Lynn Fuller - Chairman and CEO Bruce Lee - President Bryan McKeag - EVP and CFO Andrew Townsend - EVP and Chief Credit Officer.

Jeff Rulis - DA Davidson Nathan Race - Piper Jaffray Steve Moss - FBR Damon DelMonte - KBW Andrew Liesch - Sandler O’Neill Daniel Cardenas - Raymond James.

Greetings and welcome to the Heartland Financial USA, Inc Third Quarter 2017 Conference Call. This afternoon, Heartland distributed its third quarter press release and hopefully, you’ve had a chance to review the results. If there is anyone on this call who did not receive a copy, you may access it at Heartland’s website at www.htlf.com.

With us today from management are Lynn Fuller, Chairman and Chief Executive Officer; Bruce Lee, President; Bryan McKeag, Executive Vice President and Chief Financial Officer; and Andrew Townsend, Executive Vice President and Chief Credit Officer.

Management will provide a brief summary of the quarter and then we will open up the call to questions from analysts.

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.

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 on 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 would like to turn the call over to Mr. Lynn Fuller at Heartland. Please go ahead, sir..

Thank you, Tim and good afternoon. We appreciate everyone joining us today as we discuss Heartland’s performance for the third quarter of 2017. 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, Bruce Lee, who will cover progress on our key operating strategies.

Then Bryan McKeag, our EVP and CFO will provide additional color on Heartland's quarterly results followed by Andrew Townsend, our EVP and Chief Credit Officer who will offer insights on credit related topics.

Well, I'm pleased to open my remarks this afternoon by reporting that Heartland's third quarter performance was very good albeit somewhat noisy.

We accomplished much during the quarter and to summarize, we completed the Citywide Banks acquisition and invested considerable effort in integrating our largest acquisition to-date into the Colorado Bank, which had 2.4 billion in assets is now Heartland's largest charter.

During the quarter, we were delighted to see organic growth in loans and deposits along with an increased net interest margin, stable credit quality, and further improvement in our efficiency ratio. It was a very busy quarter and a lot was accomplished. All-in-all we're pleased with the quarter.

Now that said, considerable acquisition expenses associated with the Citywide merger were flowing through the income statement and will be substantially reduced next quarter. Nevertheless, last third quarter net income available to common shareholders was 21.6 million, a 7% increase over the third quarter of 2016.

On a per share basis for the quarter, Heartland earned $0.72 per diluted common share. Year-to-date net income available to common shareholders set a new record of 61.6 million, slightly ahead of 61 million earned in the first nine months of 2016. Year-to-date diluted earnings per share were $2.21 compared to $2.48 per diluted share last year.

The reduction in EPS can be attributed to the increased number of shares we issued in the Founders and Citywide acquisitions this year. Return on average assets for the quarter and year-to-date were 0.89% and 0.94% respectively. Return on average common equity for the quarter and year-to-date were 8.99% and 9.88% respectively.

And return on average tangible common equity for the quarter and year-to-date were 12.41% and 12.9% respectively. Our tangible common equity was 7.46% for the quarter, near the midpoint of our current target range of 7% to 8%. Book value and tangible book value per common share continue to increase ending the quarter at $32.75 and $23.61 respectively.

Now looking at the balance sheet, total assets ended the quarter at 9.8 billion reflecting 1.5 in assets acquired from Citywide. As we inch closer to 10 billion in assets, we will continue to strategically manage the balance sheet to remain under 10 billion throughout the remainder of 2017.

Now that said, we are very pleased to report that organic loan growth zoomed during the quarter growing by 63 million or 4.7% annualized. We also experienced solid organic deposit growth of 92 million or 5.2% annualized and exceptional growth in non-time deposit.

Our deposit mix continues to improve with noninterest demand deposits now at 37% of total deposit. In a moment, Bruce Lee will discuss loans and deposits in more detail. Heartland securities portfolio currently represents 24% of assets.

With our target 20%, we still have room to convert cash flow from our securities portfolio into loans without increasing our asset size. Currently, our available for sale portfolio duration is between 4.5 to 5 years with a portfolio yield now at 3.13%.

We've also completed a restructuring of the newly acquired Citywide investment portfolio that will more closely align with our asset liability position and better perform in a wide range of interest rate scenarios.

Well credit quality is stable with both non-performing loans and delinquency ratios moving lower and in a few minutes, Drew Townsend will provide more detail on credit related topics.

We were also very pleased to record a solid increase in net interest margin, which increased by 12 basis points to 4.26% from the previous quarter and stands at 4.19% year-to-date. Incidentally, this is the best margin Heartland has reported in over ten years.

And finally, another real positive for Heartland's efficiency ratio which improved for the quarter falling by over 1 percentage point from the previous quarter to 64.54%.

I commend that the Heartland team's ongoing efforts to streamline processes hold the line on headcount and realize the projected cost saves and efficiencies identified in our newly acquired banks. Following Bruce Lee's comments Bryan McKeag will address noninterest expense in more detail.

Now moving on to M&A, we completed the systems integration of Citywide Banks into Centennial Bank and Trust in mid October. And I'm pleased to report the largest conversion in our history proceeded smoothly. Our operations teams have fine-tuned the art and science of systems integrations and I congratulate them for a job well done.

We continue to pursue a number of opportunities and see the potential for more announcements yet this year. Through both organic and acquired growth our goal is to grow assets to 12 billion by mid-2019 to mitigate the adverse impact that crossing 10 billion will have on both revenue and the cost of regulatory compliance.

In concluding my comments today, I am pleased to report at its October meeting the Heartland Board of Directors authorized a dividend of $0.11 per common share payable on December 1, 2017. I'll now turn the call over to Bruce Lee, Heartland's President who will provide an overview of the company's strategic initiatives.

Bruce?.

Thank you, Lynn. Good afternoon, Heartland's ten community banks turned in a very good third quarter with $63 million of organic loan growth and $92 million of organic deposit growth representing approximately 5% annualized growth across both measures.

Collectively, seven of the ten Heartland banks increased their loan portfolio balances and six of ten banks grew total deposits. As I spend time in our markets, I continue to hear our bankers and customers express cautious optimism.

While they are seeking to ensure stability, they are also looking to enable growth while keeping a watchful eye on the strength of the economy. The loan portfolio reflects this positive customer sentiment. Last quarter, we reported an encouraging trend in new money advance to new and existing clients in our commercial and agribusiness portfolio.

This positive trend accelerated in the third quarter with $238 million in new advances in this quarter, an increase of 11% over last quarter.

Also extremely positive is the significant increase in brand new borrowing relationships for the banks with $77 million in new advances this quarter more than doubling the 34 million in new relationship advances in the second quarter. I will add that organic loan growth remains a high priority.

And to that point, will mention that our pipeline of loans to be funded is healthy and we're optimistic that we'll produce continued loan growth in the fourth quarter. Moving to deposits, as we stated, Heartland had strong deposit growth in the quarter and continues to experience exceptional organic growth in non-time deposits.

The addition of Citywide banks, high quality deposit portfolio produced a positive and significant change in mix to our deposit portfolio. Heartland’s non-interest bearing demand deposits now represent 37% of total deposits, up from 32% just one year ago. Non-time deposits now account for 88% of our total with time deposits at 12%.

For the third quarter, our total deposit interest expense is 25 basis points, up just 2 basis points from last year's third quarter.

Now moving to residential real estate, Heartland's mortgage loan production slowed in the third quarter, originating nearly 200 million in new loans compared with 324 million in last year's third quarter producing a significant downward impact on net gains on sale.

We are disappointed with this performance and our mortgage unit has put into action plans that focus on delivering consistently profitable results.

You will note a significant reduction from the second quarter of nearly $1 billion in Heartland's mortgage servicing portfolio and a corresponding decrease of over $8 million in servicing rights on the balance sheet.

The reduction is largely attributed to the sale of our seven $774 million GNMA servicing portfolio and the associated $7 million of servicing rights. As stated in the earnings release, this transaction did not have a significant impact on Heartland's results of operations.

As a result of the GNMA sale, we now show 24 million of MSRs on our books with a fair value of approximately $35 million or 11 million more than book value. In a few minutes, Drew Townsend will discuss the expected impact of this sale on Heartland's impaired loan metrics.

Back to the income statement, we also saw improvement during the quarter from service charges and fees with good increases in treasury management and payments revenue attributed in part to the acquisition of Citywide Bank's solid commercial book of business.

Touching on our retail division for a minute, I want to point out that the Heartland banks are originating new deposit accounts online with good initial results. The new online capability is already accounting for nearly 10% of all consumer new account opening.

With strong initial performance, over time we expect to capture 25% of total new consumer checking account openings via the online channel in line with leading banks offering this capability. I would also like to mention that we have closed and consolidated three branches locations in the Denver market and closed one rural branch this quarter.

We are continuously reviewing our physical network to improve effectiveness and efficiency. I'm pleased to welcome a new member to the Heartland Executive Team. Laura J. Hughes recently joined us as Executive Vice President and Chief Marketing Officer.

She brings 20 years of financial marketing experience including positions at JPMorgan Chase and the Federal Reserve System. We look forward to Laura's leadership on our company's growing and diverse marketing efforts.

In concluding my comments today, I want to acknowledge and thank the large number of Heartland team members who orchestrated a nearly flawless conversion of Citywide Banks two weeks ago in Colorado.

I also want to acknowledge the Citywide team led by Kevin Quinn, they demonstrated commitment to their customers and to our company throughout the transition. Kevin and his Colorado team will serve the largest market in the Heartland family with over $2.3 billion in assets and we look forward to celebrating their future successes.

I am proud to work with so many talented, engaged and dedicated people who day after day make Heartland the great company that it is by supporting our member banks and delivering excellent products and services to our valued clients. And with that I will turn the call over to Bryan McKeag for more detail on our quarterly financial results..

Thanks Bruce and good afternoon. As Lynn mentioned, it was a very busy and noisy quarter. So I’ll try to bring some clarity to the noise. Starting with the tangible common equity ratio which declined 51 basis points yet remains strong at 7.46%.

The Citywide acquisition reduced the ratio by 76 basis points, which was partially offset by a small 3 basis point add from the changes in market value of our investments and derivatives and a 22 basis points increase from the retained earnings for the quarter.

Lynn and Bruce have already commented on loans and deposits, so I will only comment on a couple of other balance sheet items. First, goodwill and core deposit intangibles increased 95 million and 14 million respectively this quarter as a result of the Citywide transaction.

Second, other borrowings increased 20 million as a result of our assumption of Citywide’s existing [indiscernible]. Moving to the income statement, net interest income totaled 89.8 million this quarter, up 15.3 million from the prior quarter. The primary driver of the increase was a $14.2 million increase attributable to the Citywide acquisition.

And there was also one additional calendar day this quarter. Net interest margin on a tax equivalent basis improved nicely to 4.26% which is a 12 basis point increase from last quarter.

Loan yields increased 14 basis points and investment yields increased 7 basis points offset by higher interest costs on deposits and borrowings, which climbed 6 basis points compared to last quarter.

This quarter the net interest margin includes 16 basis points from the amortization of purchase accounting discounts which compares to 12 basis points in the prior quarter. Noninterest income totaled 25 million for the quarter, down 600,000 from last quarter.

When compared to last quarter, gain on sales securities was up 300,000 and the gain on sale of loans was down 1.8 million. Service charges and fees increased again this quarter, up almost 400,000 over last quarter, primarily from the addition of Citywide Banks.

Switching to noninterest expense, total noninterest expense was 78.8 million this quarter, an increase of 9.5 million from the prior quarter with most categories showing increases from the second quarter due to the inclusion of Citywide Banks.

M&A and system conversion related costs increased from $1 million last quarter to $2.8 million this quarter and are spread across multiple expense categories. Our largest expense category, salary and benefits increased $4.1 million or 10% compared to last quarter.

The primary driver of this increase was a higher full-time equivalent employee count, which increased by 162 or 9%. The increase in employee count includes the addition of Citywide, which added 180. So excluding Citywide, the employee count would have been 18 lower than last quarter.

Occupancy and FF&E costs combined were up 1.4 million from last quarter, due to the inclusion of Citywide run rate costs and also included 400,000 of lease buyouts and equipment rental costs related to the Citywide acquisition. Professional fees increased 900,000 again due to Citywide’s run rate.

M&A and conversion costs in this category were 800,000 this quarter, which is a similar level to last quarter. Gains and losses on the sale or valuation of assets was worse by 1.5 million, particularly from the write-off of assets such as leasehold improvements and old signage that was necessary due to the Citywide acquisition.

Other noninterest expenses were up 800,000 over last quarter as this quarter includes both Citywide run rate increases and just over 200,000 of software maintenance write offs again related to the Citywide conversion. For the quarter, the efficiency ratio was 64.54%, down from 65.61% last quarter.

Although improved from last quarter, the ratio was negatively impacted this quarter by the higher level of M&A and system conversion costs, and inefficiencies related to the lower mortgage banking revenue. Effective tax rate for the quarter was just under 29%. We believe a normalized tax rate of around 30% is reasonable on a going forward basis.

Lastly, our expectations for Heartland results for the rest of 2017 would be that the net interest margin on a tax equivalent basis will stay in the 4.20% to 4.25% range. Mortgage production is expected to decline slightly due to the normal seasonal fourth quarter declines.

Core fee income excluding mortgage and security gains is expected to show continued improvement. We do expect loan servicing fees to be down slightly due to the GNMA servicing sale. However, deposit services and other fee increases will more than offset the decline in loan servicing income.

Core expenses excluding M&A related costs should remain well controlled in the 76 million per quarter range. We anticipate Citywide Banks savings cost to be about $2 million per quarter starting in December and should be fully phased in by January of 2018.

In addition to core expenses, we also see lower costs for M&A and system conversion activities for Citywide next quarter which we estimate will be around $500,000. And lastly, long and deposit growth in the fourth quarter on an annualized percentage basis is expected to be in the low-single digits.

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

Thank you, Bryan. This afternoon I'll begin my credit related remarks by discussing the changes in Heartland's non-performing loans. Total nonperforming loans remain relatively unchanged in the third quarter at 65.8 eight million. However reduced as a percent total loans from 1.24% at the end of the second quarter to 1.03% at the end of the third.

During the quarter, $5.2 million of nonperforming loans in all categories were resolved. New nonperforming loans identified during the quarter from the legacy portfolios equaled 9.1 million of which 8 million were originated by Heartland member banks and 1.1 million came from Citizens Finance, Heartland’s consumer finance company.

It is noted 1.1 million in nonperforming loans were acquired in the third quarter. The new bank nonperforming loans by loan type included 4.2 million or 46% attributed to the commercial loan portfolio, 2.3 million or 26% in the ag portfolio and 2.6 million or 28% from the retail portfolios.

Heartland wide there are only eight non-performing borrowing relationships with loan outstandings exceeding $1 million. In aggregate, these eight borrowers totaled 29.6 million or 45% of total nonperforming loans.

In the retail portfolios, 16.2 million or 25% of all nonperforming loans are repurchased residential real estate loans from our service loans portfolio.

This number remain flat between the second and third quarter and it is anticipated this total will trend downward in the future due to the previously mentioned sale of the GNMA servicing book of business. These loans are government guaranteed and are estimated loss exposure is considered to be minimal.

Other real estate owned increased from 9.3 million in the second quarter to 13.2 million in the third. The increase was largely the result of the acquisition of Citywide Banks and their portfolio of other real estate assets in the amount of 6.9 million.

In total nonperforming assets as a percent of total assets decreased from 0.93% as of June 30 to 0.82% as of September 30. This improvement was anticipated based upon the stable credit quality of the legacy Heartland loan portfolios as well as the very solid credit metrics of the acquired Citywide Bank.

When reviewing Heartland's overall loan quality metrics during the third quarter, the company continued to demonstrate a favorable level of total sub-rated loans, those risk created watch or substandard.

At 5.93% the non-pass credits as a percent of total loans are in a level which compares very favorably to both recent quarters as well as levels over the past several years. With respect to total delinquencies, the 30 to 89 days delinquency ratio reduced from 0.38% to 0.33% from the prior quarter to the current quarter.

This level of delinquency is somewhat lower than the delinquency percentages reported in the last several quarters. As we review the allowance for loans, it is noted that provision expense was 5.7 million during the third quarter.

Organic loan growth, continued migration of acquired loans from the purchase accounting pool to the allowance pool, and newly identified impairments on one large commercial and one large agribusiness credit relationship all were contributing factors to Heartland’s third quarter provision expenses being elevated from previous quarters.

Total charge-offs for the third quarter of 2017 were 5.8 million compared to 3.3 million for the third quarter of 2016. The increase is primarily attributable to $3 million of charge-offs related to two previously reserved commercial loan relationships at Dubuque Bank and Trust and Arizona Bank and Trust respectively.

It remains noteworthy that $1.7 billion of loans from our most recent acquisitions reside in the purchased accounting pool and are covered by the valuation PCI reserves. As credit decisions are made on these loans in future quarters, a provision expense will be necessary to establish the associated allowance for these acquired loans.

As shown in the earnings release, our coverage ratio of allowance for loan losses as a percent of nonperforming loans was 83.41% in the third quarter, up from 81.78% in the second quarter. The allowance for loan losses as a percent of total loans decreased from 1.02% as of June 30 to 0.86% as of September 30.

This is again mainly due to the addition of our largest acquisition to-date with almost all of these newly acquired loans being covered by evaluation reserves as opposed to the allowance. Valuation reserves total $42.8 million are recorded for the aforementioned loans obtained from the acquisitions.

Excluding the 1.7 billion of loans covered by the valuation reserves would result in allowance to loans ratio of 1.17% as of the end of the third quarter, down slightly from June 30 at 1.20%. In summary, non-performing assets, as a percent of total assets, decreased during the third quarter as previously outlined.

Additionally, total sub rated loan levels as of quarter end continued to show improvement in trends for various other asset quality metrics, including delinquency levels, continued to demonstrate favorable results. Overall, credit quality for the company is considered very stable.

Finally, providing additional support for this assessment of credit quality at the Heartland member banks were the results of our recently completed regulatory examinations.

The exams of the banks were collectively conducted during the third quarter and the results were favorable with no significant issues or material risk rating changes or classifications identified. That concludes my remarks. I will turn the call back to Lynn and remain available for questions..

Thank you, Drew. We’ll now open the phone lines for questions from our analysts..

[Operator Instructions] Our first question comes from the line of Jeff Rulis of DA Davidson..

Kind of tough to pull out the loan growth segmented performance with the Citywide acquisition. Any comment on maybe just where the segmented growth was coming from by loan category and by region if you could..

Yes, Jeff. It was -- it came from many of our banks and we were just looking at the data here a little bit ago, it was not nailed down in any specific industry. I think as Bruce may have mentioned, it was seven of the banks actually showed loan growth. Bruce..

Yeah. Jeff, this is Bruce. The three banks that had the most organic loan growth during the quarter are Arizona Bank & Trust, Illinois Bank & Trust and Wisconsin Bank & Trust. New Mexico and Minnesota Bank & Trust also had very nice organic growth and it was spread across many categories, including agribusiness, manufacturing.

There was some real estate as well as some healthcare. It was really broad based..

And then I think it was, maybe Bryan on the, you talked about the gain on sale outlook to be down sequentially in Q4, some seasonality, but how about the balance of ’18 and your expectations on that line item..

Yeah. We’re working on our budgets right now. I think we're probably looking at ’18, we hope to be slightly better than ’17, but again, I don't see any catalysts in the market where the market's going to be up a whole lot. So I think it's going to be again a continued fight to grow our market share and Bruce, I don’t know if you..

Yeah. Jeff, this is Bruce again. I would say in the residential mortgage business, the only way that we're going to exceed the 2017 performance is to grow our business in both Colorado and California to take advantage of the most recent acquisitions out there.

We're disappointed in our performance, primarily in both of those markets, haven't gained the traction that we anticipated. So we're really taking a hard look at our entire mortgage business and where the opportunities are in our markets..

And maybe just one last one maybe for Drew, on the credit quality front, it's been a slow creep in the NPA, I think nine consecutive quarters up and you talk about the early stage delinquency numbers are trending better.

I guess vetting those two, on the provision expense, if we're in the kind of a return to growth on the portfolio, any thoughts on the provisioning if perhaps charge-offs aren't as lumpy as they were in this quarter? Thanks..

Yeah. Bryan and I have discussed this. I think conversation we’re having is we’ve kind of put the first three quarters of the year together, kind of average amount, you'd land back at the 3 to 3.5 range I believe quarterly.

Obviously, the thing that probably causes some pause in truly nailing that down is when you have that 1.7 billion in valuation reserve depending on the pace with which deals move through the credit process and move from one space to the other. That's probably a variable, it's a little harder to peg.

Again, I think we feel well or good about the legacy banks and how we have identified risk in those. So that would be my thoughts. Bryan, I don't know if you have anything to –.

I think that's pretty reasonable..

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

Bryan, maybe starting with you on the core margin. I appreciate the guidance you provided for the reported margin of between 4.20 and 4.25 going forward, but kind of excluding purchase accounting, can you kind of give us a sense of where the core margin goes from here.

Obviously, it’s up nicely quarter over quarter here, but any color you can provide in terms of where new loan pricing is relative to the core portfolio yield around 5%, also on ecommerce and deposit pricing after these last couple of rate hikes..

Well, there is a couple of questions in there. I would say and Lynn and Bruce, you guys can jump in. I think, our loan pricing has probably been in the upper 4s to mid 4s, maybe at the low range, depending upon the type of products. So I think that's hanging in there in terms of maintaining our margin.

Deposit pricing, to this point, has been pretty good. We've got a small -- 3% to 5% of our book is variable. So that moves with the market, but the rest of it as we price it has been pretty slow to move upward with no big moves from competitors who are in our market.

So, the next move, that's a little bit harder to judge, given that we've had two or three moves here where deposit prices haven't moved. So how much pent up pricing change is there, I don't know. So those are the things we're struggling with there.

The core, as I looked at it, going from the 4.14 to the 4.26 this quarter, we had about, I think, six basis points or so that came from the Fed move. We've been getting about 5 or 6 the last couple of moves in terms of basis points.

So, that next move I wouldn't think would be more than that because we may get a little bit of deposit pressure along with it. So that's why I think, we have a hard time basing what the amortization is going to be. I think it was 16 basis points this quarter. I don't think it's going to go higher now with Citywide in.

So that's why we hedge a little bit and say, I think, between 4.20 and 4.25 is probably a reasonable number for the margin..

What I see in these, we’re getting and have historically been able to get better pricing out west than we get in the Midwest. That said, we see tight pricing on large, high quality credits. So credits in that 15 million to 25 million that are very high quality are getting priced a lot tighter than smaller credits.

And on the deposit side, we've been very fortunate not to have a lot of pressure to increase interest rates on deposits. And again, you can see that we continue to improve our deposit mix. So, if we get another rate hike, which we'd like to see in December if the Fed chooses to hike another quarter, that will help us.

It may create a little more pressure for us to increase rates on deposits..

And just changing gears and going back to Bruce, on the growth outlook going forward, it doesn't sound like Colorado contributed too much of the growth you guys had here in 3Q.

So just curious kind of what the early indications are in terms of loan growth out of that book and what if any kind of one off expectations you guys have for [indiscernible] going forward?.

Yeah. I would say that the Citywide banks, their credit policy and credit appetite is very similar to ours.

There is nothing in their portfolio that we do not want to continue to attract that type of relationship and actually we're pretty pleased that for the quarter, we would consider their organic growth, the new Citywide combined with Centennial was basically flat for the quarter.

So we're pretty pleased given everything going on with the conversion of both our Centennial staff and the new Citywide coming in with that. So we expect them to be in the mid-single digit growth in the fourth quarter and going forward..

From a deposit side on Citywide, we just saw a report today that since the announcement, we've been able to retain, I think, it was very close to 99.5%. It was 99.8% of the deposit. So we've been very good at retaining the business of that bank and once we get through that conversion expense, they're going to be a great contributor to our earnings..

And they did have organic deposit growth in the third quarter. So we're very pleased with their financial contribution, even in the short, roughly three months, just a little less than three months that they've been part of the Heartland family..

And just going back to the credit conversation, Drew, I was wondering if you can just help us kind of understand how criticized are classifieds. Migration occurred within the ag portfolio this quarter and I know we're still in the early process of going through credit renewals for 4Q and 1Q.

But just kind of any early indications in terms of what you guys expect in terms of criticized migrations in 4Q and into 1Q and as well as how that may impact growth within ag going forward as well..

All right. I did a quick look back here over the last seven quarters. Our growth has been relatively nominal. We concluded 2015 at 472 million. We concluded the third quarter here at 513. The pace of growth of the aggregate portfolio has not been high. We have experienced.

It's been largely flat so far in the year 2016, watch in sub brain 65 million to end at 2016, 66 right now. But that is up. It was about 8% of the total portfolio at the end of 2015 and it's been hanging at 13% of the total portfolio in 2017. So, I think the outlook will be crops -- yields are good. I was just speaking to one of our dairy farmers.

I think we’re lenders. I think overall, production is good, prices are still challenged though. So, the good news in the sub rated, we are, I think, very good about using FSA guarantees. We typically have solid land equities in our portfolios.

So even though the portfolio is showing a big more stress, I don't think the level of loss exposure is elevating to any significant degree..

I would just add to that that we are seeing milk prices go up, so that's improving, livestock prices, cattle and hogs are improving. And even though we're seeing lower prices on corn and beans, which is most of what our guys are raising to feed through their livestock, the production this year and the area we're lending into is very good.

They're getting more bushels per acre. So even if your prices are a bit lower, they still are coming out okay. So I don't see things getting much worse. I would hope that I think ’18 is going to be little tough because we've got so much more supply than we have demand.

They're carrying supply of beans and corn over plus we've got crops in our area again. So I think it's going to be an issue in ’18 where we just are going to see low prices on crops, it’s because of the heavy supply and less demand..

Our next question comes from the line of Steve Moss of FBR..

Circling back to the loan pipeline, just wondering the detail as to where you're seeing the demand for loans these days..

The pipeline is very similar to what we originated here in the third quarter. We're seeing it across our footprint. Most of our markets are seeing the demand and it's mixed. We're seeing some manufacturing demand, some medical, we're also seeing some real estate and then there's some demand in ag.

I would say those are sort of the four areas that we're seeing the demand in right now..

And then Drew, I heard your comments about the reserves turning higher as acquired loans are renewed or runoff. I was wondering how we should think about the loan loss reserves by year end ’18, excluding acquisitions..

I guess it really depends on the way, to answer the question. I mean Citywide, I would say, does have a bit more pace to its portfolio and what I mean by that is in there, they're larger relationships, take construction deals. Oftentimes, they may source -- provide the construction financing with the end financing to be handled outside of the bank.

And so unlike maybe some of the other more recent acquisitions that may have had longer tenured loans, I would think that will potentially weigh in a little greater pace in terms of movement out of the purchase reserve and into the regular allowance.

But with that said, and in C&I, I guess that would be the other component is they do have a sizable C&I portfolio as well and those will be working their way through the end of the year in the annual renewal.

So I doubt we see a whole lot of impact over the next 90 days, but I would expect as we move through the first half of 2018, we'll start to see some more -- a larger number in that transfer. That would be my take..

Yeah. Steve -- I'll add to that Drew. Steve, the impact in ’18 to a great extent should be offset by additional acquisitions. I mentioned in my comments that you can expect some additional announcements this year.

We won’t close additional deals this year because we're going to stay under the 10 billion asset size, but as the Citywide loans start to roll off, we'll have additional loans from additionally acquired banks coming on board. So I would hope to see that some offset..

But on M&A, I was just wondering here in terms of acquisitions going forward, is it more likely to be one or two large deals, are you thinking a couple of smaller deals..

It would be a mix of larger and smaller ones. As I said in my comments, our goal is to get to 12 billion in total assets through both organic and acquired growth by mid-2019. So we're going to have to have a good number of those boarded in 2018..

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

First question, Bryan, could you just walk us through again some of the details on the merger charges. I got down some of them, but if you could just run through that again, that would be helpful..

Just a second. Let me get my sheet here. So in my comments, the total this quarter was 2.8 million. We had -- there's about 400 that went through occupancy. There's another 800 or so that went through professional fees.

I think about 1 million went through -- of that 1.5 million was related to on the gain or loss on sale of other assets was related to the acquisition. There's another 200 that went through other. And I think then the balance would have gone through very small component in salaries and benefits. I don't know if that all added up to 2.8.

I kind of read them off here, I didn't do all the math, but those are the pieces I had written down..

Yeah. That would be pretty close. Yeah. Okay.

And then with regards to the outlook for Durbin, whenever that comes in, which I think you guys are saying like mid ’19, you'd be impacted by that, is that correct?.

Yeah. We've figured it was going to be 5 million pretax at 10 billion. So when we get to 12 billion, if we're there when we cross, it probably should be around 6 billion or 6 million sorry..

And then, with the banks that you've acquired in California, has there been any impact with the wildfires that we've seen?.

No. They were not impacted at all during the quarter. We did not go up into -- none of our operations or up into wine country. We had no customers or employees that were impacted..

We did have to close the branch. This was not the latest fire, that was an earlier fire around mid-year that we had to close the branch for, I think it was three days, but we didn't have any damage to the bank or homes in the near vicinity of Yosemite..

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

Just one follow-up question for me Bryan. Just the expenses, I think you said 76 million here in the fourth quarter with 2 million of cost saves coming in in December.

So should -- just to clarify, is that a $74 million run rate to start next year?.

We should be in close to that ballpark. I would say the only thing that would go against that is we continue to add some expenses for crossing 10 billion. So, there might be a little add to that, but I would say the first quarter, we should enter.

Now, we get -- the one other thing that tends to happen is we get some resets on some of our accruals that we do for the year. So we should be, I would say, 74% to 74.5% probably is where we should see our run rate as we go into next year..

Our next question comes from the line of Daniel Cardenas of Raymond James..

Just one quick question. In terms of your M&A outlook, I mean are you seeing more opportunities in the western part of your franchise or is it more of the Midwest or is that a good mix as well..

It's a mix of Midwest and West. We don't see an awful lot in Iowa or Wisconsin or Illinois at this time. But, we are seeing opportunities in Minnesota and then out west, we're seeing opportunities. There's not a lot left Dan to buy in Arizona.

So that's pretty quiet there and nothing currently in New Mexico, but there are opportunities elsewhere out west..

And would you consider kind of going outside your current footprint right now or it's the goal really just kind of to build up each state to do 1 billion plus in assets?.

Yeah. That's a good question. In the past, we've always said that our first priority is in our current states to get each of the charters to 1 billion plus.

We've got four of them now and I would hope in 2018, we'd have 6 to 7 of the banks over 1 billion, but we would look at very strategic opportunities if they were in neighboring states to where we're already located in. It made a great deal of sense now.

We're going to be very, very picky if we go into a new state, they're going to have to have a great management team. We're going to have to see a bank that has great quality of earnings and very high quality loan assets.

So as you know, there's a lot more risk when you go outside of your footprint, so we'd be very picky if we end up going outside of the footprint..

We have a follow-up question from the line of Nathan Race of Piper Jaffray..

Bryan, just on the tax rate. I think in the past, you’ve guided 30% to 31%.

Is that still a good range to use going forward?.

Yeah. I would say 30 probably maybe for the fourth quarter, you might bump it to 31 with hopefully some better earnings next year..

There are no further questions over the audio portion of the conference. I would now like to turn the conference back over to management for closing remarks..

Great. Thanks, Tim. Well, in closing, we were very happy with the quarterly results as well as our year-to-date performance. And just to recap real quickly, Heartland’s organic, and I am going to emphasize organic loan and deposit growth rate was 5% annualized. So that was good to see the organic loan growth pick up again.

We maintained solid credit quality and improvement in non-performers and delinquencies. Our company continues to maintain its net interest margin at an enviable 4.26% level and that is the best we've seen in ten years, pretty remarkable.

Our efficiency ratio at 64.5% is improving as we realize efficiencies in our operations and cost takeouts in our acquisitions and we are strategically managing our balance sheet to remain under the 10 billion total asset level for the remainder of 2017, while advancing a number of additional M&A prospects, which will eventually mitigate the adverse impact that we talked about for reduced revenue as a result of Durbin and the increased cost of regulatory compliance.

So in closing, as we assimilate Citywide and other acquisitions into the Heartland organization, we'll continue to see improvement in our earnings. I’d like to thank everyone for joining us today and hope you can join us again for our next quarterly conference call, which is scheduled for January 29, 2018. So with that, everyone, have a good evening..

This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time. Have a wonderful rest of your night..