 million or 8.7% on an annualized basis. Our efficiency ratio continued to improve to 45.8% and we realized the benefit of tax reform this quarter with the September 30th fiscal year and our federal tax rate dropped to 24.5% and will drop again to 21% on October 1st. Now, for more insight on our first quarter financial results, I would like to turn the call over to our Chief Financial Officer, Peter Chapman. Pete?

[Peter Chapman:]

Thanks, Ken, and good morning everybody. Thank you for joining us today. As Ken mentioned, there were few unusual items in our financial results for the quarter that I would like to spend a little bit of time discussing with you. Like many of our peers, the lower corporate tax rates made us revisit the value of deferred tax assets. We recognized the charge of $13.6 million during the quarter, reducing our tangible book value per share by approximately 1.3% and our total capital ratio by approximately 15 basis points. This item is one-time in nature and as such we treat it as the non-GAAP adjustment within our adjusted net income. Next, because we file our income taxes in conjunction with our September fiscal year-end, we were required to apply a blended federal statutory tax rate beginning with our current fiscal year, starting on October 1, 2017. The blended rate for FY18 is 24.5% and we expect all-in effective tax rate of approximately 26% for the year. We will then step down to the 21% statutory tax rate in FY19. Our provision for income taxes was approximately $5 million lower this quarter because of this change. Next, our net interest margin which we calculate on a fully tax equivalent basis is impacted because the tax equivalent adjustment is less valuable as a result of the lower tax rate. The tax equivalent adjustment was approximately $600,000 less this quarter, resulting in NIM and adjusted NIM being approximately 2 basis points lower as a result. And finally, for the current quarter and all other periods presented, we’ve reclassified credit card interchange income from interest income to non-interest income. This change has no impact to net income, total revenue or the efficiency ratio but does impact our net interest margin calculation for each period presented. The reduction to margin was approximately 7 to 8 basis points. So, there is no meaningful change to margin trends we have talked about over the last few years. Moving to revenue, net interest income was $102.2 million for the quarter, a small increase compared to the prior quarter, primarily driven by loan interest income increases from loan growth partially offset by higher interest expense related to deposits and borrowings. Our net interest margin was 3.89% for the quarter and our adjusted NIM was 3.8%. Adjusted NIM declined 2 basis points quarter-over-quarter as a result of the lower tax equivalent adjustment while high asset yields and liability cost is largely offset. Noninterest income for the quarter was $16.7 million, a 13% increase compared to the linked quarter, which was more than driven by $2.2 million favorable variance in the valuation of our fair value loan portfolio and related to derivatives. Service charges and other fees declined $600,000, primarily a result of the full quarter impact of the Durbin Amendment cap on debit card interchange. This change is now fully reflected in run rate and we don’t expect additional reduction interchange income. Finally, non-interest expenses were $54.9 million for the quarter, a reduction of just under 1% compared to the prior quarter and in line with our expectations. A $1.6 million increase in salaries and benefits, which was primarily driven by items related to our fiscal year-end was more than offset by lower non-interest expense and data processing costs. We expect some marginal increases in the next quarter, primarily driven by annual salary increases and approximately $500,000 per quarter as a result of salary adjustments we announced earlier this month in relation to the text reform. Other than these items, we expect our expense run rate to be broadly in line with this quarter. Efficiency ratio improved to 45.8% also for the quarter, as Ken has mentioned. All regulatory capital ratios remain comfortably about well-capitalized levels, with Tier 1 and total capital ratios at 11.3 and 12.3 respectively and our tangible common equity ratio remained strong at 9.2%. Finally, our Board has again approved the $0.20 quarterly dividend, payable on February 21. I’d now like to turn over the call to Doug Bass to discuss our balance sheet activity.

[Doug Bass:]

Thanks Pete and good morning everyone. We are happy to report a second consecutive quarter of strong loan growth. Loan balances increased $197 million compared to September 30, an annualized growth rate of nearly 9%. Growth was most robust in owner-occupied commercial real estate, construction and agriculture segments of our portfolio. Unfunded construction commitments were nearly $700 million as of December 31st compared to $425 million 12 months prior. Therefore, we expect continued growth in this segment in the coming quarters, despite some finished projects refinancing into the secondary market. Of the agriculture loan growth during the quarter, we believe approximately $20 million represent short-term advances used by many of dairy customers for tax planning purposes. These advances occur each year and were repaid in early January. Geographically, growth was distributed across our footprint with the exception of South Dakota which declined slightly as a result of exiting stressed agriculture relationships. Deposit growth during the quarter was approximately $47 million on a net basis. We had a small outflow of commercial deposits which we typically see in the fourth calendar quarter more than offset by consumer deposit growth. Our loan to deposit ratio of just over 100% remains well within our targeted range. Let’s turn the call over now to our Chief Credit Officer, Michael Gough, who will take us through asset quality developments. Michael?

[Michael Gough:]

Thank you, Doug and good morning all. Turning our attention now to the slide on asset quality. Provision for loan losses was $4.6 million for the quarter, a slight decrease compared to the previous quarter. Net charge-offs for the quarter were $4 million or 18 basis points of average loans on an annualized basis. Our ALLL as percentage of total loans was 70 basis points, down one basis point from September 30th, despite the fact we provided more than what’s charged off during the quarter. Our comprehensive credit coverage, which includes credit related fair value adjustments on our long-term loan portfolio and purchase accounting marks, remained sound at 106 basis points of total loans compared to September 30, 2017, we saw $24 million reduction in Watch credits and $15 million increase in Substandard credits, each of which were primarily driven by the deterioration of a small number of commercial real estate credit which also drove the increase in non-accrual loans. In the agricultural space, I’m happy to report that we have completed annual reviews on approximately 70% of our portfolio with maturities in November, December and early January, largely in Watch and worse classified credit, these are primarily grain producers. In general, farmers’ performance in 2017 was in line with our expectations and we expect minimal risk rating changes with upgrades modestly outpacing downgrades. We continue to monitor the grain portfolio closely and remain unwilling to extend additional credit to those producers that are resistant to adjusting their business plans in light of continued lower grain prices. There has also been a downward trend in milk prices in recent months. We are monitoring the dairy segment of our portfolio closely but don’t have widespread concerns with that segment of the portfolio. With that, let’s turn the call back to Ken for some closing remarks.

[Ken Karels:]

Thank you, Michael. As you can see, this was the strong quarter for GWB. Besides the benefit of tax reform, we had great loan growth, managed our margin well, maintained our pure lean efficiency ratio and credit quality, pipelines are strong and consumer optimism is growing. As we look forward, we’re very positive we can achieve safe, profitable growth. Thank you for your continued interest in GWB. And now, we will open the call up for questions.

[Operator:]

[Operator Instructions] The first question will come from Dave Rochester of Deutsche Bank. Please go ahead.

[Dave Rochester:]

Good morning, guys. On that expense outlook, can you just go through the details again, what you thought might grow? I know you said you thought expenses would be roughly in line with the run rate this quarter and in the next quarter. But could you just highlight some of those increases you are talking about?

[Ken Karels:]

I think on a net basis, because salaries and employee benefits, was up quite a bit this quarter, as I mentioned there a bit of that was year-end stuff. Look, I think, I’d say salaries and benefits will probably be down by about 400,000 or so, offset by sort of smaller increase across data processing and a couple of other lines to sort of get back to a largely flat basis.

[Dave Rochester:]

And just switching to the NIM, just given the rate hike, we are just wondering what you are expecting for the NIM trends in the March quarter. And then, if you could just talk about what you are seeing on the deposit pricing front. It looks like you guys had those costs well contained in this quarter but any color there would be great.

[Ken Karels:]

Yes, sure. Look, Dave, we obviously didn’t get any benefit from the December hike really in this quarter, expect a small benefit. So, look, margins are expected to be sort of flat to up a point or so. And on the deposit cost front, obviously, seeing a little bit more competition out there. Certainly, Doug Bass, if you would like to provide a bit more color there as well?

[Doug Bass:]

Yes. Dave, I think, when you look at our overall funding strategy, we have a number of different options as far as in markets that we can look at. We are seeing pressure in some of those for slight increases. However, we are looking at overall targets of NIM and spread to be very consistent as we go forward, as a result of material amount of the loan fundings are also on a variable basis as well.

[Dave Rochester:]

And then, just switching to capital, I know that continues to grow here. We are just wondering how you’re thinking about buybacks or dividends, if you guys don’t end up capturing a deal this year. And then, just specifically on M&A, what do you think the prospects are that something does get done this calendar year? And, are you still seeing that smaller bid-ask spread that you were talking about in the last call?

[Ken Karels:]

Yes, maybe on capital first. It’s always our intent to manage that. As we started to see some banks now starting to raise dividends, we’ll be in discussion on that with our Board here shortly to manage the capital levels at near where we are at. That said, obviously acquisitions is still our first preferred use of excess capital and we continue to look at acquisitions every quarter. And if the right opportunity that’s accretive to our shareholders come along, we will execute that. It’s a little difficult to project whether we’ll do one or not in 2019, just because of the where the opportunities are and whether from a pipeline standpoint on it too. But definitely, we also -- there is dips in stock price; we will continue to look at stock repurchase. But really, acquisition probably first either stock repurchase or dividends is the preferred use of the access capital.

[Dave Rochester:]

Are you still saying a little bit more favorable bid-ask spread there on the M&A front, as to what you were talking about last quarter?

[Ken Karels:]

I think the part that hasn’t been -- and it’s just the tax reform yet, how much of that’s baked into prices yet and how much that will make a difference on, I think that’s still being digested by both buyers and sellers.

[Operator:]

The next question will be from Ebrahim Poonawala of Bank of America Merrill Lynch. Please go ahead.

[Ebrahim Poonawala:]

I think, if you could first start out just in terms of your outlook on loan growth. And I’m sorry if I missed this. But, how much of the seasonal advance that you saw in the fourth quarter do we expect will be running off relative to the year-end loan balances? And then, Ken, just in terms of when you think about the mid single digit loan growth sort of outlook we had for most of 2017, do you feel like we could move towards more, more like high single digit this year? And any color on that would be helpful?

[Ken Karels:]

Dough, go ahead and start, and then I’ll finish.

[Doug Bass:]

I think what we saw on the pay down first, we experienced about $20 million of pay down as a result of year-end tax planning only on the dairy side and that’s already been pay down in early January. And I think as we take a look at a longer term run, when we experienced about 9% in the first quarter, we typically see a little softer run rate in January, February and March. We pick up later in March-April, as we head into spring work on the ag side, construction draws, economic activity is more robust in many of our Midwest market. I think as we look at full year, we’re going to be in the single-digit and the mid to upper range of that single-digit growth.

[Ken Karels:]

Yes. So, I think as we flagged through last year, the lower loan growth, we are seeing it tick up. So, as Dough said, I think it can go up into mid to high single digits is probably what we’re looking at for this year.

[Ebrahim Poonawala:]

Understood. And in terms of opening new sort of lending offices or hiring talent, Ken, any markets that you’re looking at or is there a pipeline of hiring that you anticipate over the next few months?

[Ken Karels:]

We continue to look at a number of markets, probably two or three that could be opened in next year, obviously, getting the talent hired, some of those we’ve started, some of them we’re working on and having communications with, but definitely, part of our strategy. So, we’ll continue to look at which markets we can expand to hire talent in those markets to start loan production offices to start with and then eventually full service branches.

[Ebrahim Poonawala:]

Understood. And just one sort of housekeeping question. I just want to make sure I understand your tax rate guidance clearly. Should we expect the tax rate to be 26% for this ongoing fiscal year, which is 18 through September and then fall to 21 in 2019?

[Peter Chapman:]

No. So, 26 is the all-in effective rate this year, Ebrahim, based on the 24.5% statutory rate. And then the statutory rate will drop to 21% next year. So, that 23.5 or so percent or so in the next fiscal year.

[Ebrahim Poonawala:]

So, 23.5%? Okay.

[Peter Chapman:]

That number, yes.

[Operator:]

The next question will come from Steven Alexopoulos of JP Morgan. Please go ahead.

[Steven Alexopoulos:]

I wanted to start on expenses. What impact should we anticipate for expense growth this year as you guys reinvest some of that tax benefit?

[Peter Chapman:]

Not a significant change, Steve. The only change really as a result of that tax benefit is around that $500,000 a quarter, as a result of the salary increases that we announced earlier this month around living wages.

[Steven Alexopoulos:]

And then, when we look at the efficiency ratio, you ended at 45.8, which is really good. I think, we could safely say you are now well below the sub 50 target. What are the thoughts on a more realistic target here for 2018?

[Peter Chapman:]

Look, I think, a lot depends on NIM base, Steve. So, certainly, it would hold up with NIM. As we said, hopefully, we get a little bit of benefit with NIM in the next quarter. So, look, I think a lot depends on what happens on spread. But from expense base perspective, as we have said, sort of that inflationary, sort of 3% over the course of the year seems to be manageable, based upon where we are now.

[Steven Alexopoulos:]

And on the NIM, you said flat to up only 1 basis point, which seems a little light given how late in the quarter we saw that hike. Why such a limited benefit in the first quarter?

[Doug Bass:]

Really, there is couple of things there, Steve. We’re seeing a little bit more pressure on deposits. So, deposit costs were very well contained this quarter, so maybe a little bit there as well and then on the loan front. There is still spread compression there. Certainly, we are not seeing increased spread base. So, that’s the only reasons to be a little cautious there.

[Steven Alexopoulos:]

Okay. And then, just as final one looking at the loan growth detail, commercial real estate was strong. And I know one point, you guys were slowing growth in CRE, last few quarters look pretty good. Have you changed your thoughts around CRE and your appetite grow that at this point?

[Ken Karels:]

Yes. Go ahead Doug or Michael.

[Doug Bass:]

I think what we are looking at is the opportunities are with very high capitalized businesses, borrowers, a majority of the loan-to-value are 70%, 60%, sometimes even lower. So, we are seeing opportunity with some very long-term trended revenue streams, borrowers that provide strong capital as a secondary source of repayment and then strong assets positioned in some of our metro areas. So we are taking an opportunistic look to take a look at the credit opportunities that make sense in strong markets and strong borrowers.

[Steven Alexopoulos:]

So, it’s higher quality credit, that’s what changed your view on CRE?

[Doug Bass:]

I would say so, yes, because again we are taking a posture of some lower loan to value. I think some of the other increase you are seeing is probably in the construction piece as well and the owner-occupied, both of those increased as well, some of the owner occupied ties into new C&I relationship acquisition. C&I relationship acquisition was about 60% of our growth and continues to look at about 50% to 60% of our pipeline, going forward.

[Michael Gough:]

Steven, it’s Michael. I would absolutely echo everything that Doug said. I would add just two other items. Number one, we are doing this with a consistent, not a changed or not in any way, shape or form a loosened loan policy and underwriting guidelines and also over concentration limits are well within range, when we look at the composition of our loan book.

[Operator:]

The next question will come from Jeff Rulis of D. A. Davidson. Please go ahead.

[Jeff Rulis:]

Just a few questions on the, maybe on the credit quality side. So, Mike, I may have missed the one CRE loan that was added. Was that -- what was the type of loan there, was it ag related?

[Michael Gough:]

Actually, the big -- we had a couple that were mentioned. One was actually in the nursing care space; another one would have been a hotel, so really not ag related at all.

[Jeff Rulis:]

Okay. What was the ag migration, if you look at just the NPA bucket, both in the accruals, in the OREO? Did you have then increase just to kind of flow through the non-performing bucket? And maybe a one-off, if the provision levels for the balance of the year, any sort of loose guidance on kind of where you were last year versus this fiscal year?

[Peter Chapman:]

Yes. Sorry, Jeff. Just on the ag piece, you’ll see that when it comes out in the Q. But from NPA perspective, they were -- that would end quarter-on-quarter in ag.

[Ken Karels:]

Ag was down.

[Jeff Rulis:]

I’m sorry, that was down within the NPA bucket?

[Peter Chapman:]

Correct, yes. NPAs in the ag bucket were down.

[Jeff Rulis:]

And then, Pete, while got you, did you mention that you now expect kind of service charges now that these have fully bottomed and we could presume to some growth at that point?

[Peter Chapman:]

Yes, that was. In the current quarter that was about a $1 million due to Durbin. So, quarter-on-quarter, that will go. So, we would expect that to start growing again.

[Jeff Rulis:]

And maybe one last one. On just the tax rate, just so I get this right. In fiscal 2018 -- I guess the effective 26% ongoing that will be for each quarter going forward. It’s not like we’re getting a blended average for the full fiscal year of 26%, given we had almost 50%, I guess what we saw in Q1, is that correct?

[Peter Chapman:]

Yes, ex the DTA. So, that’s ex the DTA adjustment for this quarter. We’re assuming that 26% is our effective rate going forward for the next three quarters.

[Operator:]

The next question will come from Jon Arfstrom of RBC Capital Markets. Please go ahead.

[Jon Arfstrom:]

Pete, just back on the margin. Just hypothetically, if we get a few interest rate increases in 2018. , do you expect the NIM to be able to migrate higher over time? I guess that’s one of the things I wanted to clarify because I thought maybe you’re a little more asset sensitive than maybe you’re implying?

[Peter Chapman:]

Look, if we get a couple of more rate rises, I would, Jon. As you’ve seen, about two-thirds of our book on the loan side is variable or swapped into variable. So, if we get couple of more rate rises, then I would expect the loan margin to outpace deposit growth.

[Jon Arfstrom:]

Doug, maybe if you -- the commercial, just the straight commercial lending category, it’s kind of been a little bit more erratic and not growing like the commercial real estate bucket. Can you maybe talk a little bit about what’s happening there in terms of demand and your expectations?

[Doug Bass:]

Sure. Yes, I think the commercial non-real estate bucket is -- again, probably a bulk of the originations that we had and the bulk of the pipeline 50%, 60% are going to be in the C&I bucket. And then, when you break that down, we are probably seeing more than half of that that are being structured into the real estate component of the relationships. So that would indicate that this will be probably flat, up slightly. But I think again, what we are seeing are probably significant retention and profits in a lot of those relationships which are driving average line usage flat to down slightly. So, as we acquire the new C&I relationships which first quarter would indicate, pipeline would indicate and profitability in most of that segment is very good, we will probably see that flat to just up slightly.

[Jon Arfstrom:]

And maybe for you or Ken, my impression is you are in kind of a CapEx heavy part of the country. And with some of the tax law changes, obviously, it favors equipment purchases. And I’m just wondering if you are seeing any kind of change in sentiment or pipelines are moved from some of those changes.

[Ken Karels:]

Yes. I mean, there is definitely the optimism there. I think others are still sorting through exactly how they are going to use the tax benefits. We’re just completing the survey and gathering results. I don’t think we have been totally in yet from our bankers just what we are seeing from our C&I customers, are they going to start spending more in capital. I think the general intent is they will be, although we haven’t seen big dollars spent or committed to do that yet. So, we can get some one-offs and certain customers are doing certain things. But I would say generally, and part of the reason we’ve led to higher loan growth for our thoughts this next year is that we will see that benefit fall through increased loan demand.

[Jon Arfstrom:]

Michael, just one follow-up for you on credit. And I think the good news is it feels like ag is somewhat settled for you but the nonperforming numbers continue to creep up. Just curious if you have any thoughts in terms of when you think this NPA balance might crest. I mean, do you have some of bigger pieces that could move out or do you feel like it’s a steady state? Just give us your thoughts on that.

[Michael Gough:]

Overall, I think it has been mentioned a couple times before and you even mentioned yourself that ag is certainly stabilizing and nonperforming assets down. Right now, as we look at things compared to last year, grains, I think you could stay stabilized, not at a great historic level but not far off the norm. Proteins, hogs, cattle, somewhat improved; dairy, recent months, certainly down a little bit. Overall, I would describe the nonperforming book as lumpy. And some of the reasons -- and your observation is accurate, that has stayed frustratingly high. We do have some big chunks in there that we do hope to get progressed out of there one way or another this year. But overall, what we are seeing is the overall trend in the loan book is improvement. Again, never going to say we are not going to have any downgrades but we are expecting upgrades to outpace downgrades.

[Operator:]

The next question will come from Nathan Race of Piper Jaffray. Please go ahead.

[Nathan Race:]

Good morning. Question on the securities portfolio, from here, any thoughts on just in terms of you expect it to shrink on absolute basis going forward from here?

[Ken Karels:]

Relative to balance sheet size, I’d say, will shrink a little, Nate. Absolute side, I’d probably expect it to be pretty steady step.

[Nathan Race:]

And then just on deposit growth expectations for 2018. Any thoughts on just kind of where you guys expect that to shake out?

[Ken Karels:]

I think it’s going to be up from what we saw in the first quarter and that’s going to be predicted upon the expectation of loan growth in the mid upward single digit range. And I think it’s going to be part-in-part with funding demands on the loan side. We expect that to grow. We expect the deposit, core funding side increase as well.

[Operator:]

The next question will come from Erik Zwick of Stephens, Inc. Please go ahead.

[Erik Zwick:]

First, if I could just ask on the nice growth you’ve seen in the construction portfolio. Can you provide any color in terms of what geographies are driving that, what’s the ultimate use of the buildings, and maybe your expectations for retaining the relationships as the loan transition to permanent financing?

[Ken Karels:]

Sure. I think when you take a look at the construction growth, it’s probably been about 80% or 90% located in about half a dozen key metro areas. It would be in a number of segments, whether it be multifamily, hospitality. I would say as far as long-term trajectory, the interest rate structure that we have in place on virtually all those are variable. So, in the current rate environment, it will be a positive increasing from a NIM impact. And I think long-term, there are probably more loans that will flow to a secondary market and a repayment on the multifamily sides and would be retained. The senior housing component would generally be a sector that would be retained, because those are typically owner versus investor owned.

[Doug Bass:]

Just looking at the by state breakdown, it’s pretty balanced across Nebraska, South Dakota, Arizona and Colorado as the main states there.

[Erik Zwick:]

Okay. And maybe just follow-up on that one, given that you expect a number of these to flow to the secondary market. How does the pipeline look today to continue adding new loans to potentially kind of replace those that would leave the balance sheet?

[Ken Karels:]

Yes. A majority of the pipeline in that sector would be in the exact same markets that the originations happened and we would see net growth in that sector over the next 12 months plus. A lot of these projects are projects that take 2 to 4 years to be built, seized and stabilized. And again, the pipeline is a backfill. So, I’d say the net position will probably continue to increase over the next 12 months. Economics, 24 to 36 months out would probably be the impact as to what the net change would be. But, in the near-term, it will be a net increase.

[Erik Zwick:]

And maybe just one more moving on to deposits. Obviously overall deposit costs were well controlled this quarter. The rate on time deposits did increase about 7 basis points quarter-over-quarter. Was that a response to market competition or customer demands or maybe something more proactive on year-end?

[Ken Karels:]

It’s a different market set between rural and metro. A lot of our rural markets in the Midwest and the customer base, the core customer base there still look at investment alternatives as being certificate of deposit. And to retain and continue to work with those core customers we have dealt with for a long time, the increasing CD component, I don’t necessarily think it was a material change in dollars but interest rate is in reaction to working with core customers that we have had. The metro markets in comparison or again I think we highlighted in the last quarter, the segmentation as our Company has changed over the last couple of years, would reflect more growth in non-time deposits, more money market checking account growth which is what the metro markets are focused and continue to grow.

[Operator:]

The next question will come from Damon DelMonte of KBW. Please go ahead.

[Damon DelMonte:]

Just a couple of quick follow ups. Could you give a quick update as to where you stand in the some of those ag relationships that you are working off of the balance sheet?

[Ken Karels:]

Michael, do you have anything to add?

[Michael Gough:]

I’ll certainly start, anybody can chime in. Damon, overall, we have got a group within credit, called SBS, strategic business services that is charged with loan rehabilitations and workouts. As you know, when you are dealing with ag, specifically grain producers, it’s one cycle a year. And so, those have, if you will, a bit of a longer tail on them to work out of the bank. We have been chipping away balances, helping them rehabilitate. We hope to see on the couple of the larger ones, without naming names, possibly a pretty sizable upgrade over the coming quarter, and also one that we hope -- to be able to hope find financing elsewhere. So it’s really a combination of when you look those larger relationships, they do take more time than the non-ag deals do. And the larger they are sometimes a little bit slower they are as well. But overall, it’s a combination of can we get it rehabilitated, can we get them refinanced elsewhere and in some severe cases, voluntary or involuntary liquidation. So, it’s really a combination of all three strategies with the larger -- and really with any problem credit.

[Ken Karels:]

Yes. I think we just -- we have hit early and fairly hard as far as those that weren’t making the change in their operations. And that has been a drag on some growth as we pointed out. I think we’re kind of bottomed out on that as some number I’ve mentioned, we’re starting to see the some of the improvement and we expect that to somewhat continue.

[Damon DelMonte:]

And then, could you just give a little bit of update on your metro market strategy, specifically, what’s happening in the Iowa markets? I know last quarter we talked about a bunch of the different markets that you guys have recently expanded into. I just want get an update on that.

[Ken Karels:]

Yes, Damon. As far as Iowa specifically, we’ve had a couple of markets where we have opened loan production offices. And I think at that point in time, those will probably convert some time later in 2018 or 2019 into full-service branches. We’ve had a couple commercial banker hires in those markets this year. We’ve got a couple more that are queue in Iowa probably here in the first quarter of 2018, calendar 2018. And then relative to some other markets, we’ve got two other markets in other states, current states that we exist in that we have made some key hires in. And we will be expanding some lending staff probably here in this quarter as well. And those will be some of the western markets that we have made those hires in and we will continue to emphasize with the growth opportunities with the strong economics.

[Damon DelMonte:]

And then, I guess just lastly for Pete. If you look at the non-interest income line, I heard the commentary on service charges and kind of bottoming out and the impact from Durbin. But, could you kind of provide a loose range as to what a reasonable expectation is for the next couple of quarters?

[Peter Chapman:]

I think, the next couple of quarters, obviously, I’ve mentioned $13 million that comes out. So, service charges I would expect to increase. So, [indiscernible] with this quarter once you back that out. Other major line items around the wealth and mortgage, wealth we expect to continue to increase modestly; mortgage banking income were pretty soft this quarter. Damon, just seasonally, if you have to look at our trends, it slows down before it peaks back up again in the next two quarters as the main line item. So, they are probably the key movers I’d say there.

[Operator:]

The next question will come from Tim O’Brien of Sandler O’Neill & Partners. Please go ahead.

[Tim O’Brien:]

Hi. Just one follow-up, guys. The decline in the Watch list loans, that’s a reflection. Is this some reflection of the annual credit review in ag in those declines?

[Michael Gough:]

Tim, the answer to that is yes. And the only thing I’d stress about Watch credits is that’s meant to be transitional. So, you can have movement both ways. Certainly, as we work through that 70% of the maturing ag loans, largely Watch and worse in the ag space more upgraded than downgraded, but we did have movement both ways from the Watch rating.

[Tim O’Brien:]

So, some went to criticize just like we saw in overall numbers?

[Michael Gough:]

I’m sorry. Say, it again.

[Ken Karels:]

Criticized.

[Michael Gough:]

Some did, yes. But more moved out of Watch in a good way than went down to certainly bad way.

[Tim O’Brien:]

Last -- I am going to throw one more at you. How long, when do you think that overall review will be completed approximately, another -- end of this quarter?

[Michael Gough:]

On the grain space, the answer would be absolute positively yes; that should be by March 31st, when we look at the other sectors, especially dairy that has more December year-end reporting and account prepared, reviewed or audited financial statements, it will be a little later than that. But the grain space absolutely should be largely completed by March 31st.

[Operator:]

And the next question will be follow-up from Jeff Rulis of D.A. Davidson. Please go ahead.

[Jeffrey Rulis:]

Just a quick, the $2.2 million favorable impact on the net effective, the loan fair value and derivative adjustments, is that just a one quarter event or given the changes elsewhere in the quarter, is that -- I guess, would you anticipate that number on a net basis to pop back up in the 3 million to 3.5 million range drag, all things being equal, and then drift lower?

[David Hinderaker:]

Yes. Jeff, this is Dave. There was about $1 million on the loan line this quarter that was credit related. As you know that bounces around a bit as we effectively provide or release provision on those loans. So, about a $1 million of the favorable in the loan line, we would not expect to be recurring.

[Jeffrey Rulis:]

Okay. So, if you’re -- kind of a core -- now it’s $2.5 million on net. And then as we discuss -- I guess, it’s a pattern of just drifting lower over time?

[David Hinderaker:]

Yes. We’re about -- the current cost of the derivatives was just under $2.5 million this quarter. And I think we have called out before that’s the line where we see a lot of the benefit on the rate hikes. So, we will continue to see improvement on that.

[Operator:]

And ladies and gentlemen, that will conclude our question-and-answer session. I would like to hand the conference back to Ken Karels for his closing remarks.

[Ken Karels:]

Thank you. Obviously, we are very happy with another strong and steady quarter for GWB. We are positive on the future, as we mentioned, with higher organic loan growths as we are looking forward on it. So thank you for your investment and your interest.

[Operator:]

Thank you, sir. Ladies and gentlemen, the conference has now concluded. Thank you for attending today’s presentation. At this time, you may disconnect your lines.