MidWestOne Financial Group, Inc. (NASDAQ:MOFG) Q1 2020 Earnings Conference Call May 1, 2020 12:00 PM ET
Company Participants
Charles Funk - President and Chief Executive Officer
Barry Ray - Chief Financial Officer
Gary Sims - Chief Credit Officer
Conference Call Participants
Jeff Rulis - D.A. Davidson
Andrew Liesch - Piper Sandler
Damon DelMonte - KBW
Brian Martin - Janney Montgomery
Operator
Good morning and welcome to the MidWestOne Financial Group, Incorporated First Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]
This presentation contains forward-looking statements relating to the financial condition, results of operations and business of MidWestOne Financial Group, Incorporated. 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, Incorporated undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances after the date of this presentation.
After today's presentation there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.
I would now like to turn the conference over to President and CEO, Charles Funk. Please go ahead.
Charles Funk
Thank you very much, Ian and welcome to everyone and thank you for joining us on the call this morning. I'm joined in Iowa City by Barry Ray, our Chief Financial Officer; Jim Cantrell, our Treasurer and Chief Investment Officer and Gary Sims, who's our Chief Credit Officer.
And I would begin by acknowledging what we all know that we do live in unprecedented times. And I for years at MidWestOne, and I'm sure at other institutions we've developed and tweaked various disaster recovery plans, wondering if they would ever be put into practice. We're very pleased at MidWestOne with the response we've had from our team. The entire team has worked long and hard and with little complaints and I would add with significant success.
We've had three primary constituencies at the forefront of our planning during this time, our employees, our customers and our communities, and as I know many other banks around the country have done, they've done we've all done many things to help these constituencies. So taking in order and going through these briefly, our employees, we've limited our lobbies to appointment only and there has been very low traffic in lobbies throughout our footprint. Our drive ups have remained open and busy.
Our total transactions are down about 10% since the pandemic started. Social distancing continues to be observed. Right now we have one third of our workforce working from home. We are capable in more dire circumstances of up to 70% of our workforce working remotely. We've increased cleaning services throughout our footprint. Business travel restrictions have been placed and basically that means no travel. We've rigorously adhered to the CDC guidelines. We've made special accommodations to those with pre-existing conditions. And we've had pandemic pay benefits for those directly affected by COVID-19.
For our customers, we've promoted digital banking capabilities. And I'm happy to report that our online banking sessions are up about 26% since we closed our lobbies. Online account opening was up 34% in March, it's even higher than that in April although I don't have final numbers at this time. Our call centre was staffed up. We responded to increased volume of calls from our customers due to the government payments both PPP and EIP payments and we've had minimal wait times. We did send a deck out with this quarter's earnings release and you can refer to that, but I would just report a few things.
Payment deferrals have been approved for 755 customers, which represents $346 million in loans outstanding or roughly 10.1% of the March 31 portfolio. Six month payment forgiveness, there's not been a lot of that, so far 120 loans representing $600,000. We do get a fair amount of questions on one-to-four family real estate loans. As of our most recent reporting date, we've had 34 requesting deferrals representing $7.3 million. Those were all in house loans and a relatively low number.
As per the PPP program, very pleased with our company's success, we were on this early and as you have seen with other banks around the country, we delivered for our customers. Most Recent totals we have – that we have completed loans for 20 – we have completed 2,190 loans representing $332 million in loans outstanding, or an average of roughly $151,600 alone. And many associates working 12 to 18 hour days to serve our customers and communities, we've had very few delays in getting our loans approved and funded. And right now I would say we're caught up and working the applications as they come to us.
And we also would want to talk about our communities. In our communities, pain is real, in communities large and small throughout our footprint. We did make an unbudgeted pledge of $150,000 in additional giving to organizations throughout the footprint, and the specific giving decisions were left up to the local leaders in our markets. We've also encouraged shop local our media outreach and we've supported local restaurants throughout our footprint by purchasing recognition lunches for employees who are still coming to work each day.
And with that, let's move on to the quarter as well as what lies ahead of us. The loan loss provision or our credit loss expense of $21.7 million was the dominant line item in this quarter's income statement. We did an autopsy so after much discussion, we opted to move forward and we thought that was the right thing to do for our company. And frankly, we believe we took an aggressive approach to this line item, as we believe the future is very unclear at this time.
At quarter end, we showed a loan loss reserve to total loans of 1.49%. If you add in the purchase discounts that we have, that number goes up to 2.11%, so when you add in the purchase discount, we believe that a 2% plus allowance allows us to provide the loss content in our portfolio and of course, we hope that we're wrong and it doesn't come to that.
Looking back as of 3/31, our total non-performing assets were virtually unchanged from year-end at $49.6 million. Net charge offs of 14 basis points, very acceptable. And as was noted in the release, it's my opinion that we did make progress in our collection efforts, but the progress now has been stalled as our court system is in recess, all things considered, I would characterize the asset quality as of 3/31 showing modest progress.
So now we'll talk about the current environment, what's happened since the end of the quarter? We also included in the deck a listing of vulnerable industries and really when we think of vulnerable industry related to COVID-19, one could concoct a scenario where just about any vulnerable – any borrower is vulnerable. With that said in our deck, we identified six industries that comprise 20% of the portfolio as vulnerable.
We continue to reach out to many customers during this time and it will be very important that we continue to do so in the weeks and months ahead because we know that consistent communication is very important during this time. It will be a few months before we know which borrowers are most affected and showing undue stress, but we'll continue to ask our customers and talk to our customers and work with our customers.
I do want to give the quarterly ag update as we've done for the past couple of years. And with ag I think we should talk about what happened up to 3/31 and then what's happened afterwards. Through the renewal season, we did renew some operating lines. These customers either found financing elsewhere or chose not to plant a crop this year. As of 3/31, the ag portfolio represented 9.2% of our total loan portfolio or $314.3 million.
In the ag portfolio as of 3/31, 9.6% was substandard – rated substandard, that is down slightly from year-end. Our watch credits also declined slightly from year-end we're 9% of the portfolio. So if you add watch and substandard, that's 18.6% of our ag portfolio was rated either watch or substandard. I do think it's wise to step back and have some perspective on this. Two years ago as of 3/31, 2018, this number was 23.6% and it was 19.8% at year-end 2019. Again at 3/31, 2020 18.6% of the ag portfolio rated watch or substandard. Progress is being made in the portfolio, but now we have to look forward.
And since the pandemic, prices have got – what we thought were already poor prices have gotten worse. In the MidWestOne footprint, what we most follow are soybeans, corn and dairy, pork to a lesser degree, but in all four of these instances, we've seen erosion in prices. Land prices are down from their highs of about – in 2013 of roughly 13% to 15%. The most recent reading that we got on land prices for the last six months was down 2%, so not a huge fall off of the cliff, but certainly continued modest erosion in land prices.
So in summary on our ag portfolio, we think it has stabilized as of 3/31. We're very confident in our portfolio monitoring and management, but prices do need to improve because our borrowers will continue to face increasing headwinds if they don't. Gary Sims will be available to answer more specific questions on asset quality, portfolio composition and other credit items in the Q&A.
Turning to the balance sheet, the highlight for the quarter was that we had very good deposit growth, which adds to already excellent liquidity in our company. Also, there was a three or four day period of market illiquidity in late March and we use that period to make some very good fixed income purchases, all investment grade securities at what we thought were widespread. And as I said, this only lasted a few days and we were able to take advantage of that. We think that bodes well for the margin going forward.
We also saw a roughly $25 million reduction in our loan portfolio. If you look at it, you could say that's entirely accounted for in the one-to-four family reduction of 28 million, much of that was due to refinancing activity under the secondary market. We had a $16 million decline in CMD, construction and development loans and a $10 billion reduction in multifamily CRE, which is primarily pay offs. C&I loans were up more than $29 million, ag was up slightly and will continue to go up as operating lines are utilized during the planning season.
We also continue to read many headlines about credit line usage, life credit usage nationally. We did not see that trend at MidWestOne and to give you a little bit of color on that. At 12/31, 2019, our line usage was about 46% that has declined to 43% on March 31. So we did not follow the national trend there.
Turning to the margin, the net interest margin, my comments on the margin will focus on our core margin which declined from 342 to 331. My personal opinion is that our past management of the core margin has been pretty good in our company. I don't think it was quite that good in quarter one for several reasons, which I will highlight. The 150 basis point decline in short-term rates in March was too fast for our ability to re-price, our liability rates. That should catch up somewhat in April.
We also had an unfavorable mix change. As previously noted, the nice increase in deposits combined with a slight decline in loans was not helpful to the margin. And more specifically on the liability side, we believe we have roughly $600 million in liabilities that re-priced lower in early April. And we also notice shift that continues to occur from CDs back to non-maturity deposit. This is somewhat reminiscent of what we saw the 2008 to 2015 period. That should modestly help the margin as well. So we do expect improvement in the quarter two core margin, but would also acknowledge there will be much noise around the margin as the PPP program comes and goes.
Non-interest income was generally a good quarter in our company. Excellent progress, I would say in almost every segment. Trust and investment services was up 4% from the fourth quarter. They also had a good April, only slightly behind budget. But this unit does face headwinds due to market conditions. Nevertheless, good progress in trust and investment services.
We had good mortgage activity roughly the same amount of loans closed in the first quarter of 2020 as the fourth quarter of 2019 at $1.261 million. The headwind of course was the MSR adjustment of $447,000. Commercial loan swap activity, by far the best number in our company's history that's reflected in other non-interest income. And so you add all those up and overall our non-interest income was up roughly 10% from the fourth quarter.
Non-interest expense will be important going forward. Very pleased to report that despite the drop in the net interest margin, our efficiency ratio held in at 57.7%. We will continue to keep an eye on this as we've been very focused on this for the last 12 to 15 months. Notably on non-interest expense, we do not have any plans to reduce technology spending because we think that's our future. And we will continue to give generously in our charitable contributions to our communities, which are in need.
Turning to capital and liquidity, we did include a slide on the liquidity position. We believe we have a strong liquidity position. We have significant liquidity in the investment portfolio. We've listed many our sources of liquidity in the deck. But if you add all of those up, you come to a billion dollars pretty quickly. So we think from a liquidity point of view, our resources are ample.
In terms of capital, overall capital, tangible common equity at 8.11%, that's within the 8% to 9% range that we've talked about for many years as being a target. We also included our regulatory ratios this quarter, we estimate CET1 end of the quarter at 9.25%, Tier 1 capital at 10.25% and Tier 1 leverage at 9.39%, all above regulatory minimums, and I'd say well above regulatory minimums.
We did temporarily discontinue our share repurchase in mid March. We do not plan to reopen this in the near future. But we will continue to monitor. We expect to maintain our current dividend which was unchanged from the prior quarter. So in looking ahead, it will take several months to know exactly where our primary focus should be. For now, we will continue to increase our loan portfolio monitoring as well as continue to provide support and encouragement and resources to our employees, customers and communities.
And with that, Ian I will turn it back to you and we will be happy to entertain any questions you might have.
Question-and-Answer Session
Operator
Absolutely, we will now begin the question-and-answer session. [Operator Instructions] And our first question today comes from Jeff Rulis of D.A. Davidson. Jeff, please proceed.
Jeff Rulis
Thanks. Good morning. Well, I
Charles Funk
Good morning, Jeff.
Jeff Rulis
Wanted to ask about the – the fee income was pretty strong. Charlie you touched on the swap side as sort of a record high. I'm trying to think about looking forward, maybe you can't count on record levels every quarter. I just want to kind of see how that line item has progressed into the second quarter. And I guess if you – that's the kind of the accounting adjustment there. And you could be back all things being equal up in the 10.5 million, but wanted to check in with you on how maybe mortgage and swap can carry into the second quarter.
Charles Funk
I'll take – yeah, thank you, Jeff for the question. I'll take mortgage first, mortgage in terms of fees should have a better second quarter. They've had robust activity and have kept up with the demand, which we're very pleased about. So I think the second quarter should be really strong for mortgage, but we don't know as the mortgage servicing rights adjustment and we'll just have to see where that falls out. In terms of swap income, I would expect that to be down for a number of reasons. The markets changed a little bit, as you know the credit spreads have changed. And so I think we will still have some swap revenue, but I doubt that it approaches what we saw in the first quarter.
Jeff Rulis
Would those two offset or is that mortgage going to be – in terms of – is that a trade off? I guess it's anyone's guess though.
Charles Funk
Yeah, it's anyone's guess. We're just – month end of the quarter, mortgage will be higher. My guess is that swap income would be lower. And it would be – I don't know how to say this. Mortgage will be up, but not up as much as the swap income will be down. How's that?
Jeff Rulis
Fair enough. Okay, that'll work. Let's see here, in the expenses, Charlie you also look back to –you're not going to pull back on technology spending all, but that's a pretty good number at 30 million per quarter. Any puts in takes that we got to think about in terms of – as you've responded to the health crisis and there's some savings there, but some added cost there. Just thoughts on kind of maintaining the level or is it some growth from there given the commitment to tax spend?
Barry Ray
Hey, Jeff, this is Barry. I'll take that question. I think with respect to the run rate, the experience that we had in the first quarter of $30 million is probably a good run rate. There are going to be some factors that add noise to that in the near term. For example, as you said, we're going to incur some additional expenses for cleaning from the COVID-19 pandemic, some additional software applications from the SBA PPP program, so those are going to be add. There are going to be some near term positives. The one that I would highlight here is the loan cost offset through compensation and benefits associated with the SBA PPP origination, and I pick that around 1.2 million and that's going to be a near term adjustment – favorable adjustment. But overall, the $30 million is probably a good near term run rate.
Jeff Rulis
Thanks Barry and maybe one last one. Any thoughts on – have you entertained testing for goodwill impairment or had some initial discussions if that's an avenue you want to go down?
Barry Ray
We have entertained testing for goodwill impairment, Jeff. We identified that there was a triggering event in the first quarter because of the deterioration in economic conditions that occurred at the end of the quarter. And we did do an interim impairment assessment of goodwill at quarter end or as of quarter end and we concluded that there was no impairment of goodwill from that. But we will continue to monitor throughout each subsequent quarter whether or not there is another recruiter event in advance of our normal October 1 annual test date to determine if we need to do yet another interim test of goodwill impairment.
Jeff Rulis
Okay, thank you.
Operator
Our next question comes from Andrew Liesch of Piper Sandler. Andrew, please proceed.
Andrew Liesch
Good morning everyone. Just a question on the deferrals, curious what the pay for them has been and how that's transpired into April and May.
Gary Sims
Andrew, this is Gary Sims. The number that we have in the slide deck, fairly up to date number on the deferrals, so we saw a good pace as we got started, as we put the program together in mid March. We saw a good pace in March, but it really picked up in April and a lot of the deferral activity did take place in April. As it stands right now, we do expect that deferral activity to continue into May as we continue to work with our customers and create opportunities for them to adjust their business model and for us to cope with that. So we expect that pace to continue for May.
Andrew Liesch
Okay and then just curious, the provision, obviously pretty big here. So what were some of the economic forecasts going into that and is that – I suspect of a more up to date number of an economic forecast later in April rather than May, so I was kind of curious, what were some of the underlying assumptions behind that?
Barry Ray
Andrew, this is Barry. I'll take that one for a start. We use the – for our loss estimation process, we utilize the Moody's baseline forecast. And so the specific forecast that we utilize for our March 31 allowance for credit losses was the forecast as of March 27. So that was the Moody's baseline forecast as of March 27. Some of the economic data that drives our loan credit loss experience is Midwest unemployment.
Andrew Liesch
Okay, got you. That's it for me for now. Thanks. I'll step back.
Operator
Our next question comes from Damon DelMonte of KBW. Damon, please proceed.
Damon DelMonte
Hey, good afternoon everybody. Hope everybody's doing well during these times.
Charles Funk
Hi, Damon.
Damon DelMonte
Good morning. So my first question just related to the participation in PPP, what are the expected fees you intend to realize from these loans?
Barry Ray
Damon, this is Barry. Our approximate net fee is around $10 million is what we expect for the PPP.
Damon DelMonte
Okay and did you guys participate in the second round to that?
Barry Ray
Yeah, we did yes.
Gary Sims
That includes our second round participation, Damon.
Damon DelMonte
Okay.
Barry Ray
We've got a – yeah, we estimate the gross fee at about 11.5 million as I indicated earlier, there is some cost offset, it's going to reduce that down to approximately $10 million net. And that's what I'm talking about with respect to the spread income component, there's additional expenses that we discussed related to applications and such as well as kind of what I would characterize and the unknown as the agent fees. So $10 million is our best estimate right now of what we're expecting for PPP loan fees to run through spread income.
Damon DelMonte
Got it, okay, that's helpful. Thank you. And then with respect to your vulnerable industries, that slide that you had, could you talk a little bit about maybe some of the sizes of the loans and those different categories like – specifically like hotel and restaurant, like, how chunky are those loans and maybe like the number of borrowers?
Gary Sims
Damon, I don't have the number of borrowers for you. Our hotel relationships, generally speaking, hotels tend to be larger CRE loans, so the loans are going to be $5 million to $10 million individual loans for hotels. That's pretty typical for that space. I don't have the actual number of borrowers for you. Our hotel operators, they are generally local based operators and we bank those hotels within our footprint. So it tends to be a fairly local effort in that regard. In the restaurant space, we really stand the spectrum between a relatively large McDonald's franchisee based out of Iowa City, down to Mom and Pops in our communities across our footprint.
Damon DelMonte
Got it, okay, that's helpful. Thank you. And then I think that's it. I think my other questions have already been asked and answered. So thank you. Stay safe.
Barry Ray
Thanks Damon.
Operator
Our next question comes from Brian Martin of Janney, Montgomery. Brian, please go ahead.
Brian Martin
Hey, good morning, guys.
Barry Ray
Good morning Brian.
Gary Sims
Good morning Brian.
Brian Martin
Say maybe just one. Going back, Charlie to that swap and kind of just to get arms around that number, I happen to know the differential between 4Q and 1Q, how much was the swap income in 4Q versus what it was in 1Q, just to kind of gauge how much of a difference there was.
Charles Funk
We're looking.
Brian Martin
If I can – the other question I had was just surrounding the PPP in Damon's question, just the revenue you expect to recognize timing wise, do you expect most of that to occur in, based on the forgiveness you're thinking in 2Q and 3Q or is it extend out or just how are you thinking about that in general?
Charles Funk
Well, the unknown is we don't know what the forgiveness process is going to look like. And I think that's something that bankers are talking about around the country. We know there is forgiveness, but there really hasn't been a whole lot of guidance in terms of process and how it's going to work. And now you've thrown this whole notion of audits for the larger ones into this. So I think we had originally thought that we would recognize some income in the second quarter, and we probably will. But I've got to think this is just the guess that there'll be – it'll be second and third quarter and what percentage of swift, we just don't know. It's really hard to say. Yeah.
Brian Martin
Yeah, okay, that's helpful. Just the other thing I had on that PPP was the other 10 million what level of loans I guess does that entail? With Phase I and Phase II, how many loans are you guys anticipating or do you expect there?
Charles Funk
Well, Phase I, I think we got roughly 1,200 to 1,300 approved. And so we're probably at 800 to 900 in Phase II and still taking applications, but the applications that are coming in now in Phase II are – they tend to be pretty small. And we will continue to book loans, but I don't know that it's going to add significantly to our totals.
Brian Martin
So you adjust the total loans, Charlie that you expect and just ballpark it, if you – I guess, maybe Phase II, that's why I was asking. So if I did, I apologize. But just the total loans you're thinking right now would be a –
Charles Funk
I believe what we reported was 2,261 loans. I believe that's what we said and so if it was 2,261 we'll probably be 2,300, 2,400 loans, maybe 2,500 on the top right [indiscernible] money lost as well.
Brian Martin
Right, just that, but the dollar amount of loans showing that's the number of loans, I guess if you disclose that that's why –
Charles Funk
335 to 340.
Brian Martin
Yeah. Got you, okay. Perfect. Thank you. And going back to – on the swap income, just a second question on fees was just the – from a fee income perspective, how much of a haircut, if any, I guess how you guys thinking, whether it be service charges or trust as we think about the impact of COVID and how that impacts the – those couple fee line items going forward?
Barry Ray
Yeah, this is Barry, Brian. I think I'll have – I'll give you the Q1 swap income number. I don't have that in front of me. I do think there's going to be downward pressure on the investment services and trust activities and line items as well as service charges and fees. And so I don't have what that number is going to be, but I think there's going to be downward pressure on it.
Brian Martin
Okay, alright. And that's from 1Q level correct?
Barry Ray
From 1Q level.
Charles Funk
Yes, yeah.
Brian Martin
Yeah. Okay. Just to be clear. Okay. And then just maybe last two for me. It was just – I don't know who – just – Charlie, you made some comments about the margin – the core margin, but just as far as the accretion schedule, does that change with the adoption of CECL – I guess the 25 to 30 basis points of benefit on that accretion number, does that change materially or is there something in that schedule as you kind of look out over the next several quarters?
Charles Funk
Yeah, I don't think the accretion schedule won't change Brian as a result as a result of CECL. So I think we were at around $3 million of benefit this quarter. Again, that is front loaded recognition and so it will diminish over time. We'll all be variable based upon repayment activity.
Brian Martin
Okay. That's all I needed. I'll circle back on the on the commercial swap income. Thanks for taking the question guys.
Charles Funk
Yeah, thank you Brian.
Barry Ray
Thanks Brian.
Operator
[Operator Instructions] At this time we have no further questions. This concludes our question-and-answer session. I'd now like to turn the conference back over to Charlie Funk, President and CEO.
Charles Funk
Well, thank you everyone for joining us on the call. And we are definitely in uncharted waters in our industry and in our country and we just wish everyone good health and safety. Thank you for joining us.
Operator
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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