Great Western Bancorp, Inc.
Q3 2017 Earnings Call Transcript

Published: 27 Jul 2017

[Operator:]

Good morning. And welcome to the Great Western Bancorp Third Quarter Fiscal Year 2017 Earnings Announcement 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 that today's event is being recorded. I would now like to turn the conference over to Ms. Ann Nachtigal. Please go ahead.

[Ann Nachtigal:]

Thank you, Andrea, and good morning, everyone. Joining us this morning on Great Western Bancorp's third quarter fiscal year 2017 conference call are

[Kenneth James Karels:]

Thank you, Ann, and good morning, everyone. We are once again glad to discuss the results for the most recent quarter. Key takeaways include net income was $35.1 million, representing a 1.25% return on average assets; net interest margin continue to expand compared to our second fiscal quarter, reflecting higher asset yields, partially offset by higher deposit costs; we grew loans by $94 million, erasing last year's net loan reduction and net charge-offs were 20 basis points - excuse me, last quarter's net loan reductions - net charge-offs were 20 basis points of average loans on an annualized basis, more in line with our longer-term expectations. I'd also like to introduce Michael Gough. Michael is our Chief Credit Officer. Michael will be joining our call this morning for our Q&A and taking a more prominent role on these calls going forward. Michael has a 34-year career in banking, including 21 years with Great Western Bank and its predecessors. Now, for greater details on our third quarter financial results, I'd like to turn the call over to Peter Chapman. Pete?

[Peter Robert Chapman:]

Thank you, Ken, and good morning, everybody. As we look at our revenue slide, you can see net interest income was $101 million for the third quarter of fiscal 2017, an increase of nearly 8% compared to the same quarter last year, driven primarily by an increase in average loans. This represents a net interest margin of 4% for the quarter and an adjusted net interest margin, which is the metric we manage to, of 3.87%. NIM and adjusted NIM increased by 2 basis points and 4 basis points respectively, compared to our second fiscal quarter. We continue to benefit from the impact of Federal Reserve rate hikes with our overall yield on interest earning assets increasing by 6 basis points quarter-over-quarter, while the cost of interest bearing liabilities increased by 4 basis points. However, our cost to deposits increased by 6 basis points, partially offset by a reduction in average FHLB advances outstanding. Our cost of interest rate swaps related to hedging the interest rate risk on a $1.1 billion of loans at fair value also moved lower by approximately $0.5 million, compared to the March quarter as a result of higher one-month LIBOR. We expect our NIM and our adjusted NIM to move modestly higher in the next quarter or two as we capture the full benefit of the June rate hike. Non-interest income for the quarter was $15.5 million. I'd like to break non-interest income into two parts, income from products and services and the change in the fair value with certain long-term loans and the related derivatives. Income from products and services accounted for a $1.7 million increase, representing a 10% increase driven by increases in wealth management revenue, debit card interchange fees and other income. While mortgage revenue was relatively flat. We estimate that the benefit to our interchange income as a result of being able to charge higher rates was approximately $2.6 million. As a result of exceeding $10 billion in total assets, we will revert to the lower rate structure beginning in the current quarter, resulting in a reduction in this revenue stream of approximately half. The change in fair value of long-term loans and the related derivatives accounted for the balance of the increase were approximately $4.7 million, comprising a $3 million favorable change in credit adjustment on the loans and a $1.7 million reduction in the current cost of derivatives, resulting from lower LIBOR rates. Now, looking at the slide on expenses, provision and earnings, non-interest expense was $54.9 million for the quarter, which was a 12% increase over the same quarter in fiscal 2016, after adjusting out non-recurring acquisition related expenses in that period. Majority of the increase was driven by higher salaries and employee benefits, which includes additional FTEs [ph] hired to address regulatory and risk management expectations, higher long-term incentive compensation and higher cost of employee healthcare. Data processing and professional fees also increased by $800,000 respectively. Despite higher non-interest expenses, we delivered an efficiency ratio of 46.7%, well in line with our expectations. For the September quarter, we expect that we will write off approximately $1 million in net fixed assets when we place an upgraded branch telecapture [ph] system into service across our branch network, which we expect will yield efficiencies over time and improve the customer experience. Despite this charge, we will continue to expect a sub-50% efficiency ratio. Our effective tax rate for the quarter was 34.5%, consistent with our expectations for an effective tax rate in the absence of material one-off items. All regulatory capital ratios remain stable compared to March 31, 2017, with tier 1 capital and total capital at 11.5% and 12.6% respectively. We'll again pay a quarterly cash dividend of $0.20 per share. To conclude, we remain very happy with our return profile year-to-date, including a 1.26% return on average assets and a 15.5% return on average tangible common equity. I'd now like to turn the call over to Doug to discuss the balance sheet activity for the quarter.

[Douglas Richard Bass:]

Thanks, Pete, and good morning, everyone. We had total loans outstanding of $8.79 billion as of June 30. This represents growth of $94 million, compared to March 31 and brings our fiscal year to date growth to 1.3% as compared to prior year comparable period, growth was $185 million or 2.1%. The $94 million of net growth included $115 million of commercial real estate and $26 million of C&I loans, partially offset by a $27 million net reduction in agricultural loans primarily in our Midwest markets, along with continued reductions in residential real estate and consumer loans, which are aligned with our commercial and Ag focused strategy. Growth during the quarter included both seasonal demand and increasing commercial pipelines across many of our metro markets, based upon third quarter closing activity, pipelines and closing scheduled in the fourth quarter, we anticipate mid-single-digit loan growth for the full fiscal year, as previously indicated. The pace of loan growth accelerated in the third quarter and the rate of prepayments has slowed. We have had a strong month of loan originations in July. We are optimistic about the outlook for the remainder of this year, given our current pipelines. Total deposits declined by $133 million compared to March 31, which was consistent with our expectations for seasonal deposit outflows that we have seen for many consecutive years. We believe this is driven by a number of factors including retail and business customers paying income taxes, increased consumer spending in the summer months, and state and municipal real estate tax outflows. Our loan deposit ratio was 98%, which is within our targeted range. We are closely monitoring weather conditions across our footprint. Crop conditions are stressed in parts of central South Dakota. However, a majority of our markets are expected to meet multi-year averages we use in our cash flow assumptions. We expect crop insurance coverages along with strong equity positions to mitigate any declines in 2017 profit. Let's turn the call over now to our Chief Risk Officer, Steve Ulenberg, who will take us through asset quality developments. Steve?

[Stephen John Ulenberg:]

Thank you. Thank you, Doug. Turning our attention now to the slide on asset quality, provision for loan losses was $5.8 million for the quarter, approximately $400,000 higher than the same quarter last year. Net charge-offs for the quarter totaled $4.3 million or 20 basis points of average loans on an annualized basis. This compares favorably to the 38 basis points of net charge-offs we recorded in our second fiscal quarter, and it's more consistent with our longer term expectations. On a fiscal year-to-date basis, our net charge-offs stand at 27 basis points of average loans on an annualized basis. Net charge-offs recognized during the quarter were primarily within the C&I segment of the loan portfolio. Our ALLL as a percentage of total loans was 73 basis points, a slight improvement compared to 72 basis points at the end of last quarter, resulted from higher provisions for loan losses rather than net charge-offs. Our comprehensive credit coverage, which includes credit related fee value adjustments on our long-term loan portfolio as well as purchase accounting marks remained sound at 119 basis points of total loans. Key asset quality metrics remained sound during the quarter with Watch, Substandard, non-accrual loan balances all showing small improvements compared to March 31. OREO increased by $2.1 million over the same period, driven almost entirely by the reposition of one parcel of collateral, but total OREO remains low at $9.1 million. Doug, as already provided some color around the challenges, a limited number of our grain producing customers in the Midwest are facing and we remain comfortable with asset quality treating across our loan portfolio. With that, I'll turn the call back to Ken for some closing remarks.

[Kenneth James Karels:]

Okay. Thank you, Steve. While our non-interest expense in the quarter were higher than we would have liked in order to meet regulatory and risk management expenses, and covered higher cost in employee benefits. We are very proud that we were still able to deliver a sub 47% efficiency ratio. We are confident, we were doing the right things to meet our obligations as efficiently as possible, and that we can drive positive operating leverage over time. We are also seeing loan demand beginning to accelerate and we will continue to explore new products and markets to serve our customers and help drive growth. Thank you again for your interest in Great Western Bank. And we're now happy to open it up for questions.

[Operator:]

We will now begin the question-and-answer session. [Operator Instructions] And our first question comes from Ebrahim Poonawala of Bank of America Merrill Lynch. Please go ahead.

[Ebrahim Poonawala:]

Good morning, guys.

[Kenneth James Karels:]

Good morning.

[Peter Robert Chapman:]

Hey, Ebrahim.

[Ebrahim Poonawala:]

Hey, just first question, I guess, Ken, I wanted to ask on loan growth. It felt like over the last year or at least last six months where you sort of scaled back expectations on loan growth. I recognize you've kept the guidance at mid-single-digits the same. But just hearing you talk about it, it feels like you're a little more optimistic on growth outlook than we've been in the past six months or so. So would love some color around where you're seeing growth and if that's in fact the case.

[Kenneth James Karels:]

Yeah, thanks. And I'll have Doug Bass chime in here too. But during the last quarter here, we saw pretty good growth in April, actually a reduction in May and then it picked up the last week or so, some really good growth. And that carried over now into July and the pipelines are stronger. Growth has come a little tougher than we have expected, plus the headwinds of pay-down in Ag, which is really a part of intentionally bias has helped the strong headwind of the growth. But, Doug, maybe give a little color on what we're looking at, type of loans.

[Douglas Richard Bass:]

Yeah, I think on the one side with the Ag loans, we had a much more modest reduction in the quarter on the Ag side, which offset significant pipeline growth that we're seeing across our metro markets. When you look at the segments, it is fairly evenly spread between commercial, commercial real estate as owner occupied and commercial real estate for non-owner occupied. We intend to continue to keep balanced portfolios within those segments per our risk appetite. However, we feel fortunate that lot of the growth in the metro markets is part seasonal as we've experienced in prior years. But, again, very well balanced across several states and several metro markets.

[Ebrahim Poonawala:]

And how much more do you expect in terms of run-off in the Ag book, in terms of the intentional run-off over the next few quarters? And like where do you see that book sort of leveling out as a percentage of loans?

[Kenneth James Karels:]

Well, yeah, it dropped to, what, 23% now?

[Douglas Richard Bass:]

[We're about 20%] [ph].

[Kenneth James Karels:]

But I think that will come down a little bit more. And we are seeing some growth in the non-grain side of it, particularly dairy. And I think there is some opportunity for us to grow there. But exact dollars from the grain side of it could be, what, $50 million to $100 million of reduction over the next probably a year, more than a quarter on it. So I think we still have a little bit of a headwind on the Ag grain side of it. And then it will start leveling out at that point. That might - it'd be my best guess.

[Douglas Richard Bass:]

And I think what we're looking at probably in opportunities in the protein sector, as Ken mentioned, primarily in the dairy, in our Western and Southwestern markets. We're continuing to see very positive profitability profiles. Commodity prices are very positive. We're seeing strong opportunities with many of our borrowers and some new customers, both for expansion and growth. So we see that as an accelerated growth opportunity, probably in the Ag sector, but it would be predominantly in the Southwestern markets.

[Ebrahim Poonawala:]

Understood. And just quickly switching to margin, Pete, you mentioned about expecting continued margin expansion driven by the June rate hike. Should we expect that margin expansion to be in the neighborhood of the kind of improvement we saw this quarter versus last quarter, so about 4 basis points and level off from there absent rate hike? Is that sort of the right way to think about it?

[Peter Robert Chapman:]

Yeah, probably not quite 4, probably 2 to 3 I would say, Ebrahim, maybe. Deposit costs are creeping up a little bit as well. But, yeah, I would expect some increase there.

[Ebrahim Poonawala:]

And just on the deposit cost, like if you can talk about what we are seeing either in terms of the breakdown of deposit, between commercial versus retail or across your markets how you're seeing competition pick up, I think that color would be helpful.

[Peter Robert Chapman:]

Yeah, sure. I'm probably seeing a little more competition on the business side, than the retail side, Ebrahim. On the business side, businesses are certainly aware that rates have started moving. So we're seeing a little bit of pressure there. The way we're trying to manage that is we're not publishing new rate sheets. We are just doing exception pricing, just so we're not re-pricing the whole book. On the consumer side, a few CD specials around, compared to a couple of quarters ago, but still not seeing as much pressure there at this stage.

[Ebrahim Poonawala:]

Got it. Thanks for taking my questions.

[Kenneth James Karels:]

Thank you.

[Peter Robert Chapman:]

Thank you.

[Operator:]

Our next question comes from Jeff Rulis of D.A. Davidson. Please go ahead.

[Jeffrey Rulis:]

Thanks, good morning. A question on the expense side, citing regulatory risk admin [ph] kind of driving cost up in the short-term. I guess, is that suggesting that you're close to a flattening off of maybe the earning - or the expense ramp? And, I guess, excluding the fixed asset write-off you expect next quarter, maybe it's, put best, just what are your expectations for expense growth in fiscal 2018?

[Kenneth James Karels:]

Pete, go ahead.

[Peter Robert Chapman:]

Yes, so, Jeff, thank you. Look, I'd say, within the current quarter, even though expenses are a little elevated. There are some things in there that we wouldn't expect to reoccur next quarter, so we still have some healthcare claims coming through. Unfortunately, for employees also there is some model risk management and defile spend in that quarter as we get prepared for our sort of voluntary submission this quarter on the defile side of things. So to be honest with that - with the write off included in the next quarter, I'd expect expense levels to be consistent with where they are this quarter, sort of around that $55 million mark is sort of where the expectation is, sort of plus or minus a small amount from there.

[Kenneth James Karels:]

And that's with the $1 million.

[Peter Robert Chapman:]

That's with the $1 million in there, because within this quarter there is a couple of hundred thousand or few hundred thousands are spent on that project. And also, a few other things that we wouldn't expect to be recurring next quarter. And that project, we would expect that to give us a bit of an operating leverage through our branch network and operations department, but that's probably a more phased in over time than anything significant in the next quarter or two.

[Jeffrey Rulis:]

Okay. So when you say leverage, it's more holding while on expenses and hopefully ramping revenue.

[Peter Robert Chapman:]

Yeah, exactly, yeah.

[Jeffrey Rulis:]

I'm just trying to get my arms around the quarterly run rate on non-interest expense in the fiscal 2018. I guess, if you think you're kind flat lining in Q4 with some puts and takes, how does that translate in 2018?

[Peter Robert Chapman:]

Yeah, and then for 2018, I'd expect modest growth from there, so sort of inflationary growth from there. So sort of in that 3% to 4% range, I'd say overall.

[Jeffrey Rulis:]

Fair enough, okay, thanks.

[Peter Robert Chapman:]

No problem.

[Jeffrey Rulis:]

And then, last one, but we're on to the - more on the fee income side. I just wanted to clarify, as the Durbin impact kind of rolls in next quarter, so kind of feathered in with not a full quarter. But that service charge and other fees, is that kind of a 10.6, 10.7 a quarter is kind of where you think that settles in and then potentially grow from there?

[Peter Robert Chapman:]

Yeah, look, I would think so. As you say, we get one month of income in this September quarter. We get one month out of the quarter at the elevated Durbin and then we drop away. And then, going forward, I mean, as we've said, we'd expect about $2.5 million a quarter on a full quarter basis to drop off from the December quarter onwards for the next, going forward.

[Jeffrey Rulis:]

Okay. Thanks.

[Operator:]

Our next question comes from Dave Rochester of Deutsche Bank. Please go ahead.

[David Rochester:]

Hey, good morning, guys.

[Kenneth James Karels:]

Hey, Dave.

[Peter Robert Chapman:]

Good morning.

[David Rochester:]

So I've been watching the TCE ratio that continues to increase. We're now 9.2%. Now, I think I remember, Pete, you were saying that 9% is kind of at the upper end of the range you want to be at. I was just wondering when you think it makes sense to reengage in the buyback and then if you can just talk about the M&A environment. Do you think the bid/ask spread there has improved at all and what the conversation activity looks like? That'd be great.

[Kenneth James Karels:]

Yeah, I think a good point. Capital has continued to grow with a strong ROA that we have. We definitely will look at, and have authority to buy back stock as an opportunist. So we'll continue to watch and see if there is time to do that. Then on the M&A circuit here, definitely a lot of activity and discussion this last quarter. We are seeing the price increase substantially. And obviously, you've seen a couple of deals announced here this last week where bank stocks have dropped or the acquirer stock has dropped 5% to 8%. So it tells me we're a little overheated on price. Definitely, we'll be continuing to look, knock on doors, talk to people on it. But we'll be very disciplined in what we pay and doing the deal to make sure we reward our stockholders and not the sellers' stockholders only. So definitely looking at it, definitely we'll do it if the deal is right, if it fits the criteria that we've announced before, but it has to be also at the right price.

[David Rochester:]

Okay, great. And then, you had mentioned some stress, I guess, in the South Dakota portion of the grain book. I was just wondering if you could give any kind of numbers around that, in terms of the actual size of the Ag portfolio within that market and then whether it's weighted to corn or some other crop.

[Kenneth James Karels:]

Michael Gough, you want to go ahead?

[Michael Gough:]

Happy to. Thank you, Ken. Overall, if you look at our grain production book overall, it's about $730 million, roughly 40% of that is in the state of South Dakota. Overall, as was mentioned in the presentation it's really the central part of South Dakota that is under the most stress. We have a fair amount of production in the Northeast part of the state. But it has gotten some decent rainfall the last week or so. Overall, we are obviously watching the situation very closely. With the number of - we consider Watch credits in that grain space, we think it's a very manageable number, not expecting it to have a significant increase on provision. Obviously, we've got to finish out the year to see where actual results come in.

[David Rochester:]

And then, what can you do on the meantime? I know, you mentioned that you got the crop insurance that can help you out. What other steps can you take to help these guys avoid any issues?

[Michael Gough:]

Great question. What we've been trying to do very proactively for certainly the past few years, and this is across all of our book, it's - the production is almost a given in that space, that our operators know how to grow whatever the crop is. Key differentiator is really marketing practices. And we have worked very closely, our line staff has worked very hard to get a better handle on marketing plans of our borrowers even while the prices are maybe lower than they were four, five years ago. We look at the price is down more as normal. And it's really a focus of working with our producers to make sure we certainly are going to tell them how and when to sell. But we can make sure to fit our risk appetite that they have a plan. I would say that's the other big focus that we have in managing our Ag book.

[David Rochester:]

Great. I appreciate the color. And then, just one last one on deposit growth, I know, you seasonally have a little bit of dip this quarter, so that was expected. We are just wondering what your thoughts are going forward on deposit growth in a competitive environment?

[Douglas Richard Bass:]

I think when we take a look, David, to markets. We are seeing again metro markets having an uptick in growth, I think the headwind becomes with increasing interest rates, and increasing earnings credit. We need also understand that non-interest bearing balances will tick down as earnings credit increases with increasing interest rates. But we are seeing again growth in the metro markets, low-single-digit non-interest bearing balances from a growth percentage. Seasonally, as we mentioned, we are seeing a lot of outflows, which have happened in other years as public entities spend with no revenue sources through this summer, and that usually has always come back in the fall. We see influxes on September 30 through early October with a lot of our public entities with tax receipts.

[David Rochester:]

Okay.

[Kenneth James Karels:]

And also Dave, if you look at the average deposits for the quarter, averages were up quarter-on-quarter, so the spot was down and just a little bit of run-off towards the end of June.

[David Rochester:]

Sounds good. All right. Thanks, guys.

[Kenneth James Karels:]

Thanks, Steve.

[Operator:]

Our next question comes from Steve Moss of FBR. Please go ahead.

[Stephen Moss:]

Good morning. I was wondering, with regard - if you could give some color around the decline in multifamily real estate this quarter?

[Kenneth James Karels:]

I am not sure, we had much decline in there, Steve. I saw your early note on it here and we were kind of looking through that at the point. So I'm not sure, what you've seen or where you've seen it.

[Stephen Moss:]

Just looking at the [Multiple Speakers].

[Kenneth James Karels:]

Yes, we did. We did have some pay offs into the secondary market through the quarter. [Multiple Speakers]

[Douglas Richard Bass:]

Yes. I think typically you'll see many of our multifamily loans, we just handle the construction piece and a lot of the term component after stabilization rolls into non-recourse, 30-year amortization with long-term fixed rate. So our niche has really been construction lending and not taking a long-term position risk in that asset class.

[Stephen Moss:]

Okay. Perfect. And then with regard to the pickup in loan growth, have you seen any changes in loan pricing here or are you holding - it will hold the line?

[Peter Robert Chapman:]

Doug can chime in here too. We've struggled to get the increase on five year fixed, as a lot of banks have. Obviously, it's gone up some, but has been tighter. I think banks are fighting for it more. Competition is worse as it's been for a while.

[Douglas Richard Bass:]

Yes, I think it varies, Steve, across some of our markets. In the Midwestern market, the supply demand component, there is certainly probably more demand than supply, so probably seeing more pressure on rates and NIM in Midwestern markets or Western markets. Supply and demand probably have more of an equilibrium, and I think reflective overall, as Pete mentioned, it was 6 basis points up in average loan yields that would be fairly consistent with probably a higher mix on the variable side.

[Stephen Moss:]

Okay.

[Douglas Richard Bass:]

I think as mentioned earlier on the - even on the non-owner occupied piece, a majority of our segment there would be construction lending, which additionally carries variable rate indexes and we have not felt as much pressure on the variable rate segments.

[Stephen Moss:]

Okay, great. And just on agriculture here, I heard you guys on the $50 million to $100 million in pay downs going forward. But just wondering, what are you thinking for near-term trends here, with regard to seasonality on agriculture and pay-downs?

[Peter Robert Chapman:]

Probably don't see a lot this next quarter, do we? When the - actually we'll probably with advances yet, for crop yet we'll probably even maybe could go up some this next quarter. Pay-downs really will come towards our first fiscal quarter or in the fourth calendar quarter in then January, February timeframe on. And we'll see probably more of it.

[Douglas Richard Bass:]

I think another piece, there is probably about 7% of our pipeline that is in the Ag area that's mostly in the Southwest or Western markets. And given profitability in 2017 in the protein and dairy segments, we will continue to see income deferrals. So we should see some increases probably through calendar year-end in that segment. And then, decline as we've seen in January every other year due to deferred payment of commodity revenue.

[Stephen Moss:]

Got you. Thank you very much.

[Operator:]

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

[Jon Arfstrom:]

Thanks. Good morning.

[Kenneth James Karels:]

Good morning, Jon.

[Jon Arfstrom:]

Maybe a question for Michael, just a follow-up. You're talking about some of the stresses, but I think you've also said, you don't see any significant change to the provision that I hear you right on that?

[Michael Gough:]

For what we know today, you absolutely did hear me correctly. The other point that was has to be said, there was the year is not finished out, and a lot can happen still between now and harvest. But for what we see right now, I'm not expecting significant changes from the events what we have today.

[Jon Arfstrom:]

Okay, okay. And outside of Ag, any other credit concerns or any areas that you're watching closer?

[Michael Gough:]

From talking to the regulators, the one space, we know the regulators are concerned with is actually multifamily. But that is more on the coasts. And that's not where our multifamily exposures are on the projects. That we do have Doug mentioned that, that space will have not only the term financing, but also do a fair amount of construction. I would not elevate it to saying it is a problem. But it is absolutely an area that we watch closely to make sure that the projects that we do get into in that space are in areas that are not showing signs of being overbuilt at all.

[Jon Arfstrom:]

Okay, okay. Good.

[Kenneth James Karels:]

I think, the majority of our multifamily lending is probably in the 60% plus or minus loan to cost ratio, which again provides us considerable cushion. Additionally, we've been very cautious about some of the higher overheated metro markets relative to high to lower cap rates and implications there. So I think, we feel pretty good about the multifamily market that we've done here.

[Jon Arfstrom:]

Okay, okay. Maybe Doug or Ken, why do you think the growth was better in July, and why do you think it's picking up? I know, you kind of touched on the trend earlier, but any - can you put a finger on why you think it's happening?

[Douglas Richard Bass:]

Well, I think when you look at a couple of the segments that the growth occurred in, we had a commercial real estate, we had several significant projects that we had been working on for a period of time that came to fruition at close. There is a fairly long lead time. There is a lot of objective to get those closed by at quarter end. There were a number of opportunities that also spilled into early July as referenced earlier in the comments. And when we look at some - both some expansionary activity and some of our C&I book, a couple of acquisitions, also a couple of expansions and acquisitions in the dairy protein book that funded part of that growth toward the end of our fiscal Q3 and the beginning of fiscal Q4. I think we are seeing those same segments continue to show strong pipeline activity on metro markets. And I think the other piece as mentioned too is the headwinds have lessened, partly based on seasonality on the declining Midwest Ag, simply because of crop year and time of year. And that will come - that will happen again as everybody noted once we hit a calendar year-end.

[Jon Arfstrom:]

Okay, okay. Good. Thank you.

[Operator:]

Our next question comes from Steven Alexopoulos of JPMorgan. Please go ahead.

[Steven Alexopoulos:]

Good morning, everyone. Just a follow-up on the loan growth commentary, have you guys already booked enough growth in July to hit the guidance, so do you need a very strong August and September?

[Peter Robert Chapman:]

Well, we've had good growth in July. I think, that will continue through August and September, especially with what we have from pipelines.

[Steven Alexopoulos:]

Okay. But we are relaying on a strong August and September to hit the guidance though, would you say that's fair?

[Peter Robert Chapman:]

I wouldn't say strong. I think a more realistic growth number for July and August would be a better way to say it.

[Kenneth James Karels:]

So a lot of the growth came in late in the quarter, so June, Steve. So if you have a look at the average balances for loans are up a lot less than the spot numbers. So some lines hit the books light in the quarter and then there is just a bit of momentum coming into July, as Doug mentioned before.

[Steven Alexopoulos:]

Got it, yeah. Okay. And sorry if I missed this on the provision expense, but how are you thinking about the trajectory for total provision here compared to the current quarter?

[Peter Robert Chapman:]

Relatively consistent, Steve, if you look at charge-offs around the 20 points. As Ken mentioned in his commentary, that's more in the expectation line than what the prior quarter was and for a provisioning coverage perspective, we were comfortable with where we are from coverage levels.

[Steven Alexopoulos:]

Got it. Okay. And then just one final one. Ken, regarding your comments around M&A and acquirers seeing selling pressure, that's typically been associated with fairly meaningful tangible book dilution being reported. Can you remind us, what's your threshold for tangible book dilution and the earn-back period that you will tolerate in the deal?

[Kenneth James Karels:]

Yes, yes, we are looking at between the three and four years max for that. And for us the more meaningful number to look at besides, that is really what EPS accretion we're going to get based upon the deal size on it. And that's part of where we are seeing the struggle is that some of the deals, being price with very little EPS accretion.

[Steven Alexopoulos:]

Okay. And is that three or four years based on static method or is it some bet method bankers make up to justify acquisitions?

[Kenneth James Karels:]

No, it's on static. And just - good time to remind, I think, Home Federal, we said it was going to be, what, less than two years. And it ended up being about, what, six months to do it. So, yes.

[Steven Alexopoulos:]

Okay. Fair enough. Thanks for taking my questions.

[Kenneth James Karels:]

Yes. Thank you.

[Operator:]

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

[Erik Zwick:]

Good morning, guys.

[Kenneth James Karels:]

Good morning.

[Erik Zwick:]

In the first part of the year, you spent a fair amount of time reviewing the Ag portfolio with the result being you proactively exiting a number of kinds of stressed or unprofitable relationships. Is that process largely done at this point, and then future efforts will be more of just a normal monitoring of the portfolio?

[Kenneth James Karels:]

Michael, you want to tackle that?

[Michael Gough:]

I'll be happy to, Ken. Thank you. Overall - don't think we sugared into specific numbers on this. But we have exited with full or partial pay downs many, many times over the amount of loans that we've charged off in the calendar year 2017. We have a group within the bank's strategic business services that really are - focuses on both exits and rehabilitation. So certainly not going to say that that process is ever done, we always have - book our size, there is always going to be some small percentage of loans that we need to look at rehab or exiting. So it is still - absolutely still a focus to us. And while we have exited many, many more times, the amount of loans that we've charged off. We have also upgraded about four times the amount of loans that we've charged off this calendar year. So Ag is still - again, it's going 20% of our book. It is an important part of what we do, it is certainly not all that we do. But I don't say that - well, it may be leveling off, we're certainly not done, that looking at rehabs and exits in that space.

[Erik Zwick:]

And then a follow-up on the provisioning discussion, can you provide some color into what rates you're provisioning for new loan growth today, specifically CRE and C&I?

[Kenneth James Karels:]

I think we provided that in the past. Have we?

[Peter Robert Chapman:]

No, we haven't. But just that we haven't had any changes to that for a number of years. So we bring it on pretty consistently. So with what our coverage is, that we don't specifically [indiscernible] according to what part of the portfolio it is.

[Erik Zwick:]

Fair enough, thanks for taking my questions today.

[Kenneth James Karels:]

Okay. Thank you.

[Peter Robert Chapman:]

Thanks.

[Operator:]

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

[Damon DelMonte:]

Good morning, guys. Thanks for taking my question. Most of my questions have been already asked. But just kind of wondering, are there any new markets you guys are looking to get into, whether it'd be through de novo or as you have discussions in M&A, are there any areas of the Midwest that you're not in that you'd consider getting into?

[Kenneth James Karels:]

Yeah, definitely looking at new markets and we've been going in at one or two a year for the last three or four years. We're looking at continuing to do that, where there is the opportunity. And as we've said before, it's really led by hiring good banking or banking teams in those markets and then growing. So that has been a strategy of ours. We will continue with that strategy as well see the opportunities and work on more opportunities.

[Damon DelMonte:]

Okay. Great. I guess, everything else was asked and answered. So thank you very much.

[Kenneth James Karels:]

Thank you.

[Operator:]

Our next question comes from Tim O'Brien of Sandler O'Neill. Please go ahead.

[Timothy O'Brien:]

Thanks. I just want to ask one question. Can you give the background on how big is the dairy portfolio? And are most of those loans that you - or is that new business that you're looking to grow primarily in the Arizona market or how much is it spread over your overall geographic footprint?

[Kenneth James Karels:]

Go ahead, Doug.

[Douglas Richard Bass:]

Yeah, thanks, Tim. The Dairy book today as far as growth is going to be predominantly centered in the Southwest. So you have - lending opportunities would be predominantly in the Arizona market, spill a little bit into New Mexico and to the tip of California. We are seeing opportunities in the Colorado book as well in Dairy. I would say the dairy growth is going to be predominantly West and Southwest.

[Timothy O'Brien:]

And how big is that portfolio? Is it - dollar-wise I guess.

[Peter Robert Chapman:]

They're around $450 million or so. It's just about twenty odd percent of our Ag book. And then as Doug said, probably 70%, 75% of that is down in the Southwest area.

[Timothy O'Brien:]

And the structure of those loans, are they - can you give a little color on that? Are they production loans that renew annually or every couple of years or are they typically backed by the property or what's the profile there?

[Peter Robert Chapman:]

Yeah, it's really the combination of both, Tim. The typical structure would be probably - 60% to 70% of the structure would be based on current assets, on lines of credit that renew annually and another 30% to 40% of our exposure would come, secured by real estate, fixed assets under amortizations that run from 10 to 15 to maybe 20 years.

[Timothy O'Brien:]

Thanks, guys. Thanks for answering the question.

[Kenneth James Karels:]

Thank you.

[Operator:]

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

[Kenneth James Karels:]

Okay. Thank you. We've had strong income, ROA, efficiency ratio, stable or improving asset quality and starting - as Doug commented on, starting to see loan demand pick up, so we're pretty happy with that. But I want to thank you again for joining us on our call.

[Operator:]

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