Great Western Bancorp, Inc.
Q1 2017 Earnings Call Transcript

Published: 26 Jan 2017

[Operator:]

Good morning and welcome to the Great Western Bancorp, Inc. First Quarter Fiscal Year 2017 Earnings Announcement and 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. I would now like to turn the conference over to Ann Nachtigal, Director of Corporate Communications at Great Western Bancorp. Please go ahead.

[Ann Nachtigal:]

Thank you, Andrew, and good morning, everyone. Joining us this morning on Great Western Bancorp’s first quarter fiscal year 2017 conference call is Ken Karels, President and Chief Executive Officer; Peter Chapman, Chief Financial Officer; Steve Ulenberg, Chief Risk Officer; and David Hinderaker, Head of Investor Relations. Before we get started, I’d 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 on 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. With that said, let me turn it over now to Great Western Bancorp’s President and Chief Executive Officer, Ken Karels. Ken?

[Kenneth Karels:]

Thank you, Ann, and good morning, everyone. We have good reason to be pleased with our most recent financial results. Key takeaways for the first quarter include

[Peter Chapman:]

Thank you, Ken, and good morning, everybody. As we look at our revenue slide, you can see net interest income was $100.8 million for the first quarter of fiscal 2017, an increase of $13 million or 14.8% compared to the same quarter in fiscal 2016. This increase was mainly due to higher loan interest income driven by an 18.4% growth in average loans outstanding between the two periods, including both organic and inorganic growth related to the 2016 acquisition of HF Financial. This was partially offset by an 8 basis point decrease in the yield on total loans. Net interest margin was 3.89%, 3.92% and 3.98% respectively for the quarters ended December 2016, September 2016, and December 2015. The adjusted NIM, which is the measure we manage to was 3.71%, 3.73% and 3.73% respectively for the same periods. Adjusted net interest margin was 2 basis points lower compared to the same quarter of fiscal 2016. The decrease in net interest margin between the two periods was primarily driven by an 8 basis point decrease in the yield on total loans and a 3 basis point increase in the cost of deposits. Compared to the most recent quarter ended September 30, 2016 the 2 basis point decrease was driven by a high average cash balances with loan yields and deposit costs remaining consistent across the two quarters. While we cannot predict all external influences, we look to the net interest margin to stabilize and improve should interest rates increase through the remainder of 2017. Noninterest income was $13.9 million for the quarter ended December 2016, an increase of $5.3 million or 60.9% compared to the first quarter of fiscal 2016. The increase was primarily driven by a $1.6 million or 15.5% increase in service charges and other fees, which primarily resulted from higher debit interchange income partially offset by lower OD and NSF charges. Mortgage banking income increased by $1.4 million and wealth management income also increased by $600,000 or 39.8%. Looking now at the slide on expenses, provision, and earnings, we see total noninterest expense was $52.5 million for the quarter ended December 2016, an increase of $8.3 million or 18.8% compared to the same quarter last year. The decrease was primarily driven by a $6.3 million increase in salaries and benefits, primarily driven by 13% increase in full-time equivalent employees mostly related to the HF acquisition. Higher incentive compensation due in large part to increases in wealth management and mortgage revenues, and also higher health insurance costs. Net OREO costs increased by $0.8 million, and also in the current quarter there were $700,000 of HF Financial Corp. integration related expenses. The efficiency ratio was 45.1% for the quarter equal to the same quarter of fiscal 2016 and down from 48.5% in the September 2016 quarter. The sequential decrease was primarily driven by an 8.4% decrease in noninterest expenses between the two periods, which included reductions in professional fees and acquisition related expenses. The provision for income taxes for the quarter ended December 2016 was $16.1 million, reflecting an effective tax rate of 30.3%. The lower effective tax rate for the quarter was driven by a favorable resolution of a $1.6 million income tax payable with the company’s former parent. As we now look at our balance sheet slide, we can see the total loans increased by $96.5 million compared to the September 30, 2016. Loan growth was impacted by a $63.5 million reduction in the fair value of $1.08 billion segment of the loan portfolio carried at fair value resulting from changes in interest rates. Aside from this change, which was offset by the changes in the fair value of the related derivatives hedging the interest rate risk of this portfolio, and which had no impact on net income, customer loan balances increased by $159.9 million or 1.8%. Majority of the loan growth during the quarter occurred within the CRE segment of the portfolio. Total deposits grew by $101.5 million or 1.2% during the quarter. The growth was driven by s $74.4 million increase in non-interest bearing deposits and $27 million of interest bearing deposit growth. The quarterly growth on both the loans and deposits was consistent with our expectations communicated on our last earnings release call. Tier 1 and total capital ratios were 11.2% and 12.3% respectively as of December 2016, and the common equity tier 1 capital ratio was 10.4%. The tier 1 leverage ratio was 9.7% as of December 31, 2016. All regulatory capital ratios remain above regulatory minimums to be considered well capitalized, with the increases in capital during the quarter reflective of our strong earnings and return on equity. Now, let’s turn over to our Chief Risk Officer, Steve Ulenberg, who’ll take us through the loan and asset quality trends seen through the quarter. Steve?

[Stephen Ulenberg:]

Thank you, Pete. Turning our attention now to the slide on asset quality, provision for loan losses was $7 million for the quarter ended December 31, 2016. This compared to $5 million for the previous quarter ended September 30, 2016 and $3.9 million in the same quarter of fiscal year 2016. Net charge-offs for the quarter were $4.9 million or 0.22% of average loans on an annualized basis. This compares with the previous September 30, 2016 quarter net charge-offs of $4.6 million. For the comparable period in fiscal year 2016, net charge-offs were negligible. The ratio of ALLL to total loans increased 2 basis points to 0.76% at December 31, 2016 from 0.74% as of September 30, 2016. The balance of the ALLL increased from $64.6 million to $66.8 million over the same period. Included within total loans are approximately $1.08 billion of loans for which management has elected the fair value option. These loans are excluded from the ALLL process, but management has estimated that approximately $7.9 million of the fair value adjustment for these loans relates to credit risk. This translates to an additional 0.09% of total loans. The total remaining purchase discount on all acquired loans equates to 0.42% of total loans. Loans graded Watch were $334 million, an increase of $7.1 million or 2.2% compared to September 30, 2016, and an increase of $36 million or 12.1% compared to December 31, 2015. Loans graded Substandard were $249 million, an increase of $7.9 million or 3.3% compared to September 30, 2016 and an increase of $19 million or 8.5% compared to December 31, 2015. Non-accrual loans were $124 million at December 31, 2016 with $3.9 million of this balance covered by FDIC loss-sharing arrangements. Total nonaccrual loans decreased by $2.2 million during the quarter and increased by $69 million compared to the same quarter in fiscal 2016. The year-over-year increase was primarily driven by the impacts of the deterioration in ag commodity prices as we’ve previously advised. Total OREO balances were $8.1 million at December 31, 2016. This was a decrease of $2.2 million or 21% compared to prior quarter and a decrease of $7.4 million or 47% compared to December 31, 2015. We accelerated 2016 maturity dates and annual reviews for many of our grain borrowers including those that exhibited the most financial stress in 2015. And we’ve already completed many of these reviews. We believe this will contribute to making timely and conservative underwriting decisions for the 2017 growing seasons, including discontinuing relationships with least successful borrowers. While many borrowers had better-than-expected 2016 growing seasons and, we continue to work closely with all our ag customers. The majority of the results of these reviews to-date are reflected in our numbers. And we are currently not expecting substantial credit losses in excess of current ALLL levels. Meanwhile beef and milk prices have each rallied since early-October lows, leading to improved near-term profitability outlooks for many producers in those industries. In summary, overall asset quality remained relatively stable over this last quarter. With that, let’s turn the call back to Ken for some closing remarks.

[Kenneth Karels:]

Okay. Thank you, Steve. We continue to be very excited about the future of this company. We are hopeful that all banks will see some easing of the regulatory burden and that the incoming administration’s economic policies will encourage businesses to invest in growth with increased confidence. We are hopeful that more M&A prospects will come to the forefront in the coming months, though we don’t have anything specific to report at this time. After coming off a successful integration with HF Financial last July, we feel confident we are doing the right things to position GWB for continued stability, growth and profitability over the next year. We are happy to take your questions now.

[Operator:]

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Dave Rochester of Deutsche Bank. Please go ahead.

[David Rochester:]

Hey, good morning, guys.

[Kenneth Karels:]

Good morning, Dave.

[David Rochester:]

Steve, I just wanted to start with payroll [ph] real quick. I want to make sure, I heard you correctly. It sounded like you said, you accelerated the review process to your Ag customers and have the majority of those loans reviewed baked into the quarterly results. Is that right?

[Stephen Ulenberg:]

Yes, that’s correct, Dave. Yes.

[David Rochester:]

And so, when you’re saying majority are you half way there or are you talking 75% or 90%, just I’m trying to get a more detailed sense?

[Stephen Ulenberg:]

Yes, Dave. I think, I mean, look, the typical annual review cycle for ag farmers, they’re balanced end of December. So, of course, it straddles pre and post December. But for the higher risk bucket, we’re probably about 90% through those reviews, Dave.

[David Rochester:]

90% of the reviews?

[Stephen Ulenberg:]

Nine-zero, correct.

[David Rochester:]

Zero? Okay. That’s great. And then how much of this quarter’s provision in migration in the Watch and Substandard books relates to the Ag book? Do you have those stats?

[Kenneth Karels:]

Pete is checking on that here. And a little bit of it, Dave, did relate to, but certainly nothing material compared to prior quarters. Let me just pull it up.

[David Rochester:]

Sure…

[Peter Chapman:]

Have you got other questions, Dave, as we pull it together?

[David Rochester:]

Yes, sure, absolutely. I’ll switch to the NIM. And can you just talk about the impact you anticipate from the rate hike in this coming quarter. And then if you can talk about your deposit pricing post hike, and if there has been any movement there, and if you see any movement at your competitors, that’d be great?

[Kenneth Karels:]

Yes, look, this quarter I wouldn’t expect too much, Dave, a little bit similar to this quarter. It’s helped stable - it’s been stable this quarter. Hopefully, that would help relieve some of the pricing pressure on the loan book in the next quarter. So look, I’d expect that to help, but certainly not lead to much expansion over the next quarter. But as that rolls through the portfolio over the rest of the calendar year, I’d expect that there could be some increase there. The positive side of things, look, seeing a little bit of competition around sort of CD and money market rates, but I wouldn’t say anything much more post-rate-hike than we saw pre-rate-hike, Dave, to be honest so.

[David Rochester:]

Great. That’s helpful. So it sounds like you are looking for at least some degree of NIM expansion here, as we head into the next quarter from the rate hike and higher rates generally.

[Kenneth Karels:]

Look, I’d say sort of flattish over the next quarter, maybe a little bit of an increase depending on balance sheet mix. We hold a little bit more cash this quarter. There wasn’t much in the securities way to purchase this quarter, we held off a little bit. So if we hold a little less cash that will help as well. So, yeah, I’d say so too.

[Stephen Ulenberg:]

Dave, it’s Steve here. Look, maybe the best way to answer, just at a macro-level in terms of - if you at the metrics over the quarter for watch, substandard, non-accrual, I mean, those were very stable. They were flat. So, certainly some increases, some gross increases came through in ag, but equally some pay-downs have been made there, some repayments, and some reductions in other parts of the book have had kept that very stable.

[Kenneth Karels:]

And the watch on the ag, Dave, is less than $20 million bucks up on the ag side, so pretty flat quarter on quarter.

[David Rochester:]

That’s great. I appreciate the color there. And, I guess, just one last one switching to just the M&A backdrop, as you guys are around the market talking to folks, so just curious if you guys feel like the environment has improved and if the bid-ask spread is narrowing. And just conversation level in general, if there are any comments there, it would be great. Thanks.

[Kenneth Karels:]

Yes, Ken here. Definitely more conversations are going on. There is more talk and discussions going on. But I cannot say that the bid-ask has narrowed. The higher valuations especially of public company are still having the expectations of getting a substantial premium over that, and in some instances I would say the spreads even widened somewhat. So we’ll see overtime if that narrows, which I think it needs to make some M&A activity profitable for both sides of it too, so definitely more conversations going on, but no narrowing them to spread at this point.

[David Rochester:]

Okay. Great. Thanks, guys.

[Operator:]

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

[Steven Alexopoulos:]

Hey, good morning, everybody.

[Kenneth Karels:]

Hi there.

[Steven Alexopoulos:]

I wanted to follow-up first on the expectations for the NIM to be relatively stable near-term. We think about the fed move in December, the high percentage of variable rate loans. Why are you not looking for more pronounced NIM expansion here near-term?

[Peter Chapman:]

Look, I think that will come. And the thing we’re seeing from new book originations though, Steve, is I wouldn’t say new book originations in terms of rate - followed up and taken that. There’s a little bit of a competition on the front book. So I think that will just hold it back a little bit. And also from a loan to deposit perspective we are 100% loan to deposit as well, Steve. So maybe that factors into our thinking a little bit as well, how we look at NIM.

[Kenneth Karels:]

Steve, I think the point is we aren’t looking at flat. We are looking at slight increase though.

[Peter Chapman:]

Yes. I think so, yes.

[Steven Alexopoulos:]

Okay. Are new loans coming into the portfolio is still below the overall portfolio yield?

[Peter Chapman:]

Look, it’s come up a little bit compared to the overall portfolio yield, but were still in the mid 4 range, Steve, I would say. So in terms of that 25 point cash increase, we haven’t seen all of that flowed through to new book originations in our footprint [ph] at this stage.

[Steven Alexopoulos:]

There we go. And, Peter, what’s the deposit beta you’re assuming this year?

[Peter Chapman:]

Look, we haven’t disclosed that specifically, Steve. But overall, our book, I don’t think there is anything there that would suggest that would move materially different to others with a similar mix. So I don’t think there is anything with it in house that gives us concern that would be different to many others of the banks you cover.

[Kenneth Karels:]

Ken here. I can say though with this last quarter we have not seen very many banks move up in rates or any competitive market. So as we earlier said and this last quarter or a year ago we didn’t see much deposit pressure. This last quarter increase a little bit more, but not much deposit pressure. So I think a lot of that, the beta will be a lot less for this increase than what you could see in two or three more increase [indiscernible].

[Steven Alexopoulos:]

Okay. And then shifting gears on the loan growth, can you talk about what you’re seeing from a business sentiment view and do you still think mid-single-digit loan growth is reasonable for 2017?

[Kenneth Karels:]

Yes, I will start here and I’ll have Steve answer as far specifics on it too. Yes, I think the answer is, yes. The optimism since the election is stronger. We’re not seeing that yet into activity in any major sense. I think they’re still waiting to see what happens from some of the infrastructure spending and tax cuts, some of those things that are going to happen yet, so definitely optimism there, but there’re still some of the pullback as far as expansion.

[Stephen Ulenberg:]

Yes, and Steve here. Yes, just in terms of what we’re seeing coming through the pipeline, still good demand for commercial real estate. We’re maintaining our origination standards, but we’re seeing some good [money from there] [ph] from a number of our markets. We were within our risk appetite limits on that too [or hasten to add] [ph]. And C&I, we’re seeing some good prospects coming through the pipeline there. As you know those take a little bit longer to come to fruition, because you tend to have an incumbent bank, but we see some good opportunities there. It goes without saying not much growth in agri. We’re seeing - with the exception of dairy, there are some opportunities we’re seeing coming through there. And then in a couple of newer markets, both Minnesota and North Dakota again there are some selective, particularly commercial real estate opportunities we’re pursuing there as well.

[Steven Alexopoulos:]

So is mid-single-digit growth still expected for loan growth?

[Stephen Ulenberg:]

Yes.

[Kenneth Karels:]

Yes, that’s we’re still keep flagging anyway.

[Steven Alexopoulos:]

Okay. And if I could squeeze one more in there, and that the $7 million provision you guys took in the quarter, how much of it is related to the change in the reserve loss rates that you cite here in the release?

[Kenneth Karels:]

Probably about $1.5 million.

[Steven Alexopoulos:]

Okay. Okay. Thanks for all the color.

[Kenneth Karels:]

Thanks.

[Operator:]

The next question comes from Ebrahim Poonawala of Bank of America. Please go ahead.

[Ebrahim Poonawala:]

Good morning.

[Kenneth Karels:]

Good morning.

[Ebrahim Poonawala:]

I think the first question, I just wanted to follow-up on the margin beyond the first quarter. Do we need rates to move further higher and do you need multiple rate hikes for the margin to be stable relative to whatever little expansion we get in 1Q? And absent any additional increase in rates long-end and short-end, could the margin actually trend lower?

[Kenneth Karels:]

Look, in the absence of any interest rate move on flat, Ebrahim, we’ve said sort of the 1 to 2 basis point decrease a quarter. The guidance we’ve given ex the cash hold this quarter we will flat. So I just want to say, flattish to maybe down one in the absence of rate hikes. In terms of overall increases, we benefit more from two increases than one. If you look at the book there is obviously a high proportion to variable of the loan flows. There is about 83 basis point average to go through [our lows.] [ph] But once we get through two rate hikes, a substantial amount of those would go through, so two would be more helpful than one. But if we do get another one in the next quarter I’d expect that to be going from sort of flat to helping expand NIM.

[Ebrahim Poonawala:]

Well, that’s very helpful. And switching back on the ag book, as we think about sort of the outlook and obviously the ag customers have been under pressure for several years now. As we think about sort of the next year, what is it that would provide relief to sort of - or what you consider the higher risk customers? Is it simply the commodity prices need to go up, or is there anything else that they are doing at their end, which could make them less riskier as this year proceeds?

[Kenneth Karels:]

I think the bigger thing is not commodity prices going up, because we aren’t hopeful that that will happen. It’s really getting their cost down, which we are seeing happen and they are doing. And so a lot of what we are seeing from a cash flow standpoint, as we get into 2017, starting to cash flow with the same commodity prices, just because we are getting cash grants [ph] and other cost down. And if you look back into the prior history of this than the three or four years, where we saw substantially higher commodity prices, they survived on commodity prices that are where they are at today with lower yields. So it’s really a matter of getting the costs back down to where they were during those periods.

[Stephen Ulenberg:]

Steve here. Just a couple of things I’d add that too. We have seen very good yields come through this year. USDA announced both in beans and corn, crops are 10% up from last year, so that’s going to help a little bit. And the other thing we keep focusing on is marketing, one thing to grow up. But customers are getting much better at looking in forward sales, so they are hedging their risk.

[Ebrahim Poonawala:]

Understood. And if I can ask one last question, in terms of expenses obviously we had a pretty decent decline sequentially. And I’m sorry if I missed it, if you talked about the outlook on expense growth and how we should think about it relative to where we were at the end of - for the fourth quarter?

[Kenneth Karels:]

Yes, look on expenses. I think it’s a pretty reasonable quarter from a run rate perspective, Ebrahim. I think it’s probably - and maybe it’s $1 million light from a run rate perspective, if you’re looking at run rate. Efficiency we still expect to be in the mid-40s range, and then also on the income side, particularly on the noninterest income, maybe that’s about $0.5 million to three quarters of $1 million light as well this quarter. And we went through a pretty large reissuance of cards for the EMV chips that that came into this quarter as it try to help on the fraud cost side of things, so that’s probably the color I can add there.

[Ebrahim Poonawala:]

All right. Very helpful. Thank you very much.

[Kenneth Karels:]

No problem.

[Operator:]

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

[Jon Arfstrom:]

Thanks. Good morning.

[Kenneth Karels:]

Good morning, Jon.

[Jon Arfstrom:]

A couple of questions here. Steve, you talked about discontinuing some ag relationships with weaker borrowers. What’s the magnitude of that?

[Stephen Ulenberg:]

Look, I wouldn’t put a number on it. I mean, obviously, we try to - all other options before we go to that level, but, yes, it’s certainly a minority of the customers we do work with. And they can restructure, recapitalize over time. And we work closely with them on that. So it’s certainly not floodgates.

[Jon Arfstrom:]

Okay. Good. Maybe in commercial real estate, kind of where and what are you seeing in terms of opportunities, and maybe touch on commercial real estate pricing.

[Kenneth Karels:]

Right, look, in terms of opportunities, look, we still see some pretty good demand down the Colorado, Arizona way, particularly that’s driven hospitality, health [indiscernible]. As I see it in couple of newer markets, there are still multifamily opportunities particularly in commercial construction opportunities going on there. In terms of pricing…

[Peter Chapman:]

Yes, just on your - sure, Jon, consistent with the rest of the portfolio I think we’re seeing flattening pricing there. In this part of the world you’re not seeing an uptick on - some of the East Coast banks have talked about an uptick in the non-owner occupied pricing. But maybe a few people on this fall on that as yet, so sort of flattish pricing there rather than increasing in this part of the world.

[Jon Arfstrom:]

Okay. And then, Pete, as long as you have the mike, that provision has crept up a bit over the last several quarters. And, I guess, we all expect that. But it sounds like you all are feeling pretty comfortable with the credit picture. Do you feel like you need to continue to slowly increase the provision or does it feel like you have enough right now and this is a pretty good rate of provision?

[Peter Chapman:]

We feel pretty comfortable. I think if you look at that all-in rate, Jon, it’s at 128, once you put the acquired loans in and the sort of the accounting rules on what you can take across each of those portfolios. But overall we’re pretty comfortable. I think as Steve said on the ag side, we’re comfortable with the levels of ALLL and so we’ll just monitor it quarter by quarter. We’re certainly not looking to build toward specific level as we’ve said before.

[Jon Arfstrom:]

Okay. Got it. And, Ken, maybe one last one for you. Slide 8, the first bullet is attract and retain high-quality relationship bankers. I think you touched on it last quarter, but maybe give us an update on competitive dynamics and are you more optimistic at all on your ability to hire away from competitors or at least move market share?

[Kenneth Karels:]

Yes. We continue to add new bankers, as well competitive - and lost very few over the last quarter. So definitely feel confident that we can continue to do that.

[Jon Arfstrom:]

Okay. All right. Thank you.

[Operator:]

The next question comes from Erik Zwick of Stephens Inc. Please go ahead.

[Erik Zwick:]

Good morning, guys.

[Kenneth Karels:]

Good morning.

[Erik Zwick:]

First, maybe just looking at the loans, the average balances were up less than at period end. Was that a factor of ag borrowers starting to draw on lines after taking their normal annual rest periods or was there something else that drove that and could that momentum continue into here and to the second quarter?

[Kenneth Karels:]

Yes. I think most of our growth came in December. And part of it was some of the season lists in ag, although that was substantially less than we saw on other years. And so the pay-downs in January obviously will be less. I think which is more just the timing of when we find it…

[Kenneth Karels:]

But there is a lot more growth just in the December month in terms of just when things drew down. Good observation.

[Erik Zwick:]

And when do you expect that momentum to continue here into the second quarter?

[Kenneth Karels:]

Yes. I don’t think we’d see any change. I mean, I think it’s - we’d probably see more level of funding this quarter than we saw last quarter.

[Peter Chapman:]

Yes. And, Ken, talking to mid-single-digits, if you annualize that where we are it is circa 7% year to date. So in terms of where we are it’s pretty consistent with the guidance for the full year. It’s certainly not going to be a straight line over the course of the full quarters and we’re pretty comfortable with that for the full year.

[Erik Zwick:]

And with regard to the C&I balances, they were down quarter-over-quarter, and if I recall from last quarter on the conference call, you were pretty optimistic about the opportunities there. Has anything changed there? Is it taking a little bit longer to come to fruition or is it kind of the pay-downs that affected the balances this quarter?

[Stephen Ulenberg:]

Yes, look, Steve here, I’ll take that. No, certainly the outlook hasn’t changed. As I said, the pipeline has got some good solid C&I opportunities. But unlike a CRE loan, the lead-time to convert that into a new customer, they have to change banks. It’s really you’re moving an incumbent bank out that metric, just takes longer than some of the other segments that you’re building.

[Erik Zwick:]

Maybe just a follow-up on the M&A and acquisition opportunity comments from earlier, it sounded like the - for public banks the bid-ask spreads are still wide. If you think about private banks, who often have a target mind, whether it’s some multiple relative to tangible book value, is a fact that you’re a publicly traded bank does that potentially help those discussions with private banks?

[Kenneth Karels:]

It’s a good point. We think it will. Just whether they will follow a public bank pricing from a book to tangible - price to tangible book value or not, is yet to be seen. But we think there will be probably more opportunity in the private versus the public bank sector.

[Erik Zwick:]

Great. Thanks for taking my questions.

[Kenneth Karels:]

Yeah. Thank you.

[Operator:]

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

[Nathan Race:]

Hey, guys, good morning.

[Kenneth Karels:]

Hey, good morning.

[Nathan Race:]

A question, Pete, on this securities portfolio, just curious with the buildup in excess liquidity in the quarter, kind of how you guys are looking about timing and the type of security reinvestments here looking at as we go through 2017?

[Peter Chapman:]

Yeah, sure. As we’ve said before, Nathan, we are holding more genies [ph] in the portfolio than I’d think going forward. So I do expect to see that to continue to trickle down. And then also look to reinvest in - we’ve building our muni portfolio, and also just treasuries, and agencies I’d say from a general spread. It’s obviously an uprights outlook compared to where we were though the September - December quarter. And we’ll probably put a little bit more to work over the coming couple of quarters than we did in December I’d say.

[Nathan Race:]

Okay. Got it. And can you give us a good tax rate to use in 2017?

[Peter Chapman:]

Yeah, look, I’d expect they’re around closer to 34, sort of high 33s, just under 34.

[Nathan Race:]

Okay. Great. Thank you.

[Peter Chapman:]

No problem.

[Operator:]

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

[Damon DelMonte:]

Hey, thanks. Good morning, guys. Just want to get a point of clarification. Peter, I think you said that the service charges were down this quarter, because you guys rolled out new cards. Is that correct?

[Peter Chapman:]

Yeah, that was one of the factors and there is a bit of seasonality in there. That, yes, there is probably about $400,000 out of card reissue cost in there, yes.

[Damon DelMonte:]

Okay. And then, the Durbin impact, which you highlighted as about $2.4 million this quarter, that’s going to be included through June 30, is that correct?

[Kenneth Karels:]

July 31.

[Peter Chapman:]

Yes, July 31. Yes, it [runs a month in arrears] [ph], yes.

[Damon DelMonte:]

Okay, got it. And then we can back it out to at that point. Okay. And then, most of my other questions have been answered. I guess, just kind of one kind of broader based M&A question. Could you just kind of remind us of your appetite for size and for geographic location? Would you consider going into a state that you guys don’t currently operate in and kind of how big of a transaction would you look to do?

[Kenneth Karels:]

Yeah, we’ve - it doesn’t change, roughly $0.5 billion to $3 billion to $4 billion from a size standpoint. States that we’re in are joining to where we were at we definitely would look at. But for us go to East Coast, West Coast would be something out of our appetite.

[Damon DelMonte:]

Okay. It’s all that I had. Thank you very much.

[Kenneth Karels:]

Yes. Thank you.

[Operator:]

The next question comes from Tim O’Brien of Sandler O’Neill. Please go ahead.

[Timothy O’Brien:]

Good morning. Just one last question for me, you mentioned in the press release, loan growth was impacted by $63 million reduction in fair value on the $1.08 billion segment of loan portfolio due to changes in interest rates. Can you give a little bit more color on what changes those were and if that has the potential of being a recurring item here in the first quarter and beyond?

[Peter Chapman:]

Yes. Thanks for the question. Does that have the potential? And it’s always been in there. Tim, just with rates increasing more through the current quarter, obviously on those fixed rate loans, they’re worth less. But we’ve hedged that on the derivate side. So it’s always been there. It’s been negligible from a portfolio perspective. So, look, haven’t quantified what the look-forward could be, but certainly we will look to call it out, because if rates do continue to increase we would expect that number to potentially increase as well. So it’s something we look to continue to give guidance on I’d say.

[Kenneth Karels:]

I think the point with that, Tim, is that we have hedged that, so what decreases in loan fair market value is offset by the derivative.

[Peter Chapman:]

Absolutely. No P&L…

[Kenneth Karels:]

There is no P&L impact on it. And in essence it helps our margin, because we’ve swapped those loans to variable rates. So we do see increase in interest income as that goes off. So actually it’s a positive for us, but the way the accounting is, you’ll see the loan balance go down, and you will see the derivative offset on it.

[Peter Chapman:]

And if anything else to add, Dave, I know you’ve done a lot of work on that.

[Kenneth Karels:]

Hinderaker.

[Timothy O’Brien:]

And then one other…

[David Hinderaker:]

No, it’s really just a function of the magnitude this quarter that we’ve felt that it was prudent to call it out.

[Timothy O’Brien:]

Thanks for the color, guys. And then one another question, just with regard to the comments you made on expense outlook, overhead cost outlook. Does that include seasonal FICA and other kind of start of year cost for - looking at the first quarter, Peter?

[Peter Chapman:]

Yes, good question. Look, there’s probably a little bit of that, in terms of sort of saying we are a little light this quarter compared to the go-forward. Our annual merit increases, they come in from January 1, Tim. So there is a little bit of that, and then there are taxes, and the head and the like with that. Lot of the health insurance costs they’re reset at the start of the year as well. So those sort of things, so that’s included in that guidance.

[Timothy O’Brien:]

Thanks for answering my questions.

[Peter Chapman:]

That’s all right.

[Operator:]

This concludes our question-and-answer session. I would like to turn the conference back over to Ken Karels, President and CEO for any closing remarks.

[Kenneth Karels:]

Okay. Thanks for joining us this morning. As I said earlier, we are excited about the future of our company. And as a banker, it’s exciting to be a banker again with some of the changes we are seeing on the regulatory front, interest rates, potential infrastructure spending in the economy and growth. And all those aren’t reflected in any of our guidance on there, it is some things that look positive, and I think reflected in all banks stock price. So again thank you for joining us. That’s it for us.

[Operator:]

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.