Q4 2019 Earnings Call
Right.
Ladies and gentlemen, thank you for standing by and welcome to the fourth quarter 2019, Midland States Bancorp incorporated earnings Conference call.
This time, all participants' lines are in listen only mode.
After the speakers presentation, there will be a question and answer session to ask a question. During this session you need to press Star then one on your telephone.
Please be advised to today's conference is being recorded if you require any further assistance. Please press star then zero.
I'd now like to hand, the conference over to your speaker today, Mr., Tony Rafi, a financial profiles, Sir you may begin.
Thank you Crystal.
Good morning, everyone and thank you for joining us today for the Midland seats Bancorp fourth quarter 2019 earnings call joining us for Midlands management team or Jeff what grid, President Chief Executive Officer Air Gluski, Chief Financial Officer.
We were using a slide presentation as part of our discussion. This morning, if you've not done so already please visit the webcasts and presentations page a bit looks investor relations website to download a copy of the presentation.
Management team will discuss the fourth quarter results and then we'll open up the call for questions.
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 middling seats Bancorp and involve risks and uncertainties.
These 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 FCC 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 or other quantitative information to be discussed today as well as the reconciliation of the GAAP to non-GAAP measures 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 fourth quarter. We generated 51 cents an earnings per share, which included a $1.6 million valuation adjustment to mortgage servicing rights and our commercial lumpy tape business, which impacted earnings per share by.
Five cents.
During the fourth quarter. We also recorded integration acquisition expense a loss on the repurchase of subordinated debt and they net gain on security sales.
On an adjusted basis, we had 64 cents in earnings per share.
We ended the year with a strong quarter in business development, our total loans increased at an annualized rate of 6.7%.
We had another good quarter of commercial loan growth driven primarily by our equipment finance business, which continues to produce loans and leases with them more attractive risk adjusted yields that we are targeting over.
Over the course of 2019, we successfully executed on our balance sheet management strategies.
Towards that end this put us in a favorable position from a liquidity standpoint to be more active and growing our consumer loan portfolio, which contributed to the stronger loan growth in the fourth quarter.
We also had a very successful quarter and deposit gathering with our total deposits increasing at an annualized rate of 8.8%. Once again. This deposit growth was entirely driven by core deposits Weve introduced some new depository products for commercial customers and we continue to be very active in our calling effort.
This has resulted in strong inflows of core deposits from new customers as well is getting more of the wallet share from existing customers improving our deposit mix was one of our top priorities and 29 team and we're very pleased with the success we've had in this area.
The strong inflow core deposit enabled us to steadily run off higher cost broker deposit.
As a result, our net noncore funding dependency ratio declined to 7.8% at the end of 2019 down from 17.9% at the end of the prior year.
We also continued to make good progress on another key initiative and proving our efficiency ratio.
With the successful integration of Homestar banks core system conversion in October we were able to recognize additional costs is from this acquisition.
This resulted in our efficiency ratio further improving to 59.5% in the fourth quarter down from 60.6% in prior quarter.
Finally, we continued to effectively manage our capital our earnings continue to rebuild our TC ratio another key priority for us in 2019.
Compared to the end of the prior year, our TC ratio increased 32 basis points. Despite the impact of the home store acquisition.
We also continue making what we believe is an attractive investment for the company through our stock repurchase program as we repurchased approximately 85000 shares during the fourth quarter at an average price of $25.69 per share while also continuing to pay an attractive dividend to our shareholder.
There's.
At this point I want to introduced our new Chief Financial Officer, Eric Lemke.
Eric joined Midland in 2018, as our director of assurance and audit and Weve been very impressed with his business and financial acumen. During his time here.
Eric was previously the CFO of Metropolitan Capital Bancorp in Chicago, and also served as a partner and the financial services practice at RSM.
So we're very confident that he has the experience and skill set to effectively lead our finance team now Eric is going to walk us through more details on the financial performance in the quarter Eric.
Thanks, Jeff and good morning, again, everyone I'm going to start with our loan portfolio on slide four or total loans outstanding increased 72.6 million from the end of the prior quarter driven as Jeff mentioned earlier by growth in the commercial and the consumer loan portfolios, our commercial loans and leases portfolio was.
Up 7.4% on a leap linked quarter basis, largely due to the growth in our equipment finance business.
Outstanding balances in our equipment finance business increased $66.8 million from the end of the prior quarter or 11.8%.
Our consumer portfolio increased 100 million from the end of the prior quarter, which represented all of the growth in this portfolio during 2000 or during 2019.
As we've indicated in the past we have a lot of flexibility in our consumer loan production and can increased production when it makes sense from a liquidity and a balance sheet management standpoint, as it did during the fourth quarter the growth in the commercial and consumer portfolios help helped to offset continued run off in the commercial real estate.
Folio, where we continue to see elevated pay offs being driven by aggressive pricing offered in our markets.
In addition, declining interest rate environment impacted our loan yields during the fourth quarter as yields including accretion income declined by nine basis points to 5.22%.
Turning to deposits on slide five.
Total deposits were 5.4, 0.5 4 billion at the end of the fourth quarter, an increase of approximately $99 million from end of the prior quarter substantially all the growth came in our checking in our money market balances, which is attributable to the success of the deposit gathering initiatives that.
Jeff previously discussed.
Also during the fourth quarter, we intentionally reduced our balances a broker time deposits by another $44 million.
With this run off brokered time deposits represented just 1% of our total deposits at the end of 2019 down from 4% at the end of the prior year.
Our overall cost of deposits dropped four basis points to 0.8% in the fourth quarter, but we'll talk a little bit more about that in the next slide and turning to that so that next slide let's talk a little bit about net interest income in our net interest margin.
Our net interest income decreased 1.5% from the prior quarter.
Excluding the impact of accretion income our net interest margin declined 17 basis points from the prior quarter as we expected the increase in subordinated debt. Following our 100 million dollar issuance in September 2019 put pressure on our margin and in the fourth quarter the additional.
The negatively impacted our margin by eight basis points.
Strong deposit growth that we saw in the quarter increased our level of cash balances.
Combined with lower rates earned on those cash balances the excess liquidity negatively impacted our margin by another seven basis points.
And then as a result of the 75 basis point reduction in fed funds rate that occurred over a period of three months in mid to late 2019, lower average loan yields negatively impacted our margin by four basis points. All of these factors were partially offset by lower rates on deposits, resulting from a reduction in rates.
Uncertain deposit accounts and the improvement in our deposit mix.
Now looking ahead, we see a number the number of factors that should have a positive impact on our net interest margin as we move throughout the year 2020 in particular will be redeeming our high cost higher cost subordinated debt in June of 2020.
We also have approximately 280 million of time deposits maturing from March through June that should renew at much lower rates.
We expect to continue to see a positive shift in our deposit mix and pass through more of the recent rate cuts to our depositors', which should further lower our cost of deposits.
And we expect that the higher yielding equipment finance portfolio will continue to comprise a larger percentage of our overall loan mix.
So assuming no changes in the fed funds rate going forward. We believe that these factors can help stabilize our net interest margin during the first half of 2020, excluding the impact of accretion income and then help us move back towards the 3.5% range in the second half of the year.
On a reported basis, we will still see some downward pressure on our net interest margin as our scheduled accretion trends lower throughout the year.
Okay.
Now turning to wealth management on slide seven.
At the end of the quarter our assets under administration were $3.41 billion, an increase of 129 million from the end of the prior quarter.
The increase was primarily attributable to improve market performance during the quarter, our wealth management revenue decreased 10.4% from the prior quarter to $5.4 million, which was primarily attributable to a decline in our state fees.
Turning to slide eight noninterest income.
Our total noninterest income decreased 3.0% from the prior quarter to 19.0 million.
In the fourth quarter, our noninterest income included a 0.6 or $600000 in net gains on sales of investment securities.
The decline from the prior quarter was primarily due to factors that decline and lower wealth management and lower commercial FHLB revenue.
Our commercial FHLB revenue was negatively impacted this quarter by 1.6 million dollar impairment to mortgage servicing rights in this business.
Those declines were partially offset by an increase in bridge loan fees generated from referrals through love funding, which are recognized and other non interest income.
Looking ahead over the long term, we still expect commercial FHLB revenue to range from 12 million to 20 million annually. However, given that up the operating environment for commercial FHLB remained similar to the conditions that we saw in 2019, we expect revenue.
From this business to be fairly similar to what we saw during this past year.
Turning to slide nine.
And our expenses and efficiency ratio, we incurred $3.3 million and integration and acquisition expense in the fourth quarter, a 1.8 million dollar loss on the repurchase of subordinated debt and a loss on mortgage servicing rights held for sale of $95000.
Excluding these adjustments are non interest expense decreased 3.9% on a linked quarter basis.
That decline was primarily due to additional cost savings realized after the Homestar system conversion was completed in October as a result of the decline in our expense levels, our efficiency ratio improved to 59.5% compared to 60.6% in the prior quarter.
Moving to slide 10 will take a look at asset quality.
We saw general improvement and asset quality this quarter as reflected by the decline in our nonperforming loans and net charge offs compared to the prior quarter.
We recorded a provision for loan losses of $5.3 million during the quarter. This reflected the stronger growth we had in the loan portfolio that provision also included a $1.4 million specific reserve established for an existing nonperforming loan.
When that property was put on the market at a lower price than our most recent appraisal data.
This particular loan is unrelated to the nonperforming loan that impacted our provision expense during the prior quarter.
The fourth quarter provision brought our allowance for loan losses to 64 basis points of total loans at December 30, Onest and our credit marks accounted for another 39 basis points.
Now let me provide a few comments on our expectations for the implementation of seasonal.
Based on our loan portfolio balances and current economic forecasts at the end of 2019, our best estimate of the increase the allowance for loan losses and reserve for unfunded commitments from the implementation of Cecil is approximately 20% $25 million.
This range reflects the uncertainty of economic forecast used to record those additional reserves, we're continuing to finalize these and certain other key assumptions used in our Cecil model and methodologies.
Looking ahead at this point in economic cycle, why we continue to see generally healthy trends in the portfolio. We've seen a continuation of one off credit events impacting our net charge offs and provision expense.
These one off credit events have not been concentrated within any particular industry or property type and we're not seeing broad weakness in our portfolio in AG loans retail loans health care loans or any of the other industries, where there is concern on a macro level.
Our portfolio continues to be very well diversified and the one off credit events. We have seen have been and unique situations that havent been related to deteriorating fundamentals in any particular industry.
For that reason, we're expecting our quarterly provision expense to be in that $3 million to $4 million range. During 2020, However, that'd be under current economic conditions under Cecil provision expenses will be subject to more volatility depending on changes in those economic forecast in a variety of other factors.
So with that I'll turn the call back over to Jeff Jeff. Thanks, Eric will wrap up on slide 11, with some comments on the outlook for 2020.
Since our IPO in 2016, we've acquired three banks and to wealth management businesses.
As a result in a period of three and a half years, we've doubled our total assets and had substantial growth in our wealth management business.
As we start 2020, our focus will be squarely on organic earnings growth and improving our performance metrics, including our efficiency ratio, which we are targeting to be under 60% on a sustainable basis by the end of the year, if an attractive acquisition opportunity emerges, we certainly will consider it.
But that's not is not our focus for 2020.
We believe that our shareholders will be best served if we utilize 2020 to focus on optimizing the performance of the of the existing bank and continuing to build our tangible book value per share.
From a balance sheet management perspective, we expect to have a continuation of the trends we experienced in 2019.
We expect low single digit organic loan growth, primarily driven by continued growth in our equipment finance portfolio. We also expect to have continued success in gathering core deposits and improving our deposit mix.
We'd like to continue to keep our loan to deposit ratio in the mid 90%.
Although we expect just modest balance sheet growth. This year, we believe we're well positioned to generate a year of strong earnings growth for a number of reasons first we will have a full year of realizing the synergies from the Homestar acquisition.
Second we will continue we will complete the consolidation of the previously announced six branches by the end of the first quarter, which will reduce the costs associated with our branch network.
Third earlier this week, we made adjustments in our staffing levels that reflect the shift in.
And customer preferences towards digital and mobile banking and our continued focus on efficiency.
We eliminated approximately 50 full time employee positions with approximately 30% of those positions coming out of our retail branches and the remainder primarily coming from back office support and non revenue generating positions.
These staffing adjustments will result in approximately 3.9 million an annualized cost savings beginning in the second quarter.
Following the staffing adjustments, we expect our quarterly run rate for non interest expense to be in the range of $42 million to $43 million per quarter in 2020.
Fourth we will leverage the significant investments, we have made and technology over the past few years to drive additional efficiencies.
Further streamline our operations and enhance our digital banking experience and fit as Eric laid out earlier, we expect to see an expansion in our net interest margin later in the year, which should help drive an increase in our net interest income.
We believe that solid execution on these initiatives will put us in a good position to deliver strong earnings growth in 2020, and further improve the level of returns that we generate for our shareholders with that we'll be happy to answer any questions. Anyone has operator, please open the call.
Thank you.
Ladies and gentlemen, if you have a question at this time. Please press the star followed by the number one key on your Touchtone telephone. If your question has been answered or you wish or move yourself from the Q. Please press the pound.
Once again to ask a question. Please press star and then one now.
And our first question comes from Michael Perito from KBW. Your line is open.
Hey, good morning, happy new year.
Good good morning, Mike.
I wanted to start so obviously appreciate all the forward looking commentary, but I wanted to start maybe just on the credit side.
I mean, you provided a.
Pretty much a 40 basis point Ray last year, and clearly pretty pretty high above where most of your peers are.
But it sounds like the portfolio you guys still remain confident kind of the makeup and underwriting portfolio and then.
So I'm just trying to pull the pieces together here I mean, what type of loss content is the two to 4 million provision for next year, assuming does it assume that charge offs remain slightly higher than peers like you experienced in 2019, and then low single digit growth are there other assumptions that kind of make up that step provision expectations.
Yes, I think we're looking if you look back at 19, we probably.
Averaged about $4 million a quarter.
We think that have come down slightly and the range that we gave of three to four kind of puts us in that in that range.
I think charge offs, we probably think are probably.
Going to look a little bit like 19.
We do have.
As we disclose more detail around our allowance we do have a fair amount of specific reserves that are sitting in the allowance today. So as those get resolved we could see some some charge offs come through on on those specific reserves, but those are already provided for so kind of excluding maybe that group of loans, we don't.
Probably expect though that's under 20 basis point.
Kind of charge off level.
As we look at the portfolio today and.
And the diversification that we have.
Okay.
Helpful. Thanks, and.
Switching over to the margin.
It can you guys I guess two part question one can you remind me.
If there is another cut in fed funds, what kind of the negative sensitivity to the margin will be in that scenario.
And then secondly can you just provide a little bit more color on on the kind of time deposit repricing opportunity as you see it today, maybe where the kind of the yields on the book are and where the other new yields are coming in and what the potential pickup could be there that that seems to be a big driver the potential margin pickup in the back half a year.
Yes, Thats a good question. So I guess I'll start with the time deposits. So we've got to we did quite a few CD specials during the first and second quarter last year at this time and so we've got about 280 million that are going to be maturing between March and June .
June and so the way we're kind of modeling. It is we think theres potentially an 80 basis point pickup. However, we're also modeling that we won't be able to retain necessarily all of those funds.
But that's a that's a pretty significant picked up to that during the course of the next year.
Okay, and then the sensitivities on the potential for another cotton the fed funds.
Yes, so maybe I'll take that one wolf will.
I think well what we'll see as what we saw in the in the fourth quarter will see initial pressure on the asset side and then it will take us a quarter or two to continue to adjust.
Deposit rates across the board. So there will be somewhat of a lag. So I think will we would see some initial pressure and then be able to work it back.
But the initial pressure I mean, the fourth quarter compression the core margin I mean, there that was partly debt part of the liquidity driven I mean would it be to that magnitude right it'd probably be something like two to five basis point range and then work back overtime is that does that a fair way to think about interest in a kind of ice isolated.
I think so I mean, the eight basis points was with sub debt seven basis point was additional liquidity. So yes, it'd be it would be more in that mid single digit basis point range.
Okay and then.
Just as I think about capital here Jeff.
29 team was was it.
So all your capital levels build and and based on the efficiency. It and recent profitability kind of production I would think that will continue next year.
It seems like it's still another kind of internally focused year of kind of sustaining the improvements you guys have made and returns and then kind of expanding on that if you can does that led to maybe kind of behind the scenes utilizing share repurchases and.
Deploying some capital that way or or any updated thoughts I guess, just in general about capital deployment outside of M&A and organic growth.
Yes, so maybe I'll start with dividends, though we have a long track record I think probably 15 year track record of increasing dividends by 10%. So we're going to continue to pay a good dividend. We do have a share repurchase program. We've used that I'll say defensively to this point as our stock price.
As you saw in the fourth quarter, we when we bought we bought in the $25 range.
I think at least in the short term, we're going to continue to use it defensively.
Our Tc ratio is still not to eight we'd like to ideally get to above eight so we need to continue to work the Tc ratio.
We need to continue to work booked value.
And as you know as you buy your stock back that works against you. So I think we'll continue to use it defensively.
Continued to build tangible book value continue to continue to build Tc E. And then as the TC ratio begins to get back over eight.
Maybe we'll we'll use that that share buyback.
And a different way, but I.
I think we got it we have to get there first.
Okay.
Helpful. Thank you guys I appreciate you taking all my questions, yes, Thanks, Mike.
Thank you. Our next question comes from Terry Mcevoy from Stephens. Your line is open.
Good morning, everyone.
Good morning, Terry.
Thanks for all the disclosure around day, one and due to seasonal very helpful.
And I also understand the drivers of the margin upside from Fourq you through I guess, the second half of next year I believe in the past you have provided some thoughts on on accretion I know you said accretion would come down which would impact the reported NIM, but but any thoughts on accretion over the next two to four quarters or for full year night full year two.
2020.
Yes. The challenge, we're having right now is some of that accretion kind of.
Those out of accretion and goes into I'll say normalizing, our normalized margin number and we're still trying to get our hands around what that looks like so yeah.
And pure dollars, it's probably.
Four or $5 million decrease year over year, so something like that.
Now whether that as we get into 2012 shows up in that line item or not thats, where it gets a little confusing with the adoption of Cecil.
So there is there's four or $5 million a headwind there.
Okay, and then moving over to fee income.
The wealth management.
My notes here seasonality in state fees put pressure on wealth management fees. So what are your thoughts on that line of business in 2020, and then on the FHLB unclear. If 2020 looks like looks pretty similar to 2019 does that include the MSR impairment or should we adjust for any MSR volatility that.
Was experienced in 19.
So regarding FHLB if rates.
Stay the same we don't expect more impairment in that in that portfolio.
So I would say excludes.
The impairment part of the revenue I think you were even looking at maybe from a disclosure point of view pulling that out of that revenue line and disclosing that separately on the income statement that's for another day.
On the on the wealth business, we've we've changed our revenue recognition late in the year around the state fees. So that should as we get the 2020 begin to.
Be more.
Normalized through through each of the quarters will begin to recognize the state fees as we earn them instead of when the estate closes so that was providing some.
If you will lumpiness in the revenue line.
That should start to smoothed out a little we continued to have a fair amount of a states that we're working on so that revenue line should start to smoothed out a little bit.
And I think we're positioned well with the increase in assets in the back part of the year to begin to drive revenue increases from that fourth quarter revenue line, nor that revenue number in the fourth quarter.
And then just one last follow up.
The $42 million to $43 million of expenses in 2020 on a quarterly basis do you feel good about that that number for Q1, given the comments earlier about the ft reductions and the benefit not showing up until the second quarter.
You think it'd probably be on the higher end to that that range in the first quarter without it include.
Yes, I think the higher end of that range in the first quarter.
Great. Thanks, everyone and good day Yep. Thanks.
Thank you and again, ladies and gentlemen to ask a question. Please press Star then one now.
And our next question comes from Andrew Liesch from Piper Sandler Your line is open.
Good morning, everyone.
Morning, Andrew.
Just follow up question here on the margin just for the excess liquidity thats been sitting on the balance sheet.
Kind of thoughts on what's the plan with that is that going to be how's that going to be deployed them, but what sort of timing I do anticipate with that.
Yes, so we've been working hard.
To address our excess liquidity and I think with them some modest loan growth.
We do have some additional noncore.
Liabilities that we will continue to pay down.
As Eric said earlier as those $280 million of Cds Reprice will there will be some attrition associated with that.
And and and we've made some additional investments in the investment portfolio itself. So.
In the short term and Thats, what were doing to address that liquidity.
Okay, Great you value of covered all my other questions.
All right. Thanks.
Thank you and I am showing no further questions from our phone lines and I'd like to turn the conference back over to management for any closing remarks.
Yes, thanks for joining today and we will see you next quarter. Thanks.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program you may all disconnect everyone have a great day.