Midland States Bancorp, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Unaudited consolidated results; dollar amounts below are in millions unless stated otherwise. The company is a diversified financial holding company focused on community banking, lending, equipment finance, commercial FHA mortgage origination and servicing, and wealth management.
Business context and reporting period
Results reflect the February 28, 2018 acquisition of Alpine Bancorporation, which added 19 northern Illinois banking locations. The acquisition was valued at approximately $173.2 million, comprising $33.3 million cash and 4,463,200 common shares. Alpine’s results are included from the acquisition date; the June 2017 Centrue acquisition also affects year-over-year comparisons. Management cautions that interim results are not necessarily indicative of full-year results.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net interest income (GAAP) | $48.3 | $29.4 | $86.5 | $56.9 |
| Net interest margin (tax-equivalent) | 3.91% | 3.70% | 3.81% | 3.78% |
| Provision for loan losses | $1.9 | $0.5 | $3.9 | $2.0 |
| Noninterest income | $15.9 | $13.6 | $32.6 | $30.0 |
| Noninterest expense | $46.6 | $37.6 | $96.2 | $68.4 |
| Income before income taxes | $15.8 | $4.9 | $19.0 | $16.4 |
| Net income | $12.8 | $3.5 | $14.6 | $12.0 |
| Diluted EPS | $0.52 | $0.20 | $0.63 | $0.71 |
For the six months, operating cash flow was $50.1 million, investing cash flow was negative $21.1 million, and financing cash flow was $32.1 million. Cash and cash equivalents rose $61.1 million from year-end 2017 to $276.3 million at June 30, 2018.
Financial position, liquidity and credit
- At June 30, 2018, assets were $5.73 billion, loans $4.10 billion, deposits $4.16 billion, total liabilities $5.14 billion, and shareholders’ equity $592.5 million. Assets increased $1.32 billion from year-end, primarily due to Alpine.
- Deposits increased $1.03 billion from year-end, including approximately $1.11 billion acquired with Alpine. FHLB advances and other borrowings were $678.9 million; short-term borrowings were $114.5 million; subordinated debt was $94.1 million; and trust preferred debentures were $47.6 million.
- Available liquidity included $116.4 million of unused Federal Reserve Discount Window capacity and $90.0 million of unused federal funds lines. Management stated it believes cash and available borrowing sources are sufficient to meet obligations.
- The allowance for loan losses was $18.2 million, or 0.45% of total loans, compared with $16.4 million and 0.51% at year-end. Six-month net charge-offs were $2.0 million; the reported ratio to average loans was 0.11%.
- Nonperforming assets were $31.5 million, or 0.55% of assets, versus $30.9 million and 0.70% at year-end. Nonaccrual loans increased to $24.8 million from $21.3 million; potential problem commercial loans increased to $83.9 million from $67.0 million.
- The company and its banking subsidiaries were reported as “well-capitalized” under Basel III at June 30. The company’s total risk-based capital ratio was 12.27%; Midland States Bank’s was 12.28%.
Material changes versus comparable periods
- Q2 net income rose to $12.8 million from $3.5 million, while six-month net income increased to $14.6 million from $12.0 million. Six-month diluted EPS declined to $0.63 from $0.71, reflecting substantially more weighted-average shares, including shares issued for acquisitions.
- Net interest income and margin increased. Management attributed growth chiefly to the larger acquired loan and securities balances, higher market rates, and purchase-accounting accretion. Acquired-loan accretion was $5.5 million in Q2 and $7.4 million for the first half; it increased reported margin by 40 and 29 basis points, respectively.
- Noninterest expense increased substantially, reflecting acquisitions and integration-related costs. First-quarter 2018 salaries included $9.3 million of Alpine-related change-in-control, severance and other benefit costs. Q2 2017 salaries included $4.1 million of Centrue-related costs, affecting the quarterly comparison.
- Noninterest income growth was partially offset by lower commercial FHA revenue: $0.3 million in Q2 versus $4.2 million, and $3.7 million for the half-year versus $10.8 million. Management cited reduced FHA rate-lock commitments. Residential mortgage banking revenue also declined for the half-year.
- Available-for-sale securities had a $4.1 million after-tax other comprehensive loss for the first half, contributing to accumulated other comprehensive loss of $2.3 million at June 30.
Outlook, commentary, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management describes a strategy of building a diversified financial-services company anchored by a community bank; it expects integration costs to be expensed as incurred. Forward-looking statements are subject to economic, market, interest-rate, acquisition-integration and other risks.
- Management attributed the higher loan-loss provision to portfolio growth and specific reserves associated with two commercial loans that were classified as nonaccrual in Q1 and charged off in Q2. Six-month charge-offs were $3.3 million, partly offset by $1.2 million of recoveries.
- Interest-rate exposure remains material. At June 30, modeled net interest income fell 0.5% under an immediate +100-basis-point shock and 1.3% under +200 basis points; modeled economic value of equity rose 4.4% and 7.6%, respectively. The NII sensitivity profile differed from year-end 2017.
- Residential mortgage servicing rights continued to be reduced or sold: the company sold $2.7 million of rights in June and recorded a $0.4 million loss. Six-month servicing-rights impairment charges were $0.6 million; mortgage servicing values depend on assumptions including prepayment speeds and discount rates.
- The company expects the new lease accounting standard, effective for it in 2019, to increase reported assets and liabilities. It could not yet estimate the impact of the expected-credit-loss standard, effective in 2020 for the company, including any opening allowance adjustment.
- Commitments to extend credit were $767.3 million and standby letters of credit were $144.4 million. The company reported no material pending legal proceedings and anticipated no material losses from claims or actions in the ordinary course.
Most important facts for investors to verify
- How much of earnings and margin growth is sustainable after acquired-loan accretion and acquisition-related effects are excluded.
- Whether Alpine integration delivers expected operating benefits and whether further integration costs, including the disclosed $13 million of Alpine transaction and integration costs incurred through June 2018, remain.
- Credit trends behind higher nonaccrual loans, potential problem loans, charge-offs and the provision, including performance of acquired and consumer/equipment-finance portfolios.
- Funding costs, deposit retention and reliance on FHLB advances as interest rates change; assess liquidity and capital alongside the reported sensitivity measures.
- Valuation assumptions and future impairment risk for mortgage servicing rights and securities, and the eventual balance-sheet and allowance effects of upcoming accounting standards.