Midwestone Financial Group Inc (IOWA) (MOFG) 2015 Q2 法說會逐字稿

Good day and welcome to the MidWestOne Financial Group Inc. 2015 second quarter conference call.

(Operator Instructions)

Please also note today's event is being recorded. I would now like to turn the conference over to Mr. Charles Funk, President and CEO. Please go ahead sir.

Thank you very much, Rocco, and thank you for joining us on the call this morning.

As I always do, let me begin by saying and reminding you this presentation contains forward-looking statements relating to the financial condition, results of operations and business of MidWestOne Financial Group. Forward-looking statements generally include words such as believes, expects, anticipates and other similar expressions.

Actual results could differ materially from those indicated among the important factors that could cause actual results to differ materially, interest rates, changes in the mix of the Company's business, competitive pressures, general economic conditions, and the risk factors detailed in the Company's periodic reports and registration statements filed with the SEC. MOFG undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances after the date of this presentation.

And with that out of the way, I guess I would begin by saying it's very obvious there is a lot going on at our company right now. And I have to say the broad overview is that most of it is very positive. It's no surprise our numbers are full of one-time items.

And I'll try to at the end of my prepared remarks give you a few metrics that take out as much of the noise as we've been able to take out, to give you an idea of what we think the run rate was actually in May and June. It wasn't even for the full quarter.

General remarks at the top of my list is that I think it's very obvious and not only at MidWestOne, but as I talk to others around the country, deposits are becoming much more precious today. Certainly in both of our banks, deposits were down a little bit in June and we're certainly directing more attention to this aspect of our business. I think it's fair to say that in the Central Bank culture there hasn't been a lot of emphasis in the past on deposits, so we think there is a lot of potential there as we change focus. But certainly in Iowa there is a lot of competition for deposit dollars. Resultingly, our loan-to-deposit ratios moved into the high 80s which has been good for the margin, been good for our earnings, but something that we are keeping an eye on.

During the quarter, loans were essentially flat in the Iowa footprint. If you look at year-to-date growth it's still in the 4.5% to 5% range. In the Twin Cities, loan growth continues at a brisk pace. You have to remember when you look at Central Bank that they are getting large pay downs from the FDIC covered loans, so when they can put loan growth in the 6% to 7% to 8% range that's a net number and reflects very robust business conditions in the Twin Cities. Competition has ramped up in both states. It's I think maybe a little bit more notable in Minnesota, but even then we've been able to grow the bank pretty well. During the summer months, it's typical for loan growth to slow in that footprint, but I think there's still a little bit of growth yet to be had in the Twin Cities part of our footprint.

There is a consistent theme and the consistent theme is that pricing pressure has ramped up. I think that maybe pricing pressure has come a little later in the Twin Cities, but it's definitely there.

And we're also seeing some relaxation of credit, but I wouldn't say the relaxation of credit is with every competitor. But there certainly continues to be some competition that is due to relaxation of credit standards.

Just a couple of other comments about our company. Even though it's a small part of the company now, wealth management in Iowa continues to be very strong. Even though our trust department is running a little bit behind last year, I think we will be ahead of last year by the end of the third quarter. Our investment services are doing well and our insurance division is on target to have a record year in 2015.

One thing that I should talk about on the call, briefly, is that we wound up not purchasing central insurance and we had announced when the deal was announced that we were going to buy central insurance. But at the end of the day I think we found that it would be best for all parties if we didn't consummate that transaction. And so that particular agency went in a different direction and I think it will be good for everybody with that result.

Expense management is something that we are very focused on and you are probably going to hear the same thing for the next few calls. It's a work in progress, but there is definite progress. When I compare this to 2008, there's no comparison. We're well ahead of 2008. We plan to merge the banks, the two banks together, in early April. And I think it's fair to say that we see expense opportunities -- expense savings opportunities in both banks. Not just the Central Bank, but also we see some opportunity at MidWestOne as well.

I also -- it's fair to say that with any merger of this magnitude, getting buy in is a process and we're moving forward there. And when I compare the amount of buy in that we have today compared to what we had in the last merger we are well ahead. There is still work to do there. But I see a lot of progress and I see no reason that we can't get to where we need to get in terms of our non-interest expense.

As far as credit quality, I think it's pretty much what you have seen in prior periods with the Iowa bank. And of course we marked the central loan portfolio to market and mergers so what you see there is a result of that. We know we need to build the loan loss reserve and we did put $450 thousand and I believe the number was in the loan loss reserve at Central Bank in June and so that will be a process going forward. We know we need to rebuild the loan loss reserve, because as you know with the mark it starts out a zero. In the Iowa Bank we continue to run in the 140% to 145% range as a percent of total loans. And as I said, in Iowa the credit quality is not much different than what you've seen in prior periods.

Purchase accounting, adjustments again they've moved things around a lot and there's been a lot of discussion around that over the last 60 days. Clearly, we thought our tangible common equity based on our estimates would be in the 760% to 770% range and we actually came in lower than that at just over 720%. I think, as I talked to others, that is just the nature of the game whenever you do purchase accounting, because when you try to model out the transaction, you're just estimating and the actual marks were a little bit different than we had expected. Of course, those of you who follow our company for any period of time know that our strategic goal is to be in the 8% to 8.5% range for tangible common equity and I think we can get there in short order with just normal earnings accretion.

I will say the regulatory ratios in terms of capital are just fine in both banks. We don't anticipate any issues there. Hindsight is always 20/20, but looking back I am very pleased and happy and glad that we did raise a small amount of equity earlier in the quarter.

As for the income statement, I just would say and perhaps emphasize very, very strongly that it's very hard to say with great certainty where we are now with the income statements. So, when you look at the last two months, and we try to take the one-time items out, we think we know what the run rate is but we're not going to say this is the run rate with any degree of certainty; because I just think you have to let things shake out and everyone has to get a better comfort level with that.

With that said, let me give you a few items. First of all, obviously we have accretion and amortization from purchase accounting that in this particular quarter helped our margin and I think the reported number was 405. We think it was closer to 370 without all of those adjustments. And then when you take the one-time expenses out, we estimate that the return on assets for the quarter was 106 and for the half year was 112. We estimate that the return on average tangible equity was just over 16% for the quarter and just over 13.75% for the six months and that's versus a reported number for the quarter of 1121. So we like those numbers but again let's let this thing play out for a couple of quarters and get a comfort level before we say that for sure that's the run rate.

Efficiency ratio, we reported 65%. We think it was just over 60% and that seems a little bit on the low side to me, but that's what we came up with. So if that's helpful, that's where we think we wound up absent one-time items.

So in summary, I would say that we believe in what we're doing. And we think that we are making lots of progress. I have been very, very pleased with the leadership and we have talked for several years that we work really hard to develop strong leadership at MidWestOne. And I think a number of people have stepped up and are really contributing in big ways. And there are also a couple that have come from the Central Bank side that are also stepping up and showing strong leadership and are really adding to the company. So I think people-wise and from a senior management point of view that we sit in a very, very good spot right now.

We believe in our formula. We think that if we can keep our loan-to-deposit ratio in the 80s, and right now it's in the height 80s, continue to grow our non-interest income and over time, bring the efficiency ratio of our bank back down into the 50s. We think that, that's a very, very good formula to have success in the future.

We acknowledge that all of this is going to take some time. But for right now we like where we stand and we know that there's a lot of work in front of us and we are anxious to get there.

So, Rocco, with that, those would be my comments and we would be happy to entertain any questions that you might have.

Thank you, sir. We will now begin the question and answer session.

(Operator Instructions)

Jeff Rulis, DA Davidson.

Charlie, you mentioned kind of backing in or taking some time to flesh some of this noise out, but I guess on the expense side, if you have got it at $2.7 million in one-time cost netted against the central acquisition for a full quarter. What does that profile look like in Q3 in a -- even if it's a broad range?

Yes, I am going to turn that one over to Gary. Before I do, I will say one thing, that we had a surprise and in the one-time items, there was a $950 thousand item that we originally had not thought we would have to recognize in that manner but we did.

So that was an unfortunate surprise. But beyond that, for quarter three, I don't know Gary. What do you think?

Yes, Jeff. I would say most of the larger dollar, one-time items are behind us. So $300,000 to $500,000 run rate going forward, which would be mostly I would think professional-fees oriented, but that may even be at a high range I guess.

And there will be some severance too.

Yes there will be.

Okay. So the $300,000 to $500,000 is the additional off of the core which is the Q2 level less the one-time items.

That's correct.

Okay. Fair enough.

And then on the margin -- you've got some noise there. But also with the private placement is that -- you mentioned some debt retirement. Within that, any thoughts on how the margin shakes out and expected direction there?

Yes, I think the 405 that we had for this quarter is certainly at the high end, and clearly the purchase accounting adjustments were the biggest contributor to that number. Most of the purchase accounting marks, the loan mark and even the CD mark were accretable to earnings, and will come off probably a more rapid pace than those that are on the amortizable side, which are down in the non-expense category.

So I think for several quarters here you're going to see a higher-than-normal margin just because of those purchase accounting marks, and then also factored in there is the covered loans and the collections on those certainly factors into the margin as well. And I think in the narrative we mentioned that there was a $1.4 million mark and that was [a deposit very favaorable] to the margin this quarter.

Okay. So you might have some semi-artificial boost to the margin, but on the core basis do you expect improvement from the debt retirement or has that already been retired or portions of that?

It has been retired.

It has been retired. And I think just because Central brought a lot of low-cost deposits to the bank, combined with the fact that we have, obviously, changed the mix of loans and bonds that are impacting our margin. Certainly more loans than bonds in the past.

But I know our bond portfolio yield has effectively increased while we were selling off some bonds to raise cash for the deal. But you combine that higher bond portfolio mixed with the higher -- or yield of the higher loan-over-bond mix, I think we should see a higher core.

And I think if the 370 was any indication of the margin without the one-time -- without the purchase accounting marks, I think we are at 362 in the comparable quarter. So you can see there is a slight increase there and I think it is just again attributed to the loan-bond mix and the cheaper funds coming in from Central, plus the pay off of the debt.

That's great. Thanks Gary. That's helpful.

And maybe one last one if I could. Just the thoughts on loan growth in organic-based -- I got into an organic loan growth of about 5.5% annualized. Is that correct, and then the second part of that is just expectations for the second half of the year.

Yes Jeff. This is Kent and I will answer that.

The 5.5% organic growth rate is net of the acquired loan run off and that is what Charlie was alluding to. As you look forward to the second half of the year, and I think again we analyze it from a net standpoint, we will see a -- anticipate loan growth rate annualized in the 6% to 7% range.

Got you. Okay thanks. I'll step back.

(Operator Instructions)

Andrew Lees, Sandler O'Neill.

Congrats on getting the deal closed.

Yes, thank you.

Just wondering if I could drill down to these -- the one-time expense items a little closer. You said the 2.7% -- most of it was in the professional fees line item. I was just curious how much was there and were there any chunks in some other line items?

Yes. About $1.5 million of the $2.7 million was in the professional fees category, and a little over $1 million was in the other operating expense, and certainly the majority of that was the $950 thousand item that Charlie had mentioned. And there was probably another $150,000 or so in the salary cost area.

Okay. That's helpful.

And then on the -- maybe I was being too optimistic, but the fee income came in a little bit less than I was looking for. I'm just curious how is the fee income going at Central and how is that in the second quarter, like I said, at MidWestOne relative to your expectations?

I would say that we really haven't focused a lot on fee income at Central right now, other than to say I think there is some opportunity there over the next six months to do some things maybe that they are not doing right now to improve the fee income. One of the things they are doing really well and it will help our company, is they are much better than -- at Central Bank it is much better than the Iowa Bank in terms of one-to-four family mortgage origination and our results have been disappointing in Iowa -- very, very disappointing in that particular realm.

And I think Central brings a lot of expertise to the table and over time, we will see -- we will benefit in Iowa from what they bring to the table. But in terms of the Iowa Bank, I would say that the service charges continue to run a little bit below our budget and I think that's a nationwide trend. I don't think that is unique to us.

But as I said, the wealth management area is really doing well and we expect another good quarter from them. With the increased size of our company however, that has less impact than it would have whenever we were the old MidWestOne Bank.

So I didn't answer your question directly, but I gave you the components. And I think there is some potential over a six-month period to have a little bit better run rate.

Got you. That was definitely helpful.

And then can you just refresh us on the asset-sensitivity nature of the balance sheet? I believe it has shifted slightly asset sensitive, but I just wanted to confirm that.

Yes. That's what Jim Cantrell tells us, and that's what the model shows. I think a lot of the reason for that is a large amount of non-interest bearing deposits that they have at Central Bank. That is by far the biggest driver of that and we think that we are in the slightly asset-sensitive position right now.

Great. Thanks for taking my questions. I'll step back.

Yes. Thank you.

(Operator Instructions)

Brian Martin, FIG Partners.

Gary, maybe can you just elaborate on your earlier question on the expenses. Maybe I just missed what you were saying.

But the $300,000 to $500,000 number you were mentioning -- maybe I'm just confused by what you were referring to there. Was that the add to expenses, core expenses for the additional days next quarter that the Central will be in the numbers, or is that more nonrecurring stuff?

Yes. It is the add to expenses, and still would be a combination of additional professional fees and severance pay that is taking place. For the most part those would be the two major items.

Okay. And that will just be a third quarter event? Or beyond?

I would think as we move beyond the third quarter the professional will continue to decrease, but the severance will hold steady there for a little while.

Okay. All right.

And maybe can you just reconcile -- if you start at the 405 margin you reported this quarter to be, I think you said in the prepared remarks, internally that 370 might be more of a core number this quarter. Can you just give us some reconciliation -- what you pull out to get to the 370 in basis points terms?

Yes. The numbers I pulled out were the positive impact that a accretive purses accounting marks on the loans and on the CD interest expense had on the margins. Those were both very positive impact items.

And so basically we had a few marks on the debt that affected the interest expense in a negative way. But they were so small in comparison that again the two major numbers were the loan mark accretion, discount accretion number, and the CD interest expense.

And do you have what those numbers were. How much were they Gary?

Oh yes. The loan was in the $1.4 million range and the CDs in the $0.6 million range.

Okay. And you had said your thoughts of the margin going forward -- that 370 core number ought to be a reasonable place to think about the core and then maybe the additional, when you look at the loan mark going forward, the benefit there in this $1.4 million, that is only a partial quarter.

Could that number go higher for a full quarter in the third and fourth quarter, and then begin to tail off in 2016? Is that how we should be thinking about it?

Yes. I think it's pretty easy to answer the CD interest portion of that, but the loan portion of that is a little bit more difficult to answer.

Both of those marks are being amortized on a sum of the year's digits, so obviously it front loads the accretion items or the accretion amount. The one piece that's a little bit of the unknown is that portion of the loan number that relates to the collection on the covered loans.

And obviously, if the collections on those increase over expectations there is going to be a higher mark, and that is the one that is a little bit of a bogey for us each quarter. The rate mark on both the loans and the CDs is a little easier to project forward for you, and again, given that we are using the sum of the year's digit methodology for that, those numbers will come down over time.

But again, the one bogey is the collection on the covered loans, which is going to be -- it's not unlike the loan pools when we were not sure what the number were going to be on a quarter-to-quarter basis. We're going to have that same issue for a little while with the covered loans.

Okay. But the full quarter impact wouldn't surprise you to see that number be higher on the $1.4 million loan mark for a third or fourth quarter potentially.

Yes, it could be, but as I'm looking at the schedule now for the three months, versus the two months it will certainly be a little bit higher.

Okay. All right. That's helpful and then can you just maybe give a little thought maybe it's yourself or Charlie just on the tangible common equity in being a little bit lower than you thought.

It looks like maybe there was a piece of the goodwill and TDI in the balance sheet that is not been deducted. Maybe it is an impact of the tax liability as far as when you calculate in the TCE, but just maybe any commentary on that.

And then secondarily, as far as getting to the 8% type of level. Maybe a timing issue and if that does involve any balance sheet shrinkage at all as a result in the transaction?

Well I will let Gary talk about the calculation. And it's a good question Brian. As far as the 8%, yes, there could be some balance sheet shrinkage. If we do in any of that, it'll be strategic in nature.

But I think that when we've modeled this, we're thinking and certainly in the next 12 months to 18 months through regular earnings accretion we should be able to get into the 8% range. We didn't plan on it being 720, but at the end of the day, we don't regard it as a big deal one way or the other. It was more of a surprise.

One thing that I did mention in my opening remarks, when we start talking about risk-based capital, the sale of the loan pools, we think removes quite a bit of risk even though they were relatively small when you start talking about risk-based capital. That was a big component in the calculation.

So the fact that they were gone at a very modest cost we think is very positive. But anyway, I will let Gary speak to the calculation.

Yes, Brian there were two, main marks that came in much lower than we expected. The loan mark, or certainly the interest rate mark on the loans, and actually the mark on the premises of equipment both came in at much lower levels than we anticipated. And then the tax effect that -- so the [deferred] tax was certainly an issue as well.

But those two things while they work against us from the point of view of coming in lower than we expected and therefore the equity number not being as high as we expected, the positive side of that is that, as we accrete those numbers back into earnings, there will be a more beneficial effect there. So we should be able to accrete back much more quickly than we thought as well. So I hope that helps you.

Yes. It's helpful. And then, Charlie, just as far as the balance sheet goes, in the next quarter or two you talked about Iowa being -- there's some seasonality in the Twin Cities area than normal maybe for the Iowa market.

With the dynamics of the balance sheet would you expect the balance sheet to be a bit smaller in the second or third quarter here just as you go through this portfolio and get things together or not necessarily?

Not necessarily. I think that loan growth may lag a little bit during the summer months, but I think as Kent indicated there will still be loan growth. It would not surprise me at all if our loan-to-deposit ratio company-wide creeped into the low 90s.

And I would remind those of you who have been around for a while you know it was close to 100 after the 2008 merger. But over time, we certainly expect that to settle in the 80s, because one of our strategic drivers is to have a loan-to-deposit ratio in the 80s and have relatively less leverage than many of our peers. We just think that is a better way to run our particular business.

Yes, there will still be a little bit of growth, Brian, loan growth. But in terms of balance sheet growth, I wouldn't look for a lot of balance sheet growth, but I think there will still be some loan growth.

Okay. And maybe the other question was just the expenses. It sounds like some of these nonrecurring stick around for a little bit. When do you expect to see a clean quarter from an expense standpoint, more reflective of the anticipated cost savings?

It may be a while. It may be a few quarters.

Okay.

(multiple speakers)

When was the integration of the merger?

April 2. We've got it scheduled for April 2.

Okay. So it could be and not until the second quarter of next year you really start to see sort of a cleaner run rate on expenses?

Yes. I would agree with that Brian. And it may even be a little bit later, but it's hard to tell as you know.

Okay. Perfect. And then maybe just the last thing.

How comfortable, given so much uncertainty in the next couple quarters, would be the initial thoughts as far as the accretion, EPS accretion the deal would bring in maybe the 20% range in 2016. Does that still feel like a comfortable target as far as what is achievable based on kind of what you guys see today?

I would answer that and say that I haven't focused on that in the last month or two, that specific metric. But based on what I'm seeing right now, I'd say that we are very pleased with what we see. The numbers I gave to you, when you take the one time out, those certainly are better than we expected to see.

But again I caution you, Brian, and everybody else, that it is only two months and let's see where we run the next couple of quarters. But overall I think we are ahead of what we had anticipated.

Okay. So realistically if the -- that bogey or better it could be the case. Minimum it seems like you're -- if things are tracking better today, more reason to back off the initial thoughts right now? Okay.

There's no reason to back off of them, but let's check back in 90 days. See where we are.

Okay. And then just the last thing for Kent. And that is with the renewal of this central loan portfolio. The provisioning was up this quarter just reflective of that.

The current run rate on the provisioning or a touch higher depending on the adds here. Does that seem like a new run rate type for the provision looking forward?

Brian, yes, I would agree with that. The only thing I would qualify would be new, organic growth in Central Bank, we will be providing for. So if that is greater than what we anticipate we will be providing more than what you saw in the second quarter. But from the MidWestOne standpoint I would anticipate it being in the range that you saw in the second-quarter.

Yes. Okay. All right.

I'll just step back. Thanks, guys.

Thank you.

Daniel Cardenas, Raymond James.

I think most of my questions have been asked. Just maybe if you could give me a little bit of color on the increases in the OREO balances as well as the loans 30 to 89 days past due.

Yes, the increase on the OREO was driven by bringing the Central Bank numbers together. And, you know, the number of properties you saw was north of 60. And that on the surface looks like quite a bit, Dan, but actually a little over 30 of those are zero balance properties that we're going to let go to a tax sale.

We just have to work through the process because the attachments on those are much greater than the value of the property. So that skewed the numbers. So the number of properties would be about half of that.

I will tell you that we are comfortable with the marks that were done as part of the process that we will continue to see those head south as we move forward. We actually have roughly seven properties that are sold or under contract that we're anticipating closing this quarter. And the pipeline in both banks aren't as great as what we had anticipated for closing.

So at this point in time, we see that number moving south in other real estate. As far as the 30 to 89 days, the look on that was from again bringing the banks together, the MidWestOne portion was comparable to what we have seen in the past. At Central Bank we did have one loan that was just at 30 days that skewed those numbers a little bit, but it is now current. So again I didn't see anything of concern when we reviewed the 30 to 89 days.

All right, good. That will do it for me for right now. Thanks guys.

This concludes our question-and-answer session. I'd like to turn it back over to the management team for any final remarks.

Thank you everybody for being on the call this morning and as you have further questions, don't hesitate to pick up the phone and call either Kent, Gary, or myself. Thanks for being on the call.

And thank you sir. Today's conference has now concluded. We thank you all for your participation. You may disconnect your lines. And have a great day.