MidWestOne Financial Group Q3 2023 Earnings Call Transcript

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October 27, 2023

There are 4 speakers on the call.

Operator

Morning, ladies and gentlemen, and welcome to the Midwest 1 Financial Group Third Quarter 2023 Earnings Call. During today's presentation, all parties will be in a listen only mode. Following the presentation, the conference will be opened for questions with instructions to follow at that time. As a reminder, this call is being recorded.

Speaker 1

I would now like to turn

Operator

the call over to Barry Rae, Chief Financial Officer of Midwest 1 Financial Group. Please go ahead.

Speaker 2

Thank you everyone for joining us today. We appreciate your participation in our Q3 2023 earnings conference call. With me here on the call are Chip Reeves, our Chief Executive Officer Lynn DeVacher, our President and Chief Operating Officer and Gary Sims, our Chief Credit Following the conclusion of today's conference, a replay of this call will be available on our website. Additionally, a slide deck complement of today's presentation is also available on the Investor Relations section of our website. Before we begin, let me remind everyone on the call that Actual results could differ materially from those indicated.

Speaker 2

Among the important factors that could cause actual results to differ materially are interest rate, 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. Midwest 1 Financial Group, Inc. Undertakes no obligation to publicly revise or Thank you, Barry, and good morning. On today's call, I'll provide an update on the continued progress of our Financial Results. As discussed on our Q1 call and outlined on Page 4 of our earnings presentation, we've developed a strategic plan with 5 key pillars.

Speaker 2

Despite a difficult interest rate environment, which continues to impact our net interest margin, I could not be more pleased with our strategic plan as outlined on Slide 5. A key tenet of our strategic plan was a review of our geographic footprint With a focus on improving our scale in attractive markets and accelerating our profitability, our September announcement of the sale of our Florida operations With the proceeds reinvested into the acquisition of Denver Bancshares is a significant step towards the realization of our goals. Importantly, this merger accelerates our Denver market growth by 3 to 4 years, while enabling us to more effectively recruit bankers to further accelerate our already attractive growth trajectory. Another pillar of our strategic plan is to expand and move up tier During the Q3, in addition to the Denver Bancshares announcement, we also made progress in the Twin Cities, having recruited a seasoned banker He will lead the C and I team for a larger regional bank in this important market. At MOFG, he will lead our middle market C and I lending team, which is an untapped opportunity and one that we're focused on further building out as we drive scale in the Twin Cities, we are very excited to be able to attract Such a talented lender to lead our middle market team.

Speaker 2

Treasury Management is also a strategic imperative to our C and I up tiering We've been investing to expand our talent, platform and product offerings. Here in the Q3, we made strong progress as we named a new Director of treasury management sales people in our metro markets. Overall, we expect to see a significant improvement in fee income over the next 12 months. Turning to our Wealth Management business. Our focus has been to build our wealth business through team lift outs, like the recruiting of the wealth teams in the Twin Cities and Cedar Rapids, Which has contributed to significant asset growth over the last several years.

Speaker 2

To further propel this segment, we started an executive search For the leader who will transform our wealth business as we invest and grow the business through the next tier. We'll also continue to actively recruit wealth management teams in our core markets To drive asset growth and fee income. In our specialty business lines, we hired an experienced agribusiness lending team from a Midwestern based Regional Bank, late in the 2nd quarter. The team has already closed their first relationships and their pipeline has built to more than 40,000,000 They'll be pivotal as we move up market and go after opportunities with larger growers, producers and suppliers. Government guaranteed lending is also a natural fit for our local and metro bank markets and our desire is to become one of the leading bank 7 lenders in our Our 2023 originations have increased by 39%, and we believe we'll have additional SBA Business Development Officers recruited in the Q4 and Q1 of next year.

Speaker 2

As such, we continue to anticipate this initiative will be a meaningful fee income contributor in 2024 and beyond. Overall, we've been very pleased with our success recruiting bankers to Midwest 1 and the client relationships As I previewed last quarter, we did expect loan growth to moderate in the 3rd quarter to the mid Single digits given the general economic outlook and our own selectivity. Looking forward, we expect to deliver mid single digit loan growth in the 4th quarter before reaccelerating the high single digit growth in both 2024 2025. Turning our focus to improving our operational effectiveness, we outlined a plan to reduce our operating expense base by 5% and then reallocate 2 point percent into more productive profitable markets and departments. I'm very pleased with the initial results of our operating expense review, which can be seen in our Q3 non interest expense performance.

Speaker 2

Looking forward, we'll be reinvesting a portion of these cost saves And the people and capabilities to accelerate revenue, while also continuing to look for further expense saves and operational efficiencies. Our focus is to drive excellence across the bank in all facets of our business. To conclude, we've made substantial Financial results. We've accomplished much while also navigating a very challenging market environment. While we have more to do, I could not be more pleased with the successes that we've achieved.

Speaker 2

Importantly, none of this would be possible without our employees'

Speaker 1

Thank you, Chip, and good morning, everyone. As I discussed on our Q2 call, Our sales teams across the bank have remained focused on retaining and gathering deposits and the results are showing. We are pleased with the 3rd quarter having generated strong core deposit growth as highlighted on Slide 6. This increase in customer deposits positioned us to reduce higher cost broker deposits. Notably, we see consumer deposits stable and commercial deposits increasing, more than Our commercial banking team is driving strong growth on the asset side of the balance sheet too.

Speaker 1

Our nearly $37,000,000 of commercial loan growth in the 3rd quarter was driven by our Denver accounted for more than half of the growth and Twin Cities continues to show steady Growth in CRE and ad helped offset a $20,000,000 decline in line utilization. The commercial team also helped our borrowers navigate the current interest rate environment, Generating $600,000 of swap income in the quarter. Our loan story is about Growth, but also about profitability and soundness. We are pleased that our weighted average coupon of New commercial originations in the 3rd quarter was 7.49%, up from 6.85% in the 2nd quarter. As outlined on Slide 8, our asset quality metrics were impacted by 1 senior living credit That was moved to non accrual, which drove the rise in our non performing assets.

Speaker 1

That said, Our credit risk profile remains solid with low net charge offs of only 4 basis points And the leading indicator of 30 plus day delinquency at a very low 16 basis points. As Slide 9 shows we are well positioned with a diversified loan portfolio without outsized Concentration in CRE and only 3.7% in non owner occupied office exposure. Turning to Slide 10. The talent investments in Wealth also continue to bear fruit. Year to date, the wealth team has been entrusted with new assets under management of $170,000,000 As Chip mentioned, we see an opportunity to further grow our wealth business with talent additions at the executive leader and relationship management levels.

Speaker 1

With that, I'm pleased to turn the call over to our CFO, Barry Ray To discuss our financial results.

Speaker 2

Thank you, Lynn. I'll walk through our financial statements beginning with the balance sheet on Slide 12. Starting with assets, loans increased $47,400,000 or 4.8 percent annualized from the linked quarter to 4,070,000,000 Strength in the Q3 was led by commercial real estate loans, which increased $41,400,000 or 8% annualized from the linked quarter. The overall portfolio yield was 5.19 percent, a 14 basis point improvement from the linked quarter. During the quarter, the allowance for credit losses increased $1,200,000 to $51,600,000 or 1.27 percent of loans held for investment at September 30.

Speaker 2

The increase was due to credit loss expense of $1,600,000 attributable to organic loan growth. Turning to deposits. Our core deposits increased $83,200,000 or 1.8 percent from the linked Core deposit growth in the 3rd quarter positioned us to reduce our broker deposits by $145,600,000 to $220,100,000 at quarter end as compared to $365,600,000 at the end of the 2nd quarter. Taken together, total deposits declined $18,100,000 to $5,360,000,000 at September 30 as compared to June 30. The rising interest rate environment continued to pressure deposit costs and our total funding costs in the 3rd quarter.

Speaker 2

Specifically, the cost of interest Finishing the balance sheet. Total shareholders' equity experienced an increase of $4,100,000 to 505 point $1,000,000 driven primarily by 3rd quarter net income, partially offset by an increase in accumulated other comprehensive loss and dividends paid during the Q3 of 2023. Turning to the income statement on Slide 15, net interest income declined $2,400,000 in the 3rd quarter to 30 Our tax equivalent net interest margin declined 17 basis points to 2.35% in the 3rd quarter as compared to 2 point 5% 2% in the linked quarter. Our NIM in the 3rd quarter continued to be impacted by the Federal Reserve's rising interest rates resulting in an increase in our funding costs, which significantly outpaced the increase of 12 basis points in our total interest earning asset yields. Non interest income in the 3rd quarter increased 1 Finishing with expenses.

Speaker 2

Total non interest expense in the 3rd quarter was $31,500,000 a decrease of $3,400,000 or 9.7 percent from the linked quarter. As Chip discussed, improving our It's important to point out that we continue to invest in our business and as a result, we expect our run rate non interest expense to gradually increase going forward. Importantly, we remain on track to reduce our annual expense run rate by approximately $3,250,000 with the eventual reallocation

Operator

Thank you.

Speaker 1

Okay. We do have our

Operator

first question comes from Terry McEvoy from Stephens. Terry, your line is now open. Please go ahead.

Speaker 1

Hi, thanks. Good morning. Maybe first off a question for Barry on the I was trying to follow along there, but can you help us think about the 4th quarter expense run rate? I know in the Q3, there were some medical insurance benefits that Contributed to a bit of a decline. And I guess maybe just clear up a little bit the savings versus the reinvestment And how you think that will actually impact or what expenses will look like?

Speaker 2

Yes. Kind of how we're looking at the 4th quarter Terry is we expect probably around $32,500,000 be the run rate for the 4th And as we said in our prepared remarks, when you look into 2024, obviously there's going to be some typical Annual increases and so we probably get up to the $33,500,000 $34,000,000 range in the beginning of 2024.

Speaker 1

Okay. Thanks for that. And then sticking on 24, How should we think about the loan growth comments we heard from Chip earlier? How do we how are you thinking about the size of the balance sheet overall in terms of growth next

Speaker 2

I think this is Barry, Terry. I think we'll probably see Loan growth of the, let's call it, mid single digits. And Terry, this is Chip too. So I think in the loan growth, Yes, Mike. In prepared comments, you mentioned reaccelerating to the high single digits.

Speaker 2

And so let's just hit the middle of that high, mid single and go 8%. We believe that's very feasible with the originations that we're seeing and the talent that we are bringing on. In terms of our Positive base for 2024. We've seen stabilization and some increase here in Q3 and we're seeing that frankly the same at the beginning of Q4, so we extrapolate that and it's still a hand to hand combat battle on the deposit front. But if we extrapolate that a little bit, Well, end up 2%, 3% deposit growth in 2024 and then the remaining of the fundings of the loan growth will come from the securities cash

Speaker 1

Perfect. Okay. And maybe one last question. On the Q1 call, you provided some financial targets For the end of 'twenty four and I believe into 'twenty five. And when I look at the ROA and At least in the Q3, it's quite

Operator

a bit of step up

Speaker 1

to get there and I don't know if that's feasible. So Chip, is it really just The interest rate environment and the pressure on net interest income that's going to keep the ROA below that target? Or are there some other things that I'm not I just can't see as an

Speaker 2

No, Terry, I think that's extremely well said. I'm very pleased in terms of the Strategic plan execution that we've laid out from April to here in the end of September, I think it's actually we Probably achieved more in a quicker timeframe than even I had laid out previously, especially when you consider the Strategic announcements we did at the end of September, the decrease in our non interest expense run rate as quickly as we've been able to achieve such Some of that talent hiring, it truly is the movement of the forward curve from where we were in February, March Timeframe to where we stand today, and as you know, we have a liability sensitive balance sheet, so that higher longer is Truly about the only reason that those metrics are a little bit off today. Great.

Speaker 1

Appreciate it. Have a good weekend everyone.

Speaker 2

Thanks, Jeremy. Thank you.

Operator

Our next question comes from Damon DelMonte from KBW. Damon, your line is now open. Please

Speaker 1

Hey, good morning, everyone. Hope you're all doing well today. Just wanted to start off on the margin and kind of the outlook there. Barry, could you maybe just provide a little bit more context and color around some of the dynamics you're seeing here going into year end? It was a pretty sizable This quarter compared to what I think most of us were looking for.

Speaker 1

So how do we kind of think about the margin over the next say couple of quarters and where it may trough?

Speaker 2

Yes. Thank you, Damon. So here's some of the dynamics that we're seeing on the margin. I would say on the asset side, On the loan yield, we're seeing about 4 basis points per month of increase in asset yield. And so that's been a fairly standard pattern over the past 6 months As our loans reprice and renew.

Speaker 2

And then if I flip to the liability side, our cost of deposit that pace has Slowed such that it's around 6 basis points per month. And so as we look out into 2024 And assuming that the FOMC is mostly done with their moves and we continue to experience the deposit stabilization that we're seeing right now, We think that there's still some room for margin compression certainly in the 4th quarter, Perhaps not quite of the magnitude we observed quarter over quarter this quarter, perhaps some additional compression and starting to trough in the first half of 2024, Damon. Those are the dynamics that we're seeing.

Speaker 1

Great. That's helpful. Thank you. And then with regards to the outlook here for credit, you did note that there was one commercial relationship that Went into nonperforming status and I think you said it was like a senior living center or something. Any update on that as far as like what the resolution would be there?

Speaker 1

It doesn't appear that much if any of it came through in charge offs. So Are you optimistic about being able to resolve this and exit without any material losses associated with this?

Speaker 2

Hey Damon, this is Chip. And our Chief Credit Officer, Gary Sims is with us today. So we'll turn it over to Gary for that.

Speaker 3

Yes. Damon, really the move to non performance in that asset was driven by

Operator

Good.

Speaker 2

During the quarter

Speaker 3

That entity went into receivership. So it's actually in the hands of a receiver right now and being managed by a third party management company. The goal being to stabilize that asset for eventual sale. So in the quarter, we actually did Take a reserve against that $15,300,000 asset of $2,400,000 So that really positions us well To be able to work with the receiver to manage that asset to a conclusion. Sometime in the future, senior living assets Take a while to work through and get moved on, but we feel confident that we have a clear

Speaker 1

Great. I appreciate that color. And then with regards to kind of the outlook for provision, How should we think about that if loan growth slows a little bit and credit maintains pretty stable levels? You kind of keep the provision level similar to this quarter or maybe a little bit lower?

Speaker 3

Damon, I really see the provision being in the range of what you've seen over the past Quarter 2, a few quarters. I think that's pretty representative of what we're going to see on a go forward basis.

Speaker 1

Our next question comes from Brian Martin from Janney. Brian, your line is now open. Please go ahead. Hey, good afternoon, everyone. Hi, Brian.

Speaker 1

Say, maybe Just one more follow-up for Gary, just on the increase in the quarter in the special mention category. Was there something driving that as well? Is that this one credit you were referring to? I guess it was looks like it was up about 30,000,000 the quarter.

Speaker 3

Right. Brian, it was not the asset that we just discussed, the Senior Living Assets that credit was already a substandard and then went to a substandard non accrual. The increase in special mention for the quarter Really was driven by a couple of assets in our Twin Cities markets. They were CRE assets, specifically office and multifamily and we recognized Potential weakness in those credits. So it really kind of was associated with those 2.

Speaker 1

Okay. So of the office exposure then how much of the office exposure is currently classified or special mention today? I mean what's The is that picked? It sounds like it's moved up a little bit, not a lot.

Speaker 3

You're right, Brian. It has moved up a little bit. Right now, we have $151,000,000 in office exposure that represents 3.7% of our loans. Of that exposure, 33% is criticized and 13% is classified.

Speaker 1

Okay. 1313. Okay. All right. Fair enough.

Speaker 1

And then how about just Flipping over to maybe just one for Chip. I think, Chip, you talked about The substantial pickup or however you qualified it on the fee income front just from the couple items, I mean the specialty business obviously and The Treasury Management Services. Can you give us some way to think about that? I mean, as far as the magnitude given this is All the a lot of new initiatives kind of coming on board here. And the best way to think about how to how much of a contribution we could see from that in the coming periods?

Speaker 2

So as we look Through the various specialty lines here, Brian, one you saw in this quarter, we had Some uptick, perhaps you could call it significant increase in our swap income customer hedging program. We believe that will continue at a good pace perhaps around the same levels. We did not sell any SBA or government guaranteed loans into that in the marketplace in Q3. And we believe as for Q4 and into 2024, we will have increased activity there. Yes.

Speaker 2

Joe, I believe between the swap as well as the gain on sale from SBA activity, those will probably end up being $500,000 to $750,000 or so a quarter in 2024. And then our treasury management initiatives, that will be a Slower build, but by the Q4 of next year, we expect that to have some more meaningful impact

Speaker 1

Okay. So not much so really mostly driven by the specialty rather than the treasury management in the Near term. And then as far as the kind of the efficiencies, I mean just as you make these investments and get that out of And how should we think about the efficiency ratio as you proceed over the next 4 or 5 quarters? From where it's at today, Can you give any thought on that to just kind of manage that? Where do you think that's directly trending to?

Speaker 2

And so I'll let Barry speak to the specifics of the efficiency ratio. But let me Just to even give some additional highlights of what we're been reviewing in the expense side here, Brian. For instance, what you saw in the Q3 was Really the actions that we took in primarily Q2, we announced obviously a voluntary retirement program, but The individuals that accepted that program really did I'll leave the institution until early to mid September. So we still have some run rate, if you want to call it Reduction from that. We've also announced internally as well as with the FDIC that we have a branch closure that will occur in the 4th Quarter.

Speaker 2

And so there's a few other pieces that we have. Then as Barry mentioned and as did I, we'll continue to reinvest Into our franchise. What that means for the overall efficiency ratio and the guidance that Barry gave on the expense Syed, as we go to probably 32.5% in Q4, that probably rises to a 33.5% for us 34% as we migrate throughout the quarters of 2024, but Barry from an efficiency ratio? Yes. I think from an efficiency ratio, Brian, The challenge on the efficiency ratio is going to be the

Speaker 1

revenue side of the house on that. And

Speaker 2

so Managing the efficiency ratio is certainly going to be really a function

Speaker 1

of what's happening on the revenue side. And so I guess I'll just say it's going to be To maintain the efficiency ratio until we start to see some relief on the rate side. Yes. And I guess I'm really trying to get at where you guys exit 2024 given the investments you're making sound like they Start like Chip just outlined, start to kind of come together where you start seeing that pickup even if it's specialty side early and then Treasury management later as you kind of exit 2024, do you expect to be a fair amount lower than where you are today even if we're just kind of talking 4Q as opposed to the annual. I understand that the ramp up is going to occur and the dynamics play out.

Speaker 1

But is that how we should be thinking about it?

Speaker 2

Brian, I think we have actually pretty darn good control in terms of our, what I'll call, non interest expense Run rate today as well as the reinvestment and we'll frankly overachieve in terms of our strategic plan of the 5% and thus the 2.5 Reallocation, what is difficult to say to your answer to your question is, our efficiency ratio So will likely be more driven by the overall interest rate environment as we move through 2024. So I think that's the Hesitancy for us to truly answer that question. If rates come down by 150 basis points, Our efficiency ratio will be better than it is today. If we're at exactly the same rate in Q4 of 2024 as Yes, we are today. That efficiency ratio will probably be about the same, maybe even a tick higher.

Speaker 1

Got you. Okay. Well, that's helpful. I appreciate the color on it. I know it's difficult just trying to think about it and kind of put some thoughts together.

Speaker 1

And just the last one for me was just on the margin. Maybe just Barry, if you can just give us what the if you had it, what The spot margin was for September. And I'm just curious, the other item was how many how much in the way of fixed rate loans you guys have Pricing over the next 12 months, just how to think about that impact of the flow through margin?

Speaker 2

Yes. Brian, the September net interest margin was 2 point 231 percent compared to 2.35 percent compared to 2.35 percent for the quarter. Okay.

Speaker 1

Okay. And any thought on While Barry is following up on that, Brian, just a little color on that too. I highlighted it this is Len. I highlighted in my comments about Our coupon on origination, I'd also point out on the renewal side That's been nice for us. So average in 2023 in the commercial book, our average month is about $50,000,000 of renewal.

Speaker 1

And in September that weighted average was 8.33%. So that gives you a bit of a flavor of just What we're seeing that way on the renewal side of the house.

Speaker 2

And Brian, we have about so about 60% of our loan portfolio is fixed. And so About $2,500,000 and maybe 10% of that reprices in the next Yes. Over the 3 year period for the net, about 33% of it over a 3 year period, maybe a third of it.

Speaker 1

Okay, perfect. Okay. I appreciate you guys taking the questions. Thank you.

Speaker 2

Thanks, Brian.

Operator

We currently have no further questions. So I would like

Speaker 1

to hand the call back to the management team for closing remarks. Thank you.

Speaker 2

Great. Thank you for joining us today and we are for your continued support. We look forward to speaking to you all again at the in January for our Q4 report. Thank you all.

Operator

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

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Key Takeaways

  • Midwest 1 advanced its five-pillar strategic plan by divesting Florida operations to fund the acquisition of Denver Bancshares, accelerating its Denver market growth by 3–4 years and improving scale in attractive regions.
  • The bank is up-tiering its C&I franchise, recruiting a veteran banker in the Twin Cities to lead a new middle-market team and expanding treasury management sales to boost fee income over the next 12 months.
  • Wealth management grew via team lifts in core markets and an ongoing executive search for a new division leader, while specialty lending added agribusiness talent and boosted SBA originations 39% year-to-date.
  • Q3 delivered mid-single-digit organic loan growth, with new commercial loans repriced at a 7.49% coupon and core deposits up $83.2 million, enabling a $145.6 million reduction in costly brokered funding.
  • Despite a 17 bp net interest margin decline to 2.35%, the bank cut non-interest expense by 9.7% and remains on track to reduce its annual expense run-rate by $3.25 million while reinvesting savings in growth initiatives.
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Earnings Conference Call
MidWestOne Financial Group Q3 2023
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