Midland States Stock: Rosy Outlook For Rate-Sensitive Topline (NASDAQ:MSBI)

Earnings of Midland States Bancorp, Inc. (NASDAQ:MSBI) will benefit from the topline’s high sensitivity to interest rate changes this year. Further, loan growth will likely remain remarkable this year due to management’s initiatives. On the other hand, normalization of provision expense will likely drag earnings. Overall, I’m expecting Midland States Bancorp to report earnings of $3.37 per share in 2022, down 5% year-over-year. Despite the dip, earnings will likely remain much higher than the pre-pandemic level. Compared to the estimates given in my last report on MSBI, I have revised upwards my earnings estimate due to revisions in both margin and loan growth. The year-end target price suggests a decent upside from the current market price. Therefore, I’m maintaining a buy rating on Midland States Bancorp.

Management’s Efforts to Lift the Loan Portfolio

Midland States Bancorp surprised me by reporting high loan growth in the last quarter of 2021. The loan portfolio grew by 6.5% during the quarter, or 25.8% annualized. The management expects the loan growth momentum to continue through 2022. As mentioned in the earnings presentation, the management is expecting high-single-digit loan growth this year. In my opinion, this loan growth target is achievable, as discussed below.

Midland States Bancorp operates mostly in Illinois with some presence in Missouri. Illinois’s unemployment rate was worse than the national average in February 2022. According to official sources, the state reported an unemployment rate of 4.8% in February, while the country reported an unemployment rate of 3.8%. Further, the state’s GDP growth was below the national average in the fourth quarter of 2021, according to official sources.

Despite the less than conducive economic environment, the outlook on loan growth is bright because of the management’s proactive attitude and other company-specific factors. These positive factors are given below.

1. Fintech partnerships. As mentioned in the conference call, Midland States Bancorp expects to remain in the Green Sky program through at least 2023. Further, Midland States is in the final stages of establishing a new fintech partnership with an originator of consumer loans. The management expects this new partnership to result in $200 million to $250 million worth of loans over the next couple of years. To put this number in perspective, $250 million was around 4.8% of total loans at the end of 2021.
2. Strong pipelines. The management mentioned in the conference call that it already has strong pipelines in the commercial loan segment, including equipment finance, and commercial real estate segments.
3. Acquisition. Midland States Bancorp plans to acquire some of the loans and deposits of FNBC Bank and Trust, as mentioned in the 10-K filing. The acquisition will likely add loans totaling $26 million and deposits totaling $86 million.
4. Lower PPP forgiveness. As the remaining Paycheck Protection Program (“PPP”) loans make up only a small part of the total loan portfolio, the upcoming forgiveness will have a limited impact on the total loan portfolio size. According to details given in the 10-K filing, PPP loans outstanding made up just 1.0% of total loans at the end of December 2021.

Considering these factors, I’m expecting the loan portfolio to increase by 8.2% this year. In my previous report on Midland States Bancorp, I expected loan growth of only 4.1% in 2022. I have revised upward my loan growth estimate partly because the portfolio’s performance surprised me in the last quarter of 2021. Further, I have more confidence regarding the management’s capabilities now.

Meanwhile, I’m expecting other balance sheet items to grow mostly in line with loans. The following table shows my balance sheet estimates.

	FY17	FY18	FY19	FY20	FY21	FY22E
Financial Position
Net Loans	3,210	4,117	4,373	5,043	5,174	5,600
Growth of Net Loans	39.3%	28.2%	6.2%	15.3%	2.6%	8.2%
Other Earning Assets	501	694	673	824	955	1,034
Deposits	3,131	4,074	4,544	5,101	6,111	6,614
Borrowings and Sub-Debt	792	907	800	1,067	575	623
Common equity	447	609	662	621	664	714
Book Value Per Share ($)	24.4	25.8	27.0	26.6	29.4	31.7
Tangible BVPS ($)	18.1	17.3	18.6	18.5	21.2	23.4
Source: SEC Filings, Author’s Estimates (In USD million unless otherwise specified)

High Rate-Sensitivity to Boost Revenues in 2022

The net interest income of Midland States Bancorp is highly sensitive to rate changes because of the nature of its loan portfolio. The portfolio is well-diversified with considerable exposure to loan segments that are usually rate-sensitive, including consumer loans and commercial and industrial loans. Further, Midland States has excess cash on its books, which gives the company flexibility to shift its asset mix as rates are increased. Cash and cash equivalents surged to $680.4 million at the end of December 2021 from $341.6 million at the end of December 2020.

On the liability side, Midland States Bancorp has a large balance of non-interest-bearing deposits that will make the average deposit cost upwards sticky in a rising interest-rate environment. Non-interest-bearing deposits made up 36.8% of total deposits at the end of December 2021. However, Midland States Bancorp also has a large balance of transaction deposits that will reprice soon after every rate hike. Transaction deposits, including interest-bearing checking, money market, and savings deposits, made up 52.5% of total deposits at the end of December 2021. As a result, the deposit book is only moderately sensitive to rate changes.

The management’s interest-rate sensitivity analysis given in the 10-K filing shows that a 200-basis point increase in interest rates can boost the net interest income by a whopping 21.2% over twelve months. However, this analysis assumes an interest rate shock. A gradual increase in rates will have a softer impact on net interest income.

Considering these factors, I’m expecting the margin to increase by nine basis points in 2022. In my previous report on Midland States Bancorp, I was expecting the margin to increase by only four basis points this year. I have revised upwards my net interest margin estimate because the Fed has increased its Federal Funds rate projection since the release of my last report on MSBI.

Provision Expense Normalization to Drag Earnings

The net provision expense remained subdued in 2021 because of heightened reserve releases. Following these releases, the allowance dipped to 0.98% of total loans at the end of December 2021, from 1.18% at the end of December 2020. The existing allowance level appears just enough for the portfolio’s current credit risk. Allowances made up 0.98% of total loans, while non-performing loans made up 0.81% of total loans at the end of December 21, as mentioned in the presentation. As a result, I’m not expecting further big provision reversals in the year ahead.

The loan growth described above will most probably require further provisioning for expected loan losses. Overall, I’m expecting the provision expense, net of reversals, to return to a normal level this year. I’m expecting net provision expense to make up 0.37% of total loans in 2022, which is the same as the average provision-expense-to-total-loan ratio for the last five years.

Earnings to Remain Much Higher than the Pre-pandemic Level

Due to the provision normalization, earnings for 2022 will likely decline on a year-over-year basis. However, earnings will likely remain much higher than the pre-pandemic level due to high anticipated loan growth and margin expansion. Overall, I’m expecting the company to report earnings of $3.37 per share in 2022, down 5% year-over-year. The following table shows my income statement estimates.

	FY17	FY18	FY19	FY20	FY21	FY22E
Income Statement
Net interest income	130	180	190	199	208	236
Provision for loan losses	10	9	17	43	3	21
Non-interest income	59	72	75	61	70	73
Non-interest expense	153	192	176	185	175	185
Net income – Common Sh.	16	39	55	22	80	76
EPS – Diluted ($)	0.87	1.66	2.26	0.96	3.57	3.37
Source: SEC Filings, Earnings Releases, Author’s Estimates (In USD million unless otherwise specified)

In my last report on Midland States Bancorp, I estimated the company to report earnings of around $3.04 per share in 2022, I have revised upwards my earnings estimate because I have increased my margin expectation and revised my loan growth estimate.

Actual earnings may differ materially from estimates because of the risks and uncertainties related to the COVID-19 pandemic and the timing and magnitude of interest rate hikes.

Maintaining a Buy Rating Due to a High Total Expected Return

Midland States Bancorp is offering a dividend yield of 4.0% at the current quarterly dividend rate of $0.29 per share. The earnings and dividend estimates suggest a payout ratio of 34% for 2022, which is easily sustainable. MSBI usually increases its dividend only once per year; therefore, I’m not expecting another increase in the dividend level in the year ahead.

I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Midland States Bancorp. The stock has traded at an average P/TB ratio of 1.339 in the past, as shown below.

Multiplying the average P/TB multiple with the forecast tangible book value per share of $23.4 gives a target price of $31.3 for the end of 2022. This price target implies an 8.5% upside from the March 31 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.

P/TB Multiple	1.24x	1.29x	1.34x	1.39x	1.44x
TBVPS – Dec 2022 ($)	23.4	23.4	23.4	23.4	23.4
Target Price ($)	29.0	30.2	31.3	32.5	33.7
Market Price ($)	28.9	28.9	28.9	28.9	28.9
Upside/(Downside)	0.4%	4.5%	8.5%	12.6%	16.6%
Source: Author’s Estimates

The stock has traded at an average P/E ratio of around 12.28x in the past, as shown below. Excluding the outlier in the early part of 2021, the P/E multiple has tended towards 10.0x in the past.

Multiplying the P/E multiple of 10.0x with the forecast earnings per share of $3.37 gives a target price of $33.7 for the end of 2022. This price target implies a 16.9% upside from the March 31 closing price. The following table shows the sensitivity of the target price to the P/E ratio.

P/E Multiple	8.0x	9.0x	10.0x	11.0x	12.0x
EPS 2022 ($)	3.37	3.37	3.37	3.37	3.37
Target Price ($)	27.0	30.4	33.7	37.1	40.5
Market Price ($)	28.9	28.9	28.9	28.9	28.9
Upside/(Downside)	(6.5)%	5.2%	16.9%	28.6%	40.3%
Source: Author’s Estimates

Equally weighting the target prices from the two valuation methods gives a combined target price of $32.5, which implies a 12.7% upside from the current market price. Adding the forward dividend yield gives a total expected return of 16.7%.

I haven’t changed my target price much compared to the target price given in my previous report on Midland States Bancorp. The market price has rallied since my last report, but there is still some upside left. As a result, I’m maintaining a buy rating on Midland States Bancorp.