Midland States Bancorp, Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Amounts are in U.S. dollars; financial statement amounts are in thousands unless otherwise noted. The filing is unaudited.
Business context
Midland States is an Illinois-based diversified financial holding company whose businesses include community banking, commercial FHA mortgage origination and servicing, equipment leasing, and wealth management. On June 9, 2017, it completed its acquisition of Centrue Financial Corporation, adding 20 branches, principally in northern Illinois. Management intended to merge Centrue Bank into Midland States Bank in the third quarter of 2017. The company also acquired CedarPoint Investment Advisors in March 2017.
Key financial results
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net interest income | $29.4 million | $28.0 million | $56.9 million | $52.0 million |
| Provision for loan losses | $0.5 million | $0.6 million | $2.0 million | $1.8 million |
| Noninterest income | $13.6 million | $14.0 million | $30.0 million | $26.6 million |
| Noninterest expense | $37.6 million | $30.9 million | $68.4 million | $58.5 million |
| Net income | $3.5 million | $6.8 million | $12.0 million | $11.9 million |
| Diluted EPS | $0.20 | $0.50 | $0.71 | $0.92 |
| Tax-equivalent net interest margin | 3.70% | 4.20% | 3.78% | 4.01% |
At June 30, total assets were $4.49 billion, loans $3.18 billion (net $3.17 billion), deposits $3.33 billion, and shareholders’ equity $452.0 million. Cash and cash equivalents were $334.4 million. These balance-sheet increases versus year-end 2016 principally reflect the Centrue acquisition.
For the first half, operating cash flow was $51.6 million, investing cash flow was negative $183.3 million, and financing cash flow was positive $275.4 million. Cash and cash equivalents increased $143.6 million. The operating cash flow comparison was negative $25.4 million in the first half of 2016.
Borrowings at June 30 included $170.6 million of short-term borrowings, $400.3 million of FHLB advances and other borrowings, $54.6 million of subordinated debt, and $45.2 million of trust preferred debentures. The company reported $77.0 million of unused federal funds lines, $109.4 million of available Federal Reserve Discount Window lines, and $513.3 million of additional FHLB borrowing capacity.
Material changes versus comparable periods
- Q2 net income declined 47.9% year over year despite higher net interest income. The company attributed the net interest income increase mainly to loan growth, while higher expenses and lower commercial FHA revenue weighed on results.
- First-half net income was broadly flat year over year, but diluted EPS fell to $0.71 from $0.92; weighted average diluted shares increased to 16.84 million from 12.94 million, largely reflecting acquisition-related share issuance.
- Tax-equivalent NIM compressed year over year. Management cited lower acquired-loan discount accretion: $1.3 million in Q2 2017 versus $4.9 million in Q2 2016, and $4.0 million versus $6.8 million for the first half.
- Q2 noninterest income fell $0.4 million: commercial FHA revenue declined $4.4 million, partly offset by gains in residential mortgage banking and wealth management. First-half noninterest income rose $3.3 million, including acquisition-driven wealth management growth and the absence of prior-year FDIC loss-sharing expense and securities impairment.
- Noninterest expense increased $6.7 million in Q2 and $9.9 million for the first half. The company cited Centrue-related change-in-control, severance, integration and professional costs; first-half acquisition and integration costs totaled $6.7 million.
- Gross loans increased $864.1 million from year-end, including $688.1 million acquired from Centrue; management also reported $176.0 million of organic loan growth. Deposits rose $928.7 million, including $741.8 million acquired.
Credit, capital, risks and outlook
- The allowance for loan losses was $15.4 million, or 0.48% of gross loans, versus $14.9 million and 0.64% at year-end. First-half net charge-offs were $1.4 million, compared with $3.0 million in the prior-year period.
- Impaired loans were $27.6 million versus $31.6 million at year-end, and nonperforming assets were $33.2 million versus $34.6 million. However, nonaccrual loans increased to $25.0 million from $16.9 million, and other real estate owned rose to $7.0 million from $3.6 million.
- Regulatory capital ratios exceeded stated minimums; the Bank and Centrue Bank were reported as well-capitalized. The company reported compliance with the covenants on its $40 million term loan.
- Management provided no numerical earnings or financial guidance. It cautioned that interim results are not necessarily indicative of full-year results. The Centrue bank merger was planned for Q3 2017; integration, anticipated synergies and acquisition costs remain important execution factors.
- Key risks include credit quality and loan concentration, interest-rate and mortgage-prepayment sensitivity, acquisition integration, and the uncertain value or timing of use of Centrue deferred tax assets, which may be limited under tax law including Section 382. A putative shareholder lawsuit over the Centrue merger now seeks monetary damages; the company says it believes the claims are without merit, but the outcome is uncertain.
- Other notable items: the company recorded $1.1 million of impairment on two facilities planned for closure and expected five additional facility closures following the acquisition. Mortgage servicing rights remain sensitive to prepayment assumptions; impairment charges totaled $1.7 million in the first half of 2017. The filing reports $632.7 million of commitments to extend credit and $71.2 million of standby letters of credit.
Important facts for investors to verify
- How much of reported loan, deposit and earnings growth is organic versus acquired, and whether Centrue integration delivers expected benefits.
- Whether acquisition-related costs decline and operating expenses normalize; also track the effect of share issuance on per-share earnings.
- Trends in NIM, funding costs, acquired-loan discount accretion and sensitivity to changing interest rates.
- Developments in nonaccrual loans, commercial real estate exposure, charge-offs, the allowance and other real estate owned.
- Liquidity and funding mix, including brokered deposits, borrowings, available borrowing capacity and loan commitments.
- Utilization and realizability of Centrue’s deferred tax assets, the merger litigation, and further branch-closure or mortgage-servicing impairment charges.