MidWestOne Financial Group, Inc.
Q3 2019 Earnings Call Transcript

Published: 27 Oct 2019

[Operator:]

Good day, and welcome to the MidWestOne Financial Group, Inc. Third Quarter two019 Earnings Conference Call. [Operator Instructions]. Please note, this event is being recorded.I would now like to turn the conference over to Charlie Funk, CEO. Please go ahead.

[Charles Funk:]

Thank you very much, Alley. Good morning or good afternoon, as the case may be, to everyone. Thank you for joining us this morning, and I'll begin, as always, with the forward-looking statements message that says

[Operator:]

[Operator Instructions]. Our first question comes from Nathan Race with Piper Jaffray.

[Nathan Race:]

Maybe just start on expenses. Charlie, your comments around some investments that you're making on the technology side of things. That's pretty well managed this quarter. And it looks like you have the FDIC assessment credit as well. So just curious how we should kind of think about expenses into 4Q. And perhaps maybe just early expectations for expense growth in 2020 as well would be helpful.

[Charles Funk:]

Well, I can talk generally. Barry may wish to talk specifically. We're still in the budgeting process for next year. I think we may have disclosed in a prior earnings call that in 2019, we budgeted roughly at 25% to 28% increase in our technology budget. I'm not sure we're going to use all that this year but that is what was budgeted. So I mean, technology is a small part of our overall budget, but also it's something that we need to invest. And so I think that line item is going to have an above average rate of increase going forward. I don't know if you want to add to that, Barry.

[Barry Ray:]

Currently don't have anything necessarily to add to that, Charlie, more specifically because as you indicated, we're still in the budget process.

[Nathan Race:]

Understood. And maybe just for 4Q, in particular, is it fair to kind of expect flattish expenses of around 29-or-so? Or do you expect it to be trending a little higher into the fourth quarter this year, Barry?

[Barry Ray:]

Yes. I don't know if I'd turn it a little bit -- a little higher in the fourth quarter. Probably the thing for expenses this quarter was the FDIC insurance credit. So I think we're going to -- that's going to more normalize in the fourth quarter, Nate. So I would increase it back to a more normal level for the FDIC insurance, and then have it fairly flat from there.

[Nathan Race:]

Okay. That's helpful. And then just on the core NIM going forward. Obviously, with the Fed trading rates, it doesn't sound like it's as much of an issue for Charlie's comments versus what happens with the curve, so to speak. So I'm just curious maybe how we should think about the margin in the fourth quarter. And within that context, how much of an opportunity further exists to bring down deposit cost after a pretty good progress here in 3Q.

[James Cantrell:]

Yes. Nate, this is Jim. I thought about this going forward. I think we're guiding to a relatively flat margin going forward, whether or not we get a Fed cut next week or in December, the last few Fed cuts we've been pretty good without moving deposit rates down, as Charlie mentioned. And I think there's a little bit of powder left to do that some more, if we need to. So as Charlie said, I think the real determinant on margin, and it's is a slow-moving item, is the shape of the yield curve. That's probably a bigger factor. So if we get some rate cuts, and as a result of the curve steeping down a little bit, that could be a good thing for us. But I would project basically flat going forward.

[Nathan Race:]

Okay. That's great to hear. And if I could just ask one more kind of housekeeping question on the purchase account accretion outlook. Also is -- you elevated this quarter. How should we think about accretion levels for 4Q?

[Charles Funk:]

Yes. This quarter was skewed by a couple of things, Nate. Prepayments factor into that, and I think we indicated that was $2.3 million of -- I'm thinking about it in terms of in the near-term, at least, probably $1 million to $1.3 million would be the monthly run rate. So let's call it $3 million to $3.5 million -- oh, I'm sorry, $3 million and $3.5 million per quarter, and then declining from there in 2020.

[Operator:]

Our next question comes from Jeff Rulis with D.A. Davidson.

[Jeffrey Rulis:]

Charlie, you kind of walked through the loan growth outlook and the credit visibility on pay downs is, I expect, that's a challenging item to peg. I guess, if we look at '20 growth kind of on a net basis, and based on what you're seeing, with customers and look, that's coming from economy, it's coming from some credit pruning, it's coming from competition as you wind up the pay downs. But think about a net growth number in '20, all things being equal, would you think that the pay downs subside?

[Charles Funk:]

Yes, it's a good question. And before I answer it, I neglected to introduce who's in the room, and I should do that. You've already heard from Jim Cantrell, our Treasurer; Barry Ray, our Chief Financial Officer; and we also have Gary Sims, our Chief Credit Officer here.The fourth quarter is pretty -- was unclear because we have a couple of larger deals that we're looking at that by no means are in the barn, so to speak. That can change our outlook. We know we're going to get some pay downs yet in the fourth quarter. I think for next year, we start every year with a goal of, I think, 4% to 5% in terms of loan growth, and that's an expectation. I think one of the things that is in our favor is that we do have some activity we know we'll fund in the first quarter of 2020 to get us off to a pretty good start. But so much depends on the economy that it's just really hard to say. But so I would say fourth quarter is unclear, and we looked at, as we always do, 4% to 5%, when we set our goals next year.

[Jeffrey Rulis:]

Got it. Okay. And I wanted to clarify the expense discussion. Barry, I think ex merger cost, you're at 29, and then you just suggested that add back and normalized FDIC expense in a mid-29 range is in the ballpark?

[Barry Ray:]

For the fourth quarter, yes.

[Jeffrey Rulis:]

Great. Okay. And did you -- I can't remember if you talked about if you got your expenses, cost saves behind you or on track for that. I guess, have you talked about an expense growth rate for 2020?

[Barry Ray:]

Well, we've not talked about an expense growth rate for 2020. As we alluded to earlier, we're still in the midst of our budget process and hashing out some of those 2020 expenses. And so we've not discussed that, Jeff.

[Jeffrey Rulis:]

Okay. And just lastly, I guess, Charlie, the investment services in Trust, you did allude to some momentum there. That's been pretty strong growth, I know, as you get your arms around the acquisition and your folks. But maybe if you could speak to continued success there. Is that -- are we seeing a leg up and now, maybe it moderates once everybody's on the same team? An outlook would be great there.

[Charles Funk:]

Yes. It's a good point. The positive thing, as I've said in my opening comments, is that there's been very little customer attrition. And I would call it important customer attrition from the Trust transition, which is by far the bigger of the 2 areas. A lot, as you know, in Trust and investment services depends on what the markets do, because, obviously, when market values go up, it makes it easier. But they've been able to routinely, over the past few years, do 5% to 10%, in terms of, what I would call, bottom line growth, because even though in our financial statements that we provided to you, we don't break them out separately. But internally, they've been able to show net income growth of 5% to 10%, and I would expect that to continue. We have good leadership there. We have good people. And I think we have good products to sell. And we brought good products to American Trust, the former American Trust in Dubuque. So we're very optimistic about that.

[Operator:]

Our next question comes from Andrew Liesch with Sandler O'Neill.

[Andrew Liesch:]

Nice to see the deposit growth at the legacy MidWestOne franchises. Is there anything specific driving that?

[Charles Funk:]

As I said, I think everyone -- all operations in our company are positive. We've had a few retail promotions over the course of the year and have attracted retail money market accounts, and most of that is stock as we've adjusted pricing. Denver has been terrific. We're up in the $55 million to $60 million range in Denver, which has so far exceeded our earlier projections. Florida is up 8% to 10%, which is really nice, even though they have maybe $100 million. They still have 8% to 10%. And Iowa continues to do well. And the Twin Cities, overall, the Twin Cities has been a very, very good story for us in deposit. So it's really not any one thing, it's the whole company. And we're very pleased with the performance.

[Andrew Liesch:]

Great. And then just on the legacy ATBancorp franchise now. Do you expect any more runoff on some of those higher cost funds? Or has that's pretty much all played out?

[Charles Funk:]

There could be little more. There could be a little more. They -- as many of you know, they operated with a net interest margin that was less than 3%. And there was a lot of high-cost money in the bank, and we've lost a couple bids. And to be honest, the bids were above the LIBOR, above the Fed funds rate. And we were able to replace that money elsewhere in our footprint cheaper. So there might be a little bit more, but I think the bulk of that has passed. The other thing I think that's positive about Dubuque, in particular, is that the commercial bankers there are uniformly complementary of our treasury management process. And I think we brought a lot of products and expertise in treasury management that they did not have before. So I would think over the next year, that probably bodes pretty well for the eventual deposit growth there.

[Andrew Liesch:]

Certainly. And then just on the CD rates. The cost of the CD is up about 3 basis points compared to last quarter. Now maybe some of that was from the fourth quarter of ATB. But what -- where are repricing rates coming on now versus the maturities? And any sort of repricing schedule that you guys can provide would be helpful.

[James Cantrell:]

Yes. Andrew, this is Jim. I'll take that one. I would say, I would characterize this we've reached pretty much an inflection point, as we look at the CD book. Yields coming on. We've been able to lower our CD pricing a little bit over the last quarters, and we're tracking pretty close to FHLB rates when we look at our pricing. And so we've now crossed over where current CDs coming on the book is probably just little below 2%. Whereas in the second quarter, they were -- CDs coming on were above 2%. So it's a slow -- it's kind of a slow boat to turn. The average life is a little over a year on that CD book, and it's material. And that's one of the areas where if we got further Fed easing and the short-term rates come down relative to longer rates, that CD book repricing will be one area where we would see a little bit of a lift in net interest margin. But that's yet to come. So that's one of the areas where a flat yield curve isn't helping us particularly.

[Operator:]

Our next question comes from Damon DelMonte with KBW.

[Damon DelMonte:]

First question. I was just wondering, Barry, could you just revisit the comments you made on the accretable yields? And what the expectations are kind of on a quarterly basis?

[Barry Ray:]

Yes. Sure, Damon. As I said, the comments were the $7.2 million accretion this quarter was impacted by about $2.3 million of that was prepayment and renewal. And so it's -- obviously, that's going to impact that quarter in an unexpected manner each quarter. But I think it's probably around $1 million to $1.3 million per month. And so I would say around $3 million to $3.5 million per quarter would be in the near term, and then it's going to drop off thereafter in 2024.

[Damon DelMonte:]

Okay. Okay. Great. That's helpful. And then have you guys completed the review on the acquired loans for the reserving methodology?

[Barry Ray:]

Yes. Damon, this is Barry. I know you've recorded a provision for the acquired loans as we transition into our standard allowance methodology this quarter. And my past experience would indicate that, that process resulted in kind of this onetime provision in credit quality remaining equal. There's not a similar impact in the upcoming quarters. Now one difference in 2020, we're going to be estimating allowance under a different methodology. But I would say that we had, to your question, we've completed our transition for our standard allowance methodology for the American Trust and American banking trust loans.

[Operator:]

Our next question comes from Brian Martin with Janney Montgomery.

[Brian Martin:]

So just a couple for me. Just maybe for Barry on the fee side. When you look at this quarter and kind of adjust for that MSR, is this a pretty clean quarter reflective of AT and it's a normalized level?

[Barry Ray:]

Yes. I would say that's true, Brian. What I did was I looked at Q3 to Q1, just to kind of get an idea of what the increase in fees, and the Q2 only had 2 months of American Trust. And if I back out the mortgage servicing right, and the only other thing I adjusted for was I also, from the first quarter, backed on insurance commissions because we don't have that going forward. I come up with about a $3.5 million increase quarter-over-quarter. And I think that's probably a pretty reasonable expectation.

[Brian Martin:]

Okay. All right. I just want to make sure of that. And just maybe one for Charlie or whomever. Just with your comments, Charlie, about growth slowing a little bit, I mean, does M&A become more important? Or is it -- can you just comment on how you're viewing M&A today with kind of AT, I guess, in the rearview mirror, if you will, a little bit?

[Charles Funk:]

Yes. It's a good question. I would say AT is probably not in the rearview mirror for some in our company because it took a lot of effort by a lot of our support people. And so right now, I think we're digesting that. We're digesting it internally. We certainly are aware, and will be aware, of any opportunities that come forward. I think right now, though, I wouldn't rule out anything that is relatively small. But I think what we need to do is adjust what we have, and make sure that the machine that we're currently operating becomes more efficient, continues to grow. And then we'll see where it takes us. But certainly not in the next 3 months, we'll be looking at anything of any size.

[Brian Martin:]

Okay. And then just on the buy back. I know you commented about that. Just is your expectation to use the full authorization on the buyback? I know you said you're -- I guess, or is it more price-sensitive and we shouldn't expect a lot more of that?

[Charles Funk:]

I will say it's price sensitive. And when we think it represents excellent value, we step in. But probably the best words, and you used them, are price sensitive.

[Brian Martin:]

Yes, okay. All right. And then maybe just one for Jim on the margin. I appreciate the color. I guess, if you get to a scenario, Jim, where you get 3 more rate decreases here in the next 3 meetings, would you be surprised if the margin wasn't flat? I mean, it sounds as though you're, I guess, assuming -- I guess it builds the caveat that we don't get a flattening, as you mentioned, would be hurtful. But if you don't -- if you get a little bit maybe more steepening or just staying with that and you have 3 cuts, your thought would be you can hold the margin on a core basis where it's at today?

[James Cantrell:]

Brian, I do think, just to answer very directly, I think we can probably hold the margin as we get through cuts. And part of the reason I say that is when we look at -- I kind of took an inventory of our prime and our LIBOR-based assets, and that's about $820 million. Not worse on the asset side. So those are repriced down relatively quickly. I will say, of that $820 million, roughly $220 million is either at or sitting on a quarter. So really, it's only $600 million moving down going forward. If I look at the liability side of the balance sheet, we've got about $250 million of liabilities that are contractually tied to short-term rates like CAGR and LIBOR. So that's $250 million there. And we've got another, roughly, I'll say, $650 million that are in deposits and liabilities that I would call high beta, meaning, we have some discretion. They're priced probably a little higher than the market. If the rates move down, we wouldn't move it down basis point per basis point. But that's -- it's $650 million of them -- $650 million that we could move down in pretty good fashion if we were to go down 75. So that balances out the repricing on the asset side relatively well, in my opinion. So I hope that answers your question.

[Brian Martin:]

Yes. That's helpful. And just maybe the tax rate. Any -- it looked like it was a little bit lower this quarter. Anything, I guess, we should be thinking about kind of a go-forward rate on that?

[Barry Ray:]

This is Barry, Brian. Yes, I think we'd probably use -- or use, like, around 21% would be the tax rate that I would utilize.

[Operator:]

[Operator Instructions]. This concludes our question-and-answer session. I would like to turn the conference back over to Charlie Funk for any closing marks.

[Charles Funk:]

Well, I would just say thank you for joining us this morning. If we need to provide further clarification on anything, we'll be happy to do it as time allows. So we wish everyone a good rest of your day and a great weekend. And back to you, Alley.

[Operator:]

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