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Midland States Bancorp, Inc. - Quarter Report: 2020 March (Form 10-Q)

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2020

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______________ to _______________

Commission File Number 001-35272

MIDLAND STATES BANCORP, INC.

(Exact name of registrant as specified in its charter)

Illinois

37-1233196

(State of other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

1201 Network Centre Drive

Effingham, IL

62401

(Address of principal executive offices)

(Zip Code)

(217) 342-7321

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Trading symbol(s)

Name of each exchange on which registered

Common stock, $0.01 par value

MSBI

Nasdaq Global Select Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer 

Accelerated filer 

Non-accelerated filer

Smaller reporting company 

Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes  No

As of April 24, 2020, the Registrant had 23,203,015 shares of outstanding common stock, $0.01 par value.

Table of Contents

MIDLAND STATES BANCORP, INC.

TABLE OF CONTENTS

Page

PART I. FINANCIAL INFORMATION

Item 1.

Financial Statements:

Consolidated Balance Sheets at March 31, 2020 (Unaudited) and December 31, 2019

2

Consolidated Statements of Income (Unaudited) for the three months ended March 31, 2020 and 2019

3

Consolidated Statements of Comprehensive Income (Unaudited) for the three months ended March 31, 2020 and 2019

4

Consolidated Statements of Shareholders’ Equity (Unaudited) for the three months ended March 31, 2020 and 2019

5

Consolidated Statements of Cash Flows (Unaudited) for the three months ended March 31, 2020 and 2019

6

Notes to Consolidated Financial Statements (Unaudited)

7

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

44

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

62

Item 4.

Controls and Procedures

62

PART II. OTHER INFORMATION

Item 1.

Legal Proceedings

63

Item 1A.

Risk Factors

63

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

64

Item 6.

Exhibits

66

SIGNATURES

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PART I – FINANCIAL INFORMATION

ITEM 1 – FINANCIAL STATEMENTS

MIDLAND STATES BANCORP, INC.

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except per share data)

    

March 31, 

    

December 31, 

 

    

2020

    

2019

 

(unaudited)

Assets

Cash and due from banks

$

445,097

$

392,694

Federal funds sold

 

4,299

 

1,811

Cash and cash equivalents

 

449,396

 

394,505

Investment securities available for sale, at fair value (allowance for credit losses of $75 at March 31, 2020)

 

656,254

 

649,433

Equity securities, at fair value

5,640

5,621

Loans

 

4,376,204

 

4,401,410

Allowance for credit losses on loans

 

(38,545)

 

(28,028)

Total loans, net

 

4,337,659

 

4,373,382

Loans held for sale

 

113,852

 

16,431

Premises and equipment, net

 

90,118

 

91,055

Operating lease right-of-use asset

14,078

14,224

Other real estate owned

 

7,892

 

6,745

Nonmarketable equity securities

 

46,068

 

44,505

Accrued interest receivable

 

16,532

 

16,346

Loan servicing rights, at lower of cost or fair value

 

44,566

 

53,824

Mortgage servicing rights held for sale

1,460

1,972

Goodwill

 

172,796

 

171,758

Other intangible assets, net

 

33,124

 

34,886

Cash surrender value of life insurance policies

 

143,323

 

142,423

Accrued income taxes receivable

 

7,130

 

6,362

Other assets

 

68,342

 

63,545

Total assets

$

6,208,230

$

6,087,017

Liabilities and Shareholders’ Equity

Liabilities:

Deposits:

Noninterest-bearing

$

1,052,726

$

1,019,472

Interest-bearing

 

3,597,914

 

3,524,782

Total deposits

 

4,650,640

 

4,544,254

Short-term borrowings

 

43,578

 

82,029

FHLB advances and other borrowings

 

593,089

 

493,311

Subordinated debt

 

169,505

 

176,653

Trust preferred debentures

 

48,420

 

48,288

Accrued interest payable

 

7,078

 

6,400

Deferred tax liabilities, net

9,911

11,278

Operating lease liabilities

15,048

15,369

Other liabilities

 

39,801

 

47,524

Total liabilities

 

5,577,070

 

5,425,106

Shareholders’ Equity:

Common stock, $0.01 par value; 40,000,000 shares authorized; 23,381,496 and 24,420,345 shares issued and outstanding at March 31, 2020 and December 31, 2019, respectively

 

234

 

244

Capital surplus

 

468,750

 

488,305

Retained earnings

 

153,722

 

165,920

Accumulated other comprehensive income

 

8,454

 

7,442

Total shareholders’ equity

 

631,160

 

661,911

Total liabilities and shareholders’ equity

$

6,208,230

$

6,087,017

The accompanying notes are an integral part of the consolidated financial statements.

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MIDLAND STATES BANCORP, INC.

CONSOLIDATED STATEMENTS OF INCOME—(UNAUDITED)

(dollars in thousands, except per share data)

    

Three Months Ended

March 31, 

    

2020

    

2019

 

Interest income:

Loans:

Taxable

$

53,539

$

51,882

Tax exempt

 

836

 

974

Loans held for sale

191

299

Investment securities:

Taxable

 

4,094

 

3,683

Tax exempt

 

987

 

1,066

Nonmarketable equity securities

605

621

Federal funds sold and cash investments

 

1,062

 

907

Total interest income

 

61,314

 

59,432

Interest expense:

Deposits

8,362

7,363

Short-term borrowings

101

237

FHLB advances and other borrowings

2,967

3,847

Subordinated debt

2,509

1,514

Trust preferred debentures

724

870

Total interest expense

 

14,663

 

13,831

Net interest income

 

46,651

 

45,601

Provision for credit losses on loans

10,569

3,243

Net interest income after provision for credit losses on loans

 

36,082

 

42,358

Noninterest income:

Wealth management revenue

5,677

4,953

Commercial FHA revenue

1,267

3,295

Residential mortgage banking revenue

1,755

834

Service charges on deposit accounts

2,656

2,520

Interchange revenue

2,833

2,680

Gain on sales of other real estate owned

15

66

Impairment on commercial mortgage servicing rights

(8,468)

(25)

Other income

2,863

2,752

Total noninterest income

 

8,598

 

17,075

Noninterest expense:

Salaries and employee benefits

21,063

22,039

Occupancy and equipment

4,869

4,853

Data processing

5,334

4,724

FDIC insurance

1

435

Professional

1,855

2,073

Marketing

981

1,234

Communications

1,290

817

Loan expense

516

360

Other real estate owned

711

93

Amortization of intangible assets

1,762

1,810

Loss on mortgage servicing rights held for sale

496

Other expense

3,797

2,659

Total noninterest expense

 

42,675

 

41,097

Income before income taxes

 

2,005

 

18,336

Income taxes

456

4,354

Net income

1,549

13,982

Preferred stock dividends and premium amortization

34

Net income available to common shareholders

$

1,549

$

13,948

Per common share data:

Basic earnings per common share

$

0.06

$

0.58

Diluted earnings per common share

$

0.06

$

0.57

Weighted average common shares outstanding

 

24,433,975

 

23,998,119

Weighted average diluted common shares outstanding

 

24,538,002

 

24,204,661

The accompanying notes are an integral part of the consolidated financial statements.

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MIDLAND STATES BANCORP, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME—(UNAUDITED)

(dollars in thousands)

Three Months Ended

March 31, 

    

2020

    

2019

 

Net income

$

1,549

$

13,982

Other comprehensive income:

Investment securities available for sale:

Unrealized gains that occurred during the period

 

1,321

7,708

Provision for credit loss expense

75

Income tax effect

 

(384)

(2,120)

Change in investment securities available for sale, net of tax

 

1,012

 

5,588

Other comprehensive income, net of tax

 

1,012

 

5,588

Total comprehensive income

$

2,561

$

19,570

The accompanying notes are an integral part of the consolidated financial statements.

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MIDLAND STATES BANCORP, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY—(UNAUDITED)

(dollars in thousands, except per share data)

    

    

    

    

Accumulated

other

Total

Preferred

Common

Capital

Retained

comprehensive

shareholders'

stock

stock

surplus

earnings

income (loss)

equity

Balances, December 31, 2019

$

$

244

$

488,305

$

165,920

$

7,442

$

661,911

Cumulative effect of change in accounting principles (Note 2)

(7,172)

(7,172)

Balances, January 1, 2020

244

488,305

158,748

7,442

654,739

Net income

 

 

1,549

 

1,549

Other comprehensive income

 

 

 

1,012

1,012

Common dividends declared ($0.2675 per share)

 

 

(6,575)

 

(6,575)

Common stock repurchased

(10)

(20,552)

(20,562)

Share-based compensation expense

 

 

602

 

602

Issuance of common stock under employee benefit plans

 

 

395

 

395

Balances, March 31, 2020

$

$

234

$

468,750

$

153,722

$

8,454

$

631,160

Balances, December 31, 2018

$

2,781

$

238

$

473,833

$

133,781

$

(2,108)

$

608,525

Net income

 

 

 

13,982

 

13,982

Other comprehensive income

 

 

 

 

5,588

5,588

Common dividends declared ($0.2425 per share)

(5,823)

(5,823)

Preferred dividends declared

(82)

(82)

Preferred stock, premium amortization

(48)

48

Share-based compensation expense

846

846

Issuance of common stock under employee benefit plans

 

 

 

1,132

 

1,132

Balances, March 31, 2019

$

2,733

$

238

$

475,811

$

141,906

$

3,480

$

624,168

The accompanying notes are an integral part of the consolidated financial statements.

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MIDLAND STATES BANCORP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS—(UNAUDITED)

(dollars in thousands)

Three Months Ended

March 31, 

    

2020

    

2019

 

Cash flows from operating activities:

Net income

$

1,549

$

13,982

Adjustments to reconcile net income to net cash provided by operating activities:

Provision for credit losses

 

11,579

3,243

Depreciation on premises and equipment

 

1,677

1,601

Amortization of intangible assets

 

1,762

1,810

Amortization of operating lease right-of-use asset

670

708

Share-based compensation expense

 

602

846

Increase in cash surrender value of life insurance

 

(900)

(903)

Investment securities amortization, net

 

702

964

Gain on sales of other real estate owned

 

(15)

(66)

Impairment of other real estate owned

 

605

16

Origination of loans held for sale

 

(69,332)

(84,231)

Proceeds from sales of loans held for sale

 

73,114

99,323

Gain on loans sold and held for sale

 

(2,178)

(3,121)

Loss on disposals of premises and equipment

9

7

Amortization of loan servicing rights

790

678

Impairment of loan servicing rights

8,468

25

Impairment of assets held for sale

642

Net change in operating assets and liabilities:

Accrued interest receivable

 

(186)

(109)

Accrued interest payable

 

678

1,399

Accrued income taxes receivable

 

(768)

3,739

Operating lease liabilities

(943)

(741)

Other assets

 

(4,912)

(1,920)

Other liabilities

 

(8,062)

(7,252)

Net cash provided by operating activities

 

15,551

 

29,998

Cash flows from investing activities:

Investment securities available for sale:

Purchases

 

(50,442)

(15,565)

Maturities and payments

 

44,242

27,023

Equity securities:

Purchases

 

(23)

(16)

Net (increase) decrease in loans

 

(85,972)

44,390

Purchases of premises and equipment

 

(765)

(1,282)

Proceeds from sales of mortgage servicing rights held for sale

3,288

Purchases of nonmarketable equity securities

 

(1,563)

(7,971)

Sales of nonmarketable equity securities

 

4,434

Proceeds from sales of other real estate owned

 

120

1,164

Net cash (used in) provided by investing activities

 

(94,403)

 

55,465

Cash flows from financing activities:

Net increase (decrease) in deposits

 

106,386

(37,882)

Net decrease in short-term borrowings

 

(38,451)

(8,403)

Proceeds from FHLB borrowings

 

100,000

195,000

Payments made on FHLB borrowings

 

(200)

(165,196)

Payments made on other borrowings

 

(1,429)

Payments made on subordinated debt

(7,250)

Cash dividends paid on preferred stock

 

(82)

Cash dividends paid on common stock

 

(6,575)

(5,823)

Common stock repurchased

 

(20,562)

Proceeds from issuance of common stock under employee benefit plans

 

395

1,132

Net cash provided by (used in) financing activities

 

133,743

 

(22,683)

Net increase in cash and cash equivalents

54,891

62,780

Cash and cash equivalents:

Beginning of period

394,505

213,700

End of period

$

449,396

$

276,480

Supplemental disclosures of cash flow information:

Cash payments for:

Interest paid on deposits and borrowed funds

$

13,985

$

12,432

Income tax paid (net of refunds)

 

898

 

337

Supplemental disclosures of noncash investing and financing activities:

Transfer of loans to loans held for sale

$

99,688

$

Transfer of loans to other real estate owned

1,813

The accompanying notes are an integral part of the consolidated financial statements.

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MIDLAND STATES BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(UNAUDITED)

Note 1 – Business Description

Midland States Bancorp, Inc. (the “Company,” “we,” “our,” or “us”) is a diversified financial holding company headquartered in Effingham, Illinois. Its wholly owned banking subsidiary, Midland States Bank (the “Bank”), has branches across Illinois and in Missouri and provides a full range of commercial and consumer banking products and services, business equipment financing, merchant credit card services, trust and investment management, and insurance and financial planning services. In addition, multifamily and healthcare facility Federal Housing Administration (“FHA”) financing is provided through Love Funding Corporation (“Love Funding”), our non-bank subsidiary.

On July 17, 2019, we completed the acquisition of HomeStar Financial Group, Inc. (“HomeStar”) and its banking subsidiary, HomeStar Bank and Financial Services (“HomeStar Bank”), as more fully described in Note 3 to the consolidated financial statements. Through the acquisition of HomeStar, we expanded our commercial and retail banking presence in northern Illinois.

Our principal business activity has been lending to and accepting deposits from individuals, businesses, municipalities and other entities. We have derived income principally from interest charged on loans and, to a lesser extent, from interest and dividends earned on investment securities. We have also derived income from noninterest sources, such as: fees received in connection with various lending and deposit services; wealth management services; residential mortgage loan originations, sales and servicing; and, from time to time, gains on sales of assets. Our income sources also include Love Funding’s commercial FHA loan origination and servicing income. Our principal expenses include interest expense on deposits and borrowings, operating expenses, such as salaries and employee benefits, occupancy and equipment expenses, data processing costs, professional fees and other noninterest expenses, provisions for credit losses on loans and income tax expense.

Note 2 – Basis of Presentation and Summary of Significant Accounting Policies

Basis of Presentation

The consolidated financial statements of the Company are unaudited and should be read in conjunction with the consolidated financial statements and related notes contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, filed with the Securities and Exchange Commission (the “SEC”) on February 28, 2020. The consolidated financial statements have been prepared in accordance with the accounting principles generally accepted in the United States of America (“GAAP”) and conform to predominant practices within the banking industry. A discussion of these policies can be found in Note 1 – Summary of Significant Accounting Policies included in the Company's 2019 Annual Report on Form 10-K. Since December 31, 2019, the Company has adopted ASU No. 2016-13 “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” and ASU No. 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement”. See “Accounting Guidance Adopted in 2020” for additional information. Management of the Company has made a number of estimates and assumptions related to the reporting of assets and liabilities to prepare the consolidated financial statements in conformity with GAAP. These estimates and assumptions are subject to many risks and uncertainties, including changes in interest rates and other general economic, business and political conditions, including the effects of the Coronavirus Disease 2019 (“COVID-19”) pandemic, including its potential effects on the economic environment, our customers and our operations, as well as any changes to federal, state and local government laws, regulations and orders in connection with the pandemic. The Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) was signed into law on March 27, 2020, which provides a variety of provisions, including, among other things, a small business lending program to originate paycheck protection loans, temporary relief for community bank leverage ratio, and temporary relief for community banks related to troubled debt restructurings. Actual results may differ from those estimates. In the opinion of management, all adjustments, consisting of normal recurring accruals considered necessary for a fair presentation of the financial condition and results of operations for the interim periods presented herein, have been included. Certain reclassifications of 2019 amounts have been made to conform to the 2020 presentation. Management has evaluated subsequent events for potential recognition or disclosure. Operating results for the three months ended March 31, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020 or any other period.

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Principles of Consolidation

The consolidated financial statements include the accounts of the parent company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated. Assets held for customers in a fiduciary or agency capacity, other than trust cash on deposit with the Bank, are not assets of the Company and, accordingly, are not included in the accompanying unaudited balance sheets.

Accounting Guidance Adopted in 2020

FASB ASU No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” – On January 1, 2020, the Company adopted ASU No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” (“CECL”). The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loan receivables. It also applies to off-balance sheet (“OBS”) credit exposures not accounted for as insurance (loan commitments, standby letters of credit, financial guarantees, and other similar agreements). In addition, ASC 326 made changes to the accounting for available-for-sale debt securities. One such change is to require credit losses to be presented as an allowance, rather than as a write-down, on available-for-sale debt securities management does not intend to sell or believe that it is not more likely than not they will be required to sell.

The Company adopted ASC 326 using the modified retrospective method for all financial assets measured at amortized cost and OBS credit exposures. Results for reporting periods beginning after December 31, 2019, are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable GAAP. The Company recorded a net decrease to retained earnings of $7.2 million as of January 1, 2020 for the cumulative effect of adopting ASC 326.

The Company adopted ASC 326 using the prospective transition approach for financial assets purchased with credit deterioration (“PCD”), previously classified as purchased credit impaired (“PCI”) and accounted for under ASC 310-30. In accordance with the standard, management did not reassess whether PCI assets met the criteria of PCD assets as of the date of adoption. On January 1, 2020, the amortized cost basis of the PCD assets was adjusted to reflect the addition of $4.2 million of allowance for credit losses (“ACL”) on loans. The noncredit discount of $2.9 million, based on the adjusted amortized cost basis, will be accreted into interest income at the effective interest rate as of January 1, 2020.

The following table illustrates the impact of ASC 326. 

January 1, 2020

As Reported

Impact of

Under

Pre-ASC 326

ASC 326

(dollars in thousands)

ASC 326

Adoption

Adoption

Assets:

Loans

Commercial

$

1,056,986

$

1,055,185

$

1,801

Commercial real estate

1,528,119

1,526,504

1,615

Construction and land development

209,551

208,733

818

Residential real estate

570,882

568,291

2,591

Consumer

710,646

710,116

530

Lease Financing

332,581

332,581

Allowance for credit losses on loans

(40,811)

(28,028)

(12,783)

Liabilities:

Allowance for credit losses on unfunded commitments

(1,507)

(1,244)

(263)

Loans

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at amortized cost. Amortized cost is the principal balance outstanding, net of purchase premiums and discounts, fair value hedge accounting adjustments, and deferred loan fees and costs. Accrued interest receivable totaled $11.9 million at March 31, 2020 and was reported in accrued interest receivable on the consolidated balance sheets. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs,

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are deferred and recognized in interest income using the effective yield method without anticipating prepayments.

Interest income on mortgage and commercial loans is discontinued and the loan is placed on nonaccrual status at the time the loan is 90 days delinquent unless the loan is well secured and in process of collection. Mortgage loans are charged off at 180 days past due, and commercial loans are charged off to the extent principal or interest is deemed uncollectible. Consumer and credit card loans continue to accrue interest until they are charged off at an earlier date if collection of principal or interest is considered doubtful.

All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Under the cost-recovery method, interest income is not recognized until the loan balance is reduced to zero. Under the cash-basis method, interest income is recorded when the payment is received in cash. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

The Company provides financing leases to small businesses for purchases of business equipment. Under the direct financing method of accounting, the minimum lease payments to be received under the lease contract, together with the estimated unguaranteed residual values (approximately 3% to 15% of the cost of the related equipment), are recorded as lease receivables when the lease is signed and the leased property is delivered to the customer. The excess of the minimum lease payments and residual values over the cost of the equipment is recorded as unearned lease income. Unearned lease income is recognized over the term of the lease on a basis that results in an approximately level rate of return on the unrecovered lease investment. Lease income is recognized on the interest method.

Purchased Credit Deteriorated Loans

The Company has purchased loans, some of which have experienced more than insignificant credit deterioration since origination. PCD loans are recorded at the amount paid. An ACL on loans is determined using the same methodology as other loans held for investment. The initial ACL on loans determined on a collective basis is allocated to individual loans. The sum of the loan’s purchase price and ACL on loans becomes its initial amortized cost basis. The difference between the initial amortized cost basis and the par value of the loan is a noncredit discount or premium, which is amortized into interest income over the life of the loan. Subsequent changes to the ACL on loans are recorded through provision expense.

Allowance for Credit Losses on Loans

The ACL on loans is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged off against the allowance when management believes the loan balance is confirmed to no longer be collectible. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off.

Management estimates the allowance balance using relevant information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. Historical credit loss experience provides the basis for the estimation of expected credit losses. Adjustments to historical loss information are made for differences in current loan-specific risk characteristics such as differences in underwriting standards, portfolio mix, delinquency level, or term as well as for changes in environmental conditions, changes in unemployment rates, property values or relevant factors.

The Company considers the following when estimating credit losses: 1) available information relevant to assessing the collectability of cash flows including internal information, external information or a combination of both relating to past events, current conditions and reasonable and supportable forecasts; 2) relevant qualitative and quantitative factors relating to the environment in which the Bank operates and factors specific to the borrower; 3) off-balance-sheet credit exposures; and 4) credit enhancements.

ACL on loans is measured on a collective basis and reflects impairment in groups of loans aggregated on the basis of similar risk characteristics which may include any one or a combination of the following: internal credit ratings, risk ratings or classification, financial asset type, collateral type, size, industry of the borrower, historical or expected credit loss patterns, and reasonable and supportable forecast periods. The ACL for a specific portfolio segment is computed by multiplying the loss rate by the amortized cost balance of the segment. As appropriate, newer credit

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products or portfolios with limited historical loss may use applicable external data for determining the ACL until experience justifies that sufficient product maturity supports the estimate of expected credit losses.

Specific reserves reflect impairment on loans identified for evaluation or individually considered nonperforming, including troubled debt restructurings and receivables where the Company has determined foreclosure is probable. These loans no longer have similar risk characteristics to collectively evaluated loans due to changes in credit risk, borrower circumstances, recognition of write-offs, or cash collections that have been fully applied to principal on the basis of nonaccrual policies. At a minimum, the population of loans subject to individual evaluation include individual loans and leases where it is probable we will be unable to collect all amounts due, according to the original contractual terms. These include, nonaccrual loans with an effective balance greater than $500,000, accruing loans 90 days past due or greater with an effective balance greater than $100,000, specialty lending relationships and other loans as determined by management. ACL for consumer and residential loans are, primarily, determined by meaningful pools of similar loans and are evaluated on a quarterly basis.

The provision for credit losses on loans on individually evaluated loans is recognized on the basis of the present value of expected future cash flows discounted at the effective interest rate, the fair value of collateral adjusted for estimated costs to sell, or the observable market price as of the relevant date.

The table below identifies the Company’s loan portfolio segments and classes.

Segment

Class

Commercial

Commercial
Commercial Other

Commercial Real Estate

Commercial Real Estate Non-Owner Occupied
Commercial Real Estate Owner Occupied
Multi-Family
Farmland

Construction and Land Development

Construction and Land Development

Residential Real Estate

Residential First Lien
Other Residential

Consumer

Consumer
Consumer Other

Lease Financing

Lease Financing

The principal risks to each segment of loans are as follows:

Commercial – The principal risk of commercial loans is that these loans are primarily made based on the identified cash flow of the borrower and secondarily on the collateral underlying the loans. Most often, this collateral consists of accounts receivable, inventory and equipment. Inventory and equipment may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. If the cash flow from business operations is reduced, the borrower’s ability to repay the loan may be nonperforming. As such, repayment of such loans is often more sensitive than other types of loans to adverse conditions in the general economy.

Commercial real estate – As with commercial loans, repayment of commercial real estate loans is often dependent on the borrower’s ability to make repayment from the cash flow of the commercial venture. While commercial real estate loans are collateralized by the borrower’s underlying real estate, foreclosure on such assets may be more difficult than with other types of collateralized loans because of the possible effect the foreclosure would have on the borrower’s business, and property values may tend to be partially based upon the value of the business situated on the property.

Construction and land development – Construction and land development lending involves additional risks not generally present in other types of lending because funds are advanced upon the estimated future value of the project, which is uncertain prior to its completion and at the time the loan is made, and costs may exceed realizable values in declining real estate markets. Moreover, if the estimate of the value of the completed project proves to be overstated or market values or rental rates decline, the collateral may prove to be inadequate security for the repayment of the loan. Additional funds may also be required to complete the project, and the project may have to be held for an unspecified period of time before a disposition can occur.

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Residential real estate – The principal risk to residential real estate lending is associated with residential loans not sold into the secondary market. In such cases, the value of the underlying property may have deteriorated as a result of a change in the residential real estate market, and the borrower may have little incentive to repay the loan or continue living in the property. Additionally, in areas with high vacancy rates, reselling the property without substantial loss may be difficult.

Consumer – The repayment of consumer loans is typically dependent on the borrower remaining employed through the life of the loan, as well as the possibility that the collateral underlying the loan, if applicable, may not be adequately maintained by the borrower.

Lease financing – Our financing leases are primarily for business equipment leased to varying types of businesses, nationwide, for the purchase of business equipment and software. If the cash flow from business operations is reduced, the business’s ability to repay may become nonperforming.

Loans that do not share risk characteristics are evaluated on an individual basis. Loans evaluated individually are not included in the collective evaluation. The Company applies the collateral-dependent practical expedient, to calculate the ACL on loans for an individually evaluated collateral-dependent loan by measuring the fair value of collateral at the reporting date, regardless of whether foreclosure is probable. Fair value of collateral is adjusted for costs to sell when repayment or satisfaction of the loan depends on the sale of the collateral. ACL on loans adjustments for estimated costs to sell are not appropriate when the repayment of the collateral-dependent loan is expected from the operation of the collateral.

Determining the Contractual Term

Expected credit losses are estimated over the contractual term of the loans, adjusted for expected prepayments when appropriate. The contractual term excludes expected extensions, renewals, and modifications unless either of the following applies: management has a reasonable expectation at the reporting date that a troubled debt restructuring will be executed with an individual borrower or the extension or renewal options are included in the original or modified contract at the reporting date and are not unconditionally cancellable by the Company.

Troubled Debt Restructurings (“TDR”)

A loan for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, is considered to be a TDR. The ACL on loans on a TDR is measured using the same method as all other loans held for investment, except that the original interest rate is used to discount the expected cash flows, not the rate specified within the restructuring.

Allowance for Credit Losses on Off-Balance Sheet Credit Exposures

The Company estimates expected credit losses over the contractual period in which the Company is exposed to credit risk via a contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the Company. The ACL on OBS credit exposures is adjusted as a provision for credit loss expense included in other expense on the consolidated income statement. The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over its estimated life. Expected utilization rates are compared to the current funded portion of the total commitment amount as a practical expedient for funded exposure at default.

Allowance for Credit Losses on Available-For-Sale Securities

For available-for-sale debt securities in an unrealized loss position, the Company first assesses whether it intends to sell, or it is more likely than not that it will be required to sell, the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income. For debt securities available for sale that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an ACL is recorded for the credit loss, limited by

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the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an ACL is recorded in other comprehensive income.

Changes in the ACL are recorded as provision for, or reversal of, credit loss expense. Losses are charged against the allowance when management believes the uncollectibility of an available-for-sale security is confirmed or when either of the criteria regarding intent or requirement to sell is met.

FASB ASU No. 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement” – On January 1, 2020, the Company adopted the provision of ASU 2018-13, which modifies the disclosure requirements on fair value measurements. The amendment removes certain disclosures required by Topic 820 related to transfers between Level 1 and Level 2 of the fair value hierarchy; the policy for timing of transfers between levels; and the valuation processes for Level 3 fair value measurements. The update also adds certain disclosure requirements related to changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. For certain unobservable inputs, the Company may disclose other quantitative information in lieu of the weighted average if we determine that other quantitative information would be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop Level 3 fair value measurements. The adoption of this new guidance did not have a material impact on our consolidated financial statements.

Note 3 – Acquisitions

HomeStar Financial Group, Inc.

On July 17, 2019, the Company completed its acquisition of HomeStar, and its wholly owned subsidiary, HomeStar Bank, which operated five full-service banking centers in northern Illinois. In aggregate, the Company acquired HomeStar for consideration valued at approximately $11.4 million, which consisted of approximately $1.0 million in cash and the issuance of 404,968 shares of the Company’s common stock. The acquisition was accounted for under the acquisition method of accounting. Accordingly, the Company recognized amounts for identifiable assets acquired and liabilities assumed at their estimated acquisition date fair values, while $7.4 million of transaction and integration costs associated with the acquisition were expensed as incurred.

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Management’s valuation of the tangible and intangible assets acquired and liabilities assumed, which are based on assumptions that are subject to change, and the resulting allocation of the consideration paid for the allocation is reflected in the table below. Prior to the end of the one-year measurement period for finalizing the consideration paid allocation, if information becomes available which would indicate adjustments are required to the allocation, such adjustments will be included in the allocation in the reporting period in which the adjustment amounts are determined. During the first quarter of 2020, the Company updated its valuation of deferred tax assets and other liabilities, which required a measurement period adjustment of $1.0 million to increase goodwill.

(dollars in thousands)

    

    

HomeStar

Assets acquired:

Cash and cash equivalents

$

70,900

Investment securities available for sale

 

54,963

Equity securities

2,153

Loans

 

211,070

Loans held for sale

 

3,562

Premises and equipment

 

4,049

Operating lease right-of-use asset

5,177

Other real estate owned

 

1,092

Nonmarketable equity securities

 

454

Accrued interest receivable

 

1,185

Loan servicing rights

1,089

Mortgage servicing rights held for sale

 

1,701

Intangible assets

 

4,600

Deferred tax assets, net

 

2,732

Other assets

 

1,541

Total assets acquired

 

366,268

Liabilities assumed:

Deposits

 

321,740

FHLB advances and other borrowings

 

31,369

Accrued interest payable

 

115

Operating lease liabilities

 

6,232

Other liabilities

 

3,575

Total liabilities assumed

 

363,031

Net assets acquired

 

3,237

Goodwill

 

8,123

Total consideration paid

$

11,360

Intangible assets:

Core deposit intangible

$

4,300

Customer relationship intangible

300

Total intangible assets

$

4,600

Estimated useful lives:

Core deposit intangible

12 years

Customer relationship intangible

6 years

Goodwill arising from the acquisition consists largely of the synergies and economies of scale expected from combining the operations of HomeStar into the Company. The goodwill is assigned as part of the Company’s banking reporting unit. The portion of the consideration paid allocated to goodwill will not be deductible for tax purposes.

The identifiable assets acquired from HomeStar included core deposit intangibles and customer relationship intangibles, which are being amortized on an accelerated basis as shown above.

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Note 4 – Investment Securities

Investment Securities Available for Sale

Investment securities as of March 31, 2020 and December 31, 2019 were as follows:

March 31, 2020

Allowance

    

Gross

Gross

for credit

Amortized

unrealized

unrealized

losses on

Fair

(dollars in thousands)

    

cost

    

gains

    

losses

investments

    

value

 

Investment securities available for sale

U.S. government sponsored entities and U.S. agency securities

$

46,428

$

929

$

$

$

47,357

Mortgage-backed securities - agency

 

317,332

 

9,417

49

 

 

326,700

Mortgage-backed securities - non-agency

 

28,121

 

840

 

 

27,281

State and municipal securities

 

112,500

 

3,897

284

 

19

 

116,094

Corporate securities

 

140,287

 

1,168

2,577

 

56

 

138,822

Total available for sale securities

$

644,668

$

15,411

$

3,750

$

75

$

656,254

December 31, 2019

 

Allowance

    

Gross

Gross

for credit

Amortized

unrealized

unrealized

losses on

Fair

(dollars in thousands)

cost

    

gains

    

losses

investments

    

value

Investment securities available for sale

U.S. government sponsored entities and U.S. agency securities

$

59,600

$

442

$

22

N/A

$

60,020

Mortgage-backed securities - agency

 

321,840

 

3,368

 

234

N/A

 

324,974

Mortgage-backed securities - non-agency

 

17,198

 

3

 

53

N/A

 

17,148

State and municipal securities

 

119,371

 

5,195

 

11

N/A

 

124,555

Corporate securities

 

121,159

 

2,131

 

554

N/A

 

122,736

Total available for sale securities

$

639,168

$

11,139

$

874

N/A

$

649,433

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Unrealized losses and fair values for investment securities available for sale as of March 31, 2020, for which an ACL has not been recorded, and December 31, 2019, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are summarized as follows:

March 31, 2020

Less than 12 Months

12 Months or more

Total

Fair

Unrealized

Fair

Unrealized

Fair

Unrealized

(dollars in thousands)

    

value

    

loss

    

value

    

loss

    

value

    

loss

Investment securities available for sale

    

    

    

    

    

    

    

    

    

 

Mortgage-backed securities - agency

$

10,175

$

42

$

1,255

$

7

$

11,430

$

49

Mortgage-backed securities - non-agency

25,849

840

25,849

840

Corporate securities

 

41,499

1,287

 

41,499

 

1,287

Total available for sale securities

$

77,523

$

2,169

$

1,255

$

7

$

78,778

$

2,176

December 31, 2019

Less than 12 Months

12 Months or more

Total

Fair

Unrealized

Fair

Unrealized

Fair

Unrealized

(dollars in thousands)

value

loss

value

loss

value

loss

Investment securities available for sale

    

    

    

    

    

    

 

U.S. government sponsored entities and U.S. agency securities

$

7,200

$

22

$

$

$

7,200

$

22

Mortgage-backed securities - agency

 

75,336

170

7,170

64

 

82,506

 

234

Mortgage-backed securities - non-agency

11,059

53

11,059

53

State and municipal securities

 

1,813

11

 

1,813

 

11

Corporate securities

 

20,269

481

3,915

73

 

24,184

 

554

Total available for sale securities

$

115,677

$

737

$

11,085

$

137

$

126,762

$

874

For all of the above investment securities, the unrealized losses are generally due to changes in interest rates and other market conditions, and unrealized losses are considered to be temporary as the fair value is expected to recover as the securities approach their respective maturity dates.

At March 31, 2020, 74 investment securities available for sale had unrealized losses with aggregate depreciation of 2.81% from their amortized cost basis. The unrealized losses related principally to the fluctuations in the current rate environment. In analyzing an issuer’s financial condition, we consider whether the securities are issued by the federal government or its agencies and whether downgrades by bond rating agencies have occurred. The Company does not intend to sell and it is likely that the Company will not be required to sell the securities prior to their anticipated recovery.

The table below presents a rollforward by major security type for the three months ended March 31, 2020 of the ACL on investment securities available for sale held at period end:

State and municipal

Corporate

(dollars in thousands)

    

securities

    

securities

Balances, January 1, 2020

$

$

Impact of adopting ASC 326

Additions for securities for which no previous expected credit losses were recognized

19

56

Balances, March 31, 2020

$

19

$

56

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The following is a summary of the amortized cost and fair value of the investment securities available for sale, by maturity, at March 31, 2020. Expected maturities may differ from contractual maturities in mortgage-backed securities because the mortgages underlying the securities may be prepaid without penalties. The maturities of all other investment securities available for sale are based on final contractual maturity.

    

Amortized

    

Fair

 

(dollars in thousands)

cost

value

 

Investment securities available for sale

Within one year

$

33,584

$

33,801

After one year through five years

 

78,025

 

79,387

After five years through ten years

 

169,041

 

169,579

After ten years

 

18,565

 

19,506

Mortgage-backed securities

345,453

353,981

Total available for sale securities

$

644,668

$

656,254

There were no sales of investment securities available for sale for the three months ended March 31, 2020 and 2019.

Equity Securities

Equity securities are recorded at fair value and totaled $5.6 million at March 31, 2020 and December 31, 2019. There were no sales of equity securities for the three months ended March 31, 2020 and 2019. During the three months ended March 31, 2020, the Company recognized unrealized losses of $1,000, while unrealized gains of $67,000 were recognized during the three months ended March 31, 2019. Net unrealized gains and losses on equity securities are recorded in other income in the consolidated statements of income.

Note 5 – Loans

The following table presents total loans outstanding by portfolio class, as of March 31, 2020 and December 31, 2019:

 

March 31, 

December 31,

 

(dollars in thousands)

2020

2019

 

Commercial:

Commercial

$

649,403

$

628,056

Commercial Other

443,376

427,129

Commercial real estate:

Commercial real estate non-owner occupied

809,628

825,874

Commercial real estate owner occupied

471,360

464,601

Multi-family

142,770

146,795

Farmland

83,522

89,234

Construction and land development

208,361

208,733

Total commercial loans

2,808,420

2,790,422

Residential real estate:

Residential first lien

441,495

456,107

Other residential

106,519

112,184

Consumer:

Consumer

85,162

100,732

Consumer Other

588,242

609,384

Lease financing

346,366

332,581

Total loans, gross

$

4,376,204

$

4,401,410

Total loans include net deferred loan fees of $2.9 million and $2.2 million at March 31, 2020 and December 31, 2019, respectively, and unearned income of $40.1 million and $39.6 million within the lease financing portfolio at March 31, 2020 and December 31, 2019, respectively.

At March 31, 2020, the Company had commercial, residential and consumer loans held for sale totaling $113.9 million compared to $16.4 million at December 31, 2019. During the first quarter of 2020, the Company had committed

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to a plan to sell certain loans and transferred $99.7 million of consumer loans to loans held for sale with no gain or loss recognized upon the transfer. The sale is expected to be completed in May 2020. During the three months ended March 31, 2020 and 2019, the Company sold commercial and residential real estate loans with proceeds totaling $73.1 million and $99.3 million, respectively.

The aggregate loans outstanding to the Company’s directors, executive officers, principal shareholders and their affiliates totaled $21.7 million and $23.0 million at March 31, 2020 and December 31, 2019, respectively. During the three months ended March 31, 2020, there were $80,000 of new loans and other additions, while repayments and other reductions totaled $1.3 million.

The following table represents, by loan portfolio segment, a summary of changes in the ACL on loans for the three months ended March 31, 2020 and 2019:

Commercial Loan Portfolio

Other Loan Portfolio

 

Commercial

Construction

Residential

 

Real

and Land

Real

Lease

 

(dollars in thousands)

Commercial

Estate

Development

Estate

Consumer

Financing

Total

 

Changes in allowance for credit losses on loans for the three months ended March 31, 2020:

Balance, beginning of period

$

10,031

$

10,272

$

290

$

2,499

$

2,642

$

2,294

$

28,028

Impact of adopting ASC 326

2,327

4,104

724

1,211

(594)

774

8,546

Provision for credit losses on loans

 

1,730

 

5,755

 

(549)

 

257

 

256

 

3,120

 

10,569

Initial PCD Allowance

1,045

1,311

809

1,015

57

4,237

Charge-offs

 

(3,398)

 

(7,873)

 

(12)

 

(388)

 

(598)

 

(948)

 

(13,217)

Recoveries

 

5

 

14

 

59

 

44

 

191

 

69

 

382

Balance, end of period

$

11,740

$

13,583

$

1,321

$

4,638

$

1,954

$

5,309

$

38,545

Changes in allowance for credit losses on loans for the three months ended March 31, 2019:

Balance, beginning of period

$

9,524

$

4,723

$

372

$

2,041

$

2,154

$

2,089

$

20,903

Provision for credit losses on loans

 

118

1,945

63

514

329

 

274

 

3,243

Charge-offs

 

(112)

 

(58)

 

(44)

 

(153)

 

(556)

 

(459)

 

(1,382)

Recoveries

 

15

 

7

 

7

 

22

 

210

 

66

 

327

Balance, end of period

$

9,545

$

6,617

$

398

$

2,424

$

2,137

$

1,970

$

23,091

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The following table represents, by loan portfolio segment, details regarding the balance in the allowance for loan loss and the recorded investment in loans as of December 31, 2019 by impairment evaluation method:

Commercial Loan Portfolio

Other Loan Portfolio

 

Commercial

Construction

Residential

 

Real

and Land

Real

Lease

 

(dollars in thousands)

Commercial

Estate

Development

Estate

Consumer

Financing

Total

 

Allowance for credit losses on loans:

Loans individually evaluated for impairment

$

3,563

$

5,968

$

$

290

$

$

156

$

9,977

Loans collectively evaluated for impairment

 

69

 

100

14

444

39

122

 

788

Non-impaired loans collectively evaluated for impairment

 

6,380

 

3,643

272

1,269

2,500

2,016

 

16,080

Loans acquired with deteriorated credit quality (1)

 

19

 

561

4

496

103

 

1,183

Total allowance for credit losses on loans

$

10,031

$

10,272

$

290

$

2,499

$

2,642

$

2,294

$

28,028

Recorded investment (loan balance):

Impaired loans individually evaluated for impairment

$

5,767

$

22,698

$

1,245

$

5,329

$

$

697

$

35,736

Impaired loans collectively evaluated for impairment

 

511

764

 

104

 

3,695

 

376

 

896

 

6,346

Non-impaired loans collectively evaluated for impairment

 

1,045,829

1,482,935

 

201,707

 

546,630

 

708,528

 

330,988

 

4,316,617

Loans acquired with deteriorated credit quality (1)

 

3,078

20,107

 

5,677

 

12,637

 

1,212

 

 

42,711

Total recorded investment (loan balance)

$

1,055,185

$

1,526,504

$

208,733

$

568,291

$

710,116

$

332,581

$

4,401,410

(1)Loans acquired with deteriorated credit quality were originally recorded at fair value at the acquisition date and the risk of credit loss was recognized at that date based on estimates of expected cash flows.

The Company utilizes the Probability of Default (“PD”)/Loss Given Default (“LGD”) methodology in determining expected future credit losses. PD is the risk that the borrower will be unable or unwilling to repay its debt in full or on time. The risk of default is derived by analyzing the obligor’s capacity to repay the debt in accordance with contractual terms. PD is generally associated with financial characteristics such as inadequate cash flow to service debt, declining revenues or operating margins, high leverage, declining or marginal liquidity, and the inability to successfully implement a business plan. In addition to these quantifiable factors, the borrower’s willingness to repay also must be evaluated.

As a method for estimating the allowance, it is a form of migration analysis that combines the estimated probability of loans experiencing default events and the losses ultimately associated with the loans experiencing those defaults. The LGD component is the percentage of defaulted loan balance that is ultimately charged off. Multiplying one by the other gives the Company its loss rate, which is then applied to the loan portfolio balance to determine expected future losses.

Within the model, the LGD approach produces segmented LGD estimates using a loss curve methodology, which is based on historical net losses from charge-off and recovery information. The main principle of a loss curve model is that the loss follows a steady timing schedule based on how long the defaulted loan has been on the books.

The Company’s expected loss estimate is anchored in historical credit loss experience, with an emphasis on all available portfolio data. The Company’s historical look-back period includes January 2012 through the current period, on a monthly basis. When historical credit loss experience is not sufficient for a specific portfolio, the Company may supplement its own portfolio data with external models or data.

Historical data is evaluated in multiple components of the expected credit loss, including the reasonable and supportable forecast and the post-reversion period of each loan segment. The historical experience is used to infer probability of default and loss given default in the reasonable and supportable forecast period. In the post-reversion period, long-term average loss rates are segmented by loan pool.

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Qualitative reserves reflect management’s overall estimate of the extent to which current expected credit losses on collectively evaluated loans will differ from historical loss experience. The analysis takes into consideration other analytics performed within the organization, such as enterprise and concentration management, along with other credit-related analytics as deemed appropriate. Management attempts to quantify qualitative reserves whenever possible.

For the initial implementation, the Company’s CECL estimate applies a 12-month forecast that incorporates macroeconomic trends (i.e., unemployment, real estate prices, etc.), political environment, and historical loss experience. Management also took into consideration forecast assumptions used in budgeting, capital planning and stress testing. These considerations influenced the selection of a 12-month period, combined with a 12-month reversion period, for a 24-month period before historic loss experience is applied to the expected loss estimate, consistently for every loan pool.

The Company segments the loan portfolio into pools based on the following risk characteristics: financial asset type, collateral type, loan characteristics, credit characteristics, outstanding loan balances, contractual terms and prepayment assumptions, geographic location, effective interest rate, vintage, industry of borrower and concentrations, historical or expected credit loss patterns, and reasonable and supportable forecast periods.

Within the PD segmentation, credit metrics are identified to further segment the financial assets. The Company utilizes risk ratings for the commercial portfolios and days past due for the consumer and the leasing company portfolios.

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The Company has defined five transitioning risk states for each asset pool within the expected credit loss model. The below table illustrates the transition matrix:

Consumer Loans and

Commercial Loans

Equipment Finance Loans and Leases

Risk State

Risk Rating

Days Past Due

1

0-5

0-14

2

6

15-29

3

7

30-59

4

8

60-89

Default

9+ and nonaccrual

90+ and nonaccrual

Expected Credit Losses

In calculating expected credit losses, the Company includes loans on nonaccrual status, loans past due 90 days or more and still accruing interest, and loans modified under TDRs.

The following table presents amortized cost basis of individually evaluated loans on nonaccrual status as of March 31, 2020 and December 31, 2019:

March 31, 2020

December 31, 2019

 

Nonaccrual

Nonaccrual

with no Allowance

with no Allowance

 

(dollars in thousands)

Nonaccrual

for Credit Loss

Nonaccrual

for Credit Loss

 

Commercial:

Commercial

$

1,948

$

$

1,492

$

119

Commercial Other

2,504

371

4,351

1,519

Commercial real estate:

Commercial real estate non-owner occupied

 

9,639

 

4,489

 

10,915

 

4,572

Commercial real estate owner occupied

11,672

6,613

4,396

2,648

Multi-family

10,557

2,392

6,231

1,430

Farmland

200

150

Construction and land development

4,954

693

1,304

1,245

Total commercial loans

 

41,274

 

14,558

 

28,889

 

11,683

Residential real estate:

 

 

 

 

Residential first lien

8,414

789

6,140

2,416

Other residential

2,289

1,656

912

Consumer:

 

 

 

 

Consumer

480

341

7

Consumer Other

Lease financing

 

1,775

 

 

1,375

 

116

Total loans

$

54,232

$

15,347

$

38,401

$

15,134

During the first quarter of 2019, as part of the adoption of CECL, $9.8 million of PCD loans were reclassified to nonaccrual loans. These PCD loans are predominantly well secured and in the process of collection.

There was no interest income recognized on nonaccrual loans during the three months ended March 31, 2020 and 2019 while the loans were in nonaccrual status. Additional interest income that would have been recorded on nonaccrual loans had they been current in accordance with their original terms was $890,000 and $653,000 for the three months ended March 31, 2020 and 2019, respectively. The Company recognized interest income on commercial and commercial real estate loans modified under troubled debt restructurings of $20,000 and $32,000 for the three months ended March 31, 2020 and 2019, respectively.

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Table of Contents

Collateral Dependent Financial Assets

A collateral dependent financial loan relies solely on the operation or sale of the collateral for repayment. In evaluating the overall risk associated with a loan, the Company considers character, overall financial condition and resources, and payment record of the borrower; the prospects for support from any financially responsible guarantors; and the nature and degree of protection provided by the cash flow and value of any underlying collateral. However, as other sources of repayment become inadequate over time, the significance of the collateral’s value increases and the loan may become collateral dependent.

The table below presents the value of collateral dependent loans by loan class as of March 31, 2020:

(dollars in thousands)

March 31, 2020

Commercial

Commercial Other

$

371

Commercial Real Estate

Non-Owner Occupied

8,874

Owner Occupied

7,264

Multi-Family

10,338

Construction and Land Development

2,941

Residential Real Estate

Residential First Lien

110

Total Collateral Dependent Loans

$

29,898

The aging status of the recorded investment in loans by portfolio as of March 31, 2020 is as follows:

Accruing Loans

 

30-59

60-89

Past Due

 

Days

Days

90 Days

Total

 

(dollars in thousands)

Past Due

Past Due

or More

Past Due

Current

Total

 

Commercial:

Commercial

$

214

$

498

$

$

712

$

646,743

$

647,455

Commercial Other

7,367

3,474

147

10,988

429,884

440,872

Commercial real estate:

Commercial real estate non-owner occupied

 

7,754

 

176

 

 

7,930

 

792,059

 

799,989

Commercial real estate owner occupied

149

93

242

459,446

459,688

Multi-family

132,213

132,213

Farmland

108

108

83,414

83,522

Construction and land development

2,410

156

8

2,574

200,833

203,407

Total commercial loans

 

18,002

 

4,397

 

155

 

22,554

 

2,744,592

 

2,767,146

Residential real estate:

 

 

 

 

 

 

Residential first lien

1,151

248

1,399

431,682

433,081

Other residential

888

888

103,342

104,230

Consumer:

 

 

 

 

 

 

Consumer

357

75

432

84,250

84,682

Consumer Other

4,913

4,063

8,976

579,266

588,242

Lease financing

 

5,601

 

945

 

376

 

6,922

 

337,669

 

344,591

Total loans

$

30,912

$

9,480

$

779

$

41,171

$

4,280,801

$

4,321,972

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Table of Contents

The aging status of the recorded investment in loans by portfolio (excluding PCI) as of December 31, 2019 is as follows:

Accruing Loans

30-59

60-89

Past Due

Days

Days

90 Days

Total

(dollars in thousands)

Past Due

Past Due

or More

Past Due

Current

Total

Commercial

$

5,910

$

3,086

$

$

8,996

$

1,037,268

$

1,046,264

Commercial real estate

 

2,895

 

399

 

 

3,294

 

1,481,361

 

1,484,655

Construction and land development

 

1,539

 

72

 

 

1,611

 

200,141

 

201,752

Residential real estate

 

588

 

1,561

 

145

 

2,294

 

545,564

 

547,858

Consumer

 

6,701

 

4,154

 

 

10,855

 

697,708

 

708,563

Lease financing

 

1,783

 

1,188

 

218

 

3,189

 

328,017

 

331,206

Total loans (excluding PCI)

$

19,416

$

10,460

$

363

$

30,239

$

4,290,059

$

4,320,298

Troubled Debt Restructurings

Loans modified as TDRs for commercial and commercial real estate loans generally consist of allowing commercial borrowers to defer scheduled principal payments and make interest only payments for a specified period of time at the stated interest rate of the original loan agreement or lower payments due to a modification of the loans’ contractual terms. TDRs that continue to accrue interest and are greater than $50,000 are individually evaluated for impairment on a quarterly basis, and transferred to nonaccrual status when it is probable that any remaining principal and interest payments due on the loan will not be collected in accordance with the contractual terms of the loan. TDRs that subsequently default are individually evaluated for impairment at the time of default.

The CARES Act provides all banks with the option to elect either or both of the following from March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the termination of the national emergency:

(i) to suspend the requirements under GAAP for loan modifications related to the COVID–19 pandemic that would otherwise be categorized as a TDR; and/or

(ii) to suspend any determination of a loan modified as a result of the effects of the COVID–19 pandemic as being a TDR, including impairment for accounting purposes.

If a bank elects a suspension noted above, the suspension (i) will be effective for the term of the loan modification, but solely with respect to any modification, including a forbearance arrangement, an interest rate modification, a repayment plan, and any other similar arrangement that defers or delays the payment of principal or interest, that occurs during the applicable period for a loan that was not more than 30 days past due as of December 31, 2019; and (ii) will not apply to any adverse impact on the credit of a borrower that is not related to the COVID–19 pandemic.

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Table of Contents

The Company’s TDRs are identified on a case-by-case basis in connection with the ongoing loan collection processes. The following table presents TDRs by loan portfolio as of March 31, 2020 and December 31, 2019:

March 31, 2020

December 31, 2019 (3)

(dollars in thousands)

Accruing (1)

Non-accrual (2)

Total

Accruing (1)

Non-accrual (2) 

Total

Commercial

    

$

60

    

$

1,181

    

$

1,241

    

$

435

    

$

369

    

$

804

Commercial real estate

 

1,692

 

6,032

 

7,724

 

1,720

 

9,834

 

11,554

Construction and land development

 

43

 

163

 

206

 

45

 

167

 

212

Residential real estate

 

1,328

 

2,414

 

3,742

 

1,083

 

1,993

 

3,076

Consumer

 

32

 

 

32

 

35

 

 

35

Lease financing

 

 

52

 

52

 

 

55

 

55

Total loans

$

3,155

$

9,842

$

12,997

$

3,318

$

12,418

$

15,736

(1)These loans are still accruing interest.
(2)These loans are included in non-accrual loans in the preceding tables.
(3)TDRs as of December 31, 2019 exclude PCI loans.

The ACL on TDRs totaled $760,000 and $2.0 million as of March 31, 2020 and December 31, 2019, respectively. The Company had no unfunded commitments in connection with TDRs at March 31, 2020 and December 31, 2019.

The following table presents a summary of loans by portfolio that were restructured during the three months ended March 31, 2020 and 2019 and the loans by portfolio that were modified as TDRs within the previous twelve months that subsequently defaulted during the three months ended March 31, 2020 and 2019:

Commercial Loan Portfolio

Other Loan Portfolio

Commercial

Construction

Residential

Real

and Land

Real

Lease

(dollars in thousands)

Commercial

Estate

Development

Estate

Consumer

Financing

Total

For the three months ended March 31, 2020

Troubled debt restructurings:

    

    

    

    

    

    

Number of loans

 

 

 

6

 

 

6

Pre-modification outstanding balance

$

$

$

$

675

$

$

$

675

Post-modification outstanding balance

 

 

 

670

 

 

 

670

Troubled debt restructurings that subsequently defaulted

Number of loans

 

 

 

 

 

 

 

Recorded balance

$

$

$

$

$

$

$

For the three months ended March 31, 2019:

Troubled debt restructurings:

    

    

    

    

    

    

Number of loans

 

3

 

1

 

7

 

1

 

12

Pre-modification outstanding balance

$

$

1,924

$

62

$

224

$

15

$

$

2,225

Post-modification outstanding balance

 

 

1,838

 

17

 

222

 

15

 

 

2,092

Troubled debt restructurings that subsequently defaulted

Number of loans

 

 

 

1

 

 

 

 

1

Recorded balance

$

$

$

43

$

$

$

$

43

Credit Quality Monitoring

The Company maintains loan policies and credit underwriting standards as part of the process of managing credit risk. These standards include making loans generally within the Company’s four main regions, which include eastern, northern and southern Illinois and the St. Louis metropolitan area. Our equipment leasing business provides financing to business customers across the country.

The Company has a loan approval process involving underwriting and individual and group loan approval authorities to consider credit quality and loss exposure at loan origination. The loans in the Company’s commercial loan portfolio are risk rated at origination based on the grading system set forth below. All loan authority is based on the aggregate credit to a borrower and its related entities.

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Table of Contents

The Company’s consumer loan portfolio is primarily comprised of both secured and unsecured loans that are relatively small and are evaluated at origination on a centralized basis against standardized underwriting criteria. The ongoing measurement of credit quality of the consumer loan portfolio is largely done on an exception basis. If payments are made on schedule, as agreed, then no further monitoring is performed. However, if delinquency occurs, the delinquent loans are turned over to the Company’s Consumer Collections Group for resolution. Credit quality for the entire consumer loan portfolio is measured by the periodic delinquency rate, nonaccrual amounts and actual losses incurred.

Loans in the commercial loan portfolio tend to be larger and more complex than those in the other loan portfolio, and therefore, are subject to more intensive monitoring. All loans in the commercial loan portfolio have an assigned relationship manager, and most borrowers provide periodic financial and operating information that allows the relationship managers to stay abreast of credit quality during the life of the loans. The risk ratings of loans in the commercial loan portfolio are reassessed at least annually, with loans below an acceptable risk rating reassessed more frequently and reviewed by various individuals within the Company at least quarterly.

The Company maintains a centralized independent loan review function that monitors the approval process and ongoing asset quality of the loan portfolio, including the accuracy of loan grades. The Company also maintains an independent appraisal review function that participates in the review of all appraisals obtained by the Company.

Credit Quality Indicators

The Company uses a ten grade risk rating system to monitor the ongoing credit quality of its commercial loan portfolio, which includes commercial, commercial real estate and construction and land development loans. These loan grades rank the credit quality of a borrower by measuring liquidity, debt capacity, and coverage and payment behavior as shown in the borrower’s financial statements. The risk grades also measure the quality of the borrower’s management and the repayment support offered by any guarantors.

The Company considers all loans with Risk Grades of 1 – 6 as acceptable credit risks and structures and manages such relationships accordingly. Periodic financial and operating data combined with regular loan officer interactions are deemed adequate to monitor borrower performance. Loans with Risk Grades of 7 are considered “watch credits” categorized as special mention and the frequency of loan officer contact and receipt of financial data is increased to stay abreast of borrower performance. Loans with Risk Grades of 8 – 10 are considered problematic and require special care. Risk Grade 8 is categorized as substandard, 9 as substandard – nonaccrual and 10 as doubtful. Further, loans with Risk Grades of 7 – 10 are managed and monitored regularly through a number of processes, procedures and committees, including oversight by a loan administration committee comprised of executive and senior management of the Company, which includes highly structured reporting of financial and operating data, intensive loan officer intervention and strategies to exit, as well as potential management by the Company’s Special Assets Group. Loans not graded in the commercial loan portfolio are monitored by aging status and payment activity.

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Table of Contents

The following tables present the recorded investment of the commercial loan portfolio by risk category as of March 31, 2020 and December 31, 2019:

    

Term Loans

 

Amortized Cost Basis by Origination Year

(dollars in thousands)

2020

2019

2018

2017

2016

Prior

Revolving Loans

Total

Commercial

Commercial

Acceptable credit quality

$

36,244

$

118,192

$

50,709

$

79,205

$

39,003

$

64,281

$

226,404

$

614,038

Special mention

945

 

379

 

3,643

 

34

 

431

 

4,314

 

7,795

 

17,541

Substandard

 

823

 

692

 

849

 

89

 

4,633

 

8,790

 

15,876

Substandard – nonaccrual

 

 

66

 

38

 

433

 

514

 

897

 

1,948

Doubtful

 

 

 

 

 

 

 

Not graded

 

 

 

 

 

 

 

Subtotal

37,189

119,394

55,110

80,126

39,956

73,742

243,886

649,403

Commercial Other

Acceptable credit quality

63,535

197,784

69,918

1,046

537

1,253

96,875

430,948

Special mention

152

1,188

825

5

15

2,050

4,235

Substandard

76

58

572

30

46

5

4,772

5,559

Substandard – nonaccrual

1,229

836

49

12

378

2,504

Doubtful

Not graded

61

69

130

Subtotal

63,824

200,259

72,151

1,081

647

1,270

104,144

443,376

Commercial Real Estate

Non-Owner Occupied

Acceptable credit quality

21,416

124,691

84,571

125,985

147,992

252,159

9,777

766,591

Special mention

4,479

110

271

27

10,647

15,534

Substandard

906

282

5,204

474

10,707

250

17,823

Substandard – nonaccrual

456

111

3,495

5,577

9,639

Doubtful

Not graded

41

41

Subtotal

22,322

129,667

85,074

131,460

151,988

279,090

10,027

809,628

Owner Occupied

Acceptable credit quality

27,644

59,290

37,062

65,814

77,379

150,209

4,084

421,482

Special mention

1,723

253

380

3,037

8,538

13,931

Substandard

368

796

169

2,630

19,708

604

24,275

Substandard – nonaccrual

264

170

249

33

9,962

994

11,672

Doubtful

Not graded

Subtotal

27,644

61,645

38,281

66,612

83,079

188,417

5,682

471,360

Multi-Family

Acceptable credit quality

795

15,248

21,586

32,871

22,933

32,045

1,101

126,579

Special mention

1,348

1,348

Substandard

198

4,008

80

4,286

Substandard – nonaccrual

8,029

2,528

10,557

Doubtful

Not graded

Subtotal

795

15,446

21,586

32,871

34,970

36,001

1,101

142,770

Farmland

Acceptable credit quality

1,702

11,046

8,414

11,405

8,071

36,196

2,358

79,192

Special mention

465

193

18

280

105

1,061

Substandard

52

602

323

2,146

146

3,269

Substandard – nonaccrual

Doubtful

Not graded

Subtotal

1,702

11,563

9,209

11,728

8,089

38,622

2,609

83,522

Construction and Land Development

Acceptable credit quality

2,604

102,813

29,700

25,183

5,151

9,022

19,590

194,063

Special mention

2,410

1,447

3,857

Substandard

153

225

919

1,297

Substandard – nonaccrual

150

4,804

4,954

Doubtful

Not graded

4,190

4,190

Subtotal

2,604

107,156

29,925

27,593

5,301

16,192

19,590

208,361

Total

Acceptable credit quality

153,940

629,064

301,960

341,509

301,066

545,165

360,189

2,632,893

Special mention

1,097

8,234

5,024

3,100

3,528

26,574

9,950

57,507

Substandard

982

1,652

3,169

6,575

7,247

38,198

14,562

72,385

Substandard – nonaccrual

1,949

1,183

287

12,189

23,397

2,269

41,274

Doubtful

Not graded

61

4,231

69

4,361

Total Commercial Loans

$

156,080

$

645,130

$

311,336

$

351,471

$

324,030

$

633,334

$

387,039

$

2,808,420

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Table of Contents

December 31, 2019

Commercial

Construction

Real

and Land

(dollars in thousands)

Commercial

Estate

Development

Total

Acceptable credit quality

$

1,005,442

$

1,398,400

$

194,992

$

2,598,834

Special mention

17,435

18,450

2,420

 

38,305

Substandard

23,387

67,805

1,250

 

92,442

Substandard – nonaccrual

5,843

21,742

1,304

 

28,889

Doubtful

 

Not graded

3,090

 

3,090

Total (excluding PCI)

$

1,052,107

$

1,506,397

$

203,056

$

2,761,560

The Company evaluates the credit quality of its other loan portfolios, which includes residential real estate, consumer and lease financing loans, based primarily on the aging status of the loan and payment activity. Accordingly, loans on nonaccrual status, loans past due 90 days or more and still accruing interest, and loans modified under troubled debt restructurings are considered to be nonperforming for purposes of credit quality evaluation. The following tables present the recorded investment of our other loan portfolio based on the credit risk profile of loans that are performing and loans that are nonperforming as of March 31, 2020 and December 31, 2019:

Term Loans

Amortized Cost Basis by Origination Year

(dollars in thousands)

2020

2019

2018

2017

2016

Prior

Revolving Loans

Total

Residential Real Estate

Residential First Lien

Performing

$

2,041

$

29,994

$

68,525

$

149,262

$

107,088

$

74,763

$

371

$

432,044

Nonperforming

110

572

920

698

7,151

9,451

Subtotal

2,041

30,104

69,097

150,182

107,786

81,914

371

441,495

Other Residential

Performing

242

3,235

4,495

2,999

1,872

2,746

88,102

103,691

Nonperforming

15

24

158

8

199

2,424

2,828

Subtotal

242

3,250

4,519

3,157

1,880

2,945

90,526

106,519

Consumer

Consumer

Performing

2,970

19,553

23,622

14,689

11,131

9,753

2,932

84,650

Nonperforming

29

81

120

101

178

3

512

Subtotal

2,970

19,582

23,703

14,809

11,232

9,931

2,935

85,162

Consumer Other

Performing

146,912

337,739

53,885

12,215

14,943

2,249

20,299

588,242

Nonperforming

Subtotal

146,912

337,739

53,885

12,215

14,943

2,249

20,299

588,242

Leases Financing

Performing

44,905

147,056

89,465

32,284

24,106

6,399

344,215

Nonperforming

62

865

563

533

128

2,151

Subtotal

44,905

147,118

90,330

32,847

24,639

6,527

346,366

Total

Performing

197,070

537,577

239,992

211,449

159,140

95,910

111,704

1,552,842

Nonperforming

216

1,542

1,761

1,340

7,656

2,427

14,942

Total Other Loans

$

197,070

$

537,793

$

241,534

$

213,210

$

160,480

$

103,566

$

114,131

$

1,567,784

December 31, 2019

Residential

    

    

Lease

    

(dollars in thousands)

Real Estate

Consumer

Financing

Total

Performing

$

546,630

$

708,528

$

330,988

$

1,586,146

Nonperforming

 

9,024

 

376

 

1,593

 

10,993

Total (excluding PCI)

$

555,654

$

708,904

$

332,581

$

1,597,139

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Table of Contents

Note 6 – Premises and Equipment, Net

A summary of premises and equipment as of March 31, 2020 and December 31, 2019 is as follows:

March 31, 

December 31, 

(dollars in thousands)

    

2020

    

2019

Land

$

19,123

$

19,123

Buildings and improvements

 

77,028

 

77,296

Furniture and equipment

 

32,658

 

31,846

Total

 

128,809

 

128,265

Accumulated depreciation

 

(38,691)

 

(37,210)

Premises and equipment, net

$

90,118

$

91,055

Depreciation expense of $1.7 million and $1.6 million was recorded for the three months ended March 31, 2020 and 2019, respectively.

Note 7 – Leases

The Company has operating leases for banking centers and operating facilities. Our leases have remaining lease terms of 3 months to 13 years, some of which may include options to extend the lease terms for up to an additional 5 years. The options to extend are included if they are reasonably certain to be exercised.

The Company had operating lease right-of-use assets of $14.1 million and $14.2 million as of March 31, 2020 and December 31, 2019, respectively and operating lease liabilities of $15.0 million and $15.4 million for the same time periods, respectively.

Information related to operating leases for the three months ended March 31, 2020 and 2019 was as follows:

Three Months Ended
March 31,

(dollars in thousands)

2020

2019

Operating lease cost

$

781

$

708

Operating cash flows from leases

945

741

Right-of-use assets obtained in exchange for lease obligations

511

10,677

Weighted average remaining lease term

7.83 years

6.00 years

Weighted average discount rate

2.97

%

3.12

%

The projected minimum rental payments under the terms of the leases as of March 31, 2020 were as follows:

(dollars in thousands)

    

Amount

Year ending December 31:

2020 remaining

$

2,060

2021

 

2,966

2022

 

2,808

2023

 

2,209

2024

 

1,356

Thereafter

 

5,588

Total future minimum lease payments

16,987

Less imputed interest

(1,939)

Total operating lease liabilities

$

15,048

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Note 8 – Loan Servicing Rights

Commercial FHA Mortgage Loan Servicing

The Company serviced commercial FHA mortgage loans for others with unpaid principal balances of $4.01 billion and $4.08 billion at March 31, 2020 and December 31, 2019, respectively. Changes in our commercial FHA loan servicing rights for the three months ended March 31, 2020 and 2019 are summarized as follows:

Three Months Ended

March 31, 

(dollars in thousands)

    

2020

    

2019

    

Loan servicing rights:

Balance, beginning of period

$

57,637

$

56,252

Originated servicing

 

 

213

Amortization

(728)

(678)

Balance, end of period

 

56,909

 

55,787

Valuation allowances:

Balance, beginning of period

 

4,944

2,805

Additions

 

8,468

25

Reductions

Balance, end of period

 

13,412

 

2,830

Loan servicing rights, net

$

43,497

$

52,957

Fair value:

At beginning of period

$

52,693

$

53,447

At end of period

$

43,497

$

52,957

The Company recorded impairment on commercial FHA loan servicing rights of $8.5 million and $25,000 for the three months ended March 31, 2020 and 2019, respectively. The impairment recognized in the current quarter was primarily the result of a reduction in the assumed earnings rates related to escrow and replacement reserves.

The fair value of commercial FHA loan servicing rights is determined using key assumptions, representing both general economic and other published information, including the assumed earnings rates related to escrow and replacement reserves, and the weighted average characteristics of the commercial portfolio, including the prepayment rate and discount rate. The prepayment rate considers many factors as appropriate, including lockouts, balloons, prepayment penalties, interest rate ranges, delinquencies and geographic location. The discount rate is based on an average pre-tax internal rate of return utilized by market participants in pricing the servicing portfolio. Significant increases or decreases in any one of these assumptions would result in a significantly lower or higher fair value measurement. The weighted average prepayment rate was 8.38% and 8.20% at March 31, 2020 and December 31, 2019, respectively, while the weighted average discount rate was 11.43% and 11.02% for the same periods, respectively.

United States Small Business Administration (“SBA”) Loan Servicing

At March 31, 2020 and December 31, 2019, the Company serviced SBA loans for others with unpaid principal balances of $47.8 million and $48.2 million, respectively. At March 31, 2020 and December 31, 2019, SBA loan servicing rights of $1.1 million are reflected in loan servicing rights in the consolidated balance sheet.

Residential Mortgage Loan Servicing

At March 31, 2020 and December 31, 2019, the Company serviced residential mortgage loans for others with unpaid principal balances of $365.5 million and $381.6 million, respectively. At March 31, 2020 and December 31, 2019, total residential mortgage servicing rights of $1.5 million and $2.0 million, respectively, are reflected in mortgage servicing rights held for sale in the consolidated balance sheet.

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Note 9 – Goodwill and Intangible Assets

At March 31, 2020 and December 31, 2019, goodwill totaled $172.8 million and $171.8 million.

The following table summarizes the carrying amount of goodwill by segment at March 31, 2020 and December 31, 2019.

March 31, 

December 31, 

(dollars in thousands)

2020

2019

Banking

    

$

157,158

    

$

156,120

Commercial FHA origination and servicing

10,892

10,892

Wealth management

 

4,746

 

4,746

Total goodwill

$

172,796

$

171,758

The Company’s intangible assets, consisting of core deposit and customer relationship intangibles, as of March 31, 2020 and December 31, 2019 are summarized as follows:

March 31, 2020

December 31, 2019

 

Gross

Gross

 

Carrying

Accumulated

Carrying

Accumulated

 

(dollars in thousands)

Amount

Amortization

Total

Amount

Amortization

Total

 

Core deposit intangibles

    

$

57,012

    

$

(32,131)

    

$

24,881

    

$

57,012

    

$

(30,674)

    

$

26,338

Customer relationship intangibles

 

14,071

 

(5,828)

 

8,243

 

14,071

 

(5,523)

 

8,548

Total intangible assets

$

71,083

$

(37,959)

$

33,124

$

71,083

$

(36,197)

$

34,886

Amortization of intangible assets was $1.8 million for both the three months ended March 31, 2020 and 2019.

Note 10 – Derivative Instruments

As part of the Company’s overall management of interest rate sensitivity, the Company utilizes derivative instruments to minimize significant, unanticipated earnings fluctuations caused by interest rate volatility, including interest rate lock commitments, forward commitments to sell mortgage-backed securities and interest rate swap contracts.

Interest Rate Lock Commitments / Forward Commitments to Sell Mortgage-Backed Securities

The Company issues interest rate lock commitments on originated fixed-rate commercial and residential real estate loans to be sold. The interest rate lock commitments and loans held for sale are hedged with forward contracts to sell mortgage-backed securities. The fair value of the interest rate lock commitments and forward contracts to sell mortgage-backed securities are included in other assets or other liabilities in the consolidated balance sheets. Changes in the fair value of derivative financial instruments are recognized in commercial FHA revenue and residential mortgage banking revenue in the consolidated statements of income.

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The following table summarizes the interest rate lock commitments and forward commitments to sell mortgage-backed securities held by the Company, their notional amount and estimated fair values at March 31, 2020 and December 31, 2019:

Notional Amount

Fair Value Gain

    

March 31, 

    

December 31, 

    

March 31, 

    

December 31, 

(dollars in thousands)

2020

2019

2020

2019

Derivative Instruments (included in Other Assets):

Interest rate lock commitments

$

239,119

$

222,654

$

4,305

$

3,350

Forward commitments to sell mortgage-backed securities

197,756

221,052

Total

$

436,875

$

443,706

$

4,305

$

3,350

Notional Amount

Fair Value Loss

March 31, 

December 31, 

March 31, 

December 31, 

(dollars in thousands)

    

2020

    

2019

    

2020

    

2019

Derivative Instruments (included in Other Liabilities):

Forward commitments to sell mortgage-backed securities

$

28,266

$

$

329

$

During the three months ended March 31, 2020 and 2019, the Company recognized net gains of $626,000 and $1.3 million, respectively, on derivative instruments in commercial FHA revenue and residential mortgage banking revenue in the consolidated statements of income.

Interest Rate Swap Contracts

The Company entered into interest rate swap contracts sold to commercial customers who wish to modify their interest rate sensitivity. The swaps are offset by contracts simultaneously purchased by the Company from other financial dealer institutions with mirror-image terms. Because of the mirror-image terms of the offsetting contracts, in addition to collateral provisions which mitigate the impact of non-performance risk, changes in the fair value subsequent to initial recognition have a minimal effect on earnings. These derivative contracts do not qualify for hedge accounting.

The notional amounts of the customer derivative instruments and the offsetting counterparty derivative instruments were $8.8 million and $9.0 million at March 31, 2020 and December 31, 2019, respectively. The fair value of the customer derivative instruments and the offsetting counterparty derivative instruments was $888,000 and $306,000 at March 31, 2020 and December 31, 2019, respectively, which are included in other assets and other liabilities, respectively, on the consolidated balance sheets.

Note 11 – Deposits

The following table summarizes the classification of deposits as of March 31, 2020 and December 31, 2019:

    

March 31, 

    

December 31, 

 

(dollars in thousands)

    

2020

    

2019

 

Noninterest-bearing demand

$

1,052,726

$

1,019,472

Interest-bearing:

Checking

 

1,425,022

 

1,342,788

Money market

 

849,642

 

787,662

Savings

 

534,457

 

522,456

Time

 

788,793

 

871,876

Total deposits

$

4,650,640

$

4,544,254

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Note 12 – Short-Term Borrowings

The following table presents the distribution of short-term borrowings and related weighted average interest rates as of March 31, 2020 and December 31, 2019:

Repurchase Agreements

March 31, 

December 31, 

(dollars in thousands)

2020

2019

Outstanding at period-end

    

$

43,578

$

82,029

Average amount outstanding

 

55,616

 

121,168

Maximum amount outstanding at any month end

 

52,013

 

138,907

Weighted average interest rate:

During period

 

0.73

%  

 

0.69

%

End of period

 

0.20

%  

 

0.67

%

Securities sold under agreements to repurchase, which are classified as secured borrowings, generally mature within one to four days from the transaction date. Securities sold under agreements to repurchase are reflected at the amount of cash received in connection with the transaction, which represents the amount of the Bank’s obligation. The Bank may be required to provide additional collateral based on the fair value of the underlying securities. Investment securities with a carrying amount of $46.6 million and $87.4 million at March 31, 2020 and December 31, 2019, respectively, were pledged for securities sold under agreements to repurchase.

The Company had available lines of credit of $17.7 million and $21.6 million at March 31, 2020 and December 31, 2019, respectively, from the Federal Reserve Discount Window. The lines are collateralized by a collateral agreement with respect to a pool of commercial real estate loans totaling $19.9 million and $24.3 million at March 31, 2020 and December 31, 2019, respectively. There were no outstanding borrowings at March 31, 2020 and December 31, 2019.

At March 31, 2020, the Company had available federal funds lines of credit totaling $20.0 million. These lines of credit were unused at March 31, 2020.

Note 13 – FHLB Advances and Other Borrowings

The following table summarizes our Federal Home Loan Bank (“FHLB”) advances and other borrowings as of March 31, 2020 and December 31, 2019:

    

March 31, 

    

December 31, 

 

(dollars in thousands)

    

2020

    

2019

 

Midland States Bancorp, Inc.

Series G redeemable preferred stock - 181 shares at $1,000 per share

$

181

$

181

Midland States Bank

FHLB advances – fixed rate, fixed term of $27.8 million and $28.0 million, at rates averaging 2.56% at March 31, 2020 and December 31, 2019 – maturing through June 2023, and putable fixed rate of $565.0 million and $465.0 million, at rates averaging 2.02% and 2.34% at March 31, 2020 and December 31, 2019, respectively – maturing through February 2030 with call provisions through August 2021

592,908

493,130

Total FHLB advances and other borrowings

$

593,089

$

493,311

The Company’s advances from the FHLB are collateralized by a blanket collateral agreement of qualifying mortgage and home equity line of credit loans and certain commercial real estate loans totaling approximately $1.95 billion and $1.94 billion at March 31, 2020 and December 31, 2019, respectively.

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Note 14 – Subordinated Debt

The following table summarizes the Company’s subordinated debt as of March 31, 2020 and December 31, 2019:

    

March 31, 

    

December 31, 

(dollars in thousands)

2020

2019

Subordinated debt issued June 2015 – fixed interest rate of 6.00% through June 2020 and a variable interest rate equivalent to three month LIBOR plus 4.35% thereafter, $31,075 and $38,325 at March 31, 2020 and December 31, 2019, respectively - maturing June 18, 2025

$

31,057

$

38,273

Subordinated debt issued June 2015 – fixed interest rate of 6.50%, $550 - maturing June 18, 2025

 

545

 

544

Subordinated debt issued October 2017 – fixed interest rate of 6.25% through October 2022 and a variable interest rate equivalent to three month LIBOR plus 4.23% thereafter, $40,000 - maturing October 15, 2027

39,513

39,496

Subordinated debt issued September 2019 – fixed interest rate of 5.00% through September 2024 and a variable interest rate equivalent to three month SOFR plus 3.61% thereafter, $72,750 - maturing September 30, 2029

71,596

71,549

Subordinated debt issued September 2019 – fixed interest rate of 5.50% through September 2029 and a variable interest rate equivalent to three month SOFR plus 4.05% thereafter, $27,250 - maturing September 30, 2034

26,794

26,791

Total subordinated debt

$

169,505

$

176,653

During the first quarter of 2020, the Company repurchased $7.3 million of the $38.3 million subordinated debentures issued in June 2015 with a fixed interest rate of 6.00% for the first five years, and a floating rate of interest equivalent to the three-month LIBOR plus 435 basis points thereafter. The Company recognized losses of $193,000 on the repurchase, which included the premium paid for the repurchase and the remaining unamortized debt issuance costs on the repurchase, in other noninterest expense in the consolidated statements of income.

The subordinated debentures may be included in Tier 2 capital (with certain limitations applicable) under current regulatory guidelines and interpretations.

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Note 15 – Earnings Per Share

Earnings per share are calculated utilizing the two-class method. Basic earnings per share are calculated by dividing the sum of distributed earnings to common shareholders and undistributed earnings allocated to common shareholders by the weighted average number of common shares outstanding. Diluted earnings per share are calculated by dividing the sum of distributed earnings to common shareholders and undistributed earnings allocated to common shareholders by the weighted average number of shares adjusted for the dilutive effect of common stock awards. The diluted earnings per share computation for the three months ended March 31, 2020 and 2019 excluded antidilutive stock options of 89,603 and 97,628, respectively, because the exercise prices of these stock options exceeded the average market prices of the Company’s common shares for those respective periods. Presented below are the calculations for basic and diluted earnings per common share for the three months ended March 31, 2020 and 2019:

    

Three Months Ended

    

March 31, 

(dollars in thousands, except per share data)

    

2020

    

2019

    

Net income

$

1,549

$

13,982

Preferred dividends declared

 

 

(82)

Preferred stock, premium amortization

48

Net income available to common shareholders

 

1,549

 

13,948

Common shareholder dividends

 

(6,510)

(5,776)

Unvested restricted stock award dividends

 

(65)

(47)

Undistributed earnings to unvested restricted stock awards

 

(65)

Undistributed (loss) earnings to common shareholders

$

(5,026)

$

8,060

Basic

Distributed earnings to common shareholders

$

6,510

$

5,776

Undistributed (loss) earnings to common shareholders

 

(5,026)

 

8,060

Total common shareholders earnings, basic

$

1,484

$

13,836

Diluted

Distributed earnings to common shareholders

$

6,510

$

5,776

Undistributed (loss) earnings to common shareholders

 

(5,026)

 

8,060

Total common shareholders earnings

 

1,484

 

13,836

Add back:

Undistributed earnings reallocated from unvested restricted stock awards

 

Total common shareholders earnings, diluted

$

1,484

$

13,836

Weighted average common shares outstanding, basic

 

24,433,975

23,998,119

Options and warrants

 

104,027

206,542

Weighted average common shares outstanding, diluted

 

24,538,002

 

24,204,661

Basic earnings per common share

$

0.06

$

0.58

Diluted earnings per common share

 

0.06

 

0.57

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Note 16 – Fair Value of Financial Instruments

Fair value is defined as the exchange price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date reflecting assumptions that a market participant would use when pricing an asset or liability. The hierarchy uses three levels of inputs to measure the fair value of assets and liabilities as follows:

Level 1: Unadjusted quoted prices for identical assets or liabilities traded in active markets.
Level 2: Significant other observable inputs other than Level 1, including quoted prices for similar assets and liabilities in active markets, quoted prices in less active markets, or other observable inputs that can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

Assets and liabilities measured and recorded at fair value, including financial assets for which the Company has elected the fair value option, on a recurring and nonrecurring basis as of March 31, 2020 and December 31, 2019, are summarized below:

March 31, 2020

 

Quoted prices

 

in active

Significant

 

markets

other

Significant

 

for identical

observable

unobservable

 

assets

inputs

inputs

 

(dollars in thousands)

Total

(Level 1)

(Level 2)

(Level 3)

 

Assets and liabilities measured at fair value on a recurring basis:

    

    

    

    

    

    

    

    

Assets

Investment securities available for sale:

U.S. government sponsored entities and U.S. agency securities

$

47,357

$

$

47,357

$

Mortgage-backed securities - agency

 

326,700

 

 

326,700

 

Mortgage-backed securities - non-agency

27,281

27,281

State and municipal securities

 

116,094

 

 

116,094

 

Corporate securities

 

138,822

 

 

137,897

 

925

Equity securities

5,640

5,640

Loans held for sale

 

113,852

 

 

113,852

 

Interest rate lock commitments

 

4,305

 

 

4,305

 

Interest rate swap contracts

888

888

Total

$

780,939

$

$

780,014

$

925

Liabilities

Interest rate swap contracts

$

888

$

$

888

$

Assets measured at fair value on a non-recurring basis:

Loan servicing rights

$

44,566

$

$

$

44,566

Mortgage servicing rights held for sale

1,460

1,460

Nonperforming loans

 

15,972

 

 

15,450

 

522

Other real estate owned

909

909

Assets held for sale

 

3,790

 

 

3,790

 

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Table of Contents

December 31, 2019

 

Quoted prices

 

in active

Significant

 

markets

other

Significant

 

for identical

observable

unobservable

 

assets

inputs

inputs

 

(dollars in thousands)

Total

(Level 1)

(Level 2)

(Level 3)

 

Assets and liabilities measured at fair value on a recurring basis:

    

    

    

    

    

    

    

    

Assets

Investment securities available for sale:

U.S. government sponsored entities and U.S. agency securities

$

60,020

$

$

60,020

$

Mortgage-backed securities - agency

 

324,974

 

 

324,974

 

Mortgage-backed securities - non-agency

 

17,148

 

 

17,148

 

State and municipal securities

 

124,555

 

 

124,555

 

Corporate securities

 

122,736

 

 

121,781

 

955

Equity securities

5,621

5,621

Loans held for sale

 

16,431

 

 

16,431

 

Interest rate lock commitments

 

3,350

 

 

3,350

 

Interest rate swap contracts

 

306

 

 

306

 

Total

$

675,141

$

$

674,186

$

955

Liabilities

Interest rate swap contracts

$

306

$

$

306

$

Assets measured at fair value on a non-recurring basis:

Loan servicing rights

$

53,824

$

$

$

53,824

Mortgage servicing rights held for sale

1,972

1,972

Nonperforming loans

14,693

12,518

2,175

Assets held for sale

3,974

3,974

The following table provides a reconciliation of activity for assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2020 and 2019:

Three Months Ended

March 31, 

(dollars in thousands)

2020

2019

Balance, beginning of period

$

955

$

1,923

Total realized in earnings (1)

2

22

Total unrealized in other comprehensive income (2)

(30)

7

Net settlements (principal and interest)

(2)

(22)

Balance, end of period

$

925

$

1,930

(1)Amounts included in interest income from investment securities taxable in the consolidated statements of income.
(2)Represents change in unrealized gains or losses for the period included in other comprehensive income for assets held at the end of the reporting period.

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Table of Contents

The following table provides quantitative information about significant unobservable inputs used in fair value measurements of Level 3 assets measured at fair value on a recurring basis at March 31, 2020 and December 31, 2019:

Valuation

Unobservable

(dollars in thousands)

Fair Value

technique

input / assumptions

Range (weighted average)(1)

March 31, 2020

Corporate securities

$

925

Consensus pricing

Net market price

-1.5% - 2.0% (1.0%)

December 31, 2019

Corporate securities

$

955

Consensus pricing

Net market price

-2.0% - 2.5% (1.5%)

(1)Unobservable inputs were weighted by the relative fair value of the instruments.

The significant unobservable inputs used in the fair value measurement of the Company’s corporate securities is net market price. The corporate securities are not actively traded, and as a result, fair value is determined utilizing third-party valuation services through consensus pricing. Significant changes in any of the inputs in isolation would result in a significant change to the fair value measurement. Generally, net market price increases when market interest rates decline and declines when market interest rates increase.

The following table presents losses recognized on assets measured on a nonrecurring basis for the three months ended March 31, 2020 and 2019:

Three Months Ended

March 31, 

(dollars in thousands)

    

2020

    

2019

 

Loan servicing rights

$

8,468

$

25

Mortgage servicing rights held for sale

496

Nonperforming loans

12,919

981

Other real estate owned

605

16

Assets held for sale

146

Total losses on assets measured on a nonrecurring basis

$

22,634

$

1,022

The following tables present quantitative information about significant unobservable inputs used in fair value measurements of Level 3 assets measured on a nonrecurring basis at March 31, 2020 and December 31, 2019:

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Table of Contents

Valuation

Unobservable

(dollars in thousands)

Fair Value

technique

input / assumptions

Range (weighted average)(1)

March 31, 2020

Loan servicing rights:

Commercial MSR

$

43,497

Discounted cash flow

Prepayment speed

8.00% - 22.50% (8.38%)

Discount rate

10.00% - 27.00% (11.43%)

SBA servicing rights

$

1,069

Discounted cash flow

Prepayment speed

8.31% - 9.21% (8.60%)

Discount rate

No range (11.70%)

MSR held for sale

$

1,460

Discounted cash flow

Prepayment speed

14.04% - 26.28% (16.92%)

Discount rate

9.00% - 11.50% (10.13%)

Other:

Nonperforming loans

$

522

Fair value of collateral

Discount for type of property,

No range (4.50%)

age of appraisal and current status

December 31, 2019

Loan servicing rights:

Commercial MSR

$

52,693

Discounted cash flow

Prepayment speed

8.00% - 18.00% (8.20%)

Discount rate

10.00% - 14.00% (11.02%)

SBA servicing rights

$

1,131

Discounted cash flow

Prepayment speed

8.31% - 9.21% (8.60%)

Discount rate

No range (11.70%)

MSR held for sale

$

1,972

Discounted cash flow

Prepayment speed

8.64% - 26.28% (12.42%)

Discount rate

9.50% - 12.50% (10.75%)

Other:

Nonperforming loans

$

2,175

Fair value of collateral

Discount for type of property,

4.32% - 8.00% (5.22%)

age of appraisal and current status

(1)Unobservable inputs were weighted by the relative fair value of the instruments.

Loan Servicing Rights. In accordance with GAAP, the Company must record impairment charges on loan servicing rights on a non-recurring basis when the carrying value exceeds the estimated fair value. The fair value of our servicing rights is estimated by using a cash flow valuation model, which calculates the present value of estimated future net servicing cash flows, taking into consideration expected loan prepayment rates, discount rates, servicing costs, replacement reserves and other economic factors which are estimated based on current market conditions. The determination of fair value of servicing rights relies upon Level 3 inputs.

Nonperforming loans. Nonperforming loans are measured and recorded at fair value on a non-recurring basis. All of our nonaccrual loans and restructured loans are considered nonperforming and are reviewed individually for the amount of impairment, if any. Most of our loans are collateral dependent and, accordingly, we measure nonperforming loans based on the estimated fair value of such collateral. The fair value of each loan’s collateral is generally based on estimated market prices from an independently prepared appraisal, which is then adjusted for the cost related to liquidating such collateral; such valuation inputs result in a nonrecurring fair value measurement that is categorized as a Level 2 measurement. When adjustments are made to an appraised value to reflect various factors such as the age of the appraisal or known changes in the market or the collateral, such valuation inputs are considered unobservable and the fair value measurement is categorized as a Level 3 measurement. The nonperforming loans categorized as Level 3 also include unsecured loans and other secured loans whose fair values are based significantly on unobservable inputs such as the strength of a guarantor, cash flows discounted at the effective loan rate, and management’s judgment.

ASC Topic 825, Financial Instruments, requires disclosure of the estimated fair value of certain financial instruments and the methods and significant assumptions used to estimate such fair values. Additionally, certain financial instruments and all nonfinancial instruments are excluded from the applicable disclosure requirements.

The Company has elected the fair value option for newly originated commercial and residential loans held for sale. These loans are intended for sale and are hedged with derivative instruments. We have elected the fair value option

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to mitigate accounting mismatches in cases where hedge accounting is complex and to achieve operational simplification.

The following table presents the difference between the aggregate fair value and the aggregate remaining principal balance for loans for which the fair value option has been elected as of March 31, 2020 and December 31, 2019:

March 31, 2020

December 31, 2019

Aggregate

Contractual

Aggregate

Contractual

(dollars in thousands)

fair value

Difference

principal

fair value

Difference

principal

Commercial loans held for sale

    

$

1,706

$

48

$

1,658

$

8,236

$

206

$

8,030

Residential loans held for sale

    

12,458

667

11,791

8,195

446

7,749

Consumer loans held for sale

99,688

99,688

Total loans held for sale

$

113,852

$

715

$

113,137

$

16,431

$

652

$

15,779

The following table presents the amount of gains and losses from fair value changes included in income before income taxes for financial assets carried at fair value for the three months ended March 31, 2020 and 2019:

Three Months Ended

March 31, 

(dollars in thousands)

2020

2019

Commercial loans held for sale

$

(158)

$

(328)

Residential loans held for sale

255

(57)

Total loans held for sale

$

97

$

(385)

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The carrying values and estimated fair value of certain financial instruments not carried at fair value at March 31, 2020 and December 31, 2019 were as follows:

March 31, 2020

 

Quoted prices

 

in active

Significant

 

markets

other

Significant

 

for identical

observable

unobservable

 

Carrying

assets

inputs

inputs

 

(dollars in thousands)

Amount

Fair Value

(Level 1)

(Level 2)

(Level 3)

 

Assets

Cash and due from banks

    

$

445,097

    

$

445,097

    

$

445,097

    

$

    

$

Federal funds sold

 

4,299

 

4,299

 

4,299

 

 

Nonmarketable equity securities

 

46,068

 

46,068

 

 

46,068

 

Loans, net

 

4,337,659

 

4,387,244

 

 

 

4,387,244

Accrued interest receivable

 

16,532

 

16,532

 

 

16,532

 

Liabilities

Deposits

$

4,650,640

$

4,661,375

$

$

4,661,375

$

Short-term borrowings

 

43,578

 

43,578

 

 

43,578

 

FHLB and other borrowings

 

593,089

 

631,450

 

 

631,450

 

Subordinated debt

 

169,505

 

160,344

 

 

160,344

 

Trust preferred debentures

 

48,420

 

42,391

 

 

42,391

 

Accrued interest payable

 

7,078

 

7,078

 

 

7,078

 

December 31, 2019

Quoted prices

in active

Significant

markets

other

Significant

for identical

observable

unobservable

Carrying

assets

inputs

inputs

(dollars in thousands)

Amount

Fair Value

(Level 1)

(Level 2)

(Level 3)

Assets

Cash and due from banks

    

$

392,694

    

$

392,694

    

$

392,694

    

$

    

$

Federal funds sold

 

1,811

 

1,811

 

1,811

 

 

Nonmarketable equity securities

 

44,505

 

44,505

 

 

44,505

 

Loans, net

 

4,373,382

 

4,385,768

 

 

 

4,385,768

Accrued interest receivable

 

16,346

 

16,346

 

 

16,346

 

Liabilities

Deposits

$

4,544,254

$

4,548,327

$

$

4,548,327

$

Short-term borrowings

 

82,029

 

82,029

 

 

82,029

 

FHLB and other borrowings

 

493,311

 

506,832

 

 

506,832

 

Subordinated debt

 

176,653

 

182,189

 

 

182,189

 

Trust preferred debentures

 

48,288

 

53,811

 

 

53,811

 

Accrued interest payable

 

6,400

 

6,400

 

 

6,400

 

Note 17 – Commitments, Contingencies and Credit Risk

In the normal course of business, there are outstanding various contingent liabilities such as claims and legal actions, which are not reflected in the consolidated financial statements. No material losses are anticipated as a result of these actions or claims.

We are a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. The contract amounts of those instruments reflect the extent of involvement we have in particular classes of financial instruments.

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Our exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank used the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The commitments are principally tied to variable rates. Loan commitments as of March 31, 2020 and December 31, 2019 were as follows:

    

March 31, 

    

December 31, 

 

(dollars in thousands)

    

2020

    

2019

 

Commitments to extend credit

$

728,472

$

725,506

Financial guarantees – standby letters of credit

 

55,676

 

106,678

The Company estimates expected credit losses over the contractual period in which the Company is exposed to credit risk via a contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the Company. The ACL on off-balance sheet credit exposures is adjusted as a provision for credit loss expense included in other expense on the consolidated income statement. The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over its estimated life. Expected utilization rates are compared to the current funded portion of the total commitment amount as a practical expedient for funded exposure at default. At March 31, 2020, the ACL for off-balance sheet credit exposures was $2.4 million.

The Company establishes a mortgage repurchase liability to reflect management’s estimate of losses on loans for which the Company could have a repurchase obligation based on the volume of loans sold in 2020 and years prior, borrower default expectations, historical investor repurchase demand and appeals success rates, and estimated loss severity. Loans repurchased from investors are initially recorded at fair value, which becomes the Company’s new accounting basis. Any difference between the loan’s fair value and the outstanding principal amount is charged or credited to the mortgage repurchase liability, as appropriate. Subsequent to repurchase, such loans are carried in loans receivable. There were no losses as a result of make-whole requests and loan repurchases for the three months ended March 31, 2020 and 2019. The liability for unresolved repurchase demands totaled $289,000 at March 31, 2020 and December 31, 2019.

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Note 18 – Segment Information

Our business segments are defined as Banking, Wealth Management, Commercial FHA Origination and Servicing, and Other. The reportable business segments are consistent with the internal reporting and evaluation of the principle lines of business of the Company. The banking segment provides a wide range of financial products and services to consumers and businesses, including commercial, commercial real estate, mortgage and other consumer loan products; commercial equipment leasing; mortgage loan sales and servicing; letters of credit; various types of deposit products, including checking, savings and time deposit accounts; merchant services; and corporate treasury management services. The wealth management segment consists of trust and fiduciary services, brokerage and retirement planning services. The commercial FHA origination and servicing segment provides for the origination and servicing of government sponsored mortgages for multifamily and healthcare facilities. The other segment includes the operating results of the parent company, our captive insurance business unit, and the elimination of intercompany transactions.

Selected business segment financial information as of and for the three months ended March 31, 2020 and 2019 were as follows:

    

    

    

Commercial FHA

    

    

Wealth

Origination and

(dollars in thousands)

Banking

Management

Servicing

Other

Total

Three Months Ended March 31, 2020

Net interest income (expense)

$

49,927

$

$

(64)

$

(3,212)

$

46,651

Provision for credit losses on loans

 

10,569

 

 

 

 

10,569

Noninterest income

 

10,213

 

5,677

 

(7,232)

 

(60)

 

8,598

Noninterest expense

 

37,074

 

3,613

 

2,094

 

(106)

 

42,675

Income (loss) before income taxes (benefit)

 

12,497

 

2,064

 

(9,390)

 

(3,166)

 

2,005

Income taxes (benefit)

 

3,909

 

205

 

(2,629)

(1,029)

 

456

Net income (loss)

$

8,588

$

1,859

$

(6,761)

$

(2,137)

$

1,549

Total assets

$

6,132,963

$

21,875

$

81,394

$

(28,002)

$

6,208,230

Three Months Ended March 31, 2019

Net interest income (expense)

$

48,518

$

$

(176)

$

(2,741)

$

45,601

Provision for credit losses on loans

 

3,243

 

 

 

 

3,243

Noninterest income

 

8,940

 

4,953

 

3,238

 

(56)

 

17,075

Noninterest expense

 

35,371

 

3,247

 

2,811

 

(332)

 

41,097

Income (loss) before income taxes (benefit)

 

18,844

 

1,706

 

251

 

(2,465)

 

18,336

Income taxes (benefit)

 

4,975

 

140

 

71

(832)

 

4,354

Net income (loss)

$

13,869

$

1,566

$

180

$

(1,633)

$

13,982

Total assets

$

5,582,494

$

19,039

$

94,797

$

(54,550)

$

5,641,780

1Note 19 – Related Party Transactions

A member of our board of directors has ownership in a building the Company utilizes for office space located in Effingham, Illinois. During the three months ended March 31, 2020, the Company paid rent on this space of $17,000.

The Company utilizes the services of a company to act as a general manager for the construction of new facilities. A member of our board of directors is a substantial shareholder of this company and currently serves as its Chairman. During the three months ended March 31, 2019, the Company paid $210,000 to this company for work on various projects.

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Note 20 – Revenue From Contracts with Customers

The Company’s revenue from contracts with customers in the scope of Topic 606 is recognized within noninterest income in the consolidated statements of income. The following presents noninterest income, segregated by revenue streams in-scope and out-of-scope of Topic 606, for the three months ended March 31, 2020 and 2019.

Three Months Ended

March 31, 

(dollars in thousands)

2020

2019

Noninterest income - in-scope of Topic 606

Wealth management revenue:

Trust management/administration fees

$

4,209

$

3,617

Investment advisory fees

529

529

Investment brokerage fees

395

219

Other

544

588

Service charges on deposit accounts:

Nonsufficient fund fees

1,866

1,754

Other

790

766

Interchange revenues

2,833

2,680

Other income:

Merchant services revenue

351

375

Other

938

818

Noninterest income - out-of-scope of Topic 606

(3,857)

5,729

Total noninterest income

$

8,598

$

17,075

Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and investment securities. In addition, certain noninterest income streams such as commercial FHA revenue, residential mortgage banking revenue and gain on sales of investment securities, net are also not in scope of Topic 606. Topic 606 is applicable to noninterest income streams such as wealth management revenue, service charges on deposit accounts, interchange revenue, gain on sales of other real estate owned, and certain other noninterest income streams. The noninterest income streams considered in-scope by Topic 606 are discussed below.

Wealth Management Revenue

Wealth management revenue is primarily comprised of fees earned from the management and administration of trusts and other customer assets. The Company also earns investment advisory fees through its SEC registered investment advisory subsidiary. The Company’s performance obligation in both of these instances is generally satisfied over time and the resulting fees are recognized monthly, based upon the month-end market value of the assets under management and contractually determined fee schedules. Payment is generally received a few days after month end through a direct charge to each customer’s account. The Company does not earn performance-based incentives. Optional services such as real estate sales and tax return preparation services are also available to existing trust and asset management customers. The Company’s performance obligation for these transactional-based services is generally satisfied, and related revenue recognized, at a point in time (i.e., as incurred). Payment is received shortly after services are rendered. Fees generated from transactions executed by the Company’s third party broker dealer are remitted by them to the Company on a monthly basis for that month’s transactional activity.

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Service Charges on Deposit Accounts

Service charges on deposit accounts consist of fees received under depository agreements with customers to provide access to deposited funds, serve as custodian of deposited funds, and when applicable, pay interest on deposits. These service charges primarily include non-sufficient fund fees and other account related service charges. Non-sufficient fund fees are earned when a depositor presents an item for payment in excess of available funds, and the Company, at its discretion, provides the necessary funds to complete the transaction. The Company generates other account related service charge revenue by providing depositors proper safeguard and remittance of funds as well as by delivering optional services for depositors, such as check imaging or treasury management, that are performed upon the depositor’s request. The Company’s performance obligation for the proper safeguard and remittance of funds, monthly account analysis and any other monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. Payment for service charges on deposit accounts is typically received immediately or in the following month through a direct charge to a customer’s account.

Interchange Revenue

Interchange revenue includes debit / credit card income and ATM user fees. Card income is primarily comprised of interchange fees earned for standing ready to authorize and providing settlement on card transactions processed through the MasterCard interchange network. The levels and structure of interchange rates are set by MasterCard and can vary based on cardholder purchase volumes. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with completion of the Company’s performance obligation, the transaction processing services provided to the cardholder. Payment is typically received immediately or in the following month. ATM fees are primarily generated when a Company cardholder withdraws funds from a non-Company ATM or a non-Company cardholder withdraws funds from a Company ATM. The Company satisfies its performance obligation for each transaction at the point in time when the ATM withdrawal is processed.

Other Noninterest Income

The other noninterest income revenue streams within the scope of Topic 606 consist of merchant services revenue, safe deposit box rentals, wire transfer fees, paper statement fees, check printing commissions, gain on sales of other real estate owned, and other noninterest related fees. Revenue from the Company’s merchant services business consists principally of transaction and account management fees charged to merchants for the electronic processing of transactions. These fees are net of interchange fees paid to the credit card issuing bank, card company assessments, and revenue sharing amounts. Account management fees are considered earned at the time the merchant’s transactions are processed or other services are performed. Fees related to the other components of other noninterest income within the scope of Topic 606 are largely transactional based, and therefore, the Company’s performance obligation is satisfied and related revenue recognized, at the point in time the customer uses the selected service to execute a transaction.

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Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion explains our financial condition and results of operations as of and for the three months ended March 31, 2020. Annualized results for this interim period may not be indicative of results for the full year or future periods. The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes presented elsewhere in this report and our Annual Report on Form 10-K for the year ended December 31, 2019, filed with the SEC on February 28, 2020.

In addition to the historical information contained herein, this Form 10-Q includes “forward-looking statements” within the meaning of such term in the Private Securities Litigation Reform Act of 1995. These statements are subject to many risks and uncertainties, including the effects of the COVID-19 pandemic, including its potential effects on the economic environment, our customers and our operations, as well as any changes to federal, state or local government laws, regulations or orders in connection with the pandemic; changes in interest rates and other general economic, business and political conditions, including the effects of widespread disease or pandemics; changes in the financial markets; changes in business plans as circumstances warrant; risks related to mergers and acquisitions and the integration of acquired businesses; and other risks detailed from time to time in filings made by the Company with the SEC. Readers should note that the forward-looking statements included herein are not a guarantee of future events, and that actual events may differ materially from those made in or suggested by the forward-looking statements. Forward-looking statements generally can be identified by the use of forward-looking terminology such as “will,” “propose,” “may,” “plan,” “seek,” “expect,” “intend,” “estimate,” “anticipate,” “believe,” or “continue,” or similar terminology. Any forward-looking statements presented herein are made only as of the date of this document, and we do not undertake any obligation to update or revise any forward-looking statements to reflect changes in assumptions, the occurrence of unanticipated events, or otherwise.

Significant Developments and Transactions

Each item listed below materially affects the comparability of our results of operations for the three months ended March 31, 2020 and 2019, and our financial condition as of March 31, 2020 and December 31, 2019, and may affect the comparability of financial information we report in future fiscal periods.

Impact of COVID-19. The progression of the COVID-19 pandemic in the United States has had an adverse impact on our financial condition and results of operations as of and for the three months ended March 31, 2020, and is expected to have a complex and significant adverse impact on the economy, the banking industry and our Company in future fiscal periods, all subject to a high degree of uncertainty.

Effects on Our Market Areas. Our commercial and consumer banking products and services are delivered primarily in Illinois and Missouri, where individual and governmental responses to the COVID-19 pandemic have led to a broad curtailment of economic activity beginning March 2020. In Illinois, the Governor issued a series of orders, including an order that, subject to limited exceptions, all individuals stay at home and non-essential businesses cease all activities, other than minimum basic operations. This order was effective beginning March 21, 2020 and a subsequently modified version currently extends the order through May 30, 2020. In Missouri, the Director of the Missouri Department of Health and Senior Services issued an order that individuals stay at home and that businesses abide by certain limitations on gathering sizes. This order was effective from April 6, 2020 and currently extends through May 3, 2020. The Bank and its branches have remained open during these orders because banking is deemed an essential business, although it has suspended lobby access at its branches since March 17, 2020.

Each state has experienced a dramatic increase in unemployment levels as a result of the curtailment of business activities, with over 755,000 new claims processed from March 1 through April 18, 2020, according to the Illinois Department of Employment Security, and with approximately 400,000 claims, representing approximately 13% of Missouri’s labor force, filed from March 14 through April 18, 2020, according to the Missouri Department of Labor and Industrial Relations, and these levels are expected to rise further.

To date, many of the public health and economic effects of COVID-19 have been concentrated in large cities, but we anticipate that similar effects may occur on a more delayed basis in smaller cities and communities, where our banking operations are primarily focused.

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Policy and Regulatory Developments. Federal, state and local governments and regulatory authorities have enacted and issued a range of policy responses to the COVID-19 pandemic, including the following:

The Federal Reserve decreased the range for the federal funds target rate by 0.50% on March 3, 2020, and by another 1.0% on March 16, 2020, reaching a range of 0.0 – 0.25%.
On March 27, 2020, President Trump signed the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) which established a $2.0 trillion economic stimulus package, including cash payments to individuals, supplemental unemployment insurance benefits and a $349.0 billion loan program administered through the SBA, referred to as the paycheck protection program (“PPP”). Under the PPP, small businesses, sole proprietorships, independent contractors and self-employed individuals may apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. The Bank is participating as a lender in the PPP. On or about April 16, 2020, the SBA notified lenders that the $349.0 billion earmarked for the PPP was exhausted. On April 24, 2020, an additional $310.0 billion in funding for PPP loans was authorized, with such funds available for PPP loans beginning on April 27, 2020. In addition, the CARES Act provides financial institutions the option to temporarily suspend certain requirements under GAAP related to TDRs for a limited period of time to account for the effects of COVID-19.
On April 7, 2020, federal banking regulators issued a revised Interagency Statement on Loan Modifications and Reporting for Financial Institutions, which, among other things, encouraged financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations because of the effects of COVID-19, and stated that institutions generally do not need to categorize COVID-19-related modifications as TDRs and that the agencies will not direct supervised institutions to automatically categorize all COVID-19 related loan modifications as TDRs.
On April 9, 2020, the Federal Reserve announced additional measures aimed at supporting small and midsized business, as well as state and local governments impacted by COVID-19. The Federal Reserve announced the Main Street Business Lending Program, which establishes two new loan facilities intended to facilitate lending to small and midsized businesses: (1) the Main Street New Loan Facility (MSNLF), and (2) the Main Street Expanded Loan Facility (MSELF). MSNLF loans are unsecured term loans originated on or after April 8, 2020, while MSELF loans are provided as upsized tranches of existing loans originated before April 8, 2020. The combined size of the program will be up to $600 billion. The program is designed for businesses with up to 10,000 employees or $2.5 billion in 2019 revenues. To obtain a loan, borrowers must confirm that they are seeking financial support because of COVID-19 and that they will not use proceeds from the loan to pay off debt. The Federal Reserve also stated that it would provide additional funding to banks offering PPP loans to struggling small businesses. Lenders participating in the PPP will be able to exclude loans financed by the facility from their leverage ratio. In addition, the Federal Reserve created a Municipal Liquidity Facility to support state and local governments with up to $500 billion in lending, with the Treasury Department backing $35 billion for the facility using funds appropriated by the CARES Act. The facility will make short-term financing available to cities with a population of more than one million or counties with a population of greater than two million. The Federal Reserve expanded both the size and scope its Primary and Secondary Market Corporate Credit Facilities to support up to $750 billion in credit to corporate debt issuers. This will allow companies that were investment grade before the onset of COVID-19 but then subsequently downgraded after March 22, 2020 to gain access to the facility. Finally, the Federal Reserve announced that its Term Asset-Backed Securities Loan Facility will be scaled up in scope to include the triple A-rated tranche of commercial mortgage-backed securities and newly issued collateralized loan obligations. The size of the facility is $100 billion.

Effects on Our Business. The COVID-19 pandemic and the specific developments referred to above will have a significant impact on our business. In particular, we anticipate that a significant portion of the Bank’s borrowers in the hotel, restaurant, gaming, long-term healthcare and retail industries will continue to endure significant economic distress, which has caused, and will continue to cause, them to draw on their existing lines of credit and adversely affect their ability to repay existing indebtedness, and is expected to adversely impact the value of collateral. These developments, together with economic conditions generally, are also expected to impact our commercial real estate portfolio, particularly with respect to real estate with exposure to these industries, our equipment leasing business and loan portfolio, our consumer loan business and loan portfolio, and the value of certain collateral securing our loans. As a

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result, we anticipate that our financial condition, capital levels and results of operations will be adversely affected, as described in further detail below.

Our Response. We have taken numerous steps in response to the COVID-19 pandemic, including the following:

To protect the health and safety of our employees and customers, we instituted the following measures:
oOn March 17, 2020, we closed our banking center lobbies but continued to serve clients by appointment or through our drive-up lanes.
oOn March 23, 2020, we closed our corporate offices, effectively leveraging our investments in technology to transition to working remotely
To meet the financial needs of our customers, we have instituted the following measure:
oThe Company has received requests for payment deferrals totaling $665 million through April 20, 2020 and we are working with our customers to address their specific needs.
oThe Bank participated, as a lender, in the PPP and began taking applications on the first day of the program. Through April 16, 2020, we had processed $263 million in PPP loans that had been approved by the SBA.

Adoption of CECL. Effective January 1, 2020, the Company adopted CECL. The CECL model requires a reporting entity to estimate credit losses expected over the “life” of an asset, or pool of assets. The estimate of expected credit losses will consider historical information, current information, and the reasonable and supportable forecasts of future events and circumstances, as well as estimates of prepayments. The ACL on loans and related provision for credit losses on loans was modeled under the provisions of CECL for the three months ended March 31, 2020, as opposed to the incurred loss model for periods prior to January 1, 2020.

Issuance of Subordinated Debt. On September 20, 2019, the Company issued, through a private placement, $100.0 million aggregate principal amount of subordinated notes, which was structured into two tranches: $72.75 million aggregate principal amount of 5.00% Fixed-to-Floating Rate Subordinated Notes due 2029, and $27.25 million aggregate principal amount of 5.50% Fixed-to-Floating Rate Subordinated Notes due 2034. On January 13, 2020, the Company completed its offer to exchange all $100.0 million aggregate principal amount of subordinated notes for substantially identical subordinated notes that were registered under the Securities Act of 1933, in satisfaction of the Company’s obligations under a registration rights agreement entered into with the purchasers of the subordinated notes in the private placement transaction. The Company used a portion of the net proceeds from the offering to repay a $30.0 million senior term loan and intends to use the remaining net proceeds for general corporate purposes.

Stock Repurchase. On July 29, 2019, the Company redeemed, in whole, the shares of Series H preferred stock. The price paid by the Company for such shares was equal to $1,000 per share plus any unpaid dividends.

Recent Acquisitions. On July 17, 2019, the Company completed its acquisition of HomeStar and its wholly-owned banking subsidiary, HomeStar Bank, which operated five full-service banking centers in northern Illinois. The Company acquired $366.3 million in assets, including $211.1 million in loans, and assumed $321.7 million in deposits.

Purchased Loans.  Our net interest margin benefits from accretion income associated with purchase accounting discounts established on the purchased loans included in our acquisitions. Our reported net interest margin for the three months ended March 31, 2020 and 2019 was 3.48% and 3.73%, respectively. Accretion income associated with accounting discounts established on loans acquired totaled $2.2 million and $2.5 million for the three months ended March 31, 2020 and 2019, respectively, increasing the reported net interest margin by 16 and 17 basis points for each respective period. In the first quarter of 2020, PCI loans were reclassified as PCD loans and due to this change, accretion income will decrease going forward.

Results of Operations

Overview. During the three months ended March 31, 2020, we generated net income of $1.5 million, or diluted earnings per common share of $0.06, compared to $14.0 million, or diluted earnings per common share of $0.57, in the comparable period of 2019. Earnings for the first quarter of 2020 compared to first quarter of 2019 declined primarily due to a $7.3 million increase in provision for credit losses on loans, an $8.5 million decrease in noninterest income and a $1.6 million increase in noninterest expense. These results were partially offset by a $1.1 million increase in net

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interest income and a $3.9 million decrease in income tax expense. As discussed in further detail below, the COVID-19 pandemic and the adoption of CECL had a significant impact on net income for the first quarter of 2020, resulting in the negative quarter over quarter comparison.

The following table sets forth condensed income statement information of the Company for the three months ended March 31, 2020 and 2019:

For the Three Months Ended

March 31,

(dollars in thousands, except per share data)

2020

2019

Income Statement Data:

Interest income

$

61,314

$

59,432

Interest expense

14,663

13,831

Net interest income

46,651

45,601

Provision for credit losses on loans

10,569

3,243

Noninterest income

8,598

17,075

Noninterest expense

42,675

41,097

Income before income taxes

2,005

18,336

Income taxes

456

4,354

Net income

1,549

13,982

Preferred stock dividends and premium amortization

34

Net income available to common shareholders

$

1,549

$

13,948

Basic earnings per common share

$

0.06

$

0.58

Diluted earnings per common share

0.06

0.57

Net Interest Income and Margin. Our primary source of revenue is net interest income, which is the difference between interest income from interest-earning assets (primarily loans and securities) and interest expense of funding sources (primarily interest-bearing deposits and borrowings). Net interest income is influenced by many factors, primarily the volume and mix of interest-earning assets, funding sources, and interest rate fluctuations. Noninterest-bearing sources of funds, such as demand deposits and shareholders’ equity, also support earning assets. The impact of the noninterest-bearing sources of funds is captured in net interest margin, which is calculated as net interest income divided by average interest-earning assets. Net interest margin is presented on a tax-equivalent basis, which means that tax-free interest income has been adjusted to a pretax-equivalent income, assuming a federal income tax rate of 21% for the three months ended March 31, 2020 and 2019.

As described above, one of the factors that impacts net interest income is interest rate fluctuations. The Federal Reserve decreased the target federal funds interest rate by 25 basis points in each of August 2019, September 2019 and October 2019. In addition, in response to the COVID-19 pandemic, the Federal Reserve decreased the target federal funds interest rate by a total of 150 basis points in March 2020. These decreases impact the comparability of net interest income between 2019 and 2020.

During the three months ended March 31, 2020, net interest income, on a tax-equivalent basis, increased to $47.1 million compared to $46.1 million for the comparative prior year quarter. The tax-equivalent net interest margin decreased to 3.48% for the first quarter of 2020 compared to 3.73% in the first quarter of 2019.

Average Balance Sheet, Interest and Yield/Rate Analysis. The following table presents the average balance sheets, interest income, interest expense and the corresponding average yields earned and rates paid for the three months ended March 31, 2020 and 2019. The average balances are principally daily averages and, for loans, include both performing and nonperforming balances. Interest income on loans includes the effects of discount accretion and net deferred loan origination costs accounted for as yield adjustments.

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Three Months Ended March 31, 

2020

2019

Average

Interest

Yield /

Average

Interest

Yield /

(tax-equivalent basis, dollars in thousands)

    

Balance

    

& Fees

    

Rate

    

Balance

    

& Fees

    

Rate

 

EARNING ASSETS:

Federal funds sold and cash investments

$

337,851

$

1,062

1.26

%  

$

152,078

$

907

2.42

%

Investment securities:

Taxable investment securities

 

536,895

 

4,094

3.05

 

500,672

3,683

 

2.94

Investment securities exempt from federal income tax (1)

 

125,555

 

1,250

3.98

 

154,092

1,349

 

3.50

Total securities

 

662,450

 

5,344

 

3.23

 

654,764

 

5,032

 

3.07

Loans:

Loans (2)

 

4,282,828

53,539

5.03

 

4,020,502

51,882

 

5.23

Loans exempt from federal income tax (1)

 

101,378

1,058

4.20

 

108,391

1,234

 

4.61

Total loans

 

4,384,206

 

54,597

 

5.01

 

4,128,893

 

53,116

 

5.22

Loans held for sale

19,844

191

3.87

30,793

299

3.94

Nonmarketable equity securities

45,124

605

5.39

44,279

621

5.69

Total earning assets

 

5,449,475

$

61,799

 

4.56

%

 

5,010,807

$

59,975

 

4.85

%

Noninterest-earning assets

 

624,594

 

618,996

Total assets

$

6,074,069

$

5,629,803

INTEREST-BEARING LIABILITIES:

Checking and money market deposits

$

2,191,295

$

3,795

0.70

%  

$

1,813,875

$

3,377

 

0.75

%

Savings deposits

 

525,994

 

130

0.10

 

449,174

 

220

 

0.20

Time deposits

 

803,996

 

4,258

2.13

 

652,576

 

2,702

 

1.68

Brokered deposits

 

28,230

 

179

2.55

 

178,354

 

1,064

 

2.42

Total interest-bearing deposits

3,549,515

8,362

0.95

3,093,979

7,363

0.97

Short-term borrowings

 

55,616

101

0.73

 

135,337

237

 

0.71

FHLB advances and other borrowings

 

532,733

2,967

2.24

 

673,250

3,847

 

2.32

Subordinated debt

 

170,026

2,509

5.90

 

94,156

1,514

 

6.43

Trust preferred debentures

 

48,357

724

6.02

 

47,848

870

 

7.38

Total interest-bearing liabilities

 

4,356,247

$

14,663

 

1.35

%  

 

4,044,570

$

13,831

 

1.39

%

NONINTEREST-BEARING LIABILITIES

Noninterest-bearing deposits

 

986,178

 

919,185

Other noninterest-bearing liabilities

 

78,943

 

51,838

Total noninterest-bearing liabilities

 

1,065,121

 

971,023

Shareholders’ equity

 

652,701

 

614,210

Total liabilities and shareholders’ equity

$

6,074,069

$

5,629,803

Net interest income / net interest margin (3)

$

47,136

 

3.48

%  

$

46,144

 

3.73

%

(1)Interest income and average rates for tax-exempt loans and securities are presented on a tax-equivalent basis, assuming a federal income tax rate of 21%. Tax-equivalent adjustments totaled $485,000 and $543,000 for the three months ended March 31, 2020 and 2019, respectively.
(2)Average loan balances include nonaccrual loans. Interest income on loans includes amortization of deferred loan fees, net of deferred loan costs.
(3)Net interest margin during the periods presented represents: (i) the difference between interest income on interest-earning assets and the interest expense on interest-bearing liabilities, divided by (ii) average interest-earning assets for the period.

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Interest Rates and Operating Interest Differential. Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest-earning assets and interest-bearing liabilities, as well as changes in average interest rates. The following table shows the effect that these factors had on the interest earned on our interest-earning assets and the interest incurred on our interest-bearing liabilities. The effect of changes in volume is determined by multiplying the change in volume by the previous period’s average rate. Similarly, the effect of rate changes is calculated by multiplying the change in average rate by the previous period’s volume. Changes which are not due solely to volume or rate have been allocated proportionally to the change due to volume and the change due to rate.

Three Months Ended March 31, 2020

 

Compared with

 

Three Months Ended March 31, 2019

 

Change due to:

Interest

 

(tax-equivalent basis, dollars in thousands)

    

Volume

    

Rate

    

Variance

  

EARNING ASSETS:

    

    

    

Federal funds sold and cash investments

$

854

$

(699)

$

155

Investment securities:

Taxable investment securities

 

271

 

140

 

411

Investment securities exempt from federal income tax

 

(267)

 

168

 

(99)

Total securities

 

4

 

308

 

312

Loans:

Loans

 

3,563

(1,906)

 

1,657

Loans exempt from federal income tax

 

(72)

(104)

 

(176)

Total loans

 

3,491

 

(2,010)

 

1,481

Loans held for sale

(105)

(3)

(108)

Nonmarketable equity securities

14

(30)

(16)

Total earning assets

$

4,258

$

(2,434)

$

1,824

INTEREST-BEARING LIABILITIES:

Checking and money market deposits

$

695

$

(277)

$

418

Savings deposits

 

29

 

(119)

 

(90)

Time deposits

 

728

 

828

 

1,556

Brokered deposits

 

(922)

 

37

 

(885)

Total interest-bearing deposits

530

469

999

Short-term borrowings

 

(142)

6

 

(136)

FHLB advances and other borrowings

 

(780)

(100)

 

(880)

Subordinated debt

 

1,170

(175)

 

995

Trust preferred debentures

 

12

(158)

 

(146)

Total interest-bearing liabilities

$

790

$

42

$

832

Net interest income

$

3,468

$

(2,476)

$

992

Interest Income. Interest income, on a tax-equivalent basis, increased $1.8 million to $61.8 million in the first quarter of 2020 as compared to the same quarter in 2019 primarily due to an increase in average earning assets. Average earning assets increased to $5.4 billion in the first quarter of 2020 from $5.0 billion in the same quarter in 2019 primarily driven by an increase in average loan balances resulting from the $211.1 million of loans added from the acquisition of HomeStar. The yield on earning assets decreased 29 basis points to 4.56% from 4.85%. The decrease in yield on earning assets was primarily driven by a decrease in the yield on loans due to the impact of lower market interest rates and a reduction in accretion income associated with accounting discounts established on loans acquired, which totaled $2.2 million and $2.5 million for the three months ended March 31, 2020 and 2019, respectively.

Interest Expense. Interest expense on deposits increased to $8.4 million in the first quarter of 2020 from $7.4 million in the first quarter of 2019. The $1.0 million increase was primarily due to an increase of $0.5 million in both rate and volume of deposits. The increase in rate was primarily attributable to higher interest rates paid on time deposits which have yet to reprice down due to the recent decrease in market rates. The increase in volume was primarily attributable to the addition of $321.7 million of deposits added from the acquisition of HomeStar, and an increase in our average balances of $301.2 million from our Insured Cash Sweep (“ICS”) product offering. With the increase in deposits from the acquisition of HomeStar and organically, we have been able to replace, in part, wholesale funds through the intentional decrease in brokered time deposits which results in lower average rate paid on deposits.

Interest expense on subordinated debt increased $1.0 million to $2.5 million due primarily to the issuance of $100.0 million of subordinated debt in September 2019. The increase was partially offset by the redemption of $16.5

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million of subordinated debt during the fourth quarter of 2019 and an additional $7.3 million in the first quarter of 2020. In turn, the reported cost of funds decreased 53 basis points to 5.90% in the current quarter.

Provision for Credit Losses on Loans. The provision for credit losses on loans totaled $10.6 million and $3.2 million for the three months ended March 31, 2020 and 2019, respectively. The methodology used to calculate the required ACL on loans, and ultimately the provision for credit losses on loans was CECL for the first quarter of 2020 and the incurred loss model for the first quarter of 2019. The CECL model recognizes losses over the expected life of the loan as opposed to the losses expected to already have been incurred. The increase in provision for credit losses on loans is primarily a result of an increase in qualitative reserves due to a change in forecasting assumptions because of the COVID-19 pandemic, as the economic forecast assumed a significant increase in unemployment due to a slowing economy for the second and third quarters of 2020 before starting to show a recovery. The provision was also impacted by a higher level of net charge-offs experienced in the first quarter of 2020, specifically, one loan in the amount of $3.6 million. This charge off was in excess of the specific reserves of $1.4 million resulting in a $2.2 million additional provision for the quarter.

Noninterest Income. The following table sets forth the major components of our noninterest income for the three months ended March 31, 2020 and 2019:

Three Months Ended

 

March 31, 

Increase

 

(dollars in thousands)

2020

    

2019

    

(decrease)

 

Noninterest income:

Wealth management revenue

$

5,677

$

4,953

$

724

14.6

%

Commercial FHA revenue

 

1,267

 

3,295

 

(2,028)

(61.5)

Residential mortgage banking revenue

 

1,755

 

834

 

921

110.4

Service charges on deposit accounts

 

2,656

 

2,520

 

136

5.4

Interchange revenue

 

2,833

 

2,680

 

153

5.7

Gain on sales of other real estate owned

 

15

 

66

 

(51)

(77.3)

Impairment on commercial mortgage servicing rights

(8,468)

(25)

(8,443)

33,772.0

Other income

 

2,863

 

2,752

 

111

4.0

Total noninterest income

$

8,598

$

17,075

$

(8,477)

(49.6)

%

Wealth management revenue. Income from our wealth management business increased $0.7 million for the three months ended March 31, 2020 as compared to the same period in 2019. Assets under administration decreased to $2.97 billion at March 31, 2020 from $3.10 billion at March 31, 2019, primarily due to the decline in the market as a result of COVID-19. The decline primarily offset the addition of $181.2 million of wealth management assets under administration from the acquisition of HomeStar. Estate fees increased this quarter by $0.3 million from the same period one year ago.

Commercial FHA revenue. Commercial FHA revenue for the three months ended March 31, 2020 was $1.3 million, a decrease of $2.0 million from the first quarter of 2019. Interest rate lock commitments were $13.3 million in the current quarter compared to $64.5 million for the comparable period in 2019.

Residential mortgage banking revenue. Residential mortgage banking revenue for the three months ended March 31, 2020 totaled $1.8 million, compared to $0.8 million for the same period in 2019. The increase was primarily attributable to an increase in production as the decrease in the 10-year treasury rate stimulated a significant increase in mortgage refinance activity. Loans originated in the first quarter of 2020 totaled $72.4 million, with 49% representing refinance transactions versus purchase transactions. Loans originated during the same period one year prior totaled $30.5 million.

Impairment of Commercial Mortgage Servicing Rights. Impairment of commercial mortgage servicing rights was $8.5 million for the three months ended March 31, 2020 compared to impairment of $25,000 for the three months ended March 31, 2019. Loans serviced for others totaled $4.01 billion and $3.97 billion at March 31, 2020 and 2019, respectively. The impairment was primarily the result of a reduction in the assumed earnings rates related to escrow and replacement reserves.

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Noninterest Expense. The following table sets forth the major components of noninterest expense for the three months ended March 31, 2020 and 2019:

Three Months Ended

 

March 31, 

Increase

 

(dollars in thousands)

2020

    

2019

    

(decrease)

 

Noninterest expense:

    

    

    

Salaries and employee benefits

$

21,063

$

22,039

$

(976)

(4.4)

%

Occupancy and equipment

 

4,869

 

4,853

 

16

0.3

Data processing

 

5,334

 

4,724

 

610

12.9

FDIC insurance

 

1

 

435

 

(434)

(99.8)

Professional

 

1,855

 

2,073

 

(218)

(10.5)

Marketing

 

981

 

1,234

 

(253)

(20.5)

Communications

 

1,290

 

817

 

473

57.9

Loan expense

 

516

 

360

 

156

43.3

Other real estate owned

 

711

 

93

 

618

664.5

Amortization of intangible assets

 

1,762

 

1,810

 

(48)

(2.7)

Loss on mortgage servicing rights held for sale

496

496

Other

 

3,797

 

2,659

 

1,138

42.8

Total noninterest expense

$

42,675

$

41,097

$

1,578

3.8

%

Salaries and employee benefits. Salaries and employee benefits expense decreased $1.0 million during the three months ended March 31, 2020 as compared to the same period in 2019. The Company employed 1,027 and 1,102 employees at March 31, 2020 and 2019, respectively. In January 2020, the Company announced a reduction in its staffing by approximately 50 full-time employee positions, representing approximately 5% of the Company’s workforce.  The Company recorded a $0.8 million one-time charge related to this staffing level adjustment in the first quarter of 2020. This charge was offset by a reduction in annual bonus expense in the first quarter of 2020 compared to the same period one year ago due to anticipated financial results not meeting established thresholds for these annual awards.

Data processing fees. The $0.6 million increase in data processing fees during the three months ended March 31, 2020, as compared to the same period in 2019, was primarily the result of our continuing investments in technology to better serve our growing customer base.

FDIC insurance. The $0.4 million decrease in FDIC insurance during the three months ended March 31, 2020, as compared to the same period in 2019, was primarily the result a $0.4 million small business tax credit received from the FDIC. This credit was provided by the FDIC to banks with total consolidated assets of less than $10.0 billion for the portion of their assessments that contributed to the growth in the FDIC’s reserve ratio. The Company expects to recognize additional credits of $0.2 million in a future period.

Communication expense. The increase in communication expense of $0.5 million for the three months ended March 31, 2020, as compared to the same period in 2019, was primarily due to continued investment and standardization of services and technology across our banking center network.

Other real estate owned expense. The increase in other real estate owned expense of $0.6 million for the three months ended March 31, 2020, as compared to the same period in 2019, was primarily due to impairment recorded on one property due to a decline in property value from one year ago.

Loss on mortgage servicing rights held for sale. The Company recognized a $0.5 million loss on mortgage servicing rights held for sale for the three months ended March 31, 2020. Market disruption as a result of COVID-19 resulted in a decreased demand by potential acquirers and a resulting decrease in value.

Other noninterest expense. The increase in other noninterest expense of $1.1 million for the three months ended March 31, 2020, as compared to the same period in 2019, was primarily due to $1.0 million increase in our reserve for unfunded commitments related to one borrower.

Income Tax Expense. Income tax expense was $0.5 million and $4.4 million for the three months ended March 31, 2020 and 2019, respectively. The effective tax rate decreased to 22.7% for the first quarter of 2020 as compared to

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23.7% for the first quarter of 2019. The decrease in the effective tax rate was primarily attributable to the impact of tax-free revenues having a greater impact to pre-tax income due to the reduced level of earnings this quarter.

Financial Condition

Assets. Total assets increased to $6.21 billion at March 31, 2020, as compared to $6.09 billion at December 31, 2019.

Loans. The loan portfolio is the largest category of our assets. At March 31, 2020, total loans were $4.38 billion compared to $4.40 billion at December 31, 2019. The following table shows loans by category as of March 31, 2020 and December 31, 2019:

March 31, 

December 31

(dollars in thousands)

    

2020

    

2019

 

Commercial

$

1,092,779

$

1,055,185

Commercial real estate

 

1,507,280

 

1,526,504

Construction and land development

 

208,361

 

208,733

Total commercial loans

2,808,420

2,790,422

Residential real estate

 

548,014

 

568,291

Consumer

 

673,404

 

710,116

Lease financing

 

346,366

 

332,581

Total loans, gross

$

4,376,204

$

4,401,410

Allowance for credit losses on loans

(38,545)

(28,028)

Total loans, net

$

4,337,659

$

4,373,382

Total loans decreased $25.2 million to $4.38 billion at March 31, 2020 as compared to December 31, 2019. We continued to see loan growth from our equipment financing business, which is booked in the commercial loans and lease financing portfolios. These increases were offset by several large loan payoffs and principal reductions in the commercial real estate portfolio, and payoffs and repayments in the residential real estate portfolio. Consumer loans declined as $99.7 million was transferred to loans held for sale in the first quarter of 2020. We anticipate that loan growth will remain slow in the future for our commercial real estate, consumer and lease financing loan portfolios as a result of COVID-19 and the related decline in economic conditions in our market areas.

The principal segments of our loan portfolio are discussed below:

Commercial loans. We provide a mix of variable and fixed rate commercial loans. The loans are typically made to small- and medium-sized manufacturing, wholesale, retail and service businesses for working capital needs, business expansions and farm operations. Commercial loans generally include lines of credit and loans with maturities of five years or less. The loans are generally made with business operations as the primary source of repayment, but may also include collateralization by inventory, accounts receivable and equipment, and generally include personal guarantees.

Commercial real estate loans. Our commercial real estate loans consist of both real estate occupied by the borrower for ongoing operations and non-owner occupied real estate properties. The real estate securing our existing commercial real estate loans includes a wide variety of property types, such as owner occupied offices, warehouses and production facilities, office buildings, hotels, mixed-use residential and commercial facilities, retail centers, multifamily properties and assisted living facilities. Our commercial real estate loan portfolio also includes farmland loans. Farmland loans are generally made to a borrower actively involved in farming rather than to passive investors.

Construction and land development loans. Our construction and land development loans are comprised of residential construction, commercial construction and land acquisition and development loans. Interest reserves are generally established on real estate construction loans.

Residential real estate loans. Our residential real estate loans consist of residential properties that generally do not qualify for secondary market sale.

Consumer loans. Our consumer loans include direct personal loans, indirect automobile loans, lines of credit and installment loans originated through home improvement specialty retailers and contractors. Personal loans are generally secured by automobiles, boats and other types of personal property and are made on an installment basis.

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Lease financing. Our equipment leasing business provides financing leases to varying types of businesses nationwide for purchases of business equipment and software. The financing is secured by a first priority interest in the financed asset and generally requires monthly payments.

The following table shows the contractual maturities of our loan portfolio and the distribution between fixed and adjustable interest rate loans at March 31, 2020:

March 31, 2020

 

Within One Year

One Year to Five Years

After Five Years

 

Adjustable

Adjustable

Adjustable

 

(dollars in thousands)

    

Fixed Rate

    

Rate

    

Fixed Rate

    

Rate

    

Fixed Rate

    

Rate

    

Total

 

Commercial

$

41,803

$

295,524

$

414,216

$

83,600

$

202,030

$

55,606

$

1,092,779

Commercial real estate

 

258,789

 

77,516

 

673,474

 

133,549

 

77,348

 

286,604

 

1,507,280

Construction and land development

 

17,083

 

43,515

 

24,363

 

97,048

 

1,954

 

24,398

 

208,361

Total commercial loans

 

317,675

 

416,555

 

1,112,053

 

314,197

 

281,332

 

366,608

 

2,808,420

Residential real estate

 

4,284

9,366

12,185

36,557

212,067

273,555

 

548,014

Consumer

 

3,436

4,641

650,665

10,331

4,306

25

 

673,404

Lease financing

 

8,919

262,132

75,315

 

346,366

Total loans

$

334,314

$

430,562

$

2,037,035

$

361,085

$

573,020

$

640,188

$

4,376,204

Loan Quality

We use what we believe is a comprehensive methodology to monitor credit quality and prudently manage credit concentration within our loan portfolio. Our underwriting policies and practices govern the risk profile, credit and geographic concentration for our loan portfolio. We also have what we believe to be a comprehensive methodology to monitor these credit quality standards, including a risk classification system that identifies potential problem loans based on risk characteristics by loan type as well as the early identification of deterioration at the individual loan level. In addition to our ACL on loans, our purchase discounts on acquired loans provide additional protections against credit losses.

Analysis of the Allowance for Credit Losses on Loans. The following table allocates the ACL on loans, or the allowance, by loan category:

March 31, 2020

December 31, 2019

(dollars in thousands)

    

Allowance

% (1)

    

Allowance

% (1)

    

Commercial

$

11,740

1.07

%

$

10,031

0.95

%

Commercial real estate

 

13,583

 

0.90

 

10,272

0.67

Construction and land development

 

1,321

 

0.63

 

290

0.14

Total commercial loans

26,644

 

0.95

20,593

0.74

Residential real estate

 

4,638

 

0.85

 

2,499

0.44

Consumer

 

1,954

 

0.29

 

2,642

0.37

Lease financing

 

5,309

 

1.53

 

2,294

0.69

Total allowance for credit losses on loans

$

38,545

 

0.88

$

28,028

0.64

(1)Represents the percentage of the allowance to total loans in the respective category.

The allowance represents our estimate of expected credit losses using relevant information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. Historical credit loss experience provides the basis for the estimation of expected credit losses. Adjustments to historical loss information are made for differences in current loan-specific risk characteristics such as differences in underwriting standards, portfolio mix, delinquency level, or term as well as for changes in environmental conditions, such as changes in unemployment rates, property values or relevant factors.

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The following table provides an analysis of the ACL on loans, provision for credit losses on loans and net charge-offs for the three months ended March 31, 2020 and 2019:

As of and for the

Three Months Ended

March 31, 

(dollars in thousands)

    

2020

    

2019

    

Balance, beginning of period

$

40,811

$

20,903

Charge-offs:

Commercial

 

3,398

 

112

Commercial real estate

 

7,873

 

58

Construction and land development

 

12

 

44

Residential real estate

 

388

 

153

Consumer

 

598

 

556

Lease financing

 

948

 

459

Total charge-offs

13,217

1,382

Recoveries:

Commercial

5

15

Commercial real estate

14

7

Construction and land development

59

7

Residential real estate

44

22

Consumer

191

210

Lease financing

69

66

Total recoveries

382

327

Net charge-offs

12,835

1,055

Provision for credit losses on loans

10,569

3,243

Balance, end of period

$

38,545

$

23,091

Gross loans, end of period

$

4,376,204

$

4,092,106

Average loans

$

4,384,206

$

4,128,893

Net charge-offs to average loans

 

1.18

%  

 

0.10

%  

Allowance to total loans

 

0.88

%  

 

0.56

%  

Individual loans considered to be uncollectible are charged off against the allowance. Factors used in determining the amount and timing of charge-offs on loans include consideration of the loan type, length of delinquency, sufficiency of collateral value, lien priority and the overall financial condition of the borrower. Collateral value is determined using updated appraisals and/or other market comparable information. Charge-offs are generally taken on loans once the impairment is determined to be other-than-temporary. Recoveries on loans previously charged off are added to the allowance. Net charge-offs to average loans were 1.18% and 0.10% for the three months ended March 31, 2020 and 2019, respectively. Approximately $10.2 million of the net charge-offs in the first quarter of 2020 were related to three loans that had been on non-performing status with specific reserves held against them for at least one year. These charge-offs were unrelated to the impact of the COVID-19 pandemic.

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Nonperforming Loans. The following table sets forth our nonperforming assets by asset categories as of the dates indicated. Nonperforming loans include nonaccrual loans, loans past due 90 days or more and still accruing interest and loans modified under troubled debt restructurings. The balances of nonperforming loans reflect the net investment in these assets, including deductions for purchase discounts. For December 31, 2019, PCI loans are excluded from nonperforming status.

    

March 31, 

    

December 31, 

    

(dollars in thousands)

2020

    

2019

Nonperforming loans:

    

    

Commercial

$

4,659

$

6,278

Commercial real estate

 

33,560

 

23,462

Construction and land development

 

5,005

 

1,349

Residential real estate

 

12,279

 

9,024

Consumer

 

512

 

376

Lease financing

 

2,151

 

1,593

Total nonperforming loans

 

58,166

 

42,082

Other real estate owned, non-guaranteed

 

8,992

 

7,945

Nonperforming assets

$

67,158

$

50,027

Nonperforming loans to total loans

 

1.33

%  

 

0.96

%  

Nonperforming assets to total assets

 

1.08

%  

 

0.82

%  

We did not recognize interest income on nonaccrual loans during the three months ended March 31, 2020 or 2019 while the loans were in nonaccrual status. Additional interest income that would have been recorded on nonaccrual loans had they been current in accordance with their original terms was $890,000 and $653,000 for the three months ended March 31, 2020 and 2019, respectively. The Company recognized interest income on commercial and commercial real estate loans modified under troubled debt restructurings of $20,000 and $32,000 for the three months ended March 31, 2020 and 2019, respectively.

We use a ten grade risk rating system to categorize and determine the credit risk of our loans. Potential problem loans include loans with a risk grade of 7, which are "special mention," and loans with a risk grade of 8, which are "substandard" loans that are not considered to be nonperforming. These loans generally require more frequent loan officer contact and receipt of financial data to closely monitor borrower performance. Potential problem loans are managed and monitored regularly through a number of processes, procedures and committees, including oversight by a loan administration committee comprised of executive officers and other members of the Bank's senior management team.

The following table presents the recorded investment of potential problem commercial loans by loan category at the dates indicated:

Commercial

Construction &

 

Commercial

Real Estate

Land Development

 

Risk Category

Risk Category

Risk Category

 

(dollars in thousands)

    

7

    

8 (1)

    

7

    

8 (1)

    

7

    

8 (1)

    

Total

 

March 31, 2020

$

21,776

$

21,375

$

31,729

$

48,103

$

3,857

$

1,297

$

128,137

December 31, 2019

17,435

22,952

18,450

66,231

2,420

1,250

128,738

(1)Includes only those 8-rated loans that are not included in nonperforming loans.

Loans Held for Sale. At March 31, 2020, the Company had commercial, residential and consumer loans held for sale totaling $113.9 million compare to $16.4 million at December 31, 2019. During the first quarter of 2020, the Company had committed to a plan to sell certain consumer loans and transferred $99.7 million of consumer loans to loans held for sale with no gain or loss recognized upon the transfer. The sale is expected to be completed in May 2020.

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Investment Securities. Our investment strategy aims to maximize earnings while maintaining liquidity in securities with minimal credit risk. The types and maturities of securities purchased are primarily based on our current and projected liquidity and interest rate sensitivity positions.

The following table sets forth the book value and percentage of each category of investment securities at March 31, 2020 and December 31, 2019. The book value for investment securities classified as available for sale is equal to fair market value.

March 31, 2020

December 31, 2019

Book

% of

Book

% of

(dollars in thousands)

    

Value

    

Total

    

Value

 

Total

    

Investment securities, available for sale:

    

    

    

    

    

U.S. government sponsored entities and U.S. agency securities

$

47,357

7.2

%  

$

60,020

 

9.2

%  

Mortgage-backed securities - agency

 

326,700

49.8

 

324,974

 

50.0

Mortgage-backed securities - non-agency

 

27,281

4.2

 

17,148

 

2.7

State and municipal securities

 

116,094

17.7

 

124,555

 

19.2

Corporate securities

 

138,822

21.1

 

122,736

 

18.9

Total investment securities, available for sale, at fair value

$

656,254

100.0

%

$

649,433

 

100.0

%

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The following table sets forth the book value, maturities and weighted average yields for our investment portfolio at March 31, 2020. The book value for investment securities classified as available for sale is equal to fair market value.

March 31, 2020

 

Weighted

 

Book

% of 

Average

 

(dollars in thousands)

    

Value

    

Total

    

Yield

 

Investment securities, available for sale:

    

    

    

U.S. government sponsored entities and U.S. agency securities:

Maturing within one year

$

18,112

2.8

%  

2.5

%

Maturing in one to five years

22,269

3.4

2.4

Maturing in five to ten years

6,632

1.0

2.4

Maturing after ten years

344

0.0

2.6

Total U.S. government sponsored entities and U.S. agency securities

$

47,357

 

7.2

%  

2.4

%  

Mortgage-backed securities - agency:

Maturing within one year

$

13,754

2.1

2.9

Maturing in one to five years

229,756

35.0

2.7

Maturing in five to ten years

33,189

5.1

2.8

Maturing after ten years

50,001

7.6

2.8

Total mortgage-backed securities - agency

$

326,700

 

49.8

%  

2.7

%  

Mortgage-backed securities - non-agency:

Maturing within one year

$

0.0

0.0

Maturing in one to five years

0.0

0.0

Maturing in five to ten years

0.0

0.0

Maturing after ten years

27,281

4.2

3.0

Total mortgage-backed securities - non-agency

$

27,281

 

4.2

%  

3.0

%  

State and municipal securities (1):

Maturing within one year

$

10,500

1.6

4.6

Maturing in one to five years

39,335

6.0

4.1

Maturing in five to ten years

47,097

7.2

4.0

Maturing after ten years

19,162

2.9

3.9

Total state and municipal securities

$

116,094

 

17.7

%  

4.1

%  

Corporate securities:

Maturing within one year

$

5,189

0.8

4.0

Maturing in one to five years

17,783

2.7

4.0

Maturing in five to ten years

115,850

17.6

5.1

Maturing after ten years

Total corporate securities

$

138,822

 

21.1

%  

4.9

%  

Total investment securities, available for sale

$

656,254

 

100.0

%  

3.4

%  

(1)Weighted average yield for tax-exempt securities are presented on a tax-equivalent basis assuming a federal income tax rate of 21%.

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The table below presents the credit ratings at March 31, 2020 at fair value for our investment securities classified as available for sale.

March 31, 2020

 

Amortized

Estimated

Average Credit Rating

 

(dollars in thousands)

    

Cost

    

Fair Value

    

AAA

    

AA+/−

    

A+/−

    

BBB+/−

    

<BBB−

    

Not Rated

 

Investment securities available for sale:

U.S. government sponsored entities and U.S. agency securities

$

46,428

$

47,357

$

37,897

$

9,460

$

$

$

$

Mortgage-backed securities - agency

 

317,332

 

326,700

 

2,564

 

324,136

 

Mortgage-backed securities - non-agency

28,121

27,281

1,432

25,849

State and municipal securities

 

112,500

 

116,094

 

20,863

 

74,239

 

9,223

2,599

491

8,679

Corporate securities

 

140,287

 

138,822

 

 

 

25,808

79,857

33,157

Total investment securities, available for sale

$

644,668

$

656,254

$

62,756

$

433,684

$

35,031

$

82,456

$

491

$

41,836

Cash and Cash Equivalents. Cash and cash equivalents increased $54.9 million to $449.4 million as of March 31, 2020 compared to December 31, 2019. The Company chose to increase its cash holdings and improve liquidity in light of the uncertainties due to COVID-19.

Liabilities. Total liabilities increased to $5.58 billion at March 31, 2020 compared to $5.43 billion at December 31, 2019.

Deposits. We emphasize developing total client relationships with our customers in order to increase our retail and commercial core deposit bases, which are our primary funding sources. Our deposits consist of noninterest-bearing and interest-bearing demand, savings and time deposit accounts.

The following table summarizes our average deposit balances and weighted average rates for the three months ended March 31, 2020 and 2019:

Three Months Ended March 31,

2020

2019

Weighted

Weighted

Average

Average

Average

Average

(dollars in thousands)

    

Balance

    

Rate

    

Balance

    

Rate

    

Deposits:

    

    

    

    

Noninterest-bearing demand

$

986,178

 

$

919,185

Interest-bearing:

Checking

 

1,379,661

 

0.58

%  

 

990,612

0.54

%  

Money market

 

811,634

 

0.89

 

823,263

1.02

Savings

 

525,994

 

0.10

 

449,174

0.20

Time, less than $250,000

 

685,933

 

2.08

 

571,344

1.64

Time, $250,000 and over

 

118,063

 

2.40

 

81,232

1.96

Time, brokered

 

28,230

 

2.55

 

178,354

2.42

Total interest-bearing

$

3,549,515

 

0.95

%  

$

3,093,979

 

0.97

%  

Total deposits

$

4,535,693

 

0.74

%  

$

4,013,164

 

0.74

%  

The following table sets forth the maturity of time deposits of $250,000 or more and brokered time deposits as of March 31, 2020:

March 31, 2020

 

Maturity Within:

 

Three

Three to Six

Six to 12

After 12

 

(dollars in thousands)

    

Months or Less

    

Months

    

Months

    

Months

    

Total

 

Time, $250,000 and over

$

41,001

$

23,982

$

14,030

$

31,720

$

110,733

Time, brokered

 

 

 

4,835

 

17,994

 

22,829

Total

$

41,001

$

23,982

$

18,865

$

49,714

$

133,562

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Total deposits increased $106.4 million to $4.65 billion at March 31, 2020, as compared to December 31, 2019. The increase primarily resulted from organic deposit growth of $133.3 million, partially offset by the intentional reduction of $26.9 million in brokered money market deposits and brokered time deposits. At March 31, 2020, total deposits were comprised of 22.6% of noninterest-bearing demand accounts, 60.4% of interest-bearing transaction accounts and 17.0% of time deposits. At March 31, 2020, brokered time deposits totaled $22.9 million, or 0.5% of total deposits, compared to $49.7 million, or 1.1% of total deposits, at December 31, 2019.

Capital Resources and Liquidity Management

Capital Resources. Shareholders’ equity is influenced primarily by earnings, dividends, issuances and redemptions of common stock and changes in accumulated other comprehensive income caused primarily by fluctuations in unrealized holding gains or losses, net of taxes, on available-for-sale investment securities.

Shareholders’ equity decreased $30.8 million to $631.2 million at March 31, 2020 as compared to December 31, 2019. The Company generated net income of $1.5 million during the first three months of 2020 and had an increase in accumulated other comprehensive income of $1.0 million. Offsetting these increases to shareholders’ equity were $6.6 million of dividends to common shareholders and $20.6 million in stock repurchases. In addition, the Company recorded a $7.2 million reduction to retained earnings related to the adoption of CECL effective January 1, 2020.

On August 6, 2019, the Company announced that its Board of Directors authorized the Company to repurchase up to $25.0 million of its common stock, which amount was increased to $50.0 million on March 11, 2020 by an amendment approved by the Board of Directors. Stock repurchases under the program may be made from time to time on the open market, in privately negotiated transactions, or in any manner that complies with applicable securities laws, at the discretion of the Company. The amended program will be in effect until December 31, 2020, with the timing of purchases and the number of shares repurchased under the program dependent upon a variety of factors including price, trading volume, corporate and regulatory requirements and market condition. The repurchase program may be suspended or discontinued at any time without notice. As of March 31, 2020, $24.6 million, or 1,219,341 shares of the Company’s common stock, had been repurchased under the program.

Liquidity Management. Liquidity refers to the measure of our ability to meet the cash flow requirements of depositors and borrowers, while at the same time meeting our operating, capital and strategic cash flow needs, all at a reasonable cost. We continuously monitor our liquidity position to ensure that assets and liabilities are managed in a manner that will meet all short-term and long-term cash requirements. We manage our liquidity position to meet the daily cash flow needs of customers, while maintaining an appropriate balance between assets and liabilities to meet the return on investment objectives of our shareholders.

Integral to our liquidity management is the administration of short-term borrowings. To the extent we are unable to obtain sufficient liquidity through core deposits, we seek to meet our liquidity needs through wholesale funding or other borrowings on either a short- or long-term basis.

Securities sold under agreements to repurchase, which are classified as secured borrowings, generally mature within one to four days from the transaction date. Securities sold under agreements to repurchase are reflected at the amount of cash received in connection with the transaction, which represents the amount of the Bank’s obligation. The Bank may be required to provide additional collateral based on the fair value of the underlying securities. Investment securities with a carrying amount of $46.6 million and $87.4 million at March 31, 2020 and December 31, 2019, respectively, were pledged for securities sold under agreements to repurchase.

The Company had available lines of credit of $17.7 million and $21.6 million at March 31, 2020 and December 31, 2019, respectively, from the Federal Reserve Discount Window. The lines are collateralized by a collateral agreement with respect to a pool of commercial real estate loans totaling $19.9 million and $24.3 million at March 31, 2020 and December 31, 2019, respectively. There were no outstanding borrowings at March 31, 2020 and December 31, 2019.

The Company will have additional liquidity by participating in the Paycheck Protection Program Lending Facility (“Facility”). Under the Facility, the Company will pledge its PPP loans to the Federal Reserve Bank as collateral for available advances. PPP loans pledged as collateral to secure extensions of credit under the Facility will be valued at the principal amount of the PPP loan.

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At March 31, 2020, the Company had available federal funds lines of credit totaling $20.0 million, which were unused.

The Company is a corporation separate and apart from the Bank and, therefore, must provide for its own liquidity. The Company’s main source of funding is dividends declared and paid to us by the Bank. There are statutory, regulatory and debt covenant limitations that affect the ability of the Bank to pay dividends to the Company. Management believed at March 31, 2020, that these limitations will not impact our ability to meet our ongoing short-term cash obligations.

Regulatory Capital Requirements

We are subject to various regulatory capital requirements administered by the federal and state banking regulators. Failure to meet regulatory capital requirements may result in certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for “prompt corrective action”, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting policies.

At March 31, 2020, the Company and the Bank exceeded the regulatory minimums and the Bank met the regulatory definition of well-capitalized based on the most recent regulatory notification.

The following table presents the Company and the Bank’s capital ratios and the minimum requirements at March 31, 2020:

 

Minimum

Regulatory

Well

Ratio

    

Actual

Requirements (1)

    

Capitalized

 

Total risk-based capital ratio

Midland States Bancorp, Inc.

 

13.73

%  

10.50

%  

N/A

Midland States Bank

12.38

10.50

10.00

%

Common equity Tier 1 risk-based capital ratio

Midland States Bancorp, Inc.

8.47

7.00

N/A

Midland States Bank

11.76

7.00

6.50

Tier 1 risk-based capital ratio

Midland States Bancorp, Inc.

9.76

8.50

N/A

Midland States Bank

11.76

8.50

8.00

Tier 1 leverage ratio

Midland States Bancorp, Inc.

8.39

4.00

N/A

Midland States Bank

10.12

4.00

5.00

(1)Total capital (to risk-weighted assets), Common Equity Tier 1 capital (to risk-weighted assets) and Tier 1 capital (to risk-weighted assets) includes the capital conservation buffer of 2.5%.

Contractual Obligations

The following table contains supplemental information regarding our total contractual obligations at March 31, 2020:

Payments Due

 

Less than

One to

Three to

More than

 

(dollars in thousands)

    

One Year

    

Three Years

    

Five Years

    

Five Years

    

Total

 

Deposits without a stated maturity

$

3,861,847

$

$

$

$

3,861,847

Time deposits

 

446,051

317,831

24,859

52

788,793

Securities sold under repurchase agreements

 

43,578

43,578

FHLB advances and other borrowings

 

3,901

81,499

327,508

180,181

593,089

Operating lease obligations

 

2,396

5,111

2,705

4,836

15,048

Subordinated debt

 

169,505

169,505

Trust preferred debentures

 

48,420

48,420

Total contractual obligations

$

4,357,773

$

404,441

$

355,072

$

402,994

$

5,520,280

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We believe that we will be able to meet our contractual obligations as they come due through the maintenance of adequate cash levels. We expect to maintain adequate cash levels through profitability, loan and securities repayment and maturity activity and continued deposit gathering activities. We have in place various borrowing mechanisms for both short-term and long-term liquidity needs.

Quantitative and Qualitative Disclosures About Market Risk

Market Risk. Market risk represents the risk of loss due to changes in market values of assets and liabilities. We incur market risk in the normal course of business through exposures to market interest rates, equity prices, and credit spreads. We have identified two primary sources of market risk: interest rate risk and price risk.

Interest Rate Risk

Overview. Interest rate risk is the risk to earnings and value arising from changes in market interest rates. Interest rate risk arises from timing differences in the repricings and maturities of interest-earning assets and interest-bearing liabilities (reprice risk), changes in the expected maturities of assets and liabilities arising from embedded options, such as borrowers’ ability to prepay residential mortgage loans at any time and depositors’ ability to redeem certificates of deposit before maturity (option risk), changes in the shape of the yield curve where interest rates increase or decrease in a nonparallel fashion (yield curve risk), and changes in spread relationships between different yield curves, such as U.S. Treasuries, LIBOR and SOFR (basis risk).

Our board of directors established broad policy limits with respect to interest rate risk. Our Enterprise Risk Committee (“ERC”) establishes specific operating guidelines within the parameters of the board of directors’ policies. In general, we seek to minimize the impact of changing interest rates on net interest income and the economic values of assets and liabilities. Our ERC meets quarterly to monitor the level of interest rate risk sensitivity to ensure compliance with the board of directors’ approved risk limits.

Interest rate risk management is an active process that encompasses monitoring loan and deposit flows complemented by investment and funding activities. Effective management of interest rate risk begins with understanding the dynamic characteristics of assets and liabilities and determining the appropriate interest rate risk posture given business forecasts, management objectives, market expectations, and policy constraints.

An asset sensitive position refers to a balance sheet position in which an increase in short-term interest rates is expected to generate higher net interest income, as rates earned on our interest-earning assets would reprice upward more quickly than rates paid on our interest-bearing liabilities, thus expanding our net interest margin. Conversely, a liability sensitive position refers to a balance sheet position in which an increase in short-term interest rates is expected to generate lower net interest income, as rates paid on our interest-bearing liabilities would reprice upward more quickly than rates earned on our interest-earning assets, thus compressing our net interest margin.

Income Simulation and Economic Value Analysis. Interest rate risk measurement is calculated and reported to the ERC at least quarterly. The information reported includes period-end results and identifies any policy limits exceeded, along with an assessment of the policy limit breach and the action plan and timeline for resolution, mitigation, or assumption of the risk.

We use two approaches to model interest rate risk: Net Interest Income at Risk (“NII at Risk”) and Economic Value of Equity (“EVE”). Under NII at Risk, net interest income is modeled utilizing various assumptions for assets, liabilities, and derivatives. EVE measures the period end market value of assets minus the market value of liabilities and the change in this value as rates change. EVE is a period end measurement.

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The following table shows NII at Risk at the dates indicated:

Net Interest Income Sensitivity

 

Immediate Change in Rates

 

(dollars in thousands)

    

-100

    

+100

    

+200

 

March 31, 2020:

    

    

    

Dollar change

$

(7,340)

$

5,839

$

4,784

Percent change

 

(3.8)

%  

 

3.0

%  

 

2.5

%

December 31, 2019:

Dollar change

$

(10,540)

$

2,404

$

1,750

Percent change

 

(5.4)

%  

 

1.2

%  

 

0.9

%

We report NII at Risk to isolate the change in income related solely to interest-earning assets and interest-bearing liabilities. The NII at Risk results included in the table above reflect the analysis used quarterly by management. It models −100, +100 and +200 basis point parallel shifts in market interest rates, implied by the forward yield curve over the next twelve months. We were within Board policy limits for the +100 and +200 basis point scenarios at March 31, 2020.

Tolerance levels for risk management require the continuing development of remedial plans to maintain residual risk within approved levels as we adjust the balance sheet. NII at Risk reported at March 31, 2020, projects that our earnings exhibit increased sensitivity to changes in interest rates compared to December 31, 2019.

The following table shows EVE at the dates indicated:

Economic Value of Equity Sensitivity (Shocks)

 

Immediate Change in Rates

 

(dollars in thousands)

    

-100

    

+100

    

+200

 

March 31, 2020:

    

    

    

Dollar change

$

(74,212)

$

95,257

$

144,678

Percent change

 

(14.0)

%  

 

18.0

%  

 

27.3

%

December 31, 2019:

Dollar change

$

(91,101)

$

49,546

$

73,267

Percent change

 

(16.3)

%  

 

8.9

%  

 

13.1

%

The EVE results included in the table above reflect the analysis used quarterly by management. It models immediate −100, +100 and +200 basis point parallel shifts in market interest rates.

We were within board policy limits for the +100 and +200 basis point scenarios at March 31, 2020.

In September 2018, the Federal Reserve increased the range for the federal funds target rate, which led to an increase in the magnitude of the declining rate scenario to −100 basis points from the prior −50 basis point floor. Tolerance levels for risk management require the development of continuing remediation plans to reduce residual risk within tolerance if simulation modeling demonstrates that a parallel 100 basis point increase or 100 basis point decrease in interest rates over the twelve months would adversely affect net interest income over the same period by more than the tolerance level. The Company, at March 31, 2020, exceeded the established tolerance level for the −100 basis point sensitivity.

Price Risk. Price risk represents the risk of loss arising from adverse movements in the prices of financial instruments that are carried at fair value and subject to fair value accounting. We have price risk from equity investments and investments in securities backed by mortgage loans.

Item 3 – Quantitative and Qualitative Disclosures About Market Risk

The quantitative and qualitative disclosures about market risk are included under “Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Quantitative and Qualitative Disclosures About Market Risk”.

Item 4 – Controls and Procedures

Evaluation of disclosure controls and procedures. The Company’s management, including our President and

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Chief Executive Officer and our Chief Financial Officer, have evaluated the effectiveness of our “disclosure controls and procedures” (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (“Exchange Act”)), as of the end of the period covered by this report. Based on such evaluation, our President and Chief Executive Officer and our Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures were effective as of that date to provide reasonable assurance that the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its President and Chief Executive Officer and its Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in internal control over financial reporting. There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Exchange Act) during the first quarter of 2020 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Part II – Other Information

Item 1 – Legal Proceedings

In the normal course of business, we are named or threatened to be named as a defendant in various lawsuits, none of which we expect to have a material effect on the Company. However, given the nature, scope and complexity of the extensive legal and regulatory landscape applicable to our business (including laws and regulations governing consumer protection, fair lending, fair labor, privacy, information security, anti-money laundering and anti-terrorism), we, like all banking organizations, are subject to heightened legal and regulatory compliance and litigation risk. There are no material pending legal proceedings to which the Company or any of its subsidiaries is a party or of which any of their property is the subject.

Item 1A – Risk Factors

In addition to the risk factors set forth under Part I, Item 1A “Risk Factors” in the Company’s Form 10-K for the fiscal year ended December 31, 2019, the following risk factor applies to the Company. The outbreak of Coronavirus Disease 2019 (“COVID-19”) has adversely impacted, or an outbreak of other highly infectious or contagious diseases could adversely impact certain industries in which the Company’s customers operate and impair their ability to fulfill their obligations to the Company. Further, the spread of the outbreak could lead to an economic recession or other severe disruptions in the U.S. economy and may disrupt banking and other financial activity in the areas in which the Company operates and could potentially create widespread business continuity issues for the Company.

The spread of highly infectious or contagious diseases could cause, and the spread of COVID-10 has caused, severe disruptions in the U.S. economy at large, and for small businesses in particular, which could disrupt the Company’s operations. We are starting to see the impact from COVID-19 on our business, and we believe that it will be significant, adverse and potentially material. Currently, COVID-19 is spreading through the United States and the world. The resulting concerns on the part of the U.S. and global population have created the threat of a recession, reduced economic activity and a significant correction in the global stock markets. We expect that we will experience significant disruption across our business due to these effects, leading to decreased earnings, significant slowdowns in our loan collections and loan defaults.

COVID-19 may impact businesses’ and consumers’ desire and willingness to borrow money, which would negatively impact loan volumes. In addition, certain of our borrowers are in or have exposure to the hospitality, restaurant, gaming, and long-term health care industries and/or are located in areas that are quarantined or under stay-at-home orders, and COVID-19 may also have an adverse effect on our commercial real estate, consumer, and equipment leasing (primarily in the transportation industry) loan portfolios. A prolonged quarantine or stay-at-home order would have a negative adverse impact on these borrowers and their revenue streams, which consequently impacts their ability to meet their financial obligations and could result in loan defaults.

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Table of Contents

The outbreak of COVID-19 or an outbreak of other highly infectious or contagious diseases may result in a decrease in our customers’ businesses, a decrease in consumer confidence and business generally, an increase in unemployment or a disruption in the services provided by the Company’s vendors. Disruptions to our customers could result in increased risk of delinquencies, defaults, foreclosures and losses on our loans, declines in assets under management and wealth management revenues, negatively impact regional economic conditions, result in declines in local loan demand, liquidity of loan guarantors, loan collateral (particularly in real estate), loan originations and deposit availability and negatively impact the implementation of our growth strategy.

The Company relies upon its third-party vendors to conduct business and to process, record, and monitor transactions. If any of these vendors are unable to continue to provide the Company with these services, it could negatively impact the Company’s ability to serve its customers. Furthermore, the outbreak could negatively impact the ability of the Company’s employees and customers to engage in banking and other financial transactions in the geographic areas in which the Company operates and could create widespread business continuity issues for the Company. The Company also could be adversely affected if key personnel or a significant number of employees were to become unavailable due to the effects and restrictions of a COVID-19 outbreak in our market areas. Although the Company has business continuity plans and other safeguards in place, there is no assurance that such plans and safeguards will be effective.

We believe that the economic impact from COVID-19 will be severe and could have a material and adverse impact on our business and that it could result in significant losses in our loan portfolio, all of which would adversely and materially impact our earnings and capital.

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds

Unregistered Sales of Equity Securities

None.

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Issuer Purchases of Equity Securities

The following table sets forth information regarding the Company’s repurchase of shares of its outstanding common stock during the first quarter of 2020.

Total Number

Approximate

of Shares

Dollar Value of

Purchased as

Shares That

Total

Part of Publicly

May Yet be

Number

Announced

Purchased

of Shares

Average Price

Plans

Under the Plans

Period

Purchased (1)

Paid Per Share

or Programs

or Programs (2)

January 1 - 31, 2020

84,723

$

26.83

83,297

$

18,747,945

February 1 - 29, 2020

149,702

26.24

146,155

14,915,308

March 1 - 31, 2020

834,287

17.40

833,140

25,418,212

Total

1,068,712

$

19.39

1,062,592

$

25,418,212

__________________________________

(1)Represents shares of the Company’s common stock repurchased under the employee stock purchase program, shares withheld to satisfy tax withholding obligations upon the vesting of awards of restricted stock and/or pursuant to a publicly announced repurchase plan or program, as discussed in footnote 2 below.
(2)On August 6, 2019, the Company announced that its Board of Directors authorized the Company to repurchase up to $25.0 million of its common stock. On March 11, 2020, the Company announced that its Board of Directors authorized the Company to repurchase up to an additional $25.0 million of its common stock in addition to the amount remaining under the prior authorization. This program will be in effect until December 31, 2020. Stock repurchases under these programs may be made from time to time on the open market, in privately negotiated transactions, or in any manner that complies with applicable securities laws, at the discretion of the Company. The timing of purchases and the number of shares repurchased under the programs are dependent upon a variety of factors including price, trading volume, corporate and regulatory requirements and market condition. The repurchase program may be suspended or discontinued at any time without notice. As of March 31, 2020, $24.6 million, or 1,219,341 shares of the Company’s common stock, had been repurchased under the program.

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Item 6 – Exhibits

Exhibit No.

Description

10.1

Amendment No. 4 to Employment Agreement, dated as of January 13, 2020, between Midland States Bancorp, Inc., Midland States Bank and Jeffrey G. Ludwig (incorporated by reference to Exhibit 10.8 to the Company’s Annual Report on Form 10-K filed with the SEC on February 28, 2020).

10.2

Amendment No. 3 to Employment Agreement, dated as of January 13, 2020, between Midland States Bancorp, Inc., Midland States Bank and Douglas J. Tucker (incorporated by reference to Exhibit 10.12 to the Company’s Annual Report on Form 10-K filed with the SEC on February 28, 2020).

10.3

Amendment No. 3 to Employment Agreement, dated as of January 13, 2020, between Midland States Bancorp, Inc., Midland States Bank and Jeffrey S. Mefford (incorporated by reference to Exhibit 10.24 to the Company’s Annual Report on Form 10-K filed with the SEC on February 28, 2020).

10.4

Amendment No. 2 to Employment Agreement, dated as of January 13, 2020, between Midland States Bank and James R. Stewart (incorporated by reference to Exhibit 10.27 to the Company’s Annual Report on Form 10-K filed with the SEC on February 28, 2020).

10.5

Change of Control Agreement, dated as of February 1, 2020, between Midland States Bank and Donald J. Spring (incorporated by reference to Exhibit 10.36 to the Company’s Annual Report on Form 10-K filed with the SEC on February 28, 2020).

31.1

Chief Executive Officer’s Certification required by Rule 13(a)-14(a) – filed herewith.

31.2

Chief Financial Officer’s Certification required by Rule 13(a)-14(a) – filed herewith.

32.1

Chief Executive Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – filed herewith.

32.2

Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – filed herewith.

101

Financial information from the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2020 formatted in iXBRL (Inline eXtensible Business Reporting Language): (i) Consolidated Balance Sheets; (ii) Consolidated Statements of Income; (iii) Consolidated Statements of Comprehensive Income; (iv) Consolidated Statements of Shareholders’ Equity; (v) Consolidated Statements of Cash Flows; and (vi) Notes to Consolidated Financial Statements – filed herewith.

104

The cover page from Midland States Bancorp, Inc.’s Form 10-Q Report for the quarterly period ended March 31, 2020 formatted in inline XBRL and contained in Exhibit 101.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Midland States Bancorp, INC.

Date: April 30, 2020

By:

/s/

Jeffrey G. Ludwig

Jeffrey G. Ludwig

President and Chief Executive Officer

(Principal Executive Officer)

Date: April 30, 2020

By:

/s/

Eric T. Lemke

Eric T. Lemke

Chief Financial Officer

(Principal Financial Officer)

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