Midwestone Financial Group Inc (IOWA) (MOFG) 2011 Q4 法說會逐字稿

Good afternoon, and welcome to the MidWestOne Financial Group Inc. fourth quarter earnings release conference call. All participants will be in listen-only mode. (Operator Instructions) After today's presentation there will be an opportunity to ask questions. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Mr. Charles Funk. Please go ahead, sir.

Thank you, Denise, and thank you for joining us today. As we always will on these calls, I want to start out with the reminder that the comments today could contain forward-looking statements that are based on management's existing expectations. The statements are not a guarantee of future performance and results may differed materially from those projected. And as always, we ask you to refer to our SEC filings for a full discussion of the Company's risk factors. I will also begin by saying that this is our first call and next month we will release earnings a bit sooner than an hour before, so any inconvenience that caused today, we apologize.

I won't repeat, and I'm sure you're all happy that I won't repeat, word for word our earnings statement. I will go over a couple of highlights, and then we'll have plenty of time for questions and answers. There is no question we're very pleased with our full-year of earnings, the $1.47 per share, and we're very pleased that sets an all-time record for our Company in its 77-year history. The previous record was $1.39 per share in 2004. We're not where we want to be yet, but clearly we're making progress. And I think, when you look back to the merger in 2007, 2008, we have been through a lot, and to reward our shareholders with record earnings we think is the highlight of the year.

A little bit about our fourth quarter earnings, we were a little bit short of where we were in the third quarter, and I think there are several reasons for that. First and foremost, the loan pools had not a very good quarter in quarter four. We also took the opportunity toward the end of the year to write down one of our OREO properties. We wrote off all of the goodwill from MidWestOne Insurance and we wrote off most of the purchased accounting from our merger on a number of buildings and properties that we own, bank buildings and properties that we own. So, you can find all of those, and it works out to I think most of the shortfall to the third quarter.

I think one of the key things for the year was our balance sheet growth. I think a year ago, if you would have told me that we were going to have 7% plus balance sheet growth, I wouldn't have believed that. We were thinking more in the lines of 3% to 4%. With the balance sheet growth, I think the deposit growth was a little over 7% as well. It was important that we increase our loans, especially in the last six months of the year, we began to see loan demand in our footprint and especially in the last quarter, we saw some nice increases in our loan totals. I think Kent can talk more about that in a few minutes, if you like.

I think the increase came from three major sectors. The healthcare industry, specifically hospitals. We have been involved in several hospital loans, and when you look at the balance sheets, at least the ones we've seen in that sector, they appear to be pretty strong and we think have been good opportunities for us. Also, assisted living has been good to us over the last six months, and we had one hotel loan that we put on the books of some size. So, I think those three categories in particular would account for much of the loan growth.

The Ag economy, as you all know, remains very strong and we're now in the renewal season for Ag lines. And a couple of things, comments, I think the balance sheets that we see continue to be stronger as farmers continue to make good profits. The competition is very keen. Other banks are out looking for business, and farm credit remains a very, very fierce competitor, and that is something that we've seen the last several years. Overall, the Iowa economy appears to be doing reasonably well. The last unemployment rate in Iowa that was announced was 5.6%, and that is the lowest since December of 2009. So, I think that accounts for a lot of the reason for our good credit quality numbers, which is a good segue to talk a bit about our credit quality. It is the best it has been in a while.

At year-end, the MPAs were at 1.84%, you know, down from over 2% a year ago. We continue to be very pleased by the net charge-offs at 30 basis points. And I do want to remind everybody that, you know, we went through 2008, 2009 and 2010 and never did charge-off more than 50 basis points of our loan portfolio on a net charge-off basis. So, back down at 30 basis points, I think is really, really good performance. Also very, very happy about the coverage in our loan loss reserve of 86.6%. That's the highest it's been in a while, and we feel very good about that. And our 30 to 89 day past dues came down to about $7 million, and we can talk about that a little bit more if you like in the Q&A. I think Kent would tell you, that might be pretty close to a floor for our Company, but at $7 million, I think that reflects good performance.

A couple of concerns that I have. The first one would be, you know, the loan pools had a yield of 0.05%. That is 5 basis points. That's an all-in yield for the quarter. It was 1.85% a year ago. That's the bad news. The good news is that the loan pools are down to about $50 million in total right now. They were $66 million a year ago. And at $50 million, they're just under 3% of our total assets. Those of you who followed our Company for a while will remember that right after the merger, they represented close to 7%, 7.5% of our total assets. A year ago they were 4.2%, now they're just under 3%. And I will remind everyone we continue to be on a path to exit that line of business.

One other concern is in the service charge line, you will see our service charges were down for the fourth quarter. I think that's something that I've seen in most banks' earnings releases for the fourth quarter. That's purely from, I think, the regulatory pronouncements on overdrafts, as well as some of the regulations from Dodd Frank that are starting to filter in. Capital management, I think we're very pleased to have been able to repurchase 102,000 shares, basically, in the last six months of 2011. The share repurchase continues ahead, and the dividend increase, which we announced last week, really does put us in line with our -- the payout percentages that we've identified from a strategic point of view. It's the low end of our range, but the current payout, if you apply it to our 2011 earnings, is roughly 23% of earnings.

One of the things we've talked about is that several -- maybe little over a year ago, maybe 18 months ago, we moved the state's resources or the loan pool OREO to the holding Company. So, we've really begun to focus on the performance of MidWestOne Bank. I'll talk about that through three quarters, because we haven't filed a call report yet, but the fourth quarter numbers won't be materially different from that which we experienced over the first three quarters. We think that when you look at our bank, it represents the way our Company will look in the future once we're out of the loan pool business. And consistently, the bank has been able to do just under 1% ROA, just under 11% return on tangible equity. One of the things I'm most excited about is that our efficiency ratio has been running in the [fifty-nines] for the MidWestOne Bank. I just think we continue to have to focus on the bank, because that's really what our Company will look like in the future. That's really all I have. I have in the room our Chief Operating Officer, Sue Evans, I have Gary Ortale, our Chief Financial Officer and Kent Jehle, our Chief Credit Officer. And I will be happy to -- we will be happy to entertain questions, so I'll turn it back to you, Denise.

Thank you. We will now begin the question-and-answer session. (Operator Instructions) At this time, we will pause momentarily to assemble our roster. Brad Milsaps of Sandler O'Neill.

Hey, Charlie, had some really nice loan growth during the quarter. Just see if you could maybe talk about that a little bit more, what pricing you're seeing? How you feel you're set up as you enter 2012.

I would say, and Kent can jump in if I leave something out, I would say pricing is very competitive. It is especially competitive on things that are five years and less. I will also tell you, we let a couple of things go, because we didn't think the pricing really fit with our criteria. The key, as we've said before is, to see what happens to the operating lines in the AG renewals season because a lot of our floors have been set at 4.75% and 5%. We've seen a few deals where we have been able to keep the floors. We've seen others where they have been -- gone down perhaps 25 to 50 basis points, but not anymore than that. So, 4.25% to 4.5%, and probably a quarter from now, we'll have a better idea of how that all shakes out.

Brad, the only thing I would add from a pipeline perspective, I think it's comparable to what we've seen the last few months of the year. So, we continue to look forward to 2012 as well. But the other thing you need to remember is we will be in our transition time, as Charlie alluded to, that will see our 2011 AG operating lines being paid off here in the first quarter and into the second quarter as the -- our customers sell their grain. So, there will be a net effect of that going forward.

Okay. I was just going to see if you guys could -- or Gary, spend a moment on operating expenses. If you could maybe break out some of those one-time items that you talked about. I assume some of that showed up in the occupancy line item. If you could maybe break that out for us, it would be helpful and determine the run rate going forward.

Yes, sure, Brad. Charlie did a pretty good job of explaining of what most of those were, and as he did mention, he mentioned the OREO charge-off. Maybe covering the other operating expense items first. What went through that category was the OREO write-down on a property of a significant amount, roughly $100,000. We also charged off or impaired to goodwill, if you recall, the Company purchased an insurance agency in the fourth quarter of 2008, Butler Brown. There was a goodwill established at that time, also in the $100,000 range that we have subsequently now charged off, just because of the level of earnings from that have not, lived up to the expectations at that time. So, there was a charge for that.

Then, there was just a multitude of other OREO related expenses and even some fraud that was experienced during the late part of last year that came close to the $100,000. In the net occupancy and equipment expense category, we also took, as Charlie alluded to, some purchase accounting adjustments. Over the course of the three, almost four years, really, from the merge of the holding companies and the banks, all the purchase accounting adjustments that were booked at the time have now been taken care of with exception of some of the buildings.

We did take the majority of those -- although I say that, and there's still close to a, I want to say $0.75 million of purchase accounting related to three facilities that we have. Mostly in the Oskaloosa and in the Burlington area. But all of the marks -- or all of the purchase accounting adjustments on all of the other facilities that we acquired in the merge have now been removed from the books.

Would that equal roughly the $400,000 change on a link quarter basis?

Yes.

Okay, so would you surmise that, an expense run rate in 2012 would be somewhere south of the $10.8 million you had this quarter?

Yes, most definitely.

Okay. Great. Thank you.

(Operator Instructions) Daniel Cardenas of Raymond James.

So, of the loan growth that we saw in the quarter, which was about $30 million, you said it came from three areas, with a hotel loan being one of them. I mean, how large was that hotel loan? I mean --

Mid-seven digit area.

Okay, so it accounted for a good chunk growth that we saw this quarter.

Yes, we had another health care funding -- a loan that we funded, Dan, that was in the $10 million range.

Yes, the hotel was probably 25% or so, give or take a few basis points.

Okay. All right. Then, just jumping over to the margin. I mean, that number held on a sequential quarter basis. Are there any levers that you guys can pull to help sustain that number, or is the expectation for pressure as we look into 2012?

Well, I'll start out with that. I think the expectation is always for pressure, as long as the Federal Reserve continues with this monetary policy. We do have some levers we can pull, yet. We still have some still room on the deposit side. As I think we've talked about in prior quarters, Iowa tends to be a high cost of fund state. That is particularly true in our footprint with a very aggressive credit union and just a lot of community banks, our cost of funds tends to be a little bit higher. That being said, I think there is room to still come down and will probably need to come down because we're going to have pressure on the loan side. So, it's not without hope, but it is something that is really going to be challenging to us as management.

Okay. Got you.

Dan, the only thing I would add to that is, as Charlie alluded to, there is some certainly downward pressure on our loan side just because of the loan yields, just because of the competitive pressures that we have in this community. Certainly, with the size of our bond portfolio, we are going to continue to see pressure -- downward pressure, on those -- as we reinvest items that are maturing this year. But the liability side, we do have, as Charlie said, perhaps a little bit higher cost of funds than most banks. But certainly for the state of Iowa, I think we're relatively close to our peer. And we do have room. CDs, we continue to see the CDs, especially on the individual side, roll into money market. But we do have room with our current yields, where they're at to bring those costs down.

I'd also mention that we do have what we refer to as a power checking account that, has a tier, a high tier, a first tier on the first $25,000. There's one or two competitors in our area that have something similar, but we can continue to bring that tier rate -- top tier rate down. But I would also say that, because of the way it's structured, there is benefits to the bank in other ways that don't show up in the interest expense category through, lower operating expense or maintenance expense and through some fee income things. But that artificially keeps our cost of funds a little higher, perhaps, than it otherwise would be, so.

I would also add to that, the thing on the power checking, that really has been instrumental in our interchange fees from debit cards. I have to knock on wood when I say this, but our interchange income continues to be very strong. So, our Company hasn't yet seen a negative impact from the Durbin Amendment, but it's only been one quarter.

Got you. Okay. Then just on the capital front, I missed it when you threw out the number, but how many shares did you guys buy back this quarter?

Just over 100,000. 102,000?

About 102,000, a little over. A little under $1.5 million was spent, an average price of $14.66.

Okay. And then assuming, we don't see any more growth opportunities, I mean, are we going to continue to expect buy backs from you guys?

Yes, absolutely. We have a plan in place, I think through the 31st, that totals $5 million, and we fully expect to continue to exercise that whenever we can.

Through December 31.

What did I say?

Through the 31st. December 31, I apologize.

Got you, got you. Okay, and then maybe if you can just comment on what you are seeing on the M&A side. I mean, we've seen a few small banks raise up the white flag and look for partners. Are you seeing -- are you getting increased number of phone calls, and what's the environment look like from a seller perspective?

I wouldn't say that it's materially different than it has been, Dan. There might be a few more phone calls, but the state of banking in Iowa continues to be pretty good. I don't think -- perhaps Dodd Frank has gotten far enough along in its implementation that -- anyone that I know of has thrown their hands up and say, I can't deal with this anymore. But, we continue to think that there will be opportunities. I think one of the things that I have been heartened by is I think that anytime there is something that is on the market, we get a phone call. So, we've had the opportunity to look a number of times, but as we've said before, it has to make sense for our shareholders and it has to fit with our strategic plan.

Okay. Then any plans for organic expansion, some de novo branching in any markets, or anything?

None discussed or none contemplated right now. I think we're really all about recognizing as many efficiencies as we can within our existing footprint. We think we have more opportunities internally but the easy efficiencies have been gained. So now, I think it's a much harder thing to realize efficiencies, but they are out there for us.

Okay. Great. Thank you.

Yes, thank you.

Brian Martin of FIG Partners. Please go ahead.

Charlie, you talked about the high cost of funds and just your willingness to try and bring it down a little bit from the current level. I mean, what's a realistic target as far as cost of funds goes, if you have to bring it down? Where do you think it's possible to bring it down to, given the competition in your market, just the credit unions and what not that you're competing against?

Well, that's a great question, and I don't know that I have a number for you, Brian. Gary is shaking his head as well, but I do know that -- I will give you an example. The credit union that we compete with in Iowa City is still paying 3.25% on their checking accounts -- and you heard that right, 3.25%. At one time two years ago, our rate was within 25 basis points, maybe 30, 40 basis points of them. We're now well under 1%, on the same type of account, below them. Has it had any effect on our balances? Perhaps a little bit, but we haven't really lost a whole lot. So, I think we have been more and more willing to press the envelope on cost of funds because we have to. I think if this interest rate environment goes on through 2014, I don't have any qualms that you will continue to see our cost of funds come down, and it won't just be CDs. I can't give you a specific number, because I -- primarily because I don't have one.

Brian, if I could add to that, I would just -- what I would tell you is that we were able to bring the cost of funds down around 36 basis points in 2010. We dropped them another 29 in 2011. So, to suppose that we could do another 29 basis points this year would bring us down to 1%. I just don't think that's realistic. So again, I wouldn't throw out any a cost of funds either, but if we could get down to 110 basis points or 120 basis points range, I think that would be pretty respectable for us. As you know, we have to balance that with the growth targets that we have, as well. So, that would be all I could add.

Okay. All right. How about just -- Charlie, you talk about in the release about the target payout ratio and just balancing the capital objectives as you look forward with M&A, and dividends, and buy back. What is the target payout ratio you guys have? I guess, would your expectation be that you guys could see another dividend increase sometime in 2012 -- depending on, how things play out and on the other forces that are impacting capital?

Great question, Brian. Typically, we have increased dividends, and I'm going back to before we were a public Company. We've typically increase dividends at the January board meeting, and I think it was unusual in 2010 because we paid off TARP in the middle of the year, and we wanted to raise our dividend nominally at that time. I say nominally, it was still a 20% increase. So, that was a little bit unusual to raise them twice, but I would not expect anything until a year from now, all other things being equal. As far as payout ratio, typically our Company has been in, between 25% and 35%. A lot of that is going to have to do with our capital levels, a lot of that is going to have to do with the price of our stock. I think as everybody understands with our stock trading where it is right now, the buy backs are relatively, I think, more attractive. We also need to balance that against our shareholders that would like a little bit increased return. But probably not much change going forward, but clearly in that 25% to 35% range, and normally, the January board meeting is when we talk about that.

Okay. Just from a credit quality perspective, Charlie, things are obviously, significantly better than they have been over the past year or two. What areas, at this point, still cause you a little bit of pause as far as, looking at the economic conditions in Iowa? I mean, knowing --you talked about the unemployment rate, and you've seen the numbers move down. I mean, is it really just the farm exposure you have? Or what is it and what -- I guess, can you give any color on that?

Brian, this is Kent, I'll add to that. Charlie did allude to it in his opening comments about the 30-day to 89-day that may be a low point. The reason for that, as you mentioned, we have seen increased unemployment in some of our markets, which would be under the state average for what we're seeing across the state of Iowa. About half of that total is related to residential house loans, and we've always taken the position of working with our customer in that 30-day to 89-day range. As things continue, as they possibly tire as a borrower, we could see that number shift just because of the amount of activity that's going on in that particular area of 30-day to 89-day.

So, that is something that we have our eye on, on the AG side, very minimal past-dues related to that particular area. Also, commercial really hasn't crept up at all. So, having said that, when you look at $7 million and half of that being related to residential. That only leaves $3.5 million for the rest of the portfolio, and given our portfolio's size, that is not very much. So, any type of slippage by one or two commercial credits will affect that number, and that's why somewhat in our view right now, that could be a low point for that particular bucket. We continue to work through the [MPLs] through the process, and we mentioned that in the fourth quarter release as well. We're seeing an increase -- a little bit of an increase in other real estate, but we're very active in marketing those properties and moving them through the system. So, the key is always look at is that 30-day to 89-day. Right now, as I mentioned, we're seeing a little pressure on the residential side in that area.

Okay. Hey, Kent, how about just from a standpoint of looking at classifieds and looking at special mention trends. What do you -- I mean, fair to say that the trends that we see in the nonperformings should match what we see in classifieds? Then, if you have any thought on, the special mention credits, I think it -- they were up a little bit in the third quarter from the second quarter and directionally, is that -- did that move back down? Or, I guess, is it flattish, or what are you seeing there?

I think your statement on the nonperforming, it's fair that it is a reflection of what is going on with the classified. When I allude to the fact that residential is where we're seeing a bit of a stagnant area, those are smaller loans that add up to that. So, the special mention or watch credits, I would say would be comparable to the nonperforming.

Okay. So, special mention and classifieds are both comparable as far as they're actually moving down to --

Correct.

Okay. All right. Maybe, one last question on credit. Kent, when you look at the movement around nonperformings in the quarter, how have the inflows to non-accrual been? Are those at a cycle-type of loan we're at today? Have they stayed a little bit higher? Or I guess, how have those been trending? I assume they have been down, I guess.

Well, the flow has been related to what I consider smaller credits. We still have a handful of larger credits we're working through. So our goal is, if we can reduce that -- the handful down to two or three, and move them from a non-accrual perspective, that's really going to be a positive. Because that creates more room, if you have two or three smaller ones move in. So, our goal is that -- and our focus is we have not seen larger credits moving into that category, and we're working through others around our larger ones. We're trying to make headway with those large ones to get them moved one way or another out of that particular bucket of non-accrual.

Just remind me, last thing was in the nonperformings, what are the larger, the top two size nonperforming loans in the, I guess in the $11 million non-accrual. What are the larger credits before it drops off?

We have two AG credits, and those, as we've talked about in the past related to the [Aug] industry from a couple of years ago that they had issues, and we're working through that. Right now, with those two particular credits, and the next largest one would be a construction/development out of the quad cities.

Okay, and those three credits or relationships, what do they total relative to the $11 million in nonperforming? How big a percentage --

Those three together would be approximately half.

Okay. So, about half of it. Okay. Then, just one last question. Charlie, you mentioned in the release of the termination of defined benefit pension plan. What impact does that have? If you already answered, it, I apologize, I jumped on a little bit late. But what impact does that have in 2012 to earnings, if any?

No, it has a definite impact, a one-time impact, and I think we disclosed that perhaps in our filing last quarter. We don't know the exact amount, but I think what we said in the filing is we didn't expect it to exceed $5 million, but it's going to be in that direction.

Okay. When -- and that will occur -- you would expect that to be a second quarter event, or is that a third quarter event?

No, we expect that to be a second quarter event.

Second quarter event. Okay --

I've learned more about pension accounting and pensions than I ever cared to learn.

Okay, I appreciate that. Just the last thing, on the bond portfolio and just the other comprehensive income and the benefit that plays in that. Can you at least talk about what the impact of that is, or just how you think about whether you harvest some of those gains or you don't harvest them. I don't know what the number was this quarter. So, if it changed materially, I apologize for the question, but I'm just trying to get a sense for how you guys are viewing that.

Well, it did change materially. I'm not sure I mentioned that in my comments. We had more bond gains in the third than we did in the fourth. I think in both quarters, the bond gains -- and we talked about this last quarter as well, were involuntary. In other words, they were bonds that were called, that we owned, at a discount. So, we had to record the gain as opposed to taking profits, which I consider to be an overt action. I think that there may be some of that this year, but for the most part, probably comparable to 2011. But our portfolio is -- still remains about 3.5-year average life. There is a lot of convexity in the portfolio. I mean, there is obviously, call risk in the portfolio. But I think compared to other bank portfolios, we probably have a little bit more convexity, and convexity serves you well in this type of environment.

Okay, all right. I appreciate it. Thanks for taking my questions, Charlie.

Absolutely.

Thank you, Brian.

(Operator Instructions) And showing no additional questions in the queue, I would like to turn the conference back over to Mr. Funk for any closing remarks.

Well, thank you for joining us. Again, for those that came on the call late, we will endeavor to get these out several hours ahead of time next quarter. Feel free to follow up with any of us if you have further questions.