Ladies and gentlemen, thank you for standing by and welcome to the Third Quarter 2020 Midland States Bancorp, Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's call is being recorded. [Operator Instructions]. I would now like to hand the call over to Tony Rossi. Please go ahead.

Thank you, Michelle. Good morning, everyone, and thank you for joining us today for the Midland States Bancorp third quarter 2020 earnings call. Joining us from Midland’s management team are Jeff Ludwig, President and Chief Executive Officer; and Eric Lemke, Chief Financial Officer. We will be using a slide presentation as part of our discussion this morning. If you have not done so already, please visit the Webcast and Presentations page of Midland’s Investor Relations website to download a copy of the presentation. 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 including those related to the impact of the COVID-19 pandemic. Various factors could cause actual results to be materially different from any future results expressed or implied by such forward-looking statements. 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 would like to turn the call over to Jeff. Jeff?

Good morning, everyone. Welcome to the Midland States earnings call. I'm going to start on Slide 3 with the highlights of the third quarter. Our reported results reflected the one-time charges related to the branch and facilities optimization plan that we announced last month. And I will talk more about that plan a little later in the call. Excluding those charges, we delivered a strong performance this quarter, in light of the continuing challenges presented by the ongoing pandemic, with adjusted earnings of $12 million or $0.52 per diluted share. This performance was driven by solid balance sheet growth, significant contributions from many of our sources of non-interest income, and disciplined expense management. While overall economic activity remains muted due to the pandemic, we're effectively targeting those areas of the economy where we are seeing healthy loan demand. As a result, we were able to generate annualized loan growth of 8.4% during the quarter. And we continue to see positive trends in gathering core deposits, which resulted in 6.8% annualized growth in our total deposits this quarter. Looking at asset quality, in general, we were pleased with the trends that we saw during the quarter and the improvement we saw in the health of most of our borrowers. This was most notably in the decline we saw in deferred loans, as the vast majority of these loans returned to regular payment schedules during the third quarter. We did see an increase in non-performing assets, but this was largely driven by three commercial real estate relationships. These were three credits that were adversely graded prior to the pandemic. And with the downturn in the economy, their conditions deteriorated to an extent where they moved to non-accrual status. Outside of these loans, we didn't see other migration to non-performing during the third…

Thanks, Jeff, and again, good morning, everyone. I'm starting on Slide 7, and we'll take a look at our loan portfolio. Our total loans increased a $102 million, or 2.1% from the end of the prior quarter. The increase was primarily driven by three areas. First, equipment finance, which continues to experience strong demand in both construction and manufacturing. Next, consumer loans increased coming through our partnership with GreenSky. And finally, we realized increases in warehouse lines of credit to commercial FHA originators, including the relationship with Dwight Capital that Jeff previously discussed. The growth in these areas has helped to offset a decline in our residential real estate portfolio, as we are not making an effort to retain loans that are looking to refinance to lower rates. At the end of the quarter, we moved some of our GreenSky loans to held-for-sale as part of our strategies to manage the concentration levels of consumer loans in the portfolio. We sold this portfolio in October at par. On Slide 8, we've provided an update on our equipment finance portfolio. As of September 30th, we had $75 million of deferrals, which represents a decline of 68% since the end of the last quarter. The majority of the deferrals represent borrowers in the transit and ground transportation industry, many of which are operators of tour buses, who have been temporarily impacted by the decline in travel. On Slide 9, we've provided an overview of our hotel/motel portfolio. At September 30th, we had $106 million of loan deferrals in this portfolio, which is down 28% from the end of the prior quarter. Over the past couple of months, more of these borrowers have had increases in occupancy rates that allow them to return to at least a breakeven level. With these improving trends,…

Thanks, Eric. I’ll wrap up with a few comments on our near term outlook and priorities. First and foremost, we will continue to focus on maintaining strong capital and liquidity positions. We will also continue to capitalize on those areas where we see loan demand in the current environment. The equipment finance continues to have a strong pipeline, and we have additional opportunities to expand our commercial lending relationship with Dwight Capital. As a result, we believe that we'll see another quarter of growth in average loan balances although our end of period loan growth might be impacted by volatility that we see in warehouse line utilization and forgiveness of our PPP loan portfolio. We also continue to see strong demand in residential mortgage lending and should see another good quarter of revenue from this group. From an operations perspective, we will be focused on implementing our branch network and corporate facilities reduction plan, ensuring that we provide a smooth transition for customers using new locations. As we approach the end of 2020, while this has been an extremely challenging year due to the pandemic, it's also been one that has been extremely productive for the company in terms of repositioning and refocusing our franchise on areas of the business that we believe present the best opportunities for future growth and deliver the most attractive returns. With the changes we have made and the improved operating leverage that has resulted, we feel that we have made important progress in positioning Midland to deliver more consistent financial performance and earnings growth as the economy strengthens. With that, we'll be happy to answer any questions you might have. Operator, please open the call.

[Operator Instruction]. Our first question comes from Michael Schiavone of KBW. Your line is open.

So you guys had some nice loan growth in the quarter from three different verticals. Can you just provide some more color on the main drivers and then discuss the pipelines? And if the growth -- how stable is the growth going forward?

Yes, we saw nice growth in consumer loans in our GreenSky relationship and that’s a relationship where we sort of set limits, if you will, and we increased the limits in the quarter. So I think there'll be a little bit -- it could be a little bit of growth in that area. But it's something that we sort of control. Eric talked about, we sold some portfolios in that group. So as the volume comes down a little heavier than we would like, we are able to partner with GreenSky and sell on some of those loans at par, which I think continues to support the fact that there's very limited credit loss in that portfolio. I think there's opportunity on the commercial FHA warehouse lines, that those businesses are seeing some pretty good activity. So I would expect some nice draws in this quarter. And the equipment finance business continues to have a very strong pipeline. Fourth quarter is typically their strongest quarter. So we would continue to see similar activity in the fourth quarter as we did in the third quarter.

Great, thanks. And can you also shed some color on the new relationship with Dwight Capital and what type of revenue and deposit growth opportunities we might expect?

I don't want to get real specific on customers on an earnings call, but I think what we said in the call is, we've got a warehouse line with them, and you'll start to see it. I mean we've got another customer as well in that space. So as we move forward sort of call that out as the balances move in and out. But those -- a couple of companies that we provide financing to, they need a lot of line availability in the hundreds and millions of dollar types range. So we have -- so that’s the warehouse lines. And then, just like we have with Love Funding, we bridged -- we did some commercial loan bridging from an origination of a loan, hold it on the balance sheet for a period of time, and then take it to the secondary market. So we'll also provide that type of financing when needed to that customer as well. So, yes, I think there's a good opportunity to generate some revenue with that new customer and offset some of the revenue and earnings loss from Love Funding.

And then final one. Do you expect that capital can start to build from here, just given pre-tax pre-provision earnings outlook should improve after all the cost initiatives? And then also, what is your appetite for continued share repurchases versus other uses of capital at this point?

Yes. So we're trying to -- that's a balance for us. We're -- we want to build capital. But with our stock trading at $0.70 on the dollar, there's a small appetite there to repurchase some shares each quarter. So we're sort of balancing that as we move forward with the idea that we'd like to build -- need to build our tangible common equity ratios. Now our bank capital ratios are very strong, and we hold a lot of liquidity at our holding company. So from a overall capital position, we feel really good. But we do need to build some better ratios at the holding company level. And that improved earnings and improved pre-tax pre-provision is going to help with that.

[Operator Instructions] Our next question comes from Nathan Race of Piper Sandler. Your line is open.

I was hoping to just follow-up on the operating expense discussion. Eric, appreciate your guidance for the first quarter. I guess I'm just curious if there's going to be some redundant costs, just given that you guys are kind of working through those branch optimizations here in 4Q, which may carry over into 1Q and just how we should kind of think about the core run rate has been through the second quarter of '21?

Do you want me to take that? Yes. So I think we've gotten some nice cost saves through both the branch rationalization and office rationalization and Love Funding. We had a really good expense year in terms of -- we had a nice medical cost year. Our incentive plans are half of what they would normally be in a normal year. And so we're sort of projecting those would sort of come back to '19 levels. And so there's some expense headwind when you compare to 2020. And maybe that's -- maybe what you're trying to get at is, thinking that the quarterly run rate might be less than a $39 million to $40 million run rate, but there are some expense headwinds that we're seeing as we head into 2021.

And then just changing gears on credit. The provision has been pretty stable last few quarters. I guess, obviously, it was elevated this quarter with the commercial real estate credits and so forth. Those 3 isolated incidents, it seems like. How should we be thinking about additional reserve build just given the macro inputs that factor into your CECL model and just given how you guys are seeing deferrals trend at this point and just overall changes in criticized and classified loans as well, at least in the fourth quarter, I suppose?

Yes. I mean we continue to get a better look at deferrals. And as that starts to narrow, you get a better look at where you might have real problems, right? So I think what we said at the end of last quarter is that provisioning in the back part of the year would be similar to the first part of the year. And I think we probably continue to see it that way. So hopefully, that helps, yes.

Our next question comes from Cooper Brown of Stephens. Your line is open.

This is Cooper on for Terry. Just wanted to quickly touch on the equipment finance portfolio. I think you mentioned you're expecting some growth going forward like you saw this quarter. Specifically, it was from construction and manufacturing. Any additional industries that are worth noting that you might have seen the demand from?

I think those are the sectors. We think we have a well-diversified approach to the equipment finance business. We think we're in areas that have some growth. Obviously, the shuttle bus area is sort of shut down. But there's -- we're seeing good demand in construction and manufacturing. So it's in those sectors.

And then just quickly, do you -- can you provide the total size of the transit and ground passenger portfolio where I think deferrals are elevated within the -- within equipment finance?

Yes. We know the deferrals, I don't know what the total portfolio is, but it's -- the majority of that portfolio is in deferrals.

And then just finally, I think you guys touched on some opportunities to help the NIM out in this coming quarter. With the CD maturities, how are things looking for early '21? And are there any other deposit cost reduction opportunities over the next several quarters?

Yes. I mean we're through most of the deposit reductions. There are still CDs that we have that will continue to roll down even as we go into 2021, I think as much as $400 million that's going to mature next year or within the next 12 months, maybe that's what I was just looking at, that will roll down over time. So -- and that's really the only area at this point where there's opportunity. I mean maybe it's a few basis points, a couple of basis points here and there, but for the most part, in the last 2 quarters, we've gotten our deposit costs down to reflect really where the market is right now.

Our next question comes from David Konrad of D.A. Davidson. Your line is open.

I just had a quick follow-up question on the NIM. You just kind of filled in the questions on the CD side. But on the asset side, I thought loan yields held up remarkably well. I’m just curious on the equipment finance, kind of a front book, back book. What's the current yields you're booking now versus the portfolio yields? Is there a gap there? And maybe the same question for the securities portfolio for maybe if there's any pressure on that as we look into next year?

They're -- I'm pretty sure -- and you might need to look it up, but I'm pretty sure that our portfolio yield is a little higher than what we're putting new production on today. But new production in that business is north of 4, probably pushing 4.5, and we've been able to increase spreads over the last 3 to 4 months in that area as well. So although we're losing some yield as that portfolio pays down and we put new on, that spread, that difference isn't significant.

And then on the securities portfolio?

Yes. Right. I mean, it's rolling. I mean, Eric, you can talk about it. It's rolling. It's rolling down.

Yes. David, on the securities portfolio, that yield continues to drop. We've been looking at new purchase opportunities, and those are in the range of 100 basis points to 140 basis points depending on what type of security in the duration. Yes, we're continuing to expect that to roll down a little bit over the course of next few quarters.

But then I guess the flip side of that is if you can deploy some of the cash at probably 10 bps into the leasing portfolio that will help offset some of those pressures?

Correct.

I show no further questions. I'd like to turn the call back over to management for closing remarks.

Alright. Thanks, everybody for joining today, and we'll see everybody in 2021. Thanks.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.