MidWestOne Financial Group Q4 2022 Earnings Call Transcript

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January 27, 2023

There are 9 speakers on the call.

Operator

Ladies and gentlemen, welcome to the Midwest 1 Financial Group Inc. 4th Quarter 2022 Earnings Call. My name is Glenn, and I will be the moderator for today's call. I will now hand you over to your host Barry Wei, CFO of Midwest 1 to begin. Barry, please go ahead.

Speaker 1

Thank you, everyone, for joining us today. We appreciate your participation in our Q4 2022 earnings conference With me here on the call this morning is Chip Reeves, our Chief Executive Officer and Lynn DeBacher, our President and Chief Operating Following the conclusion of today's conference, a replay of this call will be available on our website. Before we begin, Let me remind everyone on the call that this presentation contains forward looking statements relating to the financial condition, results of operations and Business of Midwest 1 Financial Group, Inc. Forward looking statements generally include words such as beliefs, expects, anticipates and other similar expressions. Actual results could differ materially from those 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 and Exchange Commission.

Speaker 1

MidWestOne Financial Group, Inc. Undertakes no obligation to publicly revise or update these forward looking statements reflect events or circumstances after the date of this presentation. I would now like to turn the call over to Chip.

Speaker 2

Thank you, Barry, and good morning, everyone. I'm excited to be here today and thankful for the opportunity to succeed Charlie as MidwestOne's next CEO. Through Charlie's 22 years of leadership and vision, Midwest 1 has grown to $6,600,000,000 in assets, while expanding our geographic footprint to 5 states. Charlie has also developed an enduring culture focused on our employees, communities and customers that's firmly positioned this company for future success. I'm honored to succeed Charlie and grateful for his wisdom and counsel through my 1st 90 days.

Speaker 2

I'd also like to acknowledge Linda Vacher, our President and COO, who did quite simply an outstanding job as Interim CEO. For those who don't know me, I spent my banking career at both super regional and community banks in both rural and metro markets, Building organic growth engines while developing new lines of business through a combination of a disciplined strategic process and talent acquisition. I've been fortunate to work with outstanding bankers and teams that executed on strategic priorities, ultimately delivering improved financial results and shareholder value. Here at Midwest 1, I see a bank with a strong foundation, compelling markets and diverse business lines. Our commercial banking franchise has benefited from initiatives implemented 18 to 24 months ago, which can be seen in our Q4 and full year results.

Speaker 2

We also have a significant wealth business that during 2022 has strategically added talent and AUM in our growth markets. While year over year revenue in the business is muted due to equity valuations, This business line is prepared for substantial growth. In addition, MidwestOne enjoys dominant community bank market share in many of our core Iowa Banking markets. We now need to translate these foundational strengths into our operating performance. Looking at our 4th quarter results in more detail, they reflected many of these initiatives with loan growth exceeding 10% annualized for the 3rd consecutive quarter.

Speaker 2

This growth driven by talent acquisition and our relationship banking model occurred primarily in our select metro target markets of the Twin Cities, Denver and Metro Iowa. Turning to credit quality. Through expertise within 4th quarter strategic Our asset quality metrics improved measurably with the non performing assets ratio decreasing 16 basis points to 0.24 percent. Our allowance coverage ratio is at 1.28 percent and our 30 to 89 day delinquencies remained at historically low levels. We've now remedied our organization's legacy credit issues and are positioned well for 2023's uncertain economic conditions.

Speaker 2

Our 4th quarter results, however, were impacted by higher funding costs and are primarily fixed rate earning asset composition leading to net interest margin compression. In addition, non interest income was impacted due primarily to lower mortgage origination volumes. Both pressured our profitability and earnings. Looking forward, I believe there's an opportunity to improve our operations while enhancing and further developing our growth engines with the ultimate goal of becoming a top performing bank. To accomplish this, we commenced the development of a strategic plan that will position Midwest 1 to achieve this goal.

Speaker 2

While we outlined more details of the And our late April Q1 2023 earnings call, let me share some high level thoughts on our review. First, a clear area of focus is to more actively manage the bank's balance sheet, given that we are liability sensitive. We're reviewing a broad range of initiatives to address this challenge. 2nd, we will review our business lines and the geographies in which we operate. We must ensure that we are in businesses and markets that to provide opportunities for scale and profitable responsible growth.

Speaker 2

3rd, as we review our business lines, A commensurate review of our operating expense base will occur. This will likely lead to a reallocation of resources to drive growth as well as efficiency. You'll hear me say this often, we want to be a high performing bank with an organic growth engine to power our results. Once again, I'm honored to be a part of Midwest One Bank. This is a special place with a strong foundation, compelling markets and talented bankers, and we look forward to creating a high performing organization.

Speaker 2

With that, I'll turn the call over to Len, who will

Speaker 3

Thank you, Chip, and good morning, everyone. With Chip's arrival, the leadership team is aligned, And we are committed to the acceleration of our journey to build Midwest 1 into a high performing bank. While that journey has begun, We're just getting started. Looking back over the past year, I am proud of our accomplishments as we executed on our strategic priorities, including: number 1, driving loan growth while improving the risk Profile of our portfolio number 2, scaling up our wealth business and number 3, integrating the Iowa First acquisition. I'll offer some high level perspective on each of these focus areas.

Speaker 3

Looking at our commercial loan growth, Denver and Twin Cities led the way, each growing more than $120,000,000 in 2022. We are very pleased that Twin Cities commercial portfolio now exceeds $1,000,000,000 Iowa Metro has also been a strong contributor to growth, Des Moines growing more than 25,000,000. These are different markets, but with one common thread, recruiting new talent. These talent investments have driven increased volume, But just as importantly, an improving risk profile. Non performing assets are down by more than half, a nearly $16,000,000 reduction, while 30 day past dues have followed the same trend.

Speaker 3

Finally, I should point out that while commercial is the needle mover in our loan growth engine, our retail team continues Looking forward, our commercial pipeline remains solid. In the current environment, we feel mid Single digits is an appropriate growth range to target. At the same time, given the new talent we've onboarded and our low loan to deposit ratio, we will continue to add new customer relationships opportunistically When the risk and return profile is a shareholder win. Our belief is that some of the uncertainty of 2023 could present opportunities for our credit disciplined relationship approach to take advantage and gain share, especially in our growth market. The wealth business is the same talent story.

Speaker 3

While the revenue growth has been slower to materialize than we planned, the momentum over the back half of twenty twenty two bodes well for the future. We are pleased that we saw AUM grow materially faster than the S and P 500 with our wealth teams bringing on $180,000,000 of new AUM.

Speaker 1

As we look forward,

Speaker 3

we are encouraged with a pipeline of similar magnitude And we will be opening our new Cedar Rapids wealth and commercial office in the next 90 days. Finally, Iowa First has performed according to plan with expense takeouts realized and earnings contribution evident. With Iowa First now fully integrated, we are positioned to focus our technology and operations capacity on strategic initiatives in the year ahead to drive growth and efficiency. Let me now turn the call to Barry to discuss our financial results.

Speaker 1

Thank you, Lynn. I'll walk through our financial statements beginning with the balance sheet. Starting with assets, Loans increased $94,200,000 or 10.4 percent annualized from the linked quarter to 3,800,000,000 Strength in the Q4 was led by commercial loans, which increased $82,500,000 or 11.2 percent annualized from the linked quarter. In the quarter, new loans were brought on at an average coupon of 6.06% and at a premium from 4.94% in the Q3 of 2022. The overall portfolio yield was 4.66 percent, resulting in a 20 basis point improvement in interest earning asset yields as compared to the linked quarter.

Speaker 1

As Chip discussed, we took strategic actions through the 4th quarter to improve the credit profile of our loan portfolio, which positions the bank for an uncertain economic outlook. During the quarter, the allowance for credit losses declined $2,900,000 to $49,200,000 or 1.28 percent of loans held for investment at December 31. The decline was due to net loan charge offs of 3,500,000 partially offset by credit loss expense of $600,000 Deposits were down slightly from the linked quarter, but up 6.9% of $5,500,000,000 as compared to year end 2021. During the quarter, we experienced increased competition for deposits, which required us to raise our rates to maintain deposit relationships. Looking at this more closely, the cost of interest bearing liabilities increased 44 basis Finishing the balance sheet.

Speaker 1

Total shareholders' equity rose $20,600,000 to $492,800,000 driven primarily by net income of $16,000,000 and a favorable change in AOCI of $7,600,000 partially offset by cash dividends of 3,700,000 Turning to the income statement. Net interest income declined $2,100,000 in the 4th quarter to 43,600,000 as compared to the linked quarter due primarily to the higher cost of funds combined with the increased level of high cost borrowings and partially offset by the increase in interest earning asset levels and yields. Our net interest margin declined 15 basis points to 2.93% in the 4th quarter as compared to 3.08% in the linked quarter. Our NIM was impacted in the 4th quarter by an increase in our funding which rose more rapidly than the increase in our total interest earning asset yields. Non interest income in the 4th quarter declined $1,600,000 to $10,900,000 as compared to the linked quarter.

Speaker 1

The decline was primarily due to an $800,000 decline in loan revenue due to a smaller increase in the fair value of our mortgage servicing rights and a decline in our mortgage origination fee income, Combined with a $700,000 decrease in other income due primarily to a one time settlement recorded in the Q3 of 2022, which was partially offset by an increase of $2,500,000 in the bargain purchase gain recorded in connection with the IOFB acquisition. Finishing with expenses, total non interest expense in the 4th quarter was 34,400,000 a slight decline of $200,000 from the linked quarter. The decline was largely due to a $400,000 decline in merger related expenses from the IOFB The acquisition related to data processing, marketing and legal and professional fees, partially offset by a $400,000 increase in compensation and employee benefits at MLFG, reflecting an increase in incentive compensation expense. Looking forward, we believe our quarterly expense run rate will approximate the

Operator

We have our first question comes from Brandon Nossa from Piper Center. Brandon, your line is now open. Brendan?

Speaker 1

Operator, we're not hearing Brendan.

Speaker 4

Hey, can you guys hear me?

Speaker 2

We can, Brandon. Hi. Yes. Hello.

Speaker 4

Hey, sorry about that folks. My apologies. Maybe just to start off on the equation between kind of loan growth and funding. So it sounds like mid single digit pace out of loan growth is a reasonable expectation. Just kind of curious on how you think about funding that growth looking ahead.

Speaker 4

I mean, it looks like the securities reinvestment can fund a piece, but just kind of Thinking about the balance of that.

Speaker 1

Brennan, this is Barry. I'll start. Yes, the securities cash flows would fund Upwards of about to the mid single digits of loan growth. To the extent that we are able to exceed that particular target, Then we're looking at wholesale funding sources. What we're looking at right now are broker deposits As an alternative given their favorable cost over the short run and then obviously FHLB advances.

Speaker 5

Got it. Got it. Okay.

Speaker 4

And then maybe a second one, just on kind of general deposit pricing pressures. Assuming we get a couple more hikes out of the sense here, where do you think we are in the cycle of pricing pressures at this point?

Speaker 1

I think we're in the thick of deposit pricing pressures is how it feels, Brendan. I think we indicated in our release that our Cycle to date deposit beta has been 15%, which I think we believe is respectable when we see what's happening out there in the industry. It did ramp up in the Q4, quarter over quarter to 25%, which we also indicated in the release. I expect those pressures to continue and perhaps those quarter over quarter betas to ramp up as well. Got it.

Speaker 1

Okay. The FOMC Reaches their terminal rate whenever that

Speaker 2

may be. And Brendan, this is Jeff. Actually, it's 2. Through the cycle or it's at least to date through the cycle, we've been Actually pretty impressed with our granular core deposit franchise in terms of beta of only 15%. And what I'll tell you is we're going to digitally protect That core deposit franchise and the granularity of it.

Speaker 2

So I would expect to, to Barry's point, that beta to rise here, I hear and this deposit pressures continue, but we also believe it's a huge part of our franchise value. So we're going to

Operator

Thank you, Brandon. We have our next question comes from Terry MacCullay from Stephens. Terry, your line is now open.

Speaker 6

Hi, thanks. Good morning, everyone. How are you?

Speaker 3

Good. Good. Good morning, Terry.

Speaker 6

Maybe start off with how far along are you through the portfolio review of the loan portfolio? And guess said another way, should we expect additional kind of credit actions to resolve some of those legacy loan issues?

Speaker 2

Yes, let me go ahead and hit this first and we also have Gary Sims, our Chief Credit Officer with us, Terry. So when I first joined obviously November 1. One of the first pieces that we began to look at was, let's finish the credit job of the legacy credit issues. So We put in place obviously the review and then went with the actions that we did. Ultimately, Anything that we did not believe we would be able to resolve in 2023, we remedied through either a sale or some other resolution.

Speaker 2

So with that impact, we were able to reduce that non performing asset ratio down to 24 Basis points. Gary, if you want to speak to any more of those particulars or even the portfolio as a whole.

Speaker 7

Yes. Thanks, Chip. And what I see On the portfolio and specifically the non performing portfolio that we Have left on the books at 1231. There is still potential resolutions as Chip identified in 2023. So I think that Existing book will continue to resolve and decline throughout 2023.

Speaker 7

As we've talked about before, we do a very thorough review of the portfolio at the end of the year and touched Virtually every credit of material size by the end of the year, and we don't see A migration continued into the nonperforming book in 2023. So Generally, I think you're going to continue to see that book go down as we continue to resolve credits. Does that help?

Speaker 6

It does. Yes. Thanks for the response. And then as a follow-up, when I look at your shareholder value strategy slide, Well, the 3rd or 4th bullet is down since strengthening the commercial banking franchise. And should I interpret that as adding commercial bankers?

Speaker 6

If so, is that in your expense outlook? And what about incremental products? Do you have the product set to compete within the commercial banking space to the degree that you can be successful?

Speaker 2

This is Chip Terry. I'm going to have a couple of comments and then turn it to Len Devasher who really led this effort over the last 24 months. I believe what you'll see as we begin to unveil more of our strategic plans for internally within the bank as well as for the External market, we'll have more of a lean into our commercial banking space than even we do today, and we've made significant progress The last 2 years. In terms of talent and where it goes, absolutely in terms of adding Commercial bankers, and I think we'll be adding those in our select metro markets of Minneapolis, Denver And Metro Iowa, in terms of our product set, I think some of the things that we'll begin to continue to accelerate It is our treasury management initiatives as well. Len, any further comments there?

Speaker 3

I think, Chip, that hits it well. I think the only thing I might add is We do feel like the to the extent there's any clouds of uncertainty in a macro level over this environment that there will be opportunities for companies like ours that can take advantage and take share When the risk profile is there, the pricing makes sense where other folks might be on the sidelines a little bit. And we enjoy that loan to deposit ratio that positions us to do that. So I think that helps our recruiting story.

Speaker 2

And then, Terry, I think the second part of your question is, is that in the expense base today? So, in terms of the guidance that Barry mentioned, We have a significant number of new hires built into that new base, but it will also take a reallocation of some of our current expense base to ensure that we hit that guidance.

Speaker 6

Great. Thanks for taking my questions. Appreciate it.

Speaker 5

Yes, absolutely, Terry.

Operator

Thank you, Terry. We have our next question comes from Damon D'Amonti from KBW. Damon, your line is now open.

Speaker 8

Hey, good morning, everyone. Hope you guys are all doing well today. Just wanted to dig in a little bit more on the margin. I understand you're Seeing some near term pressure here, but, Barry, if you guys there's 2 more rate hikes of 25 basis points by the Fed. Just kind of given the market dynamics and on the funding side

Speaker 5

of the equation, can you give us

Speaker 8

a little bit more Perspective on where the margin could kind of bottom out?

Speaker 1

Yes. It's Obviously, Damon, there's a lot of puts and takes with respect to where the margin ultimately lands. I'll I'll do my best to answer your question. I think in the near term, there will be downward pressure on the margin As expected, the FOMC continues to increase short term rates and our deposit betas pick up. As we discussed earlier, on the so that's going to be on the liability side.

Speaker 1

On the asset side, We will have some benefit on the asset side to those same rates as about 17% of our Portfolio re prices every within a quarter or so. So those would be some of the positives. And the reason why it's difficult to articulate where it's going to bottom is there's uncertainty around what's going to happen, What's going to happen to deposits, for example? The shape of the yield curve is a challenge. So it's difficult to answer.

Speaker 1

My best answer, Damon, is I There's going to be some downward pressure in the near term.

Speaker 8

Okay. Can you do you have the December margin For

Speaker 2

the month?

Speaker 1

We're around $287,000,000 for the month of December.

Speaker 7

Okay. So

Speaker 1

all right.

Speaker 8

So it ended higher than

Speaker 5

for the quarter? Okay.

Speaker 8

All right. Great. Thank you. And then just with respect to Exposure to asset classes, which may come under additional pressure in the coming quarters. You guys could do a lot in the office space.

Speaker 8

Can you remind

Speaker 2

This is Gary Sims, Chief Credit Officer that will answer that for us, Damon. Go ahead, Gary.

Speaker 7

Hey, Damon. Thank you. Like most banks our size, office is not really a Preferred asset class right now, as a result, we're not overexposed. We have 4.5 And that's down year to year, that's down from 4.7 down to 4.5. And to kind of give you an idea of our stance on it, when you look at our construction category, we don't have any office exposure in our construction category.

Speaker 5

So for the

Speaker 7

most part, we're not doing new office space. That probably gives you the best idea of how we feel about office. The existing office portfolio, Primarily well, about 60% of it is in the Minnesota and Twin Cities market. We feel that, that Portfolio is relatively stable right now, backed up by good leases, etcetera, but we're just not in the market to be adding to that exposure right now. Does that help?

Speaker 8

Great. Yes, that's very helpful. I appreciate the color. That's all that I had for now. Thanks a lot.

Speaker 2

Thank you.

Operator

Thank you, We have our next question comes from Brian Martin from Jenny. Brian, your line is now open.

Speaker 5

Hi, good morning, everyone.

Speaker 1

Good morning, Brian.

Speaker 5

Just maybe one last one, Barry, I'd have to beat a dead horse on the margin, but it sounds as though without quantifying where they go, it Sounds like maybe the margin troughs in the second quarter, is that how you would think about it today based on the pressure and the competitive factors that you're currently

Speaker 1

2nd quarter and maybe Potentially flat into the Q3 and then maybe some positive benefit in the latter half of the year, Brian, is how I think about it.

Speaker 5

Yes. Okay. And just remind me remind us the level of you talked about, I think, Portion that reprices, how much of the loan book would reprice over maybe the next 12 months? Is that do you have a handle on what that is or could you give us a little perspective on I

Speaker 1

think about 35% of our earning assets reprice and or mature Over the course of the year.

Speaker 5

Okay. And the new loan yield you're putting on today, the origination rate, Where was it? I think you said that or maybe I missed it.

Speaker 1

Yes. In my comments, it was just above 6% That was the coupon, average coupon in the 4th quarter.

Speaker 5

Got you. Okay, cool. Thank you. And then How about just maybe, I don't know, maybe it's for you, Barry or someone else, Chip, just on the

Operator

fee income outlook. I mean, Chip talked about The opportunities on

Speaker 5

the wealth side, maybe being a little muted with the performance in the market this year, but it sounds like a significant opportunity. Maybe just kind of frame The outlook on mortgage and wealth is just kind of fee income in general, how we should think about that or at least maybe near term and maybe mortgage divulge at your as You haven't done your plan, but any help on the fee income side would be appreciated.

Speaker 2

Yes, Brian, Minus equity valuations, we're bullish on the wealth management space here at MLF right now. Lynn mentioned that $180,000,000 of AUM was brought on in 2022. We believe that number will increase and potentially increase substantially here in 2023. Obviously, equity valuations May determine a little bit of actually what comes to the revenue line item there. Mortgage banking is challenged.

Speaker 2

I think We know that from other earnings from the housing inventories is still low, rates are high, our Pipelines in the mortgage business, it's obviously seasonally adjusted as well now, but are challenged. And so that is a business that frankly we do not expect great momentum in 2023.

Speaker 5

Okay. And then maybe just in general how to think about the maybe growth, I don't know whether you look at growth year over year And fee income in aggregate or just there's a lot of puts and takes last year as far as the noise going through there and even so just trying to think about what the run rate is, A realistic run rate to start the year and maybe as you progress and get some momentum, but is 4th quarter's level Kind of that level or is it should we be thinking about it being lower to start?

Speaker 2

I think this is Chip again, Brian. Yes, that $8,500,000 to $9,000,000 range is, I think, a good range to begin the year.

Speaker 5

Okay, perfect. And just last one for me, more housekeeping. Just On the outlook for accretion income, Barry, any insight as far as how that may evolve through the year? I guess, is it just Kind of stair step down from where we are today, is that how to best think about it absent any significant payoffs or paydowns? Is this

Speaker 1

Yes. That's the way I think about it, Brian. Take the 4th quarter and stair step it down throughout the year And in future years as well.

Speaker 5

Okay. That's all I had. Thank you for taking the questions guys.

Speaker 2

Thanks, Brian. Thank

Operator

you, Brian. We have no further questions on the line. I will now hand back to the team for closing remarks.

Speaker 2

Great. Thanks everyone for joining today. I look forward to sharing more of our strategic plan and priorities in late April as we continue our journey to becoming a soft performing bank. Thanks everyone.

Operator

Thank you. Ladies and gentlemen, this concludes today's call. Thank you for joining. You may now disconnect your lines.

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MidWestOne Financial Group Q4 2022
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