First Midwest Bancorp, Inc.
Q2 2018 Earnings Call Transcript

Published: 25 Jul 2018

[Operator:]

Good morning, ladies and gentlemen, and welcome to the First Midwest Bancorp 2018 Second Quarter Earnings Conference Call. At this time, I would like to inform you that this conference is being recorded and that all participants are in a listen-only mode. [Operator Instructions] At the request of the Company, we will open the conference up for questions and answers for analysts only after the presentation. It is now my pleasure to turn the floor over to Nick Chulos, Executive Vice President, General Counsel and Corporate Secretary of First Midwest Bancorp. Sir, you may begin.

[Nicholas Chulos:]

Good morning, everyone and thank you for joining us today. Following the close of the market yesterday, we released our earnings results for the second quarter of 2018 and also issued presentation materials that we will refer to during our call today. These provide both historical financial information and our outlook for remainder of 2018. If you would like a copy of our earnings release or the presentation deck, they are available on our website in the Investor Relations section or you may obtain them by calling us at area code 708-831-7483. During the course of the discussion today, our comments and the presentation materials may include forward-looking statements. These statements are not historical facts, are based upon our current beliefs and are not guarantees of future performance or outcomes. The risks, uncertainties and Safe Harbor information contained in our most recent 10-K and our other filings with the SEC. As well as the forward looking statement, non GAAP and additional information included in our earnings release should be considered for our call today. Lastly, I would like to mention that we will not be updating any forward-looking statements following this call. Here this morning to discuss our second quarter results and outlook are Mike Scudder, Chairman, President and Chief Executive Officer of First Midwest; Mark Sander, our Senior Executive Vice President and Chief Operating Officer; and Pat Barrett, our Executive Vice President and Chief Financial Officer. With that, I will now turn the floor over to Mike Scudder.

[Michael Scudder:]

Thanks, Nick. Good morning, everyone. Thanks for joining us today. It's great to be with you. As we have left couple of calls and in continuation of a practice that we started, we provided a supplemental presentation for you to follow on with and certainly Pat and Mark will carry the bulk of the work load here as we go through that. So with that let me start with the highlights and then as I said, Mark and Pat can walk you through the components. For us it was a really a very strong and active quarter. We saw continued execution on a number of business and strategic fronts. From an earnings perspective net income for the second quarter was 29.6 million or $0.29 a share that compares to $0.33 per share for the first quarter of 2018 and $0.34 per share for the second quarter of 2017. As we expected and as we have signaled before this quarter absorbed about $0.11 related implement patient cost from our delivering excellence initiatives while last year was impacted by acquisition and integration related expenses. If you exclude those costs with both periods our operating earnings for the quarter were $0.40 and that represents a 21% improvement over the first quarter and 14% over second quarter 2017. When we are considering the quarter, I would offer the following highlight that we really had solid and sales and business production across the team. Our loans were up 8% annualized from last quarter and they are up about 6% from year ago. Importantly, our average deposits which is one of the hallmarks of our Company for the quarter increased from last year while we also retained our core transactional mix, which currently stands still at about 85%. Largely as a result of those two factors, our net interest income, combined also with a higher rate environment expanded by 7% and 8% from the prior quarter and year as margin improved by 11 and three basis points, respectively. Now because we had heavy amount of acquisition activity last year, and Pat can speak more there in a minute if you kind take the differential out for acquisition related accretion our actual underlying margin between the years was up 17 basis points. Our credit cost came in line with our expectations with linked quarter provisioning expense reflecting the competing impacts of both lower charge offs in just a greater level of incremental loan growth. Our overhead continued to be well-controlled, our efficiency ratio improved to about 60% and included about $0.01 per share in moving costs related to our new corporate headquarters location which we are very pleased to be speaking to you from today. Separately our delivering excellence initiatives remains on track as do our expectations for performance improvement coming from that initiatives. Our pending acquisition of northern states financial Corporation also continue to go well remains on page for the fourth quarter close in conversion, which will see us add as a reminder about 400 million in deposit which about 90% of our deposits are core and about 300 million outstanding. We also have been very pleased with the overall collogue and customer action to this opportunity for us so that continues to progress very well for us. And as I mentioned earlier, we are very pleased to have completed our relocation of our headquarters in Chicago property with our new headquarters location. As reported of the opportunity to co locate the number of our teams upgraded the quality of our overall space and provide greater accessibility across our footprint, as well as greater capacity for continued growth. So with that as a backdrop, let me turn it over to Mark and Pat and they can offer some additional color.

[Mark Sander:]

Thanks Mike. On Page 3 of the presentation. We detail our broad-based loan growth in Q2. Again this quarter, we are pleased to see contributions across multiple teams who generated net growth slightly higher than our guidance last quarter. Our middle market and specialty groups in particular posted strong results reflective of the prior investment in and our ongoing commitment to these businesses. Our C&I growth was a robust 5%, which more than offset the continuing pressure in commercial real estate. We again saw significant CRE payoffs entitled for good reasons, most notably property sales at attractive prices. Notwithstanding the good news here for our customers this can be a headwind for us but is one we have consistently been ever growth through due to solid overall commercial production across multiple teams. Our consumer group also posted a strong quarter. Loans in our retail bank were up $100 million half from organic growth in mortgage and installment lending and half from the timing of some transaction activity. Our outlook for loan growth for the remainder of the year is unchanged namely mid-single digits annualized and I would say likely at the upper end of that range given what we see today. Our credit metrics improved in Q2 as expected after the outsize actions last quarter, charge offs of 36 basis points were consistent with our expectations and long-term outlook. Our provision was slightly above guidance and simply recognized stronger loan growth. Overall, asset quality is well-balanced at normalized levels as such, our guidance for charge-offs and provision for the remainder of the year are relatively unchanged at approximate 30 basis points and $10 million respectively per quarter. Moving on to deposits on Page 5. As Mike indicated, our results here were also very favorable in Q2. Core deposits grew slightly despite very modest pricing pressures. Seasonal publican flows came in as expected and our time deposits promotions are performing as planned. With the core deposit ratio of 84% and pricing well-controlled our funding advantage translated into strong margins as Pat will explain.

[Patrick Barrett:]

Thanks Mark. Good morning, everyone on the call. Turning to net interest income and net interest margin on Slide 6. Net interest income was up $9 million or 7% compared to the prior quarter and up $10 million or 8% compared to the same period in 2017 consistent with our overall expectations. Compared to both prior periods the second quarter benefited from higher interest rates and growth in loans and securities, partially offset by lower acquired loan accretion and higher cost of funds. Acquired loan accretion contributed $4.4 million to the quarter, down from approximately $5 million in the prior quarter and $9 million for the same period in 2017 and we continue to project modest declines each quarter going forward. Of the $18 million in schedule accretion for this year, we have reported $10 million in the first half and expect $8 million in the second half, approximately $4 million per quarter. As always some volatility should be expected. Moving to net interest margin. Tax equivalent net interest margin for the current quarter of 3.91% was up 11 basis points compared to the prior quarter and three basis points from the same period in 2017. Excluding accretion margin was 377 for the quarter up 13 basis points and 17 basis points from the same period a year ago. Compared to both prior periods the benefit of higher interest rates and earning asset growth drove the increase partly offset by lower accretion. Compared to our expectations, margin benefited from higher rates and more favorable funding mix as well as slower increases in overall cost of funds. Turning to earning assets and funding sources average interest earning assets were up $430 million linked quarter and up more than $800 million compared to prior year due to the loan growth and securities purchases. Average funding sources increase by more than $400 million linked quarter and $630 million year-on-year, driven by increases in time deposits, core deposits, and FHLB advances. Moving to our outlook. We continue to expect full-year earning asset growth excluding the acquisition of NorStates in the mid single-digit range and GAAP net interest income growth in the high single-digit range when compared to the full-year of 2017. Net interest margin on FTE basis is expected to be relatively stable to full-year compared to 2017 as the benefits of earning asset growth and higher rates are offset by lower accretion. Excluding accretion we expect modest expansion in net interest margin on an FTE basis. Once again, I want to remind you that projections are subject to volatility due to movements in interest rates, pace of loan growth and seasonal municipal deposits growth. Mark with that, I will turn it back over you to discuss non-interest income on Slide 7.

[Mark Sander:]

Great thanks Pat. On seven, you see our Q2 results were right in line with guidance, which remains unchanged going forward as well. This is a little noisy due to certain accounting reclassifications in Durban, so we try to give you an adjusted view to provide you to provide the most accurate measures of our performance. On this basis our linked quarter increase was 5% and broad-based across categories. Year-over-year we are down slightly due to outsized gains from asset sales in Q2 of last year. Excluding such gains our fee income streams were up 3% versus the year ago period. Our wealth management, treasury management and card businesses continue to perform well and in Q2 we also saw strong swap activity in our capital markets area. Back to you Pat.

[Patrick Barrett:]

Moving on to expenses on Slide 8. Several items to note that effect our quarterly expense run rate. First the current quarter includes $15 million of delivering excellence implementation cost associated with the initiatives primarily driven by branch valuation adjustments, employee severance, general restructuring and advisory services. As Mark referenced and as we mentioned last quarter, card and merchant revenues and expenses for each quarter of 2018 had been impacted by $4 million reclassification of both categories of fees to non interest income. Prior periods were not adjusted, so we tried to bridge this change bringing in some additional disclosures on the earnings release and on Slide 7 and 8. Keep in mind this is re-class there is no impact to operating or net income. Finally, acquisition and integration expense was 1 million impacted the second quarter of 2017. Away from these items quarterly expenses remain tightly controlled and in line with our guidance of $96 million to $98 million per quarter with an efficiency ratio of 60% down from 61% in the first quarter and up modestly from 59% a year ago. Our guidance on expense growth remains largely unchanged aside from the impact of delivering excellence, the initial nonrecurring costs as well as ongoing benefits. Away from these impacts, our previous guidance for total noninterest expenses was 96 million to 98 million per quarter on average remains a good proxy. With these initiatives delivering excellence is expected to further reduce expenses by about $4 million in the second half of the year largely reflected as reductions in staff costs while the remaining one-time costs are expected to be approximately $7 million. Both the recurring benefits and the one-time cost in the second half will likely be more heavily weighted to the fourth quarter. Although, we do expect around a third of each of these numbers to incur in the third quarter. As a result when including the recurring benefits, we are updating our guidance for non interest expense to expect 94 million to 96 million per quarter on average. Also note the Northern States acquisition is expected to results in approximately $12 million of nonrecurring integration costs at closing which we continue to expect to be in the fourth quarter of this year. Last note on Texas before I leave the slide. Our effective tax rate for the quarter was 25% consistent with the prior quarter after excluding $1 million tax benefit share based payments. This compares to 36% a year ago with the decrease driven by the lower corporate tax rate. For the year 2018, our expected effective rate continues to be approximately 25% reflecting that lower grade. But note, there may be a lower - in the third quarter as the impact of tax reform adjustments are finalized in our tax routine. Moving to capital on Slide 9. We continue to maintain capital at strong levels. In general, the capital ratios are consistent with the prior quarter with the benefit of earnings offset by increases in risk weighted assets resulting from loan growth. Mark has few comments on delivering excellence on the next couple of slides.

[Mark Sander:]

Thanks Pat. As Mike touched on our delivering excellence program is simply on track. We remain highly confident we will meet or beat the targets we established around client service improvements, deepening relationships and the financial impact. Specifically as to the numbers on Page 11. We feel good about the targets we disclosed in May, as most of the underlying initiatives are either complete or well underway at this point. Our longer-term focus remains on leveraging our processes and systems to build upon our client experience and service commitment. And our teams are adjusting well to the culture of responsiveness and continuous improvement that this will require. Our two way communication is keeping college engagement high while providing the necessary valuable feedback for further enhancements. As a result, while delivering excellence remains a key ongoing strategic priority for us, as we move past the fourth quarter this year, its ongoing implementation will become more targeted and transitions more to a business as usual. Pat is now going to cover our recently announced acquisitions.

[Patrick Barrett:]

Few quick details on our acquisition of North States or Northern States Financial Corporation in addition to Mikes earlier remarks. Transaction is expected to generate around $0.05 of earnings per share in its first full year, they are best estimate that we will see approximately 75% of the benefit in 2019 and 100% in 2020. On a quarterly basis we would expect to be getting a full run rate benefit by the middle of 2019. The economics of the acquisition are favorable with relatively quick tangible book value earned back at less than 2.5 years reflecting favorable valuation multiples. Finally, we are excited about the expansion of our accounting presence as well as the addition of the core deposit franchise is very similar to our legacy deposit base. Now turning back over to Mike for final remarks.

[Michael Scudder:]

Thanks Pat. So certainly as I started with it has been busy and active quarter, as we talked about for some time. We remain very excited about our positioning and feel good about where we are at, our balance sheet remains strong, core deposit base is outstanding, our sales teams are hitting there strides as investments and talent and our business continue to pay dividends for us. Our credit cost while at times can be lumpy given the nature of today’s low world, we are still operating at a very historically low and favorable environment and those continue to average out in line with our expectations. So when you take all of that with against a positive operating back drop, the future that we would anticipate while delivering excellence in our pending combination with northern states. We feel good about of our ability to go through and continue to strengthen our client commitment, we feel good about our market positioning and we feel very good about our overall business momentum. So with that as a backdrop. Why don’t we open it up for questions.

[Operator:]

Thank you sir. [Operator Instructions] The first question comes from Brad Milsaps of Sandler O'Neill. Please state your question.

[Brad Milsaps:]

Hey good morning guys.

[Michael Scudder:]

Good morning Brad.

[Brad Milsaps:]

I appreciate all the color on all the different aspects of business. I just want to kind follow up on the NIM. The loan yields this quarter were up on a core basis may be around 20 basis points, which was maybe little more than I thought and maybe more than you have kind of seen in the past. Just curious kind of your thoughts around some of the drivers there I know you had some pay downs in the CRE book just of curious if there are any bigger prepayment fees that may have driven that higher or all else equal, if we get the June rate hike maybe another move in LIBOR would you expect a similar type of expansion in loan yield in the back half of the year?

[Patrick Barrett:]

Hey Brad its Pat. I will take a run at that. First on fees, our typical run rate is probably in the $750 million to $800,000 a quarter range and this was actually a lighter than normal quarter. We had just of $500,000 and which is up linked quarter, but still little below our average. So that had an impact, but it wasn’t a meaningful one. Probably a bigger driver of that was the ALN slots that we have, just because of the timing of those that we have entered into and the rising rates those have gone from being in the money to out of the money, the swing was about $750,000 linked quarter and probably $2 billion from the same quarter a year ago. So that was definitely driver of that. Depending on where rates are versus the slots that could bounce around a little bit, but that has trended on average to be pretty similar to lumpy $0.5 million to $750 a quarter.

[Brad Milsaps:]

But generally you have taken all that into account for your guidance of modest core expansion over the back half of the year.

[Patrick Barrett:]

Yes. Probably we were surprised by the strength of the NIM expansion this quarter. We were expecting something that is probably five to six basis points lower and we are not really expecting a term related late creep into this year to be meaningfully different than what we previously thought we think it just been accelerated a bit, because of rate changes and mix changes. But we will stick with the same NIM guidance. We are though increasing our NII guidance from mid to high single digit, reflecting a really strong first half.

[Brad Milsaps:]

Got it and that’s really helpful. And then just to follow-up on the expense initiatives. Does it still makes sense to you sort of I think last quarter when you gave your update you kind of gave a starting point of 97 million and then annualize and then back out what you think you can save plus some inflation in the occupancy cost? Is that still the best starting point? Obviously you are getting some benefit here in the back half of the year, your updated guidance but is that still the best way to think about as you go into 2019 and start to see the actual savings?

[Patrick Barrett:]

Well we have kicked down our expense guidance or improved it from an average of 97 to average of 95 per quarter. So we will probably exit the year with a run rate of about 95. That would be a good starting point to annualize from. I think it’s fair to assume some modest inflation, particularly on salaries and benefits, which make up about half our expense base. And then we are going to work really hard through about the initiative and just discipline to try and maintain as much steadiness and stability in our run rates as we can.

[Brad Milsaps:]

Great. That’s helpful. Thank you very much.

[Operator:]

The next question comes from Michael Young of SunTrust. Please go ahead.

[Michael Young:]

Hey good morning. I wanted to start with the outlook on the loan growth kind of moving it to the higher end of the range and you expressed confidence maybe in the back half of the year. Could you just talk about what are some of the puts and takes you are seeing obviously with CRE pay down still elevated that are driving you to a better outlook?

[Michael Scudder:]

Michael here Michael. Fundamentally, the pipeline that held up nicely, despite the fact that we have had two slightly outsize cores of loan growth, so the fact that our pipeline as we enter Q3 with the pipeline about the same as it was after a couple of strong quarters makes us feel that the midpoint is pretty solid and maybe we can be towards the upper end of that range, I guess the best way to say it. So we have faced that headwind of fewer repay offs really for the at least four quarters I would say. And we have been able to grow through it because of the diversity of the teams and as we said the investments we have made previously across a number of platforms. So yes again, upper end of that mid single-digit range we feel quite confident in.

[Michael Young:]

And maybe could you give a little more color, just are there any specific winning niches that are particularly maybe punching above their way or just kind of broad based small middle market shrinks that you are seeing, just any color there?

[Michael Scudder:]

So a number of quarters our specialty group have punched above their weights to zero analogy which I like the fraise zoology. Our middle market teams are getting nice solid production. Our business banking has very modest growth expectations, but still growth expectations. So again diverse across platform, little outsized in the specialty areas.

[Michael Young:]

Okay great and one last one if I could sneak it in, just Pat on the 2018 guidance that all excludes NorStates is there any.

[Patrick Barrett:]

With the exception of the expense guide that does reflect what a little bit of fourth quarter activity, but it is primarily going to be trapped in acquisition integration expense. So I would look for the run rate to be primarily hitting us from NorStates in Q1. So I guess short answer would be yes.

[Michael Young:]

Okay, perfect. Thanks a lot.

[Operator:]

The next question comes from Nathan Race of Piper Jaffray. Please go ahead.

[Nathan Race:]

Hey guys good morning.

[Michael Scudder:]

Good morning.

[Nathan Race:]

Pat, just to clarify on the expenses that guidance does not include any one-time cost that you will incur with the delivering excellence.

[Patrick Barrett:]

Correct, for integration expense from NorStates, so that the delivering excellence would be about $7 million, largely weighted towards the fourth quarter and NorStates will be all in the fourth quarter and our best estimate is 12 on that.

[Nathan Race:]

Got you. And then on the loan growth side obviously really impressive to see high growth, just curious if there are any participations or shared national credit so that help drive some of that growth in the quarter.

[Michael Scudder:]

Not really Nathan, we just don't do a lot of that. So it wasn’t a significant factor this quarter.

[Nathan Race:]

Okay, perfect. And then just lastly obviously a pretty large transactions in Chicago that was announced earlier in the quarter. So just curious, how you guys see it and benefit from that transaction or if you think you can benefit without having gone higher or if you think your current calling efforts will be sufficient to hopefully capture some of the benefits that gives some in the wake of that transaction.

[Michael Scudder:]

I would say yes to all the above Nathan. So fundamentally as we think of what our prospects in our natural block and in - certainly should be a high degree of overlap relative to some of our local competitors, so that being one. Relative to changes in the business, anytime a disruption of course it’s an opportunity and in this on case perhaps more than most I would suggest, and so we would be forced to not consider possibilities that that might come out of that. So more to come and we love to see certainly, others will fight hard, so not let those things happen, but again we certainly view this as opportunities for us on few fronts.

[Nathan Race:]

Sure. Okay, I appreciate all the color guys. Congrats on a solid quarter.

[Michael Scudder:]

Thank you.

[Patrick Barrett:]

Thank you.

[Operator:]

[Operator Instructions] The next question comes from Kelly Motta of KBW. Please go ahead.

[Kelly Motta:]

Hi this is Kelly on for Chris McGratty today. I guess turning back to margin, what are you in terms of deposit data in that forward version, there is a little increase in deposit cost which is what we are seeing with a lot of banks during the quarter. So wondering kind of what you are seeing there. Thank you.

[Michael Scudder:]

Sure, hey Kelly welcome to the call. We are really seeing our biggest impact on deposit reprising coming out of our public funds and public clients, municipals and large corporate and we see those reflected through both our now accounts republic and money market for the business. Both of those experience 25 to 30 basis points of beta on the last 25 basis point rate hike, but still through the cycle they just remain very, very low beta. So we are starting to see that. On our savings account which is again 90%, 95% retail, we are essentially seeing no pressure on that and remarkably little competition, our competitions really coming on time deposits which for most folks and certainly for us is really just an exercise in keeping up with that rate hike. So we have been pretty consistently running promotions on 13 and 23 months fee days, have generated nearly one billion of new money over the last six quarters. And we just keep reprising those with rate hikes so that we remain pretty competitive on those prices.

[Kelly Motta:]

Thank you.

[Operator:]

[Operator Instructions] If there are no further questions, I will now turn the call back over to Mr. Scudder for closing comments.

[Michael Scudder:]

Okay, well, thank you. So just before we close and just to reiterate, we are extremely pleased about our business momentum, our positioning to take advantage of the opportunities that lie before us. Before we leave, I also want to take the opportunity to thank all of our colleagues for their contributions to and investment in our performance, they are the base of our Company. They deliver on our promise to our clients every day and they are the reason that folks want to be a part of this. We also look forward to welcoming our newest colleagues from Northern States to the First Midwest team. So once again I would thank all of you for your interest in and attention to our story as we share our ongoing belief that First Midwest is a great investment. So have a great day everybody. Thank you.

[Operator:]

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.