Midwestone Financial Group Inc (IOWA) (MOFG) 2019 Q4 法說會逐字稿

Good day and welcome to the MidWestOne Financial Group, Inc. Fourth Quarter 2019 Earnings Conference Call. (Operator Instructions)

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, 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 Securities and Exchange Commission. MidWestOne Financial Group, Inc. undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances after the date of this presentation. Please note, this event is being recorded.

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

Thank you very much, Eiley, and good morning or good afternoon to everyone on the call, and thank you for joining us. We're joined on the call this morning by Gary Sims, our Chief Credit Officer; Barry Ray, our Chief Financial Officer; and our Treasurer, Jim Cantrell.

I'll just begin with a few preliminary remarks, as usual, and would say that the headline numbers certainly are very good, and we're all very pleased because there was a lot of hard work that went into 2019 throughout our company, and we are very, very pleased to see that be rewarded with much improved financial results.

To recap, $0.83 a share for the quarter, $2.93 for the year. Those include merger-related expenses, and obviously, the numbers are better when those merger-related expenses are taken out. I would also note that our efficiency ratio made a nice move downward during the year, roughly 57.5% for the year. It was -- the efficiency ratio was inflated a bit in the fourth quarter due to the $3.9 million expense for tax credits, and we essentially gained this back in the reduced taxes we paid. And of course, the expense was recognized above the line and the reduced tax expense below the line, hence the higher efficiency ratio.

It's been a tough 6 months. I'll start with the balance sheet. It's been a tough 6 months for loan volumes, and I think there are multiple reasons. There's not any one reason in our particular footprint. First of all, we've had a lot of liquidity events, and we talked about those liquidity events in our last call last quarter. Those -- many of those liquidity events continue to come where folks are just selling their businesses and paying off their loans with us, and we saw that again during the fourth quarter. We've seen some loans refinanced out of MidWestOne. In some cases, that had to do with relaxed credit terms, not in every case, but we did see several credits move that we were not willing to meet the credit terms other institutions were offering. And then especially in the ag sector, we have been able to work some substandard and problem loans out of our bank, and when those leave, our loan volumes go down.

I would also mention of note that our Denver market had large unexpected paydowns on their lines of credit in the fourth quarter. It did not involve loss of customers, just in the normal flow of business, but these were unexpected and certainly hurt our loan volumes. And I did talk this morning to one of our regional presidents in the Twin Cities who reported that, from their perspective, business has been slower in our customer base in November, December, but reported that as the calendar changed into a new year, that the outlook might be a little bit better.

So as we look at 2020, we have budgeted 5% loan growth. We have a decent pipeline. But I think we will see some other opportunities to evaluate deals during the first quarter, and that would be especially true in our Denver market where we have a number of opportunities that we will be looking at over the next 30 to 60 days.

Better news on the balance sheet would be that this was a very good year for deposit growth, one of the best, I think, in the history of our company. And the reason I say that is that in the legacy MidWestOne footprint, every region saw an increase in deposits during the year. And I think what's especially gratifying and noteworthy is that the rural markets, and we do serve a number of rural markets, but in our regions that comprise rural markets, they were some of the better deposit gatherers of 2019. That being said, the Twin Cities footprint had a good deposit year, as did our 2 Florida offices, as did Denver. And I'd go back to the fact that we want to build our franchise on our core deposits, and over the long term, we remain very confident in our ability to grow our loan book. And I think we will continue to do that and see progress again in 2020.

One thing that I would note for the call, one of our strategic objectives for 2020 is we will be hiring more bankers in our Denver market. We think there remains significant opportunity there. And I would remind everyone listening that we have mostly commercial and industrial loans in that market, which we think gives us a good balance to the commercial real estate loans we have in the Twin Cities. We've already hired a couple of very, very good support people in Denver. And I think during the first quarter, we will be able to add a couple of bankers, and I think that will manifest itself with better loan volume from that market in 2020, '21 and '22.

Good year, in my opinion, for noninterest income. I'll start with wealth management. Both our Trust Department and our investment services areas had record years. And I'll remind folks that we essentially tripled the size of our Trust Department when we acquired American Trust, and that integration has gone exceptionally well. We've had very little customer attrition out of our Dubuque Trust Department, and that's really thanks to the good work of a lot of people. Investment services is a smaller piece of the wealth management pie. They also had a record year. We did add 2 investment representatives with the AT acquisition, and those 2 have hit the ground running with MidWestOne. We have excellent momentum in investment services, and we expect, both in investment services and in Trust, that we will add salespeople in 2020 and hopefully be able to expand our footprint a bit. But again, that depends on our ability to hire good people and the right people for those jobs.

The Home Mortgage Center had a good year. Of course, the servicing rights hurt us to the tune of approximately $1 million of a negative adjustment during the year in 2019. The integration with American Trust could not have come at a worse time for our mortgage people because just as their volumes were ramping up, we had to integrate the systems. But that particular market is now doing very well. We were very gratified to hear that we retained in Dubuque our traditional #2 place in the market. Credit -- there's a credit union there that's #1, but we have retained our #2 ranking in mortgage in that market, and we look forward to a good year in mortgage. In 2020, we start the year with a pipeline that's much larger than it normally is at this time of the year. And I would also remind everyone that we do now service about $1.1 billion in mortgage loans. So depending on the interest rate environment, that should be a steady source of fee income going forward.

Turning to the net interest margin. Probably, the one thing I want to talk about in these remarks would be the fact that our core margin fell from 3.48% to 3.42%, which was a bit of a surprise to us. And I think I can explain 5 of the 6 basis points away pretty easily. We did charge off some interest on ag loans. And for those who are familiar with ag loans, they typically pay interest at the beginning of the year or the end of the calendar year. And when you charge off interest on ag loans late in the calendar year, you typically charge off a lot of interest. So 2 basis points of our core margin shrinkage is just due to charge-off of interest. And then 3 basis points is attributable to the lower loan-to-deposit ratio, in other words, an unfavorable mix change. As we look forward, we would expect our core margin to be, in the near term, certainly 3.40% to 3.45%. And absent a change in the yield curve or interest rates, I think we feel pretty confident in our ability to operate in that range.

Turning to asset quality. We did have a $9.5 million increase in nonaccrual loans. And as we noted in the earnings release, $2.2 million of those loans paid off already in January and are no longer in our bank. And of the remaining $7.3 million that are on nonaccrual, none of those represent surprises. I would characterize those as simply a deterioration of existing credits. And we certainly believe we're reserved properly on those credits at this point in time. I would also note, for those who model our financial performance, that we have a scheduled pay-off of $3 million on other real estate owned next week. And so our OREO should go down by $3 million in the next week to 10 days.

We also expect, more importantly, that there will be more resolutions of some of these problem credits coming in the first and second quarters of 2020. So the outlook on credit and asset quality is we don't really see anything on the horizon beyond what we've talked about this morning. There does continue to be stress with our weaker borrowers of the ag community. I'll talk more about that in just a second. And if you look at our 39 -- 30- to 89-day past dues reported at the end of 2019, they were certainly at the levels that we've seen in the past and have no -- we have no cause for concern.

We did put a statement about CECL in the earnings release. And the only thing I would add to that would be that we think the CECL adjustment will be plus or minus 10 basis points to our capital ratio. So certainly not something to be overly concerned about from a capital point of view.

I'd like to give a brief outlook because we get a lot of questions about the ag sector. This is the ag renewal season, and our customers are starting to come in, and we're renewing, in most cases, their operating lines for 2020. A reminder that in some parts of our footprint, there are still crops in the field, which is very unusual for this time of the year. And on average, 2019 yields were 10% to 20% below 2018 yields. And again, to remind everyone, 2018 was a bumper crop. So 10% to 20% down from a bumper crop in 2018.

I would characterize ag much the same way as I've been characterizing it for the last 3 or 4 years. It's not great. I do not think it's a widespread crisis, certainly not in our company. But I would say, for marginal borrowers in the ag space, this is a very, very tough time. I don't think that will change. And that's where most of the energy is focused around problem credits. For high-quality and average and above-average ag producers, this current environment is very, very manageable, and there will be a lot of survivors who come through this. At the end of the year, ag loans comprised 9.3% of our portfolio. That's down just a touch from the prior quarter, primarily due to paydowns on operating lines and movement out of the bank, as I talked about before on problem credits.

I'll give you a few metrics to measure the movement in substandard and watch credits. If you look back, the high for our ag portfolio in terms of watch and substandard credits was 23.6%, and that was in March of 2018. At year-end, we were at 19.8%. That's -- that was a slight increase from the prior quarter but significantly down from the high of March of 2018. Our substandard loans were up a little bit. Substandard loans at 9/30/19 were 7.6%, and they were at 9% of the ag portfolio as of year-end. And again, that's off the high of 11.8% in March of 2018. So directionally, I think we're still in a pretty good place.

We acquired a number of dairy loans when we purchased AT. And I think it's fair to say that the dairy industry has stabilized a bit, slightly improved operating margins, and there's certainly more optimism in that sector than there has been for several years.

Soybean and corn prices are well off their lows. I think the trade deal is probably a modest positive. And again, the summary here would be that we will have bumps along the way, but we think we're able to manage through this. And I think what I feel most confident in is that we've been able to identify where the issues are in the portfolio and then act accordingly.

In terms of capital, I think we're in good shape on capital. We're certainly in the sweet spot of where we want to be in terms of tangible common equity, and we continue to accrete capital at a pretty good clip. The dividend increase that we announced is the largest in some years for our company, and we still do have room on the buyback plan, the stock repurchase plan when we think it makes sense for our shareholders.

So to summarize, I would say 2020 will be a year for us to return to a more normal loan growth pattern. And if you look at our company, I think Denver, the Twin Cities and Florida still have very, very strong economies. And in our metro Iowa communities, we also have some opportunity to pick up loan volume in 2020. In one of the rural regions in Iowa, we already know that we're probably going to increase our loans just because of what's in the pipeline, by 5% to 10% this year. So overall, we think a 5% loan growth goal is attainable for our company in 2020. And we also think that at least now, the momentum in noninterest income, mortgage, trust and investment services and opportunities for interest rate swaps for our commercial borrowers is also strong. So the outlook for noninterest income should be pretty good as well.

With that, we're happy to entertain any questions you might have. And I will turn it back to you, Eiley, as you get the questions in order.

(Operator Instructions) Our first question comes from Jeff Rulis with D.A. Davidson.

Just wanted to kind of check in. Charlie, you mentioned the core efficiency ratio at 57.5%. Kind of as we look into '20 and if we think about kind of the, I guess, conversion of ATB and getting all that in, I guess, do you have a target for a core efficiency? Do you think you can improve upon that? That's a pretty skinny number. But is the balance of '20 the moving pieces on expenses? And if you can kind of confirm whether you think there's any more cost to squeeze out of the merger.

Barry and I were talking about the cost saves yesterday, and we are very confident that we've achieved the cost saves that we said we would from AT. It's a good question. Our goal had been to get below 60%. It would not surprise me if it ticked up a little bit towards 60%, but we'll sort of have a stake in the ground at 60%, below 60% for our core efficiency ratio. We'll have to see how it all plays out, Jeff. But I would think somewhere in the mid- to high 50s would be something that we should be able to attain over the long term. I hope that answers your question.

Yes, that's helpful. And I think in the release and also, Charlie, you mentioned in the prepared remarks just this strain on loan volumes with liquidity events and refis and some work out, but I think there was even a comment on weaker loan demand. What are the spots? And you may have pegged it, I guess, kind of the rural Iowa, if you point to Twin Cities, Florida, Colorado as being strong, is that the market, the geography that's particularly weak and maybe within the segment that is the weakest for demand?

Yes. The -- so maybe with an anecdote is the best way to answer the rural footprint. One of our better ag bankers who's been with our company a long time and is one of our top bankers likes to talk about that he's been calling on certain farmers for years and wanting to bring them into the bank and had the opportunity to look at their financial statements within the last year. And when he saw the financial statements, thought to himself, "I just can't believe that it doesn't look any better than this, and we passed on the opportunities." And I think that's what you see in the ag space.

And the better borrowers in the ag spaces are still being called on by other institutions, and we have to get pretty competitive on price. But in general, we have rural markets not only in Iowa but also in Wisconsin and up northeast of the Twin Cities, and those are not economically strong regions. So when we look at budgeting, we -- basically, if you can do 3% or 4% in those footprints, that's pretty good because their economies are just not growing.

You get closer to the Twin Cities or as we talked about Denver and then Naples, especially, those are strong markets. In Iowa, Dubuque is still doing pretty well, and we're -- we expect Dubuque to increase loans, their loan totals during the coming year. And I think we'll get a nice lift at Iowa City this year as well.

So that's kind of a rundown of our footprint.

Great. And just one last one, quick one for -- maybe for Barry. Just the tax rate in '20, what you would expect that number to be.

Yes, no problem, Jeff. It was certainly -- our effective tax rate this year reflected the benefits related to the tax credit investment, as we articulated in the release. We do have one additional renewable energy tax credit investment scheduled to provide tax benefits in 2020, though smaller in magnitude than we experienced in 2019. As a result, I would estimate the effective tax rate in 2020 will be about 18%.

Our next question comes from Andrew Liesch with Piper Sandler.

Charlie, I'm sorry if I missed this, but -- because I know you've given this guidance in the past. Can you talk about what your expectations are for provisioning? And maybe it's different under CECL, but I'm sorry if I missed it if you did.

Well, that's a good question. That's above my pay grade. I should let Barry and Gary talk about that because CECL does change the dynamic significantly.

Yes, Andrew, this is Barry. I'll start. With the adoption of CECL in 2020, it's difficult to provide a good estimate of provision expense. As like others, we have little experience in estimating credit losses under the new guidance. And so given the CECL guidance, provision expense is likely to be all over the math in the near term and likely more volatile in general. So as CECL impacts, the timing recognition of credit losses and not the ultimate dollar amount of credit losses, I suggest investors would consider evaluating credit quality on other metrics than just the level of the provision. But that's an nonanswer, I realize, Andrew, but I don't have a good answer for what we think our provision will be.

Do you have anything to add, Gary?

Yes. I mean, I agree with Barry in terms of how to look at provision for the year. I mean, ultimately, our credit quality is going to be driven by net charge-offs, levels of NPAs, et cetera. And I would say that you could look for the levels of net charge-offs for 2020 and the NPAs for 2020 to be an improved picture relative to 2019.

Okay. That's a good way to look -- to think about it. And then, Charlie, the bankers that you're looking to hire, like what's the sort of background that you're looking for? I mean, what's this banker's background? Is it big bank experience, small bank experience, regional bank? Like what's an ideal person that you're looking to bring on?

Well, we are fortunate that our team in Denver is very well connected, and they worked for a long time in the Wells Fargo office in Denver and then for another community bank for 4, 5 or 6 years before they joined MidWestOne. And the fact that they're well connected, I think they have a lot of strong relationships. Probably, these are going to be bankers who have been in that market for a while, who have established customer relationships and who fit our culture. That's probably the best way I could answer that. And we're not necessarily looking to hire bankers who specialize in commercial real estate because we've said that we want that market to be primarily focused on C&I loans, which gives us -- if you look at the portfolio out there, there's a big diversification in terms of industry represented and things such as that. So established bankers who can bring customers to MidWestOne and who fit our culture.

Our next question comes from Damon Delmonte with KBW.

So first question, just wondering, in relation to the margin, maybe we get a little bit more color on the outlook for the accretable yield impact. Obviously, it was down pretty significantly this quarter. I know last quarter was a bit of an aberration, but is there a way we can kind of frame out what we're expecting on a quarterly basis?

Yes. This is Barry, Damon. I'll take that. Yes, we've had -- looking at my notes. Discount accretion was $3.9 million in the fourth quarter and $7.2 million in the third quarter. And obviously, the level of discount accretion is impacted by payoffs, for example, but we also know that it's an amount that we recognize more upfront. And so of the $3.9 million, a good chunk -- a portion of that was attributable to payoffs as well. I would attenuate that number, looking forward, to somewhere in the 2s and then going down from there, low -- high 2s to low 3s and then going down. Damon, that's the best way I could think about it.

Okay. Okay, great. And then the core margin, you said, is expected to be in the 3.40% to 3.45% range. Is that correct?

Yes.

Yes.

Okay. And then are there opportunities to -- I saw like the CD rates -- sorry, the cost of CDs picked up a little bit this quarter. Is there some opportunity to lower those in the coming quarters?

Yes, Damon, this is Jim. I'll answer that question. The number you saw, we're floating right around 2%, just below 2% for that CD yield. And I would say, in the fourth quarter, we had a little bit of a drop-off in the purchase accounting adjustment that probably is worth about 2 basis points in total. My view is that when I look at just the coupon of the CD book, just the coupon alone, we hit a peak in the third quarter. We're actually down in coupon, although we get less purchase accounting benefit in the fourth quarter. We're actually down in coupon in the fourth quarter. It's going to trail down. The coupon will probably trail down. We're putting on CDs a little bit lower book average. So we're -- the book average is in the upper 190s. We're putting on CDs on average in the -- probably in the 180s, upper 170s. So it's slow. It's not going to move very fast, but the trend ought to be down in the coupon.

Okay. That's helpful. And then with respect to expenses, Barry, can you give us a little outlook here as to how we should think about the quarterly run rate, especially if you guys are able to bring on some additional commercial lenders in the Denver area?

Yes, I'll give you the best I can on that, Damon. So excluding the $3.9 million of amortization of the tax credit investments in the fourth quarter and merger-related expenses, noninterest expense was $29.8 million in the fourth quarter. So I would say that the going forward run rate, probably $29 million to $30 million is a good range from what we would anticipate.

Okay. And does the FDIC insurance expense come back in the first quarter of '20? Or does it come back in the second quarter?

It comes back in the first quarter, Damon. We used all of our remaining small bank assessment credit in the fourth quarter. So we'll be back to a normal rate in Q1 of '20.

Okay. All right, great. And then just lastly, Charlie, I think you mentioned that you're hopeful that some of those nonperforming loans or nonaccrual loans are going to be resolved in the next quarter or so. Are you referring to the ones that just came on, like that remaining $7 million or so? Or are you talking about the legacy previous to last quarter?

Yes. Damon, this is Gary. What -- the way you think about it is, the entire pool of loans in the first quarter, second quarter, we expect to have a pretty good couple of quarters in terms of resolutions, not necessarily the new ones that came on this last quarter because when you're working through problem credits, it normally does take several quarters. So the resolutions, we'll get in the first quarter, and then second quarter, probably credits that we recognized throughout the course of 2019.

(Operator Instructions) Our next question comes from Brian Martin with Janney Montgomery.

Guys, just one question on the capital, just with the buyback and then just kind of use of capital at this point, just kind of the M&A outlook. I know you talked about where you are on a [TC] basis is pretty optimal, but just how are conversations on the M&A side? Or just -- is that a -- is that something that has been heating up? Or is it not so?

Well, I'll take that one, Brian. I would say that the environment is such, especially with the cost that banks are finding with -- in regard to technology spending, that a number of the smaller institutions are certainly evaluating where they want to be 2 or 3 or 4 years from now. So yes, I think there's probably a lot more conversation now than there has been over the past year or 2. At the same time, any conversations we're having are at the very initial stages. So we're not deep in discussion with anyone, but I do think there's a pipeline of banks that will sell in 2020 and '21. That's my gut feeling.

Okay. That's helpful. And maybe just one for Jim on the margin, just kind of the puts and takes. I mean, if your outlook, Jim, is that rates are stable, I mean, what could take the margin higher or lower here, kind of the upper end of the band or the lower end as you look out over the next couple of quarters?

Yes. Thanks, Brian. I do view the margin as in a static rate environment. I think we've shown if rates go up or if rates come down, if there is movement on the short-term rates, we've been able to manage pretty well. What really is painful to us, and I suppose most banks who are configured like we are, is this flat yield curve. So as I look at -- I would say forget about rates up or down, just look at the shape of the yield curve is really going to be the biggest determinant of what our margin is going to look like going forward. And I was looking at a graph this morning. And for us, I think -- and probably most banks like us, some short-term index, whether it's overnight funds or 3-month bills as compared to the 5-year treasury is probably the most relevant part of the yield curve. And in the last 2 years, that's just been very flat. You look at over 5 years, there's been some slope, historically, average 75 basis points of positive slope. We're right now at 0 slope, 0, overnight to 5 years. So if that continues, I think we are going to still see some pressure, if we get that continuation of this very flat yield curve.

Got you. Okay. That's helpful, Jim. And then last 2 was just on the -- Charlie or, I guess, whoever gave the commentary on the expenses. Just as far as the -- your comfort level at least for 2020 and staying sub-60% on the efficiency, given, Charlie, you've talked about the investments in technology in kind of balancing that, but, I guess, it sounds as though fair to assume that the -- balancing all that, you would still expect to be sub-60% in 2020?

Yes.

Okay. And I think just the last one was just on fee income. The current level that we're -- that you're at this quarter, I guess, should that be a good benchmark to use or a good baseline to build off of as we go into first quarter '20?

I'll take that one, Brian. This is Barry. So excluding the mortgage servicing right adjustment and investment securities gains, fee income was $8.7 million in the fourth quarter and $8.6 million in the third quarter. There are obviously some lumpy items in there like swap revenue. And so adjusting for those, I'd probably put it at a quarterly run rate of 8.3 to 8.5, acknowledging that sometimes we're going to do better, sometimes right in that range.

Okay. That's fair enough. And Charlie, you talked about the Denver office. Just remind me how big that operation is today. How is it staffed? And if you guys look to add people, just remind us on how many lenders you have out there currently, if you could.

We have 4 commercial bankers, plus a hybrid, so maybe a fifth. We have a treasury management person who's done a phenomenal job for us. And then a couple of other support people. They had a downturn in deposits at the end of the year because they had some year-end distribution payments, which is not uncommon for privately held businesses. They hit $60 million in deposits. I think they ended the year around $50 million, maybe a little bit less, but that needle is pointed upward. And their loans, as I said, they had some paydowns on lines at the end, but I think they got up near $120 million in loans and then a bit below that at year-end. So hopefully, that's helpful to 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.

I want to thank everyone for being on the call this morning. And as always, if you have follow-up questions, you're free to contact any of us who spoke on the call this morning. Have a great day and a great weekend.

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