Greetings, and welcome to the Heartland Financial USA, Inc. Third Quarter 2019 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 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 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.

Additional information on these factors is included from time to time in the Company's 10-K and 10-Q filings, which may be obtained on the Company's website or the SEC website. 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..

Thank you, Diego. Good afternoon, and welcome, everyone to our third quarter 2019 earnings conference call. We appreciate everyone joining us today as we discuss the Company's performance for the third quarter of 2019. In 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 Company performance and progress on strategic initiatives. Then, Bryan McKeag, our EVP and CFO, will provide additional color around Heartland's results. Also joining us today on the call is Drew Townsend, our EVP and Chief Credit Officer.

Well, I am pleased to report that we had an excellent quarter. Let's start with net income available to common shareholders for the quarter at $34.6 million compared to Q3 2018 of $33.7 million.

Year-to-date, net income available to common shareholders was $111.3 million, an impressive increase of $26.5 million, a 31% increase over the same period in 2018.

Fully diluted earnings per common share for the quarter was $0.94 compared to $0.97 for Q3 2018, and year-to-date, fully diluted earnings per common share was $3.11 versus $2.59 for the same period in 2018, and that's a 20% increase. Return on average tangible common equity for Q3 and year-to-date were 13.78% and 16.13%, respectively.

Annualized return on average assets for the quarter and year-to-date were 1.12% and 1.27%, respectively. For the quarter, our fully tax-equivalent net interest margin held up at 4.02%, our efficiency ratio came down to 61.92% for the quarter. And Bruce Lee and Bryan McKeag will share more detail on these areas. Now moving on to the balance sheet.

Assets ended the quarter at $12.6 billion compared to Q3 2018 at $11.3 billion, nearly an 11% increase. As planned, our balance sheet is extremely liquid with nearly 25% of our assets in the investment portfolio and very little in non-core funding.

We had excellent organic loan and non-time deposit growth for the quarter and in a few minutes, Bruce Lee will cover loan and deposit growth. The book value and tangible book value this quarter were at $42.62 and $29.62, respectively, an increase over Q3 2018 of nearly 15% and 22%, respectively.

Our tangible common equity ratio non-GAAP ended the quarter at 8.99% compared to 7.7% for Q3 2018. Now onto M&A. The Bank of Blue Valley system conversion was completed on August 23 and it went extremely well. Once again, I want to recognize and congratulate our M&A integration and conversion teams for a job well done.

Also in August, we announced that our Illinois bank charter, Illinois Bank & Trust will acquire the assets of Rockford Bank and Trust Company. This is an all-cash purchase and assumption transaction with an estimated value of approximately $59 million.

This will expand Heartland’s community banking operations in Rockford and establish Illinois Bank & Trust as a premier community bank with approximately $1.3 billion in assets and the number one deposit market share bank in Winnebago County. We are scheduled to close on this transaction at the end of November 2019 and convert systems in Q1 2020.

We continue to have a strong pipeline of M&A prospects in both Heartland's financial performance and banking model are very attractive to community banks looking for a strong partner. With respect to our dividend, I am very pleased to report that last week the Heartland Board declared a dividend of $0.18 per common share.

The dividend will be paid on November 29, 2019 to shareholders of record November 15, 2019. I'll now turn the call over to Bruce Lee, Heartland's, President and CEO, who will provide an overview of the Company's performance and strategic initiatives.

Bruce?.

Signature Bank that joined our Minnesota Bank & Trust charter, and First Bank & Trust in Lubbock, Texas. Both banks are now fully experiencing what we call the power of one.

They are focusing their efforts on building relationships and serving customers and leaving the back office functions to Heartland’s support centers, and both are delivering impressive organic growth.

During the third quarter, Ken Brooks and his team at Minnesota Bank & Trust delivered 9% annualized commercial organic loan growth and organic non-time deposit growth of 17%. And Barry Orr and his team at First Bank delivered 9% annualized organic commercial loan and ag loan growth and 11% organic non-time deposit growth.

Congratulations to both teams on exceptional performance. Turning to key credit metrics. I am pleased to report that we continue to see an improvement in our credit quality.

Overall, non-performing assets as a percentage of total assets decreased from 71 basis points in the second quarter to 63 basis points in the third quarter, the lowest in the past six years. Other real estate decreased from $6.6 million to $6.4 million over the same period.

The delinquency ratio improved to 28 basis points in the third quarter from 31 basis points in the second quarter. Non-pass-rated loans increased slightly to 6.4% in the second quarter to 7% in the third quarter, however, still compare favorably to the levels over the past several years.

Lastly, net loan charge-offs for the third quarter were reported at $2.8 million, which represents 14 basis points of net charge-offs to average loans. Next, I would like to provide a brief update on our strategic initiatives starting with Operation Customer Compass.

Last quarter, I shared that we have realized over $23 million of gains from streamlining activities across the company.

We have trimmed operations that no longer align with our growth plan and we are reinvesting into several strategic initiatives that focus our people, our processes, our technology to support our growth plan, improve efficiency, enhance profitability, and ultimately provide superior customer experiences.

We have already identified and realized most of our goal of $10 million of expense reductions by the end of the third quarter. That will be reflected in ongoing run rates. During the quarter, Our FTE count declined by 78, which can be attributed to operational efficiencies and synergies realized with our acquisition of Bank of Blue Valley.

As a result of these initiatives, we have created significant operating leverage that has enabled us to keep expenses flat from third quarter of 2018 to third quarter of 2019, while adding $1.2 billion in assets over the same period.

Our efforts to streamline the company and improve operating processes can also be seen in improvement in our efficiency ratio. The third quarter efficiency ratio is 61.9%, down 289 basis points in linked quarters and 59 basis points from the same quarter in 2018.

Two other significant strategic initiatives are the implementation of the Salesforce platform, which is an industry-leading customer relationship management system and nCino, an industry-leading loan origination platform.

The upgrade to Salesforce and nCino will significantly improve our ability to manage the sales process and improve the effectiveness of our commercial sales teams. The integration between nCino and Salesforce will improve efficiencies in our back office and shorten the sales cycle.

These two projects are now well underway and will be ongoing into mid-2020. We believe these significant investments in technology combined with our outstanding teams in our organic and acquired growth strategies, position us well for the future.

Before I turn it over to Bryan McKeag, I would like to share that in August, we completed the Bank of Blue Valley system conversion. The conversion went smoothly and Bob Regnier, Wendy Reynolds and the entire team should be proud that during conversion, they not only grew deposits, but also had a very minimal 1.7% account attrition.

The Kansas team is very well positioned for future success. In August, we also announced our intention to acquire Rockford Bank and Trust to grow our Illinois franchise. When completed, Illinois Bank & Trust will be our seventh charter to exceed $1 billion in assets.

We look forward to welcoming Tom Budd and the Rockford Bank and Trust team to the Heartland family later this year. Lastly, I would like to welcome Tamina O'Neill to the Heartland executive leadership team. Tamina comes to Heartland with many years of banking risk management experience and now serves as Executive Vice President and Chief Risk Officer.

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

Thanks, Bruce, and good afternoon. I'll begin my comments today by referencing the press release, which shows our reported earnings per share of $0.94 per share this quarter.

This was a much less eventful quarter than in the past couple quarters with only non-core items including asset write-downs of $356,000, M&A-related costs of $1.5 million, and an MSR valuation expense of $626,000. So this quarter, we delivered solid core earnings and continued to show positive trends in almost all aspects.

I'll start with our strong and liquid balance sheet, which grew $400 million this quarter, and includes a strong loan and deposit growth, Bruce mentioned in his comments. As a result, total assets ended the quarter at approximately $12.6 billion with the tangible common equity ratio approaching 9% and a loan-to-deposit ratio that's just under 76%.

Investments grew over $450 million this quarter and comprised 25% of assets with the tax equivalent yield of 2.88%, a duration of just over five years and generating $34 million of cash flow per month.

When combined with total borrowings of only $386 million or 3.1% of assets, our capital, liquidity and leverage all remain in great shape and position us well to pursue growth strategies and opportunities going forward. The allowance for loan losses as a percentage of total loans increased 2 basis points for the quarter to 0.83%.

As mentioned in previous quarters, $1.7 billion of loans from recent acquisitions are covered by valuation and PCI reserves totaling $42.1 million or 2.6%. Excluding these loans from total loans would result in an allowance-to-loans ratio of 1%, which is consistent with last quarter. Moving to the income statement.

Net interest income totaled $111.3 million this quarter, up $4.6 million compared to the prior quarter. The increase is primarily due to one additional day this quarter, the addition of Bank of Blue Valley for a full quarter and our strong balance sheet growth.

The net interest margin, which on a tax equivalent basis this quarter was 4.02%, declined 8 basis points from last quarter, primarily due to higher net interest cost on deposits and borrowings, which increased 4 basis points from last quarter.

This quarter, the net interest margin includes 23 basis points of purchase accounting accretion compared to 18 basis points in the prior quarter. Provision for loan losses was $5.2 million this quarter, up slightly from last quarter's provision of $4.9 million and was just over the expected normal range of $3 million to $5 million.

Non-interest income totaled $29.4 million for the quarter, down $2.7 million from last quarter. When compared to last quarter, gain on sale of loans was up $330,000, and gain on sale of securities was down $1.6 million.

We also recorded a $626,000 valuation adjustment to PrimeWest's MSR reflecting a further reduction in mortgage rates during the quarter.

Service charges and fees on deposits decreased $2.3 million from last quarter as last quarter included a $700,000 annual Visa incentive with the remaining decrease primarily due to the impact of Durbin on our debit card revenue.

Loan servicing income declined $507,000 driven by higher MSR amortization and write-offs due to the higher level of refinances we are experiencing in this low interest rate environment. Moving to non-interest expense. Total non-interest expense was $93 million this quarter, up $17.9 million compared to last quarter.

However, last quarter included $18.3 million of asset gains compared to $400,000 of asset losses this quarter. This quarter M&A and system-related costs totaled $1.5 million, compared to $1 million last quarter.

So on a core run rate basis, that is, excluding M&A costs, tax credit costs, restructuring charges and asset gains and losses, those costs were $88.2 million, compared to $90.9 million last quarter or a $2.7 million decrease. That decrease was primarily driven by lower professional fee costs.

More specifically, salaries and benefits were flat compared to last quarter as lower costs due to headcount reductions were offset by higher bonus and incentive accruals. Professional fees decreased $2.8 million due to several items, including a $1.6 million decrease in consulting costs for technology and process improvements.

FDIC costs were lower by $1.8 million due to a premium moratorium as the FDIC's small bank insurance reserves are now above the required levels. And in addition, M&A costs in this category were $200,000 higher than last quarter.

Core deposit intangible amortization decreased $414,000 from last quarter as last quarter included write-offs of $350,000 related to the branch sales. Other non-interest expenses were up $2.8 million with $1.6 million attributed to higher tax credit costs this quarter and $400 million increases in M&A costs.

The remaining expense categories are relatively flat compared to last quarter. The effective tax rate for the quarter was 18.66%, compared to 23.12% last quarter. We believe that a normalized effective tax rate in the 21% to 22% range is reasonable going forward. Next, I'll summarize some of our thoughts for the fourth quarter.

Commercial loan growth is projected to be in the mid-single digits on an annualized percentage basis, ag loans will likely remain flat, our residential mortgages and consumer loans are expected to continue to decline. Non-time deposit growth is expected to be in the low-to-mid single digits on an annualized percentage basis.

Net interest margin on tax equivalent basis is expected to decline next quarter into the 3.9% to 3.95% range as we expect purchase accounting accretion to be lower.

Provision for loan losses are generally expected to continue to be in the range from $3 million to $5 million per quarter and will fluctuate based on the rollover of loans acquired portfolio and the organic loan growth.

Service charges and fees are expected to improve next quarter from this quarters levels due to strong growth in credit card revenue and good growth in our non-time deposits in the last half of 2019. Gain on sale of loans is expected to show the normal seasonal decline of about 30% next quarter.

Core expenses are expected to decline from this quarter's run rate into the $86 million to $87 million range next quarter, and we expect these declines in core expenses to drive the efficiency ratio lower to near 60% next quarter. Lastly, we expect to close on the Rockford Bank and Trust transaction at the end of November, 2019.

As a result, we expect loans held to maturity will increase by $375 million, net of an estimated loan mark of 2.4%. Investments should increase $70 million. Total deposits should increase $400 million.

I’ll remind you, RB&T carries a net interest margin of 2.9% and a core non-interest run rate of $600,000 per quarter and net of Durbin that is, and has a higher efficiency ratio in the upper 70%. Second, we anticipate paying $59 million of cash at closing. We are currently estimating goodwill of $13 million and core deposit intangible of $5 million.

Obviously these estimates could change once the fair values marks are finalized. Lastly, we expect integration and conversion costs of nearly $2 million spread over the next two quarters. Systems conversion is currently planned for mid first quarter 2020, so we will not begin to see the realized 40% cost saves until the second quarter of 2020.

And with that, I'll turn the call back over to Bruce for questions..

Thank you, Bryan. Diego, if you could open up the line for questions now..

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Jeff Rulis with D.A. Davidson. Please state your question..

Thanks. Good afternoon..

Hi, Jeff..

Good afternoon, Jeff..

I guess Bryan, on the expenses, I’m trying to get the difference between the [92.9 in expenses versus the 88 to core]. The balance is merger costs and asset write-down.

There was a third item you outlined in there?.

Yes. The tax credit costs, and I think we detailed those on our reconciliation of our efficiency ratio. You can pick that number up there. I think it's….

Just three items for the – what – almost $4 million, $5 million there?.

Yes..

Got it. And yes, that range of the core in Q4, I guess in the process of the strategic or the strategy that you've held cost flat year-over-year.

Any thoughts on 2020 and perhaps on that run rate, what potential growth of that or how long do you intend to hold the line there outside of the ad from the Rockford group?.

Yes. I think – and Bruce you can hop into. We are expecting that we can keep those costs relatively flat next year with the Operation Customer Compass projects that we've had going on and the other efficiency areas we're working on, maybe some trimming at the branch, network, et cetera..

Yes. So Jeff, I would say that what our intention is to keep our costs flat and we feel that we can probably add another $1 billion of capacity over and above what we've already added this year plus Rockford Bank and Trust..

Without having to add backroom costs, that is. Obviously….

Right. Sure. Okay. That's great.

And then have you guys thrown out any kind of initial CECL assumptions or what that maybe for early next year?.

Yes. We haven't, Jeff. We've been working on this for well over a year. We've got our external partner. We've built our models. We've done some – we've done parallel runs for the first and second quarter on the quantitative components. So on the fourth quarter, we'll make refinements to that. We've got a model validation coming up.

I will also just have to make sure that the model is working the way it's supposed to. So once we complete those steps, I think we'll be in pretty good shape. The other thing is we'll have to see how and determine what that economic forecast piece is, which we're also still looking at and working on.

I think what we're seeing is kind of similar to what others in the industry are seeing on. And that is the longer-dated assets that typically sit in the residential, the commercial portfolios, which is a little bit smaller for us, thankfully I think at least in this regard, and then kind of a less of an impact on the commercial portfolio.

So we kind of feel like we'll be in line with that general things that we're seeing. But we'll need to work some more and have really something to disclose when we talk again in the next quarter..

Okay. Got you..

Hey Bryan, I think when you said commercial, you meant consumer?.

Yes. The residential and consumer are the longer-dated portfolios and they are smaller for us. I'm sorry if I misspoke..

Good clarification. One last one for Drew, a nice reduction in the non-accrual balance, if you could provide any color as to maybe what that was or where it came from, that would be great? Thanks..

Sure. It really was a kind of a widespread reduction, Jeff. We had about a handful of deals, over $1 million across the footprint that accounted for the lion share of the decrease.

And I think the other positive I look at is for the first time we saw the backfill or the new non-performers came down to a much better level than kind of the space it had been with in over the last several quarters. So we actually saw the reduction and we didn't see as much new coming in, so that really accounted for the nice improvement..

Okay. That's it for me. Thanks..

Our next question comes from Nathan Race with Piper Jaffray. Please state your question..

Hi guys, good evening..

Hi, Nathan..

Bryan, maybe start on the margin outlook from here. Appreciate the guidance for 4Q between $390 million and $395 million. I guess as we look towards the first quarter of 2020, curious to know what we should anticipate for the impact from Rockford Bank and Trust.

It sounds like based on the numbers you provided, there is some balance sheet deleveraging there that should help support the margin outlook, and obviously within that context how you see the margin responding to a likely a Fed cut here in October?.

Yes. So a couple of things. I guess to get to my 395 kind of the top end of that, we had I think an extra 5, maybe 6 basis points of purchase accounting this quarter just with the way some of the loans that moved, and we had a one that PCI loan that paid off.

So if you take that off, you're at 398, 397, and I think the core just is going to grind down a bit. So that kind of gets you to 395. And then if we get another rate cut, we typically have been seeing 3 to 5 basis points of – after we adjust our – get our deposit cost to adjust.

And so that's where I'm kind of coming up with that range of 395 to 390 for the last quarter here. I think you could see another 5 basis points kind of wind in there as – if we get one more cut, and then if we get another cut could be another 5, 6 basis points. So it really depends on what the Fed does.

I think with Rockford coming in, even though they're going to start with a lower margin that 290 kind of start point. We think we can get that better and we'll get some purchase accounting, but that also will probably have a slight drag on our margin overall.

But remember, it's pretty small component compared to the whole boat, so it may have a basis point or two total impact, but not huge..

Got it.

So if we’re at maybe 379 core NIM in the third quarter that probably grinds lower to – maybe the low 370 range for 4Q and then maybe a little over 3 to 5 bps to your point in the first quarter of next year?.

I think that sounds pretty close, yes. And then you put purchase accounting back on top of that, yes..

Got it.

And I guess within that context, loan growth was pretty strong this quarter and curious to kind of how the pipeline stands for heading into the fourth quarter, if we can kind of expect some of the excess liquidity and deposits that were gathered here in the third quarter to be deployed to kind of support the margin outlook as well into 4Q and into 2020 as well?.

Yes. Bruce can probably talk to the pipeline..

Yes. Nathan, what I would say is if our deposits continue to grow, we probably cannot fund the loans to the level that we currently have our deposit growth happening. As you saw here in the third quarter, we do believe that our loans will grow in the fourth quarter, but not to the level that they did here in the third quarter.

And I think kind of what we're trying to do is balance the deposit growth with the loan growth. So on a go-forward basis, we think that our deposits will fund our loans..

Yes. And we do have a lot of liquidity, Nate. So you might see us put a few more dollars into the investment portfolio just to get a little more earnings out of our liquidity..

Okay. Helpful. And I guess kind of two follow-up questions along those lines.

Curious what kind of the average reinvestment rate is relative to your securities deal today? And also just curious on any thoughts around deposit costs, perhaps in an inflection point in the fourth quarter versus maybe the 3 basis point increase we saw in total deposit costs here in 3Q?.

Yes. I think deposit costs, we've been working on those pretty hard. What I've seen is we kind of peaked in July. And I'm talking about the interest-bearing non-time deposits. Those were kind of peaked out at just under 1%. And I think now in October, it looks like we've gotten that down almost 14 or 15 basis points from where it peaked.

So hopefully, we continue to work on that. And certainly if we get more Fed cuts, we'll work on that harder anyway, so I think you're going to see those come down..

Got it. Helpful.

And then just on the securities side of things, just curious where the reinvestment rates are today?.

Yes. I mean our total portfolio is at 288. Don't have those off the top, but I think they're probably just slightly under that today. But I don't have a number for you off the top of my head, Nate..

Okay. No worries. I appreciate all the color. Thank you. .

Our next question comes from Terry McEvoy with Stephens Inc. Please state your question..

Hey. Good afternoon, everyone..

Hi, Terry..

Hi. Maybe a question for you, Bruce and it might be a tough one, but how much of the organic growth this last quarter? How much of the 127 new relationships came from the technology upgrades and the process improvements that you've been talking about in the last couple of quarters.

Can you quantify that? And I guess what I'm getting to is how are you coming up with the $10 million run rate improvement that you cited earlier on the call?.

Yes. So first I would say the vast majority of the organic loan growth came more from the sales process and strategic prospecting that we've been talking about really, beginning a year-ago.

That's where that came from and it was evenly spread, really 34% of the growth came out of – with C&I and 27% was owner occupied commercial real estate associated with those C&I transactions. So it was really our focus in operating companies, not in investment real estate.

So again, that would be the effort that we put forth over the last three quarters to four quarters. And the cost save of $10 million primarily comes from FTE reductions, that as we've improved our processes as well as some technology that we've stopped using and the new technology that we put in place..

Great.

So the $10 million is purely the expense side, not the new synergies?.

Correct. That's right. It's 100% on the expense side. And it also does not include what we call a capacity where we could add the additional $1 billion over and above Rockford as well as the banks that we've already acquired Bank of Blue Valley this year..

And then a follow-up for Bryan.

The $86 million to $87 million of core expenses that does not include the core kind of deposit intangible amortization, so on a GAAP basis, is that $89 million to $90 million in the fourth quarter?.

Well, let's see. It doesn't – I include the amortization in that number, Terry. The only thing I'm backing out – let me just got to make sure I read this right. So I take out the M&A costs and I take out any tax credit costs, and in restructuring if we have any, we haven't had – those don't hit very often.

And then the asset gains and losses that are in our listing there. So I leave in the amortization because it just kind of chugs along and it's always there..

Okay. So I mean, that step down from – the step down, if I back out the $3 million for the tax credit projects, there's another step down in the fourth quarter.

Is that what you're getting at?.

Yes. We should see – I'm thinking there's another $1 million plus. If things break right, could be a little bit more, but I think it's at least a $1 million, which gets me to the $87 million..

Okay. And then just the last expense question. The FDIC expense, and I apologize if it's in the release.

What was it in the third quarter? Do you have credits remaining and when do you kind of get back to that a more normal level and what would that look like?.

I think what's going to happen, and I'm going to say I think because we've looked at this and I've read some other people's comments on this. But we had almost nine, so our run rate coming in was about $800,000 to $900,000 a quarter. We got the credits in the third quarter, and we also had a quarter accrued.

So we kind of picked up a quarter by getting the credits and the reversals. So think of it as $900,000 – negative $900,000. So that's the $1.8 million delta for this quarter. Next quarter, expense will probably be zero, which would kind of be $900,000 the other way.

And then I think as we go into 2020, we'll have to start accruing because I think we'll get the first bill in Q1, which is – or in Q2, which is for Q1.

I hope I said that right?.

You did. I understood you correctly. Yes, perfect. Thanks Bryan..

Yes..

Our next question comes from Andrew Liesch with Sandler O'Neill. Please state your question..

Hey, everyone..

Hi, Andrew..

Just one follow-up for me just on the – are you talking about the deposit pricing on the non-maturity accounts, but just on the CDs, I know there are only 11% of the funding, but when do you think those peak? And what sort of renewal rates do you have versus what's rolling off right now?.

I think what we talked about, we didn't spend a lot of time talking about this getting ready for the call, and because it is that only 11%. I think our rates are now down from where they were probably 15 to 25 basis points. But we won't see that kind of dropping off because of the timing of those.

And I don't think that's going to happen till, mid-2020, early-to-mid 2020. It takes a while for those one-year CDs to start rolling off at those higher levels..

Got you. And then….

Andrew, it's Bruce. The other thing I would say is we're seeing – because rates are so low, we're starting to see some of our consumers want to extend. So we're actually on those new ones where they're moving from a six-month CD out into an 18-month CD.

So we are starting to see some increased costs there as the old one-year CDs are starting to roll off..

Got you. But that could probably be made up elsewhere, some lower pricings on savings accounts and....

That's correct..

Just due to liquidity you're bringing in. Great. You've covered all my other questions. Thanks..

Thank you. Our next question comes from Damon DelMonte with KBW. Please state your question..

Hey. Good afternoon, guys. So pretty much most of my questions have been asked and answered.

But just kind of from a higher level perspective, anecdotally are you hearing anything from your customers about concerns over the ongoing trade war and any impact that might be having on, whether it be the manufacturing sector or agricultural sector?.

Yes. Damon, this is Bruce. So for the first time really this quarter, our Midwestern manufacturers are starting to talk about a little bit of a slowdown and they're almost all talking about the trade war as it being the primary reason for that.

We are also seeing a little bit of a slowdown in housing in a couple of our markets out West and here in the Midwest. Ag really hasn't changed too much over the last couple of quarters..

Got it. Okay.

So based on what you're hearing and what you're seeing, you're not overly concerned about any impact on overall growth as you go through 2020?.

I would say that we are not. We're just making sure that our relationship managers are asking those extra couple of questions, and making sure that our customers, kind of have a plan A and a plan B if things do continue to slowdown..

Got it. Okay. And then from just at a active net growth perspective, excluding the acquired portfolio you're getting from Rockford.

Do you still think something in that mid single-digit range, call it 4% to 5% is a reasonable outlook for 2020?.

I would say for 2020, yes. I think that the fourth quarter on a net basis after we have some – as the residential and consumer portfolio runs off, I don't think it will be quite that strong in the fourth quarter. But I think in 2020, we still feel pretty good about that number..

Okay. That's all that I had. Thank you..

Thank you. Our next question comes from Daniel Cardenas with Raymond James. Please state your question..

Good afternoon, guys..

Hi, Dan..

Hi, Dan..

So just maybe if you could provide a little bit of color as to what drove the increase in the non-pass ratio this quarter, and maybe categorically and geographically, where you were seeing the increase come from?.

Yes. I would say – Dan, this is Drew. Ag has continued to tick up. We saw another $11 million that moved to a $9 million on a watch rating in that space. Then I think it's a little bit more spotty.

I think there is a little bit of a manufacturing C&I that I'm aware of in the upper Midwest that we've taken a proactive conservative stance on and moved it from a low pass to a watch. I think off the top of my head, those are the two areas that I believe probably drove the number up a little bit.

So the other piece to it too, just for everybody's understanding is the full conversion of Blue Valley happened in August and so those watch-rated deals would have flowed into our numbers. And I would say as kind of a standard practice, we do take, I would say, a bit a conservative posture on our due diligence.

And so those may have rolled over in that Kansas City market portfolio for – at the time we did the due diligence, a lack of more current financial information. Oftentimes, we will see that trend back the other way as we have them for a period of time and current financials are brought in and the ratings come back up.

So I think it's a combination of those three things that probably drove a bit of an uptick..

Okay.

And then in terms of the provision, how much of the provision was growth related and how much of it was related to the minor uptick here in non-pass loans?.

Bryan, do you have those numbers off the top of your head?.

Yes. I don't have off the top of my head, Dan. It gets a little tricky because our growth is we've got growth and we've got items moving from the purchase portfolio to the main portfolio that we provide for. I don't remember off the top of my head. I'm sorry..

All right. No problem..

I do think – I think in the allowance meeting, we allocated about $3 million related to the new organic loan growth. And we had the transition that what Bryan just stated of deals coming from the purchase valuation into our regular allowance. So I think, say, 60% came from the transition and the loan growth, Dan..

Okay. Perfect. All right. All my other questions have been answered. Thanks guys..

Thank you. Ladies and gentlemen, there are no further questions at this time. I would like to turn the floor back over to Mr. Fuller for closing comments. Thank you..

Thank you, Diego. In closing, we had a great quarter with outstanding organic loan and non-time deposit growth. Our M&A integration and conversion teams, as I said, continue to do a great job as we are retaining an extremely high percentage of acquired deposits and loans. And additionally, our pipeline of quality merger candidates remains very strong.

Our fully tax equivalent net interest margin held up above 4% and our efficiency ratio continues to improve. Our balance sheet remains extremely liquid and our capital ratios are very strong. As a result, we are well positioned with a lot of momentum as we work towards the end of the year.

I'd like to thank everyone for joining us today and hope you can join us again for our next quarterly conference call in late January 2020. Have a great evening everyone..

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