Loan Repricing And Expanding SBA Platform Will Drive Stronger Future Performance

Catalysts

About MidWestOne Financial Group

MidWestOne Financial Group is a regional banking organization that provides commercial, consumer and wealth management services across key Midwestern and Rocky Mountain markets.

What are the underlying business or industry changes driving this perspective?

• Acceleration in higher coupon loan originations and meaningful back book repricing, combined with time deposits rolling down in cost, is expected to steadily expand net interest margin and drive outsized growth in net interest income and earnings.
• Deliberate hiring of seasoned commercial and wealth bankers in growth markets such as the Twin Cities and Denver should translate into stronger C&I and wealth management pipelines over the next 12 to 24 months, supporting above peer revenue growth and operating leverage.
• Rapidly scaling SBA platform, now producing double last year’s fee income and ranking in the top 10 percent nationally for SBA 7(a) production, positions the bank to capture more high yielding, fee rich small business relationships and lift noninterest income and returns.
• Ongoing investments in commercial digital banking, end to end workflow automation via ServiceNow and internal process automation are expected to unlock substantial operating efficiencies, allowing expense growth to lag revenue growth and supporting higher net margins.
• Improving credit metrics outside a single isolated CRE office exposure, combined with a well capitalized balance sheet and an allowance expected to normalize toward historical levels, should lower future provision expense and enable stronger, more stable earnings growth.

Assumptions

This narrative explores a more optimistic perspective on MidWestOne Financial Group compared to the consensus, based on a Fair Value that aligns with the bullish cohort of analysts. How have these above catalysts been quantified?

• The bullish analysts are assuming MidWestOne Financial Group's revenue will grow by 16.5% annually over the next 3 years.
• The bullish analysts are assuming MidWestOne Financial Group's profit margins will remain the same at 26.4% over the next 3 years.
• The bullish analysts expect earnings to reach $92.6 million (and earnings per share of $4.48) by about December 2028, up from $58.5 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bullish analyst cohort, the company would need to trade at a PE ratio of 13.3x on those 2028 earnings, down from 14.7x today. This future PE is greater than the current PE for the US Banks industry at 12.0x.
• The bullish analysts expect the number of shares outstanding to decline by 0.88% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.96%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Persistent structural weakness in office real estate, evidenced by the $24 million nonowner occupied suburban Minneapolis CRE office loan moving to nonaccrual and being classified as a distressed property, could foreshadow further stress in CRE office exposures over time, leading to elevated credit loss expense and lower earnings.
• Strategic expansion into growth markets such as the Twin Cities and Denver through seasoned, higher cost commercial and wealth hires, combined with rising software license and technology expenses, may not scale as quickly as expected, compressing operating leverage and limiting net margin improvement.
• Reliance on continued loan repricing, securities runoff into higher yielding loans and a benign funding environment to support gradual improvement in net interest margin could be undermined by a lower for longer rate backdrop or intensified deposit competition, reducing net interest income growth.
• Growing dependence on fee income from cyclical and potentially volatile lines such as SBA gain on sale and mortgage originations, even with recent strength and year-to-date SBA fees roughly doubling versus last year, may not be sustainable through a downturn, pressuring noninterest income and overall earnings stability.
• Ambitions for future M&A in the current banking landscape, where integration risk, credit surprises in acquired portfolios and the need to maintain CET1 within the 11% to 11.5% target range are all material, could result in capital dilution, higher credit costs and weaker returns on assets if deals fail to deliver the expected revenue and margin synergies.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bullish price target for MidWestOne Financial Group is $50.0, which represents up to two standard deviations above the consensus price target of $36.75. This valuation is based on what can be assumed as the expectations of MidWestOne Financial Group's future earnings growth, profit margins and other risk factors from analysts on the bullish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $50.0, and the most bearish reporting a price target of just $30.0.
  
• In order for you to agree with the more bullish analyst cohort, you'd need to believe that by 2028, revenues will be $350.6 million, earnings will come to $92.6 million, and it would be trading on a PE ratio of 13.3x, assuming you use a discount rate of 7.0%.
  
• Given the current share price of $41.76, the analyst price target of $50.0 is 16.5% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.