Q3 2020 Midwestone Financial Group Inc (IOWA) Earnings Call
Good morning, and welcome to the mid West One financial group Inc. third quarter 2020 earnings call all.
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I would now like to turn the conference over to Charlie Funk CEO. Please go ahead.
Thank you very much.
Thank you to all.
During our call this morning.
We will open with just a brief discussion about the goodwill impairment of 31 and a half million dollars that as we all know that's.
That's a non cash charge and good to have behind us and I will also add the time and expense that we undertake to measure this or are very significant and as stated in the earnings release. Other goodwill impairment has no impact on our regulatory capital cash flows or our liquidity.
Turning to the quarter, we felt like it was a decent quarter and if you look at the Big picture a return on tangible equity of 12.5% efficiency ratio of 55.4%. We think are a solid metrics.
Earnings per share ex goodwill adjustment were 73 cents, which was consistent with the SEC.
Second quarter of 2020.
Very very pleased that our M. P is a nonperforming assets were stable down $3 million in the quarter to 120 basis points, which is a decline of six basis points.
And I might add that we continue to build up our credit loss reserve and I will talk about that a little bit more in a few moments.
Briefly on the balance sheet, obviously, we continue to see the positive inflows as a there is a lot of liquidity in the system right now that's consistent with other companies too.
As I believe.
And our loans.
Were down $60 million during the quarter and we referenced the load a line of credit usage in our.
Our earnings release, and there's no doubt that the PPP is really influence stuff. This decline in line usage around our company.
Our Denver offices, and our southwest, Florida offices have continued to maintain and build.
Our loans and their pipeline, it's been pretty quiet in the twin cities that Iowa, a we've seen pay downs in those markets as we look to the fourth quarter were a little encouraged that we've seen a little bit of a boost in our loan totals during the month of October and we would expect that to continue certainly not robust but we.
We are seeing a little bit of loan growth as the fourth quarter It gets underway.
In terms of the net interest margin clearly the zero interest rate policy really does hurt us hurts, our industry and we see new long rates continuing to fall there is still a good competition.
For high quality credits and I would say that most of the deals that we are getting done are getting done in the low to mid 3% range.
We do have room on our balance sheet to selectively continue to reduce some liability rates I think much of the heavy lifting in terms of decline has already happened, but we've been able to do a few things up since the quarter ended and we do have a little larger CD book than most companies. So.
That was the Cds mature, we will see a moderate declines in our cost to funds by virtue of those maturities it's interesting to know.
Many of the Cds are rolling into non maturity accounts rather than renewing.
In other Cds.
In terms of non interest income pretty good story I think for Midwest one of our mortgage a unit again has been a huge contributor with the loan revenues at $1.3 million during the quarter we.
We did have an MSR adjustment mortgage servicing rights adjustment of $560000 during the quarter.
Or that into a $745000 in the second quarter of 2020 and also encouraging is that our mortgage pipeline is still very robust for the fourth quarter. It may slow down a little bit in December but the visibility we have right now is that the fourth quarter should.
Be a good quarter for mortgage.
Our investment services, which is represents our LP, our LPL brokers continue to head toward a record year. They have just hit it out of the park this year.
In terms of our Trust Department, our trust revenues are coming down just slightly behind our plan, but through good expense control, we should be able to make up our operating plan and in our trust Department one of the headwinds with our Trust Department faces is that due to the pandemic their their ROI.
Not at this stage that are getting out of probate courts. So we've gotten very very little a court appointed fees honest states and we'll get those eventually it may be in 2000.
21, but we've been able to maintain our revenue growth in trust up despite the fact, we're not getting as much in the way of a state fees.
And as I talk about mortgage and I talk about trust I'd have to acknowledge that up the former 80 Bancorp has really contributed significantly in both of those areas and that that part of the merger has really worked very very well for our company.
Finally on non interest income, it's very nice to see our card revenue rebound I'm not sure we anticipated that but we had a nice rebound in the third quarter on card revenue.
In terms of expenses I would say very good expense control efficiency as I said earlier at 55.4% despite the the NIM contraction.
And I would also note that very quietly during that 2020, we have been able to reduce our staff through attrition not through layoffs, but through attrition and we've also renegotiated a number of vendor contracts and while some of those won't take effect until 2021.
We continue to evaluate all areas of our company in terms of ways that we can improve our efficiency.
As I move on to asset quality, I think stable to better is the right description there net charge offs of 20 basis points, which is pretty much consistent with prior quarters MPS as I said before the 120 basis points.
We ended the quarter with the allowance for credit losses of 182 basis points ex PPP loans, and what I would say about our provision. This particular quarter is that as we've listened to other earnings calls and read analyst reports.
I think our outlook is about the same as we've heard from other companies I think we are if we would go back six months than what we expected to be that where we expected to be today compared to where we were six months ago. I think we're pleasantly surprised and most of our portfolio seems to be in pretty good shape, but I also.
I don't think Weve.
Tried to lean toward the conservative side of the ledger as we evaluated what adequate reserves really mean.
So I think we've continued to lean into the wind on on this particular item and as we sit here today. The overwhelming majority of our portfolio is performing pretty well with hospitality, especially hotels being the the one area of concern currently for our company.
Our deferrals, we're down to 3% of our loans, 3.6% ex PPP and we had a we had $41 million or there were still in the first deferral at the end of the third quarter and as of.
Today, another $20 million is out of.
The first deferral period and did not take a second deferral. So we continue to work those numbers down and I would ask you to refer to the attached a deck that we put with our earnings release for more information.
In terms of AG agricultural loans, I think we have a pretty good story this quarter.
Thank AG is probably as good a shape as it's been in for several years. This is shaping up to be a good year in Iowa, especially for us soybean and corn growers.
And I think there are four things that contribute to that crop prices, both soybeans and corn have moved significantly higher government stimulus has been significant into the AG sector. The ratio, which is the high winds that came through some of our AG footprint in Iowa and knocked a lot of.
Crops down there will be a lot of insurance payments made for that crop destruction, which really does help our growers and then finally, the fourth thing would be that China is buying more of our crops and you add all four of those things up and.
It's a pretty good year for corn and soybean farmers in the state of Iowa at least in our footprint.
Dairy, we do have some dairy exposure in southwest, Wisconsin dairy had a good year in 2020 for a we'll have we'll have had a good year in 2020, perhaps the best year. It's had for the last few years I would say the outlook for 2021 is a little more uncertain in terms of dairy.
But overall a pretty good year this year.
In terms of substandard loans in our AG portfolio. They were down marginally during the third quarter, we always get questions about land prices and what I would say about land prices as they tend to be have tended to be relatively stable. During the last three months. So in summary, I think we feel okay.
Right now about our AG portfolio and based on what we see that today in terms of our whole loan portfolio. Our entire loan portfolio. We think we are set up to to be able to handle whatever comes our way, which does include ongoing difficulties in the hospitality sector.
Finally, I would wrap up by talking about our capital position.
I would note that our core earnings our earnings up X goodwill nicely covered our dividend our tangible common equity is stable from the prior quarter at 7.82%, but its a well in excess of 8% if you adjust for PPP loans.
And as many of the.
Longtime followers of Midwest, one know that are for for many years our goal on tangible common equity has been in the 8% to 9% range. So we feel like we're okay. There all of our regulatory capital ratios appear to be very very sufficient at this time and you will also note that we did to reinstate our share.
Third our repurchase program and we do believe or at these levels are that Midwest. One is an excellent value in terms of its common stock.
And so with that I neglected to introduce the persons in the room with me I have we have.
Very rare Chief Financial Officer, Gary Sam's, our Chief Credit Officer, Linda base sure, our President and Jim Cantrell, Our Treasurer and Chief investment Officer in the room, we're happy to take your questions at this time and I will send it back to you I really.
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Our first question today comes from Brendan knows all the hybrid.
Hey, good morning, everybody how are you doing.
Brent I'm wondering front end.
Good Thanks your deed.
Remarks, definitely helped to answer a lot of the questions I had coming in.
Just wanted to start off on the margin here.
Yeah, I mean I appreciate the rate environment is incredibly tough and a lot of the flex you've had on the liability side. It is mostly played out but still sending black.
Just hoping you could kind of help us understand what you expect for the core margin to do from here outside of any PPP related noise.
Brendan This is Jim I'll take that we've had a lot of internal discussion about what it's going to happen on the margin and I guess the way I would choose to answer the question is this.
We have done some forecasting and.
The big unknown right now is as PPP loans in the forgiveness, though we've modeled out a scenario where.
$340 million worth of PPP loans are forgiven in the fourth quarter and then on into the first quarter 2021.
And we'd model.
Corresponding amount of liabilities.
We'll run off the balance sheet more or less simultaneously with some lag some amount of lag.
Pretty close after the PPP loans are forgiven, if only that happens.
If only that happens we would actually see a slight.
Increase in the core margin and I'd say slight probably at the end of the period were looking at five basis point increase in margin and if you think about it we're offloading PPP loans that are yielding as I think Barry told me to 54 in the third quarter. So we're offloading 340 million of relatively low yielding.
So that would mean a reduction in net interest income, but an increase in the margin.
If on the other hand or.
The other scenario I guess at the other extreme.
If the PPP loans are forgiven cash comes on but we don't see a corresponding run off in liabilities and we have to reinvest that that cash and securities at say, 1%.
That will lead to a decline in the margin of roughly five basis points.
Over over the course of the next year. So it's hard to answer that question without.
Surmising, what's going to happen on the balance sheet.
I hope that helps you.
Yeah, No. It's helpful. I know that it's a tough question to answer given all the moving pieces that we have today all right. Good and then one more for me Charlie you mentioned leaning into the wind down on the reserve to date and you build to what have you made a very strong level here 182, X. PPP again, a tough question.
The answer here, but yes.
And what you can see today do you think that that's a level that you're comfortable at or do you want to keep leaning into the win so to speak over the next couple of quarters.
Brendan This is Barry I'll take that question I think.
With respect to how we feel today from what we can see what we can see right now we feel good about our adjusted allowance for credit loss ratio one point, 82%.
All things equal would expect credit loss expense in the future to reflect how we feel about it today.
Okay wonderful thank you for taking the questions.
Thank you Brad.
Our next question comes from Jeff Rulis with da Davidson.
Thank you good morning, good morning.
Yes My question couple.
A couple of questions on the income statement first on expenses I guess, if I get to a core kind of in the mid 28 million level.
Trying to get a sense for how you manage expenses in that I.
Charlie you mentioned some some contract.
Re negotiations with vendors.
And you know it's a pretty.
Revenue challenged environment, but but also are there any investments in play any just flesh out the expense initiatives relative to investments would be helpful.
Jeff This is Barry I will take that I think that overall, if we look at the if we look at the ongoing run rate of expenses I think that the run rate of 29 to 30 million that we discussed on this call are recently is is a good run rate, we do expect a slight uptake.
In the fourth quarter as we start to hone in on some of our year end accruals, but I do think that $29 million to $30 million number is a is a good number as we think about as we think about managing expenses. We do continue to look for opportunities as Charlie alluded to through attrition, we save money, we continue to look at other opportunities.
In branch rationalization.
Then your contracts and so.
Given that I think that there is still some opportunity for us on the expense side.
Got it so I read at net if you talk about a 29 to 30 run rate.
Over the course of 21 sounds like maybe some investments offset by some savings and a relatively.
Moderate growth expectation.
I think thats, a good way to think about it Jeff.
Okay. Thank you and.
Then jump into the fee income side.
Sounds like Q4, starting pretty robust or continuing to stay.
Solid on the mortgage REIT.
You know a little further out if that whether we follow and be a forecaster or not.
It works at Wayne.
It's a nice crawl back in that service charge, you know I guess trust is kinda perking, along but but the card business.
I guess, if you think about that line item.
In those other areas and a step in to supplant it if we see a rollover in mortgage.
Any any further kind of.
Longer term thoughts on on the fee income outlook.
Yeah, I'll start with that Jeff that's a good question and one of the things that I really have neglected to mention in the opening comments on the trust side is up we have for the first time hired a wealth management person is a trust officer in our twin cities up market.
And we are very interested in adding to that that will be a near term drag on expenses, but these this is a very very seasoned person and we believe.
I believe over the next couple of years, we're going to see nice growth out of the twin cities market, which we think is a fertile market for trust services and wealth management services, So mortgage will probably.
Remained strong into the first quarter and up I think our investment services and trust units are probably are poised to continue to show you know not not home runs, but but lots of singles and doubles in terms of increases in revenue and.
Service charges and card revenues I think your your guess is probably as good as mine but.
As I said, we were pleasantly surprised with what we saw in card revenues in the quarter in our service charges also but especially the card revenues.
Thanks for the thoughts I'll step back.
Our next question comes from Terry Mcevoy with Stephens.
Hi, good morning, everyone.
Good morning.
Maybe lets just start with the commentary about October loan volume picking up a bit was wondering if you could just expand on that were.
Kind of are you seeing some some early signs of growth within the portfolio.
Well Denver continues to be a strong Florida is very very steady and I think there's a there's a little bit in the pipeline from Iowa City, and there was a little bit in the pipeline from the twin cities. So.
So it's a little bit of a probably those four markets.
And then as a follow up I was wondering if you could discuss the enhanced risk rating review in the third quarter, where you looked at 23% of the loan portfolio I'm, just curious upgrades downgrades and maybe some some commentary specific to hotels as you looked at that portfolio last quarter again.
Sure. Jerry this is Gary the in and what we did in the third quarter was really a.
Mirror image of what we have done in the in the second quarter the differentiation with the third the credits that we have downgraded into a non pass categories. In the second quarter were then part of the loan strategy process and so it was a smaller subset of credits that we were focused on in the.
Third quarter and.
As as pass rated credits most other airport, our hospitality portfolio had already migrated to a watch status or worse.
So as a result, we really didnt see that material a migration continued migration into watch or worse, where the third quarter and I see carry I did not expect to but you know I think it's prudent to continue for the third quarter that enhance risk.
Creating.
Analysis does that help Terry.
That does vary very much I appreciate that and thanks, everyone.
Hi, how are you.
[laughter].
Our next question comes from Damon Delmonte with KBW.
Hey, everybody hope everybody doing well today.
Hi, David This morning, David.
Good morning, Good afternoon, My my time morning, everybody good afternoon.
So just a quick question on the hotel portfolio you know in this slide it shows that the average loan size like a million point for you know what is what are some of your larger exposures in there and can you give a little <unk> you know.
Perspective, or our color on those and kind of how you're feeling about does that at this point in the cycle.
Oh, Hi, Damon this is Gary I'll I'll I'll take a stab at that one and see.
See if I can give you a little bit more color on that portfolio. It ended the quarter at about 120, well over 120 million a as I said earlier with Terry most of that portfolio is now non pass rate until it's either watch or substandard and a key differentiation between.
Whether it's in watch or substandard and those credits that have asked for a second round a deferral or are they pretty much migrated to the substandard category at this point in time very little into the in the non performing category.
That would really be driven by additional need for accommodation et cetera, but.
But generally I mean, we have several larger credits the largest credit in that portfolio is 60 million. It's a it's a twin cities based major flight hotel.
And from there it goes down to smaller and smaller credits. We have Q2 credits in the portfolio that are over 10 million. So it gets pretty granular pretty fast Damon I guess is the best way to say it and honestly, we've been talking pretty actively on an ongoing basis with our operators and.
The performance a lot of the performance is based upon where the location is our our hotels tend to be Interstate based you know a flat flagged hotel. So generally we're doing pretty well. We don't have you know Convention center hotel things of that nature.
We do expect.
That that portfolio, there will be a small subset that we'll continue to struggle as we go into the fourth quarter and beyond.
Does that help Dan I think that yet that's very good color. Thank you.
And then I guess, maybe more broadly speaking Charlie can you give a little bit more color and perspective on kind of the dynamics in the market right now with the rising cases throughout Iowa.
You know at least from the East coast. It sounds like there's a pretty high positivity rate going through the state in a classic the greater Midwest and do you know how that impacts the daily life and in business activity and things like that because I have a feeling that the approach out in the Midwest is a lot different than what we're seeing here on the east coast.
Thanks.
Yeah, I have a very good friend who's a banker in Connecticut, and it's been much different.
Hi, Wood, and Wisconsin for sure and someone Minnesota than in Connecticut.
And so you're right about that.
Yeah, I think there's there's no question, our hospitalizations set a new record yesterday in Iowa, and I think the same is true in Wisconsin, I don't think Minnesota has set records up.
At this point.
But.
We yeah, we have we probably had more employees who have suffered from this weve been able to keep our offices open generally.
Generally speaking, though the the economy and I was pretty good and I think the last unemployment numbers were right around 6% in our state and I think I.
I think our governor has done a good job of keeping the economy open and probably a little bit at the expense of a rise in cases.
The deaths still remain a fairly low in our skin in our home state of Iowa, So yes.
Thank you see less people and in restaurants, and you see you see more restrictions on bars and that sort of thing, but but by and large I think people are going about their daily businesses and with up I do think more people are wearing masks and and whatnot, but there is no doubt that it's a critical time right now is cases.
Continue to rise.
Got it okay. That's some good color. Thank you.
My questions have been asked and answered so thank you very much thanking David.
Do you have any further questions. Please press star one to join our Q.
Our next question comes from Brian Martin with Janney Montgomery.
Hey, good morning.
Good morning, Brian Brian Hey, just they are just one question Charlie your point on the <unk> on the buyback just curious what your thoughts are there given given where the valuation levels are and your comments about feeling pretty good about capital today.
We we think our stock represents a very very good value and I think.
I think one of the things that are.
Really caused us to be.
Be a little bit more optimistic about the lifting the oh the up the.
The curtailment of the share repurchase program is the fact that we feel so much better about credit than we did whenever we instituted that and as I left that was sort of part of my opening.
Opening commentary, but Oh, we.
We think weve been a very.
Very conservative in our approach to our reserve and up given the fact, our valuation is where it is we think it's good value and and.
The management team and the board felt like this was a good move for Midwest one to make at this particular point to lift the curtailment of the share repurchase.
The suspension of the share repurchase.
Okay and would you expect to get relatively active here I guess is that is that kind of the plan and what kind of what we're hearing.
Well, it's a day by day decision right, Brian, but the best thing I can tell you is that we find it very attractive at current levels Yep got you. Okay. Just yeah. Just one one follow up here just on the on the PPP process I don't know if.
Jim or somebody else, but just the the remaining just how you think that may play out as far as it forgiveness Coas and then just if you could remind us the remaining under.
Unearned.
Loan fees that you still have yet to to bring into the piano.
Brian This is Barry the remaining unearned fees from the ESB loans at September Thirtyth was $8.1 million.
With respect to how we anticipate that flowing into the balance sheet.
There's some uncertainty involved what we've been contemplating internally is 50 per cent payoff in the.
First are the latter half of this year and then with the remaining 50% in 2000 and.
21.
Okay. So a good chunk of it coming here in Fourq you.
Yes, but it's really just a guess.
We don't know how fast we don't know how fast the SP will respond to so it's really just an estimate.
Okay.
I mean this is Gary just one piece of color on that we have started the forgiveness process with our customer.
Customer base that started a couple of three weeks ago. We have started submitting a trend you know transactions for forgiveness approval with the FDA Espańa has 90 days.
Good to do their approval. However, you know our peer group that we interact with.
The experiences that its not taking 90 days very often so that's really what kind of colors are you know we were at the end of October we feel like there's a there's a decent chance that some of that will be forgiven by the end of the quarter.
Gotcha, Okay, and then just the last one to two the criticized and classified levels. It sounds, though so those were pretty stable from and you look from Twoq to Threeq. You is that seem fair was it was there. So I think you said it was maybe I misunderstood what you said on that.
Yes, the I, what I would say is we did have some continued migration into Chris criticized and classified most of what you saw migrating into classified had already been identified and the criticized category so not as much my.
Gration into criticized as you did see in the classified it's really kind of a continuation of what we thought would be happening relative to that hospitality portfolio Brian.
Okay.
Got you Okay. That's all I had guys I appreciate it thank you.
Thank you Brian.
This concludes our question and answer session and I'd like to turn the call back over to Charlie funk for any closing remarks.
Well, thank you again for being on the call and as always if anyone has further.
Color they need on any of what's been discussed today feel free to.
To call any of us and I will be happy to respond and I'll turn it back to you Eileen. Thank you good day, a good weekend.
The conference is now concluded. Thank you for attending today's presentation you may now disconnect.