10-K: Midland States Bancorp Restates Financials, Reports Steep Profit Decline, and Anticipates Major Goodwill Impairment Amidst Credit Deterioration

Midland States Bancorp, Inc. has restated prior financial statements due to accounting errors in third-party loan programs, reported a substantial decline in 2024 net income, and anticipates a significant goodwill impairment charge in Q1 2025, reflecting deteriorating credit quality and strategic portfolio reductions.

Summary

• Midland States Bancorp, Inc. (MSBI) reported a net income of $38.0 million for the fiscal year ended December 31, 2024, a significant decrease from $61.2 million in 2023 and $100.2 million in 2022.
• Diluted earnings per common share for 2024 was $1.32, down from $2.33 in 2023 and $4.28 in 2022.
• The company restated its consolidated financial statements for the years ended December 31, 2023 and 2022, and interim periods in 2024 and 2023, due to errors in accounting for loans originated through third-party programs (GreenSky and LendingPoint), where payments were incorrectly netted as interest income instead of being grossed up with credit losses and credit enhancement payments recorded separately as a derivative.
• The decrease in net income was primarily driven by a $12.5 million decrease in net interest income, a $37.8 million increase in provision for credit losses, and a $14.8 million increase in noninterest expense.
• The company expects to recognize a goodwill impairment expense between $135.0 million and $154.0 million in the first quarter of 2025, primarily related to its Banking reporting unit, attributed to deteriorated credit quality and stock price trends.
• Total assets were $7.51 billion at December 31, 2024, a decrease from $7.79 billion at December 31, 2023.
• Total loans decreased by $936.0 million, or 15.3%, to $5.17 billion at December 31, 2024, mainly due to strategic reductions in non-core consumer loan portfolios and equipment financing.
• Nonperforming loans increased by $94.5 million to $150.9 million at December 31, 2024, from $56.4 million at December 31, 2023, with a majority of the increase attributable to multi-family construction/projects ($57.6 million) and healthcare-related loans ($15.5 million) outside the company's core market.
• Net charge-offs surged to $167.4 million in 2024 from $52.1 million in 2023, with significant contributions from specialty finance ($25.3 million), consumer loans ($98.1 million), and equipment finance ($28.8 million).
• The company sold its LendingPoint portfolio in Q4 2024, recognizing $17.3 million in net charge-offs, and committed to sell its GreenSky portfolio, recognizing $35.0 million in net charge-offs, with a participation interest of $317.5 million in the GreenSky portfolio sold in April 2025.
• Material weaknesses in internal control over financial reporting were identified related to risk assessment for non-routine transactions, accounting for third-party credit enhancement contracts, and controls over loan data from third-party service organizations.

Sentiment

Score: 2

Explanation: The company reported a substantial decline in net income and diluted EPS, a significant increase in credit losses and nonperforming loans, and anticipates a large goodwill impairment. The restatement of prior financial statements due to accounting errors and identified material weaknesses in internal controls further compound the negative sentiment, indicating severe operational and financial challenges.

Positives

• Wealth management revenue increased by $3.1 million, or 12.2%, for 2024, with assets under administration growing to $4.15 billion at December 31, 2024, from $3.73 billion at December 31, 2023.
• Income on company-owned life insurance increased by $3.2 million, or 73.1%, for 2024, due to the company's repositioning of certain low-yielding policies.
• The company maintains regulatory capital in excess of Federal Reserve requirements and was well-capitalized as of December 31, 2024, with a Common Equity Tier 1 Capital ratio of 11.18% for the Bank (above the 6.50% well-capitalized minimum).
• The company's NII at Risk modeling projects increasing profitability in a declining interest rate environment, consistent with its modeling at December 31, 2023.
• The company has developed and implemented a comprehensive information security program, including a dedicated internal cybersecurity team, continuous monitoring tools, third-party Security Operations Center, and regular assessments.
• Management believes its strategic actions around credit administration, including tightening credit standards and ceasing new construction loans in the Specialty Finance Group, will better position the company going forward.

Negatives

• Net income decreased significantly to $38.0 million in 2024 from $61.2 million in 2023 and $100.2 million in 2022.
• Diluted earnings per common share declined to $1.32 in 2024 from $2.33 in 2023 and $4.28 in 2022.
• Net interest income decreased by $12.5 million to $236.3 million in 2024.
• Provision for credit losses increased by $37.8 million to $120.3 million in 2024.
• Net charge-offs surged to $167.4 million in 2024 from $52.1 million in 2023.
• Nonperforming loans increased by $94.5 million to $150.9 million at December 31, 2024, from $56.4 million at December 31, 2023.
• The company expects to recognize a goodwill impairment expense between $135.0 million and $154.0 million in the first quarter of 2025.
• Prior financial statements for 2023 and 2022, and interim periods in 2024 and 2023, were restated due to accounting errors related to third-party loan origination programs.
• Material weaknesses were identified in internal control over financial reporting, specifically in risk assessment for non-routine transactions, accounting for credit enhancement contracts, and controls over loan data from third-party service organizations.
• Total loans decreased by $936.0 million, or 15.3%, at December 31, 2024, primarily due to strategic reductions in non-core consumer loan portfolios and equipment financing.
• Elevated charge-offs of $15.3 million were experienced in the trucking industry within the equipment finance portfolio in Q4 2024.
• Impairment expense of $3.6 million was recognized on an OREO property related to a former assisted living loan in Q4 2024.
• Impairment on leased assets and surrendered assets totaled $7.9 million in 2024, primarily related to assets associated with the trucking industry.
• Loan collection expenses increased to $3.7 million in 2024 from $2.1 million in 2023 due to increased volume of nonperforming loans and assets.
• Other real estate owned expense increased significantly to $5.6 million in 2024 from $0.3 million in 2023.

Risks

• A decline in general business and economic conditions, including U.S. and global trade policy, could harm business, financial position, results of operations, and growth prospects.
• Failure to effectively manage credit risk may lead to increased levels of nonperforming loans, charge-offs, and delinquencies, requiring increases in the provision for credit losses.
• A significant portion of the loan portfolio is secured by real estate, the value and liquidity of which can be negatively affected by economic conditions and environmental issues.
• Commercial loans, particularly to small to midsized businesses, involve greater risks and may be more sensitive to adverse economic conditions.
• Real estate construction loans are based on estimates of costs and values that may be inaccurate, exposing the company to significant losses.
• Real estate market volatility and future changes in disposition strategies could result in net proceeds from OREO sales differing significantly from appraisals, leading to additional losses.
• Nonperforming assets require significant time to resolve and adversely affect results of operations and financial condition.
• The occurrence of fraudulent activity, breaches or failures of information security controls, or cybersecurity-related incidents could have a material adverse effect.
• Dependence on information technology and telecommunications systems of third parties means any system failures, interruptions, or data breaches could adversely affect operations.
• Operational risks, including customer or employee fraud and data processing system failures and errors, could lead to financial losses or regulatory sanctions.
• Any acquisitions may expose the company to financial, execution, and operational risks, including integration challenges and unknown liabilities.
• The company may not be able to continue growing its business, particularly through organic loan growth, due to mature market areas.
• High dependence on the management team means the loss of senior executive officers or other key employees could harm the ability to implement strategic plans.
• The company may be liable to purchasers of mortgage loans and mortgage servicing rights due to breaches of representations and warranties.
• The ability to maintain the company's reputation is critical, and failure to do so may materially adversely affect business and stock value.
• The company has a continuing need for technological change and may not have the resources or may experience operational challenges when implementing new technology.
• Reliance on the accuracy and completeness of information provided by customers and counterparties could lead to negative financial impacts if information is misleading or fraudulent.
• Strong competition from financial services companies and other companies, including online businesses and FinTech, could harm the business.
• The development of the Banking-as-a-Service (BaaS) platform may expose the company to liability for compliance violations by BaaS partners or fall short of targeted financial impact.
• Identified material weaknesses in internal control over financial reporting could adversely affect the ability to report results accurately and timely.
• The company may incur impairment charges to goodwill, which would negatively impact business, financial condition, and results of operations.
• The risk management framework may not be effective in mitigating risks and/or losses.
• Involvement in suits, legal proceedings, information-gathering requests, investigations, and proceedings by governmental and self-regulatory agencies may lead to adverse consequences.
• Legislative and regulatory actions taken now or in the future may increase costs and impact business, governance structure, financial condition, or results of operations.
• Failure to comply with stringent capital requirements may impact dividend payments and limit activities.
• Federal and state regulators periodically examine the business, and the company may be required to remediate adverse examination findings.
• Risk of noncompliance and enforcement action with the Bank Secrecy Act and other anti-money laundering statutes and regulations.
• Failure to comply with numerous laws designed to protect consumers, including the Community Reinvestment Act and fair lending laws, could lead to sanctions.
• The Federal Reserve may require the company to commit capital resources to support the Bank.
• Monetary policies and regulations of the Federal Reserve could adversely affect business, financial condition, and results of operations.
• Fluctuations in interest rates may reduce net interest income and otherwise negatively impact financial condition and results of operations.
• Losses on securities held in the securities portfolio could be recognized, particularly if interest rates continue to increase or economic and market conditions deteriorate.
• Mortgage banking revenue has been and could continue to be adversely impacted by an elevated interest rate environment.
• Liquidity risks could affect operations and jeopardize business, financial condition, and results of operations.
• The company may need to raise additional capital in the future, and failure to maintain sufficient capital could adversely affect financial condition, liquidity, and regulatory compliance.
• The company may be adversely affected by the soundness of other financial institutions.

Future Outlook

Management expects to recognize a goodwill impairment expense between $135.0 million and $154.0 million in the first quarter of 2025. The company continues to take steps in 2025 to resolve nonperforming assets and improve its overall credit profile, including foreclosures, short sales, pursuit of guarantors, and sales of notes. The company expects to begin distributing assets to defined benefit plan participants in early 2025. The proposed Basel III Endgame Proposal is not expected to be adopted in its current form, and a new version may be issued. The CFPB's retreat from aggressive regulation may benefit the Bank's operations. The company's NII at Risk modeling projects increasing profitability in a declining interest rate environment.

Management Comments

• "We believe that our strategic actions around credit administration will better position the Company going forward."
• "Our strategic plan focuses on delivering a superior customer experience through a high-tech, high-touch approach, while remaining committed to core community banking and relationship-driven growth."
• "We intend to be very selective in our approach to developing BaaS partnerships to ensure that any partners that are added meet our high standards for risk management."
• "Management believes it is more likely than not that we will realize the benefits of these deductible differences [deferred tax assets]."
• "Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our internal control over financial reporting... concluded that our internal control over financial reporting... was not effective as of December 31, 2024, due to certain material weaknesses."
• "While we expect that the implementation of these controls will address the material weaknesses, management continues to evaluate the effectiveness of the remedial actions on an ongoing basis."

Industry Context

The financial services industry is highly competitive, with Midland States Bancorp facing competition from various entities including other community banks, large banks, FinTech companies, and online businesses. The company's performance is significantly influenced by Federal Reserve monetary policy, with recent interest rate cuts impacting asset yields and funding costs. The regulatory environment is evolving, with discussions around Basel III reforms and the Community Reinvestment Act, though the proposed Basel III Endgame is not expected to significantly impact the company due to its size. The industry is also experiencing heightened scrutiny on liquidity risk management following recent bank failures and on concentrations in commercial real estate lending. The company's strategic shift away from certain third-party loan origination programs and its focus on core community banking and wealth management reflect broader industry trends and competitive pressures.

Comparison to Industry Standards

• The company's executive compensation program aims to be competitive with those offered by its peers, using a peer group that includes City Holding Company, First Merchants Corporation, Park National Corporation, and others for benchmarking.
• The company strives to be among the top performing community banks in the nation.
• The company's cumulative total shareholder return (TSR) is compared against the S&P Small Cap 600 Banks Index.
• The Bank was well-capitalized as defined by Federal Reserve regulations as of December 31, 2024, exceeding the minimum capital requirements.
• The company's commercial real estate (CRE) concentrations did not exceed the supervisory criteria (300% of capital for total CRE loans or 100% of capital for construction and land development loans) as of December 31, 2024.

Management Changes

Corporate Governance

Legal Proceedings

• No material pending legal proceedings other than ordinary routine litigation incidental to the business.
• The company faces an elevated risk of legal proceedings in connection with the financial statement restatement and LendingPoint's 2023 system conversion.
• An accrual related to various legal actions was recorded during the second quarter of 2024.

Related Party Transactions

• Loans and commitments to loan with directors, executive officers, principal shareholders, and their affiliates were made in the ordinary course of business on substantially the same terms, including interest rates and collateral, as those prevailing for comparable loans with non-insiders.
• These transactions did not involve more than the normal risk of collectability or present other unfavorable features.
• All such loans were approved by the Bank's board of directors in accordance with bank regulatory requirements.
• Certificates of deposit and depository relationships with these persons were also made in the ordinary course of business and involved substantially the same terms, including interest rates, as those prevailing for comparable depository relationships with non-related parties.

Stakeholder Impact

• Shareholders: Significant negative impact due to substantial decline in net income and EPS, restatement of financials, anticipated goodwill impairment, increased nonperforming loans and charge-offs, and identified material weaknesses in internal controls. The delayed 10-K filing affects S-3 eligibility for capital raises.
• Employees: The company strives to offer competitive salaries and benefits, and provides training programs (Midland University, MASTERS). Executive compensation is tied to performance, and a clawback policy is in place, which may affect executive bonuses.
• Customers: The company's strategic plan focuses on delivering a superior customer experience. However, cybersecurity risks could impact customer data, and changes in lending policies and portfolio reductions may affect certain customer segments.
• Creditors: Increased nonperforming loans and credit losses could raise concerns, although the company maintains strong regulatory capital ratios and liquidity, which should mitigate immediate concerns for creditors.
• Regulatory Authorities: The restatement of financial statements and identified material weaknesses in internal controls will lead to increased scrutiny and oversight from regulatory bodies, requiring significant remediation efforts.

Next Steps

• Continue to resolve nonperforming assets and improve the overall credit profile in 2025 through foreclosures, short sales, pursuit of guarantors, and sales of notes.
• Begin distributing assets to defined benefit plan participants in early 2025.
• Implement controls to remediate identified material weaknesses in internal control over financial reporting, including a more formal risk assessment process, enhanced internal control training, and formal accounting policies for non-routine transactions and guarantees/variable-rate features.
• Evaluate and enhance internal control processes over the review of loan data provided by certain third-party service organizations.
• The Audit Committee will conduct a recovery analysis of incentive-based compensation received by executive officers based on corrected actual results, as required by the Clawback Policy.
• Update related disclosures upon adoption of FASB ASU No. 2023-09 (Income Taxes) and FASB ASU No. 2024-03 (Income Statement Expenses).

Key Dates

Recommendation

Keywords

Midland States Bancorp, MSBI, financial restatement, goodwill impairment, credit quality, nonperforming loans, loan portfolio, banking, wealth management, financial results, earnings, net interest income, provision for credit losses, charge-offs, internal controls, risk management, FinTech, GreenSky, LendingPoint, commercial real estate, equipment financing, capital ratios, liquidity, interest rates, corporate governance, executive compensation, SEC filing, 10-K