Midland States Bancorp, Inc.
Q4 2020 Earnings Call Transcript

Published: 29 Jan 2021

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to the Midland States Bancorp's Fourth Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. . Please be advised that today's call is being recorded. . I would now like to hand the call over to your speaker today, Mr. Tony Rossi of Financial Profiles. Thank you. Please go ahead.

[Tony Rossi:]

Thank you, Brandi. Good morning, everyone, and thank you for joining us today for the Midland States Bancorp fourth quarter 2020 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. I'm going to start on slide three with the highlights of the fourth quarter. Our reported results reflected one-time charges related to the prepayment of FHLB advances. Excluding those charges, we delivered another strong performance this quarter despite the continuing challenges presented by the ongoing pandemic. We had adjusted earnings of $12.5 million, or $0.54 per share, which included $3.2 million impairment of commercial mortgage servicing rights. Excluding this impairment charge, we also had adjusted pretax, pre-provision income of $28.9 million. This represents an adjusted pretax, pre-provision return on average assets of 1.69%, which reflects the strong overall level of profitability that we are now producing. The FHLB prepayments were part of our over restructuring of our FHLB advances that we did to better match our near term funding needs and reduce our interest expense. We've prepaid $114 million of longer term advances that had a weighted average rate of 2.1%. These prepayments resulted in a one-time charge of $4.9 million that we expect to earn back in approximately three years. By prepaying these advances, we will reduce our interest expense by $2.3 million in 2021, which should positively impact our net interest margin by two to three basis points.

[Eric Lemke:]

Thanks, Jeff. I'm starting on slide six, and we'll take a look at our loan portfolio. Our total loans increased to $162 million, or 3.3% from the end of the prior quarter. If you exclude the impact of PPP loans and the run off, we had related to forgiveness then our total loans increased $255 million or 5.5% from the prior quarter. This increase was primarily driven by four areas. First, $137 million increase in warehouse lines of credit to commercial FHA originators, which includes the new relationship with Dwight Capital that we entered into as part of the sale of our origination platform. Next, the expansion of two existing relationships resulted in an increase in commercial loans of approximately $59 million. After that, a $46 million increase in the equipment finance portfolio, which continues to experience strong demand in both construction and manufacturing. And finally, a $29 million increase in commercial real estate loans. The growth in these areas has helped to offset a decline in our residential real estate portfolio as we're not making an effort to retain loans that are looking to refinance.

[Jeff Ludwig:]

Alright. Thanks, Eric. We'll wrap up on slide 18, with a few comments on our outlook and priorities for 2021. First and foremost, we will continue to focus on maintaining strong capital and liquidity, so that we are well-positioned to continue supporting our clients and communities through the duration of the pandemic. We will also continue to capitalize on those areas where we see loan demand in the current environment. We expect equipment finance to continue to grow at a strong rate, and commercial FHA warehouse lines will be a larger contributor to the overall loan mix. Although there will be fluctuations in those balances as I mentioned earlier. We're also looking to increase loan production in our traditional community and commercial banking areas. Given the trends we are seeing in commercial real estate, we believe we could have better opportunities to stem off the runoff we have seen in the portfolio in recent years, if not grow those balances. And we have also made some recent hires with an eye on increasing our production in a few niche areas; SBA, agribusiness lending and especially finance. We intend to sell the guaranteed portion of the SBA production. We don't expect it to be a meaningful source of non-interest income this year, but over time, it's a new source of revenue and loan growth that we look to expand. But the growth expected in equipment finance, commercial FHA warehouse lines, and commercial real estate. We are targeting loan growth in the low to mid single digits excluding activity in the PPP portfolio. This should lead to higher net interest income and with the lower cost structure we have in place, following the actions we took last year, we should be able to increase our operating leverage and see more of our revenue growth fall to the bottom line. Our goal is to continue to tightly manage expenses, although we will continue to invest in technology to improve our operations. Over the last few years, our technology spend was primarily focused on upgrading older systems, and adding new resources that reduce costs and improved efficiencies. And these efforts have been very successful in building the foundation of a robust digital platform. We recently launched online retail account opening and digital origination portfolio portal for mortgage applications. And later this year, we will be adding peer-to-peer payments, and digital loan platforms for consumer and small business lending. Going forward will shift more of our technology spend towards investments that will enable us to capture more wallet share from existing clients and enhance our revenue generation. These investments include data analytics that we will use to create an automated analytics based marketing platform to help us determine the most appropriate products and services to offer both new and existing customers. We've already seen good results from many of our initiatives. And we're confident that these investments will continue to positively impact our deposit gathering, loan production and fee generation. With the pandemic continuing, we will remain internally focused and as a result, we are not expecting a significant acquisition this year. However, we are evaluating opportunities for smaller add-on acquisition and niche business lines such as wealth management. As we have had a number of successful acquisitions in the wealth management area in the past and would like to further increase the source of reoccurring revenue. And finally, we intend to employ a balanced approach to capital deployment. While we expect to continue to increase the amount of capital that we return to shareholders, through increases in our quarterly dividends and share repurchase activity, the decision on the amount of the increase will be balanced with our objective to raise our capital ratios above our current levels, so that we are better positioned to support continued organic growth and eventually M&A opportunities. In closing, while it's hard to say that we are optimistic in the middle of a pandemic. It does accurately characterize how we feel about the progress we've made in restructuring our operations over the last two years to create a more efficient, more profitable institution. In 2018, our efficiency ratio was 66.1%. And by the end of 2020, we had brought it down to 58.6%. In the last year alone, we have eliminated expenses through our branch consolidations, and the sale of our commercial FHA platform, restructure our FHLB advances to reduce interest expense, and support our net interest margin, and continued investing in technology to enhance efficiencies and improve revenue generation. As a result of all these actions, we begin 2021, we are in much better position to realize strong operating leverage as we continue to grow our balance sheet and drive higher earnings and improve profitability in the years to come. With that, we'll be happy to take any questions. Operator, you can open the call.

[Operator:]

Thank you. Your first question comes from Michael Perito of KBW.

[Michael Perito:]

Hey, good morning, everyone. Thanks for taking my questions.

[Jeff Ludwig:]

Good morning, Mike.

[Michael Perito:]

Happy New Year. I want to start on slide 18 here. I was wondering if you could maybe spend a minute Jeff on some of these new commercial banking verticals that you're expanding into. SBA is traditional 7(a) that you're doing. Is it regionally focused? Or is it national? Maybe a little bit more color or example about the agribusiness lending and then ditto on the specialty finance as well?

[Jeff Ludwig:]

Yes. So we've always done some SBA 7(a) business. So we've sort of dabbled in it. I think at this point, we're starting to put some dedicated sales folks on that line, and it'll be sort of in market, so not a national footprint. It's I think, a good additional product line for the Community Bank group. So we're going to start with within the markets and we think there's some opportunities there. On the agribusiness side, we're in the middle of Ag country. As you know, there's corn all around us. And we do some ag, not a lot. But there's an opportunity there for us, we believe. And we've hired a lender in that space to help us pursue some agribusiness, not necessarily farm operations, but sort of the next ring out of farm operations on agribusiness. And we think there's some opportunity there, given our geography. And then, on the specialty finance, it's a sort of the term we use internally. We have what we call our specialty finance group, and they do tax credit deals and commercial real estate rehab type of projects that are maybe a little more complex if you will. And we're adding another lender sort of that team. And we've seen some good growth out of that group. And so we're encouraged with those hires as we can continue to build some loan growth going forward.

[Michael Perito:]

That's really helpful. Jeff. Thanks. And it seems like yes, you got those two lines, the equipment connects unit continues to have some success and the consumer balances kick off, and then CRE activity seems elevated. So when I think about your low to mid single digit growth for 2021, I mean, it would seem like maybe there are some other portfolios you guys might be de emphasizing. And I'm just curious, I guess, is that true? And then and/or is it just really the PPP loans potentially running off at some point, presumably. And then follow up to that just would be, how do you see the loan mix kind of shifting over the next 12 to 24 months? Maybe is there a target? Are you guys like trying to make a purposeful effort to get some higher yielding stuff? Or how should we think about that?

[Jeff Ludwig:]

Yes. I would say on the consumer side, I think we're planning for this year to hold the consumer portfolio sort of flat. So that sort of maybe be the remix. We've seen a fair amount of runoff in commercial real estate. I think, in some regards its been disciplined over the last few years to maybe not chase them deals. And our commercial real estate as a percent of capital is fairly low and quite a bit lower than our peer group. So I think we have an ability -- we have some capacity to put some commercial real estate on the books. And so maybe, less on the consumer side, we're not we're not putting residential mortgages. Those are any payoff there, we're trying to refinance in the secondary market. Consumer, I think we're going to try to hold relatively flat, and then the mix change are probably mostly being commercial real estate and commercial, I mean, our Midland Equipment Finance Group continues to see some good demand in the market, mostly around the manufacturing, construction type of industries.

[Michael Perito:]

Got it. That's helpful. And then just lastly for me on the comment about wealth acquisitions. Curious if you could help, frame that a little bit more for us. I know, you guys have done that a few different ways in the past. What's the appetite look like? What are you guys out there looking for? And how's the kind of the pricing and competition for those types of deals at this point in the marketplace?

[Jeff Ludwig:]

Yes. So smaller add-on, nothing that's going to materially change the trajectory of that business. But if we could find something that could add 10%, 15% would be a good add on, trying to find good businesses at good pricing. And the pricing can at times get challenging. But we do see an opportunity or two out there that we're sort of hopeful on.

[Michael Perito:]

But it would be kind of regional.

[Jeff Ludwig:]

Yes. Build sort of building out current business lines within wealth management in current geographies.

[Michael Perito:]

Got it. Awesome. Very helpful, guys. Thank you very much.

[Jeff Ludwig:]

Thanks, Mike.

[Operator:]

Your next question comes from line of Terry McEvoy of Stephens.

[Terry McEvoy:]

Morning, guys.

[Jeff Ludwig:]

Good morning.

[Terry McEvoy:]

Appreciate the outlook on expenses for the first couple quarters of 39 to 40. I guess as you think about the full year, could you just talk about whether there's a need to invest in technology? Jeff, you kind of ran through some new hires on the lending side. Along the same lines are there also opportunities to kind of think about the branch network and reduce the footprint there?

[Jeff Ludwig:]

Yes. The way I think of expenses is that sort of guidance for me is and it's hard to predict out the whole year, but it's sort of how we think about the whole year. So that 39 to 40 is sort of how I at least think about every quarter in 2021. I think we've -- the technology spend, we've been spending in that area for many years now. I think, I don't see us spending more money. I see the money that we're spending sort of shifting and where we're spending from, getting some foundational technology in play to now moving to how do we use those foundational technology plays that we've invested in to generate revenue. So it's a -- to me a shift in how we're spending the dollars, not necessarily spending more dollars. And then on the sales side, some of this is a sort of a reallocation of resources into other lines.

[Terry McEvoy:]

Thanks. And then, Jeff, I guess reading between the lines is the buyback on hold just given the growth commentary on loans and the need to build capital. When I look back at last quarter capital did come down a bit and you were active repurchasing stock?

[Jeff Ludwig:]

Yes. So we have roughly $5 million, $6 million left in the plan. And I guess what I would say is if our stocks trading under tangible book value, you will be a small player in buybacks. But what we're trying to do now is build the capital ratios. But if there's an opportunity in the quarter to buy some stock back at below tangible book value, we'll probably do that.

[Terry McEvoy:]

Thanks. And then, just a follow up. Last question here. I look at the ACL for equipment finance, it's about $11 million. And then there's $44 million of deferrals in the transit & ground passenger portfolio. And another bank move that to non-accrual this past quarter. So, could you just help me get comfortable with the reserve specific for that equipment finance portfolio, given just the elevated level of deferrals? And what could be some additional kind of stress and loss potential there?

[Jeff Ludwig:]

So, I'll pick the beginning of that. But I think there's two pieces in there, right? There's a equipment. There's a loan piece and the lease piece in. About 2.5% -- or 2% to 2.5% of the balance. So I think it's more than -- maybe you can look that up, Eric. But we're, as you can imagine, we're stressing that portfolio on a regular basis, that I think we're really encouraged by the fact that a lot of those customers are now making a payment, whether it's interest only contact payment, a partial payment. So that is encouraging. And I think as it relates to accrual, non-accrual, I think those decisions will begin to get clear for us as we get through the first and into the second quarter. Anything else, Eric?

[Eric Lemke:]

Yes. Terry, to kind of follow up on that. So, that portfolio is kind of split into loans and leases. And when you look at our entire portfolio, we have about $17 million, $18 million in reserves against it. We're constantly stress testing that transportation portfolio in general and reaching out to those borrowers and understanding where they are. We have started to see some small losses from that transportation portfolio. But kind of, as Jeff said, we're trying to set payment plans to get them through to about April, when we hopefully can see elevated travel or at least travel somewhat back to some sort of sustainable level and get then reassessed from there.

[Terry McEvoy:]

Great. I appreciate the additional color. Thanks.

[Operator:]

Your next question comes from line of Nathan Race of Piper Sandler.

[Nathan Race:]

Hey, guys, good morning.

[Jeff Ludwig:]

Good morning.

[Nathan Race:]

Just continuing the credit discussion. Just a quick question around how we should think about the provision entering 2021. Obviously, non performers came down, charge-offs came down. But it seems like deferrals are still elevating some segments, but you guys are expecting much losses, generally, I guess, near term or as this cycle continues to unfold. So just any kind of commentary just in terms of what we can expect in terms of additional ACL builds starting off this year?

[Jeff Ludwig:]

Yes. I'd be happy to answer that. So there's still a fair amount of economic uncertainty out there. But I think at this point, how we view it is that we've sort of reached peak ACL build, and going forward any increases would be from loan growth, or mixes to that loan portfolio, as we kind of discussed earlier. And so provisions going forward would be to replenish because of any charge-offs that we see. And we will see some -- I think we're kind of expecting to see those come through maybe late second, third quarter.

[Nathan Race:]

Got you. And Eric, can you kind of just like frame up those charge-off expectations. Things are a little bit elevated early last year. But I imagined it may not repeat to that same degree. So we talked in like 30 bps as charge-offs potentially increase?

[Eric Lemke:]

Yes. That's a difficult question, but I'll take a shot at it. So Nathan, if you remember, our charge-offs were elevated, we took a lot of charge-offs in the first quarter resolving some old specific reserves and some older loans that we had on the books last year. And so that's partially why we're elevated in 2020. Going forward, what we're kind of thinking is that, an estimate could be somewhere between 40 and 50 basis points of total loans with the Met portfolio being on the high end of that range and other portfolio being on the lower end of that range.

[Nathan Race:]

Okay. Got it. That's helpful. And then…

[Jeff Ludwig:]

Yes. So we think, provision will be less this year than it was last year.

[Nathan Race:]

Understood. That's helpful. And just changing gears. In terms of the core income outlook for 2021, if we kind of strip out some of the servicing impairment, adjustments in those marks last year. Just any thoughts on just in terms of overall income growth this year? Mortgage obviously be a challenge to offset, but just generally, how you kind of think about the run rate entering 2021?

[Jeff Ludwig:]

Yes. I think our fees for the quarter if you add back the impairment is a number that's not a bad starting point. I think we feel good that we can continue to grow our wealth management revenue. I think there's some comps, as we look back to 2020, that are going to -- they would be helpful, right, when it comes to service charges and interchange. So those trends should continue to move in the right direction as long as the pandemic doesn't revert back and the stimulus sort of, when it comes out sort of puts a little pressure on some of those revenue lines. You're right. Mortgage is going to be -- there's a little bit headwind there in terms of -- we don't we don't expect as much refinance business in 2021 is 2020. But we're putting some more capacity there as well to sort of offset some of the refinance business that we might may lose. So -- and then, and then commercial FHA is going to look a lot probably like the current quarter. There's not going to be a lot of revenue there. It's going to be the servicing revenue that comes off that servicing book.

[Nathan Race:]

Got it. That's very helpful. I appreciate you taking the questions. Thank you.

[Operator:]

At this time, I show no further questions. I would now like to turn the call back over to management for any closing remarks.

[Jeff Ludwig:]

All right. Thanks, everybody. I think we believe we had a very productive year and 2020 and really excited about what we can do in 2021. So thanks for joining. And we'll see you next quarter.

[Operator:]

Thank you for participating in today's conference. You may now disconnect your lines.