Midland States Bancorp, Inc. — Q2 2019 Form 10-Q
Business context and reporting period
Unaudited results for the quarter and six months ended June 30, 2019. Midland States is an Illinois-based financial holding company providing banking, equipment finance, commercial FHA lending and servicing, and wealth management. Comparisons with 2018 are affected by the February 2018 Alpine Bancorporation acquisition and subsequent integration.
Financial performance and condition
- Q2 earnings: Net income was $16.4 million versus $12.8 million; diluted EPS was $0.67 versus $0.52. Income before taxes was $21.4 million versus $15.8 million.
- Six-month earnings: Net income was $30.3 million versus $14.6 million; diluted EPS was $1.24 versus $0.63.
- Revenue and margin: Q2 net interest income was $46.1 million, down from $48.3 million; noninterest income was $19.6 million, up from $15.8 million. Tax-equivalent net interest margin was 3.76% versus 3.91%. For the first half, net interest income rose to $91.7 million from $86.5 million, while margin eased to 3.75% from 3.81%.
- Drivers and expenses: Higher loan yields and balances supported interest income, but higher deposit and borrowing costs weighed on quarterly net interest income. Q2 provision for loan losses rose to $4.1 million from $1.9 million. Noninterest expense fell to $40.2 million from $46.5 million, reflecting lower personnel, professional and other expenses, including reduced Alpine integration-related costs.
- Cash flow: First-half operating cash flow was $53.5 million versus $37.0 million; investing activities provided $119.4 million versus using $8.0 million; financing activities used $141.2 million versus providing $32.1 million. Cash and cash equivalents were $245.4 million at June 30, up from $213.7 million at year-end.
- Balance sheet and funding: Total assets were $5.55 billion, down from $5.64 billion at December 31, 2018. Loans were $4.07 billion, down $64.0 million; deposits were $4.01 billion, down $63.0 million. Shareholders’ equity increased to $639.9 million from $608.5 million. Period-end short-term borrowings were $113.8 million, FHLB advances and other borrowings $582.4 million, subordinated debt $94.2 million, and trust preferred debentures $48.0 million.
- Credit quality: The allowance for loan losses increased to $25.9 million, or 0.64% of loans, from $20.9 million, or 0.51%. Nonperforming assets rose to $54.5 million from $45.9 million at year-end; nonperforming assets were 0.98% of total assets versus 0.81%. Management attributed the higher provision and allowance mainly to specific reserves on problem credits and loan downgrades.
- Capital and liquidity: At June 30, the company’s total risk-based capital ratio was 13.49% and the Bank’s was 13.22%; the Bank met the regulatory definition of well-capitalized. The company reported $50.9 million of unused Federal Reserve discount-window capacity and $45.0 million of unused federal funds lines.
Material changes, outlook and risks
- Deposit interest expense increased as deposit pricing rose amid market competition. First-half loan growth in average balances partly reflected Alpine; period-end loan balances declined, principally due to commercial real estate payoffs and reductions.
- Management provided no specific earnings or revenue guidance and cautioned that interim results are not necessarily indicative of full-year results.
- The Bank exceeded its established tolerance for a 100-basis-point rate decline: modeled 12-month net interest income fell 5.1% (approximately $9.4 million). The company reported it was within policy limits for +100- and +200-basis-point scenarios. The filing says tolerance breaches require remediation planning.
- CECL was scheduled for adoption in 2020. The company expected adoption to increase the allowance, but said the amount would depend on portfolio composition and economic conditions; model validation and implementation work were underway.
- Off-balance-sheet commitments included $761.8 million to extend credit and $127.1 million of standby letters of credit. Management reported no material anticipated losses from ordinary-course legal claims and no material pending legal proceedings.
- Subsequent events: the company completed its acquisition of HomeStar on July 17, 2019, for $11.4 million in cash and stock; HomeStar had approximately $370.4 million in assets. On July 29, the company redeemed all Series H preferred stock. On August 6, the board authorized a common-stock repurchase program of up to $25 million through June 30, 2020.
- The company adopted lease accounting on January 1, 2019, recognizing $10.2 million of operating lease right-of-use assets and $10.7 million of lease liabilities at quarter-end; management said adoption did not materially affect income.
Important facts for investors to verify
- Whether credit deterioration continues, especially in commercial real estate, and whether the higher allowance adequately reflects losses.
- Whether deposit-cost pressure persists and how it affects net interest margin and earnings.
- The extent of the expected CECL allowance increase and implementation progress.
- HomeStar’s final purchase accounting, integration costs, and contribution to results; the filing had not yet determined acquired fair values.
- Use of the $25 million repurchase authorization, alongside the preferred-stock redemption and common dividends.
- Management’s response to the interest-rate-decline sensitivity breach and any resulting change in risk exposure.