MSBI - NASDAQ

Ladies and gentlemen, thank you for standing by and welcome to the First Quarter 2020 Midland States Bancorp Earnings Conference Call. At this time, all participant lines are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference may be recorded. [Operator Instructions]I would now like to hand the conference over to your host today, Mr. Tony Rossi of Financial Profiles. Please go ahead, sir.

Thank you, Liz. Good morning, everyone and thank you for joining us today for the Midland States Bancorp first quarter 2020 earnings call. Joining us from Midland's management team are Jeff Ludwig, President and Chief Executive Officer; Eric Lemke, Chief Financial Officer. We will be using a slide presentation as part of our discussion this morning. If you've not done so already, please visit the Webcast and Presentations page of Midland's Investor Relations website to download a copy of the presentation.Before we begin, I'd like to remind you that this conference call contains forward-looking statements with respect to the future performance and financial condition of Midland States Bancorp that involve risks and uncertainties including those related to the impact of the COVID-19 pandemic. Various factors could cause actual results to be materially different from any future results expressed or implied by such forward-looking statements. These factors are discussed in the company's SEC filings, which are available on the company's website. The company disclaims any obligation to update any forward-looking statements made during the call. Additionally, management may refer to non-GAAP measures, which are intended to supplement, but not substitute for the most directly comparable GAAP measures. The press release available on the website contains the financial and other quantitative information to be discussed today as well as the reconciliation of the GAAP to non-GAAP measures.And with that, I'd like to turn the call over to Jeff. Jeff?

Thanks, Tony. Good morning, everyone. Welcome to the Midland States earnings call. I would like to begin by thanking the entire Midland team for the extraordinary efforts they’ve made over the past couple of months. The COVID-19 pandemic has impacted all aspects of our lives and I’m very proud of the way our team has responded and made certain that we can continue to support our clients and communities during this challenging time.I appreciate the positive attitude of our team members throughout this crisis as well as their commitment to maintaining exceptional service levels and productivity during the unprecedented conditions that we’re dealing with.Given the extraordinary changes in the operating environment brought on by COVID-19 pandemic, we wanted to spend most of the time on our call today providing overviews of our response and the components of our loan portfolio. Overall, we had a good quarter and we were pleased with our trends in a number of areas, most notably reducing our expense levels, maintaining good stability in our normalized net interest margin and increasing deposits.However, the rapid decline in interest rates resulted in a large impairment to our commercial mortgage servicing rights. While our adoption of CECL resulted in a significant provision for credit losses that negatively impacted our financial results, resulting in only marginal earnings for the quarter. Obviously, the big story of the quarter was the rapid spread of COVID-19.As the quarter progressed, we took a number of steps to protect our employees and customers, as described on Slide 4. As the crisis unfolded, we moved very quickly to protect the health and safety of our employees and customers. These steps included closing our bank branch lobbies, servicing customers primarily through our drive-through facilities, rotating branch staff on a week on week off schedule, and transitioning approximately 95% of our non-retail employees to a remote working environment.Due to the investments we have made in technology and the incredible effort of our entire team, we've been able to efficiently transition to remote working without much impact to our level of productivity, and our digital banking platform was well-prepared to handle the increase used by our customers.Moving to Slide 5, I wanted to review our response to clients since the crisis started. From a customer engagement standpoint, our relationship managers have been reaching out to customers to assist them in managing through this crisis. We were able to quickly get up and running our PPP process and have utilized that as a first option for assisting our clients.Through April 16, we had processed $263 million dollars in PPP loans that had been approved by the SBA for almost 1,300 of our commercial clients, which assisted approximately 26,000 employees in our markets. Estimated fee income for the PPP loans is approximately $9.2 million, which will be recognized over the life of the loans.Through April 20, we have received requests for loan payment deferrals of approximately $665 million of loans. These payment deferrals are primarily from one to three months in length and the loans will continue to accrue interest during that time.Our hope is that working with our customers through payment deferrals combined with the proceeds from the PPP, it will allow the vast majority of our small businesses to make it through this pandemic and get to the other side.Our clients and local communities have been extremely appreciative of our efforts. We are receiving great feedback about the value of working with the community bank, who is committed to relationship banking.Looking at other trends, we have not seen significant draw downs on credit lines the way some other banks have reported. Throughout the month of March, credit line utilization rates remain consistently in the 66% to 68% range. Despite the reduced operations in our branch network, the pace of new consumer deposit and commercial treasury management account openings has remained relatively consistent.As we -- as would be expected, debit card transactions and check processing volumes decreased quite a bit towards the end of March when Illinois imposed the stay-at-home order. And our wealth management business as we have done in commercial banking, we spent a lot of time talking with clients and staying in close contact throughout the crisis.To date, we've had discussions with approximately 80% of our wealth management clients and they have indicated they plan to remain consistent in their investment strategy. And finally, interest rate locks for residential mortgage loans in the first quarter more than doubled from the prior quarter as a result of the decline in interest rates.Turning to Slide 6, we have provided a more detailed view of our loan portfolio. We feel that we have a broadly diversified portfolio with no significant concentrations in any one industry. As you know, one of our objectives over the past couple of years has been growing our equipment finance portfolio. We continue to do that in the first quarter as this portfolio increased by approximately $40 million.At the end of the first quarter, commercial loans represented 72% of our portfolio, while consumer loans, which includes residential real estate loans, represented 28% of the portfolio. 88% of our consumer portfolio consists of loans that are originated by greenside credit in accordance with underwriting criteria that we have provided to them. These borrowers have an average FICO score in the 730s, and it's a very granular portfolio.We also have credit enhancements due to the way the economics of the program are structured. This has been a very successful program for Midland as we have experienced no charge-offs in this portfolio in the nearly 10 years we have been partnering with GreenSky.On Slide 7, we showed a breakout of our commercial loans by industry. This includes traditional C&I loans, commercial real estate loans and equipment finance loans and leases. It's a broadly diversified portfolio. Among the more troubled industries, our retail trade exposure represents just 8% of commercial loans and health care represents just 5% of commercial loans.On Slide 8, we show our commercial real estate portfolio broken down by collateral type. Our largest segment is retail, which had 18% of CRE loans, represents 6.2% of our total loan portfolio. Amongst some of the more troubled industries, our hotel, restaurant and elder care facility exposure each represents 10% of our CRE loans.With that, let me turn the call over to Eric and have him walk through a few additional slides. Eric?

Thanks, Jeff, and good morning again, everyone. Looking at Slide 9, I want to spend a couple of minutes talking about the impact of our adoption of CECL, and it's -- and what it did to the level of our overall loan reserves. We've provided a walkthrough of the drivers of the change from the allowance for credit losses that we held at December 31, 2019.We had a day one adjustment of $12.8 million, which was less than our initial expectations. Our day one adjustment decreased from that initial estimate as we continued to fine tune our model and evaluate certain economic forecasts and our methodology for incorporating those forecasts into our overall loss factors. We also charged off approximately $9 million in specific reserves that we held as of December 31.Then in terms of how the reserve was impacted by what we saw in the first quarter, the changes in our portfolio contributed $2.5 million to that overall change. This reflects the impact of new loans that we booked, changes in credit quality, the aging of the existing portfolio and other charge-offs and recoveries that we had in the quarter.And finally, the changes in our economic factors contributed approximately $4.7 million to the reserve. That primarily reflects the downgrade and economic forecasts due to the impact of COVID-19. This resulted in an allowance for credit losses of $38.5 million at March 31, which represented 88 basis points of total loans, up from our previous allowance for loan and lease losses of 64 basis points of total loans at the end of the prior quarter.Turning to Slide 10, we want to talk about some of the factors impacting our net interest margin. As Jeff mentioned earlier, first we were able to stabilize the normalized margin as it decreased by 1 basis point over the previous quarter. We've been successful in passing through deposit rate reductions to our customers and our overall cost of deposits decreased 6 basis points in the first quarter.Due to the lower rate environment, the average rate on new and renewed loans declined to 4.59% compared to 4.8% in the previous quarter. We expect to continue to benefit from repricing our CD portfolio, particularly as time deposits that were previously offered at promotional rates last year continued to mature.We have approximately $194 million in CDs scheduled to mature over the second quarter of 2020 at a weighted average interest rate of 2.14%.Our current CDs are being offered at a rate from 25 to 55 basis points depending on term, so we should see a significant reduction in our costs of time deposits.On the negative side, we intend to continue to build liquidity on our balance sheet to help us manage through this crisis and that will weigh on our margin going forward. And we continue to carry higher balances of sub-debt, and that continues to impact our net interest margin.In light of the pandemic, we expect to retain, at least in the short-term, the approximately $30 million of subordinated debentures that are callable in June 2020. However, the sub-debt will move to a quarterly floating rate in June, and that will reduce the interest rate on that debt by approximately 50 basis points.And then finally, on the positive side, our participation in PPP is expected to positively impact our margin in the second and third quarters, with the largest impact coming in the third quarter as customers qualify for and received debt forgiveness.Moving to Slide 11, let's take a look at our capital and liquidity positions. We've included both our bank level and consolidated capital ratios. We believe that we're in a good position from a capital standpoint, particularly at the bank level, to continue supporting our customers through the duration of this crisis, including through the additional stimulus programs approved by Congress.We're also in a strong liquidity position with nearly $1.2 billion in primary liquidity sources and $185 million in secondary liquidity sources. Should we need it? We also have the ability to tap into a $250 million credit facility and add up to $500 million in brokered CDs.We also plan to utilize the PPP liquidity facility, which will provide another source of funding. We've included all of our usual slides reviewing our first quarter results in the earnings deck, but we are planning to walk through them this quarter due to the current environment. If you'd like additional color on any of those items, we'd be happy to provide it during the question-and-answer session.And then with that, I'll turn the call back over to Jeff. Jeff?

Thanks, Eric. We'll wrap up with a few additional comments on our near-term outlook and priorities. As Eric mentioned, we believe we are well positioned from a capital and liquidity standpoint to continue supporting our customers and communities through this temporary downturn in the economy.While it's hard to know how long the crisis will persist or the full impact it will have, our principal capital management priorities will be supporting the credit needs of our customers and maintaining our dividend. Given the level of uncertainty around the severity and the duration of the crisis, it's very difficult to forecast how the rest of the year is going to go.That being said, we want to provide a few general comments. We plan to continue to tightly manage expenses and in the second quarter we will see the full quarter benefit of the staffing level adjustments we made in the first quarter. We will also continue to manage our deposit costs down and hold the line on loan pricing.With respect to our wealth management fees in the second quarter, it seems likely we will see a decline unless the overall market moves back up to pre-COVID levels. Pipelines in our originate to sell businesses, including both commercial FHA and residential mortgage, have increased in the current rate environment.Credit, of course, continues to be the great unknown. As we wrap up, this is certainly a challenging time. But for a 140 years, the communities we serve have counted on Midland to help them manage through difficult times, and this current crisis will be no different.With that, we'll be happy to answer any questions you might have. Operator, please open the call.

[Operator Instructions] Our first question comes from line of Michael Perito with KBW. Your line is now open.

Hey, Jeff, Eric, good morning. Thanks for the time and for the extra added disclosure. So with everything going on in the slide deck, it's helpful.

Good morning, Mike.

I wanted to start on the credit side. I was wondering, Jeff, if you could give us a little bit more color into the 7% of commercial loans that are a combination of food service. You know what, maybe some of the larger credits are in there and how that portfolio has looked thus far? I imagine there's probably quite a bit of deferral in there. Just curious what some of the metrics are at this point.

Yes. I mean, we're seeing -- those are probably the first deferrals that were coming in when this began in March and we were fairly proactive with those customers in the middle of March on that topic. I think as we've probably discussed in prior calls, our -- we don't have a lot of large loans. And I think our loans greater than $50 million are less than 15. So we don't have all, big, big exposures on any particular credit. And I think most of our loans then are under $10 million. So I think the granularity of the portfolio should help here. And it's sort of a philosophy of ours any way as to have a lot of granularity in the portfolio so that, that the credit here or credit there doesn't perform. It doesn't -- it for sure hurts, but it doesn't take you down.

Okay. And the charge-offs in the quarter, I know you flagged the vast majority of it is being related to those items that have been on NPL for a year or greater. But the remainder of that, I think it was a couple of million, was any of that related to the pandemic, or was that still earlier in the quarter actions that kind of predated what's going on now?

Yes. Mike, this is Eric. So as we pointed out in the slide deck about 10.2 of the charge-offs were related to three larger specific credits that had been in our specific reserves for some time. The remainder of those charge-offs were primarily earlier in the quarter and really unrelated to the overall impact. I think we experienced those prior -- the bulk of those prior to March before this current crisis kind of kicked in.

Okay. Switching gears a little bit. On the PPP loans, do you guys have a sense of -- I mean, it seems like there is going to be a second wave of them here. Do you guys have a sense of what kind of -- I imagine you’ve a lot of applications kind of in the pipeline, so to speak, for additional funding there. Do you have a sense of what that dollar amount looks like? And also what you kind of expect the approximate kind of fees to look like that could potentially come in over the next two quarters, related to the PPP program in total?

Yes. So I'll say our team did a fantastic job of getting the applications that we received the day before through April 15. We -- I think we had 80%, if not 90% of those total applications we got approved to the SBA. So I think our teams did a really good job. We got on a quick and got the vast majority of the clients through the SBA portal. We do have a pipeline. It's not -- I think it'll be small, quite a bit smaller around two for a couple reasons. I think we've taken care of most of our customers and there's some left we still need to take care of; two, I think it's going to go even quicker this time. And the bigger players are even more prepared going into this one than they were before. I think the smaller community banks were able to, like us, rally pretty quickly, get our teams together, get out in front of clients and get a lot of these loans approved. And so I think going it would be smaller going forward. I don't really have an estimate on what I think those fees might look like, but I think it'll be quite a bit less than what the first round was.

Do you have -- I'm sorry, if I missed it, but you know approximately what the fees will be related to the PPP loans that you've already approved?

Yes, I think in Eric script, that was $9.2 million …

Yes.

… $9.2 million in originations.

Okay. All right. Sure. Thank you. And then just lastly for me on capital. You mentioned, Jeff, that the priorities kind of support the bank and support the dividend. But the bank sub-ratios obviously are quite high, but the equity ratios at the holding company are a bit lower. Do you expect those to kind of build? I mean, was that some of the moving parts with CECL and the provision in the first quarter that really weighed on that amongst other things? And do you expect those to kind of rebound going forward with most of that noise now hopefully behind you?

Yes, I think so. Right. I mean, we would, in this time frame, be focused on building capital. So, yes, I mean I think CECL, the day one adjustment was $12 million with a -- what $8 million sort of hit to equity.

[Indiscernible].

Yes, $7 million or $8 million hit to equity. So, yes, that had some weight to it. And we bought some stock back in the first quarter, so …

Right. And then that -- are you guys going to kind of suspend that activity for the time being now on the repurchase program?

We've not suspended our program at this point. We have a Board meeting next week and we'll talk about it. But my expectation is we'll continue to keep that in play and keep our options and flexibility because this thing is pretty fluid. So I think we'll keep it out there and continue to assess our capital and the market.

Okay.

Okay. But from like a modeling perspective, before trying to think about your buyback appetite, I mean, if the environment stays as current, if the country stays closed for the mid -- till mid-May, I mean, is it safe to assume that, that probably won't be heavily utilized until there's some type of more clear trajectory for recovery?

Yes, I'm not sure. We're going to sort of keep our options open. I can't imagine there's to be a material change in what we've been doing. So, again, I think I'll stick with our comments of we're going to support our clients credit needs and support the dividend. So …

Okay. Excellent. Thank you guys for taking the questions and be well and talk more soon.

Yes. Thanks, Mike.

Our next question comes from Terry McEvoy with Stephens. Your line is now open.

Hi. Good morning, guys.

Good morning, Terry.

Good morning.

Maybe just start with the margin. It sounds like great opportunity to reprice the CDs down, which Eric talked about. But then you've got to balance the excess liquidity and just low interest rates overall. So I guess, what are your thoughts on the core margin for the second quarter as you think about some of the puts and takes?

I mean I'll take a shot at it. I mean, still very fluid. I think what we're trying to do is kind of support the current margin, right? I think as we talked about at the last call was the first couple of quarters we're going to be sort of a -- try to maintain the current margin in that 330 range. And then we get to the back part of the year with the CDs repricing, which was still -- is still going to happen. The sub-debt -- we're going to pay off sub-debt in June, that was going to help. And as we got to the back part of the year, we thought we could start to move that margin back to that 350 range. A lots changed since the last call and I think we're going to have a lot of guidance on the margin. I think we've tried to put out there, where the pulls and takes were, I guess I'm hopeful that we can move the margin up. But a lot happened at the end of March with rate cuts. So -- but we were -- I think we moved quickly, reducing our deposit costs as well. So, yes, I guess I'm hopeful that it will trend up as we move to the second quarter. And I think the PPP loans, will sort of help, too.

And just a question, the payment deferral request that you cite in the presentation here, is that through mid April or is that a March -- end of March number?

That's I think mid April, April 20 or so. Yes, and those are requests not processed. But I think our expectation is the vast majority of those requests will get processed.

And then just the last question, what's a good run rate of expenses to think about as a starting point for modeling, specifically trying to layer in the cost saves from some of the actions you took in the first quarter and the benefits that you mentioned in the presentation?

Yes. I think on expenses, we didn't guide to a number -- we didn't guide for a reason, because there's still a lot of uncertainty out there. I think the first quarter is a -- as a benchmark to where we think expenses, give or take around that number will be probably where expenses are.

Okay. That's it. Thanks so much. Stay healthy.

Yes, thanks.

Our next question comes from Andrew Liesch with Piper Sandler. Your line is now open.

Good morning, guys.

Good morning, Andrew.

Hi. Just curious, what were the loan -- the consumer loans that were moved -- held for sale? Were those GreenSky loans?

Yes, they were.

And I guess what is your appetite to do more of that? And really what drove the decision to just sell these?

Yes, I think there's an opportunity to do it with working with GreenSky. They have -- they’re building some other partner relationships and we were able to move $100 million to held for sale, generate some liquidity for us. We thought it was a smart thing to do. I'm not sure that something that will continue to happen, but we had an opportunity and thought that was a smart thing to do.

Okay. And then with the CECL adjustment, part of the provision, the change in the macroeconomic variables and forecast, were those based on March 31 economic outlook or later on in April, just trying to get a sense of the timing that you guys are using for this forecast?

Yes. Andrew, this is Eric. I can take that one. So those economic forecasts were used right around quarter end, right around March -- March 31. We use the base case for forecasts. We kind of look out over the next 12 months in our forecasting and then there's a 12-month sort of reversion back to the mean. And then we also kind of evaluated how those impacted all of our various portfolios, which I think that answers your question unless you need to -- you want to go into it a little bit more.

Well, what -- if you have any detail around like what unemployment rate you're looking at, or what trends in GDP, like how long the recession lasts? If you have that handy.

We -- so we use Oxford Economics for our modeling. Oxford Economics, I don't recall the exact unemployment number. We look at both of those factors that you kind of mentioned focused in the state of Illinois with the exception of our equipment of finance portfolio that we look nationally. The modeling that we did used had us kind of snapping back and sort of a U-shaped kind of recovery through the fourth quarter on both of those measures that you mentioned, unemployment rate and GDP.

Okay. And then just the $9.2 million in fees for the PPP loans. Any sort of thoughts on how quickly those could be realized in the second quarter, or do you think they will be more heavily weighted towards the third?

That's a good question. I think that's sort of a big question. I think how we're sort of thinking about it internally is, we've got sort of eight weeks and then customers will start applying for that forgiveness, and then it will be another 30 to 60 days, possibly, for the SBA to actually return those funds. So I guess we're kind of thinking that we will start to receive those funds back maybe that July and August time frame.

Okay. That's very helpful. Covered my question. Thanks.

[Operator Instructions] Our next question comes from David Konrad with D.A. Davidson. Your line is now open.

Hey, good morning.

Hi, David.

Good morning. Hey. A couple of follow-up questions on the GreenSky portfolio. Given how short the duration typically is for the point-of-sale financing, and I would guess a lot lower demand, near-term, given everything going out, I just wanted the outlook for the balances in the commercial loan -- or the consumer loan portfolio.

Yes, I think those are all I think facts around that portfolio. But I think we continue to see some credit flow. So I think our expectation is that the balance should stay relatively flat.

Okay. And then …

I don't know [multiple speakers].

Yes, yes. There you go. On the reserve, I was just curious if you had a kind of adjusted pro forma reserve to loan ratio if you took the marks from the acquired loans and effectively made that a reserve where the coverage ratio would stand.

Can you -- David can you -- I'm sorry, can you ask that question again?

Yes. With the reserve to loan ratio, I was curious if you took the marks embedded in the acquired loans and took those marks and put them in the reserve, what the pro forma coverage would look like.

So I think last quarter we indicated that our reserve was around 66 basis points and then credit marks got us to just over 100 basis points. And so, in moving to CECL, some of those credit marks ended up in sort of that initial adoption, but we ended up with a CECL balance at March 31 of about 88 basis points of total loans, which that reduction from the credit marks before was primarily -- in fact, it was all reducing our specific reserves on the portfolio through those charge-offs in the first quarter.

Okay, great. And then the last question for me. Thanks for the slide on the commercial and lease and the diversification by sector. I was just wondering specifically in equipment lease portfolio, does that differ much from the diversification of the overall portfolio?

It probably does because there's no commercial real estate in it. That first graph was all commercial loans. The second one was just commercial real estate. So, I think it would differ. I think the industry -- we've talked about it before kind of where the equipment finance guys play. Manufacturing, construction, waste management, trucking and transportation are some of the more key industries that they play in.

Okay, perfect. Thank you.

Yes.

I'm showing no further questions at this time. I would like to turn the call back to management for closing remarks.

All right. Well, thanks everybody. And we will talk next quarter.