MidWestOne Financial Group Q2 2023 Earnings Call Transcript

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Provided by Quartr
August 1, 2023

There are 4 speakers on the call.

Operator

Good morning, ladies and gentlemen, and welcome to the Midwest 1 Financial Group Incorporated Second Quarter 2023 Earnings Call. During today's presentation, all parties will be in a listen only mode. As a reminder, this call is being recorded. I would now like to turn the call over to Barry Rae, Chief Financial of MidWestOne Financial Group. Please go ahead.

Speaker 1

Thank you everyone for joining us today. We appreciate your participation in our Q2 2023 earnings conference call. With me here on the call are Shipper Reeds, our Chief Executive Officer and Lynn Devasher, our President and Chief Operating Following the conclusion of today's conference, a replay of this call will be available on our website. Additionally, A slide deck to complement 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 this presentation contains forward looking statements relating to the financial condition, results of operations and business of Midwest One Financial Group Inc.

Speaker 1

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. Midwest 1 Financial Group undertakes no obligation to publicly revise or I would now like to turn the call over to Chip. Thank you, Barry, and good morning.

Speaker 1

On today's call, I'll provide an update on the solid progress we've achieved and the strong loan growth that we delivered once again this quarter as well as continued strong results in our Wealth Management business. Barry will then conclude with an in-depth review of our 2nd quarter financial results. As we discussed on our Q1 call, we've developed a strategic Plan as outlined on Slide 4 of our earnings presentation with 5 key pillars focused on our culture, our strong local banking franchise, Expanding our Commercial Banking and Wealth Management businesses, expanding into specialty business lines and improving our efficiency and operations. As outlined on slide 5, I'm very proud to say that we've made solid progress executing our plan through the 2nd quarter in what's been a very challenging operating environment. Starting with our Commercial Banking and Wealth Management businesses, we're focused on expanding and moving up tier in our major metro markets of the Twin Cities, Denver and Eiler.

Speaker 1

This is a continuation of the strategy that we've been executing for several years where we've been hiring experienced relationship bankers and Wealth Management Professionals to drive organic growth. That said, we'll be doubling down in these markets with a plan to add bankers and expertise targeting revenue from $20,000,000 to $100,000,000 So far this year, we've added several producers in the Twin Cities and we'll continue to add experienced bankers as we work to take Share in these attractive markets. This has been a successful strategy as can be seen in our 2nd quarter loan growth of 10% annualized. Overall, we would expect second half loan growth to moderate to mid single digits based on the general economic outlook and our own selectivity before reaccelerating the high single digit growth in 2024 2025. In our Wealth Management Group, we've also achieved significant assets under management growth, driven by the teams recruited in 2021 2022, which to drive asset growth and fee income.

Speaker 1

In our specialty business lines, we're focused on expanding and developing our specialty commercial banking markets or verticals where expertise in customer solutions will drive additional customer acquisition, full relationships and thus drive our company's profitability. As I discussed on our Q1 call, our plans call for immediate verticals in agribusiness, government guaranteed blending, notably in SBA and Commercial Real Estate. Starting with Agribusiness. We've been in the Ag business for a long period of time, primarily focused on small farms in our home state of Iowa. That said, we've been missing significant business opportunities with larger growers and producers as well as suppliers To address this opportunity, late in the Q2, we hired an experienced agribusiness lending team from a Midwestern based regional bank.

Speaker 1

This group has led agribusiness teams for a decade and has strong expertise and relationships across the industry and are already beginning to move full relationships The Midwest 1. Government Guarantee Lending is also a natural fit for our local and metro bank markets. Our desire is to become one of the leading bank 7 lenders in our footprint. Our SBA leader joined in 2021 and Our sales team is being developed. That said, we're seeing momentum building with positive second quarter results and we Anticipate this initiative will be a meaningful fee income contributor in 2024 and beyond.

Speaker 1

As I mentioned on our Q1 call, Our Twin Cities commercial banking leader has extensive super regional bank experience in the CRE space and is leading this segment for the bank. We're designing the CRE vertical for consistency, robust portfolio management and client selection. A key aspect of our strategic initiatives is improving our operational effectiveness and we're working to identify areas for efficiency gains and cost reduction in order to achieve our goal. Our expectations are to reallocate 2.5% of our operating expense base in the more productive profitable markets and departments And then to reduce an additional 2.5 percent of our Q4 2022 operating expense run rate that will improve our go forward operating We initiated the first action in mid April as we scaled back our mortgage operations reflecting the current macro environment as well as a sharpened focus on mortgage originations from Midwest loan customers. Additional actions commenced in June including a voluntary employee retirement program, the expense of which was taken in our Q2, while the full compensation reduction realization will be the Q4 of As we drive change across the bank, I could not be more proud of our employees' continued commitment to our company, Customers and communities, we are in the midst of reorienting our culture.

Speaker 1

1, continue to be focused on our clients and employees As we increase our focus on innovation, performance and results, and I'm very proud of the progress that we're making. It's a testament to our employees in the bank, We have been nationally recognized as a top workplace in both our Iowa and Twin Cities markets as well as Newsweek's Best Small Bank in Iowa. To conclude, we've made substantial progress executing our strategic initiatives over a very short period of time, all the while in the midst of a challenging market environment. Though we have much more work to do, I remain confident in our goal of delivering financial results at the median of our peer group as we exit 2025. Now I'd like to turn the call over to Thank you, Chip, and good morning, everyone.

Speaker 1

Our sales teams across the bank are clear About our number one priority, deposit generation. We are seeing the fruit of those efforts. In the first half of this year, we are proud of a net new account growth rate of more than 1%. As slide 6 illustrates, we were able to arrest the deposit decline in June and we're pleased To see those balances remain stable in July. Notably, our deposit results in the 2nd quarter are driven by balanced growth in our commercial segment offsetting a runoff of public funds time deposits particularly in the month of May.

Speaker 1

Speaking of our commercial team, we are driving strong growth on the asset side of the balance sheet too. Our nearly $94,000,000 of balance growth in the 2nd quarter was driven by Twin Cities, Iowa Metro And Denver, these same three regions have led the way in our year to date loan growth. Compared to the first half of twenty twenty two, new originations this year are up 4% and loan origination fee production is up 22%. Our loan story is about growth, but it's also about profitability and risk. We are pleased that our weighted average coupon of new commercial originations in June was 7.13%, which is up from 6.68 percent in April.

Speaker 1

Our credit risk profile with Loan net charge offs of only 9 basis points, stable non performing at only 22 basis points and the leading indicator of 30 plus day delinquency at a very low 15 basis points. As slide 9 shows, we are well positioned with a diversified loan portfolio without undue concentration in CRE and only 3.8% in non owner occupied office exposure. Turning to slide 10, The talent investment in wealth also continue to bear fruit. AUM and revenue continue to climb And we are pleased that our year to date new AUM ended at $97,000,000 more than twice the same period last year. In our Investment Services division, 2nd quarter revenue was up 10.6% from the Q1.

Speaker 1

Wealth momentum Continues to be strong. With that, I'm pleased to turn the call over to our CFO, Barry Ray, to discuss our financial results. Thank you, Lynn. I'll walk through our financial statements beginning with the balance sheet on Slide 12. Starting with assets, loans increased $99,200,000 or 10.6 percent annualized from the linked quarter to $4,000,000,000 Strength in the 2nd quarter was led by commercial loans, which increased $93,900,000 or 12.2 percent annualized from the linked quarter and the overall portfolio yield was 5.05%, a 10 basis point improvement from the linked During the quarter, the allowance for credit losses increased $600,000 to $50,600,000 or 1.25 percent of loan sales per investment at June 30.

Speaker 1

The increase was due to credit loss expense of $1,600,000 attributable to organic loan growth, which was partially offset by net loan charge offs of $900,000 Turning to deposits. The dislocation following the bank failures in March of this impacted our deposit franchise as we experienced net deposit outflows through April May, but positively that trend reversed in June. That said, total deposits decreased $109,700,000 to $5,400,000,000 from the linked quarter. Public funds deposits accounted for nearly $98,000,000 of the net deposit outflows as the cost of retaining those deposits exceeded the cost of alternative funding sources for similar The rising interest rate environment combined with the residual, though subsiding stress in the banking sector has resulted in firm competitive dynamics for deposits, while also having impacted our cost of funds to incur a further increase during the Q2. Specifically, the cost of interest bearing liabilities rose Finishing the balance sheet.

Speaker 1

Total shareholders' equity experienced an increase of $700,000 to $501,300,000 driven primarily by 2nd quarter net income, partially offset by an unfavorable accumulated other comprehensive $3,800,000 and cash dividends of $3,800,000 Turning to the income statement. On slide 15, net interest income declined $3,100,000 in the 2nd quarter to $37,000,000 as compared to the linked quarter, due primarily to higher funding costs and volumes and a reduction in interest earning asset volumes, partially offset by higher interest earning asset yields. Our net interest margin declined 23 basis points to 2.52% in the 2nd quarter as compared to 2.75% in the linked quarter. Our NIM in the 2nd quarter continued to be impacted by the Federal Reserve's rising interest rates, resulting in an increase in our funding cost, which significantly outpaced the increase of 12 basis points in our total interest earning asset yields. Non interest income in the 2nd quarter increased $12,800,000 primarily due to the investment securities losses of $15,200,000 in the linked quarter related to our balance sheet repositioning in the Q1.

Speaker 1

Finishing with expenses. Total non interest expense in the Q2 was $34,900,000 an increase of $1,600,000 or 4.8 percent from the linked quarter. The increase was primarily due to $1,400,000 of one time expenses related to a voluntary early retirement program and executive relocation expenses. Excluding these one time expenses, non interest expense was stable from the 1st quarter's level. As Chip mentioned, we remain focused on improving our efficiency Including cost reductions, a key pillar of our strategic plan.

Speaker 1

Specifically, by the end of this year, we expect to reduce Our annual expense run rate by approximately $3,250,000 and reallocate another $3,250,000 of our annual expense base into more productive, Profitable Markets and Departments. We expect our quarterly expense run rate for the balance of the year to be in line with the Q1. And with that, I'll turn it back to the operator to open the line for questions.

Operator

Thank you. We will now begin the question and answer Our first question comes from the line of Brendan Mossell with Piper Sandler. Brendan, please go ahead. Your line is now open.

Speaker 2

Hey, good afternoon guys. Hope you're doing well.

Speaker 1

Good. Hi, Brendan.

Speaker 2

Just to start off here,

Speaker 1

Maybe to start off on the margin, can

Speaker 2

you just walk us through how the NIM trended over the course of the quarter and where that ended up for the month of June Just trying to gauge a good general off point for the 3rd quarter.

Speaker 1

Yes. Over the course of the quarter, the margin It was as follows. We were at 2.64% in the month of April, 2.46% in May and then 2.48% in June, Brandon.

Speaker 2

Okay. All right. That's super helpful. Maybe one more before I step back. Notice you drew from the bank term funding program during Just take us through the use of that funding source versus other options and expected borrowing needs as we move through the back half of the

Speaker 1

Yes. We saw an opportunity to take advantage of the Attractive features of the bank term funding program, Brendan, since we were continuing to see net deposit outflows. And so to the extent that We continue to utilize that in the future. That's really going to be dependent upon what we can see with deposits. As we said, we were pretty happy with deposits Stabilizing in the 3rd month of the quarter and on into July.

Speaker 1

And so that was how we were thinking about the bank term funding program. It had some attractive Sure. And Brandon, it was a cheaper cost of funds than overnight borrowing at the time that we've done it and likely actually still remains so.

Speaker 2

Got it. That makes sense. Okay. Thank you for taking my questions.

Speaker 1

Thanks, Brady.

Operator

The next question comes from Ben Gurlinger with Hovde Group. Ben, please go ahead. Your line is open.

Speaker 1

Curious, if we the loan growth is pretty solid and I think the guidance was for kind of a step down kind of the mid single digit range. I was curious, is it more so a function of deposit gatheringcosts associated there? Is it risk The yield that you're just kind of getting competed out on? Or is it more so just an economic beer in general? Or obviously, the mix The 3, but I was kind of just waiting those as sort of the reason why they stepped down in loan growth projections?

Speaker 1

So Ben, this is Chip. I'll take a little bit, but I'm trying to lend for more of the market view. I think the step down for us is the origination activity we believe will still be Extremely solid, but we are being more selective frankly in when what we're putting on the books and not just from a Credit standpoint, but from an interest rate. And then in our commercial loan renewals, specifically our maturity schedules, I would say that we're Exiting non relationship driven customers that do not have deposits with us as we cycle through renewal schedules. So as we do that and become a little bit more selective, we See our asset dampening touch from our first half of the year, but overall solid originations and I'll have Len speak to that.

Speaker 1

Yes. Thanks, Chip. Ben, I would just add, we're very active in managing the pipeline. And when we talk about pipeline, we talk about really three things: Origination, funding and payoffs. And so just as we look ahead and think about, oh, what's going We handicap

Speaker 2

when we think closings are going

Speaker 1

to happen and the funding to follow those. And then Also on the payoff side, we do have a couple of our commercial customers selling assets, Selling a business, those kinds of things that we anticipate in the Q3. So that impacts that. And then the last variable that really is A little harder to handicap is line usage. I would note that line usage is down for us.

Speaker 1

When we exited the Q1, it was at 36%, it's down to 33% as we exited the 2nd quarter. So all of that is factoring in. Got you. That's helpful. And then I guess that the expense Has some relatively one time items, whether it be the retirements, but you're also hiring some people across the footprint.

Speaker 1

I get that these kind of more so one Some items could be you get a clean quarter at 4Q, but all the while you're hiring crypto as well. Just any guidance you can give to kind of what the non What a core expense base will be going forward or when we should see just pure core expenses? Yes. I would say that as we said in the comments, dollars 33,500,000 What we're thinking of as a core expense run rate in the near term. When we get to that, a lot of the That we've been talking about with respect to improving our efficiency of operations are going to be happening throughout this year.

Speaker 1

So I would say Q1 of next year is when you're going to see what I would call a core expense line rate. Got you. That's helpful. Thank you. I'll turn back

Operator

in queue. Our next question comes from Terry McEvoy with Stephens. Terry, please go ahead. Your line is open.

Speaker 2

Hi. Good morning. Maybe a first question for Barry on just managing interest rate sensitivity. How is the bank's balance sheet position today for the rate cut we just had and maybe one more later this year? And How are you thinking about managing around some potential rate cuts next year if the forward curve is accurate?

Speaker 1

We're liability sensitive, Terry. And so if we get rate cuts, I would say that would be a positive for us with respect to the way our So that's how we're thinking about that. With respect to some of the things that we're doing from balance sheet management perspective should Rates stay where they are. We're continuing to look at given the fact that we are liability sensitive, we are looking at balance sheet hedging strategies To mitigate the interest rate risk sensitivity and our liability sensitivity.

Speaker 2

Thanks. And then maybe a couple of questions on the banker hires and teams. I guess the new Agribusiness team, do they have a different skill set or business model compared to kind of the existing ag bankers? I'm just trying to see if they bring something different or is an expansion of kind of the existing business model and focus?

Speaker 1

Terry, this is Chip. And then again, I'll have Lynn provide some further commentary. There, I think ultimately across Commercial Banking franchise both in any of the specialty lines that we begin to build, but also just in our core C and I business in our Invested the markets that we label as investment markets, we're really moving up here in terms of our overall strategy and the Customer base that we're reaching and the prospect base that we're reaching. So, Len, do you want to articulate around the agro business team? Yes.

Speaker 1

Thanks, Chip. It really is a story. The team is coming to us from a larger regional that has they've got the track record and importantly, the relationships That has shown in our footprint to be able to go to that next segment, because our legacy business has done Great job serving communities and smaller producers and family farms, those kinds of things. This is really a complement to that legacy. And to give you a sense there, Terry, our average account size or loan size in our current Business space is only about $400,000 to $500,000 And this group typically plays in the $2,000,000 to $10,000,000 Space in terms of loan relationship.

Speaker 1

We've already seen positive activity and it's not just been on the lending side. This is also full relationship and deposit

Speaker 2

That's great color. Thank you. And maybe if I could squeeze one more in. The Government Lending Group, as that evolves, will that Generate a line item on the income statement for fees related to the sale of those loans as well as Will you hold the unguaranteed portion? And if so, what would be the targeted size over time as a percentage of the portfolio?

Speaker 1

I'll take Barry, this is Barry. I'll take the piece. The gain from the SBA loan sale Would be included in what we have on our income statement as a loan revenue item. So the $250,000 was still that we generated This quarter is included in that line item. Did that answers your question?

Speaker 2

And the unguaranteed part on the balance sheet and that will be held on the balance sheet?

Speaker 1

Terry, over time, So let's go into the span of our strategic plan 2025. We could see this being about $40,000,000 a year of Annualized originations, if you go 25% being held, that's only $10,000,000 in terms of Being held on an annualized basis moving forward. So as by percentage of our loan portfolio, de minimis As a percentage of some of the fee income being generated from gain on sale activity, it Would be end up being a meaningful contributor to us.

Speaker 2

Great. Thanks for taking my questions.

Speaker 1

Yes. Thanks, Terry. Thanks, Terry.

Operator

The next question comes from Damon DelMonte with KBW. Damon, please go ahead. Your line is open.

Speaker 2

Hello, everybody. Hope everybody is doing well today. Just wanted to start off with a question on the margin kind of as a follow-up here. Barry, thanks for the color on the quarterly levels. As we kind of think about the back half of the year, Do you feel you're going to be able to kind of mitigate some of the pressures that you've seen in the last couple of quarters?

Speaker 2

Or is it going to start to slow as New loans continue to come on the books? Or could you just provide a little color around the expected cadence for the back half of

Speaker 1

Yes. Thank you, Damon. And some of the things that we've been modeling internally is assuming that The FOMC hit pause on their rate increases and then deposits stabilized as we've experienced over the course The past couple of months and we continue the loan growth. How we're expecting the margin would be, we expect some continued Fresh into the Q3 and then stabilizing in the Q4 and perhaps inflecting in early part of next year is kind of how we're thinking The margin based upon our internal model. That's our expectations,

Speaker 2

Damon. Okay. Helpful. Thank you. And then with respect to the agribusiness hires, How big of a component of your overall loan portfolio do you envision the ag portion being?

Speaker 2

Especially since you guys noted bigger credits that they put on versus kind of what the legacy portfolio has.

Speaker 1

Yes. Damon, this is Len. As you know, our ag portfolio today represents about 7% of our loan portfolio. So I would expect it to move forward to move up. And what I would say the other thing is that some of what they'll be doing is really Outside the farm gate and it's going to show up in the C and I piece as well as we think about the business of Agribusiness.

Speaker 1

So I think we probably cap out in that 10% or less range.

Speaker 2

Got it. Okay. From the ag specific, not what goes into C and I as well?

Speaker 1

You got it. 10% or less on the ag Good morning.

Speaker 2

Got it. Okay. That's helpful. Thank you. And then just lastly on the expenses.

Speaker 2

In the prepared remarks, did you guys say that you expect kind of 3rd quarter level to be similar more similar to the Q1 level? Did I hear that correctly?

Speaker 1

You did Damon, but again on a core basis I would

Speaker 2

say. Yes.

Speaker 1

Just like Damon, this is We're moving through enough just continued review of our Efficiency in operations that we may be lumpy here. Obviously, we had some one time in Q2. We may have some one time in Q3 as well. And I think Barry alluded to core should be that 33.5% range and not that what we end up being from a Stated number Q4 to Q1 where we'll see the settling down of any of the one timers.

Speaker 2

Got it. Okay. That's all that I have. Thank you.

Speaker 1

Thank you.

Operator

The next question comes from Brian Martin with Janney Montgomery Scott. Brian, please go ahead.

Speaker 2

Hey, good afternoon, everyone. Hey, Ryan. Say, Just one follow-up on the expenses, Barry. I mean, can you give some kind of thought on where the expenses, Would they normalize as you enter next year? It sounds like the next two quarters, it sounds like there's some consultants with some Possibilities a little bit more improvement here in the back half.

Speaker 2

But just as you talked about the step down as you get into next year, can you kind of give How we should be thinking about expenses for next year as you jump into Q1?

Speaker 1

Yes. As we've discussed, kind of when we think about an actual dollar reduction in expenses, Brian, we've been talking about that in terms of like the $3,250,000 on Annual basis. And so I would say that we're going to have some normal expense increases in the Q1 Next year just for salaries for example. So whatever you're modeling for that and then the number that we're targeting is the $3,250,000 for Annual reduction. So you put those two pieces together that should approximate a good run rate for next beginning of next year.

Speaker 2

Got you. Okay. That's perfect. And then how about just The funding of the loan growth in the second half of the year, the contraction you saw on deposits versus the better rates elsewhere, How should we think about you guys funding the loan growth back half of the year? And just kind of how to go the loan with your outlook on deposit flows?

Speaker 1

Yes. We're going to continue to take advantage of our investment portfolio is continuing to run down, Brian. I think in 2024, we'll get about $160,000,000 of cash flows off of that and that's going to ramp up a bit more in 2025. So the second half of the year, We'll continue to leverage investment portfolio cash flows to the extent that we need to supplement any deposit outflows. We would look at Borrowing overnight perhaps and then what can we do with the hedging strategy with respect to that?

Speaker 2

Okay. And the cash flows in the second half of the year, Barry, on the bond portfolio, how much is that? Or did you disclose that?

Speaker 1

I didn't disclose that, Brian. I don't have it in front of me, but I can get it to you.

Speaker 2

Okay. Yes, maybe it's about half of what you were talking about. I think we're

Speaker 1

roughly about 150,000,000 Let's call it $75,000,000

Speaker 2

Yes. Okay. That sounds about right. Okay. I appreciate it.

Speaker 2

And then just the last one for me was on Criticizing classified levels. You talked and the NPAs were pretty stable, but some increases in both criticized and classifieds. Maybe can you just give a little thought on that? And I guess, how you feel about these credits or kind of the portfolio where else you're seeing some distress?

Speaker 1

Sure, Brian. This is Chip Reeves. Gary Sims, our Chief Credit Officer is with us in the room today and we'll have Gary answer that question for Gary?

Speaker 3

Yes. Thanks, Chip. Hi, Brian. As we did point out, our Increase in criticized and classified, it's primarily in that non owner occupied category. And like most of our peers, We are seeing weakness in the office space.

Speaker 3

We believe we've identified The appropriate level of weakness and that office space total portfolio is 3.8% of the overall portfolio. So we feel like it's manageable through this cycle.

Speaker 2

Okay. So the 2 credit both office properties, Barry, or I guess, or are they

Speaker 3

Yes. Yes, Brian. And the increase in the classified were both office, non owner occupied office. When you take into account the increase in the credit size as well, we did see some deterioration in our senior living Credit as well. So from a thematic perspective, senior living and office is where we've seen the weakness so far, That helps.

Speaker 2

Okay. Yes, yes. And just in general, the senior living, how big How big a portfolio is that? Is that relatively small in size versus the office portfolio?

Speaker 3

Yes. The office portfolio is 3.8 percent of our overall loan portfolio. The senior living is 6.1 percent of our overall portfolio.

Speaker 2

Okay. 6.1%. Okay. And just one credit right now that's past due there or just been criticized?

Speaker 3

Right. It is not past due. We did downgrade it to criticized status and it was one credit that drove most of that increase. There is more than one credit that is in the criticized and classified portfolios in the senior living.

Speaker 2

Okay. Yes. Okay. I think that helps me out. So I appreciate it, Gary.

Speaker 2

Thank you so much for taking the questions.

Speaker 1

Thanks, Brian.

Operator

Those are all the questions we have for today. So I'll turn the call back to Chip Reese for closing remarks.

Speaker 1

Thank you everyone for your time and interest in MLFG. As mentioned today, we're making solid progress on our Strategic Plan Initiatives and we look forward to sharing out more details next quarter. Thanks everyone.

Operator

Thank you everyone for joining us today. This concludes our call and you may now disconnect your lines.

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Earnings Conference Call
MidWestOne Financial Group Q2 2023
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