Q1 2020 Earnings Call
He Midlands State Bank Corp. earnings Conference call.
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I'd now like to hand, the conference over to your hosts today Mr., Tony Rossy financial profiles. Please go ahead Sir.
Thank you Liz good morning, everyone and thank you for joining us today for the mid lets say its bancorp first quarter 2020 earnings call joining us from Midlands management team or Jeff, What <unk>, President and Chief Executive Officer, NERC Lemke, Chief Financial Officer will be using a slide presentation as part of our discussion. This morning, if you've not done saw ready please visit the website.
Some presentations page of Bedouins 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 at financial condition, a bid on seats Bancorp and involve risks and uncertainty, including those related to the impact of the cobot 19 pandemic various factors could cause actual results to be materially different from any future results expressed or implied by such forward looking statement.
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 no 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 with that I'd like to turn the call over to Jeff Jeff.
Thanks, Tony Good morning, everyone. Welcome to the mid month States earnings call I'd like to begin by thanking the entire Midland team for the extraordinary efforts. They have made over the past couple of months. The cobot 19 pandemic has impacted all aspects of our lives and I'm very proud of the way our team has responded.
And made certain that we can continue to support our clients and communities. During this challenging time.
I appreciate the positive attitude of our team members throughout this crisis as well as their commitment to maintaining exceptional service levels and productivity during the unprecedented conditions that we are dealing with.
Given the extraordinary changes and the operating environment brought on by Cobot 19 pandemic.
We wanted to spend most of the time on our call today, providing overviews of our response.
On the components of our loan portfolio.
Overall, we had a good quarter and we're pleased with our trends in a number of areas, most notably reducing our expense levels maintaining good stability in our normalized net interest margin and increasing deposits.
However, the rapid decline the interest rates resulted in a large impairment to our commercial mortgage servicing rights well our adoption Cecil resulted in a significant provision for credit losses that negatively impacted our financial result, resulting in only marginal earnings for the quarter.
Obviously, the big story of the quarter was the rapid spread of Cobot 19.
As the quarter progressed, we took a number of steps to protect our employees and customers as described on slide four.
As the crisis unfolded, we moved very quickly to protect the health and safety of our employees and customers.
These steps included closing our bank branch lobbies servicing customers, primarily through our drive through facilities.
Rotating branch staff on a week on week off schedule and transitioning approximately 95% of our non retail employees to a remote working environment.
Due to the investments we've made in technology and the incredible effort of our entire team we've been able to efficiently transition to remote working without much impact to our level of productivity and our digital banking platform was well prepared to handle the increase used by our customers.
Moving to slide five I wanted to review our response to clients since the crisis started.
From a customer engagement standpoint.
Our relationship managers have been reaching out to customers to assist them in managing through this crisis.
We were able to quickly get up.
And running our PPP process and have utilized that as a first option for assisting our clients through April 16th.
We had process $263 billion and PPP loans that had been approved by the SPJ for almost 1300 of our commercial clients.
Which assisted approximately 26000 employees in our markets.
Estimated fee income for the PPP loans is approximately 9.2 million, which will be recognized over the life of the loans.
Through April 20th we have received requests for loan payment deferrals of approximately $665 million of loans.
These payments deferrals are primarily from one to three months in length.
And the loans will continue to accrue interest during that time.
Our hope is that working with our customers through payment deferrals combined with the proceeds from the PPP. It will allow the vast majority of our small businesses to make it through this pandemic and get to the other side.
Our clients and local communities have been extremely appreciative of our efforts, we're receiving great feedback about the value of working with a community bank, who is committed to relationship banking.
Looking at other trends, we have not seen significant drawdowns on credit lines. The way. Some other banks have reported throughout the month of March credit line utilization rates remained consistently in the 66% to 68% range.
Despite the route.
Reduce operations in our branch network, the pace of new consumer deposit and commercial Treasury management account openings has remained relatively consistent.
As we as would be expected debit card transactions and check processing volumes decreased quite a bit towards the end of March when Illinois and posed to stay at home order.
And our wealth management business as we have done in commercial banking, we spent a lot of time talking with clients and staying in close contact throughout the crisis.
To date, we've had discussions with approximately 80% of our wealth management clients and they have indicated they plan to remain consistent in their investment strategy.
And finally interest rate locks for residential mortgage loans in the first quarter more than doubled from the prior quarter as a result of the decline in interest rates.
Turning to slide six.
We have provided a more detailed view of our loan portfolio.
We feel that we have a broadly diversified portfolio with no significant concentrations in any one industry.
As you know one of our objectives over the past couple of years has been growing our equipment finance portfolio.
We continue to do that in the first quarter as this portfolio increased by approximately $40 million.
At the end of the first quarter commercial loans represented 72% of our portfolio, while consumer loans, which includes residential real estate loans represented 28% of the portfolio.
88% of our consumer portfolio consists of loans that are originated by Greenside credit in accordance with underwriting criteria that we have provided to them.
These borrowers have an average FICO score in the seven Thirtys and it's a very granular portfolio. We also have credit enhancement due to the way the economics and the program are structured.
This has been a very successful program for Midland as we have experienced no charge offs in this portfolio in the nearly 10 years, we have been partnering with Greens Guy.
On slide seven we showed a breakout of our commercial loans by industry. This includes traditional see an eye loans commercial real estate loans and equipment finance loans and leases.
I would say broadly diversified portfolio.
Among the more troubled industries, our retail trade exposure represents just 8% of commercial loans and healthcare represents just 5% of commercial loans.
On slide eight we show our commercial real estate portfolio broken down by collateral type.
Our largest segment is retail, which at 18% of CRT loans represent 6.2% of our total loan portfolio.
Among some of the more troubled industries, our hotel restaurant and elder care facility exposure each represent 10% of our CRT loans with that let me turn the call over to Eric and have been walk through a few additional slides Eric Thanks, Jeff and good morning again, everyone.
Looking at slide nine I want to spend a couple of minutes talking about the impact of our adoption of seasonal and its and then what it did to the level of our overall loan reserves, we provided a walk through the drivers of the change from the allowance for credit losses that we held at December 30, Onest 2019.
We had a day one adjustment of 12.8 million, which was less than our initial expectations. Our day one adjustment decreased from that initial estimate as we continued to fine tune, our model and evaluate certain economic forecasts and our methodology for incorporating those forecasts into.
Overall boss factors.
We also charged off approximately 9 million in specific reserves that we held as of December 31.
Then in terms of how the reserve was impacted by what we saw in the first quarter. The changes in our portfolio contributed $2.5 million to that overall change. This reflects the impact of new loans that we book to changes in credit quality, the aging of the existing portfolio and other charge offs.
And recoveries that we had in the quarter.
And finally, the changes in our economic factors contributed approximately $4.7 million to the reserve that primarily reflects a downgrade and economic forecast due to the impact of cobot 19.
This resulted in an allowance for credit losses of 38.5 million at March 30, Onest, which represented 88 basis points of total loans up from our previous allowance for loan and lease losses of 64 basis points of total loans at the end of the prior quarter.
Turning to slide 10.
We want to talk about some of the factors impacting our net interest margin as Jeff mentioned earlier first we were able to stabilize the normalized margin as it decreased by one basis point over the previous quarter.
We've been successful in passing through deposit rate reductions to our customers and our overall cost of deposits decreased six basis points in the first quarter.
Due to the lower rate environment, the average rates on new and renewed loans declined to 4.59% compared to 4.8% in the previous quarter.
We expect to continue to benefit from repricing, our CD portfolio.
Particularly as time deposits that were previously offered up promotional rates last year continue to mature we have approximately 194 million in Cds scheduled scheduled to mature over the second quarter of 2020 at a weighted average interest rate of 2.14% our currency.
These are being offered at a rate from 25 to 55 basis points, depending on term. So we should see a significant reduction in our cost of time deposits.
On the negative side.
We intend to continue to build liquidity on our balance sheet to help us manage through this crisis and that will weigh on our margin going forward.
And we continue to carry higher balances of sub debt and that continues to impact our net interest margin in light of the pandemic, we expect to retain at least in the short term. The approximately 30 million of subordinated debentures that are callable in June 2020. However, this.
Subdebt will move to a quarterly floating rate in June and that will reduce the interest rate on that debt by approximately 50 basis points.
And then finally on the positive side our participation in PPP is expected to positively impact our margin in the second and third quarters with the largest impact coming in the third quarter as customers qualify for and receive debt forgiveness.
Moving to slide 11, let's take a look at our capital and liquidity positions.
We've included both our bank level and consolidated capital ratios, we believe that we're in a good position from a capital standpoint, particularly at the bank level to continue supporting our customers through the duration of this crisis, including through the additional stimulus programs approved by Congress. We're also had a strong liquidity position.
With nearly $1.2 billion in primary with liquidity sources and $185 million in secondary liquidity sources should we need. It. We also have the ability to tap into a $250 million credit facility and add up to 500 million in brokered Cds.
We also plan to utilize the PPP liquidity facility, which will provide another source of funding.
We've included all of our usual slides reviewing our first quarter results in the earnings deck, but we are planning to walk through them. This quarter due to the current environment, if you'd like additional color on any of those items, we'd be happy to provided during the question answer session and then with that I'll turn the call back over to Jeff Jeff. Thanks, Eric.
I'll wrap up with a few additional comments on our near term outlook and priorities as Eric mentioned, we believe we are well positioned from a capital and liquidity standpoint to continue supporting our customers and communities through this temporary downturn in the economy.
Well, it's hard to know how long the crisis will persist or the full impact it will have our principal capital management priorities will be supporting the credit needs of our customers and maintaining our dividend.
Given the level of uncertainty around the severity in the duration of the crisis, it's very difficult to forecast how the rest of the year is going to go.
That being said, we want to provide a few general comments.
We plan to continue to tightly manage expenses and in the second quarter, we will see the full quarter benefit of the staffing level adjustments, we made in the first quarter.
We will also continue to manage our deposit cost down and hold the line on loan pricing.
With respect to our wealth management fees in the second quarter. It seems likely we will see a decline unless the overall market moves back up to pre cobot levels.
Pipelines in our originate to sell businesses, including both commercial FHLB and residential mortgage has increased in the current rate environment.
Credit of course continues to be the great unknown as we wrap up this is certainly a challenging time, but for 140 years. The communities. We serve have counted on Midland to help them manage through difficult times and its current crisis will be no different.
With that we'll be happy to answer any questions you might have operator, please open the call.
Ladies and gentlemen, if you'd like to ask a question at this time. Please press. The Star then the number one key on your touched on telephone to withdraw your question press the pound key.
Our first question comes from the line of Michael Fareeda with KBW. Your line is now open.
Hey, Jeff Good morning, Thanks for the time and for the extra added disclosure so with everything going on in the slide deck that's helpful.
Good morning, Mike.
I wanted to start on on the credit side I was wondering Jeff if you could give us a little bit more color into the 7% of commercial loans that are accommodation in foodservice, what maybe some of the larger credits are in there and how that portfolio look thus far I imagine, there's probably quite a bit of deferred.
All in there just curious what some of the metrics are at this point.
Yes, I mean, we're seeing the those are probably the first deferrals, though that we're coming in.
When when this began.
In March and we were fairly proactive with those customers in the middle of March on that topic.
I think as Weve probably discussed in prior calls are.
Don't have a lot of large loans I think.
Our loans greater than 15 million are less than 15. So we don't have all big big exposures.
On any particular credits and I think most of our loans that are under 10 million. So I think the granularity of the portfolio.
Should help here and and sort of a philosophy of ours.
Any way is to.
Have a lot of granularity in the portfolio so that.
Credit here credit there.
It doesnt perform it doesn't.
It for sure hurts, but it doesn't take you down.
Okay and the.
Steve did charge offs in the quarter I know you flagged the vast majority of it as being related to those items that have been on NPL for your greater but the the remainder that I think it a couple of million was any of that related to the pandemic or or was that still earlier in the quarter actions that.
Predated what's going on now.
Yes, Mike This is Eric so as we pointed out in the split this slide deck about 10.2 of the charge offs were related to three larger specific credits that had been in our specific reserves for some time. So the remainder of those charge offs from primarily earlier in the quarter and really unrelated.
To the overall impact I think we experienced those prior the bulk of those prior to March before this current crisis kind of kicked in.
Okay.
Switching gears, a little bit on the PPP loans.
Do you guys have a sense of it seems like there was going to be a second wave in the near.
You guys have a sense of what kind of I imagine you have a lot applications kind of in the pipeline so to speak for additional funding there could you give a sense of what that dollar amount looks like and also what you kind of expect the approximate kind of fees to look like that could potentially come in over the next two quarters.
Related to the PPP program in total.
Yes, so ill say our team did a fantastic job of getting the applications that we received.
You know.
The day before through April 15th we I think we had.
80%, if not 90% of those total applications. We got approved the Dsps. So I think our teams did a really good job we got on a quick and got.
The vast majority of the clients.
Through the FDA portal, we do have a pipeline, it's not I think it to be small quite a bit smaller around too.
For a couple of reasons.
I think we've taken care, most our customers and Theres. Some some left we still need to take care of.
Two I think it's going to go even quicker the timing and the bigger players or are even more prepared going into this one than they were before I think the.
Smaller community banks were able to two like us.
Rally pretty quickly get our teams together get out in front of clients and and get a lot of these loans.
Approved and and so I think it'd be smaller going forward I don't really have an estimate on what I think those fees might look like but I think as me quite a bit quite a bit less than what what the first round was.
Do you have.
Im sorry, if I missed it but you know of approximately what the fees will be related to the the PPL until you've already approved.
Yes, I think generic script. It was 9.2 million 9.2 million in origination fees.
Sure.
Thank you and then just lastly from me on on capital.
You mentioned, Jeff that the priorities kind of support the bank and support the dividend but.
Did the bank. So ratios, obviously are quite high but to be equity REIT ratios at the holding company or a bit lower do you expect those to kind of build I mean would that some of the the moving parts would cecil the provision in the first quarter that that really wait on that and amongst other things in do you expect those to kind of rebound going forward with most of that noise now hopefully behind you.
Yes, I think so right I mean, we would.
And this timeframe, we focused on building capital.
So, yes, I mean, I think Cecil that they want adjustment was $12 million with of what 8 million sort of hit to equity.
Yes, seven or $8 million equity, so, yes that had some weight to it.
And we bought stock back in the first quarter. So.
Right and then that are you guys going to kind of suspend activity for time being now on the repurchase program.
We've not suspended our program at this point.
We have a board meeting next week and we'll talk about it but my expectation is we'll continue to keep that in play and keep keep our.
Options and flexibility because as the things pretty fluid.
So I think we'll we'll we'll keep it out there and.
Continue to assess our capital and the market.
But from from like a modeling perspective before trying to think about your buyback appetite I mean, if the environment stays as current you know if the country's stays close for the till mid May I mean, it's is it safe to assume that that probably won't be heavily utilized until there is some type of more clear trajectory for recovery.
Yes.
Im not sure you know, we're going to sort of keep our options open I can't I can't imagine there is to be a material change in what we've been doing.
So.
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Yes, again, I think I'll stick with our comments of were and support our clients credit needs and and support the dividend. So.
Okay.
Excellent. Thank you guys for taking the questions and be well and talk more so.
Yes, Thanks, Mike.
Our next question comes from Terry Mcevoy with Stephens. Your line is now open.
Hi, good morning, guys.
Good morning, Terry.
Maybe just start with the margin.
It sounds like great opportunity to reprice, the Cds down, which Eric talked about but then you've got to balance the excess liquidity in just low interest rates overall, so I guess what are your thoughts on the core margin for the second quarter as you think about some of the puts and takes.
It may I'll take a shot added I'm still very very fluid.
I think what we're trying to do is kind of support the current current margin right.
I think as we talked about at the last call.
The first couple of quarters, we're going to be sort of.
Try to maintain the current margin in that 330 range and then we get to the back part of the year with the the Cds repricing, which was still is still going to happen.
The sub debt, we are going to pay off sub debt in June that was going to help and as we got to the back part of the year. We thought we could start to move that margin back to that 350 range.
Lots changed since the last call.
And I think were.
I don't have a lot of a lot of guidance on the margin I think we try to put out there where the puts and takes were.
I guess I'm hopeful that we can move the margin up but a lot happened at the end to end of March.
With rate cuts, so, but we were I think we moved quickly reducing our deposit costs as well. So yes, I guess I'm hopeful that will trend up.
As we move the second quarter and I think the PPP loans.
We will sort of help too.
Just a question that payment deferral requests that you site in the presentation here.
Is that through mid April or is that a march end of March number.
Thats I think a mid April may April twentyth, or so, yes, and those are request not process, but my our think our expectation is the vast majority of those requests will get process.
And then just the last question, what's a good run rate of expenses to think about that as a starting point for modeling.
Specifically trended later in the cost saves from some of the actions you took in the first quarter and the benefits that you mentioned in the presentation.
Yeah, I think on expenses.
We didn't guide to a number we didn't guide for a reason because there's still a lot of uncertainty out there and I think the first quarter is is as a benchmark to where we think expenses.
Give or take around that number.
We will be probably where expenses are.
Okay. That's it thanks, so much stay healthy.
Yes. Thanks.
Our next question comes from Andrew Liesch with Piper Sandler Your line is now open.
Morning, guys.
Morning Andr.
Hi, just curious what were the loan the consumer loans that were moved to held for sale were those greenfield alone.
Yes, they were.
And I guess, what is your appetite to do more of that and.
Really what drove the decision to do to just how these.
I think theres an opportunity to do it.
Working with Greens Guy they have.
Bill in some other partner relationships and we were able to.
Move 100 million to held for sale generate some liquidity for us we thought it was a smart thing to do.
I'm not sure that's something that we'll continue to happen but.
We had an opportunity.
But that was a smart thing to do.
Okay.
And then with the.
The seasonal adjustment that part of the provision.
Chains in the macroeconomic variables and forecast for those.
We are those based on March 31st economic outlook or later on in April just trying to get a sense of.
Good the time that you guys either into this forecast.
Yeah. Andrew This is Erik I can take that one so so those economic forecasts were used right around quarter end right around March.
March 31.
We used the base case for forecasts, we kind of look out over the next 12 months in our forecasting and then there is a 12 month sort a reversion back back to the mean.
And then we also kind of evaluate and how those impacted all of our various portfolios.
Which I think I think that answers. Your question unless you do you want to go into it a little bit more.
What.
If you have any detail around like when unemployment rate, you're looking at or what would trend than GDP like how long are essentially last if you have that Andy.
You know, we so we use Oxford economics for our modeling, Oxford Economics, I don't recall, the exact and employment number we look at both of those factors that you kind of mentioned.
Focusing on the state of Illinois, with the exception of our meth ER, our equipment finance portfolio that we look Nash that we look nationally the modeling that we did used had had us kind of snapping back and sort of a U shaped kind of recovery through the fourth quarter.
On both of those measures that you mentioned unemployment rate and GDP.
Okay.
Ben just the the 9.2 million in fees.
Pvp loans.
And sort of thoughts on how quickly those but for those can be realized in the second quarter or do you think there'll be more heavily weighted towards.
That's a good question I think thats sort of a big question I think how we're sort of thinking about it internally as we've got sort of eight weeks and then customers will start applying for that forgiveness amendment will be another 30 to 60 days, possibly for the SBH to actually return those funds. So I guess, we're kind of thinking.
We will start to receive those funds back maybe maybe that July and August timeframe.
Okay.
Okay.
So it's very helpful. My question. Thanks.
As a reminder, ladies and gentlemen that is star then one if you'd like to ask a question.
Next question comes from David Conrad with da Davidson. Your line is now open.
Hey, good morning.
Couple of follow one eight a couple of follow up questions.
On the Green Skype portfolio.
Given our struck the duration typically is for the point of sale financing and I would guess a lot lower demand.
Near term given everything going on or just one of the outlook for the balances in the commercial loan or the consumer loan portfolio.
Yes, I think thats, what those are all I think.
Facts around that portfolio.
But I think we know we continue to see some credit flow. So I I don't I think our expectation is that the balance should say relative relatively flat.
Okay.
And then I've said this disclosure.
Okay.
On the reserve I was just curious if you had a kind of adjusted pro forma reserve to loan ratio. If you took the marks from the acquired loans and effectively made that a reserve were there where the coverage ratio which stand.
Yes, David you I'm, sorry can you ask that question again.
Yes, I was with the reserve to loan ratio I was curious if you took the marks embedded in the acquired loans and took those marks and put them into reserves what the coverage pro forma coverage would look like so I think last last quarter. We indicated their reserve was around 66 basis points on.
Then credit marks got us to just over 100.
And so in moving to cease all some of those credit marks ended up in sort of that initial adoption.
But we ended up with us Cecil balance at March 30, Onest of about 88 basis points of total loans.
Which that that reduction from from the credit marks before was was primarily in fact, it was all reducing our specific reserves on the portfolio through those charge offs in the first quarter.
Okay, Great and then the the last question for me. Thanks for the the slide in the commercial and lease and the diversification by sector. I was just wondering and the specifically an equipment lease portfolio.
Does that differ much from the diversification of the overall portfolio.
It probably does.
Because there is on commercial real estate in it that first graph was all commercial loans, the second largest commercial real estate. So.
I think.
It would differ.
What we I think the industry, we've talked about for manufacturing kind of where the equipment finance guys play.
That manufacturing construction.
Waste management trucking and transportation.
Our some of the more key industries that they plan.
Yes.
Okay perfect. Thank you.
Yes.
I'm showing no further questions at this time I'd like to turn the call back to management for closing remarks.
Alright, Thanks, everybody and will we'll talk next quarter.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating you may now disconnect.
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