PDF ATTACHED: MOFG Update 8-31-16
Close $29.85 / “Outperform” / Price Target: $32.00 / HQ= Iowa City, IA / $341 Mil. Mkt. Cap.
We recently visited with the management team of MOFG. Key takeaways from our meeting are highlighted below.
The Agriculture market has weakened following 2Q16 earnings were announced. Recall MOFG conducted a stress test of its Agriculture portfolio; 10% of total loans, during 2Q16 to determine the risk to the company in adverse scenarios. MOFG’s stress test highlighted three scenarios: Optimistic, Reasonable, and Worst case. Back in July, management indicated they did not expect much impact on its credit quality over the next three to four quarters based on the then current conditions in the Agriculture market.
The recent drop in commodity prices and corresponding weakening in the agriculture market signals caution and suggests to us that the outlook today could fall somewhere between the reasonable and worst case scenarios. The table on Page 3 highlights the key assumptions of all three scenarios. Notably, the worst case scenario entails: 1) a 20% decline in crop sales, 2) a 15% drop in land values, 3) a 15% increase in operating expenses and 4) a 20% decline in corn and soybean prices. If all of these conditions are met, management estimates that an additional $4.2 Mil. in reserves would be required to address credit deterioration. This equates to approximately $0.30 per share or nearly two months of earnings. At present only one of the conditions of the worst case scenarios has been met—the 20% drop in the price of corn—leaving us comfortable conditions today are closer to the “reasonable scenario” rather than the “worst case scenario”. Importantly, the impact to EPS is manageable even if the worst case scenario unfolds. Further, we think any additional provisioning required to address deterioration in credit quality would occur over several years rather than all at once.
Loan growth has picked up in 3Q16 following some disruption in 2Q16 stemming from the exit of several producers in the Minneapolis market. However, the sale of the Davenport office in early August which included $33 Mil. in loans is expected to mute net loan growth in the near term. Our forecast calls for 3Q16 loan balances to be mostly unchanged from 2Q16 levels inclusive of the branch sale.
Management signaled that accretion income is expected drop in 2H16 versus 1H16 due to increased amortization expense on the FDIC receivable reflecting improved credit quality. As a result, we are lowering our 2H16 accretion income forecast by ~$800,000 to $1.1 Mil.; which compares to $2.2 Mil. in 1H16. Our forecast for 2017 calls for ~$3.1 Mil. in accretion income. Our core NIM outlook for 3Q16 is unchanged and calls for modest expansion as excess liquidity is deployed into Securities and Loans.
M&A remains an area of interest for MOFG and management noted an increase in dialogue across its markets (mostly smaller banks) which seems to suggest an increase in activity over the next 6-12 months. Nothing appears imminent for MOFG as they continue to focus on achieving cost saves from the Central deal and improving profitability. In our view, any near term deal for MOFG would likely be on the smaller side and in the Minnesota market (either fill in or in market deals).
We are trimming our 2016 EPS by a nickel to $2.29 to reflect our outlook for lower accretion income. There is no change to our 2017 EPS of $2.60 though we note our forecast could prove aggressive if the agriculture market weakens further and additional provisioning is required.
There is no change to our “Outperform” rating or Price Target of $32 which reflects ~12x our 2017 EPS or 150% of one year forward Tangible Book Value. We continue to expect earnings power to pick up in the back half of 2016 with momentum continuing into 2017.