Charles Funk - President and CEO Kevin Kramer - COO Kent Jehle - CCO Katie Lorenson - CFO.

Jeff Rulis - D.A. Davidson Andrew Liesch - Sandler O'Neill Brian Martin - FIG Partners Daniel Cardenas - Raymond James.

Hello and welcome to the MidWestOne Financial Group Inc. 2016 Fourth Quarter Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] 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 Mr. Charles N. Funk, President and CEO. Please go ahead..

Thank you very much, Amy. Good morning or good afternoon everyone. As we always do, let’s start with the forward-looking statement and remind you this presentation contains forward-looking statements relating to the financial condition, results of operations, and business of MidWestOne Financial Group Inc.

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, change 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 SEC.

MOFG undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances after the date of this presentation. And with that, I will say in the room, we have Kevin Kramer, our Chief Operating Officer, Kent Jehle, our Chief Credit Officer and Katie Lorenson, our Chief Financial Officer.

And I will begin by saying this is not a year or a quarter that we had expected or wanted and let’s talk about the headline first, which is asset quality. As we noted in the earnings release, the larger, much larger than expected provision was driven by five credits.

These credits, if you look at the credits and break them down and you can ask more questions afterward if you care to, [indiscernible] although there were events during the quarter that accelerated their deteriorate, but these are credits that have been marked and on our radar screen for - in some cases years.

Two were total surprises, one of those was a retailer and one was a company in the medical services field.

When you look at the big picture, we charged off 26 basis points, our net charge-offs for the loan portfolio for the year and historically, that's been a good number, but in 2016, where the industry has had almost benign credit quality, these numbers just don’t feel very good to us at all.

One of the larger loans that were impaired and/or charged off were in the Iowa footprint. Right now, we would say that the twin cities in Southwest Florida footprints have good to excellent credit quality. There will be questions about the ag economy and only one of the problem loans related to the ag economy and it was not a surprise.

We simply decided to force the issue with this particular borrower at this point in time. One thing that I do want to highlight is maybe an emerging trend is that we are seeing weakness throughout our footprint and in all states in light manufacturing.

These are not large numbers per se, but it's a large number of borrowers, a relatively large number of borrowers who doesn't seem to be confined to any one footprint or industry for that matter. The common theme would be like manufacturing.

Going forward, as we've said always on the January earnings call, when we get questions about how is the ag renewal season going, we're about halfway through it right now and there's some deterioration in the credit quality, but the deterioration is more, a few borrowers that have been migrated from past to watch, we’re not seeing a lot of migration to sub-standard which is when you really start to get concerned.

But it is fair to say that there are several borrowers that five or six years ago were in outstanding or good to outstanding condition financially are now watch credits and I think that's indicative of the ag economy.

We ended the year basically at the indicated reserve, at the loan loss reserve and our commitment is to continue to operate around or above the indicated reserve. That hasn't changed from prior years. I move on and talk a little bit about loan and deposit activity, which was good in the fourth quarter.

There was a large loan that we spoke of, actually when I first heard about this loan, we were told that it was going to close in October and November. It's $16 million. It's in the Twin Cities’ footprint.

At this point, we're not sure it will close in the first quarter, but we do expect it to close this year and the reason is, it’s dependent on new market tax credits, which can be very volatile in terms of the timeframe, but we still have a confidence level, a high confidence level that the project will close, but we're not sure if it will be late in the first quarter or early in the second quarter.

If you look at our loan pipeline, the pipeline, I would say, is okay. I wouldn't say it's robust and I wouldn't say it's weak, but I would say it's okay.

If you look at the deposit growth, the Iowa footprint produced the highest deposit growth in the company last year and we continue to think in 2017 that there is a lot of potential in the Twin Cities footprint to increase core d deposits, both on the retail and business side and we would say that, as we look at things right now, we still think 4% to 6% loan and deposit growth is very, very doable in our company this year.

As we noted in the earnings release, the strongest areas of the footprint economically would be in no particular order, the Iowa City area, the Twin Cities area and Southwest Florida where the economy tends to be in all three of those areas, very, very good.

If we look at our non-interest income, in the home mortgage center, our fees improved this year, but we continue to think we're under achieving our potential. We, about two months ago, undertook a search for a new Head of the Home Mortgage Center. We have three outstanding candidates for that position.

Those candidates have very, very good experience and would bring a much higher level of expertise than we've ever had in either company in this particular area and we expect to have an announcement there in the next two to three to four weeks, as we said we’re in the final rounds of interviews.

If you look at next year for the Home Mortgage Center, I think that if interest rates continue to go up, that it’s possible there will be more portfolio lending, because generally what happens when rates go up, as borrowers take shorter terms, but that would mean more portfolio lending, less secondary market lending, but still a good thing for the company.

I think the benefit of - the primary benefit of getting a new Home Mortgage Center will be that all of our mortgage originators will be encouraged and incented to cross sell relationships because we truly believe that one of the benefits of mortgage lending is whenever you're able to cross-sell retail customers and get more retailer accounts and I think we have a lot of untapped potential there.

In terms of wealth management, in total, it wasn't a horrible year, but it wasn’t a particularly strong year. We expect growth in revenues in all three components this year, insurance, the investor center and the trust department. We continue to look aggressively for new producers, for new producers.

We were able to add two new producers in the last four months of 2016, but we still have to be able to close the deal to get new producers on board and I think that's one where we just have to wait and see, but we continue to be aggressively looking for new producers and wealth management. I think the best news is on expenses.

We're essentially at the goal that we set at merger and we will proceed that in 2017.

We talked about consultant study that was concluded late in the third quarter of 2016 and we think the first round of going through their recommendations, we will realize somewhere in the neighborhood of $600,000 in additional expenses, reduced in 2017 and that would be as a run rate, not necessarily all 600,000 realized in 2017, but we're not finished, but we're through the first round of recommendations and very, very happy with what we see.

The goal continues to be operate somewhere around an efficiency ratio of 60% in the fourth quarter of 2017. But keep in mind, the efficiency ratio also depends on revenue growth as well as good expense management.

As I think everyone could see, we were making good progress toward our 8% tangible common equity goal, but we have some balance sheet growth in the fourth quarter, but also we had the sell-off in the bond market, which took some basis points out of other comprehensive income.

And so we ended with a little bit of a setback in the T to E, but our internal forecast would suggest that either at the end of this year or sometime in the first quarter of 2018, we should be back around 8%. But as we all know, there are a lot of moving parts there, especially with the bond market and what that can do to other comprehensive income.

So looking forward, decent deposit and loan pipelines, they could be better, they could be worse. But I would characterize them as decent. We will continue to be vigilant on credit.

If you look at the long-term record of this company on credit, it's always been good and I would remind everyone that - when we say this, but we've never charged off more than 50 basis points a year during the recession and so we're quite disappointed with our credit performance in the fourth quarter, but have confidence that we will return to much better performance, more toward our standards in 2017.

I want to end my portion of the remarks and give you a few things that we're willing to talk about for the first time that are not 100% certain, but they probably deserve a mention on this call.

The first one would be that about a year ago, we placed $11 million credit on non-accruals and it’s been on non-accrual since then and we continue to believe now and talk about it that there's opportunity to resolve this in the first or second quarter of 2017.

It's about 100% possibility, but it is far enough along, but it's worth talking about right now. That would be favorable to MidWestOne. We also have been ramping up in the last week or two, negotiations with one of the five credits that we identified in the fourth quarter.

We have a tentative settlement with that particular credit, but there's nothing signed on paper yet. Again, where we’d come through an agreement there that would have a positive impact on our loan loss reserve and our coverage ratio and so forth.

One other item, as you know, Central Bank had a number of failed bank transactions with the FDIC and we are negotiating with the FDIC to exit the loss share arrangement. I would have thought by now, we would have heard from them. We haven't, but we expect to hear from them in the next week or two.

I don't know what the outcome will be there, but we’re very, very hopeful that we'll have favorable resolution there that would be good for our shareholders.

And finally I would just say that I can't talk specifics, but we do expect to announce a hiring of a group of bankers during the month of February, no specific shift, but sometime in the next two or three weeks, we do expect to make an announcement in that regard.

I would end by saying that we realized as much as anything that our company has begun to produce top line revenue growth and we have all hands on deck at MidWestOne to do just that. So with that Amy, I will turn it back to you and again, you’ve got Katie, Kent, Kevin and myself available to answer any questions you might have..

[Operator Instructions] The first question is from Jeff Rulis at D.A. Davidson..

Thanks and good morning.

First question is in regards to expenses and additional merger costs expected, can we assume that's kind of one-time in Q1, we won’t see anymore?.

I’ll take that one, Jeff. This is Katie Lorenson. No, we do not anticipate any further merger related expenses. With the banks merging in April, we put that all behind us. And I would also like to comment on the non-interest expenses if I could at this time.

We did have merger expenses reported as 400,000, but I would also like to note there was approximately another 400,000 in the total that I would characterize as non-recurring. So just to give light on that number..

What line item would that be in?.

There was about 600,000, including the merger related that flowed through the salaries and benefits expense line item and then the balance of about 200,000 [ph] was in the other non-interest expense line item..

Great. And so I guess, if you get those, call it 800,000 reduction, I guess netting out and in the release, I think it was sort of Charlie's comments, still looking to address additional cost savings. You just talked about a team of bankers coming on in February.

Netting that out, is this looking like a kind of a low $20 million run rate for total non-interest expense on a quarterly basis?.

Excluding the [indiscernible] we are looking at below 19 million excluding the amortization which is what we set our cost saves goal at. Now, adding those bankers of course will increase that, but top line revenue will also increase going forward..

Got it. Okay. And maybe switching gears just by the question is on margin, just want to confirm you guys have, you are asset sensitive and then, so that's I guess question one. And question two, I guess what the allotted charge off to interest, you said margin roughly stable, I guess your outlook in ‘17 given kind of rate hike outlook. Thanks..

Yeah. You're right. The margin was roughly stable once you net out the charged off interest and, yes, I think we're dependent not only on whether rates go up or not, but on what the slope of the yield curve is.

And there's probably some benefit that if the yield curve steepens, that wouldn’t be unique just to MidWestOne and our models do show that we're somewhat sensitive.

The next question is from Andrew Liesch at Sandler O'Neill..

Good morning. So just another question on the expenses here, just the data processing line bounced around quite a bit last year and it bounced up just shy of 1 million in the fourth quarter. I know that there are different things in there, but at what level do you think is a good place to be looking at this for 2017..

Thanks, Andrew. This is Katie. I do want to also note that we did in fourth quarter, we grossed up our debit interchange income that had been netted out and we understand industry practice and our peers’ practices to actually gross up the income in the other service charge and charge even fees.

You’ll see that jumped up a little bit also and then net, report the expense where it belongs in the DP processing. So both numbers are grossed up this quarter because of that reclassification, but I would expect the run rate going forward to be around the 750 to 800 range..

Okay. That's very helpful. Thank you. And then just on the balance sheet movement this quarter, looks like you guys added securities and now we’re 21% or so of total assets.

And just looking at the balance sheet going forward, is that kind of how you're modeling and forecasting or you’re expecting some of this liquidity to draw down?.

No. Once interest rates rose after the election, we saw an opportunity because we are somewhat asset sensitive and we added as you see some securities.

Those with all the liquidity that we have in our bond portfolio that can be self-liquidating during the year or that can be used to fund the security materials during the year can be used to fund loans if we need it there, but we just saw the opportunity because we had some balance sheet capacity to provide a little bit of net interest income, it really doesn't hurt our asset liability sensitivity at all..

[Operator Instructions] Our next question is from Brian Martin of FIG Partners..

Just one thing just maybe for Katie on the margin, maybe just kind of reconcile what the core margin is and just kind of your assumptions at least as you look forward to you know can you talk a little bit about what your expectation is on the recent rate the Fed hike, how that influences a margin and maybe you can extrapolate them there but just at least some color on them and just reconciling what the corner [indiscernible] you guys dealing with absent the accretion income?.

Sure, no problem. So without the accretion income, the margin came in at about 358 [ph], but again adjusting for that non-accrual write-off it was right at 362 [ph] which is where it would have been last quarter without the accretion, excluding the accretion. Looking forward, we do anticipate obviously a rate hike will help us.

All the [indiscernible] core deposit changes come about and those are cost of funds overall remain fairly stable. The discount accretion because we were anticipating the FDIC termination that did draw down this year and we expect it to bounce back next year so that will help our margin also..

And just that last comment about what was [indiscernible] what you said Katie, about the what was grossed up, the line items that were impacted just I think you said the data processing was grossed up and I didn't catch the other line item on that..

On the noninterest income the other service charges and fees that’s what this quarter also [indiscernible]..

And is that level on that line item then, can I [indiscernible] change like this, I think you said the data processing might fall back a little bit from the current level as the other line item and fee income, does that change this, the 1.8 million or so, does that change the run rate?.

Yes, it should that should pop up around 1.4 to 1.5 going forward..

And Brian, and I would just interject in terms of prime increases, the prime increases is helpful but it's not like ten basis points, it's a couple of basis points through the margin but it's not much more than that..

Okay. That’s helpful.

[indiscernible] kind of restrictive earlier on and accelerated later, just it's - is that fair to say?.

There's a few for us, but increasingly they don't come into play as we have additional increases..

I think Charlie you mentioned I forget the amount, $600,000 was that related to the consultant, just can you walk back through kind of what you're thinking [indiscernible] run rate impact, but just kind of how are you thinking about that if you run back through that..

We broke the recommendations down and the things that could be implemented relatively quickly and then those that would turn a little time. And we've identified $600,000 in savings, all of those will get implemented during 2017 if they haven't already.

So it's not a $600,000 impact in 2017 but going forward it will be a run rate of $600,000 has come out of the expense line..

And fully out of it by fourth quarter but maybe it’s just a little bit each quarter between now and then that comes out..

I think more in the near term but some of it is delayed in the third quarter or fourth quarter..

And you said that's phase 1, so I guess there's other things you're looking at on these account systems….

They’ll take a little bit more analysis and we've had a lot of things going on. So we took the ones that were a little easier at the beginning but now we're starting to go to phase 2..

And just you talked about a couple of things, Charlie [indiscernible] conversation about in your prepared remarks about things that will be better or you know more beneficial on the credit front and impact on to the reserves and whatnot.

Can you just run through a little bit of what you’re expecting there and just how things may play out as you look at you know [indiscernible] then the other one in the five credits it may get resolved in the near term..

We want to forecast any specific outcome but what I'm saying is that you know discussions are far enough long now that we thought it was it was worthwhile to talk about it but in terms of talking about specific numbers we wouldn’t want to do that until we have agreements in place.

But we have as I said two problem credits including a large one that we think we have the opportunity to have a favorable resolution..

So I mean this - could that possibly I guess you would think about the serving for 2017 would that be somewhat of a tailwind there on what you're going to end up reserving if you get a good resolution on those..

We would anticipate that, yes..

You talked about the need to generate the - I guess the hiring of the - the potential hiring of [indiscernible] I guess is that just the - sounds like you feel good about the expense front but the challenge really is on the revenue side and I guess finding a group of lenders possibly just, should we think about this as being kind of an end market type of thing, a market extension you may look at or just - maybe because it sneaks away the possibility of M&A, I know you had talked a couple quarter ago, I'm not sure what call it was.

You thought at some point in time this activity might pick up at Iowa on the M&A front, so just kind of trying to connect the dots between I left out if you will versus M&A transaction a whole bank deal..

As we said we didn't speak to M&A, so it is a - it's not a team of lenders, it’s a team of bankers. So we think we will have deposit generation capacity as well but at this point I really don't want to talk about the geographic part of it. In turn, but I will talk about topline revenue and how you should think about it in our company.

So I identified the strong markets and there are three, Twin Cities, Iowa city, and southwest Florida in our company right now. And what’s not strong is rural Iowa and rural Wisconsin, those economies are not strong right now. They're not in depression, they're not even in recession but they're not strong.

So the growth in revenues for the most part needs to come in our company from the markets I mentioned and so I think it behooves us to look at bankers in any strong market and try to find ways that we can bring them into our company and increase help increase top line revenue growth..

Okay. Just as it relates, maybe I missed what you’ve said there but about the M&A so absent the lift out maybe you’re looking at just M&A in general, I guess crystal ball on that, I mean, what are the likelihood of finding something that fits your criteria as you look at ‘17 here..

We have we have discussions going from time to time but my crystal ball is 90 days right now, and right now I don't really see a lot in terms of M&A. There are always branch sales and things like that and we look at a lot of things but in terms of M&A, really aren’t having any discussions right now..

All right, and maybe just I’ll step backwards, it sounded as though you feel a little bit care about credit quality now that you kind of make some actions here in the fourth quarter but you also referenced the potential emerging trend of you know like manufacturing kind of across your footprint.

I guess given kind of those comments I guess is it - because it feels like the commentary you're kind of directing us is that maybe that has to do more with growth, let me do less growth going forward as opposed to more problems potentially coming out of those emerging weakness if it is - if it does continue.

So I don't know you can comment or I just - and to maybe just to think about how we think about the reserving for 2017 kind of some of the commentary..

Yes, Brian this is Kent, talking specially about light manufacturing in the wholesale business. At this point again we've seen some softening but that deterioration wouldn't require a huge amount of additional provision or allocation if you will related to that.

It's just on our radar and given the fact we see it on our radar right now that is certainly the comments that we're driven by Charlie. So our goal now is to continue to monitor those credits.

They're certainly performing credit at this point in time and look at the industries that they are in and we're already seeing some signs and one particular I can think of, they're starting to come out of it.

So as a community bank we've gone through this before and the key is that we're working closely with those clients to ensure that we can track with where they're heading based on the specific industry.

The other thing I would add is going back to the ag sector and Charlie highlighted as well, with our review we have gone through our larger and our credits that have exposure or previous years carry over.

So we do feel other than the one off we've talked about that we realize in the fourth quarter that we've gone through those credits and we're comfortable at this point moving through 2015 those two work through the cycle on the ag side as well. So those would be my specific comment..

And then just as it relates to maybe it's more you know either Katie or Charlie but as it relates to the kind of core margin actually the equation. And I think last quarter the commentary was that maybe you know I felt like there was a little bit of downward pressure on that core number.

And this is kind of before the rate change and the election and whatnot. Can you just give - I guess is that still a fair assumption, I assume that’s changed and kind of rate increase here just to make sure we're on the same page as far kind of where - what the expectations are just kind of what comes out looking forward..

We probably feel a little bit better about our margin right now, Brian. And one of the things I neglected to say in my opening remarks that I had attended to was that loan pricing is a little bit better right now. It hasn’t adjusted as much as the bond market has adjusted but it is a little bit better. Terms are still very, very competitive.

So I think we might be a little bit more sanguine about margin than we would have been 90 or 180 days ago..

And so, you didn’t reference anything - I think a quarter ago, two quarters ago, you talked about kind of your expectation as far as earnings and certain comfort with the range of estimates that are out there.

I guess any change is this, positive or negative to that as you look at ‘17?.

No, what I said 90 days ago is what I would repeat that we're very comfortable with what the estimates are right now for 2017. Our budget at Midwest one would reflect that..

The next question is from Daniel Cardenas of Raymond James..

Just a couple of quick questions.

On the ag portfolio I know you're going through renewal season right now, it doesn't sound like there's anything popping up that's causing you concern, but how significantly would your concerns change if we have another bad year in 2017?.

Dan, this is Kent, good question. The one positive as we relate to work commodity prices are in with the assumption that commodity prices stay in these softer low environment. We are seeing clients starting to pull levers on the expense side.

And that’s related specifically to crop inputs, we've seen those back, back off from what we've seen in the last couple years and also more importantly cash rent on ground obviously they're running and producing on, we have seen our clients being proactive either trying to renegotiate those leases and in some cases even walking away from the leases if they can't obtain rent level that reasonable as they put their forecasts together.

So the headline from that standpoint is, we see the results from 2016 a little better than we thought it would be and as we roll into ‘17 and put our projections together we certainly aren't in any deterioration.

Obviously to remind you we had the one off that we did decide to push forward with an address in the fourth quarter that we weren't comfortable that the comment I just eluded to would be the same for that one specific credit..

For that one credit was it more that they were just kind of bad managers or was it combination of a number factors?.

Exactly I would characterize it as bad managers and started in 2014, they had a run of three years or four years, when we would see, there would have been opportunities to improve those years based on the management that occurred..

And what percentage of your portfolio has a crop insurance?.

Basically 100% of our portfolio has crop insurance at some level..

And then last question here.

Can you remind us what your footprints in Florida are?.

Yes, roughly between 90 and 95 million in deposits and right at $130 million dollars in loans and if you think of it this way, when we announced the merger two years ago, it was $80 million in deposits and $90 million in loans.

So there has been really nice growth down there and we have a wonderful staff in Florida and they do a really good job in Naples and Fort Myers..

At this time I show no further questions. This concludes our question and answer session. I would like to turn the conference back over to Mr. Funk for closing remarks..

Thank you for being on the call this morning and as always if we can be - answer questions or be of further service, you call any one of us and we're happy to respond. Back to you Amy, thank you..

Thank you. The conference is now concluded. Thank you for attending today’s presentation, you may now disconnect..