Great Western Bancorp, Inc.
Q4 2017 Earnings Call Transcript

Published: 26 Oct 2017

[Operator:]

Good morning. And welcome to the Great Western Fourth Quarter Year-End 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. Please go ahead.

[Ann Nachtigal:]

Thank you, and good morning everyone. Joining us this morning on Great Western Bancorp’s fourth quarter fiscal year 2017 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. With that said, I would like to turn it over to Great Western Bancorp’s Chairman, President and Chief Executive Officer, Ken Karels. Ken?

[Ken Karels:]

Okay, thank you, Ann, and good morning, everyone. Thank you for taking the time to join us this morning to discuss our most recent financial results. We ended our fiscal year with great results and I’d like to point out a couple highlights. Net income for the quarter was $37.7 million or $0.64 per fully diluted share. That brought out net income for the full fiscal quarter to $144.8 million, an increase of 19% compared to the prior year, which translates to a 1.27% return on assets and a 15.4% return on tangible equity. Total loans grew $177 million during the quarter bringing our annual increase in customer loan balances to 4.1% for the year. We also took advantage of a temporary decline in our share prices to repurchase approximately 200,000 shares of GWB stock during the quarter at a weighted average price of 34.46. Now for greater details on our financial results, I’d like to turn the call over to our Chief Financial Officer, Peter Chapman. Pete?

[Peter Chapman:]

Thank you, Ken and good morning everybody. Taking a look at our revenue slide, net interest income was $103.7 million for the quarter, a 2.8% increase over the linked quarter primarily driven by an increase in average loans outstanding. This represents a net interest margin of 4% for the quarter and adjusted net interest margin which is the metric we manage through a 3.9%. NIM was flat quarter-on-quarter while adjusted NIM increased by 3 basis points driven by a $600,000 reduction in the cost of interest rate swaps compared to the June quarter as a result of higher one employable. Our overall yield on earning assets increased by 6 basis points quarter-over-quarter matched by a 6 basis point increase in the cost of interest-bearing liabilities. Having no more accretion of interest income on the pool of purchased credit impaired loans, partially offset by an increase in write-offs of interest on loans going to non-accrual compared to the linked quarter drove this result. We expect our NIM and adjusted NIM to stabilize in the next quarter or two absent additional federal reserve write-offs. Non-interest income for the quarter was $12.8 million, a $2.6 million decrease compared to the linked quarter. The most significant driver of this decline was a reduction of $900,000 in debit card interchange income as a result of crossing $10 billion in total assets at the end of 2016. We expect a further reduction of approximately $1.5 million in the December quarter bringing the total impact in line with a $2 million to $2.5 million per quarter estimate we have shared previously. We also saw a $700,000 reduction in other non-interest income and a $600,000 drag related to the changes in fair value of loans and the related derivatives recorded at fair value. Looking now at the slide on expenses provision and earnings, non-interest expense was $55.3 million for the quarter, an increase of just under 1% compared to the linked quarter and in line with the expectations we communicated on last quarter’s call. Included in this overall number are approximately $800,000 of fixed asset write-offs and other associated costs related to an upgrade of our branch teller system which is non-recurring and OREO expenses of $500,000 that are more one-time in nature. Salaries and employee benefits declined by $1.6 million. Efficiency ratio for the quarter was 47.1% well within our sub-50% target. Our effective tax rate for the quarter was approximately 31%. The lower effective tax rate was driven primarily by tax benefits relating to the vesting of shares of company stock including approximately $1.4 million related to shares granted concurrent with our IPO in 2014 divested this quarter and were one-time in nature. All regulatory capital ratios remains stable compared to March 31, 2017 with Tier 1 capital and total capital at 11.4% and 12.5% respectively. As Ken mentioned, we deployed approximately $5.6 million of capital during the quarter to repurchase shares under our approved repurchase plan. Finally, our Board again approved a $0.20 quarterly dividend payable November 22. I’d now like to turn over to Doug Bass to discuss our balance sheet activity.

[Doug Bass:]

Thanks, Pete and good morning everyone. Loan growth during the quarter was robust as total loans increased by $177 million or approximately 8% on an annualized basis compared to June 30. The overall growth included a $159 million of both owner occupied and non-owner occupied commercial real estate growth and $35 million of Ag growth, primarily in our Southwest markets, partially offset by a small decline in residential real estate loans. The majority of the growth during the quarter came from our Arizona and Colorado markets with more modest growth in the Midwest markets of Nebraska and Iowa. For the full year, customer loan balances increased by $350 million or 4.1%. I’d like to remind you that during the first fiscal quarter, growth in total loans was hampered by a $64 million reduction in the fair value of certain loans driven by changes in market interest rates. This also impacts our full year growth calculation but is no bearing on customer loan obligations and is entirely offset by the increase in the fair value of related interest rate swaps. Total deposits increased slightly compared to June 30 ending September at $8.98 billion representing annual growth of $373 million or 4.3%. Our loan to deposit ratio was approximately 100% which is well within our targeted operating range. As we look forward to fiscal 2018, we expect organic loan and deposit growth to be in the mid single-digit range. Many of our more rural markets we serve are driven by Ag-based economics and offer modest growth opportunities. It’s critical that we maintain our market share in these markets due to their attractive customer base and sound client base. However, the lack of growth opportunities do limit our overall growth potential. Since the end of fiscal 2013, compound annual loan growth in our metro markets was 15% for loans and 9% for deposits compared to 3% and 4% respectively in our rural markets. At the end of fiscal 2013, metro markets represented 63% of our loan book versus 72% at the end of September 2017. One of our key strategic priorities over the next two years is to continue to expand our presence in larger metro markets in and adjacent to our footprint, either organically or inorganically. To maximize our growth potential, we have opened five de novo office full-service offices and two loan production offices over the last few years and we expect to continue to explore similar opportunities. We have also significantly increased the number of business bankers and cash management staff in our key metro markets. 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. Turning our attention now to the slide on asset quality, provision for loan losses was $4.7 million for the quarter, a decrease of approximately $1.1 million compared to the linked quarter. Net charge-offs for the quarter totaled $5.4 million or 24 basis points of average loans on an annualized basis bringing net charge-offs for the fiscal year to 26 basis points of average loans. While this represents an increase compared to especially low net charge-off levels for the last three fiscal years, the result for the year was similar to what was expected and budgeted. Our allowance for loan and lease losses as a percentage of total loans was 71 basis points, down 2 basis points from June 30 as our net charge-offs during the quarter had primarily been provided previously, our comprehensive credit coverage which includes credit-related fair value adjustments on our long-term loan portfolio and purchase accounting marks remains sound at a 113 basis points of total loans. There was some fluctuation in key asset quality metrics during the quarter all of which we feel are consistent with our efforts to actively manage watching substandard credits. Loans on watch status increased 4% compared to June 30, while substandard loans decreased by 7% over the same period. Non-accrual loans increased by $14.7 million during the quarter driven by a small number of relationships that have been monitored closely for a number of quarters, compared to the end of fiscal year 2016, watch loans and substandard loans have decreased 5% and 4% respectively. With that, let’s turn the call back to Ken for some closing remarks.

[Ken Karels:]

Okay, thank you, Michael. We are very happy with the underlying results for the quarter and the fiscal year. We grew our balance sheet in line with expectations. Our net interest margin expanded. We successfully managed through a small number of problem credits and minimized credit losses and we maintained our very attractive efficiency ratio. All of this led to top tier return on assets, return on tangible equity and a superior return profile for our shareholders. Thank you again for your interest in and support of Great Western Bank and we look forward to do everything we can to deliver another outstanding results in 2018. We are now happy to open up for questions.

[Operator:]

[Operator Instructions] Our first question comes from Ebrahim Poonawala with Bank of America. Please go ahead.

[Ebrahim Poonawala:]

Good morning, guys.

[Ken Karels:]

Good morning.

[Ebrahim Poonawala:]

I just wanted to follow-up on sort of the guidance you gave for loan growth in mid single-digits, it means, clearly we had pretty strong loan growth this quarter, I would love to hear your thoughts in terms of – it felt like loan growth reset lower about 12, 18 months ago and we’ve seen a pick up this quarter. You’ve been quite optimistic on some of the initiatives that you guys have undertaken, some of the hires you’ve made. Is mid single-digits being conservative and should we see this 7% to 8% kind of growth as realistic next year and how much more runoff do you expect on the Ag book that might offset loan growth?

[Ken Karels:]

Yes, Ebrahim. I think the mid single-digit is a nice – is a good mark to go for. We will have some runoff of the Ag book, yes, that will be a headwind for us. We are doing a number of initiatives like Doug talked about with de novo offices and some other product lines that we have been doing and we’ll be expanding in. Doug, do you want to comment anymore?

[Doug Bass:]

Yes, I think, relative to I think the metro market, concentration we mentioned a little bit ago, Ebrahim, as we’ve gone over the last few years and increased the metro market share. We continue to see very good pipelines in a number of commercial real estate both in owner occupied, non-owner occupied and C&I opportunities across our metro markets, probably slightly up from where we may have been one year ago from a pipeline standpoint. And I think that coupled with the increasing concentration of metro markets and the business lines and new offices that Ken mentioned that continue to have more traction and get a little more age and traction in the markets we are in gives us the confidence that we mentioned to hit the mid single-digit number.

[Ebrahim Poonawala:]

Understood. And moving on – move to credit, you called out a couple of C&I loans, I would appreciate any color around that whether those were sort of Ag-related loans and also if you can comment on your annual review which you do at this time of the year in terms of going for the portfolio and where you are on that, that will be great?

[Ken Karels:]

Go ahead, Michael.

[Michael Gough:]

Thank you, Ken. Overall, the couple loans that we mentioned, while they may have been in the C&I space. They certainly had an Ag component to them when we talk about the couple larger problems that we have and are continuing to work through. Overall, what we do with our annual look and I understand how you ask the question, I think we are looking at our Ag loans more frequently. But obviously, grains in the upper Midwest, that’s an annual cycle. So, really over the next 90 to 120 days, we’ll have a better view for how that particular book of business did. I know we talked last quarter about the drought in the Central - Northern part of South Dakota. Overall, interestingly since we last talked, the delay now in South Dakota is more getting the corn out of the ground. The bean harvest is well underway. I think over 75% done, better yields than expected. From what has been harvested in South Dakota in corn already, the yields are already a little better than planned, but I believe the harvest is only, it’s still less than 20% complete. So overall, as we’ve progressed from the last quarterly call, we’re actually have gotten better news in the Ag sector, certainly seeing better yields than expected, but we will know more by the time we have our next quarterly update call.

[Ebrahim Poonawala:]

And would you say that have you sort of approached this cycle over the next 90 to 120 days, you feel better about generally the borrowers are from their financial health relative to a year ago or compared to the last few years?

[Ken Karels:]

I would answer that question, Ebrahim, is, yes, and the reason being really our staff over the last couple years with the line and credit staff working hand and glove has really I think stepped up our game regarding how well we are communicating with our customers. Lot of it’s blocking and tackling. You could say making sure there is sound marketing plans in place and making sure that the contacts that we have with those customers not just around harvest time, really get an idea on how the operation is going everything from expense to control marketing plans, family living expense expectations. So the short answer to your question is, yes. I would say, we feel better than we did a year ago.

[Doug Bass:]

I think one other comment to some of our borrowers that haven’t been making the changes that we want and really borrowing more money as we sometimes call doing a reverse mortgage in the lending area, we’ve asked to leave the bank and surprisingly they’ve had two or three offers from other banks to refinance and so I think it shows the conservative nature our bank has and the collateral that we have and others are looking at that and feeling that they can finance some and kind of do this reverse mortgage.

[Ebrahim Poonawala:]

Ken, can you quantify the amount of Ag loan that – want to derisk. I wasn’t sure, it was a $30 million to $40 million number or larger in terms of what you expect would runoff because of what you just outlined?

[Ken Karels:]

Yes, I don’t think we’ve quantified that in the past year. I am not sure we have a number that we would be willing to share. I mean, there is some headwind, but I think we’ve quantified that.

[Ebrahim Poonawala:]

Got it. Thanks for taking my questions.

[Ken Karels:]

Okay, thank you.

[Operator:]

Next question comes from Dave Rochester with Deutsche Bank. Please go ahead.

[Dave Rochester:]

Hey, good morning guys.

[Ken Karels:]

Good morning.

[Dave Rochester:]

Hey, to sum that Ag piece, do you have any updated LTV metrics on the grain book that I think you first really paying a year or so ago. I remember that the LTV is being really lowed. Just to know your update of those?

[Ken Karels:]

No, we haven’t updated but I would think there is no change on the admin, you guys can clear with that.

[Michael Gough:]

Absolutely, we’ve been watching the land prices and also equipment prices pretty closely. Land prices have held up very, very well, actually increased in the couple of our geographies. Equipment will have a little bit more of a fluctuation to it depending on how much is coming on in a specific geography for sale. But I would say, they’d be very consistent Ken.

[Ken Karels:]

One of the other things we saw is lot of our producers have good mine and machinery and equipment they had bought during the good times and that’s, so those are running off. So their cash flow is actually improving in many cases.

[Dave Rochester:]

Okay, great color. And then, you mentioned expanding into metro markets a little bit more over the next year, what are some of the top markets that you are focused on at this point?

[Ken Karels:]

Doug, go ahead.

[Doug Bass:]

Maybe historically the ones that we’ve opened up would have been Scottsdale, Arizona, Greeley, Colorado and then in Iowa we opened, Iowa City, Waterloo Iowa. We’ve got an LPO application that’s been filed for the Quad Cities, one in process for Cedar Rapids and as mentioned we are looking at some other opportunities in some other metro markets that we’ve yet to file any applications on but we are in the hiring process and hope to have probably some of those in place by the next quarterly call.

[Dave Rochester:]

Any inorganic opportunities do you see potentially in those markets?

[Doug Bass:]

We continue to look at acquisitions, probably more strongly than we have in the past. There is some great opportunities out there. As we’ve always said, we are cautious to make sure they fit our profile in pricing. And so it provides decent return to our existing investors. But definitely in the market and actively looking for acquisitions.

[Dave Rochester:]

Any sense for what conversation level has looked like recently? I know, you mentioned over the last couple quarters, there has been a little bit wider just given valuations. Any update there?

[Doug Bass:]

I think it is getting closer. I think buy, sell prices are starting to come and makes sense for us. So, hopefully we will see some things that will happen in the next year or two.

[Dave Rochester:]

Great. Just one last one on the NIM. Curious to get your sense for what you expect to be the NIM impact from the next rate hikes, will that still be positive?

[Ken Karels:]

Pete, go ahead.

[Peter Chapman:]

Yes, I think I’ll do that. We are seeing a little uptick in deposit costs from the business side, consumer side, probably not as much and then on the loan side, probably spread over LIBOR or treasury rate is just probably coming a little bit, but given those both benchmarks have increased the actuals on head loan runrate has increased a little. So, I would expect a slight uptick if we’d be getting another right.

[Dave Rochester:]

The stable as NIM without a rate hike, slight uptick with the rate hike.

[Peter Chapman:]

Yes, fair enough.

[Dave Rochester:]

Great, all right. Thanks guys.

[Peter Chapman:]

Thanks, Dave.

[Ken Karels:]

Thank you.

[Operator:]

Next question comes from Geoff Loos with D. A. Davidson. Please go ahead.

[Geoff Loos:]

Thanks, good morning. Just a couple detail on the line item. The drop in other non-interest income, what was that?

[Peter Chapman:]

The non-interest income, yes, we had a – just a small recovery loss, or we had a recovery loss last quarter and we had a write-off this quarter just in the small assets both quarter. So it was a just a quarter-on-quarter effect there, but I wouldn’t expect that going forward next quarter as well that had been running in the kind of $1 million, $1.5 million range, that’s a comfortable range kind of going forward. That’s a better range than where we are this quarter.

[Geoff Loos:]

And then on the other non-interest expense that was the fixed asset write-off, is that correct?

[Peter Chapman:]

Yes, well, that was mainly the telecapture system, there was a couple 100,000 of what we call pre-OREO costs, before a property potentially goes in OREO, we may pay some amount to keep taxes current. There was also couple 100,000 in donations just from a timing perspective on the charitable side, there. So, I’d expect that to decrease by about 800,000 next quarter to $1 million.

[Geoff Loos:]

Great, thanks, and then, I guess a last detail, just the tax rate for the balance of fiscal 2018, the expectations there?

[Peter Chapman:]

Look, our expectation is to normalize back where we are – around where we before this quarter. Somewhere around 34%. There is a little bit of more volatility with that new stock-based compensation accounting standard depending on where our stock price is when grants but we’ll certainly call any of that out assets over the course of the year, but sort of around the 34%.

[Geoff Loos:]

Okay, thanks, Pete.

[Peter Chapman:]

No problems.

[Operator:]

Next question comes from Jon Arfstrom with RBC Capital Markets. Please go ahead.

[Jon Arfstrom:]

Thanks, good morning.

[Ken Karels:]

Good morning.

[Jon Arfstrom:]

Just, Peter, bigger picture for you on expenses, you talked a little bit about, Doug has talked about the new offices, but help us a little bit in terms of the puts and takes what you are seeing in expenses for the coming year? I know the efficiency continues to get better, but help us understand the cost of the offices and if there is anything else out there we should be aware of?

[Peter Chapman:]

Look, I think manageable within runrate jump. I think we’ve said sort of a 3% to 4% expense increase is sort of what we are thinking internally sort of that – sort of inflation rates have increased, just the timing of expenses as offices come on. There is probably more CapEx and OpEx with some of those, but we think the increase is manageable within runrate with the offices running, maybe we will see a little bit more of a ramp up in the second half of fiscal 2018, but sort of nothing we are seeing big picture that would materially affect the efficiency ratio.

[Jon Arfstrom:]

Okay, okay, good. Just to touch on deposits. We had a little bit of an increase in deposit cost and I am just curios how you feel about deposit gathering in the coming year and if there is, Doug, you touched on the loan to deposit ratio, if there is an upper-end of loan to deposit ratio in terms of your comfort zone?

[Doug Bass:]

Upper-end, not where we sit at the moment, Jon, sort of we’ve hovered around that 98 to 100 from a cyclical perspective we see some routes in the June quarter, a little bit of stabilization in September quarter. We typically see some inflow in the December quarter from a deposit perspective. So, look, operating around the current range we are fine around that 100% range and that’s well within internal limits. From a cost perspective, as I said, sort of on the business side, we are seeing a little bit of an uptick but on the consumer side, still manageable. So, I’d still say a steady increase from what we have seen so far and then we’ll just revisit that if there is another right hock on what that does to competition. There is a way as a couple of people doing headline CD special, but certainly nothing that in our markets that that is unmanageable at the moment.

[Jon Arfstrom:]

Okay, good. Ken, bigger picture question for you. It’s the end of your fiscal year, you guys had a good year. What are your top priorities for the coming year? Anything new that you are focused on?

[Ken Karels:]

No, not really, Jon. I mean, as Doug elated to, we are focusing on some areas that will help loan growth and we think those will happen where there is no offices, where there is different lines of loans that we used – that we did that we can expand on. I think that will help. Obviously, we always manage expenses that will continue. We’ve gone through and done a lot of the – over $10 billion regulatory requirements and added the cost that we need over the last couple of years here. So we are feeling pretty good that we’ve put the cost in that we need that we’ve done a good job of doing that. So, it’s really a steady head, but helping to pick up loan growth and manage expenses.

[Jon Arfstrom:]

Okay, good. All right. Thank you.

[Ken Karels:]

Thanks.

[Operator:]

Next question comes from Steven Alexopoulos with J. P. Morgan. Please go ahead.

[Steven Alexopoulos:]

Hey, good morning everybody.

[Ken Karels:]

Good morning.

[Steven Alexopoulos:]

I wanted to start on the loans that moved into NPL in the quarter, you cited an Ag component. Are those credits fully protected by crop insurance?

[Michael Gough:]

For those Ag loans that are grains, yes, absolutely, positively true. Not all the – obviously, some of the Ag book and other sectors as well, but our practice and procedures and policies are that if we do great loans, we require crop insurance to be in place.

[Steven Alexopoulos:]

Okay, and can you give us a sense of the NPLs that moved in, what portion of those did have that crop insurance and what were in other sectors?

[Michael Gough:]

It’s probably going to be mostly other sectors, because really we made the call on our Ag operators with 2016 results and very late 2016 and the first quarter, couple quarters in 2017, just had a couple outliers. So I believe most of those NPLs are going to be non-grain areas.

[Steven Alexopoulos:]

Okay. And then on the loan growth, we are seeing couple of other banks slowing down their commercial real estate lending, citing floppiness in the market. You guys had really strong growth in the quarter, particularly in non-owner occupied. Can you give me a sense what types of properties, LTVs are you finding opportunities now?

[Ken Karels:]

Steve, I think our appetite and our underwriting standards have been pretty conservative really over the last, probably 12 to 18 months and some of the opportunities we’ve looked at are in very spread out among hospitality, warehouse, industrial, multi-family. A lot of the loan to values are in the 60% to 65% range of cost, lower of cost to market and really again spread out over most of our metro markets. And probably the other key is it’s with developers or investors that have significant resources, other projects, other properties, other means of cash flow. Very little if any of it comes into speculative nature relative to development lending or projects that do not have predetermined tenant basis. So I think from a diversity in both asset class, geography and then we go back to the – sort of the underwriting standards of LTV, LTC and cash flow, really it’s a lot of sectors we feel comfortable in. We have seen several markets that do have more significant risk profiles, especially in multi-family and we’ve been very cautious on those for several quarters.

[Steven Alexopoulos:]

And when we think about why you saw so much growth this quarter? Were other banks pulling out of the market? Was it larger loans that you are booking this quarter? I am trying to figure out why you saw so much growth this quarter?

[Ken Karels:]

The lead time on putting opportunities together that are in the $10 million to $25 million range are probably two to four months. There are a lot of transactions that tended to come inline and just happen to close here in our fiscal fourth quarter. I think the other thing you are seeing are a lot of construction loans that probably closed in the spring, when construction season starts in March and April and as we work through borrower cash, we start to see draws on construction loans start typically in the third quarter of the fiscal – of our calendar year. So, I think you are also seeing some construction draws on projects that probably closed earlier in the year.

[Steven Alexopoulos:]

Okay. That’s helpful. Exciting, then we look at the C&I loans, they are pretty flat in the quarter. I don’t know if paydowns were a factor, but maybe you could give us some color on the pipelines for C&I and what the outlook is there?

[Ken Karels:]

We are seeing some pretty good profitability in a lot of C&I segments, consequently, really no loss customer base, just profits that are being retained with very modest expansion. You also start to see a slowdown in construction-related activity with suppliers as the season nears and end here toward the end of the year. So you see those businesses, steel, construction, distribution and those segments start to slow and will continue to slow into the fourth calendar quarter. I think some of the expansions we’ve looked at, we’ve had a couple customers that have made acquisitions in distribution, manufacturing, non-Ag manufacturing, I probably should note. But manufacturing sectors that are very diverse with customer base and again, those are probably more in our Midwest markets and we’ve seen a couple large distribution opportunities in our Colorado market. One food processing company that’s doing very well that’s had some significant expansion in our Colorado market as well.

[Steven Alexopoulos:]

Okay. Thanks and maybe if I could squeeze in one more. What was behind the decline in the non-interest-bearing deposits in the quarter? Thanks.

[Doug Bass:]

Do you have that? Nothing that really jumped out – to say, there wasn’t – there certainly wasn’t anything from a large depositor or significant sort of concentration or mix that jump out at us.

[Ken Karels:]

I think the other thing you are probably seeing, Steve is as I mentioned a little bit ago on the construction loans, many of the large construction projects we have that are going to be escrowing their 20% to 40% equity upfront. And as those balances draw down, the loans draw up, you are seeing probably a decline in non-interest-bearing balances because of equity that’s starting to be spent in projects.

[Steven Alexopoulos:]

Right. Okay, thanks for taking all my questions.

[Operator:]

Next question comes from Nathan Race with Piper Jaffray. Please go ahead.

[Nathan Race:]

Hey guys. Good morning.

[Ken Karels:]

Good morning.

[Nathan Race:]

Going back to the commercial real estate discussion, just curious kind of how pricing and spreads trended within that segment in the quarter given the pressure that we saw in the five, seven year part of the curve and if loan growth remains weighted in commercial real estate going forward, just curious how you see that being added to or dilutive to your kind of core loan yield as that’s here today on the portfolio?

[Ken Karels:]

One thing that has helped us Nathan, is with the uptick in treasuries here, when treasuries took the low to the mid part of the calendar quarter, calendar year, we had some – so we quote on spreads to treasury and several of those rates are spread to LIBOR swap and those were down. So we are seeing some uptick probably in the last 30 to 60 days in some of the funding rates.

[Nathan Race:]

Okay, got it. And then, just changing gears, a question for you Pete on the overall securities portfolio and balance sheet dynamics, the portfolio was pretty flat quarter-over-quarter. Just curious if you think it is kind of hold stable here if you guys think you can bring the absolute balance of the securities portfolio down as you guys deliver 5%, 6% loan growth into 2018?

[Peter Chapman:]

Yes, look, I’d expect the securities portfolio to be relatively flat, Nathan. So, certainly, increases in deposits, firstly you’ll got loans, you may see a slight increase in some on balance sheet liquidity, but sort of within the $100 million range. So, certainly not a material move in terms of overall composition.

[Nathan Race:]

Okay, got it. I appreciate the color guys.

[Peter Chapman:]

Thank you.

[Operator:]

Next question comes from Damon DelMonte with KBW. Please go ahead.

[Damon DelMonte:]

Hey, good morning guys. Most of my questions have been asked and answered, but just a quick follow-up on the kind of the expansion efforts into the metro markets. How far ease would you guys would you guys consider moving out into?

[Ken Karels:]

Well, obviously into Illinois away is we would be interested in doing, some of those markets are similar to what we have. So, as we’ve said before, getting too far away from us, we are a little cautious two or three states away would be probably more of a stretch that we are willing to do.

[Damon DelMonte:]

Okay. And then, as far as, like moving westward, would you try to – would you build on your Colorado and the Arizona exposure further than what you already have?

[Ken Karels:]

Definitely we would look at Colorado, Arizona too from an acquisition standpoint, we aren’t seeing much opportunities in Arizona, probably more opportunities could happen in Colorado although it tends to be a very attractive market for a lot of people. So, competition to do an acquisition there would be very strong we expect.

[Damon DelMonte:]

Okay, great. And then, one other question on fee income, probably for Pete, you guys noted in the release you are expecting another $1.5 million of interchange income that will be lost next quarter. Is that correct?

[Peter Chapman:]

Yes, that’s right, Damon.

[Damon DelMonte:]

Okay, so, if we kind of – do you think that something in the mid-$15.5 million range is a decent expectation for the December quarter?

[Peter Chapman:]

Look with that sort of going into specific line items, that’s probably a little heavy just given we’ve got another $1.5 million coming off, Damon, I’d say. If you look at our wealth management number, that was little soft this quarter, last quarter and most quarters usually have sort of one-time state management fees and it wasn’t much of that in this quarter. So, look, well, I think it’s a little softer this quarter and that should come up a little bit next quarter. But overall, I think that’s a little bit heavy given the $1.5 million drop-off.

[Damon DelMonte:]

Okay, that’s all that I had. Thanks a lot.

[Peter Chapman:]

Thanks.

[Operator:]

Next question comes from Steve Moss with FBR. Please go ahead.

[Steve Moss:]

Good morning. Most of my questions have been answered here, but just circling back to M&A here, given the organic expansion you are doing in the metro markets, wondering if your M&A is going to be also focused more towards metro? Or will it be more rural markets in terms of your thinking?

[Ken Karels:]

It depends upon the opportunity. I think what we’ve been looking at has both the component of metro and rural markets. We’d say, we understand that very, very well. But it really depends on the opportunity, what type of bank they are, what we think we could do and what we could get for return in those markets. So, sort of general answer is, both. There is metro opportunities available, we do it. If there is a combination metro, rural we’d also take a look at that.

[Peter Chapman:]

Usually you need a bit of a combination to have the growth component in the rural markets, as maybe not the growth you need. So, I’d say something with a bit of a metro component with a rural that usually makes it more attractive.

[Ken Karels:]

And the other side, the rural markets provide a very sound and very cheap deposit base. So it’s something we would be attracted to also.

[Steve Moss:]

All right. Thank you very much.

[Ken Karels:]

Thank you.

[Operator:]

Next question comes from Tim O’Brien with Sandler O’Neill & Partners. Please go ahead.

[Tim O’Brien:]

Good morning. I have two quick questions. One, you’ve made a comment about the corn harvest being 25%, is that across your footprint? And how does that compare to prior years?

[Ken Karels:]

That really is – that specific for South Dakota, the numbers…

[Tim O’Brien:]

Thank you.

[Ken Karels:]

I was quoting, Doug may have some more information on Iowa and Nebraska. For South Dakota, historically would that be a little behind? Yes. And really, nothing sinister is simply a function of a fairly wet after the drought conditions for a lot of the year that was mainly central, but the state got very wet in the late part of the growing season. That’s just delayed the start.

[Doug Bass:]

I would say, Tim, across, probably the rest of our footprint, we are probably seeing higher levels, probably depending on soybeans and corn in aggregate, we are probably seeing 40% to 60% depending on the geography, maybe some as high as 70%. We are also probably important to note we are seeing yield expectations that are going to be 10% to 15% on the low side above cash flow metrics that were used at the start of the fiscal year. So I think, we are far enough long in many markets, we are going to see bushels and volume in excess of cash flow expectations.

[Tim O’Brien:]

And pricing of the commodities, how is – what’s that looking like for your growers?

[Doug Bass:]

Well, I think it all depends on the individual. The individuals were proactive. You can look in the rearview mirror and say when was that and had they done a lot of pricing in probably the second calendar quarter of 2017, that would have exceeded most of the assumptions that we had. We still see a lot of people that – or customers that have probably sold, or presold between 60% to 75% of their crops. So they are in pretty good shape. The piece that’s important to note is the customer base that’s in the Southwest, which is the largest Ag sector that we have in the company now has also about $1.50 positive basis. So, I think that is a factor that provides significant cushion profitability and cash flow margin, which now is continuing to be a bulk of the Ag business for the company.

[Tim O’Brien:]

Well, that’s encouraging and then, one other question, how much share repurchase authorization do you guys have outstanding and what’s the outlook look like for additional repurchases here before the end of the calendar year?

[Ken Karels:]

Well, we have about $95 million left. We had a $100 million to start with and we had just the $5 million this last quarter on it. We will continue to be opportunists as we look at share price and if we see some major dips, and be in the market taking a look and see that makes sense to buyback.

[Tim O’Brien:]

Thanks for answering my questions.

[Ken Karels:]

Thank you.

[Operator:]

Next question comes from Erik Zwick with Stephens Incorporated. Please go ahead.

[Erik Zwick:]

Good morning guys.

[Ken Karels:]

Good morning.

[Erik Zwick:]

Maybe just a quick question to start, any thoughts on a target range for the loan loss provision in 2018?

[Ken Karels:]

Michael, go ahead.

[Michael Gough:]

I'll take the first crack at that one. Overall, I think what our expectations are, it’s going to be relatively flat. As you can tell from some of the comments here, overall we are seeing some more rays of optimism in the Ag sector than we’ve seen in the past couple of years. Overall, the other sectors, we are not seeing any fundamental change in our credit metrics that would make us think we have any reason to do substantial increases. Obviously, we have to set some aside for growth, but I would certainly see it relatively flat.

[Ken Karels:]

Yes, I would say, the runrate we had this year is probably going to be what we are expecting next year. I think there is more potential for that being lower than higher as we look forward and see where credit quality is continuing to improve.

[Erik Zwick:]

All right, great. And then, the quarterly value of the current realized derivative loss continues to come down which makes sense we have short-term LIBOR continuing to go up. I guess, based on your expectations for rates over the next 12 months, do you expect the 2018 value to be lower than it was this year? And if so, by how much?

[Peter Chapman:]

Look, hard to quantify that one given certainly the outlook is uncertain on LIBOR, but if LIBOR continues to rally, certainly I’d expect that to continue to track positively as well. Broadly speaking, about 250 grain to rate hike.

[Erik Zwick:]

Understood. And just one last one, your FHLB balances in borrowing have increased over the past few quarters. Still lower than a year ago, but can you talk about your decision to utilize that source of funding more recently versus the alternative?

[Peter Chapman:]

Yes, look, that’s a primary source of funding outside of deposits. So, we’d continue to utilize that. We think it’s cost-effective. It’s very efficient to use. As you pointed out, significantly lower than what it was September last year, so the deposit base is much stronger than it was 12 months ago. But certainly if we would like to put more on-balance sheet liquidity or if there is a timing difference between deposit raises and loan fundings, you will continue to see that move up and down. But that will continue to be a primary source of funding outside of deposits in the next 12 months.

[Erik Zwick:]

Great. Thank you for taking my questions.

[Ken Karels:]

Thank you.

[Peter Chapman:]

Thank you.

[Operator:]

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

[Ken Karels:]

Yes, thank you for joining us. We are excited that we had such a great year and happy to share our results with you and also excited about the prospects for next year and some of the initiatives that we have going on. So, thanks again for taking your time.

[Operator:]

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