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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 June 30, 2019

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 July 31, 2019, the Registrant had 24,363,400 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 June 30, 2019 (Unaudited) and December 31, 2018

2

Consolidated Statements of Income (Unaudited) for the three and six months ended June 30, 2019 and 2018

3

Consolidated Statements of Comprehensive Income (Unaudited) for the three and six months ended June 30, 2019 and 2018

4

Consolidated Statements of Shareholders’ Equity (Unaudited) for the three and six months ended June 30, 2019 and 2018

5

Consolidated Statements of Cash Flows (Unaudited) for the six months ended June 30, 2019 and 2018

6

Notes to Consolidated Financial Statements (Unaudited)

6

Item 2.

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

36

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

55

Item 4.

Controls and Procedures

55

PART II. OTHER INFORMATION

Item 1.

Legal Proceedings

55

Item 1A.

Risk Factors

55

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

56

Item 6.

Exhibits

57

SIGNATURES

1

Table of Contents

PART I – FINANCIAL INFORMATION

ITEM 1 – FINANCIAL STATEMENTS

MIDLAND STATES BANCORP, INC.

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except per share data)

    

June 30, 

    

December 31, 

 

    

2019

    

2018

 

(unaudited)

Assets

Cash and due from banks

$

244,239

$

210,780

Federal funds sold

 

1,176

 

2,920

Cash and cash equivalents

 

245,415

 

213,700

Investment securities available for sale, at fair value

 

609,657

 

657,451

Equity securities, at fair value

3,369

3,334

Loans

 

4,073,527

 

4,137,551

Allowance for loan losses

 

(25,925)

 

(20,903)

Total loans, net

 

4,047,602

 

4,116,648

Loans held for sale, at fair value

 

22,143

 

30,401

Premises and equipment, net

 

94,824

 

94,840

Operating lease right-of-use asset

10,226

Other real estate owned

 

3,797

 

3,483

Nonmarketable equity securities

 

43,175

 

42,472

Accrued interest receivable

 

15,509

 

16,560

Mortgage servicing rights, at lower of cost or fair value

 

54,191

 

53,447

Mortgage servicing rights held for sale

159

3,545

Intangible assets

 

33,893

 

37,376

Goodwill

 

164,673

 

164,673

Cash surrender value of life insurance policies

 

140,593

 

138,783

Accrued income taxes receivable

 

2,032

 

8,809

Deferred tax assets, net

 

 

1,251

Other assets

 

54,797

 

50,900

Total assets

$

5,546,055

$

5,637,673

Liabilities and Shareholders’ Equity

Liabilities:

Deposits:

Noninterest-bearing

$

902,286

$

972,164

Interest-bearing

 

3,108,921

 

3,102,006

Total deposits

 

4,011,207

 

4,074,170

Short-term borrowings

 

113,844

 

124,235

FHLB advances and other borrowings

 

582,387

 

640,631

Subordinated debt

 

94,215

 

94,134

Trust preferred debentures

 

48,041

 

47,794

Accrued interest payable

 

5,455

 

4,855

Deferred tax liabilities, net

3,869

Operating lease liabilities

10,719

Other liabilities

 

36,430

 

43,329

Total liabilities

 

4,906,167

 

5,029,148

Shareholders’ Equity:

Preferred stock, Series H, $2 par value; $1,000 per share liquidation value; 2,636 shares authorized, issued and outstanding at June 30, 2019 and December 31, 2018

2,684

2,781

Common stock, $0.01 par value; 40,000,000 shares authorized; 23,897,038 and 23,751,798 shares issued and outstanding at June 30, 2019 and December 31, 2018, respectively

 

239

 

238

Capital surplus

 

477,412

 

473,833

Retained earnings

 

152,387

 

133,781

Accumulated other comprehensive income (loss)

 

7,166

 

(2,108)

Total shareholders’ equity

 

639,888

 

608,525

Total liabilities and shareholders’ equity

$

5,546,055

$

5,637,673

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

2

Table of Contents

MIDLAND STATES BANCORP, INC.

CONSOLIDATED STATEMENTS OF INCOME—(UNAUDITED)

(dollars in thousands, except per share data)

    

Three Months Ended

    

Six Months Ended

June 30, 

June 30, 

    

2019

    

2018

    

2019

    

2018

 

Interest income:

Loans:

Taxable

$

53,021

$

50,699

$

104,903

$

91,730

Tax exempt

 

918

 

802

 

1,892

 

1,269

Loans held for sale

451

295

750

723

Investment securities:

Taxable

 

3,606

 

3,756

 

7,289

 

6,399

Tax exempt

 

1,061

 

1,235

 

2,127

 

2,251

Nonmarketable equity securities

597

482

1,218

881

Federal funds sold and cash investments

 

982

 

1,014

 

1,889

 

1,535

Total interest income

 

60,636

 

58,283

 

120,068

 

104,788

Interest expense:

Deposits

 

8,437

5,005

 

15,800

9,122

Short-term borrowings

 

210

116

 

447

240

FHLB advances and other borrowings

 

3,541

2,582

 

7,388

4,453

Subordinated debt

 

1,514

1,514

 

3,028

3,028

Trust preferred debentures

 

857

780

 

1,727

1,474

Total interest expense

 

14,559

 

9,997

 

28,390

 

18,317

Net interest income

 

46,077

 

48,286

 

91,678

 

86,471

Provision for loan losses

 

4,076

 

1,854

 

7,319

 

3,860

Net interest income after provision for loan losses

 

42,001

 

46,432

 

84,359

 

82,611

Noninterest income:

Wealth management revenue

 

5,504

5,316

 

10,457

9,395

Commercial FHA revenue

 

4,917

326

8,187

3,656

Residential mortgage banking revenue

 

611

2,116

1,445

3,534

Service charges on deposit accounts

 

2,639

2,693

 

5,159

4,660

Interchange revenue

 

3,010

2,929

 

5,690

4,974

Gain (loss) on sales of investment securities, net

 

14

(70)

 

14

(5)

(Loss) gain on sales of other real estate owned

 

(12)

166

 

54

473

Other income

 

2,904

2,371

 

5,656

5,662

Total noninterest income

 

19,587

 

15,847

 

36,662

 

32,349

Noninterest expense:

Salaries and employee benefits

 

21,134

23,467

 

43,173

51,862

Occupancy and equipment

 

4,500

4,708

 

9,332

8,960

Data processing

 

4,987

5,106

 

9,878

9,585

FDIC insurance

 

367

539

 

802

1,087

Professional

 

2,410

3,195

 

4,483

6,944

Marketing

 

1,118

1,411

 

2,352

2,617

Communications

 

677

741

 

1,348

2,317

Loan expense

 

616

552

 

976

1,076

Other real estate owned

 

101

166

 

194

256

Amortization of intangible assets

 

1,673

1,576

 

3,483

3,251

(Gain) loss on mortgage servicing rights held for sale

(515)

188

 

(515)

188

Other expense

 

3,126

4,803

 

5,785

7,808

Total noninterest expense

 

40,194

 

46,452

 

81,291

 

95,951

Income before income taxes

 

21,394

 

15,827

 

39,730

 

19,009

Income taxes

 

5,039

 

3,045

 

9,393

 

4,421

Net income

16,355

12,782

30,337

14,588

Preferred stock dividends and premium amortization

34

36

68

72

Net income available to common shareholders

$

16,321

$

12,746

$

30,269

$

14,516

Per common share data:

Basic earnings per common share

$

0.67

$

0.53

$

1.25

$

0.64

Diluted earnings per common share

$

0.67

$

0.52

$

1.24

$

0.63

Weighted average common shares outstanding

 

24,081,777

 

23,815,436

 

24,040,032

 

22,365,927

Weighted average diluted common shares outstanding

 

24,303,211

 

24,268,111

 

24,254,612

 

22,817,472

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

Six Months Ended

June 30, 

June 30, 

    

2019

    

2018

    

2019

    

2018

 

Net income

$

16,355

$

12,782

$

30,337

$

14,588

Other comprehensive income (loss):

Investment securities available for sale:

Unrealized gains (losses) that occurred during the period

 

5,098

 

(2,252)

 

12,806

(5,589)

Reclassification adjustment for realized net (gains) losses on sales of investment securities included in net income

 

(14)

 

70

 

(14)

5

Income tax effect

 

(1,398)

 

595

 

(3,518)

1,519

Change in investment securities available for sale, net of tax

 

3,686

 

(1,587)

 

9,274

 

(4,065)

Other comprehensive income (loss), net of tax

 

3,686

 

(1,587)

 

9,274

 

(4,065)

Total comprehensive income

$

20,041

$

11,195

$

39,611

$

10,523

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

For the three months ended June 30, 2019:

Balances, March 31, 2019

$

2,733

$

238

$

475,811

$

141,906

$

3,480

$

624,168

Net income

 

 

16,355

 

16,355

Other comprehensive income

 

 

 

3,686

3,686

Common dividends declared ($0.2425 per share)

 

 

(5,840)

 

(5,840)

Preferred dividends declared

(83)

(83)

Preferred stock, premium amortization

(49)

49

Share-based compensation expense

 

 

493

 

493

Issuance of common stock under employee benefit plans

1

1,108

1,109

Balances, June 30, 2019

$

2,684

$

239

$

477,412

$

152,387

$

7,166

$

639,888

For the six months ended June 30, 2019:

Balances, December 31, 2018

$

2,781

$

238

$

473,833

$

133,781

$

(2,108)

$

608,525

Net income

 

 

30,337

 

30,337

Other comprehensive income

 

 

 

9,274

9,274

Common dividends declared ($0.4850 per share)

 

 

(11,663)

 

(11,663)

Preferred dividends declared

(165)

(165)

Preferred stock, premium amortization

(97)

97

Share-based compensation expense

 

 

1,339

 

1,339

Issuance of common stock under employee benefit plans

 

 

1

2,240

 

2,241

Balances, June 30, 2019

$

2,684

$

239

$

477,412

$

152,387

$

7,166

$

639,888

For the three months ended June 30, 2018:

Balances, March 31, 2018

$

2,923

$

236

$

470,937

$

112,009

$

(720)

$

585,385

Net income

 

 

 

12,782

 

12,782

Other comprehensive loss

 

 

 

 

(1,587)

(1,587)

Common dividends declared ($0.22 per share)

 

 

 

(5,233)

 

(5,233)

Preferred dividends declared

(83)

(83)

Preferred stock, premium amortization

(47)

47

Share-based compensation expense

398

398

Issuance of common stock under employee benefit plans

1

872

873

Balances, June 30, 2018

$

2,876

$

237

$

472,207

$

119,522

$

(2,307)

$

592,535

For the six months ended June 30, 2018:

Balances, December 31, 2017

$

2,970

$

191

$

330,148

$

114,478

$

1,758

$

449,545

Net income

 

 

 

14,588

 

14,588

Other comprehensive loss

 

 

 

 

(4,065)

(4,065)

Common dividends declared ($0.44 per share)

(9,472)

(9,472)

Preferred dividends declared

(166)

(166)

Preferred stock, premium amortization

(94)

94

Share-based compensation expense

831

831

Acquisition of Alpine Bancorporation, Inc.

45

139,876

139,921

Issuance of common stock under employee benefit plans

 

 

1

 

1,352

 

1,353

Balances, June 30, 2018

$

2,876

$

237

$

472,207

$

119,522

$

(2,307)

$

592,535

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)

Six Months Ended

June 30, 

    

2019

    

2018

 

Cash flows from operating activities:

Net income

$

30,337

$

14,588

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

Provision for loan losses

 

7,319

3,860

Depreciation on premises and equipment

 

3,186

3,083

Amortization of intangible assets

 

3,483

3,251

Amortization of operating lease right-of-use asset

1,353

Share-based compensation expense

 

1,339

831

Increase in cash surrender value of life insurance

 

(1,810)

(1,737)

Investment securities amortization, net

 

1,925

1,814

(Gain) loss on sales of investment securities, net

 

(14)

5

Gain on sales of other real estate owned

 

(54)

(473)

Impairment of other real estate owned

 

16

126

Origination of loans held for sale

 

(233,845)

(251,501)

Proceeds from sales of loans held for sale

 

248,704

269,899

Gain on loans sold and held for sale

 

(7,563)

(5,372)

Loss on disposals of premises and equipment

9

Amortization of mortgage servicing rights

1,353

1,671

(Recapture) impairment of mortgage servicing rights

(534)

633

(Gain) loss on mortgage servicing rights held for sale

 

(515)

188

Net change in operating assets and liabilities:

Accrued interest receivable

 

1,051

1,329

Accrued interest payable

 

600

667

Accrued income taxes receivable

 

8,209

3,789

Operating lease liabilities

(1,483)

Other assets

 

(3,308)

(8,994)

Other liabilities

 

(6,210)

(640)

Net cash provided by operating activities

 

53,548

 

37,017

Cash flows from investing activities:

Investment securities available for sale:

Purchases

 

(32,539)

(59,031)

Sales

 

28,465

16,869

Maturities and payments

 

62,680

71,483

Equity securities:

Purchases

 

(31)

(29)

Sales

 

105

7,733

Net decrease (increase) in loans

 

59,998

(86,122)

Proceeds from sale of premises and equipment

31

183

Purchases of premises and equipment

 

(3,210)

(4,087)

Proceeds from sales of mortgage servicing rights held for sale

3,288

13,101

Purchases of nonmarketable equity securities

 

(10,271)

(14,045)

Sales of nonmarketable equity securities

 

9,568

6,601

Proceeds from sales of other real estate owned

 

1,274

3,226

Net cash acquired in acquisition

 

36,153

Net cash provided by (used in) investing activities

 

119,358

 

(7,965)

Cash flows from financing activities:

Net decrease in deposits

 

(62,963)

(82,362)

Net decrease in short-term borrowings

 

(10,391)

(41,590)

Proceeds from FHLB borrowings

 

295,000

657,000

Payments made on FHLB borrowings

 

(350,393)

(491,257)

Payments made on other borrowings

 

(2,857)

(1,429)

Cash dividends paid on preferred stock

 

(165)

(166)

Cash dividends paid on common stock

 

(11,663)

(9,472)

Proceeds from issuance of common stock under employee benefit plans

 

2,241

1,353

Net cash (used in) provided by financing activities

 

(141,191)

 

32,077

Net increase in cash and cash equivalents

31,715

61,129

Cash and cash equivalents:

Beginning of period

213,700

215,202

End of period

$

245,415

$

276,331

Supplemental disclosures of cash flow information:

Cash payments for:

Interest paid on deposits and borrowed funds

$

27,790

$

17,111

Income tax paid (net of refunds)

 

612

 

528

Supplemental disclosures of noncash investing and financing activities:

Transfer of loans to other real estate owned

$

1,719

$

765

Transfer of mortgage servicing rights at lower of cost or market to mortgage servicing rights held for sale

3,649

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 finance, 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.

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 loan losses 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, 2018, filed with the Securities and Exchange Commission (the “SEC”) on February 28, 2019. 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 2018 Annual Report on Form 10-K. There has been one change to our significant accounting policies since December 31, 2018, which is described below. 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. 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 results of operations for the interim periods presented herein, have been included. Certain reclassifications of 2018 amounts have been made to conform to the 2019 presentation. Management has evaluated subsequent events for potential recognition or disclosure. Operating results for the three and six months ended June 30, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019 or any other period.

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 consolidated financial statements.

Accounting Guidance Adopted in 2019

FASB ASU 2016-02, “Leases (Topic 842)” – In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842),” which requires lessees to recognize leases on-balance sheet and to disclose key information about leasing arrangements. Topic 842 was subsequently amended by ASU No. 2018-10, “Codification Improvements to Topic 842, Leases;” and ASU No. 2018-11, “Targeted Improvements.” The new standard established a right-of-use (“ROU”) model, that requires a lessee to recognize ROU assets and lease liabilities on the balance sheet for all leases with a term longer than 12 months. Under the new guidance, leases are classified as either finance or operating, with classification

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affecting the pattern and classification of expense recognition in the statement of income. The Company adopted the new standard on January 1, 2019, and used the effective date as our date of initial application.

A modified retrospective adoption approach is required, applying the new standard to all existing leases in effect at the adoption date and new leases going forward. Consequently, financial information will not be updated and the disclosures required under the new standard will not be provided for dates and periods prior to January 1, 2019. This update also allows lessors to not separate non-lease components from the associated lease component if certain conditions are met.  The Company elected the “package of practical expedients” permitted by ASU 2018-11, which allows us not to reassess under the new standard our prior conclusions about lease identification, lease classification and initial direct costs.

The new standard also provides practical expedients for ongoing accounting. The Company elected the short-term lease recognition exemption for our office equipment leases. This means, for those leases that qualify, we did recognize ROU assets or lease liabilities, and this includes not recognizing ROU assets or lease liabilities for existing short-term leases of those assets in transition.

At the adoption date, the Company reported increased assets and liabilities of approximately $12.1 million on its consolidated balance sheet as a result of recognizing ROU assets and lease liabilities related to non-cancelable operating lease agreements for office space. The adoption of this guidance did not have a material effect to its consolidated statement of income.

Accounting Guidance Issued But Not Yet Adopted

FASB ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” – In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“CECL”).” The objective of this update is to improve financial reporting by providing timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The ASU requires an organization to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will use forward-looking information to better understand their credit loss estimates. For public companies that are filers with the SEC, this update is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. As previously disclosed, the Company has established a cross-functional governance structure, which oversees overall strategy for implementation of Topic 326. Additionally, a working group was formed and has developed a project plan focused on understanding the ASU, researching issues, data requirements, technology solutions and future state processes. The project plan is targeting the model validation completion by a third party during the third quarter of 2019, with parallel processing of our existing allowance for loan loss model with CECL prior to implementation during the third and fourth quarters of 2019. The working group has identified 12 distinct loan portfolios for which a model has been developed and internally validated. The Company continues to focus on researching and resolving interpretive accounting issues in the ASU, contemplating various related accounting policies, developing processes and related controls and considering various reporting disclosures. The Company also continues to believe that the adoption of the standard will result in an overall increase in the allowance for loan losses to cover credit losses over the estimated life of the financial assets. However, the magnitude of the increase in its allowance for loan losses at the adoption date will depend upon the nature and characteristics of the portfolio at the adoption date, as well as macroeconomic conditions and forecasts at that time. 

FASB ASU No. 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement” – In August 2018, the FASB issued ASU No. 2018-13 to improve 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; 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, an entity may disclose other quantitative information in lieu of the weighted average if the entity determines 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 amendments in this update become effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019, with early adoption

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permitted. The Company is currently evaluating the impact of adopting the new guidance on its consolidated financial statements, but it is not expected to have a material impact.

Note 3 – Acquisitions

Alpine Bancorporation, Inc.

On February 28, 2018, the Company completed its acquisition of Alpine Bancorporation, Inc. (“Alpine”) and its banking subsidiary, Alpine Bank & Trust Co. (“Alpine Bank”), which operated 19 locations in northern Illinois. In the aggregate, the Company acquired Alpine for consideration valued at approximately $173.2 million, which consisted of approximately $33.3 million in cash and the issuance of 4,463,200 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 $22.4 million of transaction and integration costs associated with the acquisition were expensed as incurred. As of February 28, 2019, the Company finalized its valuation of all assets acquired liabilities assumed in its acquisition of Alpine, resulting in no material change to acquisition accounting adjustments.

Note 4 – Investment Securities

Investment securities as of June 30, 2019 and December 31, 2018 were as follows:

June 30, 2019

Gross

Gross

    

Amortized

unrealized

unrealized

Fair

(dollars in thousands)

    

cost

    

gains

    

losses

    

value

 

Available for sale securities

Government sponsored entity debt securities

$

74,286

$

589

$

$

74,875

Agency mortgage-backed securities

 

294,432

 

3,126

 

196

 

297,362

State and municipal securities

 

138,181

 

5,559

 

11

 

143,729

Corporate securities

 

92,874

 

1,251

 

434

 

93,691

Total available for sale securities

$

599,773

$

10,525

$

641

$

609,657

Equity securities

$

3,369

December 31, 2018

 

    

    

Gross

    

Gross

    

 

Amortized

unrealized

unrealized

Fair

 

(dollars in thousands)

cost

gains

losses

value

 

Available for sale securities

U.S. Treasury securities

$

25,018

$

$

368

$

24,650

Government sponsored entity debt securities

 

76,554

 

17

 

887

 

75,684

Agency mortgage-backed securities

 

329,690

 

371

 

3,756

 

326,305

State and municipal securities

 

156,795

 

3,282

 

815

 

159,262

Corporate securities

 

72,302

 

383

 

1,135

 

71,550

Total available for sale securities

$

660,359

$

4,053

$

6,961

$

657,451

Equity securities

$

3,334

Unrealized losses and fair values for investment securities available for sale as of June 30, 2019 and December 31, 2018, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are summarized as follows:

June 30, 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

Available for sale securities

    

    

    

    

    

    

    

    

    

 

Government sponsored entity debt securities

$

$

$

$

$

$

Agency mortgage-backed securities

 

25,257

30

40,366

166

 

65,623

 

196

State and municipal securities

 

836

4

3,348

7

 

4,184

 

11

Corporate securities

 

18,053

287

6,390

147

 

24,443

 

434

Total available for sale securities

$

44,146

$

321

$

50,104

$

320

$

94,250

$

641

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December 31, 2018

Less than 12 Months

12 Months or more

Total

Fair

Unrealized

Fair

Unrealized

Fair

Unrealized

(dollars in thousands)

value

loss

value

loss

value

loss

Available for sale securities

    

    

    

    

    

    

 

U.S. Treasury securities

$

5,012

$

1

$

19,638

$

367

$

24,650

$

368

Government sponsored entity debt securities

 

51,717

195

23,223

692

 

74,940

 

887

Agency mortgage-backed securities

 

139,115

528

126,561

3,228

 

265,676

 

3,756

State and municipal securities

 

15,791

146

27,692

669

 

43,483

 

815

Corporate securities

 

32,616

575

8,535

560

 

41,151

 

1,135

Total available for sale securities

$

244,251

$

1,445

$

205,649

$

5,516

$

449,900

$

6,961

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

We evaluate securities for other-than-temporary impairment (“OTTI”) on a quarterly basis, at a minimum, and more frequently when economic or market concerns warrant such evaluation. In estimating OTTI losses, we consider the severity and duration of the impairment; the financial condition and near-term prospects of the issuer, which for debt securities considers external credit ratings and recent downgrades; and the intent and ability of the Company to hold the security for a period of time sufficient for a recovery in value.

At June 30, 2019, 51 investment securities available for sale had unrealized losses with aggregate depreciation of 0.68% from their amortized cost basis. The unrealized losses relate principally to the fluctuations in the current interest 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 have the intent to sell and it is not more likely than not that it will be required to sell a security in an unrealized loss position prior to recovery in value; therefore, the Company does not consider these securities to be other than temporarily impaired at June 30, 2019.

For the three and six months ended June 30, 2019 and 2018, the Company did not recognize OTTI losses on its investment securities.

The following is a summary of the amortized cost and fair value of the available-for-sale investment securities, by maturity, at June 30, 2019. 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 available-for-sale investment securities are based on final contractual maturity.

    

Amortized

    

Fair

 

(dollars in thousands)

cost

value

 

Available for sale securities

Within one year

$

47,428

$

47,545

After one year through five years

 

79,332

 

81,206

After five years through ten years

 

152,041

 

155,775

After ten years

 

26,540

 

27,769

Mortgage-backed securities

294,432

297,362

Total available for sale securities

$

599,773

$

609,657

Proceeds from the sale of securities available for sale were $28.5 million for both the three and six months ended June 30, 2019. Gross realized gains and gross realized losses from the sale of securities available for sale were $126,000 and $190,000, respectively, for both the three and six months ended June 30, 2019.

Proceeds from the sale of securities available for sale were $15.3 million and $16.9 million for the three and six months ended June 30, 2018, respectively. Gross realized gains from the sale of securities available for sale were $8,000 and $73,000 for the three and six months ended June 30, 2018, respectively. Gross realized losses from the sale of securities available for sale were $25,000 for both the three and six months ended June 30, 2018.

Proceeds from the sale of equity securities were $105,000 for the three and six months ended June 30, 2019.

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Gross realized gains from the sale of equity securities were $78,000 for the three and six months ended June 30, 2019. There were no gross realized losses from the sale of equity securities for the three and six months ended June 30, 2019. During the three and six months ended June 30, 2019, the Company recognized net unrealized losses of $30,000 and net unrealized gains of $37,000, respectively, on equity securities, which was recorded as other income in the consolidated statements of income.

Proceeds from the sale of equity securities were $7.7 million for the three and six months ended June 30, 2018. Gross realized losses from the sale of equity securities were $53,000 for the three and six months ended June 30, 2018. There were no gross realized gains from the sale of equity securities for the three and six months ended June 30, 2018. During the three and six months ended June 30, 2018, the Company recognized net unrealized losses of $18,000 and net unrealized gains of $93,000, respectively, on equity securities, which was recorded as other income in the consolidated statements of income.

Note 5 – Loans

The following table presents total loans outstanding by portfolio, which includes non-purchased credit impaired (“Non-PCI”) loans and purchased credit impaired (“PCI”) loans, as of June 30, 2019 and December 31, 2018:

June 30, 2019

December 31, 2018

 

Non-PCI

PCI

Non-PCI

PCI

 

(dollars in thousands)

Loans

Loans (1)

Total

Loans

Loans (1)

Total

 

Commercial

$

848,587

$

2,974

$

851,561

    

$

806,027

$

4,857

$

810,884

Commercial real estate

 

1,508,683

15,686

1,524,369

 

1,619,903

19,252

1,639,155

Construction and land development

 

244,188

6,226

250,414

 

223,898

8,331

232,229

Total commercial loans

 

2,601,458

24,886

2,626,344

 

2,649,828

32,440

2,682,268

Residential real estate

 

544,061

8,345

552,406

 

569,289

8,759

578,048

Consumer

 

595,728

1,240

596,968

 

611,408

1,776

613,184

Lease financing

 

297,809

297,809

 

264,051

264,051

Total loans

$

4,039,056

$

34,471

$

4,073,527

$

4,094,576

$

42,975

$

4,137,551

(1)The unpaid principal balance for PCI loans totaled $45.0 million and $56.9 million as of June 30, 2019 and December 31, 2018, respectively.

Total loans include net deferred loan fees of $3.0 million and $11.6 million at June 30, 2019 and December 31, 2018, respectively, and unearned income of $34.2 million and $29.2 million within the lease financing portfolio at June 30, 2019 and December 31, 2018, respectively.

At June 30, 2019 and December 31, 2018, the Company had commercial and residential loans held for sale totaling $22.1 million and $30.4 million, respectively. During the three and six months ended June 30, 2019, the Company sold commercial and residential real estate loans with proceeds totaling $149.4 million and $248.7 million, respectively, and sold commercial and residential real estate loans with proceeds totaling $115.9 million and $269.9 million for the comparable periods in 2018, respectively.

The aggregate loans outstanding to the directors, executive officers, principal shareholders and their affiliates totaled $24.5 million and $26.5 million at June 30, 2019 and December 31, 2018, respectively. During the three and six months ended June 30, 2019, there were $1.6 million and $3.1 million of new loans and other additions, respectively, while repayments and other reductions totaled $643,000 and $5.1 million, respectively.

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. All loans in the commercial loan portfolio have an assigned relationship manager, and most borrowers provide periodic financial and operating information that allows the

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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’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.

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. 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” 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. 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.

The following table presents the recorded investment of the commercial loan portfolio (excluding PCI loans) by risk category as of June 30, 2019 and December 31, 2018:

    

June 30, 2019

December 31, 2018

 

Commercial

Construction

Commercial

Construction

Real

and Land

Real

and Land

(dollars in thousands)

Commercial

Estate

Development

Total

Commercial

Estate

Development

Total

 

Acceptable credit quality

$

796,947

$

1,403,625

$

238,050

$

2,438,622

$

748,296

$

1,536,127

$

218,798

$

2,503,221

Special mention

 

22,391

 

23,284

 

2,491

 

48,166

 

35,103

 

15,306

 

3,448

 

53,857

Substandard

 

21,086

 

53,152

 

884

 

75,122

 

14,139

 

46,976

 

 

61,115

Substandard – nonaccrual

 

8,163

 

28,622

 

1,312

 

38,097

 

8,489

 

21,494

 

1,171

 

31,154

Doubtful

 

 

 

 

 

 

 

 

Not graded

 

 

 

1,451

 

1,451

 

 

 

481

 

481

Total (excluding PCI)

$

848,587

$

1,508,683

$

244,188

$

2,601,458

$

806,027

$

1,619,903

$

223,898

$

2,649,828

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The Company evaluates the credit quality of its other loan portfolio 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 impaired for purposes of credit quality evaluation. The following table presents the recorded investment of our other loan portfolio (excluding PCI loans) based on the credit risk profile of loans that are performing and loans that are impaired as of June 30, 2019 and December 31, 2018:

June 30, 2019

December 31, 2018

    

Residential

    

    

Lease

    

Residential

    

    

Lease

    

 

(dollars in thousands)

Real Estate

Consumer

Financing

Total

Real Estate

Consumer

Financing

Total

 

Performing

$

535,528

$

595,339

$

296,776

$

1,427,643

$

562,019

$

610,839

$

263,094

$

1,435,952

Impaired

 

8,533

 

389

 

1,033

 

9,955

 

7,270

 

569

 

957

 

8,796

Total (excluding PCI)

$

544,061

$

595,728

$

297,809

$

1,437,598

$

569,289

$

611,408

$

264,051

$

1,444,748

Impaired Loans

Impaired loans include loans on nonaccrual status, loans past due 90 days or more and still accruing interest and loans modified under troubled debt restructurings. Impaired loans at June 30, 2019 and December 31, 2018 do not include $34.5 million and $43.0 million, respectively, of PCI loans. The risk of credit loss on acquired loans was recognized as part of the fair value adjustment at the acquisition date.

There was no interest income recognized on nonaccrual loans during the three and six months ended June 30, 2019 and 2018 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 $666,000 and $1.3 million for the three and six months ended June 30, 2019, respectively, and $346,000 and $846,000 for the three and six months ended June 30, 2018, respectively. The Company recognized interest income on commercial and commercial real estate loans modified under troubled debt restructurings of $29,000 and $61,000 for the three and six months ended June 30, 2019, respectively, and $28,000 and $58,000 for the comparable periods in 2018, respectively.

The following table presents impaired loans (excluding PCI loans) by portfolio and related valuation allowance as of June 30, 2019 and December 31, 2018:

    

June 30, 2019

    

December 31, 2018

Unpaid

Related

Unpaid

Related

Recorded

Principal

Valuation

Recorded

Principal

Valuation

(dollars in thousands)

Investment

Balance

Allowance

Investment

Balance

Allowance

Impaired loans with a valuation allowance:

Commercial

$

7,863

$

8,380

$

5,311

$

7,945

$

8,102

$

4,448

Commercial real estate

 

13,616

 

14,235

 

4,395

 

7,496

 

13,844

 

523

Construction and land development

 

109

 

155

 

12

 

171

 

171

 

54

Residential real estate

 

5,174

 

5,915

 

668

 

4,055

 

4,662

 

554

Consumer

 

379

 

427

 

34

 

428

 

444

 

45

Lease financing

 

494

 

494

 

262

 

766

 

766

 

361

Total impaired loans with a valuation allowance

 

27,635

 

29,606

 

10,682

 

20,861

 

27,989

 

5,985

Impaired loans with no related valuation allowance:

Commercial

 

915

3,991

983

 

4,392

 

Commercial real estate

 

16,967

23,739

16,372

 

16,921

 

Construction and land development

 

1,251

1,253

1,136

 

1,136

 

Residential real estate

 

3,359

3,639

3,215

 

3,516

 

Consumer

 

10

12

141

 

145

 

Lease financing

 

539

538

191

 

191

 

Total impaired loans with no related valuation allowance

 

23,041

 

33,172

 

 

22,038

 

26,301

 

Total impaired loans:

Commercial

 

8,778

12,371

5,311

8,928

12,494

4,448

Commercial real estate

 

30,583

37,974

4,395

23,868

30,765

523

Construction and land development

 

1,360

1,408

12

1,307

1,307

54

Residential real estate

 

8,533

9,554

668

7,270

8,178

554

Consumer

 

389

439

34

569

589

45

Lease financing

 

1,033

1,032

262

957

957

361

Total impaired loans (excluding PCI)

$

50,676

$

62,778

$

10,682

$

42,899

$

54,290

$

5,985

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The difference between a loan’s recorded investment and the unpaid principal balance represents: (1) a partial charge-off resulting from a confirmed loss due to the value of the collateral securing the loan being below the loan’s principal balance and management’s assessment that the full collection of the loan balance is not likely and/or (2) payments received on nonaccrual loans that are fully applied to principal on the loan’s recorded investment as compared to being applied to principal and interest on the unpaid customer principal and interest balance. The difference between the recorded investment and the unpaid principal balance on loans was $12.1 million and $11.4 million at June 30, 2019 and December 31, 2018, respectively.

The average balance of impaired loans (excluding PCI loans) and interest income recognized on impaired loans during the three months ended June 30, 2019 and 2018 are included in the table below:

Three Months Ended June 30, 

2019

2018

    

    

Interest Income

    

Interest Income

Average

Recognized

Average

Recognized

Recorded

While on

Recorded

While on

(dollars in thousands)

Investment

Impaired Status

Investment

Impaired Status

Impaired loans with a valuation allowance:

Commercial

$

8,007

$

7

$

1,229

$

7

Commercial real estate

 

9,435

 

23

2,589

 

21

Construction and land development

 

111

 

100

 

1

Residential real estate

 

5,236

 

8

4,167

 

10

Consumer

 

395

 

166

 

Lease financing

 

494

 

447

 

Total impaired loans with a valuation allowance

 

23,678

 

38

8,698

 

39

Impaired loans with no related valuation allowance:

Commercial

 

937

864

Commercial real estate

 

21,313

15,876

Construction and land development

 

1,252

1

711

Residential real estate

 

3,367

3

2,360

2

Consumer

 

10

1

20

Lease financing

 

538

321

Total impaired loans with no related valuation allowance

 

27,417

 

5

20,152

 

2

Total impaired loans:

Commercial

 

8,944

7

2,093

7

Commercial real estate

 

30,748

23

18,465

21

Construction and land development

 

1,363

1

811

1

Residential real estate

 

8,603

11

6,527

12

Consumer

 

405

1

186

Lease financing

 

1,032

768

Total impaired loans (excluding PCI)

$

51,095

$

43

$

28,850

$

41

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The average balance of impaired loans (excluding PCI loans) and interest income recognized on impaired loans during the six months ended June 30, 2019 and 2018 are included in the table below:

Six Months Ended June 30, 

2019

2018

    

Interest Income

    

Interest Income

Average

Recognized

Average

Recognized

Recorded

While on

Recorded

While on

(dollars in thousands)

Investment

Impaired Status

Investment

Impaired Status

Impaired loans with a valuation allowance:

Commercial

$

8,448

$

13

$

1,279

$

17

Commercial real estate

9,381

 

50

2,769

 

41

Construction and land development

119

 

101

 

2

Residential real estate

5,264

 

19

4,173

 

21

Consumer

413

 

175

 

Lease financing

494

 

447

 

Total impaired loans with a valuation allowance

24,119

 

82

8,944

 

81

Impaired loans with no related valuation allowance:

Commercial

955

888

Commercial real estate

21,512

16,138

Construction and land development

1,261

1

725

Residential real estate

3,379

5

2,381

2

Consumer

11

1

21

Lease financing

538

321

Total impaired loans with no related valuation allowance

27,656

 

7

20,474

 

2

Total impaired loans:

Commercial

9,403

13

2,167

17

Commercial real estate

30,893

50

18,907

41

Construction and land development

1,380

1

826

2

Residential real estate

8,643

24

6,554

23

Consumer

424

1

196

Lease financing

1,033

768

Total impaired loans (excluding PCI)

$

51,776

$

89

$

29,418

$

83

The aging status of the recorded investment in loans by portfolio (excluding PCI loans) as of June 30, 2019 and December 31, 2018 were as follows:

    

    

    

    

    

    

    

 

Accruing

 

30-59

60-89

Past Due

 

Days

Days

90 Days

Total

Total

 

(dollars in thousands)

Past Due

Past Due

or More

Nonaccrual

Past Due

Current

Loans

 

June 30, 2019

Commercial

$

3,828

$

2,777

$

$

8,163

$

14,768

$

833,819

$

848,587

Commercial real estate

 

1,489

 

1,501

 

 

28,622

 

31,612

 

1,477,071

 

1,508,683

Construction and land development

 

 

 

 

1,312

 

1,312

 

242,876

 

244,188

Residential real estate

 

544

 

643

 

 

7,831

 

9,018

 

535,043

 

544,061

Consumer

 

5,456

 

3,774

 

4

 

338

 

9,572

 

586,156

 

595,728

Lease financing

 

1,112

 

430

 

302

 

731

 

2,575

 

295,234

 

297,809

Total (excluding PCI)

$

12,429

$

9,125

$

306

$

46,997

$

68,857

$

3,970,199

$

4,039,056

December 31, 2018

Commercial

$

4,013

$

2,581

$

4

$

8,489

$

15,087

$

790,940

$

806,027

Commercial real estate

 

1,667

 

945

 

149

 

21,494

 

24,255

 

1,595,648

 

1,619,903

Construction and land development

 

989

 

 

85

 

1,171

 

2,245

 

221,653

 

223,898

Residential real estate

 

1,292

 

728

 

566

 

5,894

 

8,480

 

560,809

 

569,289

Consumer

 

5,211

 

2,533

 

51

 

388

 

8,183

 

603,225

 

611,408

Lease financing

 

4,322

 

932

 

206

 

751

 

6,211

 

257,840

 

264,051

Total (excluding PCI)

$

17,494

$

7,719

$

1,061

$

38,187

$

64,461

$

4,030,115

$

4,094,576

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’

15

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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 allowance for loan losses on TDRs totaled $412,000 and $557,000 as of June 30, 2019 and December 31, 2018, respectively. The Company had no unfunded commitments in connection with TDRs at June 30, 2019 and December 31, 2018.

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 (excluding PCI loans) as of June 30, 2019 and December 31, 2018:

June 30, 2019

December 31, 2018

(dollars in thousands)

Accruing (1)

Non-accrual (2)

Total

Accruing (1)

Non-accrual (2) 

Total

Commercial

    

$

615

    

$

386

    

$

1,001

    

$

435

    

$

406

    

$

841

Commercial real estate

 

1,961

 

10,695

 

12,656

 

2,225

 

9,103

 

11,328

Construction and land development

 

48

 

174

 

222

 

51

 

 

51

Residential real estate

 

702

 

1,467

 

2,169

 

810

 

853

 

1,663

Consumer

 

47

 

 

47

 

130

 

 

130

Lease financing

 

 

 

 

 

 

Total loans (excluding PCI)

$

3,373

$

12,722

$

16,095

$

3,651

$

10,362

$

14,013

(1)These loans are still accruing interest.
(2)These loans are included in non-accrual loans in the preceding tables.

The following table presents a summary of loans by portfolio that were restructured during the three and six months ended June 30, 2019 and the loans by portfolio that were modified as TDRs within the previous twelve months that subsequently defaulted during the three and six months ended June 30, 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 June 30, 2019

Troubled debt restructurings:

    

    

    

    

    

    

Number of loans

1

 

 

 

2

 

 

3

Pre-modification outstanding balance

$

249

$

$

$

106

$

$

$

355

Post-modification outstanding balance

 

249

 

 

109

 

 

 

358

Troubled debt restructurings that subsequently defaulted

Number of loans

 

 

 

 

 

 

 

Recorded balance

$

$

$

$

$

$

$

For the six months ended June 30, 2019

Troubled debt restructurings:

    

    

    

    

    

    

Number of loans

1

 

3

 

1

 

9

 

2

 

16

Pre-modification outstanding balance

$

$

1,924

$

62

$

330

$

15

$

$

2,331

Post-modification outstanding balance

 

249

 

1,838

 

16

 

324

 

16

 

 

2,443

Troubled debt restructurings that subsequently defaulted

Number of loans

 

 

 

1

 

 

 

 

1

Recorded balance

$

$

$

43

$

$

$

$

43

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The following table presents a summary of loans by portfolio that were restructured during the three and six months ended June 30, 2018 and the loans by portfolio that were modified as TDRs within the previous twelve months that subsequently defaulted during the three and six months ended June 30, 2018:

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 June 30, 2018:

Troubled debt restructurings:

    

    

    

    

    

    

    

    

    

    

    

    

Number of loans

 

1

 

 

 

3

 

4

 

8

Pre-modification outstanding balance

$

23

$

$

$

212

$

19

$

$

254

Post-modification outstanding balance

 

22

 

 

 

207

 

19

 

 

248

Troubled debt restructurings that subsequently defaulted

Number of loans

 

 

 

 

 

 

 

Recorded balance

$

$

$

$

$

$

$

For the six months ended June 30, 2018:

Troubled debt restructurings:

    

    

    

    

    

    

    

    

    

    

    

    

Number of loans

 

1

 

 

 

3

 

4

 

8

Pre-modification outstanding balance

$

23

$

$

$

212

$

19

$

$

254

Post-modification outstanding balance

 

22

 

 

 

207

 

19

 

 

248

Troubled debt restructurings that subsequently defaulted

Number of loans

 

 

 

 

 

 

 

Recorded balance

$

$

$

$

$

$

$

Purchased Credit Impaired Loans

The Company has purchased loans for which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected.

Accretable yield of PCI loans, or income expected to be collected, was as follows:

Three Months Ended

Six Months Ended

June 30, 

June 30, 

(dollars in thousands)

    

2019

    

2018

    

2019

    

2018

 

Balance, at beginning of period

$

11,063

$

7,630

$

12,240

$

5,732

New loans purchased – Alpine acquisition

 

 

 

 

1,245

Accretion

 

(1,937)

 

(1,190)

 

(3,013)

 

(2,351)

Other adjustments (including maturities, charge-offs and impact of changes in timing of expected cash flows)

 

194

 

(181)

 

88

 

479

Reclassification from non-accretable

 

1,079

 

5

 

1,084

 

1,159

Balance, at end of period

$

10,399

$

6,264

$

10,399

$

6,264

Accretion recorded as loan interest income totaled $1.9 million and $3.0 million during the three and six months ended June 30, 2019, respectively, and $1.2 million and $2.4 million for the comparable periods in 2018, respectively.

Allowance for Loan Losses

The Company’s loan portfolio is principally comprised of commercial, commercial real estate, construction and land development, residential real estate and consumer loans and lease financing receivables. The principal risks to each category 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 impaired. As such, repayment of such loans is often more sensitive than other types of loans to adverse conditions in the general economy.

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Table of Contents

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.

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 impaired.

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The following table represents, by loan portfolio, a summary of changes in the allowance for loan losses for the three and six months ended June 30, 2019 and 2018:

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 loan losses for the three months ended June 30, 2019:

Balance, beginning of period

$

9,545

$

6,617

$

398

$

2,424

$

2,137

$

1,970

$

23,091

Provision for loan losses

 

558

 

2,262

 

(85)

 

174

 

326

 

841

 

4,076

Charge-offs

 

(2)

 

(269)

 

 

(223)

 

(465)

 

(691)

 

(1,650)

Recoveries

 

14

 

29

 

3

 

49

 

221

 

92

 

408

Balance, end of period

$

10,115

$

8,639

$

316

$

2,424

$

2,219

$

2,212

$

25,925

Changes in allowance for loan losses for the six months ended June 30, 2019:

Balance, beginning of period

$

9,524

$

4,723

$

372

$

2,041

$

2,154

$

2,089

$

20,903

Provision for loan losses

 

676

4,207

(22)

688

655

 

1,115

 

7,319

Charge-offs

 

(114)

 

(327)

 

(44)

 

(376)

 

(1,021)

 

(1,150)

 

(3,032)

Recoveries

 

29

 

36

 

10

 

71

 

431

 

158

 

735

Balance, end of period

$

10,115

$

8,639

$

316

$

2,424

$

2,219

$

2,212

$

25,925

Changes in allowance for loan losses for the three months ended June 30, 2018:

Balance, beginning of period

$

5,902

$

5,485

$

328

$

2,504

$

1,309

$

2,176

$

17,704

Provision for loan losses

 

1,224

 

(310)

 

157

 

279

 

522

 

(18)

 

1,854

Charge-offs

 

(1,120)

 

(99)

 

 

(103)

 

(349)

 

(473)

 

(2,144)

Recoveries

 

197

 

301

 

20

 

62

 

147

 

105

 

832

Balance, end of period

$

6,203

$

5,377

$

505

$

2,742

$

1,629

$

1,790

$

18,246

Changes in allowance for loan losses for the six months ended June 30, 2018:

Balance, beginning of period

$

5,256

$

5,044

$

518

$

2,750

$

1,344

$

1,519

$

16,431

Provision for loan losses

 

1,791

 

197

 

(58)

 

18

 

826

 

1,086

 

3,860

Charge-offs

 

(1,145)

 

(259)

 

 

(139)

 

(783)

 

(959)

 

(3,285)

Recoveries

 

301

 

395

 

45

 

113

 

242

 

144

 

1,240

Balance, end of period

$

6,203

$

5,377

$

505

$

2,742

$

1,629

$

1,790

$

18,246

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Table of Contents

The following table represents, by loan portfolio, details regarding the balance in the allowance for loan losses and the recorded investment in loans as of June 30, 2019 and December 31, 2018 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

June 30, 2019:

Allowance for loan losses:

Loans individually evaluated for impairment

$

5,242

$

4,361

$

$

294

$

$

235

$

10,132

Loans collectively evaluated for impairment

 

69

 

34

 

12

 

374

34

27

 

550

Non-impaired loans collectively evaluated for impairment

 

4,788

 

3,481

 

304

 

1,349

1,992

1,950

 

13,864

Loans acquired with deteriorated credit quality (1)

 

16

 

763

 

 

407

193

 

1,379

Total allowance for loan losses

$

10,115

$

8,639

$

316

$

2,424

$

2,219

$

2,212

$

25,925

Recorded investment (loan balance):

Impaired loans individually evaluated for impairment

$

8,175

$

30,286

$

1,251

$

4,926

$

$

792

$

45,430

Impaired loans collectively evaluated for impairment

 

603

 

297

109

3,607

389

241

 

5,246

Non-impaired loans collectively evaluated for impairment

 

839,809

 

1,478,100

242,828

535,528

595,339

296,776

 

3,988,380

Loans acquired with deteriorated credit quality (1)

 

2,974

 

15,686

6,226

8,345

1,240

 

34,471

Total recorded investment (loan balance)

$

851,561

$

1,524,369

$

250,414

$

552,406

$

596,968

$

297,809

$

4,073,527

December 31, 2018:

Allowance for loan losses:

Loans individually evaluated for impairment

$

4,405

$

476

$

48

$

233

$

$

330

$

5,492

Loans collectively evaluated for impairment

 

43

 

47

6

321

45

31

 

493

Non-impaired loans collectively evaluated for impairment

 

4,971

 

3,356

318

1,051

1,926

1,728

 

13,350

Loans acquired with deteriorated credit quality (1)

 

105

 

844

436

183

 

1,568

Total allowance for loan losses

$

9,524

$

4,723

$

372

$

2,041

$

2,154

$

2,089

$

20,903

Recorded investment (loan balance):

Impaired loans individually evaluated for impairment

$

8,520

$

23,431

$

1,249

$

3,929

$

5

$

668

$

37,802

Impaired loans collectively evaluated for impairment

 

408

437

 

58

 

3,341

 

564

 

289

 

5,097

Non-impaired loans collectively evaluated for impairment

 

797,099

1,596,035

 

222,591

 

562,019

 

610,839

 

263,094

 

4,051,677

Loans acquired with deteriorated credit quality (1)

 

4,857

19,252

 

8,331

 

8,759

 

1,776

 

 

42,975

Total recorded investment (loan balance)

$

810,884

$

1,639,155

$

232,229

$

578,048

$

613,184

$

264,051

$

4,137,551

(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.

Note 6 – Premises and Equipment, Net

A summary of premises and equipment as of June 30, 2019 and December 31, 2018 is as follows:

June 30, 

December 31, 

(dollars in thousands)

    

2019

    

2018

Land

$

20,231

$

20,231

Buildings and improvements

 

78,782

 

76,141

Furniture and equipment

 

30,194

 

29,858

Total

 

129,207

 

126,230

Accumulated depreciation

 

(34,383)

 

(31,390)

Premises and equipment, net

$

94,824

$

94,840

Depreciation expense of $1.6 million and $3.2 million was recorded for the three and six months ended June 30, 2019, respectively, and $1.6 million and $3.1 million for the comparable periods in 2018, respectively.

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Note 7 – Leases

The Company determines if a lease is present at the inception of an agreement. Operating leases are capitalized at commencement and are discounted using the Company’s FHLB borrowing rate for a similar term borrowing unless the lease defines an implicit rate within the contract. For operating leases existing prior to January 1, 2019, the rate for the remaining lease term as of January 1, 2019 was used.

The ROU assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent the obligation to make lease payments arising from the lease. Operating lease ROU assets and operating lease liabilities are recognized on the lease commencement date based on the present value of lease payments over the lease term. No significant judgments or assumptions were involved in developing the estimated operating lease liabilities as the Company’s operating lease liabilities largely represent future rental expenses associated with operating leases and the borrowing rates are based on publicly available interest rates.

The Company has operating leases for banking centers and operating facilities. Our leases have remaining lease terms of 2 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.

As of June 30, 2019, operating lease ROU assets totaled $10.2 million and operating lease liabilities totaled $10.7 million.

Information related to operating leases for the three and six months ended June 30, 2019 was as follows:

Three Months Ended

Six Months Ended

(dollars in thousands)

June 30, 2019

June 30, 2019

Operating lease cost

$

706

$

1,415

Operating cash flows from leases

742

1,483

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

181

12,281

Weighted average remaining lease term

5.9 years

5.9 years

Weighted average discount rate

3.12

%

3.12

%

The projected minimum rental payments under the terms of the leases as of June 30, 2019 were as follows:

(dollars in thousands)

    

Amount

Year ending December 31:

2019 remaining

$

1,143

2020

 

2,382

2021

 

2,229

2022

 

2,119

2023

 

1,594

Thereafter

 

2,322

Total future minimum lease payments

11,789

Less imputed interest

(1,070)

Total operating lease liabilities

$

10,719

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Note 8 – Mortgage Servicing Rights

The Company serviced commercial FHA mortgage loans for others with unpaid principal balances of approximately $4.03 billion and $3.98 billion at June 30, 2019 and December 31, 2018, respectively. Changes in our commercial FHA mortgage servicing rights were as follows for the three and six months ended June 30, 2019 and 2018:

Three Months Ended

Six Months Ended

June 30, 

June 30, 

(dollars in thousands)

    

2019

    

2018

    

2019

    

2018

    

Mortgage servicing rights:

Balance, beginning of period

$

55,787

$

56,039

$

56,252

$

55,714

Originated servicing

 

1,350

 

911

 

1,563

 

1,912

Amortization

(675)

(682)

(1,353)

(1,358)

Balance, end of period

 

56,462

 

56,268

 

56,462

 

56,268

Valuation allowances:

Balance, beginning of period

 

2,830

3,387

2,805

3,254

Additions

 

500

25

633

Reductions

(559)

(559)

Balance, end of period

 

2,271

 

3,887

 

2,271

 

3,887

Mortgage servicing rights, net

$

54,191

$

52,381

$

54,191

$

52,381

Fair value:

At beginning of period

$

52,957

$

52,652

$

53,447

$

52,460

At end of period

$

54,191

$

52,381

$

54,191

$

52,381

The following table is a summary of key assumptions, representing both general economic and other published information and the weighted average characteristics of the commercial portfolio, used in the valuation of servicing rights at June 30, 2019 and December 31, 2018. Assumptions used in the prepayment rate consider 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.

    

    

    

Remaining

    

    

    

 

Servicing

Interest

Years to

    

Prepayment

Servicing

    

Discount

(dollars in thousands)

Fee

Rate

 Maturity

    

Rate

Cost

    

Rate

June 30, 2019:

Commercial FHA mortgage loans

0.12

%

3.68

%

29.9

8.21

%

$

1,000

10 - 14

%

December 31, 2018:

Commercial FHA mortgage loans

0.13

%

3.67

%

30.1

8.24

%

$

1,000

10 - 14

%

We recognize revenue from servicing commercial FHA and residential mortgages as earned based on the specific contractual terms. This revenue, along with amortization of and changes in impairment on servicing rights, is reported in commercial FHA revenue and residential mortgage banking revenue in the consolidated statements of income. Mortgage servicing rights do not trade in an active market with readily observable prices. The fair value of mortgage servicing rights and their sensitivity to changes in interest rates is influenced by the mix of the servicing portfolio and characteristics of each segment of the portfolio. The Company’s servicing portfolio consists of the distinct portfolios of government-insured residential and commercial mortgages and conventional residential mortgages. 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 mortgage loan prepayment rates, discount rates, cost to service, contractual servicing fee income, ancillary income, late fees, replacement reserves and other economic factors that are determined based on current market conditions.

At June 30, 2019 and December 31, 2018, the Company serviced residential mortgage loans for others with unpaid principal balances of approximately $58.6 million and $897.6 million, respectively. During the three and six months ended June 30, 2019, the Company sold mortgage servicing rights held for sale of zero and $3.3 million, respectively, and sold mortgage servicing rights held for sale of $2.7 million and $12.9 million for the comparable periods in 2018, respectively. At June 30, 2019, total residential mortgage servicing rights of $159,000 are reflected in the consolidated balance sheet as mortgage servicing rights held for sale.

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Note 9 – Goodwill and Intangible Assets

At June 30, 2019 and December 31, 2018, goodwill totaled $164.7 million.

The following table summarizes the carrying amount of goodwill by segment at both June 30, 2019 and December 31, 2018.

(dollars in thousands)

Goodwill

Banking

    

$

149,035

Commercial FHA origination and servicing

10,892

Wealth management

 

4,746

Total goodwill

$

164,673

The Company’s intangible assets, consisting of core deposit and customer relationship intangibles, as of June 30, 2019 and December 31, 2018 are summarized as follows:

June 30, 2019

December 31, 2018

 

Gross

Gross

 

Carrying

Accumulated

Carrying

Accumulated

 

(dollars in thousands)

Amount

Amortization

Total

Amount

Amortization

Total

 

Core deposit intangibles

    

$

52,712

    

$

(27,691)

    

$

25,021

    

$

52,712

    

$

(24,803)

    

$

27,909

Customer relationship intangibles

 

13,771

 

(4,899)

 

8,872

 

13,771

 

(4,304)

 

9,467

Total intangible assets

$

66,483

$

(32,590)

$

33,893

$

66,483

$

(29,107)

$

37,376

Amortization of intangible assets was $1.7 million and $3.5 million for the three and six months ended June 30, 2019, respectively, and $1.6 million and $3.3 million for the comparable periods in 2018, respectively.

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.

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 June 30, 2019 and December 31, 2018:

Notional Amount

Fair Value Gain

    

June 30, 

    

December 31, 

    

June 30, 

    

December 31, 

(dollars in thousands)

2019

2018

2019

2018

Derivative Instruments (included in Other Assets):

Interest rate lock commitments

$

183,562

$

264,710

$

3,791

$

4,492

Forward commitments to sell mortgage-backed securities

183,280

276,871

Total

$

366,842

$

541,581

$

3,791

$

4,492

Notional Amount

Fair Value Loss

June 30, 

December 31, 

June 30, 

December 31, 

(dollars in thousands)

    

2019

    

2018

    

2019

    

2018

Derivative Instruments (included in Other Liabilities):

Forward commitments to sell mortgage-backed securities

$

$

54

$

$

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During the three and six months ended June 30, 2019, the Company recognized net losses of $2.0 million and $701,000, respectively, on derivative instruments in commercial FHA revenue and residential mortgage banking revenue in the consolidated statements of income.

During the three and six months ended June 30, 2018, the Company recognized net losses of $2.0 million and $2.1 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. These 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 these customer derivative instruments and the offsetting counterparty derivative instruments were $9.2 million and $9.5 million at June 30, 2019 and December 31, 2018, respectively. The fair value of the customer derivative instruments and the offsetting counterparty derivative instruments was $286,000 and $145,000 at June 30, 2019 and December 31, 2018, 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 June 30, 2019 and December 31, 2018:

    

June 30, 

    

December 31, 

 

(dollars in thousands)

    

2019

    

2018

 

Noninterest-bearing demand

$

902,286

$

972,164

Interest-bearing:

Checking

 

1,009,023

 

1,002,275

Money market

 

732,573

 

862,171

Savings

 

442,017

 

442,132

Time

 

925,308

 

795,428

Total deposits

$

4,011,207

$

4,074,170

Note 12 – Short-Term Borrowings

The following table presents the distribution of short-term borrowings and related weighted average interest rates as of June 30, 2019 and December 31, 2018:

Repurchase Agreements

June 30, 

December 31, 

(dollars in thousands)

2019

2018

Outstanding at period-end

    

$

113,844

$

124,235

Average amount outstanding

 

128,058

 

138,135

Maximum amount outstanding at any month end

 

138,907

 

173,387

Weighted average interest rate:

During period

 

0.70

%  

 

0.51

%

End of period

 

0.68

%  

 

0.71

%

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 $128.8 million and $132.2 million at June 30, 2019 and December 31, 2018, respectively, were pledged for securities sold under agreements to repurchase.

The Company had lines of credit of $50.9 million and $56.8 million at June 30, 2019 and December 31, 2018, respectively, from the Federal Reserve Discount Window. The lines are collateralized by a collateral agreement with

24

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respect to a pool of commercial real estate loans totaling $60.0 million and $67.6 million at June 30, 2019 and December 31, 2018, respectively. There were no outstanding borrowings at June 30, 2019 and December 31, 2018.

At June 30, 2019, the Company had available federal funds lines of credit totaling $45.0 million. These lines of credit were unused at June 30, 2019.

Note 13 – FHLB Advances and Other Borrowings

The following table summarizes our Federal Home Loan Bank (“FHLB”) advances and other borrowings as of June 30, 2019 and December 31, 2018:

    

June 30, 

    

December 31, 

 

(dollars in thousands)

    

2019

    

2018

 

Midland States Bancorp, Inc.

Term loan - variable interest rate equal to LIBOR plus 2.25%, which was 4.75% and 4.63% at June 30, 2019 and December 31, 2018, respectively, – maturing May 25, 2020

$

29,989

$

32,840

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

181

181

Midland States Bank

FHLB advances – fixed rate, fixed term of $22.3 million and $87.7 million, at rates averaging 2.37% and 2.35% at June 30, 2019 and December 31, 2018, respectively – maturing through February 2023 and putable fixed rate of $530.0 million and $520.0 million at rates averaging 2.24% and 2.09% at June 30, 2019 and December 31, 2018, respectively – maturing through August 2025 with call provisions through August 2021

552,217

607,610

Total FHLB advances and other borrowings

$

582,387

$

640,631

In May 2017, the Company entered into a loan agreement with another bank for a revolving line of credit in the original principal amount of up to $10.0 million and a term loan in the original principal amount of $40.0 million. The term loan matures on May 25, 2020 and has a variable rate of interest equal to one-month LIBOR plus 2.25%. Beginning September 1, 2018, the Company was required to make quarterly principal and interest payments on the term loan of $1.4 million with the remaining principal and any unpaid interest due at maturity. The loan is unsecured with a negative pledge of shares of the Bank’s common stock. The loan agreement contains financial covenants that require the Company to maintain a minimum total capital to risk-weighted assets ratio, a minimum adjusted loan loss reserves to nonperforming loans ratio, a minimum fixed charge coverage ratio and a maximum percentage of nonperforming assets to tangible capital. At June 30, 2019, the Company was in compliance with each of these financial covenants.

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 $2.01 billion and $2.22 billion at June 30, 2019 and December 31, 2018, respectively.

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Note 14 – 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 and six months ended June 30, 2019 and 2018 excluded antidilutive stock options of 96,837 and 31,259, 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 and six months ended June 30, 2019 and 2018:

    

Three Months Ended

    

Six Months Ended

    

June 30, 

June 30, 

(dollars in thousands, except per share data)

    

2019

    

2018

    

2019

    

2018

    

Net income

$

16,355

$

12,782

$

30,337

$

14,588

Preferred dividends declared

 

(83)

 

(83)

 

(165)

 

(166)

Preferred stock, premium amortization

49

47

97

94

Net income available to common shareholders

 

16,321

 

12,746

 

30,269

 

14,516

Common shareholder dividends

 

(5,791)

(5,201)

(11,567)

(9,409)

Unvested restricted stock award dividends

 

(49)

(32)

(96)

(63)

Undistributed earnings to unvested restricted stock awards

 

(85)

(44)

(150)

(31)

Undistributed earnings to common shareholders

$

10,396

$

7,469

$

18,456

$

5,013

Basic

Distributed earnings to common shareholders

$

5,791

$

5,201

$

11,567

$

9,409

Undistributed earnings to common shareholders

 

10,396

 

7,469

 

18,456

 

5,013

Total common shareholders earnings, basic

$

16,187

$

12,670

$

30,023

$

14,422

Diluted

Distributed earnings to common shareholders

$

5,791

$

5,201

$

11,567

$

9,409

Undistributed earnings to common shareholders

 

10,396

 

7,469

 

18,456

 

5,013

Total common shareholders earnings

 

16,187

 

12,670

 

30,023

 

14,422

Add back:

Undistributed earnings reallocated from unvested restricted stock awards

 

1

1

1

1

Total common shareholders earnings, diluted

$

16,188

$

12,671

$

30,024

$

14,423

Weighted average common shares outstanding, basic

 

24,081,777

23,815,436

24,040,032

22,365,927

Options

 

221,434

452,675

214,580

451,545

Weighted average common shares outstanding, diluted

 

24,303,211

 

24,268,111

 

24,254,612

 

22,817,472

Basic earnings per common share

$

0.67

$

0.53

$

1.25

$

0.64

Diluted earnings per common share

 

0.67

 

0.52

 

1.24

 

0.63

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Note 15 – 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 June 30, 2019 and December 31, 2018, are summarized below:

June 30, 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:

Government sponsored entity debt securities

$

74,875

$

$

74,875

$

Agency mortgage-backed securities

 

297,362

 

 

297,362

 

State and municipal securities

 

143,729

 

 

143,729

 

Corporate securities

 

93,691

 

 

92,756

 

935

Equity securities

3,369

3,369

Loans held for sale

 

22,143

 

 

22,143

 

Interest rate lock commitments

 

3,791

 

 

3,791

 

Interest rate swap contracts

286

286

Total

$

639,246

$

$

638,311

$

935

Liabilities

Interest rate swap contracts

$

286

$

$

286

$

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

Mortgage servicing rights

$

54,191

$

$

$

54,191

Mortgage servicing rights held for sale

159

159

Impaired loans

 

13,170

 

 

10,842

 

2,328

Other real estate owned

47

47

Assets held for sale

 

1,297

 

 

1,297

 

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Table of Contents

December 31, 2018

 

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. Treasury securities

$

24,650

$

24,650

$

$

Government sponsored entity debt securities

 

75,684

 

 

75,684

 

Agency mortgage-backed securities

 

326,305

 

 

326,305

 

State and municipal securities

 

159,262

 

 

159,262

 

Corporate securities

 

71,550

 

 

69,627

 

1,923

Equity securities

3,334

3,334

Loans held for sale

 

30,401

 

 

30,401

 

Interest rate lock commitments

 

4,492

 

 

4,492

 

Interest rate swap contracts

 

145

 

 

145

 

Total

$

695,823

$

24,650

$

669,250

$

1,923

Liabilities

Interest rate swap contracts

$

145

$

$

145

$

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

Mortgage servicing rights

$

53,447

$

$

$

53,447

Mortgage servicing rights held for sale

3,545

3,545

Impaired loans

11,238

9,226

2,012

Other real estate owned

 

1,439

 

 

1,439

 

Assets held for sale

1,687

1,687

The following table presents gains (losses) recognized on assets measured on a non-recurring basis for the three and six months ended June 30, 2019 and 2018:

Three Months Ended

Six Months Ended

June 30, 

June 30, 

(dollars in thousands)

    

2019

    

2018

     

2019

    

2018

 

Mortgage servicing rights

$

559

$

(500)

$

534

$

(633)

Mortgage servicing rights held for sale

515

(188)

515

(188)

Impaired loans

(1,252)

(2,041)

(2,233)

(2,916)

Other real estate owned

(126)

(16)

(126)

Total loss on assets measured on a nonrecurring basis

$

(178)

$

(2,855)

$

(1,200)

$

(3,863)

The following table presents activity for assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and six months ended June 30, 2019 and 2018:

Three Months Ended

Six Months Ended

June 30, 

June 30, 

(dollars in thousands)

2019

2018

2019

2018

Balance, beginning of period

$

1,930

$

4,787

$

1,923

$

4,779

Total realized in earnings (1)

20

63

 

42

119

Total unrealized in other comprehensive income

5

562

 

12

562

Net settlements (principal and interest)

(1,020)

(55)

 

(1,042)

(103)

Balance, end of period

$

935

$

5,357

$

935

$

5,357

(1)Amounts included in interest income from investment securities taxable in the consolidated statements of income.

28

Table of Contents

The following table presents quantitative information about significant unobservable inputs used in fair value measurements of non-recurring assets (Level 3) at June 30, 2019:

Non-recurring

Fair Value

Valuation

Unobservable

fair value measurements

(dollars in thousands)

technique

input / assumptions

Range (weighted average)

Mortgage servicing rights

$

54,191

Discounted cash flow

Prepayment speed

8.00% - 18.00% (8.21%)

Discount rate

10.00% - 27.00% (11.03%)

Impaired loans

$

2,328

Fair value of collateral

Discount for type of property,

4.32% - 8.00% (5.51%)

age of appraisal and current status

The following table presents quantitative information about significant unobservable inputs used in fair value measurements of non-recurring assets (Level 3) at December 31, 2018:

Non-recurring

Fair Value

Valuation

Unobservable

fair value measurements

(dollars in thousands)

technique

input / assumptions

Range (weighted average)

Mortgage servicing rights

$

53,447

Discounted cash flow

Prepayment speed

8.00% - 18.00% (8.24%)

Discount rate

10.00% - 27.00% (11.12%)

Impaired loans

$

2,012

Fair value of collateral

Discount for type of property,

5.00% - 7.26% (5.26%)

age of appraisal and current status

Mortgage Servicing Rights. In accordance with GAAP, the Company must record impairment charges on mortgage 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 mortgage 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. The fair value of mortgage servicing rights was $54.2 million and $53.4 million at June 30, 2019 and December 31, 2018, respectively.

Impaired loans. Impaired loans are measured and recorded at fair value on a non-recurring basis. All of our nonaccrual loans and restructured loans are considered impaired and are reviewed individually for the amount of impairment, if any. Most of our loans are collateral dependent and, accordingly, we measure impaired 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 impaired 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 residential and commercial loans held for sale. These loans are intended for sale and are hedged with derivative instruments. We have elected the fair value option to mitigate accounting mismatches in cases where hedge accounting is complex and to achieve operational simplification.

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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 June 30, 2019 and December 31, 2018:

June 30, 2019

December 31, 2018

Aggregate

Contractual

Aggregate

Contractual

(dollars in thousands)

fair value

Difference

principal

fair value

Difference

principal

Residential loans held for sale

    

$

7,198

$

364

$

6,834

$

8,121

$

484

$

7,637

Commercial loans held for sale

14,945

301

14,644

22,280

595

21,685

Total loans held for sale

$

22,143

$

665

$

21,478

$

30,401

$

1,079

$

29,322

The following table presents the amount of gains (losses) from fair value changes included in income before income taxes for financial assets carried at fair value for the three and six months ended June 30, 2019 and 2018:

Three Months Ended

Six Months Ended

June 30, 

June 30, 

(dollars in thousands)

2019

2018

2019

2018

Residential loans held for sale

$

38

$

168

$

(19)

$

60

Commercial loans held for sale

34

260

(294)

25

Total loans held for sale

$

72

$

428

$

(313)

$

85

The following tables are a summary of the carrying values and fair value estimates of certain financial instruments as of June 30, 2019 and December 31, 2018:

June 30, 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

    

$

244,239

    

$

244,239

    

$

244,239

    

$

    

$

Federal funds sold

 

1,176

 

1,176

 

1,176

 

 

Investment securities available for sale

 

609,657

 

609,657

 

 

608,722

 

935

Equity securities

 

3,369

 

3,369

 

 

3,369

 

Nonmarketable equity securities

 

43,175

 

43,175

 

 

43,175

 

Loans, net

 

4,047,602

 

4,056,912

 

 

4,056,912

 

Loans held for sale

 

22,143

 

22,143

 

 

22,143

 

Accrued interest receivable

 

15,509

 

15,509

 

 

15,509

 

Interest rate lock commitments

 

3,791

 

 

3,791

Interest rate swap contracts

286

286

Liabilities

Deposits

$

4,011,207

$

4,016,503

$

$

4,016,503

$

Short-term borrowings

 

113,844

 

113,844

 

 

113,844

 

FHLB and other borrowings

 

582,387

 

594,404

 

 

594,404

 

Subordinated debt

 

94,215

 

93,761

 

 

93,761

 

Trust preferred debentures

 

48,041

 

55,218

 

 

55,218

 

Accrued interest payable

 

5,455

 

5,455

 

 

5,455

 

Interest rate swap contracts

286

 

 

 

286

 

30

Table of Contents

December 31, 2018

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

    

$

210,780

    

$

210,780

    

$

210,780

    

$

    

$

Federal funds sold

 

2,920

 

2,920

 

2,920

 

 

Investment securities available for sale

 

660,785

 

660,785

 

24,650

 

634,212

 

1,923

Nonmarketable equity securities

 

42,472

 

42,472

 

 

42,472

 

Loans, net

 

4,116,648

 

4,091,438

 

 

 

4,091,438

Loans held for sale

 

30,401

 

30,401

 

 

30,401

 

Accrued interest receivable

 

16,560

 

16,560

 

 

16,560

 

Interest rate lock commitments

 

4,492

 

4,492

 

 

4,492

 

Interest rate swap contracts

145

145

145

Liabilities

Deposits

$

4,074,170

$

4,069,098

$

$

4,069,098

$

Short-term borrowings

 

124,235

 

124,235

 

 

124,235

 

FHLB and other borrowings

 

640,631

 

641,050

 

 

641,050

 

Subordinated debt

 

94,134

 

91,926

 

 

91,926

 

Trust preferred debentures

 

47,794

 

56,805

 

 

56,805

 

Accrued interest payable

 

4,855

 

4,855

 

 

4,855

 

Interest rate swap contracts

145

145

145

Note 16 – 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.

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 June 30, 2019 and December 31, 2018 were as follows:

    

June 30, 

    

December 31, 

 

(dollars in thousands)

    

2019

    

2018

 

Commitments to extend credit

$

761,832

$

663,555

Financial guarantees – standby letters of credit

 

127,135

 

142,859

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 2019 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. As a result of make-whole requests and loan repurchases, the Company incurred losses totaling $9,000 and $20,000 for the three and six months ended June 30, 2018, respectively. There were no losses as a result of make-whole requests and loan repurchases for the three and six months ended June 30, 2019. The liability for unresolved repurchase demands totaled $289,000 and $492,000 at June 30, 2019 and December 31, 2018, respectively.

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Table of Contents

Note 17 – Segment Information

Our business segments are defined as Banking, Commercial FHA Origination and Servicing, Wealth Management, 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 commercial FHA origination and servicing segment provides for the origination and servicing of government sponsored mortgages for multifamily and healthcare facilities. The wealth management segment consists of trust and fiduciary services, brokerage and retirement planning services. 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 and six months ended June 30, 2019 and 2018 were as follows:

    

    

Commercial FHA

    

    

    

Origination and

Wealth

(dollars in thousands)

Banking

Servicing

Management

Other

Total

Three Months Ended June 30, 2019

Net interest income (expense)

$

48,930

$

(138)

$

$

(2,715)

$

46,077

Provision for loan losses

 

4,076

 

 

 

 

4,076

Noninterest income

 

9,025

 

5,116

 

5,504

 

(58)

 

19,587

Noninterest expense

 

33,809

 

3,004

 

3,772

 

(391)

 

40,194

Income before income taxes

 

20,070

 

1,974

 

1,732

 

(2,382)

 

21,394

Income taxes (benefit)

 

5,132

 

551

 

197

(841)

 

5,039

Net income (loss)

$

14,938

$

1,423

$

1,535

$

(1,541)

$

16,355

Total assets

$

5,478,515

$

88,320

$

19,398

$

(40,178)

$

5,546,055

Six Months Ended June 30, 2019

Net interest income (expense)

$

97,448

$

(314)

$

$

(5,456)

$

91,678

Provision for loan losses

 

7,319

 

 

 

 

7,319

Noninterest income

 

17,965

 

8,354

 

10,457

 

(114)

 

36,662

Noninterest expense

 

69,180

 

5,815

 

7,019

 

(723)

 

81,291

Income (loss) before income taxes (benefit)

 

38,914

 

2,225

 

3,438

 

(4,847)

 

39,730

Income taxes (benefit)

 

10,107

 

622

 

337

(1,673)

 

9,393

Net income (loss)

$

28,807

$

1,603

$

3,101

$

(3,174)

$

30,337

Total assets

$

5,478,515

$

88,320

$

19,398

$

(40,178)

$

5,546,055

    

    

Commercial FHA

    

    

    

Origination and

Wealth

(dollars in thousands)

Banking

Servicing

Management

Other

Total

Three Months Ended June 30, 2018

Net interest income (expense)

$

51,050

$

(95)

$

$

(2,669)

$

48,286

Provision for loan losses

 

1,854

 

 

 

 

1,854

Noninterest income

 

5,681

 

447

 

5,316

 

4,403

 

15,847

Noninterest expense

 

38,216

 

4,718

 

3,257

 

261

 

46,452

Income (loss) before income taxes (benefit)

 

16,661

 

(4,366)

 

2,059

 

1,473

 

15,827

Income taxes (benefit)

 

5,201

 

(1,402)

 

151

 

(905)

 

3,045

Net income (loss)

$

11,460

$

(2,964)

$

1,908

$

2,378

$

12,782

Total assets

$

5,780,313

$

94,481

$

17,171

$

(161,365)

$

5,730,600

Six Months Ended June 30, 2018

Net interest income (expense)

$

91,766

$

(58)

$

$

(5,237)

$

86,471

Provision for loan losses

 

3,860

 

 

 

 

3,860

Noninterest income

 

14,698

 

3,968

 

9,395

 

4,288

 

32,349

Noninterest expense

 

82,582

 

8,256

 

5,643

 

(530)

 

95,951

Income (loss) before income taxes (benefit)

 

20,022

 

(4,346)

 

3,752

 

(419)

 

19,009

Income taxes (benefit)

 

6,580

 

(995)

 

292

 

(1,456)

 

4,421

Net income (loss)

$

13,442

$

(3,351)

$

3,460

$

1,037

$

14,588

Total assets

$

5,780,313

$

94,481

$

17,171

$

(161,365)

$

5,730,600

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1

Note 18 – Related Party Transactions

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 and six months ended June 30, 2019, the Company paid $325,000 and $535,000, respectively, to this company for work on various projects, which was approved in accordance with the Company’s related party transaction policy.

Note 19 – Revenue From Contracts with Customers

On January 1, 2018, the Company adopted ASU No. 2014-09 “Revenue from Contracts with Customers” (Topic 606) and all subsequent ASUs that modified Topic 606. As stated in “Note 2 Basis of Presentation and Summary of Significant Accounting Policies,” the implementation of the new standard did not have a material impact on the measurement or recognition of revenue. Since the impact of applying the standard was determined to be immaterial, the Company did not record a cumulative effect adjustment to beginning retained earnings on January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts were not adjusted and continue to be reported in accordance with previous GAAP.

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 the new guidance. 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 recognition of revenue associated with these noninterest income streams did not change significantly from current practice upon adoption of Topic 606. 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.

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.

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Table of Contents

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.

Gain on Sales of Other Real Estate Owned

The Company records a gain or loss from the sale of other real estate owned (“OREO”) when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. When the Company finances the sale of OREO to a buyer, the Company assesses whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the OREO asset is derecognized and the gain or loss on sale is recorded upon transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Company adjusts the transaction price and related gain or loss on sale if a significant financing component is present.

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, 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.

The following presents noninterest income, segregated by revenue streams in-scope and out-of-scope of Topic 606, for the three and six months ended June 30, 2019 and 2018.

Three Months Ended

Six Months Ended

June 30, 

June 30, 

(dollars in thousands)

2019

2018

2019

2018

Noninterest income - in-scope of Topic 606

Wealth management revenue:

Trust management/administration fees

$

4,082

$

4,322

$

7,699

$

7,441

Investment advisory fees

539

495

1,068

960

Investment brokerage fees

232

286

451

550

Other

651

213

1,239

444

Service charges on deposit accounts:

Nonsufficient fund fees

1,801

1,991

3,555

3,441

Other

838

702

1,604

1,219

Interchange revenues

3,010

2,929

5,690

4,974

Other income:

Merchant services revenue

389

460

764

798

Other

788

687

1,606

1,747

Noninterest income - out-of-scope of Topic 606

7,257

3,762

12,986

10,775

Total noninterest income

$

19,587

$

15,847

$

36,662

$

32,349

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Table of Contents

Contract Balances

A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before payment is due (resulting in a contract asset). A contract liability balance is an entity’s obligation to transfer a service to a customer for which the entity has already received payment (or payment is due) from the customer. The Company’s noninterest revenue streams are largely based on transactional activity, or standard month-end revenue accruals such as asset management fees based on month-end market values. Consideration is often received immediately or shortly after the Company satisfies its performance obligation and revenue is recognized. The Company does not typically enter into long-term revenue contracts with customers, and therefore, does not experience significant contract balances. As of June 30, 2019 and December 31, 2018, the Company did not have any significant contract balances.

Contract Acquisition Costs

In connection with the adoption of Topic 606, an entity is required to capitalize, and subsequently amortize into expense, certain incremental costs of obtaining a contract with a customer if these costs are expected to be recovered. The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (for example, sales commission). The Company utilizes the practical expedient which allows entities to immediately expense contract acquisition costs when the asset that would have resulted from capitalizing these costs would have been amortized in one year or less. Upon adoption of Topic 606, the Company did not capitalize any contract acquisition costs.

Note 20 – Subsequent Events

Acquisition of HomeStar Financial Group, Inc. – Completed on July 17, 2019

On July 17, 2019, the Company completed its acquisition of HomeStar Financial Group, Inc. (“HomeStar”), and its wholly owned subsidiary, HomeStar Bank and Financial Services, which operates 5 full-service banking centers in northern Illinois, for total consideration of $11.4 million, consisting of $1.0 million in cash and 405,000 shares of the Company’s common stock. The Company has not yet determined the estimated acquisition date fair values for identifiable assets acquired and liabilities assumed. As of June 30, 2019, HomeStar had approximately $370.4 million in assets, $219.5 million in loans and $321.8 million in deposits. The Company anticipates there will be goodwill and core deposit intangibles recorded with this acquisition.

Redemption of Fixed Rate Non-Voting Perpetual Non-Cumulative Preferred Stock, Series H

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

Stock Repurchase Program

On August 6, 2019, the Board of Directors also approved a stock repurchase program that authorizes the Company to repurchase up to $25.0 million of its common stock. Stock repurchases under the program may be made from time to time on the open market, in privately negotiated transactions, or in any other manner that complies with applicable securities laws, at the discretion of the Company. The program will be in effect until June 30, 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 conditions. The repurchase program may be suspended or discontinued at any time without notice.

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Table of Contents

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 and six months ended June 30, 2019. 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, 2018, filed with the SEC on February 28, 2019.

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 changes in interest rates and other general economic, business and political conditions, including 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 Transactions

Each item listed below materially affects the comparability of our results of operations for the three and six months ended June 30, 2019 and 2018, and our financial condition as of June 30, 2019 and December 30, 2018, and may affect the comparability of financial information we report in future fiscal periods.

Recent Acquisitions. On February 28, 2018, the Company acquired Alpine for total consideration valued at approximately $173.2 million. Consideration transferred by the Company consisted of $33.3 million in cash and 4,463,200 shares of common stock. All identifiable assets acquired and liabilities assumed were adjusted to fair value as of February 28, 2018, and the results of Alpine’s operations have been included in the consolidated statements of income beginning on that date. Intangible assets recognized as a result of the transaction consisted of $66.0 million in goodwill, $6.3 million in customer relationship intangibles and $21.1 million in core deposit intangibles.

Purchased Loans.  Our net interest margin benefits from favorable changes in expected cash flows on our PCI loans and from accretion income associated with purchase accounting discounts established on the non-PCI loans included in our acquisitions. Our reported net interest margin for the three months ended June 30, 2019 and 2018 was 3.76% and 3.91%, respectively. Accretion income associated with accounting discounts established on loans acquired totaled $3.4 million and $5.5 million for the three months ended June 30, 2019 and 2018, respectively, increasing the reported net interest margin by 25 and 40 basis points for each respective period. The reported net interest margin for the six months ended June 30, 2019 and 2018 was 3.75% and 3.81%, respectively. Accretion income associated with purchase accounting discounts established on loans acquired totaled $5.9 million and $7.4 million for the six months ended June 30, 2019 and 2018, respectively, increasing the reported net interest margin by 21 and 29 points for each respective period.

Results of Operations

Net Interest Income. 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 and six months ended June 30, 2019 and 2018.

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Table of Contents

As described above, one of the factors that impact net interest income is interest rate fluctuations. The Federal Reserve implemented quarterly interest rate increases in 2018, with the last increase of 25 basis points in December 2018. These increases impact the comparability of net interest income between 2018 and 2019 as further discussed below. The Federal Reserve has not changed interest rates in the first half of 2019.

During the three months ended June 30, 2019, net interest income (on a tax-equivalent basis) was $46.6 million as compared to $48.8 million for the comparative prior year quarter. The tax-equivalent net interest margin was 3.76% for the second quarter of 2019 compared to 3.91% in the second quarter of 2018.

During the six months ended June 30, 2019, we generated $92.7 million of net interest income (on a tax-equivalent basis), which was an increase of $5.3 million, or 6.11%, from $87.4 million during the six months ended June 30, 2018. The tax-equivalent net interest margin was 3.75% for the first six months of 2019 compared to 3.81% for the first six months of 2018.

Average Balance Sheet, Interest and Yield/Rate Analysis. The following tables present average balance sheet information, interest income, interest expense and the corresponding average yields earned and rates paid for the three and six months ended June 30, 2019 and 2018. 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.

Three Months Ended June 30, 

2019

2018

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

$

162,110

$

982

2.43

%  

$

227,499

$

1,014

1.79

%

Investment securities:

Taxable investment securities

 

488,341

 

3,606

2.95

 

555,053

 

3,756

 

2.71

Investment securities exempt from federal income tax (1)

 

148,605

 

1,344

3.62

 

175,964

 

1,564

 

3.55

Total securities

 

636,946

 

4,950

 

3.11

 

731,017

 

5,320

 

2.91

Loans:

Loans (2)

 

3,979,705

53,021

5.34

 

3,880,427

 

50,699

 

5.24

Loans exempt from federal income tax (1)

 

107,015

1,161

4.35

 

102,531

 

1,015

 

3.97

Total loans

 

4,086,720

 

54,182

 

5.32

 

3,982,958

 

51,714

 

5.21

Loans held for sale

40,177

451

4.50

31,220

295

3.79

Nonmarketable equity securities

44,217

597

5.42

38,872

482

4.97

Total earning assets

 

4,970,170

$

61,162

 

4.94

%

 

5,011,566

$

58,825

 

4.71

%

Noninterest-earning assets

 

618,023

 

639,864

Total assets

$

5,588,193

$

5,651,430

INTEREST-BEARING LIABILITIES:

Checking and money market deposits

$

1,735,198

$

3,306

0.76

%  

$

1,822,290

$

1,925

 

0.42

%

Savings deposits

 

450,185

 

225

0.20

 

465,478

 

190

 

0.16

Time deposits

 

749,806

 

3,779

2.02

 

660,089

 

1,835

 

1.12

Brokered deposits

 

172,471

 

1,127

2.62

 

210,959

 

1,055

 

2.00

Total interest-bearing deposits

3,107,660

8,437

1.09

3,158,816

5,005

0.64

Short-term borrowings

 

120,859

 

210

0.70

 

120,794

 

116

 

0.38

FHLB advances and other borrowings

 

607,288

 

3,541

2.34

 

573,107

 

2,582

 

1.81

Subordinated debt

 

94,196

 

1,514

6.43

 

94,035

 

1,514

 

6.44

Trust preferred debentures

 

47,982

 

857

7.17

 

47,488

 

780

 

6.59

Total interest-bearing liabilities

 

3,977,985

$

14,559

 

1.47

%  

 

3,994,240

$

9,997

 

1.00

%

NONINTEREST-BEARING LIABILITIES

Noninterest-bearing deposits

 

921,115

 

1,025,308

Other noninterest-bearing liabilities

 

60,363

 

47,229

Total noninterest-bearing liabilities

 

981,478

 

1,072,537

Shareholders’ equity

 

628,730

 

584,653

Total liabilities and shareholders’ equity

$

5,588,193

$

5,651,430

Net interest income / net interest margin (3)

$

46,603

 

3.76

%  

$

48,828

 

3.91

%

(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 $526,000 and $541,000 for the three months ended June 30, 2019 and 2018, 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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Table of Contents

Six Months Ended June 30, 

2019

2018

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

$

157,122

$

1,889

2.42

%  

$

183,133

$

1,535

1.69

%

Investment securities:

Taxable investment securities

 

494,472

 

7,289

2.95

 

486,458

 

6,399

 

2.63

Investment securities exempt from federal income tax (1)

 

151,333

 

2,693

3.56

 

153,640

 

2,850

 

3.71

Total securities

 

645,805

 

9,982

 

3.09

 

640,098

 

9,249

 

2.89

Loans:

Loans (2)

 

3,999,991

104,903

5.29

 

3,648,407

 

91,730

 

5.07

Loans exempt from federal income tax (1)

 

107,699

2,395

4.48

 

83,426

 

1,606

 

3.88

Total loans

 

4,107,690

 

107,298

 

5.27

 

3,731,833

 

93,336

 

5.04

Loans held for sale

35,511

750

4.26

36,003

723

4.05

Nonmarketable equity securities

44,248

1,218

5.55

36,892

881

4.82

Total earning assets

 

4,990,376

$

121,137

 

4.90

%  

 

4,627,959

$

105,724

 

4.61

%

Noninterest-earning assets

 

618,507

 

588,592

Total assets

$

5,608,883

$

5,216,551

INTEREST-BEARING LIABILITIES

Checking and money market deposits

$

1,774,319

$

6,683

0.76

%  

$

1,702,919

$

3,576

 

0.42

%

Savings deposits

 

449,682

 

445

0.20

 

405,302

 

351

 

0.17

Time deposits

 

701,460

 

6,481

1.86

 

612,507

 

3,285

 

1.08

Brokered deposits

 

175,396

 

2,191

2.52

 

197,685

 

1,910

 

1.95

Total interest-bearing deposits

3,100,857

15,800

1.03

2,918,413

9,122

0.63

Short-term borrowings

 

128,058

447

0.70

 

134,671

 

240

 

0.36

FHLB advances and other borrowings

 

640,087

7,388

2.33

 

531,567

 

4,453

 

1.69

Subordinated debt

 

94,176

3,028

6.43

 

94,014

 

3,028

 

6.44

Trust preferred debentures

 

47,915

1,727

7.27

 

47,431

 

1,474

 

6.27

Total interest-bearing liabilities

 

4,011,093

$

28,390

 

1.43

%  

 

3,726,096

$

18,317

 

0.99

%

NONINTEREST-BEARING LIABILITIES

Noninterest-bearing deposits

 

920,156

 

904,409

Other noninterest-bearing liabilities

 

56,124

 

44,012

Total noninterest-bearing liabilities

 

976,280

 

948,421

Shareholders’ equity

 

621,510

 

542,034

Total liabilities and shareholders’ equity

$

5,608,883

$

5,216,551

Net interest income / net interest margin (3)

$

92,747

 

3.75

%  

$

87,407

 

3.81

%  

(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 $1.1 million and $936,000 for the six months ended June 30, 2019 and 2018, 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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Table of Contents

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 June 30, 2019

Six Months Ended June 30, 2019

 

Compared with

Compared with

 

Three Months Ended June 30, 2018

Six Months Ended June 30, 2018

 

Change due to:

Interest

Change due to:

Interest

 

(tax-equivalent basis, dollars in thousands)

    

Volume

    

Rate

    

Variance

    

Volume

    

Rate

    

Variance

  

EARNING ASSETS:

    

    

    

    

    

    

Federal funds sold and cash investments

$

(343)

$

311

$

(32)

$

(265)

$

619

$

354

Investment securities:

Taxable investment securities

 

(472)

 

322

 

(150)

 

112

778

 

890

Investment securities exempt from federal income tax

 

(245)

 

25

 

(220)

 

(42)

(115)

 

(157)

Total securities

 

(717)

 

347

 

(370)

 

70

 

663

 

733

Loans:

Loans

 

1,310

1,012

 

2,322

 

9,030

4,143

 

13,173

Loans exempt from federal income tax

 

47

99

 

146

 

503

286

 

789

Total loans

 

1,357

 

1,111

 

2,468

 

9,533

 

4,429

 

13,962

Loans held for sale

93

63

156

(10)

37

27

Nonmarketable equity securities

69

46

115

189

148

337

Total earning assets

$

459

$

1,878

$

2,337

$

9,517

$

5,896

$

15,413

INTEREST-BEARING LIABILITIES:

Checking and money market deposits

$

(128)

$

1,509

$

1,381

$

210

$

2,897

$

3,107

Savings deposits

 

(7)

 

42

 

35

 

41

53

 

94

Time deposits

 

351

 

1,593

 

1,944

 

650

2,546

 

3,196

Brokered deposits

 

(222)

 

294

 

72

 

(247)

528

 

281

Total interest-bearing deposits

(6)

3,438

3,432

654

6,024

6,678

Short-term borrowings

 

 

94

 

94

 

(17)

224

 

207

FHLB advances and other borrowings

 

177

 

782

 

959

 

1,081

1,854

 

2,935

Subordinated debt

 

3

 

(3)

 

 

5

(5)

 

Trust preferred debentures

 

8

 

69

 

77

 

16

237

 

253

Total interest-bearing liabilities

$

182

$

4,380

$

4,562

$

1,739

$

8,334

$

10,073

Net interest income

$

277

$

(2,502)

$

(2,225)

$

7,778

$

(2,438)

$

5,340

Interest Income. The $2.5 million, or 4.8%, increase in interest income on loans (on a tax-equivalent basis) for the second quarter of 2019 was primarily due to a 2.6% increase in the average balance of loans outstanding combined with an 11 basis point increase in the average yield. The increase in the average balance of loans outstanding was primarily due to growth in commercial loans, construction and land development loans, and lease financings. The increase in the average yield on loans was mainly due to the impact of higher market interest rates. Accretion income associated with accounting discounts established on loans acquired totaled $3.4 million and $5.5 million for the three months ended June 30, 2019 and 2018, respectively, increasing the reported net interest margin by 25 and 40 basis points for each respective period.

For the six months ended June 30, 2019, the $14.0 million, or 15.0%, increase in interest income on loans was primarily due to a 10.1% increase in the average balance of loans outstanding combined with a 23 basis point increase in the average yield. The average balance increase was primarily due to a full six month effect of loans added from Alpine in February 2018. The reported yield on total loans for the six months ended June 30, 2019 and 2018 was 5.27% and 5.04%, respectively. The increase in the average yield on loans was mainly due to the impact of higher rates on new and renewed loans as compared to the same period last year. Accretion income associated with purchase accounting discounts established on loans acquired totaled $5.9 million and $7.4 million for the six months ended June 30, 2019 and 2018, respectively, increasing the reported net interest margin by 21 and 29 basis points for each respective period.

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Interest income on our investment securities portfolio on a tax-equivalent basis decreased $0.4 million for the three months ended June 30, 2019 compared to the prior year period, which was mainly attributable to decreases in the average balance of investment securities of 12.9%, partially offset by a 20 basis point increase in the average yield. The decrease in average balance was primarily attributable to the liquidation of the securities in the U.S. Treasury portfolio, which were reinvested in other assets, including corporate securities and loans, as well as a higher level of paydowns of agency mortgage backed securities and municipal securities during the second quarter of 2019. The increase in the average yield was driven by higher market rates.

For the six months ended June 30, 2019, the $0.7 million, or 7.9%, increase in interest income on our investment securities portfolio on a tax-equivalent basis was primarily attributable to a 20 basis point increase in the average yield. The increase in the rate was driven by higher market rates.

Interest Expense. Interest expense on interest-bearing liabilities increased $4.6 million to $14.6 million for the second quarter of 2019, and $10.1 million to $28.4 million for the six months ended June 30, 2019.

Interest expense on deposits increased to $8.4 million for the three months ended June 30, 2019 from $5.0 million for the comparable period in 2018. The $3.4 million, or 68.6%, increase in interest expense on deposits for the second quarter of 2019 was primarily due to a 45 basis point increase in the average rate paid. The increase in the average rates paid was primarily due to the impact of market competition.

For the six month period June 30, 2019, the $6.7 million, or 73.2%, increase in interest expense on deposits was mainly attributable to a 40 basis point increase in the average rate paid coupled with the average balance of deposits increasing 6.3%. The increase in the average rates paid were primarily due to market competition. The increases in the average balance of deposits reflected the addition of $770.2 million of interest-bearing deposits from Alpine in February 2018.

Interest expense on borrowings increased to $6.1 million for the three months ended June 30, 2019 as compared to $5.0 million for the comparable period in 2018. The $1.1 million increase in interest expense on borrowings for the three months ended June 30, 2019 was primarily due to the impact of higher market interest rates on new FHLB advances and our variable rate trust preferred debentures combined with the expanded usage of FHLB advances as a short-term and long-term funding source.

For the six months ended June 30, 2019, the $3.4 million increase in interest expense on borrowings to $12.6 million from $9.2 million for the first six months of 2018 was primarily attributable to the impact of higher market interest rates on new FHLB advances and the addition of $18.1 million of FHLB advances assumed from Alpine.

Provision for Loan Losses. The provision for loan losses totaled $4.1 million and $1.9 million for the three months ended June 30, 2019 and 2018, respectively. The increase in provision for loan losses was primarily driven by an increase in specific reserves on a credit placed on nonaccrual in the second quarter of 2019.

The provision for loan losses totaled $7.3 million and $3.9 million for the six months ended June 30, 2019 and 2018, respectively. The increase in provision for loan losses was primarily attributable to an increase in specific reserves on two credits placed on nonaccrual and a downgrade of one commercial real estate loan and one residential real estate loan during the first half of 2019.

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Noninterest Income. The following table sets forth the major components of our noninterest income for the three and six months ended June 30, 2019 and 2018:

Three Months Ended

Six Months Ended

 

June 30, 

Increase

June 30, 

Increase

 

(dollars in thousands)

2019

    

2018

    

(decrease)

    

2019

    

2018

    

(decrease)

 

Noninterest income:

    

    

    

Wealth management revenue

$

5,504

$

5,316

$

188

$

10,457

$

9,395

$

1,062

Commercial FHA revenue

 

4,917

 

326

 

4,591

 

8,187

 

3,656

 

4,531

Residential mortgage banking revenue

 

611

 

2,116

 

(1,505)

 

1,445

 

3,534

 

(2,089)

Service charges on deposit accounts

 

2,639

 

2,693

 

(54)

 

5,159

 

4,660

 

499

Interchange revenue

 

3,010

 

2,929

 

81

 

5,690

 

4,974

 

716

Gain (loss) on sales of investment securities, net

 

14

 

(70)

 

84

 

14

 

(5)

 

19

(Loss) gain on sales of other real estate owned

 

(12)

 

166

 

(178)

 

54

 

473

 

(419)

Other income

 

2,904

 

2,371

 

533

 

5,656

 

5,662

 

(6)

Total noninterest income

$

19,587

$

15,847

$

3,740

$

36,662

$

32,349

$

4,313

Wealth management revenue. Noninterest income from our wealth management business increased $1.1 million for the six months ended June 30, 2019, primarily due to an increase in trust fees and the addition of $1.0 billion of wealth management assets under administration from the Alpine acquisition in February 2018.

Commercial FHA revenue. The $4.6 million increase in commercial FHA revenue for the three months ended June 30, 2019 is attributable to an increase in gain premiums, partially offset by lower loan costs. Interest rate lock commitments increased to $42.2 million in the second quarter of 2019 from $11.1 million for the comparable period in 2018. Included in the increase of commercial FHA revenue was a $0.6 million recapture of mortgage servicing rights in the second quarter of 2019 as compared to $0.5 million of impairment in the second quarter of 2018.

For the six months ended June 30, 2019, the $4.5 million increase in commercial FHA revenue was driven by an increase in gain premiums, partially offset by lower loan costs as compared to the first half of 2018. Interest rate lock commitments increased to $106.7 million from $91.5 million for the six months ended June 30, 2019 and 2018, respectively. Included in the increase was a $0.6 million recapture of mortgage servicing rights in the first half of 2019 as compared to $0.6 million of impairment for the comparable period in 2018.

Residential mortgage banking revenue. The decrease of $1.5 million of residential mortgage banking revenue for the three months ended June 30, 2019 was primarily attributable to a decrease in servicing fees as a result of the reduction of residential mortgage loans serviced for others due to the sale of residential mortgage servicing rights during 2018 and the first quarter of 2019 and a decline in closed production and interest rate lock commitments that were due in part to a smaller loan production team as compared to the three months ended June 30, 2018.

For the six months ended June 30, 2019, the decrease of $2.1 million of residential mortgage banking revenue was primarily attributable to a decrease in servicing fees as a result of the reduction of residential mortgage loans serviced for others due to the sale of residential mortgage servicing rights during 2018 and the first quarter of 2019 and a decline in closed production and interest rate lock commitments that were due in part to a smaller loan production team as compared to the first half of 2018.

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Noninterest Expense. The following table sets forth the major components of noninterest expense for the three and six months ended June 30, 2019 and 2018:

Three Months Ended

Six Months Ended

 

June 30, 

Increase

June 30, 

Increase

 

(dollars in thousands)

2019

    

2018

    

(decrease)

2019

2018

(decrease)

 

Noninterest expense:

    

    

    

    

    

    

    

    

Salaries and employee benefits

$

21,134

$

23,467

$

(2,333)

$

43,173

$

51,862

$

(8,689)

Occupancy and equipment

 

4,500

 

4,708

 

(208)

 

9,332

 

8,960

 

372

Data processing

 

4,987

 

5,106

 

(119)

 

9,878

 

9,585

 

293

FDIC insurance

 

367

 

539

 

(172)

 

802

 

1,087

 

(285)

Professional

 

2,410

 

3,195

 

(785)

 

4,483

 

6,944

 

(2,461)

Marketing

 

1,118

 

1,411

 

(293)

 

2,352

 

2,617

 

(265)

Communications

 

677

 

741

 

(64)

 

1,348

 

2,317

 

(969)

Loan expense

 

616

 

552

 

64

 

976

 

1,076

 

(100)

Other real estate owned

 

101

 

166

 

(65)

 

194

 

256

 

(62)

Amortization of intangible assets

 

1,673

 

1,576

 

97

 

3,483

 

3,251

 

232

(Gain) loss on mortgage servicing rights held for sale

(515)

188

(703)

(515)

188

(703)

Other

 

3,126

 

4,803

 

(1,677)

 

5,785

 

7,808

 

(2,023)

Total noninterest expense

$

40,194

$

46,452

$

(6,258)

$

81,291

$

95,951

$

(14,660)

Salaries and employee benefits. The $2.3 million decrease in salaries and employee benefits expense during the three months ended June 30, 2019 as compared to the same period in 2018 was primarily driven by a decrease in average full-time equivalent employees after the integration of Alpine into the Bank in the third quarter of 2018.

For the six months ended June 30, 2019, the $8.7 million decrease in salaries and employee benefits was mainly due to the incurrence of Alpine acquisition expenses of change in control payments, severance costs and other benefit-related expenses in the first half of 2018.

Professional fees. For the six months ended June 30, 2019, the $2.5 million decrease in professional fees was primarily due to the decrease in professional fees incurred on various technology and other integration projects related to the Alpine acquisition.

Other noninterest expense. The decrease in other noninterest expense of $1.7 million and $2.0 million for the three and six months ended June 30, 2019, respectively, as compared to the same periods in 2018 was primarily due to certain nonrecurring items that impacted expense levels during the second quarter and first half of 2018.

Income Tax Expense. Income tax expense was $5.0 million and $3.0 million for the three months ended June 30, 2019 and 2018, respectively. The effective tax rate increased to 23.6% for the second quarter of 2019 as compared to 19.2% for the second quarter of 2018. The effective tax rate in the second quarter of 2019 was negatively impacted by the state deferred tax assets and liabilities adjusted as a result of a decreased tax rate.

Income tax expense was $9.4 million and $4.4 million for the six months ended June 30, 2019 and 2018, respectively. The increase of the effective tax rate to 23.6% for the first half of 2019 as compared to 23.3% for the first half of 2018 was primarily due to the negative impact of the BOLI death benefit recorded in 2018.

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Financial Condition

Assets. Total assets decreased to $5.55 billion at June 30, 2019, as compared to $5.64 billion at December 31, 2018.

Loans. The loan portfolio is the largest category of our assets. At June 30, 2019, total loans were $4.07 billion. The following table shows loans by non-PCI and PCI loan category as of June 30, 2019 and December 31, 2018:

June 30, 2019

December 31, 2018

Non-PCI

PCI

Non-PCI

PCI

(dollars in thousands)

    

Loans

    

Loans

    

Total

    

Loans

    

Loans

    

Total

 

Commercial

$

848,587

$

2,974

$

851,561

$

806,027

$

4,857

$

810,884

Commercial real estate

 

1,508,683

15,686

 

1,524,369

 

1,619,903

 

19,252

 

1,639,155

Construction and land development

 

244,188

6,226

 

250,414

 

223,898

 

8,331

 

232,229

Total commercial loans

2,601,458

24,886

2,626,344

2,649,828

32,440

2,682,268

Residential real estate

 

544,061

8,345

 

552,406

 

569,289

 

8,759

 

578,048

Consumer

 

595,728

1,240

 

596,968

 

611,408

 

1,776

 

613,184

Lease financing

 

297,809

 

297,809

 

264,051

 

 

264,051

Total loans

$

4,039,056

$

34,471

$

4,073,527

$

4,094,576

$

42,975

$

4,137,551

Loans decreased $64.0 million to $4.07 billion at June 30, 2019 as compared to December 31, 2018. The decrease in loans was primarily due to several large loan payoffs and principal reductions in the commercial real estate portfolio in addition to payoffs and payments in the residential real estate and consumer portfolio during the first six months of 2019. These decreases were partially offset by organic loan growth primarily from our commercial equipment finance business.

The principal categories 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.

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 first priority interest in the financed asset and generally require monthly payments.

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The following table shows the contractual maturities of our loan portfolio and the distribution between fixed and adjustable interest rate loans at June 30, 2019:

June 30, 2019

 

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

 

Loans:

    

    

    

    

    

    

    

Commercial

$

31,134

$

259,011

$

338,291

$

69,864

$

115,192

$

38,069

$

851,561

Commercial real estate

 

194,061

 

75,981

 

784,195

 

182,278

 

60,661

 

227,193

 

1,524,369

Construction and land development

 

9,191

 

73,197

 

41,459

 

121,222

 

158

 

5,187

 

250,414

Total commercial loans

 

234,386

 

408,189

 

1,163,945

 

373,364

 

176,011

 

270,449

 

2,626,344

Residential real estate

 

5,382

7,234

21,675

40,030

197,346

280,739

 

552,406

Consumer

 

4,650

3,721

573,741

14,444

389

23

 

596,968

Lease financing

 

7,254

262,517

28,038

 

297,809

Total loans

$

251,672

$

419,144

$

2,021,878

$

427,838

$

401,784

$

551,211

$

4,073,527

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 allowance for loan losses, our purchase discounts on acquired loans provide additional protections against credit losses.

Discounts on PCI Loans. PCI loans are loans that have evidence of credit deterioration since origination and for which it is probable at the date of acquisition that we will not collect all contractually required principal and interest payments. These loans are recorded at estimated fair value on their purchase date without a carryover of the related allowance for loan losses. At June 30, 2019 and December 31, 2018, we had PCI loans totaling $34.5 million and $43.0 million, respectively. The decrease in PCI loans was primarily driven by a loan pay off and a loan transferred to OREO.

In determining the fair value of purchased credit-impaired loans at acquisition, we first determine the contractually required payments due, which represent the total undiscounted amount of all uncollected principal and interest payments, adjusted for the effect of estimated prepayments. We then estimate the undiscounted cash flows we expect to collect. We incorporate several key assumptions to estimate cash flows expected to be collected, including probability of default rates, loss given default assumptions and the amount and timing of prepayments. We calculate fair value by discounting the estimated cash flows we expect to collect using an observable market rate of interest, when available, adjusted for factors that a market participant would consider in determining fair value. We have aggregated certain credit-impaired loans acquired in the same transaction into pools based on common risk characteristics. A pool is accounted for as one asset with a single composite interest rate and an aggregate fair value and expected cash flows.

The difference between contractually required payments due and the cash flows expected to be collected, considering the impact of prepayments, is referred to as the nonaccretable difference. The nonaccretable difference, which is neither accreted into income nor recorded on our consolidated balance sheet, reflects estimated future credit losses expected to be incurred over the life of the loans. The excess of cash flows expected to be collected over the estimated fair value of PCI loans is referred to as the accretable yield. This amount is not recorded on our consolidated balance sheet, but is accreted into interest income over the remaining life of the loans or pool of loans, using the effective yield method. The outstanding customer balance for PCI loans totaled $45.0 million and $56.9 million as of June 30, 2019 and December 31, 2018, respectively.

Subsequent to acquisition, we periodically evaluate our estimates of cash flows expected to be collected. These evaluations, performed quarterly, require the continued use of key assumptions and estimates, similar to the initial estimate of fair value. Subsequent changes in the estimated cash flows expected to be collected may result in changes in the accretable yield and nonaccretable difference or reclassifications between accretable yield and the nonaccretable difference. Decreases in expected cash flows due to further credit deterioration will result in an impairment charge to the provision for loan losses, resulting in an increase to the allowance for loan losses and a reclassification from accretable yield to nonaccretable difference. Increases in expected cash flows due to credit improvements will result in an increase

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in the accretable yield through a reclassification from the nonaccretable difference or as a reduction in the allowance for loan losses to the extent established on specific pools subsequent to acquisition. The adjusted accretable yield is recognized in interest income over the remaining life of the loan, or pool of loans.

The following table shows changes in the accretable yield for PCI loans for the three and six months ended June 30, 2019 and 2018:

Three Months Ended

Six Months Ended

June 30, 

June 30, 

(dollars in thousands)

2019

2018

2019

2018

    

Balance, beginning of period

    

$

11,063

$

7,630

    

$

12,240

$

5,732

New loans purchased - Alpine acquisition

 

1,245

Accretion

 

(1,937)

 

(1,190)

 

(3,013)

 

(2,351)

Other adjustments (including maturities, charge-offs, and impact of changes in timing of expected cash flows)

 

194

 

(181)

 

88

479

Reclassification from non-accretable

 

1,079

 

5

 

1,084

 

1,159

Balance, end of period

$

10,399

$

6,264

$

10,399

$

6,264

As of June 30, 2019, the balance of accretable discounts on our PCI loan portfolio was $10.4 million compared to $12.2 million at December 31, 2018. We may not accrete the full amount of these discounts into interest income in future periods if the assets to which these discounts are applied do not perform according to our current expectations.

We have also recorded accretable discounts in purchase accounting for loans that are not considered PCI loans. Similar to the way in which we employ the fair value methodology for PCI loans, we consider expected prepayments and estimate the amount and timing of undiscounted cash flows in order to determine the accretable discount for non-PCI loans. Such discounts are accreted into income on a level yield basis.

Analysis of the Allowance for Loan Losses. The following table allocates the allowance for loan losses, or the allowance, by loan category:

June 30, 2019

December 31, 2018

(dollars in thousands)

    

Book Value

    

% (1)

    

Book Value

    

% (1)

    

 

Loans:

Commercial

$

10,115

1.19

%  

$

9,524

1.17

%  

Commercial real estate

 

8,639

 

0.57

 

4,723

 

0.29

Construction and land development

 

316

 

0.13

 

372

 

0.16

Total commercial loans

 

19,070

 

0.73

 

14,619

 

0.55

Residential real estate

 

2,424

 

0.44

 

2,041

 

0.35

Consumer

 

2,219

 

0.37

 

2,154

 

0.35

Lease financing

 

2,212

 

0.74

 

2,089

 

0.79

Total allowance for loan losses

$

25,925

 

0.64

$

20,903

 

0.51

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

The allowance and the balance of nonaccretable discounts represent our estimate of probable and reasonably estimable credit losses inherent in loans held for investment as of the respective balance sheet date. We assess the appropriateness of our allowance for non-PCI loans separately from our allowance for PCI loans.

The allowance for loan losses was $25.9 million at June 30, 2019 compared to $20.9 million at December 31, 2018. The increase in the allowance at June 30, 2019 compared to December 31, 2018 was mainly attributable to an increase in specific reserves on two credits placed on nonaccrual and the downgrade of one commercial real estate loan and one residential real estate loan during the six months ended of 2019.

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 0.12% and 0.11% for the three and six months ended June 30, 2019, respectively, as compared to 0.13% for the year ended December 31, 2018.

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Allowance for non-PCI loans. Our methodology for assessing the appropriateness of the allowance for non-PCI loans includes a general allowance for performing loans, which are grouped based on similar characteristics, and a specific allowance for individual impaired loans or loans considered by management to be in a high-risk category. General allowances are established based on a number of factors, including historical loss rates, an assessment of portfolio trends and conditions, accrual status and economic conditions.

For commercial and commercial real estate loans, a specific allowance may be assigned to individual loans based on an impairment analysis. Loans are considered impaired when it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. The amount of impairment is based on an analysis of the most probable source of repayment, including the present value of the loan's expected future cash flows and the estimated market value or the fair value of the underlying collateral. Interest income on impaired loans is accrued as earned, unless the loan is placed on nonaccrual status.

Allowance for PCI loans. PCI loans are recorded at their estimated fair value at the date of acquisition, with the estimated fair value including a component for estimated credit losses. An allowance related to PCI loans may be recorded subsequent to acquisition if a PCI loan pool experiences a decrease in expected cash flows as compared to the expected cash flows projected in the previous quarter. Loans considered to be uncollectible are initially charged off against the specific loan pool’s non-accretable difference. When the pool’s non-accretable difference has been fully utilized, uncollectible amounts are charged off against the corresponding allowance.

The following table shows our allowance by loan portfolio and by non-PCI and PCI loans as of June 30, 2019 and December 31, 2018:

June 30, 2019

December 31, 2018

Non-PCI

PCI

Non-PCI

PCI

(dollars in thousands)

    

Loans

    

Loans

    

Total

    

Loans

    

Loans

    

Total

    

 

Loans:

Commercial

$

10,099

$

16

$

10,115

$

9,419

$

105

$

9,524

Commercial real estate

 

7,876

 

763

 

8,639

 

3,879

 

844

 

4,723

Construction and land development

 

316

 

 

316

 

372

 

 

372

Total commercial loans

18,291

779

19,070

13,670

949

14,619

Residential real estate

 

2,017

 

407

 

2,424

 

1,605

 

436

 

2,041

Consumer

 

2,026

 

193

 

2,219

 

1,971

 

183

 

2,154

Lease financing

 

2,212

 

 

2,212

 

2,089

 

 

2,089

Total allowance for loan losses

$

24,546

$

1,379

$

25,925

$

19,335

$

1,568

$

20,903

Provision for Loan Losses. In determining the allowance and the related provision for loan losses, we consider three principal elements: (i) valuation allowances based upon probable losses identified during the review of impaired commercial, commercial real estate, and construction and land development loans, (ii) allocations, by loan classes, on loan portfolios based on historical loan loss experience and qualitative factors, and (iii) valuation allowances on PCI loan pools based on decreases in expected cash flows. Provisions for loan losses are charged to operations to adjust the total allowance to a level deemed appropriate by us.

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The following table provides an analysis of the allowance for loan losses, provision for loan losses and net charge-offs for the three and six months ended June 30, 2019 and 2018:

As of and for the

As of and for the

Three Months Ended

Six Months Ended

June 30, 

June 30, 

(dollars in thousands)

    

2019

    

2018

    

2019

    

2018

    

Balance, beginning of period

$

23,091

$

17,704

$

20,903

$

16,431

Charge-offs:

Commercial

 

2

 

1,120

 

114

 

1,145

Commercial real estate

 

269

 

99

 

327

 

259

Construction and land development

 

 

 

44

 

Residential real estate

 

223

 

103

 

376

 

139

Consumer

 

465

 

349

 

1,021

 

783

Lease financing

 

691

 

473

 

1,150

 

959

Total charge-offs

1,650

2,144

3,032

3,285

Recoveries:

Commercial

14

197

29

301

Commercial real estate

29

301

36

395

Construction and land development

3

20

10

45

Residential real estate

49

62

71

113

Consumer

221

147

431

242

Lease financing

92

105

158

144

Total recoveries

408

832

735

1,240

Net charge-offs

1,242

1,312

2,297

2,045

Provision for loan losses

4,076

1,854

7,319

3,860

Balance, end of period

$

25,925

$

18,246

$

25,925

$

18,246

Gross loans, end of period

$

4,073,527

$

4,095,811

$

4,073,527

$

4,095,811

Average loans

$

4,086,720

$

3,982,958

$

4,107,690

$

3,731,833

Net charge-offs to average loans

 

0.12

%  

 

0.13

%  

 

0.11

%  

 

0.11

%  

Allowance to total loans

 

0.64

%  

 

0.45

%  

 

0.64

%  

 

0.45

%  

Impaired Loans. The following table sets forth our nonperforming assets by asset categories as of the dates indicated. Impaired 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 impaired loans reflect the net investment in these assets, including deductions for purchase discounts. PCI loans are excluded from nonperforming status because we expect to fully collect their new carrying values, which reflect significant purchase discounts. If our expectation of reasonably estimable future cash flows from PCI loans deteriorates, the loans may be classified as nonaccrual loans and interest income will not be recognized until the timing and amount of future cash flows can be reasonably estimated.

    

June 30, 

    

December 31, 

    

(dollars in thousands)

2019

    

2018

Impaired loans:

    

    

Commercial

$

8,778

$

8,928

Commercial real estate

 

30,583

 

23,868

Construction and land development

 

1,360

 

1,307

Residential real estate

 

8,533

 

7,270

Consumer

 

389

 

569

Lease financing

 

1,033

 

957

Total impaired loans

 

50,676

 

42,899

Other real estate owned, non-guaranteed

 

3,797

 

3,000

Nonperforming assets

$

54,473

$

45,899

Impaired loans to total loans

 

1.24

%  

 

1.04

%  

Nonperforming assets to total assets

 

0.98

%  

 

0.81

%  

We did not recognize interest income recognized on nonaccrual loans during the three and six months ended June 30, 2019 and 2018 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 $666,000 and $1.3 million for the three and six months ended June 30, 2019, respectively, and $346,000 and $846,000 for the three and six months ended June 30, 2018, respectively. The Company recognized interest income on commercial and commercial real estate loans modified under troubled debt restructurings of $29,000 and $61,000 for the three and six months ended

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June 30, 2019, respectively, and $28,000 and $58,000 for the comparable periods in 2018, 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 impaired. 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 (excluding PCI 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

 

June 30, 2019

$

22,164

$

20,697

$

23,284

$

51,378

$

2,491

$

884

$

120,898

December 31, 2018

34,857

12,956

14,934

45,263

3,448

111,458

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

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 June 30, 2019 and December 31, 2018. The book value for investment securities classified as available for sale and equity securities is equal to fair market value.

June 30, 2019

December 31, 2018

Book

% of

Book

% of

(dollars in thousands)

    

Value

    

Total

    

Value

 

Total

    

Available for sale securities

    

    

    

    

    

U.S. Treasury securities

$

%  

$

24,650

 

3.7

%  

Government sponsored entity debt securities

 

74,875

12.2

 

75,684

 

11.5

Agency mortgage-backed securities

 

297,362

48.5

 

326,305

 

49.4

State and municipal securities

 

143,729

23.5

 

159,262

 

24.1

Corporate securities

 

93,691

15.3

 

71,550

 

10.8

Total investment securities, available for sale, at fair value

 

609,657

99.5

657,451

 

99.5

Equity securities

3,369

0.5

 

3,334

 

0.5

Total investment securities, at fair value

$

613,026

 

100.0

%  

$

660,785

 

100.0

%  

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The following table sets forth the book value, maturities and weighted average yields for our investment portfolio at June 30, 2019. The book value for investment securities classified as available for sale is equal to fair market value.

June 30, 2019

 

% of Total

Weighted

 

Book

Investment

Average

 

(dollars in thousands)

    

Value

    

Securities

    

Yield

 

Investment securities, available for sale:

    

    

    

Government sponsored entity debt securities:

Maturing within one year

$

28,658

4.7

%  

2.4

%

Maturing in one to five years

 

33,321

5.4

2.4

Maturing in five to ten years

 

12,480

2.0

2.6

Maturing after ten years

 

416

0.1

2.6

Total government sponsored entity debt securities

$

74,875

 

12.2

%  

2.4

%

Agency mortgage-backed securities:

Maturing within one year

$

3,462

0.5

%  

2.8

%

Maturing in one to five years

 

266,417

43.5

2.8

Maturing in five to ten years

 

24,248

4.0

2.8

Maturing after ten years

 

3,235

0.5

3.0

Total agency mortgage-backed securities

$

297,362

 

48.5

%  

2.8

%

State and municipal securities (1):

Maturing within one year

$

14,874

2.4

%  

3.6

%

Maturing in one to five years

 

42,822

7.0

4.3

Maturing in five to ten years

 

58,680

9.6

4.4

Maturing after ten years

 

27,353

4.5

4.1

Total state and municipal securities

$

143,729

 

23.5

%  

4.2

%

Corporate securities:

Maturing within one year

$

4,013

0.7

%  

3.6

%

Maturing in one to five years

 

5,063

0.8

3.6

Maturing in five to ten years

 

84,615

13.8

5.2

Maturing after ten years

 

Total corporate securities

$

93,691

 

15.3

%  

5.0

%  

Total investment securities, available for sale

$

609,657

 

99.5

%  

3.4

%

Equity securities:

No stated maturity

$

3,369

0.5

%  

2.5

%

Total investment securities and equity securities

$

613,026

 

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%.

The table below presents the credit ratings at June 30, 2019 at fair value for our investment securities classified as available for sale.

June 30, 2019

 

Amortized

Estimated

Average Credit Rating

 

(dollars in thousands)

    

Cost

    

Fair Value

    

AAA

    

AA+/−

    

A+/−

    

BBB+/−

    

<BBB−

    

Not Rated

 

Investment securities available for sale:

Government sponsored entity debt securities

$

74,286

$

74,875

$

$

74,875

$

$

$

$

Agency mortgage-backed securities

 

294,432

 

297,362

 

5,394

 

291,968

 

State and municipal securities

 

138,181

 

143,729

 

27,844

 

89,558

 

9,304

6,116

488

10,419

Corporate securities

 

92,874

 

93,691

 

 

 

9,557

43,228

7,260

33,646

Total investment securities, available for sale

$

599,773

$

609,657

$

33,238

$

456,401

$

18,861

$

49,344

$

7,748

$

44,065

Cash and Cash Equivalents. Cash and cash equivalents increased $31.7 million to $245.4 million as of June 30, 2019 compared to December 31, 2018. This increase was primarily due to cash flows from investing activities and operating activities totaling $119.4 million and $53.5 million, respectively. These increases were offset in part by cash flows used in financing activities of $141.2 million. Cash flows provided by investing activities primarily consisted of a

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$60.0 million decrease in loans offset in part by $32.5 million in purchases of investments securities available for sale and $10.3 million in purchases of nonmarketable equity securities. Cash flows provided by operating activities primarily reflected $30.3 million of net income and $248.7 million of proceeds received from sales of loans held for sale exceeding $233.8 million in originations of loans held for sale. Cash used in financing activities primarily reflected $350.4 million of payments made on FHLB borrowings, which exceeded proceeds received from FHLB borrowings.

Operating Lease Right-of-Use Asset. We adopted ASU 2016-02, Leases (Topic 842) on January 1, 2019, which required the recognition of operating lease ROU assets. Operating lease ROU assets represent the lessee’s right to use, or control the use of, specified assets for the lease term. Operating lease ROU assets are recognized based on the present value of lease payments over the lease term. Operating lease ROU totaled $10.2 million at June 30, 2019.

Liabilities. Total liabilities decreased to $4.91 billion at June 30, 2019 compared to $5.03 billion at December 31, 2018.

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 June 30, 2019 and 2018:

June 30, 2019

June 30, 2018

Weighted

Weighted

Average

Average

Average

Average

(dollars in thousands)

    

Balance

    

Rate

    

Balance

    

Rate

    

Deposits:

    

    

    

    

Noninterest-bearing demand

$

921,115

 

$

1,025,308

 

Interest-bearing:

Checking

 

990,413

 

0.60

%  

 

1,001,628

 

0.23

%  

Money market

 

744,785

 

0.99

 

820,662

 

0.66

Savings

 

450,186

 

0.20

 

465,478

 

0.16

Time, less than $250,000

 

650,125

 

1.97

 

576,245

 

1.10

Time, $250,000 and over

 

99,680

 

2.33

 

83,844

 

1.21

Time, brokered

 

172,471

 

2.62

 

210,959

 

2.00

Total interest-bearing

$

3,107,660

 

1.09

%  

$

3,158,816

 

0.64

%  

Total deposits

$

4,028,775

 

0.84

%  

$

4,184,124

 

0.48

%  

The following table sets forth the maturity of time deposits of $250,000 or more and brokered time deposits as of June 30, 2019:

June 30, 2019

 

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

$

12,565

$

7,045

$

51,564

$

34,450

$

105,624

Time, brokered

 

54,111

 

44,876

 

27,208

 

13,777

 

139,972

Total

$

66,676

$

51,921

$

78,772

$

48,227

$

245,596

Total deposits decreased $63.0 million to $4.01 billion at June 30, 2019, as compared to December 31, 2018. This decrease primarily resulted from an intentional reduction of $111.7 million in brokered money market deposits and brokered time deposits. At June 30, 2019, total deposits were comprised of 22.5% noninterest-bearing demand accounts, 54.4% interest-bearing transaction accounts and 23.1% of time deposits. At June 30, 2019, brokered time deposits totaled $140.0 million, or 3.5% of total deposits, compared to $161.6 million, or 4.0% of total deposits, at December 31, 2018.

Operating Lease Liabilities. The adoption of ASU 2016-02, Leases (Topic 842) on January 1, 2019 also required the recognition of operating lease liabilities. Operating lease liabilities represent a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis. Operating lease liabilities totaled $10.7 million at June 30, 2019.

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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 increased $31.4 million to $639.9 million at June 30, 2019 as compared to December 31, 2018. The increase in shareholders’ equity was due primarily to $9.3 million increase in accumulated other comprehensive income and $30.3 million of net income, partially offset by $11.7 million of declared dividends to common shareholders.

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 $128.8 million and $132.2 million at June 30, 2019 and December 31, 2018, respectively, were pledged for securities sold under agreements to repurchase.

The Company had lines of credit of $50.9 million and $56.8 million at June 30, 2019 and December 31, 2018, 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 $60.0 million and $67.6 million at June 30, 2019 and December 31, 2018, respectively. There were no outstanding borrowings at June 30, 2019 and December 31, 2018.

At June 30, 2019, the Company had available federal funds lines of credit totaling $45.0 million. These lines of credit were unused at June 30, 2019.

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 believes 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.

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At June 30, 2019, 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 June 30, 2019:

 

Fully Phased-In

Guidelines

Well

Ratio

    

Actual

Minimum (1)

    

Capitalized

 

Total risk-based capital ratio

Midland States Bancorp, Inc.

 

13.49

%  

10.50

%  

N/A

Midland States Bank

13.22

10.50

10.00

%

Common equity Tier 1 risk-based capital ratio

Midland States Bancorp, Inc.

9.38

7.00

N/A

Midland States Bank

12.63

7.00

6.50

Tier 1 risk-based capital ratio

Midland States Bancorp, Inc.

10.85

8.50

N/A

Midland States Bank

12.63

8.50

8.00

Tier 1 leverage ratio

Midland States Bancorp, Inc.

9.27

4.00

N/A

Midland States Bank

10.80

4.00

5.00

(1)As of January 1, 2019, the capital conservation buffer was fully phased in at 2.5%.

Contractual Obligations

The following table contains supplemental information regarding our total contractual obligations at June 30, 2019:

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

$

3,085,899

$

$

$

$

3,085,899

Time deposits

 

573,659

323,850

27,798

1

925,308

Securities sold under repurchase agreements

 

113,844

113,844

FHLB advances and other borrowings

 

35,374

26,629

410,384

110,000

582,387

Operating lease obligations

 

2,080

4,056

2,905

1,678

10,719

Subordinated debt

 

94,215

94,215

Trust preferred debentures

 

48,041

48,041

Total contractual obligations

$

3,810,856

$

354,535

$

441,087

$

253,935

$

4,860,413

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 and LIBOR (basis risk).

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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.

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

 

June 30, 2019:

    

    

    

Dollar change

$

(9,352)

$

2,503

$

2,851

Percent change

 

(5.1)

%  

 

1.4

%  

 

1.6

%

December 31, 2018:

Dollar change

$

(8,497)

$

2,694

$

4,623

Percent change

 

(4.3)

%  

 

1.4

%  

 

2.4

%

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 June 30, 2019. The Bank, at June 30, 2019 has exceeded the established tolerance level for the −100 basis point sensitivity. Tolerance levels for risk management require the development of remedial plans to maintain residual risk within approved levels. NII at Risk

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reported at June 30, 2019, projects that our earnings exhibit increased sensitivity to changes in interest rates compared to December 31, 2018.

The following table shows EVE at the dates indicated:

Economic Value of Equity Sensitivity

 

Immediate Change in Rates

 

(dollars in thousands)

    

-100

    

+100

    

+200

 

June 30, 2019:

    

    

    

Dollar change

$

(81,442)

$

45,031

$

63,750

Percent change

 

(15.1)

%  

 

8.4

%  

 

11.9

%

December 31, 2018:

Dollar change

$

(80,035)

$

40,599

$

69,461

Percent change

 

(12.7)

%  

 

6.4

%  

 

11.0

%

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 June 30, 2019.

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 remediation plans to maintain 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 Bank, at June 30, 2019 has 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.

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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 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 fiscal quarter to which this report relates 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

There have been no material changes from the risk factors previously disclosed in the “Risk Factors” section included in our Annual Report on Form 10-K for the year ended December 31, 2018.

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

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 second quarter of 2019.

Total

Maximum

Number of

Number of

Total

Average

Shares Purchased

Shares that May

Number

Price

as Part of Publicly

Yet Be Purchased

of Shares

Paid Per

Announced Plans

Under the Plans

Period

Purchased (1)

Share

or Programs

or Programs

April 1 - 30, 2019

1,152

$

25.49

-

-

May 1 - 31, 2019

2,829

27.10

-

-

June 1 - 30, 2019

461

26.33

-

-

Total

4,442

$

26.60

-

-

__________________________________

(1)Represents shares of the Company’s common stock repurchased under the employee stock purchase program and/or shares withheld to satisfy tax withholding obligations upon the vesting of awards of restricted stock. These shares were purchased pursuant to the terms of the applicable plan and not pursuant to a publicly announced repurchase plan or program.

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Item 6 – Exhibits

Exhibit No.

Description

10.1

Midland States Bancorp, Inc. 2019 Long-Term Incentive Plan (incorporated by reference to Exhibit 4.6 of the Company’s Registration Statement on Form S-8 (File No. 333-231323) filed with the SEC on May 9, 2019)

10.2

Form of Incentive Stock Option Award Agreement under the Midland States Bancorp, Inc. 2019 Long-Term Incentive Plan (incorporated by reference to Exhibit 4.7 of the Company’s Registration Statement on Form S-8 (File No. 333-231323) filed with the SEC on May 9, 2019)

10.3

Form of Nonqualified Stock Option Award Agreement under the Midland States Bancorp, Inc. 2019 Long-Term Incentive Plan (incorporated by reference to Exhibit 4.8 of the Company’s Registration Statement on Form S-8 (File No. 333-231323) filed with the SEC on May 9, 2019)

10.4

Form of Restricted Stock Unit Award Agreement under the Midland States Bancorp, Inc. 2019 Long-Term Incentive Plan (incorporated by reference to Exhibit 4.9 of the Company’s Registration Statement on Form S-8 (File No. 333-231323) filed with the SEC on May 9, 2019)

10.5

Form of Restricted Stock Award Agreement under the Midland States Bancorp, Inc. 2019 Long-Term Incentive Plan (incorporated by reference to Exhibit 4.10 of the Company’s Registration Statement on Form S-8 (File No. 333-231323) filed with the SEC on May 9, 2019)

10.6

Amended and Restated Midland States Bancorp, Inc. Employee Stock Purchase Plan (Amended and Restated May 3, 2019) (incorporated by reference to Exhibit 4.11 of the Company’s Registration Statement on Form S-8 (File No. 333-231323) filed with the SEC on May 9, 2019)

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 June 30, 2019, 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.

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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: August 7, 2019

By:

/s/

Jeffrey G. Ludwig

Jeffrey G. Ludwig

President and Chief Executive Officer

(Principal Executive Officer)

Date: August 7, 2019

By:

/s/

Stephen A. Erickson

Stephen A. Erickson

Chief Financial Officer

(Principal Financial and Accounting Officer)

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