KBRA Affirms Ratings for MidWestOne Financial Group, Inc.

KBRA affirms the senior unsecured debt rating of BBB, the subordinated debt rating of BBB-, and the short-term debt rating of K3 for Iowa City, Iowa-based MidWestOne Financial Group, Inc. (NASDAQ: MOFG) ("MidWestOne" or "the company"). In addition, KBRA affirms the deposit and senior unsecured debt ratings of BBB+, the subordinated debt rating of BBB, and the short-term deposit and debt ratings of K2 for its main subsidiary, MidWestOne Bank. The Outlook for all long-term ratings is Negative.

Key Credit Considerations

The Negative Outlook for MOFG’s ratings is primarily due to its challenging earnings profile and below average capital ratios compared to similarly rated peers. However, the company has accomplished meaningful and strategic initiatives that could facilitate modest growth in both categories during 2024. For example, MidWestOne has completed two balance sheet restructurings since 1Q23, in which the company sold low-yielding securities and used cash to de-lever noncore funding or re-invest cash into higher yielding assets (securities or loans). These initiatives, combined with the closing of its acquisition of Denver Bankshares, Inc. and the sale of its FL-based branches in 1H24, should provide an enhanced earnings capacity. In common with most banks, MidWestOne suffered a meaningful decline in NIM throughout 2023 due to the higher for longer environment impacting deposit costs, though was also due to its elevated level of investment securities, which grew following the excess liquidity created from the pandemic. This portfolio accounted for 34% of earning assets in 2023 vs. 19% for the five-year average pre-pandemic, and management plans to return a 20% composition as securities mature. With the normalization in the securities portfolio, repositioning of operations and the balance sheet, MOFG is anticipating NIM expansion moving forward, which was observed in 1Q24. As such, KBRA expects ROA to trend moderately higher for the remainder of 2024 (core ROA of ~0.55% during 1Q24). With respect to capital management, the closing of two all-cash transactions since 2022, steady commercial loan growth, and decreasing earnings power has limited upward movement in core capital ratios in recent years. As of 1Q24, both the TCE and CET1 ratios track well below the rated peer group (CET1 ratio of 9.0% as of 1Q24), though are expected to improve following the sale of its FL-based branch network in 2Q24. Moreover, further capital build is projected over the next couple of years. The ratings continue to acknowledge MOFG's quality core deposit franchise, which represents 80% of total funding and tracks above peer levels, supported by its recent acquisition in 1Q24. Moreover, KBRA positively views the stability in core deposit levels following the bank failures in 2023. Management is determined to maintain and grow deposits and hopes to sustain the level of noninterest bearing to total deposits of 16%, which would help alleviate the upward movement in deposit costs. Despite the lower NIB component, the company's deposit beta has performed admirably and deposit costs remain considerably lower than similarly rated peers. MidWestOne has experienced some deterioration in credit quality metrics in recent quarters, with a higher NPA and classified loans ratio, which has stemmed from headwinds in the office and senior living sectors, which together account for 10% of loans. With that said, the company believes that these measures should decrease moving forward without meaningful loss content. Moreover, the office portfolio is largely operated in suburban markets. KBRA also recognizes MOFG's diverse loan portfolio and revenue mix. The company reflects below average exposures to both investor CRE and C&D lending, and the loan book is more spread out from a geographic standpoint compared to similarly rated peers. Moreover, noninterest income has averaged above 20% of total revenues the past five years (23% for 1Q24) and consists of more stable/recurring revenue sources, including a growing wealth management division.

Rating Sensitivities

Given the Negative Outlook, positive rating momentum is not expected, though a reversion to a Stable Outlook could occur from stronger core capital ratios, improved earnings, and sound credit performance over time. Conversely, a downgrade could occur over the medium term, which would transpire from an inability to rebuild capital in a timely manner (+10% CET1 ratio by 2H25) and a lack of improvement in earnings. Moreover, any further deterioration in asset quality, meaningful core deposit outflows, or liquidity issues could precipitate negative rating action.

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