Heartland Financial USA Inc (HTLF) 2016 Q3 法說會逐字稿

Greetings, and welcome to the Heartland Financial USA, Inc. third-quarter 2016 conference call. This afternoon, Heartland distributed its third-quarter press release, and hopefully you've had a chance to review the results. If there's anyone on this call who did not receive a copy, you may access it at Heartland's website at www.htlf.com.

With us today from Management are Lynn Fuller, Chairman and Chief Executive Officer; Bruce Lee, President; Bryan McKeag, Executive Vice President and Chief Financial Officer; and Andrew Townsend, Executive Vice President and Chief Credit Officer. Management will provide a brief summary of the quarter, and then we will open up the call to questions from analysts.

Before we begin the presentation, I would like to remind everyone that some of information Management will be providing today falls under the guidelines of forward-looking statements as defined by the Securities and Exchange Commission. As part of these guidelines, I must point out that any statements made during this presentation concerning the Company's hopes, beliefs, expectations, and predictions of the future are forward-looking statements and actual results could differ materially from those projected. Additional information on these factors is included from time to time in the Company's 10-K and 10-Q filings which may be obtained on the Company's website or the SEC's website.

(Operator Instructions)

As a reminder, this conference is being recorded. At this time I will now turn the call over to Mr. Lynn Fuller at Heartland. Please go ahead, sir.

Thank you, Matt, and good afternoon. We appreciate everyone joining us today as we discuss Heartland's performance for the third quarter of 2016. For the next few minutes I will touch on the highlights for the quarter, I will then turn the call over to Heartland's President Bruce Lee who will cover progress on our key operating strategies.

Then Bryan McKeag, our EVP and CFO, will provide additional color on Heartland's quarterly results, followed by Drew Townsend, our EVP and Chief Credit Officer, who will offer insights on credit-related topics. Well, I am very pleased to open my remarks today with reporting Heartland's third excellent quarter for 2016. Third-quarter net income available common shareholders was $20.2 million. That's a 40% increase over the third quarter of 2015.

On a per share basis for the quarter, Heartland earned $0.81 per diluted common share, and that's a 17% increase over the same quarter last year. Year to date, net income available to common shareholders set a new record, $61 million, or $2.48 per diluted common share, and that compared to $44.8 million, or $2.16 per common share for the first nine months of 2015. And that's a 36% increase in net income and a 15% increase in EPS.

Our trailing 12 month earnings stand at $3.14 per diluted common share, and at our peer's current earnings multiple, our stock price should continue to have good upside potential. Return on average assets for the quarter and year to date were $0.98 and $0.01 respectively, return on average common equity for the quarter and year to date were 11.64% and 12.28% respectively, and return on tangible equity for the quarter and year to date were 14.93% and 15.87% respectively.

While our tangible common equity ratio improved by 25 basis points to 6.85% for the quarter, at the upper end of our current target range of 6% to 7%. Now, as Heartland approaches the $10 billion asset dollar mark our target for this ratio will move up accordingly into the 7% to 8% range.

Book value and tangible book value per common share continue to increase ending the quarter at $28.48 and $22.34 respectively. Net interest margin increased for the quarter to 4.14%, the result of continued reduction in funding costs and improved deposit mix. Net interest income in dollars has increased each quarter for four straight years.

Now looking at the balance sheet, total assets held steady at $8.2 billion. Organic loan growth continued to be soft for the quarter, however, we continue to experience strong deposit growth to fund future loan growth. I should add that our residential mortgage operation had another solid quarter, and Bruce Lee will discuss mortgage in more detail along with loan and deposit growth.

Heartland's security portfolio currently represents 24% of assets. With our target at 20%, we still have room to fund some future loan growth by selling bonds and booking security gains as we utilize a total return approach to actively manage our securities portfolio. Our current duration is 3.5 to 4 years, with a portfolio yield approaching 3%. Overall credit quality remained sound, although we experienced a modest increase in nonperforming assets for the quarter and in a few minutes, Drew Townsend will provide more detail on credit-related topics.

I am also pleased to report our progress on lowering Heartland's efficiency ratio, which dropped to 63.9% for the quarter, surpassing our goal to reach 65% by year-end 2016. I commend our Heartland team's ongoing efforts to streamline (technical difficulty), hold the line on headcount, [projected] cost saves and efficiencies identified in our newly acquired banks. Following Bruce Lee's comments, Bryan McKeag will address non-interest expense in more detail.

Now, moving on to M&A. Expansion of our banking franchise through mergers and acquisitions remains a high priority for Heartland. This morning, we were pleased to announce the signing of the definitive agreement with Founders Bancorp, parent company of Founders Community Bank, a profitable $200 million asset commercial banking company headquartered in San Luis Obispo, California, with banking offices in Paso Robles and Morrow Bay. Subject to all approvals, the transaction is expected to close in early 2017, with system conversions to follow in the spring.

Founders Community Bank will be merged into our Premier Valley Bank subsidiary, with their banking offices continuing to operate under the Founders brand. The Founders offices will join a full-service banking center of Premier Valley Bank in San Luis Obispo scheduled to open early next year. Heartland's presence in the central valley and central coast of California will grow to nine locations with assets exceeding $800 million.

Founders Community Bank is a perfect fit for Heartland. We are extremely impressed with the quality of the company and especially its exceptional credit culture with virtually no nonperforming loans (technical difficulty) as an area is known for its educational institutions such as Cal Polytech State University, and it boasts one of the highest rates of college-educated residents in the state. The economy is solidly supported by agriculture, health care, energy and tourism. Following the merger, Heartland will grow to 112 full-service banking locations operating across 12 states.

Founders Bancorp represents one of a number of small to mid core acquisition opportunities in our pipeline, allowing us to be very selective with respect to culture, fit, and pricing. We continue to pursue our goal to exceed $1 billion in assets in each state where Heartland operates, building on our M&A experience, Heartland is in great position to leverage new acquisitions, adding scale and realizing cost savings. Well, with respect to our dividend, I am pleased to report that at its October meeting, the Heartland Board of Directors elected to maintain our dividend at $0.10 per common share payable on September 2, 2016.

I will now turn the call over to Bruce Lee, Heartland's President, who will provide an overview of the Company's strategic initiatives. Bruce?

Thank you, Lynn. I'm pleased to comment today on the collective result at the Heartland banks and revenue producing business lines as we pursue profitable and sustainable growth.

I will begin my remarks with lending where we continue to encounter heated competition in every Heartland market. We are looking at many credits with thin margins and exercising caution with commercial real estate deals. As we have previously stated, we take a disciplined approach to pricing, both loans and deposits and loan sacrificed profitability in pursuit of growth.

When we look at our lending activity on a more granular level, three Heartland markets with recent large acquisitions stand out. In each case these banks are experiencing negative loan growth as commercial real estate exposure is brought into balance and challenged credits are resolved. Outside of these transitioning markets, loan growth is positive.

I can add that organic loan growth remains a high priority, and to that point, will mention that our pipeline of loans to be funded is that higher than at any point so far this year, and we are optimistic that we will produce loan growth in the fourth quarter. On the deposit side, total deposits increased by slightly more than 1% over the second quarter.

We continue to emphasize non-timed deposits and are very pleased with 4% quarter over quarter in noninterest demand deposits. These now comprise 33% of the deposit mix with savings representing 54% and timed deposits at 13%.

For the third quarter, our total deposit expense has dropped to just 23 basis points, essentially matching our high-performing peer group. Moving now to residential real estate, Heartland experienced another solid quarter with new originations of $324 million. Our efforts to improve profitability in the mortgage unit are meeting with success.

To that point, our pretax profit is up $2 million year to date compared with prior year on a slightly lower level of originations. We attribute the increase to diligent margin management, as opposed to emphasis on volume. We are very pleased with the results so far from a right sized and more profitable mortgage unit that now operates primarily within our footprint.

I am also pleased to announce that Jack Lloyd will be guiding the Heartland mortgage division going forward as Mortgage President. With 40 years of banking and lending experience, Jack joined Heartland last week from BMO Harris in Chicago where he served in a variety of mortgage, leadership and community banking positions.

Heartland's mortgage servicing portfolio continues to grow, exceeding $4.25 billion on September 30. We show $30 million of MSRs on our books, which have fair value of approximately $6.5 million more than book value.

Beyond mortgage, we saw improvement during the quarter from service charges and fees, trust and brokerage, and gains on sales of loans. Noteworthy among these is commercial card services. With Heartland's acquisitions of Morrill & Janes Bank three years ago, we also acquired a seasoned team of credit card professionals with the expertise and drive to expand card services across the Heartland footprint.

The unit was recently featured in the Nielsen report, which is a leading publication covering payment systems worldwide. In June 2016, the report indicated Heartland ended 2015 with $139 million of purchasing volume, a growth of 219% over the previous year, the highest among US, Visa and MasterCard commercial card issuers. This included purchase volume from corporate, travel and entertainment cards, purchasing cards and small business cards combined. Additionally, we were recognized for our individual growth in small business credit card volumes and purchase cards where we ranked in the top 50 credit card issuers nationwide.

Total non-interest income without securities gains increased quarter over quarter by 2%, or 8% annualized, spurred in large part by growth in credit card and debit card interchange. As with commercial card services and mortgage origination, we see opportunity in developing all our fee-producing business lines into solid revenue production units with a steady stream of new clients as we acquire new community banks.

Our consumer and finance subsidiary, Citizen Finance, continues to turn in solid results as well with year to date net income of $1.3 million and a return on equity of 13.6%. Planning is in the final stages for Citizen's 15the office, which will be located in the Kansas City market.

With retail banking practices in the headlines, now is an appropriate time to comment on Heartland's proactive sales approach which is geared to providing solutions to specifically identified customer needs. Every retail sales practice is oriented toward uncovering and presenting products that improve our customers ' financial situation.

We are confident that our compensation and sales management structure does not introduce the level of pressure that would incent the wrong behaviors in our sales force. Among our various checkpoints, we've recently implemented and automated customer feedback system to actively monitor all customer complaints, complements, and suggestions for improvement to ensure that our senior management team is listening carefully to our valued customers.

Finally, this is the time of year when we focus on planning and budgeting for 2017 and beyond. Despite heated competition, uncertainties in the economic and political environments, we are heartened by the prospects at each of the Heartland banks and the results of their collective efforts this year including the fact that all of our banks are profitable this quarter, and year to date.

Going forward, we are excited about the many opportunities to grow our franchise by adding value to our clients and ensuring benefits to our employees, our communities and shareholders. And as a timely case in point, I am happy to add my personal welcome to Thomas Sherman and his team at Founders Community Bank and our growing team in the great state of California. With that, I will now turn the call over to Bryan McKeag for more detail on our quarterly financial results.

Thanks, Bruce, and good afternoon. I will begin my comments today on the balance sheet. Starting with the investment portfolio, where investments available for sale increased $89 million and investments held to maturity declined $5 million. The total investment portfolio ended the quarter at just above $1.9 billion, representing slightly less than 24% of assets.

Tax equivalent yield on the portfolio increased 2 basis points over the last quarter over the last 2.87%, the duration of the available for sale portfolio ended the quarter at 3.6 years and it was 4.1 years for the entire portfolio, which is unchanged from the prior quarter.

Borrowings declined at the quarter by a total of $94 million, and the lack of asset growth combined with strong deposit growth allowed us to reduce both short-term and other borrowings. As a result, interest expense on borrowings declined almost $200,000 this quarter compared to last quarter.

Capital ratio showed good improvement again this quarter with our top tangible common equity ratio including 25 basis points over the last quarter to 6.85%. In addition, when we file our regulatory reports in the last few days, our regulatory ratios are expected to improve from last quarter and remain comfortably above well-capitalized levels. I would also note relative to capital that we have a new universal shelf registration in place that was filed with the SEC late in July shortly after our last earnings call.

Moving on to the income statement, net interest income continued to grow, reaching $73.7 million this quarter, up $600,000 from prior quarter. Net interest margin remained strong at 4.14%, that's up 2 basis points from last quarter, and yields on loans and investments increased by 1 basis point and 2 basis points respectively and interest cost on deposits and borrowings decreased 1 basis point compared to last quarter.

This quarter the net interest margin includes the positive effect of 15 basis points from the amortization of purchase accounting discounts which represents an increase of 10 basis points from the prior quarter. The amortization increase is due to a higher volume of loans moving out of the purchased accounting pools than in prior quarters.

Non-interest income totaled $28.5 million for the quarter, down $2.5 million from last quarter as the gain on sale securities declined $3 million and gain on sale to loans for the quarter was up $200,000 for compared last quarter. In addition, service charges and fees which totally $8.3 million this quarter increased $300,000 or 3% over last quarter, and have increased $1.9 million or 30% compared to the third quarter last year. This growth is being driven by better treasury management and commercial card penetration, as well as solid growth in non-timed deposits.

Switching to non-interest expense, total expenses were $68.4 million this quarter, a decrease of $2.6 million from the prior quarter. Our largest expense category, salary and benefits, decreased $1.3 million as compared to last quarter largely due to lower incentive and benefit accruals. Professional fees also declined $1.5 million from last quarter's levels as costs related to M&A activity declined significantly this quarter.

For the quarter the efficiency ratio was 63.88%, down from 67.95% last quarter as core operating expenses decreased $3.4 million, while core in revenue increased $1.2 million compared to the prior quarter. As I have noted before, our efficiency ratio will shows quarter to quarter variations from acquisition activities and also from the seasonality and related revenue and expenses mismatches that are inherent in the mortgage business. The movement in the efficiency ratio this quarter is primarily related to lower core operating expenses, as M&A and benefit costs were lower and other categories were also well controlled compared to last quarter.

The effective tax rate this quarter was 29% compared to 32.4% last quarter. The reduction was due to an adjustment of state tax accruals as the final state returns for 2015 were completed during the quarter. The normalized tax rate was in the 31% to 32% range.

To wrap up, I'd add the following comments relative to our results going forward. First, net interest margin is expected to remain strong, but is likely to pull back a bit into plus or minus the 4.1% range and will be impacted by the level of loans moving out of the purchase accounting pools as well as the continued low interest rate environment. Mortgage production, which had a solid third-quarter, is expected to follow the normal seasonal fourth-quarter slowdown.

Other fee income areas are expected to show continued modest improvement as we work to increase the penetration of services into both our existing base and our newly acquired customer bases and markets. And finally, core expenses should remain relatively flat with the exception of a likely increase in professional fees for M&A activities. And with that I will turn the call over to Drew Townsend, our Executive Vice President and Chief Credit Officer.

Thank you, Bryan. This afternoon I will begin my remarks by discussing the changes in Heartland's nonperforming loans during the third quarter. During the quarter, nonperforming loans showed a slight net increase of $851,000, which resulted in a 0.02% change from 1.04% to 1.06% of total loans.

New nonperforming loans identified during the third quarter equaled $10.9 million with $9.5 million generated from the Heartland member banks and $1.4 million from Citizens Finance, Heartland's consumer finance committee. Within the member bank total, 1.9%, or 20% was attributed to loan portfolios acquired through bank acquisitions since January 2015, with the remaining $7.6 million, or 80% originating from the legacy bank portfolios.

At the bank level, $6.5 million, or 68% was attributed to new commercial and ag nonaccrual loans and $3 million, or 32% from the retail portfolios. The increase in nonperforming loans in the commercial and agricultural sector was concentrated primarily in three of our banks: Dubuque Bank and Trust, Centennial Bank and Trust, and New Mexico Bank and Trust.

Those loans identified in Centennial Bank were primarily in the acquired portfolio. While the increase in our New Mexico Bank is largely due to two legacy agricultural (inaudible) totaling $3.1 million representing 28% of all new nonperforming loans during the third quarter. The increase in the Dubuque market is primarily in the retail portfolio, including repurchased government guaranteed mortgages from the secondary market.

When reviewing the new nonperforming loans in greater detail, it is noted that Heartland-wide there are only eight nonperforming burrowing relationships with loans outstanding exceeding $1 million. In aggregate, these eight borrowers total $23.2 million, or 40% of our total nonperforming loans. Five of these borrowers totaling $9.7 million came with the acquisitions closed in 2015 and year to date 2016.

In the retail portfolios, $9.8 million, or 17% of our total nonperforming loans are repurchased residential real estate loans from our service loans portfolio. Of this total, $9.3 million of these loans are either FHA, VA, or USDA guaranteed, and which our loss exposure is considered minimal.

In summary, the level of nonperforming loans, although slightly elevated from year-end 2015, remained stable during the third quarter. The number of nonperforming borrowers has also remained relatively constant as well.

As I indicated last quarter, the new nonperforming loans are not attributed to either a specific geography, market or business segment. I would also point out that as the result of our efforts in special assets group, $7 million of nonperforming loans were resolved during the third quarter. In addition, a $1.6 million nonperforming commercial relationship was paid off subsequent to the end of the third quarter.

When reviewing Heartland's overall loan quality metrics, I am pleased to report that the Company's positive trend with respect to total sub rated loans, those risk-weighted watch or substandard, continued during the third quarter with a combined total decreasing by $28.9 million. These decreases were the result of either risk rating upgrades, desired paydowns, or planned exits of credit with a minimal amount of decrease attributed to charge-offs.

As it relates to the delinquency totals, the 30 to 89 days delinquency ratio is down nicely from 0.73% to 0.40% from the second period of the third quarter. Other real estate owned declined slightly during the third quarter to $10.7 million with a limited number of additions of new properties and sales of existing real estate assets.

Our existing portfolio is made up of eight residential properties aggregating to $1.5 million and 35 commercial properties that aggregate to $9.2 million. In total, nonperforming assets as a percent of total assets remain flat at 0.85% as of September 30 compared to 0.84% at June 30.

Based upon our current forecast for the third quarter regarding the resolution of various nonperforming assets, it would be our expectation that continued improvement in Heartland's credit quality metrics should be attainable with limited credit losses.

With respect to the allowance for losses -- loan losses, it is noted that provision expense was $5.3 million during the third quarter, an increase of $3.2 million as compared in the second quarter. The increase in provision expense is primarily due to the fact that total recoveries during the third quarter were $2 million less than total recoveries collected during the second quarter. The other item of note related to the increased provision expense during the quarter was that net charge-offs from Citizens Finance increased by approximately $500,000 over the previous quarter.

This increase in Citizens Finance charge-offs is isolated to a couple of the newer branch locations, and does not represent a more systemic problem. $1 billion of loans from our acquisition still reside in the purchased accounting pool, and are covered by the valuation PCI reserve. As credit decisions are made on these accounts in future quarters, a provision expense will be necessary to establish the associated allowance for those loans.

As noted in the in earnings release, our coverage ratio of allowance for loan losses as a percentage of nonperforming loans was 94.39% in the third quarter, up from 90.72% in the second quarter. The allowance for loan losses as a percentage total loans increased from 0.94% to 1% this quarter. Valuation reserves totaled $28.9 million are recorded for those $1 billion in loans obtained in acquisitions. When excluding those loans covered by the valuation reserves, the result is an allowance-to-loan ratio of 1.23%, which would compare to 1.2% at June 30.

As a follow-up to comments made last quarter with respect to Heartland's exposure to the agricultural sector, it is noted that Heartland banks to date have seen a limited number of downgrades to borrowers in these portfolios. Since December 2015, new downgrades to a watch rating have equated to $15.9 million, or 3.24% of total agricultural loans. The increases primarily have occurred in our two largest Midwestern banks with our largest ag portfolios, Dubuque Bank and Trust, $3 million and Wisconsin Bank and Trust, $10 million. Limited loss exposure has been identified within these subrated ag loans.

In conclusion, asset quality remain stable in the Heartland credit portfolios based upon the global metrics across the bank's footprint. That concludes my remarks. I will turn the call back to Lynn and remain available for questions.

Thanks, Drew. We will now open the phone lines for questions from our analysts.

Thank you.

(Operator Instructions)

Jeff Rulis, D.A. Davidson.

Thanks, good evening. A question on the Founders acquisition. Any additional color on cost savings, projected goodwill and CDI, any loan marks taken on that transaction expected?

I can tell you that the cost saves are in the 30% to 35% range and our loan marks we think are going to be pretty strong given the fact that they've got a pretty low level of non-performers and delinquencies.

Yes, we almost always put in 2% regardless at a minimum to be very conservative, Jeff, but they really don't have any non-performers on their books and they are only 55% loaned up due to deposits, so it's a very, very clean bank.

And then if we were to go to the goodwill and CDI in the $13 million range, is that reasonable? And back on the -- sorry?

Just a second. I am looking to see if we have an estimate.

If I could fire a quick question for Andrew on the provision. Just on the -- I guess given the sort of mixed but stable credit statistics -- and yet you've got net loan runoff, I guess trying to project or back into a quarterly provision, any idea of where that range would be? Is it somewhere in between Q2, Q3? Any comments there?

Jeff, real quick, I just looked at that. It's $10.5 million of goodwill.

Okay. Got it. Thank you.

And as it relates to the provision expense, Jeff, I would say the run rate we just had here in the third quarter was probably not atypical. So I don't foresee anything significantly above that, but I wouldn't say that the third quarter is an unreasonable estimate.

Yes, I think Jeff, the first two or three quarters here -- the last three quarters before this one, we've had pretty good recoveries, and I would think that those are going to slow down and be more normal like they were this quarter. And if we get any sort of loan growth, you know, I think the combination of that I think will be in this range plus or minus a little bit.

Okay. That's helpful. Thank you.

Damon DelMonte, KBW.

Good evening guys, how's it going today?

Good, David.

Good. Just a couple questions on the loan growth and the outlook there. Could you just talk a little bit more about what's driving some of the declines in the portfolio? Is it ag-related loans, is it commercial real estate, residential mortgage? What's the flavor out there in the loan portfolio?

Yes, David, this is Bruce. We've had -- our ag portfolio is -- actually grew slightly during the third quarter. Most, if not all, of the decrease has been coming from three markets that had recent acquisitions, and it's almost all commercial, commercial real estate, or challenged credit. We did see a decrease in our residential mortgage portfolio of about $18 million as rates remained low, and those are being refinanced out into the secondary market.

Okay. And when you say that there's M&A activity in those markets, you mean those are markets you've bought into and those loans are just running off, or there's other activity happening?

No, those are markets that we bought into, banks that we've acquired that we are trying to right size the real estate exposure in, or work through some challenged credits.

Got you. Okay. That's helpful. And then kind of going back on the provision and the loan loss level, it looks like loans were down this quarter, provision was up and more than covered net charge-offs, so do we look at the reserve build that we saw this quarter -- is this a sign that you guys are maybe a little bit less optimistic about the credit trends going forward?

I think one thing that comes to mind is as we move loans from the PCI and the valuation reserves, they -- that will continue to grow the allowance, and so as I noted, as the portfolio -- portfolios, plural -- are cycling through and we are underwriting them, they are transitioning. So I think that is as much a driver as anything to the growth.

Again, I wouldn't say more globally when I look at our levels of [watch] rated and substandard credits, but that necessarily would suggest that the allowances are going to grow because of that. But I think we collectively know that the economy is challenged on different fronts, but I don't think that in and of itself in the near-term feels like the real -- the biggest driver of our allowance or our provision.

Got it. Okay. And then Bryan, just on the expenses, I just want to make sure I have this correctly. So you said the lower professional service fees obviously for lack of M&A activity over the last few months, but we could expect that level to pick back up now that you had the Founders deal and potentially a couple more down the road?

Yes, I think so. We've been carrying $1 million to maybe a little bit more than that in the prior quarters. We had pretty limited, if any, in this last quarter just because we got through all of our conversions and really, you know, had been -- not had any new announcements.

So, in the fourth quarter you might see some of that start to come back. One, coming in there will be a little bit but if you see us having any more announcements that will pick up and we will probably get back to that more normal. We were running $1 million to $1.5 million of expenses through in a quarter.

Got you. Okay. And then, I guess lastly on the loans. You guys commented you are optimistic you're going to see some loan growth here in the fourth quarter, but as you look into 2017, what do you think a reasonable full-year target is based on what you're seeing across your markets today?

I think our thought is that we ought to be able to be growing at that 1%, maybe 1.5% per quarter, so 4% to 6% probably range for next year is what we are kind of thinking.

And David, that's the organic growth.

Right. Doesn't include any acquisitions. Got it. Okay, that's all that I had for now. Thank you very much.

Andrew Liesch, Sandler O'Neill.

Hey, guys, how are you?

Good, Andrew.

Just a couple of questions. Congrats on getting the Founders deal announced. I'm just curious if you guys have run any analysis on what you think the earn back on the tangible book value dilution is?

I think we estimate it's under four years.

Got you. And then just a question on the loan growth because I think you've highlighted the CRE pay downs and working on some challenged credits for a couple of quarters now.

As you look in the fourth quarter and you see what's in the portfolio, is there more of that to come? Has the pace sped up, has is slowed down? Any thoughts there would be appreciated.

I would say that the pace of new originations in our other markets is increasing and getting better in our pipelines are reflecting that. And again, when you back out the three markets we had positive growth everywhere else. So that's why we feel optimistic about the loan growth.

Okay, great. Thank you. Those are my questions.

(Operator Instructions)

Nathan Race, Piper Jaffray.

Hey, guys, good evening. Bryan, maybe a question for you. Was there an MSR write down in the quarter that impacted the service team [at the income level]?

No. No, there wasn't. We -- our -- I think I've said this before but we with the -- and I think Bruce mentioned this, we have about a $6.5 million higher market value than book value on our MSR, so we actually could take probably -- certainly 25 and maybe even up to 50 basis points of lower rates before the prepayment speeds would cause us to have any valuation issues based on where it stands today.

Okay, great. And can you just remind us as we think about 2017 expenses kind of what you guys are baking into the run rate as you prepare to cross $10 billion in assets?

Yes, I think we will certainly be adding expenses in the risk area, probably a little bit in systems area, and we will start to gear up a little bit around [de-fast] and start to work our way there. We will ladle it in.

It will come in over time and we're working on finding other ways to offset some of that so we're hoping to keep -- short of having again, a lot of M&A activity which could cause us to change our thoughts, but on an organic basis we should see certainly middle digit growth in expenses at the most.

Okay. Great. And then Drew, can you give us any additional details around those ag credits in New Mexico that went on -- that were impaired this quarter by industry? Are they grain, dairy, livestock? Any additional color on those spreads would be helpful.

The two that I've noted are both livestock, both cattle transactions.

And are you expecting to foreclose on those credits? Or how are you guys thinking about those (multiple speakers)?

We have recognized some impairments on both, and we are working through collection efforts that -- one may be an actual complete closeout collection. Another, there's a strategy moving forward with the borrower.

Okay. Thanks. All my other questions have been answered.

Daniel Cardenas, Raymond James.

Hey, good afternoon everybody. Just a couple of quick questions. Bryan, I missed your NIM outlook guidance for going forward. Could you repeat that?

Yes, plus or minus [410] -- we are at [414]. I think all things being equal that's probably going to grind down a bit just in this lower environment.

The only thing that would keep it up is if we have a little bit higher number of loans that move out of the purchase accounting pool and then we could take a little more amortization, but I don't think that's probably going to be markedly higher than it was this last quarter, so I think we're going to see a few basis points come down all things being equal.

And then how should we be thinking about the tax rate going forward? Does that kind of fall back into a more normal level? I know that's a little tough to predict.

I think it will. I think it's probably going to be -- I think I said in the 31% to 32% range going forward. That assumes without any tax credits because those come in as you know lumpy, so we continue to work on those but I would say at least 31% maybe 32%. You are in the ballpark.

Okay. And as we think about the $1 billion pool of purchase loans, any color as to how quickly those would get renewed and perhaps have reserves against them -- built up against them?

I don't off the top of my head. It's across four different banks and it's retail. It's mortgage retail and commercial. Some of it is commercial real estate which tends to be a little bit longer, so I don't have a blended number for you, Dan.

Okay, that's fair. All right. Everything else has been asked and answered. Thanks, guys.

Thanks, Dan.

Jeff Rulis, D.A. Davidson.

Thanks, just one quick follow-up. On the -- what is your -- if you could remind us on the commercial real estate concentration as a percent of capital on that sort of regulatory soft cap?

Yes, Jeff, it's right about $180 million for all the Company rolled together. At this point all of the banks fall in the 100%, 300% threshold except one of the new acquired that we -- that tips slightly over the 300%. But in general, we are well within regulatory guidelines.

Great. Thank you.

(Operator Instructions)

If there are no further questions I would like to turn the floor back over to Management for any closing comments.

Thanks, Matt. In closing, we are obviously very pleased with our excellent third quarter and year to date performance, and I will just recap very briefly. Heartland continues to maintain its net interest margin above 4%, and as a result our early earnings are strong and year to date EPS at $2.48 is a 15% increase over last year. So nice increase.

The Company continues to produce double-digit returns on average common equity and average common tangible equity. Our efficiency ratio at 63.9% continues to move in the right direction and surpassed our goal of 65%.

Finally, our pipeline of acquisition opportunities remains strong through both organic and acquired growth. We're moving closer to our goal of $1 billion of assets in each state where we operate.

In summary, we continue to produce strong financial performance metrics as we work toward another record year. I would like to thank everyone for joining us today and hope you can join us again for our next quarterly conference call which will be January 30, 2017. So have good evening, everyone.

This concludes today's teleconference. Thank you for your participation. You may disconnect your lines at this time.