Q4 2019 Earnings Call

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Actual results could differ materially from those indicated among the important factors that could cause actual results to differ materially our interest rates changes in the mix of the company's business of 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 lend 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. Please note this event is being recorded. I would now like to turn the conference over to Charles Funk president and CEO , please go ahead. Thank you very much highly and good morning or good afternoon to everyone on a call and thank you for joining us. We're joined on the call this morning by Gary Sims our chief credit officer Barry Ray our Chief Financial Officer and our treasure Jim Cantrell.

I'll just begin with.

The few preliminary Mark remarks as usual and would say that the headline numbers, uh, certainly are very good and we're all very pleased because there was a lot of hard work that went in June 2019 throughout our company and we are very very pleased to see that be rewarded with much-improved financial results to recap 83 cents a share for the quarter down to $93 for the year $2.93 for the year those include merger-related expenses. And obviously the numbers are better when those merger-related expenses are taken out. I would also note that our efficiency ratio made a nice move downward during the year roughly fifty seven and a half percent for the year. It was the efficiency ratio was inflated a bit in the fourth quarter due to the 3.9 million dollar expense for tax credits, and we essentially gained this back in the reduced taxes. We paid off

And of course the expense was record.

Not as the above the line and the reduced tax expense below-the-line. Hence the higher efficiency ratio.

It's been a tough six months. I start with the balance sheet. It's been a tough six months for loan volumes. And I think there are multiple reasons. There's not any one reason in our particular football. First of all, we've had a lot of liquidity events and we talked about those liquidity events in our last call last quarter. Those many of those liquidity events continued to come down where folks are selling their businesses and paying off their loans with us. And we saw that again during the fourth quarter. We've seen some loans refinance check out of Midwest one in some cases that had to do with relaxed credit terms not in every case, but we we did see several credits moved that we were not willing to meet with the credit terms of their institutions were offering and then especially in the egg sector we have been able to work some substandard and problem loans out of birth.

And when those leave our our loan volumes go down.

I would also mention of note that our Denver Market had large unexpected pay Downs on their lines of credit in the fourth quarter did not involve loss of customers just in the normal flow of business, but these were unexpected and certainly hurt our loan volumes and I I did talk this morning to one of our regional presidents in the Twin Cities who reported that uh from their perspective business has been slower in our customer base in November December but reported that as as the calendar changed into a new year with the Outlook might be a little bit better. So as we look at 2020, we have budgeted 5% loan growth. We have a decent pipeline wage. I think we will see some other opportunities to evaluate deals during the first quarter and that would be especially through in our Denver Market where we have a number of opportunities that we will be looking at over the next month.

3 to 60 days

News on the balance sheet would be that this was a very good year for deposit growth. One of the best I think in in the history of our company and the reason I say that is that in the Legacy Mid West Palm footprint every region saw an increase in deposits during the year and I think what's especially gratifying and noteworthy. Is that the rural markets and we do serve a number of Rural Market wage, but in our our regions that comprise rural markets they were some of the better deposit gathers in 2019. That being said the Twin Cities footprint had a good deposit here as dead are to Florida offices as did Denver and you know, I go back to the fact that we we want to build our franchise on our core deposits and over the long-term main very confident in our ability to grow our loan book and I think we will continue to do that and and see progress again in 2020. One thing that I would note for wage.

Call one of our strategic objective.

It's for 2020 is we will be hiring more Bankers in our Denver Market. We think there remains significant opportunity there and I would remind everyone listening that we have mostly commercial and Industrial loans in that market, which we think gives us a good balance to the commercial real estate loans we have in the Twin Cities. We've already hired a couple of months very very good support people and Denver and I think during the first quarter we will we will be able to add a couple of bankers and I think that will manifest itself with better loan volume from that market in 2020 21 and 22

better

Goodyear in my opinion for non-interest income. I'll start with with wealth management both our trust department and our Investment Services areas had record years, and I remind folks that we essentially tripled the size of our trust department when we acquired American Trust and that integration has gone exceptionally. Well, we've had very little customer attrition it out of our Dubuque trust department, and that's really thanks to the good work of a lot of people Investment Services is a small piece of the wealth management pie. They also had a record year. We did add two investment Representatives with the 80 acquisition and those to have hit the ground running with Midwest Thursday. We have excellent momentum in Investment Services, and we expect both an investment services and entrust that we will add sales people in 2020 and Hope phone number.

be able to expand our footprint of

Got uh, but again that depends on our our ability to hire good people in the right people for those jobs. The home mortgage center had a good year. Of course, the servicing rights record us to the tune of approximately a million dollars of a negative adjustment during the year in 2019. The the integration with American Trust could not have come at a worse time for our mortgage people because just as their volumes were wrapping up we had to integrate the systems. But but that particular Market is now doing very well. We were very gratified to hear that we retained in Dubuque our traditional number to place in the market credit. There's a credit union there. That's number one, but we have lunch and our number two ranking it in Mortgage in that market and we look forward to a good year and Mortgage in 2020. We start the year with a with a pipeline. That's much. Yep.

Charger than it normally is at this time.

Of the year and I would also remind everyone that we do now service about one point 1 billion dollars in mortgage loans. So depending on the interest rate environment, that should be a steady source of income going forward.

Turning to the net interest margin probably the the one thing I want to talk about in these remarks would be the fact that our core margin fell from 3:48 to 3:52, which was a bit of a surprise to us. And I think I can explain five of the six basis points away pretty easily. We did charge off some interest on loans and for those who are familiar with with ag loans, they typically pay interest at the beginning of the year or the end of the calendar year. And when you charge when you charge you off interest on loans late in the calendar year, you typically charge off a lot of interests. So two basis points of our core margin shrinkage is due to charge off of interest and then three basis points is attributable to the lower loaner deposit ratio, in other words an unfavorable mix change as we look forward. We would expect our core margin to be in the near-term wage.

Like 3:40 to 3:45.

And uh absolute change in the yield curve or interest rates. I think we feel pretty confident in our ability to operate in that range.

Turn into asset-quality. We did have a nine point five million dollar increase in non-accrual loans. And as we noted in the earnings release two point two million dollars of those loans paid off already in January and are no longer in our bank and of the remaining 7.3 million that are on non-accrual none of those represent surprises. I would characterize those as gently deterioration of existing credits and we certainly believe we're Reserve properly on those credits at this point in time. I would also note for those who model our financial performance that we we have a scheduled pay off of $3 on other real estate owned next week. And so are are Oreo should go down by three million dollars a month, um in the next week to ten days. We also expect more importantly that there will be more resolutions of some of these probably problem credits coming in the first and second call log.

as of 2020

So the outlook on credit and asset quality is we don't really see anything on the horizon beyond what we've talked about this morning there does continue to be stress with our weaker borrows borrowers of the community. I'll talk more about that in just a second and if you look at ar3932 89 day past dues reported at the end of 2019. They were a certainly wage levels that we've seen in the past and and have no we have no cause for concern we did put a statement about the Cecil in the in the earnings release and the only thing I would add to that would be that we think the Cecil adjustment will be plus or minus ten basis points to our Capital ratios. So certainly not that's not something to be overly concerned about from a capital point of view.

I'd like to give a brief Outlook because we get a lot of questions about the AG sector. This is the Agri Newell season and our customers are starting to come in and we're we're renewing in most cases. They're operating lines for 2020 a reminder that in some parts of our footprint. There are still crops in the field, which is very unusual for this time of the year. And on average wage 2019 yields were ten to twenty percent below 2018 yields and again to remind everyone 2018 was a bumper crop. So 10 to 20% down from a bumper crop in in 2018. I would characterize as much the same way as I've been characterizing it for the last three or four years. It's not great. I do not think it's a widespread crisis certainly not in our company, but I would say for marginal borrowers in our in the egg space. This is a very very tough time. I don't think that will change.

that's where most of the

The energy is focused around problem credits for high quality and average and above-average egg producers. This current environment is very very manageable and there will be a lot of survivors who come through this at the end of the year loans comprise 9.3% of our portfolio that's down just a touch from the prior quarter of primarily due to pay Downs on operating lines and movement out of the bank as I talked about before on problem credits. I'll give you a a few metrics to measure wage or the movement in substandard and watch credits if

If you look back the high for our portfolio in terms of watch and substandard credits was 23.6% And that was in March of 2018 at your end. We were 19.8% That's that was a slight increase from the from the prior quarter but significantly down from the high of March of 2018 are substandard loans were up a little bit sub-standard loans at 9:30 19. We're 7.6% and 89% of the portfolio as of your end. And again that's off the high of 11.8% in March of 2018. So directionally, I think we're still in a pretty good place. We we acquired a number of dairy loans when we purchased a t and I think it's fair to say that the dairy industry has stabilized a bit slightly off.

proved operating margins

And there's certainly more optimism in that sector than there has been for for several years. So I mean in corn prices are well off their lows. I think that the trade deal is probably a modest possible. And again the summer here would be that we will have bumps along the way but we think we're able to manage through this and I think what I feel most confident in is that we've been able to identify where the issues are in the portfolio and then act accordingly in terms of capital. I think we're in good shape on Capitol. We're certainly in The Sweet Spot of where we want to be in terms of tangible, equity. And we and we continue to accrete Capital at a pretty good clip the dividend increase that we announced is the largest in some years for our company and we took do have room on the buyback plan the stock repurchase plan when we think it makes sense for for our shareholders. So to summarize I would say 2020 wage.

You're for us to return to a more more normal.

Loan growth pattern and if you look at our company, I think Denver the Twin Cities and Florida still have very very strong economies and and in our Metro Iowa communities. We also have some opportunity to pick up alone volume in 2020 and one of the rural regions in Iowa. We already know that we're probably going to increase our our loans just because of what's in the pipeline by 5 to 10% this year. So overall we think of 5% loan growth goal is is attainable for our company in 2020. And we also think that at least now the momentum and non-interest income mortgage trust and Investment Services and opportunities for interest rate swaps for a commercial Borrowers is also strong. So the the outlook for non-interest income should be pretty good as well with that. We're happy to entertain any questions you might suck.

And I will turn it back to you. I lie as you get

the questions in order

we will now begin the question-and-answer session to ask a question. You can press * then 1 on your touchtone phone. If you're using a speaker phone, please pick up your handset before pressing the keys to withdraw your question, please press * then two.

Our first question comes from Jeff with d a Davidson.

I guess morning wanted to kind of check in Charlie. You mentioned the core efficiency ratio and 57 and 1/2 kind as we looking at 5:20. And if we think about one of the I guess conversion of of a TV and and and getting all that in I guess do you have a target for Palm Court Efficiency? Do you think you can you can improve upon that that's a pretty skinny number but just a balance of 22 moving pieces on expenses and if you can kind of confirm whether you think there's any more cost to squeeze out of the the merger.

Barry and I

We're talking about the cost saves yesterday and we are very confident that we've achieved the cost saves that we said we would from a t it's a good question. You know, our goal had been to get below 60 per month that it would not surprise me if it picked up a little bit towards sixty but we uh, we sort of have a stake in the ground at 60% below 60% for a core efficiency ratio will have to see how it all plays out and Jeff but I would think somewhere in the mid-to-high 50s would be something that we we should be able to obtain over the long-term. Hope that answers your question. Yeah, that's that's helpful. And I think of the release in in also Charlie you mentioned in the prepared remarks just this this strain on low-wage volumes with liquidity events and revised and some workout, but I think there was even a comment on on week or loan demand. What are the spots and you may have pegged it I guess wage.

none of the rural Iowa if you

If you went to Twin Cities, Florida, Colorado is being strong. Is that the market the geography that's particularly weak and and maybe within the segment that that that is Thursday, August 4th demand.

Yeah, the it so maybe with an antidote is the best way to answer the rural footprint, you know, one of our better Bankers who's been with our office a long time and is one of our top Bankers likes to talk about that. He's been calling on certain Farmers for years and wanting to bring them into the bank and had the opportunity to look at their financial statements within the last year and when he saw the financial statements thought to himself, I just can't believe that it doesn't look any better than this and we passed on the opportunities and I think that's what you see in the app space and the the better borrowers in the egg spaces are still being called on by other institutions and we have to get pretty competitive on price but in general we have a real markets not only in Iowa, but also in Wisconsin and and dead.

And up north east of the Twin Cities.

And you know those those are not economically strong regions. So when we look at budgeting, we basically if you can do three or four percent and those Footprints that's pretty good because there or economies are just not growing you get closer to the Twin Cities or as we talked about Denver and and then Naples especially those are strong markets in Iowa. Dubuque is still doing pretty well and we're we we expect Dubuque to increase loans their loan totals during the coming year and I think we'll get a nice lift at Iowa City this year as well. So that's kind of a rundown of our footprint. Great. Thanks in just one last one quick one for maybe for Barry just to the tax rate in 20 what you would expect wage to be. Yeah. No problem. Jeff certainly are effective tax rate this year reflected the benefits related to the tax credit Investments as we articulated in their release. We do have one additional

renewable energy tax credit investment scheduled to provide tax benefits and twenty-twenty though smaller in magnitude than we

Experience in 2019 as a result. I would estimate the effective tax rate in 2020 will be about 18%

Okay. Thank you.

Our next question comes from Andrew leash with Piper Sandler.

Morning, everyone.

I ordered hi Charlie. I'm sorry if I missed this, but cuz I know you've given this guy into the past that you talk about what your expectations are for provisioning and maybe it's different under Cecil, but I'm sorry if I missed if you did.

Well, that's a good question. That's that's above my pay grade. I should let Barry and Gary talk about that cuz Cecil does change the dynamic significantly.

Yeah Andrew, this is Barry. I'll start with the adoption of Cecil in 2020. It's difficult to provide a good estimate of provision expense as like others we have little experience in estimating credit losses under new guidance. And so

given the seagull guidance provision expenses likely to be all over the map in the near-term and and likely more volatile in general. So as Cecil impacts the month timing recognition of credit losses and not the ultimate dollar amount of credit losses. I suggest investors would consider evaluating credit quality on other metrics than just the level of the provision but off at the non-answer, I realize Andrew but I don't have a good answer for what we think are provision will be the other things I Had Gary. Yeah, and I mean and I I agree with Chuck Berry in terms of how to look at Provisions for the year. I mean ultimately our our credit quality is going to be driven by net charge-offs levels of npas Etc. And I often say that you could look for the levels of net charge-offs for 20 20 and the npa's for 2020 to be an improved picture wage.

relative to 2019

Thank you so much. And then Charlie the the baker's that you're looking to hire like what's what's the sort of background that you're looking for? What's his what's his Bankers background is in wage Big Bang experience small Bank experience Regional Bank, like what's an ideal person that you're looking to bring on?

Well are we are fortunate that our team in Denver is very well connected and you know, they work for a long time and the Wells Fargo office in Denver and then for another Community Bank for four or five or six years before they joined Midwest one and the fact that they're well-connected. I think they have a lot of strong relationships. Probably these are going to be Bankers who have been in that market for a while back who have established customer relationships and who fit our culture. That's probably the best way I could answer that and we're not necessarily looking to hire, you know Bankers who specialize in commercial real estate because we've said that we want that market to be primarily focused on C&I loans, which gives a if you look at the portfolio out there. There's a there's a big diversification in terms of Industry represented in and things such as that so, you know, established Bankers who can bring customers to Midwest one and who fit our Culture Club

Great that covers on the quest.

Something so much. Thank you, Andrew.

Our next question comes from Damon Delmont with KBW. Good afternoon guys. How's it going today? Good afternoon. So first question, I'm wondering in relation to the margin. Maybe we get a little more color on the outlook for the credible yield impact obviously, it was down pretty significantly this quarter. I know last quarter was a bit of an aberration but is Thursday we can get a frame out what we're expecting on a quarterly basis.

Yeah, this is Barry Damon. I'll take that. Yeah, we had in my notes just kind of creation was three point nine million in the fourth quarter and the seven point two million a Thursday. And obviously the level of discount accretion is impacted by payouts for example, but we also know that it's it's an amount that we recognize more upfront. And so with the three point nine million a good chunk of a portion of that was a tradable to pay offs as well. I would attenuate that number looking forward to somewhere in the in the twos and then go back down from their high to low threes and then going down payment. That's the best way I could think about it.

Okay, that that that's a good way to look think about it.

Okay. Okay, great. And then the

Marjan you said is expected to be in the 3:40 to 3:45 range. Is that correct? Okay, and then you know their opportunities to I saw the dog race. Sorry. The cost is TVs picked up a little bit this quarter. Is there some opportunity to to lower those in the coming quarters?

Yeah, Dave and this is Jim. I'll I'll answer that question. The number you saw we're floating right around 2% just below two-per-cent for that CD yield and I would say in the fourth quarter off, but we had a little bit of a drop-off in a purchase accounting adjustment. That probably is worth about two basis points in total. My view is that when I look at just the coupe of the CD book just the coupon alone. We had a peek in the third quarter. We're actually down in coupon. Although we get we get less purchase accounting benefit in the fourth quarter. We're actually down in coolant in the fourth quarter. It's going to Trail down the coupon will probably Trail down. We're putting on CDs a little bit Low Book average. So we're the book average is in the upper 190s.

We're putting on CDs on.

Average in the probably in the 180s one upper 170 so it's slow it's not going to move very fast, but it's the trend ought to be down in the coupon. Okay, that's fine. Thanks. And then with respect to expenses, you know Barry, can you give us a little a little outlook here as how we should think about the quarterly run rate, especially if you guys are able to bring on some additional commercial lenders wage and the Denver area. Yeah. I'll I'll give you the best I can on that Damon. So excluding the the 3.9 million of amortization of the tax credit investments in the fourth quarter and merger-related expensive not interest expense was 29.8 million in the fourth quarter. So if I would say that the going forward run-rate probably 29 to 30 million dollars is is a good range for what we would anticipate.

Okay, and does the FDIC Insurance expense come back this in the first quarter of 20 or is it come back in the second quarter?

It comes back in the first quarter of Damon. We used all of our remaining small Bank assessment Credit in the fourth quarter. So we'll be back to a normal rate in q1 and 20.

Okay. All right, great. And then just lastly Charlie. I think you mentioned that you know, you're hopeful that some of those non-performing loans are not accrue loans are going to be resolved in the next quarter or so. Are you referring to the ones that just came on Thursday like that remaining seven million or so or are you talking about the Legacy, you know previous the last quarter?

Damon this is Gary what you know the way you think about it is the the entire pool alone in the first quarter second quarter long, we expect to have a pretty good couple of quarters in terms of resolution. Not necessarily the new ones that came on this last quarter because you know, when you're when you're working through problem credit, it normally does take several quarters. So the resolutions will get in the first quarter and then second quarter probably credits that we recognized throughout the course of twenty. Nineteen months. Got it. Okay, that's helpful. That's all that I had. Thanks a lot guys. Appreciate it. Thank you.

again, if you have a

question, you can press * then 1

our next question comes from Brian Martin with Janney Montgomery.

Hey, good morning, Woody. Brian Brian . Hey guys, just one question on the capital just with the buyback and then just kind of you know use of capital at this point. Just kind of the m&a out you talked about. You know, where you are at EC basis is is pretty optimal, but just you know how our conversations on the m&a side or just is that a is that something that has been heating up or is it just not so

Well, I'll take that one Brian . I would say that you know, the environment is such especially with the cost that banks are finding with in regard to technology spending that you know, a number of the smaller institutions are are certainly evaluating, you know, where they want to be two or three or four years from now. So, yeah, I think there's probably a lot more conversation now than there has been over the past year or two at the same time any conversations were having or you know at the very initial stages. So we're not we're not deep in discussion with anyone. But but I do think there's a pipeline of banks that will sell in in 2012 or 21. That's that's my gut feeling.

Okay.

Maybe just one for gym on the margins just just kind of the puts and takes me with you if your outlook Jim is it rates are stable. I mean what could take the margin higher or lower here or kind of the up the band of the lower end as you look out of the next couple of quarters? Yeah. Thanks Brian . I do view the margins in the in the static rate environment. I think we've shown to go up or afraid to come down. If there is movement on the short-term rates. We've been able to manage pretty well what really is painful to us and and I suppose most banks who are configured like we often is this flat yield curve. So as I look at I would say, you know forget about rates up or down just look at the shape of the yield curve is really going to be the biggest determinant of what our margin it's like going forward and I was looking at a graph this morning and and for us I think in probably the most banks like us, you know, some short-term index whether it's overnight funds or or three months.

Sales as compared to the five-year treasuries probably the most relevant part of the Joker and in the last two years, that's just been very flat. You know, you look at over five years. There's been some

To slope historically average seventy five basis points of positive slope. We're right now at zero slow zero overnight to five years. So at that continues, I think we are going to you know, slowly see some pressure if we if we get that continuation of this very flat Joker.

Gotcha. Okay, that's helpful gym. And then last two was just on the I guess whoever gave the commentary on the the expenses just as far as the your comfort off at least for twenty twenty and staying sub-60 on the efficiency, you know, given Charlie you talked about the the investments in technology and kind of balancing that but I guess it sounds as though. Assume that the balancing all that you would still expect to be sub-60 in 2020.

Yes.

Okay, and I think just the last one was just on the income, you know, the current level that were that you're at this quarter. I guess should that be a good bank to use our good Baseline to build off of it as we go into first quarter twenty.

I'll take that one Brian . This is Barry. So excluding the mortgage servicing right adjustment and investment Securities gains fee income with 8.7 million in the fourth quarter and eight point six million in the third quarter off. There are obviously some lumpy items in there like swap revenue and so adjusting for those. I probably put a coil run rate of 8.3 to 8.5 acknowledging that sometimes when I do better sometimes right in that price range.

Okay, that's fair enough and Charlie you talked about the Denver office just reminds me how big that operation is today. And how is it staffed? And you know, if you guys look to add people just remind us on the edge many lenders you have out there currently if you could

We have we have four we have for commercial Bankers plus a hybrid. So maybe a fifth. We have a treasury mayonnaise person who's done a phenomenal job for us and then a couple of other support people. They they they had a downturn in deposits at the end of the year because they had some urine distribution payments, which is not uncommon for private privately held businesses, you know, they hit sixty million in deposits. I think they ended the year round 5 or maybe a little bit less but you know that needle is pointed upward and their loans as I said, they had some pay Downs on lines at the end, but I think they got a $520 billion in loans and then a bit below that at your end, so hopefully that's helpful to you Brian . Yeah. No, that's that's great. I appreciate it. That's all I had guys. Thanks. Thank you, Brian birth.

This concludes our question-and-answer session. I would like to turn the conference back over to Charles funk for any closing remarks want to thank everyone for being on the call this morning, and as always if you just follow up questions, you're free to contact any of us who spoke on the call this morning. Have a great day and a great weekend.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.