MidWestOne Financial Group, Inc. (MOFG) Earnings Call Transcript & Summary

Hello, everyone, and thank you for joining us. Today, MOFG announced the sale of Florida operations and completion of strategic acquisition in Denver. My name is Sierra, and I'll be your moderator today. [Operator Instructions] I would now like to pass the conference over to our host, Barry Ray with MOFG. Please proceed.

Thank you, Sierra. Thank you, everyone, for joining us this afternoon. We appreciate your participation on today's call. With me here on the call are Chip Reeves, our Chief Executive Officer; and Len Devaisher, our President and Chief Operating Officer. Following the conclusion of today's conference, a replay of this call will be available on our website. Additionally, a presentation to complement today's commentary is also available on the Investor Relations section of our website. Before we begin, let me remind everyone on the call that 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, changes in the mix of the company's business, competitive pressures, general economic conditions and the risk factors detailed in the company's periodic reports and registration statements filed with the Securities and Exchange Commission. MidWestOne Financial Group, Inc. undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances after the date of this presentation. I would now like to turn the call over to Chip.

Thank you, Barry, and good afternoon. I'm excited to discuss the 2 transactions we announced this week as they represent important steps in the successful execution of our strategic plan. In April this year, we shared the results of our Board's strategic planning discussions, which included a review of our geographic footprint as we reimagined our footprint and allocation of capital within our geographies. Our focus was on improving our scale in attractive markets, targeting our investment of resources and ultimately, accelerating our profitability as we strive to become a high-performing bank producing consistently strong returns. Turning to the summary of our transactions. I'll point to Page 4 of our investor presentation. We've executed a purchase and assumption agreement for the sale of our Florida operations to DFCU Financial, a Michigan-based credit union was $6.4 billion in assets and with prior experience in the acquisition of commercial banking assets in Florida, while also executing a definitive merger agreement for the acquisition of Denver Bankshares, a long-established $272 million asset bank in the highly attractive Denver MSA. While our Florida operations have contributed profit to our bottom line since the acquisition of Central Bank shares in 2015, we have not built the scale or the reach needed for this region to be a growth driver for MOFG. Thus, as announced Monday afternoon, we've chosen to divest our Florida operations and reinvest the proceeds into our Denver market through today's announced acquisition of Denver Bankshares, becoming more geographically congruent while making progress on our goal to achieve the necessary critical mass in our Denver MSA. Importantly, this merger accelerates our Denver market growth by 3 to 4 years, while enabling us to be more effectively recruit bankers to further accelerate our already attractive growth trajectory. The combination of these 2 transactions allow us to reap the benefits of a strong deposit premium for our undersized Florida franchise, while almost doubling our already growing Denver franchise, achieving a reallocation of our growth capital. During our extensive due diligence review of the Bank of Denver, we found our 2 organizations to be highly compatible culturally including credit risk appetite. When coupled with our existing Denver presence, the strength of our Denver leadership team and the small relative size to our $6.5 billion in total assets, we believe this in-market Denver expansion represents a low execution risk opportunity. In a few minutes, Barry will discuss the expected financial impact to our company of these transactions in detail. But in highlight on Page 5 that we believe the combined impact to our capital, earnings per share and tangible book value present strong outcomes, especially given how strategically important this geographic reallocation is to our franchise. We expect to drive meaningful EPS accretion, modest tangible book value per share dilution and highly attractive internal rates of return, all while maintaining solid capital levels, which capital is poised to grow quickly as retained earnings are accelerated. In this environment, as virtually all banks have made core deposit cost and composition of fundamental focus, the Bank of Denver's cost of funds and almost 33% noninterest-bearing deposit mix provides us with additional net interest margin accretive fuel for our growth in this large commercially robust MSA. As we illustrate on Page 7, with 98 basis points cost of deposits over the first half of this year and with a loan-to-deposit ratio below 85%, coupled with the size of the Denver MSA and the highly attractive demographic trends in the region, we believe this acquisition will set us on a path to build a $1-plus billion franchise, high-performing franchise in the coming years. I'll now turn the call over to Barry to cover the key assumptions and projected financial impact of these transactions. Barry?

Thank you, Chip. Page 8 of the investor presentation shows selected accretion, dilution and return measures from the Denver acquisition, both with and without the Florida divestiture. We believe these transactions accelerate our ability to reach our financial objectives as we implement our strategic plan. Focusing on the left-hand column for the combined transactions, tangible book value per share dilution expected at transaction close is a modest 3.7%. Double-digit earnings per share accretion then drives a 2.58 year earn-back of that tangible book value dilution. Further, the strong internal rates of return expected in these transactions drive accelerated capital accretion in future periods, adding to our well-capitalized position immediately following closing. Importantly, these projected financial results stem from what we believe are conservative and achievable assumptions as summarized in the appendix of our investor presentation on Pages 13 and 14. Our bottom-up and phase-in cost savings analysis detailed purchase accounting assumptions driven by extensive due diligence and other conservative deal drivers provide us with confidence of our ability to achieve these results. Pages 9, 10 and 15 of the investor presentation illustrate buildups of both pro forma earnings and tangible book value per share as well as isolated earnings, tangible book value and capital measures, excluding interest rate related purchase accounting marks. With respect to pro forma earnings, the sale of our Florida franchise comes with an attractive 7.5% deposit premium or approximately $11.9 million based on our Florida deposits on June 30, 2023. And our loss of income from that divestiture is eclipsed by the earnings generated by the Denver acquisition. Turning to pro forma tangible book value. As with any all-cash acquisition that incorporates the interest rate marks currently required, tangible book value is diluted at deal closing. However, we view less than 4% tangible book value per share dilution and approximately 2.5 years of dilution earn-back timing as attractive. Now I will turn the call back over to Chip for closing comments.

Thanks, Barry. From a timing perspective, we anticipate the Denver Bankshares acquisition to close late in the first quarter or early in the second quarter of 2024 with the closing of the Florida divestiture to take place in the second quarter of 2024. I would like to take this time to thank our Florida-based team members for their hard work over the years. I'm also very pleased that DFCU is committed to retaining our Florida-based team following consummation of the transaction. Denver Bankshares established by the Rock family has an 8-year history in the market and has built an enviable core deposit franchise, highlighted by a long tenured customer base. While no revenue synergies have been modeled, we believe there are ample opportunities with larger lending limits, additional product lines and a more robust treasury management platform to outperform our modeled financial metrics. Our organization and I personally are extremely excited that Lauri Ratliff, CEO of the company, will be joining our Denver market leadership team, bringing her and her team's decades of relationships to our Denver market. Looking forward, we'll continue to execute our strategic initiatives with a focus on further organic expansion in our targeted markets of the Twin Cities, Denver and Iowa. Of course, we will continue to focus on improving our operational effectiveness and efficiency. I'm pleased to say that we remain on track with previously announced expense reductions as we maintain a balanced approach of investment and efficiency. To conclude, we continue to make substantial progress executing our strategic initiatives and this week's announcements, reflecting our geographic and profitability focus are significant steps towards reaching our goals. Now I'd like to turn the call back to the operator to open the line for questions.

[Operator Instructions] Our first question today comes from Brendan Nosal with Piper Sandler.

Maybe just to start off here, I think in your prepared remarks, you've folks mentioned Denver being $1 billion in asset franchise over time for MidWestOne, is that kind of the scale number that you think you eventually need to hit to really make the most of that part of the franchise?

So this is Chip, Brendan. As I look across our geographies, and I speak in terms of relevance within the marketplace and the internal target, if you wish to call it that, is really $1 billion in a couple of our major metros as well as in the corridors of Iowa. So we have achieved that throughout our Iowa City to Cedar Rapids to [indiscernible]. We've achieved that in Minneapolis, the Twin Cities area, and then that will also be the ultimate target in Denver. Obviously, we move closer to that here with the merger with the Bank of Denver, and then we'll continue to hire bankers and expand that marketplace in the coming years.

Got it. Okay. That's helpful color. Then maybe turning to some of the financial assumptions and outcomes. Just curious why it looks like 2024 is more accretive to EPS versus 2025. Looking it as something to do with the Florida piece because stand-alone Denver deal is more accretive than '25 versus '24, both with and without the mark. So just curious what's driving that?

Yes, Brendan, this is Barry. I believe that it reflects the benefit in the credit loss expense for the -- from the older transaction, so you're spot on.

Understood. Okay. So it will be a lighter provision in '24 tied to removing that on portfolio.

Correct. Yes.

Understood. And perhaps one last one for me before I step back. Just looking at the fair value marks related to interest rates on I guess, most of their loans and their securities. Just kind of curious how many years it takes for those to accrete back into equity via the income statement?

Yes. We expect for the investment securities portfolio, Brendan, it's fairly long-term -- long-duration municipals. I expect that we will sell those bonds and reinvest those proceeds or use those proceeds differently. But for modeling purposes, I believe we have that around 5 years. And then [indiscernible] on the interest rate loan market.

Our next question comes from Damon DelMonte with KBW.

I hope everybody is doing well. Just a question on the interest rate market attrition. I think you noted some of the year digits. Is that correct for 5 years?

Correct.

So as we think out until like '25 and beyond, that $0.26 of accretion expected in '24, so that's going to obviously tail off at a decent clip, right, in '25 as we go forward. And I guess how comfortable are you unable to like sustain the initial contribution from that?

Well, let me answer that a couple of -- let me answer that one way. Let me clarify what I said to Brendan, the amortization of the securities portfolio marks over 4 years, not 5, as I said. And so can you clarify your question, Damon? You were expecting that the accretion tails off in later years. Can you clarify your question?

Sure. So if you're getting a notable accretion here in the first year and then that dollar amount goes down substantially each year thereafter, how comfortable are you that you're going to be able to maintain a similar contribution going forward? I mean is it just an assumption that you're going to reinvest at current rates, which are higher than where the book was marked initially?

Yes.

Okay. Also on Slide 13, I think it was in the footnotes, you made a mention of the deal -- with the deal closing about a net worth threshold, a tangible net worth threshold at closing. Could you clarify what that is the net worth threshold?

Yes. We have in there a net worth threshold of $16 million.

Okay. And what is net worth though? Is that from the family component of the bank basically they can't sell out of their position...

Tangible book, Damon.

Okay. And then Barry, do you happen to have the expected goodwill amount that you guys will be taking under the combined transactions? Do you want circle back on that? That's fine.

Yes. Let me circle back on that one, Damon, thank you.

Okay. I guess -- yes, I guess that's pretty much all that I had. Congrats, it seems like 2 good transactions for you.

Our next question comes from Terry McEvoy with Stephens.

This is Brandon Rud on for Terry. So my first question is on Denver Bankshares. How does the commercial bank platform compare to yours today and where you want to build it out under the strategic plan? And on top of that, I think you mentioned potential revenue synergies. Can you talk maybe about the -- maybe specifically about the opportunities within Wealth Management?

Yes, absolutely. Let me speak to the kind of the commercial banking presence in their loan portfolio currently. As noted at [ 6/30 ], it's about $198 million in loans. They're very commercially oriented or in terms of their loan book as well as their customer acquisition strategy primarily today, commercial real estate and our Denver franchise there is about $400 million in loans. And of that $400 million were primarily C&I. So relatively complementary as we bring these 2 loan portfolios together. Bank of Denver brings us a very nice component in terms of that commercial real estate perspective as well as relationships. But frankly, we don't have quite as much of in Denver. And then I think we'll be able to provide some additional C&I expertise for Bank of Denver itself. In terms of the synergies, the larger lending limits as we spoke with Lauri Ratliff and her team, they have produced a -- here a customer base that we can expand relationship with a larger lending limit as well as from a treasury management perspective or the platform perspective is something that we believe we'll be able to bring to the table and add more as well. In terms of wealth today, we have limited wealth presence in our Denver region, and then Bank of Denver does not offer today wealth services. It is something that we will likely be adding to the franchise in Denver, and we expect that to be very nicely accretive for us.

Got it. Perfect. One of the slides you mentioned a 10% runoff in deposits, I think through 2Q '24. You kind of talk through the thought process there. And will there be any loan run off them either client-driven or is maybe internal de-risking? Maybe is that associated with -- or I'm sorry, could there be some associated with the deposit runoff?

The terrific thing here in terms of derisking a loan portfolio, which you might see in a number of different mergers. Today, the Bank of Denver has 0 NPLs, 0 ORE and almost 0 30-day past dues. So we're very comfortable, and we did a third-party review of the credit portfolio, where we -- our coverage percentage was in the 65% to 70% range. We are very comfortable with the credit risk profile of the Bank of Denver, they're very good underwriters, and they know their customer debate extremely well. And so there will be no de-risking of the loan portfolio, a 10% deposit runoff frankly, in this environment, we're just being conservative in our assumptions or modeling assumptions there. And frankly, our internal goal is obviously to exceed that.

Understood. Got it. And maybe just 2 modeling questions. The first one on capital. Just due to the timing of the deals with the acquisition potentially closing in 1Q and the divestiture in 2Q. I see on slide 8, here, would it be a fair assumption that CET1 and TCE takes a step down kind of at the end of 1Q, looks at about 8.5% for CET1, 6.2% for the TCE ratio. And after the divestiture closes, that adds another looks about 40 basis points of CET1 and 30 to the TCE ratio.

Yes. That's correct, Brandon. That's what we're expecting based upon how we believe the transactions will close. That's exactly right.

Okay. Perfect. Just my last one here is on the cost savings. I see 75% in 2024 and 100% realized in '25 and thereafter. Is that 75% the exit rate of '24? Can you just kind of maybe build on that?

Whenever we modeled the cost as we were looking at their 2023 expenses, and so we're taking 75% of that. So Yes. The answer to your question is, yes, the exit rate of 2024, we'd be at the 75% cost savings target.

Okay. Perfect. Those are my questions. I appreciate your time.

Thanks, Brandon.

Our next question comes from Brian Martin with Janney.

Congratulations on the transactions. Just a couple quick questions for myself. Within the Denver acquisition, can you talk about the -- just what the office exposure is in that portfolio?

Brian, this is Chip Reeves. We do have our Chief Credit Officer with me here in the room, Gary Sims, who can answer that question for you. Gary?

Okay. Got it. And -- the office exposure is $17 million as of our due diligence date.

$17 million, okay. And all of that income of the Denver market?

Yes. It is all in the Denver Front Range market. It is all pass rated. Generally speaking, loan to values were pretty strong on those credits as well.

Brian, if memory serves me correct, I believe there is only one in downtown or one metro office building there, and it was under 50% loan to value. So we became very comfortable with their office exposure.

Yes. Okay. And then -- and then I guess maybe one for Chip. Just on the C&I side, given the smaller size of their C&I book relative to your outlook, your portfolio, I mean, where do you think you can take this -- the portfolio there about 1%. Where do you think you can take that over time? Or what is your expectation on maybe where that book trends over time?

I think ultimately, for the Bank of Denver as we come together, and you'll see that the loan portfolio compositions, obviously in the appendix, we're running far higher in terms of C&I, I would anticipate the Bank of Denver's portfolio. We'll continue to originate primarily commercial real estate or the relationship managers that are coming from -- joining our organization from Bank of Denver. In aggregate, what I would see is that our C&I portfolio would be in the 35% to 40% range over the coming years in the Denver marketplace.

Got you. Okay. That's helpful. And maybe just one last one. Just with what you've done here with Florida and Denver now, it sounds like there's still opportunity to -- looking at the remainder of the franchise in the Wisconsin market, whether that may not be, I guess, a core franchise going forward? Is that -- should we still expect that you're continuing to kind of look at that part of the franchise as well as we go forward here?

I think the other parts of our franchise are all performing nicely and have very nice geographic, I call it, congruency with our footprint. So I believe from a divestiture standpoint, at least for the current period of time that we've done the moves that we're going to do here in the near future.

Okay. So [indiscernible] Wisconsin part of the franchise is core for the time being unless something changes?

Yes.

Thank you for your questions. There are currently no questions registered. [Operator Instructions]

Operator, while we're waiting, I'll circle back to Damon's question. Damon, it is about $10 million is what we expect the goodwill to be from this acquisition. There will be some goodwill established with the Denver acquisition and then some write-off of goodwill associated with Florida. But the net of that is about $10 million. And then finally, going back to your question on the earnings accretion going forward. There's a Slide 15 in the deck that shows earnings accretion of the combined transaction without interest rate marks in 2025, it was about 4%, which is consistent with what we'd expect going forward.

There are no questions reading at this time.

This is Chip Reeves. Thank you, everyone, for joining us today. And once again, I'd just like to reiterate how excited we are about welcoming the Bank of Denver team members and customers to MidWestOne, and we're also extremely excited about these positive steps in the execution of our strategic plan. We look forward to speaking to everybody at the end of October here. Thanks, everyone. Bye-bye.

That will conclude today's conference call. Thank you all for your participation. You may now disconnect your lines.