Good day, ladies and gentlemen, and welcome to the Q1 2019 Midland States Bancorp, Inc. Earnings Conference Call. [Operator Instructions]. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. Tony Rossi, from Financial Profiles. Mr. Rossi, you may begin.

Thank you, Josh. Good morning, everyone, and thank you for joining us today for the Midland States Bancorp First Quarter 2019 Earnings Call. Joining us from Midland's management team are Jeff Ludwig, President and Chief Executive Officer; and Steve Erickson, Chief Financial Officer. We will be 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 of Midland's Investor Relations website to download a copy of the presentation. The management team will discuss the first quarter results and then we will 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 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 the 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'd like to turn the call over to Jeff. Jeff?

Good morning, everyone, and welcome to the Midland States earnings call. I'm going to start on Slide 3 with the highlights of the first quarter. We generated $0.57 in earnings per share, which compared to $0.67 in the prior quarter. Our prior quarter results included a number of items that favorably impacted our bottom line, including higher-accretion income on purchase loan portfolios, higher estate fees in our Wealth Management business and the recapture of mortgage servicing rights in our commercial FHA business. When adjusting for these items, our financial performance was relatively consistent with the prior quarter. And once again, we had a solid quarter of internal capital generation that resulted in strong increases in all of our capital ratios. We've made excellent progress on rebuilding our capital ratios, following the Alpine acquisition last year, which enabled us to execute on our acquisition strategy and announced another attractive transaction that I will touch on in a few moments. Our strong performance is also helping us to quickly earn back the tangible book value dilution from prior acquisitions, as our tangible book value per share increased by 4% in the first quarter. Our first quarter performance reflects solid execution on the near-term priorities we have outlined for the company. We are prudently managing our balance sheet to protect our net interest margin, which, on a normalized basis, increased 2 basis points in the quarter. We are focusing our new loan production in the areas with the most attractive risk-adjusted yields. Most notably, we continue to see strong growth in our equipment finance portfolio, which is helping to drive an increase in our overall normalized yield on loans and leases that is more than offsetting the increase we are seeing in our deposit costs. The impact of the focus on more attractive…

Thanks, Jeff. I'm going to start with our loan portfolio on Slide 4. Our total loans outstanding declined $45.4 million from the end of the prior quarter. This is primarily due to declines in portfolios that we are deemphasizing due to their less attractive risk-adjusted yields in the current environment, most notably residential and commercial real estate. This is partially offset by growth in our commercial loan and leases. Our equipment finance group continues to perform well, and our total outstanding balances increased by $57.5 million or 15.3% from the end of the prior quarter. Year-over-year, this portfolio was up $206.1 million or 91%, and the expansion of the equipment finance business has had the positive impact that we anticipated when we made the investment to bring this new team on board. Turning to deposits on Slide 5. Total deposits were $4.04 billion at the end of the first quarter, a decline of approximately $37.9 million from the end of the prior quarter. The decline was primarily attributable to outflows of commercial deposits and a decline in public funds. We partially offset the decline by adding to our balances of time deposits and broker deposits. Turning to Wealth Management on Slide 6. At the end of the quarter, our assets under administration were $3.1 billion, an increase of $152 million from the prior - from the end of the prior quarter. The increase was primarily attributable to improved market performance. Our Wealth Management revenue declined 12.4% from the prior quarter to $5 million, which was primarily attributable to lower estate fees and other onetime revenue items that we recorded in the prior quarter. On a year-over-year basis, our Wealth Management revenue increased to 21.4%. Turning to our net interest income and net interest margin slide on Page 7. Our net…

Thanks, Steve. We'll wrap up on Slide 11 with some comments on our outlook. We're going to remain focused on protecting our margin and controlling expenses, and we expect to deliver strong earnings. Although we saw a decline in loan balances during the first quarter, we still feel comfortable that we will generate low single-digit organic loan growth this year based on the level of demand we are seeing in our markets. As we have discussed, our loan growth needs to match our ability to fund new production with lower cost deposits. The HomeStar acquisition will assist in this effort with more than $100 million it has in excess deposits. The HomeStar acquisition is highly accretive transaction that is small enough in size to allow us to continue our ongoing focus on enhancing efficiencies throughout our organization. Given the number of banks in our markets, we believe that we can continue to drive value through our acquisition strategy within our existing footprint. With that, we'll be happy to answer any questions you may have. Operator, please open the call.

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

Just a question on the equipment finance loans. I know you talked about the 5.70% renewal in new loan rate. How much above that average are the equipment finance loans? I remember them being quite a bit above that 5.70%.

Yes. I think in the current quarter, the rates on the equipment finance business did come down a little bit, given the flatter yield curve in the quarter. It was probably in the 15 to 20 basis points above that number in the current quarter. And we, in prior quarters, have seen it in the - probably touching 6% and a little above 6%.

And then - thank you there. And moving over to just deposits. I know you talked about just some outflows and decline in public funds in Q1. Do you typically see a seasonal rebound in the second quarter? And to keep the balance sheet flat, do you just bring down some of the brokered funding?

Yes. That's a strategy for sure. If we have excess deposits come in, we do have some brokered deposits that we can let go if we don't have the loan demand. I think from a seasonality point of view, given the growth we've had in the last two years, we're still - we still can't see maybe seasonality. Centrue has been on here for couple years now, Alpine just now for about a year. So we're not necessarily pinpointing seasonality right now. I think as we continue to move forward with this larger balance sheet and these customers, I think we'll get a better feel of seasonality as we move forward.

And then just one last question. On HomeStar, what was unique with those - the outstanding trumps? And has that been finalized completely in order to move forward with the eventual closing of the deal? Or are there are still some - is there still some uncertainty there?

I wouldn't say there's any uncertainly. I mean there's a little bit of legal work that still needs to happen, but we're pretty confident based on communications back and forth between the trustee and the debt holders that the final legal paperwork work will be - will work through. So we don't see that as an obstacle, no.

And our next question comes from Michael Perito of KBW.

I had a handful of things I want to hit on. First, on the loan growth side, I mean it seems like for the last few quarters here, the equipment finance team has really been kind of tilt the loan driver of net production. I mean is that going to be kind of the case moving forward? Or are there other segments within the portfolio that there does seem to be growth opportunities on it that you're willing to share?

Yes. So I think what we're seeing in the other portfolios, we're seeing pretty good pipeline, actually. What's happening is there's probably an elevated level of payoffs in attrition that we've been seeing for several quarters now. And some of these are raised in terms that we're not going to chase on the commercial real estate side. And that's where we're probably seeing - we're probably seeing the runoff impacting balances more than we're seeing a lack of production. In terms - so in terms of other growth, yes, I mean, our shining star right now is the equipment finance business. We continue to focus on the other areas of the business. And if - I think if we see attrition slow down, we'll see some lift on some of these other portfolios, although we are deemphasizing residential real estate right now. So we would...

Yes, that's going to be my next question. I mean how much of the attrition is intentional versus kind of just elevated payoff activity and stuff of that nature?

Yes. So some of it is intentional. The residential real estate portfolio in prior quarters, we were - we had a doctor program we are running, which put some residential real estate on our books. We've stopped that program, so we would expect that - those portfolios to continue to do it to kind of decrease over time. We were doing - an Alpine was doing some indirect lending, and we stopped that a quarter or so ago. So you don't necessarily see that on the consumer line item, but there is some a natural pay downs in that book as well. And those are both lower yielding, less profitable loans.

Okay. On the fee income side, can you maybe just give us a little commentary about where the - the Love Funding pipeline is as we think about the next quarter or so? And then also the residential mortgage piece continues to jump around a little bit. What's kind of the production outlook at this point for that unit?

So on the loan funding side, for most of the quarter - not most of the quarter, 1/3 of the quarter, the government had shut down, so we had kind of a low - in production. The pipeline is fairly - it's stable. It's probably about the same as it was to begin the year, so we feel good about the pipeline. We'll get three months of production in the quarter, not two. So I think we are - we're optimistic that Love Funding can have a better quarter this quarter than - the second quarter than it did the first quarter. So I think things are working pretty well on that front. We've made management changes last year. Those are working well. And I think we feel pretty good about the next several quarters of the Love business. And our guidance of that $3 million to $5 million in revenue, we're good with that guidance continuing. On the resi side, I think pipelines are up from where they were at the end of the year. We do have some focus to bring some producers on and generate some revenue. I would expect revenue to be up in that line item in the second quarter. It's seasonally better, but I wouldn't say it's going to be materially - it's going to be a material change in the second quarter. We're going to continue to look to build that business back over a period of time, not ramp it up in the next quarter or two.

Okay. And then on the - on expenses, I mean, obviously, the quarter looked pretty good. Can you talk about what is going to drive the increase, I guess, back into that $42 million, $43 million range from where we were in the first quarter?

Yes, this is Steve. When we look at where we're sitting at with the $41.1 million, it was, as we said, across all categories where we saw the decline. Going forward, our annual salary increases take place April 1 and so all of that will kick in starting in the second quarter. And that's why we haven't pulled down our expectations of $42 million to $43 million. So that's the primary driver of why we believe that, that $42 million to $43 million is still the correct guidance for now.

Okay. Is there a room for that data processing line to come down low? I mean it still seems like it's operating at a little bit of an elevated figure, but I know it's jumped around a lot with some of the deal activity we're noticing. What's the outlook there?

So as we look at the work that we're doing internally, we kind of look at something like data processing as something that's not an expense that can be materially impacted over a 3 to 6 month period. That's a bit longer process and involves looking at how we do things internally, but it also involves managing different vendor contracts. And so while that may be an item, along with others that can be brought down, it's going to be a longer-term exercise in doing so, but it is something that we are focused on.

Okay. And then just one last one, if I can. Just on the tax rate, seems a little a high relative to last year's total full year rate. Just any thoughts on where that will trend for the rest of the year?

Last year is probably impacted a little bit for Alpine and all the kind of onetime expenses that are rolling through. So there is some noise, if you will, in the tax rate. Yes, I think our tax rate, correct me if I'm wrong, Steve, we expect it to be in that 24% range for the year.

Okay. So consistent with where it was in the first quarter.

Yes. We have higher level of profitability that's going to increase that tax rate a little bit.

[Operator Instructions]. Our next question comes from Andrew Liesch of Sandler O'Neill.

Just wanted to talk about the consumer portfolio. It sounds like maybe there were some runoff of some indirect that Alpine used to be doing, but the - what's your take right now with the GreenSky and that relationship? And what's the outlook for growth there? And what - was there any growth from the last quarter?

Yes. So GreenSky was flat quarter-over-quarter, and that's kind of what we've been managing to the last couple of quarters. So - and it's a relationship we assess periodically. And we'll increase our volumes as we feel appropriate. And it's something that we continue to look at and it may - in the future, we might increase some volumes there. But at this point, no concrete plans to do that. Hopefully, that's helpful.

Yes. And then just on the Wealth Management line. The - looks like this was the lowest quarter since the Alpine deal was done. The other quarter, like second and third quarter of last year, also have some onetime items in there. I'm just trying to get a sense of what the - what a good run rate is going forward from here.

Yes. So each quarter, we generally do have some of those items. It's a business that we have as part of that group when we manage an estate, that type of thing. And those fees, while they are onetime in nature, we generally have some every quarter. It just happened to be in the fourth quarter we had quite a bit more than we normally do. And in the first quarter, we had quite a bit less than we normally do. Those - that stream is not really predictable or consistent. So we will still have those items, and it's just hard to predict where they will be.

And our next question comes from Kevin Reevey of D.A. Davidson.

I have a question related to the commercial real estate loan that was down during the quarter. First, can you give us some color on the type of loan and the type of collateral? And was this a legacy Midland States credit? Or was this a credit that was part of a prior acquisition?

This was a legacy Midland credit. It's an assisted living center in Northern Illinois that's a municipality-based credit. So we feel okay about the - about loss rates today, that we won't take a loss. But there are some issues with the credit, and we needed to move into nonperforming.

And I'm not showing any further questions at this time. I would now like to turn the call back over to Jeff Ludwig for any further remarks.

Thank you. I'd like to thank everybody for joining our call today, and we'll talk next quarter. Thanks.

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 wonderful day.

Thank you.