Midland States Bancorp, Inc. — Q3 2018 Form 10-Q
Business context and reporting period. The unaudited filing covers the three and nine months ended September 30, 2018; balance-sheet comparisons are with December 31, 2017. Midland is an Illinois-based financial holding company providing banking, equipment financing, commercial FHA mortgage origination and servicing, and wealth-management services. The February 2018 Alpine acquisition expanded its northern Illinois presence; Alpine’s results are included from the acquisition date.
Financial results and position
- Q3 earnings: Net interest income was $45.1 million, up from $36.8 million; net income was $8.5 million versus $2.0 million; diluted EPS was $0.35 versus $0.10. Total noninterest income was $18.3 million and noninterest expense was $50.3 million.
- Nine-month results: Net interest income was $131.6 million versus $93.6 million; net income was $23.1 million versus $14.1 million; diluted EPS was $0.98 versus $0.78. Noninterest income was $50.6 million and noninterest expense was $146.3 million.
- Margins and costs: Tax-equivalent net interest margin was 3.59% in Q3 versus 3.78% a year earlier, and 3.73% for the nine months versus 3.78%. Deposit and borrowing costs rose as balances and market rates increased.
- Cash flow: For the nine months, operating cash flow was $65.9 million, investing cash outflow was $53.7 million, and financing cash flow was $15.0 million. Cash and cash equivalents ended at $242.4 million, up $27.2 million from year-end.
- Balance sheet and funding: Assets were $5.72 billion, loans $4.16 billion, deposits $4.14 billion, and shareholders’ equity $594.1 million. Total borrowings, excluding deposits, were approximately $939.5 million: short-term borrowings $145.5 million, FHLB and other borrowings $652.3 million, subordinated debt $94.1 million, and trust preferred debentures $47.7 million.
- Capital: The company reported a 12.35% total risk-based capital ratio and an 8.24% Tier 1 leverage ratio; the Bank reported 12.22% and 9.86%, respectively. Both were described as well-capitalized.
- Credit quality: The allowance for loan losses was $19.6 million, or 0.47% of loans, versus $16.4 million, or 0.51%, at year-end. Nonperforming assets rose to $41.6 million from $30.9 million; impaired loans were $38.6 million versus $26.8 million. Nine-month net charge-offs were $2.8 million.
Material changes versus comparable periods
- Growth in assets, loans, and deposits primarily reflects Alpine, acquired for approximately $173.2 million in cash and stock. The acquisition added $786.2 million of loans and $1.1 billion of deposits at acquisition; the company also issued 4.46 million common shares.
- Interest income increased with larger loan and securities balances, while higher market rates and funding needs increased interest expense. The nine-month increase in tax-equivalent net interest income was 39.1%.
- Nine-month noninterest income increased $5.3 million, with gains in wealth management, deposit charges, and interchange revenue partly offset by lower commercial FHA and residential mortgage revenue.
- Nine-month noninterest expense increased $29.5 million. The filing reports $23.5 million of acquisition and integration expenses, primarily related to Alpine. Q3 data-processing expense included $2.8 million of contract termination charges and $1.3 million of system-conversion charges.
- Available-for-sale securities had $6.5 million of net-of-tax unrealized losses in other comprehensive income for the nine months, primarily attributed to interest-rate movements.
Outlook, commentary, and risks
- The filing gives no numerical earnings or growth guidance and cautions that interim results are not necessarily indicative of full-year or future results. Management expects to meet contractual obligations through cash, earnings, repayments and maturities, deposit gathering, and borrowing facilities.
- Management noted continued Alpine integration and said remaining integration costs will be expensed as incurred. The preliminary Alpine purchase-price allocation remained subject to adjustment during the measurement period.
- Interest-rate sensitivity modeling estimated that an immediate 100-basis-point increase would raise net interest income by 1.4%, while a 100-basis-point decrease would reduce it by 3.8%. Management said the company was within policy limits for the modeled +100 and +200 basis-point scenarios.
- The company is preparing for CECL, effective for it in 2020. It expects a one-time opening allowance adjustment but cannot yet estimate its size or the standard’s overall impact. The company also expects the 2019 lease standard to add right-of-use assets and lease liabilities; the amount is not yet determined.
- Credit risks include borrower cash-flow weakness, commercial real estate and construction exposures, and deterioration in acquired-loan cash flows. The filing cites specific commercial-loan reserves and higher impaired and nonperforming assets. It reports no material pending legal proceedings, no material changes to previously disclosed risk factors, and effective disclosure controls.
Important facts for investors to verify
- How much reported earnings growth reflects Alpine and purchase-accounting accretion, versus organic growth; nine-month acquired-loan accretion was $9.1 million.
- Whether Alpine integration costs and system-conversion charges decline, and whether expected cost savings or revenue benefits materialize.
- Trends in net interest margin, deposit pricing, wholesale funding reliance, and the maturity and repricing profile of borrowings.
- Whether impaired loans, nonperforming assets, criticized commercial credits, and net charge-offs continue to rise, and whether the allowance remains adequate.
- The eventual CECL opening adjustment and lease-accounting balance-sheet impact, neither of which was quantified in this filing.
- The effect of interest rates on securities values, mortgage servicing rights, and earnings; available-for-sale unrealized losses increased during the period.