Midwestone Financial Group Inc (IOWA)
NASDAQ:MOFG
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Midwestone Financial Group Inc (IOWA)
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Good morning, ladies and gentlemen and welcome to the MidWestOne Financial Group, Incorporated Second Quarter 2023 Earnings Call. [Operator Instructions] As a reminder, this call is being recorded.
I would now like to turn the call over to Barry Ray, Chief Financial Officer of MidWestOne Financial Group. Please go ahead.
Thank you everyone for joining us today. We appreciate your participation in our second quarter 2023 earnings conference call. With me here on the call are Chip Reeves, our Chief Executive Officer; and Len Devaisher, our President and Chief Operating 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.
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 MidWestOne Financial Group Inc. Forward-looking statements generally include words such as believes, expects, anticipates and other similar expressions. Actual results could differ materially from those indicated.
Among the important factors that could cause actual results to differ materially are interest rates, changes in the mix of the company’s business, competitive pressures, general economic conditions and the risk factors detailed in the company’s periodic reports and registration statements filed with the Securities and Exchange Commission. MidWestOne Financial Group, Inc. undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances after the date of this presentation.
I would now like to turn the call over to Chip.
Thank you, Barry and good morning. On today’s call, I will provide an update on the solid progress we have achieved executing our strategic initiatives as we focus on building the foundation for a high performing bank with consistent performance.
Len will then provide an update on our major markets 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 second quarter financial results.
As we discussed on our first quarter call, we have developed a strategic plan as outlined on Slide 4 of our earnings presentation with five 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 have made solid progress, executing our plan through the second quarter and what has been a very challenging operating environment. Starting with our commercial banking and wealth management businesses, we are focused on expanding and moving up tier in our major metro markets of the Twin Cities, Denver and Iowa.
This is a continuation of the strategy that we have been executing for several years where we have been hiring experienced relationship bankers and wealth management professionals to drive organic growth. That said, we will be doubling down in these markets with a plan to add bankers and expertise targeting revenue companies from 20 million to 100 million.
So far this year, we have added several producers in this Twin Cities, and we will 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 second 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 and 2025.
In our wealth management group, we have also achieved significant assets under management growth driven by the teams recruited in 2021 and 2022, which Len will discuss in more detail. As with our commercial banking business, we will continue to actively recruit wealth management teams in our core markets to drive asset growth and fee income.
In our specialty business lines, we are 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 first quarter call, our plans call for immediate verticals in agribusiness, government guaranteed lending, notably in SBA and commercial real estate.
Starting with agribusiness, we have 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 have been missing significant business opportunities with larger growers and producers as well as suppliers to this industry.
To address this opportunity late in the second quarter, we hired an experienced agribusiness lending team from a Midwestern based regional bank. This group has led agribusiness teams for a decade and has strong expertise in relationships across the industry, and they are already beginning to move full relationships to Midwest one.
Government guaranteed lending’s also a natural fit for our local and metro bank markets. Our desire is to become one of the leading bank 7A lenders in our footprint. Our SBA leader joined in 2021 and our sales team is being developed. That said, we are seeing momentum building with positive second quarter results, and we anticipate this initiative will be a meaningful fee income contributor in 2024 and beyond.
As I mentioned on our fourth quarter call, our Twin Cities commercial banking leader has extensive super regional bank experience in the CRE space, and as leading this segment for the bank, we are 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 are 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 space in the more productive, profitable markets and departments, and then to reduce an additional 2.5% of our Q4 2022 operating expense run rate. That will improve our go forward operating expenses.
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 one customers.
Additional actions commenced in June, including a voluntary employee retirement program, the expense of which was taken in our second quarter, while the full compensation reduction realization will be the fourth quarter of 2023. We continue to engage with a third-party consultant to review remaining efficiencies with additional opportunities likely in the third quarter.
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. One, continue to be focused on our clients and employees. As we increase our focus on innovation, performance and results. I’m very proud of the progress that we are making.
It is a testament to our employees in the bank who 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 have 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 pure group as we exit 2025.
Now, I would like to turn the call over to Len.
Thank you, Chip, and good morning everyone. 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 are pleased to see those balances remain stable in July. Notably, our deposit results in the second quarter are driven by balance growth in our commercial segment, offsetting a runoff of public funds, time deposits, particularly in the month of May.
Speaking of our commercial team, they are driving strong growth on the asset side of the balance sheet too. Our nearly $94 million of balance growth in the second 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 2022 new originations this year are up 4% and loan origination fee production is up 22%.
Our loan story is about growth, but it is 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% in April.
Our credit risk profile with low net charge offs of only nine 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 investments and wealth also continue to bear fruit. AUM and revenue continue to climb, and we are pleased that our year-to-date new AUM is at $97 million more than twice the same period last year. In our investment services division, second quarter revenue was up 10.6% from the first quarter. 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, Len. I will walk through our financial statements beginning with the balance sheet on Slide 12. Starting with assets, loans increased 99.2 million or 10.6% annualized from the linked quarter to $4 billion.
Strength in the second quarter was led by commercial loans, which increased 93.9 million or 12.2% annualized from the linked quarter, and the overall portfolio yield was 5.05%, a 10 basis point improvement from the linked quarter.
During the quarter, the allowance for credit losses increased 26 million to 50.6 million or 1.25% of loans held for investment at June 30th. The increase was due to credit loss expense of $1.6 million attributable to organic loan growth, which was partially offset by net loan charge offs of $0.9 million.
Turning to deposits, the dislocation following the bank failures in March of this year impacted our deposit franchise as we experienced net deposit outflows through April and May. But positively, that trend reversed in June. That said, total deposits decreased $109.7 million to $5.4 billion from the linked quarter.
Public funds deposits accounted for nearly $98 million of the net deposit outflows as the cost of retaining those deposits exceeded the cost of alternative funding sources for similar tenors. The rising interest rate environment combined with the residual of those 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 second quarter.
Specifically, the cost of interest-bearing liabilities rose 39 basis points to 1.98% comprised of increases to our interest-bearing deposits, short-term borrowing costs, and long-term debt costs. Finishing the balance sheet, total shareholders’ equity experienced an increase of $0.7 million to $501.3 million, driven primarily by second quarter net income, partially offset by an unfavorable accumulated other comprehensive loss of $3.8 million and cash dividends of $3.8 million.
Turning to the income statement. On Slide 15, net interest income declined $3.1 million in the second quarter to $37 million as compared to 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 second quarter as compared to 2.75% in the length quarter. Our NIM in the second 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 second quarter increased $12.8 million, primarily due to the investment securities losses of $13.2 million in the linked quarter related to our balance sheet repositioning in the first quarter.
Finishing with expenses, total non-interest expense in the second quarter was $34.9 million, an increase of $1.6 million or 4.8% from the linked quarter. The increase was primarily due to $1.4 million 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 first quarter’s level.
As Chip mentioned, we remain focused on improving our efficiency and operations, including cost reductions, a key pillar of our strategic plan. Specifically by the end of this year, we expect to reduce our annual expense run rate by approximately $3.25 million and reallocate another $3.25 million 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 first quarter.
And with that, I will turn it back to the operator to open the line for questions.
[Operator Instructions] Our first question comes from the line of Brendan Nosal with Piper Sandler. Brendan please go ahead, your line is open.
Just to start off here. Maybe to start off on the margin. Can you just walk us through how the kind NIM of trended over the course of the quarter and where it ended up for the month of June, just trying to gauge a good jumping off point in the third quarter.
Yes. Over the course of the quarter, the margin was as follows: We were at 2.64% in the month of April, 2.46% in May and then 2.48% in June, Brendan.
Okay. All right. That is super helpful. Maybe one more before I step back. I noticed you drew from the bank term funding program during the quarter. 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 year.
Yes, we saw an opportunity to take advantage of the attractive features of the bank term funding program. For an instance, we were continuing to see net deposit outflows. And so to the extent that we continue to utilize that in the future, that is really going to be dependent upon what we can see with deposits.
As we said, we were pretty happy with deposits stabilizing in the third month of the quarter and on into July. And so that was how we were thinking about the bank term funding program has some attractive features.
It was a cheaper cost of funds than overnight borrowing at the time that we have done it and likely actually still remains so.
Next question comes from Ben Gerlinger with Hovde Group. Ben please go ahead, your line is open.
The loan growth was pretty solid and I think the guidance was for kind of a step down kind of the mid-single-digit range. Just curious more so a function of deposit gathering costs there. Is it risk-adjusted yields that you are just kind of getting competed out on or is it more so just an economic fear in general or obviously, the mix of the three, but I was just kind of just waiting those as sort of the reason why it stepped down in loan growth projections?
So Ben, this is Chip. I will take a little bit and turn it to Len for more of the market view. I think that step down for us is the origination activity, we believe, will still be extremely solid. But we are being more selective, frankly, in what we are 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 are 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 for asset dampening as such from our first half of the year. But overall, solid originations, and I will have Len speak to that.
Yes. Thanks, Chip. Ben, I would just add, we are 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, what is going to happen, we handicap when we think closings are going to happen if 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 third quarter. 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. When we exited the first quarter at 36%, it is down to 33% as we exited the second quarter. So all of that is factoring in.
Got you. That is helpful. And then I get that the expense has some relatively onetime I don’t know it would be the retirements, but you are also hiring some people across the footprint. I guess these kind of more so onetime items could be - you get a clean quarter in 4Q. But all the while, your hiring people as well, just any guidance you can give to kind of what the non-core - excuse me, what a core expense base would be going forward or when we should see just pure core expenses?
Yes. I would say that, as we said in the comments, $33.5 million is kind of what we are thinking of is a core expense run rate in the near term. When we get to that, a lot of the actions that we have been talking about with respect to improving our efficiency of operations are going to be happening throughout this year. So I would say, first quarter of next year is when you are going to see core expense run rate.
Our next question comes from Terry McEvoy with Stephens. Terry please go ahead, your line is open.
Maybe a first question for Barry, 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?
We are 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 balance sheet is positioned. So that is how we are thinking about that.
With respect to some of the things that we are doing from a balance sheet management perspective should rates stay where they are, we are 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.
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? So I’m just trying to see if they bring something different or is an expansion of kind of the existing business model and focus.
Terry, this is Chip. And then again, I will have Len provide some further commentary. There, I think ultimately, across our commercial banking franchise, both in any of the specialty lines that we begin to build, but also just in our core C&I business in our invested markets that we label as investment markets we are really moving up here in terms of our overall strategy and that customer base that we are reaching and the prospect base that we are reaching. So Len, do you want to articulate around the agribusiness team?
Yes. Thanks, Chip. It really is a story. This team is coming to us from a larger regional that has - they have got the track record and importantly, the relationships that have shown in our footprint to be able to go to that next segment because our legacy business has done a 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, Terry, our average account size or loan size in our current Ag business space is only about $400,000 to $500,000. And this group typically plays in the $2 million to $10 million space in terms of loan relationship, while we have seen positive activity, and it is not just been on the lending side, this is also full relationship and depository.
That is a great color. 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.
This is Barry. I will take the piece. The gain from the SBA loan sale will be included in what we have on our income statement as a loan revenue item. So the $250,000 or so that we generated this quarter is included in that line item. Did that answer your question?
And the unguaranteed part on the balance sheet and that will be held on the balance sheet?
Terry overtime, so let us go into the span of our strategic plan 2025, we could see this being about $40 million a year of annualized originations. If you go 25% being held, that is only $10 million in terms of being held on an annualized basis moving forward.
So as a 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.
The next question comes from Damon DelMonte with KBW. Damon please go ahead, your line is open.
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 are going to be able to kind of mitigate some of the pressures that you’ve seen in the last couple of quarters? 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 the year?
Yes. Thank you, Damon. And some of the things that we have been modeling internally is assuming that the FOMC hits pause on their rate increases and then deposits stabilize as we have experienced over the course of the past couple of months and we continue the loan growth, how we are expecting the margin would be - we expect some continued compression into the third quarter and then stabilizing in the fourth quarter and perhaps inflecting in early part of next year is kind of how we are thinking about the margin based upon our internal model. That is our expectations, Damon.
Okay. That is helpful. And then with respect to the agri business hires, how big of a component of your overall loan portfolio do you envision the Ag portion being especially since as you guys noted, bigger credits that they put on versus kind of what the legacy portfolio has?
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 and 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 is going to show up in the C&I piece as well as we think about the business of agri business. So I think we’d probably cap out in that 10% or less range.
Got it. Okay. From the Ag specific, not what goes into C&I as well?
You got it, 10% or less on the Ag component.
Got it. Okay. That is helpful. And then just lastly on the expenses. In the prepared remarks, did you guys say that you expect kind of third quarter level to be similar - more similar to the first quarter level? Did I hear that correctly?
You did, Damon. But again, on a core basis, I would say.
Yes, just Damon - this is - we are moving through enough just continued review of our efficiency and operations that we may be lumpy. Here, obviously, we had some onetime in Q2. We may have some onetime in Q3 as well. And I think Barry alluded to core should be that 33.5% range and not where we end up being from a stated number, Q4 to Q1 where we will see the settling down of any of the one-timers.
The next question comes from Brian Martin with Janney Montgomery Scott. Brian please go ahead.
So just one follow-up on expenses, Barry. I mean, can you give some kind of thought on where the expenses - will they normalize as you enter next year? It sounds like the next two quarters, it sounds like there is some consultants or some possibility a little bit more improvement here in the back half. But just as you talked about the step down as you get into next year, can you kind of give us a how we should be thinking about expenses for next year as you jump in the first quarter?
Yes. As we have discussed kind of when we think about an actual dollar reduction in expenses, Brian, we have been talking about that in terms of like the $3.25 million on an annual basis. And so I would say that we are going to have some normal expense increases in the first quarter of next year, just for salaries, for example.
So whatever you are modeling for that and then the number that we are targeting is the $3.25 million per annual reduction. So if you put those two pieces together, that should approximate a good run rate for beginning of next year.
Got you. Okay. That is perfect. And then how about just the funding of the loan growth in the second half of the year, the contraction you saw in 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 that goes along with your outlook on deposit flows?
Yes. We are going to continue to take advantage of - our investment portfolio is continuing to run down, Brian. I think in 2024, we get about $160 million of cash flows off of that and that is going to ramp up a bit more in 2025.
So the second half of the year, we will 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.
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?
I didn’t disclose that, Brian. I don’t have it in front of me, but I can get it to you.
Okay. Yes. Maybe it is about half of you talk about maybe in a range -.
I think we are roughly about $150 million for the year, Brian, so let’s call it, $75 million.
Yes. Okay. That sounds about right. Okay. I appreciate it. And then just the last one for me was on criticized and classified levels. I mean the NPAs were pretty stable, but some increases in both criticized and classified. 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 are seeing some of the stress?
Sure, Brian. This is Chip Reeves. Gary Sims, our Chief Credit Officer, is with us in the room today, and we will have Gary answer that question for you. Gary?
Yes. Thanks, Chip. Hi Brian, as we did point out, our increase in criticized and classified, it is primarily in that non-owner-occupied category. And like most of our peers, we are seeing weakness in the office space. We believe we have identified the appropriate level of weakness and that office space total portfolio is 3.8% of the overall portfolio. So we feel like it is manageable through this cycle.
Okay. So are the two credits, both office properties, Barry, or I guess the -.
Yes. Yes, Brian, the increase in the classified were both office, non-owner-occupied office. When you take into account the increase in the credit side as well, we did see some deterioration in our senior living credits as well. So from a thematic perspective, senior living and office is where we have seen the weakness so far, Brian. Does that help?
Okay. Yes, yes. And just in general, the senior living, how bigger portfolio is that? Is that relatively small in size versus the office portfolio?
Yes. The office portfolio is 3.8% of our overall loan portfolio. The senior living portfolio is 6.1% of our overall portfolio.
Okay. Okay. And just on credit right now that is past due there or just in criticized?
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 portfolio in the senior living.
Those are all the questions we have for today. So I will turn the call back to Chip Reeves for closing remarks.
Thank you, everyone, for your time and interest in MOFG. As mentioned today, we are making solid progress on our strategic plan initiatives, and we look forward to sharing more details next quarter. Thanks, everyone.
Thank you, everyone, for joining us today. This concludes our call, and you may now disconnect your lines.