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Edited Transcript of HTLF earnings conference call or presentation 29-Jul-19 9:00pm GMT

Q2 2019 Heartland Financial USA Inc Earnings Call

Dubuque Aug 21, 2019 (Thomson StreetEvents) -- Edited Transcript of Heartland Financial USA Inc earnings conference call or presentation Monday, July 29, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Andrew E. Townsend

Heartland Financial USA, Inc. - Executive VP & Chief Credit Officer

* Bruce K. Lee

Heartland Financial USA, Inc. - President, CEO & Director

* Bryan R. McKeag

Heartland Financial USA, Inc. - Executive VP & CFO

* Lynn Butch Fuller

Heartland Financial USA, Inc. - Executive Chairman of the Board

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Conference Call Participants

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* Andrew Brian Liesch

Sandler O'Neill + Partners, L.P., Research Division - MD

* Damon Paul DelMonte

Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director

* Jeffrey Allen Rulis

D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst

* Nathan James Race

Piper Jaffray Companies, Research Division - VP & Senior Research Analyst

* Terence James McEvoy

Stephens Inc., Research Division - MD and Research Analyst

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Presentation

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Operator [1]

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Greetings, and welcome to the Heartland Financial USA, Inc. Second Quarter 2019 Conference Call.

This afternoon, Heartland distributed its first 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 htlf.com.

With us today from management are Lynn Fuller, Executive Operating Chairman; Bruce Lee, President and CEO; and Bryan McKeag, Executive Vice President and Chief Financial Officer. Management will provide a brief summary of the quarter and then will open the call to your questions.

Before we begin the presentation, I would 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 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 website.

(Operator Instructions) As a reminder, this conference is being recorded.

At this time, I'd like to turn the call over to Mr. Lynn Fuller at Heartland. Please go ahead, sir.

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Lynn Butch Fuller, Heartland Financial USA, Inc. - Executive Chairman of the Board [2]

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Thank you, Doug, and good afternoon. And welcome, everyone, to our second quarter 2019 earnings conference call. We appreciate everybody joining us today as we discuss the company's performance for the second quarter of 2019. For the next few minutes, I'll touch on the highlights for the quarter. I'll then turn the call over to Heartland's President and CEO, Bruce Lee, who will cover progress on business performance. And then, Bryan McKeag, our EVP and CFO, will provide additional color around Heartland's results. Also joining us today on the call is Drew Townsend, our EVP and Chief Credit Officer.

Well, I am pleased to report that we had record earnings for both the quarter and year-to-date. In fact, it was the best quarter in our history. And I will be sharing some very impressive percentage increases for many of our financial performance metrics.

Let's start with net income available to common shareholders at $45.2 million compared to Q2 2018 of $27.9 million, an impressive increase of over $17 million or 62% over the same quarter last year. Year-to-date, net income available to common shareholders was $76.7 million, an impressive increase of over $25.5 million or a 50% increase over the first half of 2018. And even more important for our shareholders, fully diluted earnings per common share for the quarter was $1.26, also a new record, compared to $0.85 for Q2 2018, and that's over a 48% increase. And year-to-date, fully diluted earnings per common share was $2.17 versus $1.61 for the first half of '18, and that's a 35% increase. Return on average tangible common equity and average common equity for the second half was 19.52% and 12.56%, respectively. And finally, annualized return on average assets for the quarter and year-to-date, 1.55% and 1.35%, respectively. Our net interest margin held up over 4%, and our efficiency ratio came down below 65%. And Bruce Lee and Bryan McKeag will share more detail on these areas.

Now moving on to the balance sheet. Assets ended the quarter at $12.2 billion compared to Q2 of '18 at $11.3 billion, nearly an 8% increase. And as planned, our balance sheet is extremely liquid with very little in noncore funding. In a few minutes, Bruce Lee will cover loans and deposits. Book value and tangible book value this quarter were $41.48 and $28.40, respectively, an increase over Q2 2018 of nearly 14% and 21%, respectively. Our tangible common equity ratio ended the quarter at 8.92% compared to 7.46% for Q2 '18. Now that's also nearly a 20% increase. And at 8.92%, we are approaching the top of our targeted range of 8% to 9% TCE.

Now on the M&A front, Bank of Blue Valley closed in May, and our system conversion is scheduled for August 23 of this year. And we have a strong pipeline still of M&A, a lot of prospects, and we continue to be highly respected and sought after by community banks.

With respect to our dividend, I'm very pleased to report that earlier this month, the Heartland Board declared a dividend of $0.18 per common share, which is an increase of $0.02 a share or 13% increase. The dividend will be paid on August 30, 2019, to shareholders of record August 9, 2019. Also, you may have seen our announcement this month that Barry Orr, our Chairman and CEO of FirstBank and Trust, Lubbock, Texas was elected to the Heartland Board as a Class II Director.

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

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Bruce K. Lee, Heartland Financial USA, Inc. - President, CEO & Director [3]

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Thank you, Lynn. Good afternoon. I am pleased to report another excellent quarter. Lynn shared that we again delivered record-setting results. This includes the proactive steps we have taken in branch sales and working to streamline the company by divesting several business lines. And as discussed on previous calls, our effort to trim operations that no longer align with our growth plan has improved our franchise and positions us for continued growth. Those transactions have been completed as we exit the second quarter.

Today, I would like to begin by providing an update on some of the company-wide strategic initiatives that we have been working on over the past several quarters. We are using a portion of the over $23 million of gains we recorded during the first half of 2019 from these streamlining transactions to invest in our people, improve processes and upgrade technology, which we believe is necessary to support our growth plan, improve efficiency and ultimately provide a superior customer experience and enhance profitability. Three of the most significant investments in technology and process improvement are a project we call Operation Customer Compass, which is focused on streamlining and automating processes. We believe this project will create back-office capacity for growth and enhance the customer experience. We expect to realize over $10 million of expense reductions once the project is completed, which we anticipate will be the end of 2019.

An upgrade to our existing customer relationship management system to the Salesforce platform, which is an industry leader for relationship management, and the implementation of nCino, a premier commercial loan origination system. The upgrade to Salesforce and the implementation of nCino will significantly improve our ability to manage the sales process and improve the effectiveness of our commercial sales teams. The integration between nCino and Salesforce will improve efficiencies in our back office and shorten the sales cycle. These 2 projects are now underway and will be ongoing into mid-2020. We believe these significant investments in technology combined with our outstanding teams and our organic and acquired growth strategies position us well for the future.

In addition to these projects, we completed the acquisition of Bank of Blue Valley on May 10, and I'd like to welcome Bob Regnier and his teams to the Heartland family.

I will now provide comments regarding several key areas of our second quarter performance. Bryan McKeag, our CFO, will provide more specific detail on our financial performance after my comments.

Starting with the balance sheet. Organic deposit growth for the second quarter totaled $184 million or 9% on an annualized basis. This quarter, we had 7 of our 11 banks show growth in non-time deposits, with Illinois Bank & Trust, New Mexico Bank & Trust, Citywide Bank and Arizona Bank & Trust leading the way. The deposit growth has been primarily from commercial deposits as we have focused on building and growing our commercial relationships. We expect non-time deposit growth to continue in the low to mid-single digits on a percentage basis. Our deposit mix remains favorable with 34% in noninterest-bearing accounts and 89% in non-time account balances. Deposit costs continued to rise during the quarter, up 9 basis points for the first quarter -- from the first quarter. We have developed strategies that will help us remain competitive and also maintain our strong pricing discipline as we navigate through the ever-changing interest rate environment. Going forward, we expect deposit rates will level off if the Fed remains on pause. If the Fed changes course and reduces rates, we would expect our deposit costs will quickly follow.

Moving to loans. On an organic basis, total loan balances declined $20.5 million during the second quarter. This includes the residential mortgage portfolio, which continue to experience runoff, declining $34 million for the quarter, which was expected as we remain in the current low interest rate refinance market. Excluding the mortgage runoff, loans grew $14 million for the quarter. Our emphasis continues to be focused on growing commercial loans, which grew $33.4 million during the first half of 2019. We continued our targeted derisking program this quarter, which has resulted in a reduction of balances in these specifically identified commercial and ag credits of $50 million year-to-date.

On a more positive note, we have a very strong pipeline of commercial loans to be funded next quarter and feel confident that we will have a strong third quarter of commercial loan growth that could approach $100 million. Asset quality remained solid as nonperforming loans as a percentage of total loans decreased to 1.02% for the second quarter from 1.08% the prior quarter. The ratio of nonperforming assets to total assets improved to 0.71% from 0.75% last quarter. In addition, the ratio of delinquent loans to total loans improved to 0.31% from 0.47% last quarter.

Our streamlining efforts and focus on expense control has resulted in core expenses remaining relatively flat over the past 4 quarters and a decline in FTEs of 176 or 8% while assets grew almost $1 billion or 8%, and quarterly earnings per share grew by $0.41 or almost 50% during the same time period. Our efficiency ratio for the first half of 2019 was 65%, a 150 basis point improvement over the first half of 2018. Going forward, we expect core expenses to decline $2 million per quarter in the back half of the year as Bank of Blue Valley's conversion is completed and we begin to see the positive impact from our process improvement initiatives. The declines in core expenses are expected to drive the efficiency ratio to 60% or below as we exit 2019.

Overall, we are pleased with our second quarter results. We have put significant effort, resources and money into streamlining the company and are investing for the future, which will enhance our financial performance results and our customer experience.

With that, I'll turn it over to Bryan McKeag, who will provide more detail on our financial performance for the second quarter.

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Bryan R. McKeag, Heartland Financial USA, Inc. - Executive VP & CFO [4]

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Thanks, Bruce, and good afternoon. I'll begin my comments today by referencing the press release, which shows our reported earnings per share of $1.26 this quarter. This was another very busy quarter during which we completed virtually all of our previously announced transactions, including closing the Bank of Blue Valley acquisition, completing the sale of our loan servicing portfolio for a net gain of $13.3 million and completing the sale of 5 branches in Colorado, Illinois and Iowa for a total gain of $6.1 million, net of a $350,000 write-off of CDI. Offsetting these large gains were several items, including branch closure-related real estate write-downs of $1 million, M&A-related costs of $1 million and an MSR valuation expense of $364,000 and a $2.9 million increase in consulting expenses related to the process improvement and sales management initiatives that Bruce outlined in his remarks. I'll provide more detail on these items in my comments. However, the net impact of these items when you use our marginal tax rate of 28% was an increase in earnings after tax of about $10.2 million or $0.28 per share.

After filtering out all this noise for the quarter, we delivered solid core results and continued to show positive trends in most aspects this quarter, starting with our strong and liquid balance sheet, which grew to over $12 billion in total assets this quarter with a tangible common equity ratio approaching 9% and a loan-to-deposit ratio that is just under 78%. Investments comprised 22% of assets with a tax equivalent yield of 3.05%, a duration of 4.7 years and generating $30 million of cash flow per month. And when you combine that with the total borrowings of only $390 million or 3.2% of assets, our capital, liquidity and leverage ratios all remain in great shape and position us well to pursue growth strategies and opportunities going forward.

The allowance for loan losses as a percentage of total loans decreased 4 basis points for the quarter to 0.81%. As previously mentioned in prior quarters, we have $1.8 billion of loans from recent acquisitions that are covered by valuation and PCI reserves totaling $48.2 million or 2.6%. Excluding these loans from total loans would result in an allowance-to-loans ratio of 1% at June 30, 2019, which is 1 basis point lower than last quarter.

Moving to the income statement. Net interest income totaled $106.7 million this quarter, up $3.8 million compared to the prior quarter. This increase was primarily due to the addition of Bank of Blue Valley. The net interest margin, which on a tax equivalent basis this quarter, was 4.1%, a decline of 8 basis points from last quarter primarily due to higher interest costs on deposits and borrowings, which increased by 8 basis points compared to last quarter. This quarter, the net interest margin includes 18 basis points of purchase accounting accretion compared to 16 basis points in the prior quarter. The provision for loan loss was $4.9 million this quarter, up from last quarter's provision of $1.6 million but still within the expected normal range of $3 million to $5 million.

Noninterest income totaled $32.1 million for the quarter, up $5.3 million from last quarter. When compared to last quarter, gain on sale of loans was up $1.2 million, and the gain on sale of securities was up $2 million. We also recorded, as I previously mentioned, a $364,000 valuation adjustment on PrimeWest's MSR due to further reduction in mortgage rates during the quarter. Service charges and fees and deposits increased $1.8 million over last quarter as credit card revenue was up $900,000, and the addition of Bank of Blue Valley contributed $300,000 of the increase. Loan servicing income declined $400,000, as we expected, due to the sale of our MSRs that was expect -- effective on May 1, 2019. We expect the run rate for loan servicing income to decline another $100,000 from the second quarter level and then stabilize at a run rate of about $1.25 million per quarter.

Moving to noninterest expense. Total noninterest expense was $71.5 million this quarter, down $13.1 million compared to last quarter. This quarter, M&A and system conversion-related costs totaled $1 million compared to $400,000 last quarter. Core run rate costs, that is, excluding M&A costs, tax credits, restructuring charges and asset gains and losses, were $90.9 million compared to $87.5 million in core costs last quarter or a $3.4 million increase. The increase was driven by a $2.9 million higher consulting expenses related to process improvement and sales management systems, as previously mentioned. In addition, Bank of Blue Valley added $1.9 million of core costs for the quarter. More specifically, salary and benefits decreased $300,000 compared to last quarter and includes a $1 million increase due to the addition of Bank of Blue Valley. So ex Blue Valley, costs declined $1.3 million in this category.

Professional fees increased $3.6 million primarily due to the previous mentioned $2.9 million increase in consulting costs for technology and process improvement projects. In addition, M&A-related costs in this category were $200,000 higher than last quarter. Core deposit intangible amortization increased $470,000 from last quarter. Included in this category were write-offs of $350,000 related to branch sales this quarter compared to $330,000 last quarter. Amortization related to Blue Valley -- Bank of Blue Valley added $500,000. So a good run rate going forward in this category will be about $3 million per quarter. Other noninterest expenses were up $1.5 million with $1 million attributed to higher tax cost -- tax credit cost this quarter. The remaining expense categories were relatively flat compared to last quarter. The efficiency ratio for the quarter was 64.81%, which is a modest 42% improvement over last quarter. I would point out that this includes both the $1 million of M&A-related costs and the $2.9 million of higher consulting costs. Excluding those 2 items, the efficiency ratio would have been near 62% or almost 300 basis points lower.

The reported effective tax rate for the quarter was just over 23% compared to 21% last quarter as this quarter had a smaller portion of nontaxable income, which drove the rate higher, and was offset by a higher level of tax credits. We believe that a normalized effective tax rate in the 21% to 22% range is still reasonable going forward.

Next, I'll summarize just a couple of thoughts around Heartland as we move forward. Commercial loan growth, as Bruce stated in his comments, is expected to pick up next quarter and to the upper single digits on an annualized percentage basis and then continue at a mid-single-digit pace into Q4. Other loan categories are likely to remain flat except residential mortgages, which is expected to continue to decline. Non-time deposit growth is expected to continue to run in the low to mid-single digits on an annualized percentage basis. The net interest margin on a tax equivalent basis should remain in the 4.05% to 4.15% range as we expect purchase accounting accretion to stabilize and we expect less upward pressure on deposit pricing going forward.

The provision for loan losses are expected to generally range from $3 million to $5 million per quarter, with quarterly fluctuations primarily reflecting the level of rollover in the acquired loan portfolios and organic loan growth. Service charges and fees are expected to remain relatively flat for the remainder of the year as beginning this month, Durbin has kicked in, which will reduce our quarterly debit card income by about $1.5 million, which will largely offset the underlying continued loan growth -- or growth in credit card revenue and other deposit fees. Gain on sale of loans is expected to improve slightly next quarter and then will show the normal seasonal decline in Q4.

Core expense with the full quarter of Bank of Blue Valley are still expected to decline from last quarter's run rate into the $89 million to $90 million range next quarter and then decline another $2 million in Q4 as Blue Valley's conversion is completed and we begin to see the positive impacts from our new process improvement initiatives. And as Bruce said, we expect these declines in core expenses to drive the efficiency ratio to 60% or below as we exit 2019. And lastly, we expect the remaining Blue Valley integration and conversion costs will be in the $1 billion to $1.5 million range and fall primarily in the third quarter.

And with that, I'll turn the call back over to Lynn.

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Lynn Butch Fuller, Heartland Financial USA, Inc. - Executive Chairman of the Board [5]

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Terry McEvoy with Stephens.

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Terence James McEvoy, Stephens Inc., Research Division - MD and Research Analyst [2]

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I guess just start with the $23 million of gains so far this year. Could you just talk about how much of that has been invested in people, process and updating the technology? And then any sense for how much of that will be used? I know you said a part of it, but do you have a feel for how much of it will be?

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Bryan R. McKeag, Heartland Financial USA, Inc. - Executive VP & CFO [3]

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Yes. Some of it's going to be capital, Terry, but I can give you, at least, off the top of my head. Obviously, we had the $3 million increase this quarter that we talked about. We had probably another million or so go through licensing costs, which is a different line item, then that will be ongoing. And then we probably have another $3 million or $4 million to go in terms of capitalized costs that will go in primarily into the nCino system and the Salesforce system as we get that -- those systems implemented. And then going forward from that, it will be just the amortization of those costs and the licensing fee into 2020 and beyond.

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Bruce K. Lee, Heartland Financial USA, Inc. - President, CEO & Director [4]

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So Terry, in round numbers, we think this year, we'll spend between $8 million and $10 million of the gains that we've harvested on either -- and what Bryan's referring to is primarily technology. We also have made some new hires on the people front, a Chief Information Officer for the first time in our company's history as an example. We have a few more hires like that. That's why I'm kind of giving you that $8 million and $10 million range.

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Terence James McEvoy, Stephens Inc., Research Division - MD and Research Analyst [5]

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Then Bruce, a follow-up for you. The commercial pipeline you mentioned, the $100 million of potential growth and kind of a strong third quarter, anything specific stand out in terms of markets or what's behind the pipeline and your optimism for the third quarter?

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Bruce K. Lee, Heartland Financial USA, Inc. - President, CEO & Director [6]

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Yes, Terry, we've been talking in the last few quarters that we've been working very hard in our sales process. And right now, it looks like we're going to have strong quarters from 3 of our banks. Dubuque Bank & Trust, Citywide and Arizona Bank & Trust sort of lead the geography for the third quarter and our optimism there. And the big turnaround there is Citywide. As you know, they've had a lot of -- their construction loans have been paying off, and we've sort of seen that turnaround. And most of the growth will come from operating companies so we feel -- that's one of the reasons that we feel so positive about the third quarter growth and beyond.

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Operator [7]

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Our next question comes from the line of Jeff Rulis with D.A. Davidson.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [8]

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The margin discussion, I just wanted to make sure your -- in that guidance, does that include a rate cut or cuts?

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Bryan R. McKeag, Heartland Financial USA, Inc. - Executive VP & CFO [9]

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Yes. No, it doesn't. I think that's what would happen if the Fed remains on pause. Obviously, as Bruce stated, if the Fed does cut rates, we will be working quickly with our deposit customers. We do have and have been working always to have floors in our loans, prepayment language in our loans. So we've really been working to kind of protect that downside as well. But we've had internal discussions that we want to be -- obviously, we have to watch what the market does, but we don't want to lag too far, and we want to work those rates down, if we can, should the rate go down.

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Bruce K. Lee, Heartland Financial USA, Inc. - President, CEO & Director [10]

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Yes, we've put a plan in place, Jeff, that if rates do decrease, we're prepared really immediately to make rate cuts on our deposits on both the consumer and the commercial side.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [11]

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Got it. So the sensitivity would be -- it's kind of asset sensitive, but it sounds like you've got some quick levers to pull that would kind of neutralize that. I mean it doesn't sound as if...

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Bryan R. McKeag, Heartland Financial USA, Inc. - Executive VP & CFO [12]

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Yes. I would say our models say we're asset sensitive with kind of a normal 40-ish beta. We think, at least for the first cut or 2, we would probably be quicker than that and have a bigger beta and therefore make up, but the model says would be asset sensitivity.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [13]

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And then I also wanted to clarify the expense guidance as well. Does that include then the investments that you're making, the $8 million to $10 million that Bruce alluded to, that's kind of embedded in the run rate?

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Bryan R. McKeag, Heartland Financial USA, Inc. - Executive VP & CFO [14]

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It is. Yes. And so a lot of what we expensed this quarter was the upfront consulting, identifying the systems, helping us to negotiate statements of work, et cetera. So we're past that point. Now what will be spent going forward will mostly, not all but mostly, be capitalized and then amortized. So that expense run rate will, in effect, slow down, and that is built into what I -- what we're trying to give you for guidance on core going forward.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [15]

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That's great. And maybe one last one, if I could. Just Butch, I think you mentioned the capital was -- is on the high side of where you like to have it. You've done a lot of kind of asset sales in streamlining the business. I guess if you could just tackle a broad question about capital use. And is there anything else you'd look to sell? But also kind of how do you deploy that capital from here?

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Lynn Butch Fuller, Heartland Financial USA, Inc. - Executive Chairman of the Board [16]

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Yes. We set a range of 8% to 9% last year that we wanted to achieve. And so we're up at the top of that range at almost 9%. And we will have issuance of stock on acquisitions. The last few acquisitions, we've been anywhere from 100% stock to 90% stock, so that's a possibility. I would hope that we could use our continued earnings to go into good returning M&A activity versus having to turn to buy back our own stock. I really would not want to have to do that, to be honest with you. I mean we've got a deep pipeline of M&A, so I think we can utilize that capital and stay in that 8.5% to 9% range.

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Bryan R. McKeag, Heartland Financial USA, Inc. - Executive VP & CFO [17]

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Yes. I think probably on a priority basis. And you saw, Jeff, that we just recently announced that we increased the dividend. So that's one of the ways that we're recognizing that we're getting to a level of really strong equity and good earnings, so that's one thing. The second thing is, Butch mentioned, to put more cash into future M&A activities since we don't need as rich an add to the equity. And the third thing that's coming along that we have to keep our eye on is what will happen with CECL, right? So that's going to move equity off -- out of equity and onto the other part of the balance sheet. So we're kind of being mindful of all those. And so we think we're in a really good spot. We think our cash being generated from earnings is good. So the ability to use cash and M&A is there not only on a capital basis but on a cash flow basis as well. So I think all those are doable. And towards the end of our list will be any stock buybacks or things like that.

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Operator [18]

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Our next question comes from the line of Nathan Race with Piper Jaffray.

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Nathan James Race, Piper Jaffray Companies, Research Division - VP & Senior Research Analyst [19]

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I just wanted to clarify on the core NIM outlook from here. Bryan, if we go from the maybe 3.92% level on a core basis, excluding purchase account accretion, we do get a Fed cut this week of 25 bps. How should we kind of think about the core NIM trajectory into 3Q? Is it may be down a few bps and then stability thereafter once you guys get that loan growth and improve the position?

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Bryan R. McKeag, Heartland Financial USA, Inc. - Executive VP & CFO [20]

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I think it's something like that. Our model, if we just ran the betas that we have, I think is around 6 or 7 basis points. I think we can work that down with some of the things that Bruce talked about. So I would hope, and I know it's hard to figure exactly, but I would hope we're in the low single digits in terms of a decrease in the margin. We're going to do as much as we can to try and hold it, but it's probably realistic to say it's probably going to tick down a couple of basis points, 2, 3 basis points.

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Nathan James Race, Piper Jaffray Companies, Research Division - VP & Senior Research Analyst [21]

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Okay. Perfect. And then just on expenses, I appreciate your guidance for the back half of this year, but -- and I don't want to get too far out in front of us in terms of thinking about 2020 run rates. But I guess with Operation Customer Compass being largely wrapped up by the end of this year, any sense for how we can maybe think about operating expenses starting 2020?

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Bryan R. McKeag, Heartland Financial USA, Inc. - Executive VP & CFO [22]

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I don't know about the level, I haven't thought much about that. I will tell you that we have been talking internally, and our goal is to get our efficiency ratio to get into that upper 50s or somewhere between 55% and 60% and get it there next quarter -- or next year. So we're going to continue to work on our expenses at least in relation to our revenue to get additional leverage out of growth and do good expense control.

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Bruce K. Lee, Heartland Financial USA, Inc. - President, CEO & Director [23]

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Nathan, I think one of the things that I would say, and I mentioned capacity as we continue to grow, one of the things that's come out of Operation Customer Compass in addition to the actual expense reduction that I referenced is we believe that we should be able to grow 10% to 15% and not add anything to our back office. So it really depends on our organic growth as well as the M&A activity to where those expenses will line up in 2020.

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Nathan James Race, Piper Jaffray Companies, Research Division - VP & Senior Research Analyst [24]

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Understood. That's really helpful. And if could I just ask one more on deposit growth. I appreciate that deposit growth has been pretty strong year-to-date. So just curious, as you look forward, given how the rate environment is changing, I mean do we expect deposit growth to lag loan growth going forward? So perhaps, you guys are going to grow some of that excess liquidity that's on the balance sheet today.

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Bryan R. McKeag, Heartland Financial USA, Inc. - Executive VP & CFO [25]

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I think that's probably a fair assumption. I think what we said in our guidance is probably that upper percentages single digits on loans and low to mid on deposits. So there's a little -- we're kind of showing you that we think we can grow deposits a little bit faster than -- or loans faster than deposits in the last half of the year.

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Bruce K. Lee, Heartland Financial USA, Inc. - President, CEO & Director [26]

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And Nathan, and I would say also because a lot of our deposit growth has come from the commercial side, there will be a little bit of a lag there. The retail side, I think, depending upon where rates go, it'll be much more difficult to continue to grow retail deposits.

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Operator [27]

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Our next question comes from the line of Andrew Liesch with Sandler O'Neill.

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Andrew Brian Liesch, Sandler O'Neill + Partners, L.P., Research Division - MD [28]

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Just one clarification question on the expense guidance, does that include amortization of intangibles?

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Bryan R. McKeag, Heartland Financial USA, Inc. - Executive VP & CFO [29]

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Yes. We -- I include that by core. You see, we back it out for our efficiency ratio, but I'm including that in the core. I'm only -- you can go back and probably see what I backed out, but that's not one of the things I'd back out.

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Andrew Brian Liesch, Sandler O'Neill + Partners, L.P., Research Division - MD [30]

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Okay. I thought so. I just wanted to make sure. And then secondly, just on the well-publicized flooding and the current conditions in the agriculture economy, it seems like everything was okay. But Drew, if it's possible, can you just give an update where things stand and how trends progressed in the quarter?

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Andrew E. Townsend, Heartland Financial USA, Inc. - Executive VP & Chief Credit Officer [31]

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Yes. Andrew, let me first speak to ag. As odd as it sounds, where we're situated predominantly with the majority of our portfolio in -- around the Dubuque, Iowa area and in Southern Wisconsin, our crops and -- are largely in the ground. And so now what we're seeing is because of the broader stress in the industry that will reduce overall yields, prices have ticked up. And so corn, as an example, has trended up over $4 now. Soybeans are taking it on the chin, still, a little bit more, and that relates more to the trade issues, the tariff situation. But the other bright spot is dairy. That is also seeing some uptick in the pricing. And so as I was speaking with our ag leadership, they feel our projections in both the grain and in the dairy space is we're probably more conservative. Now we've got to get to the end of the year, got to get crops out of the field, et cetera, but maybe finally see a little relief in those 2 spaces. They represent about 63% of our overall ag book, the grain and dairy.

And the other thing that's positive for us is we do have -- most of our portfolio's kind of multiline, if you will. So large acreages, growing grain more times than not feeding it to livestock, which tends to provide some natural hedge as well.

I think outside of that space, we haven't seen any headwinds created by the weather necessarily on any of the commercial side of things. There is a little bit of a residual carryover back to the ag and some on the agribusiness side. And so we're watching that space closely, those businesses that track the ag economy. But generally speaking, the quarter was very stable. And I think we look forward to, cautiously, have a favorable third quarter.

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Bruce K. Lee, Heartland Financial USA, Inc. - President, CEO & Director [32]

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Andrew, we were very fortunate, our ag clients really were not affected by the flooding that you saw in other parts of the country. We were very, very fortunate.

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Operator [33]

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Our next question comes from the line of Damon DelMonte with KBW.

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Damon Paul DelMonte, Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director [34]

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Just a couple of quick questions. First, on noninterest income, if we kind of normalize that, sort of the gain on sale of securities and the MSR write-down, that's about $28.8 million this quarter. Bryan, could you just give a little color on your expectations over the next couple of quarters?

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Bryan R. McKeag, Heartland Financial USA, Inc. - Executive VP & CFO [35]

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Yes. I would think that next quarter, you should see just, I'm hoping, just a small uptick. But as I said, Durbin's going to kick in, so our -- the main -- the biggest piece of that is our service charges and fees. And I think that's going to remain relatively flat. I think you'll see a little downtick, as I mentioned, in the loan servicing. And then for our -- the loan -- gain on sale of loans, I think that will be flattish to slightly up. We had a pretty good quarter this quarter, and so I think we can do just maybe slightly better there. PCIs and some of the trust and the brokerage, I think, can stay flat to maybe go up a little bit. We seem to have a little bit of momentum there. So I think you could see that number maybe get just a little bit over 29%, but it's not going to go -- it's going to be fairly flattish given Durbin and all the other things. So -- and then you'll see a little downturn, obviously, the normal, I don't know if it's 25% or whatever, in loan sales on the mortgage side. When we go into the fourth quarter, it does tick down, so you'll see something relatively normal there.

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Damon Paul DelMonte, Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director [36]

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Got it. That's helpful. And then do you have like a schedule on your expected accretable yield?

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Bryan R. McKeag, Heartland Financial USA, Inc. - Executive VP & CFO [37]

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I don't. But I think it's going to be, for at least the next few -- oh, the accretable yield. I'm sorry. I was thinking about CDI. Damon, it's really hard because loans prepay or they come up for renewal quicker or they pay off, all of which triggers that additional dollars to flow in. I think my sense is that it's probably going to stay at where it is. Maybe it could go up a tick or 2, probably not down in terms of basis point because we just have got Bank of Blue Valley coming in. And we've been -- there really is not a whole lot of amortization this first quarter because they're so new. So that's what I think. But I've been wrong on that before because it can swing because of those prepayments.

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Operator [38]

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There are no further questions in the queue. I'd like to hand the call back to Mr. Fuller for closing remarks.

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Lynn Butch Fuller, Heartland Financial USA, Inc. - Executive Chairman of the Board [39]

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Very good. Thanks, Doug. Well, in closing, we're very pleased, obviously, with the record earnings for the quarter and for year-to-date. And we see a lot of momentum going into the second half of this year with a very liquid balance sheet and a strong equity position.

I'd like to thank everyone for joining us today and hope you can join us again for our next quarterly conference call in late October. So with that, everyone, have a nice evening.

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Operator [40]

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Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.