Midland States Bancorp, Inc.
Q2 2021 Earnings Call Transcript

Published: 23 Jul 2021

[Operator:]

Good morning, ladies and gentlemen, and welcome to the Second Quarter Midland States Bancorp, Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. . I would now like to turn the conference over to your host, Mr. Tony Rossi. Please go ahead.

[Tony Rossi:]

Thank you, Deb. Good morning everyone and thank you for joining us today for the Midland States Bancorp second quarter 2021 earnings call. Joining us from Midland’s management team are Jeff Ludwig, President and Chief Executive Officer; and Eric Lemke, Chief Financial Officer.

[Jeff Ludwig:]

Good morning, everyone. Welcome to the Midland States earnings call. We’re going to start on Slide 3 with the highlights of the second quarter. We continue to see the higher level of profitability that we targeted through the strategic initiatives we implemented over the past couple of years to focus more of our attention and resources on higher return businesses, creating a more consistent revenue mix and improving efficiencies. On a GAAP basis, we generated net income of $20.1 million or $0.88 per diluted share. As we announced last month, we had a number of items that impacted our second quarter results, both positively and negatively. These include a tax benefit related to a settlement of a prior tax issue, stemming from the treatment of gains on FDIC-assisted transactions, the professional fees we incurred in pursuing the tax benefit, and an FHLB advance prepayment penalty. When these items are excluded, we had adjusted earnings of $19.8 million or $0.86 per diluted share, which still represents the highest quarterly earnings in the history of the company. We're also seeing improvement in our level of returns with return on equity coming in at 12.6% and return on tangible common equity coming in at 17.9% for the quarter, both of which were higher than the prior quarter and significantly above the levels that we have historically generated.

[Eric Lemke:]

Thanks, Jeff, and again good morning, everyone. I'm starting on Slide 6, and we'll take a look at our loan portfolio. Our total loans decreased $75 million from the end of the quarter. This was due to the continued runoff we are seeing in the residential real estate portfolio due to refinancing activity, the forgiveness of PPP loans and a $75 million decline in period end balances on commercial FHA warehouse lines. This offset increases in the equipment financing, commercial real estate and construction portfolios resulting from the higher level of loan production in these areas during the quarter. As Jeff mentioned, we added to the consumer portfolio through our GreenSky partnership to help offset the runoff in the residential real estate portfolio. At June 30, our balances of PPP loans were down to $147 million. Excluding PPP loans and commercial warehouse credit lines, total loans increased by $66 million, or 1.5% for the quarter, an annualized growth rate of 6%. On Slide 7, we've provided an update on our equipment finance portfolio. As of June 30, we had $36 million of deferrals, which represents the decline of 23% since the end of the last quarter. We continue to see a steady recovery of our borrowers in the transit and ground transportation industry as the trends in business and recreational travel improve.

[Jeff Ludwig:]

Thanks, Eric. We'll wrap up on Slide 18 with a few comments on our outlook. We believe that we are very well positioned to deliver a strong second half of the year. Economic conditions are steadily improving, and we expect this trend to continue borrowing any setbacks related to the emergence of the Delta variant. This should lead to reductions in problem loans, a continued decline in deferrals and increased loan demand. And with a higher level of loan growth, we believe we will see a favorable shift in the mix of earning assets and further increases in profitability. One potential tailwind for future loan growth should be a return to a more normalized utilization rate on our commercial lines of credit. At the end of the second quarter, we had $1.96 billion of credit line commitments, excluding commercial FHA warehouse lines. The utilization rates stood at 56% compared to a historical average in the 62% to 64% range. As the economy continues to recover, and the utilization rates return to a more normalized level, this could add another $100 million to $130 million of loans to our balance sheet, independent of our new loan production. Looking at the current pipeline after a seasonally slow start to the year, production in the equipment finance is starting to pick up. We're also seeing more opportunities in commercial real estate, including our specialty finance group. Overall, within the community bank group, the loan pipeline is about 14% higher than it was at the end of the first quarter. This reflects the higher level of loan demand that we are seeing, as well as the contributions being made by new bankers that we have added over the past several months. We've previously talked about the additions we have made in the areas of SBA, agribusiness, and specialty finance. More recently, we've added some new bankers to increase our business development activity in St. Louis, and other high growth areas in Northern Illinois. We're about a $500 million bank in St. Louis. And given the size of the market, there's a lot of opportunity for us to grow market share. We have a new market president in St. Louis, and we have added experienced commercial bankers in order to build a larger, more productive team. As a result, we are seeing more lending opportunities in that market, and we are having more success in cross selling our wealth management services. It's still early in this initiative, but the initial results are positive. And we think that our results in building our St. Louis presence can help drive a higher level of organic growth in the future. We are seeing the benefits of improved efficiencies from our technology investments. We continue to leverage technology. And we have some additional rollouts scheduled later this year that will help us take out some other costs and move down towards the bottom of the targeted expense range that Eric provided earlier. On a final note, since the beginning of 2020, we indicated that our priority would be to focus internally on improving our operations and optimizing our business model, while building our capital ratios. We've made significant progress on the goals we set, which is reflected in our higher level of profitability and increased capital ratios. While we still have many internal initiatives we are working on to further improve our performance, we are now at a point where we believe that we can resume evaluating small M&A opportunities. It's an active market for M&A. The low rate environment, low growth environment is pushing more banks to consider selling. And we want to be a participant in the consolidation where it makes sense for us. So where there are opportunities that present a compelling strategic and economic rationale, and would not disrupt the positive momentum we have built, we are open to executing on small scale transactions that we believe could enhance the value of our trend, of our franchise and generate a good return for our shareholders. With that, we'll be happy to answer any questions you might have. Operator, please open the call.

[Operator:]

. Your first question comes from the line of Michael Perito with KBW.

[Michael Perito:]

Hi. Good morning.

[Jeff Ludwig:]

Good morning, Mike.

[Michael Perito:]

A few questions for me. I wanted to start on the -- just the expense guide. I just wanted to clarify the comments there. So it sounds like the higher -- the 40 million to 42 million, which is a little higher than what you were guiding to last quarter, sounds like that more is for the third quarter where expenses could be between 41 million and 42 million. But by the exit of the year, you expect to be closer to that $40 million number. Is that I guess capturing the comments in the prepared remarks accurately?

[Jeff Ludwig:]

Yes, I think that's exactly how we sort of see it right now.

[Michael Perito:]

Okay. And I guess just on that point, the $40 million run rate, how do you think about growth, Jeff, longer term as you continue to invest and look to add lenders and do those things? What's kind of a decent growth rate as far as you guys see it with what you have on the docket today that we should be thinking of, off of that 40 million plus or minus number?

[Eric Lemke:]

Yes. And a lot of what we've done this year is the bankers we’re adding were sort of trading up. So we're not adding sort of net new bankers. So we're a lot more productive in our commercial staff today than we were a year ago. We have I think a better lineup of bankers and frankly, less bankers. So we haven't necessarily as we've added these bankers, added new expense which I think is a real positive. And I think as we think forward, we still -- I still think that we've got sort of -- hold expenses in line, so I wouldn't be thinking of a 3% increase in expenses going forward. It’s sort of something less than that.

[Michael Perito:]

Got it. That's really helpful. And then on the credit piece, on the three hotel/motel properties that I think you guys mentioned will just have kind of a longer recovery period. I was wondering if you could maybe just give a little bit more color in terms of kind of what the exposure is, like what's been charged off or hasn't yet or any reserves? And just how you -- what the performance is today, but it sounded like -- you guys can correct me if I'm wrong, but it sounds like there were still a decent amount of confidence that they will recover or just take more time, just wondering if you could expand on that a little bit further?

[Jeff Ludwig:]

Yes. They're more in that business travel market, which their occupancy rates are still sort of lagging where they need to be the cash flow. So as we said, two of them we feel pretty good about. We're in good collateral positions. The third one, maybe not so much and we did put about 1.2 million aside on specific reserves. We haven't charged anything off at this point, but we feel that we're appropriately reserved to handle where these properties go in the future.

[Michael Perito:]

So the $1.2 million, is that specific reserve on the one property?

[Jeff Ludwig:]

Yes.

[Michael Perito:]

And what's the size of that property, Jeff, or of that credit rather?

[Jeff Ludwig:]

It's probably a $5 million, $6 million loan balance.

[Michael Perito:]

Got it. Okay, helpful. And then on the loan growth side, I was curious if you could just -- all the comments at the end of the prepared remarks they were helpful in terms of the line utilization and the potential upside. I was wondering if you could just comment on kind of the appetite and pipeline for additional consumer lending, and if we should continue to expect that to contribute kind of similarly to what it did in the second quarter. And then also just the commercial FHA lines, is that something that could normalize back up and be a tailwind or was it elevated and this is a better kind of level set figure for us to consider moving forward?

[Jeff Ludwig:]

Yes. That's a hard one for us to sort of forecast. I would -- in that business, we really look at sort of where the average balances for the quarter. And I think the average did come down quarter-over-quarter. I think our average was probably in that $125 million range in the second quarter. I think where we're at right now is probably a good spot. I don't -- maybe there could be a little bit of tailwind. We have a drop in interest rates that could create some more refinancing with our partners that are going to need to draw on that line some more. But the net income or the margin impact is fairly small, right? As we look quarter-over-quarter, we're looking at hundreds -- a few $100,000 difference in margin dollars as those balances move around. So it's not -- it looks like it should have a bigger impact when they move on the balance sheet, and you're only looking at spot balances at the end of the quarter. And maybe what we could do is provide some average disclosure to give you a better sense of what that looks like. So, I wouldn't say a significant tailwind, even if it goes back to where it was last quarter in terms of averages, the margin would be up a few $100,000.

[Michael Perito:]

Got it. And then in terms of GreenSky?

[Jeff Ludwig:]

Yes. So I think what we talked about last quarter was we were going to increase that position between 75 million and like 125 million over the course of the remaining part of this year. I think GreenSky was up roughly $40 million this quarter. So we still have more and more increases as we move forward. So that will be some tailwind. But we -- I sort of looked at that as it's offsetting a lot of the residential runoff. Residential consumers are sort of consumer lending and it's really offsetting that runoff. It would be nice if the resi would slow down, but I'm not sure what's going to happen either with where rates are.

[Michael Perito:]

Got it, helpful. Thank you, guys, for taking my questions. I appreciate it.

[Jeff Ludwig:]

Thanks, Mike.

[Operator:]

And your next question comes from the line of Nathan Race with Piper Sandler.

[Nathan Race:]

Yes. Hi, guys. Good morning.

[Jeff Ludwig:]

Good morning, Nathan.

[Nathan Race:]

Maybe just starting on fee income in the quarter. With ATG in the quarter for only about a month, and assuming kind of equity market valuations remain where they are, is it just fair to assume that we should layer on another 200,000 or so in related revenue in that wealth line for the back half of this year on a quarterly basis?

[Jeff Ludwig:]

Yes, I think that's a fair position.

[Nathan Race:]

Okay, great. And then just on the card line, obviously, nice growth sequentially there. How much of that is just attributable to just some pent-up spending, stimulus efforts and so forth? And do you kind of expect that card revenue line to revert back to maybe what we’ve seen going back to the back half of '19 that's maybe on a more normalized environment basis?

[Jeff Ludwig:]

We don't think so. I do think there's probably some pent-up demand going there. But we've had a lot of effort going on within this company to get on the retail front, get cards in consumers’ hands that might not have a card attached to their checking account. And with the online account opening, there's -- I think we see a higher level of card activation and usage. So I think we do see here that we've got a lot more cards activated and being used. So I think that bodes well for even if spending comes down. We do think that we've made some really good progress since the end of '19. And that over '19, the revenue is going to be higher.

[Nathan Race:]

Understood. That's helpful. Thanks, Jeff. And maybe just changing gears on the margin outlook and kind of the core spread revenue growth expectations to the back half of this year. It sounds like we've hit a trough on the core net interest income ex-PPP. Just curious if you guys kind of frame up expectations in terms of growth from this level here in 2Q? It sounds like the loan pipeline is obviously pretty strong compared to the end of March. They obviously see some variability in the warehouse lines and so forth from a bottom line loan growth perspective. But I'm just curious how we should kind of layer on NII growth with some ongoing redeployment of the elevated excess liquidity, both into loans and I imagine to some extent into securities as well going forward?

[Jeff Ludwig:]

Yes. Nathan, I’ll take the first shot at it. But the liability restructure that we did should add -- ex-PPP should add $1 million a quarter or fairly close to that. We had nice loan growth in the second quarter, which is going to help going into the third quarter and we've got good pipelines heading into the third quarter, so we should see some nice loan growth. So we -- that's sort of the PPP forgiveness, we think it's a 1 million plus in margin dollars.

[Nathan Race:]

Got you. Okay, that's helpful. And maybe just one last one, just curious on the charge-off in the quarter. I believe it was tied to the credit that moved to non-performing in the first quarter. So just any additional details on that one would be helpful?

[Jeff Ludwig:]

Yes, it was an acquired loan as an operating business had what we think could have a little bit of fraud going on in the company where the inventory receivables at some level wasn't there. And we put it on non-accrual. We've now dug in and thought that at this point, it's appropriate to take the charge-off. I think we feel that we've taken the losses on that credit as of now, but we're continuing to work on that to sort of work that credit out.

[Nathan Race:]

Got it, very helpful. I will step back for now. Thank you, guys.

[Jeff Ludwig:]

Thanks.

[Operator:]

. Your next question comes from Terry McEvoy with Stephens.

[Unidentified Analyst:]

Good morning. It’s Brandon Rood on for Terry. A couple of questions quick. The first one, following your last comments there was about M&A. It kind of seemed like you might be open to maybe some smaller bank acquisitions as well as fee generating. Can you just kind of maybe talk a bit more about that?

[Jeff Ludwig:]

Yes, I think we feel like we've made -- in the last 18 months made a lot of progress internally on efficiencies, sort of streamlining the businesses we want to be in, exiting the businesses we didn't want to be in, and building out sort of our commercial line, right, to really begin to build pipelines. And there's some more things we've got planned on technology and efficiencies for the back part of this year and into next year. But we're getting to the end and feel that -- we did ATG and it was small, not very impactful internally. So our folks could continue to work on the initiatives we had internally, and sort of are looking at banking the same way. It will still be small, and there will be in market that are sort of less disruptive to the company.

[Unidentified Analyst:]

Okay. Thank you for that. Another one here. The impairment on your commercial servicing rights, they kind of bounced around the past couple of quarters. Is that just tied to wherever interest rates finish the quarter at, or how I guess looking forward can we model that out?

[Jeff Ludwig:]

Yes. Well, when you figure that out, you let me know. So it is tied to -- I think it's tied to interest rates, right. These are commercial mortgage servicing rights. And when rates are low, there's more loan modifications going on in the portfolio and more refinancing going on in the portfolio. So when rates are lower, there's an opportunity for borrowers to sort of refinance to a lower rate. And so what we're seeing mostly is a higher level of payoffs that are happening within that book that's driving the valuation. We amortize that asset off, but that the amortization or the estimate of what we think the paydowns are going to be, the paydowns have been running higher, so then we have to further write that asset down. Since we're not in the Love Funding business anymore, we're not adding to the book to sort of offset some of that that might be going on.

[Unidentified Analyst:]

Sure. Okay. Thank you. One last one on deposits. You said they came down about 2.5% this last quarter due to the commercial FHA deposits and retail deposits. Can you maybe quantify a little bit between the two? How much was driven from the retail deposits versus the FHA?

[Jeff Ludwig:]

The vast majority of it was the servicing book.

[Unidentified Analyst:]

Okay.

[Jeff Ludwig:]

I would say the servicing book was north of $100 million and retail is probably in that maybe $40 million range.

[Unidentified Analyst:]

Okay, got it. All right. Thank you.

[Operator:]

And you have a follow-up question from the line of Nathan Race with Piper Sandler.

[Nathan Race:]

Yes. I appreciate you taking the follow-up question. Just want to go back to just the credit discussion a little bit just in terms of thinking about provisioning charge-off and kind of where the ACL is going to trend over the next couple of quarters? It doesn't sound there's much loss content expectations with the hotel credits that were placed on non-accrual in the quarter. And I imagine maybe there's some need to provide for growth, but you also have some excess unallocated reserves. So just any expectations just in terms of charge-off levels of provisioning over the next couple of quarters would be helpful?

[Jeff Ludwig:]

Yes. I think we feel good on the charge-off front. I think we've sort of pushed through this quarter what we thought we probably have losses in. And on the provision side, there's still -- the economic forecast I think can still get better. So that potentially could offset any growth that we would need to fund the reserve. So I think that maybe somewhat similar to this quarter as I sit here and just think about next quarter. I don't think it's going to be -- it won't be as high as the first quarter. I think it will be closer to what it was in the second quarter. Maybe I’ll just say that.

[Nathan Race:]

Okay, got it.

[Jeff Ludwig:]

And very well could be zero again. That could very much be the case.

[Nathan Race:]

Got you. So as soon charge-offs come down and provisioning remains pretty muted maybe near the level that we saw here in the second quarter, it's probably fair to expect a reserve to come down albeit to a lesser degree than we saw in 2Q just with charge-offs coming down?

[Jeff Ludwig:]

Yes.

[Nathan Race:]

Okay. Perfect. I appreciate all the color, guys. Thanks, again.

[Jeff Ludwig:]

Yes.

[Operator:]

I’m showing no further questions in queue. I would like to turn the call back over to management for closing comments.

[Jeff Ludwig:]

Thanks for joining the earnings call today, and we'll see and talk to everybody next quarter. Thanks.

[Operator:]

This does conclude today's call. You may now disconnect your lines.