Midland States Bancorp, Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016; balance-sheet comparisons are to December 31, 2015. Amounts are in millions unless otherwise noted. The company is an Illinois-based financial holding company whose businesses include community banking, commercial FHA mortgage origination and servicing, equipment leasing, residential mortgage banking, and wealth management.
Financial results and condition
- Q2 earnings: Net income attributable to Midland States was $6.8 million, versus $6.7 million in Q2 2015. Diluted EPS was $0.50, compared with $0.55; the increase in average shares following the IPO contributed to lower EPS.
- First-half earnings: Net income attributable to the company was $11.9 million, down from $13.2 million in the first half of 2015. Diluted EPS was $0.92 versus $1.08.
- Net interest: Q2 net interest income was $28.0 million versus $28.3 million; on a tax-equivalent basis it was $28.7 million versus $29.0 million. First-half GAAP net interest income was $52.0 million versus $53.0 million. Reported net interest margin declined to 4.20% from 4.79% in Q2 and to 4.01% from 4.60% for the first half. Excluding acquired-loan accretion, margins were 3.52% and 3.54% in 2016, respectively.
- Noninterest income and expense: Q2 noninterest income was $14.0 million, broadly unchanged year over year; first-half income fell to $26.6 million from $32.2 million. Commercial FHA revenue increased, while residential mortgage banking revenue fell substantially. Noninterest expense was $30.9 million in Q2 versus $30.7 million and $58.6 million for the first half versus $62.2 million.
- Credit costs and asset quality: Provision for loan losses was $0.6 million in Q2 and $1.8 million for the first half, below prior-year levels. The allowance was $14.8 million, or 0.68% of gross loans, at June 30. First-half net charge-offs were $3.0 million. Nonperforming loans were $18.4 million, or 0.85% of loans, down from $24.9 million, or 1.25%, at year-end.
- Growth and liquidity: Total assets rose 4.7% to $3.02 billion. Gross loans increased 8.3% to $2.16 billion, with growth in commercial real estate, construction, residential, consumer, and lease financing. Deposits declined 0.6% to $2.35 billion; management attributed this mainly to seasonal real-estate-tax deposits at year-end. Cash and cash equivalents fell to $123.4 million from $212.5 million.
- Cash flow: First-half operating cash flow was negative $25.2 million, compared with positive $17.2 million in 2015; investing cash outflow was $185.2 million and financing cash inflow was $121.3 million. Operating cash use reflected loan originations held for sale exceeding sales, while investing cash use included loan growth and a $20 million life-insurance purchase.
- Funding and capital: At June 30, deposits were $2.35 billion; short-term borrowings were $125.0 million; FHLB and other borrowings were $97.6 million; subordinated debt was $54.5 million; and trust preferred debentures were $37.2 million. Shareholders’ equity increased to $316.3 million, including $71.7 million of net IPO proceeds. The Bank reported a 9.85% Tier 1 leverage ratio, 11.31% common equity Tier 1 ratio, and 11.89% total capital ratio, and was classified as well-capitalized.
Material changes, outlook, and notable items
- The company completed its IPO in May and June, issuing 3.59 million shares and receiving $71.7 million net proceeds. It contributed $25 million to the Bank and used $8 million to repay 8.25% subordinated notes; the payoff generated a $0.5 million discount write-off expense.
- Q2 commercial FHA revenue rose to $8.5 million from $4.1 million, supported by increased loan-sale gains and higher rate-lock volume. First-half residential mortgage banking revenue declined to $2.2 million from $10.8 million, including lower production and $5.0 million of mortgage-servicing-rights impairment for the half. Falling long-term rates increased expected prepayments and reduced servicing-rights value.
- Q2 included a paid-in-full acquired PCI loan: the company recorded $1.8 million of accretion income and a $0.8 million provision credit, but also $1.5 million of FDIC loss-sharing expense for reimbursement of prior covered-loss payments. The FDIC loss-sharing term for covered securities expired July 1, 2016.
- Management expects acquired-loan accretion income to continue declining during 2016 as acquired loans run off. The filing provides no formal earnings or revenue guidance. Management stated that liquidity should be supported by cash, loan and securities repayments and maturities, deposit gathering, and available borrowing facilities.
- Interest-rate modeling estimated that a +100-basis-point rate shift would increase one-year net interest income by 2.8%; a +200-basis-point shift by 5.6%. Economic value of equity was estimated to fall 6.4% under a 50-basis-point decline and rise 9.6% under a 100-basis-point increase. These are model estimates, not forecasts.
- A proposed acquisition of approximately $400 million in wealth-management assets for about $4.8 million was expected to close in Q3 2016, subject to regulatory approval and other conditions.
- Commitments to extend credit totaled $497.9 million; standby letters of credit totaled $22.4 million. The company reported a $0.4 million liability for unresolved mortgage repurchase demands and $83,000 of related losses in the first half. Management did not expect material losses from ordinary legal proceedings.
Key investor verification points
- Track loan growth against funding costs, deposit mix, and the continued use and pricing of brokered deposits and borrowings.
- Assess whether lower acquired-loan accretion and further mortgage-servicing-rights impairment affect future margins and earnings.
- Review charge-offs, nonperforming assets, commercial real-estate and construction exposures, and the adequacy of the loan-loss allowance.
- Confirm the post-expiration implications of the FDIC loss-sharing agreement and performance of formerly covered assets.
- Verify the closing, purchase economics, and integration of the proposed wealth-management transaction, and monitor liquidity and capital after the IPO and debt repayment.