MSBI - NASDAQ

Good morning ladies and gentlemen, and welcome to the Q1 2021 Midland States Bancorp 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. If anyone should require further assistance during the conference, please press star then zero on your touchtone telephone. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Mr. Tony Rossi of Financial Profiles. Thank you, please go ahead.

Thank you Stacy. Good morning everyone and thank you for joining us today for the Midland States Bancorp first 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. We will be using a slide presentation as part of our discussion this morning. If you have not done so already, please visit the Webcast and Presentations page at 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. The 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 to the GAAP to non-GAAP measures. With that, I’d like to turn the call over to Jeff. Jeff?

Good morning everyone. Welcome to the Midland States earnings call. I’m going to start on Slide 3 with the highlights of the first quarter. Over the last couple of years, we have talked a lot about the strategic initiatives we have implemented to position the company for improved financial performance. These initiatives range from branch consolidations to the sale of the commercial FHA loan origination platform to the acceleration of our investment in technology to improve efficiencies and enhance revenue generation. Our first quarter performance reflects a significant increase in our level of profitability resulting from these efforts to enhance efficiencies and optimize our business model. Despite growing in a low growth, low interest rate environment, we generated net income of $18.5 million or $0.81 per diluted share, which represents the highest level of quarterly earnings in our history. We are also seeing the improvement in our performance metrics that we targeted. Our efficiency ratio improved to 56.9% from 58.6%. Our return on average shareholders equity exceeded 12% in the quarter and our return on average tangible common equity exceeded 17%. Our adjusted pre-tax, pre-provision return on average assets was 1.75%. All these metrics represent our best core operating performance since we became a public company. The strong performance is resulting in a significant amount of internally generated capital that is positively impacting our capital ratios and our book value. Building up our capital ratios was one of the priorities for 2021 that we talked about on our last earnings call, and in the first quarter, all of our capital ratios increased between 21 and 49 basis points and our book value and tangible book value per share increased 2.2% and 3.5% respectively from the end of the prior quarter. Notably, we were able to achieve this improved financial performance without the benefit of high loan balances. During the first quarter, we saw an elevated level of pay offs and pay downs across most of our major portfolios and our loan production reflected the seasonally slower activity that we typically experience in the first quarter. However, we continued to have strong inflows of low cost deposits. While this added to our excess liquidity in the near term, it continues to improve our positioning to capitalize on stronger loan demand later in the year and redeploy this liquidity in the higher yielding earning assets. On our last earnings call, we also mentioned that while we intended to remain internally focused this year, we would look on smaller add-on acquisitions in niche business lines, such as wealth management. We were able to find an attractive opportunity with the acquisition of ATG Trust Company that we announced in February. With nearly $400 million in assets under management, ATG will further increase the scale and diversification of our wealth management business. ATG has built up a good network of referral sources that we can leverage across the broader platform of wealth management and trust services that we provide, which we believe will enhance our new business development efforts. Over the years, we have effectively utilized acquisitions to grow our assets under administration and better leverage our wealth management platform, and we expect ATG to contribute to the continued growth in the stable recurring fee income that we generate from this line of business. Moving to Slide 4, we’ll provide an update on our PPP efforts and the impact that these loans have had on various line items in the first quarter. Through March 31, we had originated $79 million in loans through the second PPP program. During the first quarter, approximately $53 million of the loans from the first program received forgiveness. This brought our total balances of PPP loans to about $212 million at the end of the first quarter. The amount of loans forgiven in the first quarter was lower than the prior quarter, which resulted in lower PPP fee income recognized. We recognized $2.1 million in fees during the first quarter, down from $3.1 million last quarter. As of March 31, we still had $6 million in fees to be recognized, which is a little less than half of the total amount of fees earned through the first two rounds. Turning to Slide 5, we’ll provide an update on the loan deferrals. At March 31, we had $219 million in loan deferrals, which was up a bit from the end of the prior quarter but still under 5% of our total loans. The increase primarily came from hotel borrowers who had resumed contractual payments after an initial loan modification then experienced some seasonal decline in occupancy during the first quarter, so we provided three-month deferrals to help them get through the soft part of the year. Based on current occupancy trends, we would expect many of these borrowers to get back to scheduled payments during the second quarter. We also had some new borrowers in the assisted living industry that required modifications during the first quarter, but we’ve since received some pay outs on these loans that should result in lower deferrals at the end of the second quarter. These new modifications offset a decrease in deferrals in our equipment finance portfolio. At March 31, about 40% of loan deferrals were making interest-only or some other form of partial payment. At this point, I’m going to turn the call over to Eric to provide some additional details around our first quarter performance. Eric?

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 $193 million from the end of the prior quarter. As Jeff mentioned, we experienced an elevated level of pay offs and pay downs across most of our major portfolios during the quarter. This included lower line utilization from our ag borrowers and the continued run-off we are seeing in the residential real estate portfolio due to refinancing activity. More than a third of the decline in total loans was attributable to period end balances on commercial FHA warehouse credit lines that were $68 million lower than the end of the prior quarter. While there can be some volatility in the period end balances, this lending area continues to generally increase for us as the average balances were higher in the first quarter than in the fourth quarter. Offsetting the pay offs and pay downs in other areas was a $27 million increase in our PPP loan balances as our production in the second round of the program more than offset the level of forgiveness we saw in loans originated in the first round. On Slide 7, we’ve provided an update of our equipment finance portfolio. As of March 31, we had $46 million of loan deferrals, which represents a decline of 8% 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 continue to improve. We’ve seen more borrowers return to scheduled payments as well as others that remain on deferral starting to make some form of partial payment. Seventy-eight percent of the borrowers on deferral in this portfolio are now making a partial payment. On Slide 8, we’ve provided an overview of our hotel portfolio. At March 31, we had $117 million of loan deferrals in this portfolio, which as Jeff mentioned is up from the end of the prior quarter as a number of borrowers had to return to a modified loan status. As of March 31, we had approximately 21% of our deferred loans in this portfolio making interest-only or some other form of payment. Looking at Slide 9, we’ve provided an update on the consumer loan portfolio that we have through our relationship with GreenSky. We had just under $4 million in deferred loans in this portfolio at March 31, which represents about half of 1% of the total loans. The portfolio continues to perform well over the past few quarters and the delinquency rate has stayed in the 30 to 40 basis point range. In addition to the strong performance, the escrow account is available to cover any deficiency in Midland’s principal balances. The escrow account stood at just over $30 million at the end of the first quarter. Our total balances in the GreenSky portfolio remained relatively flat during the first quarter. Given our current liquidity, we may grow this portfolio during the last half of the year. Turning to Slide 10, we’ll take a look at our deposits. Total deposits increased $240 million or 4.7% from the prior quarter. The growth was largely attributable to an increase in demand deposits from commercial customers as well as retail deposit inflows resulting from the latest round of stimulus payments. Looking ahead to the second quarter, we will have additional opportunities to re-price higher cost time deposits. We have $159 million of CDs maturing at a weighted average rate of 1.06%. As these deposits renew at current rates, we should see a positive impact on our deposit costs. Looking at Slide 11, we’ll walk through the trends in our net interest income and margin. Our net interest income decreased 3.1% from the prior quarter due to lower accretion income and lower PPP income. Excluding accretion income, our net interest margin was unchanged from the prior quarter as a favorable shift in the mix of earning assets and a reduction in our average cost of funds were offset by a decline in the average yield on both loans and securities. Our net interest margin for the quarter excluding the impact of PPP income was 3.38%. We used a portion of our excess liquidity to reduce our balances of FHLB advances as we continued to look to reduce our reliance on wholesale funding. Our FHLB borrowings were $250 million lower than at the end of the prior quarter. In the near term, our focus will be to support net interest income even if that means giving up a bit of margin. We plan to add to the investment portfolio during the second quarter to generate some additional interest income, but we still should have plenty of liquidity remaining to redeploy into higher yielding assets as loan growth increases in the future, excluding the impact of forgiveness of our PPP portfolio. Turning to Slide 12, we’ll look at the trends in our wealth management business. We had an $80 million increase in our assets under administration, primarily due to market performance. The higher assets under administration resulted in a 1.1% increase in our revenue compared to the prior quarter. On Slide 13, we’ll take a look at non-interest income. We had $14.8 million in non-interest income in the first quarter, up 3.3% from the prior quarter. We recorded impairments on commercial mortgage servicing rights in both quarters, with the impairment in the first quarter being about $1 million lower than the impairment in the prior quarter. Excluding these impairments, our non-interest income was down from the prior quarter primarily due to lower levels of residential mortgage banking revenue and service charges on deposit accounts. While our refinancing production in the residential mortgage banking business held fairly steady with the prior quarter, we saw a decline in purchase production which accounted for the lower level of revenue in the first quarter. Turning to Slide 14, we’ll review our non-interest expense. At $39.1 million, our non-interest expense came in at the low end of the run rate we projected to start 2021, even including the small amount of acquisition and integration expenses that we incurred in the first quarter. This represents a significant decline from the expense levels we had in 2020 and reflects the first full quarter benefit of the consolidations we made in our branch network and corporate facilities. As a reminder, we also recorded an accrual for one-time rollover of vacation time due to COVID-19 that impacted our salaries and benefits expense last quarter. While continuing to invest in our technology initiatives, we believe that we can maintain our quarterly operating expense in the range of $39 million to $40 million for the foreseeable future. Turning to Slide 15, we’ll look at asset quality trends. Our non-performing loans decreased $1.2 million from the end of the prior quarter as we continued to resolve some of our longer term problem loans without any material additional losses being incurred. However, with the decline in our total loans, the ratio of non-performing loans to total loans increased two basis points to 1.08%. Our net charge-offs continued to be very manageable and were just $1.7 million, or 14 basis points of average loans. We recorded a provision for credit losses of $3.6 million, which was primarily driven by additions to specific reserves as the trends we saw in the broad portfolio were generally stable to positive during the quarter. At March 31, approximately 90% of our ACL was allocated to general reserves. On Slide 16, we show the components of the change in the allowance for credit losses from the end of the prior quarter. Our ACL increased $2.2 million and strengthened our reserve to 128 basis points of total loans from 118 basis points at the end of the prior quarter. The biggest contributor to the provision this quarter was additions to specific reserves which offset some reserve release resulting from an improvement in economic forecasts utilized in our ACL model. On Slide 17, we show our ACL broken out by loan portfolio. The reserve build this quarter was primarily driven by an increase in coverage on our commercial real estate portfolios. We continue to add to our reserves in these portfolios due to the ongoing impact of COVID-19 and ongoing loan deferrals in certain portfolio segments, including hotels, assisted living, and other industries. In addition to the ACL to total loans, we also track the coverage ratio when excluding loan portfolios with certain credit enhancements or government guarantees, including the PPP portfolio, our GreenSky loans, and commercial FHA warehouse lines. When these loans are excluded, our ACL coverage increased to 1.64% compared to 1.52% at the end of the prior quarter. With that, I will turn the call back over to Jeff. Jeff?

Thanks Eric. We’ll wrap up on Slide 18 with a few comments on our outlook. We’re very pleased with our start to the year and delivering on higher profitability that we targeted. While the pandemic is still very much top of mind, we are seeing signs of improving economic conditions and borrowers that were most impacted by the pandemic continue to steadily improve their financial performance. We believe this should lead to continued reduction in deferrals as we move through the spring and summer and our ACL coverage ratio will remain relatively stable. The improving economic conditions is reflected in our growing loan pipeline, and the new bankers we added in the areas of SBA, agribusiness, and specialty finance have been very productive in their first few months and are contributing to the increases we are seeing in the loan pipeline. We are optimistic that the growing pipeline will result in stronger loan production and loan growth as we move through the year. With stronger loan growth, we will be able to redeploy our excess liquidity into higher yielding assets, generate more revenue growth, further increase our operating leverage, and drive additional improvement in our level of profitability. The ATG acquisition is on track to close in the second quarter and this will provide a further increase in our fee income over the second half of the year. The continuation of our strong financial performance and the further improvement we expect to deliver as we enter a more favorable environment for generating loan growth should help us to make additional progress in strengthening our capital ratios, which will better support our continued organic and acquisitive growth in the future. 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 Terry McEvoy from Stephens.

Hey, good morning everyone.

Good morning.

I guess two questions. Of the leasing business and GreenSky, it sounds like GreenSky, you’re thinking about increasing just your concentration to GreenSky, if I heard correctly, and if that’s the case, to what degree? I guess on the leasing, it’s 17.5% - is that an area you’re looking to grow this year or from a concentration standpoint, is that kind of your level of comfort?

Yes, so I’ll start with the Midland equipment finance business. We had a little bit of a slower first quarter, which is not unusual. Usually the fourth quarter is pretty robust as companies are buying equipment towards the end of the year, and that business typically starts a little slower in the first quarter, so we expect it to sort of pick up and we expect those balances to grow as we move through the balance of the year. We’re sort of targeting a relatively same production level as we did last year, so as the balance gets--as the portfolio balance gets bigger and we keep production at about the same level, the growth rate’s obviously just going to continue to slow, and to your concentration point, we do sort of have some targets that we think we need to maintain, which we think we can still grow the portfolio some but then at some point we’re going to--we need to grow the rest of the bank to be able to continue to grow that portfolio. As it relates to GreenSky, yes, we are going to--because of the liquidity that’s coming on the balance sheet and PPP, as it continues to get forgiven, is going to provide even more liquidity, we’re going to increase that balance, I’ll say anywhere from maybe $75 million to $150 million is sort of how we think about that for the remaining part of the year, so not all at once but as we move through the balance of the year.

Then just as a follow-up question, the volatility in commercial FHA warehouse credit lines, is that just something we’re going to have to live with going forward, and maybe could you just talk about how large those quarterly swings could be, just to frame expectations going forward?

Yes, so it will go up and down and depending at the end of the quarter whether those warehouse lines are drawn or not. There will be fairly large swings and those swings could be in the $100 million to $200 million range, probably. We’ve probably got commitments that are around $500 million, so depending on where they’re at in their closing cycles, yes, we could see $100 million to $200 million swings in that, in those spot balances, but we expect the averages to sort of average out and not have as much swing on an average balance point of view during each quarter.

Great, thanks Jeff.

Your next question comes from Michael Perito from KBW.

Mike, are you there?

I am. Can you guys hear me?

Yes.

All right, sorry about that. Good morning, how are you guys?

We’re good.

Good. I wanted to start on the expense side, so $39 million to $40 million, I guess if I heard you guys correctly is kind of the near term run rate. Two part question here, I guess. One, Jeff, the mix of the business has changed a decent amount over the last year and a half or so. I was just wondering if you guys had any kind of thoughts about structurally what type of efficiency ratio you guys are targeting with this new mix of business versus historical, where you guys had some businesses that put upward pressure on that. Then secondly, I was wondering if you could maybe just provide a little bit more detail on some of the technology digital investments that are being factored into that run rate, and anything you’d pull out as particularly meaningful for your involvement here that we should be mindful of.

Yes, so our internal target, and I think I’ve probably said this in some meetings, is to get under 55% efficiency ratio. A couple years ago, it was to get under 60%, now it’s to get under 55%, and we’re sort of on track and moving in the right direction, so we feel pretty good about where we’re at. As it relates to technology, the technology investments that we’ve made, that we are making are sort of in our run rates, so there’s not, you know, some investment we’re making today that’s going to sort of go away later. The investments we’ve been making in technology have been in our run rates for many quarters now and are in our run rate today. A big part of that investment is in people, so I don’t see that necessarily accelerating to increase our expenses, nor do I see it decelerating to decrease our expenses.

Helpful, okay. Then in terms of just, you know, anything you guys are particularly working on or upgrading or rolling out in the near term here that you’re excited about, or that you’d highlight as critical?

Yes, so we’ve rolled out online account opening, both on the retail side and the business side. We’re seeing good activity there. I think on the retail side, we’re seeing about a third of our new account openings happening online, so that’s encouraging. We introduced

Great, okay. Then just on margins, Eric, did I hear you correctly that the impacts from PPP forgiveness, 7 basis points I guess, it was 3.38 excluding versus the 3.45 reported?

Correct, yes.

Okay. If I look at the purchase accounting accretion and the PPP, that puts you guys kind of on an adjusted basis about 3.30, which I think was up modestly over the fourth quarter. Is it fair to think that between some liability re-pricing here and if you guys are able to--are successful in adding some of the GreenSky balances and deploy the liquidity, there should be some positive NIM movement here, adjusted for any of the PPP volatility over the next few quarters?

Towards the back half of the year, Mike. We’re looking at this next quarter a little conservatively given the decreases in loans that we experienced in the first quarter. Our pipelines are good, but it will take us a little time to get those loan balances back. But we are working on plans to reinvest that excess liquidity that we had at quarter end through GreenSky securities purchases and a few other things out there, so we may see our NIM come down a couple of basis points in the second quarter but then build back up and keep it flat, with maybe a couple basis points upside toward the back half of the year.

Helpful. Then just a clarification - on the GreenSky piece, that’s--I don’t want to call it easy, but that’s a fairly straightforward growth mechanism for you guys, right? You basically just indicate that you have more appetite and more volume comes through, is that correct? It’s not necessarily as un-predictive maybe as the commercial portfolio, where the pay offs or the closing dates could be a little bit more hard to pin down?

Yes Mike, I’d agree with that. GreenSky still has pretty good activity and so it’s just a matter of us talking with them about what our credit metrics look like, and we don’t plan to change those at all, and just kind of accepting a little bit more of activity in raising our overall levels.

Great.

And as Jeff mentioned, we won’t do that all at once.

No, makes sense. Thank you guys for taking my questions. I appreciate it.

Yes, thanks.

Once again, if you would like to ask a question, that is star followed by the number one on your telephone keypad. If your question has been answered or you wish to remove yourself from queue, please press the pound key. Your next question comes from Nathan Race from Piper Sandler.

Hi guys, good morning. Was hoping to just dive into--on the outlook slide, the expectations for a relatively stable ACL over the next quarter or two. Within that, I’d love to get an update in terms of what you guys are seeing in terms of charge-off activity, and if we can kind of expect provisioning to match charge-offs. I know it’s difficult to pinpoint provisioning in any given quarter under a CECL framework, but was just hoping to kind of dive into some of the underlying pieces behind that ACL outlook.

Yes Nate, good morning. Good question. We had pretty good charge-off activity in the first quarter - you know, $1.7 million, 14 basis points. As we kind of mentioned in the call, we did have a loan relationship move into non-performing that added to some of our specific reserves, and so we do expect to see some charge-offs towards the last half of the year. But I think as I look at our ACL right now and where we’re at, and as the economic forecasts continue to improve, I think we can be in a position where we’ll provide for charge-offs and that’s roughly my expectation. I think one of the reasons we added to the ACL this particular quarter was because we continued to see some elevated levels of deferrals in those couple of industries, so that’d be why we added to our CRE, those commercial real estate loan buckets. But I think going forward, we’ll provide for our reserves and sort of keep that ACL where it is, depending on other circumstances as they come and as they occur.

Got it, that’s helpful. Thanks Eric. Just following up on that, it sounds like with 90% of the reserve unallocated or on a general basis, you guys may not necessarily need to provide for that kind of mid-single digit growth that we’re expecting to build over the course of this year. Is that a fair characterization?

Yes, it could be. It depends on where some of those loans end up, what types of industries and what type of mix, but I think that very well could be likely, Nate.

Yes, as we add GreenSky, our reserve percentages there are not very significant because of all the credit enhancements we have around GreenSky, so that growth doesn’t come with a lot of provisioning.

Got it, makes sense. Then if I could just ask one more on just the appetite for additional share repurchases. It looks like the remaining authorization is fairly low, and I know one of the major priorities for this year is to continue to build capital levels, so would just love to get some color in terms of the appetite for additional buybacks. Obviously the stock’s had a great run over the last several weeks, so just curious on your updated thinking about buybacks and additional appetite with the remaining authorization towards being kind of depleted at this point.

Yes, I think I was pretty clear on last quarter’s call that we would continue to buy our share back below the tangible book value, and we did through the first couple days of February and then our stock did go on that nice run, and we stopped. At this point, I’ll say if our stock ever goes back below its tangible book value, we’ll probably buy it back, but at this point I hope that doesn’t happen and I don’t see it. I think we’re on the sidelines on buybacks and now we’re clearly focused on building capital ratios and putting all of our earnings after the dividend into capital.

Okay, great. Sounds good. I appreciate all the color. Thank you guys.

Thanks.

I am showing no further questions at this time. I would now like to turn the conference back to management for any closing remarks.

Thanks for joining today. We had a record quarter and it was a good quarter, and we look forward to talking to everybody next quarter. Everybody have a good day. Thanks.