Business context and reporting period
Midland States Bancorp, Inc. filed this audited Form 10-K for the fiscal year ended December 31, 2016. It is a diversified financial holding company with community banking, residential mortgage, wealth management, commercial FHA lending and equipment leasing businesses. The company completed its IPO in May 2016 and acquired approximately $400 million of wealth-management assets from Sterling in November.
Financial performance and condition
- Revenue and earnings: Net interest income was $105.3 million and noninterest income was $72.1 million, totaling $177.3 million. Net income was $31.5 million, up from $24.4 million in 2015; diluted EPS rose to $2.17 from $2.00. Pretax income was $50.4 million. The effective tax rate increased to 37.5% from 31.2%.
- Margins and costs: Fully taxable-equivalent net interest margin fell to 3.92% from 4.38%; excluding acquired-loan accretion, it was 3.54% versus 3.74%. Noninterest expense increased 3.0% to $121.3 million. The efficiency ratio rose to 68.66% from 66.15%.
- Cash flow: Operating cash flow was $25.5 million, down from $73.6 million. Investing activities used $360.4 million, primarily reflecting loan growth; financing activities provided $313.0 million, including IPO proceeds and increased FHLB funding. Cash and cash equivalents ended at $190.7 million, down from $212.5 million.
- Balance sheet and funding: Assets grew 12.1% to $3.23 billion; gross loans rose 16.3% to $2.32 billion, and deposits increased 1.6% to $2.40 billion. Combined short-term borrowings, FHLB advances, subordinated debt and trust-preferred debentures totaled approximately $461.0 million, up from $246.6 million. The loan-to-deposit ratio increased to 96.49% from 84.29%.
- Capital and asset quality: Shareholders’ equity was $321.8 million. The consolidated Tier 1 leverage ratio was 9.76% and total capital ratio 13.85%; the Bank was reported well-capitalized. Nonperforming loans increased to $31.6 million, or 1.36% of loans, from $24.9 million, or 1.25%. The allowance was $14.9 million, 0.64% of loans and 47.03% of nonperforming loans; net charge-offs were 0.31% of average loans.
- Liquidity: The company reported $310.8 million of additional FHLB borrowing capacity and $30.0 million of unused federal funds lines at year-end, as well as a $35.1 million unused Federal Reserve Discount Window line, subject to eligible collateral.
Material changes versus 2015
- Net interest income was nearly flat, as higher loan balances were largely offset by increased funding costs and lower acquired-loan accretion. Net interest margin contracted.
- Net income rose, but results included a $14.3 million gain from selling previously FDIC-covered mortgage-backed securities; total net securities gains were $14.7 million. Adjusted earnings, a non-GAAP measure, declined to $27.4 million from $29.2 million.
- Loan growth was broad, notably in commercial real estate, residential real estate, consumer lending and equipment leases. Commercial loans declined as repayments exceeded new originations.
- The allowance declined from $16.0 million, while nonperforming loans rose. Management cited a $10.0 million commercial real estate loan classified as a troubled debt restructuring as a principal driver of the nonperforming-loan increase.
- The IPO generated $71.5 million of net proceeds. The company contributed $25.0 million to the Bank and used $8.0 million to repay older subordinated notes.
Outlook, commentary, risks and unusual items
- Management described continued acquisition and organic-growth opportunities, while expecting higher administrative, integration, staffing and infrastructure costs. The filing provides no quantified earnings or margin guidance.
- In January 2017, the company agreed to acquire Centrue Financial Corporation for estimated consideration of $175.1 million, expected to be 65% stock and 35% cash, with closing anticipated mid-2017 subject to approvals and other conditions. The company expected to use cash on hand and approximately $40 million of planned borrowing for the cash portion.
- A putative shareholder lawsuit challenged the Centrue transaction and sought to enjoin it; the outcome was uncertain and could delay or prevent closing.
- The company announced a plan to reduce banking offices from 46 to 39 by March 2017, recording $1.9 million of facility impairment and $0.2 million of related charges. It also paid $0.6 million to terminate remaining FDIC loss-sharing agreements; future losses on formerly covered assets will no longer be shared.
- Key risks include commercial and real-estate credit exposure, interest-rate and margin sensitivity, liquidity and funding costs, acquisition integration and acquired-loan estimates, cybersecurity and third-party operations, regulation, and mortgage servicing-rights valuation. The filing also identifies CECL adoption, effective for the company after December 15, 2019, as a potential source of higher credit-loss allowances; its impact was not yet quantified.
- The company declared $0.72 per share in dividends for 2016. Future dividends remain subject to board discretion, regulatory limits, capital conditions and debt covenants.
Important facts for investors to verify
- How much of 2016 earnings and capital generation is sustainable excluding the securities-sale gain and other adjusting items.
- Whether margin pressure, acquired-loan accretion runoff and higher deposit or borrowing costs continue, and how loan growth is funded.
- Credit trends behind the increase in nonperforming loans and TDRs, adequacy of the allowance, and performance of rapidly growing consumer, construction and real-estate portfolios.
- Final Centrue transaction terms, financing, litigation and approval status, integration costs, and expected benefits.
- Whether branch consolidation delivers the expected savings, and the effect of ending FDIC loss-sharing coverage on future credit costs.
- The company’s liquidity and capital position after planned acquisition funding, and its ability to maintain dividends under regulatory and contractual restrictions.