First Midwest Bancorp, Inc.
Q1 2017 Earnings Call Transcript

Published: 26 Apr 2017

[Operator:]

Welcome to the First Midwest Bancorp 2017 First Quarter Earnings Conference Call. [Operator Instructions]. It is now my pleasure to turn the floor over to Nick Chulos, Executive Vice President, Corporate Secretary and General Counsel 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 first quarter of 2017. If you have not received a copy of this press release, it is available on our website or you may obtain it by calling us at [phone]. During the course of the discussion today, our comments may include forward-looking statements. These statements are not historical facts and are based upon our current beliefs. Our comments also are subject to certain assumptions, risks and uncertainties and are not guarantees of future performance or outcomes. The risks, uncertainties and safe harbor information contained in our most recent 10-K and other SEC filings 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 first quarter results and outlook are Mike Scudder, 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:]

Great. Thanks, Nick. Good morning and thanks for joining us today. We're off to a great start in 2017. And as we have shared, the quarter was expected to be and certainly was significantly influenced by our acquisition of Standard Bancshares as well as our underlying organizational response to that acquisition. Because of the distorted impact on the quarter versus prior periods, I'm going to briefly cover some of the highlights and then leave more time for additional detail and color for Mark and Pat. From a higher altitude, the quarter was generally in line with our expectations and certainly reflective of our ongoing business priorities that we've discussed before. Let me start with some of the highlights. We reported earnings for the quarter of $0.23 per share versus $0.25 for 2016's fourth quarter and $0.23 versus the linked quarter. When you exclude cost largely responsive to acquisitions and organizational growth, our earnings were $0.34, that's up 25% versus a year ago and 6% versus the linked quarter and that's all on an EPS basis. We closed the quarter with $13.8 billion in total assets. Standards closing largely drove that balance sheet increase, adding $1.8 billion in loans and $2 billion in deposits. The transaction closed on January 6 and thus completes the system-related conversions in early February. We would expect to see the full benefit of our combined operations beginning in the second quarter and, again, would expect those to continue to be in in line with our expectations. From a legacy perspective, the first quarter is tended to be seasonally softer, given both the number of days and general production ramp up and this quarter was certainly no exception to that. Loan growth was relatively modest with our production again and pipelines remaining solid and expected to ramp up over the course of the remaining quarters of the year. Credit quality was a bright spot with net charge-offs at $2.8 million, that's 45% lower than last quarter as well as the same point a year ago and came in at 12 basis points of average loans. Fee-based revenues were again solid, with wealth management continuing to perform very well for us. Finally, our expenses remained well controlled and again, largely in line with where we thought they would come in at. Mid quarter, we were pleased to announce our acquisition of Premier Asset Management. That's a Chicago-based registered investment adviser that we have known for a long period of time and certainly been in discussion with for a number of years. We've long out of the strength of our wealth platform and Premier certainly has a very talented team to our expanded wealth offerings. So with that -- that probably is a good segue to Mark for some additional color.

[Mark Sander:]

Thanks, Mike. And as Mike mentioned, loan growth this quarter was relatively modest, yet our outlook for the remains quite positive. Commercial production got off to a slow start based on a number of factors, including normal seasonality, the impact associated with an in-market acquisition and the aftereffects of a very robust second half of 2016, in which we exceeded expectations, particularly in commercial real estate. We also experienced this quarter a headwind from some outsized payoffs, for reasons that were predominantly good news. And by that I mean payoffs driven by several commercial real estate properties as well as a few larger C&I clients which all sold at attractive valuations. Still, through all this, we were able to grow legacy C&I loans in line with the market at about 4% annualized. On the retail side, we had solid production from all of our teams, resulting in loan growth away from acquisitions of about 5% over the linked quarter. Our guidance on all topics for 2017 is shifting away from separating the dialogue into organic and acquisition components and rather, we will offer consolidated views going forward. Applied net approach to loan growth guidance, we expect a mid-single-digit increase from here over the remainder of year, essentially unchanged from previous calls. We foresee steady quarterly growth as our pipelines remain favorable. And thus, we're comfortable that this is achievable even as we maintain our credit disciplines in a highly competitive market. Turning to fee income, we had a solid quarter across the board, in line with our expectations. Service charges grew 20% year-over-year principally through our acquisitions, but organically, we were also able to more than offset declines in NSF fees with treasury management growth. Wealth management turned in a very good quarter, as Mike mentioned, in all areas of focus, namely retention of acquired portfolios and above-market growth in both our trust and retail brokerage businesses. Card income was up about 7% organically and 21% inclusive of acquisitions year-over-year in the quarter based on our continuing net household growth. Mortgage had a solid quarter, up from a year ago in this seasonally slow period, but down from linked quarter due to the absence of MSR gains that we posted at the end of last year. Lastly, capital markets income was comparatively softer, reflective of the lighter production, most notably in commercial real estate in the quarter, a segment that tends to drive a long swap activity. So for the year, we previously discussed low double-digit fee growth in 2017, factoring in anticipated organic growth, acquisition and the impact of Durban on card revenue. Our results in Q1 and our current view for the year are both consistent with this forecast. In terms of credit, results were favorable compared to our plans and guidance. Net charge-offs of 12 basis points were really 14 basis points on the nonacquired portfolio, still favorable to expectations. Our nonperformer [indiscernible] despite the addition of about $9 million of OREO from Standard as we moved about 20% of the year-end balance of these assets out to this quarter. Our adverse performing ratio ticked up slightly, given the acquisition activity, but still remains well within what we consider our normalized range. Based on all these results and our current outlook, we continue to think that 2017 full year charge-offs will be around the levels we experienced the last 2 years. So Pat will now offer some additional perspective on mergers and expenses.

[Patrick Barrett:]

Thanks, Mark and good morning, everyone. Turning to net interest income and margin. Net interest income was up $27 million or 31% compared to the prior quarter and $34 million or 43% compared to the prior year. These increases were primarily due to the increase in earning assets and related acquired loan accretion from the Standard transaction earlier this quarter -- in the quarter, combined with the positive impact of higher interest rates. Increases to the securities portfolio and loan growth during 2016 also contributed to the increase in net interest income compared to the first quarter of 2016. Net interest income benefited from acquired loan accretion to the tune of about $11.3 million in the first quarter of 2017 compared to $2.4 million in the first quarter a year ago. Tax equivalent net interest margin for the current quarter was 3.89%, up 45 basis points from the last quarter and 23 basis points from the prior year. Compared to the prior quarter, increased margin reflected a 29 basis point increase due to the higher standard accretion, combined with the positive impacts of higher interest rates, the addition of the higher mix of fixed rate loans from Standard and the normalization of interest expense on our long term debt. Compared to the prior year, the increase in margin was driven by 27 basis point increase in acquired loan accretion, primarily from the Standard transaction, combined with the positive impact of the addition of the higher mix of fixed rate loans from Standard. These increases were partly offset by growth in lower-yielding securities and in the investment portfolio and the continued shift of loan originations in mix to lower yield in floating rate loans. Average interest earning assets were up $1.8 billion compared to the prior quarter and $3.1 billion compared to the prior year. Again, both the increases were reflecting the Standard acquisition. The year-on-year increase also reflects organic loan growth, securities purchases and the impact on average earning assets of the NI Bancshares transaction that occurred late in the first quarter of 2016. As a reminder, our outlook for the year was for net interest income to be up nearly 40% year-on-year and for net interest margin to be up 40 to 50 basis points compared to the fourth quarter of 2016 and relatively stable throughout 2017. Our results this past quarter are squarely in line with those expectations. I'd remind you, however, that the timing of the future interest rate hikes as well as acquired loan accretion can create volatility on a quarter-to quarter basis. Moving onto expenses. Total noninterest expense was up 26% linked quarter and 41% year-on-year. Excluding acquisition and integration expenses, total expenses of $98 million were up 17% and 26%, respectively which is slightly better than expected, while our efficiency ratio improved to 61%. The addition of Standard's ongoing operating expenses was the primary driver of increases and was seen across most categories. Normal merit increases and the impact of additional talent investments contributed to additional increases in salary and benefits, while higher loan workout resolutions and remediation costs resulted in a higher OREO and professional services expenses. These increases were partly offset by lower marketing expense, reflecting the timing of certain advertising costs. First quarter integration cost of $18.5 million were $1 million higher than anticipated, reflecting the cost of acquiring Premier Asset Management in March. While there may be a limited amount of acquisition expenses in future quarters, we're very pleased that we were able to complete the vast majority of our integration, cost-save goals which are largely reflected in acquisition integration expenses. Accordingly, we expect total expenses to be relatively stable throughout the remainder of the year, in line with our annual outlook, with only modest fluctuations around normal seasonality or day count. And finally, given our annual guidance for our effective tax rate to approximate 35%, I'd be remiss if I didn't comment on the first quarter tax rate of 32%. This lower rate was driven by the adoption of new accounting guidance concerning share-based compensation which resulted in $650,000 credit to tax expense. Notwithstanding this, our rate would have been 34%. And looking ahead, we would continue to expect our rate for the remainder of the year to approximate 35% on a quarterly basis. So at this point, I'll turn it back to Mike to wrap up.

[Michael Scudder:]

Okay. Thanks, Pat. So as Pat suggested, before we open it up for questions, just some closing or further remarks. As we look back on the accomplishments for the quarter, I think it's important to note as we take a step back, we greatly enhanced our balance sheet, our infrastructure and most importantly, we've greatly enhanced our ability to serve the financial needs of our clients. So with the system integration activities from Standard largely behind us, we feel good about our underlying business momentum. And combined with a strong capital foundation, we think we're well positioned to continue to grow and perform for our shareholders. At the same time, know that our short term intention here remains squarely on delivering on the existing investments that we've made in our company. Finally, as I know, a number of our colleagues take the opportunity to listen to our calls, I want to once again welcome our newest colleagues from Standard to the First Midwest family. I also want to take the opportunity to recognize that the accomplishments I've just talked about are really a testament to a very talented and engaged team of colleagues, both those who are new to our company and those who have been with us for a while and their ongoing hard work and commitment to our company. And I certainly want to take the opportunity to thank them for that effort. As we look to the rest of 2017, we feel, as I said, our business is very well positioned and our expectations remain high. So with that, let's open it up for questions.

[Operator:]

[Operator Instructions]. And your first question will come from Michael Young of SunTrust.

[Michael Young:]

Just wanted to start with, I guess, the average earning asset balance and loan balances brought over from Standard. They were a little bit lower than what I had expected. I was just curious if you could provide some additional color there?

[Mark Sander:]

So we've brought over about $1.8 billion, loan balances are down ever so slightly from there, but in line with what our expectations were.

[Patrick Barrett:]

Yes. And I would add on to that, that we made the decision early on to liquidate the securities book that they had due to it wasn't a good mix for us from a yield and duration perspective. And we utilized the cash proceeds from that to take down shorter term FHLB advances.

[Michael Young:]

Okay, great. So just kind of unwind the balance sheet a little bit there, that makes sense. And then also just going back to your interest rate sensitivity disclosure. Looks like that came down a good bit from 3Q last year to 4Q. Any specific takeaways there? Pat, I don't know if that's you getting your hands on the model and adjusting any beta assumptions or anything else we could drive from that?

[Patrick Barrett:]

Not really. I think it definitely reflects the migration of interest rate and interest rate expectations from then to now, now that have 2 rate hikes behind us. So anything that we'd predict for the future is that much closer, regardless of when we see it. We're still modeling for deposit betas to start picking up with the next interest rate hike. We were in the third quarter, when we were in the fourth quarter and we didn't see that for the first 2 rate hikes. So sort of a pushout in that. So our asset sensitivity you'll see probably will tick up a little bit this quarter when we get our 10-Q filed on that which really probably more reflects paying down the short -- some shorter term liabilities and having a long-duration core deposit base more than it does a big change in loan mix. Standard did bring in a higher fixed to floating concentration, like a 60-40 versus ours which is the inverse of that. But overall, we're really working to try to stay fairly neutral right now. And I'd take big bets on further interest rate hikes.

[Operator:]

The next question will be from Chris McGratty of KBW.

[Christopher McGratty:]

Pat, maybe to start with you. If I kind of look at the margin, the $11 million -- looking for a little help here, the $11 million of accretion in the quarter. How much of that was scheduled versus accelerated? Do you have that breakup?

[Patrick Barrett:]

Yes, well, Standard was the bulk of that. And so I would say, the majority of it was going to be scheduled. We were expecting maybe $1 million less before we finalized all the accounting and booking and classifications of PCI loans. We did have somewhere around $750,000 of accelerated accretion that came in from previous acquisitions and they were immaterial individual loans that resolved favorably from each of 3 different acquisitions, contributed, say, $250,000 each. So that was sort of the surprise to us, to the upside which is usually what you find with accretion. Otherwise, we would still think we're kind of on track to see our first year accretion after Standard total for the firm still in the range of around $30 million.

[Christopher McGratty:]

So roughly $30 million for the rest of the year? Or, I'm sorry, $30 million including the $11 million? Just trying to make sure.

[Patrick Barrett:]

Total.

[Christopher McGratty:]

So you'll see, you have a step down next quarter?

[Patrick Barrett:]

Correct. I think we'll have the usual more rapid step downs in each of the first couples of 3 quarters of a couple of million dollars and then it will settle into something that is linked in with the average weighted life of the portfolios which will be -- which will go out anywhere from 3 to 5 years, depending on which of the acquisition goals you're talking about.

[Christopher McGratty:]

Understood. Great color. Just on the core, excluding -- the [indiscernible] County was up quite a bit. And again, it benefits from what you're doing to the balance sheet. I may have missed it, what's the expectation from like low 3.50s from here?

[Patrick Barrett:]

I think it will go up. I think that where we will see some runoff due to accretion, as we talked about, but with the benefit of rising rates, both the ones that we've just gotten and some anticipation around at least 1 more rate hike before year-end, then we should see. I'd call it on average a mid-single-digit increase in margin. It will be volatile. So we might see more 1 quarter and less the next quarter, just depending on the timing of these factors as well as growth.

[Christopher McGratty:]

Okay. And you can say you've got 1 more hike to benefit in that -- in those assumptions?

[Patrick Barrett:]

Yes. We had -- I guess, last quarter, we had 3 rate hikes in for the year, be it June, September and December. And we got 1 earlier than expected in March and we're assuming that, that was the September rate hike. So we're still thinking that a mid-year rate hike and a year-end rate hike is the most likely scenario.

[Christopher McGratty:]

Great. And if I could just sneak 1 more on the tax rate. I think you said 35. Is 35 effective or is that kind of [indiscernible] to be a little bit higher on an effective basis?

[Patrick Barrett:]

It's ineffective for us. It's just -- it's a pretty good proxy and the 2 are roughly -- are fairly similar.

[Operator:]

The next question will be from Brad Milsaps of Sandler O'Neill.

[Bradley Milsaps:]

Just curious, Mark, you talked about some pay downs in the CRE book. Just curious, were the loan yields this quarter impacted by any sort of higher level of prepayment fees or any other type of loan fees that would have pushed that up a bit? And then just need a comment around kind of new and renewed loan rates that you're seeing in the market right now.

[Mark Sander:]

Yes. The margin was not pushed up. Anything that happened in terms of prepayments was insignificant to the margin, I would say. And actually our spread this quarter actually ticked up a little bit. And I don't want to forecast a long term trend, certainly higher rates benefited that. But our spreads, our new and renewed spreads over the last several quarters have been pretty stable. They actually have ticked up a little bit this last quarter.

[Bradley Milsaps:]

Okay, great. And then Pat, maybe on expenses. It looked -- obviously, you guys had good expense quarter, it looked like Standard had been running kind of in that $17 million to $18 million range on a quarterly basis. I appreciate the guidance for the year. But just curious, it looks like maybe you got the cost saves out more quickly than you thought or is there other moving parts in there that you could add some color to, kind of, relative to Standard's historic run rate on expenses?

[Patrick Barrett:]

Yes, I think we got the cost saves out or at least captured and classified within integration and acquisition costs a bit quicker than we thought. So we really did achieve pretty much our full cost saves in Q1, ahead of what we anticipated. Again, if you exclude their acquisition and integration expenses. So we were able to identify and get all the branch closures done, all of the people that were associated with that. If you get them -- everything notified and meet all the requirements, you can go ahead and classify from outside of normal run rate costs. So 98 for this quarter, if you just adjust that for day count, that's a pretty good run rate for us for the rest of the year, notwithstanding any anomalies or things that we're not seeing right now.

[Operator:]

The next question will be from Kevin Reevey of D.A. Davidson.

[Kevin Reevey:]

So first, wanted to kind of talk about if you're seeing any type of client attrition in any of your markets as a result of the Standard deal or the NI Bancshares deal, given all the competitions been taken place in the Chicago market?

[Mark Sander:]

We haven't as of yet. It's early, of course and so we're always watching for it and ready for the fight, if you will, but we have not seen client attrition at this point. Our Standard balance has ticked down ever so slightly in Q1, as I said, as expected. But really not through loss of clients, a little bit lower utilization. So we're optimistic that we can have a very, very high retention rate.

[Kevin Reevey:]

And then you're -- no surprise, your capital levels are down a little bit from the prior quarter. How should we think about capital going forward? Do you have any particularly -- any particular targeted capital levels you're looking to achieve?

[Patrick Barrett:]

This is Pat. Yes. So we did see a sharp dropoff this quarter due to both the Standard and the Premier acquisitions and it was really just the cash components of those deals that caused that drop. And we would look at this point to be in a position to, I'd say, modestly accrete with our earnings after dividends going forward. I'd say that we're pretty comfortable with the levels that we're at right now. They're well within our -- comfortably within our targets and well within a well-capitalized levels from a regulatory perspective. So don't really look for a lot of change to those, notwithstanding any future needs.

[Kevin Reevey:]

And then the last, did you see any significant changes in line utilization by your commercial customers this quarter?

[Mark Sander:]

Nothing of any consequence at all. Almost flat to the prior quarter.

[Operator:]

The next question will be from Nathan Race of Piper Jaffray.

[Nathan Race:]

Question on fee income market. I think last quarter you guided to a low double-digit year-over-year increase. Looks like fee just stepped up slightly linked quarter. Can you kind of just update us on your run rate outlook for that -- this -- for 2017?

[Mark Sander:]

Sure. We continue to expect low double-digit net fee for the full year like we posted in Q1. I'd say that's after absorbing Durban, net of everything, acquisitions and the like, we've got certain fee income categories like card, for instance, that's going to be relatively flat as we -- organic growth and acquisitions offset the hit we take from Durban. But then we've got a couple of areas, particularly with treasury management and wealth management, that we're very optimistic about. And so while both -- with the acquisition to add to us, but just our organic growth in both of those areas where we're quite optimistic about it. So again, net-net, we're looking for low double digits for the full year.

[Nathan Race:]

And just thinking about loan growth for 2017. I think if I heard you correctly, I think -- or previously, it was kind of high single-digit range. And if I heard you correctly, it sounds like that could step down this year?

[Mark Sander:]

Yes, not really. Look, they are maybe 3 off of that one. So let me try to clarify, I was worried about that. So I'm talking -- when I say mid-single digits, I'm talking about from here, from using our 331 balance. So I'm talking about mid-single digits for the remaining 9 months of the year. As we thought about it, we thought of mid- or high single digits for our legacy businesses and relatively flat for Standard. So another way to think of it is, we would expect our loans to be up nearly 30% off of the 12/31/16 number come year-end this year.

[Nathan Race:]

And then if I could just sneak 1 more question for Mark. In terms of -- I'm sorry, for Mike. Given that you closed Standard a little earlier than maybe you were expecting, the cost is out as well, earlier than expected. Can you just kind of update us on kind of the opportunities for additional depository acquisitions as you look forward?

[Michael Scudder:]

Sure. As I said in my remarks, we've gone through a period of significant growth here over the preceding year and made a number of investments that we've got in our business that we're looking to leverage. Having said all of that, those opportunities that make strategic sense for us, we will continue to consider and as they become available and they make sense for us, we're certainly don't see ourselves as not being in a position to pursue those. Having said all of that, from a practical standpoint, kind of the gestation of all of that stuff really takes a while to put into play. So I don't see a lot on that front even being realistic as we think about the rest of this year or certainly here in the short run.

[Operator:]

[Operator Instructions]. And the next question will come from Terry McEvoy of Stephens.

[Terence McEvoy:]

Just was hoping to better understand loan growth x Standard. In the release, it said it was up modestly. I think early in the call, you had mentioned C&I was up 4% and in the release it said that, kind of, mortgage and some installment was up. And so is that correct to assume that what was down or felt some pressure with the CRE? And maybe could you quantify just on an organic basis, what loans did in Q1?

[Mark Sander:]

Sure. On an organic basis, C&I, as I said, was up about 4% annualized, spread across the teams, kind of in line with market. CRE was down probably similar amounts, CRE balances fell a little bit. Production was what I'll say, okay and we had outsized payoffs. So you see a little decline there. If you think about it, we had outsized growth in CRE throughout 2016. While we still expect CRE to grow in '17, I would expected it to grow at a lower clip than it did last year.

[Terence McEvoy:]

And then [indiscernible] I'm sorry, any commentary on what you're seeing so far in April? A few of your competitors or peers have suggested a pick-up here early in Q2?

[Mark Sander:]

We're not seeing anything that's not -- we're consistent with what I -- the guidance I gave, fundamentally, steady growth from here, I would say.

[Terence McEvoy:]

Okay. And then just lastly, the final loan mark on Standard, I had 2.75% in June when you announced the deal. Was that where the final mark played out?

[Patrick Barrett:]

It drifted up just a little bit, but it was roughly in line with that, kind rounds to a 3% and probably reflects, as with most folks, the -- having a lot of extra time to really dig into each and everything and trying to be as prudent as possible, given the nature of purchase credit impaired accounting and what you can and can't do within the first year, but roughly in line.

[Operator:]

And we have a follow-up question from Chris McGratty of KBW.

[Christopher McGratty:]

I may have missed this, Pat. The dollar amount, I think, you said 30 for the year, but how much is spread over the rest of the life of loan of Standard?

[Patrick Barrett:]

So Standard added about $77 million to our total mark and probably half of that was credit and half of that was interest rate, just roughly speaking. So we'll consume about 40% of that this year. The remainder will be relatively even, although declining over the remaining 3.5 years of what's about a 4.5- to 5-year average life.

[Operator:]

And we also have a follow-up question from Brad Milsaps of Sandler O'Neill.

[Bradley Milsaps:]

Pat, just a follow-up on the NII guidance for around 40% growth. Based on your commentary around kind of mid-single-digit type loan growth from here, kind of a flattish gap NIM. Getting to 40% NII growth would imply probably about, on average, a step up in NII of $10 million or $11 million from the first quarter. Just curious, kind of, are there other balance sheet moves that you plan to make? Maybe adding a few more bonds or something else I might be missing? Or just kind of square -- trying to square all that together. Maybe any additional color there would be helpful, anything I might be missing.

[Patrick Barrett:]

There might be a little bit of that. We have run the securities book down as a percentage of the total balance sheet year-on-year a little bit, sort of natural runoff and a reluctance to reinvest cash flows and what's been, certainly last year, pretty challenging investment environment with -- municipals are down. So we're kind of on the lower end of the range. So we have the potential to grow that a little bit, but nothing that's going to be noteworthy. I think we're just going to be opportunistic and look for good times to enter into investments that stay within our relatively narrowband of risk and duration requirements. I think where we probably do have some flexibility and what's part of the predictability is assumptions on data. If we're not seeing anything yet and we still aren't, then there's a fair chance that our overall expense is probably going to be a little bit better than what we had anticipated when we originally put together our annual guidance. So that might -- those 2 things might help square that a little bit.

[Operator:]

[Operator Instructions]. And there are no further questions at this time, I will turn the call back over to Mr. Scudder for closing remarks.

[Michael Scudder:]

Well, thank you and thank you all for your interest in and attention to our story as we share our belief that First Midwest is a great investment. So have a great day.

[Operator:]

Thank you, sir. Ladies and gentlemen, this concludes the conference call for today. Thank you for participating and have a nice day. You may now disconnect your lines.