Wednesday, March 8, 2017

A current AIM holding: MidWestOne Financial Group (MOFG) by Brendan Hopkins. "Looking for other regional banks for more upside"

MidWestOne Financial Group, Inc. (MOFG, $37.20): “MidWest-Won Bank”
By: Brendan Hopkins, AIM Student at Marquette University

Disclosure: The AIM Equity Fund currently holds this position. This article was written by myself, and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.

MidWestOne Financial Group, Inc. (NYSE:MOFG) operates as a bank holding company that provides consumer and commercial banking services through its three subsidiaries: MidWestOne Bank, MidWestOne Insurance Services, and Central Bancshares.

• The bank has 23 locations in Iowa, 18 in the Twin Cities area in Minnesota and western Wisconsin, 2 locations in southwest Florida, and has recently decided to expand into Denver, Colorado with the hire of four seasoned bankers and the anticipation of a full service bank office to open later this spring.

• In 2016, there were much larger than expected credit provisions that were driven by 5 write-offs. This fiscal year is essentially the first time in the history of the company that ended with concerns regarding credit quality.

• Expenses have improved, reaching the goal that management set at the time of the merger with Central Bank and are expected to continue in this direction.

• Return on Equity declined from 10.28% to 6.7% in 2016, which is below the sector average of 7.9% and the market average of 11.2%.

Key points: Management’s earnings call for the fourth quarter was appropriately optimistic, but reading between the lines it is clear that 2016 was not a great year for their business and that certain underlying issues may be persistent moving forward. Representing their 3rd consecutive quarter of disappointing results, their agricultural, light manufacturing, wealth management, and home mortgage activity all stand out as underperforming. While the other business lines listed are anticipated to bounce back quickly, the agricultural economies they are exposed to (Iowa especially) appear to be deteriorating as clients that once had superb credit are now being moved to credit watch lists and there is an emerging trend of weakness in all states for light manufacturing.

The best news of 2016 and moving forward is the firm’s expense control. Since their merger with Central Bank, management has reached their expense benchmark and has hired a consultant who believes they can reduce expenses by an additional $600,000. Moving forward, declining operating expenses and a reduction in credit losses will result in improved operating leverage and profitability for MOFG.

Looking toward the future, MOFG’s loan pipeline appears to be modest or middle of the road – not robust or weak – but management has declared the growth of loan and deposits as a main priority and set an expectation for growth of 4-6% for 2017. Beyond this, the 5 (3 of which being total surprises) large credit provisions that occurred in 4Q16 are set to be resolved and could potentially provide nice tailwind in this upcoming year. With credit quality still being a strength outside of agriculture in Iowa and light manufacturing, favorable trends in local economies will play out nicely for the bank as it looks to increase its activities, especially in home mortgages and loan and deposits.

What has the stock done lately?
Over the course of the last three months, MOFG has traded between $34.11-39.20 and has experienced little volatility other than a sharp decline and then immediate rise in early February. Currently floating near its all-time high, it is clear that investors have been bullish on the stock.

Past Year Performance:
MOFG has increased more than 40% in value over the past year with a 52 Week Range of $25.49-39.20 and is currently trading near its high at $37.20. MOFG essentially started at its low of $25 and traded between that and $30 until November, where it sprung up to $35 and then as high as $39.20. I would accredit these price increases to the realization of their successful merger and their continued focus on growth – specifically with the announcement of creating an office in Denver.

Source: FactSet

My Takeaway
MOFG was originally pitched at $26.26 with an intrinsic value of $32.19, representing a 22.6% upside, and is currently trading at $37.20 – a premium of 15.5%. In terms of our portfolio, I believe it would be appropriate to chalk this one up as a winner. Although the merger with Central Bank is just beginning to realize its potential and growth is anticipated in several key business functions, it seems to be an appropriate time to replace it with a fresh idea because of their underperforming business lines, disappointing credit performance, and declining fundamentals. Earnings for 1Q17 will be released on April 27th. Looking at other regional banks for more upside.

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