Business context and reporting period
Midland States Bancorp, Inc. is an Illinois-based diversified financial holding company whose businesses include community banking, equipment financing, commercial FHA mortgage origination and servicing, and wealth management. This unaudited Form 10-Q covers the three months ended March 31, 2019; comparisons are with the three months ended March 31, 2018 unless otherwise noted. Dollar amounts below are in millions unless indicated.
Financial performance and condition
| Metric | Q1 2019 | Q1 2018 or comparison |
|---|---|---|
| Net interest income | $45.6 | $38.2 |
| Net interest margin, tax-equivalent | 3.73% | 3.69% |
| Noninterest income | $17.1 | $16.5 |
| Provision for loan losses | $3.2 | $2.0 |
| Noninterest expense | $41.1 | $49.5 |
| Income before taxes | $18.3 | $3.2 |
| Net income | $14.0 | $1.8 |
| Net income available to common shareholders | $13.9 | $1.8 |
| Diluted earnings per common share | $0.57 | $0.08 |
| Effective tax rate | 23.7% | 43.2% |
- Tax-equivalent net interest income was $46.1 million, up 19.6%. Higher average loan balances and yields supported interest income, while the average cost of interest-bearing deposits rose to 0.97% from 0.62% and total interest expense increased.
- At March 31, 2019, total assets were $5,641.8 million, loans were $4,092.1 million, deposits were $4,036.3 million, and shareholders’ equity was $624.2 million. At December 31, 2018, those balances were $5,637.7 million, $4,137.6 million, $4,074.2 million, and $608.5 million, respectively.
- Cash and cash equivalents were $276.5 million, up $62.8 million from year-end. Cash flow from operating activities was $30.0 million, investing activities provided $55.5 million, and financing activities used $22.7 million. The filing reports cash paid for interest of $12.4 million.
- Borrowings at quarter-end included $115.8 million of short-term borrowings, $669.0 million of FHLB advances and other borrowings, $94.2 million of subordinated debt, and $47.9 million of trust preferred debentures. The company reported unused Federal Reserve discount-window capacity of $50 million and unused federal funds lines totaling $45 million.
- The allowance for loan losses was $23.1 million, or 0.56% of total loans, versus $20.9 million, or 0.51%, at year-end. Nonperforming assets were $51.3 million (0.91% of assets), compared with $45.9 million (0.81%). Impaired loans rose to $49.3 million from $42.9 million.
- Regulatory capital ratios exceeded stated minimums. The Bank’s total risk-based capital ratio was 13.06%, common equity Tier 1 ratio 12.52%, Tier 1 risk-based ratio 12.52%, and Tier 1 leverage ratio 10.49%; the filing states the Bank met the regulatory definition of well-capitalized.
Material changes versus the prior comparable period
- Net income increased by $12.2 million year over year. Comparability is significantly affected by the February 2018 Alpine acquisition: Q1 2018 included acquisition-related change-in-control, severance, benefit, and integration costs. Management attributed much of the $8.4 million decline in noninterest expense to those prior-year costs and technology integration spending, rather than presenting it as a recurring cost reduction.
- Average loans grew 18.7% year over year, reflecting the Alpine acquisition and higher yields; acquired-loan discount accretion was $2.5 million in Q1 2019 versus $2.0 million a year earlier. Management said accretion increased reported net interest margin by 17 and 16 basis points, respectively.
- Interest expense increased as deposit pricing and borrowing costs rose. Total deposits declined $37.9 million from year-end, primarily due to commercial deposit outflows and lower public funds; FHLB advances and other borrowings increased $28.4 million.
- Quarter-end loans declined $45.4 million from year-end, mainly due to commercial real estate payoffs and principal reductions, partly offset by equipment-finance and consumer loan growth. Commercial real estate impaired loans increased to $29.6 million from $23.9 million.
- Other comprehensive income was $5.6 million, mainly reflecting a recovery in unrealized gains on available-for-sale securities; the comparable 2018 period had a $2.5 million other comprehensive loss. The company adopted lease accounting on January 1, 2019, recognizing approximately $12.1 million of right-of-use assets and lease liabilities at adoption, with no material income-statement effect.
Outlook, management commentary, risks and unusual items
- The filing provides no quantified earnings or balance-sheet guidance. Management cautions that first-quarter results are not necessarily indicative of full-year or future results.
- On April 2, 2019, the company announced a pending agreement to acquire HomeStar Financial Group for estimated consideration of $9.9 million, subject to customary conditions and approvals. The transaction was expected to close in Q3 2019. HomeStar’s outstanding trust preferred securities and subordinated debentures were expected to be repurchased or paid off before closing using approximately $23.5 million of company cash.
- Management expects adoption of the current expected credit loss standard (CECL), effective for the company in 2020, to increase the allowance for loan losses; the amount was not yet determinable and will depend on portfolio composition and economic conditions.
- Interest-rate sensitivity modeling projected a 4.9% decline in net interest income under an immediate 100-basis-point rate decrease, and increases of 1.7% and 2.9% under 100- and 200-basis-point increases. Although the filing says the modeled scenarios were within Board policy limits, it also states the Bank exceeded its established tolerance for the negative 100-basis-point sensitivity as of March 31, 2019. Economic value of equity sensitivity was negative 14.9% under that declining-rate scenario.
- Management said provision expense was primarily driven by specific reserves on a nonperforming loan and cited downgrades of commercial real estate and residential real estate loans as factors in the higher allowance. Credit risks also include borrower cash-flow weakness, real estate collateral values, and performance of acquired loans and purchase discounts.
- The company reported no material pending legal proceedings and no material changes to previously disclosed risk factors. It reported no losses from mortgage repurchase demands or repurchases in Q1 2019; unresolved repurchase-demand liability was $0.3 million at quarter-end.
Important facts for investors to verify
- Whether Q1’s lower noninterest expense persists after the prior-year Alpine acquisition and integration costs roll out of comparisons.
- Loan quality trends, particularly impaired commercial real estate loans, nonperforming assets, specific reserves, and net charge-offs.
- Deposit retention, funding mix and pricing, including the level and maturities of brokered deposits and the increased use of FHLB funding.
- The sensitivity of earnings and economic value to falling rates, and management’s response to the Bank’s reported breach of the negative-rate-shock tolerance.
- The eventual CECL allowance impact and the assumptions behind expected credit losses.
- HomeStar transaction approvals, terms, funding, integration, and expected closing timing.