Midland States Bancorp, Inc. (NASDAQ:MSBI) Q1 2022 Earnings Conference Call April 29, 2022 8:30 AM ET
Tony Rossi – Financial Profiles, IR
Jeff Ludwig – President and CEO
Eric Lemke – CFO
Conference Call Participants
Terry McEvoy – Stephens
Damon DelMonte – KBW
Nathan Race – Piper Sandler
Manuel Navas – D.A. Davidson
Good day, and thank you for standing by. Welcome to the Q1 2022 Midland States Bancorp Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there’ll be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. [Operator Instructions]
I would now like to hand the conference over to your speaker today, Mr. Tony Rossi of Financial Profiles. Mr. Rossi, the floor is yours.
Thank you, Chris. Good morning, everyone, and thank you for joining us today for the Midland States Bancorp first quarter 2022 earnings call. Joining us from Midland’s management team are Jeff Ludwig, President and Chief Executive Officer; and Eric Lemke, Chief Financial Officer.
We’ll be using a slide presentation as part of our discussion this morning. If you have not done so already, please visit the Webcast and Presentations page at 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.
Various factors could cause actual results to be materially different from any future results expressed or implied by such forward-looking statements. These 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 a 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 three with the highlights of the first quarter. As we expected, we saw a continuation of many of the positive trends we experienced in the second half of last year. Most notably, we had very strong loan growth and expanding net interest margin and disciplined expense control. This resulted in a strong quarter with net income of $20.7 million or $0.92 per share, and pretax pre provision earnings of $32 million.
Relative to the first quarter of 2021, our return on average assets return on average tangible common equity and adjusted pretax, pre-provision, return on average assets have all increased, which reflects the consistent improvement we are seeing in the level of profitability as we generate strong organic growth and realize more operating leverage.
Despite the first quarters typically being a seasonally slower period for loan production, we had another strong quarter of loan originations. We had $673 million in new commercial and commercial real estate originations, which is 115% higher than in the first quarter of last year. The higher level of loan originations reflects the more productive commercial banking teams we have built and the increased presence we now have in higher growth markets.
Our loan production was more heavily weighted towards commercial real estate this quarter, as we continue to see good results from our specialty finance group that primarily originates loans for multi-family and senior care properties and provides bridge to HUD financing.
Within commercial lending, our Midland equipment finance team had a strong quarter of originations, with production being about 60% higher than the first quarter of 2021, although a higher level of payoff impacted the growth we had in this portfolio.
From a geographic perspective, we had a strong quarter in loan production in the St. Louis market, which reflects the improved business development capabilities we have following changes in leadership and additional resources we have added to the team.
The record level of loan production resulted in 24% annualized growth in total loans. This strong growth in loans enabled us to redeploy a lot of our excess liquidity into the loan portfolio, which resulted in a favorable shift in our mix of earning assets and significant expansion in our net interest margin. We are seeing higher rates on new loan originations, which is also contributing to the increase in our net interest margin. Notably, we are generating the strong loan growth and increase in net interest income, while maintaining relatively flat expense levels.
As we have mentioned in the past, we’ve kept the size of our overall banking teams relatively consistent, but we have made many changes in personnel over the past couple of years that have upgraded the quality and productivity of the teams.
And we are also continuing to realize more efficiencies from the investments we have made in our technology platform. As a result, while we are seeing some degree of inflationary pressure, particularly in labor costs, we have been able to largely offset this pressure by increasing efficiencies and productivity, which allows more of the strong organic growth we are generating to fall to the bottom-line and improve our earnings and returns.
At this point, I’m going to turn the call over to Eric to provide some additional details around our first quarter performance
Thanks Jeff, and again, good morning everyone. I’m starting on slide four and we’ll take a look at our loan portfolio. Our total loans increased $315 million from the end of the prior quarter.
As Jeff mentioned, the strongest growth came in the commercial real estate portfolio, which increased 16% during the first quarter. We also had small increases in equipment finance, conventional, commercial, and consumer loans. These increases were partially offset by declines in commercial FHA warehouse credit lines, residential real estate loans, and the continued forgiveness of our PPP loans.
Turning to slide five, we’ll take a look at our deposits. Total deposits decreased $53 million from the prior quarter. The largest decline was in non-interest bearing deposits, which was primarily attributable to fluctuations and end-of-period balances of commercial FHA servicing deposits.
We had growth in interest bearing checking, money market, and savings deposits, which was due to inflows from new business development, as well as some clients and customers starting to transfer balances out of non-interest bearing accounts.
One of the contributors to the new business development is the increased focus we have in growing our market share in St. Louis. In the first quarter, we had $120 million increase in our commercial deposit balances in this market.
Looking at slide six, we’ll walk through the trends in our net interest income and margin. Our net interest income increased 4.7% from the prior quarter, primarily due to higher average loan balances and the increase in our net interest margin.
We brought down our cash balances by $348 million from the end of the prior quarter, which was primarily redeployed into the loan portfolio to fund our strong loan growth. This favorable shift in our mix of earning assets drove a 25 basis point increase in our net interest margin, or 26 basis points when accretion income is excluded.
As interest rates increase, we’re seeing improvement in new loan pricing, which is also positively impacting our net interest margin. In the month of March, the average rate on our new and renewed loans was 4.10%, an increased to 17 basis points from the month of December.
The most significant driver of this increase is our equipment finance business, although we are seeing some higher rates on originations across all of our commercial lending.
Turning to slide seven, we’ll look at the trends in our wealth management business. Our assets under administration decreased by $173 million from the end of the prior quarter, primarily due to market performance. Despite that decrease, our wealth management revenue was essentially flat with the prior quarter as seasonal tax preparation fees offset the decrease in assets under administration.
Compared to the first quarter of the prior year, our wealth management revenue increased 20%, which reflects our strong progress on growing our recurring sources of the income.
Turning on to slide eight, we’ll look at non-interest income. We had $15.6 million in non-interest income in the first quarter, a decrease of 30.7% from the prior quarter, which included a number of one-time items. Excluding these items, most areas of non-interest income were slightly down from the previous quarter, except for impairment on commercial mortgage servicing rights, which decreased $1.7 million due to refinancing activity as interest rates continue to increase.
Turning to slide nine, we’ll take a peek at our non-interest expenses on an adjusted basis excluding the FHLB advanced prepayment fee recorded last quarter and integration and acquisition expenses, our non-interest expense was essentially flat with the prior quarter.
We had slight variances in each major line item, some a bit higher, some a bit lower, which all essentially offset each other and enabled us to come in at the low end of the range of guidance we provided for operating expenses in 2022.
Looking ahead to the second quarter, we expect to keep expenses relatively stable, although the completion of the FNBC branch acquisition will bring on some additional personnel and occupancy expenses.
Turning to slide 10, we’ll look at asset quality trends, our non-performing loans increased $10.3 million from the end of the prior quarter, which was entirely attributable to one commercial real estate loan where no loss is currently expected.
Outside of this one credit, trends in the portfolio were generally favorable with continued upgrades of watchlist loans as more borrowers demonstrate sustained performance with the impact of the pandemic declining. We had $2.3 million in net charge-offs in the quarter or 17 basis points of average loans. We recorded a provision for credit losses on loans of $4.1 million, which was largely related to the growth and total loans.
On slide 11, will show the components of the change in our allowance for credit losses from the end of the prior quarter, our ACL increased by approximately $1.9 million. The increase was driven by growth in total loans and changes in the mix of the portfolio.
And then on slide 12, we show the allowance for credit losses segmented by portfolio. Given the positive trends we’re seeing, we continue to bring down our coverage ratios in most areas of the portfolio.
And with that, I’ll turn the call back over to Jeff. Jeff?
Thanks Eric. We’ll wrap-up on slide 13 with some comments on our outlook. Our loan pipeline remains very healthy and we continue to see good demand in both commercial and commercial real estate lending.
Based on our current pipeline, we expect another quarter of strong loan growth. Beyond that it’s difficult to predict the level of loan growth in the second half of the year, as it’s uncertain how rising interest rates will impact loan demand. But based on current trends, we expect low double-digit loan growth in 2022. Although higher rates could impact loan demand, resulting in slower growth during the back part of the year.
We’re already seeing significant expansion in our net interest margin and as we continue to grow loans and the Fed continues to increase rates, we should see further expansion in our margin.
We expect to continue to be able to fund our loan growth with low cost deposits. Our treasury management group is having more success in bringing in large commercial deposit relationships. And the closing of the FNBC branch acquisition later this quarter will provide another source of low cost deposits.
As Eric mentioned, we expect to keep expenses relatively flat, which should lead to further operating leverage, as our expected loan growth and margin expansion generate higher levels of revenue.
With the combination of continued balance sheet growth and expanding margin and greater operating leverage, we expect to see further improvement in earnings and our level of profitability as we move through the year.
While we continue to see good results from the efforts we have made to enhance our business development capabilities and improve our financial performance, we’re also making good progress on our long-term initiatives to further enhance the value of the Midland franchise.
Over the past few years, we’ve talked about the investments we’ve made that have significantly strengthened our technology platform. One of the strategies of our long-term technology roadmap is to position the company to effectively compete within the banking-as-a-service space.
Our relationship with GreenSky has given us valuable experience that we will leverage with other Fintech partnerships that can be meaningful contributors to our balance sheet growth and fee income in the years ahead.
With the improvement we have made in our technology platform, we are now in a position to begin implementing our broader banking-as-a-service initiative. Earlier this month, we announced the partnership with Synctera, which will help us develop new partnerships with other Fintechs that will contribute low cost deposits and increase the number of customers using our payment solutions.
We have a pipeline of potential Fintech partnerships that we are in the early discussions with and we look to bring onboard towards the second half of the year. We expect to announce a new partnership with a consumer lender similar to GreenSky, while we also are reviewing other Fintechs focusing on deposit gathering.
We’re being very balanced in the implementation of this initiative, doing it in a way that does not require much incremental investment in our technology platform and enables us to learn from the experiences that we can prudently manage the growth in the area over the coming years.
Over the long-term, we expect banking-as-a-service to become another important catalysts for our earnings growth and further improvement in our financial performance.
And finally, strengthening our capital ratios will continue to be a priority for the company. With the efforts we have made to increase loan production having been very successful and the pipeline remaining very healthy, we want to make sure that we can continue to have the capital strength to support our strong balance sheet growth, as well as continue to have the ability to execute on attractive transit transactions like the FNBC branch purchase.
So, as we move through the year, we will be evaluating the best options for strengthening our capital ratios, as well as optimizing our capital stack, as we have some subordinated debt that is callable later this year that we may redeem.
Whatever capital actions we take will be in the best long-term interest of shareholders and enable us to continue executing on the strategies that have contributed to the improvement in our financial performance.
With that, we’ll be happy to answer any questions you might have. Operator, please open up the call.
Thank you. [Operator Instructions] Our first question comes from Terry McEvoy of Stephens. Your line is open.
All right, good morning. Nice start to the year, Jeff and Eric.
Hey, first question. Can you just maybe expand on the growth in the CRE portfolio, multifamily retail, some segments that maybe kind of contributed to that growth? And maybe as a follow-up there, how are you stress testing the portfolio as rates continue to rise or are expected to continue to rise, how are you stress testing and getting comfortable with the relative size of your CRE portfolio?
Yes, so most of the theory, growth came in multifamily, senior care, and industrial warehouse portfolios. Retail was up a little bit, but not a lot so that those three portfolios were the main drivers.
In all of our underwriting, we’re stressing — deal-by-deal, we stress interest rates, we stress cap rates as part of the underwriting process. So, we think we’re deal-by-deal doing that. We also once a year do full stress testings on commercial real estate, where we’ll stress those things in a portfolio level. So, we’re doing that on a regular basis.
Thanks for that. And then as a follow-up, and then a lot of the discussion we just heard was growing revenue. And so I don’t know if I’m surprised, but to keep your expenses 41 to 42, I thought that would maybe go higher, given the revenue initiatives can maybe talk about how you’re balancing the investments, and then where you’re looking for kind of opportunities to reduce expenses to keep that flat this year — or at least next quarter?
Yes, I mean, our — we’ve talked about our commercial banking team now for several quarters that we’ve held that relatively flat actually might, from a total headcount be down a little, but the productivity, the pipeline management, we’ve put salesforce in this point, probably three or four years ago, and it’s really — it has matured, and the calling efforts, the follow-up on pipeline with — from the President of bank down to RMs, I think we’ve done a really nice job of managing pipelines and accountability to pipelines.
And so we’ve been able to keep headcount sort of down. And so we’re not adding a lot of — we’re not adding a lot of people to the commercial team to get the additional growth. So, I think that’s good. Now, over time, that’s going to have to change, but right now that that’s where we’re at.
And then it’s looking — the good thing about taking a pause — the pause that we’ve taken on M&A the last couple of years is to really dig into vendors, dig into how we operate and it seems like quarter-in and quarter-out, we’re finding, in some cases, bigger pieces, and then in other cases, little pieces here and there, add up over time that are allowing us to continue to grow revenue, at least now and hold expenses relatively flat. That can’t — right, that can’t go on forever, but at this point, we’re able to do that.
If I could squeeze one last one. The equipment finance yields up 76%, a big jump, was there something going on within that business last quarter to contribute to the higher yields?
Yes, that businesses is five-year contracts, prices on this sort of that five-year part of the curve and so as we saw the lift during that we were able to kind of nudge those prices up. So, when we looked at new contracts there, Terry, in the month of March, we were at about 530 or so in in the month of March compared to the prior December, which would have been sort of 450 somewhere — 460 somewhere in that range. So, we’ve still continued to see pressure on loan pricing overall, but that’s one segment of the business where we were able to get a little bit of a better lift, because it’s national, it’s that part of the curve.
And there’s still been a lot of demand. As Jeff mentioned, there was a lot of demand during that first quarter compared to the first quarter in the prior year, which is typically a little bit softer.
Great. Thanks a lot. Have a good weekend, guys.
Thank you. Our next question comes from Damon DelMonte of KBW. Your line is open.
Hey, good morning, guys. Hope everybody is doing well today.
So — yes, good morning. So, my first question, just regards to the margin, can talk a little bit about that, I mean, very impressive expansion this quarter and good detail on kind of what drove that expansion, kind of digging in a little bit deeper to the core margin. I know there’s a little bit of accritible [ph] yield. How much was the PTP impact? And I’m trying to get to like a core level and kind of figure out if there was anything else, any other one-time loan fees or items that might not be repeatable next quarter, as we try to model this out?
Yes, Damon, this is Eric. So, on the PPP impact is roughly about five basis points or so to our margin. Those fees are shrinking, of course, they’re a little bit over $1 million in the last quarter.
There were a few odds and ends. Jeff, in his remarks mentioned, some earlier deferrals that we’re seeing in equipment finance. And so we’ve seen with the increase in the price of that used equipment, we’ve had some customers that have been selling that equipment, paying off their contracts early.
So, we have seen some prepayment fees in that portfolio. And then a few other kind of odds and ends, but not more than just a few basis points overall during the course of the quarter.
Okay, so is it fair to assume that you’re kind of somewhere in the high 330s for your core?
I think probably more like low 340s.
Low 340? Okay. All right. That’s great. And then I guess, as far as the commentary on loan growth, so your pipeline continue to be strong going into the second quarter here. Do you expect it to be continued to be driven by commercial real estate or do you see other areas of the portfolio starting to contribute more?
Yes, I mean, that’s probably going to be the bigger driver, as we look at all the growth, but we do expect to see growth on the commercial side as well. The equipment finance, business should pick up. I mean, we should probably have a better second quarter — we typically have a better second quarter than first quarter. And if pay down, slow down, that will contribute more to the commercial line. Consumer, I think that’d be relatively flat, and then, more of the growth would probably be in the commercial real estate area.
Got it. Okay. And then just lastly, on the fee income, any kind of guidance there? So, what to expect for the quarterly run rate? I know the other line was lower than previous quarters? Do you think you get back up over that $16 million quarterly run rate?
Yes, I think so. We have a little lighter interchange quarter, which I think is sort of seasonal and service charges, which sort of like, sort of, go hand-in-hand. And I think just seasonally the first quarter is a little lighter. So, we do expect those to come back. But yes, I think that’s not a bad number.
Okay. All right, great. That’s all that I had for now. Thanks a lot, guys. Appreciate it.
Thank you. Next, we have Nathan Race of Piper Sandler. Your line is open.
Yes. Hi, guys. Good morning.
Question just on the deposit growth expectations. I appreciate some of the decline of the quarter was tied to the FHA servicing partnership. So, just curious how you guys are thinking about deposit growth over the course of 2022 to fund continued strong loan growth expectations?
And just within that context, it sounds like you guys are in the process of onboarding, some partnerships to drive some deposit growth as well. So, just curious how we should think about the rate sensitivity of those potential deposits coming on board relative to kind of your lower beta deposit franchise?
Yes, I mean, we had — other than — we had an influx of deposits at the end of the year with the servicing business. So, we sort of knew that was going to go out. But we had a really, really good first quarter in deposit gathering, in treasury management, and retail deposits were nicely up in the quarter as well.
And it’s sort of back to the productivity of the team has been really good and salesforce is driving pipelines, our pipelines in treasury management are in a pretty good spot going into the second quarter. We won some nice accounts in the first quarter. I think we would expect to win some nice accounts in the second quarter.
And then the branch acquisition is going to supplement that. I mean the cost of funds that the branch we’re buying is, what eight or 10 basis points. So, we’re bringing in some nice core deposits there.
So it’s working both sides of the balance sheet. We got to we got to gather deposits and we got to make loans and that’s sort of what we’re doing. And I think we’re doing a nice job on both fronts.
And then the banking-as-a-service is more of a longer term sort of play. I don’t see that impacting the financials in a big way this year, but as we start to move moving in the next year and the years after that, that’s sort of where we think there’ll be a bigger impact.
Okay, got it. So, perhaps kind of deposit growth, maybe lagged a little bit in terms of that of loans. But — flexibility to increase your loan deposit ratio from just looking at average balances at 89% of the quarter, is a fair way to–?
With the branch acquisition coming in, that number should stay relatively in that range, up some, down some based on where loan growth ends the quarter and where to deposit growth ends the quarter with the branch acquisition, that’ll help supplement that.
Okay, great. And then just kind of thinking about the margin outlook from the low 340 range on a core basis, going forward. I believe, around 35% of your portfolio’s floating rate and I imagine most floors will be not a factor, assuming the Fed moves by 0.5% next month. So, just kind of, how should we think about the progression of the core margin from here? Is it fair to just expect by the end of this year that we could get it to core margin in the mid-350 if not low 360s range or how are you guys kind of think about the cadence of the NIM over the next few quarters from that low 340 range this quarter?
Yes, Nate, I guess that’s the magic question, right. So, we are a little bit less asset-sensitive today than we were as of 12/31. Reason for that is number one, that loan growth and putting that cash to work during the course of the quarter.
We are — roughly, your numbers about right except for I think, now we’re about 67%, 68% fixed with the rest being variable in some work some rate. And then in late March, we took a little bit of our asset sensitivity off the table, and we executed to receive fixed swap on approximately $200 million of our fix — of our variable rate loans. And we picked up roughly anywhere from 190 to 195 basis points in that trade. So, we basically accelerated sort of eight rate increases. So, that took a little of our assets sensitivity off the table, too.
So, as I look out over the next quarter, we will pick up, let’s call it three or four basis points from the swap, which will help offset the PPP fees that we earn income that we talked about earlier. And then we’re largely through our floors for the remaining of that portfolio and we could pick up a couple of basis points as the, as the Fed moves that next 50 that we’re all expecting.
So, as you get through the year with sort of that same cadence, if we do see another — couple different 50 basis point rise, it could be worth roughly around 350, maybe a shade over that in core by the end of the year.
Okay, great. That’s super helpful. Thanks Eric. And maybe just one last one on the fee income outlook, excluding mortgage, which is a challenge across the industry, is the expectation outside of that line to generate some growth, just consistent with kind of what we’ve been talking about the last few quarters, increased card spending, and just share gains there across our clients? And then also, Wealth Management, I imagine would hopefully stabilize with equity market valuations hopefully stabilizing as well.
Yes, I think that’s right.
Okay, perfect. I appreciate you guys taking the questions and all the color. Congrats on a great quarter.
Thank you. [Operator Instructions] Our next question comes from Manuel Navas of D.A. Davidson. Your line is open.
Hey, good morning.
What are some of the guideposts or metrics we should watch as you as you kind of create these Fintech partnerships are continuing along the banking-as-a-service evolution, are you really focused on on-balance sheet items, the income growth, number of customers, any color that would be helpful?
Yes, I think our focus is going to be around deposit gathering and payments, so interchange, that’d be where our sort of focus is. I mean, we’ve got — we’re looking at a Fintech right now, on the loan side, but the loan side will be to continue to diversify sort of our Fintech loan partnerships, GreenSky is a pretty big piece right now. So, one of the things we’ll be doing over the course of the next 12 months is to have enough other Fintechs that were more diversified than we are today. But a big focus on the banking-as-a-service is going to be on the deposits and payments side.
Okay, that’s helpful. Maybe I missed it. Is there any change to your expectations for the GreenSky portfolio?
No, no, I think that will stay relatively up or down 3%, 4%, or 5% either way, depending on how the quarter goes, we’ve sort of set our limit and we’re about at our limit.
And kind of a modeling question that swap that you entered into that, is that going to show up in your loan yields or different part of the average balance sheet?
It’ll show up the loan yields.
Okay, that’s helpful. I appreciate that. And with kind of the swings and AOCI, folks have been seeing, have you seen that impact M&A discussions at all? And kind of where are you — you’re hearing about in your markets?
Yes, we’re keeping an eye on it. So, our investment portfolio decreased in fair value by roughly $48 million, $49 million during the course of the quarter. So, we’re keeping an eye on it. It impacted our tangible book value by call it 3.6% or so overall.
One of the things that helped us compared to some of the others in our industry is that we — because of a strong loan growth, we haven’t had as much a bigger percentage of our balance sheet in investments as some of our peers.
And then also we’ve got some forward starting swaps, that allows us to get some funding on the liability side at pretty attractive rates right now. And that increase in value is helping offset our investment securities portfolio. So, we have a little bit of a hedge there that’s helping us. Yes — but we’re keeping an eye on it pretty closely, but don’t really expect any major moves to try to address it or change it.
Is everyone’s keeping an eye on it, is that kind of limiting M&A discussions? Do you feel like it’s hurt it at all?
Yes, I mean, we’ve been pretty clear that we’re really not in M&A world right now. I mean, we’re going to — we’re looking at small acquisitions. We did a small wealth deal, all cash last year. We’re doing a small branch acquisition, which is all cash. Yes, we’re not looking at big M&A to use our stock today. So, from that perspective, not an issue.
And I think, this is accounting stuff. All this comes back, because we typically hold our bonds till maturity anyway. And so this — these losses for practically everybody, you’re going to come back. Unless you have to sell investments to fund loan growth, then you’re going to take losses, but we’re not in that position. So, this will all come back over time.
That’s great. Thank you very much.
Thank you. I’m show no additional questions at the time. I would like to turn the call over to management for any closing remarks.
Thank you. I want to thank everybody for joining. We had a — I think a really good quarter and look forward to talking to everybody next quarter. Have a good weekend. Thanks.
This concludes today’s conference call. Thank you all for participating. You may now disconnect. Have a pleasant day and enjoy your weekend.