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Heartland Financial USA (HTLF) Q2 2018 Earnings Conference Call Transcript

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Heartland Financial USA (NASDAQ: HTLF)
Q2 2018 Earnings Conference Call
Jul. 23, 2018 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings and welcome to the Heartland Financial USA, Inc. second-quarter 2018 conference call. This afternoon, Heartland distributed its second-quarter press release and hopefully you had a chance to review the results. If there is anyone on this call who did not receive a copy, you may access it at Heartland's website at www.htlf.com.

With us today from management are Lynn Fuller, 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 we will open up 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 any statements made during this presentation concerning the company's hopes, beliefs, expectations, and predictions of the future are forward-looking statements and actual results could differ materially from those projected.

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Additional information on these factors is included from time-to-time in the company's 10-K and 10-Q filings, which may be obtained on the company's website or the SEC's website. At this time, all participants are in a listen-only mode. [Operator instructions]. As a reminder, this conference is being recorded.

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

Lynn B. Fuller -- Executive Operating Chairman

Thank you, Devin, and good afternoon. We appreciate everyone joining us today to discuss Heartland's performance as we reach new heights in the second quarter of 2018. 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 our key operating strategies.

Then, Bryan McKeag, our EVP and CFO will provide additional color on Heartland's quarterly results.

You may recall that at our annual stockholder meeting in May, I announced our succession of leadership. Effective June 1, 2018, Bruce Lee became president and CEO of Heartland. To ensure a seamless transition, I remain in an active role as executive operating chairman, overseeing mergers and acquisitions, investor relations, risk management, and audit.

Over the past three years, Bruce Lee and I have worked side-by-side leading the company. Bruce has a proven track record of success and his experience in leading banks both large and small make him uniquely qualified to lead the Heartland Group of bank charters and carry on Heartland's long legacy of doubling earnings and assets every five to seven years.

Well, now on to Heartland's financial highlights for the second quarter and year to date. We are very pleased to report a solid second quarter, with net income available to common shareholders of $27.9 million and year to date $51.1 million. Diluted earnings per common share for the quarter and year to date were $0.85 and a $1.61.

Assets ended the quarter at $11.3 billion and were still on track to be at $12 billion by this time next year, a combination of both organic and acquired growth. Return on average assets for the quarter and year to date was 1.05% and 1.01%, respectively. Return on average common equity for the quarter and year to date was 9.81% and 9.58%, respectively. And return on average tangible common equity for the quarter and year to date was 14.56% and 13.82%, respectively.

Well, thanks to our excellent deposit mix with non-time deposits at 87% of total deposits, our fully tax-equivalent net interest margin was up for both the quarter and year to date at 4.3% and 4.28%, respectively. Our tangible common equity ratio ended the quarter at 7.46% and book value increased over the same quarter a year ago to $36.44, with tangible book value decreasing only slightly over the same quarter a year ago to $23.53 as a result of the stock issued in our recent acquisitions.Credit quality remained sound with non-performing assets and asset quality ratios remain consistent with the prior quarter. And today, the board of directors voted to increase our regular quarterly cash dividend on the company's common stock to $0.14 per share, payable on August 31, 2018, to stockholders of record at the close of business on August 10, 2018.

Well, now on to M&A. During the second quarter, we successfully closed FirstBank Lubbock Bancshares Inc. and are on schedule for a system conversion in mid-August. FirstBank Texas is Heartland's 11th bank charter.

Barry Orr, chairman and CEO of FirstBank Texas, leads Heartland's Texas operations, and Greg Garland remains as president. We're happy to welcome FirstBank to our family of community banks. With more than $1 billion in assets, FirstBank is Heartland's fifth bank charter to surpass that milestone.

Well, we're actively pursuing mergers and acquisitions, and our pipeline is extremely deep, with the hope of announcing one additional expansion yet this year. As we've often said, opportunities to expand within our current footprint are favored as we continue to work toward the goal of $1 billion in assets in each state where we operate. We're pursuing only those acquisitions which are accretive to our current shareholders' earnings per share, produce a minimum internal rate of return of 15% -- and that's based on conservative assumptions -- in a maximum earn back of four years. I'll now turn the call over to Bruce Lee, Heartland's president and CEO, who will provide an overview of the company's strategic initiatives.

Bruce?

Bruce K. Lee -- President and Chief Executive Officer

Thank you, Lynn. It is an honor to be addressing the group today as the new chief executive officer of Heartland Financial, USA. As you know, effective June 1, I assumed the role and responsibilities of CEO. Over the past three years, Lynn and I have worked together closely to ensure and align vision for the future and a smooth transition, and I want to thank Lynn personally for his support and friendship.

I'm also very pleased that he has agreed to remain active in the company as an executive operating chairman. I have a great feeling of gratitude and hope for the future as we share results for the second quarter.

All across Heartland, we are delivering on our promise to reach new heights in 2018. During the second quarter, we successfully acquired FirstBank & Trust in Texas with over $1 billion in assets and we put $10 billion in assets in the rearview mirror. With current assets of $11.3 billion, we are now focused on growing the company's assets to $12 billion by mid-2019. The Heartland team has been spending significant time deep in the heart of Texas with Barry Orr and his leadership team, and we are looking forward to a successful conversion in August.

The second quarter of 2018 marks Heartland's fourth consecutive quarter of organic loan growth. We delivered $51 million of loan growth in the second quarter and we have delivered $81 million in loan growth year to date; annualized, this represents about 3% organic growth. Our loan growth is driven primarily by wins in the commercial and agricultural segments across our banks.

I'm also pleased to share that Ken Brooks and his team in Minnesota delivered strong commercial loan growth after completing the systems conversion that merged the operations of Signature Bank with Minnesota Bank & Trust in late April. Curtis Crystal's team at Wisconsin Bank & Trust also contributed strongly to our focused area of commercial and agricultural loan growth during the second quarter.

Over the past quarter, I've met with dozens of customers who have an optimistic outlook for business growth, and our bankers are reporting strong lending pipelines and we expect growth to continue into the third and fourth quarters of 2018. Equally positive is our growth in deposits. We continually focus on growing deposits to fund our loans. Our focus delivered $112 million in CDA growth during the second quarter.

Our deposit mix is enviable: 87% of our deposits are non-time deposits. Likewise, non-interest-bearing demand deposits now constitute almost 36% of the mix. Our focus on deposit growth and mix have yielded excellent results. Greg Leyendecker and his team at New Mexico Bank & Trust; and Frank Walter and his team in our California charter, Premier Valley Bank, delivered exceptional deposit growth during the quarter.

Now switching to service charges and fees, overall service charges and fees for the quarter were $2 million higher than linked quarters. Our recent acquisitions, FirstBank and Signature, contributed approximately $900,000 and our commercial partner card organization again delivered strong results.

As I mentioned in our previous earnings call, during the first quarter, we began the restructuring of our mortgage operation to an outsourced processing model. The transition is nearly complete and we expect to be able to retire the dual systems early in the third quarter. In our retail business, we continue to see strong performance in consumer checking account opening. Our net new retail checking accounts are up 232% over the first half of 2017.

Since introducing online account opening in the fourth quarter of 2017, we are now opening nearly 10% of all consumer accounts online. Our retail customers are continuing to adopt our new online banking capability. In our retail business, our online banking usage continues to climb. In fact, a third of our retail online banking customers are exclusively accessing online banking from their mobile devices.

To this end, we are continuing to rationalize our branch network and have announced that we will be closing three branches in the third quarter. The closings will result in cost reductions and contribute to improved efficiency. We will continually rationalize our branch network and continue to invest in technology enhancements to respond to our customers' preferences for service delivery. Overall, we are pleased with the quarter's revenue performance and feel we have significant momentum to deliver continued positive results.

Next, I will highlight key credit metrics at Heartland. I am pleased to report that we continue to see stable credit quality at our member banks. Non-performing assets were $81 million, or 72 basis points, at June 30, compared to $77 million, or 77 basis points, at March 31. Excluding $8 million of non-performing assets acquired in the FirstBank transaction, non-performing assets decreased $4 million, or 5%, since last quarter.

Non-pass-rated loans decreased from 6.4% to 5.7% in the second quarter and continue to compare favorably to levels over the past several years. The delinquency ratio was 30 basis points at quarter-end. Lastly, net charge-offs for the second quarter were $2.2 million, or 12 basis points.

Switching gears I'd like to share an exciting leadership announcement. We are pleased to welcome Kevin Ahern to Heartland as executive vice president of our private client services business unit. You may recognize Kevin's name because he has a long-standing relationship with Heartland Financial. Kevin is the former founder, chairman and CEO of CIC Bancshares, a bank holding company that was formed in 2009.

CIC Bancshares and its subsidiary bank, Centennial Bank, was acquired by Heartland Financial in February of 2016. Kevin has decades of private client service experience and will be a tremendous asset to the organization. Kevin, who previously served as the chairman of the board at Citywide Banks, will remain as a member of their board of directors and Marty Schmitz assumed the chairman of the board of directors position effective June 1, 2018.

Lastly, I would like to share with you that we have recently launched a new Investor Relations website. The address is the same, htlf.com but the design and functionality are contemporary and mobile-friendly. I encourage you to visit the site and we are also looking forward to sharing renovated bank sites in the future.

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

Bryan R. McKeag -- Chief Financial Officer

Thanks, Bruce, and good afternoon. As Lynn and Bruce have described, we made progress on a lot of fronts this quarter. So I'll try to add some more color to their comments, starting with several key ratios. First, the net interest margin on a tax-equivalent basis increased to 4.3%, which is up 4 basis points from last quarter.

Loan yields increased 12 basis points during the quarter and included one large interest recoveries than accounts for 4 basis points of the improvement.

Investment yields also increased 1 basis point. Interest costs and deposits and borrowings increased by 9 basis points compared to last quarter, and this quarter the net interest margin includes 17 basis points from the accretion of purchase accounting discounts, compared to 22 basis points in the prior quarter. Heartland's loan-to-deposit ratio is just under 79%. And with investments at about 22% of assets, generating $27 million of cash flow per month, and total borrowings of $489 million, or 4% of assets, our liquidity position is in very good shape.

Next, the efficiency ratio was 65.04% for the quarter, down over 300 basis points from last quarter. Excluding M&A cost, the efficiency ratio for the quarter would have been 115 basis points lower, or just around 63.9%. For the first half of 2018, the ratio was down 122 basis points as compared to last year. We expect the ratio to show additional improvements in the last half of 2018 when we start to see the benefits of our mortgage restructuring and the cost saves and scale impacts of our 2018 acquisitions.

Lastly, the tangible common equity ratio which decreased 13 basis points to 7.46%. The increase in retained earnings this quarter added 14 basis points to the ratio but was more than offset by the acquisition of FirstBank Texas, which reduced the ratio by 23 basis points and the reduction in market value of our investments and derivatives also reduced the ratio by 4 basis points. Bruce has already commented on loans and deposits, so I will only comment on a couple of other balance sheet items.

First, with the acquisition of FirstBank Texas, investments available for sale increased $169 million while investments held to maturity declined $6 million during the quarter. The total investment portfolio ended the quarter at just under $2.5 billion, representing slightly less than 22% of assets. Tax-equivalent yield on the portfolio increased 1 basis point for the quarter and 2.88%. The duration of the available-for-sale portfolio is about four years.

Second, the allowance for loan losses, which as a percentage of loans, total loans declined 5 basis points for the quarter to 0.82%. As we have mentioned in previous quarters, just under $2.2 billion of loans from our most frequent -- recent acquisitions are covered by valuation and PCI reserves totaling $53.6 million, or about 2.5% of those loans. Excluding these loans from the total loans would result in an allowance to loan losses, or to loans ratio of 1.13% as of June 30, 2018, which is 1 basis point lower than last quarter.

Moving on to the income statement, net interest income totaled $101.4 million this quarter, up $9.8 million from the prior quarter. The increase was primarily driven by one additional day in the quarter, which increased interest income by approximately $1.1 million, while the addition of FirstBank Texas added $4.9 million and another $2.6 million was added from a full quarter of Signature in Minnesota. Non-interest income totaled $27.6 million for the quarter, up $2.9 million from last quarter. When compared to last quarter, gain on sales loans was up $2.7 million of which $2.3 million was for PrimeWest Mortgage in Lubbock.

For the quarter, securities losses totaled $259,000, compared to gains of $1.4 million last quarter, or a reduction of $1.7 million. Service charges were up $2 million over last quarter of which $700,000 is attributable to the addition of FirstBank Texas and an additional $200,000 at Minnesota for a full quarter of Signature. Credit card fees also increased $750,000 over the last quarter. All the categories of non-interest income were relatively flat compared to last quarter.

Moving to non-interest expense, total non-interest expense was $88.9 million this quarter, an increase of $5.2 million over the last quarter. This quarter M&A and system conversion-related costs were $1.8 million, compared to $1 million last quarter. Also, as you may recall last quarter, expenses included $2.6 million of mortgage restructuring expenses. In addition, excluding conversion writedowns, we had about $1.4 million increase in asset writedown and losses.

Excluding these items, core run-rate costs were $86 million this quarter, compared to $80 million in core costs last quarter, or an increase of about $6 million. This increase is the result of the addition of FirstBank Texas, which accounted for $4.2 million of the increase, and a full quarter of Signature expenses in Minnesota accounted for another $1.8 million, while the remaining core expense was unchanged. By category, the most significant changes were in salary and benefits, which increased $2 million compared to last quarter, with $2.6 million attributed to FirstBank Texas and $900,000 from the full quarter of Signature. The remaining components in this category were down $1.5 million.

Professional fees were up $1.5 million, of which $200,000 related to higher M&A cost and $600,000 of the increases attributable to FirstBank Texas. The remaining $700,000 increase is primarily attributable to higher loan-origination costs and higher costs on projects related to CECL readiness and model-validation work. Losses on the sale of assets were up $1.7 million, of which $363,000 related to post-conversion equipment write-offs. In addition, the loss on a branch that is being consolidated in Dubuque and the loss on the sales of commercial lots account for the bulk of the remaining increase.

And finally, other expenses were up $1.3 million: $200,000 is related to conversion costs, $500,000 is attributable to FirstBank Texas, and $200,000 is attributable to a full quarter of Signature. The reported effective tax rate for the quarter was 21.09%, compared to 14.04% last quarter, which included the tax benefit of $600,000 related to the vesting of restricted stock awards. We believe that the normalized tax rate of 21% to 22% is reasonable on a go-forward basis.

Finally, to complete my comments, I'll quickly summarize our outlook for Heartland for the last half of 2018, starting with loan and deposit growth, which on an annualized basis is expected to be in the mid-single digits. The net interest margin on a tax-equivalent basis should remain in the range of 4.25% to 4.3%, as we expect some continued pressure on deposit pricing. Provision for loan losses is expected to remain in the current range of $4 million to $5 million per quarter.

Mortgage production is expected to show improvement next quarter for the full quarter of PrimeWest and then we'll see the normal seasonal decline in the fourth quarter. Core fee income, that is excluding mortgage and security gains and losses, are expected to show high single-digit annualized increases from current run rates as we continue to have strong corporate credit card growth and sell into our newly acquired customer bases.

Core expenses, that is excluding M&A and any asset gains or losses, are expected to increase $4 million to $5 million next quarter as we get a full quarter of FirstBank Texas, offset by the benefits of the mortgage restructuring. With FirstBank Texas' system conversion currently planned for the mid-third quarter, we will not realize the remaining cost saves of about $1 million to $1.5 million per quarter until the fourth quarter of 2018. And lastly, the remaining integration and conversion costs for FirstBank Texas are expected to be $1 million to $1.25 million next quarter.

With that, I'll turn the call over to Lynn.

Lynn B. Fuller -- Executive Operating Chairman

Thank you, Bryan. We'll now open the phone lines for your questions and I might add that Drew Townsend, our EVP and chief credit officer, is also with us. He did not have a speaking position today but he is here to answer any question in credit.

Questions and Answers:

Operator

Thank you. And we'll now be conducting a question-and-answer session. [Operator instructions]. Our first question comes from the line of Jeff Rulis with D.A.

Davidson. Please proceed with your question.

Jeff Rulis -- D.A. Davidson -- Analyst

A question on, I guess, the two credits that were added, the ag credits and the two C&I loans you talked about ... an established reserve or specific reserve and then sort of, Bryan went through his provision assumption. So the $2.1 million that was established, would that suggest sort of a high 2s provision and yet you're talking about a provision rate of 4 to 5 million per quarter? Maybe you can just kind of vet those two?

Bryan R. McKeag -- Chief Financial Officer

Yes, I'll let Drew handle the specifics on the credits. The 4 to 5 million, Jeff, we get loan growth and then we've got loans moving over from the purchase accounting pool. We get a little bit of charge-offs and then there's always one or two credits that tend to have some issue during the quarter. So I think what I basically was guiding toward was that things are probably going to stay about the same here for the next couple quarters.

Jeff Rulis -- D.A. Davidson -- Analyst

Got it, OK.

Andrew E. Townsend -- Chief Credit Officer

And, Jeff, this is Drew. I wouldn't have much to add to what Bryan's comments where there again a couple of new larger ones that were identified as we moved into the inspection process from the collateral. We did effectively identify a shortfall that we had, may be understood to be there prior to this quarter.

Jeff Rulis -- D.A. Davidson -- Analyst

Absent those, it doesn't appear to be systemic or what?

Andrew E. Townsend -- Chief Credit Officer

No, I would say not. I think I would just make one comment. Obviously, we are seeing continued stress in the ag portfolio specifically and so we're paying close attention to that but I don't think there's a systemic issue with respect to overall loss exposure.

Jeff Rulis -- D.A. Davidson -- Analyst

Is there particular stress within the ag portfolio, like which segment?

Andrew E. Townsend -- Chief Credit Officer

I would say it's kind of all-encompassing. There's pressure right now on commodity prices with respect to grain, the dairy prices as well are stressed. So, those two in particular but beef as well and pork. So we'll have to see a little bit how our national economic situation unfolds and what impact that may have on the ag commodities.

Jeff Rulis -- D.A. Davidson -- Analyst

OK and maybe just another one on the margin I guess. If we were to strip out the 4 basis points from the recovery, I guess including accretion here at 426 and so the guidance then is from 425 to 430 on that is kind of flat to up. Is that like apples-to-apples on that?

Lynn B. Fuller -- Executive Operating Chairman

Yes, I think so. I think the biggest wild card in there is deposit pricing and how that may change but I think we should be able to stay in that range. And certainly for next quarter and we'll give you an update next quarter but I think it will hang in that range.

Bruce K. Lee -- President and Chief Executive Officer

I think Jeff, this is Bruce. I think Bryan, the reason he's guiding us to basically flat is, we do anticipate moving up some of our deposit pricing to continue to attract deposits. We've been very fortunate that we haven't been moving up deposit pricing but we've lagged the competition a little bit we have the organic loan growth engine going and we need to make sure that we continue to attract those new deposits.

Jeff Rulis -- D.A. Davidson -- Analyst

Thanks, Bruce. So I guess just to clarify then Bryan, you got some accretion assumption in there. I guess it's so short-term we're not looking at a drop off of accretion but over time that would be expected to drift?

Bryan R. McKeag -- Chief Financial Officer

I think it will, yes, because as I said before, we have one large acquisition that's nearing the end of its purchase accounting and that was that like a 6% discount. So as that wears off and we get some new ones but they're at a little bit lower rate going in you'll get a little bit of that differentials as well. So I think it's going to wean down, you may see with only half quarter of Lubbock, maybe one quarter, we get a little bit more of a bump up but then it will probably come back down.

Operator

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

Nathan Race -- Piper Jaffray -- Analyst

Just going back to the last question on the core margin, Bryan your guidance for the flat margin that excludes any additional rate hikes in the back half of this year, is that accurate?

Bryan R. McKeag -- Chief Financial Officer

Correct, correct, yes.

Nathan Race -- Piper Jaffray -- Analyst

And then Butch or Bruce, just curious to hear your updated thoughts on the acquisition opportunities and activities, it sounds like you are optimistic that you get a deal amount in the back half of this year. Just wondering if you could kind of speak to the magnitude of this potential transaction and geography and just the overall volume of transaction opportunities that you're seeing across the desk?

Bruce K. Lee -- President and Chief Executive Officer

I think it's about as busy as I've ever seen it, Nathan, we have opportunities in every market that was in maybe the only exception would be Arizona. We got pricing at the historic highs. So, it's a time to be cautious on, especially when we set the assumptions for the federal tax rate if we head into a recession out 18 to 24 months what happens to provision expense and growth, if the yield curve get's inverted that's going to impact this as well.

So, I mean, there's a lot of reason for being cautious but there is an awful lot of banks that are looking to get something done that these pricing levels and before the next recession hit. So, we look at a lot of deals and bid on a lot but were going to stay true to the financial metrics that we just have to have deals that are accretive to current shareholders earnings per share. We're very conservative on our assumptions and our modeling.

And so even if that, we got to have at least a 15% internal rate return and we want an earn back within four years. I see a lot of competing banks that we run up against that are showing huge cost takeouts, some of those might be believable but I just worry that some of the competing banks on the deal that we look at are being overly aggressive on the assumptions and we're just not going to go there.

Nathan Race -- Piper Jaffray -- Analyst

Got it that's great color appreciate that, Bruce. And if I can just sneak one last one for Bryan on expense. Your guidance for the $4 million to $5 million step-up, does that include the cost saves that you'll get from the restructuring that you announced last quarter?

Bruce K. Lee -- President and Chief Executive Officer

Yes.

Operator

Our next question comes from the line of Terry McEvoy with Stephens Inc. Please proceed with your question.

Terry McEvoy -- Stephens -- Analyst

Bryan, the expenses up 4 to $5 million, just to follow up on Nate, is that off the $88.9 million that was reported for 2Q? Or is that ex any of the merger charges?

Bryan R. McKeag -- Chief Financial Officer

It's ex any of the merger charges, so what I did is, I backed out merger charges and the losses that you see there, the $1.5 or 6 million, I think that should get you close to a about $86 million core run rate. And so from that 4 to 5 million up and then we'll probably have another million or so of the one-time items, so total, that puts you at 91-ish plus or minus.

Terry McEvoy -- Stephens -- Analyst

And then just a follow-up when you get some cost saves post the conversion, what are your thoughts on 4Q?

Bryan R. McKeag -- Chief Financial Officer

We should get a little bit then of cost saves coming in from Texas and that's the 1 million to 1.5 million that I think we still have coming up. And again, remember, we'll get a full quarter of the revenue as well both on interest income and non-interest expense from the Texas add.

Terry McEvoy -- Stephens -- Analyst

And then just overall, we're hearing more of a cautious message from some of the other banks on the commercial real estate, we actually think balance is down. It seems like you talk about the markets where you had organic loan growth. Was it commercial versus consumer? And then CRE, what are your big thoughts there as an asset class?

Bruce K. Lee -- President and Chief Executive Officer

This is Bruce. I'll maybe make a few comments and then let Drew add a few. The growth that we're having is not commercial real estate I mean it's core operating companies we are seeing some growth in the consumer side but not that much. So we did have growth in consumer loans as well as residential mortgage loans but we have really not been an aggressive commercial real estate lender for over a year and have seen some of those balances run-offs.

As you heard on prior calls, we had some balances that ran off in California. We had some balances that also ran off in Colorado. So our focus is core operating companies. Drew?

Andrew E. Townsend -- Chief Credit Officer

Yes, I wouldn't have much to add to that. As I look at the mix of where we saw new money go out in the quarter, as Bruce stated, it's largely owner-occupied, and if it is real estate, we had some nice C&I. And the other things I might add is that we had a nice mix across the entire footprint too. It wasn't all concentrated in one or two markets that really have spent most of our geography.

Bruce K. Lee -- President and Chief Executive Officer

And you heard us talked to the last several calls, about our focus on adding value and our commercial relationship managers adding value to the relationships, calling our new customers, strategic prospecting. And over 30% of the business that we brought in, in the quarter was from new relationships, not from making loans to our existing customer base.

So, we're quite pleased with that and it's one of the reasons why were so optimistic about the trajectory of our loan growth in the type of loans. I've spent an awful a lot of time in the last couple of months out with our bankers calling and it's a new day and how they're prospecting as well as the type of customer that we are talking to.

Operator

Thank you. Our next question comes from the line of Andrew Liesch with Sandler O'Neill. Please proceed with your question.

Andrew Liesch -- Sandler O'Neill and Partners -- Analyst

Just want to talk more on loan growth for a bit and really just more on the pay downside. Given on the past, there've been some deals you've had, you've managed some relationships out of the bank that maybe you didn't want and then you've had some declines but what are you seeing right now? Or what did you see in the second quarter on pay-downs versus like the schedule? What you expected versus what actually occurred with layout size, yes. I mean what were there outsized pay-downs in the second quarter?

Bruce K. Lee -- President and Chief Executive Officer

I would say the second quarter was really very consistent with what our expectations were. There was one relatively large relationship that moved out of the bank and there was another relationship where the company was sold but we knew both of those situations were happening and we anticipated it. So, there was nothing unexpected there at all. I would also say, we didn't have a lot of construction pay downs this quarter.

You heard us talk in the past, especially in Colorado at citywide where we had some construction loans that were completed and were either taken out to the secondary market or sold. We didn't have anything like that at all this quarter. That wasn't out of the ordinary.

Operator

Our next question is with Daniel Cardenas with Raymond James. Please proceed with your question.

Daniel Cardenas -- Raymond James -- Analyst

Maybe if you could give us a little bit of color as to whether or not there are any geographies that give you concern on the credit-quality side?

Bruce K. Lee -- President and Chief Executive Officer

Drew, I'll let you comment but right now I would say from a geography standpoint, it all feels pretty good. I would say from a product standpoint or type. The ag portfolio is stressed, as Drew mentioned, and so that might be the one area that we're paying a lot of attention to. But from a geography standpoint, it all feels pretty good and we have growth happening in really every one of our geographies, all the way from Illinois to California.

Andrew E. Townsend -- Chief Credit Officer

Only thing I might add to that, Daniel would be, we saw about a $45 million to $48 million improvement in our legacy sub rateds this quarter. Quarter over quarter we ended at about the exact same number and that's total sub-rated dollars, not watch and substandard, and that quarter now has Lubbock in it, so there is another significant amount, $750 million growth. And so we saw nice improvement quite frankly in our sub-rateds, just to reaffirm Bruce's comment. About the only thing that gives us a reason for pause or to be conscious of is that ag area, which has a lot of different headwinds, it's facing right now.

And I would reinforce, again, we've tried very hard to get into our at portfolio right, as it relates to real estate values and utilizing FSA guarantees. So, we may have a bump in the road here and there but overall I think we're in pretty good shape.

Lynn B. Fuller -- Executive Operating Chairman

Dan, this is Butch. I might just add that I think in the quarters going forward and I don't know if we'll see as much impact in the third as the fourth, but one of the opportunities that we have is that a lot of the markets we're in have a fair amount of M&A disruption. There are some of our major competitors have been bought out and I would hope that that would give us a lot of opportunity for both deposit loan growth on the organic side.

I mean, we're still involved with the M&A as I mentioned in my comments but the Twin Cities is a good example. Our two major competitors in Denver were sold. So, I really think we have a great opportunity ahead of us in a number of these markets to take advantage of the disruption that's being created by our major competitors being sold.

Daniel Cardenas -- Raymond James -- Analyst

And then maybe, Bryan, in terms of the projected cost saves you were talking about and the branch closures, I missed that number. And then maybe if you can give us a little bit of color as well as to whether there could be any additional closures in 4Q?

Bryan R. McKeag -- Chief Financial Officer

Yes, the cost saves that I referenced was from FirstBank down in Texas and I think we still have about a million to 1.5 million yet to come. We've already realized some of them, so if you went back and looked at some of our original 25% cost saves, you'd come up with a bigger number but some of the pieces already happen down there. So that's what I was referring to. The cost saves to Heartland themselves.

We've only had one or two. We'll have a couple more going forward. So they'll build over time on the branch side but it'll not be a massive number.

Bruce K. Lee -- President and Chief Executive Officer

I don't think we're probably prepared to forecast that branch save yet. I mean maybe you can do some of the math. We're talking about three branches now but we are evaluating and I think it would be our intent prior to the end of the year there will be some other either sales or closures but we're not quite ready to provide some guidance there.

Daniel Cardenas -- Raymond James -- Analyst

OK, fair enough, fair enough. And then the last question from me and I'll step back. Deposit betas, what did they look like in the quarter and then maybe some color as to what competitive factors look like on the deposit side?

Bryan R. McKeag -- Chief Financial Officer

Yes, I'll start off with the betas. They continue to be performing way under what we model. I think they picked up a little bit in the quarter for us compared to maybe the prior two or three but if you look back on last year, we've only raised our cost of deposits about 20 basis points, which are really like 16 beta, if we bought up 125. So, and we model more like 40 on the non-deposit on non-time and in the 80s to 90s for time.

So, we're running about a third or so of what our normal betas would be.

Bruce K. Lee -- President and Chief Executive Officer

On the pricing side, as I mentioned earlier, we are starting to see some pressure as we really focus on attracting new relationships that we have to be a little more aggressive in raising our pricing. It's not so much to maintain what we have but if we intend to grow and then we are going to have to increase our pricing. And it's really market by market, how much that will have to occur and we're allowing each one of our market, CEOs and their boards to determine that along with our retail and marketing staff.

Operator

[Operator instructions]. Our next question comes from the line Damon DelMonte with KBW. Please proceed with your question.

Damon DelMonte -- Keefe, Bruyette & Woods -- Analyst

So pretty much all my questions have been answered but I was just wondering you know with the weakness that you're seeing in the ag portfolio. Has there been any discussion about the recently imposed tariffs? And how that's weighing on things or is this kind of early for that?

Bruce K. Lee -- President and Chief Executive Officer

We've discussed it a lot. Time will tell, I mean the other aspect of the season as we look at it right now Damon is, there is probably a bumper crop coming as well. So, when you balance the potential change in global demand because of the tariffs scenario and then think on top of that were going to be a surplus coming out of the fields, I mean, if there's a fair amount of concern. So, I don't know it's probably too soon to tell what will quite frankly happen.

And I think there seems like on a daily basis more to come. So we'll see how it all plays out.

Bryan R. McKeag -- Chief Financial Officer

I think to our credit event, I think our backdoor is that we kept the leverage on most of our operations very low, where we see productive land prices in the Midwest, where most of our ag credits are selling for somewhere around $10,000 to $12,000 an acre. We kept the debt level down at 4,000. So on even though the clients maybe are not posting earnings and having a bit of a struggle cash flow wise, we've kept their leverage so low that that would be our backdoor. And anytime we can on a credit to get the FSA to get a guarantee we do that.

So in many cases that covers 90% of the risk.

Operator

[Operator instructions]. There seem to be no further questions at this time. So I would like to turn the call back over to Mr. Fuller for closing remarks.

Lynn B. Fuller -- Executive Operating Chairman

Thanks, Kevin. So in closing, with Heartland's assets greater than $11 billion and heading for $12 billion at this time next year, strong earnings and recent close of FirstBank Texas and a very deep pipeline of acquisition prospects, our company is well-positioned for continued profitable growth. So, I would like to thank everyone for joining us today and hope you can join us again for our next quarterly conference call on Monday, October 29, 2018. Thanks, everyone and have a great evening.

Bye.

Operator

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

Duration: 49 minutes

Call Participants:

Lynn B. Fuller -- Executive Operating Chairman

Bruce K. Lee -- President and Chief Executive Officer

Bryan R. McKeag -- Chief Financial Officer

Jeff Rulis -- D.A. Davidson -- Analyst

Andrew E. Townsend -- Chief Credit Officer

Nathan Race -- Piper Jaffray -- Analyst

Terry McEvoy -- Stephens -- Analyst

Andrew Liesch -- Sandler O'Neill and Partners -- Analyst

Daniel Cardenas -- Raymond James -- Analyst

Damon DelMonte -- Keefe, Bruyette & Woods -- Analyst

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