Good day, and thank you for standing by. Welcome to the Q4 2021 Midland States Bancorp Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there’ll be a question-and-answer session. [Operator Instructions]. I would now like to hand the conference over to your speaker today, Mr. Tony Rossi. Mr. Rossi, the floor is yours.

Thank you, Chris. Good morning, everyone, and thank you for joining us today for the Midland States Bancorp fourth 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. 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 a reconciliation of the GAAP to non-GAAP measures. And with that, I’d like to turn the call over to Jeff. Jeff?

Thanks Tony. Good morning, everyone. Welcome to the Midland States earnings call. I'm going to start on Slide 3 with the highlights of the fourth quarter. We had a very productive quarter that kept an exceptional year for the company that saw us improve our financial performance, while also making investments that we believe will enable us to continue improving our performance in the years to come. In 2021, we successfully attracted new talent to the company that enabled us to substantially improve productivity of our commercial banking teams, while keeping the overall size of the teams relatively unchanged. We increased our exposure to higher growth markets in Northern Illinois and St. Louis, which has had a positive impact on loan production. We effectively leveraged the tech investments we have made over the past few years to increase efficiencies, while continuing to make enhancements to our technology platform that will provide additional benefits in the future. We added new capabilities and increased our opportunities to grow our wealth management business in the future with the acquisition of ATG Trust Company. And we used our strong liquidity to eliminate higher cost funding sources that will benefit our net interest margin going forward. Our success in these areas enabled us to deliver a strong year of balance sheet and earnings growth, and increase our tangible book value per share by more than 12%, while returning a significant amount of capital to our shareholders through our quarterly dividend and stock repurchase program. We are very proud of what we were able to accomplish in 2021, and we want to thank the entire Midland organization for their outstanding performance in what was a challenging environment, given the continuing impact of the pandemic. Specific to the fourth quarter, we generated net income of $23.1 million…

Thanks, Jeff. I'm starting on Slide 4, and we'll take a look at our loan portfolio. Our total loans increased $309 million from the end of the prior quarter. As Jeff mentioned, the strongest growth came in the commercial real estate portfolio, while our commercial loan portfolio was just about flat, as growth in equipment finance and conventional commercial loans, largely offset declines in PPP loans, and an $88 million decline in the end of period balances on commercial FHA warehouse credit lines. Our consumer loan portfolio was also up by $74 million, which was split between growth in the GreenSky portfolio, and other direct consumer lending that we do. Excluding PPP loans, commercial warehouse credit lines, and consumer loans added through the GreenSky partnership, our total loans increased at an annualized rate of more than 40%, which reflects our improved ability to generate growth in commercial and commercial real estate loans. Turning to Slide 5, we’ve provided an update on our equipment finance portfolio. 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 improve. As of December 31, we had just $4 million of deferrals remaining, with nearly all of the deferrals making some form of partial payment. Looking at Slide six, we've provided an update on the consumer loan portfolio that we have through our partnership with GreenSky. The portfolio has performed extremely well throughout the pandemic. At December 31, we only had $500,000 of deferred loans in this portfolio, which represents just 1/10th of 1% of the total loans. And at just 26 basis points, the delinquency rate remains even better than the historical range that we've seen in this portfolio. In addition to the strong performance, the escrow account is…

All right. Thanks, Eric. We'll wrap up on Slide 15 with an update on our GreenSky partnership and a few comments on our outlook and priorities for 2022. Based on recent discussions, we now expect to remain in the GreenSky program at least through 2023. We also intend to diversify our Fintech partnerships, which will allow us to maintain our consumer loan balances going forward. Along these lines, we are in the final stages of establishing a new Fintech partnership with an originator of consumer loans. We expect a commitment of between $200 million and $250 million in loans from this partnership, with loan balances building to that level over the next couple of years. Now, looking at our expectations for 2022, we believe we are well positioned to deliver another strong performance this year. Based on the more productive commercial banking teams we have built, our current pipeline and improving loan demand, we expect to generate high single digit loan growth in 2022. The primary drivers of the growth will continue to be commercial loans, including equipment finance, and commercial real estate, and we continue to have strong pipelines in each of these areas. Our organic loan growth will also be driven by opportunities to continue adding commercial banking talent, particularly in higher growth markets. One of these markets will be the Chicagoland area. With the amount of merger activity in the Chicago market, we believe there are good opportunities to take advantage of the disruption, and add banking talent and clients over the long term. Another priority of the bank in 2022 is increasing our level of asset-sensitivity, given the outlook for higher interest rates. The improved commercial banking platform we have built is generating more variable rate loans and non-interest-bearing deposits, which is making us more asset-sensitive.…

Thank you. [Operator Instructions]. And our first question comes from Terry McEvoy of Stephens. Your line is open.

Hi. Good morning, everyone. Maybe first off, the - extending the GreenSky partnership through at least 2023, how should we think about just the balances the end of the year at 875? Do they continue to grow over the next several years, or will there be runoff consistent with your prior guidance last quarter?

We think it's going to be relatively stable, maybe down slightly. But as we also said, we'll be adding a couple of new - well, at least one new Fintech partner and looking at others so that we’re well positioned if the GreenSky portfolio does start to go down quicker, or maybe more like what we disclosed at the end of the third quarter. But we think relatively stable going forward, at least for a couple of years.

Right. And on the expense outlook, I thought a real positive run rate. And just a point of clarity. Eric, you said that run rate on Page 11 here for the first quarter of ‘22, whereas the presentation says, I guess, in 2022. So, is that the quarterly run rate you expect just in the first quarter of the year or as you think about the full year level?

Yes, Terry, good question. As I think about it, that's our guidance for really the full year for all of the quarters. we'll be on the lower end in the first quarter, and then we could see some expense increase over the course of the year as we deal with compensation and some of those other pressures from the inflationary environment. So, starting on the low end and then probably moving to that high end as we get through the year.

Okay. Thanks for clearing that up. And then maybe last one, when you think about Chicago and Chicagoland over the next three to five years how, how much - how important is that market going to be, do you think, for Midland and relative to St. Louis in your core market? So, I guess said another way, is that kind of the primary focus right now when you think about expanding the franchise?

No. I would say it's St. Louis and that sort of Collar Counties, Southern Collar Counties Chicagoland, is sort of how we think of it, and looking for opportunity in both of those areas. Now, we think that Chicagoland might provide some opportunity more in the short term with a lot of disruption going on up there with bank M&A. but if we see opportunities in St. Louis, we're going to be looking there too.

Perfect. Thanks, Jeff, and thanks, Eric. Appreciate it.

Thank you. Our next question comes from Damon DelMonte of KBW. Your line is open.

Hey, good morning, guys. Hope everybody's doing well today. Just wanted to ask a little bit about the interest rate sensitivity with the margin. How much of the loan portfolio is variable, and how much of that would actually begin to reprice immediately with a 25-basis point hike in the Fed?

Hey, Damon. Yes, I'll be happy to answer that. So, our portfolio, particularly when you look at equipment finance, and when you look at GreenSky, it's been running about 70/30, 70% fixed, 30% variable. That changed slightly during this past quarter, and we're now roughly around 65/35. So, when you look at the variable, we've got about $1 billion portfolio, give or take, that that is - will change rates either immediately or within in 30 days. So, we do have some floors on that portfolio. So, we won't see the full benefit of a rate increase immediately, but roughly about $1 billion will change rates pretty quickly.

Got it. Okay. And do you feel like your core margin has kind of reached the bottom here and maybe it's flattish in the first quarter and then starts to trend up as we go through the year? Is that fair?

Yes, I think that's fair. We still have about a six-basis point impact from PPP loans. And I think as we look into 2022, that obviously is going to go away as we get the rest of that portfolio forgiven. And then our accretion number, that impact on our margin has been sliding as well. We expect that to decrease a little bit next year, but with the loan growth that we've had, and with the potential for those up rates, as we've kind of all talked about, I think considering both of those things, we can look at to see a flat margin or maybe a little bit of upside.

Got it. Okay. And then just one more question on the expenses. Could you just elaborate a little bit more on your - one of your goals is to maintain stable expense levels, but continuing to invest in technology. So, are there other areas in the expense base that you could try to basically save in one area and reallocate to another, or what's the approach for trying to keep the expenses stable? Thanks.

We've been looking all across sort of our operations and looking at how do we drive more efficiencies with the things that we do. So, part of our technology investments has been an RPA in order to drive those efficiencies. And then we've gone back through and looked at our other technology spend and other vendors all throughout the organization, and have looked for potential savings or reductions in cost there. And then we're able to allocate those efficiencies and those costs back into other technology investments, such as the SBA portal that Jeff mentioned.

Yes. And I think another important piece there is we've built a good - a really good IT team. And so, we’re sort of - they've been working on sort of some foundational things, and we're now - we're going to point them in different directions. So, a lot of that technology spend is in the run rate and our people here that are going to be also pointed elsewhere.

Got it. That's great color. Thank you very much. I appreciate it.

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

Yes. Hi, guys. Good morning. Question, just going back to the loan growth discussion, I appreciate the high single digit guidance for 2022. And it sounds like from what we saw in the fourth quarter, a lot of that was commercial driven. And so, would just love to get some color on just the specific drivers within your commercial team that's driving a lot of that growth. And does that high single digit outlook for this year include some of the fundings from that new Fintech partnership that was described on Slide 15 in the deck?

Yes. So, color on growth. we're sort of seeing - we're seeing the growth sort of across the footprint we saw - and for the whole year, saw really nice growth in the St. Louis market. We're also seeing very good growth in that sort of Chicagoland through Rockford area, where we're putting effort. And then we mentioned on the call, our specialty finance group that we've sort of been building over the last several years around the FHA bridge. And we were doing that with our loan funding unit when we had it, and now we're doing it with some other partners. So, the combination of all those is really what's driving the growth.

Got it. So, the high single digit outlook for this year doesn't necessarily include originations stemming from the new fintech partnership?

No. I think the way I'm thinking of it right now is, this partnership's going to help us offset - if GreenSky does go down, it's going to help offset some of that. It'll probably come on late this year. We’re not quite there to the finish line with them. And it will - again, it'll start slow and with originations at a lower level to start with, and then we'll raise them as we move forward. So, it'd be probably more of a ‘23 impact, but the way I'd look at it right now is, with GreenSky and these partnerships, is to hold our consumer balances relatively stable.

Understood. I appreciate that. Thanks, Jeff. And then just lastly on loan growth, were payoffs somewhat lower in the quarter that helped drive the really strong growth this quarter? And is that kind of uncertainty around future payoff levels kind of resulting in you guys maybe taking a more conservative stance in that high single digit outlook for this year versus what we saw in the fourth quarter?

Yes. I would say that this past year, we got a lot more focused on the attrition side of the equation and trying to get ahead of some of that to see if we can slow attrition down. I think as the year went down - sort of moved on, I think we got better at the attrition side. It's sort of hard to - it’s hard to predict attrition, but I don't - I think we've seen our attrition slow down and we don't expect it to pick back up in the near term.

Got it. Very helpful. And then maybe just one last one from me on core fee income. Ex-mortgage, is it fair to expect some growth in fee income just as you guys continue to gain client wallet share with a lot of the initiatives that you guys have put in place over the last several quarters?

Yes, I think that's fair, Nate. So, we've continued to really focus on increasing wallet share. We really can - and focus on debit cards, getting more debit cards out there and increasing usage. So, we saw strong fee income in those interchange fees in 2021. I don't think we'll grow at that same rate in 2022, but we expect to see some going forward. And then we're continuing to focus on our wealth business and seeing growth there as well. And those are two of our key drivers in that non-interest income.

Got it. That's great color. I really appreciate all the insights, and thank you for taking my questions.

Thank you. And next, we have (indiscernible) of D.A. Davidson. Your line is open.

Hey, guys. How is it going? I'm here on behalf of Manuel Navas, but I jumped in the queue and he just told me he was back in the queue. So, I might just back out of here and let him ask the question. Sorry about that.

Yes. That works for us.

Thank you. And next, we have a follow-up from Nathan Race of Piper Sandler. Your line is open.

Yes. Thanks for taking the follow up perhaps while we wait there, but just wanted to ask on the outlook for the reserve going forward. Obviously, nice credit quality improvement in the fourth quarter/ charge-offs were maybe a little elevated from what we discussed last quarter. So, would just be curious to kind of get your thoughts on needs to provide for that high single organic growth outlook for 2022, and kind of where you see the reserves settling out over that timeframe.

Yes. Nate, good question. So, we're kind of modeling out net charge-offs somewhere in that 20 to 25 basis point range, a little - maybe right at the low end for sort of our commercial portfolio and then more at the high end for our Midland equipment finance portfolio. New loan growth is going on at say 120 to 130 basis points, maybe a little that higher than that if it's in the equipment finance portfolio. So, I think, based on this growth, we'll see a little bit of the reserve building and then we'll see us providing for any charge-offs we have going through in 2022.

Okay, got it. So, probably stable-ish on a relative basis as the percentage of loans. Is that fair, Eric?

Yes, think that's right. Yes, I think, based on what we see now, I think that's right.

Yes. The mix matters, right? So, the new mix is going to be at a higher reserve level than - the GreenSky and our warehouse lines are being reserved at a fairly low level. So, the new production coming on is going to be reserved at a higher level. So, overall, I expect the reserve percentage probably to go up.

Understood. And maybe just one last one, changing gears, just within the context of the asset sensitivity equation that Eric described earlier. Just with all the improvement in the deposit franchise over the last several quarters, is your expectation that you guys will perhaps have a lower deposit beta than what we saw during the 2015 to 2018 tightening cycle? Or how are you guys’ kind of thinking about the need to support new loan growth? Obviously, you guys have of a flexibility with your loan deposit ratio where it's at today around 85%. So, just curious how you kind of think about the funding equation, how the deposit base will react to higher rates going forward.

Yes, I think we've performed pretty well in the last upcycle with betas. I think our deposit base is probably stronger today than it before. So, our expectation is probably we'll perform better than before, although we do have good loan demand and it's sort of hard to predict what others around us are going to do as well. But it sounds like it’s going to probably lag as much as they can. So, I do think it'll probably be better.

Awesome. Good stuff, guys. I appreciate you taking the follow-ups. Thanks again.

Thank you. [Operator instructions] Our next question comes from Manuel Navas of D.A. Davidson. Your line is open.

Hey, good morning. I’ve appreciated a lot of the color on the loan guidance. I'm just wondering, with that high single digits, will it be as back half or as season - fourth quarter seasonality as it was this year?

I don't think so. I think it'll be a little more balanced. As we talked a lot about last year, quarter in and quarter out, at the end of 2020, we really began to focus on our commercial banking team, bringing new folks in through the year, building pipelines. And all that sort of materialized towards the back part of the year. And we saw some good growth in the third quarter and really saw a lot of nice growth in the fourth quarter. Just on a seasonal basis, typically our first quarter is a little slower, and the middle part of the year and the back of the year gets better. But I don't see it - loan growth this year should be different than it was last year, because last year we had a decrease in loans the first quarter, had some growth in the second quarter, a little more in the third, and a lot in the fourth. This year will be - I think will be more balanced. Now, our equipment finance business, usually their best quarter every year is the last quarter of the year, as companies are sort of rushing to buy their equipment before the end of the year. So, fourth quarter typically, we do typically have better fourth quarters.

I appreciate that. Thank you.

Thank you. And I'm seeing no further questions in the queue. I will turn the call back over to the management team for closing remarks.

Thanks for joining. It was a really, really good 2021, and we're really excited about ‘22, and we'll look forward to the next call in April. Thanks, everybody.

Thank you. This concludes today's conference call. Thank you all for participating. You may now disconnect. Have a pleasant day, and enjoy your weekend.