Good day, ladies and gentlemen, and welcome to the Second Quarter 2018 Midland States Bancorp, Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Ms. Allyson Pooley from Financial Profile. Ma'am, you may begin.

Thank you, Joana. Good morning, everyone and thank you for joining us today for the Midland States Bancorp's second quarter 2018 earnings call. Joining us from Midland's management team are Leon Holschbach, Chief Executive Officer; Jeff Ludwig, President; and Steve Erickson, Chief Financial Officer. We will be using a slide presentation as part of our discussion this morning. If you haven't done so already, please visit the Webcasts and Presentations page of Midland's Investor Relations website to download a copy of the presentation. The management team will discuss the second quarter results and then will open the call up for discussion -- for questions excuse me. Before we begin, I would 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 the reconciliation of the GAAP to non-GAAP measures. And with that, I will turn the call over to Leon.

Thank you, Allyson, and good morning, everyone, welcome to Midland. I'll start with Slide 3 which is a summary of the highlights of the second quarter. We did see the first full quarter since the closing of our acquisition of Alpine Bank; we saw the initial benefits from the transaction. On an adjusted basis, excluding integration and acquisition expenses, we generated $0.59 in earnings per share. This was a notable increase from our level of profitability prior to the acquisition despite a very weak quarter from Love Funding. We have executed very well on the Alpine integration and we are ahead of schedule on realizing the projected cost savings for the transaction. We have already phased-in approximately 80% of the cost saves, which positively impacted our expense levels in the second quarter. As we have discussed, since announcing the Alpine deal, one of the key benefits of the transaction is shifting our revenue mix towards the more stable and predictable businesses within our core community banking and wealth management operation. We believe this shift improves the quality of earnings that we're generating and ultimately has a positive impact on the value of our franchise. Additionally, we grew loans, while continuing to be very selective in our new originations in order to effectively manage our balance sheet and protect our net interest margin. As a result of the disciplined approach to growth that we're taking, we were able to better manage our deposit costs in this challenging rising interest rate environment. Our cost of interest bearing deposits increased just two basis points from the prior quarter resulting in a lower deposit data that we have experienced in recent quarters. This helped us maintain a relatively stable net interest margin excluding accretion income. Now I'll turn the call over to my partner, Jeff Ludwig, to walk you the performance of some of our major lines of business. Jeff?

Thanks, Leon. Starting with our loan portfolio on Slide 4, our total loans outstanding increased $67 million from the end of the prior quarter which represents an annualized growth rate of 6.6%, a pick up from the more muted growth we had in the first quarter. As Leon mentioned, we continue to be very selective in our originations, focusing our efforts around both lending areas that generate the most attractive risk adjusted returns. The two strongest areas of production in the second quarter came from our consumer lending programs and our equipment finance business. The consumer loan growth largely came from our home improvement loan program with Green Sky and these loans came on our books late in the quarter. So we should see more of the impact of these loans on our interest income next quarter. We're seeing good production from the new Equipment Finance team; we brought on board in January. This team books credit that go in both our leasing portfolio and our C&I loan portfolio. So leasing portfolio loan doesn't capture all the production that we are getting from this Group, including both leases and commercial loans the total amount of outstanding's from the Equipment Finance Group increased $38 million from the end of the prior quarter or 17%. We also saw nice growth in our residential real estate and construction portfolios. The growth in these areas was offset by declines in our commercial real estate and commercial loan portfolios. We continue to see elevated pay-offs in our CRE portfolio as well as aggressive pricing on rates and structures that we are not willing to match. The decline in our commercial loan portfolio was primarily related to the pay down of an FHA Commercial warehouse line from one large customer that tend to fluctuate from quarter-to-quarter.…

Thank you, Jeff. Starting with our net interest income and net interest margin on Slide 8, our net interest income increased by 26% from the first quarter. This was primarily the result of the fourth quarter contribution of Alpine. With respect to net interest margin, on a reported basis margin increased 22 basis points to 3.91%. However excluding the impact of accretion income, our net interest margin was relatively flat. Going forward, our scheduled accretion income was $3.1 million for the third quarter of 2018, $2.3 million for the fourth quarter, and a $7.2 million for the full-year of 2019 although there will be some volatility caused by prepayment activity. As we've indicated over the past few quarters, we continue to expect our net interest margin to be relatively flat going forward excluding the impact of accretion income. Moving to our non-interest income on Slide 9, due to the minimal contribution from Commercial FHA this quarter, our total non-interest income decreased approximately $700,000 or 4% from the prior quarter. The decline in Commercial FHA revenue was partially offset by increases in all of our other major fee generating areas primarily due to the full quarter impact of Alpine's operations and the seasonal strength in residential mortgage banking which increased 49% from the prior quarter. Now turning to our expenses and efficiency ratio on Slide 10. We incurred $2 million in integration and acquisition expense in the second quarter. Excluding this expense, our non-interest expense increased 18.1% on a linked quarter basis. The increase was primarily due to the full quarter of expenses associated with the addition of Alpine's operations. Excluding the integration and acquisition expenses and a small loss on mortgage servicing rights held-for-sale, our adjusted efficiency ratio was 67.8% in the second quarter compared to 68.5% last quarter. The…

Thanks, Steve. So I'll wrap up on Slide 12 with some comments on our outlook. Over the coming quarters, we expect to remain disciplined in our balance sheet growth in order to manage our loan to deposit ratio and protect our net interest margin. We will also continue to focus on controlling expenses and driving a higher level of efficiencies throughout the entire company. Earlier this month we completed the system conversion for Alpine and the transition has gone very smoothly. I'd like to thank all of our employees who worked so hard over the past six months to make this happen. Our teams did a great job. Although we still have some integration and acquisition expense coming in the third quarter, we are on track to enter the fourth quarter with substantially all cost savings in place. We believe this will put us in a good position to deliver additional earnings growth in 2019. And with that we would be happy to answer any questions that you might have. Operator, please open up the line for call.

Thank you. [Operator Instructions]. Our first question comes from Michael Perito with KBW. Your line is now open.

I have a few questions. I want to touch on first on the expenses, just looking at ballpark based on your commentary but also the numbers it seems like you're tracking a little healthy gain on the Alpine cost saves. But now with this and I'm taking the core expenses ex the merger stuff at about $44.5 million. So I guess my question it sounds like there is a little bit more that needs to come out from Alpine and then you have the $2 million annually that needs to come out. So I mean does that run rate move down towards $43 million by the end of the year or there any other kind of investments being made that slow that up, is there any color you can give us on that dynamic?

Yes, Mike this is Jeff. I think that’s exactly how we view it. Those are the two areas where cost should start to come down and by the end of the year fourth quarter and mostly as we get into 2019, we get to that $43 million expense run rate.

Okay. And as you look to next year, are there any kind of investments on the horizon that you guys are thinking add to that would maybe boost expense growth more than like two percentage points or at this point is it are you guys have pretty good transparency there and think that that's probably 2%, 3% is a better growth rate post Alpine?

Yes, I think that's right. We don’t expect any big investments next year. And so the $43 million and a little bit of expense growth in 2019 would be right.

Okay. I was curious if you could maybe give us a little bit more color on the -- you showed a lot of consumer production, I think is what you said was back -- kind of backend loaded obviously with Alpine on now and I believe Alpine was about six basis points dilutive to your NIM all-in and so obviously the core NIM is holding pretty well here. So I mean it would seem like you're seeing some core NIM expansion underneath kind of under the hood here and I'm curious if you kind of expect that to continue and will the consumer balances coming on, what yields are those and will that have a positive impact on NIM in the third quarter?

It might have like a slight positive to NIM but it's not going to on our balance sheet of our size today, the incremental difference isn't going to make a huge move on the NIM. I do think we continue to be disciplined on the price side, on the loan side and we are seeing loan rates increase and we've been able to hold this debate on our deposit base. So we're I think we’re comfortable that our NIM can be stable going forward.

Michael, this is Leon. And I would just add to that, that offsetting some of those not as positive is going to be the continuing battle for funding which is an industry-wide one that we're engaged in, it doesn't look like it's going to go away any time soon. And that’s why what we're pointing to stability in the margin because there will be -- there will be headwinds in the funding gathering part of the business for sure.

Okay, thanks. And then just one more from me and then I will let someone else to go at it. But just the interchange revenue has really ramped up and I think it can move around a bit but I was just curious if you can give us more color on what was in the number this quarter and the sustainability of that going forward?

Yes, so I think the big driver there was Alpine. And Alpine had some nice interchange revenue that we got a full quarter benefit from where in the first quarter we had a month of the benefit, so.

And they have a stronger retail base than we did too. They were a solid 50:50 retail and that boosts the interchange relative to the size of the balance sheet compared to ours. So that was a nice pick up.

Yes, and I do think you're right Mike, it moves around, we see it even month to month moving around based on how customers are behaving and different holiday, weekends and things like that. So it does moves around, but yes, we -- I think we had a strong quarter and expected to see those revenues to be pretty consistent moving forward, although there might be some bouncing up and down a little.

And actually just one more, just on the tax rate, it's been a little up and down over the last couple of quarters just any thoughts on where it could shake up for the last half of the year?

I think we're still, I think we guide like 24% last quarter; I think that’s still where we think it is. We still have some discreet items that come in that might bring it down quarter-to-quarter. So but and that's how we plan here.

Thank you. Our next question comes from Terry McEvoy with Stephens. Your line is now open.

Thanks. Good morning guys.

Good morning, Terry McEvoy.

Thanks.

It's all right. Would the name like old stock, I couldn't pass up the opportunity though.

That’s great. Let’s just start with Love Funding, I guess the direct question is what happened if I look back it was a $70 million quarterly business at one point and I know it was going to be lumpy that's been the message all along but was this very much an internal issue that's now been fixed and resolved or is there some fundamentals within that FHA Commercial business that you needed to adapt to here?

I think it's probably all of that, a little of all that. We are seeing, these are big credits and you go credit-by-credit and there's this issue with that one this issue with this one that we can’t get the loan to get to a rate lock position, so it’s some of that, it's some of probably the pipeline having a little bit of low in it right now and pushing back. But I think overall we feel that the revenue -- we're confident that the revenue will come back in the next quarter and that this quarter was really little bit of an aberration to come in like a zero. So we're optimistic and we -- I think we ever thought this is a $7 million year, I think we're going to have quarters there is going to be $7 million, we’re going to have quarters probably under $3 million, but I think for the majority of the quarters it’s going to be between $3 million and $5 million and that's kind of why we said that in the call.

And then if I could just add to that Terry, the changes that we've made in leadership there are important in any of the mortgage businesses, the cyclicality, and the volatility has to be managed as effectively as you can, you don't control most of it but a key to effective management is to be able to respond to that and then we think that going forward we will be positioned better to more effectively respond to the low points in production. And then just one other thing and it's not a boo-hoo about the industry, but it is understood that FHA, that the hub office excuse me, the hub office has been significantly understaffed for some time, they recently reported that the 150 open positions that they have are now expected to be filled by the end of the year. We have a couple of key people on focus group there including our head underwriter and some improvements have been made there hopefully it's incrementally improved the pace of underwriting and the speed that we can turn deals at. That’s not a major driver but another little thorn that looks like it’s going to be resolved in the near-term that should help.

Okay.

Meanwhile the pipeline has looked reasonable, they’re down from their high point but they suggest much better performance than this last quarter indicated so. So we think the reset will get the job done.

Okay, good. And then Jeff ran through the impact of this business on loans and deposits, could you just provide maybe how much of Love is within the loan portfolio today and then maybe more importantly on the deposit side, what's that dollar amount I think you have disclosed it in the past and then under this new structure do you think it stabilizes or can you see some growth in those deposits?

Yes, so on the loan side the loans that are being closed at Love Funding will show up in loans held-for-sale. So it’s not impacting kind of portfolio loans. But maybe you’re talking bridge loans.

Yes, that was it.

Yes, yes. So bridge loans, outstandings at the end of the quarter were almost $140 million. So we saw some growth in the quarter but there's a fair amount of construction loans that draw over time.

There is some over $200 million approved much of the difference in construction.

Yes, there is a total of another $51 million of commitments that are out there, so we should continue to see that balance move up. On the deposit side, average deposits in the servicing book for Love was $291 million. I think that was up or fairly stable from the prior quarter. And with the light -- with not a lot of production in the current quarter, we weren't held in the servicing book. So you would expect it to be fairly flat.

Thank you. [Operator Instructions]. Our next question comes from Andrew Liesch with Sandler O'Neill. Your line is now open.

Hey I appreciate the guidance on the $43 million run rate and the thoughts on how you’re going to able to get there on the expense side but just now looking at the fee income side, with what you had this quarter with Alpine in there several of these items, line items feel like there, in your run rate residential mortgage banking got the team there and get the FHA business back up, it's -- is like $21 million a good level to be using for the non-interest income side?

Yes, I think it’s a little less than that. As we've looked at kind of the analyst guidance it looks like there are some additional revenues fitting in some other income line items that maybe got annualized out in the prior quarter but we think it’s probably a little less than that.

Okay. Actually.

Probably more than that like $19 million, $20 million range.

Got it.

If Love performs in that range, so.

Right.

In that [indiscernible].

Certainly, you’ve actually covered all my other questions. So I will step back.

All right.

Thank you. I’m not showing any further questions at this time. I would now like to turn the call back over to management for any further remarks.

I will just say thanks everyone for joining us this morning and we will talk again in the quarter.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. And you may all disconnect. Everyone have a great day.