First Midwest Bancorp, Inc.
Q4 2020 Earnings Call Transcript

Published: 27 Jan 2021

[Operator:]

Good morning, ladies and gentlemen, and welcome to the First Midwest Bancorp 2020 Fourth Quarter and Full Year Earnings Conference Call. Following the close of the market yesterday, First Midwest released its earnings results for the fourth quarter and full year of 2020 and issued presentation materials that will be referred to during the call today. During the course of the discussion, management’s comments and the presentation materials may include forward-looking statements and non-GAAP financial information. The company refers you to the forward-looking statement, non-GAAP and other legends included in its earnings release and presentation materials, which should be considered for the call today. This call is being recorded and all participants are in a listen-only mode.

[Mike Scudder:]

Great. Thank you. Good morning, everyone. Thanks for joining us today. Great to be with you. I hope this finds everyone and your families doing well, staying healthy and certainly ready for a New Year. Let me start, I want to offer some perspective as we close the quarter and certainly close on what has been, gosh, a wild year. Just reflecting back on the year itself, it certainly has a best of times, worst of times been to it. When we set our plan for 2020, we were coming off a record 2019 moving into what was expected to be a lower, but relatively stable rate environment. And then like all we had to pivot to address the immediacy of the pandemic, the economic shutdown, a massive shift in fiscal and monetary policy, all of which seemed to last longer than most had anticipated. But certainly as we stand here today is looking to be less damaging than what we all would have been initially feared. So from my perspective, as I think about it, what we accomplished during 2020 as a company and frankly as an industry, as a whole to me was truly amazing and a true testament to the character of our company and our teams. So as we kick off 2021, while the downside risk, I believe is still there. We are certainly feeling more positive so. Our balance sheet remains very strong that provides us with a lot of management flexibility as conditions unfold in 2021. Our Tier 1 capital now is at 11.6% that’s over 100 basis points higher than when we started 2020. Our loan loss reserves stands at almost 1.7% that’s double what it was when we started the year and that’s about 40 basis points to 50 basis points higher than what day one CECL would have been when we kicked off the year. The quarter also offered several highlights as we move into 2021. Certainly the quarter reflected improvement from an EPS standpoint that was came in at $0.33 that’s up, gosh, some 57% or almost 60% versus last quarter and that’s largely on the strength of greater PPP revenue and relatively lower loss provision and expense. The forgiveness process for the 2020 program was faster than expected and accelerated the timing of receipts from what we all know and hope will eventually be a finite series of programs. The second drop program is underway. And frankly it’s going pretty well. Thanks to our team’s efforts. We’re really pleased to be able to help our clients in the community as we rollout the second year’s a second drop program and that’ll help partly offset some of the acceleration from the earlier program into 2020. So Mark and Pat get into that a little bit further.

[Mark Sander:]

Thanks, Mike, and good morning, everyone. Starting on Slide 4 of our presentation, loans increased $100 million from the prior quarter due to strong organic mortgage production and a significant remix of our balance sheet into purchase one-to-four mortgages as Mike referenced, largely offset by the decline in PPP balances we saw. Mortgage had another very strong quarter.

[Pat Barrett:]

Thanks, Mark. Good morning, everybody. Turning to net interest income and margin on Slide 11. Net interest income increased 4% compared to the prior quarter. It looks consistent with the same period in 2019. Compared to both prior periods, NII reflected the positive impact on the more than $400 million of PPP loan forgiveness during the fourth quarter, as well as lower funding costs offset by the negative impact of lower rates. Compared to the prior year, growth in both loans and securities as well as the Park Bank acquisition help partially offset the impact of lower rates. Acquired loan accretion contributed nearly $8 million to the quarter consistent with the prior quarter and down $2 million compared to the same period a year ago. Accretion was higher than scheduled due to favorable resolution of certain acquired loans. Continuing on the same slide with net interest margin, tax equivalent NIM for the current quarter of 3.14% was up by 19 basis points linked-quarter, primarily as a result of the PPP loan forgiveness and down 58 basis points from the same period a year ago. Excluding accretion, margin was 2.98% for the quarter, up 19 basis points linked and down 50 basis points from the prior year. Compared to year ago, margin compression was primarily driven by the impact of lower interest rates on loan and securities yields, as well as the impact of higher customer liquidity balances.

[Mike Scudder:]

Thanks, Pat. So before we open it up, just a couple of things to reemphasize. Clearly, as we stand here today, I think most of us would not be a stretch to say, there’s downside risks still out there. At the same time, like many of us, we are hopeful and feel better about recovery in 2021. I’ve been doing this as per this year will be 35 years at First Midwest and I’ve noticed over that period of time, as many of you had the world rarely operates in linear fashion. As we think about 2021, I really think about it in the context of building momentum over the course of the year and we would expect the second half of the year to see the greater benefit on production from the vaccination efforts and fiscal monetary stimulus and the effectiveness of the same. So as we work through all of this, just again to reemphasize, what I start with our balance sheet is really strong liquidities there, credit stable and our reserves are robust, all of which is going to create opportunity as conditions stabilize and outlooks improve. Volumes are recovering. Our core deposit base remains an undervalued strength that will differentiate as rates ultimately move higher at some point. In the interim, the efforts that we undertook this quarter also will help navigate that. Our teams are working hard as Mark suggests that pipelines are building and again, we have the flexibility that our capital offer stuff there. I would emphasize what Pat said, efficiency and optimization activities are clearly a focus as one operates in the extended low rate period. And while it’s important and those are there and the focus of that is on those, it is also equally important that they remain aligned with our broader priorities around building a superior client experience, which is ultimately what we’re trying to accomplish. Our digital and online skill sets and the investments we’ve made and are making will also mature and all of those will help us with our efforts to become more efficient in our processes and deliver on that experience. So as we navigate the near-term, our franchise priorities remain pretty much the same driver returns sustainably higher. That requires a focus on building and retaining a talented team of colleagues, building revenue, growth and breadth and continuing to focus on driving a superior and efficient experience. And as I said, we will continue to take advantage of those opportunities that present themselves, that align with those goals. So we talk about this all the time with our teams. Times, such as these present challenges, but they also present tremendous opportunities, opportunities to leverage the engagement of our people, our financial strength and continue to build on our strong relationships with our clients, better serve their needs and ultimately the long-term goal of enhancing the value of our franchise. So with that, let’s turn to it and open it up for questions, as this our practice, it just to help us from talking over each other. I’ll take the question and then just direct it among the three of us, just where the answer will come from.

[Operator:]

Thank you, sir. The question-and-answer session will begin at this time. The first question is from Chris McGratty with KBW. Please go ahead.

[Chris McGratty:]

Hey, good morning.

[Mike Scudder:]

Hi, Chris.

[Chris McGratty:]

Hey, Mike. The mid single digit loan growth, I’m interested in kind of the source you talked about building pipelines, but also you bought the mortgages in the quarter. I’m interested how you see the allocation of that for 2021. And do you expect to be buying more mortgages, like some of your peers have been doing given the better alternative to on MBS. Thanks.

[Mike Scudder:]

Go ahead, Mark.

[Mark Sander:]

Sure. So Chris, good morning. We expect that growth to come organically from both commercial and consumer. So we would expect both of those businesses, again, organically away from purchases to grow mid single digits. At this point, we’re not per se planning on transactional purchases. So much of that, of course, depends on what happens with our liquidity. And if it stays higher than we expect like it did all through 2020, we may, but that’s not contemplated in the mid single digit guidance we gave.

[Chris McGratty:]

Okay. And just a point of clarification on Slide 16, the relatively stable NII, is that – maybe Pat, is that a reported number, including the accretion and the PPP or is that stripping out that like your NIM guide does.

[Pat Barrett:]

That would be our core NIM. So stripping out the impact, I will say that we wouldn’t be surprised to see, I had plus minus 10 basis points of volatility on a quarterly basis, depending on how liquidity flows, particularly with the new PPP program and the timing of the forgiveness of the remaining already booked PPP, which we’re finding is pretty challenging to predict on a quarterly basis. But over the course of the year away from accretion, we would expect to hit or modestly exceed a three handle each quarter.

[Chris McGratty:]

Okay. That’s great. On the NII, the net interest income, is that the stable comment. Is that reported or is that core.

[Pat Barrett:]

It actually turns out to be both. If you look at it purely on a core basis, we’ll see flat to modest, like very modest increases each quarter. And of course, that’s dependent on the timing of loan growth, so away from the impact of – accretion of PPP.

[Chris McGratty:]

Okay. Got it. And then just a couple of housekeeping, the tax guide that you gave that’s a gap, that’s not a tax equivalent, right.

[Pat Barrett:]

Well, that would be our stated and afforded effective tax rate.

[Chris McGratty:]

Okay.

[Pat Barrett:]

So for the fully tax equivalent, the differential is pretty modest. We don’t have a lot of tax exempt screams.

[Chris McGratty:]

Okay. And any one-timers left from the chart from the plans you guys have been doing with the balance sheet in the first quarter?

[Pat Barrett:]

I would say de minimis. So I think if there is any – it’s likely to be in kind of in the $1 million dollar range.

[Chris McGratty:]

Got it. Okay. Thanks a lot.

[Operator:]

The next question is from Daniel Tamayo with Raymond James. Please go ahead.

[Daniel Tamayo:]

Good morning, guys. How are you?

[Mike Scudder:]

Good morning, Danny.

[Daniel Tamayo:]

Yes, maybe first on the balance sheet optimization and how that impacts your asset sensitivity. How does that compare now if we do were to see an increase in the short rates to what it was prior to the optimization efforts.

[Mike Scudder:]

Go ahead, Pat.

[Pat Barrett:]

Danny, it’s a modest improvement. So it would take us from an earnings at risk of say, 6% to 5%, not significant and puts us from an interest rate shock perspective. It doesn’t modest. It modestly changes that, but not meaningfully.

[Daniel Tamayo:]

Okay, got it. And then maybe on – now the environment is improving and you do have excess capital here. If you’re having, to the extent, I should say you’re having conversations with potential targets. How those may be changing over the last few months and kind of what expectations are out there by others?

[Mike Scudder:]

I can take that one, fundamentally, any conversation through not just in this current environment, but any time for us always starts with, how does it align strategically with what we’re trying to do and how do things match up culturally. In terms of bid as spreads on those fronts, again, these are broader perspectives there. They’re always wide. For some reason, people who are looking to sell always think their value is higher than people looking to buy. And that’s just a natural state of affairs. So but other than that, I think most people are just trying to get their feet under them relative to the environment and look out forward as to how that’s going to play out.

[Daniel Tamayo:]

Okay. That’s helpful. And can you just remind us of your area, geographically and sides, how you’re thinking about priorities there?

[Mike Scudder:]

Well, again, as we focused on our platform in our business, we look up and say, we’re operating in the metropolitan Chicago marketplace with a really strong operating presence in a very diverse and broad market. So we – the anchoring of that here is a real value to the franchise. And then from there, we just look at adjacent urban Midwestern markets as to opportunities that continue to expand much like what we did in Milwaukee.

[Daniel Tamayo:]

And is there a particular size that shifted at all recently? Or how are you thinking about size?

[Mike Scudder:]

Well, obviously, we’re a larger company. So you have to think about how does that change relative to the size of the opportunity. So it really does start, as I said, smaller, and I mean, on the small scale probably are more difficult for us to integrate culturally. At the same time, it really does start with the platform and how it aligns with what we’re trying to do. Again, it’s easier to do it in the context of looking at a Park thing, where you look up and you’ve got a billion to a financial institution that brings a really strong commercial platform into a market that we think is important to be able to grow and build on what we do from a relationship based lending standpoint, so.

[Daniel Tamayo:]

Understood. I appreciate all the color guys.

[Operator:]

The next question is from Terry McEvoy with Stephens. Please go ahead.

[Terry McEvoy:]

Good morning, everyone.

[Mike Scudder:]

Hi, Terry.

[Terry McEvoy:]

Just a question on the expense outlook, when I read the presentation, it seemed like maybe there was a downward bias to expenses. You talked about identifying further process efficiency benefits. But then listening to Pat, it sounded like, technology and investing in technology would also be something that you’d focus on this year. So I guess my question is, if there’s a dollar of cost saves that’s identified. Does that – is that really offset by just call it technology spending? Or do you think there are opportunities to maybe improve the expense outlook over the course of this year?

[Mike Scudder:]

Go ahead, Pat.

[Pat Barrett:]

Yes. Terry, that’s a great question. I think that this, because we’re continuing to invest in platform, which includes people but it is also from a product platform perspective, pretty significantly this year. I think that our kind of reasonably flat guidance is likely to be the 2021 outlook. I think the better opportunity is once we start completing the investments is, how does that drive further transaction volume to digital away from physical, which obviously has potential expense impact. And how do customer self service trends impact that? So we’re hopeful that with the investments we’re making this year, we’re setting ourselves up for further efficiency improvements and operating leverage improvements away from growth as we go into 2022. Roundabout way to sort of answer your question, so if I didn’t ask it again.

[Terry McEvoy:]

No, that’s great. Thanks, Pat. And then as a follow-up, on Slide 5, as I think about 2021, those other areas of focus, kind of retail CRE, office CRE may kind of grow an importance some among kind of the investment community. And maybe some of those elevated risks may fall off. So I don’t know, Mark, could you maybe comment on retail and office, whether those trends have improved and where do you think maybe there’s some kind of additional risk over the course of 2021 that we’ll keep it on this slide. Thanks.

[Mark Sander:]

Yes. I would say this way, Terry, I think the – what we’ve seen over these last quarter has been stability in terms of occupancy and rent collections. But in our view, the jury is still out here a little bit. And so as we’ve talked about our last few years, we’ve been cautious on retail CRE for quite some time. We’ve used leveraged finance as an important business, but a higher risk business inherently. So I think these will – those two will stay on here for some time, because as I say, I think there’s still the story remains to be seen. And that’s probably most notable in office CRE, where that’s about as murky as anything, again, rent collections have been very strong. And we feel good about our original underwriting, such that the loan values are strong, but what does that look like over the success of few years? There’s a mixed views there. And so as I say, I think you’ll see these – those three stay there for some time.

[Terry McEvoy:]

Great. Thanks everyone.

[Operator:]

The next question is from Nathan Race with Piper Sandler. Please go ahead.

[Nathan Race:]

Yes. Hi, guys. Good morning.

[Mike Scudder:]

Hi, Nate.

[Nathan Race:]

Maybe just continuing the credit discussion, just curious to kind of get some thoughts on just the charge off guidance perhaps or particularly, with increased expected in the back half of 2021 here. Is that more so a function of just the stimulus kind of abating as we get further out this year or is it somewhat of a function of just the increase in criticized loans that we saw during the last couple of quarters that may drive some of that as you guys worked through?

[Mike Scudder:]

Go ahead, Mark.

[Mark Sander:]

Yes. I think you answered your own question. I think that is it really, it’s not like we see – anything obviously if we saw charge offs with clarity. We would take them now. As we look out the next quarter or two, they seem pretty muted. But we still just think there’s enough uncertainty out there to make us believe that again, when you – with the amount of criticizing classified that we have, you have to believe that there’s some level of that may manifest itself over time. So that’s really all it reflects is our best guess on that migration.

[Nathan Race:]

Understood. And then just kind of tuning gears a little bit and just think about the growth guidance for this year of 4% to 5% loans. Curious if that’s just the function of continuing to take market share in and around Chicago with some of the M&A transactions that we’ve seen recently. Or are you guys going to shifting client demand or just some kind of a moderation and payoffs at this point.

[Mark Sander:]

A little bit of – sorry by guess, a little bit of all of the above Nathan, I would say at this way, it starts with having the right team that you feel can compete and win, which I strongly feel that we do. So I think it’s a little bit of – I think we can pick up market share. I think we expect to pick up market share in all of our core businesses. There’s a certain amount of just return to normalcy, of course built-in there. We’ve added a few people over the last few years, but not a lot, because again as I say, we have the team, I think that can go compete and win.

[Nathan Race:]

Okay, got it. If I could just ask one more on capital and share buybacks, obviously capital ratios increased across the board, I believe in the fourth quarter here. I guess just any thoughts or appetite on the buyback really this year. I know M&A is an ongoing consideration as well, but just any thoughts on buyback, particularly just given where the stocks trading today.

[Mike Scudder:]

Go ahead Pat.

[Pat Barrett:]

Yes, our capital priorities remain pretty steady, which is first and foremost to fund growth. The outlook for that is as we’ve laid out, probably kind of normal or returning to a more normal organic growth rate, sustaining a dividend level, which we feel good about where we are and expect to be from a payout ratio in the near-term to have dry powder for M&A, which Mike’s already talked about and then kind of last utilization would be capital optimization through buybacks or other means. I think where we are right now from a criticized and classified loan perspective, even though our credit is at near record positive levels for the fourth quarter. There’s still this expectation that we will see a tick up in credit. We feel very good about the reserve levels we have, but until we actually do start to see those washed through and get a higher level of confidence around that. I think it feels a little bit premature for us to be talking about planning for, or guiding to share repurchases, but you should expect this is going to be a recurring quarterly discussion that we’ll have. So I’d say more to come as we gain more certainty around both growth and ultimate credit outcomes.

[Mike Scudder:]

Yes. I would add to that and emphasize what Pat said there at the tail end. This is a ongoing and will be an ongoing inactive dialogue that we have with the board and frankly, with investors as well so.

[Nathan Race:]

Okay, great. I appreciate you guys taking questions. Thank you.

[Mike Scudder:]

Great, thanks.

[Mark Sander:]

Thanks, Nathan.

[Operator:]

The next question is from Michael Young with Truist Securities. Please go ahead.

[Michael Young:]

Hey, thanks for taking the question. Wanted to ask a follow-up on the capital return commentary you just mentioned. So stocks at 1.1 times tangible, I understand criticized classifieds are a little elevated, but I would assume the priority would be share buyback over M&A despite increases in M&A activity at these valuation levels. Is that fair?

[Mike Scudder:]

Yes, let me kind of stated differently and the answer to that is – the goal is always the same, what is the best return to our shareholders for the deployment of capital choice that we have available to us. So if – yes, you’re right, if in a world where opportunities come from an acquisition standpoint, those have to be weighed against the risk and the relative returns that those projects, so that’s kind of the screen we look through it every time. So in a world where you’re operating with valuations, where they are today have to think about that relative to how you deploy it so.

[Michael Young:]

And I guess Mike, maybe as a follow-up just on kind of geographic interest and strategy around M&A once we get – once you get back to evaluation level where you can be more active there. Is there still kind of the focus on just bolt-on cost out acquisitions? Or do you feel like this is kind of early cycle and you need to expand geographically from here?

[Mike Scudder:]

We really haven’t changed strategically in terms of where our thoughts go relative to who we are and what we do. We’re a commercial our relationship based franchise. We think that operates well in not just the markets in terms of which where we operate here in Chicago, but for those urban markets, of reasonable size and Midwestern adjacencies, those make sense for us to be able to continue to build on that. So our strategy there really hasn’t changed other than our size is larger. So the impact and the relative opportunities that are available to us, certainly can be – have to be larger to be more impactful, but the strategic goal of what we’re trying to do really hasn’t changed.

[Michael Young:]

And then last one for me, just on the kind of organic growth and hiring opportunities, there’s been a lot of M&A in your market. So I would assume there’s potentially some opportunity sets out there. Should we think of it as kind of an up hearing of talent with a focus on costs, rationalization from here, or do you want to be net adders of loan producers at this point in the cycle?

[Mark Sander:]

Let me take that Mike.

[Mike Scudder:]

Go ahead, Mark.

[Mark Sander:]

Yes. I would say Michael net a good loan producers, good relationship managers, I want to might be clear. It’s not just loans, its full relationship. Good relationship managers always pay for themselves very quickly. And so we will always be in the market for strong producers. And so even in good times and bad times, that’s our philosophy. I don’t think that we need to add a lot of people to hit the growth targets that we have, but we’ll expect to add a few people, but it’s more topping up of the talent as opposed to changing out anything that we have.

[Michael Young:]

Okay. Thanks.

[Operator:]

The next question is a follow-up from Daniel Tamayo with Raymond James. Please go ahead.

[Daniel Tamayo:]

Hey, thanks. Just quickly here, I just want to make sure I understand that the net interest income guidance does that include your expectation for the $10 million to $15 million from the second round, you kind of the 2021 PPP program.

[Mike Scudder:]

Go ahead, Pat.

[Operator:]

Mr. Barrett, did you meet your line on your end? You’re still open on ours.

[Pat Barrett:]

Well, apologies. Danny, it does, but whether you include PPP and the offset – that offsets the decline in accretion or not, you still end up with essentially the same guide. Is that make sense?

[Daniel Tamayo:]

No, I understand. I just wanted to make sure that, that I understood that correctly in terms of the reported side.

[Pat Barrett:]

Yes. I mean away just our core NII, away from the impact of accretion for PPP at all, I would expect steady, but quite modest improvement quarterly, just reflecting ongoing growth. So like 1%-ish for the year. So not significant, if you include PPP in accretion, the kind of improved or increased PPP that we would expect will offset the decline in accretion that we have scheduled versus actual in 2020. So the delta between those two tends to be a wash year-on-year.

[Daniel Tamayo:]

Okay. All right. That’s awesome. And then within the mortgage banking, a big spike in the fourth quarter, you talked about that was really on the margin side. Is that what’s driving the decline? I’m assuming that that mortgage banking is kind of is a work through the numbers you’re going to fall off from that elevated number in the fourth quarter going forward. Is that really a margin issue? Or how are you thinking about the origination side in 2021 kind of similar to the industry forecast of 20% to 30% down?

[Mike Scudder:]

Go ahead, Mark.

[Mark Sander:]

Yes. This is a short answer Danny. We’re expecting it to come down a little bit the – now that said the first quarter was not that robust, so we’ll have presumably a favorable comparison Q1 versus Q1 of 2020, but overall we’re expecting a bit of a decline this year.

[Daniel Tamayo:]

Okay. And it was a big spike in the margin in the fourth quarter that, that really drove that increase.

[Mark Sander:]

Yes. The sale price is in mortgage. We’re nice – we’re really strong in the fourth quarter. And so we just took advantage of the trade between putting on our balance sheet or the sale. We just not the sale price was attractive enough to take advantage of it.

[Daniel Tamayo:]

Understood, okay, thanks. That’s all for me, thanks.

[Operator:]

Our next question is from Chris McGratty a follow-up from him from KBW. Please go ahead.

[Chris McGratty:]

Yes, thanks. I might’ve missed it, but did you provide any color about the increase in the special mentions, which went up about what $60 million? What portfolio maybe?

[Mike Scudder:]

Go ahead, Mark.

[Mark Sander:]

We did not that almost entirely came from fitness and recreation in the quarter, Chris.

[Chris McGratty:]

Okay. And with those loans coming off deferral, is it just – are you seeing notable changes just given the pace of improvement in COVID reopening what’s the story there, Mark?

[Mark Sander:]

The latter, Chris, it’s really just the pace of improvement and the clarity with which how long it might go on, that, that caused us to downgrade a few credits there.

[Chris McGratty:]

Okay, thanks.

[Pat Barrett:]

Hey Chris, while you’re on, this is Pat, I just wanted to correct myself. You were asking about kind of one-time ongoing optimization costs in Q1. And I said $1 million, I should have said around $2 million, but that should wrap it up.

[Chris McGratty:]

Got it, thanks.

[Operator:]

If there are no further questions, I will now turn the call back over to Mr. Scudder for any closing remarks.

[Mike Scudder:]

Great, thanks. So before we close, just once again want to take the opportunity and recognize and thank all of our colleagues. I know they listened to these calls and I want to thank them on behalf of all of us for their response, particularly during these times. It’s their continued commitment to who we are and what we’re all about and the values we represent as a company that I believe makes First Midwest special. So we’re very proud to be surrounded by so many good people who try to do the right thing every day for our clients, our communities, and for each other. So with that, I’d like to thank all of you for your interest in and attention to our story. And as we share our ongoing belief, that First Midwest is a great investment opportunity. I would encourage you to take advantage of it. So have a great day.

[Operator:]

Ladies and gentlemen, this concludes the conference for today. Thank you all for participating and have a nice day. All parties may now disconnect.