Good day, and welcome to the MidWestOne Financial Group First Quarter 2021 Earnings Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note, that this event is being recorded.

This presentation contains forward-looking statements relating to the financial conditions, results of operations and businesses of MidWestOne Financial Group, Inc. Forward-looking statements generally include words such as believe, expects, anticipates and other similar expressions. Actual results could differ materially from those indicated.

Among the important factors that could cause actual results to differ materially are interest rates, changes in the mix of the Company's business, competitive pressures, general economic conditions and the risk factors detailed in the Company's periodic reports and registration statements filed with the Securities and Exchange Commission.

MidWestOne Financial Group undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances after the date of this presentation..

Thank you very much, Cole, and good afternoon or good morning as the case maybe to everyone, and thank you for joining us today. In the room with me in Iowa City, I have our Chief Financial Officer, Barry Ray; our Chief Credit Officer, Gary Sims; President, Len Devaisher; and Treasurer and Chief Investment Officer, Jim Cantrell.

A few opening comments. I would just say that clearly it was a great bottom line quarter for MidWestOne, the best in our company's history. And it's fair to say that we've never quite gotten to a result such as this in the way we did, and we will talk about that a little bit more as the call goes on.

First thing I should say is that our listeners will recall that we did take a very, very large provision for credit loss in the first quarter of 2020 that was related primarily to our adoption of CECL, as well as the pandemic and the economic forecast caused by the pandemic.

And other than the negative provision and there is more of that to come later. I think the biggest stories of the quarter were continued inflow of deposits were clearly a wash in cash in our company and in our economy.

We had solid non-interest income led by our mortgage center and wealth management and the PPP ramp up and, of course, the negative provision, which somewhat makes up and counteracts the large provision that was taken in the year-ago quarter.

On the balance sheet, deposits as I've said, continue to flow in and it's very apparent to all of us that a portion, maybe even a large portion of the stimulus payments and the PPP forgiveness payments have yet to be spent and are sitting in our bank in core deposit accounts. In terms of loans, loans ex-PPP, we are down roughly 4% linked quarter.

We noted in the earnings release that our line usage fell by almost a third from the prior year quarter. We are seeing brutal price competition and to give you an idea of some of the price competition we are seeing, we are seeing two handles on five-year loans in parts of our footprint for strong credits.

We are also seeing fixed rates that are in the low-three's, if not 3% for 10 years and in some cases, 15 years. And we are seeing a little bit of relaxation in underwriting standard. And I would just say that this is the banking industries response and trying to put all of these excess deposits to work.

So nothing unusual there, but it is – its brutal competition for good loans right now..

And we will now begin the question-and-answer session. And our first question today will come from Brendan Nosal with Piper Sandler. Please go ahead..

Hey. Good afternoon, everybody.

How are you doing?.

Hi, Brendan..

Hi, Brendan..

Just want to start off here on kind of the reserve in provisioning. So for two quarters of pretty large negative provisions, your reserve is still really, really healthy at that $63 ex-PPP. As I kind of think about where you would have been with CECL before COVID, I think it was at 96 basis point reserve after adopting CECL.

So just given how the year is shaping up, how do you think about your provisioning needs or maybe lack thereof and kind of where the reserve is headed over the next couple of periods?.

Hey. Brendan, this is Gary. I'll start to answer the question and then ask for my colleagues to help me out if I miss anything.

I think you're seeing kind of our view of the reserve appropriately as we've – as the economic conditions have improved and as our credit quality has stabilized, we've taken a position that we're more comfortable with our reserve position and adequately reserve and as a result, that's why you see the releases..

Yes. I think that's sufficient. Maybe just one more thing, Brendan. We've always thought and this goes back a decade or more and acquisitions have skewed this from time-to-time.

But for a bank like ours, under normal economic conditions, if we're in the 140 to 160 range in terms of the portfolio – the reserve to the portfolio, that's usually a comfortable range for us..

That's a good point, Charlie. The range that you land in there is kind of going to depend upon your view of the economy at that point in time. And as the economy continues to improve, our view improves as well..

Yes..

All right. Great. That's helpful. Maybe one more for me. Just moving to kind of the loan side of things. I guess that demand sounded quite soft this quarter, but I'm curious speaking geographically, what parts of the footprint this quarter we’re kind of seeing some of the more robust demand versus what pieces we're seeing in software demand..

Yes. Brendan, this is Len. So we are continuing to see where I see pockets of strength. I see activity in the Twin Cities. Continue to see consistency in Colorado and Denver. And then I would also point to here in our home market of Iowa City, I see some nice signs of strength..

All right. Thank you for taking the questions..

Thank you, Brendan..

And our next question will come from Jeff Rulis with D.A. Davidson. Please go ahead..

Thanks. Good morning..

Good morning, Jeff..

Hey, Jeff..

Charlie, you alluded to – and makes sense, the margin direction pretty dependent on yield curve and loan growth, but I don't know if that environment – you've had a pretty stable margin in the last couple quarters.

So the thought is, are you – you have some confidence that you're kind of bouncing along the bottom and from here, if you do see further yield curve improvement or loan growth pickup, it's more of an expansion. And until that point it's kind of holding the line on margin. Just want to make sure I get your expectations on the margin side..

Yes. I would repeat what I said and then I'll let Jim dive into that a little bit. But I really do think that loan growth is key and the – I don't think we've watched the slope of the yield curve as closely as we do now for many years.

And specifically, we're looking at that three months to five-year portion of the curve, and when it steepened maybe a month ago or six weeks ago, that was really a good thing for us. When it comes back in, it does make a difference in terms of the yields we're able to buy. But I'll let Jim expand on that a little bit..

Sure. Jeff, I would say you’re right on it. We've had a tremendous shift in the asset mix and that has had implications on our margin. I think on a go-forward view, I could see us bumping along the bottom here for a little bit, but that view is predicated on a couple of things.

One is that we don't see additional deposit growth and that deposit growth has really forced us to put on assets at a much lower margin than we would normally do in the last year. So assuming that we see sort of a stability on the deposit side of things, then I think we're into a period where we could see a fairly stable market.

The one item that I know that's coming due that will have an impact on that, and this kind of gets away from core margin a little bit. But we do have some PPP loans on the books that will be forgiven. That'll sort of offset some of the loans that we're expecting to come on. So it depends on that, how that interplay works out a little bit.

But that's kind of the long-winded answer to – I think we're in for a bit of stability on the margin..

Okay. Appreciate it. And maybe a question on the fee income front. A pretty strong wealth management result. Just looking over the balance of the year, Charlie referenced, I think we all think that that mortgage banking has been strong and maybe it still got a tail. But maybe that fades a bit.

I think you talked about some swap potential later in the year. So that all up, a strong wealth management, is that going to continue? But as you see that it's a pretty high number on the fee income for this quarter and thoughts of the sustainability..

Yes. Well mortgage, any of us can guess on mortgage, it's dependent on the economy and interest rates and affordability and all those things. In terms of our trust and wealth management, we typically budget in the 5% to 8% range in terms of fee income growth and more often than not, they're able to hit that.

Sometimes they do a little better, sometimes they do a little worse, but that's kind of what we expect from them each year. And of course, the direction of equity markets has a big impact on that. So that's what I would offer Jeff on wealth management.

And I do think there will be some commercial swap activity at some point this year, but that's dependent upon us to get to the finish line on the loans..

Sounds good. Thank you..

Thank you..

Thanks, Jeff..

And our next question will come from Terry McEvoy with Stephens. Please go ahead..

Hi. Thanks. Good afternoon, everyone..

Hey, Terry..

Hi, Terry..

The question is, is there any indication out there that deposit growth is slowing? And then if I look at the deposit balances in the first quarter, I'm just curious that jumbo deposit is up, call it $90 million, and given the 70% loan-to-deposit ratio.

Just curious where that jump came from and maybe why there wasn't some thought putting in – put into maybe shrinking some of those higher costing funds..

Terry, this is Jim. I'll take a crack at that one. There has been a little bit of swap growth in the first quarter. I think what we've seen in the latter part of the quarter and now into the second quarter that is sort of a slowdown in some of that growth. Specifically, some of that growth took place on the public fund side.

We've been able to bid on public funds and we’ve continued to bid on some of our local public fund depositors, but at rates that are very – what I would consider attractive. 30 basis points for one-year money as an example. And so we have maintained a bid for that type of deposit.

In terms of kind of the non-maturing business or consumer deposits, I think they've been relatively flat in the latter part of the first quarter. And so my expectation based on that short period of time is that we'll see a flatness.

We had originally thought that the PPP forgiveness might cause a little bit of exodus of deposit as some of those businesses took some of those excess funding and distributed them. Haven't seen that yet. That’s still kind of in the back of our mind that that could be a coming event later this year..

And then as a follow-up, mortgage has been strong and it sounds like that's going to continue over the near-term. I guess my question is assuming rates go higher in mortgage revenue declines.

Could you just talk about any flexibility you have on the expense side? Just so as we model out the next couple of years, we may capture some of the expense reduction that would occur in theory if revenue does come under pressure..

This is Barry, Terry. I think with respect to the flexibility that we have on the expense side, part of the things that we're looking at right now is really the – our branch network infrastructure and where we have opportunity there. I would say that's going to be at least one lever that we have to pull.

But I would also say that, we know we're going to have to continue to invest in technology as well. And so, obviously, we continue to diligently monitor expenses and I think the first quarter results show that..

And I would add to that to you specifically to your question. We might not take the approach that some of our – some of the larger banks take in terms of mortgage and with wholesale reductions in personnel. With that being said, the Head of our Mortgage unit has been in the business for a long time.

And I think that the answer is yes, there would be some rationalization of expenses over time, but it would be done very thoughtfully. If that makes sense, Terry..

A big piece of that – this is Len. The big piece of that of course is a variable comp that goes with the mortgage, right. A big piece of the mortgage comp expense is directly variable with the income..

Great. Thanks everyone..

Yes. Thank you..

And our next question will come from Damon DelMonte with KBW. Please go ahead..

Good afternoon, guys. Hope everybody is doing well today..

Hello, Damon..

Yes. Good afternoon..

Excellent. Great. So my first question just a question on the outlook for expenses. Barry, I think last quarter you guys were saying $29 million to $30 million.

I think that was for the first quarter, but is that how we should think about the future quarters, even though this quarter came in much better than that?.

Right. Yes. We try to articulate as best as we could Damon, in the release some of the nuances in the expense run rate for this quarter. I think if you take a look at that and you adjust for those items that should give you a pretty good sense of where we landed with respect to this quarter again.

For example, some of the positives that we had this quarter was PPP origination costs, which were a benefit. So I think if you adjust for those items, you should have a pretty good sense of where the expense run rate will land..

Got it. Okay. I'll check that out then. With regards to the accretable yield, this quarter I think it was like $1.1 million, which is down from last quarter and down substantially from the previous quarters in 2020.

Should we kind of look at this as the go-forward run rate for accretable yield?.

I would think that’s $1 million a year, Damon is a reasonable….

Quarter..

Quarter, sorry, I said year. $1 million a quarter is a reasonable assumption for the near-term. But again, that slows over time and so probably in the latter half of this year, it maybe slightly lower than that..

Okay. Great. And then I guess just the securities portfolio, it's almost double the size from the year-ago quarter.

I just want to confirm that that's just the kind of reallocation of the liquidity that comes on the balance sheet right? Or did you guys put on some additional leverage inside of that?.

This is Jim. Yes. I tell Charlie, I'm going to start charging him by the regular salary. Yes, that was not a design. It was a reaction to the deposit growth that we had and nothing more than that.

So it was our attempt to put to use the excess liquidity in a thoughtful way as we could, keeping in mind the constraints of the interest rate risk that we're undertaking when we do buy investments, which tend to be a little bit longer. So as Charlie said, we're really trying to focus on mortgage securities that are cash flowing at this point.

That's probably comprises more than 50% of the bonds that we're buying. And so they're high credit quality and just throwing off a lot of cash flow in the event that we're going to need it to fund liabilities that run off at some point..

Got it. Okay. So eventually over time we should expect that to kind of normalize as a percentage of average earning assets and go back to a historical level..

Yes. I mean, again, that's sort of predicated that the balance sheet kind of normalizes as you say and the deposits do flow out at some point and loan growth kicks in. And so we – it's over some period of time, I don't know what period that might be.

But we would expect to go back to a more normal 20%, 25% of the balance sheet in the investment portfolio as compared to where it is now..

Okay. Appreciate the color. Thanks a lot, guys..

Thank you, Damon..

Our next question will come from Brian Martin with Janney Montgomery. Please go ahead..

Hey. Good morning, guys..

Hi, Brian..

Good morning, Brian..

Hey. Just one – a couple for me. Just on – just the M&A and kind of the buyback. Charlie, you touched a little bit on the buyback in your prepared remarks, but just kind of M&A, I mean, there's been a lot of discussions and activity in the market.

Can you just give us an update on how you guys are – how you feel about that today and how dialogue is and just remind us or give us some update on recent period here?.

Sure. It's a good question. I would say that the first thing is on the buyback, as I said in the opening comments, we'll continue to proceed there when we think it's beneficial for our shareholders to do so. In terms of M&A, there's definitely more conversation than there has been. During 2020, there wasn't a whole lot. And there's more conversation.

We don't really have anything that's eminent. But there are some opportunities during the past 60 days that we've looked at and continue to monitor. So yes, there is more chatter and I would say it's – as banks have varying sizes as well..

Okay. And I guess just from a – maybe just jumping to credit quality for a minute.

The positive trends you saw in the criticized and classified this quarter, I guess, would your expectation be that – it sounds as though things are stabilizing and improving on the credit side that there's more of that to come as you kind of look at criticized and classified over the next several quarters, you still see some positive migration there.

Are those trending lower?.

Yes. Brian, this is Gary. And I think that's a good way to look at it. I see opportunity for continued improvement in those ratios over the coming quarters. As we look at the portfolio, we worked through the deterioration that we had and now we're kind of coming out the other end. In each quarter, I think we shouldn't see positive trends..

Got it. Okay. And then just last two for me. Just the – maybe one for Jim.

Just on the margin, on the – when you talk about the core margin, Jim, I think you kind of went through some things last quarter, but when you make your adjustments to – for the accretion and the PPP, I mean, is your belief that the core margin is somewhere in the 275, 277 type of range that type of level, and you just make those adjustments, and that's kind of the core level you're talking about.

Just talk about kind of bouncing around at the bottom kind of absent the noise, it's that level and then make our adjustments on those other two items that are a little bit more volatile..

I feel like Brian, you're looking at my piece of paper here. The numbers, yes, once adjusted for PPP and regular loan accretion, I do get a number that's in the neighborhood of between 275, 280 in that range for core margin in the current period.

And again, we'll see – the future will – that margin will be dependent on a lot of things, including the asset mix and the things we've talked about already..

Yes. Okay. Just want to make sure the right starting point.

And then just – I don't know, just on the PPP, can you guys – do you have the – how many loans were originated in round two and just kind of what the – I guess what the remaining – you gave the remaining fees in total, just what they worked for around one and two at this point or if not I can get that offline.

But just – or that would just be – if you have the round two originations, that'd be helpful..

Yes. We're at roughly 152 in terms of applications right now. And if they run out of money in the next week, that might go up a little bit, but it certainly won't go up materially. In terms of round one, and I'm looking at Gary here, I think if we did 345, I think we're between 200 and 210 maybe that have been forgiven.

And to be honest, there are two things to play there. Number one, we've been surprised that more folks haven't come forward for forgiveness. But also the larger loans, $2 million and over, the SBA has really not acted to forgive them to any large degree if at all. So those two factors are at play.

But 200 to 210 out of 345 is where we stand on round one..

Okay. And then just the remaining fees on round one.

Do you have that ballpark?.

I think on the remaining fees on round one, we put the remaining fees for the whole thing in ..

Okay. That's okay. I'm okay with that. Thank you..

Thanks, Brian..

Yes. Thank you, Brian..

And this will conclude the question-and-answer session. I'd like to turn the conference back over to Charlie Funk for any closing remarks..

Thank you, everyone for being on the call. Stay safe, stay healthy and have a great weekend. Back to you Cole. Thank you..

Thank you. And the conference has now concluded. Thank you for attending today's presentation. And at this time, you may now disconnect your lines..