Good morning ladies and gentlemen, and welcome to the Q1 2021 Midland States Bancorp 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. If anyone should require further assistance during the conference, please press star then zero on your touchtone telephone. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Mr. Tony Rossi of Financial Profiles. Thank you, please go ahead.

Thank you Stacy. Good morning everyone and thank you for joining us today for the Midland States Bancorp first quarter 2021 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 at Midland’s Investor Relations website to download a copy of the presentation. Before we begin, I’d like to remind you that this conference call contains forward-looking statements with respect to the future performance and financial condition of Midland States Bancorp that involve risks and uncertainties, 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. The 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 to 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 3 with the highlights of the first quarter. Over the last couple of years, we have talked a lot about the strategic initiatives we have implemented to position the company for improved financial performance. These initiatives range from branch consolidations to the sale of the commercial FHA loan origination platform to the acceleration of our investment in technology to improve efficiencies and enhance revenue generation. Our first quarter performance reflects a significant increase in our level of profitability resulting from these efforts to enhance efficiencies and optimize our business model. Despite growing in a low growth, low interest rate environment, we generated net income of $18.5 million or $0.81 per diluted share, which represents the highest level of quarterly earnings in our history. We are also seeing the improvement in our performance metrics that we targeted. Our efficiency ratio improved to 56.9% from 58.6%. Our return on average shareholders equity exceeded 12% in the quarter and our return on average tangible common equity exceeded 17%. Our adjusted pre-tax, pre-provision return on average assets was 1.75%. All these metrics represent our best core operating performance since we became a public company. The strong performance is resulting in a significant amount of internally generated capital that is positively impacting our capital ratios and our book value. Building up our capital ratios was one of the priorities for 2021 that we talked about on our last earnings call, and in the first quarter, all of our capital ratios increased between 21 and 49 basis points and our book value and tangible book value per share increased 2.2% and 3.5% respectively from the end of the prior quarter. Notably, we were able to achieve this improved financial performance…

Thanks Jeff, and again good morning everyone. I’m starting on Slide 6, and we’ll take a look at our loan portfolio. Our total loans decreased $193 million from the end of the prior quarter. As Jeff mentioned, we experienced an elevated level of pay offs and pay downs across most of our major portfolios during the quarter. This included lower line utilization from our ag borrowers and the continued run-off we are seeing in the residential real estate portfolio due to refinancing activity. More than a third of the decline in total loans was attributable to period end balances on commercial FHA warehouse credit lines that were $68 million lower than the end of the prior quarter. While there can be some volatility in the period end balances, this lending area continues to generally increase for us as the average balances were higher in the first quarter than in the fourth quarter. Offsetting the pay offs and pay downs in other areas was a $27 million increase in our PPP loan balances as our production in the second round of the program more than offset the level of forgiveness we saw in loans originated in the first round. On Slide 7, we’ve provided an update of our equipment finance portfolio. As of March 31, we had $46 million of loan deferrals, which represents a decline of 8% since the end of the last quarter. We continue to see a steady recovery of our borrowers in the transit and ground transportation industry as the trends in business and recreational travel continue to improve. We’ve seen more borrowers return to scheduled payments as well as others that remain on deferral starting to make some form of partial payment. Seventy-eight percent of the borrowers on deferral in this portfolio are now making a…

Thanks Eric. We’ll wrap up on Slide 18 with a few comments on our outlook. We’re very pleased with our start to the year and delivering on higher profitability that we targeted. While the pandemic is still very much top of mind, we are seeing signs of improving economic conditions and borrowers that were most impacted by the pandemic continue to steadily improve their financial performance. We believe this should lead to continued reduction in deferrals as we move through the spring and summer and our ACL coverage ratio will remain relatively stable. The improving economic conditions is reflected in our growing loan pipeline, and the new bankers we added in the areas of SBA, agribusiness, and specialty finance have been very productive in their first few months and are contributing to the increases we are seeing in the loan pipeline. We are optimistic that the growing pipeline will result in stronger loan production and loan growth as we move through the year. With stronger loan growth, we will be able to redeploy our excess liquidity into higher yielding assets, generate more revenue growth, further increase our operating leverage, and drive additional improvement in our level of profitability. The ATG acquisition is on track to close in the second quarter and this will provide a further increase in our fee income over the second half of the year. The continuation of our strong financial performance and the further improvement we expect to deliver as we enter a more favorable environment for generating loan growth should help us to make additional progress in strengthening our capital ratios, which will better support our continued organic and acquisitive growth in the future. With that, we’ll be happy to answer any questions you might have. Operator, please open the call.

[Operator instructions] Our first question comes from Terry McEvoy from Stephens.

Hey, good morning everyone.

Good morning.

I guess two questions. Of the leasing business and GreenSky, it sounds like GreenSky, you’re thinking about increasing just your concentration to GreenSky, if I heard correctly, and if that’s the case, to what degree? I guess on the leasing, it’s 17.5% - is that an area you’re looking to grow this year or from a concentration standpoint, is that kind of your level of comfort?

Yes, so I’ll start with the Midland equipment finance business. We had a little bit of a slower first quarter, which is not unusual. Usually the fourth quarter is pretty robust as companies are buying equipment towards the end of the year, and that business typically starts a little slower in the first quarter, so we expect it to sort of pick up and we expect those balances to grow as we move through the balance of the year. We’re sort of targeting a relatively same production level as we did last year, so as the balance gets--as the portfolio balance gets bigger and we keep production at about the same level, the growth rate’s obviously just going to continue to slow, and to your concentration point, we do sort of have some targets that we think we need to maintain, which we think we can still grow the portfolio some but then at some point we’re going to--we need to grow the rest of the bank to be able to continue to grow that portfolio. As it relates to GreenSky, yes, we are going to--because of the liquidity that’s coming on the balance sheet and PPP, as it continues to get forgiven, is going to provide even more liquidity, we’re going to increase that balance, I’ll say anywhere from maybe $75 million to $150 million is sort of how we think about that for the remaining part of the year, so not all at once but as we move through the balance of the year.

Then just as a follow-up question, the volatility in commercial FHA warehouse credit lines, is that just something we’re going to have to live with going forward, and maybe could you just talk about how large those quarterly swings could be, just to frame expectations going forward?

Yes, so it will go up and down and depending at the end of the quarter whether those warehouse lines are drawn or not. There will be fairly large swings and those swings could be in the $100 million to $200 million range, probably. We’ve probably got commitments that are around $500 million, so depending on where they’re at in their closing cycles, yes, we could see $100 million to $200 million swings in that, in those spot balances, but we expect the averages to sort of average out and not have as much swing on an average balance point of view during each quarter.

Great, thanks Jeff.

Your next question comes from Michael Perito from KBW.

Mike, are you there?

I am. Can you guys hear me?

Yes.

All right, sorry about that. Good morning, how are you guys?

We’re good.

Good. I wanted to start on the expense side, so $39 million to $40 million, I guess if I heard you guys correctly is kind of the near term run rate. Two part question here, I guess. One, Jeff, the mix of the business has changed a decent amount over the last year and a half or so. I was just wondering if you guys had any kind of thoughts about structurally what type of efficiency ratio you guys are targeting with this new mix of business versus historical, where you guys had some businesses that put upward pressure on that. Then secondly, I was wondering if you could maybe just provide a little bit more detail on some of the technology digital investments that are being factored into that run rate, and anything you’d pull out as particularly meaningful for your involvement here that we should be mindful of.

Yes, so our internal target, and I think I’ve probably said this in some meetings, is to get under 55% efficiency ratio. A couple years ago, it was to get under 60%, now it’s to get under 55%, and we’re sort of on track and moving in the right direction, so we feel pretty good about where we’re at. As it relates to technology, the technology investments that we’ve made, that we are making are sort of in our run rates, so there’s not, you know, some investment we’re making today that’s going to sort of go away later. The investments we’ve been making in technology have been in our run rates for many quarters now and are in our run rate today. A big part of that investment is in people, so I don’t see that necessarily accelerating to increase our expenses, nor do I see it decelerating to decrease our expenses.

Helpful, okay. Then in terms of just, you know, anything you guys are particularly working on or upgrading or rolling out in the near term here that you’re excited about, or that you’d highlight as critical?

Yes, so we’ve rolled out online account opening, both on the retail side and the business side. We’re seeing good activity there. I think on the retail side, we’re seeing about a third of our new account openings happening online, so that’s encouraging. We introduced Zelle here in the last probably 30 days, which we think that’s a big enhancement on the mobile app, really good P2P payment processing, and we hope by--you know, our plan is by the end of the second quarter to sort of have, if you will, all of our products accessible online, so all deposit--you can sort of buy online loans the same way, and then it’s all about marketing and customer journey marketing and the auto marketing journey. So yes, I think we’re pretty excited about the back part of the year. We’ve done a lot of work getting these pieces in place, and then it becomes a marketing and--you know, how do you drive traffic to your website.

Great, okay. Then just on margins, Eric, did I hear you correctly that the impacts from PPP forgiveness, 7 basis points I guess, it was 3.38 excluding versus the 3.45 reported?

Correct, yes.

Okay. If I look at the purchase accounting accretion and the PPP, that puts you guys kind of on an adjusted basis about 3.30, which I think was up modestly over the fourth quarter. Is it fair to think that between some liability re-pricing here and if you guys are able to--are successful in adding some of the GreenSky balances and deploy the liquidity, there should be some positive NIM movement here, adjusted for any of the PPP volatility over the next few quarters?

Towards the back half of the year, Mike. We’re looking at this next quarter a little conservatively given the decreases in loans that we experienced in the first quarter. Our pipelines are good, but it will take us a little time to get those loan balances back. But we are working on plans to reinvest that excess liquidity that we had at quarter end through GreenSky securities purchases and a few other things out there, so we may see our NIM come down a couple of basis points in the second quarter but then build back up and keep it flat, with maybe a couple basis points upside toward the back half of the year.

Helpful. Then just a clarification - on the GreenSky piece, that’s--I don’t want to call it easy, but that’s a fairly straightforward growth mechanism for you guys, right? You basically just indicate that you have more appetite and more volume comes through, is that correct? It’s not necessarily as un-predictive maybe as the commercial portfolio, where the pay offs or the closing dates could be a little bit more hard to pin down?

Yes Mike, I’d agree with that. GreenSky still has pretty good activity and so it’s just a matter of us talking with them about what our credit metrics look like, and we don’t plan to change those at all, and just kind of accepting a little bit more of activity in raising our overall levels.

Great.

And as Jeff mentioned, we won’t do that all at once.

No, makes sense. Thank you guys for taking my questions. I appreciate it.

Yes, thanks.

Once again, if you would like to ask a question, that is star followed by the number one on your telephone keypad. If your question has been answered or you wish to remove yourself from queue, please press the pound key. Your next question comes from Nathan Race from Piper Sandler.

Hi guys, good morning. Was hoping to just dive into--on the outlook slide, the expectations for a relatively stable ACL over the next quarter or two. Within that, I’d love to get an update in terms of what you guys are seeing in terms of charge-off activity, and if we can kind of expect provisioning to match charge-offs. I know it’s difficult to pinpoint provisioning in any given quarter under a CECL framework, but was just hoping to kind of dive into some of the underlying pieces behind that ACL outlook.

Yes Nate, good morning. Good question. We had pretty good charge-off activity in the first quarter - you know, $1.7 million, 14 basis points. As we kind of mentioned in the call, we did have a loan relationship move into non-performing that added to some of our specific reserves, and so we do expect to see some charge-offs towards the last half of the year. But I think as I look at our ACL right now and where we’re at, and as the economic forecasts continue to improve, I think we can be in a position where we’ll provide for charge-offs and that’s roughly my expectation. I think one of the reasons we added to the ACL this particular quarter was because we continued to see some elevated levels of deferrals in those couple of industries, so that’d be why we added to our CRE, those commercial real estate loan buckets. But I think going forward, we’ll provide for our reserves and sort of keep that ACL where it is, depending on other circumstances as they come and as they occur.

Got it, that’s helpful. Thanks Eric. Just following up on that, it sounds like with 90% of the reserve unallocated or on a general basis, you guys may not necessarily need to provide for that kind of mid-single digit growth that we’re expecting to build over the course of this year. Is that a fair characterization?

Yes, it could be. It depends on where some of those loans end up, what types of industries and what type of mix, but I think that very well could be likely, Nate.

Yes, as we add GreenSky, our reserve percentages there are not very significant because of all the credit enhancements we have around GreenSky, so that growth doesn’t come with a lot of provisioning.

Got it, makes sense. Then if I could just ask one more on just the appetite for additional share repurchases. It looks like the remaining authorization is fairly low, and I know one of the major priorities for this year is to continue to build capital levels, so would just love to get some color in terms of the appetite for additional buybacks. Obviously the stock’s had a great run over the last several weeks, so just curious on your updated thinking about buybacks and additional appetite with the remaining authorization towards being kind of depleted at this point.

Yes, I think I was pretty clear on last quarter’s call that we would continue to buy our share back below the tangible book value, and we did through the first couple days of February and then our stock did go on that nice run, and we stopped. At this point, I’ll say if our stock ever goes back below its tangible book value, we’ll probably buy it back, but at this point I hope that doesn’t happen and I don’t see it. I think we’re on the sidelines on buybacks and now we’re clearly focused on building capital ratios and putting all of our earnings after the dividend into capital.

Okay, great. Sounds good. I appreciate all the color. Thank you guys.

Thanks.

I am showing no further questions at this time. I would now like to turn the conference back to management for any closing remarks.

Thanks for joining today. We had a record quarter and it was a good quarter, and we look forward to talking to everybody next quarter. Everybody have a good day. Thanks.

Ladies and gentlemen, this concludes today’s conference. Thank you for your participation, and have a wonderful day. You may all disconnect.