Executive Summary / Key Takeaways

• Balance Sheet Repair in Progress: Midland States Bancorp is deliberately shrinking its riskiest portfolios—exiting GreenSky, selling LendingPoint, and ceasing equipment finance originations—to repair credit quality and simplify operations, causing near-term losses but potentially positioning for a more stable future.
• Core Franchise Shows Life: Despite the strategic retreat, the community banking segment in Illinois and St. Louis continues to grow, with net interest margin expanding to 3.79% in Q3 2025, suggesting the underlying deposit and lending franchise remains viable.
• Capital Structure Under Pressure: The $154 million goodwill impairment in Q1 2025, while non-cash, signals severe credit deterioration and leaves the bank with weakened intangible capital, though regulatory ratios remain above minimums.
• Unsustainable Capital Returns: Management increased the dividend to $0.32 quarterly and authorized a $25 million buyback despite negative earnings and a 91% payout ratio, creating a potential cash drain that may force difficult choices if credit losses persist.

• Execution Risk Defines the Thesis: The investment case hinges on whether management can successfully wind down problematic portfolios while growing the core community bank fast enough to offset lost revenue—a delicate balancing act against larger, more efficient competitors.

Setting the Scene: A 144-Year-Old Bank Confronts Its Limits

Midland States Bancorp, founded in 1881 and headquartered in Effingham, Illinois, built its reputation as a classic Midwest community bank—taking deposits, making loans, and serving local businesses. For most of its history, this straightforward model generated steady returns from interest income supplemented by wealth management fees and mortgage origination. The company’s geographic footprint expanded methodically, first into St. Louis in 2014 and later into Northern Illinois through a 2022 branch acquisition, creating a three-state presence focused on relationship banking.

The strategic inflection point arrived in 2018 when management made a bold bet on equipment finance, investing heavily to rebrand the group as Midland Equipment Finance and grow it from $200 million to over $1 billion by Q3 2022. This move represented a departure from community banking into nationwide specialty finance, aiming for higher yields and faster growth. Simultaneously, the bank embraced fintech partnerships—GreenSky for consumer loans and LendingPoint for originations—seeking fee income and low-cost deposits through Banking-as-a-Service (BaaS) initiatives.

This expansion strategy collided with reality in 2024-2025. Credit quality deteriorated sharply in the equipment finance and fintech portfolios, forcing management to recognize a $154 million goodwill impairment in Q1 2025 and ultimately cease all equipment finance originations by September 2025. The bank now finds itself in a strategic retreat, dismantling its growth engines to save the core franchise. The critical question for investors: is the remaining community bank valuable enough to justify the pain of this restructuring, or has the expansion permanently impaired the franchise?

Midland States operates in a brutally competitive regional banking market dominated by larger players like Wintrust Financial with $50 billion in assets and Old National Bancorp with similar scale. These competitors enjoy broader geographic diversification, superior technology platforms, and operating margins nearly double MSBI’s. Huntington Bancshares brings national scale and digital capabilities that smaller regional banks cannot match. MSBI’s sub-scale position—$6.9 billion in assets versus competitors’ $50-190 billion—creates a permanent cost disadvantage that only flawless execution can overcome.

Technology, Products, and Strategic Differentiation: What Remains After the Retreat

The bank’s product strategy has shifted from expansion to contraction. The equipment finance business, once the primary growth driver, is being wound down after contributing to credit losses and charge-offs. This exit eliminates a source of higher-yielding assets but removes a volatile earnings stream that damaged investor confidence. The BaaS platform, built through a Synctera partnership, remains in early stages with management focusing on deposit gathering rather than loan originations—a prudent but unproven strategy for replacing lost fee income.

Wealth management represents the one stable growth pillar. Assets under administration increased to $4.36 billion in Q3 2025, with revenue up 12.9% year-over-year. The 2022 hiring of Jayne Hladio as Head of Wealth Management appears to be bearing fruit, generating consistent fee income that helps offset net interest income volatility. This business benefits from sticky client relationships and recurring revenue, making it more valuable in the current environment than transactional lending activities.

The core community banking franchise—commercial real estate, commercial & industrial loans, and retail deposits—continues to perform adequately. The bank’s deposit beta remained in the high teens through 2022, and management has maintained pricing discipline as rates rose. The loan-to-deposit ratio stood at 99% in Q4 2022, with management targeting 90%, indicating room to fund growth from existing deposits rather than expensive wholesale funding. This deposit franchise, built over decades of local relationships, represents the bank’s most defensible moat against larger competitors who cannot replicate community ties.

Financial Performance: Evidence of a Bank in Transition

The financial results tell a story of deliberate shrinkage. Total assets fell 9.9% to $6.92 billion in Q3 2025 versus the prior year, driven by an $835.7 million decrease in average loans. The consumer loan portfolio shrank by $588 million as the bank sold LendingPoint and GreenSky participation interests totaling $317.5 million. Equipment finance balances dropped $192.7 million to $675.5 million. These reductions directly address credit concentration risk but come at the cost of interest income, which declined 9.5% year-over-year.

Net interest income, however, increased 3.6% in Q3 2025 to $63.5 million, and the tax-equivalent net interest margin expanded 45 basis points to 3.79%. This margin expansion demonstrates the core banking engine is working, as deposit costs are falling faster than asset yields. The average rate on new and renewed loans reached 7.1% in December 2022, up 150 basis points from September 2022, showing pricing power in the community bank portfolio.

Credit quality remains the critical variable. Nonperforming loans fell to $68.7 million (1.41% of total loans) at Q3 2025 from $150.9 million (2.92%) at year-end 2024, suggesting the portfolio purge is working. However, net charge-offs were still $12.3 million in Q3 2025, and the allowance for credit losses on equipment finance leases increased to 6.77% from 3.74% as management raised loss assumptions. The $154 million goodwill impairment, while non-cash and not affecting regulatory capital, signals that management overpaid for past acquisitions and that the banking unit’s fair value has collapsed—a stark admission of strategic failure.

The efficiency ratio improved to 53.1% in Q2 2022 but has likely deteriorated as revenue declines outpace expense cuts. Salaries and benefits increased $2 million in Q3 2025 due to severance costs from equipment finance staff reductions, creating near-term expense pressure while the bank shrinks. Management’s guidance of $43-44 million quarterly operating expenses appears optimistic given restructuring costs and the need to invest in compliance and risk management.

Outlook, Management Guidance, and Execution Risk

Management’s commentary reveals a leadership team attempting to project confidence while navigating a turnaround. CEO Jeffrey Ludwig acknowledges that 2023 will be “challenging” due to recession possibilities but insists the “stronger franchise” can generate “strong financial performance” through conservative underwriting. CFO Eric Lemke targets a “relatively stable” net interest margin and quarterly expenses of $43-44 million, assumptions that appear fragile given the uncertain economic environment and ongoing restructuring costs.

The guidance on loan growth is notably vague. Ludwig states it’s “difficult to provide a forecast” but believes the more productive commercial banking team and greater exposure to Chicago and St. Louis will drive growth. This optimism conflicts with the bank’s decision to cease equipment finance originations and exit fintech partnerships—moves that eliminate growth vectors. The core community bank portfolio grew only 2.9% in the first nine months of 2025, hardly enough to offset the $554 million decline in specialty finance portfolios.

The BaaS initiative remains a wild card. Management expects it to become a “long-term contributor” to deposit gathering and fee income, but the platform is still in early stages with no material revenue contribution disclosed. The experience with GreenSky and LendingPoint has made management cautious, but the bank lacks the technology infrastructure of larger competitors who can deploy digital banking solutions at scale. Success here requires execution capabilities that MSBI has not demonstrated.

The most credible guidance relates to credit quality. Management expects the ACL as a percentage of loans to “steadily rise” in 2023 as the portfolio remixes away from consumer fintech toward commercial loans. This conservative approach is appropriate but will pressure earnings through higher provision expenses. The bank’s modeling assumes a “mild recession” scenario; a deeper downturn would likely require substantially higher reserves given the CRE concentration.

Risks and Asymmetries: What Could Break the Thesis

Credit Quality Deterioration in CRE: The bank’s commercial real estate portfolio represents its largest exposure, and management acknowledges being “more selective” in new production. However, Illinois and Missouri face demographic headwinds and office space oversupply. If CRE values decline more than expected, charge-offs could overwhelm the improved trends in nonperforming loans, forcing larger provisions and potentially triggering regulatory scrutiny.

Execution Risk in Portfolio Transition: The bank is attempting to shrink specialty finance by over $550 million while growing community banking by $90 million—a five-to-one replacement ratio that may prove unsustainable. If the core franchise cannot accelerate growth, the bank will emerge from this retreat smaller and less profitable, with a permanently impaired earnings power that justifies a lower valuation multiple.

Competitive Deposit Pressure: Larger competitors like Wintrust Financial and Old National Bancorp are aggressively raising deposit rates to fund loan growth, while fintechs and money market funds offer higher yields. MSBI’s deposit beta, which remained in the high teens during the rate hiking cycle, could accelerate if customers demand more competitive rates. This would compress the NIM expansion that currently supports earnings.

Regulatory and Compliance Burden: The Nasdaq deficiency notification for delayed filings and ongoing remediation of material weaknesses in internal controls signal governance problems. For a bank, regulatory trust is paramount. Continued compliance issues could restrict the bank’s ability to pursue acquisitions, raise capital, or even maintain its charter—a catastrophic outcome for equity holders.

Capital Return Unsustainability: The 91% payout ratio and $25 million buyback program represent capital returns that exceed earnings. While the bank maintains “well-capitalized” regulatory ratios, this is only because the goodwill impairment is excluded from capital calculations. Continuing to return capital while shrinking the balance sheet and facing credit losses could deplete tangible common equity, limiting strategic options.

Valuation Context: Pricing a Turnaround

At $20.79 per share, MSBI trades at 0.95 times book value and 1.22 times sales, metrics that suggest the market views the bank as a below-average franchise. The price-to-book discount reflects the goodwill impairment and credit concerns, while the modest price-to-sales ratio indicates skepticism about earnings power. The 6.39% dividend yield, while attractive, is a warning sign when paired with a 91% payout ratio and negative ROE of -21.7%.

Comparing MSBI to direct competitors reveals the valuation gap. Wintrust Financial (WTFC) trades at 1.43 times book and 3.56 times sales with a 30.67% profit margin and 11.69% ROE. Old National Bancorp (ONB) trades at 1.13 times book and 3.91 times sales with 28.73% margins. Huntington Bancshares (HBAN) trades at 1.31 times book and 3.48 times sales with 29.62% margins. MSBI’s sub-scale operations, credit issues, and strategic uncertainty justify a discount, but the current 25-35% valuation gap to peers appears punitive if the turnaround succeeds.

The bank’s balance sheet provides some downside protection. With $584 million in shareholders’ equity and regulatory capital ratios above “well-capitalized” minimums, the bank can absorb further losses without immediate solvency concerns. The redemption of $50.8 million in subordinated debt in September 2025 eliminates $4 million in annual interest expense, modestly improving earnings power. However, the shrinking asset base and declining loan portfolio suggest the bank is sacrificing growth for stability—a trade-off that may be necessary but limits upside.

Conclusion: A Community Bank at the Crossroads

Midland States Bancorp’s investment thesis centers on whether a 144-year-old community bank can successfully execute a strategic retreat from failed expansion initiatives while preserving enough of its core franchise to rebuild value. The bank is making the right decisions—exiting equipment finance, selling fintech portfolios, and focusing on relationship banking—but these moves come after significant capital destruction and leave a smaller, less profitable institution.

The margin expansion and deposit franchise demonstrate that the underlying community banking engine still works. However, the competitive landscape demands scale and technology that MSBI lacks. Larger regional banks are growing faster, operating more efficiently, and generating superior returns. For MSBI to close this gap, the core community bank must accelerate growth dramatically while credit quality continues to improve—a tall order in a slowing economy.

The critical variables to monitor are loan growth in the community bank portfolio and the trajectory of credit losses. If the bank can grow core loans by more than 5% annually while keeping charge-offs below 0.5% of loans, the turnaround will gain credibility and the valuation discount to peers should narrow. If growth stalls or credit deteriorates again, the bank risks becoming a permanent laggard or acquisition target at a depressed price. The dividend, while currently supported by capital ratios, will likely need to be cut to fund internal growth—a move that would pressure the stock but strengthen the long-term franchise.