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Edited Transcript of ICBK earnings conference call or presentation 18-Oct-19 1:30pm GMT

Q3 2019 County Bancorp Inc Earnings Call

MANITOWOC Oct 24, 2019 (Thomson StreetEvents) -- Edited Transcript of County Bancorp Inc earnings conference call or presentation Friday, October 18, 2019 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Glen L. Stiteley

County Bancorp, Inc. - CFO & Treasurer

* Timothy Jon Schneider

County Bancorp, Inc. - President & Director

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Conference Call Participants

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* Brendan Jeffrey Nosal

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

* Brian Joseph Martin

Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts

* Kevin Kennedy Reevey

D.A. Davidson & Co., Research Division - Senior 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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Good day, and welcome to the County Bancorp, Inc. Earnings Release Third Quarter Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Tim Schneider, President of County Bank. Please go ahead.

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Timothy Jon Schneider, County Bancorp, Inc. - President & Director [2]

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Good morning, everyone. Welcome to our earnings call for the third quarter of 2019. As a reminder, we have our disclaimer on the use of forward-looking statements on our slide deck, which we currently have shown on the webcast.

I'll start with some comments on asset quality, which is on Slide 3. We're encouraged that the current level of milk prices, a year ago forward CME Class III milk prices were in the $15 to $16 range, we are now seeing forward milk prices in the $16 to $18 range. The improved milk prices were a contributor in the upgrading of 1 dairy ag relationship, which improved our adverse asset coverage ratio to 45.67% this quarter. As you can see from our slide, it does appear to be a good correlation between milk price and our adverse asset coverage ratio. We're having positive conversations related to 1 substandard performing loan and a few of our ORE properties, which we hope will allow us to lower this ratio again in quarter 4.

We also upgraded another dairy relationship from special mention to watch. The decrease in loans rated substandard performing at special mention allowed us to book $1.2 million credit to provision from loan losses this quarter. We allocate higher general reserves for loans rated watch, special mention and substandard performing in our allowance for loan loss calculation. We expect that the current milk price levels will continue to lower the dollar amount of loans rated watch and worse into 2020, which could continue to lower our reserve levels.

We're currently 92% of the way through our annual reviews of watch and worse credits. Since we prioritize higher dollar relationships in our annual reviews, should not have any material impact on the credit quality ratios or allowance levels.

We continue to see overall stability in Wisconsin farmland values, which continues to contribute positively to the strength of our credit portfolio. We are in the process of updating our capital plan during fourth quarter, and we'll begin to evaluate a stock buyback plan for 2020 with continued positive trends in milk prices and our adverse asset coverage ratio.

I'll now turn it over to Glen.

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Glen L. Stiteley, County Bancorp, Inc. - CFO & Treasurer [3]

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Thanks, Tim. Good morning, everybody. As we announced during our fourth quarter 2018 conference call, we continued to deleverage our balance sheet by continuing to use loan participation sales with servicing income attached. This has allowed us to continue to maintain profitability while continuing to improve the funding mix on the right side of our balance sheet.

We increased loan sold and serviced by $41 million this quarter. Loan servicing income this quarter grew to $1.7 million, and loan servicing right origination income grew to $1.7 million. That $1.7 million of loan servicing right origination income included $250,000 of servicing right valuation allowance, which will continue 1 more quarter in Q4. This combined with $19 million in client deposit growth allowed us to continue to reduce wholesale funding by $97 million this quarter.

We're really pleased with the change in our funding mix. Wholesale funding is now down $224 million, and client deposits are up $100 million year-over-year. Our wholesale funding now represents 28% of total funding compared to 41% year-over-year.

We will look to grow our loan balances over the next year but this will be governed by our growth in client deposits. We will target a 4% to 5% growth rate. We are still very focused on relationship lending and profitable pricing.

Our net interest margin increased during the quarter due to increasing loan yield and [flattening] funding cost. Because of our asset sensitivity and 33% of our loan portfolio being adjustable, we do expect to see some slight margin compression in Q4.

We have been able to offset the impact to rate cuts in the loan portfolio with aggressive cuts to interest rates paid on our client deposits. For example, our rate on for money market accounts with $100,000 and more has dropped from 1.95% at the end of June to 1.26% currently. Our 1-year CD has dropped from 2.05% to 1.65% during that same time period. We haven't seen much in the way of client deposit [out falls] from a rate-cutting date, but we'll have to be watchful of that as competition either increases or decreases.

And I'd like to open it up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Brendan Nosal with Sandler O'Neill + Partners.

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Brendan Jeffrey Nosal, Sandler O'Neill + Partners, L.P., Research Division - Director [2]

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Just want to start off on the expense base here. I mean thinking about the last quarter, if I recall correctly, we were thinking a run rate of around $7.2 million was kind of the expectation for the back half of the year and then obviously things were a bit higher this quarter after backing out the FDIC benefit. Can you just help us understand what you expect for expenses in the final quarter of the year and then heading into 2020?

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Glen L. Stiteley, County Bancorp, Inc. - CFO & Treasurer [3]

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Yes, Brendan. This is Glen. So one of the things that pops out is on employee compensation and benefits. We started to ratchet up our incentive comp because we're hitting a lot of our targets this year. So we ramped it up from the quarter. I think employee compensation and benefits could go up about $500,000 from where you see that level. The other level should be, I think, trending kind of similarly to what it was this quarter. So one of the contributors to employee compensation and benefits is we've started to fill some key positions we've been looking for, one on the treasury side and one on our concierge banking side. Again, a lot of it's just tied to us, continuing to make sure we can be thoughtful about how we grow client deposits. So...

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Brendan Jeffrey Nosal, Sandler O'Neill + Partners, L.P., Research Division - Director [4]

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Okay. So just to make sure I understand correctly. So I guess if you kind of add back or rather remove the FDIC benefit and then add another $500,000 of incentive comp, that kind of gets you around like at $8.2 million to $8.3 million expense level for the fourth quarter?

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Glen L. Stiteley, County Bancorp, Inc. - CFO & Treasurer [5]

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Yes. That sounds about right, so. And I think as of right now, we're just starting our budgeting process now. So going into 2020, I think that should probably be a good level, too. We'll obviously update folks as we start to get through our budget process. So...

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Brendan Jeffrey Nosal, Sandler O'Neill + Partners, L.P., Research Division - Director [6]

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Got it, great. And then moving on to the net interest margin. There's a common sight that you might see a little bit of compression in the fourth quarter of '19. Could you just help size up what that might look like? And then will there be further pressure if the Fed continues to cut rates?

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Glen L. Stiteley, County Bancorp, Inc. - CFO & Treasurer [7]

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Yes. I think it's maybe a 1% to 2% at worse, I think, compression. I mean we are seeing the long yields start to -- as we look month by month in the third quarter, we did see some pressure on loan yields. But we're -- again we were pretty aggressive on cutting rates that try to get ahead of this. Part of it just because we have a lot of excess cash, and we're trying to be cognizant of not paying up too much on rate on the deposit side. So we've been very successful with that. Again, we haven't seen any outflow. So if I'm looking at, like I said, I think a 1% to 2% at worse would be what I'd be looking at.

And then -- when I say 1% to 2%, I'm talking about the rate. So the net interest margin rate. So...

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Brendan Jeffrey Nosal, Sandler O'Neill + Partners, L.P., Research Division - Director [8]

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In basis points or...

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Glen L. Stiteley, County Bancorp, Inc. - CFO & Treasurer [9]

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Yes.

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Brendan Jeffrey Nosal, Sandler O'Neill + Partners, L.P., Research Division - Director [10]

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Okay. All right. Good. And then final one for you before I step back. Just top level, I mean, milk prices have obviously improved a great deal and the full year outlook is better. I mean if milk prices hold near here for the next 12 months, and I know that's a big if, but I mean how much reduction hypothetically could you see in overall problem asset levels?

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Timothy Jon Schneider, County Bancorp, Inc. - President & Director [11]

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Well, I think if we continue to see this kind of current milk price level, we're hopeful that we can get under the 40%, maybe into the mid-30s. That's just a guess at this point. But at this level, most if not all of our dairy farmers are in a profitable level, and the futures market is pointing to at least continued solid milk prices through the end of next year.

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Glen L. Stiteley, County Bancorp, Inc. - CFO & Treasurer [12]

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Yes, Brendan, this is Glen. It was interesting, we did -- we added something to the slide deck, milk price versus the adverse asset coverage ratio. And you can see the kind of correlation there. So again if we continue to see where milk prices at this level, we think we can get that, again, under the 40% -- down to 30% levels. So 30% I mean. So...

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Operator [13]

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Our next question comes from Kevin Reevey with D.A. Davidson.

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Kevin Kennedy Reevey, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [14]

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So first question is, I believe the bank recently underwent a regulatory exam. Without giving away too much, can you give us a sense out as to how that went?

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Glen L. Stiteley, County Bancorp, Inc. - CFO & Treasurer [15]

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Tim, you want to go ahead first?

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Timothy Jon Schneider, County Bancorp, Inc. - President & Director [16]

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I think it went pretty well. Obviously, our adverse asset coverage ratio's moving in the right direction, which they were pleased to see. They continue to compliment us in the way that we're managing through the cycle, managing our ag credits and how we're on top of them as well. I mean they were pleased with our continued kind of wholesale reduction on the right side of the balance sheet in more core deposits. And obviously, milk prices at this point have helped our overall ag portfolio to heal a little bit. So that's some -- that's positive news for all of us.

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Kevin Kennedy Reevey, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [17]

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Yes, that's great. And then as far as we've been reading about negative weather issues impacting farmers. Are you guys -- are your farmers seeing any of that in Wisconsin in a while?

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Timothy Jon Schneider, County Bancorp, Inc. - President & Director [18]

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Yes, it's been a little more challenging at this point for harvest because of the continued rainfall, and it's creating a little bit more work for them, probably a little more expense relative to trying to get the corn out of the field in particular. But I think most of them have made headways in little windows that they've had here in between the rain showers. So we hope that it will hold off a little bit and they'll be able to get the balance of the crop harvest. We're a little bit behind harvest at this point but we've got some time left here yet.

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Kevin Kennedy Reevey, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [19]

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And then lastly, you mentioned in your prepared remarks that land values continue to improve. Are there regions within Wisconsin that you see that are doing much better than others? And then what are those regions?

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Timothy Jon Schneider, County Bancorp, Inc. - President & Director [20]

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Yes. I'd say it depends upon where you are. But the essential part of the state where the bank is located, our headquarters in Manitowoc is a very strong dairy area and there still seems to be decent competition for land. You get into the kind of the northern parts of the state that's maybe less competitive. I'd say that the southern 2/3 of the state overall are still pretty solid from a land value standpoint. We're not seeing a ton of softening anywhere. It's just there isn't maybe as much competition for the land in the northern 1/3 of the state.

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Operator [21]

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Our next question comes from Terry McEvoy with Stephens.

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Terence James McEvoy, Stephens Inc., Research Division - MD and Research Analyst [22]

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Glen, maybe just start with you. I'm just trying to understand the size of the balance sheet and the earning assets in fourth quarter and beyond. I know you talk about client deposit growth target 4% to 5%. Was that -- what type of time frame was there? And how should we just think about kind of the runoff of wholesale deposit, increase in core deposits? And then what you do on the asset side as that mix changes?

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Glen L. Stiteley, County Bancorp, Inc. - CFO & Treasurer [23]

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Yes. I think the 4% to 5% is probably more our loan growth target, Terry. We're targeting a little bit higher on the client deposit side to stay ahead of that and just maintain liquidity. So client deposits, I would say, is probably in that 6% range. We're going to continue to hammer on the wholesale funding. It probably won't be as aggressive as we've had been in the last year, but we're still going to continue to drive that down. I think long-term we want to get it kind of in that 5% to 10% level compared to where we're at today but that's still going to take some time. So...

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Terence James McEvoy, Stephens Inc., Research Division - MD and Research Analyst [24]

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So as you think about 2020, do you expect the balance sheet to stabilize, grow from here?

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Glen L. Stiteley, County Bancorp, Inc. - CFO & Treasurer [25]

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I would say client deposits and loans are going to grow. I'd say we're going to continue to hatch a way at wholesale again, not to the level today. So total assets may be up a little, but again we're going to focus on growing the kind of core relationships on the loan deposit side.

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Terence James McEvoy, Stephens Inc., Research Division - MD and Research Analyst [26]

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And then a question on the loan servicing right origination, the $1.74 million in the quarter. You mentioned in the fourth quarter there'll be another $250,000 gain on the loan servicing rights, which makes sense. What happens in 2020? And I guess what are your thoughts on that line ex the rights, mortgage servicing rights, in the fourth quarter?

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Glen L. Stiteley, County Bancorp, Inc. - CFO & Treasurer [27]

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Yes. So fourth quarter, it's -- we just had so much in sales this quarter that -- usually what happens is we have more modest sales. So the amortization of that really kind of offsets the origination volume. But because the original volume was so high this last quarter, I would think that they kind of levels off. We may have a little bit of income, but I don't think it'll be as aggressive as it was this quarter for sure. So...

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Terence James McEvoy, Stephens Inc., Research Division - MD and Research Analyst [28]

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Okay. And then the last question, I understand upgrade and substandard performing, special mention's down and just feeling better about dairy overall. Though just from reading the headlines around some of your customers, NAFTA deal I guess hasn't been kind of signed and isn't a done deal yet, but we had the releasing of the reserve. And is that -- I guess, my question is, is that just the internal formulas that you have spits out the reserve releasing despite maybe the uncertainty that's still out there in the marketplace, particularly to your dairy-related borrowers?

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Glen L. Stiteley, County Bancorp, Inc. - CFO & Treasurer [29]

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Yes. And Tim can jump in after I add commentary. But the way we look at it is, milk price kind of drives loan grading but land values -- that governs impairments. So I think there's a lot of things going on. I think there is some optimism in the marketplace on milk. Supplies are regulating now. They're down from where they used to be at all-time highs a couple -- a year or 2 ago so there's a lot of positive momentum. I think the trade agreements can -- will definitely help sustain this kind of uptick in milk price, but everything that we're seeing and reading is that folks are not overly optimistic about milk price, but we think it's going to -- we think it's in a good spot and can hold for the immediate future. So -- and Tim can kind of jump in on his thought there, too, but...

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Timothy Jon Schneider, County Bancorp, Inc. - President & Director [30]

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Yes. And we're definitely consistent with our application of how we apply our allowance for loan loss. We don't want to be jumping around, and we've taken some hits in the past and increases in loan loss because of milk prices and some of our challenges for the ag portfolio. But, overall, as we've mentioned many times before, I mean, again, our heavy use of the FSA guarantees really kind of minimizes our loan loss exposure and obviously some of the improvements with the milk prices now. And I think milk prices stay here, we should continue to see some more improvement in our classified assets, which will probably drive down our need for loan loss longer term.

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Operator [31]

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(Operator Instructions) Our next question comes from Brian Martin with Janney Montgomery.

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Brian Joseph Martin, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [32]

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Just one question before going back to the margin. Just if you -- I know I appreciate the color on this fourth quarter and just one more rate cut. But I guess if you were to see multiple cuts from here, let's say you get 2 or 3 more cuts. I guess do you -- I guess, can you just give any thought on how you think the margin behaves kind of in that scenario if you were to get 1 in October, another in December and early next year? Is it kind of that -- there's a pressure begin to alleviate as the more cuts you get? Or just any color on just multiple cuts.

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Glen L. Stiteley, County Bancorp, Inc. - CFO & Treasurer [33]

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Yes. So we do have a very short loan portfolio. The duration on it, it's about a year and it's driven largely by the ag side. So we keep getting rate cuts. It's -- I mean it is going to be hard for us to maintain margin, especially if there's like 1 a quarter. That's when it gets a little challenging, I think, for us. But again we -- I would say, we're being very aggressive again on the deposit side as aggressive as we can be. So it's going to be hard for us to maintain margin levels that we get more than 1 so...

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Brian Joseph Martin, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [34]

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Okay. All right. That's helpful. And I guess maybe just one other question. You guys mentioned the buyback. I mean, I guess, are there certain hurdles you would have to kind of hit to make it more likely you would -- you go down that road? Or I guess just what are kind of the key elements you're looking at to make that decision on the buyback and how to utilize that or if you utilize it?

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Glen L. Stiteley, County Bancorp, Inc. - CFO & Treasurer [35]

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Yes. I mean I think we've been -- I think we've been consistent when we're out on the road talking to folks. It's really governed by 2 things. Milk price holding kind of where these levels are. And secondarily, getting our classified ratio under 50%. So -- and we kind of use the huddle of -- and again there's no magic behind this but if we get the classified ratio under 50% for 2 quarters straight, and we feel good about milk prices, I think we feel a lot better about kind of using -- utilizing some of our excess cash to start buying some stock back. So it's something -- it's definitely on our radar and on our plate to discuss with our Board for this quarter and hopefully have some more guidance on that as we get into the first quarter of next year. So...

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Brian Joseph Martin, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [36]

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Okay. All right. Perfect. And then just the last one or two for me. Just the watch list, Glen. It looked like it was up. I mean I guess the trend sound great with the milk pricing, but just the watch list looked like it was up a little between quarters. Is there something in that number or is that just an anomaly the way those trends were this quarter? Did I look at that wrong on the slide deck?

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Timothy Jon Schneider, County Bancorp, Inc. - President & Director [37]

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Well, it's really a product of all the upgrades that we've had. The starts moving out of the classified bucket and one big deal that moved from special mention into watch and trending in the right direction. So that's why that number's up substantially.

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Brian Joseph Martin, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [38]

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Okay. All right. And just the comment you made about if prices -- maybe I'm just confused, trying to understand that one. You say the prices of milk get better. If they're getting better, how that affects the adversely classified ratio versus just hold -- the price holding its own, the loans that you continue to look at as far as your rating and that's -- just how to think about that adversely classified ratio if the milk prices kind of stabilizes here versus gets better?

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Timothy Jon Schneider, County Bancorp, Inc. - President & Director [39]

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Well, I think if milk prices stay where they're at right now, when we get through the review cycle of the vast majority of our credits in that bucket into early first quarter and second quarter of 2020, we should see some upgrades because they're going to have a stronger 2019 because of better milk prices the last 2/3 of the year. And then if projected milk prices moving forward continue to stay at least at this level or maybe if we get some trade deals done, move up, we should see some more positive movement in that classified ratio.

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Glen L. Stiteley, County Bancorp, Inc. - CFO & Treasurer [40]

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Brian, and another way to look at it is that we get the -- we start the annual reprocess probably starting in late first quarter but I think you'll see probably something -- probably more material movements probably in second quarter of next year. We may see some upgrades in the first -- in the fourth quarter of this year and first of next year, but I think a lot of it could come in the second quarter.

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Brian Joseph Martin, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [41]

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I got you. Okay. And would you just remind me, Glen, when you guys look at the process to upgrade to credit, it looks like you're kind of reading some of the comments that you -- some of that done inter-quarter. But I mean is it more traditionally done when you get an annual view? So to your point, maybe the second quarters when you start to see a more or -- it sounds like you're upgrading intra-quarter as opposed to intra-year as opposed to just annual. Is that fair? Just how to think about that?

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Timothy Jon Schneider, County Bancorp, Inc. - President & Director [42]

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We may do that selectively, and we have done it selectively on certain deals but I'd say the vast majority of the movement's going to occur once we get through the review cycle late first quarter and in the second quarter next year. But there are certain deals that we feel have made significant improvement that are maybe still in that substandard bucket, which is what you saw in this last quarter. And as we watch them closely and see certain things change, we aren't afraid to make some of those moves inter-quarter.

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Glen L. Stiteley, County Bancorp, Inc. - CFO & Treasurer [43]

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Brian, as you're looking at that we got [about] $9 million in special mention, there's probably maybe $2 million to $3 million of that, that could move here in the fourth quarter. The rest of it could move maybe first quarter. Those are -- that's kind of an up or out category. It's not meant to be a permanent category. We're watching those -- just like all the of watch and [worse], we're watching them closely. But I guess we may see a little bit of movement fourth quarter. But hopefully, first quarter we'll see the rest of it. And we're optimistic but again we're watching pretty closely.

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Brian Joseph Martin, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [44]

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Okay. All right. And I think just the last one for me, Glen. That wholesale target, I thought you guys were -- was it 28% you were at this quarter?

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Glen L. Stiteley, County Bancorp, Inc. - CFO & Treasurer [45]

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Yes.

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Brian Joseph Martin, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [46]

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I mean did you say you're -- I guess the longer-term target was, what, 5% to 10%?

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Glen L. Stiteley, County Bancorp, Inc. - CFO & Treasurer [47]

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Yes, I'm mixing it up, Brian. So the 5% to 10% is probably more as a percentage of assets. That 28% is -- tat 28% is just mixed -- it's the funding mix based on the funding non-asset so I started to confuse the topic.

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Operator [48]

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Our next question is a follow up from Kevin Reevey with D.A. Davidson.

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Kevin Kennedy Reevey, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [49]

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Yes, Tim, can you remind us what the breakeven price level for milk are -- for milk is for farmers? Is it around $16, if I recall?

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Timothy Jon Schneider, County Bancorp, Inc. - President & Director [50]

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Yes. I still think it's in that $16, $16.5 range, something like that. So at least that's -- if you have averaged it out through our entire portfolio, that's about where the breakeven point is for our book.

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Kevin Kennedy Reevey, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [51]

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Yes, that's what I thought. And then just going back to the regulatory exam. Was that FDIC or was that OCC?

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Timothy Jon Schneider, County Bancorp, Inc. - President & Director [52]

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FDIC and state.

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Glen L. Stiteley, County Bancorp, Inc. - CFO & Treasurer [53]

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FDIC and state.

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Operator [54]

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Our next question is also a follow up from Brendan Nosal with Sandler O'Neill + Partners.

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Brendan Jeffrey Nosal, Sandler O'Neill + Partners, L.P., Research Division - Director [55]

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So it looks like you're working on an update to this stress testing model that you guys ran last year. I'm just kind of curious as to the thought process behind that. I mean, the last test showed that you had plenty of capital been since milk prices have improved and you haven't taken any dairy losses since that. So is it just to convey added comfort with the state of the portfolio?

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Glen L. Stiteley, County Bancorp, Inc. - CFO & Treasurer [56]

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Yes, I mean there's a definite expectation by regulators for anybody that's got a concentration like ours that we do more modeling around stress testing whether it's risk rating migration and/or just overall capital stress testing. So we just -- we think it's an important tool for us to make sure that we can kind of watch where we're at on the risk migration cycle, but it's also just a good capital planning tool for us to establish what we think we have and establish our capital policy limits too, Brendan. So it's something we think is really important. We're working hard to get better data as part of this. We do provide room-level data for this but the collateral data has been not as good as we'd like so we're working hard to get that better and tweak to get -- see and get better color around this. So...

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Operator [57]

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

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Timothy Jon Schneider, County Bancorp, Inc. - President & Director [58]

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I'd like to thank you all for joining us this morning, and we're excited about the strong quarter that we've had and continued outlook for the dairy space, which is important to us, and feel like we're headed in a positive direction here. So again, thank you all for joining us. And we'll -- if there are any follow-up questions, please feel free to call Glen or I and we'd be happy to answer them -- answer your questions. Thank you.

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Glen L. Stiteley, County Bancorp, Inc. - CFO & Treasurer [59]

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Thanks all.

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Operator [60]

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This conference is now concluded. Thank you for attending today's presentation. You may now disconnect.