Good afternoon and welcome to the MidWestOne Financial Group, Incorporated First Quarter 2019 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 like to now turn the conference over to Charles Funk, President and CEO. Please go ahead..

Thank you, Jacob, and good morning or good afternoon wherever you maybe this morning, and thanks for joining us on the call.

I'll begin with the forward-looking statement as always 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, the 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 out of the way, I would say that in many ways, this was a normal quarter for our Company, but for three issues that I will discuss that caused us to fall slightly short of our own internal expectations, those three issues being the size of our loan loss provision, unusually high loan paydowns in the quarter as well as a significant shortfall in our Home Mortgage Center.

And again, I will detail all three of those things in my remarks. At the end of the call, I'll also cover updated projections for the American Trust ATBancorp transaction, as we have not provided any guidance since last August and we do plan to close this transaction on May 1. So first let's talk for a minute about the balance sheet.

We showed only modest loan growth during the quarter, and we added unusual amount of paydowns, more than $20 million in paydowns that were somewhat unexpected. And I would note that a small percentage of those paydowns were Watch rated credits, which is not always a bad thing.

But we had reasonable loan growth, but the paydowns limited the overall loan growth on the balance sheet. Perhaps more importantly, the loan pipeline is still good for the second, and this is true throughout our footprint. I would say that it's very nice to see very good activity out of the Iowa City market, which has been flat for a period of time.

We have a good pipeline there. So our guidance on loan growth for this quarter is 1% to 1.5%, and we still feel comfortable of the overall year-over-year projections of 4% to 6% for 2019. Denver, the Twin Cities and Iowa City all feel confident that their pipelines are good and they will meet their goals for 2019.

Deposits were unusually strong and hit an all-time high briefly for our company. But it's fair to say, and I think we indicated this in the earnings release, we had a large amount of property tax money and public funds in our bank at quarter-end. A lot of that money has gone, but we still are showing modest year-over-year increases in our deposits.

The FEMA on deposits is the same as it's been for more than a year, and that is that it's very, very cooperative. This may have been the most competitive deposit quarter in terms of pricing that we've seen. And we have healthy competition throughout our footprint, and the competition is large banks, small banks, credit unions.

Basically any depository institution is paying up for funds and making life difficult to hold our cost of funds in check. And you'll note that our cost of funds was up 12 basis points during the quarter, which is historically a lot for us. Additionally, and I'm sure that we're not alone in the commercial banking space.

The flat yield curve really does hurt us. We're seeing – with the treasury curve trending lower and flatter, we're seeing now some pricing, for example, on five-year loans under 5% for high-quality deals.

Overall, I think we'd still be able to originate above 5% on average, but it's very, very hard to get loan pricing leverage on term deals with the treasury curve like it is or as it is. The biggest question I think is if the Fed's new stance on basically being on hold is going to filter through to deposit market, we have not seen that yet.

And again, I think this was in the earnings release, but I will say that the core margin fell 5 basis points from 3.53% to 3.48%, and I think that’s probably the largest fall we've had in any one quarter since the Fed began to raise rates. So we will continue to soldier on. But again, my main theme is the flat yield curve is difficult.

In terms of non-interest income, I'll start with loan fees. We had a very slow quarter in residential lending, and I think some of that had to do with the cold weather that we experienced in the upper Midwest, especially in Iowa and Minnesota. With that said, April has been a large month in terms of closings for the Home Mortgage Center.

They expect to catch up or nearly catch up to their annual plan in the second quarter. So we don't have a significant amount of worry about that. In addition, we also were caught with the movement in treasury rates. We have a larger than expected servicing rights adjustment of $227,000 on our servicing portfolio.

So when you put those two things together, it was a probably the slowest quarter we've had in a long time in the Home Mortgage Center. Again, we can't control what servicing rights do, but the originations look very, very positive for the second quarter. In addition, SBA was very sluggish overall. Some of that had to do with the government shutdown.

They also have a good pipeline and are shaping up to have a good second quarter. They think they will be back to their annual budget in the second quarter. And I'll again say and I've said this on past calls that our banker in Denver is doing a tremendous job.

We are getting outstanding volume out of our SBA banker in Denver and very, very important to our Company's income statement, and we expect that to continue. In terms of wealth management, trust and investment fees had a nice quarter, good year-over-year gains. We expect that for the most part to continue on.

The insurance agency, those of you who are familiar with the insurance business, the first quarter is when contingency payments are made. So we did have a nice contingency payment, which contributed to that line item on our income statement.

So I think overall, the second quarter was about as low as it's going to be for our company in terms of fee income, and we expect much better results in the second quarter and beyond. In terms of expenses, not a lot to note, the merger-related expenses added $167,000 or about $0.01 per share to our run rate.

I will say one thing that was not in the earnings release, we did announce during the quarter that we're going to close our North Hudson, Wisconsin office. We don't expect much attrition – business attrition from that due to the fact we have an office about five miles away in Hudson, Wisconsin.

And we think that the annualized reduction in expenses will be in the $250,000 to $300,000 range for that. In terms of asset quality, I have a few comments on asset quality. Non-accrual loans were up $1.4 million, and that represents a number of smaller credits, perhaps four or five smaller credits.

And from where I sit, I think we're making a lot of progress in identifying the issues in our loan portfolio. And most of the issues that we're identifying now are in credits less than $500,000. I think we’ve been through the larger credits. We’re very comfortable.

And I think this quarter, the numbers reported don't reflect the progress that I see, and I expect those numbers to change soon. We will continue to give guidance on the loan loss provision as we did in the first quarter of $4 million to $6 million.

And while it was a little larger, our run rate basis than that in the first quarter, we expect that to moderate going forward. In terms of Ag, everyone always asks about Ag, and I'm sorry to disappoint everyone, because our comments really aren't much different than they've been for a couple of years. Ag is 7.6% of MidWestOne's portfolio.

Let me give you four bullet points in terms of the big picture for ag. Borrowers that had good crop yields and good management practices generally made money and fared pretty well in 2018. That's a surprise to a lot of people.

There are a number of our customers who are doing reasonably well, not as well as a six or seven years ago, but still reasonably well. Those customers with high debt loads and poor crop yields did not fare well in 2018.

If we look – now that we're through the renewal season, if we look at cash flow projections for our corn and soybean farmers, for 2019, the cash flow projections are generally breakeven to slightly positive. And I would say the primary reason for that is low commodity prices.

So if we get any relief on tariffs at all, that could be a positive thing for our borrowers. Land prices, which is important, because a lot of these credits are still decent credits because of the land that's pledged to the bank, land prices year-over-year down 2% to 3% and 10% to 15% from their peak five or six years ago.

And that really depends on the location, but slightly lower, but not significantly lower. I'll give you three mileposts, mile markers or metrics for our portfolio. A year ago, we had just under $47 million in watch and substandard ag credits. One year later at 3/31/2019, that was $39 million, so down 17%.

If you look at just the substandard category during the same time period, that has increased about 10% from just under $19 million to $21.6 million. But if you look at the entire portfolio at MidWestOne, a year ago, we had 23.5% that was classified watch or substandard.

That's down to 21%, so I think it does reflect some progress in our portfolio overall from 23.5% to 21% watch and substandard. Again, slightly higher amount of substandard credits in the portfolio. I would say that the level of charge-offs that we've seen in ag has not been unreasonable, given the stress that is in the ag economy.

And I will say that, again, from where I sit that our level of portfolio management and administration has improved significantly. And I continue to be confident as I have been in the past that we will not experience large charge-offs in our ag portfolio.

In terms of capital, it's of note, we did continue to repurchase shares when the opportunity presented itself during the quarter, and we continue to see very good value at the price points that we hit in our repurchase program. Miscellaneous items, we did recently complete an FDIC exam with really nothing unusual to report on that front.

In terms of the American Trust transaction, a bit of news for everyone, and I think it's all good news. We do expect to close the transaction on May 1. I'll remind everyone, this one took longer to approve than most, because we had regulatory approval in short order, but we required the disposition of American Trust retirement division.

That was a long and arduous process, but that has been completed, and my understanding is that will close today, which clears the desk for our May 1 close. It's been an exciting time for our company, and we think that our shareholders will be very excited as well.

We did rerun the projections that we put out last August, because we had not run the projections since last August, because we didn't know for sure what the close date would be. And the good news is that these numbers or projections have not changed materially since last August.

Transaction costs are going to wind up being a little bit higher, which I attribute to the long timeframe that took to close and that the ongoing negotiation that took place between three parties during this time frame. The earnings per share accretion, excluding transaction costs in 2019 is projected to be 12.4%.

We project the earnings per share accretion in 2020 is in the 18% to 19% range and in 2021 in the 15% range, give or take a few tenths of a percent. We feel very good about our ability to execute on the cost saves. In fact, much of that has been completed already. We have a little bit yet to do, but feel very, very good about that.

American Trust, two banks' asset quality continues to be well above average when you look at their peer group, so that asset quality has been maintained during this period of time.

One thing that the American Trust has never focused on is deposit growth, and we think that we can benefit by having a renewed emphasis or our initial emphasis in that company on the importance of core deposits. So we're excited about that.

They have, in all of their locations, excellent commercial bankers, and we've been able to maintain that commercial banking team in large part and we're very, very pleased about that. They have a good branch network.

And again, I will remind those who may have forgotten that the MidWestOne Trust Department will essentially triple, bringing over the large American Trust Department and again, very little attrition in that Trust Department since the announcement. And I think that adds a new dynamic to our company that we haven't had before.

Certainly, trust will be a much bigger contributor to our income statement than it has been in the past. So I would summarize and say that business conditions throughout our footprint, with the exception of the ag, are such that we expect to return to loan growth and normal non-interest income growth in quarter two.

And we do look forward to getting back to where we can show topline revenue growth, and that's certainly our plan for the rest of this year.

So in the room, we have Barry Ray, who is our Chief Financial Officer; Gary Sims, our Chief Credit Officer; Jim Cantrell, our Treasurer and Chief Investment Officer; and Kevin Kramer, our Chief Operating Officer. And we will be happy to answer any questions you might have. So I would turn it back to you, Jacob..

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Damon DelMonte with KBW. Please go ahead..

Good afternoon, guys.

How is going today?.

Good Damon..

Good morning, Damon..

Hi, Damon..

Hi, Damon..

Good morning. So just wanted to see if we can get a little guidance. The deal, as you said, is closing on May 1. And obviously, a lot of moving parts here in the second quarter and you probably won't get a clean run rate almost until the fourth quarter.

But just wondering if we can get a little perspective as to what we can expect for the non-interest expense over the next couple of quarters?.

Damon, this is Barry. I would say that from a non-interest expense perspective, probably had about $20.5 million. I might pick up the number - another $25 million to $27 million per quarter – or I'm sorry, for the year..

Okay. Is $25 million for the year..

Yes..

Yes, I am sorry okay, $25 million. Got it. And then can we just maybe talk a bit about the margin dynamics? And I think when you take out accretive yield. The core margin was down five basis points on the quarter.

How are you seeing the competitive landscape here? I know you said it was competitive, but how are you see in upcoming quarters maybe now with the way the Fed has paused? And what can we expect with that core margin?.

Yes, Damon, this is Jim. I think Charlie did a pretty good job of summarizing it upfront when he talked about our cost of funds were increasing. And I would say, in the quarter, we played a lot of defense when we came to managing some of our larger balance accounts.

We had a lot of customers come in and talk to our – or tried to talk – or I should say a lot of competitors come in and make efforts to woo some of our better and larger deposit customers away from us with rate.

And so I would say it's hard for me to even enumerate the number of times we had to move rates from say 1% or 1.25% on an account up to 2% and even 2.25%. So I wish I could tell you that that had been abating. We haven't had a Fed increase since December. And so we did not have a Fed increase in the first quarter.

And yet I would say we were playing as much defense in the first quarter as we've played all in 2018..

Okay..

So that’s kind of give you some color for what we're seeing..

And you don't really expect that to change in the next couple of months?.

Yes. Well, I would like for it to change. I see nothing in front of me that indicates to me that it's going to change. And Charlie mentioned, yield curve too, I think that's the other thing for our balance sheet. It's positioned like ours. We've got roughly 70% of earning assets that are pricing somewhere in three to five-year sector.

Since the end of the third quarter, we probably lost 75 or 100 basis points on the curve, as Charlie said, in terms of flatly with Fed increasing once and term rates coming down. So I think it's going to be a challenge for us moving forward. So that's about how I see it right now..

Okay, fair enough.

And then, Charlie, you kind of reiterated your full-year outlook for loan growth, any particular asset classes that are showing better opportunities than others?.

I would say that if C&I and commercial real estate would be the primary tool.

One of the things that – we have been getting a little closer to our internal guidance on that on our occupied commercial real estate and bringing American Trust on, they have – that percentage of our total portfolio will actually go down, because American Trust tends to be more of a C&I bank, although they do have commercial real estate.

So I think the primary drivers of that are going to be C&I and commercial real estate. Certainly, C&I out of Denver and little C&I out of Iowa City and commercial real estate out of the Twin Cities and Iowa City..

And Damon, this is Kevin Kramer. I'll also add, some of the new bankers, new talent that we've been able to bring on in the Twin Cities and other parts of our market have been C&I-focused. So we'll start our mix of commercial ops focus on C&I continues to improve..

Great, okay. That’s all I had for now. Thank you very much guys..

Thank you, Damon..

The next question comes from Jeff Rulis with D.A. Davidson. Please go ahead..

Thanks. Good morning..

Hi, Jeff..

Good morning, Jeff..

Good morning, Jeff..

I guess, first question is on – and I'm sorry, I hopped on a little late, but the – if you could talk about the flood impacts in the region and maybe your exposure, if you can range-bound that from what you're seeing?.

Actually, most of the flooding was in Southwest Iowa where we have no offices. There could be a little bit in Eastern Iowa as the – depending on the spring ranged, but I don't think we have a lot of exposure to flood. I mean, I don't see any. I'll let Gary may have better knowledge, but….

Yes. Jeff, this is Gary Sims. We did survey our Ag bankers, and we don't have any exposure to that Southwest Iowa area that experienced that primary flooding..

Okay. Well, thank you. And just wanted to dig in a little bit more on the fee income, I guess, expectations for mortgage to come back.

But overall, could we talk about run rate or path of potential kind of for the full year where you see that figure headed either broadly or more specific?.

This is Barry, Jeff. As we stated, looking back probably the fourth quarter of 2018 where we were $5.8 million for fee income is probably the closer estimate of the run rate..

Okay. So that's kind of a core figure, $5.8 million. And maybe growth off of that or notwithstanding ATB, but the legacy – would you think that $5.8 million kind of expands from there or….

Yes. No, it's a good point, and there's room for that. I think there's some swap – there's some opportunities for swap income that could move that higher for sure. And there are a couple of transactions that are in the pipeline right now, I'm not sure that closed yet, but they are certainly being contemplated and discussed with the borrowers.

So yes, there is room for growth off of that and especially in the Home Mortgage Center, because it is their busy season. And so yes, obviously, there would be room for growth off of that..

Jeff, this is Kevin Kramer.

The only thing I would add is we've made some investments in technology as well from a service charge point of view that will allow us to better customize pricing, and that will add to an increased opportunity on the service charge, especially commercial service charge platform that we've been able to implement in prior years..

Okay. That’s good color. Thank you..

[Operator Instructions] The next question comes from Brian Martin with FIG Partners. Please go ahead..

Hey, guys..

Hi, Brian..

Hi, Brian..

Hi, Brian..

Just a couple of things for me just as it relates to the closing on the transaction, Charlie or whomever. Just kind of the – just to add for the fee income and expense for the acquisition, can you kind of just give an idea of what the add is broadly for the fee income component of AT and then the expense side.

And then just when the conversion is, so when you actually convert it, so we know when there's clean quarter from an expense standpoint. I think earlier someone mentioned maybe fourth quarter, but just want to kind of look at that conversion.

I mean, what AT brings for those buckets?.

Yes, I'll give you the easy part on the conversion. They have two banks. We're going to convert the smaller Wisconsin bank on May 20, and we're going to convert the Dubuque bank on July 15 – in the middle of July. So that's when we convert, but they become part of our company, obviously, on May 1. So I might let Barry – are you ready to answer that or….

Yes, on the fee income side, probably around on an annual basis about $12 million sort of fee income..

Okay.

And then the expense side, I think you said was the $25 million you said earlier, was that just the remaining balance?.

It's not the annual numbers, though for the balance of the year, and again, not including merger-related costs. Let’s call it, probably somewhere in the $7 million per quarter addition, again excluding merger-related costs..

Okay. So the $25 million was just three quarters. It wasn't the full-year. I was just trying to make sure I had the right annual numbers.

The annual numbers are more like the $28 million it adds to the expense for the year?.

Please remember we ended $26 million, $27 million range. Yes, $28 million..

Okay, perfect. Okay. And then just, Charlie, you talked – you mentioned the part about the provision in kind of the guidance. I mean, even though the first quarter was a bit higher and you expected to step back.

Were you suggesting that the guide that you had kind of given, the 4% to 6% is still a good level to think about?.

It's an appropriate level to think about. And some of it depends on how much progress we continue to make, but we feel very comfortable with 4% to 6% for the whole year..

I got you. Okay. And then maybe one just for Jim on the margin. It sounds – I mean, you referenced in your remarks, Charlie, about the margin being the greatest decline this quarter and really not abating.

I mean, it didn't sound like, I guess, the outlook is still just in the core margin is lower based on what you're seeing today and maybe just less of a decline going forward? Or maybe not – you're not stating that, because it sounds like it's not getting better.

So could it be another 5 basis points or would that be out of the question as you guys look at it today?.

Brian, this is Jim. As you suggest, 5 basis points seemed a little bit big to me for a quarter. I would not expect that we're going to see – that that's going to represent kind of new norm in terms of our margin.

But I do think we will see some, but I think five basis points a quarter is probably too much to anticipate in terms of – I hesitate somewhat to give you a number, but somewhere between zero and five, how’s that?.

Yes, that's fine. But I guess, bottom line, as you might think – if the Fed is on pause, you might see a little bit of easing of that pressure in the back half of the year or maybe second quarter is still a little bit higher, but it could level out a little bit after that..

Yes, I would – a lot of it's going to depend on just the competition in our marketplace and what we have to do to react to keep large deposits. I do think the CD book, which is $700 million – almost $750 million, $27 million in the quarter, we – the rate of increase on that will slow down, because we're close to the terminal value.

That's a portfolio that turns out pretty quickly. And so we'll quickly move and then we'll slow down in the next, I would think, quarter or two this year, slowdown the CD book increase..

The other thing, Brain, just to remind you and the others who are on call that American Trust margin is nowhere close to ours. They're running right around 3%, give or take, maybe even a little less than 3%.

And I think it's fair to say that we have modeled a slow, but sure expansion of the legacy American Trust margin as well, because I just think we'll focus on that maybe a little bit more. And we foresee some improvement, but we're going to just – when you put the two together, the – our margin is going to go down, because our margin is lower..

Okay. Yes. And that's helpful. Okay, I appreciate that, Charlie. And then maybe just you talked about the branch closure and the savings that comes from that. When do you begin to start to see some of that flow through? I didn't hear when you're closing the branch. Maybe I missed that..

Yes. And I apologize, I should have said that. We plan to complete that project at the end of this quarter. So it should be a relatively clean run rate in the third quarter relatively. Could be a little bit lingering, but all of it's going to be done in June and there may be some carryover expenses into July. But the annualized savings are $250 to $300..

Okay. That’s helpful. And then just last one on expenses. So if you have the conversion, I guess, made in – I think you said June and July. Fourth quarter would be the best way to think about a clean quarter from an expense standpoint..

Yes. This is Barry. I would say the fourth quarter would be again fully – got the best quarter for the clean run rate, yes..

Yes. Okay, all right. I think that’s all I had guys. I appreciate it..

Yes. Thank you, Brian..

This concludes our question-and-answer session. I would like to turn the conference back over to Charles Funk for any closing remarks..

Yes. Thank you, Jacob. Well, thanks for everyone – to everyone for being on the call this morning. And as always, if there's something we missed or you need further information or questions answered, please don't hesitate to give any of us a call. So this concludes our call, and thanks again for joining..

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