Midwestone Financial Group Inc (IOWA) (MOFG) 2015 Q4 法說會逐字稿

Good day and welcome to the MidWestOne Financial Group Incorporated 2015 earnings call.

(Operator Instructions)

Please note: this event is being recorded. I would now like turn the conference over to Charles Funk. Please go ahead.

Thank you for joining us this morning. I do want to give props to SNL because we felt we were at the Boston Pops when we were listening to the music while [in the] waiting period.

I will get started, as I always do, with the forward-looking statement message and remind you that this presentation contains forward-looking statements [that result of operation and business] of MidWestOne Financial Group Inc. 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 are interest rates, changes in the mix of the Company's business, competitive pressure, general economic conditions, and the risk factors detailed in the Company's periodic reports and registration statements that are 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 the presentation.

And with that out of the way, let me begin and say my comments may be a little more lengthy than they normally are. And I think the reason is we have so many moving parts, certainly more so than usual in our quarter. And I will talk about a few perhaps that were discussed in the earnings release. Let me start with the quarter.

I think if you look at the quarter -- very good loan growth in the quarter, primarily, I think, as a result of the Central Bank operation in the Twin Cities. Please keep in mind that we sold $17 million in loans when the (inaudible) office went away. We had generated $70 million in loans just to stay even, and if you look at the deposits, the deposits were basically flat. But again, $33 million of deposits left with the sale. We did have some growth in deposits, actually decent growth when you factor out the transaction. The margin held in there pretty well. I think the reported margin was 404 versus 408 last quarter, and I will not comment on the purchase accounting adjustments. If you care to ask, we have Katie Lorenson, who is the Chief Financial Officer at Central Bank; and of course Gary Ortale, our MidWestOne Financial Group Chief Financial Officer also on the call.

It was tough going, I think, in the fee-related areas, specifically wealth management; and when you consider our trust and investment services operations, they tend to be fee-related and tied to the market. And with the market down, that has made for rough going in those areas. I think mortgage was somewhat seasonal, but we continue to see good volume considering the time of the year it is for our mortgage operations.

If you look at our expense items -- I want to talk a little bit about this -- there are several important notes. The run rate was quite a bit higher in the fourth quarter compared to the third quarter, so let me go down through the list on those. The first thing is, we really got behind in our accruals for incentive payoffs at Central Bank. That was about $600,000 worth that we had to catch up in the fourth quarter and I think we will be on a better track going forward. We also finalized the amortization of our intangibles, and that was a difference of about $335,000 in amortizations. And just as a note, we think the run rate for our intangibles next year -- or this year, 2016 -- will be in the $300,000 range for quarter, I believe is what I heard yesterday. That is a little bit of guidance for you.

Also, we have had a couple large fraud losses in the fourth quarter, and when you combine that with a little bit of extra loan collection expense, that was about a $250,000 difference from the third quarter, and I think the activity was a little bit elevated. We don't expect it to continue at that rate going forward, although you never can forecast when you're going to have a debit card fraud loss.

We had those things, and then one which is a little more complicated, and when you start talking about complicated accounting issues -- I have to keep is a simple as I can -- in the third quarter we had a mapping error. And so, if you look at our third-quarter numbers we basically overstated non-interest expense to the tune of -- well, excuse me, let me go back. We understated non-interest expense by roughly $430,000 in our third quarter. That particular $430,000 got mapped to deposit expense, interest expense. So our margin wound up being understated by about $430,000, and likewise our expenses were also understated by about $430,000, which makes the expense build in the quarter worse than it actually was. The year-to-date numbers you see are correct, and we will make these corrections in the 10-K whenever it is filed.

Again, I talked about the Wapella office was sold in the first few days of December, and with that went $33 million in deposits and $17 million in loans. It's been an arduous process to collect the historic tax credits and they all came to fruition actually just after the first of the year but were recognized in the fourth quarter. [Kendall] equity building a little bit faster perhaps than we had expected and got over the 7.5% mark and hopefully on the way to 8%. And as all of you know who listen on a regular basis, we prefer to operate in the 8% to 8.5% percent range for this particular ratio. And I would remind you when we reported earnings for the first time after our merger, our potential equity was just under 7.25%. So we had a nice build over six months.

I want to talk a minute about credits. We continue to rebuild the reserve in a prudent manner, and we feel good about the coverage, the NPA coverage as reported. We have talked over the last 12 to 15 months periodically about one large loan in Iowa, and we continue to work through issues on that particular credit; it's a commercial loan. It is a one-off in terms of these sorts of issues, and I think it's fair to say that when we file the10-K, you'll see that it has an effect on our reserve adequacy. We are still in the acceptable range on our reserve; however, we are a little lower in the range that we have been for several years. But as all of you know, our intent is always to operate toward the higher end of that range. We are in the range and you will see that whenever we file the 10-K. And again, we believe this is a one-off item.

The agricultural sector certainly is a concern to any bank in the Midwest that does ag lending. I will remind all of you that the ag portfolio is less than 10% of our overall portfolio. We are under the renewal season big-time right now, where we renew lines of credit, operating lines for the coming year. We are about 50% through that process, and I can say that we do have more carryover debts this year in our Company than we saw a year ago. We expected this and I think we've been pretty clear that the longer these crop prices continue to persist at these levels there will continue to be erosion in any bank's portfolio. I think we have a good read on the quality of our ag portfolio. We'll certainly have a better read next quarter because when we report next quarter all of our ag renewals should have been completed by then.

We are also watching our commercial loans in our smaller communities that get tied to ag -- i.e., if we have auto dealerships that would bank with us -- and we have a few -- certainly the people in the ag sector aren't going to be buying nearly as many new pickups, for example, as they have in prior years. And then the other thing that tends to bleed into our portfolio are the Quad Cities, in Oskaloosa and in Cedar Falls-Waterloo, is we have a number of customers who might be subcontractors for John Deere. And as John Deere doesn't produce as much, there's not as much work for these particular credits. I don't know that we have any identified problems in our portfolio, but at this particular point in time it is something that we are keeping an eye on.

A word about cost saves, non-interest expense -- I am pleased with where we are right now. I would say we are a little ahead of schedule in the identified cost savings and we have identified roughly 75% of our goal. So the task in 2016 will be, over the course of a year, to identify the remaining 25% of cost saves that we promised we will deliver. These will all come to fruition in 2016, but our goal would be that almost all of them will have been identified and implemented during the 2017 calendar year. I've been very clear with our own employees and I think I've been clear on this call that the last 25% is always the hardest. It was the hardest in our 2008 merger, but we are committed to do this, and the first six months, I think, will be spent in large part identifying where these particular saves can be recognized.

Our two banks, Central Bank and MidWestOne Bank, will merge on April 2 and will be under the flag of our corporate logo, MidWestOne Bank. Looking forward, we have a good loan pipeline in particular in the Twin Cities. They had a big fourth quarter at Central Bank, and while their pipeline is a little lower than has been in prior quarters, there still is a pretty good pipeline up there and we appreciate that. And I would say we are holding steady in Iowa for sure.

A reminder, it was in our earnings release that Rice Lake and Barron, Wisconsin, offices will be sold in February. We are on track to consummate that transaction. $30 million in deposits, $20 million in loans will go out the door whenever that transaction occurs. And then the other thing, before I turn it over in the Q&A, would be that in addition to the cost saves, I think our biggest corporate challenge is deposit generation in both footprints, both the Twin Cities footprint -- and of course they have two offices in Florida at Central Bank -- but also in Iowa. We want to deliver 3% to 4% deposit growth overall in our Company this year, and we've tied a lot of our goals, management goals and incentives to this. Our own deposit ratio is up into the high 80s and I think everyone knows that our goal is to run an efficient bank that operates a loan to deposit ratio in the 80s. We are comfortable with where we are right now, but we realize we're going to have to generate core deposits better than we have the last few years in order to continue to run as we would like to.

I told you we have Gary Ortale and Katie Lorenson on the call. We also have Kent Jehle, our Chief Credit Officer; and Sue Evans, our Chief Operating Officer. So Chad, at this time I think we're ready for questions and answers.

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

(Operator Instructions)

Our first question comes today from Andrew Liesch, Sandler O'Neill. Please go ahead.

Hello, everyone.

Hello, Andrew.

So Charlie, I understand you're kind of [tier] on deposit growth being a priority, and I think I remember you saying that you've launched some new products at Central Bank. Just curious if you can give us an update on how the deposit growth there is coming. It sounds like loath growth is good but how is deposit generation?

Thanks, that's is a good question, Andrew, and thank you for asking it. So a couple things would come to mind. I think if you look at Central Bank and where they've come from, they had a lot of liquidity and so their loan build they focused much more on getting their loan-deposit ratio up to where they wanted it, and so they have been terrifically successful generating loans and really haven't had a lot of focus on deposits and that has turned over the last few months.

We did, to address your question specifically, we have rolled out one retail checking account product in the Twin Cities, and it's been a soft rollout to get our employees comfortable with the idea of the account, and we can report that we've got between $2 million and $3 million perhaps in new deposit dollars that have come in and that's with the soft rollout. So I would say that we are on the right track there, $2 million to $3 million doesn't move the needle in our company but it is early in the game. I think we have a little bit of momentum that is hopefully growing.

We did put in our earnings release that we hired a seasoned treasury management professional and this is someone who has both Community Bank and large regional bank experience, and I think he will be a very good fit for our culture, will also help us of little bit in Iowa rolling out some of our products. So over a period of 12 to 24 months I think it is very positive for deposit generation and most of his efforts will be in the Twin Cities.

And perhaps most importantly is that our regional presidents in the Twin Cities have really been come on board and they are fully committed to making sure we get deposit momentum that would come toward and be at the same level of our loan momentum in these markets. I think when you put those three or four things together, Andrew, I feel pretty good about the direction we are heading.

Okay, that's good to hear. And then following up on your question on the amortization from Central, is that $300,000 per quarter in total, or is it going to be an aggregate to what was there before Central? $400,000 a quarter? $300,000 a quarter? Just curious on the right number there.

This is Gary. I was going to correct Charlie mid-sentence but chose not to. It's more like $300,000 per month or $900,000 per quarter. The number is a little bigger than what he indicated there. We are running at -- the run rate for 2016 is probably in the $900,000 but it is on a declining balance method, so it will be coming down but still for an average for the quarter it will be $900,000 range.

Got you. And then just one last question on the other fee income charges backing out the sale of the Ottumwa branch, it looked like that was still an increase for the quarter and I'm sorry if I missed it in your prepared remarks, but just curious what the driver behind that might have been?

I believe our service charge income was better and I think some of that came from Central Bank as we started to rollout different service charge schedules. We did that a little bit ahead of the bank merger. I think it was mainly in the service charge line that offset any shortage that was elsewhere.

Okay. Very good. Thank you so much.

Thank you, Andrew.

Next question is from Matt with D.A. Davidson.

Hi, this is Matt Yamamoto sitting in for Jeff. I just have two quick questions. What was the reason for the sell off of the branch in Ottumwa, Iowa and the future selloff of the two branches in Wisconsin?

Good questions and I can take those. I think that we as a company saw limited growth potential in both markets. The Ottumwa office, we were there since our merger. We had those offices for about seven years and really didn't see much growth at all in either loans or deposits. We ran a fairly efficient operation there that was profitable but we really didn't see much growth opportunity. We can certainly feel like we can grow over time to replace those deposits and loans and in the near term it really helps our capital ratios.

Those would be the major things and I think the same could be said about Rice Lake and Barron. With Rice Like and Barron if you look on a map they are quite a long ways from the Twin Cities and actually a little bit of an outlier in the footprint. Both offices were profitable but we think over time probably the bottom line is we can better deploy our capital in other markets.

Okay. Thank you.

You're welcome.

Next question is from Daniel Cardenas with Raymond James. Please go ahead.

As you work through your deposit growth goals for 2016, can you maybe comment a little bit on if you're seeing any pickup in competitive factors and what kind of impact on your margin would hitting that 3% or 4% deposit growth, what kind of impact on margin would there be?

I think it's a great question. I think that there will be some impact on the margin but I think we would -- I just talked to Jim Cantrell our Head of Asset Liability Management about this a couple days ago and we expect any margin erosion would be in the single digits. I don't know that it's more competitive on the deposit front. It is very, very competitive in Iowa and that's driven by the credit union competition and just to a lesser extent other community banks, but it's mainly the credit unions that drive it in Iowa.

But I think in the Twin Cities the higher rates are being paid by smaller community banks. US Bank and Wells Fargo comprise just a little over 75% of that market. So that keeps the deposit cost down there. We actually think that we can maybe thread the needle a little bit in between the rates we have to pay in Iowa and pay maybe just a little bit more in the market in the Twin Cities and we think that could be a chief source of deposits.

But we're still orchestrating that strategy. So it's a little bit incomplete at this point in time. The specific answer or the best guess I can give you would be, any erosion in the margin would be in the single digits.

Low single digits or high single digits?

Low to mid.

Okay, and then just a couple quick questions about your franchise, any plans for some additional branch rationalization and then maybe some comments on the integration of the transaction seems to be going well, maybe even a little ahead of schedule, your appetite for any additional M&A?

Great questions. I'm thinking of the first part had to do with other branch rationalization. I think what we would say is what we said to our employees, that we are always going to be looking for opportunities where we think our capital could be better deployed. And so that's probably -- I should probably just leave it at that that it is ongoing and we want to do what is best for our shareholders. The second thing had to do -- what was the second part?

Appetite for M&A?

You commented on the merger going well. I think we have to be focused on the merger of our banks on April 2 and making sure that that goes off. We know it's not going to be flawless but I think we're on track to have a good merger of the banks, certainly better than we had in 2008. And I think what we have to be cognizant of as a management team is that we are really working people very hard especially in our operations areas and support areas. IT, deposit operations, those areas, and we want to make sure that they are allowed to stop and catch their breath.

We also have to make sure that as we bring the banks together that we are all on the same page and we are all moving in the same direction, and I think everyone would acknowledge that there's never been a bank merger where you didn't have hiccups, with morale and with things like that. And I think overall we've done a wonderful job in that regard. But I think what we have to do is make sure we are all pointed in the same direction.

I would think, Dan, that if an opportunity came along in the second or third quarter and again the word is if, we would be in a position to where we could say, yes, we want to take a look at this. I think we all have to be going in the same direction before we can say that that happens. I think as I look at a right now we will be.

All right. For loan growth it sounds like the majority of the growth is going to be coming out of the Minnesota markets. Is that a safe assumption?

Dan, this is Kent, I would agree with that the pipeline we look at it today we would say that roughly 75% of the pipeline is through the Minnesota/Wisconsin markets and the balance would be throughout the rest of our footprint.

Okay. Great. That's it for me right now. Thanks, guys.

(Operator Instructions)

The next question from Brian Martin with FIG Partners.

Hi, guys.

Hello, Brian.

Charlie, I'm not sure who takes it. But talking about the margin and the discount accretion, just the -- what you guys viewed as a core margin this quarter. How we're thinking about that going into 2016 would be helpful. Maybe more high level full year type of thoughts, and if you can give any color on that, that would be helpful.

Since I obviously don't have all of the numbers added up right I'm going to give it to the guy that does it for a living and that would be Gary Ortale.

Hi, Brian. The margin, as it's indicated in the report, shows [4.04%] for the quarter and obviously that's a little bit off because of the mapping error that Charlie alluded to earlier in the discussion. Just correcting for that alone would have dropped by about five or six basis points.

To your question about discount accretion. Obviously I have been in close contact with Katie on this number, and I think our assessment is that collections have been coming in a little bit faster than expected and the discount accretion has been recognized a little faster than expected as well. If you take out the discount accretion that's reflected in either the quarter or the year, our yield for the quarter would have dropped from that [3.98%, 3.99%], range down to the low [3.70%s, 3.73%, 3.74%] range. Almost a 25 basis point impact for the quarter. For the year I think we're showing a [3.71%] margin and that is a good number. It was not impacted by the mapping error that took place in the third quarter. And again after allowing for the discount accretion we're looking at a [3.54%]. Not quite a 20 basis point drop but a little bit of a drop.

As we look at next year I think again a little bit there's always that dichotomy between deposit growth and improving margins, and a little bit of margin might be sacrificed as well in trying to come up with deposit growth amongst one of our ways. But I don't think we're looking at too much of an impact. I would agree with Charlie that hopefully the impact would be any more than four or five basis points.

So the other maybe big thing that impacts 2016 is, again, the discount accretion numbers. And as I look at what we are expecting in terms of accretion flow for 2016, the number will be certainly down from what it was in 2015. And even when you consider the fact that we only had eight months of accretion and 2015 and we've got a full 12 months in 2016, the number is still lower -- the 12 month number for 2016 is even lower than the eight month number for 2015.

So I can't recall obviously we have a budget that we put together and as I think about the yield that was reflected there, I still think it was a yield that we were holding steady pretty much with what we experienced in 2015.

Okay. And just to be clear, the 4 to 5 basis points potentially in the margin that either yourself or Charlie talked about, is that from the current level or is that you talking from the full year 2015 number? Just be clear on that. If you think about the [3.70%, you said something like [3.70%, 3.73%, 3.74%] as being core, is it off of that type of run rate you're thinking on the decline in the margin potential?

I would say from the current level is what we're talking, Brian.

Okay. Thanks for that. And then just a couple other things. On the fee income you talked about that other line item and the services charges potentially contributing much of that felt from last quarter to this quarter. Just curious what the crystal ball looks like as far as the sustainability of that.

Just given that it is in that other column which -- if it was service charges, if you back off of the branch gain on the quarter, it probably puts that number all in fee income around the $6 million level. Is that a realistic run rate or is there something that's kind of unusual that was adjusted other than that in the fourth quarter?

I can talk generally. Gary may be able to talk a little more specifically. I think unless there is some change in the macro environment -- and the reason I give you that qualifier, Brian, is because you know what's happened to NSF charges over the last four or five years. They have just gone down for most banks and they have gone down 3%, 4%, 5%, 6% a year and it adds up over time. All other things being equal, I think our run rate should be pretty sustainable because we rolled these charges out in the Central Bank footprint and maybe -- I don't know any reason our run rate would decline by very much. I would think it might even increase a little bit as we get more retail deposits in that footprint.

Okay.

Brian, the other thing, let me just say we have not rolled out our NSF program at Central Bank and there is a lot of potential to gather much more fee income there, and because of the regulatory scrutiny we are being very careful and we want to roll it out in exactly a prudent and correct manner. But there should be a little bit of lift from that. That hasn't been rolled out yet. I can't quantify it but I know there will be a lift.

Okay. It just seems like that make sense with the mortgage being a little seasonably weak you said, the wealth management being a little weak. If you had to additional in that other line item up from here it seems to be the right way to think about it.

And then maybe just jumping to the expenses, Charlie, you put out a slew of items there that were kind of nonrecurring or unusual items if you will, I guess I couldn't write them down quite that quickly. It sounded like it was in the neighborhood of $1 million or so, in that range. If you back off that type of dollar amount if it's $1 million or if you can suggest what the core number was for this quarter? How are you thinking about expenses cuts?

It seems as though, like you said in your last quarter, a little bit slower to materialize than initially planned and I guess just trying to get any comfort on what the expense number actually looks like and when you actually begin to see notable improvement? Sound like next quarter you get some from these unusual items and just thereafter. Some thoughts on the expenses or just additional commentary would be helpful.

Yes, Brian, this is Gary, I will try to tackle that one. If you look at the fourth quarter noninterest expense in total you will see that it's well over the $22 million mark and after adjusting for the mapping error and some of these catch ups on accruals and one-time events, we could probably easily bring that down to the $21 million range.

I would have said to you if you were to ask me what is our core noninterest expense quarterly going forward, it will be between the $20 million and $21 million range and quite honestly as I think about what we put in the budget for next year, it's probably towards the low end of that range. Primarily because of, well, I shouldn't say primarily because of, but as we execute on more of these cost saves, and as we realize the effect on noninterest expense of not having Ottumwa and not having Rice Lake and Barron, those kinds of things will obviously tend to bring that down. I think a good range would be in that $20 million to $21 million.

Okay, thanks, Gary. And then just on the credit qual, or just the provisioning and reserve adequacy, it sounded like there's some things we will see in the K when it comes out, but can you talk a little bit about, it sounds as though it's not too alarming on the ag side with some of the things about John Deere and the other factors. It could trickle down to other businesses in that market. How you're thinking about the reserve and as you renew the loans at Central and as a pertains to any potential risk, if you will, on the ag side.

Brian, this is Kent, let me start with the ag side. I think the term I would use as we're going through the ag renewal season and Charlie alluded to we're about 50% through when -- where we're at with reviewing financial segments, we are just continuing to look to see where we can make prudent adjustments with our clients to set the stage for, not just 2016 but also 2017, in anticipation that prices stay where they are at this point and possibly even go lower if you look at it from land value side.

Still would characterize our borrowers with good equity positions, but again, just looking at what we would call the working capital or liquidity they have available that deteriorated and how we can look forward in that regard. We'll watch that closely, we'll monitor it as we go through the year but, again, at this point we don't see anything that gives us a huge amount of concern as it relates to the reserve itself.

Also as you know, we are continuing to build the reserve as we move forward, as loans move on the Central Bank portfolio from the purchase accounting side outside of that. That is being measured and watched and again you'll see provisions related to that. Overall, provisioning as you have seen in the fourth quarter we're looking at anticipating that being the same as we go forward, but again as you've heard a lot of it has to do with the purchase accounting rolloff and loans renewing or organic loans from Central Bank that we're reserving for as we move forward. Hopefully that answers your question.

Yes. Maybe you can touch on the provision this quarter if you break it out by the renewals versus the legacy MidWestOne. I guess what was the breakdown as far as that goes? Can you give any color on that, what the run rate was internally versus what was added?

The run rate on the legacy MidWestOne was $450,000, so the balance of that would've been related to Central Bank organic and loans that were renewed that would move out of the purchase accounting.

I got you. That's helpful. Last one for Gary and I will hop off was the tax rate. Obviously with those tax credits kind of being completed here in the fourth quarter, how should we be thinking about the tax rate, Gary, going forward, the effective rate to use in 2016?

Yes, I should have anticipated that question, Brian, I didn't, I apologize. I would guess that the effective tax rate will be back to that normal 25% to 28% range that we typically experience. Maybe a little it higher as I think about our bond portfolio and our tax-exempt securities and things of that nature. There's not as much now on a combined basis as we had previously, but I would think it would drift back to that 25% to 28% effective rate range.

Okay. Thanks very much for taking the questions, guys.

Thank you, Brian.

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

Thank you everyone for joining us on the call this morning and as always our management team is available to answer any further questions you might have. All you have to do is email us or call us. Thank you, Chad.

Thank you, sir. The conference is now concluded. Thank you for attending. You may now disconnect.