Midland States Bancorp Inc (MSBI) 2021 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Q1 2021 Midland States Bancorp Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to turn the conference over to your host, Mr. Tony Rossi of Financial Profiles. Thank you. Please go ahead.

Thank you, Stacey. Good morning, everyone, and thank you for joining us today for the Midland States Bancorp First Quarter 2021 Earnings Call.

Joining us from Midland's management team are Jeff Ludwig, President and Chief Executive Officer; and Eric Lemke, Chief Financial Officer. We will be using a slide presentation as part of our discussion this morning. If you have not done so already, please visit the Webcasts and Presentations page of Midland's Investor Relations website to download a copy of the presentation.

Before we begin, I'd like to remind you that this conference call contains forward-looking statements with respect to the future performance and financial condition of Midland States Bancorp that involve risks and uncertainties, including those related to the impact of the COVID-19 pandemic. Various factors could cause actual results to be materially different from any future results expressed or implied by such forward-looking statements. The factors are discussed in the company's SEC filings, which are available on the company's website. The company disclaims any obligation to update any forward-looking statements made during the call.

Additionally, management may refer to non-GAAP measures, which are intended to supplement, but not substitute, for the most directly comparable GAAP measures. The press release available on the website contains the financial and other quantitative information to be discussed today as well as the reconciliation of the GAAP to non-GAAP measures.

And with that, I'd like to turn the call over to Jeff. Jeff?

Good morning, everyone. Welcome to the Midland States earnings call.

I'm going to start on Slide 3 with the highlights of the first quarter. Over the last couple of years, we have talked a lot about the strategic initiatives we have implemented to position the company for improved financial performance. These initiatives range from branch consolidations, to the sale of the commercial FHA loan origination platform, to the acceleration of our investment in technology to improve efficiencies and enhance revenue generation. Our first quarter performance reflects a significant increase in our level of profitability resulting from these efforts to enhance efficiencies and optimize our business model.

Despite growing in a low growth, low interest rate environment, we generated net income of $18.5 million or $0.81 per diluted share, which represents the highest level of quarterly earnings in our history. We are also seeing the improvement in our performance metrics that we targeted. Our efficiency ratio improved to 56.9% and from 58.6%. Our return on average shareholders' equity exceeded 12% in the quarter, and our return on average tangible common equity exceeded 17%, and our adjusted pretax pre-provision return on average assets was 1.75%.

All these metrics represent our best core operating performance since we became a public company. The strong performance is resulting in a significant amount of internally generated capital that is positively impacting our capital ratios and our book value.

Building up our capital ratios was one of the priorities for 2021 that we talked about on our last earnings call. And in the first quarter, all of our capital ratios increased between 21 and 49 basis points, and our book value -- and tangible book value per share increased 2.2% and 3.5%, respectively, from the end of the prior quarter. Notably, we were able to achieve this improved financial performance without the benefit of high loan balances.

During the first quarter, we saw an elevated level of payoffs and paydowns across most of our major portfolios, and our loan production reflected the seasonally slower activity that we typically experience in the first quarter. However, we continued to have strong inflows of low-cost deposits. While this added to our excess liquidity in the near term, it continues to improve our positioning to capitalize on stronger loan demand later in the year and redeploy this liquidity into higher-yielding earning assets.

On our last earnings call, we also mentioned that while we intended to remain internally focused this year, we would look on smaller add-on acquisitions and niche business lines such as wealth management. We were able to find an attractive opportunity with the acquisition of ATG Trust Company that we announced in February. With nearly $400 million in assets under management, ATG will further increase the scale and diversification of our wealth management business. ATG has built up a good network of referral sources that we can leverage across the broader platform of wealth management and trust services that we provide, which we believe will enhance our new business development efforts. Over the years, we have effectively utilized acquisitions to grow our assets under administration and better leverage our wealth management platform, and we expect ATG to contribute to the continued growth in the stable reoccurring fee income that we generate from this line of business.

Moving to Slide 4, we'll provide an update on our PPP efforts and the impact that these loans have had on various line items in the first quarter. Through March 31, we had originated $79 million in loans through the second PPP program. During the first quarter, approximately $53 million of the loans from the first program received forgiveness. This brought our total balances of PPP loans to about $212 million at the end of the first quarter. The amount of loans forgiven in the first quarter was lower than the prior quarter, which resulted in lower PPP fee income recognized. We recognized $2.1 million in fees during the first quarter, down from $3.1 million last quarter. As of March 31, we still had $6 million in fees to be recognized, which is a little less than half of the total amount of fees earned through the first 2 rounds.

Turning to Slide 5. We'll provide an update on the loan deferrals. At March 31, we had $219 million in loan deferrals, which was up a bit from the end of the prior quarter, but still under 5% of our total loans. The increase primarily came from hotel borrowers who had resumed contractual payments after an initial loan modification then experienced some seasonal decline in occupancy during the first quarter. So we provided 3 month deferrals to help them get through the soft part of the year.

Based on current occupancy trends, we would expect many of these borrowers to get back to scheduled payments during the second quarter. We also had some new borrowers in the assisted living industry that required modifications during the first quarter, but we've since received some payoffs on these loans that should result in lower deferrals at the end of the second quarter. These new modifications offset a decrease in deferrals in our equipment finance portfolio. At March 31, about 40% of loan deferrals were making interest-only or some other form of partial payment.

At this point, I'm going to turn the call over to Eric to provide some additional details around our first quarter performance. Eric?

Thanks, Jeff, and again, good morning, everyone.

I'm starting on Slide 6, and we'll take a look at our loan portfolio. Our total loans decreased $193 million from the end of the prior quarter. As Jeff mentioned, we experienced an elevated level of payoffs and paydowns across most of our major portfolios during the quarter. This included lower line utilization from our ag borrowers and the continued runoff we are seeing in the residential real estate portfolio due to refinancing activity. More than 1/3 of the decline in total loans was attributable to period end balances on commercial FHA warehouse credit lines that were $68 million lower than the end of the prior quarter. While there can be some volatility in the period end balances, this lending area continues to generally increase for us as the average balances were higher in the first quarter than in the fourth quarter. Offsetting the payoffs and paydowns in other areas was a $27 million increase in our PPP loan balances as our production in the second round of the program more than offset the level of forgiveness we saw on loans originated in the first round.

On Slide 7, we've provided an update of our equipment finance portfolio. As of March 31, we had $46 million of loan deferrals, which represents a decline of 8% since the end of the last quarter. We continue to see a steady recovery of our borrowers in the transit and ground transportation industry as the trends in business and recreational travel continue to improve. We've seen more borrowers return to scheduled payments as well as others that remain on deferral starting to make some form of partial payment. 78% of the borrowers on deferral in this portfolio are now making a partial payment.

On Slide 8, we've provided an overview of our hotel portfolio. At March 31, we had $117 million of loan deferrals in this portfolio, which, as Jeff mentioned, is up from the end of the prior quarter as a number of borrowers had to return to a modified loan status. As of March 31, we had approximately 21% of our deferred loans in this portfolio making interest-only or some other form of payment.

Looking at Slide 9, we've provided an update on the consumer loan portfolio that we have through our relationship with GreenSky. We hedged just under $4 million of deferred loans in this portfolio at March 31, which represents about 1/2 of 1% of the total loans. The portfolio continues to perform well over the past few quarters, and the delinquency rate has stayed in the 30 to 40 basis point range. And in addition to the strong performance, the escrow account is available to cover any deficiency in Midland's principal balances. The escrow account stood at just over $30 million at the end of the first quarter.

Our total balances in the GreenSky portfolio remained relatively flat during the first quarter. Given our current liquidity, we may grow this portfolio during the last half of the year.

Turning to Slide 10, we'll take a look at our deposits. Total deposits increased $240 million or 4.7% from the prior quarter. The growth was largely attributable to an increase in demand deposits from commercial customers as well as retail deposit inflows resulting from the latest round of stimulus payments. Looking ahead to the second quarter, we will have additional opportunities to reprice higher cost time deposits. We have $159 million of CDs maturing at a weighted average rate of 1.0% -- or 1.06%, excuse me. As these deposits renew at current rates, we should see a positive impact on our deposit costs.

Looking at Slide 11, we'll walk through the trends in our net interest income and margin. Our net interest income decreased 3.1% from the prior quarter due to lower accretion income and lower PPP income. Excluding accretion income, our net interest margin was unchanged from the prior quarter as a favorable shift in the mix of earning assets and a reduction in our average cost of funds were offset by a decline in the average yield on both loans and securities. Our net interest margin for the quarter, excluding the impact of PPP income, was 3.38%.

We used a portion of our excess liquidity to reduce our balances of FHLB advances as we continue to look to reduce our reliance on wholesale funding. Our FHLB borrowings were $250 million lower than at the end of the prior quarter. In the near term, our focus will be to support net interest income, even if that means giving up a bit of margin. We plan to add to the investment portfolio during the second quarter to generate some additional interest income. But we still should have plenty of liquidity remaining to redeploy into higher-yielding assets as loan growth increases in the future, excluding the impact of forgiveness of our PPP portfolio.

Turning to Slide 12, we'll look at the trends in our wealth management business. We had an $80 million increase in our assets under administration, primarily due to market performance. The higher assets under administration resulted in a 1.1% increase in our revenue compared to the prior quarter.

On Slide 13, we'll take a look at noninterest income. We had $14.8 million in noninterest income in the first quarter, up 3.3% from the prior quarter. We recorded an impairment on commercial mortgage servicing rights in both quarters, with the impairment in the first quarter being about $1 million lower than the impairment in the prior quarter. Excluding these impairments, our noninterest income was down from the prior quarter, primarily due to lower levels of residential mortgage banking revenue and service charges on deposit accounts. While our refinancing production in the residential mortgage banking business held fairly steady with the prior quarter, we saw a decline in purchase production, which accounted for the lower level of revenue in the first quarter.

Turning to Slide 14, we'll review our noninterest expense. At $39.1 million, our noninterest expense came in at the low end of the run rate we projected to start 2021, even including the small amount of acquisition and integration expenses that we incurred in the first quarter. This represents a significant decline from the expense levels we had in 2020 and reflects the first full quarter benefit of the consolidations we made in our branch network and corporate facilities. As a reminder, we also recorded an accrual for a onetime rollover of vacation time due to COVID-19 that impacted our salaries and benefits expense last quarter.

While continuing to invest in our technology initiatives, we believe that we can maintain our quarterly operating expense in the range of $39 million to $40 million for the foreseeable future.

Turning to Slide 15, we'll look at asset quality trends. Our nonperforming loans decreased $1.2 million from the end of the prior quarter as we continued to resolve some of our longer-term problem loans without any material additional losses being incurred. However, with the decline in our total loans, the ratio of nonperforming loans to total loans increased 2 basis points to 1.08%.

Our net charge-offs continue to be very manageable and were just $1.7 million or 14 basis points of average loans. We recorded a provision for credit losses of $3.6 million, which was primarily driven by additions to specific reserves as the trends we saw in the broad portfolio were generally stable to positive during the quarter. At March 31, approximately 90% of our ACL was allocated to general reserves.

And on Slide 16, we show the components of the change in the allowance for credit losses from the end of the prior quarter. Our ACL increased $2.2 million and strengthened our reserve to 128 basis points of total loans from 118 basis points at the end of the prior quarter. The biggest contributor to the provision this quarter was additions to specific reserves, which offset some reserve release resulting from the improvement in economic forecasts utilized in our ACL model.

On Slide 17, we show our ACL broken out by loan portfolio. The reserve build this quarter was primarily driven by an increase in coverage on our commercial real estate portfolios. We continued to add to our reserves in these portfolios due to the ongoing impact of COVID-19 and ongoing loan deferrals in certain portfolio segments, including hotels, assisted living and other industries.

In addition to the ACL to total loans, we also tracked the coverage ratio when excluding loan portfolios with certain credit enhancements or government guarantees, including the PPP portfolio, our GreenSky loans and commercial FHA warehouse lines. When these loans are excluded, our ACL coverage increased to 1.64% compared to 1.52% at the end of the prior quarter.

And with that, I will turn the call back over to Jeff. Jeff?

Thanks, Eric. We'll wrap up on Slide 18 with a few comments on our outlook. We're very pleased with our start to the year and delivering on higher profitability that we targeted. While the pandemic is still very much top of mind, we are seeing signs of improving economic conditions, and borrowers that were most impacted by the pandemic continue to steadily improve their financial performance. We believe this should lead to continued reduction in deferrals as we move through the spring and summer, and our ACL coverage ratio will remain relatively stable. The improving economic conditions is reflected in our growing loan pipeline and the new bankers we added in the areas of SBA, agribusiness and specialty finance have been very productive in their first few months and are contributing to the increases we are seeing in the loan pipeline.

We are optimistic that the growing pipeline will result in stronger loan production and loan growth as we move through the year. With stronger loan growth, we will be able to redeploy our excess liquidity into higher-yielding assets, generate more revenue growth, further increase our operating leverage and drive additional improvement in our level of profitability.

The ATG acquisition is on track to close in the second quarter, and this will provide a further increase in our fee income over the second half of the year. The continuation of our strong financial performance and the further improvement we expect to deliver as we enter a more favorable environment for generating loan growth should help us to make additional progress in strengthening our capital ratios, which will better support our continued organic and acquisitive growth in the future.

With that, we'll be happy to answer any questions you might have. Operator, please open the call.

(Operator Instructions) Our first question comes from Terry McEvoy from Stephens.

I guess 2 questions. The leasing business and GreenSky, it sounds like GreenSky, you're thinking about increasing just your concentration to GreenSky, if I heard it correctly. And if that's the case, to what degree?

And I guess on the leasing at 17.5%, is that an area you're looking to grow this year? Or from a concentration standpoint, is that kind of your level of comfort?

Yes. So I'll start with the Midland Equipment Finance business. We had a little bit of a slower first quarter, which is not unusual. Usually, the fourth quarter is pretty robust as companies are buying equipment towards the end of the year, and that business typically starts a little slower in the first quarter. So we expect it to sort of pick up, and we expect those balances to grow as we move through the balance of the year.

We're sort of targeting a relatively same production level as we did last year. So as the balance gets -- as the portfolio balance gets bigger and we keep production at about the same level, the growth rate is obviously just going to continue to slow. And to your concentration point, we do sort of have some targets that we think we need to maintain, which we think we can still grow the portfolio some. But then at some point, we're going to -- we need to grow the rest of the bank to be able to continue to grow that portfolio.

As it relates to GreenSky, yes, we're going to -- because of the liquidity that's coming on the balance sheet and PPP as it continues to get forgiven, it's going to provide even more liquidity, we're going to increase that balance, I'll say anywhere from maybe $75 million to $150 million is sort of how we think about that for the remaining part of the year. So not all at once, but sort of as we move through the balance of the year.

And then just as a follow-up question. The volatility in commercial FHA warehouse credit lines, is that just something we're going to have to live with going forward? And maybe can you just talk about how large those quarterly swings could be just to frame expectations going forward?

Yes. So it will go up and down and depending at the end of the quarter or whether those warehouse lines are drawn or not, there'll be fairly large swings and the swings could be in the $100 million to $200 million range, probably. I mean, we've probably got commitments that are around $500 million. So depending on where they're at in their closing cycles, yes, we could see the $100 million to $200 million swings in that -- in those spot balances. But we expect the averages to sort of average out and not have as much swings on an average balance point of view during each quarter.

Your next question comes from Michael Perito from KBW.

All right. Sorry about that. I wanted to start on the expense side. So $39 million to $40 million, I guess, if I heard you guys correctly, is kind of the near-term run rate. Two-part question here. I guess, one, Jeff, the mix of the business has changed a decent amount over the last 1.5 years or so. I was just wondering if you guys had any kind of thoughts about structurally what type of efficiency ratio you guys are targeting with this new mix of business versus historical where you guys had some businesses that put upward pressure on that?

And then secondly, I was wondering if you could maybe just provide a little bit more detail on some of the kind of the technology and digital investments that are being factored into that run rate that -- and anything you'd pull out as particularly meaningful for your involvement here that we should be mindful of?

Yes. So -- and our internal sort of target, and I think I've probably said this in some meetings, is to get under 55% efficiency ratio. A couple of years ago, it was to get under 60%, now it's to get under 55%, and we're sort of on track and moving in the right direction. So we feel pretty good about where we're at.

As it relates to technology, the technology investments that we've made, that we are making are sort of in our run rate. So there's not some investment we're making today that's going to sort of go away later. So the investments we've been making in technology have been in our run rates for many quarters now and is in our run rate today. A big part of that investment is in people. So I don't see that necessarily accelerating to increase our expenses and nor do I see it decelerating to decrease our expenses.

Helpful. And then in terms of just anything you guys are particularly working on or upgrading or rolling out in the near-term here that you're excited about or that you'd highlight as critical?

Yes. So we've rolled out sort of online account opening, both on the retail side and the business side. We're seeing sort of good activity there. I think on the retail side, we're seeing about 1/3 of our new account openings happening online. So that's encouraging.

We introduced Zelle here in the last probably 30 to -- yes, about 30 days, which we think that's a big enhancement on the mobile app, really good P2P payment processing. And we hope by -- our plan is by the end of the second quarter to sort of have, if you will, all of our products accessible online. So all deposit, you can sort of buy online loans the same way and then it's all about marketing and customer journey marketing and the auto marketing journeys.

So yes, we're -- I think we're pretty excited about the back part of the year. We've done a lot of work sort of getting these pieces in place, and then it becomes a marketing and sort of how do you drive traffic to your website.

Right. Okay. And the take on margin. Eric, did I hear you correctly that the impacts from PPP forgiveness was 7 basis points, I guess, it was $338 million you said excluding versus the $345 million reported?

Correct. Yes, yes.

Okay. So if I look at the purchase accounting accretion and the PPP, I mean that puts you guys kind of on a real adjusted basis, about $330 million, which I think was up modestly over the fourth quarter. But I mean, is it fair to think that between some liability repricing here and if you guys are able to -- are successful in adding some of the GreenSky balances and deploy the liquidity, I mean, there should be some positive NIM movement here adjusted for any of the PPP volatility over the next few quarters?

Towards the back half of the year, Mike. So kind of -- we're looking at this next quarter a little conservatively given the decreases in loans that we experienced in the first quarter. Our pipelines are good, but it will take us a little time to get those loan balances back. But we are working on plans to reinvest that excess liquidity that we had at quarter end through GreenSky securities purchases and a few other things out there. So we may see our NIM come down a couple of basis points in the second quarter, but then build back up and keep it flat with maybe a couple of basis points upside towards the back half of the year.

Helpful. And then just a clarification. But on the GreenSky peaks, right, I mean that's -- I don't want to call it easy, but that's a fairly straightforward growth mechanism for you guys, right? I mean you basically just indicate that you have more appetite and more volume comes through. Is that correct? It's not necessarily as unpredictive is maybe like a commercial portfolio where the payoffs or the closing dates could be a little bit more hard to pin down?

Yes, Mike, I agree with that. GreenSky still has pretty good activity, and so it's just a matter of us kind of talking with them about sort of what our credit metrics look like, and we don't plan to change those at all, and just kind of accepting a little bit more of activity and raising our overall levels. And as Jeff mentioned, we won't do that all at once.

(Operator Instructions) Your next question comes from Nathan Race from Piper Sandler.

I was hoping to just dive into -- on the outlook side, the expectations for a relatively stable ACL over the next quarter or 2. Within that, I just would love to get an update in terms of what you guys are seeing in terms of charge-off activity? And if we can kind of expect provisioning to match charge-offs. And I know it's difficult to kind of pinpoint provisioning in any given quarter under a CECL framework, but was just hoping to kind of dive into some of the underlying pieces behind that ACL outlook?

Yes, Nate, so good question. So we had pretty good charge-off activity in the first quarter, $1.7 million, 14 basis points. As we kind of mentioned in the call, we did have a loan relationship move into nonperforming that added to some of our specific reserves. And so we do expect to see some charge-offs towards the last half of the year. But I think as I look at our ACL kind of right now and where we're at and as those sort of the economic forecasts continue to improve, I think we can be in a position where we'll provide for our charge-offs. And that's roughly my expectation.

So I think -- and one of the reasons we added to the ACL this particular quarter was because we continued to see some elevated levels of deferrals in those couple of industries. So that would be why we added to sort of our CRE, those commercial real estate loan buckets. But I think going forward, we'll provide for our reserves and sort of keep that ACL where it is, depending on other circumstances as they come and as they occur.

Got it. That's helpful, Eric. And just following up on that. So it sounds like with 90% of the reserve kind of unallocated or on a general basis, you guys may not necessarily need to provide for that kind of mid-single-digit growth that we're expecting to kind of build over the course of this year. Is that a fair characterization?

Yes. I mean, it could be. It depends on kind of where some of those loans end up, what types of industries and what type of mix. But I think that very well could be likely, Nate.

Yes. As we add GreenSky, we -- our reserve percentages there are not very significant because of all the credit enhancements we have around GreenSky. So that growth doesn't come with a lot of provisioning.

Got it. Makes sense. And then if I could just ask one more on just the appetite for additional share repurchases. It looks like the remaining authorization is fairly low. And I know one of the major priorities for this year is to continue to build capital levels. So I would just love to get some color just in terms of the appetite for additional buybacks. Obviously, the stocks had a great run over the last several weeks. So just curious on your kind of updated thinking about buybacks and additional appetite with the remaining authorization towards the kind of completed at this point?

Yes, yes. I think I was pretty clear on last quarter's call that we would continue to buy our shares back below the tangible book value, and we did through like the first couple of days of February. And then our stock did go on that nice run, and we stopped. So at this point, I'll say if our stock ever goes back below tangible book value, we'll probably buy it back. But at this point, that's -- I hope that doesn't happen, and I don't see it. So I think we're on the sidelines on buybacks, and now we're clearly focused on building capital ratios and putting all of our earnings after the dividend into capital.

I am showing no further questions at this time. I would now like to turn the conference back to management for any closing remarks.

Yes. Thanks for joining today, and we had a record quarter, and it was a good quarter, and we look forward to talking to everybody next quarter. So everybody, have a good day. Thanks.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may all disconnect.