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1/24/2025
Good morning, ladies and gentlemen, and welcome to the Midwest Corporate's fourth quarter 2024 earnings call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions with instructions to follow at that time. As a reminder, this call is being recorded. I would now like to turn the call over to Barry Ray, Chief Financial Officer of Midwest One Financial Group.
Thank you, everyone, for joining us today. We appreciate your participation in our earnings conference call this morning. With me here on the call are Chip Reeves, our Chief Executive Officer, Lynn Devasher, our President and Chief Operating Officer, and Gary Sims, our Chief Credit Officer. Following the conclusion of today's conference, a replay of this call will be available on our website. Additionally, a slide deck to complement today's presentation is 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 Midwest One 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. Midwest One 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. Good morning, and we truly appreciate everyone joining for this quarter's call. Today, I'll provide a high-level overview of our fourth quarter results. as well as highlights regarding the continued execution of our strategic initiatives. Len will provide an update on our lines of business, and Barry will conclude with a more detailed review of the fourth quarter and the impact of October's balance sheet repositioning. We're very pleased with our fourth quarter results, which exhibited the dramatic impact of the bond portfolio repositioning and the paydown of higher-cost borrowings. Those actions, combined with lower deposit costs, drove a 92 basis point improvement in our net interest margin, leading to a 30% quarter-over-quarter increase in net interest income. This, along with continued focus on our strategic initiatives, led to net income of $16.3 million and a return on average assets of 1.03%. Turning to the continued execution of our strategic initiatives, our premium deposit franchise showed its strength with total deposits increasing 2% compared to the link quarter. And importantly, non-interest-bearing deposits grew 4% on a link quarter basis, aided by our year-long investments in treasury management. In April of 2023, we laid out a strategic plan with emphasis on driving wealth management and establishing an SBA vertical. The results of these initiatives are seen in our fourth quarter and full-year financial results, which Len will discuss further in his comments. For the quarter, loan growth was flat, primarily due to elevated payoffs, many of which were loan resolutions, and you see the classified assets decreased substantially. We're pleased with our 2024 asset quality metrics and remain focused on problem loan resolutions while we continue with our disciplined growth strategy. Thank you to our team members who have been resolute in the transformation of Midwest One and in their commitment to our customers. Together, we've positioned the bank to become a consistent, high-performing company, and we look forward to the opportunities in 2025 and beyond. Now I'll turn the call over to Len.
Thank you, Chip. We are pleased with a 2 percent increase in total deposits from the linked quarter. The true power of our deposit franchise was on display with an improving mix. Continued strength in our commercial and consumer deposit segments has allowed us to assume a more conservative pricing posture on public funds. For the year, public funds in total were down 14%, while public funds CDs were down 40%. Meanwhile, consumer balances were up 2% and commercial balances were up 6%. This mix improvement reflects an intentional strategy to optimize our funding base. As Chip pointed out, non-interest-bearing deposits increased 4% in the quarter. This is the second consecutive quarter of increase in this important category, and the increase was across all customer segments. For the year, commercial non-interest-bearing deposits increased 7%. The growth in commercial non-interest-bearing reflects our treasury management focus. where fees were up 12% in 2024 from the prior year. While reported loan balances were flat from September 30th, we were pleased that pass-rated loan balances grew at a 4% linked quarter annualized rate and that our fourth quarter commercial originations exceeded third quarter originations by 8%. Favorable borrower sentiment and growing pipeline activity position us well for 2025. We anticipate mid-single-digit loan growth in the first quarter. As Chip pointed out, the 54 basis point decline in our classified loan ratio, 150 basis point improvement from a year ago, a decline in past due loans, and a modest CRE ratio at 224% of capital reflect our vigilant focus on asset quality. Congruent with our strategic plan initiatives, our SBA team generated more than $1.6 million of SBA gain on sale revenue in 2024, with $630,000 occurring in the fourth quarter. The momentum in this business remains strong as we enter 2025. Another strategic plan initiative is a focus on wealth management. The 11% increase over the linked quarter and the 18% increase over the same period last year demonstrate continued momentum from our private wealth and investment services teams. Our team-based, planning-driven approach is working, and we see a runway in that business, particularly in our growth markets. Deposit growth with an improving mix. Green shoots and loan demand with plenty of capacity. Momentum in our fee businesses, including wealth, SBA, and treasury management. Indeed, Midwest One's business lines are well positioned as we launch into 2025. So with that, I'm pleased to turn the call over to Barry.
Thank you, Lynn. Starting with the balance sheet on slide 11, total assets declined $316 million from September 30, 2024, due primarily to the deleveraging of our balance sheet from the repositioning executed early in the fourth quarter. As a reminder, that repositioning included the sale of $1 billion of securities primarily corporates, munis, and CMOs, that had a book yield of 1.58%. Proceeds from the sales were used to pay in full for an $18.7 million of Federal Reserve Bank Term Funding Program borrowings that were costing 4.77%, and to purchase $590 million of agency CMO and pass-through securities yielding 4.65%. Lynn covered the loan and deposit changes, so I'll touch on shareholders' equity, which decreased $2.5 million from September 30, 2024 to $560 million as an unfavorable $14 million adjustment to accumulated other comprehensive loss was only partially offset by an $11 million increase in retained earnings. The company's consolidated CET1 ratio was 10.73% a year in 2024, up 82 basis points from September 30, 2024, reflecting in part benefits from the balance sheet repositioning. Turning to the income statement on slide 13, we reported net income of $16.3 million or 78 cents per diluted common share. Net interest income increased 11.4 million in the fourth quarter to 48.9 million as compared to the linked quarter due primarily to higher earning asset yields and lower funding volumes and costs partially offset by lower earning asset volumes. Loan interest income in the fourth quarter of 2024 included 2.5 million of loan purchase discount accretion compared to 1.4 million in the linked quarter. We expect quarterly loan purchase discount accretion in 2025 to be closer to a million dollars. Our tax equivalent net interest margin increased 92 basis points to 3.43% in the fourth quarter compared to 2.51% in the linked quarter. As earning asset yields increased 60 basis points, and the cost of interest-bearing liabilities declined 35 basis points. The average loan portfolio yield for the fourth quarter was 5.86%, flat from the linked quarter, while the average yield on loan originations during the fourth quarter was 7.10%. On the liability side, the cost of interest-bearing deposits decreased 17 basis points from the linked quarter to 2.41%. We expected the balance sheet repositioning would add about 70 basis points to our net interest margin And we were pleased to exceed that expectation as our core interest margin, which excludes loan purchase discount accretion, expanded to 3.26% for the fourth quarter, 85 basis points greater than the linked quarter. Non-interest income in the fourth quarter of 2024 was $10.8 million compared to a loss of $130.4 million in the linked quarter. Adjusting for securities gains and losses and mortgage servicing right valuations, non-interest income was down $300,000 as outperformance from our wealth management business was more than offset by declines in other, BOLI, loan, and card revenue. Finishing with expenses, total non-interest expense of $37.4 million in the fourth quarter was up $1.6 million from the linked quarter. Driving the unfavorable variance was a $575,000 increase in medical claims paid, a $400,000 increase in non-merger-related legal costs, and a $300,000 increase in property tax accruals. We do not believe such costs will continue at those levels in 2025 and thus expect our 2025 annual expenses will be in the range of $145 to $147 million. And with that, I'll turn it back to the operator to open the line for questions.
Thank you. We will now open the call for questions. If you would like to ask a question, please press star followed by one on your telephone keypad now. If you change your mind and would like to exit the queue, please press star followed by two. And finally, when preparing to ask your question, please ensure that your phone is unmuted locally. Our first question today will be from the line of Brendan Nozle with Hovda Group. Please go ahead. Your line is open.
Hey, good morning, everybody. Hope you're doing well.
We're good, Brendan. Hi.
Good. Maybe to start off here on capital, none of the balance sheet restructuring is behind you. You're back to building capital in a pretty decent clip here. So just wondering how you're thinking about deployment options over the course of the year.
Yeah, I'll start with that, Brendan. This is Barry. I like to talk about the use of capital waterfall. So starting with supporting loan growth, supporting balance sheet growth, then the cash dividend, the shareholders' share repurchase, and then finally M&A. We are approaching a target of 11% CET1. We think that's a good ratio for the risk profile of our organization, and I expect that waterfall that I just walked through is how we're thinking about it. Obviously, for example, we kept the dividend flat this quarter. As we move forward throughout the year and build capital, see where we land with respect to opportunities and what we want to do with capital deployment as we go through the year.
Got it. Got it. Okay. Maybe moving to the margin, I mean, as you noted in your prepared remarks, quite a bit more expansion than you or we were expecting, which was great to see. Just kind of curious about the path from here, especially as rate cut expectations have eased off a little bit. More or less wondering if this quarter was a pull through of margin expansion you had expected to persist throughout 2025, or if there's more left in the tank as it moves through the year. Thanks.
Yeah, I think there's a little bit more left in the tank, Brendan, and kind of the data points I can give you is we highlighted that our core margin in the fourth quarter was 3.26%. If you look at the month of December, the core margin was 3.29%. So I think we got a little bit more gas in the tank with respect to margin expansion, particularly we're getting some benefit from the shape of the yield curve, which is really, I'd say mostly flat here. But yeah, I think we still have some benefit here.
And Brandon, this is Chip. I think, you know, the back book loan repricing, frankly, continues as well. Our loan yields are 586. That includes some accretion in that 586. But we're originating in the fourth quarter in the low sevens. So we believe that will continue. And so I We have a fair amount of maturity still coming at us in 25, 26. So we believe there's still some, you call it, gas in the tank margin expansion to come.
Okay, fantastic. That's helpful. Thank you for taking the questions.
Thanks, Brian. The next question today will be from the line of Terry McEvoy with Stevens. Please go ahead. Your line is open.
Thanks for taking my questions. In 2024, commercial loan growth was 5% wealth management revenue, 16% year over year. I know you said 5% loan growth for the first quarter, but is that a good run rate to use for full year loan growth? And what are your thoughts on the outlook for fee income and specifically that wealth management line?
Terry, this is Len. Thanks for the question. As we look at 2025, I think the mid-single-digit number is how we're modeling the year, just based on what we're seeing overall. And with respect to wealth in particular, we are targeting the double-digit growth to continue in that line of business. And the key strategy there for us is the talent story of where we're adding, particularly in the growth market.
And Terry, this is Jim from the loan growth side. So mid-single digits and that belly of the curve with where it is today and obviously increased in the fourth quarter, slight pullbacks here in January, but still relatively high. We're just not seeing really commercial real estate projects penciling out at this juncture. So where I could see that potentially moving higher is if the belly of the curve increases. comes down a little bit, but right now that's negating some of the potential growth that's out in the system.
Thanks, Chip. And then as a follow-up, just given the tariff talk and some of the volatility in commodity prices, could you share with us your thoughts on how your ag customers and portfolio is holding up?
Terry, this is Gary Sims. Thanks for the question. We're thinking through that as well as you relative to our ag producers. As a reminder, not an overwhelming part of our portfolio, but certainly something that we monitor. As we look into, well, first of all, 2024, pretty solid year for our producers. Prices were somewhat moderated, but very good yields. And as we go into 2025, we see pressure as a result of some of these issues. But one thing that we really gained confidence in is that over the course of the past five or six years, the portfolio of our producers that we do business with is a pretty resilient bunch. So we feel pretty confident that we can help our help our customers manage through this if, in fact, there are negative results from it. Great.
Thanks again for taking the questions. Appreciate it.
Thanks, Jerry. The next question today will be from the line of Damon Del Monte with KBW. Please go ahead. Your line is open.
Hello, everybody. Hope you're all doing well today. just wanted to start off with a little bit on credit and kind of I know Gary was just kind of touching on the ag sector there, but just kind of your thoughts on you know, where the portfolio sits today, if there's any areas of concern and kind of how you think about the reserve level at, at this, at this point, I think the reserve is up a few basis points quarter over quarter. So do you feel like you're at an adequate level or do you feel you need to maybe add a little bit more going forward? Thanks.
Good deal. Thanks for the question, Damon. And what I'm seeing from the portfolio today in terms of pressure points really hasn't shifted much over the course of 2024 and going into 2025. Office still has deterioration that we haven't identified in it. Our senior living portfolio has deterioration, but we're actually seeing improvement, operational improvement in those borrowers that have struggled. And realistically, our largest senior living troubled asset, we were able to liquidate over the course of third and fourth quarters. So not a lot of shift in terms of what I'm seeing with pressure points. As we move into 2025, as we saw in 2024, as we identified the credits, we worked through them, we created resolutions, and You saw the results that we got for the fourth quarter. First quarter and beyond, we're going to continue to see resolutions of those assets that we have identified. You mentioned the reserve. We did move that up a little bit. And we feel like what we have on tap for first quarter and beyond for resolutions, we are adequately reserved to be able to execute those resolutions. I think what you saw in 2024, you're going to continue to see in 2025. Got it.
Okay. That's helpful. Thank you. Um, and then I guess just kind of a broader based question on, on your approach for driving sustainable organic growth. Now you guys have made a lot of investments in commercial bankers and kind of ventured into some other business lines. Um, Chip, can you just give us an update as to the plans for 25? Are you guys still actively looking to add new bankers and potentially, um, you know, physical locations and other parts of your footprint?
So, Damon, the answer to that one would be yes, and I'll quantify the yes probably more from geographic areas or areas of focus for you. Twin Cities and Denver and then Iowa Metro are high-focus areas for us, and I think you'll continue to see us invest in those geographies. You'll also see us continue to invest, frankly, in what I call our infrastructure and our acquisition readiness. And there from technology, from platform to talent, risk management, platform, talent, operational talent, as we prepare ourselves for 25 being a year of execution, but between our capital levels, our newfound earnings profile, organic growth that we're expecting. I believe we're positioning ourselves to become a little bit bigger when the time is right.
Got it. Okay. Appreciate that color. That's all that I had for now. I'll cut back. Thank you. Thanks, Damon.
Thanks, Damon. Our next question will be from the line of Nathan Race with Piper Sander. Please go ahead. Your line is open.
Good morning, guys. Thanks for taking the questions. Going back to the margin discussion, Chip, you mentioned some of the back book repricing. I was wondering if you could kind of frame up just in terms of how much in loans you guys have kind of repricing over the course of this year.
Yeah, Nate, I'm going to swing that one to Barry. He has the detailed statistics.
Yeah, Nate, we've got $386 million of fixed rate loans at we expect to reprice over the course of the next 12 months. The coupon on those is 4.57%. So $386 million at 457 is what we expect to reprice.
OK. And then just generally, what are new loans coming on the portfolio at today on a blended basis?
Yeah, fourth quarter we put them on at 7.1%, so low sevens.
Gotcha. If the Fed remains on pause this year, can you kind of just talk us through kind of the CD repricing gaps that you have that could aid in deposit costs continuing to come down, and if there's any opportunities to lower pricing on non-CD products as well, at least over the next quarter or two?
Yeah. of our CD book, Nate, is less than one year. And so, yeah, we see opportunity, even if the Fed remains on pause, to lower the cost of that book as that comes due. And then to the second part of your question, we continue to look at our other non-maturity interest-bearing deposits and where we have opportunity to lower there. You know, we're still actively looking at those costs and looking for pockets to where we could perhaps lower costs, even if the Fed remains on pause.
Okay. And just one last one, Barry. Can you just update us in terms of kind of the balance sheet sensitivity and margin impact from each, if the Fed does cut this year?
Well, right now, our balance sheet models as asset-sensitive with the shock scenarios made. And again, that's plus or minus 100 parallel shock. And so we model as asset-sensitive. So if the rate is cut, that suggests that our net interest income would go down in that shock scenario. However, as I talked about earlier, what we're observing is actually the yield curve flattening out. And so, you know, I think there's still opportunity for margin expansion, but the balance sheet models as assets on a shock scenario.
Okay. Really helpful. I appreciate all the color. Thanks, guys. Congrats on the next quarter.
Thanks, Dave. As a reminder, for any further questions, please dial star one on your telephone keypad now. And the next question will be from the line of Brian Martin with Jenny Montgomery-Scott. Please go ahead. Your line is open.
Hey, good morning, guys. Good morning, Brian. Hey, Barry, if you cover this, I apologize. Did you give some thoughts on kind of the, I know you talked about the fourth quarter expenses, but just how to think about the expense run rate as we kind of head into 25 here and just puts and takes there?
Yeah, in my prepared remarks for this script, Brian, I did talk about what we expect for 2025 expenses to be in the $145 to $147 million range for the year, which suggests $36 to $37 million per quarter for the expense run rate. Gotcha. Okay, I apologize for that.
And then just in terms of fee income, Chip, I don't know, can you give – it sounds like the SBA – You know, really had a nice year here, kind of embedded in the mortgage line or the loan line there. I mean, it also kind of seems like that the mortgage side, the traditional mortgage, you know, maybe it's kind of been flattish, you know. So I guess just trying to understand if I'm thinking about that right. And the other real question is just kind of the areas you talked about in terms of initiatives on the fee side as far as, you know, expanding fee income going forward. can you just talk about outside of, you've talked about the wealth and the SBA, kind of the other business lines you've added this year, kind of, you know, what they've contributed or just, you know, kind of where the opportunity is, is can we think about fee income, you know, next year, you know, outside of, you know, wealth, which you've already covered, but just the, in SBA, but the other line items are potential that we have that get some pickup here.
Brian, this is Len. I'll take a, stab at that. So if you look at SBA as an example, so that number, you know, was 1.6 for us in 24, about four times what it was in 23, over four times what it was in 23. And, you know, if you look back, two-thirds of that number came in the last two quarters. So see good momentum there. So that's a key point on the loan line item, as you point out. The other thing is obviously the mortgage business has headwinds with the rate environment where it's been. But what I would tell you is one of the strategies tactically is to focus on leveraging our secondary market product offerings to make sure we're optimizing that as best we can. When I look at drivers, Wealth obviously was a huge story for us in 24, and I've talked about that. We see more runway there. And then treasury management, you know, the 12% number, which flows through the service charge line, that's 12% in 24 over 23. And I see more runway for us in the treasury management line as well. Then lastly, what I would tell you is, as Chip talked about, as borrowers get a little more confidence and a little more stability relative to CRE. I think our CRE business, we've got room to go there, right? When you just look at our CRE power. And I think that can help drive our swap line because that's frankly been a modest line for us these last couple of years. And I think as the CRE business picks up, I think that can help drive the swap line, too, from a fee perspective. So those would be the drivers I would see.
Gotcha. And, Len, can you talk about, I mean, I guess just give some color, you know, in terms of the outlook for growth in fee income, you know, I guess in terms of how you guys are thinking about that, you know, given some of the items you just went through in terms of, you know, where the momentum may be?
Yeah, so I'm going to say, you know, mid-high single digits is what we would be on a total for the fee income line is what we'd be looking at for 25.
Gotcha. Okay. That is helpful. I appreciate that. And, Barry, just lasting back to just the margin for one moment, the trajectory on the margin, you know, given, you know, the steepening of the curve here and just kind of a little bit of tailwind you have, it If we don't see, if we see a pretty, you know, not much activity from the Fed, the general outlook should be that, you know, given what you've outlined, that maybe a gradual trajectory in the margin kind of throughout the year. Is that how to kind of frame that up?
That's how I would frame it up, Brian, exactly like that. Yep, gradual over the course of the year.
Okay. And maybe a bit of a step down in one cue, if the accretion, I think you said the accretion goes back to around a million dollars a quarter. Is that, I think I heard that right. So yeah, give back starts first quarter.
Yeah, that's kind of how I would, if I start thinking about the first quarter, you know, that's kind of where we talked about the, that's why I was focusing on the core net interest margin, Brian, of 326. And so you start with start there and layer in that kind of million dollars plus of discount accretion or about a million dollars of discount accretion per quarter. And that should get you to kind of a launch point.
Gotcha. Perfect. And I don't know, just big picture comment in terms of profitability. I think obviously you guys were above 1% on the ROA in the quarter. As we think about it in you know, kind of an exit to 2025. Chip, can you kind of talk about where you think that exit is on ROA or just kind of how we should be thinking about that as we proceed through the year?
Yeah, we're extremely focused, Brian, in terms of obviously building that throughout the year. And what we anticipate is that that has the potential with execution to be in the 110 to 115 range as we exit 2025.
Gotcha. Okay. Perfect. Thanks for taking the questions and congrats on the quarter, guys.
Great.
Thanks, Brian. Appreciate it.
The next question will be from the line of Nathan Race with Piper Sandler. Please go ahead. Your line is open.
Yeah, thanks for taking the follow-up. You know, I'm just curious if you can kind of frame up your deposit growth expectations for this year. I know you guys are focused on adding full relationships, but, you know, just curious if you're expecting deposit growth to follow that kind of mid-school digit pace in loans.
Yeah. Nate, this is Barry. I'll take that. Kind of as we have been looking at deposit growth expectations for the year 2025, we're thinking Around 3% is probably what we're looking at for deposit growth.
Okay, great. That's helpful. And then, Barry, can you just update us in terms of the amount of cash flow coming off the bond book this year following the restructuring?
Yeah, next we expect to get around $200 million of cash flows off of the portfolio in 2025, Nate.
Okay, great. I appreciate it. Thanks, guys.
We have no further questions in the queue at this time, so I would now like to hand the call back to CEO Chip Reeves for closing remarks.
All right. Thanks, everyone, for joining us today. And we truly look forward to our April call to share our continued progress in becoming that consistent, high-performing company that we've spoken about over the last few years and began to demonstrate even further with our fourth quarter results. Thanks everyone.
This concludes today's conference call. Thank you all for joining. You may now disconnect your lines.