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Edited Transcript of MOFG earnings conference call or presentation 25-Jan-19 5:00pm GMT

Q4 2018 Midwestone Financial Group Inc Earnings Call

IOWA CITY Feb 4, 2019 (Thomson StreetEvents) -- Edited Transcript of Midwestone Financial Group Inc earnings conference call or presentation Friday, January 25, 2019 at 5:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Barry S. Ray

MidWestOne Financial Group, Inc. - CFO, Principal Accounting Officer & Senior VP

* Charles N. Funk

MidWestOne Financial Group, Inc. - President, CEO & Director

* Gary L. Sims

MidWestOne Financial Group, Inc. - Chief Credit Officer

* James M. Cantrell

MidWestOne Financial Group, Inc. - CIO, VP & Treasurer

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Conference Call Participants

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* Brian Joseph Martin

FIG Partners, LLC, Research Division - VP & Research Analyst

* Damon Paul DelMonte

Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director

* Jeffrey Allen Rulis

D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst

* Nathan James Race

Piper Jaffray Companies, Research Division - VP & Senior Research Analyst

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Presentation

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Operator [1]

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Good day, everyone, and welcome to the MidWestOne Financial Group, Inc. Fourth Quarter 2018 Earnings Conference Call. (Operator Instructions) Please note that today's event is being recorded.

And with that, I'd like to turn the conference over to Mr. Charlie Funk, President and CEO. Please go ahead.

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Charles N. Funk, MidWestOne Financial Group, Inc. - President, CEO & Director [2]

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Thank you very much, Brian, and welcome to everyone this morning from chilly Iowa City, where as we speak, the temperature is 1 degree below 0, we're hoping to make it into positive territory today.

Let me begin with the forward-looking statement that simply says this presentation contains forward-looking statements relating to the financial condition, results of operations and business of MidWestOne Financial Group, Inc. Forward-looking statements generally include words such as believes, expects, anticipates and other similar expressions. Actual results could differ materially from those indicated.

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

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

And with that, thank you, again, for joining us on the call this morning. We have a lot to discuss. I'll move through this relatively quickly to get to the Q&A.

The first thing I think that should be noted is that 2018 was the highest earnings per share and net income in the history of MidWestOne Financial Group. And we think a lot more went right than wrong in 2018. Ex merger-related charges, we calculate $2.54 a share and a return on tangible equity of 12.1%. But that said, we're not satisfied and we expect and plan for improvement in 2019, and I think we'll be able to do that.

To the quarter, just talking about the balance sheet for a minute, loan growth slowed slightly, and especially the last 10 days of the year we spent most of December over $2.4 billion in loans, got a few pay-downs late in the month and that took us just under $2.4 billion for the year on a point-to-point basis.

We had a good start in January. Our pipeline looks decent for the first quarter. We would look at maybe 1% to 2% growth, non-annualized growth. In the first quarter, pay-downs, of course, always being the wildcard.

For the year, we guided last year 4% to 6% and we were right in the middle of that. We calculate point-to-point was 4.9% loan growth. Interestingly enough, if you look at average balance 2017 versus average balance 2018, our loan portfolio was up just short of 7%. So we think we did a good job on loan growth for 2018. And I would have the same guidance for you for 2019 of 4% to 6%, maybe toward the high end of that, but 4% to 6% is a good range.

On deposits, a little bit of a story. I think we made a lot of progress in our deposit raising culture in our company, and our average balances were up for the year between '17 and '18, 4.4% which we consider to be a success. However, at the end of 2017, we had a lot of large temporary deposits in the bank that left shortly after the calendar turned to 2018. We had the reverse happen in 2018 and we had money leave the bank at the end of the year, so the point-to-point is relatively flat. Much of that was in public funds. Our public funds balances were just over $25 million lower at the end of 2018 compared with the third quarter -- end of the third quarter.

So we do have work to do as most banks do in terms of deposits. Deposit competition is keen. It's interesting, we see a lot of our bank competitors now above the FHLB rate in terms of the some of the CD offerings that they're putting out there. So it's clearly expensive to generate deposits in this environment.

So as I said, we're guiding 4% to 6% on loans. Our guidance on deposits would be 4% to 5% for the year. I think deposits, based on what we see now, will be a much bigger challenge than loans. That said, I think we do have plans to continue to increase our deposits to fund our loans.

In terms of net interest margin, I think there is a success story there. Just for information, we still face headwinds from reduced accretion. Accretion added 17 basis points to our margin in 2017. It added 9 basis points to our margin in 2018. We calculate that our core margin absent accretion was 3.53% for the fourth quarter of 2018.

And it's interesting, if you look at our core margin and compare the end of '17 with what happened in 2018, if you adjust for accretion and tax reform, we calculate our margin was relatively flat -- our core margin was relatively flat during 2018, and we think that's very good performance in this environment, especially with the flat yield curve and the deposit competition.

In terms of noninterest income, I think, a decent year. Wealth management was hampered, of course, by the decline in the financial markets and that hurt fourth quarter fees. I would highlight that our Trust Department, especially showed higher revenues during the year and the prospects in Trust especially for 2019 are very, very good.

Much progress in our mortgage unit was massed a little bit by the weaker mortgage markets that we saw in 2018. If you compare our mortgage unit to 2 years ago, it's night and day difference. We've significantly reduced the time to close and we have better pricing -- more competitive pricing and profitability. And we're building a nice servicing portfolio that adds to our income. Our servicing portfolio at the end of 2018 was $477 million, which is up significantly from a year or 2 year ago. Interestingly enough, when we bring American Trust fund, which I'll talk about in a few minutes, we will more than double that servicing portfolio, again, which we think will provide a nice annuity so to speak for fee income.

Swap income from our Commercial Banking unit was a little disappointing in the fourth quarter. We do think that 2019 with the flat yield curve, especially that there is potential, and we do plan for more swap income in 2019.

A little bit of a shout out to our SBA unit. They had a very good quarter in the fourth quarter. We think they have more to come in 2019 as a contributor. And I will also say that hiring an SBA banker in Denver has really been beneficial to our company and to the SBA unit. The gentleman we have in Denver is doing an outstanding job.

So overall, for noninterest income, it's hard to predict what the mortgage market will be and the financial markets will be in 2019. All other things being equal, '19 should be a better year than 2018 and we thought '18 was pretty good.

In terms of noninterest expense, there is progress, reducing our run rate on noninterest expense, we did make some progress during the fourth quarter. We plan for more progress in 2019. And we would just say that if you look at the legacy MidWestOne, MidWestOne as it exists right now, our goal is for a $21 million run rate for noninterest expense in the fourth quarter of 2019 and that's a goal that's front and center with our management team and many of our senior officers.

In terms of asset quality, the large commercial loan that we charged off in the fourth quarter of 2017 had been moving toward resolution in bankruptcy court, and there was an auction that took place in the middle part of December. We had always planned for it to have a charge-off of up to $3.5 million in the fourth quarter of 2018 and we were reserved for that. And throughout 2018, we continued to test that $3.5 million amount as to adequacy, and our internal and external analysis was that this was a sufficient amount.

Unfortunately, when the auction occurred, the reserved amount had to increase by -- we proved to be $1.5 million short. So it was a complete surprise to everyone involved and we've had very little inclination that we would be short this amount.

So $1.5 million of the provision was due to this shortfall, and fortunately, we have that behind us and we'll settle on this transaction on February 1. We don't expect any further negative impact from this transaction and this loan. We also had one commercial loan in the Waterloo-Cedar Falls market that required roughly $1 million provision, and that was simply a loan that had significantly deteriorating business conditions and we felt compelled to move in that direction.

As we've said on past calls, there's been a significant amount of time spent analyzing our loan portfolios throughout the company. I will say that during the fourth quarter, we had 2 external loan reviews done in addition to our internal loan reviews. And really found good news in terms of there were no ratings disagreements. So the external and internal analysis in terms of loan reviews agree with our analysis done by our bankers. So we think we are headed in the right direction and continued significant resources will be applied to this area.

In terms of guidance for our provision in 2019, the guidance is $4 million to $6 million. And I also want to give an Ag update because Ag always comes up when we're talking about MidWestOne. The 20,000-foot view on Ag would be slight deterioration, no cause for panic, in line with the Ag economy. By the numbers, about 7.7% of our portfolio -- of our loan portfolio is Ag related, direct Ag exposure, that's $185.6 million.

If you compare the end of '17 to the end of '18, at the end of '17 we had 18.8% of the portfolio rated watch or substandard. That was the end of '17. At the end of '18 it was 20.9%, so a slight increase in terms of watch and substandard ratings in the Ag portfolio. The biggest change, however, was more loans were subs -- were deemed to be substandard than watch, and that's due to 2 factors, which we've talked about before.

Number one, there's a deterioration in some of our borrowers' balance sheets in the Ag sector, that's obvious. But I also think it's fair to say that we're doing a better job of accurately rating our loans internally perhaps than we were a year ago. A breakdown of the 20.9% loans that are rated watch or substandard in the Ag portfolio, 9.6% is watch, 11.3% is substandard.

We continue to forecast very low charge-offs in the Ag sector. We had one charge off and that was in the third quarter of 2018 that you could call large in terms of Ag, and we expect some recovery on that loan in 2019, not assured, but we do think there's a good -- high likelihood that we will have some recovery on that loan.

In terms of land prices, we get asked about that a lot, and let me be very specific to the MidWestOne footprint in Iowa. In our footprint, we estimate that land prices were down 3% to 6% during 2018. And I can report that our collateral margins are still good on most of the credits that we have in our Ag loan portfolio. It's interesting, we have -- and this is always a hard thing to do, we have declined to renew a few operating loans to some of our more troubled borrowers during this renewal season. Again, that's a tough thing for both the customer and for our employees when that happens.

I also think it's very important to say on this call that many of our Ag customers that had decent crop yields in 2018 reported a profit, not a loss. They reported a profit. If they had reasonable debt loads and they had good crop yields, these borrowers may not have made as much money as in past years, but they did show net operating income.

So despite the elevated provision during the fourth quarter, we do see light at the end of the tunnel on credit. We have Gary Sims, our Chief Credit Officer in the room and we'll be happy to discuss that during the Q&A.

In terms of American Trust, ATBancorp, we have all regulatory approvals. As many of you know, that merger -- the closing of that merger is contingent on the sale of their retirement business. That's taking a little bit longer than we had anticipated, but ATBancorp does have a bona fide buyer, and we still hope to close late in the first quarter. That's not assured, but our expectation is sometime in March that we can get that transaction closed.

In terms of modeling, what that means for our company in 2019, it's hard to do simply because we don't know the exact date of the close, but we still feel very, very good about the cost saves that we had projected. As I indicated on the last earnings call that we had, we'll probably have to move a few of those cost saves to 2020, but we still believe the earnings per share accretion numbers that we laid out in August, whenever we announced the transaction are relevant and good.

The culture fit, as we continue to get to know the folks in Dubuque and Wisconsin and other places and their footprint, the culture fit we think is very good. The asset quality at ATBancorp continues to be excellent by any measure, their NPAs have been relatively low and their past dues are a little higher than our past dues in the 30 to 89 day bucket, but still very, very good by any historical measure.

When we do know the definite close of the transaction, we'll be able to be a little more transparent in terms of 2019 projections as well as breaking out the cost saves between 2019 and '20.

Finally, I'll talk for a minute or 2 about our capital position. We feel fine. We feel comfortable with the capital position where it is right now. It's hard to know what the purchase accounting adjustments will be on AT, but we still project between 7.5% and 7.8% TCE, whenever that transaction closes.

We did increased the dividend a few weeks ago. That dividend was less than we might have anticipated 90 days ago, but we felt that our stock price represented probably a more attractive use of our capital in terms of share repurchase than a bigger dividend increase. And you will see from the earnings release we did buy back our stock -- some of our stock in the fourth quarter, and we will continue to analyze that as we go forward. We think, at this point in time, that's the best way to reward our shareholders.

So in summary, the increased provision put a little bit of a damper on the fourth quarter, but we're very excited and we're very optimistic about 2019. We see a lot of ways that we can improve our financial performance. We think that the AT transaction will be very, very good for our shareholders. And in general, we're happy with the progress we've made, but we expect to make more in 2019.

And Brian, with that, I will send it back to you for Q&A. Before I do that, we have as I said, Gary Sims, our Chief Credit Officer in the room; Barry Ray, our Chief Financial Officer; Jim Cantrell, Chief Investment Officer and Treasurer; and Kevin Kramer our Chief Operating Officer.

And with that, back to you Brian.

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Questions and Answers

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Operator [1]

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(Operator Instructions) It looks like today's first question will be from Jeff Rulis with D.A. Davidson.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [2]

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Charlie, I wanted to follow-up on that expense comment about the -- a goal of $21 million by quarter end. Clearly, a MidWestOne only run rate, is that, excluding ATB?

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Charles N. Funk, MidWestOne Financial Group, Inc. - President, CEO & Director [3]

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Yes.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [4]

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Okay. And I guess, we're just south of $20 million in Q4, so just some modest growth is kind of the expectation throughout the year on the legacy platform?

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Barry S. Ray, MidWestOne Financial Group, Inc. - CFO, Principal Accounting Officer & Senior VP [5]

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Jeff, this is Barry. Yes, that's correct. Modest growth from what you saw in 2018. Some additional investment in technology driving some of that as well.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [6]

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Okay. And then, Charlie, you also touched on your SBA group, interested in -- a good quarter from your standpoint and given the government shutdown, is that group seeing any headwinds on impact to the business?

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Charles N. Funk, MidWestOne Financial Group, Inc. - President, CEO & Director [7]

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Well, there will be headwinds every week that goes by. I give the leader of our SBA unit a lot of credit because he was very proactive during December and even before December anticipating this. So I think we did a lot of things to -- we sped up a lot of processes in late November and December before the shutdown. And so I think to-date, I can't say that things have slowed down much, but every week that goes by, I'll be less confident making that statement. I think that would be the best way to answer that, Jeff.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [8]

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Okay. And then lastly just on the margin, kind of an outlook there. You walked through a little bit of the puts and takes, but where do you think margins settles in over the next year?

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James M. Cantrell, MidWestOne Financial Group, Inc. - CIO, VP & Treasurer [9]

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This is Jim. And I guess, I will take that. We do focus on the core margin. So I'm going to talk to core margin, by that I mean, we're backing out simply the purchase accounting adjustments. And as Charlie referred, we were flat year-over-year fourth quarter of '17 to fourth quarter of '18 when we adjusted for taxes and for the purchase accounting.

On a go forward basis, it'll be interesting to see if the Fed makes -- and that was a period where we got 4 rate hikes in 4 quarters. So we were able to essentially track our loan yields moving higher with what our deposit costs were moving higher. And there'll be function of whether or not we get another Fed increase, my guess is, we're going to be in short for some more -- a pretty flat margin. I think last year, we indicated we thought we'd see some compression, I think we were pleasantly surprised by the margin maintenance -- the core margin maintenance that we were able to achieve.

But I do think there are funding pressures, and to give you -- it gives me a chance to talk a little bit about the competition we are seeing, but for larger deposits, probably fund deposits, the market has changed pretty dramatically in the last 18 months. So that's where we're going to see some pressure. And I do think though that we'll see some increases on the loan side.

So my long-winded answer to say, I think we're going to be pretty flat on the margin going forward. That would be my best guess.

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Charles N. Funk, MidWestOne Financial Group, Inc. - President, CEO & Director [10]

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And I would add to that Jeff, that we've probably given up a little bit of growth to maintain the margin and we were happy with our loan growth. We could have had more loan growth where we're willing to cut prices. And I think the same, increasingly could be said on the deposit side. And when I talked about in my opening comments being above the home loan bank curve in some of our markets now, we won't hesitate to go to the home loan bank. We have a lot of capacity there, should that be a better deal than deposit dollars. But I concur with what Jim said, but I think it is fair to say that when we maintain our margin, we're probably giving up a little bit of growth as well.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [11]

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Right. Jim, you mentioned the core margin, I think it is 3.53% for the quarter. What was that sequentially, and I guess the relative accretion benefit?

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James M. Cantrell, MidWestOne Financial Group, Inc. - CIO, VP & Treasurer [12]

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Yes. I showed at 3.48% in the third quarter, but I'm going to put a big caveat, the 3.48% in the third quarter compared to 3.53% in the fourth would indicate 5 basis points of expansion. In the third quarter, you should know we had a fairly significant reversal of loan interest. When you back that out, you're basically, right, you're basically, flat core margin third quarter to fourth quarter. So therein lies my expectation going forward it would be flat. So that's an important piece of information to have if you're just looking at core margin third quarter to fourth quarter.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [13]

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And sequential accretion benefit was similar?

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Barry S. Ray, MidWestOne Financial Group, Inc. - CFO, Principal Accounting Officer & Senior VP [14]

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Jeff, this is Barry. We articulated in the earnings release that the benefit from discount accretion was 6 basis points to the NIM in the current quarter and 8 basis points in the linked quarter.

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Operator [15]

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Today's next question will be from Nathan Race with Piper Jaffray.

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Nathan James Race, Piper Jaffray Companies, Research Division - VP & Senior Research Analyst [16]

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I just wanted to start on deposits, actually get your thoughts on, we've seen deposit costs increase 8 to 9 basis points last couple of quarters, and I imagine we'll probably see a similar increase in the first quarter of this year. But assuming the Fed's on hold for the rest of 2019, how do you guys think deposit cost will behave in 2Q and in the back half of 2019 as well?

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James M. Cantrell, MidWestOne Financial Group, Inc. - CIO, VP & Treasurer [17]

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Yes. This is Jim. I will take my best shot at that one. And I would divide it up a couple of ways. First let's look at the CD book, which is relatively short, little over $700 million. That has been from last year repricing up at a rate of roughly 4 basis points, maybe a little more per month somewhere in the neighborhood of 12 or 13 basis points a quarter. That's not going to stop increasing if the Fed stops, so that's for the first half of the year I think we'll still see 4-plus basis points per month. And then if rates do stay here in the second half of the year, that will taper off some.

I will say, on the core deposits -- on the core deposit part of the question, I expect we're going to see a continued increase in that book as well. And again, we have some money market specials that we have run this year that are coming on at rates, that are on average above our current book market, so that's going to add some costs. And we are pursuing just the larger deposits -- depositors tend to be high beta, and so we're playing a little defense in some of our markets where we're having to move rates up simply to maintain, and I don't expect that is going to change either. So the higher balance depositor is a pretty savvy depositor at this point has been our experience. And so we'll see continued increases on both sides, the core and the CD book will both increase.

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Nathan James Race, Piper Jaffray Companies, Research Division - VP & Senior Research Analyst [18]

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And then, kind of along those lines, we've seen noninterest bearing deposit balances come down over the last few quarters on an average basis. And I know you guys are working hard on raising core deposits across some of the markets that you're in and so forth with some of the hires as well of late. So just curious, if we should expect that dynamic with noninterest bearing deposits to continue to come down in 2019 as well?

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Charles N. Funk, MidWestOne Financial Group, Inc. - President, CEO & Director [19]

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I'd say that's anybody's guess. On the other hand, if you just look at what's happening around the United States, I don't know why we would be any different. I think probably we'll continue to see contraction there.

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Nathan James Race, Piper Jaffray Companies, Research Division - VP & Senior Research Analyst [20]

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Okay. Got it. And then if I could just lastly, the credit that you guys took the greater charge off on in the fourth quarter here. If I remember correctly, it sounded like there was a possibility that you guys could come out on a gain as that credit moved through the process over the course of the back half of last year. So just curious if there was something that changed over the course of the last couple of quarters that maybe caused that assets to not be worth as much as perhaps you thought a couple of quarters ago?

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Gary L. Sims, MidWestOne Financial Group, Inc. - Chief Credit Officer [21]

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This is Gary Sims. I don't think anything on a external basis changed about the asset. We did get to the point in the fourth quarter in December as Charlie alluded to where we got to the auction. And the results of the auction just did not meet our expectations relative to what we believed we would be able to get for that asset. Not a lot of color beyond that. It just -- the auction just did not turn out the way we had expected it to.

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Operator [22]

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Next question will be from Damon DelMonte with KBW.

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Damon Paul DelMonte, Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director [23]

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So just first question, just to kind of circle back on the impact of the government. Have you noticed any change in sentiment from your Ag borrowers because of the tariffs, now that we've had them in place for whatever it might be, 6 months, 5 months?

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Gary L. Sims, MidWestOne Financial Group, Inc. - Chief Credit Officer [24]

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This is Gary Sims. I'll take a stab at answering that. We've heard from, I mean, really the vast majority of our Ag borrowers on the government assistance that was put in place in the fourth quarter, we've been able to quantify that. And for the most part, they've gotten that money in.

I will tell you that, Charlie alluded to earlier that most of our borrowers had good yields in 2018. And when they had good balance sheets going into the harvest, they were able to either break even or make money for the 2018 crop year. And I will tell you that the government assistance probably was marginally helpful for most of those farmers in achieving those results.

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Damon Paul DelMonte, Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director [25]

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Got you, okay. And then, is there any concern going forward that their creditworthiness may be compromised because of the ongoing issue with the tariffs?

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Gary L. Sims, MidWestOne Financial Group, Inc. - Chief Credit Officer [26]

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We are in the middle of our renewal season as most Ag banks are at this point in time. And what we're seeing for the 2019 crop year is that, essentially what farmers are having to do is adjust their expense basis to a new reality around prices. And we don't see just a sharp drop-off in terms of performance for 2019 crop year relative to the tariffs.

Now don't get me wrong, I think everybody has pointed towards getting this resolved and we will be in a better place when it does get resolved. But for the most part, our borrowers are positioned to be able to live with the tariffs as they exist right now on a go forward basis.

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Damon Paul DelMonte, Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director [27]

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Got it. That's great color. And then, I guess, with respect to the outlook for noninterest income, if you take out the impact from the ATBancorp, I think Charlie said, you expect it to be better in '19 than it was in '18. Are we talking kind of like mid-single-digit growth you think, or can you kind of put some parameters around that?

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Charles N. Funk, MidWestOne Financial Group, Inc. - President, CEO & Director [28]

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Well, I'm looking at our CFO on that when we talk about percentage growth.

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Barry S. Ray, MidWestOne Financial Group, Inc. - CFO, Principal Accounting Officer & Senior VP [29]

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Damon, this is Barry. With respect to growth in fee income, did you say mid-single-digit, is that what you said?

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Damon Paul DelMonte, Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director [30]

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Yes.

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Barry S. Ray, MidWestOne Financial Group, Inc. - CFO, Principal Accounting Officer & Senior VP [31]

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I think that's a good marker, Damon, yes.

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Charles N. Funk, MidWestOne Financial Group, Inc. - President, CEO & Director [32]

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Yes, I think that's -- I would just add to that. I think critical to that will be the ability of our SBA bankers to continue to improve as well as book some commercial swap transactions. Because as I said in my opening comments, Damon, the thing that's really hard to predict is you don't know where the mortgage market is, you don't know where the financial markets is which affects our wealth management. So all other things being equal, that would seem to be a reasonable estimate for noninterest income.

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Damon Paul DelMonte, Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director [33]

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Okay. Great. And then, my last question, just given where the shares trade today, and I saw you guys bought back a little bit of stock during the quarter. What are your thoughts on maybe become a little bit more aggressive or just maintaining some sort of activity going into 2019 with the buyback?

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Charles N. Funk, MidWestOne Financial Group, Inc. - President, CEO & Director [34]

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Well, I think it's fair to say that we think the price of our stock is very attractive right now. And we will continue to analyze that, and we do have a repurchase program that we have a ways to go on should we choose to do so. So that's probably the best guidance I could give you.

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Operator [35]

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(Operator Instructions) Today's next question will be from Brian Martin with FIG Partners.

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Brian Joseph Martin, FIG Partners, LLC, Research Division - VP & Research Analyst [36]

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Maybe -- I've got a handful of questions. Maybe just start with Gary and credit and just maybe, it sounds like from Charlie's comments, you feel as good as you can about credit, as good as you have been in a while in credit. Just kind of wanted to confirm that, and just get your perspective on doing a couple of reviews externally, one internally. Just kind of confirm that if you can or just any thoughts on just credit in general, with all the work you guys have done.

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Gary L. Sims, MidWestOne Financial Group, Inc. - Chief Credit Officer [37]

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I will start the conversation with, I believe that we've really hit a pretty material milestone. And the auction, the results of the auction on that one particular large credit, taking that into account and actually writing that asset down to the actual auction results. And as Charlie alluded to, we should be able to get the proceeds -- collect the proceeds in the first quarter. And that's going to be a pretty material development that we can put behind us.

And so what I see on a go-forward basis, 2018, I think was a transformative year and getting ourselves pointed in the right direction and recognizing problems on a timely basis and starting a process around working those assets out. And that's what I see in 2019. Charlie alluded to a provision in the $4 million to $6 million range. I feel comfortable that we can work within that parameter and make steady progress towards recovering our credit quality in 2019.

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Brian Joseph Martin, FIG Partners, LLC, Research Division - VP & Research Analyst [38]

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Okay. That is very helpful. And just a couple of other things for me was just maybe one for Jim. Just on the core margin, I think you talked about kind of relative stability here. Maybe just as you layer in AT, just kind of any more, now that you have had a little bit more time to kind of look at things, just kind of the impact of AT as you maybe look at second quarter? I mean, if it closes late this quarter, just kind of that drag or that impact from AT, how that plays out in Q2?

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James M. Cantrell, MidWestOne Financial Group, Inc. - CIO, VP & Treasurer [39]

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Yes. Brian, we have spent some time, I'm reluctant to give you a whole lot of detail because the numbers are pretty squishy at this point. I guess, what I would say is, as we have evaluated AT and the transaction, we have clearly noted, and I think it's public -- it's available information that their margin is narrower than our margin. And so I think it's safe to say when we bring those 2 banks together, the combined -- the margin of the combined entity is going to be narrower than our current margin is today. And that's about as much as I feel comfortable giving you right now.

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Charles N. Funk, MidWestOne Financial Group, Inc. - President, CEO & Director [40]

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Yes, I would add to that Brian, it's a good question, and I think what Jim says is exactly right. And what I would add to that would be that the efficiency that we gain bringing AT into the company is significant. And I think that will more than make up for the narrower margin that we'll have, but I don't think there is any question we'll have a narrower margin because they've been operating on a margin for a while now in the low 3s and you put that with our 3.50 plus or minus core margin, then you're going to get a little narrower margin.

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Brian Joseph Martin, FIG Partners, LLC, Research Division - VP & Research Analyst [41]

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Okay. All right. And just as far as the closing of the transaction, I mean, when are you guys intending to, if it does close later in the quarter do the conversion? I mean, just trying to reconcile when -- yes, just wonder the first linked quarter will be from an expense standpoint?

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Charles N. Funk, MidWestOne Financial Group, Inc. - President, CEO & Director [42]

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Well, they have -- the -- we don't know. We hope to close it sometime in March. In terms of converting their core systems to ours, the smaller of their 2 banks is scheduled for May 15, and the larger, I believe, for July -- in the middle part of July. So that's when we'll actually get conversion.

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Brian Joseph Martin, FIG Partners, LLC, Research Division - VP & Research Analyst [43]

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Okay. All right. That's helpful. And just on the, I guess, the expense guide Charlie, I mean, I guess if you kind of get things closed, it sounds like you could be running at a clean expense run rate with AT in the fourth quarter of this year of '19. I mean, does that -- can you give any kind of thought as far as if you're at a clean run rate from AT, where that expense number, the $21 million number, where do those 2 numbers kind of connect? And is it kind of in the $28 million range with the cost savings taken out of AT? Or is that kind of in the range $28 million, $29 million?

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Barry S. Ray, MidWestOne Financial Group, Inc. - CFO, Principal Accounting Officer & Senior VP [44]

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Brian, this is Barry. Yes. That would be a fair estimate of what the range would be. Obviously, excluding the merger-related costs, but to your point on the clean run rate, that would be a good estimate.

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Brian Joseph Martin, FIG Partners, LLC, Research Division - VP & Research Analyst [45]

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Okay. All right. And then, last 2, just kind of the operating leverage, I mean as you guys get AT in and get the operating -- start to get some operating leverage, I guess, when you get to the fourth quarter of '19, that's when we'd expect it. Charlie you have talked about kind of your efficiency goals and whatnot. If you kind of take a look at fourth quarter of '19 being a clean quarter with the acquisition, kind of talk about where you would expect to be with some noise in between, but just kind of when you get to that fourth quarter of '19, at least kind of how you're thinking about it from an ROA and a efficiency standpoint?

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Charles N. Funk, MidWestOne Financial Group, Inc. - President, CEO & Director [46]

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That's a good question. And it's an appropriate question. And I think as we looked at 2019 as a company, we realized that there was a lot of work to be done and then you throw the merger in. And the fourth quarter does seem to be an appropriate time where we could analyze just what our earnings power is. And I think it's fair to say that our goal would be the fourth quarter absent merger-related expenses somewhere in the neighborhood of 1.20% ROA, and we clearly need to be below 60% in our efficiency ratio. As we look at our peers, 60% does not seem to be a high hurdle to climb and we need to get back down. We've been there before and we need to get back down to below 60%. So below 60% efficiency and 1.20% ROA fourth quarter, absent noise would be our -- where we hope to be.

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Brian Joseph Martin, FIG Partners, LLC, Research Division - VP & Research Analyst [47]

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Okay. I appreciate that. And you didn't mention, Charlie, but just on the government shutdown and SBA, I know you're expecting SBA to be a bigger contributor. Any impact with the slowdown here? Maybe I missed it, if you said that earlier, someone answered that question, but just any impact on -- is it just more of a timing issue you still expect same amount of revenue maybe in '19 or just how does that play out?

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Charles N. Funk, MidWestOne Financial Group, Inc. - President, CEO & Director [48]

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I think any impact is anecdotal right now, and I don't know that you could prove it in the numbers. I think the SBA would be one place that you would look. But if we're still in this situation a month from today it's going to start to impact our ability to generate revenues in that area. But yes, nobody likes the shutdown, but I would say that most of what we see now would be anecdotal and I don't know it is showing up in our numbers.

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Operator [49]

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

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Charles N. Funk, MidWestOne Financial Group, Inc. - President, CEO & Director [50]

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Well, thank you, everyone, for joining us on the call this morning. And our guidance to everyone would be to stay warm over the next week to 10 days, and we wish you a good rest of this month. Thank you, again.

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Operator [51]

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The conference has now concluded. We want to thank everyone for attending today's presentation. At this time, you may now disconnect.