Midland States Bancorp, Inc. — Q2 2020 Form 10-Q
Business context and reporting period. Midland States Bancorp is an Illinois-based financial holding company with banking operations in Illinois and Missouri, equipment financing, wealth management, and commercial FHA lending and servicing. This unaudited filing covers the three and six months ended June 30, 2020; balance-sheet comparisons are with December 31, 2019. Results were materially affected by the COVID-19 pandemic and adoption of CECL on January 1, 2020.
Key financial results
| Metric | Q2 2020 | Q2 2019 | First half 2020 | First half 2019 |
|---|---|---|---|---|
| Net interest income | $49.0 million | $46.1 million | $95.6 million | $91.7 million |
| Net interest margin, tax-equivalent | 3.32% | 3.76% | 3.40% | 3.75% |
| Provision for loan credit losses | $11.6 million | $4.1 million | $22.2 million | $7.3 million |
| Noninterest income | $19.4 million | $19.6 million | $28.0 million | $36.7 million |
| Noninterest expense | $40.8 million | $40.2 million | $83.5 million | $81.3 million |
| Net income | $12.6 million | $16.4 million | $14.1 million | $30.3 million |
| Diluted EPS | $0.53 | $0.67 | $0.58 | $1.24 |
Q2 net income fell about 23% year over year; first-half net income declined about 53%. Higher credit-loss provision was the main earnings headwind. Lower interest expense and higher net interest income partly offset it. First-half noninterest income also declined, including an $8.6 million commercial mortgage servicing-rights impairment, compared with a $0.5 million recapture in first-half 2019. Q2 mortgage banking revenue increased as refinancing activity rose; deposit service charges fell amid reduced business activity.
Financial condition, cash flow and liquidity
- Balance sheet: Total assets were $6.64 billion, up from $6.09 billion at year-end 2019. Gross loans were $4.84 billion versus $4.40 billion; deposits were $4.94 billion versus $4.54 billion.
- Credit reserves and asset quality: The loan allowance was $47.1 million, or 0.97% of loans, versus $28.0 million, or 0.64%, at year-end. Nonperforming loans were $60.5 million (1.25% of loans), compared with $42.1 million (0.96%). Nonperforming assets were $74.7 million, or 1.12% of assets, versus $50.0 million, or 0.82%.
- Cash flow: For the first half, operating cash flow was $24.0 million versus $53.5 million in 2019; investing activities used $446.2 million versus providing $119.4 million; financing activities provided $547.5 million versus using $141.2 million. Cash and cash equivalents ended at $519.9 million, up from $394.5 million at year-end.
- Funding and debt: FHLB advances and other borrowings were $693.9 million, up from $493.3 million; short-term borrowings were $77.1 million. Subordinated debt was $169.6 million and trust preferred debentures were $48.6 million. The company reported $57.2 million available at the Federal Reserve Discount Window and $20.0 million in unused federal funds lines; no PPP loans had been pledged to the Federal Reserve liquidity facility at quarter-end.
- Capital and shareholder returns: Shareholders’ equity was $633.6 million, down from $661.9 million. The bank exceeded regulatory minimum capital requirements and was classified as well-capitalized. First-half common dividends were $12.8 million and stock repurchases were $27.7 million.
Material changes, outlook and risks
- CECL adoption reduced opening retained earnings by $7.2 million. The pandemic-related economic outlook also contributed to higher expected credit losses. Management cautioned that CECL provision expense may be volatile as forecasts, portfolio mix and credit conditions change.
- The bank funded $313.1 million of PPP loans through June 30; $276.0 million remained outstanding. PPP loans carry a 1% interest rate and, management said, reduced loan yields. The filing reports approximately $898 million of COVID-related loan payment deferrals; these were not classified as TDRs under the elected CARES Act relief.
- Management identified particular stress exposure in hospitality, restaurants, ground transportation, long-term healthcare and retail, and in related commercial real estate, equipment leasing and consumer lending. It anticipated adverse effects on borrowers’ repayment capacity, collateral values, asset quality, capital and earnings; it provided no quantified earnings guidance.
- Potential problem commercial loans totaled $278.1 million, up from $128.7 million at year-end. Commercial real estate loans classified as special mention increased substantially, with COVID-related deferrals cited as a factor. Net charge-offs were $15.9 million in the first half versus $2.3 million in first-half 2019.
- Other notable items included an $8.6 million first-half impairment of commercial FHA servicing rights, attributed primarily to lower assumed earnings on escrow and replacement reserves, and impairment expense on other real estate owned associated with declining property values. Management reported no required goodwill impairment after a second-quarter assessment.
- Interest-rate sensitivity modeling showed projected net interest income increasing 3.5% under a +100-basis-point shock and decreasing 2.3% under a −100-basis-point shock. The company exceeded its stated tolerance for the −100-basis-point scenario. Management said it was within board policy limits for +100 and +200 basis-point scenarios.
- Forward-looking statements are subject to substantial uncertainty, including the pandemic’s duration and economic effects, interest rates, credit losses, market conditions, and integration and execution risks. The filing reported no material pending legal proceedings and no material anticipated losses from ordinary-course claims.
Important facts for investors to verify
- How much of the approximately $898 million in loan deferrals resumed payments, and whether delinquencies, downgrades, nonaccruals or charge-offs increased thereafter.
- Whether the $47.1 million allowance adequately reflects credit exposure, particularly in commercial real estate, hospitality-related borrowers, transportation and equipment finance.
- How PPP fee recognition, loan forgiveness and repayment affect reported loan balances, yields and deposit flows.
- Whether mortgage servicing-rights valuations and other fair-value estimates remain supportable as rates, prepayments and market conditions change.
- How liquidity, borrowing costs, capital and shareholder repurchases evolve if pandemic-related losses or funding needs increase.