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MidWestOne Financial Group Inc (MOFG 2.50%)
Q3Â 2020 Earnings Call
Oct 30, 2020, 12:00 p.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good morning, and welcome to the MidWestOne Financial Group, Inc. Third Quarter 2020 Earnings Call. [Operator Instructions] This presentation contains forward-looking statements relating to the financial condition, results of operations, business of MidWestOne Financial Group, Inc. forward-looking statements generally include words such as believe, expect, anticipate and other similar expressions. Actual results could differ materially from those indicated.
Among the important factors that could cause actual results to differ materially are interest rates, changes in the mix of the company's business competitive pressures, general economic conditions and the risk factors detailed in the company's periodic reports and registration statements filed with the Securities and Exchange Commission. MidWestOne Financial Group, Inc. undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances after the date of this presentation.
I would now like to turn the conference over to Charlie Funk, CEO. Please go ahead.
Charles N. Funk -- Chief Executive Officer
Thank you very much, Eiley, and thank you to all who have joined our call this morning. We will open with just a brief discussion about the goodwill impairment of $31.5 million. And as we all know, that's a noncash charge and good to have behind us. And I will also add the time and expense that we undertake to measure this are very significant. And as stated in the earnings release, the 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, return on tangible equity of 12.5% efficiency ratio of 55.4%, we think, are solid metrics. Earnings per share ex goodwill adjustment were $0.73, which was consistent with the second quarter of 2020. Very, very pleased that our NPAs, nonperforming assets, are 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 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 deposit inflows as 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 low line of credit usage in our earnings release. And there's no doubt that the PPP has really influenced this decline in line usage.
Around our company, our Denver offices and our Southwest Florida offices have continued to maintain and build their loans and their pipelines. It's been pretty quiet in the twin cities and in Iowa. We've seen paydowns in those markets. As we look to the fourth quarter, we're 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 continue, certainly not robust, but we are seeing a little bit of loan growth as the fourth quarter gets under way. In terms of the net interest margin, clearly, the 0 interest rate policy really does hurt us, hurt our industry. And we see new loan rates continuing to fall. There's still good competition for high-quality credits. And I would say that most of the deals that we are getting done are getting down 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 since the quarter ended. And we do have a little larger CD book than most companies. So as the CDs mature, we will see moderate declines in our cost of funds by virtue of those maturities. It's interesting to note that many of the CDs are rolling into non-maturity accounts rather than renewing in other CDS. In terms of noninterest income, pretty good story, I think, for MidWestOne. Our mortgage unit, again, has been a huge contributor with loan revenues at $1.3 million during the quarter. We did have an MSR adjustment, mortgage servicing rights adjustment, of $560,000 during the quarter compare that to $745,000 in the second quarter 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 LPL brokers continue to hit for 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 in just slightly behind our plan. But through good expense control, we should be able to make our operating plan in our Trust Department. One of the headwinds that our Trust Department faces is that due to the pandemic there aren't a lot of states that are getting out of probate courts. So we've gotten very, very little core pointed fees on the states, and we'll get those eventually. It may be in 2021. But we've been able to maintain our revenue growth in Trust despite the fact we're not getting much in the way of estate fees. And as I talk about mortgage and I talk about Trust, I'd have to acknowledge that the former at Bancorp has really contributed significantly in both of those areas, and that part of the merger has really worked very, very well for our company. Finally, on noninterest 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 NIM contraction. And I would also note that very quietly during 2020, we've 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. NPAs, as I said before, 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 -- if we would go back six months and what we expected to be 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 think we've 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 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 one area of concern currently for our company. Our deferrals we're down to 3% of loans, 3.6% ex PPP. And we had $41 million that we're 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 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. I think ag is probably in 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 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 Dera Show, 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 -- will have 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 is they tend to be -- have tended to be relatively stable during the last three months. So in summary, I think we feel OK right now about our ag portfolio. And based on what we see today in terms of our whole loan portfolio, our entire loan portfolio, we think we're 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. Would note that our core earnings, our earnings ex goodwill nicely covered our dividend. Our tangible common equity is stable from the prior quarter at 7.82%, but it's well in excess of 8% if you adjust for PPP loans. And as many of the long time followers of MidWestOne know that our -- for many years, our goal on tangible common equity has been in the 8% to 9% range. So we feel like we're OK there. All of our regulatory capital ratios appear to be very, very sufficient at this time. And you will also note that we did reinstate our share repurchase program. And we do believe at these levels or that MidWestOne 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 Barry Ray, our Chief Financial Officer, Gary Sims, our Chief Credit Officer; Lynn de Bacher, 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, Eiley.
Questions and Answers:
Operator
[Operator Instructions] Our first question today comes from Brendan Nosal with Piper Sandler.
Brendan Nosal -- Piper Sandler -- Analyst
Thanks for your detailed remarks, definitely helps answer a lot of the questions I had coming in. But just wanted to start off on the margin here. I mean, I appreciate the rate environment is incredibly tough in a lot of the flex that you had on the liability side has mostly played out, but still some west. Just hoping you could kind of help us understand what you expect for the core margin to do from here outside of any PTP related noise?
James M. Cantrell -- Senior Executive Vice President, Chief Investment Officer and Treasurer
Brendan, this is Jim. I'll take that. We've had a lot of internal discussion about what is 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 those PPP loans and the forgiveness. So 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 of 2021. And we've modeled a corresponding amount of liabilities will run off the balance sheet more or less simultaneously with some lag, some amount of lag, but 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, we're looking at five basis points increase in margin. And if you think about it, we are offloading PPP loans that are yielding us, I think, Barry told me 2.54 in the third quarter. So we're offloading $340 million of relatively low-yielding assets.
So that would mean a reduction in net interest income, but it increased in the margin. If on the other hand, 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 runoff in liabilities. And we have to reinvest that cash in securities at, say, 1% that will lead to a decline in the margin of roughly five basis points 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.
Brendan Nosal -- Piper Sandler -- Analyst
Yes. No, it's helpful. I know that it's a tough question to answer, given all of the moving pieces that we have today. Right. Good. And then one more for me. Charlie, you mentioned leaning into the wind on the reserve year-to-date, and you've built to what I view as a very strong level here at 1.82% ex PPP. Again, a tough question to answer, but based on 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?
Barry S. Ray -- Senior Executive Vice President and Chief Financial Officer
Brendan, this is Barry. I'll take that question. I think with respect to how we feel today from what we can see, from what we can see right now, we feel good about our adjusted allowance for credit loss ratio of 1.82%. And and all things equal would expect credit loss expense in the future to reflect how we feel about it today.
Operator
Our next question comes from Jeff Rulis with D.A. Davidson.
Jeff Rulis -- D.A. Davidson -- Analyst
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. And Charlie, you mentioned some contract renegotiations with vendors and a pretty revenue challenged environment. But also, are there any investments in play? Any -- just flesh out the the expense initiatives relative to investments would be helpful.
Barry S. Ray -- Senior Executive Vice President and Chief Financial Officer
Jeff, this is Barry. I'll take that. I think that overall, if we look at the ongoing run rate of expenses. I think that the run rate of $29 million to $30 million that we've discussed on this call recently is a good run rate. We do expect a slight uptick 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 a good number. As we think about managing expenses, we do continue to look for opportunities. As Charlie alluded to through attrition we've saved money. We continue to look at other opportunities in branch rationalization, vendor contracts. And so given that, I think that there is still some opportunity for us on the expense side.
Jeff Rulis -- D.A. Davidson -- Analyst
Got it. So I read it net. If you talk about a 29 to 31 rate over the course of '21, it sounds like maybe some investments offset by maybe some savings and a relatively moderate growth expectation?
Barry S. Ray -- Senior Executive Vice President and Chief Financial Officer
I think that's a good way to think about it, Jeff.
Jeff Rulis -- D.A. Davidson -- Analyst
And then jump into the fee income side. It sounds like Q4 is starting pretty robust or continuing to stay solid on the mortgage front. A little further out, if that whether we follow MBA forecast or not, that, that were to wane. You see it's a nice crowback in the service charge, I guess, trust is kind of perking along, but the card business. I guess if you think about that line item, can those other areas kind of step into supplant if we see a rollover in mortgage, any further kind of longer-term thoughts on the fee income outlook?
Charles N. Funk -- Chief Executive Officer
Yes. I'll start with that, Jeff. It's a good question. And one of the things that I really neglected to mention in the opening comments on the Trust side, is we, for the first time, hired a wealth management person who's a trust officer in our twin cities market, and we are very interested in adding to that. That will be a near-term drag on expenses. But this is a very, very seasoned person, and we 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 remain strong into the first quarter. And I think our investment services and trust units are probably poised to continue to show not not home runs, but lots of singles and doubles in terms of increases in revenue. And on service charges and card revenues, I think 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, and our service charges also especially the card revenues.
Operator
Our next question comes from Terence McEvoy with Stephens.
Terence McEvoy -- Stephens -- Analyst
Everyone maybe let's just start the commentary about October loan volume picking up a bit. I was wondering if you could just expand on that where kind of -- are you seeing some early signs of growth within the portfolio?
Charles N. Funk -- Chief Executive Officer
Well, Denver continues to be strong. Florida is very, very steady. And I think there's there's a little bit in the pipeline from Iowa City, and there's a little bit in the pipeline from the twin cities. So it's a little bit of probably those four markets.
Terence McEvoy -- Stephens -- Analyst
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 commentary specific to hotels as you looked at that portfolio last quarter again?
Gary L. Sims -- Senior Vice President and Chief Credit Officer
Sure, Terry. This is Gary. The -- what we did in the third quarter was really a mirror image of what we had done in the second quarter. The differentiation was the third -- the credits that we had downgraded into nonpass 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 so it was just pass rated credits. Most of our hospitality portfolio had already migrated to watch status or worse. And so as a result, we really didn't see that material migration, continued migration into watch or worse for the third quarter. And honestly, Terry, I did not expect to. But I think it's prudent to continue for the third quarter that enhanced risk rating analysis. Does that help, Terry?
Operator
Our next question comes from Damon DelMonte with KBW.
Damon DelMonte -- KBW -- Analyst
So just a quick question on the hotel portfolio. In the slide, it shows that the average loan size is like $1,024,000 what are some of your larger exposures in there? And can you give a little perspective or color on those and kind of how you're feeling about those at this point of the cycle.
Gary L. Sims -- Senior Vice President and Chief Credit Officer
David, this is Gary. I'll take a stab at that one and see if I can give you a little bit more color on that portfolio. It ended the quarter at about 120 -- a little over $120 million. As I said earlier, with Terry, most of that portfolio is now non pass rated. So it's either watch or substandard. And a key differentiation between -- whether it's in watch or substandard is those credits that have asked for a second round of deferral. They pretty much migrated to the substandard category. At this point in time, very little into in the nonperforming category, that would really be driven by additional need for accommodations, etc. But generally, we have several larger credits, the largest credit in that portfolio is $16 million. It's a twin cities based major flag hotel and from there, it goes down to smaller credits, we have two 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 hotels tend to be interstate based flag hotels. So generally, we're doing pretty well. We don't have convention center hotel, things of that nature. But we do expect of that portfolio, there will be a small subset that will continue to struggle as we go into the fourth quarter and beyond. Does that help any?
Damon DelMonte -- KBW -- Analyst
Yes, that's very good color. And then, I guess, maybe more broadly speaking, Charlie, can you just give a little bit more color and perspective on kind of the dynamics in the market right now with the rising cases throughout Iowa at least from the East Coast, it sounds like there was a pretty high positivity rate going through the state and across the greater Midwest. And I don't know how that impacts the daily life and 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.
Charles N. Funk -- Chief Executive Officer
Yes. I have a very good friend who's a banker in Connecticut, and it's been much different in Iowa and Wisconsin, for sure and somewhat in Minnesota than in Connecticut. And so you're right about that. Yes, I think 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 at this point. But we -- yes, we have -- we probably had more employees who have suffered from this. We've been able to keep our offices open. Generally speaking, though, the economy in Iowa is pretty good. And I think the last unemployment numbers were right around 6% in our state. And I think our governor has done a good job of keeping the economy open and probably a little bit at the expense of rising cases. The that still remain fairly low in our home state of Iowa. So yes, I think you see less people in restaurants, and you see more restrictions on bars and that sort of thing. But by and large, I think people are going about their daily businesses with -- I do think more people are wearing masks and whatnot, but there's no doubt that it's a critical time right now as cases continue to rise.
Operator
[Operator Instructions] Our next question comes from Brian Martin with Janney Montgomery.
Brian Martin -- Janney Montgomery -- Analyst
I just one question, Charlie, to your point on the buyback. Just curious what your thoughts are there given where the valuation levels are and your comments about feeling pretty good about capital today?
Charles N. Funk -- Chief Executive Officer
We think our stock represents very, very good value. And I think one of the things that really caused us to be a little bit more optimistic about lifting 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 that was sort of part of my opening commentary, but we think we've been very conservative in our approach to our reserve. And given the fact our valuation is where it is, we think it's good value and the management team and the Board felt like this was a good move for MidWestOne to make at this particular point to lift the curtailment of the share repurchase for the suspension of the share repurchase.
Operator
Okay. And would you expect to get relatively active here? I guess, is that kind of the plan kind of what we're hearing?
Charles N. Funk -- Chief Executive Officer
Well, it's a day-by-day decision, right, Brian. But the best thing I could tell you is that we find it very attractive at current levels.
Brian Martin -- Janney Montgomery -- Analyst
Yes. Got you. Okay. Yes, just one follow-up here. Just on the on the PPP process, I don't know if it's Jim or somebody else, but just the remaining -- just how you think that may play out as far as the forgiveness goes? And then just if you could remind us the remaining unearned loan fees that you still have yet to bring into the P&L?
Barry S. Ray -- Senior Executive Vice President and Chief Financial Officer
Brian, this is Barry. The remaining unearned fees from the SBA PPP loans at September 30 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% payoff in the first or the latter half of this year and then with the remaining 50% in 2021.
Brian Martin -- Janney Montgomery -- Analyst
Okay. So a good chunk of it coming here in 4Q.
Barry S. Ray -- Senior Executive Vice President and Chief Financial Officer
Yes. But it's really just a gas. We don't know how fast the SBA will respond. So that's really just an estimate.
Gary L. Sims -- Senior Vice President and Chief Credit Officer
Yes. I mean, this is Gary. Just one piece of color on that. We have started the forgive this process with our customer base that started a couple three weeks ago. We have started submitting transactions forward forgiven us approval with the SBA. The SBA has 90 days to do their approval. However, our peer group that we interact with. The experience is that it's not taking 90 days very often. So that's really what kind of colors are. We're at the end of October, we feel like there's a decent chance that some of that will be forgiven by the end of the quarter.
Brian Martin -- Janney Montgomery -- Analyst
Got you. Okay. And then just the last one or two, the criticized and classified levels, it sounds though as though those were pretty stable from -- when you look from 2Q to 3Q. Does that seem fair? Was there -- did you say there was a big misunderstood what you said on that?
Gary L. Sims -- Senior Vice President and Chief Credit Officer
Yes. The -- what I would say is we did have some continued migration into criticized and classified. Most of what you saw migrating into classified had already been identified in the criticized category. So not as much migration into criticized, as you did see in to classify it. It's really kind of a continuation of what we thought would be happening relative to that hospitality portfolio, Brian?
Operator
[Operator Closing Remarks]
Duration: 34 minutes
Call participants:
Charles N. Funk -- Chief Executive Officer
James M. Cantrell -- Senior Executive Vice President, Chief Investment Officer and Treasurer
Barry S. Ray -- Senior Executive Vice President and Chief Financial Officer
Gary L. Sims -- Senior Vice President and Chief Credit Officer
Brendan Nosal -- Piper Sandler -- Analyst
Jeff Rulis -- D.A. Davidson -- Analyst
Terence McEvoy -- Stephens -- Analyst
Damon DelMonte -- KBW -- Analyst
Brian Martin -- Janney Montgomery -- Analyst
