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Edited Transcript of MBTF earnings conference call or presentation 27-Jul-18 2:00pm GMT

Q2 2018 MBT Financial Corp Earnings Call

MONROE Aug 2, 2018 (Thomson StreetEvents) -- Edited Transcript of MBT Financial Corp earnings conference call or presentation Friday, July 27, 2018 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* H. Douglas Chaffin

MBT Financial Corp. - President, CEO & Director

* John L. Skibski

MBT Financial Corp. - Executive VP, CFO, Risk Management Director, Treasurer & Director

* Thomas G. Myers

MBT Financial Corp. - Executive VP, Chief Lending Manager and MBTeam/CARE Sales Director of Monroe Bank & Trust

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Conference Call Participants

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* Brendan Jeffrey Nosal

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

* Damon Paul DelMonte

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

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Presentation

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Operator [1]

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Good morning, and welcome to the MBT Financial Corp. Second Quarter 2018 Earnings Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Doug Chaffin. Please go ahead.

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H. Douglas Chaffin, MBT Financial Corp. - President, CEO & Director [2]

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Thank you, Brandon, and good morning, everyone. At the close of business yesterday, we announced our results for the second quarter of 2018, reflecting a net profit of $4,945,000 compared to a profit of

$3,640,000 million for the second quarter of 2017, for an increase of 36%. Earnings for the first 6 months of 2018 totaled $8,847,000 compared to the $6,820,000 for the first 6 months of 2017, or an increase of 30% for the first half of this year. Taking into account nonrecurring items for both years and netting out the effect of the Tax Cuts and Jobs Act of 2017, core pretax income increased by 11% for the first half of 2018 compared to last year. Net interest income has increased $1.9 million for the first 6 months or 9.8%. This was largely a result of increase in interest rates and the continued shift in the earning asset mix for the $46 million increase in the loan portfolio since year-end 2017, an increase of 6.6% thus far this year.

Noninterest income, net of a onetime accrual adjustment in wealth advisory fees in 2017, securities and ORE transactions were relatively flat for the first 6 months, with a decline of less than 1%. Noninterest expenses were up by 5% for the first half of the year, as we continue our measured investment in talent, branding and technology.

Asset quality remained strong, with a $2.1 million reduction in classified assets over the past 12 months, and a $536,000 net recovery of loan losses during the first half of 2018. This allowed for a 0 provision in expense in the second quarter and $100,000 reversal of the loan loss reserve year-to-date. The allowance for loan losses remained strong at 1.07% of the total loans.

Tom Myers will speak to the specifics regarding our loan portfolio activity and asset quality metrics later during the call. But first, I'll ask John Skibski to discuss our financial results in greater detail. John?

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John L. Skibski, MBT Financial Corp. - Executive VP, CFO, Risk Management Director, Treasurer & Director [3]

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Thank you, Doug. Good morning. On the call today, I will provide some details behind the results Doug just summarized and update our expectations for the rest of this year.

The net interest income for the second quarter of 2018 increased $969,000 or 9.8% compared to the second quarter of 2017, even though average earning assets decreased $8.3 million as the taxable equivalent net interest margin increased 33 basis points from 3.31% to 3.64%. The cost of interest-bearing liabilities increased 3 basis points from 0.19% in the second quarter of 2017 to 0.22% in the second quarter of 2018. And the yield on earning assets increased 36 basis points from 3.40% to 3.76%.

The loan portfolio yield increased from 4.60% to 4.82%, and the investment portfolio yield increased from 1.92% to 2.16%. The $57.5 million increase in -- $57.5 million in loan growth over the past year was partially funded by reductions in interest-bearing bank deposits in the investment portfolio, and this continuing shift in earning assets from low-yielding cash and investments to higher-yielding loans is driving the increase in the yield on earning assets. The $1,023,000 improvement in interest income consisted of $618,000 due to the growth in the loan portfolio; $409,000 due to the improvement in loan portfolio yield; $293,000 due to the improvement in the investment portfolio yield; and minus $297,000 due to the reduction in the size of the investment portfolio.

We have been controlling our interest expense by keeping our deposit rates low, but a decrease in investment portfolio cash flow and a decrease in deposits required us to use borrowings to fund some of the loan growth, and this caused a small increase in the costs of funds.

For the second quarter of 2018, the average balances in the funding mix consisted of $290.9 million of non-interest-bearing demand deposits; $241.8 million of savings deposits at a cost of 2 basis points; $257.2 million of interest-bearing demand deposits at a cost of 14 basis points; $247.6 million of money market accounts at a cost of 16 basis points; $128.7 million of time deposits at a cost of 62 basis points; and $17.6 million of borrowed funds at a cost of 2.07%. We are seeing more upward pressure on time deposit rates in our market area, and we expect the cost of interest-bearing liabilities to increase slowly, while the earning asset yield improves more quickly, resulting in further improvement in the net interest margin.

We expect our quarterly net interest income to average approximately $11 million in the second half of this year. We did not record a provision for loan losses expense in the second quarter of 2017 or 2018. Loans charged off totaled $51,000 in the second quarter of 2018, while recoveries of previously recorded charge-offs were $124,000 for net recoveries of $73,000 or 0.04% of average loans annualized. The $73,000 of net recoveries provided the increase in the allowance for loan losses that was required due to the growth in the loan portfolio. The allowance includes $1 million of specific allocations on $11.6 million of loans evaluated for impairment and $7 million of general allocations on the remainder of the portfolio. Due to the anticipated loan growth, small quarterly provision expenses may be required for the remainder of 2018.

Noninterest income increased $330,000 compared to the second quarter of 2017. Wealth management income decreased $369,000 due to an adjustment of $389,000 recorded in the second quarter of 2017 to convert to accrual basis accounting for wealth management fees. Deposit account service charges decreased $91,000 or 8.75% due to an increase in the earnings credit rate and a decrease in overdraft activity.

Gains on other real estate transactions increased $579,000 mainly due to the sale of 2 properties in the second quarter of 2018. Debit Card income increased $38,000 or 5%, as interchange income increased due to increased Debit Card activity. Origination fees on mortgage loans sold remained low as refinance activity has decreased and we continue to retain many of the new loans we originate. We now expect total noninterest income should average $4 million per quarter in the second half of 2018.

Noninterest expenses increased to $178,000 or 2% compared to the second quarter of 2017. Salaries and benefits increased $98,000 or 1.9%. Occupancy expense decreased $62,000 or 9.1% due to lower depreciation and maintenance expenses. Equipment expense increased to $83,000 or 10.5% due to higher computer expense. Marketing expenses increased $165,000 or 54.6% due to increased advertising and other expenses related to our branding initiative. We expect our total noninterest expense to be between $9 million and $9.5 million per quarter in the second half of the year.

This quarter, our tax expense of $1,105,000 reflects an effective tax rate of 18.3%. Our statutory rate is 21%, and we expect our effective rate to be slightly above 18% of our pretax operating income for the second half of 2018. Our capital and liquidity positions remain strong, and we comfortably exceed the requirements to be considered well capitalized by federal banking regulators. Our large investment portfolio and our stable deposit base provide ample liquidity to fund loan growth -- fund growth in our loan portfolio. The investment portfolio also allows us to manage interest rate risk effectively, and our slightly asset-sensitive balance sheet will continue to provide a benefit to earnings from the previous as well as future interest rate increases. Due to higher interest rates, investment portfolio, cash flow and bond values have decreased, so we started using borrowed funds to fund our loan growth. Nearly 90% of our deposits are non-maturity deposit accounts and with the yield curve flattening, the use of borrowed funds also allows us to manage our interest rate risk by extending the duration of our liabilities.

We are also actively managing our capital so that we can provide a good return to shareholders, while planning for longer-term growth. Under our capital management plan, we determined that an increase in the quarterly dividend to $0.10 per share was appropriate this quarter. This reflects a payout ratio of approximately 50% of core earnings and is intended to spread out the distribution of profits throughout the year and reduce the need for a special dividend used in past -- in the last few years. Our capital decreased $12.3 million in the first half of 2018, as the dividends paid exceeded net income by $7.9 million. And the decrease in the value of our available-for-sale securities contributed to the $4.8 million decrease in the AOCI.

Total shares outstanding increased slightly, and our book value per share decreased from $5.79 at the end of 2017 to $5.24 at the end of the second quarter of 2018. During the first half of 2018, the Bank's Tier 1 leverage ratio decreased from 10.33% to 9.89%. The total risk-based capital ratio decreased from 17.20% to 15.58%, and the Common Equity Tier 1 ratio decreased from 16.27% to 14.65%. These ratios still indicate a very strong capital position to support future growth opportunities.

This concludes my remarks. I'll now turn the call over to Tom Myers.

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Thomas G. Myers, MBT Financial Corp. - Executive VP, Chief Lending Manager and MBTeam/CARE Sales Director of Monroe Bank & Trust [4]

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Thanks, John. Loan totals increased for the quarter, with the average balance increasing by $20.9 million or 3%. The increase over the past 12 months totaled $53.9 million or 8%. Our period-end loan balance increased by just over $19 million or 2.6% for the quarter and by $46 million or 6.6% over the past 2 quarters. $15 million of the year-to-date increase was due to the purchase of a pool of consumer loans related to the refinance of student debt; $17 million was due to the purchase of 3 syndicated loans; the remaining $14 million due to organic growth. Although organic growth was limited due to roughly $5 million of early payoffs in the first quarter, I remain optimistic for future growth in this category as our loan pipeline totals remain at a consistently healthy level.

The commercial pipeline averaged $82 million in 2017, and has averaged $95 million thus far in 2018. We've also seen a $4 million increase in our consumer and mortgage pipeline. It's also noteworthy that our level of unfunded commitments over the past 12 months increased from $88 million to $132 million, a 50% increase. The increase is largely due to construction projects, with unfunded commitments totaling just over $24 million. Based on these factors, I expect average loan balances to increase further in the third quarter of 2018.

Our asset quality totals are sound. The bank-wide delinquency total has been at or below 1% for 7 consecutive quarters and ended the quarter at 0.8%. Our level of NPAs showed further improvement, with a 7.7% reduction in the second quarter and a 24% reduction over the past 12 months. Although our level of classified assets declined only by a small amount in the second quarter, the overall trend remained positive with an 18% reduction over the past 12 months.

Our ratio of classified assets to capital increased year-to-date from 6.6% to 7.2% largely due to the payment of a special dividend in the first quarter. Although we've reached a comfortable level with this ratio, I expect the trend of improvement to continue. For the quarter, we recorded a 0 provision expense, which is the 16th consecutive quarter in which we've had either a 0 or a negative expense. Even with the loan growth, we were able to fund a $73,000 increase in the allowance with loan recoveries in excess of charge-offs. Our allowance for loan losses declined slightly for the quarter and over the past year has been reduced from 1.19% to 1.07%.

In summary, key results for the quarter include: continued positive long-term trends in the level of both classified asset and NPA totals; positive loan delinquency totals; steady economic activity in our market area; continued net loan growth; positive commercial pipeline totals; and indications of further loan growth during the third quarter.

That completes my comments. I'll turn the call to Doug for additional remarks.

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H. Douglas Chaffin, MBT Financial Corp. - President, CEO & Director [5]

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Thank you, Tom. Well, we feel good about the various components of our earnings profile for the first half of this year and our continued focus on shifting the earning asset mix into higher-yielding loans is yielding good results. Noninterest income remains solid and our expense structure remains well managed.

As mentioned earlier, our Board of Directors has approved an increase in a quarterly dividend of $0.10 a share for shareholders of record as of August 9, payable August 16. This is a result of our mindful approach to managing capital. We have a strong commitment to providing a return to our shareholders, while at the same time, retaining adequate capital to fund future growth. We continue our strategic focus of improving all aspects of our earnings and growth performance, managing capital appropriately, and feel that we're well positioned to take advantage of strategic growth opportunities, should they become available in the future.

We'll now accept any questions you may have.

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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 and 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 at a top level here. Just curious to hear your take on the tariff situation. I know that it's pretty fluid day to day, but any early takes on how you and your customers are viewing the potential impact to your neck of the woods, Michigan, will be helpful.

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H. Douglas Chaffin, MBT Financial Corp. - President, CEO & Director [3]

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I'll have Tom provide a little bit of color on it, the brief outline is not much, but Tom?

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Thomas G. Myers, MBT Financial Corp. - Executive VP, Chief Lending Manager and MBTeam/CARE Sales Director of Monroe Bank & Trust [4]

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That's exactly right. Brendan, our customers, obviously, certainly are aware of it, but we haven't seen any real impact from our customer base yet.

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Brendan Jeffrey Nosal, Sandler O'Neill + Partners, L.P., Research Division - Director [5]

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All right. Good. Good. Glad to hear that. Just moving over to loan growth. The number was pretty solid this quarter, both on an average and the period basis. One of the nicer quarters we've seen. Just kind of curious as to how loan demand is shaping up, since we last spoke 90 days ago. And how things look going forward?

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Thomas G. Myers, MBT Financial Corp. - Executive VP, Chief Lending Manager and MBTeam/CARE Sales Director of Monroe Bank & Trust [6]

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Brendan, it's been very, very steady this year. Certainly, some of the larger transactions don't close or fund as quickly as what I'd like to see, but our pipeline total has been very steady in the $90 million range, not just for this year, but in the prior last few months of 2017. I'm optimistic.

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H. Douglas Chaffin, MBT Financial Corp. - President, CEO & Director [7]

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Yes. We -- I think to add to that, we had a lengthy conversation about our pipeline and the strength of that with our board yesterday as we were going through some of the details. And the metrics have been very consistent for the last year or so and continue to be. We've been in that $85 million to $95 million range pretty consistently. In the pipeline, everything that we close just to get replenished over time. We're booking, on average, about 50% of the stuff that we've got in the pipeline. That's been an industry average, too, from those who we talk to. And it's a good mix, 50-50 between C&I and CRE, and 50-50 between our core market in Monroe and our growth market in the Wayne County. So it's been solid, hasn't really wavered.

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

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All right. That's great color. Looking at expenses, this quarter's number came in a good deal lower than the $9.5 million that you guys had talked about in prior quarters, and you improved the range for the back half of the year to $9 million to $9.5 million. Just kind of curious as to what drove the improvement this quarter and why you feel better about the back half of the year?

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H. Douglas Chaffin, MBT Financial Corp. - President, CEO & Director [9]

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One of the factors is going to be our ORE gain. I think that John will speak to that a bit, but that certainly added to that.

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John L. Skibski, MBT Financial Corp. - Executive VP, CFO, Risk Management Director, Treasurer & Director [10]

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Yes. We do have some more expenses for that, but the main thing was we had some unusual expenses in the first quarter. We were kind of front-loaded on some of our equipment expense, and the marketing expense was a little bit higher this quarter than we expect for the rest of the year. It will still be high compared to last year, but not quite as high as this, this quarter.

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Brendan Jeffrey Nosal, Sandler O'Neill + Partners, L.P., Research Division - Director [11]

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Okay. All right. And then last one for me for now, and then I'll step back for the time being. Just want to make sure that I heard you correctly on the dividend increase that it was partially due to the fact that you wanted to smooth out the dividends throughout the year as opposed to having a large special. So one, is that correct? And then two, could you still see the potential for a special next year, albeit at a slightly smaller level to account for the higher regular dividend?

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H. Douglas Chaffin, MBT Financial Corp. - President, CEO & Director [12]

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Yes. I'll speak to that and then John can correct me if I tell you something wrong, Brendan. But yes, the intent really was to kind of smooth out the dividend a bit. And we feel really comfortable with the 50% payout ratio, given the remaining strength of our capital base. We still have optionality, right? And so that's really built into the way we do things. I'm not going to speculate on whether or not we'll be paying a special dividend at the end of the year or the size of that, simply because we're -- it's intended to give us optionality. But yes, the answer -- the short answer is, it is intended to smooth it out a bit.

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John L. Skibski, MBT Financial Corp. - Executive VP, CFO, Risk Management Director, Treasurer & Director [13]

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The only thing I will add -- yes, I was just going to add that part of the increase, too, is that we feel pretty confident in our level of core earnings continuing, and that justifies the increase.

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Operator [14]

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(Operator Instructions) Our next question comes from Damon DelMonte with KBW.

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Damon Paul DelMonte, Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director [15]

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So first question. Just wondering if you could provide a little color around the construction loan pipeline. I know you highlighted that you had some good activity, and I think you're kind of waiting for some of those loans that have closed to be drawn down, but could you just describe some of the projects you guys are seeing? And what's going on in your markets?

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Thomas G. Myers, MBT Financial Corp. - Executive VP, Chief Lending Manager and MBTeam/CARE Sales Director of Monroe Bank & Trust [16]

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We've got within that $24 million number I quoted, there is about $6 million of just conventional residential construction, individual homeowners that is. And then the remainder are a handful of commercial construction projects. I would say nothing extraordinary about them. We obviously like the projects. We like the tenants that are going into it and we like the borrowers.

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Damon Paul DelMonte, Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director [17]

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Got you. And are most of those in Monroe County? Or are they in Wayne County?

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Thomas G. Myers, MBT Financial Corp. - Executive VP, Chief Lending Manager and MBTeam/CARE Sales Director of Monroe Bank & Trust [18]

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Most are in Wayne County.

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Damon Paul DelMonte, Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director [19]

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Okay. All right. Okay. And then, I guess, just kind of a broader question on M&A. Can you provide any updates on your outlook for M&A? I know you've got to be limited on specifics, but generally speaking, would you say that discussions have been increasing? Would you say there's a greater likelihood that a transaction could happen in the next 6 to 12 months? Or do you think that sellers are still maybe not -- buyers and sellers are not really meeting up yet? What are your thoughts on that?

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H. Douglas Chaffin, MBT Financial Corp. - President, CEO & Director [20]

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Well, let me answer it this way. There's still a lot of discussion that takes place, and we're proactive in that and we have good reception and having conversations. Expectations are high. Expectations are high, and so we have a very disciplined approach toward how we go about it. We've talked about that in the past, and we're going to remain disciplined in that approach. So it's tough for me to speculate what may occur over the next 6 to 12 months. But there still is a lot of activity. There is a lot of interest in having conversations. We're still seeing situations where there is some generational changes in ownership, where there are succession planning issues with management teams or with boards, and that's creating a lot of discussions and encouraging a lot of discussions. And I think the valuations being up the way they are today encourages a lot of discussion. But yet, expectations are high. So we'll just continue to push on and see what might fall our way when everyone's truly ready.

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Damon Paul DelMonte, Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director [21]

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Got it. Okay. And then, I guess just lastly on the margin, I kind of get the sense that you're optimistic that the -- this quarter's level could see further increases as you go over the next couple quarters. Is that fair? Probably a question for John.

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John L. Skibski, MBT Financial Corp. - Executive VP, CFO, Risk Management Director, Treasurer & Director [22]

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Yes, Damon. It's fair. We still expect it to increase, but I think the rate of increase starts slowing down fairly soon.

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Operator [23]

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(Operator Instructions) At this time, I'm seeing no further questions. I would like to turn the conference back over to Doug Chaffin for any closing remarks.

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H. Douglas Chaffin, MBT Financial Corp. - President, CEO & Director [24]

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Thank you, Brandon. Well, thanks again, everyone, for joining us this morning. We're going to continue to keep you apprised of our progress. And as always, we welcome your comments and your questions. So thanks for joining us.

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Operator [25]

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