First Internet Bancorp - Fixed- (INBKZ) Q3 2018 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the First Internet Bancorp Third Quarter 2018 Financial Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Allyson Pooley of Financial Profiles. Please go ahead.

Thank you Kate, and good afternoon everyone. Thank you for joining us to discuss First Internet Bancorp Financial results for the third quarter ended September 30, 2018. Joining us today from the management team are chairman president and CEO David Becker; and Executive Vice President and CFO Kenneth Lovik, David and Ken will discuss the third quarter results and then we'll open the call to your questions. Before we begin I'd like to remind you that this conference call contains forward-looking statements with respect to the future performance and financial condition of First Internet Bancorp that involve risks and uncertainties. Various factors could cause actual results to be materially different from any future results expressed or implied by such forward-looking statements. These factors are discussed in the company's SEC filings which are available on the company's website. The company disclaims any obligation to update any forward looking statements made during the call. Additionally, management may refer to non-GAAP measures which are intended to supplement but not substitute for most directly comparable GAAP measures. The press release available on the website contains the financial and other quantitative information to be discussed today as well as the reconciliation of the GAAP to non-GAAP measures. Now I could turn the call over to David.

Thank you Allyson. Good afternoon everyone and thank you for joining us today. Since this is our first earnings conference call, I'd like to begin with a brief overview of our company and our strategy and then I will discuss our fourth-quarter performance. Ken will then provide some additional details on our financial results. First Internet Bancorp open for business in 1999 as an industry pioneer in the branchless delivery of banking services. Our mission from the start has been to service customers in the digital economy providing them with customer centric digital banking solutions including real-time capabilities for both payments and lending while maintaining the personal touch of relationship banking. Over nearly 20 years in business we have come to understand our customers' preferences for anywhere, anytime access. Our ability to meet their needs has created a tremendous amount of customer loyalty. Today an increasing number of consumers and businesses prefer digital banking over traditional branch banking. Our national online and mobile deposit gathering and asset generation platforms capitalize on advancing technology and are highly scalable. Our business model uniquely positions us to build relationships with our customers by using technology to modernize delivery channel of an industry deeply rooted in tradition and by offering the combination of products, services, and values that they find compelling. We believe that we are well positioned to flourish within this digital banking ecosystem which is still in the early stages of a powerful secular trend. We have built a $2.4 billion nationwide branchless deposit franchise that provides consumers, small businesses, commercial clients, and municipalities with innovative technology convenient access, high-touch customer service and competitive deposit rates. Our national footprint also enables us to focus our marketing efforts on geographies that are more tech savvy increasing our overall deposit capture. The success of our deposit gathering activities is borne out by the fact that we have grown our deposits by an average of 31% per year over the last five years. Turning to the asset generation side of our [indiscernible] franchises both nationwide and on a regional basis many of which are filling market voids either the larger banks aren't dedicating the resources or where the regional community banks don't have the scale to compete. On the commercial side we have developed expertise in the area as a single tenant lease financing, public finance and most recently healthcare finance, and on the consumer side we have built a franchise and recreational vehicles and horse trailer lending and of course we have offered nationwide direct-to-consumer residential mortgages for over 10 years. We have entered each of these specialty lending areas by bringing in experienced bankers with existing relationships, institutionalizing our origination and underwriting process and scaling the business geographically. These specialty lines are rooted in sustainable industries and have included lower risk asset classes enhancing our overall asset quality and helping reduce a risk-based capital requirement. We are at various stages of nationwide penetration with each of these business lines and will continue to grow our market share over time particularly in some of our newer lending areas. We believe this provides tremendous growth potential for the company. In addition, we are continually evaluating opportunities to expand into new areas of lending to further diversify our revenue mix and drive incremental earnings growth. We also have built some more traditional commercial lending businesses and carefully selected markets that are regional in nature and are more complex requiring experienced personnel on the ground. Most of this business is in central Indiana but we also have a C&I lending group based in the Phoenix, Arizona market. As a result of this strategy we currently have a $2.5 billion loan portfolio that is both geographically and industry diverse. Over the last five years we have grown our portfolio at a 41% annual rate. We have funded our growth into the new loan verticals with a series of capital raises since our IPO of 2013. We are committed to raising capital only if it can be deployed both strategically and profitably and only if it helped us move towards achieving greater scale and operating leverage. We believe that we have met these objectives as our trailing 12 months net income has grown at a 41% compounded annual growth rate and our diluted earnings per share in an over 12% compounded annual growth rate. Our return on average assets has increased from 67 basis points to 83 basis points. Our return on tangible equity from 7.7% to nearly 10%. However, we have more work to do to drive ROA north of a 100 basis points and ROE into the [mid-teens]. We have a number of near-term objectives that should enable us to move forward on our path to higher profitability and further shareholder value creation. These include further extending the scope and market penetration and our specially lending lines while also diversifying our revenue stream with additional sources of non-interest income. We're exploring initiatives to expand deposit channels and importantly increase the mix of low-cost deposits. To achieve this we are working towards deepening our existing business relationships to attract more deposits such as going after more operating accounts from some of our municipal and commercial customers. We are also developing a nationwide small business deposit strategy to further leverage our digital infrastructure and complement our consumer deposit base. And finally we continue to build upon our entrepreneurial culture to attract top talent as our people are our greatest asset and one of the keys to our ongoing success. We've been recognized for innovation and are consistently ranked amongst the best banks to work for and we plan to keep it that way. In summary, our culture products and platform will enable us to continue to support our growth plans and further expanded both existing and new lending verticals all with a focus on driving improved profitability. Now turning to our financial results. We are pleased with our results in the third quarter driven by solid loan growth, excellent credit quality, and well-managed expenses. We continue to take a disciplined approach to capital deployment and execute on our lending strategies including our specialized area focus in public finance healthcare and single tenant lease financing. Net income for the quarter was $6.3 million which represents a year-over-year increase of 28% and an increase of 5% from the second quarter of 2018. Earnings per diluted share was $0.61 as compared to $0.71 in the third quarter of 2017 and $0.67 in the second quarter based on a higher average share count in the current quarter due to our strategic capital raises that have occurred over the last 12 months. We continue to do a good job reaching our target customers and demand for a suite of loan products continues to be strong particularly our specialty commercial and consumer loans. Our total loans outstanding increased by $120 million from the second quarter which equated to a 20% annualized growth rate and we're up 33% year-over-year from the third quarter of 2017. Our loan growth in the quarter while strong by industry standards has moderated from its historical pace. This is part of our disciplined capital deployment strategy where we seek to grow our balance sheet in a measured and profitable way and not just growth sake. On a fully taxable equivalent basis our net interest income for the quarter was $17.3 million up 4.2% from the second quarter and up 12% year-over-year. The higher level of net interest income and our well-managed expenses produced in annualized return on our average assets of 79 basis points and return on average tangible common equity of 8.9% in the third quarter which was lower than the second quarter primarily due to our June 2018 equity offering. Going forward as we continue to deploy capital in a disciplined and profitable manner we anticipate that our profitability metrics will improve. In summary, based on our third quarter performance and the positive opportunities that we're seeing we believe we will finish 2018 strong with another year of profitable growth. We remain committed to executing on our strategy to expand our specialty lending franchise and build upon our expertise in branchless banking utilizing our nationwide deposit gathering platform to fund our expected growth. Combined with our strong credit culture and highly efficient and scalable back-office operations this should continue to drive exceptional returns for the shareholders. Well, that is an overview. Let me turn the call over to Ken to provide additional details on our financial performance for the third quarter. Ken?

Thanks David and thank you everyone for joining us on our first earnings conference call. I'm going to highlight and expand on a few areas and try not to duplicate what is already in the press release. Our total loans were $2.5 billion at September 30, an increase of $120 million from the end of the prior quarter or 20% on an annualized basis. Loan growth this quarter was solid though lower than recent quarters. As David mentioned we are sticking to our focused areas and are very disciplined about deploying capital. Our commercial portfolio grew by $84 million in the quarter on a $138 million of funded originations primarily driven by increased production in public finance, healthcare lending, and single tenant lease financing. Healthcare finance loans grew at the highest rate posting a 36% increase from the second quarter albeit off a lower base. We are still at the early stages of market penetration with this loan product which we launched a little over a year ago via our strategic partnership with Lendeavor, a San Francisco based technology enabled lender focused primarily on dental practices. We also believe that we have a long runway in front of us with our public finance lending as we have the ability to expand geographically and further diversify our network for deal flow and we are putting resources into this growing business line. We particularly like this asset class due to its high credit quality and lower regulatory capital requirements and as discussed in the earnings release these loans are very easy to hedge with interest rate swaps to create LIBOR based floating rate assets. On the consumer side residential mortgages grew by $25 million more than half of the increase was due to funding construction loans that were originated in prior quarters with the other half being either jumbo or on portfolio production. Our focused areas of trailers and recreational vehicles continue to do well increasing 7% or over $14 million on a combined basis during the quarter. We have strong brand recognition in the space and look forward to continued growth. With respect to our expectations for the fourth quarter the current pipeline is solid and reasonably consistent with where it was at the end of the second quarter. We anticipate overall loan growth to be between 5% and 8% on a linked quarter basis with the range being dependent on the ultimate timing of funded originations and seasonal factors. Moving to deposits and funding; a portion of the loan growth during the quarter was funded with cash balances driven by deposits sourced late in the second quarter. The largest increase in our funding base was in broker deposits which was primarily driven by our long-term funding strategy. As discussed in the earnings release we used brokered variable rate money market deposits on a limited basis about a $100 million average balances to supplement organic deposit funding. These money market balances are converted to long-term fixed-rate funding with interest rate swaps. We had a decline in money market deposits due primarily to the loss of one large customer. This was a situation where another bank was extremely aggressive in going after the customer and at a certain level it did not make good business sense to match the extremely high rate that customer was offered. We continue to focus on opportunities to generate lower cost deposits through the expansion of our small business, municipal, and commercial relationships. Success will not come overnight, however we are happy to report that early in the fourth quarter we won the operating account business from an important local municipality. When fully funded in December we expect that it will have an average daily balance of approximately $30 million. Our commercial deposit team put forth a tremendous effort lending this account and we are optimistic we can leverage this win into additional opportunities. Turning to net interest margin as expected the continued flat yield curve combined with the current deposit pricing environment put pressure on our net interest margin. Our reported net interest margin decreased 11 basis points to 2.06% from 2.17% in the second quarter and on a fully tax equivalent basis net interest margin declined 10 basis points to 2.23% from 2.33% in the prior quarter, the decline in that interest margin was driven by higher deposit pricing as our cost of interest bearing deposits increased by 22 basis points during the quarter to 1.95%. The increase was due primarily to the cost of funds associated with the brokered money market deposits as well as higher CD cost as maturing balances were replaced with new production in the current higher rate environment. The impact of higher deposit cost was partially offset by higher yield and interest earning assets which increased 5 basis points during the quarter to 3.90% due primarily to new production we saw yields increase in the healthcare finance, consumer, commercial real estate and public finance portfolios. Looking ahead to the fourth quarter and beyond we expect a benefit from increased yields annual rate new originations re-pricing and variable rate assets and the impact of the asset hedging strategy as swaps hit their effective date. However, given the continued escalation in deposit pricing we are seeing in the market combined with our current deposit mix we would expect to see some moderate compression in our net interest margin for the fourth quarter probably in the range of 2 to 4 basis points. During the first and second quarters of 2019 we should expect to see net interest margin rebound in the range of 4 to 5 basis points per quarter. Turning to non- interest income, compared with the prior quarter our non-interest income declined 200,000 due primarily to lower revenue from mortgage banking activities as mandatory pipeline volumes were lower. In terms of product mix for the quarter 68% of [lock] volume was purchased business and 32% was refinanced. On a year-to-date basis mortgage revenue was off over 27% as home price appreciation and higher interest rates have impacted application volumes across the industry. With industry-wide origination volumes forecasted to decline we completed a thorough review of our business model to ensure that our mortgage business is efficient and profitable in the current lower volume environment. Some changes resulting from this review include the following. First, we have reduced mortgage staffing levels by 12% which is expected to produce annual savings in excess of 600,000. Second we reviewed our technology and our processes. Through the deployment of upgraded technology over the next several months we expect to improve the customer experience, streamline document collection and more effectively manage our lead generation sources. As a result we expect to lower the cost per closed loan and increase closed loan volume per loan officer and third we're increasing our focus on government programs mainly FHA and VA, year-to-date in 2018 20% of our origination volumes came from these programs as opposed to 10% in 2017 and we expect that percentage to increase further. Moving to expenses, we continue to have disciplined expense control and overall our noninterest expense decreased 137,000 from the second quarter mostly due to lower incentive compensation and medical claims experience in the salaries and benefits line-item and lower costs related to commercial other real estate owned. From a forward-looking perspective we do expect that the cost savings produced by the work force reduction in the mortgage group will be offset by staffing in other areas as we added bench strength in CRE, C&I and public finance as well as began adding experienced SBA personnel to begin building to that platform. Now turning to asset quality. Credit quality was again very solid with delinquencies 30 days or more past due representing 2 basis points of total loans are approximately 545,000 and our non-performing loans totaling 256,000 were flat at one basis point of total loans at the end of the third quarter. We continued to have minimal net charge offs which were 237,000 during the quarter or 4 basis points of average loans on an annualized basis. In general delinquencies and net charge offs were combined to the residential mortgage and consumer loan portfolios. Provision expense for the third quarter increased to 888,000 generally driven by the growth in the loan portfolio. Our allowance for loan losses the total loans was relatively stable at 67 basis points as of September 30, down one basis point from the prior quarter. Portfolio metrics continue to remain strong as the portfolio LTV in the single tenant lease financing book was 50% at quarter end and new origination came on with an average LTV of 49%. In the public finance portfolio almost 80% of the loans were made to borrowers with underlying credit ratings of BBB+ or better and over 52% of borrowers with the rating of A+ or better. Finally, I'd like to spend a few minutes discussing our capital position. While loan balances increased to $120 million during the quarter the overall balance sheet only grew $87 million or less than 3% as we deployed excess cash to fund a portion of the loan growth. As a result tangible common equity to tangible assets experienced only 7 basis points of compression ending the quarter at 8.85%. We are focused on deploying and managing capital strategically and profitably we also believe that due to the lower risk nature of our balance sheet we have the ability to stretch capital further than other comparable sized institutions. Since the launch of our public finance business in early 2017 we have seen our percentage of risk weighted assets to total assets declined. At quarter end we estimate this percentage to be approximately 70%. As a point of comparison the average percentage of risk weighted assets to total assets for publicly traded banks with total assets between $2.5 billion and $5 billion is 78% percent based on data as of June 30, 2018. With regard to asset quality as I discussed earlier our current ratio of non-performing loans to total loans is one basis point. When you add current troubled debt restructurings to non-performing loans that ratio bumps up to 3 basis points. The comparable average for similarly sized public banks is 85 basis points, again based on data as of June 30. Our current ratio of non-performing loans adjusted to include accruing TDRs is 18 basis points as compared to 72 basis points for the period. With the combination of lower risk assets and top quartile asset quality performance we feel comfortable taking tangible common equity the tangible assets down to 6.5% meaning our last equity offering in June provides capacity to handle a substantial amount of balance sheet growth. However to manage capital efficiently we'll explore opportunities to pursue loan sales when market conditions are favorable. We are currently in the process of working on a potential sale of single tenant lease financing loans totaling $21 million in the aggregate that if it gets done it should close in the fourth quarter. While pricing will be lower than prior sales the weighted average coupon of the pool is 4.4% as it consists of seasonal loans, as we are putting new single tenant loans in the range of 5.25% to 5.4% we feel that this is a good trade that will positively impact earnings and net interest margin in addition to managing balance sheet growth. And the last point I want to make on capital is that we continue to grow tangible book value per share. At quarter end tangible book value per share was $27.80 an increase of over $2 or over 8% year-over-year. With that I'm going to turn it back over to Kate so we can take your questions.

[Operator Instructions] The first question comes from Andrew Liesch of Sandler O'Neill. Please go ahead.

Hey everyone.

Good morning Andrew.

Can you just talk a little bit about your loan growth going forward 5% is certainly solid, I'm just kind of curious how are you managing loan growth versus internally generated capital and you certainly had positive comments in the release but just kind of curious for what your thoughts are with this 5% rate or could it be a little bit better?

I think as we look out to the forecast over the next quarter and beyond. I mean I think we feel good about what public finance has been doing, what single tenant has been doing, as you identified the growth itself is down a bit compared to prior periods as we've talked earlier about there's been some dynamics this year that have impacted the growth rate of the portfolio. Tax reform earlier in the year certainly impacted public financing to a certain extent the single tenant portfolio. Some of that tax reform continues to kind of work its way through the public financing the municipal market, although we may be at with rates rising up here recently we may have gotten to an inflection point on that. I think we feel pretty good about loan growth going forward. I think it's probably in terms of percentage growth I guess we're the law of large numbers is catching up with us a bit but I think we feel $120 million of growth during the quarter, we took what the market gave us that's kind of what we've done in the past. As we've talked about with investors and analysts in the past, we only whether it's single tenant or public finance we're only funding a small portion 10% to 20% of the deals we see, we maintain rate, we maintain structure there has been favorable dynamics in those areas over the past couple of years but it's slowed down a bit. I think we feel good. I think the number I threw out earlier in my prepared comments about 5% to 8% for next quarter is the range itself is going to be dependent on again the timing of funding. There's some seasonal factors that may impact the fourth quarter single tenant sometimes when the live companies have hit their [quarters] for the year, there may be an opportunity to grow balances in that space as competition diminished in the public finance space there's you have municipalities and government entities trying to get financing in place by the end of the year. So there could be some opportunities there to be on the higher end of that range. But I think in terms of like the dollar growth that we've seen over the past year or two it's probably consistent with what we expect. We have strong, we have high hopes for the healthcare finance business as well as Lendeavor gains traction in that space and gets grant gains, brand recognition and their pipelines are looking better every day. So even if single tenant in public finance are maybe not what they were last year, the consumer book is done well and healthcare and Lendeavor are doing well. So I think in terms of dollar amounts we are probably close to where we've been in the past couple years if we were to forecast for next year.

Okay.

Andrew, let me add a quick comment. That's the only area that I would add to in the C&I space, our team is just absolutely knocking it out of the park having some of the best quarters the last couple of quarters they've had since in putting the team together 7-8 years ago, but we're running a little bit in place. We've had some major pay off not by competitive forces or somebody out bidding those or anything of that nature. We've had some very large C&I clients that in the kind of economic situation we had up until yesterday sold their business and left. So C&I has actually hit all the sales targets we had forecasted for them at the beginning of the year but the net effect has been minimal because we've lost some large clients doing to the people selling the business. So that seems to be stabilizing. We don't anticipate any really big ones here into the fourth quarter. So maybe we'll see a little bit of uptake in C&I as well.

Okay. That's really helpful and then just shifting gears to the gain on sale revenue presumably there was just like with less mortgage activity. I'm just curious what your thoughts are on selling portfolio mortgages or single tenant leases advantage growth or concentrations and then also generate some current income?

Well, I mean as we mentioned we do have a sale in single tenant that we're working on that that should get if it comes together it will get done in the fourth quarter and we continue in the single tenant space we continue to talk to the loan sale desks and stay on top of market color as you guys know interest rates have risen over the past year. So it's, I guess the way that we look at it from a balance sheet management perspective new production could be sold fairly easily at a probably a pretty healthy premium but that's also going to be some of the highest coupon loans in the book. This sale that we're looking at here is really a great opportunity for us because it's a chance for us to get some of our lower yielding stuff that was originated 2, 3, 4 years ago in a lower interest rate environment and replaced that with new production in the low to mid five range. On the mortgage side, [resi] mortgage, portfolio mortgage we are always in discussions with certain parties to explore sales. We did a couple of sales last year and we continue to explore that. So we look at that and it's hard, that’s going to be based on market conditions and timing and obviously investor or other buyer appetite out there but we're always looking at just kind of hard to predict the timing of it.

Okay. Guys, thank you so much for taking my questions. I'll step back.

Thanks Andrew.

The next question is from Michael Perito of KBW. Please go ahead.

Good afternoon guys. Thanks for taking my questions.

Hey Mike.

I want to start with Ken maybe on the hedging strategy. I was wondering if you could maybe walk through the mechanics a little bit of what the specific drivers of the 4 to 5 basis point increase in margin in the first and second quarter and then also more broadly where do we kind of go from there, I mean I guess it's the hope of all this hedging activity to kind of remove the margin as a volatile variable and your income model and hold it steady or how do you see yourself positioned after that, initial rebound you expect on the early part of next year?

Yes, I mean the hedging strategy kind of from a big-picture perspective if you think about our asset classes, single tenant is a longer term fixed-rate product, although we obviously get a lot of equity up front and it's amortizing some of the consumer portfolios are longer-term, obviously mortgages and in the public finance loans by their nature are longer term as well. Really the only real variable rate asset generator we have today that's producing new assets is in C&I. So the ability to take advantage of the changes in hedge accounting and convert some of the public finance production into LIBOR based variable rate assets was an attractive opportunity for us. I think you look at it a couple different ways, one it just it adds asset sensitivity to a balance sheet where as I said earlier a lot of our organic engines we have in-house today are longer-term fixed-rate. It's certainly defensive against rising deposit costs. So it's, and obviously from a long-term interest rate risk management perspective as well it provides protection there. So I don't know if I'd characterize it as a better sale on rising interest rates per se but it's just to add asset sensitivity and make sure that our balance sheet is well positioned in an up rate environment.

Okay helpful. So I guess if I'm to summarize I mean, if short-term rates continue to move you feel at a minimum this will at least help you hold margin steady and then if short-term rates kind of stall out here, is there any negative impact from that or do you think at that point your margin would likely stabilize as well just –

No, I mean I think if short-term rates were to may be continue to climb but stall out a bit we might have some hedges that we put on this year, I mean these are simple three months LIBOR swaps where the receive side is three-month LIBOR and the pay side is what the swap rate is for that particular duration. Short-term rates were to not move here today. We probably have a number of swaps that the LIBOR hasn't reached that fixed rate. The forward curve has LIBOR continuing to move up but even if we got 25-35 basis points or so we'd probably be fairly neutral on the hedging strategy, but I guess the way that I look at it if short-term rates didn't move anymore just went up modestly but we got more slope back to the yield curve. That is beneficial to us and them as rising short rates and having variable rate assets. So there's a few different scenarios there were where NIM can expand in forward periods.

Got it. Helpful and then maybe switching over the comment in the release David about you still focused on opportunities diversify revenues I guess one where you guys kind of add in that regard, I mean, you guys raised the capital curious if there's anything getting closer in the pipeline that maybe you guys can announce per se but guide us towards the opportunities in your pipeline there and then but secondly I mean how broad is this deposit conversation guide, I mean we've seen some of your peers in this branchless bank vertical start to a white label partner with other larger firms and provide their kind of technology and digital platform as a service to those firms clients, I mean is that something you guys are exploring and I'm just curious generally speaking how broad the kind of deposit searches has gone at this point?

Michael, from that standpoint we're in same type of conversations with entities all across the country existing deposit stores using our platform to work on adding more feature functionality to their world just traditional pipelines of deposits that we have an experience in the past and also again from the capital side another the small business gains that we talked about as Ken mentioned in his comments we have already started building out some SBA internal capabilities here that we have not had in the past and anticipation of more SBA opportunity coming our way in a process hopefully at this quarter early first quarter. So, yes we're working both sides of the balance sheet, it's probably putting more effort on the deposit side than we have in the 19 year history of the organization and we're taking a lot of rocks over. We're seeing a lot of opportunities and its constant, we're working both sides of the balance sheet very heavily.

Thanks. Just one last one can you – you talked quite a bit about capital in your prepared remark, I'm sorry if I missed it but I heard you say generally speaking that you view on a relative basis, your capital ratios is able to lever down a bit further than peer given the lower balance sheet but did you actually provide or if not can you provide kind of range as a capital where you feel you're operating in kind of a efficient capital structure maybe not, I understand there's moving targets and it depends what growth looks like but just in an ideal world like where do you kind of see that sweet spot of where you want to operate?

Well, I think if we were, if we can grow and continue to execute on some of the strategic initiatives that we're working on and obviously you can't go into detail on a lot of that stuff and David mentioned some of that and get some things onboard and get that profitability up into the north of 100 basis points and in the 115, 120 ROA and we're self-sustaining with the risk profile we have, I mean I think we'd be comfortable running on a constant basis as TCE in the 7.5 to 7 range on a continual basis getting to the point of being self-sustaining on the capital side.

Got it. Make sense. Thank you guys for taking my questions. I appreciate it.

Thank you.

The next question is from Brad Berning of Craig-Hallum, please go ahead.

Good morning guys, so welcome to your first investor call. I appreciate it very much and so good color. On the deposit franchise building efforts congrats on the big meaty win there. Can you be a little bit more specific about the deposit franchise opportunities that you're seeing in the visibility on those to execute whether it will be in expanding the mini or whether there's other target markets in niches that you're looking at is just wondering if you could help us understand how visible is that effort?

The mini is big. Some of that is restricted here in the state of Indiana, for example municipalities have a requirement for particularly tax dollars to keep those within state based institutions, some other states have similar play, so it's a big opportunity right in our back door and obviously the big one that we have. We think we can leverage that through several municipalities here throughout the state of Indiana. We are looking at other states that don't have similar laws to what Indiana has as a play we continue to work on the HSA programs. We've worked up with a couple CPOs and different organizations to partner with them and getting HSA accounts out to their ultimate customers and employees. We've talked a number of times about trying to crack into the homeowners association market. We're looking at upscale opportunities, I mean we run the gamut we're out as I said earlier kicking up over every stone we can to come up with opportunities from the deposit side.

And then on the follow-up to the SBA comment. So it sounds like you're staffing up from an operational standpoint there. So I take it that you feel pretty good that you're going to be able to put some loans in early ‘19 or sometime during ‘19 to start adding fee income from that business model is that the right way to think about that?

Yes, just internally with what little effort that we put to it without going beyond that we've already turned up a $10 million pipeline within our existing base here today. We hope to add more here as I said earlier later in the quarter early first quarter we're anticipating that could easily bring us a $100 million plus an SBA originations in 2019.

And given the fee income and given the deposit work that you're doing help us understand your thoughts on ROE profile for the institution that you think about it on one 12 months, 24 months, 36 month kind of timeframe? How are you guys thinking about where do you want to get to.

Brad I think a lot of it just has to do with timing. I mean I think in kind of what the normalized capital basis, I mean I think there's no reason why we can't strive to have an ROE in the mid to high-teens. If we have everything on board and made some progress and some deposit initiatives obviously some of that you'd need a full quarter or a full year run rate but if we can get some of the good SBA on board some of the other things we're looking at some traction in the deposit world and had a full year run rate with that I mean you're probably talking in 18 to 24 months timeframe to really ramp it up to get the full benefit of all of that but we'd certainly want to be seeing incremental benefits on our way there.

No, that's very helpful. I appreciate it. Thanks a lot.

Thank you.

The next question is from [indiscernible]. Please go ahead.

Good afternoon guys.

Hey Joe.

Hey Joe.

So my question on the hedging strategy was asked just maybe one more on that maybe Ken if you could explain the genesis of the decision with the change in the accounting standard that made the hedging strategy more feasible and then also maybe walk through the mechanics of sort of the one-year delay and how that works from when you put the swaps on to when the benefits begin to kick in and sort of how that timing works maybe lay out for us when the bulk of these were put on.

Sure. Yes just without kind of going into the details of past guidance, previously hedge account it was very difficult to hedge amortizing or pre-payable assets and achieved the level of hedge effectiveness as measured as the accountants wanted you to measure it to maintain kind of that hedge accounting status. In my opinion the accounting bodies in the past corrected a long-overdue mistake with that in and kind of in the second, third quarter of last year finalized the guidance to make hedging, amortizing and pre-payable assets much easier and quite frankly what they did is they created a couple of new structures to hedge under and they made the hedge effectiveness testing much easier and in particular we've utilized two forms of the hedging in the accounting guidance. The first is called the last of layer approach and the second is called the partial term hedge. So in the public finance portfolio what we do with that is we use partial term hedges basically saying we hedge the asset not for the life of the asset but just for part of its life and then the public finance portfolio, the loans are very easy to hedge because a typical structure may be, it may have an 18 year maturity and a 10 year call meaning that the borrower can't prepay it until the call date. So what we can do from an accounting perspective and from an economic perspective is easily attach a simple three-months LIBOR swap to that loan through the call date. So in this instance if you had an 8 year or excuse me an 18 year loan with a 10 year call, we would put a swap on it to the call and then when the swap matures you're still left with an 8 year loan but something that's has already been partially amortized and probably has a weighted average life of less than four years and it's cash flowing very strongly. So that obviously makes it easier to reinvest cash and manage an interest rate risk there. So that's what we've been doing with the public finance loans. We've also utilized the last of layer structure in hedging certain long-dated, longer-dated acids in our securities portfolio namely municipal bonds and longer-term mortgage-backed securities. What you do with that is you take a pool of assets so you got a pool of a 100 million of assets that are amortizing and have pre-payable features what you do is if you have an average term in that portfolio of those assets of 10 years and you look at amortization schedules and throw a prepayment assumption on top, maybe you guess at the end of 5 years there might be $45 million left of that. Well then what you do is you hedge that $45 million hence the last of layer term. So we've done that in our securities portfolio and that's a form of hedging that would be appropriate if we wanted to go down the path and look at hedging a portion of the single tenant lease portfolio as well. The mechanics of the hedges are pretty easy. As I mentioned earlier they're just simple three-month LIBOR based swaps where we receive three months LIBOR and we pay the swap rate, so if we did a simple five year term today the five years swap rate is let's just call it 315 three months LIBOR is now close to 250. So if you put a swap in today that was effective today you would have a carrying cost there of 65 basis points if I'm doing my math right there. The difference between three months LIBOR and the five year swap rate, when I talk about the deferred start what you're able to do with some of these hedges is say you're going to let me go back to my example of the public finance loan with 18 year maturity and the 10 year call. If you had a wider divergence between say the three-month LIBOR and your 10-year swap rate but you felt that short term rates were increasing you could put a deferred start in meaning that one year from now or some point from now because not all of ours are one year starts we may line it up with the first interest payment date or the first principal date but at some point in the future that's when the swap really kicks in. So if you think that three months LIBOR is going up and the forward curve says it is what you can do is defer when the swap payments begin and get a little bit more convergence between three month LIBOR and your fixed rate.

Does that does that help Joe?

Yes, so that's really helpful color and I guess so the thought if you started this roughly a year ago I mean the bulk of these benefits should really start kicking in for you here in the fourth quarter first quarter second quarter in next year?

A year ago with we did one your deferred storage on the stuff we were doing a year ago Joe because the marketplaces talked about for two or three years since the [indiscernible] was going to do two, three, four, rate increases a year they wind up doing one or two. So we took the gambit that if they followed suit and one to two year one to two bumps this year we'd be in good position when you're out obviously the none three still talking about a fourth. So as the market if the Fed has stepped up the rate increases over the course of 2018 we shortened down the start term as Ken said a lot of the activity that we've had particularly in municipal markets we're taking it the swap will kick in at the first reset or first payment date and stuff. So some of those have been shortened from a one-year start date down to six nine months, so yes some of it will start to kick in here fourth-quarter first quarter next year and then six, twelve months out here we'll have 55% of the municipal portfolio is hedged and swap will all be in place at that point. So that's what we're talking about earlier that the pickup that we should have to 2019.

That's really helpful guys and other details on this stuff can be a little mind-- so appreciate the explanation. David on M&A, assuming that you wouldn't want to use your stock at these levels to do with you and also that you wouldn't want to issue capital to do a deal to stock price. So assuming I'm right on that do you still see opportunities out there if the stock price doesn't rebound here in the near term.

We do part of the activity that we're doing is lifting teams so and there'll be some assets that will come with it but it's not really acquisition of the company itself. So premiums are minimal, yes we think we've got a couple of opportunities that we have sufficient capital base today and sufficient cash that we could do a couple smaller opportunities have big potential upside in our world.

Okay and I know on the same token, I know you want to preserve a capital for growth potentially M&A down the line but in extreme circumstances like this if it's not closed at ‘18 on a book last night which would be opportunistic in terms of share repurchase for circumstances like this or is that not on your radar at this point?

We look at obviously all opportunities in front of us. I wouldn't put that one that's necessarily at the top of the list but if it stays down there and it's nothing else that has a better financial impact and return to shareholders comes about and it would be a consideration we're definitely looking at everything.

Okay, fair enough and then David you've had great success with the timing of the entries into the new business lines most recently with the municipal business. Any other areas that look particularly attractive, well actually you talked about that earlier but what sort of drive the decision-making process for you is that geography, is it a person or the team you're getting or is it the business line itself and then you go out and find the team to help you do that you're a sort of agnostics geography.

It's really a combination of all three of those Joe. So obviously the right people as we mentioned in my comments, I think the statement that our success over the last 20 years is finding the right people that can work in our kind of entrepreneurial space and opportunity. Something that we can do in a national footprint we obviously get economy scale gives us a much wider approach as we've done in the municipal markets and then the STL is in the consumer we bid on only 20% of the activity we see so we get a local institution that is going nuts on covenants or pricing we can walk away from it. So it really is a combination of all three the healthcare, it was built around the team the technology there time-to-market able to execute deals effectively efficiently we brought the national footprint to them, we started out kind of West Coast based, I think we're now in nine states across the U.S. they're about to sign a couple large national partnerships that could really kick start that one. The SBA program obviously is a national footprint unlike traditional C&I lending it's not as big in scope and scale there's ways you can do that on national a lot easier than you can do traditional C&I lending. So national footprint great team, great people and obviously bottom line opportunity SBA has not only good adjustable-rate assets they also have the income from sales and secondary market which would take some of the edge off the mortgage. So it's really all three points.

Okay great and last one for me Ken with the growth of some of these other areas and maybe the potential sale was $20 million or so single tenant like you talked about where would CRE concentration approximately a quarter end and you're targeting a certain level there?

I don't have the number in front of me right now I'm guessing it's probably going to be in the high 3s.

Just back then went up [indiscernible] Joe we just completed safety soundness again and I think we told you guys in the past we have regulatory blessing potentially carry that again based on the product that we're offering in the quality of the product we could go up to six times capital if we wanted to so, there's no concern about asset quality or concentration internally or externally from the regulatory focus on our CRE products.

Yes, I think I mean we include in our internal concentration, we include the owner-occupied in that regulator's exclude that when we include that we were 390 some odd percent at the end of the quarter, into the second quarter and I don't think that number would change materially and then you back out owner-occupied in your [indiscernible] in a half times, three six something like that.

But safe to say you guys operate with much higher levels in the past that you don't feel any need. This level or you're at now is fine. There is no sort of internal or external pressure into this to get that concentration levels lower.

No. None whatsoever.

Okay. Great. Thank you.

Thanks.

The next question is from John [indiscernible] Partners please go ahead.

Good afternoon guys.

Hey John.

Hey Ken, maybe just a couple quick ones the tax rate what would 10% -11% going forward or?

I think for the foreseeable future in the quarters that's probably good. For the benefit of everybody on the call I mean the effective tax rate is for us obviously it's driven and it's heavily impacted by the tax exempt income from the municipal lending business and the proportion of tax exempt revenue to taxable income. One thing with mortgage underperforming and producing lower revenue there that's I believe had an impact on that tax rate, but yes I think we're modeling internally for the foreseeable future in that 10% to 11% range.

Okay and then Ken on the only expense side you talked about some savings at a mortgage and then offset that with new hires, do you think sort of looking at 2019 you can keep total operating expense growth sort of low double digits 10% to 12%?

Yes, that's probably a good range. That's where we're looking at right now. Low double digits is where we're looking at right now.

Okay. Super. Thanks guys. Thanks for doing the call.

Yes, appreciate it.

Thanks John.

The next question is from Matt [indiscernible] Capital Management. Please go ahead.

Thank you, I was curious, want to delve a little deeper into the healthcare loans. First of can you remind me are those floating rate loans and then secondarily my other question is around the current growth that you're seeing with the, you talked about a really robust pipeline can we expect it to even accelerate from these types of quarterly levels that you are seeing here?

It will go – it will increase over what it's been through the course of this year. They're getting up to speed, we're anticipating next year that we're going to do somewhere in the range of probably $35 million to $50 million quarter, an opportunity it is mostly fixed-rate product what is coming to their market based on the 10-year term some of the newer deals we're starting to see a five-year reset on it. We also have an opportunity to do some build-out loans that have a much higher short-term yield term where that is adding new chair or new dentists to the practice and they need to do a build out for them some equipment leasing opportunity. So the bulk of the business is business acquisition or commercial real estate buying a practice in a building and that's on a 10-year term in 10 year amortization but we do see some opportunities over the next six to nine months to get into a little bit of equipment leasing with them and/or build out play that we will have a higher yield shorter return.

All right. Thank you.

The next question comes from Bill [indiscernible] Capital Management please go ahead.

Thank you. I'd like to circle back to your asset growth and how you reference the rate of growth will likely slow to simply due to the law of large numbers as a result of that are you anticipating in less capital raising activities, equity capital raising activities will take place or talk to that issue if you would please.

Hey Bill, well I think maybe just go back to my original comment in the script about capital and how we feel about our current position today. I mean I think with the current year-over-year growth and the dollar amounts probably being it's good a run rate as many to look at, I think that gives us a fair amount of time to before we'd be in a position to have to raise capital. So I don't – we don't have any capital raising plans imminent on the horizon. I think we feel like we have a lot of runway with the capital we have and obviously we have a number of things going on and number of strategic initiatives and well we don't think any of those may require capital today. It might accelerate growth in some area but everything that we're looking at are ways not only in terms of asset or deposit generation also additive to profitability and again moving that ROA, ROE far north of where they are today and again maybe hopefully getting to the position of being self-sustaining on capital.

Great. Thank you.

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

We'd just like to thank everybody for joining us for our first official earnings call. We look forward to speaking to all of you very soon. We appreciate your time today. Thank you very much.

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