Heartland Financial USA Inc (HTLF) 2017 Q4 法說會逐字稿

Greetings, and welcome to the Heartland Financial USA, Inc. Fourth Quarter 2017 Conference Call.

This afternoon, Heartland distributed its fourth quarter press release, and hopefully, you've had a chance to review the results.

If there is 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'll open up the call to questions from analysts.

Before we begin the presentation, I'd like to remind everyone that some of the 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'll now turn the call over to Mr. Lynn Fuller at Heartland. Please go ahead, sir.

Thank you, Devon, and good afternoon, and welcome to Heartland's fourth quarter 2017 earnings conference call.

We appreciate everyone joining us today, as we discuss the company's performance for the quarter and year just ended.

For the next few minutes, I'll touch on the highlights for the year and fourth quarter. I'll 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'm very pleased to begin this afternoon's call with news that excluding our onetime fourth quarter tax adjustment, Heartland's earnings set new records for the quarter and full year of 2017.

Now after the deferred tax asset charge, fourth quarter net income available to common shareholders was $13.7 million or $0.45 per diluted common share. And for the full year 2017, net income available to common shareholders was $75.2 million or $2.65 per diluted common share.

In response to the passage of the Tax Cut and Jobs Act (sic) [Tax Cuts and Jobs Act], we recorded a reduction in the value of our deferred tax asset, resulting in a onetime, noncash charge to income of $10.4 million or $0.35 per diluted common share. Excluding the deferred tax charge, fourth quarter '17 net income available to common shareholders was $24.1 million or $0.80 per diluted common share. And for the full year, net income available to common shareholders was $85.6 million, a 7% increase over 2016, marking Heartland's fifth straight year of annual earnings increases.

Now going forward, Heartland will realize a tax benefit from the reduction in the corporate tax rate from 35% to 21%. We estimate the 2018 benefit should more than cover the tax charge taken this quarter. In addition, the favorable tax impact will improve the earnings per share accretion and internal rates of return for the 12 acquisitions closed since 2012, as they were all modeled at 35% tax rate. Bryan will provide further color on effects of the tax cut in a few minutes.

In addition to delivering solid earnings for 2017, Heartland completed 2 successful acquisitions, Founders Bancorp in California and Citywide Banks of Colorado, notably Citywide is Heartland's largest acquisition to-date.

And to top off our year in the fourth quarter, we announced definitive merger agreements with Signature Bancshares, Inc., a $409 million asset bank in Minneapolis, and FirstBank Lubbock Bancshares, Inc., a commercial bank operating in Texas with over $929 million in assets.

When these 2 acquisitions are completed in the first half of this year, Heartland's assets will exceed $11 billion, providing an excellent start for 2018 and taking us closer to our goal of $12 billion in assets by mid-2019.

As we discussed in recent quarterly calls, our plan was to strategically manage our balance sheet to remain below $10 billion in assets through 2017.

We're pleased to have accomplished that goal through some strategic shifts on both sides of the balance sheet, primarily in investments and short-term borrowings. In Q1 2018, both will return to their Q3 '17 levels.

For 2017, most of our growth in loans and deposits was acquired. Although, organic loan growth was positive in Q3 and Q4 of 2017. Organic nontime deposits contracted slightly for the year, with net organic growth occurring in the second half of the year. In a moment, Bruce Lee will discuss loans and deposits in more detail.

Heartland's tangible common equity ratio was 7.53% for the quarter, moving above the midpoint of our current target range of 7% to 8%. Prior to the deferred tax asset charge, Heartland's equity went over $1 billion for the first time.

Book value and tangible book value per common share continued to increase, ending the quarter at $33.07 and $23.99, respectively.

Net interest margin moved up to 4.3% for the quarter, benefiting from the effect of purchase accounting. Nevertheless, at 4.22% for the year, we are very pleased with our margin at this enviable level. Net interest income in dollars has increased for each of the last 4 quarters.

Now with respect to Heartland's efficiency ratio, we've made significant progress over the past year, with the fourth quarter at 62.26% and the full year at 65.4%. This represents a year-over-year improvement of 85 basis points.

As we realize cost savings from acquisitions and investments in new technology, we would expect to see further improvement in this ratio going forward. Following Bruce Lee's comments, Bryan will address noninterest expense in more detail.

Now moving on to the balance sheet. Total assets increased during the year by nearly $1.6 billion or 19%, largely the result of the Founders and Citywide Bank acquisitions.

Heartland's securities portfolio currently represents 25% of assets. We expect to see this ratio decline towards 20%, as we have plenty of room for loan growth. Currently, our available for sale portfolio duration is 4 to 4.5 years, with the portfolio yield now at 2.91%.

Credit quality was positive for the quarter, with all credit-related metrics improving. I congratulate our credit teams for their diligent efforts, and also want to praise our newest additions, Founders and Citywide, for the addition of their superb portfolios. In a few minutes, Drew Townsend will provide more detail on these and other credit-related topics.

Now moving onto M&A, expansion of our banking franchise through mergers and acquisitions remains a high priority for Heartland. Looking into 2018, we continue to evaluate several attractive opportunities. The increase in Heartland's share price improves our ability to pursue these and other M&A opportunities going forward. We remain committed to achieving our goal to reach $1 billion or more in assets in each state where Heartland operates. Building on our M&A experience, Heartland is in a great position for additional accretive acquisitions.

Now with respect to our dividend, I'm very pleased to report that in December, the Heartland Board declared a special dividend of $0.07 per common share in recognition of the company's record financial performance in 2017. And at this month's January meeting, the Board approved a $0.02 increase in the regular quarterly dividend to $0.13 per common share, payable on March 2, 2018. This boosts our annual regular dividend to $0.52 per share.

Now in closing my portion of today's call, I want to add that Heartland has again received recognition from Forbes, as one of the best banks in America. Based on 10 financial metrics related to growth, profitability, capital adequacy and asset quality, Heartland ranked #60 on Forbes' list of the 100 largest U.S. banks.

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

Thank you, Lynn. Good afternoon.

As Lynn described, Heartland's financial performance for the year and the quarter was strong in all respects. Now I'm pleased to comment on those results in more detail.

I'll begin with loans, where I'm pleased to report that we delivered another quarter of organic loan growth. In the fourth quarter, we added $18 million of organic loan growth across Heartland.

During the second half of the year, organic growth exceeded $80 million. And in our highest priority category, commercial lending, we experienced net organic loan growth of over $100 million. We expect this momentum to carry into 2018 on the strength of tax cuts and strong economic tailwinds.

As I meet with our bankers and our clients across the country, I'm encouraged by their optimism, as they describe the current business climate as quite positive. Specifically, we are hearing that the tax cut, low interest rates and lower energy costs are fueling future expansion plans. The Heartland banks are well positioned to capitalize on this optimism and are looking for it to translate into stronger loan demand and deposit growth.

Now I'll turn to deposits. In the second half of 2017, we carefully monitored and managed our deposit portfolio to ensure we could strategically delay crossing the $10 billion asset mark until 2018.

During the fourth quarter, organic, nontime deposit growth was virtually flat. Year-over-year, our nontime deposits increased $1.2 billion or 21.5%. We also delivered a 7% increase in highly valued, noninterest-bearing deposits. And when including acquired deposits, we were successful in improving our deposit mix year-over-year with nontime deposits now representing 89% of the total.

In retail banking, we are getting excellent results through the online channel, with a fourth quarter promotion producing a 42% increase in new checking accounts. To maintain our new account momentum, Heartland is stepping up its digital marketing efforts. We will add online account opening for small business in the first quarter of 2018.

Turning to noninterest income in our income-producing businesses. In 2017, commercial card was a standout in the portfolio, with a 68% revenue increase year-over-year and a 22% increase compared to the fourth quarter of 2016.

Trust fees increased 6% year-over-year and service charges and fees showed an increase of 24% from December 2016.

In regard to residential real estate, Heartland's mortgage loan production was seasonally slower in the fourth quarter. We remain far from satisfied with the performance of our mortgage unit and are implementing plans that focus on delivering consistently profitable results.

Heartland's mortgage servicing portfolio totaled $3.6 billion as of December 31. We have $23 million of MSRs on our books, which have a fair value of approximately $37 million or $14 million more than book value.

In 2017, Heartland again demonstrated our strong competency in acquisition activities. So to briefly recap, in February, we completed the Founders Bancorp acquisition, merging approximately $213 million in assets into Premier Valley Bank in California.

Also in February, we announced our largest acquisition to-date. With $1.49 billion in assets, Citywide Banks of Colorado joined Heartland in July, followed by a nearly flawless systems conversion in October.

With all our acquisitions, we carefully watched deposit balances before and after conversion, and are extremely pleased with 97% of Citywide's deposit account base retained.

Indeed, throughout the integration process, we intensely focused on retention of all loan and deposit clients, and also retention of the employees who serve those clients. Our track record is strong in this respect, and we continue to focus on seamless conversions and integrations.

To expand on Lynn's earlier comments, in an active fourth quarter, we announced the pending acquisition of Signature Bancshares in Minnetonka, Minnesota, and its merger into Minnesota Bank & Trust, adding one location and creating an entity with approximately $600 million in assets. We really appreciate the potential for these 2 well-matched banks in serving the specialized financial needs of business, professionals and private clients.

Then in December, we announced the pending acquisition of FirstBank Lubbock Bancshares, with over $929 million in assets, which will significantly increase our presence in Texas and became Heartland's 11th Community Bank charter. FirstBank & Trust company brings a solid commercial banking unit, balanced with strong retail and mortgage organizations. We expect the FirstBank & Trust company team, with their considerable acquisition experience, to take the lead in facilitating additional acquisitions in attractive Texas markets.

2018 is already shaping up to be another active year for conversions and integrations, with Signature transaction expected to close in February and the FirstBank Lubbock Bancshares transaction scheduled to close in the second quarter.

In concluding my remarks, I am pleased to state that our banks are well positioned to reach new heights, as we begin the year. And we expect 2018 to be an exciting year of growth and strong performance.

With that, I'll turn the call over to our CFO, Bryan McKeag, for more detail on our financial results.

Thanks, Bruce, and good afternoon, everyone. Well as Lynn and Bruce have described, this was another eventful quarter. So I'll try to add some more color and clarity to our quarterly results, starting with tangible common equity ratio, which increased 7 basis points to 7.53%.

The already mentioned $10.4 million write-down of deferred tax assets reduced the ratio by 11 basis points, which was offset by a small 1 basis point add from changes in market value of our investments and derivatives, and a 17 basis point increase from quarterly retained earnings.

Lynn and Bruce have already commented on loans and deposits, so I will only comment on a few other balance sheet items.

First, other borrowings decreased $16 million as a result of our repurchase and retirement of $15 million of Heartland's Statutory Trust IV preferred securities.

Second, you will note that we had reductions in several nonearning asset line items. More specifically, premises and equipment declined $4.7 million and other real estate declined $2.4 million, as we sold one large bank building, wrote down another bank property we intend to sell, and sold one large OREO property. Other assets were also down $16.2 million, largely due to the reduction in our deferred tax assets.

Moving to the income statement. Net interest income totaled $92.9 million this quarter, up $3 million from the prior quarter. The primary driver of the increase was a $2.9 million increase in accretion of purchase accounting discounts on acquired loans. The net interest margin, on a tax equivalent basis, improved again to 4.3%, which is a 4 basis point increase from last quarter.

Loan yields increased 16 basis points during the quarter, due to the higher accretion of purchase accounting discounts.

Offsetting the higher loan yields was a 22 basis point decline in investment yields, related primarily to lower mix of higher-yielding tax-exempt securities. And we also had slightly higher interest costs on deposits and borrowings, which increased 1 basis point compared to last quarter.

This quarter, the net interest margin includes 28 basis points from the accretion of purchase accounting discounts, which compares to 16 basis points in the prior quarter.

Noninterest income totaled $25.5 million for the quarter, up $551,000 from last quarter. When compared to last quarter, gain on sale securities was down $300,000 and gain on the sale of loans was down $700,000.

Service charges and fees also declined slightly this quarter, down $250,000 from last quarter. However, trust fees were up by $500,000, reflecting strong market value increases, and other noninterest income was up $987,000, primarily due to the inclusion of $1.3 million gain from the repurchase and retirement of the Trust preferred securities, as I previously mentioned.

Switching to noninterest expense. Total noninterest expense was $77.8 million this quarter, a decrease of $881,000 from the prior quarter. This includes M&A and system conversion-related costs, which decreased from $2.8 million last quarter to $1 million this quarter.

Our largest expense category, salary and benefits, decreased $1.9 million compared to last quarter. The main drivers of the decrease were a lower full-time equivalent employee count, which decreased by 16 and favorable incentive and benefit accrual adjustments during the fourth quarter.

Advertising costs were up $700,000 over last quarter, primarily due to costs associated with fourth quarter deposit campaign, which Bruce previously mentioned, and additional advertising in the Denver market, surrounding the Citywide conversion that occurred this quarter.

Professional fees increased slightly, or $100,000, as M&A and conversion-related costs in this category were $700,000 this quarter, which is a similar level as last quarter.

Finally, other noninterest income -- or expense was up $600,000 over last quarter, as this quarter included costs for tax credit investments of nearly $1 million.

The reported effective tax rate for the quarter was 61.1%. However, adjusting for the $10,000 -- $10.4 million deferred tax asset write-down, the rate was 31.6%, up from 28.7% last quarter. We believe with the new tax law, which became effective January 1, 2018, that a normalized tax rate of around 20% to 22% is reasonable going forward.

I'll end my comments with a list of expectations for Heartland's core results for 2018, which exclude our 2 pending acquisitions.

Starting with loan and deposit growth, on an annualized percentage basis, is expected to be in the mid-single digits.

The net interest margin on a tax equivalent basis for 2018 should be in the 4.05% to 4.15% range, as the new tax rate -- as the new tax law will lessen the tax advantage on municipal bond interest. And also, we expect a decrease in purchase accounting accretion.

Provision for loan loss is expected to be slightly higher for the full year, as we expect higher loan growth provisioning to be partially offset by lower net charge-offs and lower purchase-accounting related provisions.

Mortgage production is expected to improve significantly after a disappointing 2017, as we gain traction in several of our newer and larger markets, and will follow normal seasonal patterns.

Core fee income, excluding mortgage and security gains, is expected to show increases nearing 10% from current run rates, as we continue to have strong corporate credit card growth and sell into our newly acquired customer bases.

And lastly, core expenses, excluding M&A-related costs, should remain well controlled and show low single-digit percent growth from current run rates.

And with that, I'll turn the call over to Drew Townsend, our Executive Vice President and Chief Credit Officer.

Thank you, Bryan. This afternoon, I'll begin my remarks by discussing the highlights of the key credit metrics for Heartland. I am pleased to report that we have been able to continue to improve credit quality, while growing our loan portfolio by over $1 billion in 2017.

Better credit quality is demonstrated by: one, continued reduction in nonperforming assets; two, the lowest delinquency ratio in the last 3 years; and three, continued low levels in total nonpass-rated loans.

I will also discuss total charge-offs and the allowance for loan loss. Allow me to provide more details on each of these.

Total nonperforming loans were further reduced during the fourth quarter, and now represent less than 1% of total loans. These loans are primarily concentrated in 7 relationships, representing 42% of the total nonperforming loans, and in the government-guaranteed repurchased residential mortgage loans, equating to 21% of the total nonperforming loans.

More broadly, nonperforming assets as a percent of total assets also continued to decrease, and now represent only 0.76% of total assets.

Delinquency totals are at the lowest levels reported in the last 3 years, and for fourth quarter 2017 are 0.27% of total loans.

At 6%, nonpass-rated loans are at a level which compares very favorably to recent quarters, as well as levels over the past several years.

Continuing, net charge-offs for the fourth quarter of 2017 were $4.5 million, primarily attributable to $3.1 million of charge-offs related to 2 previously reserved agribusiness and commercial loan relationships at Dubuque Bank & Trust and New Mexico Bank & Trust, respectively.

Finally, the allowance for loan losses as a percent of total loans remained relatively unchanged for the fourth quarter at 0.87%.

As mentioned in previous quarters, $1.5 billion of loans from our most recent acquisitions are covered by the valuation in PCI reserves, totaling $36.4 million. As credit decisions are made on these acquired loans in future quarters, provision expense will be necessary to establish the associated allowance for these acquired loans.

Excluding these loans from total loans would result in an allowance-to-loans ratio of 1.13% as of December 31.

Lastly, I'm pleased to report that only 8.5% of the total allowance is attributed to loans that are considered individually impaired.

Summarizing, we ended 2017 with a very favorable position with respect to credit quality.

In addition to our focus on loan growth in 2018, we are working closely with our member banks to optimize our credit processes and achieve a better customer experience.

That concludes my remarks. I will turn the call back to Lynn and remain available for questions.

Thanks, Drew. Now we'll open the phone lines for questions from our analysts.

(Operator Instructions) Our first question is with Jeff Rulis with D.A. Davidson.

Bryan, maybe a follow-up on the guidance there. Do you have a -- just a core fee income and expense number that we could work off of? Or at least, what was noncore, 1 or the 2?

For fee income, let me think here. So we reported 25 point -- I'll just get my number here, $25.5 million. I think from that, you guys usually, I suppose, back out the security gains. And I would probably back out $1.1 million or so -- $1.2 million or so of the gain that we had on the TruPS. The rest should be core from this point.

Okay. So you're talking a run rate off of -- just annualize that figure. And then on the expense side, same?

Yes. The expense side is kind of -- there's a lot going on. It tends to net itself out. When I looked at it, you've got some M&A costs, you've got tax credits, but then we had a fair amount of adjustments to the accruals.

So I think the core really is pretty close to what was recorded, the $78 million when you tip everything in and out of there. And so I think if you took that and grew that from there, the low single digits, I think that would put you in the ballpark.

Got you. And then just another one on the margin itself, so that -- the 4.05% to 4.15%, are you sort of excluding accretion?

Yes, well -- so the way I get there, if you start with the 4.30%, and I think our tax equivalent adjustment for the quarter, if you annualized it, is about 6 basis points going from a 35% tax rate to a 21% tax rate.

So you go back -- that gets you to 4.24%. And then this quarter, we had 28 basis points of purchase accounting accretion. We had a lot of loans that moved this quarter. I would normalize that back down to -- we've been running at the 16, 14 basis point range. So if you took that out, that puts you right at 4.10%, 4.11%, and kind of in the midpoint of that 4.05% to 4.15% for the next year.

And then, I guess, so layering in, I guess, it doesn't include any expected accretion on the deals to close in Q1 and Q2?

Correct. I don't know that number just yet. I would tell you that the 2 banks that we're acquiring, their core interest margins are in the 4.15% to 4.20%, maybe slightly plus. So they are right in the ballpark with us. So I think pulling them in shouldn't have a big impact on our margin. It should be about the same.

Our next question is with Andrew Liesch with Sandler O'Neill.

Just a couple questions here on the charge-offs. Basically have been running higher than I was expecting in the last couple quarters. Are you seeing anything else in the portfolio that's giving you any concern?

I don't believe so, Andrew. We had these identified, quite honestly, they weren't surprises. And knock on wood, as we kind of turn the corner or turn the page, we feel like we have everything pretty well identified at this point.

Okay. And Bruce, just circling back to your comments on loan growth earlier. What -- are there any markets that your bankers have been giving you even more optimism than others?

Yes, Andrew, while it doesn't appear the organic growth was fabulous during the fourth quarter, we did have growth in 7 of our 10 markets. And one of the markets, Citywide, we did go backwards there. And it actually attributed to the accretion that Bryan was talking about, as we had -- several of our large construction loans have scheduled payoffs there.

But I would say most of the Western markets right now feel pretty good. Actually, I was just in Denver last week, and they feel very positive about the momentum they have. We feel real good about what's going out in Arizona. California feels good.

So I would say, it's really across the board. It feels very, very positive. I think that we got a boost here at the end of the year with the tax cut. I think that has increased the optimism from where we were a month ago.

Okay. And then, Butch, just one follow-up from you. I was just curious, you got these 2 deals pending, when would you be comfortable announcing another transaction?

Well, I would hope we'd have another announcement before the end of '18. But I really can't give you a date, per se. We've got to -- builds in. And hopefully, we can still announce another deal by the end of '18. Maybe sooner.

Our next question is with Damon DelMonte with KBW.

So first question, regarding the provision, Bryan, I think you said we could expect a higher provision, kind of instep with loan growth. Could you kind of frame that?

I mean based on the last couple quarters, we were in that lower to mid-$5 million per quarter range. And there wasn't really a meaningful amount of growth. So I'm guessing that was more just credit-driven. What would you feel comfortable with for a -- maybe for a full year or at least a range on a quarterly basis?

Yes, I think if you took the -- what we had this year, I think it was about $15.6 million. Yes, that's roughly $4 million a quarter. Could be $4.5 million, I think, on average.

But it's going to be lumpy depending upon loan growth and if we do have any bumps, something pops up. So I think somewhere in the $4 million, maybe $4.5 million in a couple quarters would get you there.

Okay. All right. That's helpful. And then it looks like the securities jumped up this quarter. Like the balances were up, maybe -- both on an average and end-of-period basis, what was the thought behind that?

Well, I think a couple things. One, we were -- as we got to the end of the year, we had some deposits that ran off. And so you'll see that 2 things happened. One, we kind of bumped up our short-term borrowings because of that, and we left the securities go over quarter end, where we might have taken some of those in other quarters. Things kind of tend to slow down at the end of the year.

So now as we've gone into the next year, you'll see next quarter where the borrowings will come back in line and investments will probably come back down more, where they were.

Damon, in my comments, I said that those 2 items, securities and short-term borrowings, will return to the levels that you saw in Q3 of '17.

Okay, great. I missed that point. And then, in kind of looking through the individual subsidiary banks, it looks like you reported a loss in Arizona Bank & Trust this quarter? Is that accurate?

Yes. One of the things that we had to do, obviously, to -- was to spread out our deferred tax asset adjustment. And relative to their size, I think they got a little bit more. I don't know the exact reason but when we did it by bank, I think they ended up -- caused them to go negative.

Okay. So it wasn't like there was a material loss of some sort? This is part of the (inaudible) that we all considered on (inaudible)

No. I think if we would not have had the DTA write-off, I think all the banks would've been positive.

Okay. All right. That's helpful. And I guess that's -- I guess one final question, just to clarify on the merger charges. I think you said there was about $1 million of merger expense this quarter?

Yes.

And that was kind of spread out into...

Yes, about 7 or maybe just a tad bit more ended up in professional fees. The other 3 probably ended up mostly in travel and entertainment expenses for our folks traveling.

Okay. And then were there some kind of offsets in there? Because you had said to I'm not sure which -- one of the earlier folks asking questions, but you had said that, that $77.9 million is probably a good rate, because the onetime merger charges were offset by something else?

Well, we had -- so if you -- just getting my notes here. So if you backed $1 million of that out and $1 million of the tax credits out, it gets you about 70 -- almost to $76 million. But we had salary adjustments that went in there. We adjusted the bonus, trued things up. And so, when you kind of take the puts and takes, I get back to $78 million there.

Okay. Got you. That's -- I missed the comment on the salary adjustments. Okay.

Fourth quarter, unfortunately, tends to be a little noisy in the expense categories.

Our next question is with Steve Moss with FRB (sic) [B. Riley FBR].

Most of my questions have been answered here. Just one follow-up on the investment securities portfolio. A little different way of asking it and thinking about it. Given the flatter yield curve and the change in tax rate, is there any change in the investment strategy going forward?

Well I would say, right now, there is not a lot of value going out long on the curve, so we're staying relatively short. And muni spreads have, at least at end of the year or early into this year, have been pretty narrow. So as long as those stay narrow and the curve stays flat, I think we'll be operating closer to the front end of the curve in anything we might do.

Yes, in investment, Steve, in investments that throw off a good deal of cash flow, I mean, anticipating some rate hikes this year. Mortgage backs that are giving us a lot of cash flow and SBA floaters. A lot less appetite for munis but muni's taxable equivalents have been trading right on top of treasuries. So we had an opportunity to shed some of the muni inventory before year-end.

Okay, that's helpful. And just in terms of thinking about the portfolio, would it be -- going forward, favor it to pay down borrowings or run off CDs or just kind of maintain balances here at roughly current levels?

Yes. I think first is we probably would reduce some of the short-term borrowings that you saw on the balance sheet at the end of the year. And then, it's a matter of how our deposits go, really as to where we would go next. Whether we have to fund loan growth out of that investment or whether we can use the deposits.

Our next question is with Nathan Race with Piper Jaffray.

Bruce, just going back to the discussion around the Colorado operation in 4Q. I appreciate your comments in terms of some of the construction fundings in the quarter, they came down and so forth, as those projects became completed.

But, I guess, I'm just curious as well if there's any credit aspect to the shrinkage? I know historically, you guys have tended to shrink some of these acquired loan books as some of the credits may not have fit within your kind of credit criteria? Was that the case you saw here in Colorado? And any expectations in terms of Colorado growth specifically for 2018?

Yes, Nathan, none of the shrinkage was a result of any credit actions or portfolio changes that we wanted. We're very happy with the portfolio that Citywide had and brought to us as well as Centennial prior to that.

So we like the mix that we have in that portfolio. And they expect, actually, to be in that mid-single-digit to actually potentially the upper range of that in Colorado, as we look out to 2018.

As I mentioned, I was in Colorado last week for a couple of days, participating in some of their prospect meetings and pipeline meetings, and I would say that they have a very robust pipeline right now. And we feel very, very positive about what's going on out there and the loan growth potential, not only for the first half of the year but for all of '18.

Got it. And here, just going back to the charge-off discussion. I appreciate your commentary in terms of the items that you -- the charge-offs this quarter. So I guess, I'm just curious, and looking at criticized classified trends during the fourth quarter. And just kind of within the context of your expectations for charge-off levels as we go through 2018?

Yes, again, I would say, first, the criticized classified levels, we are pretty stable. We meet frequently with the banks and have, I think, good insight into their portfolios and seeing very limited downgrades.

The only sector that I would point out is Ag, and we're continuing to work on a handful of those relationships. But I don't -- I wouldn't expect loss in any material way. Really, I'm not sure I expect any loss in the Ag portfolio because of government guarantees, et cetera.

And, again, with respect to charge-offs we've got a handful of larger ones that have been somewhat sticky. And again, for the first time, I feel some optimism. We have some strategies in place that aren't multiple quarters out. And so I think in that space, we're going to see some improvement.

So I like to see charge-offs down, quite frankly. I don't -- there's nothing right now that would not make me feel optimistic that our net charge-offs won't come down in 2018.

Okay, Got it. And Bryan, just thinking about the pro forma efficiency ratio for 2018. Obviously, you guys got 2 pretty sizable deals coming online here. So any thoughts on kind of where the efficiency ratio could shake out maybe 12, 18 months from now?

Yes, I think that's really hard to gauge, but I would say, at least the core. So let's start with the core. We did -- for this year, we did 65.4% for the full year.

If you make the adjustment for the tax -- taxable income adjustment that we do, that would've added another almost 1% to that ratio had we reported under a 21% tax rate. So that puts you at in the low 66%s.

And I think our goal has been to get that down under 65%. I think we can get it under 65% even under this ratio, which really is under 64% under the old tax rate. So I think somewhere between 65% and 60%, maybe a little bit better than that for next year.

Then when you get into adding the 2 new entities, you're going to have onetime items that will hit upfront. And it will take us a while then to realize the benefit of the cost saves. So I'm saying that's maybe a push to -- it could hurt it just a little bit.

But Nathan, if you look out -- your question, 18 months after we've fully absorbed those, we would expect to -- those acquisitions will reduce our efficiency ratio and we would expect it to be much closer to 60%, 18 to 24 months out.

Yes.

Yes, that answered my question. Because if I just look at 4Q at just around 62% on an adjusted basis, that would imply the potential to get another 200 bps lower once you get the full cost saves realized from these 2 acquisitions. So I appreciate that commentary, Bruce.

Our next question is with Daniel Cardenas with Raymond James.

So, guys, for the provision that we had this quarter, the $5.4 million, how much of that was related to the movement of loans out of the purchased accounting pool into the regular portfolio?

I think, quarter-over-quarter, so the quarter change. And I looked at this on a quarter change, trying to explain the difference. We had about almost $1 million more of provision for loans moving into the portfolio than we had last quarter.

Okay. And so then as we look at the first half of 2018, I mean, are you kind of expecting the same types of movement out of the purchased accounting portfolio?

I think it would probably normalize back to what it would've been maybe last quarter, so that's where I think you can get in that. And we had a couple of downgrades this quarter that aren't specific reserves but just changed the numbers underlying our old FAS 5 calculation.

So that's why I think, with some loan growth, I think we could be in that $4.5 million, round there range. Without loan growth, organic loan growth, we're probably more in that $4 million, maybe a tad bit under range in a given quarter, all things being equal.

But, Dan, we do not expect the same level of payoffs or paydowns that we had at Citywide in the fourth quarter. We don't expect that to reoccur in the first quarter.

Yes, I think you can even go back to third quarter levels, and then when Signature and when FirstBank Lubbock come in, you'll see that number tick up again, in terms of both the margin and probably having to provide a little more as well.

Okay. And then just in terms of paydowns and payoffs. What kind of impact did that have on Morrill & James (sic) [Morrill & Janes] this quarter?

Don't always look at it on individual bank basis, Dan.

Okay. No problem -- I just -- I was just looking at quarter-to-quarter, you're down roughly $20 million.

Give me one second. I think I have it here.

One thing that does happen, Dan, within our portfolio, if their deposits have dropped a little bit, we sometimes will move some participations out of a bank to kind of help their liquidity.

That was about half (inaudible) I believe in the fourth quarter (inaudible) that they still did have net negative organic loan growth. I don't know if I see it here. I got the growth numbers but I don't know if I have the paydown separately. Do we move some loans out of them?

No.

Oh right, right. Half of their reduction was done on purpose as we moved participation.

You can see, Dan, if you look at the back columns there. I think their deposits have been down this back half of the year. And so we've been helping them with their liquidity by moving some loans around our -- to our other banks as they come up for renewal.

Got you. Okay, all right. Good, good. And then just kind of given tax reform, what are your initial thoughts in terms of putting the windfall to work? Are you looking at increasing minimum wages or onetime contributions, the HSAs or anything like that?

Yes, Dan, this is Butch. We feel really good about our benefits packages we provide our employees, there are a number of things that we do that some of the larger banks don't do for their employees. We really think where we're going to see the adds are in technology and talent.

So we're not doing a one-timer per se, but we're going to continue to be very active as we've been in the past in communicating the benefits that we do offer to our employees and continuing to support the communities through both financial support for the communities as well as our people's time in volunteering on charitable organizations.

So as a consortium of community banks that's something that we've been very proud of, so little bit different than what you've seen from the largest banks in the country.

There seems to be no further questions at this time. So I would like to turn the floor back over to Mr. Fuller for closing comments.

Thank you, Devon. In closing, we are very pleased with our excellent financial performance for 2017 and the fourth quarter. And I'll just recap, excluding the fourth quarter impact for the deferred tax charge, Heartland's earnings set new records for the quarter and for the full year of 2017. And over the past 4 years, Heartland's net income has more than doubled, growing by 132%, with EPS growing by 48%, and assets increasing by 66%.

The 12 acquisitions closed since 2012 were very accretive at a 35% tax rate. And now even more accretive at a 21% tax rate. Heartland's net interest margin increased to an enviable level of 4.22% for 2017. And our efficiency ratio continues to improve, reaching 62.26% for the quarter with ongoing efforts for further reduction.

And based on our continued financial success in 2017, our Board of Directors approved a special dividend as well as an increase to our regular quarterly dividend, which boosts our annual cash dividend to $0.52 per common share.

And finally, our 2 successful acquisitions in 2017 really set the stage for an exceptional year ahead. And with 2 more solid banks joining Heartland early this year, we have a lot of positive momentum and are poised to reach new heights in 2018.

I'd like to thank everyone for joining us today, and hope you can join us again for our next quarterly conference call, which is scheduled for April 30, 2018. Thank you, and have a good evening, everyone.

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