MidWestOne Financial Group Q4 2023 Earnings Call Transcript

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January 26, 2024

There are 8 speakers on the call.

Operator

Good morning, ladies and gentlemen, and welcome to the Midwest 1 Financial Group Incorporated 4th Quarter and Full Year 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 and instructions to follow at that time. As a reminder, this call is being recorded. I would now like to turn the call over to Barry Rae, Chief Financial Officer of Midwest One Financial Group.

Speaker 1

Thank you everyone for joining us today. We appreciate your participation in our earnings conference call this morning. 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 Officer. 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.

Speaker 1

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 believes, expects, Anticipates and other similar expressions. Actual results could differ materially from those indicated. Among the important factors that could cause The 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, Inc.

Speaker 1

Undertakes no obligation to publicly revise or update these forward looking statements to 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. On today's call, I'll provide a high level overview of our 4th quarter results and an update on the significant progress We've achieved executing our strategic plan over the last year. Len will then provide an update on our lines of business And Barry will conclude with a more detailed review of our 4th quarter financial results. Starting on Slide 3 of our earnings presentation, We delivered net income of $2,700,000 or earnings per diluted share of $0.17 During the quarter, we sold $115,000,000 of securities, resulting in a net pre tax loss of $5,700,000 as we continue to address our liability sensitive balance sheet. We also recorded $438,000 in costs related to our previously announced voluntary early retirement program, $245,000 of merger related costs and $105,000 reduction to the fair value of our MSR.

Speaker 2

Adjusting for those four items, adjusted net income was $7,700,000 or $0.49 per diluted common share. Looking deeper at our results, I'm pleased with our balance sheet trends. We delivered 6.1% annualized loan growth for the 4th quarter and 7.5% loan growth for the full year as we continue to benefit from the expansion of our major market banking teams. Additionally, we achieved modest core deposit growth in the 4th quarter and remain cautiously optimistic we can continue to grow our core deposit franchise While our balance sheet trends are encouraging, we do remain liability sensitive and the interest rate environment continued to pressure our NIM and NII through the Q4. That said, we have continued to see a moderation in the rate of our NIM decline and expect our margin will trough through the first half of twenty twenty four.

Speaker 2

Importantly, we continue to control what we can control And execute quite well on our strategic initiatives to transform Midwest One Bank and position this institution to deliver financial results At the median of our peer group by the end of 2025. As I've said on previous calls, we're working hard to become a top performing bank and believe we are firmly on track given the substantial progress we've achieved over this past year. A key accomplishment was the realignment of our

Speaker 1

geographic footprint announced in September with the

Speaker 2

sale of our Florida announced in September, with the sale of our Florida operations and the proceeds to be reinvested in the highly attractive Denver MSA through our merger with Denver Bancshares, a long established $272,000,000 asset bank. During the Q4, in that mark, we hired an SBA Officer And the Treasury Management Officer as we continue to further expand our platform and accelerate growth in this large commercially robust MSA. Looking forward, we've received all regulatory approvals and expect the merger to close on January 31. At closing, we'll have approximately $640,000,000 in loans $400,000,000 in deposits in the Denver marketplace and firmly believe We're on a path to building this MSA into a $1,000,000,000 plus franchise in the coming years. We also continue to expand and up tier our commercial banking and wealth management businesses and have enjoyed robust loan and assets under management growth in our major metro markets of the Twin Cities, Denver and Metro Iowa.

Speaker 2

Our plan is to continue to add bankers as we target middle market companies with $20,000,000 to $150,000,000 in revenue and individuals with investable assets of $3,000,000 to $20,000,000 Importantly, we're excited about the hiring of our new Head of Wealth Management, a seasoned leader with extensive super regional experience in the Midwest. We look to achieve double digit annual revenue growth In this business segment in the years to come. Additionally, we added 2 experienced commercial bankers in our Metro Iowa markets, 1 in Des Moines and 1 in Dubuque. Overall, we've made significant progress growing our product and talent capabilities In both our core markets and our specialty verticals of agribusiness and SBA, accordingly, we expect an acceleration in loan growth to the high Single digits for the full year 2024. We're also extremely pleased with our 2023 expense discipline.

Speaker 2

As part of this, we outlined a plan to reduce our operating expense base by 5% and then reallocate 2.5% into more productive, Profitable markets and departments. Through 2023, we've exceeded that stated plan and remain focused on the appropriate balance of cost containment and growth reinvestment. To conclude, we've made substantial progress transforming Midwest 1 and positioning the bank for Improved earnings power and returns for when the interest rate cycle abates. While our liability sensitive balance sheet has challenged current earnings, The execution of our strategic initiatives is progressing better and faster than what we've expected, and I remain very optimistic And what the future holds for our employees and shareholders. At this time, I'd also like to thank our employees for their continued hard work Combined with their commitment to our company, customers and communities, this journey would not be possible without their unwavering support.

Speaker 2

Now I'd like to turn the call over to Len.

Speaker 3

Thanks, Chip, and good day, everyone. Deposits have remained a consistent In 2023 and the results are showing we're especially pleased at the improving quality of the segment mix with consumer and commercial deposits muting a decline in high cost lumpy public funds. Our positive net new deposit accounts in 2023 and strong growth in services per household, which are up from 3.40 to 3.48 reflect our focus on a proactive relationship approach. Looking forward, we remain cautiously optimistic, having generated another quarter of core deposit growth as highlighted on Slide 6. Our commercial banking team continues to drive strong growth on the asset side of the balance sheet, too.

Speaker 3

Our $50,000,000 of commercial loan growth in the 4th quarter was driven by our focus markets, particularly Iowa Metro. We continue to see growth in CRE and Ag balances. And in terms of new commitments, We see strong momentum in C and I. Our long story is about growth, but also profitability and risk. We are pleased that our weighted average coupon of new commercial originations in December was up to 7.76%, an increase from 7.27 percent in September.

Speaker 3

Our renewal rate averaged 8.37% in December, Up from 8.26 percent in September. As outlined on Slide 8, our nonperforming assets ratio is stable. During the Q4, we did see 3 relationships migrate from special mention to classified, 2 in the senior living space and 1 in the office CRE space. Importantly, we saw only a de minimis amount of credit exposure Migrate from pass to special mention. The credit risk profile of our portfolio remains solid with Low net charge offs of only 9 basis points for the full year and the leading indicator of 30 plus day delinquency at a low 26 basis points.

Speaker 3

Our portfolio remains well reserved with an allowance for credit losses of 1.25%. As Slide 9 shows, we are well positioned with a diversified loan portfolio Without outsized concentration in CRE and only 3.8% in non owner occupied office. Turning to Slide 10, The talent investments in Wealth also continue to bear fruit. Year to date, the team has been entrusted with new assets of $195,000,000 which represents a nearly 60% increase compared to 2022. As Chip mentioned, We see an opportunity to further grow our Wealth business and are excited to have named a new Head of our Wealth business this past week.

Speaker 3

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

Speaker 1

Thank you, Lynn. I'll walk through our financial statements beginning with the balance sheet on Slide 12. Starting with assets, loans increased $61,000,000 or 6.1% annualized from the linked quarter to $4,130,000,000 Strength in the 4th quarter was led by commercial real estate loans, Which increased $49,300,000 or 9.3 percent annualized from the linked quarter. The overall portfolio yield was 5.34%, a 15 basis point improvement from the linked quarter. During the quarter, the allowance for credit losses decreased $100,000 to $51,500,000 or 1.25 percent of loans held for investment at December 31.

Speaker 1

The small decrease reflected loan growth in portfolio segments with Credit loss rates that are lower than other segments. Turning to deposits, excluding brokered, deposits increased $31,400,000 or 0.6 percent from the linked quarter. This is the 2nd sequential quarter of deposit growth, which points positively continued growth in the year ahead as our deposit franchise stabilizes. For the 4th quarter, total deposits increased $32,300,000 to $5,400,000,000 at December 31 as compared to September 30. This increase combined with our security sales positioned us to reduce higher cost FHLB borrowings.

Speaker 1

During the quarter, total borrowed funds decreased $74,900,000 to $423,600,000 As Chip touched on, the rising interest rate environment continued to pressure deposit costs and our total funding costs in the 4th quarter. Specifically, the cost of interest bearing liabilities rose 32 basis points to 2.65 percent comprised of increases to our interest bearing deposits, Short term borrowing and long term debt costs. Finishing the balance sheet, total shareholders' equity increased $19,000,000 to $524,400,000 driven primarily by a decrease in accumulated other comprehensive loss. Turning to the income statement on Slide 15, net interest income declined $2,000,000 in the 4th quarter to $32,600,000 as compared to the linked quarter, due primarily to higher funding costs, partially offset by lower volumes of interest bearing liabilities, higher volumes of interest earning assets and higher interest earning asset yields. Our tax equivalent net interest margin declined 13 basis points to 2.22% in the 4th quarter as compared to 2.35 percent in the linked quarter.

Speaker 1

Our net interest margin in the 4th quarter continued to be impacted by the 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 4th quarter decreased $6,000,000 primarily due to the $5,700,000 net loss on our security sale in the 4th quarter and $554,000 unfavorable change in loan revenue. As Chip touched on, we sold $115,200,000 of securities in the quarter, resulting in $6,700,000 in losses, partially offset by a $1,000,000 gain on the sale of Visa Class B shares. The decrease in loan revenue was due primarily to a $388,000 Quarter over quarter change in the fair value of our MSR and $108,000 quarter over quarter change in revenue from mortgage originations. Excluding the loss on security sales and the change in MSR, our non interest income was stable as compared to the linked quarter.

Speaker 1

Finishing with expenses. Total non interest expense in the 4th quarter was $32,100,000 an increase of $587,000 or 1.9 percent from the linked quarter. As we discussed on last quarter's call, we expected our non interest expense to gradually rise as we continue to invest in our business. Importantly, and as Chip alluded to earlier, we exceeded our expense savings target in 2023 and as a result our go forward annual expense will be at least $3,250,000 lower than had we not undertaken these undertaken those cost savings measures. Expense control remains a key focus of our management team and we are very pleased with our execution.

Speaker 1

And with that, I'll turn it back to the operator to open the line for questions.

Operator

Thank If you change your mind and would like to be removed from the queue, please press star followed by 2. Our first question today comes from the line of Terry McEvoy with Stephens. Please go ahead, Terry.

Speaker 4

Hi, thanks. Good morning.

Speaker 3

Hey, Jerry. Good morning.

Speaker 4

Barry, maybe just stick with that expense Expense outlook and commentary that you finished with success in the cost plan, but investing in the future. So how do you think about 2024 when you balance both of those and what type of an expense outlook do you have?

Speaker 1

Yes, a couple of things, Terry. Just as a reminder, in the first We'll have 2 months of the Bank of Denver coming on as well as we Florida will not roll off until the really the end of the second quarter. So, if I look at it from where we were in the Q4 of 2023, we'll be higher in the 1st and second quarters. I expect we're going to I expect we would come out of that towards the end of 2024 in the $33,000,000 to $35,000,000 range

Speaker 2

per quarter.

Speaker 4

Perfect. Thank you. And then A question on the margin, how much of the 4th quarter balance sheet restructuring was in the net interest margin in the 4th quarter? And is There an incremental benefit in the Q1. And then maybe just sticking with the margin, when the Fed hopefully begins To cut rates given your liability balance sheet, can you get ahead of that and how quickly do you think you'll see lower deposit rates?

Speaker 1

Yes. On the first part of that question, Terry, the Q4, we executed the balance sheet repositioning at the very end of the 4th quarter. So there's nothing in the 4th Quarter margin, no benefit from that transaction in the 4th quarter margin. So that'll be a 2024 tailwind, if you will, To the tune of about a couple of $1,000,000 I would say of net interest income. The second piece with respect to should the FOMC We start to lower rates and how effective can we be given our liability sensitive balance sheet.

Speaker 1

Certainly, what we're talking about internally here is How do we get in front of and be prepared for if and when those rate cuts do come? It will really be a function of obviously what's happening in the markets we serve competitive wise. I do think there's Still a lot of competition for deposits. And so I think that will drive how successful we can be at lowering our deposit costs if and when those rates come.

Speaker 4

And maybe if I could sneak one more in for Chip. There's just been a lot of hires in a lot of key markets. What areas of the bank are you still looking to add talent and where is the team complete, so to speak?

Speaker 2

I'd say our focus areas continue to be hiring within Commercial Banking and Wealth Management, Terry. Frank, I don't think we'll be done there almost ever. They are concentrated primarily in our Metro Markets as we continue to build out those. Lynn DeVacher is here as well. Lynn, any further comment?

Speaker 3

No, I would agree with that. I would say fundamentally Chip in his remarks talked about Denver and our vision for Denver and I would put that one close to the top of my list as I think about wealth hires there and with our new wealth leader, I Feel encouraged about our ability to bring on new talent and continue to grow that platform.

Speaker 4

The $1,000,000,000 objective or goal did make my notes here and catch my eyes. So, well, thanks for taking my questions and have a nice weekend.

Speaker 3

Thanks,

Operator

Ben. Our next question comes from the line of Damon DelMonte with KBW. Please go ahead, Damon.

Speaker 5

Hey, good morning, guys. Hope everybody is doing well today. Just wanted to start off with Good morning, Chip. On the loan outlook, I think you said mid to high single digits Or high single digits throughout the course of the year. I guess, I think the commentary was that You had good growth this quarter on ag and CRE and you're gaining increased optimism on C and I.

Speaker 5

Did you expect that growth to be Kind of more balanced as you go through 2024 or is there one area of the portfolio that you feel is going to outperform the others?

Speaker 3

Yes. Damon, this is Len. Good morning, and thanks for the question. So I would say Actually, good morning. I feel like we have a good balanced outlook.

Speaker 3

Actually, what I'm pretty fired up about is I see the C and I momentum going. I also see some strong things happening in our new agribusiness vertical. So as a nice complement to where we've continued to we've enjoyed historically, as you know, a lot of CRE momentum. So that's We're seeing the other pieces come into play now, so I feel good about that. I would also say that even though as you look at a balanced number From a C and I perspective, in the Q4, we did have one customer, we had a significant payoff with the sale of a business, But we replaced those balances with new nameplates, bringing over and including some nice full relationship.

Speaker 3

So Those things give me a lot of positive outlook as I look forward in 'twenty four.

Speaker 5

Got it. Okay. And then with respect to the margin, Barry, can you give us a little guidance as to what the Expected impact is going to be from Denver when they hit later this month?

Speaker 1

Yes, I think we'll get some incremental benefit in the margin from the Bank of Denver. Their net interest margin is Higher than our net interest margin, even though they're relatively a small part of our balance sheet, obviously. And then we'll also get the benefit of The accretion from the interest rate marks as well. So I expect there will be some incremental lift in the margin just From that transaction, moderated by just the size of the organization.

Speaker 5

Okay. And then did you say that with With respect to the core margin, you could see a couple of $1,000,000 of tailwind from the restructuring on NII here in the Q1?

Speaker 1

No, not in the Q1, the 1st year, Damon. 2024.

Speaker 5

The 1st year. Got it. Got it. Okay. And then so when you look at just the core margin, you feel like it bottoms here by like the end of the second quarter?

Speaker 1

That's kind of how we think about it, Damon, that perhaps the core margin trust in the middle of twenty twenty four first half of twenty twenty four.

Speaker 5

Great. Okay. That's all that I had. Thank you.

Speaker 3

Thanks,

Operator

Damon. We have no further questions. Our next question comes from the line of Brian Martin with Janney. Please go ahead, Brian.

Speaker 6

Sig, just wanted to one A couple more on the margin, Barry. I guess the margin for the month of December, can you give us an idea of where that was trending? And then Just on the restructuring, the basis point impact of that restructuring, did you give that maybe, I guess can you put that can you frame that up where that's at if you think about where the December margin was since it wasn't really in there?

Speaker 1

Yes, our net interest margin in December was 2.15%, Brian. Now that had some Negative adjustments in net interest income associated with it. And so, probably closer to our really kind of between closer to 220 perhaps. I did not put the basis points on the benefit from the bond sale transaction. But again, it's around $2,000,000 of interest income for 2024.

Speaker 6

Okay. And that'll be in there just throughout the whole year. So okay, perfect. And then, I guess, just secondly, as far as the outlook for credit, I guess, can you just talk about you talked about the Special mention being de minimis this quarter, pretty negative, very low. Please talk about What are the concerns?

Speaker 6

I know you talked about a couple of the credits that were downgraded on the assisted living front, but just kind of areas you're watching a little bit more closely in terms of Risk as you kind of stay in a certain time period here.

Speaker 2

Sure, Brian. This is Chip. And Gary Sims, our Chief Credit Officer is here in the room with us and we'll have him go ahead and walk through that for you.

Speaker 7

Hey, Brian, Gary here. Good morning. And as you've noted, the migration from special mention to substandard, Three relationships, 2 of them were in senior living, one was in office credit. And when we Think about the question of where we are focusing on potential risk in our portfolio, that really kind of crystallizes where We're focusing our efforts in identifying risk. We have seen softness in the senior living and the Office CRE.

Speaker 7

On the senior living side, for the most part, it's not about occupancy, it's about the operating statement And operating expenses, more specifically nursing care. And then on office, It is in fact about occupancy for the most part. So I'll stop, Brian. Did that answer your question? Yes.

Speaker 7

No, that's helpful. Just to give

Speaker 6

a little color in any specific areas that are of more concern, I guess, as you kind of look forward other than what you've kind of already identified or just Sectors within the commercial real estate bucket?

Speaker 7

Sure. And good place to Dave, as we said, one of the things we were encouraged with as we finished out the year, we didn't see Continued migration into the non pass categories as we finished out the Q4. That kind of gives us A picture that the portfolio we've identified the risk in the portfolio and it's not continuing to migrate. So We're encouraged by that trend as well. Beyond office and senior living, We're not seeing significant or material weaknesses in other categories at this point, Brian.

Speaker 6

Okay. All right. That makes sense with the slowdown. So thank you, Gary, for that. And then maybe, I don't know, just Chip, if you said this, I joined the call a bit late, but the Your outlook for all the hiring and the initiatives that you guys have put in place on the fee income side, Can you frame up or just talk a little bit about your outlook on fee income this year?

Speaker 6

Or maybe just kind of the cadence of given what you've done, the groundwork you've laid, Kind of how we think about the trajectory of fee income this year to kind of benefit from some of your actions.

Speaker 2

We feel so I'd say on the non interest income side, we feel really good in terms of a couple of areas there, Primarily, I'd say, led by wealth management and we divide that business line into 2 different sectors. 1, our Investment services, which is really more of our brokerage area and then our assets under management within our wealth department. Our wealth group is growing nicely, assets under management coming into that Area increased by about 60% on a year over year basis and primarily centered in a couple of our metro Markets. And in that segment, it was up about 10% from a non interest income standpoint for the year of 'twenty 3. We believe and Len mentioned and notated that we just hired a new head of wealth management as well that we believe will continue to Maintain and hopefully accelerate some of that revenue drive.

Speaker 2

Also very comfortable with the build that we've had in our Government SBA Group and we're expecting more volume there from a gain on sale in 'twenty four As well as our customer hedging or swap program showed nice trajectory increase in 'twenty three And we believe that that will continue in 'twenty four. So overall, we're feeling pretty good about that non interest income line. The other that we're investing a heck of a lot in and Len and his team have done an outstanding job in building out our treasury management Offering and department, both from a talent standpoint, also a product and then also a structural standpoint. And so we're looking For more there as well in 2024.

Speaker 6

And if you kind of frame up Kind of the if the run rate today is in the $9,500,000 $10,000,000 level, if you kind of look a year out, can you kind of give some guidepost around where you think you could get that to Given maybe it's going to happen, as you say, kind of throughout the year and just kind of building it. But if you kind of look out a year, kind of where you exit 24 in terms of kind of run rate on fees as you move forward?

Speaker 2

Ultimately, I think we can move this at the high single digit to potentially double digit levels As we exit 2024.

Operator

We have no further questions. I will turn the call back to the management team for any closing remarks.

Speaker 2

Thank you for everyone joining the call here today. Thank you to our team members for all of their work in 2023, a year of transformation for this organization, And we look forward to what 2024 and beyond brings to this institution. Thank you, 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 Q4 2023
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