Good day and welcome to the MidWestOne Financial Group, Inc. Second 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 now like to turn the conference over to Charles Funk, President and CEO. Please go ahead..

Thank you very much, Alyssa, and good morning or good afternoon.Today, I want to begin by reading the forward-looking statements message.

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.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.With that, obviously, there were a lot of moving parts in our financial statements this quarter, certainly more than usual. We'll try to walk you through these as best we can.

But overall, I would say, this was a quarter of progress in many respects in our Company, both with the merger and with the legacy bank.Just to go over reported results, the reported results showed an ROA of 101 basis points, 13.3% return on tangible equity, 63.3% efficiency and $0.72 per diluted share.

If we only take the merger-related expenses out, these numbers are 125 basis points ROA, 16.3% return on tangible equity and a 56.2% efficiency ratio, and we calculate $0.88 per share -- per diluted share.We also have two onetime items or relatively onetime items that should be noted.

Clearly, the sale of MidWestOne Insurance where we realized a $1.1 million gain was a onetime item. And the MSR write-down, mortgage servicing rights write-down of $507,000 was certainly a larger than anticipated amount.

And just for the record, that write-down was about 50-50 between MidWestOne and American Trust.So, as you can see, it was a busy quarter. If we look at the balance sheet, loan growth was relatively flat for the quarter. Generally, as I said in the earnings release, the rural regions in Iowa, Minnesota and Wisconsin showed net paydowns.

Some of this involved working problem credit out of the bank, which is a good thing. And we did show continued growth in Denver and the Twin Cities.

Though the Twin Cities is a little bit more uneven, in the Twin Cities, we have two regions with nice loan growth for the year and two that are either flat or down.Denver has gone well above the $100 million mark in loans outstanding, which is -- and they continue to do very well and we're seeing better loan growth out of Iowa City than we've seen for several years.I would say, we have a decent pipeline for the second half of this year, but we also see a few more paydowns coming.

We're also seeing very aggressive credit terms in few of our markets. And over the last 30 days, we passed on a few credits due to competitors pushing the envelope and we weren’t willing to push the envelope quite that much.Certainly a bright spot on our balance sheet has been the growth in deposits at legacy MidWestOne.

Legacy MidWestOne is up more than 4% from year end, and that’s not annualized in deposits, and up 1.5% for the second quarter. And every region in our Company has shown positive growth in deposits. And over the long term, we think that's a very good thing.The strongest markets for deposit growth have been Iowa City and Florida, as well Denver.

And I will say that the team in Denver has had a few big deposit wins that will hit our balance sheet in the third quarter as that market continues to be disruptive a little bit. I think, we have a good story of a net interest margin in a certainly a tough interest rate environment, given the slope of the yield curve right now.

Of course, the headline margin of 3.68% includes discount accretion. We calculate our core margin, which would exclude purchase accounting adjustments, would be 3.45% and decline 3 basis points during the quarter.I would also note that due to the acquisition, we took on increased debt at the holding company.

And so, between the bank loan that we have, the assumed sub-debt and troughs, we calculate that cost as 6 basis points of margin. So, that means at the core bank, we actually have an even better story relative to net interest margin.

So, I would say, that’s a positive story.On the margin, last thing on the margin, there were three things that helped our margin stabilize.

Number one, it's just a mix change, which we expected because of the higher loan to deposit ratio from the American Trust acquisition, but also we did identify $40 million of negative leverage that was on their balance sheet, and we eliminated that leverage before the merger. That had a significantly good impact.

And we also restructured their investment portfolio by selling almost every bond in their portfolio and reinvesting in bonds that are more -- have a little bit more yield and certainly in line with what we’ve done traditionally at MidWestOne.

So, again, good story on a net interest margin.On noninterest income, I think, the big thing is that we're very pleased to see the increased contribution from the Trust Department in the Dubuque.

There has been a good customer retention thus far, and the margins in their trust department are very close to where we would like them to be in the long-term, very, very positive.Investment services is having a strong 2019. I think, recently recorded the best month they’ve had in their history.

And they brought over three brokers from American Trust, which will help that area of our Company do even better going forward.Net of the MSR write-down, mortgage had a strong June above budget, and they have a very good pipeline in July and August.

And again, I want to remind everyone that American Trust has a very strong mortgage team, and we look forward to their contribution going forward. And that team is intact after the merger.Our noninterest expense, again a good story. Legacy MidWestOne had been making some progress in expense reduction.

I think, it's fair to say that progress is on hold for a few months as we go through integration, but we will continue to work at that as we go through the year. But I think, the big story is the cost saves from the AT acquisition. We think we’re well on the way to -- for 30% cost saves, which is what we said we would whenever we announce the deal.

We have no reason to think that we won't achieve that goal.And I think, on noninterest expense, before we get too excited, we still have to wait a quarter or two and see where everything settles in. But what we see right now would lead us to be very encouraged for the future.

And I think, it's fair to say that we’ve gained positive operating leverage going forward.On loan quality, again, a positive story. The provision at the legacy bank was $700,000 for the quarter, and that puts us back very close to our 2019 budget in the legacy bank. All of our charge-offs came from previously identified credits.

And it's important to note that they were marked appropriately, and you could see that because there was a little bit of recovery as well, a little over $0.5 million during the quarter.External and internal loan reviews have seen minimal, if any, ratings difference with management. That’s always a positive thing.

Most of the questions we get on credit or about the agricultural economy, I think we have a little better story to tell this quarter. And I will give you a few numbers and speak slowly, so that those of you that are recording can get them all down.We now have 9.5% of the portfolio in ag with the addition of American Trust.

So, American Trust had a little higher percentage of ag loans than legacy MidWestOne. If you look at legacy MidWestOne and you look at the ag portfolio, we had one downgrade and we had one upgrade, during the quarter.

So, that's been relatively stable.If you look back one year and you look back to June 30, 2018, 23.4% of the portfolio was either watch or substandard. That number today is 19.2%. It’s a little bit apples and oranges because American Trust is in the 19.2%, and I think American Trust portfolio is of slightly higher quality than legacy MidWestOne.

But, overall, I think, a stable to slightly improving picture.Notably, AT has more dairy exposure. So, now, at the combined company, about one-sixth of our portfolio has dairy exposure.

One thing to -- that’s very important is that American Trust did a very, very good job of getting FSA guarantees in their dairy portfolio, and they were used extensively. And for those who are familiar with FSA guarantees, that limits the credit risk to the bank. And I think that was very prudent management by AT.

AT also has some cattle exposure, mostly the smaller operators, most -- less than a 100-head. And many of those credits are secured by ag real estate as well as the cattle, and very few credit concerns right now in that portfolio.In terms of growing conditions, Iowa probably a little bit better than surrounding states.

Nevertheless, I think it's obvious that yields will be down from the bumper crops that we saw in 2017 and 2018. Good news in the last 90 days, because I think, growers projected cash flows have improved with strength in commodity prices, especially corn.

And some of our borrowers took advantage of the strength in commodity prices last month, specifically corn, to lock in prices above $4 a bushel. And that's a good thing and will probably help them with their forecasted cash flow, going forward. So, I wouldn’t call the situation rosy, but I wouldn't call it dire.

I would just say that it's probably slightly better than it was 90 days ago, but certainly the one that we have to be very, very vigilant in terms of our portfolio.For those that care about land prices. In our region, land price is down 2% in the last year and 13% after 2013 high. And one last thing on credit.

In our legacy portfolio, our loan loss reserve at quarter-end was a 125% of nonaccrual loans. We think that's a strong ratio.Moving on to capital. You never quite know where capital's going to fall out whenever you do an acquisition because of all the purchase accounting adjustments.

But we were presently surprised to see tangible equity at 8.06% at the completion of the merger and quarter-end. We had modeled that a little bit lower. So, that was a pleasant surprise.

And we continue to believe that we have room to selectively repurchase shares and also for future dividend increases.In terms of the AT transition, it was truly a marathon because of the long time between announcement and close. And just to remind everyone, ATP had to dispose off their financial management group before we could close the deal.

That took a little longer than anticipated. And we were finally able to close on May 1st. We converted the Wisconsin, their Wisconsin Bank on May 15th. That conversion went very well. We converted American Trust & Savings Bank in Dubuque two weekends ago. And that conversion has a few more issues.

I don't think it's anything that we can't handle, and we’ve had all hands on deck and a lot of people engaged over the last -- especially over the last 14 days.Very, very happy with the strong commercial bankers that we have in every one of our AT markets.

They've stayed very close to their customers, and I think we could say the same thing about our Trust staff. So, overall, I think there's reason to be optimistic, but clearly a lot more work to be done, especially over the next 90 days.So, in conclusion.

We continue to build on the momentum that we've established this quarter, continue to be positive with the direction of credit quality. And I would thank Gary Sims especially for his leadership in that regard.

And the immediate goal would be to return to a better loan growth path and continue to maintain our deposit growth and bring all of our employees who've come into our Company from ATBancorp into our strong culture.On the call today, in addition to myself, there's Gary Sims our Chief Credit Officer; Jim Cantrell, our Treasurer; and Barry Ray, who's in a remote location, our Chief Financial Officer.

And we would all be happy to answer your questions. There may be a little delay between us because Barry is not with us, but hopefully we can answer all of your questions.And with that Alyssa, we'll turn it back to you..

Thank you. [Operator Instructions] [Technical Difficulty] with the merger, costs there, I get to a core rate of closer to $26 million in the quarter. You’ll have sort of full quarter run rate with ATB in the third quarter, but you talked about some timing of conversions, a piecemeal some of it happening in this quarter.

Just wanted kind of check in to see what that run rate looks like for the balance of the year, and if there are still some outstanding things to occur, maybe even frame up 2020 growth rates on expenses and/or savings, if you could..

Hey, Jeff, this is Barry. I’ll take that one. Yes. So, we estimated the 30% cost save and that was on annual rate of about $40 million to American Trust. And so, what we're thinking given the delay in the conversion this year, we're going to stage that cost savings in at a rate of 50%.

So, I would say, we're probably -- we had about $5.3 million of additional expense from American Trust in the second quarter, which equates to about 8 million per quarter.

So, I would say our run rate for the balance of the year is probably going to be around about -- between $22 million and $23 million total attributable to American Trust.And then, going forward, our additional expense for American Trust, looking forward to 2020, so you get the quarterly expense run rate, additional expense again to about $7 million.

That would be consistent with what we anticipated for the 30% cost saves..

Okay.

So, you’re pointing to a $22 million, $23 million run rate in the third and fourth quarter?.

No. Sorry, Jeff. That’s obviously including the second quarter. So, I would say that third and fourth quarters would be somewhere around $8.5 million a quarter perhaps..

Above the….

Above our -- no, no, no. So, above our 20..

Well, you're a combined company now. So, I guess, if we just take it….

Let's call it 28.5..

28.5? Okay. Fair enough.

And then, if we kind of run that out, and then, what was the 7 remainder in 2020 that’s additional or savings?.

Moving forward to 2020, it would be, let's say, 28.5%, we’d call it $27 million a quarter, Jeff..

Got it. Okay. Thank you.

And then, the insurance sale, do we assume that both out of the fee income, does that go away out of that anything there, and is there an offset on the expense side?.

There is, and we articulated that. It is in the earnings release, but there is -- hold on one second, Jeff. On the revenue side, insurance was about $1.3 million in 2018 and the expense component of that was $1.1 million in 2018..

And then, maybe one final one, if I could, just on the -- Charlie, on the credit.

Just some detail on the increase in nonaccrual and OREO in the quarter?.

Hi, Jeff. This is Gary Sims. So, as we tried to articulate in the press releases, the legacy MidWestOne problem loan portfolio declined slightly for the quarter. But the increase that you see for the quarter is principally the problem loans that we brought on from the American Trust acquisition.

And as Charlie alluded, we did -- they did have a fairly material agricultural portfolio. And most of the problem loans that we brought into from the acquisition was from the agriculture portfolio.

We spend our time since -- as we brought them into the portfolio, we spend our time getting our arms around those problem portfolios, making sure that they were adequately collateralized and the appropriate purchase accounting discounts applied to them.

So, we feel pretty confident in our ability to manage that portfolio to the right conclusion, based on where we are at today..

The next question comes from Nathan Race of Piper Jaffray. Please go ahead..

I want to start maybe on the margin outlook on the core basis. I appreciate you guys did some balance sheet repositioning that helped kind of the core NIM in the quarter.

So, just curious, maybe how we should think about the trajectory of the core NIM in third quarter, assuming we get a Fed rate cut next week? And within that context, curious maybe where you’re putting new loans on the portfolio today relative to that core yield of around 4.77..

Yes. Nate, this is Jim. I will take that one. Everything that I'm looking at, indicates me that -- my expectation is that core margin is going to be pretty flat going forward. Now, that’s in a neutral interest rate environment, which like everybody else, I think, we're expecting that the Fed is going to make a move, I guess next week already.

I think, we're pretty well-positioned for that. My guess is, we're going to be pretty neutral. My experience would say, we will see a downward drift in asset yields because we do have some prime-based loans that are attached that will be affected. But we have some -- a fair amount of offsetting liabilities that our floating rate as well.

So, the impact on that isn't going to be very big. And that could be a small increment down in net interest income immediately, followed by a period where I think we probably earn it back pretty quickly over the next several quarters. So, again, in the long-term, I’m fairly neutral on the margin..

Yes. I would just add to that Nate that in our footprint, we’ve already selectively reduced some deposit rates with the expectation of Iowa. And in Iowa, we’ve got -- we have one primary competitor who is paying up, it was a major competitors, and we’ve not been able to lower our rates in Iowa.

But we would expect, if the Fed does reduce, as Jim says, we’d be able to reduce interest rates more selectively over the near term..

Okay. Got it. I appreciate that. So, it sounds like from a deposit cost perspective, they are likely to peak in the third quarter, assuming the Fed cuts and rates kind of remain at such level going forward..

Yes. I think, you’re right, it’s about the inflection. Third or fourth ought to be the peak in deposit costs, could be -- again, depending on a couple of variables including market competition. But, yes, I think, you are on it. Third or fourth quarter would be my expectation for the top out in deposit rate..

Okay. Got it. And just lastly on loan growth, Charlie, I appreciate your comments earlier. And it seems like payoffs were a headwind in the quarters as well, but you guys have seen pretty good production across most of your footprint.

So, just curious, how payoffs are tracking thus far in 3Q, and if you still kind of feel good about the mid single loan growth target over the back off of 2019 here?.

Yes. I knew somebody would ask me that question. I would say that we still see some payoffs. I just had a meeting this morning and we still have some payoffs, some just a regular course of business, some from borrowers that we’d like to have pay us off. So, between now and the end of the year, I would say, 1% to 3% on annualized growth.

And we will see after little bit of a wider range, we will see where things fall out. We do have potential in some of our metro regions to do better than we've done, but we sort of need to put the paddle to the metal, and I would say 1% to 3%..

The next question today comes from Andrew Liesch with Sandler O'Neill. Please go ahead..

I’ve got an accounting question for you.

Does the expense number, that guidance, does that include the intangible amortization?.

No. That number is not included in the intangible amortization, Andrew..

Got you. So, it was both $930,000 this quarter.

Should that step up here in the third quarter just with the full quarter of the transaction being in the numbers?.

It will. Yes..

Okay. Got you.

And then, trend down from there?.

Yes..

Got you. Okay. Thank you. And then, just, Charlie, deal’s been close now for a few months, just in general, can you just talk about -- and I know you talked about it on the wealth management side.

But, just customer retention at AT, just how is that going, how do you feel it’s going and then, just any update you can provide there?.

I’d say, generally, it’s pretty good. It's never going to be a 100% whenever you do something like this. But, I would say generally pretty good. And I would attribute that to the strong calling efforts, not only from our commercial bankers but also to our wealth management people. It's been a high-priority.

So, probably be a better question for next quarter. But for this quarter, I would say, pretty good..

The next question comes from Damon Delmonte with KBW. Please go ahead..

So, pretty much all my questions have been asked and answered, but, just from a more of a modeling question.

So, those $3.1 million of merger-related charges, could you kind of give us a break out as to where those were in the line items, so we can model those line items little bit more accurately going forward?.

Yes. Hi, Damon. This is Barry. On page three of our earnings release, we articulate what line items that falls into. But, for compensation and benefit, that was $1,020,000, legal and professional is 1,826,000, data processing $240,000 and other had $48,000..

Okay, perfect. I must have missed that. Sorry..

No problem..

The next question comes from Brian Martin with Janney Montgomery Scott. Please go ahead..

Maybe just one question for Jim. Just, you mentioned, Jim, on the margin, the kind of neutrality.

Can you just remind us what variable rate loans you have? And same thing on the funding side, just kind of what the breakdown is, it sounds similar because what -- and what indexes are things tied to?.

On the loan side of the balance sheet, we have a variety of indexes, the biggest single one is prime. Probably just over 20% of the loan portfolio has a prime element to it.

I think, if you look at other variable rate index, be they LIBOR indexes out to as long as one year CMT, I think we would get all that together with the prime, you get to maybe close to 35% of the portfolio. On the liability side, it’s not quite so straightforward. We clearly have some of debt and some liabilities that are tied directly to LIBOR.

But, there, we will subjectively -- as Charlie mentioned earlier, we will talk the opportunity to lower selectively and back down some of the exception pricing that we’ve exercised here over the last two years, as we paid certain accounts with higher rates to get them on board. We will start to reverse that.

And so, I don't have a number for you in terms of the total number of liabilities. But it’s going to be, I would say, quite north of $0.5 billion, about $500 million that I can just think of off the of top my head where we could unwind pricing on pretty quickly, if we need to..

Okay. And I guess, Charlie, maybe just to your point on the deposit growth.

What's been driving the growth in kind of the legacy markets that you guys have been seeing?.

Focus, I mean, that would be the biggest word. I think, those of you that have been on these calls for a while, know that we talk a lot about deposit generation. And I think, the focus has been goods in most of our Company. And for example, I believe, our Florida market has been flat for about 12 months, and they are up 8% or 9% in deposits.

And we did some things down there, not necessarily tied to rates, but we did some things and have started to see deposit growth. Same thing in the Twin Cities. Hiring David Lindstrom to lead our retail effort has been terrific. Our retail group has been up, depending on what your timeframe is, I think we're up from 4% to 6%.

And they just do a better job of cross-selling and increasing wallet share. And I think, maybe lastly or maybe two more things.

Iowa City really has turned the corner and is doing a very good job in both retail and commercial of getting deposit business.And then, finally, last but not least, as I mentioned in my opening remarks, what we're seeing out of our Denver team and some of the relationships, they are bringing in seven-figure relationships at a reasonable price.

And they are doing it through wearing out the shoe leather and calling on people. And we have a wonderful treasury management person out there, who is a pretty good closer when you get her in front of customers. So, it's not any one thing. But I would say, it's just focus.

And we have to continue to do that because as my predecessor in this Company often said, we’ve got to raise deposits because we'll always find ways to make loans and make good loans, but we have to fund them with core deposits..

[Technical Difficulty] kind of now with the transaction close and having a couple periods of time, could you kind of frame out the similar outlook on the fee income, as you guys look in the back half of this year and then into next year with AT in there?.

Yes. I think what we see and what we initially were thinking, Brian, on the fee income was we're going to get around $2.8 million to $3 million additional lift from the American Trust. What we saw in the second quarter, which was two months of American Trust operations, was about $1.8 million.

And so, just with that that would equate to about $2.7 million per quarter, so pretty close to what we were anticipating. And I think, that's -- unlike the expense side, which is more difficult to assess at this juncture, that should be fairly consistent, I would think..

And lastly for Charlie, just credit wise, Charlie. You talked about the provisioning and the decline this quarter kind of getting back to where you want on the legacy bank.

Can you just talk about -- are you seeing anything in credit that's causing a concern or the -- because you kind of look at the run rate on provisioning going forward, I guess, how do you see that unfolding the next couple of quarters or 18 months, whenever, however you want to frame it?.

No. I think we have -- we still have a few more things to work through. But one of the things I'm encouraged by is that when we're discovering things or looking at things, they're on smaller loans than we have -- than looking at previously. I think the outlook is reasonably good.

There will be a few more things to work through, but I think that things we can manage, and Gary you can answer that if you like..

Yes. The only thing I'd add to the thought there is that over the course of the past few quarters, we’ve -- as a company, as a group, and as a culture we've gotten better at recognizing our challenge credits earlier, and then, once they are recognized, creating more proactive workout strategy.

So, I think that's what you're seeing in terms of directionally. We are going in the right direction in terms of managing the credit quality of the portfolio..

The next question comes from a follow-up from Nathan Race with Piper Jaffray. Please go ahead..

Yes. I appreciate you guys taking the follow-up. I just want to ask on capital. I think, you have alluded to the fact that maybe TCE came in a little higher than maybe what you guys are anticipating.

So, just curious, how we should think about the buyback and keep it, some excess capital kind of as dry powder for potential acquisition opportunities and so forth?.

Yes. It's a good question. I think, the way we should look at that is that we've always said that our desired capital range on TCE has been 8 to 8.5, and we're certainly happy to go below that from time to time. We anticipated going below that in this acquisition, it just didn't work out that way.

In terms of buyback, repurchase activity, we certainly are willing to undertake that when we think the stock is at attractive level. And clearly, over the last six months, we think the stock has been at an attractive level, and we've exercised that as we were able. Hope that answers your question..

Yes. No, I appreciate that. That's helpful. And if I could just ask one more on the tax rate going forward.

I assume with some additional ATB acquisition related expenses likely in the 3Q number, how we should think about the tax rate in 3Q and 4Q as well?.

Yes. Nate, this is Barry. I'll take that one. I think, we're probably a little bit higher than what we've all been in the past. Probably in the 22% to 23% range would be what I would use, Nate..

And does the tax rate jump off as those onetime expenses go away in 4Q?.

We're also seeing the fact that taxes into income as a percentage of total revenue is dropping. And so I do think that the rate’s going to be probably a little bit higher, get past the 22% range..

The next question is a follow-up from Jeff Rulis from D.A. Davidson. Please go ahead..

Thanks. Just a quick housekeeping item.

The loan revenue is where you book the mortgage banking, correct?.

Yes. That's correct, Jeff..

And then, that is -- is that 648 reported, was that a net number of MSR hit?.

Yes. The MSR write-down is embedded in that loan revenue number, Jim..

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

Well, thanks to everyone for being on the call today. And for those of you who wish to follow up, please feel free to follow up with any of us who spoke on the call today. And we would wish you a good day and a good weekend. Thank you, Alyssa..

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