SB Financial Group (SBFG) CEO Mark Klein on Q3 2018 Results - Earnings Call Transcript

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About: SB Financial Group, Inc. (SBFG)
by: SA Transcripts

SB Financial Group (NASDAQ:SBFG) Q3 2018 Earnings Conference Call October 19, 2018 11:00 AM ET

Executives

Melissa Martin - Investor Relations

Mark Klein - Chairman, President and Chief Executive Officer

Tony Cosentino - Chief Financial Officer

Jon Gathman - Senior Lending Officer

Analysts

Sean Tobin - FIG Partners

Operator

Good morning everyone and welcome to the SB Financial Groups Third Quarter 2018 Earnings Conference Call.

All participants will be in a listen-only mode. [Operator Instructions] After today's presentation there will be an opportunity to ask questions. [Operator Instructions] Please also note today's event is being recorded.

At this time, I would like to turn the conference call over to Ms. Melissa Martin, Investor Relations. Ma'am, please go ahead.

Melissa Martin

Good morning, everyone. I would like to remind you that this call is being broadcast live over the Internet and will be archived and available on our Web site at www.yoursbfinancial.com under Investor Relations.

Joining me today are Mark Klein, Chairman, President and CEO; Tony Cosentino, Chief Financial Officer; and Jon Gathman, Senior Lending Officer.

This call may contain forward-looking statements regarding SB Financial's performance, anticipated plans, operational results and objectives. Forward-looking statements are based on management's expectations and are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied on our call today.

We have identified a number of different factors within the forward-looking statements at the end of our earnings release, which you are encouraged to review. SB Financial undertakes no obligation to update any forward-looking statement except as required by law after the date of this call. In addition to the financial results presented in accordance with GAAP, this call will also contain certain non-GAAP financial measures.

I will now turn the call over to Mr. Klein.

Mark Klein

Thank you, Melissa and good morning everyone. Nice to have you all with us for our third quarter 2018 webcast. Our comments today are certainly supplemented by the earnings release we filed yesterday.

Highlights briefly for the quarter include net income of $3.1 million, 14.5% improvement over the prior year quarter representing a return on average assets now 1.3% or 3 basis point increase, diluted EPS for the quarter $0.39 per share representing a decrease of $0.01 per share or 1.7% from the linked quarter and $0.04 decrease or 9.3% from the prior year quarter primarily reflecting the implications of $30 million capital raise and 1.7 million additional common shares.

Trailing 12 months EPS now stand at $1.78, 20% improvement over the prior year of $1.48. Operating revenue expanded slightly over 2Q and year-to-date as of over $3.4 million or 10.3%. Loan balances expanded over $18 million or 2.44% on a linked quarter and nearly $96 million or 14.3% from the year ago quarter. Deposits were $36 million or 4.8% and over $72 million or 10% from the year ago quarter.

Expenses were up 2.45% from a linked quarter and up 6.1% from the prior year due to staffing needs and our regulatory and compliance areas. Mortgage origination volume was down $14 million or 13% from the June quarter and up nearly $6 million or 6.8% from the year ago quarter.

Asset quality metrics as with prior quarters continue to be a strength of ours. SBA loan volume slowed a bit due to some timing constraints and was down significantly to $897,000 or 78% from the year ago quarter. For the year, originations totaled $12.5 million down $400,000 from the prior year of $12.9 million or 3%.

As with prior quarters our results continued to reflect our level of commitment through five key strategic initiatives that revenue diversity that we seek for balance, organic growth for more scale to improve performance of broader product set in each household, customized service levels for operational excellence and of course asset quality that we speak of frequently.

First, revenue diversity. This quarter we delivered over 33% of our revenue from fee based business lines down slightly from the June quarter and a bit lower from the year ago quarter of 40% due to lower mortgage volume in sales and lower SBA loan sale gains. This quarter residential mortgage volume was down slightly as I mentioned including $6 million in variable rate products that flowed to our balance sheet and constrained loan sale gain. For the year, we have originated now $263 million compared to $244 million for the prior year. SBA lending was also a bit slower this quarter as I mentioned, but our year-to-date volume remains strong with $12.5 million in originations. We are now positioned better than ever with BDOS, Business Development Officers and Westlake, Columbus, Fort Wayne and Toledo.

Slight increases in mortgage rates, our year-to-date volume has increased 8% or $19.5 million in total originations. Historically, we've sold approximately 85% of our originations, but this year sales have declined to approximately 72% due in part to our competitive variable rate products that we offer that include construction lending and some private client products.

Mortgage production for the year has been consistent with prior quarters with Columbus originating $147 million, Defiance $71 million and Finley $45 million. We intend to continue to pursue our production goal levels of over $350 million in the purchase market as we had additional mortgage loan professionals. In fact, pleased to announce in September, we hired a seasoned executive in Indianapolis, organized a fourth regional mortgage production team. We expect to add 3 producers this year and another 3 producers in 2019 from this Central Indiana expansion. But the projected total of 30 mortgage loan producers across Ohio, Indiana and Michigan, our near term goal of producing $500 million annually is certainly within our sights.

Our SBA production continues to reflect the lumpy nature of loan sale gains that accompany this business line. This quarter we only sold $670,000 with $106,000 loan sale gains. However, our pipeline is very strong with over $11 million in process and another $3.5 million close and available for sale in the fourth quarter. In 2017, we nearly doubled our volume to nearly $16 million and this year we expect to improve on this success with approximately $19 million in total originations and $1.4 million in loan sales gains. This business line deliveries cost effective capital to businesses that are growing, improves our competitiveness and markets that clearly are growing and as diversity and stability to our bottom-line as growing.

Reorganized process workflow in the back room and a more conscious approach to business line, sales, leadership at the top as well as in each market. They are committed to achieving a top 100 producer status in the U.S. by 2020. Our wealth management business line continues to make meaningful contributions to our overall performance. This quarter revenue was in line with linked quarter just over $700,000 and year-to-date now stands at $2.8 million or $100,000 over our prior year-to-date number.

Growing this business line has certainly been challenging for us, but our prospects remain strong with additional seasoned talent in our newer higher growth markets of Fort Wayne, Finely and Westlake. In fact, we will be announcing a large increase in assets under management from the Cleveland market in the fourth quarter that will give us a great momentum as we enter 2019.

Our second key initiative remains to add scale and improve efficiency, organic balance sheet growth remained strong. This quarter we expand the total assets by 3.6% and improved our year-over-year growth to 13.8% representing a $119 million expansion. Loan growth came from each of our markets, Columbus $28 million, Defiance $23 million, Toledo $6 million, Lima $6 million and Finley $19 million.

Our decentralized seasoned executive driven model is hitting the target when it comes to identifying the job to be done for our clients in each of our unique markets. Audits also expanded again this quarter by $36.5 million or nearly 5% from the linked quarter and up from the prior year by $72.6 million or 10%. To ensure we continue to deliver appropriate liquidity levels for our operation as well as generate funding, proper duration and cost required to fund loan demand, we have launched an enterprise wide deposit gathering strategy. Not only have four dedicated treasury managers staff working with our commercial lenders, they are calling on businesses with higher liquidity levels. But also includes eight small business lenders combing the markets on the street where deposit rich commercial operations as well as.

Third is our strategy to develop deeper relationships. Our retail staff owns the onboarding process to new clients and the reboarding efforts to existing clients. The goal here is to communicate with the client at the time most appropriate using the channel most desired by the client. Our efforts are delivering results.

Our total households increased to 29,300 this quarter for an increase of 710 over a year end or 2.48%. Expanding the number of households and deepening our relationships in both new and existing households enable us to expand the number of products to our clients this year by over 1460 to over 59,000 or an increase of 2.5%. In addition, the number of services to our clients has also expanded by over 1300 this year to over 27300 or a 5.29% expansion. By expanding the number of products in our households, we drive organic balance sheet growth and expanding the number of services to those households sticky products. We improved the probability of servicing them for life.

Operational excellence remains our fourth theme. Even as mortgage production has slowed from recent quarters, we continue our growth trend of building a solid mortgage servicing portfolio over $263 million in total mortgage production I mentioned representing 1380 loans for the year. Over 95% of those loans reflect not only new business, but also a new household, The State Bank.

As a result, we now service nearly 7,500 mortgages an increase of 548 over the year ago quarter or 7.9%. Our servicing portfolio now stands at $1.07 billion up from $979 million in the year ago quarter. Rates have risen modestly this year, but our weighted average coupon and our portfolio of 3.91% ensures the stability of our nearly $3 million in annual servicing revenue.

Last month, I announced to our staff the restructuring of our IT and Operations Department. The initiative here was to allow our Chief Technology Innovation Officer Ernesto Gaytan to build a deeper bench with new team members and some new leadership to better align resources processes and priorities to drive operational excellence across the entire enterprise worthy of our clients continued trust and confidence. Under the direction of Mr. Gaytan, we intend to continue pursuing both organic balance sheet growth as well as M&A opportunities. A journey that will deliver a larger balance sheet and a larger residential servicing portfolio that today stands nearly $1 billion mark on to the $2 billion mark.

We continue to do the right things for the client by offering only the right products and services that best meet and exceed the clients' needs. This client centered consulting requires every one of our 250 staff members to work interdependently as we have discussed for a number of quarters.

As a result, and this client needs have led to over 820 solutions representing $71 million in additional household products. The prospect client needs diligently and recommend client solutions judiciously. To say differently, we want to provide 100% of everything the client needs and nothing of what they do not.

Our fifth and final initiative is asset quality, the continued strength of our company. Non-performing assets increased slightly to 0.35% past due loans consistent 0.24% and net charge-offs of just 6000 for the quarter and $41,000 for the year, our reserve to non-performing loans now stand at 256%. Overall, our portfolio metrics continue to be stable and favorable to peer and an accommodative operating environment. We're focused on stress testing credits as well as maintaining our robust loan approval standards and loan review scope that applies to any credit in excess of 350,000. Finally, we anticipate that the implementation of a data driven early detection system that we put in place a little over two years ago will enable us to look around the corner and better prepare for the next credit cycle now.

I'd now like to ask Tony Cosentino to give us a little more detail Tony on our quarterly performance.

Tony Cosentino

Thanks Mark. Good morning everyone.

Recapping our earnings as Mark highlighted. Net income of $3.1 million and $0.39 per share. Net income up from the prior year, but our EPS was down due to our first quarter capital raise which added $1.7 million new common shares. Also the impact of the 2017 tax cuts are reflected in the reduction in our federal tax rate from 29.1% in 2017 to 20.9% currently.

Some highlights for the quarter, operating revenue up 5% from the prior year flat from a linked quarter. Loan growth was up $96.6 million from September of last year or 14.3%. Loan sales delivered gains of $2.2 million from mortgage, small business and agriculture. Mortgage volume of $95.3 million was higher by 6.8% from the third quarter of 2017. And lastly, we continue to hold our non-performing assets steady with the NPA ratio at quarter end of 35 basis points.

As we break down further our third quarter income statement, we will begin with our margin. Net interest income was up from the prior year by 17% up 1.2% to the linked quarter. End of period loan balances from the prior year of $96.6 million and our average loan yield for the quarter of 4.95% increased by 35 basis points from the prior year. Overall, our earning asset yield was up 43 basis points to the prior year.

In addition to the balance sheet impact, we've had four rate increases that have affected our interest income this year and have driven yields higher. With 70% of our loans of a variable nature we will continue to see higher loan yields on average, but not necessarily increasing at the same pace that we are seeing funding costs rise.

On the funding side, we continue to experience an increase in the cost of our interest bearing liabilities, which came in at 1% for the quarter up 32 basis points from the prior year and 20 basis points from the linked quarter. Net interest margin at 3.96% was up 15 basis points from the prior year, but down from the linked quarter by 18 basis points. These variances were all due to the combination of higher deposit costs, loan growth and of course reduced fees from softer mortgage loan origination.

Total interest expense costs have risen by 60% from the prior year with a variance driven by volume and a new product strategy with our private banking clients. Loan activity has influenced margin income from the prior year with total loan interest income of $9.5 million up 24% which clearly $97 million of increased loan balance is a key driver booting $18 million this quarter and $46 million in the June quarter.

We have a strong loan pipeline and expect a growth level in Q4 in line with our third quarter production. Total non-interest income of $4.2 million was down from the prior year reflecting lower SBA gains and the sale in Q1 of '18 of our DCM Technology business. And the SBA rate of this quarter was not as predicted. We had a number of SBA credits that were delayed due to reporting and documentation issues. But we expect our fourth quarter production to be up significantly from the last two quarters. Because of the lower SBA production and the continued pressure on mortgage origination fee income as a percentage of total revenue was down to 33%.

For the quarter, mortgage originations of $95.3 million were up from the prior year by 6.1% or 6.8%. And for the last 12 months, we have originated $335 million in new originations. This quarter's new purchase volume remained high at 95%. Again this quarter we had more on balance sheet residential activity as our clients have chosen to do more of our arm product than our historical averages. We are looking at alternatives to move some portfolio product off our books in the fourth quarter to ease liquidity and to increase our percentage of sold product levels.

Total gains on sale from mortgage came in at $2.1 million, which was 2.6% on our sold volume of $81 million. Our servicing portfolio of $1.07 billion provided revenue for the quarter of $653,000 and is on pace to deliver $2.6 million to $2.8 million in total revenue in 2018.

The servicing portfolio has increased by $87 million or 8.9% from the prior year. Market value on our mortgage servicing rights remain level past quarter. Our calculated fair value of 117 basis points was up 9 basis points for the prior year, but did result in $62,000 impairment.

At September 30, 2018, our mortgage servicing rights were $11.1 million up 16% from the third quarter of '17 and up 5% from the June '18 quarter. Our total temporary impairment remaining is $143,000.

In the quarter, operating expenses of $8.8 million were $0.5 million or 6.1% and compared to linked quarter expenses were up just slightly $0.2 million. The expense growth from the prior year is all from increased compensation and employee benefit expense. We have added 13 professionals to our company to supplement our SBA and mortgage sales efforts. And as our company has grown, we have added -- also added necessary resources and operations and risk management.

On a year-to-date basis, operating expenses were up 10.8% reflecting operating activity as well as the sale of our DCM business in Q1 and the tax initiatives that we've distributed also in the first quarter.

As we turn to the balance sheet, loan outstandings at September 30 stood at $772 million which was 79% of the total assets of the company. We had growth of $97 million from the prior year and up $18 million for the linked quarter. Compared to the prior year, our loan book grew in every category led by commercial real estate with $36.8 million followed closely by residential real estate at $36.7 million.

On the deposit side, we were up from the prior year by $72.6 million which is a 10.1% percent growth rate and up from the linked quarter by 36.5 or 4.8%. Included in our deposit and interest expense growth was our effort to expand our services with our private client customer base. We embarked on an aggressively priced money market product that added $20 million in deposits during the quarter. We expect the growth and expense level for that product to stabilize at their current level going forward.

As we discussed last quarter, we have been fully utilizing our balance sheet to fund our mid teens percentage loan growth. While our loan to deposit ratio is pulled back a bit this quarter to 98% from the 100% level last quarter. It is still very high for us historically. In addition, with deposit pricing rising and all of our markets competition has certainly elevated.

We forecast that our deposit costs will continue to rise but at a slower rate than experienced in third quarter of 2018.

Looking at our capital position. We finished the quarter at $127 million up $36 million or 39.8% from the prior year. We continue to be pleased with the added liquidity and sponsorship of our shares after the completion of our capital raise in February. The equity to asset ratio of 13% was also up significantly from the prior year.

As we look at asset quality, total non-performing assets now stand at 3.4 million or 0.35% of total assets. The total level of non-performing assets is down 0.3 million from the prior year but up just 0.2 million to the linked quarter. Included in our non-performing asset total was 0.9 million in accruing restructured credit. These restructured loans which are nearly all maturity extensions elevate our non-performing level by 10 basis points and absent these our total non-performing asset ratio would be just 25 basis points.

Provision expense in the quarter was zero equal to the level from the third quarter of 2017. Year-to-date, we have set aside 600,000 provision compared to 200,000 in year-to-date 2017. We had loan losses in the quarter of just 6000. As we look at our absolute level of loan loss allowance, it stands at $8.5 million up from the prior year by $0.7 million or 9.4%. Primarily due to loan growth our allowance to total loans percentage has declined from 1.2% at the prior year to 1.1% currently. This allowance level still places at the median of our peer group which is where we anticipate landing as we move forward.

We now have NPL coverage with our allowance of 256% compared to 213% at September of the prior year.

In summary, a good quarter and our year-to-date performance has been strong with net income of 8.7 million up 23%. When we look at our pretax prevision income number we are still up 9% from the prior year-to-date and with all assets under our care increasing to $2.5 billion. I will now turn the call back over to Mark.

Mark Klein

Thank you, Tony.

This quarter we continued to perform at a high level and were proud of the quarter that we've revealed. Highlighting our performance, again, was our double-digit expansion in net income reflecting 1.3% ROA driven by year-over-year loan growth of $97 million as Tony mentioned deposit growth of $72 million and $95 million in residential loan production.

Our performance through the third quarter has positioned us quite well for a strong finish to the year. Our commercial pipeline stands at over $17 million. Our SBA pipeline reveals strength for the final quarter and residential real estate lending has transitioned clearly to the purchase market with great momentum.

Our challenges will be to drive expansion of the liability side of the balance sheet to fund our loan growth at the margin given our 98% loan to deposit ratio as Tony mentioned. Our local and regional economies remain strong and clearly in concert with our intent to drive greater scale leading to improved efficiency and high performance.

And I'll turn the call back to Melissa for questions and answers.

Melissa Martin

Thank you, Mark. Operator we're now ready for our first question.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today comes from Sean Tobin from FIG Partners. Please go ahead with your question.

Sean Tobin

Thank you. Good morning.

Mark Klein

Good morning, Sean. Nice to have you with us.

Sean Tobin

Starting with loan growth. Third quarter loan growth was very healthy at 10% like annualized. Can you talk a little more about the pipeline, is it up or down from last quarter? And is there any change to your outlook for the low double-digit loan growth going forward?

Mark Klein

Jon?

Jon Gathman

No, Sean. I would say our pipeline is -- it's pretty level from last quarter for the fourth quarter. We have a number of new facilities we've approved and a number of draw notes that we'll continue to draw out here through the fourth quarter and into the first quarter of next year on some large construction projects we have done. The only challenge I see going forward because the real estate market is so good we have a number of investors and commercial real estate selling properties at gains that presumably they'll redeploy and we'll do the next loan for them as well.

But we're beginning to see some turnover of the commercial real estate again because the market is so good. I fully anticipate our pipeline will be relatively stable from the third quarter here into fourth quarter.

Mark Klein

And Sean, just a just a follow-up comment, as we've claimed for a number of quarters with our '16, '17 commercial lenders not including the SBA lenders, we're clearly built for growth and we expect to continue our ascent in that definitely high single-digit, low double-digit expansion levels.

Sean Tobin

Awesome, awesome. Thank you. And I know you touched a little on CRE what loan segments do you expect to drive growth. I know you spoke of the diversifying loan portfolio more specifically to C&I segment of the portfolio. Is that still the case?

Jon Gathman

This is Jon. Sean, no absolutely. In fact, we put a number of initiatives here in '18 like changes in incentive plan, changes in calling efforts, changes in personnel and where they're targeted. And we were going to amplify that here again in 2019. We've begun to see some fruits of that labor particularly as we're focused on in that C&I segment manufacturing small businesses in particular and things we've talked about in previous quarters. We've also restructured our retail side to include eight new business bankers that are all finding small business loans which tend obviously to be C&I deals as well. So that continues to be our focus here for the remainder of '18 and 2019.

Sean Tobin

All right. Okay. You mentioned last quarter some projects that you still expected to fund up. Did that occur this quarter? And is there more expected in the fourth quarter?

Jon Gathman

Yes. I mentioned earlier Sean that, yes, we have 2 -- 3 large projects in particular. One was delayed very nice C&I ideal as a matter of fact that was delayed because the customer is doing so well. They utilized their own cash so that delayed a little bit of when they'll start growing. But those three large projects which probably totaled somewhere around $15 million to $20 million between the three are growing as we speak and I anticipate now for fourth quarter to first quarter of 2019.

Sean Tobin

Okay, great. Can you talk about your operating markets geography? Sorry, which ones are stronger and weaker today as it defines more specifically Defiance, Columbus and Toledo? Which ones are stronger and weaker today?

Jon Gathman

In terms of loan growth Sean?

Sean Tobin

Yes, sorry.

Jon Gathman

I think so far this year we've seen a fair amount of our loan growth from -- I mean the two leading markets are Columbus and Defiance. Columbus is historically here in the last three, four years has been our strongest loan growth category or region. Certainly, we've had some nice growth from Finley, Toledo as well. In the fourth quarter looking at the pipeline interestingly that growth will be in two different markets. I think we'll see a lot of growth, some of those drawn outs we talked about earlier will be in the Fort Wayne and Lima markets. So a fair amount of diversity in terms where growth coming from here into 2018.

Sean Tobin

Okay. And then, switch fronts to the deposit side, deposits increased about 20% linked quarter annualized. Can you talk about what's driving that strength? Last quarter you mentioned implementing new strategies, I know you touched in the beginning of the call. Is that gaining traction?

Mark Klein

Well, as we mentioned before Sean, obviously, getting up to the 90 plus percentile loan to deposit. We've known for a period of time that we needed to drive the C&I portfolio. And with that transactional account, but we've also determined that a private client group and our private client portfolio can certainly grow by increasing those deposit rates and we knew that if we increased deposit rates, we need to increase the scale of the portfolio and we have to make up for lost margin.

So we've had a more conscious focused approach on deposits including from the commercial C&I. But as I mentioned with four treasury management individuals on the street literally all the time seeking to find businesses with high liquidity propensity as well as our eight individuals that we really removed from the retail operating arena and the office and moved them on the street. So we certainly expect to continue to drive the funding for our imminent loan growth that Jon has mentioned that is embedded in our existing draw notes as well as what's in the pipeline to be approved yet.

Sean Tobin

All right. Okay. And then, in terms of, obviously, it depends on the type but in terms of retail you guys offering any new rates on new money in terms of deposits and funding?

Mark Klein

Well, we certainly paid attention to our marginal cost and we love keeping it at the margin, but recent -- again giving in fact we're close to 100% mark. We've had to do what we need to do to find the liquidity and in addition to the CDs that are well into the 2% mark we launched 185 on a private client money market account which was a very competitive rate. But that now is kind of okay. So we look certainly for our cost to continue the beta on our deposits relative to competition. Certainly well above the one mark because again we just don't have much room to not grow deposits given the loan demand that we've seen. So we were optimistic that we can find those deposits and of recent note would be some large regional banks that are exiting some of our markets. So we've launched a couple [indiscernible] in several markets that we think we can continue to gain some traction albeit on deposits because that's what they're primarily comprised of because they don't have much in the way of lending opportunities and some of those higher share lower growth markets that we have had for a number of years.

Sean Tobin

Definitely. And then, your deposit outlook for 2019 going forward? Can you give a little more color on that in terms of growth?

Mark Klein

Yes. Just at a high level again with -- our beta as being greater than competition. We've always said that we're poised for a rising rate and we think we have a good mix that if yield curve steepens and rates rise certainly the economy is doing well and commercial will be driven nicely with expanding economy as we've seen, unfortunately will be met a little bit by a softening real estate market. So we continue to be optimistic that we can find the deposits albeit a number that's well in excess of our marginal cost. But it's out there and we think we can find it and we think we have some great strategies and some great people that are now on the street looking specifically not for loans. We've got the '17 lenders out there looking for loans. Now it's a matter of gearing up the staff for the liability side growth of the balance sheet.

Sean Tobin

Awesome. That's very helpful. Switching gears, I guess the margin, loan yields were flat to slightly down linked quarter. Was this related to mortgage or fees?

Jon Gathman

It was obviously a mortgage fee level has an impact on our loan fees. I'm sorry on our loan yields. I think we've really stabilized really on the loan yield side, we'll continue to see slight increases but pricing is a little stickier in some of our markets on the loan side. So we're continuing to try to drive that. But I think they'll stay on this relative range for sometime.

Sean Tobin

Okay. And then on that topic of loan pricing what type of rates are you seeing on new production today versus existing yields? And my guess is it looks like it has intensified.

Mark Klein

I think competition generally is -- loan growth strong enough that I don't know that pricing has been a significant issue, but certainly there are -- particularly this -- the non regional banks, the community banks in our various markets have been, yes.

Sean Tobin

Okay. And then there's been a lot of volatility in your margin over the last few quarters. How should we think about the margin over the next several quarters given strong outlook for loan growth and continued funding cost pressure?

Jon Gathman

I think that's absolutely the case. I mean I think as I said last quarter in our call, the 415 for the quarter was over sized given the impact of the capital raise in getting above 100% loan to deposit. I would suspect we're going to stay in the same range on a loan to deposit ratio high 90s, deposit costs will continue to rise but they're not going to rise to the level they've risen in the last two quarters on a percentage basis.

And as I said, I think loans are going to be sticky I would expect to stay in this same 3.85 to 3.95 range for margin for the near term.

Mark Klein

Now Sean just one additional comment and Jon can certainly allude to this, but several years ago we began offering swap products to make sure that that we continue to appreciate and realize the benefits of a steepening yield curve and raising rates and how much is our notional risk Jon that we have had that we've kept those on a verbal basis on a spirit of writing the yield curve, but also leaving some basis points on the table because we didn't take a fixed yield and put it on the books and actually make a wider margin on the spirit of taking more duration risk.

Jon Gathman

I think it's just approximately $40 million and as he pointed out Mark, I mean two benefits there, the yield curve is so flat right now that the cost of the hardware to go out 10 years versus five or even 15 versus 10 is minimal and we get the upside because if customers in different raising rate environment in that situation. So yes, we have some very nice increases we've seen here with LIBOR and prime rate increases recently as those continue to move up.

Mark Klein

So we're happy with our positioning there and our clients one and we've got verbal products again are increasing as the yield curve increases and those have been good for us as I mentioned the client.

Sean Tobin

Okay. How much of your portfolio is variable rate, is it tied to prime or LIBOR?

Tony Cosentino

It's in the mid to high 60s about 70% is variable.

Mark Klein

That's our current portfolio. We have another [$34 million] [ph] of undrawn lines that are in that same -- and again that's combining primarily home equity loans and CNI lines of credit.

Sean Tobin

Okay, good. Can you provide an update on mortgage outlook given the current raising rate environment?

Mark Klein

Well, again, our variable has not been -- our number, our variable has been the number of producers knowingly that refinancing have obviously going away in every market that we're in, which is why 95% of what we do is all purchase market and definitely all new to us, 5% would be about the refinancings internally that we have. But clearly, now going into Indianapolis with the team down there, which will make four regional teams and some pretty robust markets. Our expectations of that 350 million to 400 million number going forward. And clearly that 500 number we thought were going to be there back in '16 and things softened a bit in '17 with no inventory.

But we remain steadfast on delivering the $500 million in volume per year. Again not because our individuals that we currently have are going to do 20% more but it's because we're going to have 20% more producers. And as I mentioned with a total of 30 in our markets in three states we remain fairly bullish on growing not only the volume, but the servicing portfolio that is taking us 10 years to get to a billion and I don't think it's going to take quite as long and obviously to get to the $2 billion mark. But not only do we like the loan sale gains, but we certainly love getting into one more household. And our job is to try to get the service for household certainly in excess of the 1.5 to 1.6 we currently have on up in the 2 and 3 and we work hard to the retail staff to get that done, still work on.

Sean Tobin

Okay. And then, specifically in terms of mortgage origination, how should we think about that in the fourth quarter and then for the rest of 2019 or [indiscernible]?

Tony Cosentino

Yes. Sure, Sean. This is Tony. Our initial expectation on Q4 it's going to be similar to where we were in Q4 of '17. That kind of level of origination would put us up call it 5% to 7% on a year-over-year basis kind of contrast that with what we're seeing in the market which is probably a down mid teens type level for other originators.

I think we've seen that some of those fringe players have left the market. We've been able to capture market share and we've been able to capture more market share by adding more people on the street. And I think our expectation is for '19 is a similar type growth level like that high single digits to low double-digit type as we sit here today.

Mark Klein

What's kept us in, Mark, Sean also -- and I'm sure you're aware of it. We've certainly been aggressive on the construction front given the fact that there's no one doing spec loans anymore and there are certainly no one's ever heard of a loan and development of loans anymore or lot in development loans anymore. So we decided to take a position on trying to attack some of those opportunities in the construction market all be them individually. And we found some great traction there. I think we have probably $40 million or so in construction projects. So we've kind of mitigated the downside of not having a development or spec kind of loan product which nobody's doing anymore. So those will work nicely for us and those eventually find the way to this whole portfolio. So that was a good strategy, we launched about a year and a half ago or two.

Sean Tobin

Okay. That's very helpful. And then, mortgage sales picked up to 84% this quarter from 72% last quarter. Do you expect that to moderate going forward?

Mark Klein

We've historically been in kind of the mid 80s range. We saw some improvement this year from what had been kind of a down year this year. I think we have to acknowledge that the customer has become more confident in taking the arm product which has landed a bit more on our balance sheet. And we've been very successful this year in the private client market, which has added a bit more on balance sheet growth to us less of a sales function.

I think we will continue to look at opportunities to monetize some of those balances and see if we can potentially for liquidity purposes and/or pipeline move some of those off of our balance sheet but that'll be an ongoing strategy for us.

Sean Tobin

Right. Okay. And then, on the M&A from, could you talk about your outlook on M&A? Last quarter you indicated you need to get through your 2018 compliance exam, has that wrapped up? And if so, can you provide us an update on your thoughts regarding M&A outlook going forward?

Mark Klein

Sure. Sean the compliance exam was to be wrapped up at the end of September per regulator commitment they readily admit which really doesn't do much for us that they didn't meet the timeline or the hurdle. And so now they've recommitted here to finish this up in October. We continue to be optimistic about the resolution of any issues that we have on the consumer compliance side that we have 100% complied. We've done it timely; we've done it thoroughly. And they've acknowledged all that and in fact, self reporting certainly is worthy and they notate that.

So we're expecting to have that wrapped up here this month and certainly pending that would be the impetus to continuing conversations with banks that are in the area that we've strategically identified that would be of high interest to us in expanding our footprint both in marketing and adjacent markets. So while we've grown organically nicely the last five years 250 million, which we think is the most prudent way to grow our company certainly doesn't eliminate the opportunities on M&A. And clearly to get to that $2 billion mark any time soon, it's going to take two or three of those acquisitions and we continue to work at that. Again albeit a bit constrained with regulatory conversations as we speak. But we do not expect those to play guess on the long-term here.

Sean Tobin

Thank you. And then, I guess just lastly on the provision, provision was zero this quarter. Can you give us any outlook going forward on that?

Tony Cosentino

Absolutely. I think as we've looked at the improvement in our portfolio, the level of absolute relative charge offs, we felt like the level of provision, our allowances up close to 10% with the loan growth level, call it 14% on a year-over-year basis. And I think we felt like that that was a prudent level. I would guess we're still going to be in the range when we finish the year of somewhere close to $1 million in total provision expense somewhere around that range, $800,000 to $1 million. And I think as we look forward into '19, we're going to try to keep pace somewhere in that range not grow to the full level of loan growth, but something probably 60% to 70% of our loan growth levels.

Sean Tobin

Okay. Awesome. All right. Thanks for taking all my questions. Great quarter guys.

Mark Klein

Thanks for joining us on Sean. Appreciate it.

Operator

[Operator Instructions] Our next question comes from [indiscernible]. Please go ahead with your question.

Unidentified Analyst

Hi, Mark. Hi, Tony. Actually I have a question regarding you mentioned the data driven early detection system of loan performance.

Mark Klein

I'm sorry. Can you speak up little? I'm sorry we can't seem to gather your question well.

Unidentified Analyst

Hi. Sorry. You mentioned a data driven early detection system for loan performance. Could you speak a little bit more on that?

Tony Cosentino

Jon?

Jon Gathman

Sure, Tony. This is Jon. We purchased a number of years ago through Baker Hill a module that they have that rescores our portfolio on a quarterly basis. So it's the same -- it's the same data they use for small business loans. But it also applies to larger business loans. And really what it does is, it develops a base line then you look for changes from the baseline and/or it analyzes changes in other data and said our core for instance checking accounts, line of credit usage, overdrafts things like that. And the idea of their system is, is to forewarn you of those things align overdraft that could potentially give you an early indication that something has changed with the credit. We're looking at that every quarter and in fact we've integrated that as well into our loan review process. Our loan review officer is also keeping track of that score trend over time and we intend to use that to focus -- further focus our loan review process on those credits that that system divulges perhaps a potential weaknesses.

Unidentified Analyst

Okay. That's great. How has that influenced the provision or has it influenced the provision at all yet?

Jon Gathman

Well, at this point I would say it hasn't only because it hasn't really detected anything significant. Our asset quality is very, very good. I would anticipate, they going forward in a little different economic cycle perhaps that we would use that data perhaps to drive some particular with [Cecil] [ph] some looking around the corner so to speak in terms of our provision levels.

Unidentified Analyst

Okay, great. And then, changing to the deposit side. You mentioned that deposit costs will stabilize. Can you talk a little bit about the indicators that you're seeing that deposit costs will stabilize?

Tony Cosentino

What I was referencing is that we added call it 20 million to 25 million in a private client type product at a fairly high rate in the quarter. I wouldn't expect obviously our rates to dramatically increase in that product or the level of balances in that product. So from that perspective I think that had an outside impact on our interest expense costs specifically in the quarter. Clearly, the deposit market is moving but we've seen some stabilization. I mean it's kind of been a bit step -- more stair step than a kind of a gradual increase. So I still think fourth quarter, it'll be more stable certainly than it has been in the prior two.

Mark Klein

And Tony just an extra comment. We do have some strategies that I don't want to speak publicly about yet, but we do have some strategies to be a little more innovative in the deposit gathering arenas and all of our markets. And we're going to be rolling some of that out here in the fourth quarter that certainly will put us in a more competitive position and we think.

Unidentified Analyst

Okay. That's great to hear. That's all I have. Thank you very much.

Mark Klein

Thank you.

Tony Cosentino

Thank you.

Operator

And ladies and gentlemen, at this time we reach the end of today's question-and-answer session. I'd like to turn the conference call back over to Mark Klein for any closing remarks.

Mark Klein

Again thank you all for joining us. It was a pleasure talking with you here and reporting our third quarter results and we certainly look forward to chatting with you in January for our entire 2018 year result. Again, thanks for joining us and I will talk soon.

Operator

Ladies and gentlemen that does conclude today's conference call. Again, thank you for attending. You may now disconnect your lines.