Allyson Pooley - Investor Relations Leon Holschbach - President, CEO, Midland States Bancorp, Inc. Jeff Ludwig - President, Midland States Bancorp, Inc. and CEO, Midland States Bank Steve Erickson - CFO Midland States Bancorp, Inc. and Midland States Bank.

Kevin Reevey - D.A. Davidson Terry McEvoy - Stephens Michael Perito - KBW Andrew Liesch - Sandler O'Neill.

Good day, ladies and gentlemen and welcome to the Midland States Bancorp First Quarter 2018 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 be given at that time. [Operator Instructions] As a reminder, this conference call is being recorded.

I would now like to turn the conference over to Allyson Pooley of Financial Profile. Ma'am, you may begin..

Thank you and good morning, everyone. Thank you for joining us today for the Midland States Bancorp's first quarter 2018 earnings call. Joining us from Midland's management team are Leon Holschbach, President and Chief Executive Officer and Jeff Ludwig, President and Steve Erickson, Chief Financial Officer.

We will be using a slide presentation as part of our discussion this morning. If you haven't done so already, please visit the webcasts and presentations section of Midland's Investor Relations website to download a copy of the presentation. The management team will discuss the first quarter results and then will open the call for your questions.

Before we begin, I would 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.

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 will turn the call over to Leon..

Thanks Allyson. Good morning, everyone and welcome to Midland's States earnings call. On Slide 3 we have the summary and the highlights for the first quarter, including the most notable with the completion of our acquisition of the Alpine Bancorp on February 28.

This acquisition significantly adds to and enhances the profile of our bank, beyond expanding our franchise in North Illinois improves our liquidity with the addition of attractive low cost deposit base and increases our wealth management business by approximately 50%.

As a result, our business has significantly shifted towards more predictable recurring sources of revenue, generated by our core community banking and wealth management businesses.

The integration of Alpine bond very smoothly so far, one of the key elements of our acquisition strategy is to be very thoughtful and prudent with our integrations so that we make our new colleagues comfortable at Midland and ensure that there are no disruptions to customer service.

The vast majority of the cost savings will be achieved later in 2018 after we complete the system conversion which is currently scheduled for mid-July. We did however incur significant acquisition and integration related expenses in the first quarter in line with our expectations. These expenses represent $0.44 in earnings per share.

When these expenses are excluded we delivered $0.52 in earnings per share in the first quarter which we considered to be a solid performance. Given the seasonally slow first quarter, our balance sheet growth on organic standpoint was fairly muted. But we had a number of other key metrics that trended positively during the quarter.

We saw nice expansion in our net interest margin excluding accretion income due to the higher yield in our loan portfolio and well controlled funding costs. And we had good expense control with our total non-interest expenses coming in below our expectations when our merger and integration related expenses are excluded.

Although our efficiency ratio bumped up this quarter and we integrate Alpine's operations and achieve the synergy that we project for this deal, we expect to drive steady improvement inefficiencies. Another significant event in the first quarter was a next step we took in the implementation of our succession plan.

Jeff Ludwig was promoted to President of the Company and CEO of the Bank, while Jeff Mefford was promoted to President of the Bank. Both Mr. Ludwig and Mr. Mefford have been right by my side as we built the Midland franchise and have excelled in their respective roles.

The expansion of their responsibilities not only helps us to manage the larger organization that we've become, but it also positions us well for seamless transition and leadership upon my retirement. We believe that the organization benefits from the continuity of management and a clear understanding of the future leadership of the company.

We also appointed Steve Erickson as CFO. Steve has been with us for six years, most recently serving as our Director of Mergers and Acquisitions and leading our planning efforts around the acquisition of Centrue and Alpine.

Steve has a diverse background in accounting, investment banking and the financial services industry that we believe makes him well suited to lead our finance department. And now I'm going to turn the call over to Mr. Ludwig to walk through the performance of some of our major lines of business. Jeff..

Thanks Leon. I'm going to start with our lending activities. With the addition of Alpine, our total loans outstanding increased to just over $4 billion at the end of the first quarter. Following our initial purchase accounting adjustments Alpine contributed $791 million in total loans to our portfolio.

From an organic standpoint, our total loans increased $12 million or 1.5% annualized. We're continuing to be selective in the credits that we pursue in order to mitigate pressure on the loan to deposit ratio and protect our net interest margin.

One consequence of this approach was a higher level of pay off this quarter that impacted our overall loan growth. The payoff activity was particularly acute in our commercial real estate portfolio, where we're seeing competitors being very aggressive on rents and structures to win deals.

As a result of the selective approach to loan originations in the first quarter, our average rate on new and renewed loans increased 50 basis points from the prior quarter and our loan to deposit ratio declined to 95% from 103% at the end of the prior quarter.

One lending area, where we see particularly good trends within the equipment leasing as a result of the new team that joined us in January. Our lease balance increased $19 million from the end of the prior quarter and our pipeline in this business has nearly tripled. Turning to Slide 5, we'll take a look at our deposits.

Total deposits were $4.2 billion at the end of the first quarter with Alpine contributing $1.1 billion in deposits. The biggest impact that Alpine has had on our deposit composition is increasing our mix in retail deposits as a portion of total deposit mix.

At the end of the first quarter of 2018, retail deposits represented 54% of our total deposits up from 41% a year ago. From an organic standpoint, total deposits declined by 1% during the first quarter of 2018. This was due impart to normal fluctuations in public funds and servicing deposits. Turning to Slide 6, I'm going to review wealth management.

With the addition of Alpine, our assets under administration reached $3.1 billion at March 31. Our total revenue increased 17% from the prior quarter primarily due to the one month contribution from Alpine's wealth management business.

Measuring the organic growth on a year-over-year basis excluding the assets added from Alpine, our total assets under administration increased by 10% as of March 31. With the growth in this business, wealth management has become our single-largest contributor to non-interest income.

As a higher margin business that generates steady, predictable results each quarter we believe this is a significant enhancement to our overall business mix. Turning to Slide 7 and looking at Love Funding.

We originated $80 million in rate lock commitments during the quarter and had total commercial FHA revenue of $3.3 million relative to the prior quarter, our average gain on locks was higher which offset lower production volumes. Our average servicing deposits were $291 million in the first quarter up 4% from the same quarter last year.

Our weighted average costs on the servicing deposits was just 10 basis points. As we've mentioned before, this business has constantly generated annual revenue in the range of $18 million to $20 million for several years. However, it's been a number of quarters since it produced at that run rate.

The current pipeline is healthy, but indicates a year that will be backend loaded in terms of new production.

Given the size of deals and longer closing times inherent in the commercial FHA business, we believe there is, a risk that some of the deals in the pipeline could slip into 2019 which could cause annual revenue this year to come in below the historic range.

However the $2 million of variance we're possibly looking at in terms of locks revenue contribution won't have a meaningful impact on our overall financial results, given that it's becoming a much smaller portion of our business mix following the acquisition of Alpine.

Now I'm going to turn the call over to Steve to walk through some additional details on our financial results..

Thanks Jeff. Starting with Slide 8, I'll review our net interest income and net interest margin. Our net interest income increased by 6% from the fourth quarter. This was primarily the results of the one-month contribution of Alpine and was partially offset by $700,000 decline in accretion income.

On a reported basis, our net interest margin decreased four basis points to 3.69% which was entirely attributable to the decline in accretion income.

Excluding the impact of accretion income, we saw expansion in our net interest margin due to a positive shift and our mix of earnings assets, as well as loan yields increasing more than our funding costs.

As we've indicated over the past few quarters, we continue to expect our net interest margin to be relatively flat going forward excluding the impact of accretion income. Moving to our non-interest income on Slide 9. Our non-interest income increased to 30% of total revenue compared to 28% last quarter.

On an absolute dollar amount, total non-interest income increased $2.6 million were 19% from the prior quarter. The increase was primarily due to one-month of Alpine's operations.

This was partially offset by lower revenue from our residential mortgage banking business which was entirely attributable to decline in our servicing income following the sale of portion of our mortgage servicing rights at the beginning of 2018. Turning to Slide 10, we'll take a look at our expenses and efficiency ratio.

We incurred $11.9 million in integration and acquisition expense in the first quarter excluding integration acquisition expenses as well as $400,000 loss on the mortgage servicing rates recorded in the prior quarter, our non-interest expense increased $4.7 million or 14.1% on a linked quarter basis.

The increase was primarily due to one month of expenses associated with the addition of Alpine's operations combined with the expansion of the equipment financing business as well as increased payroll taxes across the company.

Excluding the integration acquisition expenses our adjusted efficiency ratio was 68.5% in the first quarter compared to 64.6% last quarter. I also want to add a note about our effective tax rate. Due to the addition of Alpine, we now have a greater percentage of our income being generated in Illinois which is a higher tax rate jurisdiction.

As a result, we're now projecting our effective tax rate to be 24% in 2018 up 1 percentage point from our previous expectation. Moving to Slide 11, we'll look at our asset quality. We saw good stability in the portfolio during the first quarter and [indiscernible] 9 basis points of net charge-offs.

Our non-performing loans were essentially unchanged from the prior quarter, but declined as a percentage of total loans due to the addition of Alpine's portfolio. We recorded a provision for loan losses of $2 million which exceeded the company's net charge-offs of $733,000.

This provision brought our allowance to 44 basis points of total loans as of March 31. Combined with our credit marks which account for another 65 basis points. With that, I'll turn the call back over to Leon..

Thank you, Mr. Erickson. We'll wrap up on Slide 12 with some comments on our future outlook. Our primary focus over the next few quarters will be completing the integration of the Alpine.

The system conversion is scheduled for mid-July and we should get some cost savings during the third quarter before seeing the bulk of the cost savings recognized in the fourth quarter.

From the standpoint of new business development, we are seeing a highly competitive market for both loans and deposits particularly in areas like commercial real estate. We're seeing many deals being done at rate that just don't make economic sense for us, when you consider the cost of the incremental funding to book those loans.

We're continuing to be very selective the loans we put on our books and as we look ahead to the remainder of 2018, we're putting more emphasis on those lending areas with more attractive risk adjusted yields such as our equipment finance business. This strategy will help us to manage our loans and deposit ratio and protect our net interest margin.

Although, it will likely result in organic loan growth coming in lower than our historical average this year, probably somewhere in the middle single digits. We believe this is a prudent approach in the current environment.

We still expect to see solid revenue growth coming from both spread income and fee income, while the integration of Alpine should drive cost savings and improve the efficiencies.

On a net-net basis with the combination of revenue growth and higher efficiencies we feel comfortable in our ability to meet the current street expectations for our earnings performance for the balance of the year. And with the larger contributions from our core banking and wealth management businesses.

Our overall revenue mix will continue to shift towards more stable sources of income, which we believe will have a positive impact on the value of our franchise. And with that, we'll be happy to take questions or any that you may have. Operator, please open up the call line..

[Operator Instructions] our first question comes from Kevin Reevey of D.A. Davidson. Your line is now open..

So just can get [ph] old clarification so it sounds like you were, when you put the community banking in wealth management that should be a larger share of total revenues.

So I think the last quarter was somewhere in the 80% to 85% range, is that still kind of the goal?.

Yes, that's the goal.

The 85% on - we'll check that quick but yes, the idea is that we're moving more to the community banking revenue and wealth management revenue which is more reoccurring and stable and predictable and less on the love funding business and mortgage business which still contribute to revenue but not at the same mix that that it had historically..

And then if I heard you correctly on the Love Funding. I know the revenue was - it sounds like the revenue was going to be a little more lumpy, but the lion share is going to be in the second half.

If I heard you correctly, is the $18 million to $20 million goal is that still achievable or is that not achievable kind of in a worst case scenario, given kind of the elongated time to close..

Yes, so as we look at the business as we see here today, it still looks achievable and the risk though is that the revenue has been pushed back in the back part of the year. Well we've seen historically that may happen in the fourth quarter deal flipped to the next year.

So I guess we're indicating there's some risk to that $18 million to $20 million kind of historical revenue rate. We still think there is we were optimistic that we can get there and we still think going forward, its $18 million to $20 million business, with some risks towards the back part of the year with some revenue being pushed back..

And then lastly, given where we are in the real estate cycle.

Are there certain areas that you're less enthusiastic about from a geographic standpoint than others?.

Our geographic lending is mostly in Illinois and surrounding states. We do follow customers outside of Illinois. Our leasing business is more on a national basis and we're seeing good demand in that businesses as we said the pipeline is tripled, so the new team we brought on earlier this year has hit the ground running and doing a nice job for us.

So most of the - in Illinois and the Midwest is typically less cyclical when it comes to real estate than we get on the coasts..

Thank you. Congrats on a nice quarter..

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

Maybe just start with question on expenses. It looks like, it was $37 million on a core basis.

If I add in two more months of Alpine, could you just help me understand maybe a good run rate for the second quarter and them maybe looking on into 4Q, 2018 will you have all the cost saves from Alpine realized and then, what are your thoughts around expenses in 4Q?.

We're little reluctant to get into some details because as you know there's a lot of moving parts as we're moving into integration of Alpine, so there's this cost coming in, there's some cost coming out and I think in Leon's outlook we said we feel pretty comfortable where analysts are with their estimates going forward.

So instead of trying to guide to particularly - items maybe a little less comfortable with that right now, maybe provide some more clarity into the fourth quarter, next quarter. But feel pretty comfortable about the bottom line numbers that are in the consensus as you move into the second, third and fourth quarter.

I know that might not be that helpful for you to pin down your expense line, but you're right I mean its Alpine is going to be in the expense line for two months next quarter and they were only in for full quarter - for the second quarter only one month in the first quarter..

Okay, I understand that. And then I guess looking at wealth management. Alpine came into the mix and you talked about on the call.

Is there any seasonality in that business and how do we think about revenue trends from here on a full quarter basis and then layering in, Alpine?.

Alpine was the primary driver in increasing revenue this quarter. So we'll have two more months, we'll pick up two months in the second quarter. And then we see that business, I don't want to say there's seasonality to the business. It's pretty steady grower, probably in that mid single-digit growth rate.

We've seen higher growth rate, our assets on an organic basis grew 10% from first quarter 2017 to first quarter 2018, so we did see nice gross, now we had a good market last year.

Well that helped, so but probably on an organic basis that kind of mid-single digits and then some market health kind of can help us push to 10%, but the market part is hard to, we don't budget to that..

And then just one last question, to help me with Love Funding and thanks for running through your thoughts on revenue. The deposits associated with that business were actually up 4% year-over-year.

Though the revenue side declines, could you just help me understand why, what makes the deposit stable and is there, risk if that business declines that you lose those very attractive deposits..

Yes, so the deposits are from our servicing portfolio. So as we're originating loans each quarter which so we originated $80 million in rate lock to $80 million. So we're putting $80 million into the servicing portfolio, that $80 million of loan has deposits associated with it replacement reserves, normal escrow payments.

There's - as we're building the servicing book of business which we do every quarter as we're as production is happening. We're increasing the deposit base there.

So the good thing is, the real nice thing about that business is yes, there's some ups and downs on the revenue side, but those loans are going into the servicing book creating deposits as pretty attractive rates that are stable and they continue to be stable..

Yes and as we kind of talked about early, good morning, this is Leon as we talked about earlier as public company as we're describing Love Funding those reserves are mandatory requirements. They're not optional.

The customers can't move them around and although we have to be sensitive about rate, they're relatively insensitive about rate because they're not investment accounts.

They're purpose accounts, CapEx and so on and so that will prove to be especially in this rising rate environment that will prove to be just the jewel of the thing because of its steadiness and its loan cost..

And Leon said, the deposits are required and even as the loans are paying down. There's still a level of requirement that needs to be there to maintain the property rate..

That's helpful. Thanks guys..

Thank you. Our next question comes from Michael Perito with KBW. Your line is now open..

I've got a handful of questions. I wanted to start for quick one on mortgage business. I guess you guys have closings every quarter and the percentage of refi purchase on those, if you go $60 million in the fourth quarter..

You have to hold a minute Mike somebody is going to grab that for us. Ask me your next question. We'll get that..

And then I guess just in terms of, can you give us kind of update on that business? I know you've done some things on the personnel side and I'm just trying to think of maybe where production could go, the next couple of quarters which are typically seasonally stronger with the team you have..

Good question, good ahead Jeff..

Yes, so I think we've put in call or two before. We're looking to rebuild the production on the residential side. As you know we lost that team in Colorado back in the second quarter of last year and we're beginning to hire LOs [ph] now.

I think we've probably put on seven net new as we're heading into the better season in the Midwest for second and third quarter. So we would expect our revenues there to increase as we head into the next quarter..

And the refi percentage loan..

Yes, so refi percentage in the current quarter, 29%..

And what was the bit the closings where they'd go $60 million last quarter..

$62 million in closings..

Helpful. Thank you. And then, I had two questions on expenses. One I guess the merger cost, are there any more that are going to come through next quarter, that you guys have in cycle [ph..

So I think when we announced the deal, we said $19.5 million roughly. So $11.5 million came through this quarter. I would expect the second quarter to be lighter and then the third quarter, when we do the conversion there's contracts that got cancelled in termination costs associated with that and some more people expense.

So lighter in the second quarter and then a little heavier in the third quarter and should be pretty light as we get to the fourth quarter and hopefully all gone as we get to 2019..

So off the $7 million or so left, you think proportionally more will be in the third quarter than next quarter..

Yes..

Okay and then, obviously I understand moving parts with Alpine [indiscernible] it seemed like I could be wrong, but it seemed like relative to expectation. The legacy mid win expense rate quarterly rate was lower, at least than what I was expecting.

And I'm just curious if there was anything notable that you guys did or that we should be thinking about as we move through the next few quarters here and layering Alpine in.

I mean was there some expense moderation that was notable, that seemed a little lower to me than what I was expecting, bit curios if you guys have any thoughts of taking it from that perspective?.

I'm not sure if there's anything notable we're continuing to manage the expense line in a very disciplined way. So I don't know if there's anything notable like anything big that we did in the quarter that would have driven expenses down here.

We had natural list in payroll taxes that you have in the first quarter, so that was ahead a little bit of headwind and we hired the bulk of the leasing team came in January, so there was a little of headwind there, but we were able to kind of save in some other areas to hold our operating expenses I think in a pretty good spot.

So I think as we move forward, we had a 68% efficiency ratio that we should be able to begin the drive that now lower..

I mean do you anticipate on the legacy side of the business, anything that would materially drive up that run rate or other hires or anything like that in the just talking legacy like excluding Alpine in the expense quarter run rate for the rest of the year..

No, our big investment this year really was our leasing team. We don't see any other big personnel hires that we need to do. I think we feel pretty good about..

They're getting rid of their CEO at the end of the year, so that will knock about $10,000 off of the selling [ph]..

Very good and then just one last quick one for me, mainly for Steve. The total [indiscernible] balance sheet the total liquidity position cash and securities was it about $1 billion give or take.

Is that a good level for the institution going forward? I mean I know the mix between cash and securities might fluctuate but is that overall level kind of a good place to be for us as we move through rest of the year..

I think as far as the liquidity is concerned. I think we need to probably bring that down a little bit. I think we'll be looking for ways to reinvest that elsewhere. And we generally probably at a good spot and but I think there's some revenue to maybe bring that down and enhance some earnings..

Depending on loan growth probably, right?.

Yes, right..

Okay. Thanks for taking my questions guys. Appreciated..

[Operator Instructions] our next question comes from the line of Andrew Liesch with Sandler O'Neill. Your line is now open..

Thanks. Covered most of my questions, but just want to look at some of the fee income items here. Namely service charges interchange via other line those are all up.

Was that driven by Alpine or was there anything in there that may not recur this quarter? Or as these good run rates been and [indiscernible] Alpine for the full quarter?.

Yes, I think that's right build on Alpine for the full quarter is probably the best way to look at it..

You've got a one month in the first quarter, the full course from here on and yes that's the most of it..

Okay that helps. That's my only question. Thank you..

Thank you and next we have a follow-up from the line of Kevin Reevey of D.A. Davidson. Your line is now open..

Yes a quick question on capital. Your capital level looks like you're TC and TA came down looks like it was about 6.9.

Do you have any targets that you're - is there an area you're comfortable with? Did you expect it to go higher?.

Yes I'll take that Kevin.

So we just did the Alpine acquisition, we knew that our PC would come down and probably come down slightly below 7%, at this point we all, I think we need to go raise any capital we're in the rebuild capital mode as we integrate Alpine in here and begin the hit the earnings targets that we've set, will drive more retained earnings and more capital and we'll begin to build that ratio back up..

Great..

And to your question Kevin on the percentage of mortgage revenue to other revenue. You're right 87% is and so 15% on mortgage and Love..

Excellent. Thanks a lot..

Thank you. And I'm showing no further questions in queue at this time. I would like to turn the conference back over to management for closing remarks..

All right, thanks for joining us everyone. That's all we have for this morning and we will talk again in quarter..

Ladies and gentlemen, thank you for your participation in today's conference. This concludes today's program. You may now disconnect. Everyone have a great day..