Midwestone Financial Group Inc (IOWA) (MOFG) 2017 Q1 法說會逐字稿

Good day and welcome to the MidWestOne Financial Group Incorporated First Quarter 2017 Earnings Conference Call. All participants will be in listen-only mode.

(Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Charles Funk, President and CEO. Sir, please go ahead.

Thank you very much Steven, and welcome to the conference call for this month or for this quarter, and I will begin as I always do with forward-looking statement, which says, this presentation contains forward-looking statements relating to the financial condition, results of operations 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, change 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.

We have today, our Chief Financial Officer, Katie Lorenson; Jim Cantrell, our Treasurer; and Kevin Cramer, our COO; and Kent Jehle, our Chief Credit Officer. If I would choose one word to describe the first quarter, it would be better. We are certainly not where we want to be or plan to be, but we're making progress, and of course, the goal is to make consistent steady progress and, I do think we achieved that this quarter.

One thing I do want to point out, we reported -- when we do the comparative periods with the last year, we do it with merger-related expenses and without, but I would also note that when you compare to last year's first quarter, that we did have two branch sales of Rice Lake and Barron, Wisconsin, where we realized a gain, a one-time gain during that period.

If you look at our overall numbers, return on assets of 89 basis points, return on tangible equity of almost 12.75%, efficiency ratio down just over 61%, a very good improvement, I think, but again, not where we want it to be, but certainly a good first step. We also put our tangible equity and tangible common equity well above 8%, and that was a big event for us and we were gratified during the quarter by the reception we had in the March transaction from the investment community.

Looking at the balance sheet loans, as you can see, we are relatively flat. We did have a few large payouts during the quarter, which were planned for the most part. We do have a nice pipeline on the board. I wish, I could say the pipeline was going to close early in the quarter, it looks to me like most of the pipeline will close in late May or during June, we would estimate that to be in the $60 million to $70 million range as we see it right now.

If you look at the flat loan growth, I noticed this morning that the GDP was reported at 0.8%. We certainly see that in part of our footprint. If you look in our footprint, most of the loan growth is going to come from the Twin Cities, Metro from Iowa City and from our new Denver market, which we do plan to open on Monday. Florida continues to be consistent, I wouldn't call our Florida operation explosive, but they continue to consistently add loans and deposits each quarter.

So on the surface, our numbers would appear to be weak, but I think there is some progress and that progress will be manifested during the second quarter. I would also note that the competition for loans is fierce, especially in Iowa City and the Twin Cities. We're seeing community banks offer five-year deals well inside of 200 basis points over the Treasury curve. We're also seeing a little bit of -- what we think is compromise on credit standards. We also realize that this sort of thing is transitory, it comes and goes. But right now, it's very, very competitive as there are a lot of, especially community banks, that are competing and competing very, very hard.

We also have seen a number of deals that we wouldn't do that, we've passed on. We probably could add some loan growth, but didn't, and I think we just need to be true to the credit disciplines that we've had over the years and the future will take care of itself just fine.

Deposit activity during the quarter was, I would say very, very strong, although as we said in the report, some of that is seasonal and has already left our Company. But I would note that we do have strong deposit growth in the Iowa City market. Denver, we think will get off to a very good start and we think that Denver deposit activity over the next year or two should be above the projections that we had whenever we began this initiative.

I would also note that a couple of our smaller rural markets and Iowa have done a very nice job of bringing up some larger deposit customers. So, I'm very encouraged because at the end of the day, we think we're going to have loan demand and we have to be able to fund the loan demand with the core deposits. One note on the deposit activity, maybe anticipating some questions that might be asked, we are having to pay up with the margin for some of the larger deposits. We have not had to raise our core accounts and they seem to be holding very steadily. But I think maybe as the case with other companies, we have our special project, our special deposit product ready to go, if and when it's needed. But at this point in time, we really haven't seen much movement in the core rates. At the margin, however, there is some movement in rate.

On non-interest income, really a nice quarter for wealth management. All three units were solid. Insurance, the brokerage area and the trust department mortgage was slow, although we did have a nice adjustment to the servicing rights. But our new Head of the Mortgage has started and I feel very, very encouraged that within a quarter or two, we will see much better production and expense control in the mortgage area. I do know that we recently hired one mortgage originator in the Twin Cities, and we will continue to look to hire producers to come on and join our -- the new head of mortgage R.J. Lang who joined us about a month ago.

I think the expense line was good. I would note that there are some Denver expenses in there and then there are some expenses that were associated with the shareholders sale during the quarter that were a little unanticipated. But overall, on expenses, I would say we're ahead of our projections in terms of cost reduction. And I think it's fair to say, expenses are being managed closely and we'll see some continued improvement on expenses, as the year goes on.

Turning to asset quality, 13 basis points net charge-off rate was really inflated a little bit. We had a final resolution of one of the loans that we disclosed in the fourth quarter and that particular one is closed out, but that represented not quite half, but the net charge-off for the quarter. So I think we're back to a more normalized charge-off rate now put for the Company.

So as we disclose, there is a little movement within the category, and I'll give you a little more color on that in terms of non-performers. I think the most notable was, we had a performing TDR that has been on our books since the MidWestOne merger of 2008, and that is now in collection mode. So, it's over 90 days and we're very well secured on that, but it could take a while to go through foreclosure, but we expect a full recovery of principal and interest, accrued interest and feel very, very confident of our collateral position.

The large $10.4 million non-accrual loan in the Iowa City area that's been on non-accrual for a little over a year now, the goal is to get that to performing TDR status. I'm hesitant to give a date on that, but -- so we're not going to declare victory, but I do think that we have a lot of progress. But victory will not be declared until we have signed documents. But we do expect that this year if not this quarter.

If you look at our footprint and you look at the State of Iowa, the State of Iowa has held up very, very well during the recession we had, but if you follow state government, the state revenues are languishing. They are just up marginally over the prior year and that's primarily due to a slow Ag sector, which bleeds over into Main Street Iowa and as most know, 60% of our footprint in Iowa, it's fair to say, is affected in one way or another by Ag.

If you look at Iowa, the mortgage market is very strong, the Iowa City market is very strong and the Cedar Rapids market is strong. The rest of the state, I would not consider to be strong. So, that's definitely in play when you look at our Company and you look at the loan growth that we may have. There is really no meaningful update on Ag beyond prior guidance that we've given in these calls. If there is any deterioration on the Ag portfolio, the deterioration mostly has been a few loans that have moved -- been moved from past to watch, but certainly not the substandard or anything worse than that. If you have further questions on that, Kent can certainly address that during the Q&A.

Our reserve levels are above the required reserve at the end of the quarter. We did have an FDIC, Safety and Soundness exam that was completed during the quarter and we have nothing further to report on that, which is good news. And again to repeat what I said at the beginning of the call, I think we took a good first step in this quarter. We do have more work to do and I think to some extent, the second quarter will be influenced by the timing of the loan closings. But the good news is that we do have a nice pipeline that's ready to go on again. At this point in time, we would expect that to be between $60 million and $70 million of production.

So with that, Steven, I can turn it back to you and if anyone has questions we're happy to address that.

Thank you. We will now begin the question-and-answer session. (Operator Instructions) Nathan Race, Piper Jaffray.

Had house-cleaning questions to start-off. Could you guys give us an amount of one-time expenses that you guys had in the quarter tied to the stock offering in 1Q that are probably non-recurring going forward?

Yes. Hi Nathan, this is Katie. It was about $200,000 on the stock expense, and about just over $100,000 related to Denver.

And then Kent, can you kind of just update us on what you're seeing across the Ag environment in Iowa. I appreciate Charlie's comments in terms of not seeing any additional deterioration across the portfolio. But can you give us an update, what you're seeing as we sit here today, particularly with commodity prices kind of finding a new equilibrium at current levels, so to speak.

Yes, Nathan. Certainly, we have gone through the season. You are starting to see our clients out in the fields, at this point time getting the corn in the ground. And our projections that we put together do show that, we have been a breakeven mode, based on current commodity prices as you described. We dared as we want to, the through the renewal season obviously analyzed from a standpoint, and we did see a migration credits from the lowest pass rating to watch and we have tracked those and we will continue to monitor those credits as we get into the season.

Primarily in July, August, we will be coming back with further review from that aspect and to match up with the projections that have been put together and in anticipation of what the yields will be, we will have a better feel as we get into August, September timeframe. So just as overall and this does include all loans. We had a net migration $24 million approximately from the past rating into the watch rated category in our portfolio based on the review of the credits going over the first quarter timeframe. So hopefully that answers your question.

Yes, no, that's great color, I appreciate that Kent. And if I could just sneak one last one in for Katie. Can you just kind of share any of your thoughts in terms of the margin going forward, and perhaps within the context of how much (inaudible)floors after the rate hike we had in March?

Yes, it's no problem. So, our core net interest margin was stable again, in this quarter at about the 3.63%, so it's held steady in the past. Three quarters, we did see the loan yields remain stable, the investment portfolio dollars that we put in helped to lift and offset an increase in the time deposits portfolio. That is up about 9 basis points core quarter over quarter -- or excuse me, year-over-year, flat for the quarter. And overall cost of funds are stable for the quarter. I will let Jim answer the question on the portfolio.

Yes. Portfolio yields, I think on a taxable basis, if you just want to look at that category, are in the low 3%s right now. It's hard to replicate the low 3%s on any new investments. So we may see a little bit of downward movement on the investment portfolio. I expect on the deposit side, a lot -- I am not going to forecast Fed rates, but globally, I think we are pretty neutral to interest rate, if we do get a Fed increase in the next quarter or so.

So I don't see a lot of movement in the margin going forward. We haven't changed deposit rates for the first 75 basis points of Fed move. I'm not sure we're going to be able to say that for the next 75 basis points. So, that's kind of the caution that we're getting folks.

Okay, that's helpful. And just quickly on the tax rate, Katie any updated thoughts on that going forward?

No, I'm still sticking to the 30% despite the -- we did have some reversal of some of our accrual this quarter. We had some favorable adjustments for the accounting change related to restricted stock. But I think forward-looking 30% is a good rate.

Got it. I appreciate the color, guys.

Damon DelMonte, KBW.

My first question is related to the loan growth outlook. Charlie gave some good color as to what the expectations are for the closings here in the second quarter. Just wondering kind of how you're viewing the full-year growth expectation for loan?

I think that we've unfortunately talked about a large loan in the fourth quarter of last year that still hasn't closed. I mean it's more than $15 million and we still expect that to close although not in the second quarter. So we think that -- we're going to put that in our full-year 2017 projection. But I think 4% to 5% is probably still reasonable for the Company, because we do think that especially when you add Denver and everything that's going on out there, I think 4% to 5%, if you had to pen me down I might be at the lower end of that. But I think we still feel reasonably confident in that.

And then kind of with regards to the Denver expansion, can you just give us a little update on the progress that the new commercial bankers have made so far? I mean are they actually booking loans currently or is that going to be more of a second quarter event?

It's a second quarter event. Our office really isn't open yet, but we're going to open next week and we've hired a third commercial banker out there that we think can bring some immediate loans as well. So we expect Denver -- I can't really give you a number from Denver for the quarter, but we think the next couple of quarters there will be nice activity from Denver.

And then I guess my last question relates to the fee income. Any expectations of the reversal of some maybe seasonal trends that we could have seen this quarter, particularly in service charges or mortgage-banking related?

Mortgage banking should improve just based on seasonality. In terms of service charges, I don't know anything that's unusual on service charges.

This is Katie. We did have the -- Charlie referenced the insurance agency, the contingency income there. That was about $100,000 and that's a first quarter event. So that would kind of be the outlier. And the MSR write up was over $200,000, although I will say a portion of that adjustment was related to increase in the volume, which is our strategic plan this year to put more into that portfolio.

So other than that, again, the volume and such in the mortgage should continue this year, and that would be the only kind of a layer in the non-interest income this quarter.

Andrew Liesch, Sandler O'Neill.

Charlie, I'm wondering if your expectations of getting the efficiency ratio down towards 60% by the fourth quarter, is that still your expectation and what additional levers can you pull to get there?

It is still the expectation, and we've been very clear that we expect the run rate either in the fourth quarter or the first quarter of next year to be right around the -- in the 60% area. Some of that depends how you calculate it too. That's based on the way we calculate it.

In terms of levers, I think it's just ongoing. We have some -- a number of initiatives that are in play, that are scheduled to be rolled out, but the great thing about the efficiency ratio as you will know is, it also takes into consideration revenue increases. And we expect to get a little bit of a lift from net interest income and the loans we're going to be putting on. So nothing really magical in terms of pulling levers, but I just think ongoing progress of what we've already planned to do.

Jeff Rulis, D.A. Davidson.

This is Matt on for Jeff. I just had a couple questions. And the first one relating to credit quality, you guys said you added seven loans to TDRs in the quarter. Could you provide more color on those and are you seeing any trends in regard to that?

We can. I'll let Kent answer the question.

Yes, Matt, seven loans, three customer relationships added up to the $3 million that were added to the TDR status. Two are in the live manufacturing area and one is in the professional services area, a smaller one of [500,000], all related to going to interest only beyond the six-month period time that is allowed with our going to the TDR status. And the other color I would add is, all three did not require any impairment and going to that status. Therefore, we do view that always as temporary in nature and will be back -- will be viewed as performing TDRs as we progress down the line.

Thank you. And also I just want to ask how do you plan on redeploying the capital from the under public offering?

It's a good question. Certainly, we think -- it gives the balance sheet room to grow, which may well come into play, given what we're seeing in Denver. And then it does give us a little bit more flexibility as we analyze any potential acquisitions that we might have. But those would be the two primary factors there.

And just one more question. Along with the public offering we saw John Morrison sell most of his position in MOFG. Do you think you could provide more details on that? What exactly are his intention in this, and is he still going for re-election in 2020?

Yes, in 2020 -- he was just re-elected to the Board at our annual meeting. John, he just -- coincidentally the day that we announced this -- it was also his 80th birthday and I think it's just a natural progression for John. If you know John's history, John has bought and sold more than a 100 banks during his career. And we made the statement publicly that he remains on the Board, he is not the Chairman. He was the Chairman in the first year of our merger. But we don't necessarily expect John to serve out the entire term of this particular Board term.

He still owns a little bit of stock in his foundation and in his trust, but I just think this is a natural progression. It's something that John and I have talked about for the last nine months, and quite frankly, I don't want to speak for John. But I think he saw a nice opportunity as a result of what we've seen since the Presidential election last November.

(Operator instructions) Brian Martin, FIG Partners.

Charles, maybe, more for Kent, just on the outlook for credit, it feels like it is, as you guys kind of talked about, maybe begin the stabilizer stabilized here. The outlook for provisioning and kind of reserving going forward given you have still a watchful eye on Ag, but maybe some improving trends, stabilizing trends elsewhere, what is the best way to think about that going forward?

Yes, Brian, I will talk about the as you look at the actual portfolio, obviously, at the purchase accounting side of it that impacts this and certainly Katie can add flavor. But as we sit today and as we forecast over the next few quarters in our classified list, we don't see any material changes. So the allocation that was provided in the first quarter is something we feel comfortable with. Given the current classification list, we have in place the impairments as we have identified to work through those more severely classified credits that are on the radar. But beyond that, on the purchase accounting, because that certainly does come into play as we migrate credits across, I would ask Katie, to add more color on that.

Yes, I think Brian as we have discussed before, the longest thing keep -- renewal keep on the pace that we have experienced. The run rate that we saw Q1 will sustain going forward if there are no other changes. Again if those renewals, if we see an uptick in those, then we will see an uptick on the P&L side on the discount accretion income to offset any additional expense.

And then maybe one for maybe Charlie or Steve. Just the core margin, I guess you kind of talked about it being stable here, and we have the rate increase. I guess if we get more rate increases, kind of our -- that seemed to be expected going forward, where is the bias on the core margin going forward? It sounds as though you are not really feeling a whole lot of pressure from a funding perspective today and it's kind of staying stable. I mean could it possibly have a downward bias or it would just be more of an upward bias, but just modestly, as you think about additional rate increases going forward?

Yes, I think it's great question, and I think it's one that every organization is dealing with and I think the answer is, you tell me what the beta is on the next 25 basis points and we can give you an idea. I heard someone say that and I can't remember who it was now, but somebody said that the beta might be 30%, but the next 25 basis points might be a 100%, and I don't know if that is necessarily true for our footprint or not, but I know it's something that we think if you get two more increases this year, certainly the core rates are going to have to change, and the question is how much. So Brian, I would just say that if you factor all those into the equation then we're probably neutral and we are going to do everything we can to sustain that. The thing that's puzzling to me is that even though the Feds increased interest rates and generally the bond market has even though rallied recently, but the bond rates are higher than they were last year at this time, and yet, some of the five-year loan rates appear to be just where they were.

And because there is this feeding frenzy, especially on commercial real estate loans, I don't think that augurs well for margins to the extent that people participate in that at a -- to a big degree. What we've tried to do is be selective on where we participate at these rates. But for the most part we've been able to get a little higher rates on the production that's in the pipeline, but I won't get anyone. We're having to be selective to retain and add customers and just hope we're making good credit decisions when we do that.

And just a couple last things. On the expense side, when you talked about a couple of unusual and kind of maybe non-recurring items in the quarter that were called out, but I guess, can you just give us an update on how the expenses trend over the balance of the year, just kind of how you're thinking about that? I guess maybe in the context that are there additional costs coming as a result of Denver, I mean, maybe there more additional folks where you are going to hire on the fee based side or just any thought on how the expenses play out would be helpful.

Thanks, Brian. Our run rate, without the amortization, and again, without those -- the non-recurring expense excluding Denver is at about 19.2% for the quarter. And that trends down just slightly each quarter. Amortization helps with that obviously too. But with adding Denver, we will see the salaries expense and the occupancy kind of where it adds I think this quarter going forward. We do have some triggers in the salaries line item, but those likely are second half of the year event. So I think we're forecasting to get to around the $90 million in Q4, but not a significant amount of change in the overall non-interest expense.

Okay and then just housekeeping, your calculation channel, you talked about the efficiency and kind of the 60% threshold or target. What methodology, or I guess, what are you guys including or excluding from that to kind of get your target 60% number?

We exclude the amortization and we include the tax equivalent income adjustment. That's about the [gist] of it. We also exclude the non-recurring gains, which there is minimal amounts at Q1. But that's our methodology.

And then, if you maybe just the -- the last question is more on the just the pipeline. Charlie, you talked about there is fair amount of credits you passed on, but the current credits out there -- and I guess, what's the difference or what difference are you seeing in the credits you got in the pipeline versus what you passed on? I guess just trying to understand what the biggest differences were there.

Brian, this is Kent. What I would add to that is that when you say passed on, it's ones that we didn't obtain the bid-on and that was over. Primarily, rate would be the main driver. With that, they would be sub 4% on ones that we would have been more in the fourth quarter or higher range. So, at 4% of slightly under.

A little bit of what we truly pass would be if the terms, i.e. higher loan to values or amortizations just didn't fit into how we would normally look at the specific credit. But primarily, the ones that we missed out on would be driven by the rate and the length of the rate being offered.

Okay. And Kent, would you consider the Denver market as competitive as what you're seeing in Iowa or is it -- I know you're going to going to be able to bring a book of business over, but the competition out there is, I guess, how would you quantify that?

Well, at this point what we're looking at, as you alluded to, are the credits that they have strong relationships with and they are bringing over and we're seeing those all fairly priced based on how we would view the overall market in Denver is competitive. So, I think that's something that we'll get more of a handle on as we go through the transition of relationships being brought on the books and they continue their calling efforts. So, it's probably a little early from my standpoint, unless there's others who would want to add that.

I think Kent said it very well, I think it's probably too early to call, but we really do like what we've seen so far.

And then maybe last one, Charlie. Just on the M&A front, I guess, can you give any update on how you're thinking about things? I guess, are you more focused on getting your own house, I guess in order to do that 50% level before you entertain looking at something else or is there any -- what appetite you have for M&A and what are the opportunities out there today?

I think, well, there is an appetite for M&A. I think they would tend to be smaller deals, maybe under $600 million or $700 million. And I think the beauty of our Company, right now in the early second quarter of 2017, is that if we don't do any M&A, I think that we have a lot of potential and opportunity inside our own Company as it stands now. With that said, there are some banks for sale, some were interested in perhaps, some were not, but there's really nothing substantive to report on this call.

And are those -- I guess would you put those in existing markets or would there be new markets and will they be more based-off of -- more targeted toward attractive funding basis or, if any color you can provide on that?

Existing markets and there's a range, some with low loan to deposit ratio, some with higher loan to deposit ratios. But as I said, there's certainly nothing imminent, that's for sure.

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

Yes, thank you to all for joining us this morning, and if there are any questions that you need further clarification on, please feel free to contact any of us who were on the call, this morning. Back to you, Steve and thank you.

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